Insurance and bank collateral

Impact of “no objection” letter 

The recent reported stipulation of the Insurance Regulatory Commission of Sri Lanka (IRCSL), to insurers to waive off the requirement of ‘no objection’ letters from the financiers on motor vehicle claims on vehicles under hire purchase or lease agreement, should be a cause of concern for all lending institutions. 

Being a personality with considerable expertise in the field of banking with greater connectivity to insurance, I wish to share some of my thoughts for the benefit of all stakeholders. 

I have consistently emphasised the importance of adhering to all aspects of insurance covering collateral, to face any calamity towards safe guarding the interest of banks and financial institutions. Insurance compliance is an integral and essential component in the management of credit. In my nearly five decades of career in banking, there have been numerous calamities and due to strict adherence of insurance compliance, we were able to safeguard the interest of the institutions. 

If the reported stipulation of waiving off the requirement of ‘no objection’ letter is adhered to by the insurers, it will result in the banks and financial institutions’ inability to have effective control over their collaterals particularly the motor vehicles, since this stipulation appears to cover only motor vehicles under hire purchase or lease agreement at present. If this stipulation is enforced, claims if any could be made in isolation without any intimation to the financiers and such claims could be processed and settled without the concurrence of the financiers, which is a major risk and will weaken the collateral.

On the collateral of motor vehicles, unlike the other collaterals of movables and immovables, there is no mechanism for the financiers to ensure its availability. In the aforesaid category of collaterals the financial institutions will ensure on periodical inspections, calling for various other data monthly, etc., in addition to various other follow-up mechanism. Such mechanism is not feasible on motor vehicles obtained as collateral as it’s always on the move and exposed to greater risk. To manage their risk the financial institutions totally depend on comprehensive insurance duly assigned in their favour which ensures their collateral is intact and safe and most importantly they are in a position to overcome any eventualities.

There have been instances, where banks were reluctant to issue ‘no claim letters’ if the borrowers have not adhered to their commitments and lack of cooperation. Even on such instances the financiers will discuss with the borrowers and arrive at an amicable settlement towards the issuance of “no objection” letters. In a worst case scenario they may instruct the insurers to remit the proceeds of the claim direct to the financiers towards the realisation of their exposure as the policies are assigned to the financiers and they have an insurable interest. If there is a wilful defaulter banks may withhold the issuance of such letters as it has to safeguard the depositor’s funds.

This is the reason, banks and finance companies make it compulsory for the assignment of insurance policies and such an assignment makes the financiers as an interested party towards ensuring the policies are in force and effectively monitor in ensuring its validity. In exceptional circumstances, if the policy holders fail to renew the policies on time, banks will take action to renew the policies on their behalf by effecting the renewal premium by granting them a temporary accommodation. Banks strictly ensure the policies are in force and will not allow it to lapse as they have an insurable interest on the asset pledged as collateral. The premium payable on comprehensive insurance is very high, hence there is always a risk of such policies being converted to a “Third party insurance” by the policy holders if the insistence of the “no objection letter” is waived off even though this is applicable towards the settlement of claims.

Insurers now appear to be caught up in a crossfire since the banks and financiers in my view will still insist on adherence to such stipulation in case of an eventuality as the fate of their collateral will be at stake. Claims could be made in isolation without any intimation to the financiers and the risks faced by the financiers are greater.

Today, unlike during yesteryears, it is no exaggeration to state banks and financial institutions operate under a very competitive environment which may at times compel the officials towards expeditious disbursement of facilities. These facilities are generally granted against acceptable collaterals or in certain instances based on the integrity and credit worthiness of the borrowers. In exceptional circumstances facilities are also considered without any collateral which is defined as “clean” in banking terminology. However, even on such instances the banks do have an interest on the assets of such entities to overcome any eventuality and most importantly to ensure the continuity of such business entities which is their primary objective hence they take solace under the umbrella of insurance. 

Realisation of the collateral towards recovery of the exposure is always considered as the last option and not the first option.

They face a major risk in realisation of their exposure due to certain eventualities beyond their control. 

This may arise unexpectedly and could take them by surprise without any prior warning or notice due to natural and manmade calamities. In Sri Lanka there were many such calamities which should be a lesson for all. The July, 1983 ethnic violence, the 2004 Tsunami, frequent floods and the recent destruction of valuable properties all of which struck Sri Lanka unexpectedly and without any prior warning should be a reminder and a lesson to all bankers and financiers towards ensuring they don’t compromise on insurance. Billions of rupees of assets and valuable lives were destroyed overnight. Banks’ dependence on insurance gave them major comfort which resulted in their ability to overcome their losses and manage the risk. Bankers depend on insurance to a very great extent to overcome any such calamity. 

Weaving off the stipulation of “no objection letters” will in my view weaken the bank’s collateral and the dependence on insurance will be at stake.