The booming credit insurance industry may be harmed by the UK prudential regulator’s proposed new capital requirements rules, according to industry figures, who also argue the reforms could dampen appetite for bank lending.

In its proposals for implementing the latest Basel banking regulation rules, the Prudential Regulation Authority (PRA) said in March it plans to wind down current practices which allow large banks to use their own models to assess the credit risks of exposures to insurers through credit insurance policies.

Instead, the UK will eventually require large banks to assess exposures to insurers with a 45% loss given default (LGD), which estimates the expected loss to a lender in the event of a default, meaning credit insurance will provide less capital relief than it does currently.

The PRA’s proposals are part of a broader package of measures to incorporate the latest tranche of Basel Committee on Banking Supervision standards in UK regulation. The PRA’s mooted treatment of some key trade finance products has also attracted warnings from lenders.

Previously a mainstay of riskier exposures to developing economies, use of credit insurance in developed countries such as the UK has soared in recent years, according to industry data.

The International Trade and Forfaiting Association (ITFA), citing a broker, says the UK became the second-largest country exposure for credit insurers in 2022, after ranking 11th in 2018, reflecting the growing popularity of credit insurance in wealthier nations. Banks nominated credit insurance as the second-most popular credit risk mitigation tool in 2020, according to an ITFA survey, bettered only by the sale of loans.

Credit insurance is widely used to lubricate trade finance. Worldwide, around €2.5tn in trade receivables is insured each year, according to the International Credit Insurance and Surety Association.

But bankers and insurers say that growth could be deflated by the PRA’s plans, which they argue overestimate the likelihood of large insurance providers collapsing and may lead to insurers retreating from credit insurance products.

A higher mandated LGD of 45% will make credit insurance a less effective credit risk mitigation strategy for larger banks, meaning they will be less likely to choose credit insurance policies or only use such cover for riskier debts that justify the less favourable economics.

That in turn could discourage insurers from making the product available. “If insurers’ risk profiles increase, credit insurance may not be such an attractive proposition for an insurance company determining where to allocate its own capital as between classes of business,” Sian Aspinall, group CEO of broker BPL Global, tells GTR. “As a result, a market contraction may well be possible.”

“If insurer supply contracted faster or greater than bank demand then insurance pricing could actually come under upward pressure at the same time as reduced lending volumes with the resultant negative impact on the real economy,” she adds.

ING managing director Jean-Maurice Elkouby, who is responsible for the bank’s credit insurance purchases, tells GTR: “At the end of the day, there will probably be less volumes insured, less lending done, or if lending is done that will probably be at a higher price as well. So, it’s all bad news.”

The process for small and mid-sized banks, which use a simpler capital treatment approach, will be left largely unchanged by the PRA’s reforms.

But larger banks – which use the advanced method to calculate exposure that is being targeted by the PRA – are responsible for around 90% of credit insurance purchases, according to Elkouby, who is also the head of ITFA’s insurance regulatory advocacy working group.

Regulators seem keen to curb the current possibility for banks to calculate their own LGDs for insurance, he tells GTR. “I think the regulator has seen too much expert judgement, and not enough statistics to back up the models that are being used.”

“They say ‘show me the stats’, but we can’t show them because there are so few default events amongst insurers. As a result, even less data is available for what you would recover under those circumstances, to peg a loss given default percentage on that.”

In a submission to the PRA’s consultation on its Basel implementation, ITFA instead argues for an LGD of around 20%, depending on the specifics of the exposure.

ITFA says the PRA’s current formulation does not recognise that the EU’s Solvency II directive, which the UK transposed when it was a member of the bloc, puts policyholders ahead of other creditors in the event of an insurer becoming insolvent.

All credit insurance claims filed in the five years preceding 2023 were paid in full by insurers, ITFA says in its submission.

Aspinall says that the Basel transposition is an opportunity for the PRA to build on a widely welcomed policy statement that it issued in March 2019, recognising credit insurance as an admitted form of eligible unfunded credit risk mitigation.

“No other regulator to date has issued such a detailed formal position which was very much welcomed by both the banks that utilise the product and the part of the insurance industry that offers it.”

The EU also intends to impose a similar treatment of credit insurance under its implementation of the latest Basel standards, but after pushback from the industry it tasked the European Banking Authority with determining a suitable LGD for credit insurance, with a report due in June 2024.

A spokesperson for the PRA declined to comment.