ICISA’s members insure trade receivables acquired by banks and other financial institutions such as factoring companies. The use of credit insurance in this way has grown substantially in recent years in Europe, but also showing strong demand in Asia. Demand for the product in other parts of the world is less pronounced. Banks value the protection and flexibility trade credit insurance can provide them when arranging financing for real economy clients.
The International Trade and Forfaiting Association (ITFA) has estimated that over EUR 600 billion of trade-related lending by banks is supported in the EU by trade credit insurance. ITFA also notes that trade credit insurance forms part of the second most important portfolio management used by banks for SMEs and corporate loans in the EU.
While credit insurers must be cautious with risk-selection, underwriting and other operational elements of supporting banks in this way, supplying credit insurance to banks has proven to be an important part of thesector today. It is also likely to be an area of further growth in the future.
The position of credit insurance in the rules framework is derived from the requirements set out in the Basel framework as it is incorporated in the EU and other rulebooks globally.
Under the EU’s Capital Requirements Directive and Capital Requirements Regulation (CRD and CRR), trade credit insurance is used as a credit risk mitigation (CRM) technique. This enables banks to manage credit risk linked to receivables financing and, ultimately, acts as an important source of capital relief for banks. Similar usage applies in other markets which drives this interaction between banks and credit insurers. No specific text describing the features of credit insurance is included in the EU’s existing framework, however, its use is acknowledged by the EBA and others alongside guarantees for this purpose.
Key to the continued use of trade credit insurance by banks, however, is ensuring appropriate treatment of credit insurance within banking rules as the Basel III framework is implemented around the world. The CRD/CRR rules framework in the EU is in advanced stages of a periodic review which aims to keep the framework up to date and fit for purpose, as well as to incorporate new features of Basel III into EU rules. Ensuring that credit insurance is accurately and appropriately reflected in these rules is a key objective of ICISA and the wider industry with an interest in this topic.
In particular, we hope to see credit insurance recognised on the basis of its key characteristics, notably that it is an insurance product offered by robustly capitalised, highly secure credit insurers which are subject to stringent, risk-based capital regimes throughout the world, including Solvency II within the EU. Doing so will bring benefits at all levels; securing the continued use of credit insurance by banks at an optimum level and equally, supporting the continued delivery of critical support to the real economy.
But what exactly is being sought and how does the process work? Within the EU, legislation is introduced through a process of negotiation between the “co-legislators”, the European Commission, European Council and European Parliament on an agreed text. To get to this point, the Commission usually provides an initial proposal, which is then discussed separately by the Parliament and Council, respectively. Both bodies then generate compromise texts based on the views of their respective bodies before a “trilogue” of the Council, Commission and Parliament occurs to achieve a final, unified version that becomes law.
In its original proposals to amend CRR from October 2021, the European Commission included the provision of a so-called enabling clause, Article 506. This clause instructed the European Banking Authority (EBA) to “…report to the Commission on the eligibility and use of policy insurance as credit risk mitigation techniques and on the appropriateness of the associated risk parameters…Based on the report by EBA, the Commission shall…amend the treatment applicable to credit insurance”. Importantly, ICISA and others have recommended that as this issue involves the interaction between banks and insurers, that t EIOPA, the EU’s insurance supervisor, should necessarily be involved in this process and this issue has been taken up within the European Parliament.
However, a further issue also emerges from the proposed report having to be delivered by 2026. This is likely too late to avoid changes in the treatment of credit insurance as other measures come into effect before the report and any legislation is prepared on this topic. As a result, other proposals have been made to avoid the emergence of a cliff-edge related to the changes in the Loss Given Default (LGD) that would apply to credit insurance, before the EBA/EIOPA report could be prepared and any resulting legislation implemented. This could see an LGD of 45% being applied to credit insurance compared to lower treatments for other techniques. As a result, the phasing of new legislation for credit insurance is necessary to avoid such an abrupt change which would likely lead to reduced lending to the real economy supported by credit insurance. This is an outcome that benefits nobody, while a phasing in of new requirements ensures that sufficient time is available to craft appropriate legislation.
Discussions are currently at the stage of Parliament and the Council confirming their compromise texts. While each body is balancing different elements to reach agreements on the much wider view of the overall review of CRR and CRD, it is hoped that the key points put forward on the topic of credit insurance’s treatment will be acknowledged in the following phases of discussions.
ICISA is pleased that a separate matter it has been highlighting has been acknowledged as an issue requiring attention and is likely to be addressed. This relates to amendments proposed by the European Commission in their original draft text which altered the eligibility criteria for certain credit protection products. This would apply if the protection of such products, including credit insurance, could be reduced or withdrawn due to fraud of the bank’s obligor. Unfortunately, this proposal did not acknowledge that a credit insurer could not indemnify a policy where financing had been provided on the basis of fraudulent invoices (despite the best efforts of the financial institution). This is known as ceding risk under factoring policies, a risk that the credit insurer excludes. ICISA believes that this inadvertent issue which could have negatively affected the use of whole turnover credit insurance by factors and others involved in invoice financing is likely to be amended sufficiently and should be avoided.
The wider context of the review and the many different elements of the banking framework being looked also matter. The review comes at a time when wider fears for the economic environment may also play into the decisions made by policymakers. Ensuring that the strong logic behind ensuring proper treatment for credit insurance comes across is important to ensuring that this does not become a bargaining chip in the wider debate on the review of the rules. Indeed, broader policy questions also have an impact on these issues too, including developments in trade policy and the evolving insurance prudential regime in Europe and beyond.
For example, ICISA and others in the private short term credit insurance sector attended a workshop in Brussels on 22 November on the topic of the feasibility of an EU strategy on export credits. There discussions were held on the need for the EU to boost support to exporters and others in the real economy in the EU with several ideas discussed, including the possible creation of a dedicated EU export credit facility. More on this topic will be covered in a post by ICISA shortly. However, one point which emerged was that improved treatment of short term private credit insurance in EU banking rules could further boost the positive effect of the industry on EU trade.
Unlocking the resources already available to EU exporters in the form of the private credit insurance could go some way to boosting trade both within the EU and outside its borders. Basel III implementation in other regions and how credit insurance’s use by banks fits into this is also important. The UK launched its own consultation on 30 November for its own review of the banking framework there. This is an important step post-Brexit and the degree of separation between the UK and the EU will be closely watched by those in the wider banking sector. One key will be the extent to which UK regulators will go beyond the strict terms of the Basel framework, which may be less flexible towards credit insurance than the approach adopted by the EU. ICISA will work closely with those involved in the market there to support the position of the industry in the UK.
Building on the strengths of credit insurance while also acknowledging its core features as an insurance product, including elements of conditionality will bring further benefits to those who rely on it. This will also encourage better regulation and continued support to those in the real economy who are the ultimate beneficiaries of its protection. This aligns with the goals of banks as customers, exporters and corporates, and regulators and policymakers in a way that can work for each distinct group. ICISA will continue to play its role in highlighting these strengths and inform important debates in the EU and beyond.