Capital requirements for banks are on the rise. Under the latest amendments to the Basel Accords, which set out international banking standards, regulators worldwide require banks to hold more capital than ever.
According to KPMG, UK banks alone may have to hold up to £50 billion (US$63.5 billion) of additional capital; yet UK banks are already among the highest capitalised banks globally. Many banks around the world, including in Asia, are struggling to fund the extra assets, and typically don’t wish to or cannot easily raise new money to capitalise existing loans.
They are on the lookout for alternatives. Over the past few years, they have begun to discover that insurance is an excellent mechanism to mitigate additional capital requirements.
Demand is therefore mounting for what is in effect contingent capital provided by insurers under conditions controlled by the insured. When insurers act as non-funding, risk-taking participants in new or existing loans, and the contracts are structured correctly, backing such loan credits under conditional policies of indemnity can be Basel compliant. The insurance market, particularly in London, is under welcome pressure to deliver these solutions.
The changing role of Lloyd’s
Lloyd’s has traditionally drawn a clear distinction between trade and non-trade credit risk insurances. Financing a sales contract or the sale of goods has been permissible, but under the former regulations dating back nearly a century the insurance of loans to entities which are not active in trade, including banks, has been unacceptable, due to the fear of moral hazard resting in synthetic transactions. That has changed in recent decades and the debate about trade versus non-trade has also seen positive movement.
The structure, credit quality, and priority of loans’ obligations as well as the (inevitably linked underlying priority of the sales contract) are the key variables when determining their insurability. Such factors are much more important than the label applied to them.
The approach of managing agents at Lloyd’s to such risks is changing. The tendency had been to assess credit risks in the same way that contract frustration insurances are underwritten, but several significant differences subvert this approach. A government cannot declare its Ministry of Finance insolvent, and successor governments are bound to the repayment of the nation’s debts incurred by earlier administrations. That makes most contract frustration risks inherently better risks than unsecured credit risks, which may see recovery of credits from bankruptcy of only cents on the dollar.
The emerging approach in Lloyd’s proffers a different way of handling financial risk. Portfolio excess of loss cover for short term credit risk for corporates differs dramatically from traditional whole account credit insurance. Under such contracts, the insured may assess credit risks itself, define the corridor of risk they wish to transfer, and agree a meaningful deductible set by insurers; the insurers will also want to approve and amend the insured’s credit manual and insist as a condition on its consistent application.
Some insurers are beginning to build a book of such credit risks, analysing a maximum of perhaps 30 buyers, mostly fewer. However, building a sizeable portfolio is a slow process and brings with it development and systems’ investment costs. It requires the conversion of existing insureds to a different way of handling and assessing risks. The insureds, in turn, enjoy cheaper insurance and greater freedom of movement.
Partnership approach
An alignment of interests and a partnership approach is crucial for underwriters of corporates and banks alike in this sector; insurers typically wish to insure only those banks that understand such insurances as a partnership. Insurers are committed – they are a hold-to-maturity market whereas not many banks are and regulators would prefer them not to be: insurers cannot ordinarily sell their contingent liabilities, and, with their bank, insureds are the first party in the queue to pay losses.
Banks often have a different approach to risk and its evaluation, and may transfer risks. Part of this is because banks see loans as assets whereas insurers treat them as contingent liabilities. Finding bankers willing to look beyond insurers’ non-funding role and understand these differences is crucial to the development of a stable book of credit excess of loss coverage; others are likely to deliver surprises.
Asian and Middle Eastern lenders are at the beginning of this journey of understanding, primarily offering in Asia credit risks acquired in other Asian territories. In Singapore, for example, most banks are subsidiaries of lenders from some other jurisdiction, and do not originate and insure domestic risk. Dedicated credit risk underwriters are very interested in such risks, those originating in, for example in Indonesia, Malaysia and South Korea – places with strong, capitalist-based economies that do not suffer the ponderous decision-making philosophy that demands enormous patience from insurers.
Geographical origin is just one factor considered when underwriters assess risks under this form of insurance, which is growing in popularity. It is not a risk for the faint of heart, but for banks working in partnership with forward-looking credit risk insurers, it is a proven solution to the increasing capital squeeze.
This article was written by Bernie De Haldevang, head of specialty, Canopius at Lloyd’s.
-
IFRS 17: Making your financial controls automation truly work for you
- September 26
Shifting towards a more automated and streamlined workstream can free up time for insurers to critically analyse results that inform future financial planning.
-
Flood resilience: Water, water everywhere…
- September 11
Floods are one of the most complex natural perils with highly localised impacts, making them challenging to insure and data is key to the effective design of an affordable product to protect the vulnerable.
-
Maritime energy transition: Data dialogue key to achieving decarbonisation goals
- August 3
Collaboration and shared learning amongst stakeholders will be vital to getting full value from the data captured as well as in achieving regulatory goals. The International Maritime Organisation’s (IMO) greenhouse gas (GHG) strategy is to reach net-zero emissions from international shipping by or around 2050, and there are various checkpoints to meet along the way. […]
-
Contentious losses: Evidence-led forensic investigations stand the test of time
- May 17
Even minor cracks in evidence capture will become exposed when it comes to recovery and repudiation. Forensic investigations form part and parcel of many insurance claims in the Asia-Pac region. Whether a loss is complex, costly, or if there are expected to be questions down the line around causation and liability, insurers and their loss […]
-
AXA XL | Low and no-cost cybersecurity actions for companies
Considering the increasing frequency of attacks, the evolving threat landscape, including the use of AI to launch more sophisticated attacks, companies today can’t afford to ignore the possibility of being targeted by cybercriminals.
-
BHSI | Managing non-Asian exposure in long-tail lines
While US-exposed business can look attractive to Asian carriers, managing the volatility around the long-term results and the ability to model those losses are crucial, say BHSI’s Marc Breuil and Marcus Portbury.
-
Sedgwick | To Handle CAT Claims Well, Multi-Step Preparation is Key
When it comes to risk, it’s not a matter of “if” it’s a matter of “when” an event will occur.
-
HSBC Asset Management | Is it time to relook at Asian currency bonds?
With diversification and performance high on investors’ agendas, it seems a good time for global portfolios to revive allocations in Asian local currency bonds – including Hong Kong dollar (HKD) bonds.
Bernie De Haldevang, Canopius
How insurers can aid additional bank asset requirements
Bernie De Haldevang, Canopius