When a Bank Guarantee (BG) issued on behalf of a customer is invoked by the beneficiary and the bank settles the claim, the bank becomes a creditor to the customer for the amount paid. If the customer fails to reimburse the bank, the bank must follow a series of operational, legal, and recovery steps as per internal policies, regulatory norms, and standard banking practices.
1. Immediate Accounting Treatment
Once the bank pays the beneficiary:
1. The BG liability (contingent) is extinguished.
2. The amount paid is converted into a **fund-based exposure** on the customer.
3. Typically recorded as:
* Demand Loan (DL) or Working Capital Demand Loan (WCDL), OR
* Temporary Overdraft (TOD) if permitted under policy.
Banks normally obtain a DPN (Demand Promissory Note) along with BG documents.
If DPN was not taken earlier, the bank may:
* Ask the customer to execute a fresh DPN for the paid amount.
If the customer refuses:
* The bank may still create the DL and record the date as the date of invocation/payment.
2. Documentation Requirements
Banks generally obtain the following at the time of BG issuance:
* General BG Agreement
* Counter Indemnity / Counter Guarantee by customer
* DPN (often for full limit)
* DP/DP Note Delivery Letter
* Hypothecation / Mortgage documents (if secured)
If no valid DPN exists:
* Execute a fresh DPN dated the date of creation of the DL.
* If customer refuses → proceed without DPN using existing indemnity as enforceable document.
3. Charging of Interest
Interest is charged:
* From the date of claim payment to the beneficiary,
* At the applicable penal / overdue lending rate as per bank policy,
* Till the customer settles the dues.
4. Follow-Up and Recovery Actions
If the customer does not reimburse promptly:
a) Immediate Measures
* Issue formal demand notice
* Freeze further non-fund credit facilities
* Review overall credit limits
* Mark internal alerts
b) Classification of Asset**
If unpaid beyond 90 days:
* The DL account will slip into NPA classification, triggering:
* Provisioning
* Reporting to CICs (CIBIL, etc.)
c) Enforcement and Recovery
Depending on security and documents:
* Invoke collateral security, if any
* Invoke corporate/personal guarantees
* Proceed under:
* SARFAESI Act (if secured by tangible assets)
* DRT filing for unsecured exposures above threshold
* Civil suit based on indemnity agreement and claim papers
d) Adjustments
* Bank may recover BG amount from any available:
* Credit balances (set-off)
* Deposits
* Receivables
* Escrow accounts (if structured)
5. Reporting Requirements
* Report default to Credit Information Companies.
* In large cases, report to SMA-1 / SMA-2 categories.
* If fraud indicators exist, follow RBI Master Directions on Frauds.
6. Preventive Measures for Future
Banks typically mitigate risk by:
* Taking adequate margin/collateral before issuing BGs.
* Monitoring customer’s financial health.
* Keeping indemnity agreements and DPNs in force.
Short Summary
When a BG is invoked and settled by the bank, but the customer fails to reimburse:
1. Convert the payment into a fund-based exposure (DL/WCDL).
2. Obtain DPN if not already executed.
3. Charge interest from date of payment.
4. Issue demand notice and follow recovery process.
5. Classify as NPA if overdue beyond 90 days.
6. Take legal action depending on documentation and security.
