The recent recommendations of the working group set up by the IRDA outlined the benefits of surety guarantees as “The Surety Bonds are proven risk management mechanisms with a long history that help ensure public and private owners execute their construction projects following the plans and specifications and ensure subcontractors and suppliers are paid. Surety bonds help provide owners of construction projects with guarantees of success and enhanced reputations.”
The recommendations go on to mention that “The Surety Bond for road/civil infrastructure projects market need has been felt since the Indian Banks are now not providing any waivers on collaterals for granting Bank Guarantees. The big corporate failures resulting in the events of Non-Performing Assets have driven the Banks to exercise tighter controls in issuing Bank Guarantees. National Highways Authority of India (NHAI) received representations from contractors, developers because obtaining Bank Guarantees are becoming very difficult. The Banks have increased two components, i.e. margin money as well as the commission. Under these circumstances, an alternative option was required.”
Coming from a working group which comprises of some of the senior-most and accomplished insurance professionals of the country, this is indeed a strong attestation of the role and the need of sureties in India.
Contractors are a critical part of the construction & the infrastructure industry and its heartening to see their woes of the availability of bank guarantees being the focus of the Government and the Regulatory bodies. There is no doubt that access to guaranteeing solutions which do not entail collaterals and margin money will help infuse a significant amount of liquidity. This resultant liquidity can be utilized in a far more efficient manner to spur economic growth for the entire industry.
However, the current narrative around the need for sureties in India only because
► the contracting community is strapped for liquidity and
► unable to participate in new projects because of their choked banking lines or
► the need to find an alternative as the banks have started exercising tighter controls
Would be equivalent to looking at it in a one-sided manner. It also creates a perception that the need for sureties is being felt to provide support to otherwise weak industry.
I have often been asked the question – How can sureties do away with the need for collaterals and margin money in a market like India? Or Aren’t Sureties aware of the moral risks involved primarily in the Infrastructure Industry where even the conservative Indian banks have burnt their fingers?
Therefore it becomes vital to understand how sureties have been able to build a thriving business model globally without the guarantees being necessarily indemnified by collaterals & margins.
A surety conducts a holistic assessment of the company which is not restricted to just the financial underwriting but also extends to capability (team, equipment etc.) to execute as well as the past performance of the contractor. The 3Cs of surety underwriting – Capital, Character & Capacity help a surety accurately assess the principal’s ability to perform the obligation as required under the contract.
As such Sureties by their effective surety risk selection process ensure that only capable and competent contractors are permitted to undertake public projects. No wonder that a study by the Canadian Centre for Economic Analysis found that a non-bonded construction enterprise is 10 times more likely to default than a bonded company.
The Surety risk selection process is all about getting right, competent parties to the contract, thus minimizing the probability of default. This approach is visible across all lines of guarantees issued by the surety, including bonds as small as rental guarantees where the tenant undergoes a detailed underwriting process before the surety agrees to extend guarantees on his behalf.
Sureties also help contractors participate in project opportunities. The current pandemic has had a ravaging impact on the Indian economy. The contracting community has been hit very severely as well. The Government has announced a slew of measures to spur economic growth which includes increased investments in critical infrastructure projects. However, a large part of the contracting segment irrespective of their execution strength is unable to participate in these projects. This is because the banks do not differentiate between high performing and marginal contractors. If two companies have the same level of financial assets, they would have a similar ability to furnish contract guarantees. Moreover, a large part of the contractors’ assets is already locked in with the bank to support their existing banking lines. In such a situation, Sureties with their ability to look beyond just the financials and to do away with the need for collaterals and margin money can act as an enabler for the contractor to participate in the new projects thus hastening the pace of economic recovery.
Did someone say, “Fast Forwarding India”.