As announced recently by the Union Minister of Road, Transport and Highways Nitin Gadkari, surety bonds will soon be launched by insurers. These bonds will replace bank guarantees that tend to lock up significant capital (up to 30 percent) of construction projects.
As a matter of fact, the first surety bonds will be launched by Bajaj Allianz on December 19, the minister had recently stated.
What are surety bonds?
Surety bonds are guarantees of payment issued by insurers, but different from bank guarantees since a sizable amount of the project cost does not get frozen.
The Centre had pushed for this idea since liquidity with the infrastructure sector became a major issue during the Pandemic.
Consequently, in the Union Budget 2022-23, Finance Minister Nirmala Sitharaman rolled out a plan to use surety bonds as a substitute for bank guarantees.
“To reduce indirect cost for suppliers and work-contractors, the use of surety bonds as a substitute for bank guarantee will be made acceptable in government procurements. IRDAI has given the framework for issue of surety bonds by insurance companies,” Ms Sitharaman had said during the Budget 2022-23 speech.
Recently the Ministry for Road Transport & Highways urged the insurance regulator Insurance Regulatory and Development Authority (IRDAI) to develop a model product on ‘Surety Bonds’ after consulting with general insurers that could be offered to highway developers.
How will it help infra sector?
Before lending money to construction companies, banks usually seek around 30 to 50 percent of cash margin as a guarantee. Alternatively, these companies will now be able to buy ‘surety bonds’ thus preventing their huge capital from getting stuck as bank guarantees.
This is because the premium charged for insurance bond is likely to be lower, making the product far more affordable in comparison to bank guarantees.
“There is a lot of financial capital that is locked because of bank guarantees. Surety bonds will free up that capital, thus making the process (of executing road projects) rapid,” said a spokesperson from Bajaj Allianz Insurance.