India sees potential regulation changes in Trade Credit market in 2020
Globally, the credit insurance market plays a vital role in the provision of trade financing. In 2018, Factors Chain International (FCI) reported that the world factoring industry volume has reached USD 2.767tn. With an estimated 50% of this volume insured, it is clear that credit insurance and financiers go hand in hand in a symbiotic relationship as they are reliant upon one another to provide short term funding to corporates under various forms of factoring, supply chain finance and trade finance structures.
The main motivation for international banks to distribute their trade finance related assets via credit insurance is primarily due to credit risk protection. Additionally, in more established markets particularly Europe, Singapore and Australia, it provides banks with capital relief.
However, since 2010 in India, the IRDAI (Insurance Regulatory and Development Authority of India) has prohibited insurers – with the exception of export credit agency, ECGC – from issuing credit insurance policies to domestic banks. This was as a result of a spate of large losses incurred by state-owned general insurers culminating in a substantial credit insurance claim to state owned Oriental Insurance of the equivalent of USD 100m following the collapse of Paramount Airlines in 2010. Consequently, IRDAI was concerned that domestic general insurers were underwriting risks that were not governed by an appropriate regulatory framework.
In the latest set of IRDAI guidelines published in March 2016, the following restrictions were included:
- No trade credit insurance policy shall cover factoring, reverse factoring, bill discounting or any other similar arrangements
- Trade credit policy shall not be issued to banks/financiers/lenders
- Assignment of proceeds of claim under the trade credit policy may be made to a bank/NBFC registered with RBI, in the manner prescribed under sec 38 of the insurance act 1938
- A trade credit policy shall not grant Indemnity of more than 85% of the trade receivables from each buyer
- A single specific trade credit policy covering only one shipment cannot be sold to a prospect
Potential New Developments in Trade Credit
More recently in September 2019, IRDAI instigated a review of its three-year old guidelines on trade credit insurance in response to co-ordinated representations from multiple stakeholders, including financial institutions and insurers. Since the regulation by IRDAI in 2010, credit insurance has evolved over the past nine years in India. It has proved its value and responsiveness to both international regulators and policyholders while concurrently remaining a profitable underwriting class for insurers. The potential change in existing regulation could come as early as this year, and if addressed correctly, it should enhance trade finance opportunities for corporates, banks and insurers alike:
- Domestic banks should be able to expand lending relationships; increase priority sector lending and draw on the vast databases of buyer data held by insurers to facilitate trade financing.
- Corporates and SMEs should have easier access to vital trade finance as banks will have a greater inclination to engage in financing with the protection from credit insurance. As such, companies can choose to add the bank as a co-insured or be backed by an insured policy held directly by the bank.
- For Lloyd’s, more than 60% of credit & political risk insurance (CPRI) of written premiums involves policies held by banks. Potential liberalisation by the IRDAI should lead to a larger private CPRI market in India and allow insurers to develop closer ties with onshore lenders and tap into one of the fastest growing economies.