Fitch Ratings said in a note on Monday that El Salvador’s move to embrace Bitcoin as legal tender poses a serious risk to its local insurance companies. As Fitch said, Salvadoran insurers will be under pressure to quickly convert Bitcoin to dollars to avoid price risk; otherwise, they could face steep losses.
In June, Salvadoran president Nayib Bukele ushered a bill through congress that made the cryptocurrency legal tender, exempting it from capital gains tax and requiring businesses and tax collectors to accept it.
Although El Salvador’s move to make Bitcoin as legal tender in the country has attracted mass amounts of attention, concerns also arose. Protests, lawsuits, and criticism followed after the decision was made, including El Salvador’s opposition party that sued the government over the new legislation.
Following the World Bank and the International Monetary Fund (IMF) warnings, as well as Moody’s concern earlier this month, Fitch Ratings likewise expressed concerns over possible adverse effects on El Salvador’s financial institutions and insurance sector if Bitcoin is adopted.
In particular, Fitch suggests that there could be negative consequences since it introduced Bitcoin as legal tender in the financial and insurance sector. The new law would force these institutions to keep their BTC or sell their cryptocurrencies to avoid price risk, Fitch said.
Most notable is the risk of exchange-rate volatility, stemming from the requirement that insurers accept Bitcoin. Such firms will be under pressure to quickly convert Bitcoin to dollars to avoid price risk. If that is not possible, insurers could face steep losses should Bitcoin sell-off.
Fitch predicts that insurance firms, which made 21% of El Salvador’s total capital in 2020, will be hesitant to adopt Bitcoin for claims or benefit payments. The agency speculates that insurers will likely seek to “convert Bitcoin into USD as quickly as possible to limit exchange risks” should policyholders opt to pay premiums in digital currency.
Bukele has reassured Salvadorans as well as international investors that using Bitcoin will be optional and that Bitcoin payments can automatically be received in dollars.
However, the underlying regulation governing Bitcoin’s official status remains uncertain yet. With Bitcoin’s legality set to come into effect on Sept. 7, Fitch described the process as “unnecessarily rushed,” adding that it “leaves insurance companies with very little time to adapt.”
Issuing its ratings for Salvadoran insurers, Fitch warns it will consider Bitcoin as a risky reserve asset, citing the cryptocurrency’s “lack of transparency.” This could leave the industry even more fragile, as many insurers already hold large caches of low-rated Salvadoran government bonds. In the July rating of El Salvador’s sovereign debt, Fitch referred to the new Bitcoin law as one of several reasons for maintaining a B- rating. As the rating agency noted, adopting Bitcoin as legal tender could imperil debt-relief talks with the IMF, further debasing the country’s bonds.