What is a Bank Guarantee?

What is a bank guarantee?

A bank guarantee is a financial instrument provided by a bank or financial institution. It is a commitment by the bank to pay a certain amount of money to a beneficiary if the principal debtor fails to fulfil its obligations. Bank guarantees are important in various situations, especially in the area of property financing and transactions in Dubai.

Types of bank guarantees

In the property sector, there are several types of bank guarantees that can be used depending on your needs:

Performance or execution guarantee: this type is often required by contractors and ensures the proper execution of a project.
Payment guarantee: This guarantee secures payment to suppliers or service providers in a construction project.
Reimbursement bond: This protects buyers against non-payment or non-fulfilment of payments by sellers or developers.

Why is a bank guarantee important in Dubai?

In Dubai, a dynamic property investment market, bank guarantees are often used in the following cases:

To create trust between buyers and sellers.
As a prerequisite for many property transactions and financing.
To minimise the risks in transactions, especially for foreign investors.

How does a bank guarantee work?

To obtain a bank guarantee, the applicant must submit an application to their bank, which will check the applicant’s creditworthiness. After checking the applicant’s documents, the bank then issues the guarantee against payment of a fee or commission. If the guarantee is called, the bank will take action to make payment to the beneficiary if the applicant is unable to fulfil his obligations.

Difference between a bank guarantee and a letter of credit

It is important to understand the differences between a bank guarantee and a letter of credit. While the latter is typically used for international trade transactions and intervenes between buyers and sellers of goods, a bank guarantee usually refers to specific performances or payments in a contract and provides a different protection mechanism.

Risks and considerations

Despite the benefits of a bank guarantee, investors should also be aware of the potential risks and challenges:

The cost of issuance can be high, depending on the guarantee offered.
Need for comprehensive documentation and proof of creditworthiness.
There is always a risk that the bank will not fulfil its obligations in full if the guarantee is called.

Illustrative example on the topic: Bank guarantee

Imagine a foreign investor is planning to buy a luxury property in Dubai. The seller requires a bank guarantee of 10% of the purchase price to ensure that the buyer is able to make the agreed payments. The investor turns to his bank, which issues the required guarantee following a credit check. In the event that the investor does not make the payments on time, the seller can call on the bank guarantee to obtain the amount due, which significantly reduces the risk for the seller.