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Union Finance Minister Nirmala Sitharaman on Tuesday gave thumbs up for surety bonds as a substitute for bank guarantees in case of government procurement and also for gold imports.

Presenting the Union Budget 2022-23, she said that in order to reduce indirect cost for suppliers and work-contractors, the use of surety bonds as a substitute for bank guarantees will be made acceptable in government procurements.

She said gold importers may also find this useful and the Insurance Regulatory and Development Authority of India (IRDAI) has given the framework for issue of surety bonds by the insurers.

Recently, the IRDAI came out with the IRDAI (Surety Insurance Contracts) Guidelines 2022 laying down the norms for this line of business.

It has capped the quantum of surety insurance contracts for an insurer at 10 per cent gross premium written subject to a maximum of Rs 500 crore per year.

The IRDAI has also stipulated that the non-life insurers wanting to underwrite the surety insurance risks should have a solvency margin of 1.25.

Non-life insurers are allowed to carry out this business from April 1 onwards.

"The norms will help regulate/develop surety as a business in India which otherwise is an accepted norm in the western countries," said Vikash Khandelwal, CEO, Eqaro Guarantees, a Mumbai-based surety solutions provider.

"However, it would have been ideal if the final norms had also provided for a specialist surety insurance company," he added.

According to Khandelwal, allowing the surety insurers to work alongside the banks and other financial institutions to share risk-related information and technical expertise will help foster a robust ecosystem and prevent contagion.

"The guidelines are also silent on the right of recourse available to a surety insurance company in the event of a default by the contractor. These are critical and may impede the creation of surety-related expertise and capacities and eventually deter insurers from writing this class of business," he added.

There are three parties to this contract viz., Surety is the person who gives the guarantee, the person in respect of whose default the guarantee is given is called the Principal Debtor, and Creditor is the person to whom the guarantee is given.

The other underwriting guidelines, as per the IRDAI, are surety insurance contracts which can be issued for infrastructure projects of government/private in all modes.

The contract bonds may include Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money, and the insurers can also underwrite Customs or Tax Bonds and Court Bonds.

However, the limit of guarantee cannot exceed 30 per cent of the contract value, the surety insurance can be issued for specific contracts alone, the insurer cannot issue any surety insurance contracts on behalf of its promoters/subsidiaries, groups, associates and related parties, and the insurer shall not enter into alternate risk transfer mechanism.

Also, surety insurance contracts cannot cover financial guarantee, and surety insurance cannot be issued where the underlying assets/commitments are outside India.