The EBA yesterday published its delayed report on the use of credit insurance as credit risk mitigation by banks under the evolving EU banking framework. This report forms part of the EU’s wider implementation of the updated global Basel standards into regulations.

The EBA report follows the 12 September report of the UK Prudential Regulation Authority (PRA) on broadly the same topic. In that report, the PRA declined to alter the approach to the default treatment that will result from Basel implementation. In doing so, they cited its view that there was a lack of sufficient evidence to adopt an approach that is not explicitly laid out in the Basel 3 standards, due to a lack of insolvencies of credit insurance companies.

In its own report, the EBA has adopted a similar approach to this question, also citing a lack of evidence relating to the performance of credit insurance in instances of the failure of the insurer (due to no failures of credit insurers), and their discomfort in adopting an approach that is outside the Basel standards. The result of its analysis is summarized in the following way: “…different datasets have been assessed that still fall short of providing satisfactory data evidence to anchor any potential re-calibration of the framework.” Due to the mentioned lack of insolvencies of credit insurance companies since the implementation of the Solvency-II framework, this is not surprising.

Its wider analysis also detailed comparisons with other forms of funded and unfunded credit protection used by banks, as well as referencing concerns relating to contagion risk between banks and insurers. This is despite the robust protections in place of Solvency II for insurers and CRR/CRD for banks. More broadly, it also assesses that the use of credit insurance as a credit risk mitigation technique by banks, “…is still expected to lead to a reduction of own funds requirements [for F-IRB banks], albeit at a lower intensity than currently”.

While this is true, the issue as highlighted by the combined banking and insurance industry advocacy on this matter is that the increase in loss given default (LGD) which leads to this calculation (i.e. to 45% from much lower levels) will be significantly higher post implementation. This potentially diminishes the economic value for banks to use credit insurance at the same volume. You can read more about what the LGD means in this context and why this increase matters in our May 2024 update on this topic.

The increased LGD may by extension have the effect of reducing bank lending volumes in comparison to the role that credit insurance plays under current arrangements. When surveyed on the reasons for using credit insurance as a credit risk mitigant, banks highlight limit management as the primary purpose, with capital relief secondary. Reduced use of credit insurance then for this purpose will likely lower volumes of financing banks can provide due to internal limits.

The EBA report is certainly a disappointing outcome for several reasons. While its analysis poses important questions to the sector, it signals an perhaps overly conservative approach. This will likely result in diminishing an activity which is well-established, and which the EBA acknowledges has performed well. Equally, it also acknowledges the significant robustness of the credit insurance sector, citing the lack of failures within the sector as part of the problem for lacking available data to compute alternative LGD levels. The report also indicates the EBA’s concern about being seen to deviate from Basel standards, despite the unique characteristics of the market in a European context (i.e. the use of credit insurance in this way is predominately a European practice).

The Basel standards have been silent on the treatment of credit insurance when used as unfunded credit protection by banks. Adopting an approach that would be specific to European markets would be additional to these base standards. However, the EBA has viewed this point narrowly and believes that doing so would be a deviation from what is expected.

A broader disappointment with the report is how it fits within the wider context of efforts by the EU to boost financing to the real economy at a time when there are market constraints and efforts to stimulate European capital markets are less effective. Former Italian President and President of the European Central Bank, Mario Draghi, recently published a ground-breaking report commissioned looking into ways to boost competitiveness in the EU. In this report, Mr. Draghi specifically and frequently highlights barriers to financing as one of the main stumbling blocks to innovation, productivity, and increased competitiveness in Europe. This should give policymakers pause when they consider how broader regulatory efforts may also hamper those same efforts.

Against this somewhat gloomy backdrop, there are perhaps yet some green shoots still to focus on. As mentioned, the report implicitly recognises the value of the protection credit insurers provide to banks. The performance of the product and the strength of the providers does not seem to be in question. This is also echoed in the positive judgement whereby the EBA has indicated no concerns with the eligibility of credit insurance in comparison to other forms of credit protection.

While the report finalises the EBA’s mandate on this matter, the final decision on what approach to adopt is ultimately for the European Commission and the European Council to decide. Both institutions have a broader remit to consider. This includes the wider context of financing the real economy and responding to the kinds of issues highlighted in the Draghi Report.

Time remains an issue with implementation of the new framework set for 1 January 2025. This is in comparison to the implementation timelines adopted by the UK and USA. The UK recently confirmed it would further extend its implementation to 1 January 2026, while the US is slated to complete by the end of June 2025. That timeline seems certain to be further pushed out with regulators there considering additional amendments as part of what they call, Basel Endgame.

ICISA and its partners will continue to work closely together to seek the best outcome for members, and ultimately an approach which enables banks and insurers continue to support the real economy.

Daniel De Burca
Daniel De BurcaHead of Policy and Regulatory Affairs