Bank guarantees: how they work and what they cost you

Anyone winning contracts in plant engineering or construction knows the clause: no bond, no contract. This is where the bank guarantee comes in. The bank stands behind your obligation but pays nothing out — it provides your creditworthiness, not its money. That preserves your liquidity, while consuming a facility just as finite as your overdraft.

This guide covers what a bank guarantee is, which types matter in the mid-market, how commission and the facility interact — and why total exposure belongs next to your liquidity plan, even though at first glance it has no place there.

What is a bank guarantee?

A bank guarantee is a facility from which your bank issues undertakings in favour of third parties. Unlike a cash loan, no money reaches your account: the bank lends its standing by assuring a customer, landlord or supplier that it will step in if you do not perform.

The sequence is always the same. Your company instructs the bank, the bank issues a deed in favour of the beneficiary, and the beneficiary holds it as security. As long as you meet your obligation nothing further happens — the guarantee stays a promise. Only if the beneficiary calls it does the bank pay out, and then reclaims the amount from you.

Economically this is lending of credit: what is lent is creditworthiness, not cash. For your company it creates no liability but a contingent liability — an obligation that turns into a payment duty only if the guarantee is actually drawn. That is also the line between a guarantee and a loan: with a loan money flows and interest runs; with a guarantee nothing flows and a commission runs. A bank guarantee is therefore not a loan in the legal sense, though your bank assesses and limits it exactly like one.

The types that matter

In project business a handful of bond types recur. They secure different phases of a contract — from the advance payment to the end of the warranty period — and tie up your facility for correspondingly different lengths of time.

The striking column is the last one. A performance bond ends at acceptance; a warranty bond frequently runs on for years. These long-dated bonds are the ones that quietly block capacity — above all when the deed was never returned to the bank after the deadline passed. Outside the project world, the rent guarantee replaces a cash deposit for commercial leases, freeing money that would otherwise sit idle.

Commission and the guarantee facility

A bank guarantee is not free, even though no money moves. The bank charges a guarantee commission — an annual percentage of the guaranteed amount, in return for making its standing and its default risk available. The level depends on your credit standing, the type of bond and the institution.

As orientation, guarantee commissions typically sit in the low single-digit percent per year on the bond amount. That is explicitly a range, not a quote — your bank sets its own rates and they can differ substantially. Only your own terms are binding.

The worked example below uses generic illustrative values and an assumed rate, not real conditions:

Commission runs for as long as the bond is outstanding — year after year. The guarantee facility is the second control: the ceiling your bank grants for the total of all open guarantees. Every bond issued consumes part of it, every deed returned frees it again. Once the facility is exhausted, the next contract cannot be secured — however full the bank account is.

Bank guarantees in the accounts

While a guarantee is unclaimed it does not appear in the balance sheet at all — there is neither a cash movement nor a liability. Under German GAAP, guarantees and warranty undertakings are instead disclosed below the balance sheet as Haftungsverhältnisse under section 251 HGB, with supplementary notes in the annex for corporations. For the reader of your accounts — above all your bank — that note is not a footnote: it shows which obligations could additionally land on the company.

Two exceptions to the below-the-line logic matter. First: if a call becomes probable — say a customer asserts defects and signals it will draw — the expected outflow must be provided for, and the contingent obligation becomes a balance-sheet item. Second: if the guarantee is actually drawn, the bank pays the beneficiary and your company owes the bank in turn.

The running commission, which banks usually invoice quarterly or annually, is ordinary expense of the period. How it is posted in your chart of accounts depends on your practice — that is a question for your accounting team or tax adviser, not for rules of thumb.

Advantages and disadvantages

The strengths are obvious. An unsecured guarantee ties up no cash — the deposit stays in your account, the overdraft stays free. Where the bank does require cash cover the picture changes: the covered amount is blocked or pledged and is no longer freely available, so treat it as tied up. The commission is as a rule considerably cheaper than interest on a cash loan of the same size. And without a bond many contracts could not be won at all: in construction and plant engineering the performance bond is simply market standard.

Against that sit three disadvantages that are regularly underestimated. The guarantee consumes credit capacity like a loan — the bank counts the exposure toward your overall engagement, which narrows the room for working-capital facilities. The commission runs as long as the deed is out, including after the deadline has passed. And the call risk remains: with bonds payable “on first demand”, the bank pays initially without examining the state of the dispute — the money is gone, the argument happens afterwards. Anyone carrying many guarantees therefore carries a real, silent liquidity risk that appears on no bank statement.

Security and alternatives to the house bank

For the bank, a guarantee is a credit risk like any other — so the facility is assessed against your standing and frequently secured, whether by assignments, land charges or cash cover for individual bonds. A guarantee facility entirely without security is close to reserved for very good credit standing and long banking relationships.

Anyone hitting the limits of the bank facility has two common alternatives. Surety insurers provide guarantee capacity outside the bank, which relieves the banking lines and spreads exposure across more shoulders. The German federal-state guarantee banks can partly substitute for missing collateral towards your house bank; state promotional institutions such as KfW, by contrast, do not themselves issue guarantees. From the second provider onwards a consolidated view pays for itself: who holds which exposure, at what rate, with which deadline?

Why guarantees belong next to the liquidity plan

At first sight a bank guarantee has no business in a liquidity plan: it moves no money as long as it is not called. That is precisely what makes it treacherous. Three reasons argue for placing it beside the plan.

First, the guarantee facility is part of your bank lines. Like the overdraft it is finite, and its utilisation co-decides whether you can take the next contract. Whoever watches only the account balance misses this second, equally hard limit.

Second, every guarantee is a latent liquidity risk. If it is called, the bank pays immediately and debits your account by the same amount — a silent undertaking becomes a real outflow overnight. Keeping total exposure in view means knowing that risk before it materialises.

Third, forgotten deadlines cost money and capacity. A warranty bond whose period expired long ago, but whose deed was never returned, keeps blocking your line and keeps generating commission. A deadline view makes those dormant items visible.

So a guarantee is not an item inside the liquidity plan but an overview beside it — a monitor of exposure by type, total exposure and deadlines. That is exactly what the guarantee overview delivers: how much facility is consumed, which bonds expire soon, and what would hit liquidity if one were called. Together with the 13-week cash forecast it produces the complete picture — cash, bank lines and guarantee exposure in one consistent financial view.

Frequently asked questions