Meaning and Conditions of Underwriting - Advanced Corporate Accounting | Advanced Corporate Accounting - B Com PDF Download

Definition of 'Underwriting'

Definition: Underwriting is one of the most important functions in the financial world wherein an individual or an institution undertakes the risk associated with a venture, an investment, or a loan in lieu of a premium. Underwriters are found in banking, insurance, and stock markets. 

The nomenclature ‘underwriting’ came about from the practice of having risk takers to write their name below the total risk that s/he undertakes in return for a specified premium in the early stages of the industrial revolution. 

Description: Today, underwriting is one of the key functions in the financial world and has become a discipline of sorts in itself. 

Underwriting in insurance 

In the insurance world, underwriters determine whether an insurance agency should undertake the risk of insuring a client. They determine the risk and exposure of clients and also how much insurance should be granted to a client, how much they should pay for it and whether or not to offer an insurance policy to the client in the first place. 

Underwriting in stock market 

In the securities market, underwriting involves determining the risk and price of a particular security. It is a process seen most commonly during initial public offerings, wherein investment banks first buy or underwrite the securities of the issuing entity and then sell them in the market. This ensures that the issuers of the security can raise the full amount of capital while earning the underwriters a premium in return for the service. 

Investors benefit a lot from the underwriting process as the information provided by an underwriting agency can help them take a more informed buying decision. An underwriter who holds a large chunk of the securities of a particular company or is the market maker for such a security provides the core liquidity for the security and enhances price stability and distribution. 

Underwriting in banking

Underwriters in the banking sector perform the critical operation of appraising the credit worthiness of a potential customer and whether or not to offer it a loan. They appraise the credit history of the customer through their past financial record, statements, and value of collaterals provided, among other parameters.