By Siddharth Acharya.
Banking and insurance are traditionally seen as two separate pillars of the financial services industry. They have distinctly different business models, operating priorities and financial requirements. This has led the financial service regulators across the globe to keep these two industries separate. In India too they are different verticals which are regulated and controlled independently. However, major banks, through their significant shareholding and presence on the board have been exercising significant, if not absolute, control over several insurance companies. RBI has been proposing to reduce the holding of banks on insurance companies but has those steps yielded the results desired?
Insurance and banking, at its core, are two different businesses. Insurance is a ‘long term’ business in which companies have to wait for long periods to break-even and make profits. Capital gets locked up for longer cycles than banking. If banks get deeply involved in insurance business their focus on lending and other banking activities would be seriously affected as the cash flow cycles of insurance may not be conducive to the needs of banking. Liquidity requirements of the two domains are drastically different. This conflict of objectives could potentially have an impact on the ability of insurers to take optimal decisions with regard to investments and managing cash flows.
The primary reason why the regulations clearly mandate a separation between banking, capital markets and insurance is to create a separate niche for each sub-vertical of the financial service industry and facilitate them to function independently and freely. Encouraging independence of the sub-verticals would ensure a stronger financial service sector as each arm can complement each other in providing services to the customer.
In addition to holding stakes in Joint Ventures and other insurance entities, banks also serve as an important channel for selling insurance. This creates a binding structure where the channel of sales is owned by the banks itself. This could adversely affect the level-playing field that other competing channels would expect to get. Bancassurance is a channel where pressure points can be generated for procuring business. For example, the bank providing loans has a major say in where the corresponding asset is insured. The bank that provides credit serves as the channel providing insurance and also as the owner of the insurer who provides the risk coverage. The entity seeking credit is often robbed of the freedom to choose the insurance service provider and the channel of purchase. Also, a lot of times, it is observed that as lender the Bank’s interest to insure is limited only to the extent of funding and issues arising out of ‘under insurance’ puts the insured at higher risk / financial losses. The insurance regulator in the past had tried to free-up insurance distribution from the clutches of Bank’s control by mandating minimum of three tie-ups each in Life, GI and Health. However, only 3.6% insurers have complied with these rules as on March 2020. Most of the Regional Rural Banks, that should help improve insurance penetration in Rural India are still continuing with only one insurance tie-up in LI & GI, needless to say with those insurers promoted by their own Parent Bank. Such practices are not healthy and conducive to development of the Indian insurance market.
This naturally leads to the question of whether limiting the ability of banks to fund insurance companies would create shortage of capital. That is unlikely to be the case as the regulations are progressively moving towards higher limits for foreign investments in insurance sector. The potential of Indian insurance market is well known. The utilization of FDI is still low and we have a clear opportunity to grow this. The inflow of FDI has not been as strong as the expectations were and the FDI in Insurance equity capital is abysmally low at 2.36% of overall FDI in service sector in March 2020. We can attribute this to either the wait and watch approach of many overseas players or the discomfort with the regulatory and the market set up. Proactive steps to demonstrate the ease of doing business and the supportive regulatory structure that we can provide would give the necessary incentive to attract overseas investments. In any case, these issues would wear off with time and the foreign investments are likely to come in sooner than later.
Overall, keeping the separation between banking and insurance with adequate facility for entities to work together smoothly should go a long way in strengthening and developing the Indian insurance industry. The level playing field that this would provide will also be a factor that could attract more foreign investments.
The writer is a practicing advocate in Banking and Insurance Law. Views expressed are his own.)