The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 19Credit Insurance, Surety Bonds, and Letters of Credit

In this chapter, we introduce three long‐standing and traditional products that protect firms against losses triggered by the default of a counterparty. Although they differ in technique, all the products enable companies to transfer credit risk to banks and insurance companies that provide the products. They are, therefore, useful to corporate risk managers anxious to reduce the amount of credit risk exposure on their own books. Most users of the products consider that the credit risk has been completely or nearly completely eliminated since losses are experienced only when a counterparty and the protection seller default simultaneously, which is highly unlikely.

Each product has its own characteristics, some imposed by regulators, some engineered over time by the main market participants, some reflecting the risk appetite of the providers. They are either bought for one's own needs or for the benefit of a third party that demands that they be provided. The buyer of the product may or may not be the beneficiary of the product; the beneficiary is the entity that seeks to transfer its credit risk exposure. Some variations of the products may have an exclusive application, and others compete with each other as substitutes. Credit risk managers' purchasing decisions are driven by what is available, what the objectives are, what they can afford, or what the situation they face requires. Table 19.1 provides a quick ...