RBI for closer look at linkages of insurance firms to financial system

The insurance sector’s linkages with the rest of the financial system needs better monitoring, to avert any possible systemic shock triggered by its core activities, the Reserve Bank of India (RBI) said today in the half-yearly Financial Stability Report.

The caution from the central bank comes as the Insurance Regulatory and Development Authority (Irda) is planning to allow banks to tie-up with two sets of insurance companies (life and non-life) to sell insurance products via the bancassurance channel.

“Inter-linkages of insurance activities with other financial institutions also could be a source of disruption in the financial system (the banking sector in particular),” RBI said.

The insurance companies are big investors in key financial markets such as equities and government securities. Their investment decisions and stability affects share movements. Similarly, exchange rate movements are affected when premiums ceded by non-life insurance companies to foreign re-insurers are significant.

“Unlike banking, where a fall in value of assets significantly below that of liabilities causes failures immediately through bank runs, insolvency in the insurance sector plays out in slow motion over several years,” RBI said.

However, the report added, Indian regulations restrict capital within a financial conglomerate, restricting the scope of such systemic risk. “In the case of insurance companies being part of a financial conglomerate, their bankruptcy can trigger systemic risk by casting doubt on the creditworthiness of the conglomerate's commercial bank, particularly if the bank is of sufficiently large size,” RBI said.

NBFCs
While the non-deposit taking non-banking finance companies (NBFCs) increased their loans and advances by a robust 27.6 per cent during 2010-11, deposit-taking NBFCs managed to grow their loans and advances by only three per cent in the same period. Whereas asset quality and profitability showed improvement from the previous year for all NBFCs, the capital adequacy ratio for non-deposit taking NBFCs showed a marginal decline.

“Keeping in view the economic role and heterogeneity of the NBFC sector and its systemic interconnectedness, the regulation of this sector has been progressively tightened. As a part of the important regulatory initiatives taken recently in this regard, the CRAR (capital adequacy ratio) of both NBFCs have been aligned to 15 per cent from the earlier stipulation of 12 per cent,” RBI said.