Letter of guarantee is a contract which is issued by the banks, on behalf of the purchaser of goods, to the supplier of the goods. The letter is issued to the supplier so that he is secured that the payment of his goods will be made to him, if in case the purchaser fails to pay, then the bank will make the due payment. 

Letter of guarantee is used when one of the parties is uncertain that the other party involved in the transaction may not make the payment or fails to make the payment, therefore as security they demand a letter of guarantee which is issued by the banks. This commonly happens in the case where one purchases costly equipment or property. The banks negotiate on the terms and decide how much they will pay if the client defaults on making the required payment. 

Letter of guarantee is used widely in the business world. In situations relating to contracting and construction, declarations for the import-export business, or in case of financing from financial institutions. 

A company may request the issuance of the letter of guarantee from the bank when the supplier expressly asks for one or when the supplier is uncertain about the company’s ability to make the necessary payment. 

For providing the letter of guarantee, the process followed by the banks is: 

1. On receiving the application for the letter of guarantee the first criteria which the banks check is whether the customer qualifies for the letter of Guarantee or not. This is determined by the bank by examining the history of transactions the company has made, the underlying transactions, and any other relevant material or information. 
2. If the customer qualifies for the letter of guarantee, then the next step is determining the fees of the bank. The fee of the bank is decided by using the principles and rates as stated in the regulations.
3. Next in the process is making amendments to the Letter of Guarantee. The banks usually provide the option of making amends in the letter before issuing the letter. The amends may be made by either of the parties, the one seeking the letter and the beneficiary of the letter. 
4. After the letter has been issued, if the supplier has supplied the goods as per the contract, and has made claims from the guaranteeing bank for compensation, then the bank first notifies the customer and then examine the necessary documents, if the bank is satisfied with the claim it proceeds with the payment. 
5. After the bank has made payment to the supplier on behalf of the purchaser, the bank then updates the same in the records of the purchasers so that it reflects on the actual transaction. After the bank ensures relief from the guarantee letter, it revokes the guarantee and recovers the credit from the customer.