Coffee, Blockchain and the Bank Guarantee Dilemma

Image credit: iStockphoto/limpido

Blockchain technology is an opportunity for partners in a value chain, and even competitors, to collaborate and create a shared infrastructure which takes out cost and increases efficiencies for all participants.

So far, examples of this among major corporates tended to be more conceptual and pilot-phase. It is why a project involving leading Australian bank Westpac and major property companies is of such significance and holds immense promise.

The mutual headache

Called “Project Lygon” and named after the Melbourne café strip where the first meetings took place, the partners are going live with a blockchain infrastructure that solves the big mutual headache of managing bank guarantees. But it also has implications and potential for the future.

The project began with a major document management issue. Australian corporates keep close to 400,000 bank guarantees in secure vaults around the country. As many as 30% of those guarantees are for the retail property industry.

Property bank guarantees are required by tenants who in lieu of cash deposits or rental bonds need to secure the lease payments on a rental property. Currently, they ask their bank for a guarantee, which is then kept by the landlord.

The version held by the landlord, or beneficiary, is the final or ‘true’ document and the paper that all parties transact on. If ever any changes are required, the beneficiary would send a requirement for the amendment to the tenant, who would then make a request to the bank. If that original copy is missing, or can’t be found, then a whole verification process needs to commence again.

Rodolf Salem, the head of customer lending journey & new technology at Westpac Institutional Bank, describes paper-based bank guarantees as an antiquated financial instrument with major pain points and risks

“Fraud and operational risk are a common occurrence because it is easy to copy these paper guarantees,” says Salem. “It’s basically a piece of paper with a wet signature at the bottom and a company letterhead at the top, that carries a risk of fraud.”

“Then there is the headache of maintaining a rigorous audit trail and, of course, the issues around document management and storage.”

A lack of standardization is also an issue. All major banks have their own standards for guarantees, a situation that has persisted despite widespread agreement that an industry-standard would streamline and simplify the process.

Back in 2017, one of Australia’s largest property giants, Scentre Group had had enough of the onerous processes involved with traditional bank guarantees.

With some 7,000 guarantees in its vaults, the group found the complexities of producing what is essentially a one-page document became particularly arduous and time-consuming if there was an error on a guarantee, or one was lost.

The mutual discussion

A meeting with a number of leading banks, including Westpac, was called to see if a collaborative solution to the problem could be found.

According to Westpac’s Salem, blockchain emerged as the solution to the problem only after a rigorous review of other alternatives and products offered by vendors. “It wasn’t a matter of finding a user case for blockchain technology, it was the other way around; it was a customer and industry problem that needed to find a solution,” says Salem.

“Bank guarantees in the current state had clear problems and over time we proved blockchain was the right solution. The other solutions weren’t addressing all the issues and problems for all of the parties in the transaction, and for the big end and small end of town.”

‘Project Lygon’, which quickly progressed to a successful pilot with 14 client users, was completed in October 2019. “We needed enough clients on board so that we could take sufficient learnings from the pilot, and we met customer expectations in terms of speed and service,” says Salem.

“Our success criteria included customers being able to amend guarantees on the platform and report the status through multiple changes: Can we issue a bank guarantee? Can a beneficiary report on bank guarantees from various organizations? Can we fully digitize a standard guarantee process?”

The response to all of these questions was “yes.” After a successful pilot, the platform will be launched commercially later in 2020.

The mutual answer

The Lygon blockchain platform eliminates the need for paper and creates a single standardized and secure version of the truth, accessible on the servers of the three parties in the transaction: beneficiary, applicant, and bank.

The advantage of the blockchain platform is not only that it creates a digital copy in a standardized template, but documents can be easily amended and re-validated and the issuing time is sped up from up to a month, to a matter of minutes.

The final document does not exist in a centralized database, but in various nodes on the servers of the participants in the transaction. Fraud is eliminated as a risk because any changes need to be accepted by multiple nodes held by different parties and validated at the same time.

Changes to guarantees go through an auditable sign-off process involving a number of parties, each of them with a unique digital fingerprint. Authorized users have up-to-date and accurate views of the status of a guarantee, a significant advance on the current system.

“Customers have said how quick and easy the platform is to use and they value the transparency it creates,” says Westpac’s Salem. “They also have an audit trail of their guarantees and a history of changes all in one place.”

The mutual future

Westpac is now a key shareholder in Lygon 1B, along with ANZ, CBA, Scentre, and IBM. The new company is set to roll out the blockchain platform as a solution to bank guarantees and will then look to extend the solution across sectors such as Government, infrastructure and service industries.

“This is new financial markets infrastructure that can be applicable to a number of industries and can effectively solve the dilemma of bank guarantees in other industries,” says Salem.

“When we sandboxed the proof-of-concept we focused on retail bank guarantees, but we thought ahead and built it for every bank guarantee in the market — whether financial, performance or environmental — thinking about areas such as Government, and the fast-moving consumer goods sector.”

Lygon solves the problem of guarantees across diverse sectors. There is also the potential for cross-border guarantees, as the U.K., U.S., New Zealand, and parts of Asia all manage guarantees in a similar way.

“Ultimately all bank guarantees create the same problems and while some terms and conditions might be different, the platform can be a solution for every guarantee in the market,” says Salem.

The author worked with Westpac on a similar article on the project and can be found here at the Westpac Institutional Bank website. Image credit: iStockphoto/limpido