Assignment on Practice of International Bank Guarantee Mutual Trust Bank Ltd (MTB) and Bangladesh Perspective

Prepared by
Md. Ashraf Ali
Senior Officer
Mutual Trust Bank Limited

Table of contents

|Introduction |3-4 |
|Guidelines (BB & URDG) |4-11 |
|Practice of International Bank Guarantee at MTB |12 |
|Problems |13 |
|Recommendations and Conclusion |14 |

Introduction

A guarantor issues a guarantee usually a bank on behalf of an exporter. It is a guarantee to the buyer that the exporter will fulfill the contractual obligations. If these obligations are not fulfilled, the guarantor undertakes to pay a sum of money to the buyer in compensation. This sum of money can be anything from 1% to 100% of the contract value.

Bank guarantee is one of the security instruments which can be utilized to reduce the risks or to recover the losses or damages involve in many business transactions to buyer and seller since it's a guarantee from a bank, where it agrees to pay if the client, on whose behalf the guarantee has been issued fails to pay.
Many genuine requirements of the business can be fulfilled with bank guarantee like purchase of machinery, obtaining goods, buy equipments or draw down loans, even when money is not available in the business, on the assurance of the bank in the form of bank guarantee. Since it is a written declaration from a bank which guarantees to satisfy a creditor’s (beneficiary's) claim for a certain financial amount for a third party based upon some conditions specified.
A bank guarantee can be obtained in the form of Advance payment guarantee, Warranty obligations guarantee, Tender guarantee, Payment guarantee, Credit guarantee, etc. Primarily Financial guarantee (ensures the payment of the interest as well as the principle amount if earlier specified conditions between buyer and seller are not met) and Performance guarantee (ensures the payment if timely execution of an agreement to have goods exported or delivered or services performed has not taken place as per the earlier specified conditions between buyer and seller) are issued frequently by the banks.

In the international trade, it usually difficult for the buyer of the goods and services to estimate financial and professional abilities of the supplier. So the buyer is interested to request a guarantee which proves that the seller is able to follow his commitments.

So a guarantee is issued by a bank on behalf of its customer, the Exporter, as financial assurance to the Importer to be collected in the event that the Exporter defaults on certain specified contractual obligations.
The bank that issues a Guarantee will pay the named beneficiary the amount specified on presentation of a written demand as outlined in the Guarantee.
While there are standard Guarantee formats, Guarantees can be tailored to meet specific contractual needs.
Guidelines
In Bangladesh the area of application are in import-export business, but also in domestic commercial business, trade and industry.
The Purpose of bank guarantee is to secure any claims by the buyer on the seller for reimbursement of the buyer's advance payment on the contract price before delivery of the goods (or advance payment of the full contract price) – in the event that the seller has failed to meet his or her contractual delivery obligations in full.
When running a business, one might come across a situation that client may ask to provide a financial guarantee from a third party.
In such circumstances, one has to approach one’s bank and ask it to stand as a guarantor on his behalf. This concept is known as bank guarantee (BG).

This is usually seen when a small company is dealing with much larger entity or even a government across border. Let us take an example of a company X bags a project from, say, the Government of Ethiopia to build 200 power transmission towers.
In this case, companies all over the world would have applied. The selection would be made on the basis of lowest cost and track record as submitted in the proposal form.
However, the government has limited ability to assess all companies for financial stability and credit worthiness.
To ensure the project is done satisfactorily and on time, the government puts a condition that company X will have to furnish a guarantee given by one or more banks.
In banking nomenclature, company X is an applicant, its bank is the issuing bank and the Government of Ethiopia is the beneficiary.
Usually, the BG is for a specified amount, which is a percentage of the total money required for the contract.
Obviously, the bank will not just issue such guarantee with its own due diligence. The bank does its own thorough analysis of the financial well being of company X to assess the amount of guarantee it can issue. After all, the bank is at a risk too, in case the client defaults. This amount is called a limit.
Here too there is a catch. The bank will issue guarantee provided the company has not exceeded its overall limit for BGs. And if the Government of Ethiopia is not satisfied with the performance of the contract at a later date, it can invoke the BG.
In this situation, the bank will have to immediately release the amount of the BG to the government.
BGs can be broadly classified into Performance and Financial BGs. As the name suggests, Performance BGs are the ones by which the issuing bank, also known as the Guarantor, guarantees the ability of the applicant to perform a contract, to the satisfaction of the beneficiary.

Foreign Exchange Regulation Act, 1947- Chapter 16 provides us the following provisions as guide to Bank Guarantee:
8. ADs may furnish guarantees to non-residents on behalf of behalf of residents only within the authority set out in the following:

i) ADs may issue bid bonds/performance bonds on behalf of suppliers in Bangladesh in favor of international agencies inviting tenders for supply of goods/services. In such cases ADs should ensure genuineness of the tender/supply contract/work order etc. before issuing of bond/guarantee.

ii) ADs may freely give guarantees on behalf of their customers in their ordinary course of business in respect of missing documents, authentication of signature, release of goods on Trust Receipts and defects in documents negotiated under LC or otherwise.

iii) ADs may furnish performance bonds or guarantees in favor of overseas buyers on account of Bangladeshi exporters without prior approval of the Bangladesh Bank subject to usual banking norms and the following conditions:

(a) The tender floated by the foreign buyer calls for bank guarantee/ performance bond;
(b) The tenderer is a bonafide importer/user/trader of the commodity/product concerned;
(c) There is no export ban in Bangladesh on the commodity/product to be supplied;
(d) The past performance of the exporter is considered satisfactory by the AD.

The remittance, if any, to the beneficiary as a result of invocation of the bond or guarantee can be made subject to report to the Bangladesh Bank.

9. ADs have to take prior permission from Foreign Exchange Policy Department, Bangladesh Bank before issuing any guarantee on behalf of industrial concerns under public/private sector credits favoring foreign suppliers towards repayment of suppliers' credits.

10. (a) Subject to such conditions as may be imposed by Banking Regulations and Policy Department from time to time, ADs may issue Taka guarantees on behalf of foreign or foreign controlled companies/firms operating in Bangladesh in favor of residents in
Bangladesh: (i) against 100% cash deposit and/or where the guarantee is required to be submitted with tender documents in lieu of earnest money deposit, subject to the condition that validity of the guarantee issued in lieu of earnest money will be limited to the period within which the decision regarding acceptance or rejection of the tender is taken, (ii) against adjustment of the amount from the overdraft limit, if any, allowed to the company/firm concerned.

(b) An AD may without prior approval of Bangladesh Bank, issue behalf of guarantee, bid bond or performance bond in foreign currency on non-resident behalf of a non-resident firm/company favoring residents in favor of Bangladesh provided a back to back guarantee covering the residents in guaranteed amount from an overseas correspondent or other bank Bangladesh abroad is held by the AD. The AD should satisfy itself about the bonafides of the overseas guarantee before issuing its own guarantee/bid bond/performance bond there against.

(c) In all other cases not specified above prior approval of the Bangladesh Bank is required for issuing guarantees on behalf of non-residents in favor of the residents in Bangladesh. Applications for these cases should be made by letter in duplicate giving full particulars of the guarantee/bond, the period, purpose and the method by which the AD will be reimbursed in the event of the guarantee/bond being invoked.

11. ADs may issue, on behalf of residents, bid bonds/performance bonds/guarantees in foreign currency in favor of local project authorities against goods/services procurement tenders financed by international/foreign donor agencies, on the condition that in case the guarantee is invoked the claim there against would be paid only in Taka equivalent and not in any other currency.

12. Non-resident international agencies may demand bank guarantees from non-resident contractors against supply of materials/down payment for the ongoing projects in Bangladesh financed by them. Such guarantee on behalf of a non-resident contractor in favour of the non-resident beneficiary may be issued by an AD against 100% counter guarantee from a reputed international bank abroad, or against 100% cash collateral in foreign exchange received from abroad through banking channel.

13. ADs may not, without prior approval of Bangladesh Bank, furnish guarantees to or hold collaterals on behalf of overseas bank branches or correspondents in respect of credit facilities or guarantees to be extended by them or for any other purpose. All applications to Bangladesh Bank should be made by letters giving details of the purpose for which guarantee is to be furnished or collateral deposited. Prior approval is not however, necessary in cases where the ADs are satisfied that the amount of the fixed deposit or other collateral held by them represents funds remitted to Bangladesh through normal banking channel from the country of residence of the borrower.

14. In cases where the extension of loans or overdrafts or guarantees require prior approval of the Bangladesh Bank, the renewal of such loans, overdrafts or guarantees shall also require prior approval of the Bangladesh Bank.

Article 1 and 2 of URDG 758 – give us fundamental guidelines

a. The Uniform Rules for Demand Guarantees ("URDG") apply to any demand guarantee or counter-guarantee that expressly indicates it is subject to them. They are binding on all parties to the demand guarantee or counter-guarantee except so far as the demand guarantee or counter-guarantee modifies or excludes them.

b. Where, at the request of a counter-guarantor, a demand guarantee is issued subject to the URDG, the counter-guarantee shall also be subject to the URDG, unless the counter-guarantee excludes the URDG. However, a demand guarantee does not become subject to the URDG merely because the counter guarantee is subject to the URDG.

c. Where, at the request or with the agreement of the instructing party, a demand guarantee or counter-guarantee is issued subject to the URDG, the instructing party is deemed to have accepted the rights and obligations expressly ascribed to it in these rules.

d. Where a demand guarantee or counter-guarantee issued on or after 1 July 2010 states that it is subject to the URDG without stating whether the 1992 version or the 2010 revision is to apply or indicating the publication number, the demand guarantee or
Counter-guarantee shall be subject to the URDG 2010 revision.

URDG 758 - Article 2
Advising party means the party that advises the guarantee at the request of the guarantor;

Applicant means the party indicated in the guarantee as having its obligation under the underlying relationship supported by the guarantee. The applicant may or may not be the instructing party;

Application means the request for the issue of the guarantee;

Authenticated, when applied to an electronic document, means that the party to whom that document is presented is able to verify the apparent identity of the sender and whether the data received have remained complete and unaltered;

Beneficiary means the party in whose favor a guarantee is issued;

Complying demand means a demand that meets the requirements of a complying presentation;

Complying presentation under a guarantee means a presentation that is in accordance with, first, the terms and conditions of that guarantee, second, these rules so far as consistent with those terms and conditions and, third, in the absence of a relevant provision in the guarantee or these rules, international standard demand guarantee practice;

Counter-guarantee means any signed undertaking, however named or described, that is given by the counter-guarantor to another party to procure the issue by that other party of a guarantee or another counter-guarantee, and that provides for payment upon the presentation of a complying demand under the counter-guarantee issued in favor of that party;

Counter-guarantor means the party issuing a counter-guarantee, whether in favor of a guarantor or another counter-guarantor, and includes a party acting for its own account;

Demand means a signed document by the beneficiary demanding payment under a guarantee;

Demand guarantee or guarantee means any signed undertaking, however named or described, providing for payment on presentation of a complying demand;

Document means a signed or unsigned record of information, in paper or in electronic form that is capable of being reproduced in tangible form by the person to whom it is presented. Under these rules, a document includes a demand and a supporting statement;

Expiry means the expiry date or the expiry event or, if both are specified, the earlier of the two;

Expiry date means the date specified in the guarantee on or before which a presentation may be made;

Expiry event means an event which under the terms of the guarantee results in its expiry, whether immediately or within a specified time after the event occurs, for which purpose the event is deemed to occur only:

a. when a document specified in the guarantee as indicating the occurrence of the event is presented to the guarantor, or b. if no such document is specified in the guarantee, when the occurrence of the event becomes determinable from the guarantor's own records.

Guarantor means the party issuing a guarantee, and includes a party acting for its own account;

Guarantor's own records means records of the guarantor showing amounts credited to or debited from accounts held withthe guarantor, provided the record of those credits or debits enables the guarantor to identify the guarantee to which they relate;

Presentation means the delivery of a document under a guarantee to the guarantor or the document so delivered. It includes a presentation other than for a demand, for example, a
Presentation for the purpose of triggering the expiry of the guarantee or a variation of its amount;

Signed, when applied to a document, a guarantee or a counter guarantee, means that an original of the same is signed by or on behalf of its issuer, whether by an electronic signature that can be authenticated by the party to whom that document, guarantee or counter-guarantee is presented or by handwriting, facsimile signature, perforated signature, stamp, symbol or other mechanical method;

Underlying relationship means the contract, tender conditions or other relationship between the applicant and the beneficiary on which the guarantee is based.

Problems

Bank guarantee is mainly limited to covering the right of unpayment provided that the payment system based on invoices is used.

Unless supported by a cash deposit or other security, a guarantee is always of an uncertain value as a security. A guarantor's financial position can change very quickly. An unsupported guarantee should only be accepted after careful investigation into the proposed guarantor's financial circumstances.

Court action may be necessary to realize the security and a technicality may defeat the bank's claim. For example, special rules apply to guarantees taken from partnerships and companies. A defeat of the bank's claim on a legal technicality would almost certainly be the result of carelessness when taking the security.

Enforcing a guarantee may cause bad feeling, particularly if the guarantor is a valued customer.

Litigation may be necessary to enforce payment where the guarantee was not supported by other (realizable) security. There are many restrictions from country laws.

Practice of International Bank Guarantee at MTB
As bank guarantee enables the customer (debtor) to acquire goods, buy equipment, or draw down loans, and thereby expand business activity so MTB facilitates clients to fulfill their needs.
Due to the restriction of the regulation of Foreign Exchange Act 1947 MTB issues International Bank Guarantee in very few cases.
MTB issue bank guarantee against LC. In case of work order issuing of BG is insignificant. We have to go for 100% counter guarantee. In case of unavailability 100% margin we apply Bangladesh Bank as special case if the clients are valued.

Recommendations and Conclusion
In Bangladesh Business Enterprises engaged in construction, supply and other business enterprise avail bank guarantee to participate tenders, execute job order and to meet any other obligation. ▪ Extensive experience of guarantees, together with a worldwide network of group offices and correspondent banks are prerequisite to meet domestic and international needs ▪ An unsupported guarantee should only be accepted after careful investigation into the proposed guarantor's financial circumstances. ▪ Global presence can provide with attractive terms on foreign guarantees ▪ Specialist Guarantees Team can provide with valuable support for business. ▪ Many genuine business requirements like obtaining goods, purchasing machinery can be fulfilled even when the enterprise does not have enough money. ▪ Enables to use bank's creditworthiness to facilitate many genuine business transactions. ▪ Providing advisory services is considered as a success factor on risks arising from the terms and conditions in bank guarantee. ▪ Take advantage of greater opportunities to expand into new markets and conduct trade with new business partners because exporters and importers can use international bank guarantee/to cushion risks that could arise in doing business with unfamiliar trade partners, or in new markets. ▪ With a network of correspondent banks worldwide, bank guarantee can help to expand international trade business extensively in Bangladesh.
The restrictions of the regulation of Foreign Exchange Act 1947 needs to be reduced on the basis of foreign exchange reserves in order to facilitate International Bank Guarantee.