What Basel 4 gets wrong about private credit insurance

Private credit insurance has become a central part of the global effort to scale sustainable finance and mobilise private capital for development. It serves as a risk transfer mechanism for private banks and increasingly also for official agencies such as multilateral development banks (MDBs), bilateral development finance Institutions (DFIs) and export credit agencies (ECAs).

Private credit risk insurers enable private and public financial institutions to make short-term (ST) and medium- and long-term (MLT) lending, guarantee and insurance capacity available in risk-constrained markets - notably in emerging markets and developing economies (EMDEs) — by providing comprehensive protection against both commercial and political risks. These risk transfer operations directly support capital mobilisation for the UN Sustainable Development Goals (SDGs) — financing ST and MLT trade, infrastructure, and climate-related projects that otherwise fall outside traditional unsecured bank operations.

Unfortunately, the current Basel capital adequacy framework for commercial banks does not explicitly recognise credit insurance as an effective risk mitigation tool, which negatively affects private insurers in their operations. It is time that Basel recognises the true strength of private credit insurance.

The Basel regulatory gap

Under the current Basel capital framework, commercial bank loans covered by private credit risk insurance do not receive preferential treatment compared to exposures to ordinary corporates. While the framework allows national regulators to classify “securities firms and other financial institutions” as “bank exposures,” such recognitions have generally not been made. As a result, exposures to credit insurers continue to be treated as corporate exposures, carrying higher risk weights than those applied to banks.

This lack of regulatory guidance is particularly challenging for local banks in many EMDEs, where central banks may be unfamiliar with credit insurance and uncertain about how its use by domestic banks should be treated for capital requirement purposes. This uncertainty partially explains the relatively low uptake of credit insurance in these markets.

Additionally, under Basel, credit exposures to banks are differentiated by maturity: short-term (ST) exposures attract lower capital requirements than medium- and long-term (MLT) exposures. ST exposures include cross-border trade finance with tenors of up to six months. By contrast, exposures to corporates - including credit insurers - do not benefit from more favorable treatment for ST exposures (see table below).

The key reason Basel regulators assign lower capital weights to exposures to banks than to corporates is that banks are subject to stringent prudential regulation and continuous supervision by central banks and other competent authorities. The preferential treatment for ST trade finance reflects short tenor, low historical default risk and the self-liquidating nature of ST trade finance, but these arguments are equally relevant for ST private insurers.

Please note: (a) Capital requirement = risk weight × exposure × 8%. In the calculations an exposure of USD 100 million is assumed. (b) Short Term (ST) concerns exposures to banks with an original maturity of 3 months or less, as well as exposures to banks that arise from the movement of goods across national borders with an original maturity of 6 months or less. These ST exposures can be assigned a ST risk weight. Source: Author

The corporate risk approach for private credit insurers in the Basel framework fails to reflect the true credit risk profile of regulated credit insurers and effectively overstates capital requirements on insured assets. In this context the following risk considerations are relevant:

• In the EU, credit insurers operate under Solvency II, a robust risk-based solvency regime broadly equivalent in prudential strength to Basel III, which applies to banks. In many non-EU countries similar prudential regulatory regimes exist for private insurers.
• In many jurisdictions, the same supervisory authority (typically the central bank) oversees both banks and insurers.
• Policyholder claims enjoy statutory priority – a “preferred creditor status” – in insolvency in most jurisdictions — meaning banks’ recoveries as policyholders are senior to unsecured creditors. Such a priority status does not apply to claims under bank guarantees.
• Credit insurers typically cede between 20% and 60% of their insured exposures to highly rated global reinsurers, thereby diversifying and reducing their net risk exposure. As a result, the payment capacity on a policyholder’s claim is ultimately supported not only by the financial strength of the insurer itself, but also - albeit indirectly - by that of its reinsurers. This risk-sharing structure has no equivalent in banking: a bank that provides a loan or guarantee generally retains 100% of the associated risk, and bank guarantees are not usually backed by any reinsurance or risk participation mechanisms. Assuming the reinsurers have credit ratings at least equal to those of the primary insurer, a well-diversified reinsurance panel enhances the overall credit quality of the insurance counterparty and thus reduces the policyholder’s counterparty risk.

These factors suggest that exposures to well-regulated credit insurers may warrant even more favourable capital treatment than exposures backed by bank guarantees. Regulators may argue that credit insurance does not fully meet the Basel framework’s definition of a qualifying guarantee because of standard policy exclusions — for instance, losses caused by a war among the permanent members of the UN Security Council or nuclear incidents. Although such events are extremely rare, their potential magnitude exceeds what the private market can reasonably absorb.

A second argument sometimes raised is that credit insurance is not unconditional, since a claim payment may be denied if the insured fails to comply with key policy obligations. However, this is standard practice across all types of insurance and merely reflects the non-compliance risk of the insured party. In Basel terminology, such risk falls under the “operational risk” of the insured bank — not under the creditworthiness of the insurer or the conditionality of the insurance contract. Operational risk is already subject to specific capital requirements under the Basel framework. And banks benefitting from guarantees are exposed to comparable compliance risks.

Inconsistency in the current framework

From a pure credit-risk and loss-given-default perspective, a bank’s exposure covered by a robust credit insurance policy is demonstrably safer than a direct unsecured loan to the same insurer — and also safer than an exposure that benefits from a standard bank guarantee. Treating exposures resulting from insurance policies provided by credit insurers as corporate risk:

• Overstates risk,
• Inflates capital charges,
• Disincentivises the use of private insurance for prudent risk transfer, and  
• Creates an unlevel playing field between regulated credit insurers and banks providing guarantees — despite the fact that a comprehensive credit insurance policy provides substantial better loss protection than a bank guarantee.

The overly conservative capital requirements for credit insurance negatively affect the use of ST and MLT credit insurance.

A well-calibrated revision of the Basel framework would deliver significant benefits, including:

• More efficient bank capital deployment. Lower risk weights on insured exposures, would free up bank capital to finance trade, infrastructure, and SME activity without weakening prudential soundness.
• Mobilisation of finance for the SDGs. Multilateral and bilateral development banks and ECAs increasingly rely on private insurers to increase their lending and insurance operations and optimise their balance sheets. A more accurate Basel treatment would multiply their catalytic impact.
• Enhanced cooperation with local banks in EMDEs. An explicit recognition of credit insurance in the Basel framework will help to improve cooperation between private credit insurers and local banks in EMDEs.
• Greater financial system resilience. Encouraging risk transfer to well-capitalised private insurers and reinsurers reduces systemic concentration.
• Improved access to finance for SMEs. Many private insurers are very active in supporting trade with SMEs acting as exporter of importer.

These policy objectives are shared by the United Nations, International Monetary Fund, Organisation for Economic Co-operation and Development, European Union, central banks, and national governments.

A call to action

As the global financial community strives to mobilise trillions in private capital for climate mitigation and adaptation, trade resilience, infrastructure and inclusive growth, regulatory consistency becomes essential. It is not proposed that exposures to credit insurance companies should all automatically be treated as bank risk. But where a bank holds a comprehensive credit insurance policy - featuring both commercial and political risk coverage - such exposures should at least receive a capital weight equivalent to that applied to exposures to banks.

This approach represents a reasonable and technically sound compromise. It would align capital requirements with actual credit risk, address the current competitive imbalance between bank guarantees and private insurance, and facilitate greater mobilisation of capital for sustainable development.

It is recommended that the Basel framework explicitly:

• Recognise comprehensive credit insurance as an important credit risk mitigation tool, providing clear global guidance for supervising central banks and commercial banks in both developed countries and EMDEs.
• Assign exposures arising from banks’ policies with prudently regulated and supervised private credit insurers a capital weight at least equivalent to that of exposures to banks, instead of the higher risk weights applied to corporates.
• Apply lower capital weights for ST counterparty risk exposure than those for MLT exposure, similar to those applicable for commercial banks.

Given the regulations’ far-reaching impact on sustainable finance, mobilisation of capital for development and global financial stability, Basel regulators should adopt a more holistic approach that considers not only risk, but also the societal and developmental consequences of their rules. This issue therefore warrants a prominent place on the international agendas of the UN, G20, and Basel Committee on Banking Supervision (BCBS).

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