SURETY VS GUARANTEE

Surety bonds have begun to outshine bank guarantees. But did they come in too late?

- SUBHOMOY BHATTACHARJEE

A few years ago, there was a scare in India's banking sector because of a surge in non-performing assets (NPAs), with the combined figure for banks rising from 2.3 per cent in 2011 to 11.2 by 2018. The result was a grave concern about the health of the sector. And it bore quick lessons all around.

One of those lessons led to the creation of the bankruptcy mechanism and the Insolvency and Bankruptcy Board of India in October 2016. The other was the rollout of the surety bonds by the insurance regulator, the Insurance Regulatory and Development Authority of India (Irdai), in February 2022, which work as an insurance against project failure or under delivery.

Both the IBBI and surety bonds seek to ring-fence banks from the horrors of loans gone bad. They also make a business case.

"The surety bonds market in India has the potential to generate billions of dollars in premiums over the coming years. With a project pipeline of almost $2.4 trillion, even a modest 10 per cent penetration would translate into substantial market size," says Akshay Bhardwaj, Senior Vice President and Practice Leader-Credit Specialities, Marsh McLennan, a global leader in risk advisory.

However, the issuers of surety bonds, predominantly the non-life insurance companies, expect sops from the Budget for 2025-26, which Finance Minister Nirmala Sitharaman is slated to present in Parliament on February 1 next year.

Unlike a conventional bank guarantee, issuers of surety bonds do not figure as financial creditors in a bankruptcy. But they want to be counted in the waterfall mechanism, which is a system that decides the preference order and percentages in which these creditors would receive their payables from the defaulting company.

Rapid transformation