As part of the 50th Annual International Trade And Forfaiting Conference (ITFA) in Cyprus, Trade Finance Global (TFG)’s Editorial Director Deepesh Patel sat down with Carol Searle, General Counsel and Group Board Director at Texel Group, to discuss her outlook for the credit insurance market at large.
Global trade expansion and digital innovations in trade finance have spurred the industry towards rapid growth. The industry is expected to deliver a compound annual growth rate (CAGR) of around 11% over the next decade, projected to double in value by 2032.
Searle has watched the market weather rapid shifts and abrupt crises, crediting a dynamic, diverse culture of innovators with the market’s year-on-year success.
Alongside her close working relationship with the team at ITFA and with a background in shipping trade law, Searle has seen the trade finance world through multiple crises—including the Argentine economic crises, the Global Financial Crisis, the COVID-19 standstill in global trade, and the ongoing supply chain volatility.
“One of the things that I love about [credit insurance] is that it’s a market that’s very nimble and very quick to move and very flexible, and that adapts to the changing environment.“
But a strong, adaptable outlook is not without its challenges, and many are wary that a tightening regulatory framework may threaten the market’s dynamism.
The rear view: Basel II
In 2004, the Basel Committee on Banking Supervision (BCBS) implemented Basel II, an amendment to the Basel regulatory framework that allowed financial institutions to establish tailored capital regimes for different levels of risk.
“Basel II introduced something very, very significant for the insurance market. It introduced the ability for a bank to use unfunded credit protection [such as insurance] to substitute the risk weight of a borrower with that of the provider [insurer] and thereby get some form of regulatory capital relief… that has been a huge area of development for our insurance market.”
Since the introduction of Basel II in 2004, the trade credit insurance market has grown significantly and is now worth more than $12.8 billion.
“There was a great use of banks in mitigating the credit risk by using insurance. And where this market really grew quite exponentially was as a result of the implementation [of Basel II in Europe in 2006],” says Searle.
Basel II allowed banks to calculate credit risk by using internal models alongside the standardised approach. This permitted a more sophisticated approach to assess diverse types of risk and introduced a risk sensitivity in capital requirements for banks, allowing flexibility that did wonders for the sector’s use of capital.
Future risks in credit insurance – Basel IV
Then came Basel III (2010), and the finalisation of Basel III in 2017: known as Basel 3.1 but also often referred to as Basel IV (critics argued that the changes were so significant that it should be treated as a distinct round of reforms). The Basel IV – reforms to the regulatory framework had two main components:
- An increase in capital requirements, requiring banks to maintain additional buffers, and
- Limits on the calculation of risk-weighted assets (RWAs).
Basel IV aims to reduce the variability in the risk sensitivity of capital requirements by constraining the use of internal models to increase the level of harmonising the way banks assess credit risk. One way this is achieved is by restricting the ability of advanced banks to model the Loss Given Default (LGD) on exposures to large corporates and financial institutions impacting the calculation of RWAs. LGDs are now pre-set to 40% for large corporates and 45% for financial institutions. For these purposes insurance companies are considered to be financial institutions.
The impact on bank’s buying of credit insurance for RWA management will depend on the regulatory impact on the underlying exposure and the regulatory treatment of insurance. Searle is concerned that the differential of RWA on exposure to a high rated borrower and an insurer may make insurance of better rated risks less appealing to a bank.
Some key stakeholders (ICISA, IACPM), including those associated with the ITFA, have provided significant feedback to lawmakers in Europe and the UK on the long-term ramifications of the reforms.
“One of the concerns that we felt at the working group in ITFA some time ago was that it would no longer be economically viable for a bank to insure the better-rated risks. As a result of this, insurers will see a less diverse portfolio of risks. More likely, they will only be shown the low-rated risks,” says Searle.
“This reduction in the diversification of the asset classes and risks being taken to the insurance market could lead to a contraction of the market, maybe people exiting from it.”
The International Association of Credit Portfolio Managers (IACPM) has highlighted that Basel IV’s standardisation of RWAs through preset LGD values could limit the ability of financial institutions to assess risk. Changes to the framework have and will impact how such institutions manage credit risk, making it more challenging for banks to optimise their capital. This could reduce their ability to lend or require them to hold more capital against the same level of risk – a blow to smaller, newer and more innovative lenders.
For context – the implementation of Basel IV is projected to leave a €52 billion hole in available capital in the European system alone.
The outlook
Basel IV’s primary aim is to strengthen the regulation, supervision, and risk management of banks. Ongoing refinement through open dialogue with the BCBS can allow the credit insurance market to strengthen confidence in their products. While Searle and her colleagues remain vigilant of these regulatory changes, there are pragmatic long-term possibilities. For example:
- Sustainable finance: Basel IV encourages institutions to better integrate environmental, social, and governance (ESG) factors and climate risk modelling.
- Digital innovation: Tightening regulatory requirements are widely expected to reduce available capital. For some, this will drive innovation and perhaps push greater adoption of digital solutions (e.g., automation) to reduce costs.
Searle has long admired the adaptability of the credit insurance market and accepts that Basel II contributed to this success. Basel II was not without similar criticism to the newer iterations, which hold their own promise alongside limitations.
The people and knowledge behind every outlook, valuation, and trade remain integral to the sector’s growth.
