(a) Broad Guidelines
In view of the risks involved in the business of issuance of guarantees, the Urban Co-operative Banks should extend guarantees within restricted limits so that their financial position is not impaired. Bank will follow certain broad guidelines in respect of their guarantee business as indicated in the following paragraphs.
- Purpose: As a general rule, bank will provide only financial guarantees and not performance guarantees.
- Maturity : It would be desirable for the Bank to confine their guarantees to relatively short-term maturities. Guarantees will not be issued for periods exceeding ten years in any case.
- Volume : The total volume of guarantee obligations outstanding at any time will not exceed 10 per cent of the total owned resources of the bank comprising paid up capital, reserves and deposits. Within the overall ceiling, proportion of unsecured guarantees outstanding at any time will be limited to an amount equivalent to 25% of the owned funds (paid up capital + reserves) of the bank or 25% of the total amount of guarantees, whichever is less.
- Secured Guarantees: Banks will preferably issue secured guarantees. A secured guarantee means a guarantee made on the security of assets (including cash margin), the market value of which will not at any time be less than the amount of the contingent liability on the guarantee, or a guarantee fully covered by counter guarantee/s of the Central Government, State Governments, public sector financial institutions and/or insurance companies. Banks should generally provide deferred payment guarantees backed by adequate tangible securities or by counter guarantees of the Central or the State Government or public sector financial institutions or of insurance companies and other banks.
- Unsecured Guarantees : Bank will avoid undue concentration of unsecured guarantee commitments to particular groups of customers and/or trades. Banks' Board of Directors will fix suitable proportions for issuance of unsecured guarantees on behalf of any individual constituent so that these guarantees do not exceed
8a - (a) reasonable proportion of the total obligations in respect of unsecured guarantees provided by the bank to all such constituents at any time, and (b) reasonable multiple of the shareholdings in the bank.
- In case Bank intends for issuing deferred payment guarantees in respect of their borrowers for acquisition of capital assets will ensure that the total credit facilities including the proposed deferred payment guarantees do not exceed the prescribed exposure ceilings.
- The proposals for deferred payment guarantees will be examined having regard to the profitability / cash flows of the project to ensure that sufficient surpluses are generated by the borrowing unit to meet the commitments as the Bank has to meet the liability at regular intervals in respect of the instalments due. The criteria generally followed for appraising a term loan proposal for acquisition of capital assets will also be applied while issuing deferred payment guarantees.
f) Guarantees in respect of Commodities covered under Selective Credit Controls
Bank will not issue, either to a Court or to Government, or any other person, a guarantee on behalf of or on account of any importers guaranteeing payment of customs duty and/or import duty, or other levies, payable in respect of import of essential commodities without taking, as security for issue of such guarantees, a cash margin equivalent to at least one half of the amount payable under the guarantee. The term "essential commodities" shall mean such commodities as may be specified by the Reserve Bank of India from time to time.
- Safeguards in Issuance of Guarantees
While issuing the financial guarantees, Bank will observe the following safe guards :
- The bank guarantees will be issued in security forms serially numbered to prevent issuance of fake guarantees. ii. Guarantees above a particular cut off point, as decided by the Bank, will be issued under two signatures in triplicate, one copy each for the branch, beneficiary and Head Office. It will be binding on the part of the beneficiary to seek confirmation of the Head Office as well for which a specific stipulation be incorporated in the guarantee itself.
- The guarantees will not normally be allowed to the customers who do not enjoy credit facilities with the bank but only maintain current accounts. If any request is received from such customers, the bank will subject the proposals to thorough scrutiny and satisfy themselves about the genuine need of the customers. The bank will be satisfied that the customers would be in a position to meet the claims under the guarantees, when received, and not approach the bank for credit facility in this regard. For this purpose the bank will enquire into the financial position of the customers, the source of funds from which they would be in a position to meet the liability and prescribe a suitable margin and obtain other security, as necessary. Bank will also call for the detailed financial statements and Wealth-tax / Income-tax returns of the customer to satisfy themselves of their financial status. The observations of the banks in respect of all these points will be recorded in banks' books.
- Where the customers enjoy credit facilities with other banks, the reasons for their approaching the bank for extending the guarantees will be ascertained and invariably, a reference will be made to their existing bankers with whom they are enjoying credit facilities.
- Bank, when approached to issue guarantees in favour of other banks for grant of credit facilities by another bank, would examine thoroughly the reasons for approaching another bank for grant of credit facilities and satisfy themselves of the need for doing so. This would be recorded in bank's books.
- When it is considered necessary to issue such guarantees, Bank will ensure that the relative guarantee document, beyond a stipulated amount, will not be signed singly but by two authorised officials jointly after obtaining proper sanction and authority and proper record of such guarantee issued being maintained. The credit proposal will be subjected to usual scrutiny by the lending bank ensuring that the proposals conform to the prescribed norms and guidelines and credit facilities are allowed only if the bank is satisfied about the merits of the proposal and the availability of another bank's guarantee will not result in a dilution of the standards of evaluation of the proposal and financial discipline in lending.
(j) Payment under Bank Guarantees - Immediate Settlement of Cases
- Probably reluctance on the part of banks to honour their commitment in respect of invoked guarantees stems from their fear of difficulty in realising the amount due from their constituents on account of such guarantees. It is possible that in their anxiety to boost up their profitability, Banks go out of the way to issue bank guarantees on behalf of constituents without subjecting the proposals to proper scrutiny and assessing the capacity and creditworthiness of their constituents to pay the amounts to the banks in case the guarantees are invoked. Dilution of security (i.e., non-obtention of adequate margin) may be another factor responsible for banks not receiving the dues in respect of invoked guarantees from their clients.
- The above aspects may inhibit bank to pay the beneficiaries promptly when guarantees are invoked and they adopt dilatory tactics in respect of invoked guarantees. It is absolutely essential for Bank to appraise the proposals for guarantees also with the same diligence as in the case of fund based limits and obtain adequate cover by way of margin so as to prevent the constituents to develop a tendency of defaulting in payments when invoked guarantees are honoured by the banks.
- The bank guarantee is a commitment made by the issuing bank to make payment to the beneficiary (albeit at the behest of the bank's constituent). Failure on the part of the bank to honour the claim legitimately made on it projects distorted picture of its functioning.
- In fact some strictures were passed by Courts in the past against banks for not honouring the guarantee commitments promptly. The Supreme Court observation are :
"We are therefore, of the opinion that the correct position of law is that commitment of banks must be honoured free from interference by the courts and it is only in exceptional cases, that is to say, in case of fraud or in case where irretrievable injustice would be done, if bank guarantee is allowed to be encashed, the court should interfere."
Banks will, therefore, honour bank guarantees issued by them promptly on their invocation as reluctance on their part to honour commitments in respect of invoked guarantees tend to bring the banking system into disrepute