PARTIES INVOLVED IN LETTERS OF GUARANTEE: There are three parties primarily involved in a

guarantee contract. They are as follows: • Guarantor: The party that assumes responsibility for the
default of another is known as a guarantor. In common business practices, banks play the role of a
guarantor in bank guarantee.

• Applicant/Debtor: The party primarily responsible for the fulfillment of the obligation or discharge of
the debt is the applicant or debtor. • Beneficiary/Creditor: The party who will be reimbursed by the
guarantor in the event that the applicant or the debtor defaults on the loan or fails to fulfill the terms of
the underlying contract signed between the Applicant/Debtor and the Beneficiary/ Creditor is known as
a beneficiary or creditor.

TYPES OF ISLAMIC GUARANTEES There are several types of Bank guarantees. Some of the common
types of guarantees are listed below:

FINANCIAL GUARANTEE: A financial guarantee is a written undertaking issued by the Islamic bank on
behalf of its customer, guaranteeing that if the customer (applicant) fails to comply with their
obligations to an underlying Shariah-compliant transaction, then the Islamic bank will financially re-
compensate the beneficiary or the creditor in accordance with the terms of the guarantee. The
guarantee issued by the Islamic bank can be either conditional or unconditional based on the agreement
between the parties.In case of claiming the financial re-compensation, the beneficiary has to present a
written demand or any other document as the evidence that the bank’s customer (debtor/ applicant)
has failed to fulfill its obligations under the underlying transaction. It is to be noted that the Islamic bank
cannot issue any financial guarantee for a conventional loan.

TENDER GUARANTEE (BID BOND): A guarantee issued by the Islamic bank guaranteeing against default
by its customer in taking up a specific tender which is to be awarded to the person. These types of
guarantees are issued by the Islamic bank to customers (applicants) who are professional contractors.
For the avoidance of doubt, such guarantees cannot be issued by an Islamic bank if the tender is going
to be awarded for any non-Shariah compliant project or activity.

PERFORMANCE GUARANTEE (PERFORMANCE BOND): As the name indicates, a performance guarantee

is issued by the Islamic bank guaranteeing against default by its customer in performing certain
responsibilities in a project as per the terms and conditions of the contract, e.g., to complete properly or
deliver the goods on time and in good condition. These types of guarantees are also issued by the
Islamic bank to the customers (applicants) who are professional contractors.

ADVANCE PAYMENT GUARANTEE: In some cases the customer (contractor) requests the beneficiary
(Project Owner) for an advance payment for the work or services to

In a bank guarantee based on the Wakala structure, the Islamic bank acts as the agent (Wakil) of the
customer. It is to be noted that under this type of bank guarantee, the Islamic bank should have 100%
margin against the guarantee when it holds the responsibility of Agent (Wakil).

108 Islamic Banking and Finance: Principles & Practices

be carried out. In such a case, the Project Owner asks for an advance payment guarantee, which can be
issued by the Islamic bank. This type of guarantee can either be issued separately or in conjunction with
a performance guarantee.
RETENTION GUARANTEE (RETENTION BOND): In some cases, the beneficiary (Project Owner) withholds
a part of payment of the customer to ensure the work or services have been completed satisfactorily. To
allow early release of the payment by the beneficiary (Project Owner) to the customer / applicant, the
Islamic bank issues a retention guarantee. A retention guarantee is issued instead of or in conjunction
with a performance guarantee or advance payment guarantee.

SHIPPING GUARANTEE: A shipping guarantee is a written undertaking issued by the Islamic bank to the
ship owner or the agent or the master of a vessel to pay any claims resulting from the premature release
of the goods and also to certify that the consignee is the rightful owner of the goods. It is generally
issued in instances where the goods have arrived at the port prior to the arrival of the shipping
documents.

STRUCTURE OF AN ISLAMIC BANK GUARANTEE:

MECHANISM OF AN ISLAMIC BANK GUARANTEE: 1. A Customer (Importer) purchases certain goods or

services from a Seller (Exporter). 2. As per the sale and purchase contract the Customer (Importer) is
principally obliged to make the payment to the Seller (Exporter). 3. On the Seller’s (Exporter’s) demand,
the Customer (Importer) applies for the Letter of Guarantee to an Islamic Bank for the payment of the
purchase price. 4. The Islamic bank issues the Letter of Guarantee for the Customer (Importer) in favour
of the Seller (Exporter). As per the guarantee the Seller (Exporter) has the right to payment of sale price
equally from the Customer (Importer) and Islamic bank (Guarantor). 5. In a case where Customer
(Importer) defaults the Islamic bank (Guarantor) would make the payment to the Seller (Exporter)
against the purchases.

If the consignment arrives at the destination before the shipping documents are received, which is
common in case of local L/C, the Islamic bank must inspect the goods and take the physical possession
thereof before selling them to the customer under Murabaha. The Murabaha Sales price (deferred
amount) shall be paid on a deferred payment date (s) to the Islamic bank by the customer.

109Islamic Banking and Finance: Principles & Practices

ISLAMIC BANK GUARANTEE AND FEE: There is a difference of opinion among Shariah scholars on
whether an Islamic bank can charge a fee or commission on providing the letter of guarantee. Generally,
it is not allowed to charge fees or commissions or remuneration on bank guarantees under the Kafala
structure. However, jurists consider that the bank can take a fee, since the bank puts its efforts into
matters like financial analysis of the applicant, credit assessment and getting required approval from the
management to issue the required guarantee. Further, if the guarantee is based on Wakala structure the
scholars are of the opinion that the Islamic bank can charge any agreed fee under the Wakala
arrangement.