Para Banking and Bancassurance: Section 6 of the Banking Regulation Act

Walk into any branch and the posters are rarely about deposits. They sell insurance, mutual funds and pension accounts, products the bank does not make, carrying risks the bank does not hold, earning commissions the bank very much keeps. This is para banking: the businesses a bank may carry on beside banking. The law here has a simple architecture, a permissive list, an outer fence, and two hard prohibitions, and a persistent problem, which is that the counter that sells a deposit one minute and an insurance policy the next trades on a trust it did not earn for the second product.

1. The architecture: Section 6 and its fence

Section 6(1) of the Banking Regulation Act, 1949 lists the forms of business a banking company may engage in in addition to the business of banking. The list is long and generous: every mode of borrowing and lending; dealing in bills, negotiable instruments and securities; letters of credit and guarantees; foreign exchange; underwriting and participating in issues; acting as agent of governments and persons; executing trusts and administering estates; safe custody and safe deposit vaults; any other business the Central Government notifies under clause (o), which is the route by which insurance business was added; and, the residual clause, anything incidental or conducive to the promotion or advancement of the business of the company.

Section 6(2) is the fence: no banking company shall engage in any form of business other than those referred to in sub-section (1). A bank is therefore a company of enumerated capacities, and every para banking activity must find its root either in a named clause or in the incidental clause as the Reserve Bank reads it.

Figure 1: The list, the fence and the prohibitions

• Section 8 prohibits a banking company from directly or indirectly dealing in the buying or selling or bartering of goods, except in connection with realising security or in the legitimate business of bills; the bank finances trade, it does not trade.
• Section 19 governs subsidiaries: a bank may form one only for the purposes the section permits, which is how the insurance, asset management and broking arms of banks exist, each with the Reserve Bank's approval, and Section 19(2) separately caps the bank's holding in any company at 30 per cent of that company's paid up capital or of the bank's own paid up capital and reserves, whichever is less.

2. The two models: distribution against manufacture

Everything in para banking policy turns on one distinction.

Figure 2: The regulatory line runs between selling and making

• Distribution without risk participation, selling third party products for a fee, needs no prior approval of the Reserve Bank: a board approved policy, compliance with the sectoral regulator's registration, and the conduct conditions suffice.
• Risk participation, setting up or investing in an insurance or asset management venture, or underwriting, engages the bank's balance sheet and therefore needs the Reserve Bank's prior approval, given against thresholds of capital adequacy, net worth, profitability and asset quality, and within Section 19.
• The customer sees one counter; the law sees two entirely different activities behind it.

3. The three distribution businesses

Figure 3: The three products and the common discipline

Bancassurance

• A bank distributes insurance as a corporate agent registered with the insurance regulator, and may place business with up to nine insurers in each line, life, general and health, a ceiling raised from three in 2022 so that the counter offers choice rather than a captive product.
• A bank may instead hold an insurance broking licence, acting for the customer rather than the insurer, with the Reserve Bank's approval.
• The agent earns commission within the regulator's limits, must disclose that it acts as agent, and the insurer carries the risk and settles the claim; the bank's liability is for its own conduct in the sale.

Mutual funds and pension

• Mutual fund units are distributed under registration with the industry body, with the scheme documents doing the talking: the bank may never suggest an assured return, and must keep execution distinct from advice, which carries its own regulatory regime.
• As a point of presence under the pension regulator, the bank opens and services accounts of the national pension system for a prescribed, disclosed fee.
• In every case the customer's money moves to the manufacturer, the product sits outside the bank's balance sheet and outside deposit insurance, and the bank must say so.

4. The conduct problem: mis-selling at a trusted counter

The recurring scandal of para banking is not product failure but sale failure: a term depositor walked out holding a seven year insurance policy, an 80 year old sold a unit linked plan, a locker applicant told that a policy would speed the allotment. The regulatory answers converge from three directions.

1. No tying. The sale of a third party product may not be made a condition, in fact or in impression, of any banking service, a loan, a locker, a sanction. The locker direction says it in terms: no fixed deposit or policy may be insisted on beyond the small term deposit the direction itself permits.
2. Suitability. The Reserve Bank's Charter of Customer Rights makes the right to suitability one of its five rights, alongside fair treatment, transparency, privacy and grievance redress: the product offered must fit the customer's assessed need, not the branch's monthly target. Incentive structures for staff are required to be designed so that they do not drive mis-sale, and the compensation guidelines reach the sales force.
3. Remedies. A mis-sold product is a deficiency in the bank's own service, whatever the manufacturer's liability: the Integrated Ombudsman and the consumer commissions both reach it, and the insurance regulator's machinery reaches the policy itself. The bank cannot pass the customer to the insurer when the complaint is about what happened at the counter.

5. Quick Revision

1. Every para banking activity must trace to Section 6(1) or fail at Section 6(2).
2. Safe custody and vaults are themselves Section 6 businesses, which is where the locker relationship roots.
3. Underwriting is permitted by the list but is risk participation, so it meets the approval regime.
4. Commission income is the attraction; conduct risk is the price.
5. The customer's remedy forks: the counter to the banking forums, the product to its own regulator.

6. Frequently Asked Questions

Why does Section 9 let a bank hold non-banking property for only seven years?

Because property comes to a bank mostly by misfortune, as security realised from a defaulted loan, and a bank that may keep what it seizes becomes a property company funded by deposits. Section 9 therefore allows immovable property other than for the bank's own use to be held only for seven years, within which it must be disposed of, the Reserve Bank being able to extend by up to five more where the bank's interest requires it. The provision completes Section 8: the bank may neither trade in goods nor warehouse land, because both would put depositors' money into price risk the licence never contemplated.

Is my mutual fund or insurance bought at a bank covered by deposit insurance?

No, and the bank is obliged to make that plain at the sale. Deposit insurance covers deposits with the bank, up to the limit in force. A mutual fund unit is your investment with the asset management company, an insurance policy is your contract with the insurer; in each case the money leaves the bank, the risk and the promise belong to the manufacturer, and the bank's failure would not touch the product just as the product's failure gives no claim on the bank. What you do have against the bank is a conduct claim: if the product was sold as if it were a deposit, that misrepresentation is the bank's own deficiency in service.

Can a branch make an insurance policy a condition for a locker or a loan?

No. Tying a third party sale to a banking service is forbidden conduct, and the locker framework addresses the oldest version of the trick expressly: a bank may take only the modest term deposit the direction permits, covering three years' rent and the breaking charges, and may not insist on any policy or larger deposit for allotment. For loans, a borrower may be offered insurance on the asset or on life, and it may even be prudent, but the choice of insurer and the choice to buy at all must remain the borrower's; a sanction conditioned on buying the bank's partner product is a conduct violation the Ombudsman reaches. Keep the paper: the complaint succeeds on the sequence of documents.

Who answers when a bank-sold policy is rejected at claim stage?

It forks on why. If the rejection flows from the policy's own terms, an exclusion, a lapse, non-disclosure by the insured, the claim lies against the insurer, through its grievance machinery, the insurance ombudsman and the consumer forums. If the rejection flows from the sale, the proposal form filled by the branch with wrong answers, a product unsuitable on the bank's own assessment, a policy issued to someone plainly outside its terms, the bank answers for its deficiency as corporate agent, and the banking forums reach it. Many real cases engage both, and nothing prevents proceeding against both; the error is suing only the insurer when the wrong happened at the counter.

7. Related Topics and Provisions

• Business restrictions on advances and assets under the Banking Regulation Act, 1949
• The duties of a banker and the operation of lockers
• Financial inclusion and the Charter of Customer Rights
• The Reserve Bank Integrated Ombudsman Scheme, 2021
• Banking and the Consumer Protection Act, 2019