The word bond often conjures up images of someone paying a bondsman to get out of jail, or an investment strategy. Bonds also apply to business situations, and people in the business world can use bank bonds, also called performance or surety bonds, to protect themselves from financial loss. Bank guarantees refer to another type of protection in the business sector. While bonds and guarantees offer similar features, it's imperative to understand key differences between the two.
Definition of Bank Bond
Bank, surety or performance bonds involve an agreement between an owner, a contractor and the institution that issues the bond. Contractors may agree to complete a project to the owner's satisfaction. However, the contractor may stop the project before completion or take the owner's money and disappear. Owners can protect themselves from mishaps by acquiring a bank bond. This is a performance bond, and this type of bond is different from investment bonds obtained from a bank. With a performance bond, the bank compensates owners for their financial loss if the contractor doesn't fulfill his obligation.
Definition of Bank Guarantee
Bank guarantees, also called letters of credit, involve a bank or other financial institution promising or guaranteeing cash to owners if a project isn't completed. If the project owner demands cash, the bank pays this cash using the letter of credit, and the contractor then acquires an interest-bearing loan and repays the lending institution.
While bank bonds and bond guarantees have similarities, differences include how an institution qualifies a contractor for coverage. Before issuing a surety, bank or performance bond, the bank closely evaluates the contractor's performance record, financial history, workload and experience to assess if the contractor is capable of completing the project. Banks require collateral with a letter of credit, and they assess the condition of such collateral to ensure that the worth supports the monetary value of the guarantee.
Bonds and letters of credit affect a contractor's borrowing capacity differently. Because bank bonds are based on a contractor's strong credit record and do not require collateral, the contractor's financial history can strengthen or improve. Quite the opposite with letters of credits, these guarantees are viewed as a liability on a contractor's financial statement and this letter can negatively impact the contractor's ability to acquire future funding.
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