This change in sentiment usually filters through to impact a wide range of financial products, and bank guarantees are no exception, with those that utilise them, manage them and issue them with potential exposure to a range of new challenges.

Economic uncertainty by definition is a situation where the outlook of the economy is unpredictable, and there is a high degree of risk or unknowns involved.

Over the last six years alone, companies have had to grapple with several significant events which have caused periods of economic uncertainty – coined ‘uncertainty shocks.’

These include Brexit in 2016, followed by Donald Trump’s U.S. presidential election win, China-U.S. trade tensions, the Covid-19 pandemic, and the beginning of the Ukraine war in 2022 (Harvard Business Review, 2022).

Despite all of these events taking place in different parts of the world, the impact of these has been felt far and wide – with financial products such as bank guarantees susceptible to change as a result.

What are the impacts of financial instability on bank guarantees?

Increased scrutiny on lending facilities

Economic uncertainty often causes organisations to think about their exposure and as a result, banks can become more cautious about the levels of credit they offer their customers.

This means organisations hoping to obtain a bank guarantee may find it more difficult, whether it is because of the industry they operate in, or a reduced risk tolerance by the banks that issue them.

Those with existing credit facilities may also find that these are reduced, and almost always, interest rates or fees for using a credit facility and bank guarantees are at risk of an increase.

Economic uncertainty increases the likelihood that banks introduce measures to protect themselves from increasing exposure, and negate the risk across several different areas they may have once accepted.

Areas like international trade for example, where bank guarantees can be used to support complex deals between international counterparties and rely on volatile currency conversions, are more susceptible than others to be impacted by these new measures.

This also works the opposite way, as organisations assess their exposure across their banking partners, it can lead to a search for better deals, lower fees and interest rates, or in recent times, a switch to a bank they feel is more financially stable given some high profile failures (Harvard Gazette, 2023).

Increasing use of features of a bank guarantee

Difficult economic environments increase the likelihood that organisations will experience financial hardship, and therefore the number of defaults on payments and inability to repay debts will also increase.

This increases the likelihood that banks will deal with a far higher number of demands on their bank guarantees, as they are required to honour the obligations for their customers made through the issuance of bank guarantees.

A higher number of demands means that the bank will be increasingly obligated to pay money out to beneficiaries.

As a result, a growing amount of work will be required by the banks to reconcile these payments with the applicant which can take months, and in some severe cases, the banks may even be out of pocket from these defaults and business closures.

This again can work the other way too, as the likelihood is that in times of hardship, more guarantees will be cancelled by counterparties as organisations relocate, suppliers are changed, or business is cut.

As these changes take place, the workload for applicants will increase as they ensure their credit facility correctly reflects their exposure.

Changes in demand for bank guarantees

Different organisations require different solutions during periods of economic uncertainty, creating an increase or reduction in an organisation's demand for a credit facility with their financial institution.

One business may need to reduce its expenditure, and paying rising costs for utilising bank guarantees may be an area they want to cut down on. On the other hand, some organisations may want to preserve their cash flow until the economy improves, resulting in a growing appetite for utilising bank guarantees.

Therefore, all parties to the bank guarantee should be prepared for a fluctuation in how many guarantees they will obtain, issue, or receive during periods of economic instability.

How do digital bank guarantees reduce these impacts?

Most of the issues above are linked directly to the fact that paper bank guarantees are not flexible enough to be an effective solution for a dynamic economic environment.

However, with digital bank guarantees, the criteria within the guarantee can be amended on an online platform, giving flexibility to those who require it during times of economic uncertainty.

The option to utilise digital bank guarantees over paper could have a knock-on effect on the demand for bank guarantees too.

The ability to easily view and manage an organisation's exposure through an online dashboard means they are more likely to be willing to utilise bank guarantees over other, harder-to-manage instruments and methods of credit management.

This means through periods of economic uncertainty, the demand for digital bank guarantees could significantly increase.

With an increase in demand, those financial institutions that are on board the Lygon platform and can give their customers access to digital bank guarantees are in a prime position to reap the benefits.