Banking and financial markets

Blockchain and letters of guarantee

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office spacePaper-intensive financial instruments, especially those that require back-and-forth negotiations between parties, are ripe for digitization and blockchain. Add in the potential for fraud with paper processes, and the rationale for blockchain is even greater. The bank guarantee, or letter of guarantee, is just such an instrument.

Bank guarantees facilitate doing business by adding trust to a contract between two parties, such as a seller and a buyer or a landlord and a tenant. The bank guarantees that the beneficiary — the seller or the landlord — will get paid if the buyer defaults or the tenant fails to meet the rent. A letter of guarantee can also cover performance, protecting the beneficiary if the other party fails to deliver a product or provide satisfactory services.

While the concept of a bank guarantee is standard across the industry, the execution is anything but. Individual banks have their own standards, forms and processes. There can be numerous drafts and negotiations prior to reaching an agreement, and if changes are required, the whole process begins again. All in all, it can take up to a month to issue what is typically a one-page agreement.

Bring new transparency, simplicity and efficiency to every financial transaction

The paper document itself is another major pain point, particularly for beneficiary companies that deal in thousands of guarantees. That final paper document has to be managed and securely stored. Once the final guarantee leaves the bank, maintaining an audit trail is challenging. And because a paper document is easily faked, fraud and forgery are not uncommon.

Proven benefits of a blockchain-based solution for letters of credit

Standardizing and digitizing the entire process and using a blockchain-based solution for letters of credit can:

  • Streamline the process end-to-end
  • Eliminate the costs of printing, issuing, exchanging and retrieving physical documents
  • Reduce the risk of disputes and manual data entry errors
  • Increase security through encryption and tamper-evident distributed ledger technology
  • Lessen the risk of fraud with a transparent process auditable by any permissioned participant

Blockchain and letters of guarantee: How it works

We have a replicable solution built on the IBM Blockchain Platform that digitizes the end-to-end process of requesting, approving, modifying, issuing and storing letters of guarantee. Typically, a consortium of financial institutions and high-volume beneficiaries will work with IBM Blockchain Services to adapt this solution to their agreed-upon standards and processes.

The solution features a simple-to-use web interface for users, a digital workflow and framework for codifying standardized terms and conditions. Blockchain smart contracts encode those agreements to create legally binding contracts and automate workflow steps to speed the approval process. Blockchain technology provides encryption to enhance security and immutable data storage to help prevent fraud. Transparency assures that every permissioned party involved in issuance of a letter of guarantee — requestor, bank, and beneficiary — can verify the status of an application or access the final digital document.

Powering an all-digital workflow for Lygon customers

Established by a consortium including Australia and New Zealand Banking Group Ltd. (ANZ), Westpac Banking Corp., Commonwealth Bank of Australia, property management company Scentre Group Limited, and IBM, Lygon is a blockchain-based platform that streamlines the bank guarantee process.

The impetus for Lygon came from the costs, risks and delays that property companies encountered managing paper letters of guarantee, which they required tenants leasing retail space. Other key issues with the status quo were lack of standards between both issuers and beneficiaries and time — it could take up to a month for a bank to issue the guarantees.

Today, issuing a bank guarantee on Lygon is a simple three-step process that is usually completed in one day. The requestor fills out a simple online form requesting the guarantee, which is automatically passed to the beneficiary for approval. When the beneficiary approves, the request is forwarded to the bank. The bank can deny or issue the guarantee. Once issued, it’s stored on the blockchain and available to be viewed by all participants. Amendments and cancellations can also be processed online.

Advancing blockchain-based financial services in Thailand

The Thailand Blockchain Community Initiative, now known as BCI (Thailand) Co., Ltd., was established to develop a blockchain-based network to support electronic letters of guarantee (eLG). Today, 22 banks and 15 companies are using the platform to support payment obligations for enterprise auctions and other domestic trading procedures.

The platform reduces letter of guarantee issuance time to less than a day, and some member companies report seeing a 200 percent reduction in transaction costs. The solution is designed to reduce the potential for errors and risk of fraud for all parties involved.

Large, medium and small companies in Thailand can easily start using BCI’s eLG services. Clients can access the BCI portal through different models, including private on-premises access, via the cloud, or via a cloud broker. Advanced capabilities of the BCI blockchain platform include equipping its network with true hybrid cloud and multi-vendor capabilities, disaster recovery and multi-region high availability.

Digitizing paper processes in the financial industry: Build on our experience and assets

The electronic letters of guarantee solution is both replicable and extensible. Because we have built it already for existing clients, we can recreate the solution quickly for other financial institutions and partnering companies. Assets such as rules for terms and conditions, codified workflows, templates for user interfaces, and APIs for connecting with existing systems of record can be customized for your particular business relationships and potential participants.

The platform is also extensible. Once your solution is in production, you and your partners can use the platform to expand into new markets or digitize other paper-based financial processes and offer new services to customers.

By taking advantage of an existing customizable solution and the expertise of IBM Blockchain Services, organizations can progress from design to working pilot in as little as three months. After applying learning from the pilot, you can begin to scale by adding new participants to the network.

The solution itself is built on the IBM Blockchain Platform, the commercial distribution of The Linux Foundation’s open source Hyperledger Fabric. The IBM Blockchain Platform is cloud agnostic, so it can run in the cloud of your choice or on-premises. Each party in the blockchain network can maintain their data on the IT infrastructure or third-party cloud vendor of their choice. The platform is GDPR compliant, so it is ready to support global business relationships.

IBM Blockchain Services can help you join either the Lygon or BCI solutions discussed in this article, or you can talk to us about how we can replicate a similar a blockchain-based digital letters of guarantee solution for your organization.

This use case telling the story of digital letters of guarantee will be followed up by more examples of how blockchain services are being used in various industries to help solve real world problems. Be sure to read our recent articles on Financial Netting, Invoice Reconciliation and Digital Ticketing and upcoming articles, or schedule a free one-on-one consultation to find out how you can benefit from this solution.

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