The law is too rushed and doesn’t equip insurance companies with the tools to meet its requirements. Fitch argues

Fitch Ratings, one of the big three American credit rating agencies, has issued a report criticising El Salvador’s plan to recognise Bitcoin as legal tender. According to the agency, this move could have unforeseen consequences and will negatively affect local insurance companies that are exposed to Bitcoin.

Fitch released a statement yesterday stating that El Salvador’s insurance industry would have to take on higher foreign exchange risk and earn volatility risks to allow Bitcoin to be accepted in its monetary system. Fitch also suggested further considerations that local insurance companies must take to mitigate regulatory and operational risks and expenses related to new IT requirements.

Fitch also considers Bitcoin a ‘risky investment’ under the Risky Asset Ratio. This means that an insurer’s exposure to Bitcoin can be credit-negative, since gains made via speculative investments are subject to rapid reverse and can create volatile earnings streams.

El Salvador approved the legislation to allow Bitcoin to be used as legal tender on June 2021.. This law will take effect on 7 September 2021., just weeks away. Fitch insists that local insurers face a difficult task because the country has yet to disclose its plans for implementation and there is no precedent comparable adoption by central bank in other global markets.

It is important to remember that, if the law is as it is now, insurance companies will have to accept Bitcoin. They will then have to decide whether they want to sell or hold the cryptocurrency.

Having Bitcoin on a company’s balance sheet for a prolonged period exposes El Salvador to the volatility associated with cryptocurrencies. Insurers would lose valuable funds if they didn’t sell Bitcoin immediately after receiving it.

El Salvador has yet to issue a regulatory and operational framework confirming whether Bitcoin can be converted immediately into USD, or if there is a minimum holding period. This adds to the confusion for the insurance industry.

“The regulation appears to be unnecessarily rushed and leaves insurance companies with very little time to adapt to its requirements, creating additional risk for the industry,” Fitch concluded.