What Is a Bank Guarantee? Types, Costs, Stamp Duty and How Tenders Use It (2026)

A buyer wants proof that you will deliver. A government department wants earnest money before it opens your bid. A customer wants comfort before paying you a 20% advance. In each case the answer is often a bank guarantee — a piece of paper from your bank that lets the other side sleep at night while your cash stays in your business. This guide is for small manufacturers, contractors, traders and exporters in India who need to give a guarantee for the first time, or want to stop overpaying for one. It explains what a bank guarantee is, the types, how it differs from a letter of credit, what it really costs in rupees, how tenders and GeM use it, and what happens if it is invoked.

Quick answer

A bank guarantee (BG) is your bank's written, usually unconditional promise to pay a named beneficiary up to a fixed amount if you — the applicant — fail to pay or perform. It replaces a cash deposit. Since 1 April 2026 banks issue guarantees under RBI's Non-Fund Based Credit Facilities Directions, 2025.

• Three types matter most: financial, performance and advance-payment guarantees (plus bid bonds for tenders)

• Cost = bank commission (published PSB tariffs ≈ 1.6%–3% a year) + GST + stamp duty + the cost of any cash margin

• Government tenders ask for bid security of 2% to 5% of the estimated value; registered MSEs are exempt from it

• A guarantee is not an LC: an LC is meant to be paid; a BG is paid only if you default

• If invoked in line with the deed, the bank must pay unless a court stops it

What is a bank guarantee?

The Indian Contract Act, 1872 defines a contract of guarantee in section 126 as a contract to perform the promise, or discharge the liability, of a third person if that person defaults. A bank guarantee is that idea applied to banking. There are three parties. You are the applicant (the law calls you the principal debtor). The party you owe something to — a buyer, a government department, a landlord, a port trust — is the beneficiary. Your bank is the guarantor. The bank tells the beneficiary in writing: if our customer does not pay or perform, we will pay you up to this amount, on your written demand, during this period.

Bank guarantees at a glance (2026)

1 April 2026

RBI Non-Fund Based Directions in force

New and renewed guarantees

2% to 5% of the estimated value

Bid security (EMD) range

GFR 2017 rule 170

3% to 10% of the contract value

Performance security range

GFR rule 171, as amended

one year from the triggering event

Minimum claim period a BG can fix

Contract Act s.28, Exception 3

What makes a bank guarantee valuable is that it is independent of the underlying contract. RBI now requires guarantees issued by banks to be irrevocable, unconditional and incontrovertible, with a clear mechanism for honouring them when invoked. The beneficiary does not have to prove a loss to the bank or win a court case first; it has to make a demand that matches the guarantee's terms. That is why buyers and government departments accept a BG as good as cash. It is also why, as the applicant, you should read the deed's wording before your bank issues it.

Behind the guarantee sits a second document you sign with your bank: a counter-indemnity. It says that if the bank ever has to pay, you will reimburse it immediately with interest. So a guarantee does not shift your risk to the bank — it shifts the beneficiary's collection risk to the bank, and the bank then collects from you. Banks therefore treat a BG as credit exposure, assess you much like a loan applicant, and usually ask for a cash margin or other security.

Only regulated lenders issue bank guarantees: commercial banks (including regional rural and local area banks), urban and state/district co-operative banks and all-India financial institutions. NBFCs fall under the 2025 Directions only for partial credit enhancement of bonds, so a "guarantee" offered by an NBFC or an individual is a different, weaker instrument. From the beneficiary's side, many government buyers also accept an insurance surety bond in place of a BG — GFR 2017 was amended in 2022 to allow surety bonds and electronic bank guarantees (e-BGs) alongside traditional paper guarantees.

Types of bank guarantee

Banks group guarantees in two broad families, and the family decides the price. A financial guarantee backs a money obligation — the bank pays if you don't pay. A performance guarantee backs a work obligation — the bank pays if you don't deliver, build or service as promised. Financial guarantees cost more because the chance of a default turning into a claim is higher. Within those families, these are the guarantees an MSME actually meets.

Financial bank guarantee

You use a financial guarantee when the beneficiary's risk is that you won't pay money. Typical cases: a supplier gives you 90 days' credit on raw material against a BG; a landlord or a port authority wants security for rent or charges; a customs or tax authority wants security for duty while a dispute or provisional assessment is pending; an oil marketing company wants a guarantee from a distributor before giving stock on credit. A deferred payment guarantee — where the bank guarantees instalments you will pay for machinery bought on credit — is also a financial guarantee.

Performance bank guarantee (PBG)

A performance guarantee assures the buyer that you will complete the contract to specification and on time, and keep your warranty promises. If you abandon the job, deliver defective goods or miss milestones, the buyer invokes the PBG and recovers the guaranteed amount. Government buyers ask for performance security under rule 171 of the General Financial Rules (GFR) 2017; after the December 2023 amendment the range is 3% to 10% of the contract value, with the exact percentage stated in each bid document. It is usually required within a few weeks of the award and must stay valid until 60 days after all contractual and warranty obligations are over. Private buyers and EPC contractors commonly ask for 5% to 10% in their purchase orders.

Advance payment guarantee (APG)

When a buyer pays you a mobilisation or material advance before you deliver, it wants that advance back if you don't perform. An advance payment guarantee covers exactly the advance. Well-drafted APGs reduce automatically as you deliver — for example, by 10% of each invoice — so you are not paying commission on an advance you have already earned. If your buyer's format doesn't say this, ask for a reduction clause before you sign.

Bid bond or EMD guarantee

A bid security (earnest money deposit, EMD) guarantee assures a tendering authority that you won't withdraw or change your bid after the deadline, and that you will sign the contract and give the performance guarantee if you win. GFR rule 170 sets bid security at 2% to 5% of the estimated value of the estimated value, valid for 45 days beyond the final bid validity period. Registered micro and small enterprises are exempt — more on that below.

Bank guarantee vs letter of credit

People mix these up because both are "non-fund based" facilities — the bank lends its name rather than its money, at least to begin with — and both appear in trade deals. The difference is in who is protected and whether the bank expects to pay. A letter of credit is a payment mechanism: the buyer's bank commits to pay the seller when the seller presents the documents the LC specifies, so in a normal deal the bank does pay. A bank guarantee is a safety net: the bank pays only when the applicant defaults and the beneficiary claims, so in a normal deal the guarantee simply expires.

That difference drives pricing and paperwork. An LC is examined against documents — invoice, bill of lading, inspection certificate — under international rules such as UCP 600 for export deals. A guarantee is examined only against the demand itself. Exporters usually meet LCs as sellers; contractors and suppliers to government usually meet guarantees as applicants. Our letter of credit guide explains how LCs work in detail.

Bank guarantee vs letter of credit

Point	Bank guarantee	Letter of credit
Purpose	Security if the applicant defaults	Payment for goods or services
Who is protected	Usually the buyer / project owner	Usually the seller / exporter
Does the bank expect to pay?	No — only on default	Yes — on compliant documents
What triggers payment	Beneficiary's written demand within the claim period	Presentation of the documents the LC lists
Typical rules	Contract Act, RBI NFB Directions, the deed itself	UCP 600 (international), bank's terms (inland)
Typical users	Contractors, suppliers to government, distributors	Exporters, importers, inland trade on credit

Purpose

Bank guarantee

Security if the applicant defaults

Letter of credit

Payment for goods or services

Who is protected

Bank guarantee

Usually the buyer / project owner

Letter of credit

Usually the seller / exporter

Does the bank expect to pay?

Bank guarantee

No — only on default

Letter of credit

Yes — on compliant documents

What triggers payment

Bank guarantee

Beneficiary's written demand within the claim period

Letter of credit

Presentation of the documents the LC lists

Typical rules

Bank guarantee

Contract Act, RBI NFB Directions, the deed itself

Letter of credit

UCP 600 (international), bank's terms (inland)

Typical users

Bank guarantee

Contractors, suppliers to government, distributors

Letter of credit

Exporters, importers, inland trade on credit

A standby letter of credit (SBLC) sits between the two: it is written as an LC but works like a guarantee, paying only on default. It is common in cross-border deals where the beneficiary's bank prefers the LC format; Indian banks issue them as authorised dealers under FEMA rules for permitted transactions.

Eligibility, margin and collateral

From 1 April 2026, RBI's Non-Fund Based Credit Facilities Directions, 2025 govern every new or renewed guarantee issued by commercial and co-operative banks (guarantees issued earlier run out under the old rules). The most practical rule for a small business is in paragraph 7: a bank may issue a guarantee only for a customer who also has a funded credit facility — a cash credit, overdraft or term loan — with it. The main exceptions are guarantees backed by a counter-guarantee from another regulated bank and guarantees fully secured by eligible financial collateral such as a fixed deposit. In plain terms: if you don't borrow from the bank, expect to place a 100% FD margin to get a guarantee.

If you do have a credit limit, the bank sanctions a separate BG limit — say ₹50 lakh — within which individual guarantees are issued as needed. The bank assesses it like a loan: your financial statements, the contracts you bid for, your past performance, and your credit history. Most banks then ask for:

• Cash margin — commonly 10% to 25% of each guarantee for rated, regular borrowers, held as a lien-marked FD that keeps earning interest. Weaker or new accounts may be asked for more, up to 100%. These margins are bank policy, not RBI-prescribed.
• Collateral — for larger limits, a charge on property, plant or receivables, often the same security as your working capital loan.
• Counter-indemnity and board resolution (for companies) authorising the guarantee.

For micro and small enterprises there is an alternative to property collateral. CGTMSE covers non-fund based facilities such as guarantees and letters of credit as well as loans, up to ₹10 crore per borrower, for an annual fee from 0.37% a year. If your bank resists a BG limit for lack of collateral, ask whether it can be covered under CGTMSE — our CGTMSE guide explains how.

How to get a bank guarantee

1. 1

   Get the beneficiary's format

   Ask the buyer or tender authority for its BG text, amount, validity and claim period. Check that the claim period is realistic and the wording matches the contract.

   Tip: Ask for an automatic reduction clause on advance payment guarantees.

2. 2

   Apply to your bank

   Submit the request with the contract, purchase order or tender award, the BG format and your latest financials. New customers usually have to open a current account and offer an FD margin.

3. 3

   Agree margin and security

   Place the cash margin as a lien-marked FD and sign the counter-indemnity. Larger BG limits need collateral or CGTMSE cover.

4. 4

   Stamp and issue

   The bank prepares the guarantee on stamp paper (or e-stamp) of the right value for your state and issues it — on paper or as an e-BG sent directly to the beneficiary's bank.

5. 5

   Track expiry and release

   Diarise the expiry and claim dates. When the contract is complete, get the original back or a written discharge so the bank releases your margin and stops charging commission.

Bank guarantee charges: commission, GST and stamp duty

There is no RBI-fixed rate for guarantee commission; each bank's board sets it in its internal policy, which the 2025 Directions require to cover fees, claim period and timelines for releasing security. Public sector banks publish their tariffs, which gives a useful benchmark. Punjab National Bank's schedule, revised with effect from 1 November 2026, charges a flat 2.00% a year for inland performance guarantees and 2.40% a year for financial guarantees up to ₹1 crore, and 1.60%–2.60% a year (performance) and 2.00%–3.00% (financial) for larger guarantees depending on the borrower's internal rating. Private banks and NBFC-backed arrangements negotiate case by case; large, well-rated companies pay well under 1% a year.

Four details in the tariff matter more than the headline rate. First, commission is usually collected upfront for the whole period, including the claim period — a 12-month guarantee with a 12-month claim period is charged for 24 months. Second, PNB charges an extra 0.25% a year if you ask to pay quarterly instead. Third, cash margin earns a discount: PNB charges only 25% of the normal commission where the guarantee is backed by at least 100% liquid margin, and 50% at 75% margin. Fourth, if you return the guarantee early, refunds cover only unexpired full quarters, with at least two quarters always retained. GST applies on bank commission and charges.

Stamp duty is a state subject and is paid where the guarantee is executed. Maharashtra inserted a dedicated Article 34A in its Stamp Act through the Maharashtra Stamp (Fourth Amendment) Act, 2026, in force from 22 July 2026. Before that, guarantees were stamped under other entries such as the security bond article, which caused disputes and double levies on renewals. Other states continue to apply their own entries for agreements, indemnity or security bonds, so ask your branch which article applies or check your state's e-stamping service.

Worked example: what a ₹4 lakh performance guarantee really costs

Suppose Shree Fabricators, a micro enterprise in Pune with a cash credit limit at a public sector bank, wins an ₹80 lakh order for steel structures from a state electricity company. The purchase order asks for a 5% performance guarantee — ₹4 lakh — valid for 24 months (supply plus warranty) with a further 12-month claim period, and the buyer is paying a 10% advance of ₹8 lakh against an advance payment guarantee.

On the performance guarantee, the bank charges commission for 36 months (24 months' validity plus 12 months' claim period). At a PSB-style tariff of 2% a year, that is ₹4,00,000 × 2% × 3 = ₹24,000, plus 18% GST of ₹4,320. Because the beneficiary is a state government company and the guarantee secures a public procurement contract, Maharashtra's Article 34A charges a flat ₹500 stamp duty. The bank asks for a 25% margin, so ₹1 lakh sits in a lien-marked FD — it still earns FD interest, but it is cash Shree can't use for raw material. All-in out-of-pocket cost: about ₹28,820, or 0.36% of the order value.

On the advance payment guarantee of ₹8 lakh, Shree negotiates a reduction clause: the guarantee falls by 10% of each invoice value as supplies are made. If deliveries are spread evenly over eight months, the average outstanding amount is roughly half the original, and Shree can ask the buyer to return the APG once the advance is fully adjusted instead of letting it run to expiry. Each month of earlier release saves commission and frees margin. Had the same order come from a private company, the stamp duty on the ₹4 lakh guarantee would have been 0.1% — ₹400 — subject to the ₹500 minimum, so the same ₹500.

Bank guarantees in tenders, GeM and the MSE EMD exemption

Government buying is where most small businesses first need guarantees. Under GFR 2017, central ministries and departments ask for bid security of 2% to 5% of the estimated value of the estimated value to stop bidders walking away, and performance security of 3% to 10% of the contract value from the winner. Both may be given as a bank guarantee (including an e-BG), a fixed deposit receipt, a demand draft or banker's cheque, an insurance surety bond, or online payment, as the bid document allows. Many central tenders instead accept a signed Bid Security Declaration, under which a bidder who withdraws is suspended from future tenders for a stated period rather than losing money.

The Public Procurement Policy for Micro and Small Enterprises gives registered MSEs free tender documents and exempts them from paying earnest money. The exemption is for manufacturers of goods and providers of services with a valid Udyam registration for the item tendered; traders, distributors and sole agents don't qualify, and works contracts are outside the policy. The Office of DC (MSME) has also clarified that the exemption does not extend to performance security — once you win, you give the performance guarantee like everyone else.

On the Government e Marketplace (GeM), bids show whether EMD is required, and eligible MSEs (and DPIIT-recognised startups, where the bid allows) claim exemption by uploading their supporting certificate with the bid. GeM's own conditions say buyers can't override the exemption through additional terms, but state government bodies and state PSUs that follow their own procurement rules sometimes still ask MSEs for EMD — read the bid's additional terms. Successful sellers submit the performance security as an ePBG or other permitted form within the period in the contract. Registering as a seller is free — see our GeM registration guide. The practical lesson: budget for a performance guarantee of a few per cent of the contract value as soon as you bid, and line up the BG limit or CGTMSE cover before the award letter arrives.

What happens when a bank guarantee is invoked

Invocation is the beneficiary's written demand to the bank to pay under the guarantee. It must reach the bank within the guarantee's validity or claim period, for an amount within the guaranteed sum, and in whatever form the deed requires — often a letter saying the applicant has failed to perform. Under RBI's 2025 Directions the bank must honour the guarantee in terms of the deed unless a court order restrains it. The bank then pays the beneficiary, debits your account (or adjusts your margin), and recovers the rest from you under the counter-indemnity. If you can't pay, the amount becomes a fund-based advance in your name, with interest and the usual consequences for your credit record.

Life of a bank guarantee

Step 1

Contract or tender award

Step 2

BG limit + margin

Step 3

Guarantee issued (paper or e-BG)

Step 4

Contract performed

BG returned, margin released

Step 5

Or default → invocation

Bank pays, recovers from you

Applicants often assume they can stop a "wrongful" invocation by telling the bank the buyer is at fault. They usually can't. Indian courts have consistently treated an unconditional guarantee as a contract independent of the underlying dispute, and grant injunctions against payment only in narrow cases — established fraud of an egregious kind, or irretrievable injustice that can't be compensated later. Contractual disputes about quality or delay are settled separately, in arbitration or court, after the guarantee has been paid.

The claim period is the other legal point to understand. Section 28 of the Contract Act normally voids clauses that cut down the time to enforce a right, but Exception 3, added from 2013, lets banks fix a claim period of not less than one year from the triggering event. That is why most guarantees say "valid until X, with a claim period up to Y" — and why banks charge for the claim period too.

Common mistakes with bank guarantees, and how to avoid them

Accepting the buyer's format without reading it. Look for open-ended validity, automatic extension clauses, "extend or pay" wording that lets the beneficiary demand payment unless you renew, and amounts that don't reduce as you deliver. Negotiate before issue; amendments cost money later.

Letting guarantees lapse into hidden costs. Commission runs until the bank gets the original back or a written discharge. Keep a BG register with issue date, expiry, claim date and return status, and chase beneficiaries for discharge letters.

Missing renewals. If a project slips and the buyer asks you to extend the guarantee, act before expiry. A buyer with work still pending will often invoke an expiring guarantee rather than lose cover. In Maharashtra, a renewal without increase now attracts 0.25% of the amount (maximum ₹25,000) in stamp duty.

Assuming the MSE exemption covers everything. As above, it covers EMD only. Using forged or unverified guarantees. Beneficiaries increasingly confirm guarantees directly with the issuing bank or use e-BGs that arrive through the bank's system; a guarantee arranged through an agent who "doesn't need your bank" is a red flag.

Before you sign, run a quick check: the amount matches the contract clause, validity and claim dates are fixed, the beneficiary's name is exactly as in the contract, stamp duty is paid for the right state and article, your margin FD is lien-marked with interest credited to you, and the expiry and claim dates are in your BG register.

Official links

• RBI Non-Fund Based Credit Facilities Directions, 2025Rules banks follow for guarantees from 1 April 2026
• Indian Contract Act, 1872 (India Code)Sections 126 (guarantee) and 28 (claim period)
• Public Procurement Policy FAQs — DC (MSME)EMD exemption, who qualifies
• GeM seller FAQsEMD, ePBG and refunds on GeM
• CGTMSECollateral-free cover for loans and non-fund based limits

What to do next

If you bid for government or large-company orders, ask your bank for a BG limit now — with your cash credit renewal is the easiest time — rather than when an award letter arrives with a 21-day deadline. Compare the bank's commission, margin and claim-period policy as carefully as you compare loan rates, and if collateral is the obstacle, ask about CGTMSE cover. For working capital planning, try the working capital calculator, and read our guides to GeM registration and the letter of credit.

This is general information, not legal or tax advice — confirm on the official source or with a professional.

Frequently asked questions

What is a bank guarantee in simple words?

A bank guarantee is a written promise by your bank to pay a named beneficiary — usually a buyer, government department or landlord — up to a fixed amount if you fail to pay or perform as agreed. The beneficiary gets certainty without waiting for a court case; you get the contract without depositing cash. You pay the bank a commission and usually keep a margin or collateral with it.

What is the difference between a bank guarantee and a letter of credit?

A letter of credit is a payment tool: the bank pays the seller when the seller presents the documents the LC asks for, so the bank expects to pay. A bank guarantee is a fallback: the bank pays only if you default and the beneficiary invokes it, so in a smooth deal it is never used. LCs mostly protect sellers; guarantees mostly protect buyers and project owners.

How much does a bank guarantee cost?

The main cost is the bank's commission, charged on the guarantee amount for the full period including the claim period. Public sector bank tariffs run roughly 1.6% to 3% a year depending on the type and your rating — PNB, for example, charges 2.00% a year for performance guarantees up to ₹1 crore — plus GST, stamp duty and the opportunity cost of any cash margin.

Are MSEs exempt from EMD in government tenders?

Yes. Under the Public Procurement Policy for Micro and Small Enterprises and GFR rule 170, registered micro and small manufacturers and service providers don't have to pay earnest money (bid security) in central government tenders, including on GeM. Traders are excluded, and the exemption does not cover performance security — winning MSEs still give a performance guarantee.

Can a bank refuse to pay when a guarantee is invoked?

Generally no. RBI's Non-Fund Based Credit Facilities Directions require banks to honour a guarantee when it is invoked in terms of the deed unless a court restrains them. Courts stop payment only in narrow cases such as established fraud or irretrievable injustice, so a dispute with the buyer is usually not enough. Check the demand matches the deed's wording, amount and dates.

What is the stamp duty on a bank guarantee?

It depends on the state where the guarantee is executed. Maharashtra created a dedicated Article 34A from July 2026: 0.1% of the amount (minimum ₹500) for guarantees up to ₹5 lakh, 0.3% of the amount (maximum ₹20 lakh) above that, and a flat ₹500 for guarantees to government bodies for public works or procurement. Other states use their own schedules, so ask your branch or check the state's e-stamping portal.

Sources & verification

Figures on this page were checked against the sources below when it was last reviewed on 9 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify

1. 1.Reserve Bank of India (Non-Fund Based Credit Facilities) Directions, 2025 — RBI/DOR/2025-26/140 (6 August 2025) — Reserve Bank of India · accessed 9 October 2026
2. 2.The Indian Contract Act, 1872 (India Code) — Legislative Department, Government of India · accessed 9 October 2026
3. 3.Maharashtra Stamp (Fourth Amendment) Act, 2026 — L.A. Bill No. LVI of 2026 (English text) — Maharashtra Legislature Secretariat · accessed 9 October 2026
4. 4.Maharashtra notifies separate stamp duty regime for Financial and Bank Guarantees — Vinod Kothari Consultants · accessed 9 October 2026
5. 5.GFR 2017 rules 170(i) and 171(i) as amended (DoE OM F.1/4/2022-PPD) — Government of Tripura adoption notification — Finance Department, Government of Tripura · accessed 9 October 2026
6. 6.Amendment in GFR 2017 — Rule 171(i) Performance Security (OM F.1/2/2023-PPD, 29 December 2023) — GConnect (reproduces DoE OM) · accessed 9 October 2026
7. 7.FAQs on Public Procurement Policy for MSEs (25 March 2022) — Office of DC (MSME), Ministry of MSME · accessed 9 October 2026
8. 8.GeM — Seller FAQs — Government e Marketplace · accessed 9 October 2026
9. 9.PNB — Credit Related Service Charges (revised w.e.f. 1 November 2026) — Punjab National Bank · accessed 9 October 2026
10. 10.Enforcement of Indian bank guarantees: a dichotomy in law — International Bar Association · accessed 9 October 2026
11. 11.CGTMSE — Credit facilities and parameters / FAQs — Credit Guarantee Fund Trust for Micro and Small Enterprises · accessed 9 October 2026