Bank guarantees: levelling up in the new digital age

Banks are investing heavily into new digital channels and platforms and corporates for the most part have been adopting these new and innovative solutions more readily.

Whilst the pandemic has been the main initiator of these changes, countless corporates are still trapped in laborious, manual and paper-based processes whilst sacrificing transparency, efficiency and the agility that comes with the use of innovative digital solutions.

Some of the main instruments relevant to treasuries; letters of credit (LCs) and bank guarantees including standby LCs and rental guarantees have been for the most part paper-intense despite their ubiquitous use across all business verticals and to this day use a lot of these antiquated processes.

In this piece, we will address how corporates today are able to modernise their communications with their banks moving away from the existing manual processes and leverage modern initiatives that allow them to streamline and manage their entire workflows and working capital efficiently.

BANK GUARANTEES:

levelling up in the new digital age.

What are bank guarantees used for?

Although letters of credit and bank guarantees serve different purposes, their fundamental difference lies in the fact that a letter of credit ensures that a transaction goes ahead as planned, whereas a bank guarantee reduces any loss incurred if the transaction does not go to plan.

Bank guarantees are commonly used in trade finance. They offer numerous benefits, protecting both importers and exporters in cross-border trade transactions. Chief among the benefits of using bank guarantees is that they grant an absolute guarantee of performance and payment to the exporter in international trade deals.

Traditional risk-related business activities can be taken care of by taking out bank guarantees. The importer is much more likely to negotiate favourable deal terms as the exporter no longer bears any payment default risk.

BANK GUARANTEES:

levelling up in the new digital age.

customers with whom they have no established relationship, in which case a bank guarantee is designed to reduce the risk which is borne by each party to a transaction.

Different types of guarantees are used by different industries. And some corporates can issue multiple types of guarantees using one bank account. Let’s examine some of the different types of guarantees:

A performance bond is an agreement under which the issuer guarantees the fulfilment of obligations that the other party in the agreement has to meet. It’s also called a contract bond and is typically issued by a bank or an insurance company to make sure a contractor completes designated projects.

For large scale infrastructure projects, we have another type of guarantees called bid bonds. This is often used to guarantees compensation to the bond owner if the bidder fails to begin a project. Some of Bolero’s MNCs also take advantage of rent guarantees which principally protects landlords against loss of income if a tenant falls behind or defaults on rent payments. Landlords typically pay for the premiums, though it is also possible to require the tenant to pay for it instead in extra rent or if the lease specifies it in writing.

Standby letters of credit are often used to facilitate international trade between companies that don’t know each other and have different laws and regulations. Standby LCs guarantee a bank’s commitment of payment to a seller in the event that the buyer–or the bank’s client–defaults on the agreement. In this case, both the buyer and seller receive their goods and payments respectively, however Standby LCs do not guarantee that the buyer will be happy with the goods.

What is the current process of application?

Treasurers are finding it exceedingly difficult to continue to use manual and, in some cases, multiple complex workflows that

involve various systems and many points of contact. This is especially true in the management and optimisation of credit lines and bank guarantees with multiple Banks.

Let’s look at the steps involved in the issuance of a bank guarantee:

Step 1 – Agreeing on the text of the guarantee

The parties involved in the transaction need to make sure the text of the guarantee is vetted and agreed between the partied. This usually involves Multiple stakeholders both within and outside the bank to agree on the guarantee text.

This is now mostly done via email and phone calls.

Step 2 – Applying for the guarantee

This is an antiquated step that requires a physical visit to the bank involving many paper documents and physically signatures. This is another long drawn out process which usually is a rate limiting factor as availability is often time limited involving Customer existence, KYC status, Guarantees text checks.

Then you have intensive checks involving multiple stakeholders – trade advisors, limit management, front-office, relationship manager and most of the communication here is mostly manual via email and phone calls.

Step 4 – Processing & Delivery

In order to process the bank grantee, the process once more is extremely manual involving data entry and verification and when done, printing the said documents and delivery through couriers.

Throughout the entire process, communication between the various different stakeholders is disjointed and Reconciliation of funds becomes extremely difficult to track.  space become increasingly popular as the pandemic has put tremendous strains on the supply chain. Here at Bolero for example, we have been supporting many corporates leverage the true power of digitisation by allowing them to manage their transactions across the supply chain, reconciling all their transactions (usually handled by multiple banks), streamlining communications with their banks, and consolidating their guarantees on a regional or even global scale.

With the increased adoption of digital trade finance solutions by banks across the globe as well as the improving interoperability between these solutions, corporates can easily communicate with all their banks and finally move away from antiquated paper processes and multiple communication channels.

Most Banks do not have portals that digitise these processes for their corporates as the cost of implementation for is usually prohibitive, usually in the millions.

Improving the process by digitisation

Over the last 18 months we have seen the adoption of technologies in the trade

Jacco De Jong, Head of global sales, Bolero International.