Non-Payment Insurance as a Key Pillar of the Financial Industry

Non-payment insurance has emerged as a key pillar in the financial industry, particularly in its role of supporting a large proportion of bank loans. Surveys by ITFA and IACPM show that a large proportion of bank loans are supported by payment defaults or credit insurance with an increase to 400 billion as of 2022, just one year's worth of lending. A significant portion of non-payment insurance is used to support trade finance innovations. It is used on a large scale, in the financing of supply chains and working capital financing, in letters of credit to support the issuing bank and confirmations for import and export.

The value of non-payment insurance for the financial sector is simplistically a balance sheet management, capital optimisation, credit substitution, using insurance and taking the risk of a counterparty and swapping it with the risk of a better rated guarantor. This in theory reduces the capital that can be allocated to the insured piece of any transaction.

Non-payment insurance is very helpful for banks, who are looking to manage the capital that they have allocated to their product lines and optimise the balance sheet, originate distribute in an efficient way, but more regularly used as a form of limit management. Non-payment insurance is used to mitigate risk exposures and to allow to do more with clients.

The development of banking regulation is important for the utilisation of non-payment insurance for the financial sector in Europe, and major challenges need to be overcome.

The insurance market, and particularly with Base II in 2004, which introduced to allow banks to use internal models to calculate their credit risk and to use an eligible guarantee as a risk weighted assets substitute for that of the borrower, saw an opportunity and used that regulation to provide a product which is eligible as a guarantee for the purpose of providing capital relief to banks.

There was something that over 80% of the banks in the survey by ITFA and IACPM do use non-payment insurance as one of their top three goals or reasons for using this to get capital relief.

Under Basel III, as it stands in Europe, it's been very good and very helpful, particularly for advanced banks who use an internal model when they calculating risk weighted assets.

Basel IV as the insurance industry is concerned, is about the economics of the use of insurance. The key features of Basel IV is to take away the variability in the calculation of credit risk and how capital is allocated. The regulators are not going to pre-set an LGD for financial institutions and insurance companies have been clearly designated as financial institution for this purpose.

The risk mitigation community now has a lot more transparent information. There is a lot more data and product knowledge that sits around insurers, insurance brokers, associations, third parties, who provide risk data provide the data and process it technically. People in the financial industry should explore and consider how to utilize the non-payment insurance product efficiently and effectively.