Losses suffered by banks as a result of documentary fraud can now be insured against following the launch of a new documentary credit fraud policy by Lloyd's syndicate SVB Group.

Financial recovery following a documentary credit fraud has always been difficult and is usually associated with high costs and the waste of a great deal of management time. The new policy aims to protect banks involved in the finance of international trade in goods and commodities, and indirectly their clients. Already in use with several major banks, it covers most commodities, subject to underwriter's acceptance, and enables banks to recover direct financial losses suffered by their clients as their own loss.

Tailored to meet the needs of each bank's portfolio, the cover offered seeks to protect six key areas of business:

-Documentary credit fraud: cover against financial losses arising from the presentation of fraudulent, forged or counterfeit documents

-Theft of loss of trade finance documents: cover against financial loss from theft, loss, damage or destruction of trade finance documents anywhere in the world, including the insured's premises

-Theft of released goods: cover against the theft of goods released by the insured against a trust receipt, which may be stolen by an employee of the client, who then has the documents of title in their possession.

-Liability under trade finance indemnities: cover for claims made under an indemnity provided by the insured to a carrier who has a second bill of lading to replace one lost or stolen.

-Contingent credit fraud: cover for loss caused by a) negligence or fraud by an inspection agency, b) dishonesty or fraud by a confirming or advising bank, c) an insurer attempting to avoid payment under a goods insurance contract on the grounds of misrepresentation or non-disclosure by the insured's clients or the shipper.

-Errors & omissions claims: cover for errors & omissions for claims against the insured when acting as an issuing, confirming, advising or nominated bank.

Conditions

The Insurance is subject to a 10 per cent excess of the invoiced purchase price of the goods. In addition, banks must declare to the insurers all the banking instruments they issued during the insurance period involving the goods covered under the insurance. Also, the applicant for the letter of credit must engage an approved independent inspection agency, which confirms the quality and quantity of the goods and supervision of their loading, prior to payment being made to the seller.

Premiums are based on a sliding scale and on a percentage of the value of the documentary letters of credit issued. A 10 per cent no-claims-bonus is granted if no claims are made during the 12-month policy period. A 24-hour legal help line has also been provided to assist with recovery opportunities.

Although heralded in many quarters as an innovative and dynamic insurance solution that has long been needed to combat a growing problem, the new policy has still to win universal praise from the banking sector. Concerns have been raised in two areas: due diligence and cost.

Concerns

At least one major bank has expressed the view that clients who know that their bank has taken out this cover may be less careful in their approach to assessing risk because they know the bank will be able to recover any loss it sustains and may take shortcuts with due diligence checks. They may also expect their bank to exercise its rights on their behalf if they fall victim to fraud.

There is little doubt that a widespread adoption of the new policy will lead to a need for a realignment of the checks and balances presently employed ahead of any transaction. The method of premium calculation based on the declared value of all transactions could also make the cost of fraud cover expensive overall, says the bank.

Noting these concerns, Martin Shaw, chairman at brokers Cooper Gay & Co Ltd is quick to point out that the nature of the policy structure ensures that even if a client knows his bank has taken out cover, he cannot rely on the bank to make good any losses he may incur as a result of fraud. "This is primary insurance for banks, not their customers, and the decision remains with the bank whether or not it will indemnify its customer. A bank can elect to include its customer and not pursue him under UCP if it chooses, but it still remains incumbent on the client to continue due diligence checks," he says. "Furthermore, because the bank can only recover 90 per cent of any loss under the policy, it too has a definite incentive to ensure it continues to focus carefully on due diligence and reviews customer accounts at regular intervals."

Certainly, a policy of this kind is extremely useful in cases, such as with Solo Industries, where banks are not aware what is happening with transactions and are unwittingly drawn into a fraud, even though there is no suggestion they are involved, and where their current chances of effecting a recovery are zero. The 20-plus banks caught up in the Solo fraud are said to have already lost in the region of US$900 million, virtually none of it likely to be recovered, and new cases are still coming to light, as a result of a systematic deception by one of their trusted customers.

Protection

As regards premium cost, Mr Shaw says the price paid for cover remains firmly within the bank's control. There is no fixed list of rates and premiums are charged based on a trader's type of business, its location and who the banks involved are. Banks have the flexibility to elect what areas of their business are covered by the policy and can exclude some of their business altogether if they choose. Furthermore, they are not asked to pay the premium when a letter of credit is issued, only at the end of the transaction when, if necessary, they can pass on the charges to their client. "We have designed the new policy to be flexible and user friendly," he says, "with banks able to cherry pick, adjust premium rates or no-claims-discount, to put together a personal package of covers that is right for their business. As the product becomes more widely accepted and traders begin to appreciate the new benefits on offer, the banks will have even more flexibility to offset the costs to them and we may eventually see a situation where the cost is delegated to the client with each letter of credit that is opened. In the meantime the policy installs another layer of protection that on the whole has been warmly welcomed." More information from Cooper Gay & Co on +44 20 7480 7322.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.