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Bancassurance - Regulatory and Supervisory Issues



With the increased structural deregulation within the financial system and globalization the banking system in India has been exposed to tough competition compelling them to move towards not only new vistas of business activity under one roof by moving towards the ‘universal banking framework’ and ultimately the emergence of financial conglomerate. Such developments bring along some regulatory and supervisory concerns. Banks have been functioning strictly on a ‘traditional banking style’ with extremely compartmentalized manner. Now that the banking system enjoys more of ‘structural freedom’ revealing themselves to nontraditional activities such as insurance, derivatives, investments banking, etc., there is possibility of migration of risks from the rest of the activities to the banking system. Thus, the increased market integration and globalization are demanding new realism on the part of the regulator and supervisor for more stricter prudential regulation and supervisor on ‘inter-sector’ activities especially, allowing for the pace with which the system is moving. This process is referred in the literature as ‘structural deregulation’ and ‘supervisory re-regulation’. While it is inevitable that Indian banks entering into insurance sector, given the size of the transactions in ‘general insurance transactions’, coupled with the type of built-in risks on the one part and that the banking system being the focal point of the payment and settlement on the other, any movement from the former to the latter will have a greater systemic implications. Therefore adequate and suitable checks and balances are required to be put in place in time by all regulatory authorities concerned.

Going by the international experience and specificity of the Indian system, the likely problem areas are being enumerated here. The problem of ‘conflict of interest’ would also occur in a different form; as banks are privy to a lot of information about the customer, especially in the context of knowing your customer (KYC) system being in place, these information could be used by the insurers for their unfair advantage. With more integration between and among various constituents of financial sector, there is greater possibility for ‘contagion effect’. In India all insurance companies in private sector of current origin and are in the process of stabilizing, also highly aggressive due to tough competition. The over ambitiousness should not smack their own restriction, especially in the case were insurance business is an internal organ of the universal banking system. Especially in a situation such as large scale natural calamities, viz., Tsunami, earthquake, floods, etc., would have a serious debilitating impact on the banking system, via insurance business. Therefore, the regulation and supervision needs to address the institution as a ‘financial conglomerate’ rather than each institution individually. The regulator of the insurance sector is of very recent origin unlike the banking sector regulatory authority, viz., RBI. Although IRDA has done appreciable work within the short period, the regulation itself is a learning experience, any major migration of risk from insurance to banking would be more devastating if that was not handled properly at the right time. In the absence of a unified regulator or a single regulator, the possibility for ‘regulatory arbitrage’ could not be ruled out. Presently there is no statutory compulsion that the regulators should part with each other the sensitive information relating to their respective regulatory areas in order to read the signal, if any, which has systemic implications.

Differences in the risk characteristics in banking and insurance will persist, relating, in particular, to the time pattern and degree of uncertainty in the cash flows and that has to be recognized and appropriately handled. The insurers’ internal risk management and control systems for managing their asset market activities, and credit risk seems to be relatively less transparent unlike the banking system as also the prudential regulatory and supervisory system towards insurance is relatively recent one and less rigor as compared with the banking system, especially in the context of the banking system moving towards the Basel II framework. Conflicts of interest between different regulators also could not be ruled out. Ensuring transparency and disclosure on activity-wise may be difficult task for the regulators, albeit it is essential. Possibility of abuse of consumers by bankers from being coerced to buy insurance products against their will need to be guarded, which RBI has been already emphasizing in its circular.Risk of ‘double gearing’ also possible as pointed out by Gentlay and Molyneux (1998). Possibility of banks using the long term insurance funds to meet their short term liquidity and the problem of asset - liability management also could not be ruled out. Recognizing the value of sound risk management practices and hence also valuations on an aggregate portfolio basis – rather than individual instrument basis – would become essential to achieve alignment of underlying economic realities with financial statements, as the system is moving towards higher integration of varieties of activities including insurance.

Deposits and Bank Accounts
Fixed deposits