The law is unnecessarily rushed and does not give insurance companies the means to adapt to its requirements, says Fitch.

Fitch Ratings, one of the three major US rating agencies, has published a report criticizing El Salvador’s plan to recognize Bitcoin as legal tender. The agency says the move will have a negative impact on the credit of local insurance companies exposed to Bitcoin and could have unintended consequences.

In a statement released yesterday, Fitch explains that El Salvador’s insurance industry will have to bear the brunt of higher currency exchange risks and income volatility in order to integrate Bitcoin into the monetary system. The agency also alluded to other considerations that local insurers will need to consider to facilitate regulatory and operational risks, as well as expenses related to new IT and administrative requirements.

Fitch further classifies Bitcoin as a “risky asset” in the risk asset ratio, which means that an insurer’s exposure to Bitcoin is inherently negative for credit, as gains made through speculative assets can reverse quickly and create a volatile revenue stream.

El Salvador passed legislation to accept Bitcoin as legal tender on June 9, 2021. The law is expected to come into force in a few weeks, on September 7, 2021. As the country has not yet revealed its plan for practical implementation of the law and there has been no comparable prior adoption by central banks in other global markets, local insurers face a challenge they are not equipped to overcome, Fitch insisted.

It is important to note that if the law is implemented in its current form, insurance companies will be forced to accept Bitcoin and will have to decide whether to keep or sell the cryptocurrency when they receive it.

Holding Bitcoin on their balance sheets for a long time exposes the already battered Salvadoran insurance industry to the volatility and risk associated with cryptocurrencies. On the other hand, the immediate sale of Bitcoin as soon as they receive them would cost insurers valuable funds that could have been used in strategic business areas.

In addition, El Salvador has yet to publish a regulatory and operational framework specifying whether Bitcoins can be immediately converted to USD or whether the law imposes a minimum holding period, which adds ambiguity for the insurance industry.

« Regulation seems to be unnecessarily rushed and leaves insurance companies very little time to adapt to its requirements, creating additional risk for the industry “, concluded Fitch.