Big construction and infrastructure projects may soon witness the concept of surety bond as an option and alternate to bank guarantees. A Working Group of insurance regulator Irdai has already recommended issuance of surety bonds by insurance companies which will function as the performance or delivery obligation to complete an insured project.
The panel, headed by former New India Assurance Chairman G Srinivasan, has proposed that the Insurance Regulatory and Development Authority of India (Irdai) may allow insurers to enter the surety bond insurance business with solvency margin above a certain threshold as the experience of surety bond insurance is yet to develop in the Indian market and the risk exposure under this business is quite significant.
The performance bonds issued may cover up to 10-20 per cent or sometimes guarantee 100 per cent of the project value, the panel has proposed. Surety bonds are typically conditional, while bank guarantees are on demand, and are offered as insurance products in the global market. Though in many nations originally banks issued bonds, the security provided by an insurer has proven equally acceptable. Insurance companies in markets such as the US, Brazil, Mexico, Germany, Australia and the Philippines issue surety bond and many leading companies in these countries have set up separate lines of credit and bonds with surety of insurers.
The need for surety bond for road and civil infrastructure projects was felt since Indian banks are not providing any waivers on collaterals for granting bank guarantees. Big corporate failures resulting in non-performing assets have driven banks to exercise tighter controls in issuing bank guarantees. The National Highways Authority of India (NHAI) received representations from contractors and developers as obtaining bank guarantees were becoming very difficult, the panel said.
Obligation for contractor
In large construction or infrastructure projects, bank guarantee or surety bond is a contractual requirement or precondition of the project owner for awarding an order to the contractor. If the contract is not honoured, the bank or insurance firm is called upon to pay the bond or assure finalisation of the contractual obligation.
In 2016, the Department of Financial Services had written to Irdai to explore the possibility of introducing surety bonds in favour of the Central Board of Indirect Taxes and Customs (CBIC) to facilitate trade by substituting bank guarantees.
In the wake of the Covid-19 pandemic and consequent economic impact on liquidity and cash flow issues in the banking sector, the Ministry of Road Transport and Highways advised Irdai to examine possible offering of surety bond being issued by general insurance companies.
The proposal under consideration is that Surety Bonds business may be revived with offering of surety bonds initially to construction companies including road projects, housing/ commercial buildings and other projects.
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