Market Financial Guarantees

 

NATURE & TYPES OF GUARANTEES:

In Market Financial Guarantees, suppliers face lender risk, i.e. the eventuality that debtors may not honor their commitments arising out of loan transactions. The interest of depositors, as a special category of lenders, is protected in many countries, including India by Deposit Insurance. The other types of lenders also seek to minimize the risk they bear by asking for guarantee. In legal terms, a 'contract of guarantee' is a contract to execute the promise, or discharge the responsibility of a third person in case of his default. Hence, in a loan transaction accompanied by a guarantee, there are three parties, viz. the guarantor, the principal debtor, and the creditor. If the chief debtor does not repay, the underwriter becomes the debtor.

Market Financial Guarantees is a type of security requested by the creditor. It cannot be used as a physical security. It is well known that creditors secure their advances against various types of tangible securities. In addition, they may also ask for Market Financial Guarantees from the borrowers. They cannot recuperate their money with the help of insolvency. In certain cases, however, guarantee may be sufficient to reinforce a clean advance.

In general, the task of finding a guarantor lies with the borrower. However, it is possible that where special guarantee corporations exist, the creditor first makes a loan and then the organization guarantees it. Special guarantee corporations charge a commission or a fee from the borrower.

As the purpose of seeking guarantee is to reduce the risk of default, it follows that the guarantor must be prestigious in the eye of the creditor, he or she must be one, or the organization must be one of undoubted credit and must have sufficient means and adequate liquid assets. Guarantee can be oral or written, although most creditors would prefer the latter. A Market Financial Guarantees can be given either by one person or more than one jointly or by an organization.

The market for loanable funds is familiar with many types of market guarantees. There are "specific guarantees" and "continuing guarantees". Specific guarantees are offered on a single transaction. 'Continuing guarantees' are offered on a series of transactions. A secured guarantee is another form of guarantees, which are backed by tangible security from the guarantor.

A guarantee can be 'explicit' or 'implicit'. Explicit guarantee is based on the type of transaction. For instance, an endorser on a bill, or a promissory note, is liable to reimburse the holder the debt represented by the instrument. There are two kinds of guarantees, that is, financial guarantees and performance guarantees. While the latter cover performance of non-financial contracts including payment of earnest money, retention money, penalty charges and advance payments, the former cover purely financial contracts. In India, such contracts can be:

·Late payment on local capital goods

·Medium and long-term loans borrowed from the other country

·Credit advanced by domestic institutions, particularly banks, for various purposes.

SUPPLIERS OF GUARANTEES

There are three suppliers of guarantees:

a)Personal Guarantees

b)Guarantees by the Government

c)Export Credit Guarantee Corporation

Let us discuss them in detail:

Personal Guarantees

Personal guarantee is an old form of guarantee. It represents an unorganized and decentralized method of rendering this service. In many cases, they are not issued in written form. In the unorganized financial market in India, there is no doubt that oral personal guarantees help to see through many loan transactions. There are reasons to believe that in obtaining loans for consumption and social purposes, personal guarantees are widely used in India. Although it is difficult to obtain statistics on the extent of borrowings backed by personal guarantees, they play a significant role in terms of size and usefulness in the loanable funds market. Personal guarantees are offered on short-term credit. In rural sector, third party guarantees amounted to 6 percent of the total borrowings.

Personal guarantees are popular in the organized sector. Banks and term-lending institutions used to give loans to industrial concerns on the basis of guarantees from managing agents, directors, and managerial personnel. First, the abolition of the managing agency system led to the disappearance of reputed, prestigious and creditworthy personal guarantors. Second, owing to the rise of a new entrepreneurial class, professionalism of managerial cadres, and improvement in the technique of financial and technical appraisal of proposals for assistance, the need to obtain guarantees as a matter of course declined. The official policy was to reduce the dependence on such personal guarantees in matters of industrial finance.

In the industrial sector, personal guarantees no more exist. In the agricultural sector, the use of personal guarantees has increased for the growth of banking in rural areas. In the post-nationalization period, the changing concept of lending meant that banks are required to grant unsecured loans to farmers and others.

Guarantees by the Government

The central and state governments are also known to provide guarantees in various cases. The state and central co-operative banks are always short of resources. The rate of default on their loans is also high. The government also guarantees public borrowings. They also offer counter-guarantees in respect of bank guarantees extended on behalf of public corporations and other bodies. The government gives full guarantee on debentures issued by apex housing finance societies. The state governments guarantee amounts, which are due to NABARD from institutions assisted by it. The central government guarantees the shares of NABARD as to the reimbursement of the principal and payment of a minimum annual dividend at a rate determined by the government. Private institutions do not provide guarantee in the credit market.

Export Credit Guarantee Corporation Limited

It was set up in January 1964 with the objective of offering financial protection to the exporter and improving his financial standing vis-á-vis his bankers. It helps to minimize the risk of non-payment of a loan. Its business falls under two heads:

1.Export credit insurance

2.Export credit guarantees

These are Market Financial Guarantees provided to banks to recover their loans to exporters both at the pre-shipment and post-shipment stages. Export credit guarantees protect the banks from any loss and encourage them to provide funds to exporters to fulfill their export commitments.

The ECGC offers:

• Packing credit guarantee

• Post-shipment export credit guarantee

• Export finance guarantee

• Export production finance guarantee

Non-financial guarantees:

• Export performance guarantee

• Transfer guarantee

• Investment insurance guarantee

The last facility was introduced in September 1978 to protect Indian entrepreneurs willing to invest abroad against political risks arising out of war, expropriation, restrictions on remittances, etc.

The extent of guarantee provided by the ECGC keeps changing from time to time and is flexible in nature. In 1974-75, it was raised from 66 percent to 75 percent of the default or loss. Recently, the ECGC raised this cover to 90 percent at the request of banks. The rate of commission keeps changing. The concessional rate is linked with the extent of cover of loss requested. The ECGC charges a high commission rate as compared to that of banks and insurance companies.

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