Vinu: Hey Manu, I was reading about bank guarantees and came across the term “recourse structure.” Can you explain what that is?

Manu: Sure, Vinu. A recourse structure in a bank guarantee means that if the principal, the person or company that requested the guarantee, fails to fulfill their obligations, the bank has the right to recover the amount from the principal.

Vinu: So, if the beneficiary calls on the guarantee, the bank can just recover the money from the principal?

Manu: Exactly. Let me give you an example. Imagine a construction company in India called Shree Constructions, which has taken on a big project from the government. The government, as the beneficiary, asks Shree Constructions to provide a bank guarantee as security for the project. Shree Constructions approaches their bank, say, State Bank of India (SBI), to issue the guarantee.

Vinu: Okay, I’m following so far.

Manu: Now, suppose Shree Constructions doesn’t complete the project on time, and the government decides to invoke the bank guarantee. SBI would pay the government the guaranteed amount. But since this is a recourse structure, SBI can then go back to Shree Constructions and ask them to reimburse the amount they paid to the government.

Vinu: So, even though SBI paid the government, Shree Constructions is still responsible for paying that amount back to SBI?

Manu: Exactly, Vinu. The bank guarantee provides security to the government, but Shree Constructions is still on the hook for the amount. If they can’t pay SBI back, the bank could take legal action or use any collateral Shree Constructions provided when they issued the guarantee.

Vinu: So, in a way, the risk eventually falls back on Shree Constructions even after SBI steps in.

Manu: That’s right. A recourse structure essentially shifts the financial responsibility back to the principal, in this case, Shree Constructions, after the bank fulfills the guarantee.

Vinu: That makes it clear. Thanks, Manu, the example really helped!

Manu: Anytime, Vinu! Glad I could make it easier to understand.