Home / Industry / Is there reason to worry about LIC’s banking linkages?

Mumbai: Here’s a little-known fact about the nation’s largest insurer: if it were a bank, Life Insurance Corp. of India, or LIC, would be ranked the country’s 11th largest in terms of loans.

This, and the fact that it owns significant equity stakes in Indian banks appear to have made the Reserve Bank of India (RBI) nervous, as the banking regulator ponders the possible systemic implications of these linkages.

The global financial crisis of 2008 led regulators across the world to pay close attention to institutions that were seen as “too big to fail". LIC, with assets under management of about 17 trillion, would arguably fall in that category in the Indian context.

While RBI has put in place more stringent norms for systemically important banks and will start disclosing their names from August, institutions such as LIC, which span different sectors, fall in a grey area.

The issue has, in fact, come up at the Financial Stability and Development Council (FSDC), a forum where regulators meet.

But the question is: Does LIC need greater supervision, and should the banking regulator have some oversight on LIC’s lending operations and banking inter-linkages?

RBI acknowledged that some of these issues may have come up for discussion but did not elaborate.

“FSDC and its sub-committee, as a part of monitoring financial stability, periodically factors in exposure and interconnectedness of other financial institutions like LIC. The Financial Stability Reports (including the latest one of June) do discuss this," said an RBI spokesperson in response to a query, without going into details.

The Insurance Regulatory and Development Authority of India (Irdai) did not reply to an email sent last week. LIC did not respond to an email sent on Thursday.

So, is there a reason to worry?

LIC’s lending business

Going by LIC’s reported loan portfolio, the insurer has a loan book the size of the country’s 20th largest bank. Add investments in debentures and bonds of companies and banks, and the book crosses 2 trillion. If this combined book was housed in a bank, it would be the 11th largest lender in the country, after IDBI Bank Ltd.

Investments in debt instruments of corporates and banks are over and above LIC’s investment in the government bonds, which, as on 31 March, was close to 10 trillion, up from 8.11 trillion a year ago.

LIC, like any other life insurance company, is guided by certain prudential and exposure norms.

For instance, there are broadly two categories of investments defined by the Irdai -- “approved investments" and “other investments". Life insurance firms are required to channel at least 85% of their life funds and 75% of their unit-linked funds into approved investments.

Approved investments consist of high-quality securities. For instance, currently it consists of bonds which are AA rated and above.

Analysts say that while LIC’s lending operations are large, there is no reason to believe that its lending standards are not as stringent as those of banks. Some say they are tougher.

“LIC, of course, is a significant lender and, to that extent, yes there is a systemic risk. But LIC’s primary job is to take money from policyholders and invest it as per prudential norms. As per these norms, LIC loans and buys bonds of companies that are AA rated and above," said Abizer Diwanji, partner and national leader, financial services, EY. He added that since banks don’t have such restrictions, they may need greater supervision.

To be sure, most lending norms followed by LIC are similar to RBI rules. For instance, LIC categorizes loans as bad debts after the borrower fails to service loans for 91 days, just like banks. Rules for provisioning against bad debt are also similar.

“Yes, there may be an issue of inconsistent underwriting/risk management practices between the banking and the insurance industry in so far as it applies to granting of loans. But instead of RBI regulating the loan portfolio of LIC, the two regulators (RBI and Irdai) may sit together and try to harmonize regulations around loans," said Sanket Kawatkar, principal and consulting actuary, Milliman India Pvt. Ltd, an actuarial services firm.

Kawatkar added that interconnectedness between various financial entities would mean that if one is in trouble, all others will get impacted.

One of the segments that LIC has heavily invested in is infrastructure.

According to bond market dealers, most of the bonds issued by infrastructure companies are routinely mopped up by LIC. As of 31 March, the insurer’s investment in infrastructure and social sector was at 1.55 trillion, up from 1.31 trillion in the year-ago period. To be sure, at least 15% of traditional funds of LIC need go into the infrastructure-related securities, which explains the heavy investments in that sector.

LIC’s clout in lending to the non-banking financial companies (NBFCs) has also risen.

The June edition of financial stability report pointed out that in fiscal 2014-15, for the first time, insurance firms surpassed banks in investing in NBFCs.

Collectively, insurance companies invested 1.76 trillion, while banks invested 1.59 trillion.

Bond dealers said that these investments were led by LIC’s investments in the infrastructure NBFCs.

While the financial markets observers say the sheer size of LIC is worth a cautious look, they also said that the insurer does not take unnecessary risks on its portfolio.

“In our interaction with the management, we have found that LIC’s risk appetite is fairly restrictive in their bond portfolio. They mostly buy papers in the AAA and AA category," said Ananda Bhoumik, head and senior director, financial institutions, India Ratings & Research, an arm of the Fitch Group.

Shareholding in banks

A second important linkage between LIC and the banking sector is the shareholding of the insurer in the country’s banks.

On an average, LIC holds 9.21% in public and private banks.

The insurer’s equity exposure, including that in banks, is 3.32 trillion, as on 31 March, according to the public disclosure of the insurer. As on 31 March, LIC held 22.54% in Corporation Bank which exceeds the maximum permitted shareholding of 15% in any company.

LIC’s holding in Bank of India and Canara Bank was just under that limit at 14.93% and 14.4%, respectively according to the most recent disclosures made by the banks. In the country’s largest lender, State Bank of India, LIC held 11.82%. LIC also holds equity in private banks, such as ICICI Bank Ltd, where it holds 8.11%.

Overall, LIC holds equity shares in 27 banks in India.

This is something that the banking regulator is worried about. The December 2014 issue of the financial stability report, which is published by RBI after taking input from all regulators, had first flagged insurance companies’ investments in banks as a clear risk to the financial stability of the country.

Without naming LIC, the central bank termed the “sizeable" investment and the interconnectedness as something that does “expose the system to contagion risks in the event of stress scenarios".

In a 21 May interview to Business Standard, RBI deputy governor S.S. Mundra reiterated this concern saying that if the insurer wants a fire-sale of its shares, it will have implications for the financial sector.

To be sure, there has always been talk that a number of these investments in the state-owned banks happen at the behest of the government, even though there is no proof of this.

“It is quite clear that too much of a proxy role (for investment) has been given to LIC by the government. Often LIC is the writer of the last cheque," said a senior official with a regulatory body, who requested anonymity for himself and the institution he works for.

LIC chairman S.K. Roy, however, dismissed such talk in a recent interview.

“Our investments are driven by only one consideration...it should be an attractive investment opportunity and should be within the regulatory provisions," Roy said in the interview.

The official cited above, however, didn’t share RBI’s concerns over LIC’s heavy investments in bank shares.

“As long as the banks are backed by the government, there is no fear that LIC has to fire sell its shares...," he said.

According to LIC’s equity investment policy, equities in approved investments should have given a dividend of at least 4% in the previous seven out of eight or nine years immediately preceding.

In terms of exposure, life insurance companies, at present, cannot buy a stake of more than 10%-15% in any one company.

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