Credit insurance can unlock greater financing for critical infrastructure projects and support lending to micro-, small- and medium-sized businesses in emerging markets.
A commonly held belief supposes that many of the world’s problems could be solved “if only we had more money”. While not entirely wrong, this view is largely misplaced. Globally, money in myriad forms is not in short supply. Instead, structural and institutional factors are the more significant impediments to creating the conditions that help people live more comfortably and securely.
The insurance industry—namely, the political risk, credit and bond segment —is collaborating with other organisations and institutions to overcome some of these impediments and therefore is helping reduce poverty and creating shared prosperity.
A region of contrasts
In Singapore we work with clients and brokers to support cross-border trade and investment in the Asia-Pacific region. Among the features of this part of the world are its contrasts. The countries are culturally diverse and have vastly different legal, regulatory and tax requirements. These multiple contrasts often present complexities and challenges for financial institutions and investors looking to support regional trade and economic development. At the same time, the region’s dynamic growth has created opportunities for higher risk-adjusted returns.
In fact, infrastructure investment in the various Asia-Pacific countries over the past decade has been more significant than in other developing regions. And it shows: visitors from different parts of the world marvel at the gleaming new airports, modern highways and widespread availability of high-speed internet, to cite just a few examples of recent progress. Nonetheless, the infrastructure in most of the region’s developing countries remains far from adequate, and many people lack proper access to basic sanitation, healthcare and electricity. Moreover, the pandemic magnified these shortcomings and highlighted the importance of infrastructure development in supporting vulnerable populations.
There are also striking contrasts between the financial markets in the different countries across the region. Places like Australia and Singapore have robust and comprehensive finance sectors that are well-equipped to support local and cross-border trade and development. However, the financial industry is less well-developed in most of the region’s emerging economies, and structural deficiencies are common. In particular, the financial inclusion gap—the inability of individuals and businesses to access useful and affordable financial products and services—remains significant in most emerging market countries. The challenges are particularly acute for women, low-income households and micro-, small and medium-sized enterprises (MSMEs) which can’t easily access whatever credit is available locally.
Mobilising private capital
Limited financial resources are a common denominator for both broad issues—inadequate infrastructure development and the financial inclusion gap. However, as noted, the world’s money supply isn’t the issue. The Asian Development Bank (ADB) notes, for instance, that only 0.8%of the private capital managed globally by pension funds, sovereign wealth funds, and other institutional investors has been allocated to infrastructure in recent years.
The challenge is how to mobilise more of this private capital since, in many of Asia’s emerging market countries, traditional lending channels have finite capacity and a limited pipeline of properly structured projects.The needs are even more acute currently as countries work to recover from the pandemic.
The International Finance Corporation (IFC)—the World Bank Group division that works with the private sector—has a similar assessment. It points out that since the 2008 global financial crisis, international banks have grown more cautious about financing private-sector projects in emerging market countries–“especially for longer tenors”. The IFC also notes that “with low yields in developed markets, many institutional investors are seeking higher-yield opportunities … and have exhibited a strong desire for debt instruments from emerging market financial institutions in particular.”
Expanding access to finance
There are many ways targeted investments could positively impact people in the Asia-Pacific region, from needed infrastructure improvements to supporting financial inclusion. And the private sector controls significant volumes of capital that could be deployed for these purposes.
What’s missing? According to the IFC, “new structures (are needed) that can connect the holders of capital and those institutions able to bear risk with emerging market beneficiaries in search of financing”.
That is where insurance, and specifically credit risk insurance, comes in. Multilateral organisations, government agencies and private insurance companies often offer credit insurance to protect against a borrower’s non-payment of a debt obligation. By partnering with a credit insurance provider who assumes a portion of the risk, institutional investors, financial institutions or other “holders of capital” can provide beneficiaries with funding that otherwise wouldn’t have been available or with a financial package greater than the lender could have delivered on its own. In some cases, the investor,might also take out political risk insurance to mitigate country risk and losses stemming from civil strife, expropriation or related disruptions.
In 2020, the IFC and a consortium of six insurers, including AXA XL, launched an initiative aiming to channel up to US$5 billion of lending through the financial systems in developing countries, including those in Asia-Pacific. That is US$2 billion more than the IFC could have offered without the credit insurance component since it helps financiers manage their internal limits and risk tolerances while also satisfying regulatory capital requirements.
One of the exciting aspects of this approach is that it is readily scalable and replicable. In addition to this IFC/World Bank initiative, similar efforts are underway with the ADB and other multilateral development agencies to use political risk and credit insurance to expand their lending capacities.
By helping mobilise “holders of capital”, political risk and credit insurance specialists play an important role in supporting cross-border trade and investment in emerging markets. Facilitating access to the world’s financial resources is becoming even more vital as emerging market countries seek to bolster their resilience to climate change and promote economic development for women, low-income households and MSMEs.
The opportunity to manage political and credit risk with insurance should encourage additional “holders of capital” to participate in emerging market finance and foster new linkages between firms in developing countries and international financial institutions.
Thomas Ng is an underwriter with AXA XL’s political risk, credit and bond team. In this role, he works with financiers, investors and corporates to develop structured credit and political risk solutions in emerging markets. He joined AXA XL in 2017 after serving in analytical roles in banking and with a credit rating agency. He is based in Singapore and can be contacted at [email protected].
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