A letter of guarantee is a written obligation issued by the bank at the request of its client (businessman) specified to a third party who is the beneficiary within a specified period (which may be extended). Cash amount must be paid to obtain the letter of guarantee.
There are three parties to the letter of guarantee:
The Bank: (the sponsor) as a financial institution that charges a specific commission from the customer in return for its guarantee. The customer: (the guaranteed) who asks the bank to issue a letter of guarantee The beneficiary: the entity or person whom the letter is issued in his favor.
Issuing a letter of bank guarantee means joining the bank’s responsibility to that of the customer in ensuring the fulfillment of its obligations towards a third party (ie the beneficiary). Letters of guarantee have become a daily work of banks in response to the multiplicity of needs of contemporary economic activity, and the demand for them has become great from businessmen, traders, contractors, suppliers, and importers. It has an important role in carrying out their business and their contracts, and concluding deals that cannot be accomplished without obtaining these letters
Letters of guarantee take different forms according to the needs of customers and are issued by traditional banks as well as Islamic banks. The most important types are the following:
First: The initial letters of guarantee are the letters required by government institutions and official bodies or other qualified contractors or bidders for the operations they need to implement, in order to ensure the seriousness of these contractors in implementing those bids.
Second: The final letters of guarantee are letters of guarantee of good implementation and performance in accordance with the required specifications and at the time specified for the implementation of the contract. These letters are payable when the customer (the contractor) fails to fulfill his obligation stipulated in the contract.
Third: Advance Payment Guarantee Letters are letters of guarantee aimed at assisting the contractor executing the bid (or project) in return for obtaining an advance payment of the bid (or contract) value before starting its implementation.
Fourth: Shipping letters of guarantee are letters of guarantee submitted by the importer's bank in favor of the shipping company. The letter includes the importer's undertaking to receive the shipping documents upon their arrival, and his pledge to pay immediately or on demand for all financial obligations.