The need to support the six million MSME has now created three approved Trade receivable exchanges – its mandatory for companies with a turnover greater than 500 Crores to register on them. IRDA allowed Treds to avail credit insurance in its draft guidelines. In effect if the Buyer defaults, there is a very high likelihood that the insurer will pay. (Click to read more)
Banks and Non Bank Financial institutions in India used credit insurance to hedge some of the risks associated with trade payment in the noughties…the period upto 2010. IRDA regulated the industry and there were only a few insurers of note – Atradius – through New India Coface through Iffco Tokio and ICICI Lombard and Euler Herms and AIG. Insurance is after all not a guarantee and Indian institutions had pretty much figured out the risks and rewards when the Paramount Airways incident happened. SBI lent about INR 4 Billion to Paramount Airways – a small airline, against a credit guarantee insurance from United India. When SBI made the claim, United India brought out the rule book – except that it had actually issued a pretty water tight guarantee and breached the IRDA guidelines… Plenty of errors on all sides surfaced and the IRDA decided to ban Credit insurance all together.. May be it sounded like Credit default swaps which caused the Great Recession of 2008.
India had never been an easy market for insurers but claims ratios were well into the high nineties. Inspite of the absence of a Public Credit Registry, banks had begun doing a tonne of factoring transactions and the insurance acted as a significant mitigant. But all the pro and cons were drowned in the wave of regulatory panic – clearly Public sector units were not to be trusted with the product. It was the time when securitisation markets had ground to a halt thanks to over zealous tax officials raiding mutual funds, freezing their accounts and demanding that tax be deducted at source ( never mind the laws)… it was the time when laws were changed retrospectively so that tax would be paid on Vodafone sale. Suddenly the first generation of India’s insurance experts had a choice – go abroad or find a new career.
But times change. Nothing lasts for ever. The market friendly finance ministers were kicked upstairs or moved on. In a slight relaxation, companies were allowed to avail credit insurance to cover their payment risks. A few more years allowed a trickle of sanity into morbid credit intelligence systems and banks were allowed to take the benefit of credit insurance policies taken by companies – they could not take the insurance themselves. But at least they were no longer denied the benefit of cash flows their clients were to get from insurance.
In May this year, the IRDA finally issued draft guidelines allowing banks and non bank institutions to avail credit insurance. In keeping with returning confidence and a spirit of letting markets figure out things a regulatory sandbox had been created, to allow players to test things out. The need to support the six million MSME has now created three approved Trade receivable exchanges – its mandatory for companies with a turnover greater than 500 Crores to register on them. IRDA allowed Treds to avail credit insurance in its draft guidelines. In effect if the Buyer defaults, there is a very high likelihood that the insurer will pay. Unlike guarantees, Insurance does not protect against fraud. Further policies require a certain degree of reporting on time and adherence to the standards that the bank or NBFC sets for itself – one cant claim from insurance if the risk would have failed to meet a normal credit appraisal without considering insurance. But but but.. its s till a significant risk mitigant. Where banks were able to take a risk of hundred rupees, they may now approve one fifty.
The implications for banks participating in Treds is immense. They would have access to a ready made pool of insured receivables with competent single source administration of the policies – remember a whole generation of insurance experts has been wiped out. This expertise is now a very scarce commodity. Insurance should help widen the base of what is deemed an acceptable credit risk, Hitherto most of the Billion plus dollars of invoices discounted are for buyers who have a AA rating or better. But access to insurance should help move the bar down to BBB or even lower clients – afterall all the insurers are rated AAA. Considering the number of BBB companies is more than ten times the AA rated ones, a huge expansion in the short term volumes is possible for the TREDS.
A few days ago two banks closed their first insurance backed deals on Receivable Exchange of India under the permissions given under the regulatory sand box. Looks like the second innings for credit insurance is soon to start.