Once a mainstay on balance sheets of top lenders, the business of issuing bank guarantees is losing its sheen.
The demand for bank guarantees has been coming down, forcing lenders to look at other avenues to boost fee income, four bankers said on the condition of anonymity. Incremental issuance of bank guarantees have dropped 30-40% by value since January, the bankers quoted above said.
A bank guarantee is essentially a contingent liability taken by a lender, on behalf of its borrowers. If the borrower is not able to deliver on a contractual payment within time, the guarantee-issuing bank makes good on this payment.
These guarantees have a wide array of applications, including in infrastructure projects, purchase of stressed assets and mergers and acquisitions. However, guarantees given in the course of bidding and executing government contracts make up a large chunk of this business.
There is no clear estimate of the quantum of bank guarantees outstanding. However, the scale of the business can be judged from the books of large banks. For instance, State Bank of India had issued guarantees worth Rs 1.67 lakh crore in FY22 on behalf of constituents in India, according to its annual report. HDFC Bank Ltd. reported guarantees worth Rs 83,391 crore last fiscal. In case of ICICI Bank, the guarantees issued stood at Rs 81,528 crore in FY21. The latest annual report for ICICI Bank is not available yet.
What Is Behind The Fall?
A change in the environment for telecom and infrastructure firms is a key reason for the drop in demand for bank guarantees.
Last year, infrastructure companies and telecom firms had met with the government and argued that the requirement for bank guarantees was inflating costs, the first two bankers quoted above said.
Against the guarantees, banks collect a fee from their borrowers.
In case of performance guarantees, where the bank backs a company's ability to execute a project, the fee ranges between 1% and 1.5% of the value of the guarantees. In case of financial guarantees, where the bank backs a project's future cash flow estimates, the fee may be higher at 2-2.5%.
The fee may be lower if the borrower is well rated, or if there is considerable competition among lenders, the first of the four bankers quoted above said.
Once a mainstay on balance sheets of top lenders, the business of issuing bank guarantees is losing its sheen.
The demand for bank guarantees has been coming down, forcing lenders to look at other avenues to boost fee income, four bankers said on the condition of anonymity. Incremental issuance of bank guarantees have dropped 30-40% by value since January, the bankers quoted above said.
A bank guarantee is essentially a contingent liability taken by a lender, on behalf of its borrowers. If the borrower is not able to deliver on a contractual payment within time, the guarantee-issuing bank makes good on this payment.
These guarantees have a wide array of applications, including in infrastructure projects, purchase of stressed assets and mergers and acquisitions. However, guarantees given in the course of bidding and executing government contracts make up a large chunk of this business.
There is no clear estimate of the quantum of bank guarantees outstanding. However, the scale of the business can be judged from the books of large banks. For instance, State Bank of India had issued guarantees worth Rs 1.67 lakh crore in FY22 on behalf of constituents in India, according to its annual report. HDFC Bank Ltd. reported guarantees worth Rs 83,391 crore last fiscal. In case of ICICI Bank, the guarantees issued stood at Rs 81,528 crore in FY21. The latest annual report for ICICI Bank is not available yet.
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