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Asserting that the current Bank Guarantee capacity of banks is insufficient to meet the credit demand for infrastructure development in the next five years, IRDAI Chairman Debasish Panda has called upon stakeholders to come together to tap the rich potential of “Surety Bonds” in meeting the gap in demand.
The current regulatory framework (for Surety Bonds) presents the general insurance industry with a unique opportunity to diversify their portfolio and play an important role in nation-building, Panda said at a CII Roundtable in the capital.
The Roundtable saw participation from senior officials from the Finance Ministry, the National Highways Authority of India (NHAI), representatives from several insurance companies, the World Bank, other public and private banks, infrastructure companies, reinsurers, and insurance brokers.
Infra Spend
Panda highlighted that India is expected to spend about ₹100-lakh crore on infrastructure through the National Infrastructure Pipeline in the next five years. This requires bank guarantees of about ₹90-lakh crore in the next five years, which banks currently do not have capacity for.
This is where surety bonds need to step in to complement bank guarantees, he noted. This is important as India is estimated to become the third-largest country with infrastructure activity by 2030, according to Panda.
A surety bond is a legally binding agreement between three parties: the obligee (the entity requiring the bond), the principal (the party required to fulfil a certain task or duty), and the surety (the party ensuring that the principal can perform the assignment).
The surety bond, which is most typically used in construction and infrastructure projects, guarantees that the principal will meet the commitments indicated in a contract. If the principal fails to meet these obligations, the surety compensates the obligee, reducing their financial risk.
Put simply, Surety Bond Insurance, which is mainly aimed at infrastructure development, is a risk transfer tool that shields the principal from the losses that may arise in case the contractor fails to perform their contractual obligation.
The product gives the principal a contract of guarantee that contractual terms and other business deals will be concluded in accordance with the mutually agreed terms.
In case the contractor doesn’t fulfil the contractual terms, the principal can raise a claim on the Surety Bond and recover the losses they have incurred.
In Budget 2022–23, Finance Minister Nirmala Sitharaman announced that Surety Bond Insurance would be allowed as a substitute for bank guarantees in cases of government procurement and also for gold imports.
Meanwhile, a research paper presented by The Infravision Foundation (TIF) on the occasion highlighted that the surety bond market is yet to take off in India due to unaddressed risks and the absence of market makers.
The research paper noted that the estimated maximum possible supply of bank guarantees over the next five years is about ₹ 35 lakh crore, as against a requirement of ₹95 lakh crore in this period.
The gap between demand and supply is about ₹60 lakh crore, indicating the rich potential for Surety Bonds to emerge as a substitute for bank guarantees in the next five years, according to the TIF paper.
Already, the Central Government has allowed contractors to use Surety Bonds as a substitute for bank guarantees for government procurements.
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