The IRDAI released surety bond guidelines to guarantee that the bonds get issued in a fair and transparent way. These guidelines have the goal to promote and control the healthy and sustainable growth of India’s surety insurance sector.

The guidelines cover a wide range of topics, including the types of surety bonds that can be issued, terms and conditions, underwriting criteria, and pricing. One could look at surety bonds as a risk management tool for economic growth.

What are surety bonds? Surety bonds found their place in the post-independence period with the Indian Contract Act of 1872, which provides a legal foundation for contract enforcement. Surety bonds gained momentum in the late twentieth century as the private sector became more involved in public projects. 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.

In a construction project, for example, the project owner (obligee) may compel the contractor (principal) to get a performance bond from a surety company. This bond would safeguard the project owner if the contractor failed to complete the project or achieve the contract’s quality standards.

The IRDAI has issued guidelines for surety bonds, which are designed to ensure that they are issued in a fair and transparent manner. The guidelines are designed to protect the interests of all parties involved in a surety bond transaction, including the surety, the principal, and the obligee.

Surety bonds, such as bid bonds, performance bonds, advance payment bonds, and retention money bonds, can be issued for a variety of purposes.

The guarantor must be financially capable of meeting its obligations under the bond. A surety bond premium must be reasonable and based on the risk involved. On the whole, the IRDAI guidelines establish a framework for the issue of surety bonds.

The shortcomings

One of the major concerns is that India’s lacks the depth of a well-established surety bond market. This can make obtaining these bonds difficult for contractors, especially small and medium-sized organisations (SMEs). There is a lack of standardisation with varying surety providers may have varying standards and processes, which can make navigating the system challenging for contractors.

Finally, surety bond enforcement in India can be a lengthy and complicated process as it entails legal conflicts, which may be time-consuming and expensive for all parties.

Surety bonds have significance in India, particularly in the developing infrastructure sector, where they serve as an important risk management tool. They provide financial stability and confidence by ensuring that contractual obligations are met. This not only protects project owners’ interests, but also promotes a more competitive market by allowing smaller contractors to bid on large-scale projects.

The need for surety bonds is likely to expand as India continues to focus on infrastructure development and public-private partnerships.

As a result, overcoming present market issues and creating a well-regulated and accessible surety bond market are critical to India’s economic development.

Saravanan is Professor of finance and accounting at IIM Tiruchirappalli, and Williams is a project manager – ESG at Good Vision Seva Trust