There has been a lot of buzz going around about Surety Bonds in India. Affirmative headlines are making their ways in the top sections of the finance sector. The insurance companies and construction businesses are eagerly waiting for the launch of this insurance product since its usage was allowed by the government in place of bank guarantees in the budget 2022-23.
Government is also working cohesively with the respective stakeholders in order to make surety bonds in India a reality.
So what are Surety Bonds? And why is there so much hype around it? Let’s take FAQs on it & dive deep into the topic at hand.
Q1. What are Surety Bonds ?
Ans. A surety bond is a contract between three parties: the principal (the company or individual who is purchasing the bond), the surety (the insurance company that issues the bond), and the obligee (the entity that requires the bond).
The surety in exchange for a premium, assumes financial obligations of the principal towards the obligee, in case the principal defaults. Thus anchoring trust between the principal & the obligee to work together.
Q2. Who can benefit from Surety Bonds ?
Ans. There are many different types of surety bonds, and each type solves a financial trust & security problem of a particular business instance. Here we enlist them according to their industry wise usage –
i. Surety bond for all those companies that work via a Contract or a Bid
This encompasses entire business community as majority of work is undertaken via a contract or a bid. From construction to software industry & everyone in between.
A Contract Bond provides assurance to the public entity, developers, subcontractors and suppliers that the contractor will fulfil its contractual obligation when undertaking a project.
A Performance bond guarantees that a contractor will complete a project according to the terms of their contract.
A Bid bond is an obligation undertaken by a bidder promising that the bidder will, if awarded the contract, furnish the prescribed performance guarantee and enter into contract agreement within a specified period of time.
Advance Payment Bond is a promise by the Surety provider (insurance company) to pay the outstanding balance of the advance payment in case the contractor fails to complete the contract as per specifications or fails to adhere to the scope of the contract.
Retention Bond, which relates to retention. Retention is financial security (also called cash retention or withheld cash) held by the lead contractor to ensure that its subcontractors adequately fulfill the obligations required of them under the contract. It is also used as a safeguard against defects in case a subcontractor fails to correct them.
A customs bond assures the concerned authorities that all import duties and taxes are or will be duly paid by the importer for the goods imported into the country.
iii. Used in Court of law
Court bonds are used by individuals when they pursue an action through a court of law. Various kinds of court bonds are Judicial Bonds, Fiduciary/Probate Bonds, Bail bonds, Appeal bonds, Counter-Replevin bonds, Release of Lien bonds, Plaintiff bonds, Attachment bonds
Injunction bonds etc.
Q3. How are Surety bonds better than already existing Letter of Credit like Bank Guarantees ?
Ans. A LC is a promise by a bank to advance up to a certain amount of money to one deal party if the other party defaults.
There are several benefits of using surety bonds over a LC, including:
i. Surety bonds don’t need COLLATERAL
A surety bond does not require collateral, unlike an LC. This means that you will not have to put up your personal assets or your working capital as collateral for the bond.
When you get a LC, the deposited funds get reserved and are unavailable for use in the business as long as the LC is outstanding. This working capital does not get blocked on buying a surety bond.
Also, Businesses only pay an annual premium to purchase a surety bond. There is no requirement of a collateral in any form. Therefore, there is no impact to their working capital (cash and cash equivalents-short term liabilities). This aspect of surety bonds is a major advantage for cash-strapped businesses like import/export and construction.
ii. Surety bonds DO NOT BLOCK the valuable LINE OF CREDIT
A surety bond is based on the financial solvency of a company. It does not diminish the company’s borrowing capacity as it is issued by an insurance company. This is not true for a LC which diminishes the company’s line of credit. The surety bond is based on the strength of your business, not your credit score.
iii. Surety bonds are CUSTOMIZable
Surety bonds are customizable to fit your specific needs. You can get a bond specifically tailored to your business and your agreement with the buyer/seller.
iv. Surety Bonds are CHEAPER
Surety Bonds are charged on pro rata basis. You pay for the time period for which the Bond is utilized. In comparison, LCs are charged either quarterly or, in some cases, annually.
Q4. How Surety bonds coming to India would benefit India Inc. ?
- Bank Guarantees freeze 20%-50% of entire working capital funds.
Now with Surety Bonds almost coming up, it will free up around ₹8 lakh crore of private funds which erstwhile were tied up as collateral for Bank Guarantees.
- Improved liquidity in the construction sector
- Increase in Construction Opportunities
- Increase efficiency in execution of projects
- Less defaults between suppliers/contractors and project owners
- An incline in private investments
- Risks will now be more diversified since insurers will now take place of banks
- A new stream of revenue for insurance companies. Which means more jobs.
- Chances of an increase in FDI in the insurance sector
Q5. What’s the update of Surety Bonds in India?
Insurance companies and business owners have been long waiting for this financial instrument to be acceptable in India. And this year they saw their wish come true.
Finance Minister announces surety bonds in union budget 2022
Hon’ble Finance Minister Sh. Nirmala Sitaraman announced in the Union Budget 2022 that Surety Bonds can be supplied in place of Bank Guarantees. But the practical application of the same is yet to begin. So far few players (insurance companies like HDFC, ICICI, etc.) have tried but Surety Se7en www.Surety0007.com seems to have gone the farthest of them all.
The reason is that there are some legal and technical glitches that are still in the way of practical application of Surety Bonds
But the government is cohesively working with insurers. According to a recent article of “The Indian Express” The Ministry of Road Transport and Highways is in talks with insurers and have asked them to develop a model product of Surety Bonds.
Mr. Nitin Gadkari meets CEO of all general insurers
Mr. Nitin Gadkari (Minister of Road Transport and Highway) had some challenges due to which the implementation of Surety Bonds hasn’t been possible till now. So after meeting with all the CEO of general insurance companies and acting in-charge of IRDAI Mr. SN Rajeswari it has been concluded that a model product with all the basic features will be developed and tested for a while. The insurers can optimize the product as it is needed during its course of time.
Surety Bonds to boost infra projects
All-in-all the major purpose of Surety Bonds to come in India is to boost the infrastructure industry and support other industries like Import-Export. It will allow new players to come in and do business. Before Surety Bonds, it was difficult for new players, especially SME’s and startups, to come in and secure a bank guarantee in order to secure and execute a contract.
Surety Bonds to boost liquidity
Bank Guarantees are also expensive. Surety Bonds will free up that extra 20% to 50% of the total project cost that banks used to keep as security before. And that 20% when added to the working capital can make a bug difference to a business owner, especially for an SME or startup.. Besides, Surety Bonds will also keep the government (obligee) secure.
So in conclusion, with Surety Bonds everyone will be happy while ensuring the economic and infrastructural development. While banks may feel that they may lose out on potential revenue, it is incumbent upon Surety Providers like HDFC, ICICI, Tata, Surety Se7en, etc. to come up with a model that is inclusive of banks as stakeholders. Surety Se7en is currently working to incorporate intermediaries like banks and insurance brokers, with lucrative commissions, in their model to make the Bonds (or as they call it 007) a commonplace product in the Indian financial ecosystem.
Q6. What is the major issue with Surety Bonds in India that will be soon solved ?
Ans. Surety bonds are a new concept in India. And insurance companies here are yet to achieve that level of risk handling required in this business.
There has been no clarity, as such, on the pricing of Surety Bonds. And the major concern of the insurance industry is that they want Surety Bonds to be at Par with Bank Guarantee in terms of recourse when a default happens. This means that the insurance companies want the Surety Underwriter to be the Financial Creditor under the Indian Bankruptcy and Solvency Code.
This happens to be a genuine concern for the industry and IRDAI is backing it. The government has also taken this positively.
And to solve this problem the government has asked for development of a model product.
Q7. How Surety Se7en (Surety007) can help?
Ans. Knowing how to utilize different financial products can help your company grow.
A knowledgeable, reputable Surety Bond partner like Surety Se7en can take the weight off your shoulders and help you to concentrate on other avenues to grow your business.
Contact us for any questions you may have or to start assessing your surety bond needs. We pride ourselves on our knowledge of the industry, customer service and loyalty as well as having some of the best relationships with the industry.