Bank guarantees — that is, a bank’s unconditional undertaking to pay one party in the event of another’s default — are used across many industries to secure contracts, be it in the trade of goods and services, financial transactions, industrial projects, the development of property, or the leasing of assets. Bank guarantees are commonly used by prospective tenants to secure commercial property leases in lieu of a cash deposit or rental bond. For tenants, they allow for more flexibility in securing their lease obligations as an alternative to cash. For commercial landlords, they provide the certainty of a financial institution in the event of the tenant’s default (e.g. where they fail to pay rent or make good1 upon vacating a property), while also avoiding the administrative burden of managing cash deposits and trust accounts.
In fact, such is the benefit to landlords, that many embed the requirement for a bank guarantee in their standard form lease agreement. But while a useful financial instrument, today’s bank guarantees are paper-based, and their physical nature gives rise to a number of inefficiencies. These include:
- Physical Document Management: costs, risks and delays associated with the physical printing, issuing, exchanging, retrieval and potential loss of guarantee documents;
- Tracking and Reporting: challenges in the tracking, reporting and overall transparency of a guarantee’s status as it undergoes potentially multiple handoffs and changes throughout its lifecycle; and
- Lack of Standardisation: manual effort required to review and negotiate the terms and conditions of a guarantee, which can vary by bank and by landlord.
A shared ledger, which could be relied on as the single source of truth for the existence and status of a bank guarantee, could resolve the first two challenges, while acting as a catalyst for the third.
In an ecosystem where three parties (i.e. the tenant, the bank, and the landlord) participate in the creation, management and expiry of a common instrument, a blockchain solution could provide the optimal medium for facilitating the necessary flow of information, while balancing the competing needs of transparency and confidentiality.
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