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The blog provides a sneak peek into the world of Surety Bonds and its applicability to International Trade business. Importers/Exporters, Trade Finance Bankers and other Trade Finance stakeholders will benefit from this article.
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The blog provides a sneak peek into the world of Surety Bonds and its applicability to International Trade business. Importers/Exporters, Trade Finance Bankers and other Trade Finance stakeholders will benefit from this article.
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The blog provides a sneak peek into the world of Surety Bonds and its applicability to International Trade business. Importers/Exporters, Trade Finance Bankers and other Trade Finance stakeholders will benefit from this article.
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29 Nov 2024
Highlights
- Surety Bonds are extensively used by Insurance companies but have been less explored by bankers in the commercial banking domain.
- Most of the stakeholders related to International Trade have limited knowledge of this financial instrument.
- There is an increase in demand for Surety Bond especially in the infrastructure space. But much more awareness and amplification is required for exponential growth of this financial instrument.
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Overview
What are Surety Bonds?
Surety Bonds are a legally binding contract between three parties.
- Principal – The party obliged to perform the task.
- Obligee – The party who requires the bond from the principal and receives the bonds protection.
- Surety – The party who provides financial protection against non-performance or any other breaches.
Surety Bonds are typically unsecured without any collateral, they are not a form of debt and to be treated as an off-balance sheet item.
Solution
How does Surety Bond Work?
The principal will request a Surety Bond with the Company/Financial institution (Surety Company) to provide a credit line and undertake financial guarantee to pay the obligee if the principal does not fulfil their obligation as per the terms listed. Obligee to raise a claim with the Surety Company as per the Surety Bond terms & not exceeding the bond value
e.g. for Trade Finance - Grainny Corp (Importer) in UK is importing grains from Wheaty Corp (exporter) in India. Grainny Corp would like to mitigate the risk of advance payment (if made) to the exporter or if the goods have not been exported. Therefore, Grainny Corp requests Wheaty Corp to arrange for a Surety Bond.
Wheaty Corp (Exporter – Principal) connects with Sureyy Corp (Surety Bond company/issuer) to arrange for a Surety Bond in favor of Grainny Corp (Importer – Obligee) to cover this risk. Sureyy Corp post all due diligence will issue the Surety Bond. Due to any unfortunate circumstances, Wheaty Corp is not able to fulfill the terms of the contract. Grainny Corp can claim financial reimbursement from Sureyy Corp. Post detailed scrutiny & investigation of the claim and the breach of terms of contract. Sureyy Corp will pay Grainny Corp. As the Surety Bond typically are with recourse, post payment to Grainny Corp, Sureyy Corp will try & recover the funds from Principal – Wheaty Corp. Above is just an example from importers standpoint but Surety Bond can be used by both importers & exporters depending upon the requirement/terms of contract.
Advantage
Key Advantages of Surety Bond
Risk Mitigant – The obligee is covered by the Surety bond if the principal defaults on the contract. In case of a default, the process of claim is much simpler and faster
Ease of doing business – The principal can enhance its overall credibility by arranging for a surety bond which helps in attracting more business & overall business growth, the process of arranging a surety bond is comparatively simple and seamless compared to other financial instruments
Cost Reduction – The overall fees both for Principal and obligee are comparatively low moreover these bonds are treated as off-balance sheet items
Conclusion
In future, we envisage Trade Finance stakeholders actively using Surety Bond as this helps them to improve their overall capital requirement, reduce cost due to lower fees, faster claims. The Surety Bond is treated as an off-balance sheet item and unlike most of the cash collateralized Letter of credit which is accounted for in Balance sheet. Lately, we have seen an increase in demand for Surety Bond especially in the Infra structure space but much more awareness & amplification is required for exponential growth of this financial instrument.
About the author
Image of Deviprasad Hegde
Deviprasad Hegde
Deviprasad Hegde is a domain expert and Head of Trade Finance Centre of Excellence with TCS’ Banking, Financial Services, and Insurance business unit.
He has over 25 years of operations experience handling the entire gamut of products under the trade finance domain operations for various global banks. For the past few years, he has been working with global, super-regional banks providing consulting services. He is a Certified Trade Finance professional (CITF) from the IFS school of finance, UK. He holds a Certificate in Trade Finance (CTF) from the Indian Institute of Banking & Finance and a Diploma in International Trade Management (DITM) from NMIMS, Mumbai. He also holds a bachelor’s degree in commerce from Mumbai University.
He has authored whitepaper on Trade Finance assets which is published on TCS website. He has been participating as panelist/moderator for numerous webinars both internal & external to TCS
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