Robust legal framework key for development of surety bonds market: IRDAI

An IRDAI working group has made a case for a robust legislation and ecosystem keeping in view the best international practices for promoting development of the surety bonds markets in the country.

Surety bonds protect the beneficiary against acts or events that impair the underlying obligations of the principal. Surety bonds guarantee the performance of a variety of obligations, from construction or service contracts, to licensing and commercial undertakings.

The working group, set up by the Insurance Regulatory and Development Authority of India (IRDAI) to study the suitability of offering surety bonds by Indian insurance industry, suggested that the exposure of an insurer under surety bond insurance may be regulated through a cap on its exposure under this business as a proportion of its net worth.

"For surety market to develop in India and keeping in mind best practices observed in other markets, a robust legislation requiring surety bonds and other non-fund based guarantees would be a necessary condition," said the report on which the IRDAI has invited comments from stakeholders by November 9.

Surety bonds are different from corporate bonds and financial guarantees. While surety bonds refer to the performance or delivery obligations to complete the insured project, the corporate bonds refer to financial obligations to repay the debts or loans.

The report notes that surety bonds are proven risk management mechanisms with a long history that help ensure public and private owners execute their construction projects in accordance with 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 working group further said the surety bonds should be accepted as an alternative form of guarantee by the Reserve Bank of India (RBI) and government departments and accordingly reflect in the appropriate contract documents.

The Ministry of Micro, Small, and Medium Enterprises runs various schemes to aid the smaller businesses in development, such as, the credit guarantee scheme, where the businesses eligible for these schemes can approach approved banks and can get collateral-free loans up to Rs 50 lakh.

"This can be extended for issuance of surety bonds also and in such cases, surety bonds and government guarantees can work more efficiently than banks to secure and promote the MSME sector within India," it said.

Further, the surety bonds business may be revived with offering of surety bonds to construction companies in India that covers road projects, housing/commercial buildings and other projects of government as well as private sector.

"The contract bonds may include bid bonds, performance bonds, advance payment bonds and retention money. The limit of guarantee may be limited to maximum 30 per cent of project value," the report said.

The working group has also suggested that the database of the bonds issued by all the insurance companies may be centralised at designated body to be decided by IRDAI. Every insurer should furnish the details of clients and exposures periodically to the designated body.