Both surety bonds & bank guarantee (or Letter of Credits/LCs) ensure that the principal satisfies his obligations to the obligee, failing which the obligee is protected from financial loss. However, surety bonds are better than bank guarantees for several reasons.
LIQUIDITY : Surety Bond versus bank Guarantee
Bank Guarantees lock up working capital, anything between 20-100% of the value of guarantee. The funds locked are either as margin money or collateral.
Unlike Bank Guarantees, Surety bonds do not require collateral or any margin money. This frees up working capital for the principal & increases their liquidity.
The freed up capital can be used in more important aspects of the project, which is beneficial for all the parties involved in the project. This is especially beneficial for cash strapped construction industry.
Line of Credit: unblocked by SURETY BONDS
Surety bond is based on the financial solvency of the principal. It does not diminish the principal’s borrowing capacity. This is not true for a bank guarantee which diminishes the company’s line of credit. The surety bond is based on the strength of your business, not your credit score.
Better RISK MANAGEMENT: SURETY COMPANIES
Surety bonds are issued by insurance companies, whereas, Bank Guarantees are issued by banks.
Banks are in the business of giving out loans & not in the business of managing risk. This is why they require a collateral to provide bank guarantee.
The bank, whose primary business is not risk analysis, is at high risk of loss if the project fails. The obligee is basing his decision on Bank Guarantee and, thus, the obligee too is at risk.
The insurance companies specialize in risk management & thus are better suited to cater to such a requirement. They pool & manage this homogeneous risk of low frequency & high severity. They do not require a collateral as their decision is based on underlying risk directly.
Flexibility : Surety bond better alternative TO BANK GUARANTEE
One of the key advantages of surety bonds over bank guarantees is their flexibility. The Insurance company has the ability to tailor the bond to the specific needs of the principal, whereas a bank guarantee is a one-size-fits-all solution.
Accessibility : easier to get than bank guarantees
Another advantage of surety bonds is their accessibility. Because surety bonds are backed by the financial strength of the surety company, they can be obtained by businesses of all sizes, even those with less-than-perfect credit. In contrast, bank guarantees are typically only available to larger, more established businesses with strong credit ratings.
This is especially helpful for SMEs which are cash strapped & cannot afford held-up collateral.
Protection : higher in surety bonds
Surety bonds also offer more protection than bank guarantees. In the event that the principal fails to fulfill their obligations, the surety company is responsible for covering the costs, up to the full amount of the bond. This provides the beneficiary (the party protected by the bond) with a higher level of protection than a bank guarantee, which is only backed by the creditworthiness of the bank.
Efficiency : SURETY BONDS faster than bank guarantee
Finally, surety bonds are faster and more efficient than bank guarantees. Because surety bonds are issued by specialized insurance companies, the process of obtaining a bond is typically faster and more streamlined than the process of obtaining a bank guarantee. This makes surety bonds a more convenient option for businesses that need to quickly obtain financial protection.