No Insurance as a Loan Condition: MSME Borrowers' Rights Under IRDAI's Anti-Bundling Proposal

IRDAI's September 2026 distribution consultation paper proposes to fold today's corporate agents, brokers and other intermediaries into a single Insurance Distribution Entity (IDE) category. Banks and NBFCs that sell insurance would register as IDEs. The paper then sets conduct rules for those lenders that go straight at the most common complaint in MSME banking: the fire or stock policy that arrives with the sanction letter.

As reported by Medianama on 30 September 2026, the draft would do four things for borrowers:

• No compulsory bundling. A bank or NBFC registered as an IDE could not make buying insurance a condition of the loan.
• Two rates on the table. The customer would be shown the interest rate with insurance and without insurance, so any pricing link becomes visible.
• Free choice of insurer. The borrower could buy cover from any insurer, not only the lender's tie-up partner.
• Premium paid separately. The premium would be paid separately by the customer, not funded out of the loan amount.

The paper also proposes to prohibit volume-linked or reward-linked incentives for bank and NBFC staff who sell insurance (Medianama, 30 September 2026; BusinessToday, 25 September 2026). One carve-out matters: a lender may take a group policy over its own loan portfolio and bear the premium as its own expense (Mondaq/Tuli & Co, 30 September 2026).

Anyone who has taken a cash credit limit or a machinery term loan from a bank knows the pattern. The sanction letter requires the hypothecated stock and machinery to be insured. The relationship manager offers to arrange it through the bank's insurance partner. The premium is debited from the current account or added to the disbursement, and the policy schedule turns up weeks later, if at all.

The bank's interest in the security is legitimate. Stock and machinery charged to the bank are its collateral, and an uninsured fire can turn a performing loan into a write-off. The problem is the step from "the asset must be insured" to "the asset must be insured through us, at the price we quote".

The incentive structure explains much of that step. Analysts covering bank earnings estimate that insurance distribution contributes roughly 16.3% of pre-provision operating profit at Yes Bank and roughly 12.4% at IDFC First Bank (synthesis of ICICIdirect and Outlook coverage, late September 2026). Income on that scale shapes branch targets, and branch targets shape what a relationship manager tells a borrower at sanction. The draft's ban on volume-linked staff incentives is aimed at exactly this pressure point.

For background on how bank-led distribution of commercial lines has developed, see our piece on bancassurance open architecture in commercial lines. The conduct issues behind it are covered in conduct risk management in bancassurance.

The draft removes the lender's power to choose your insurer. It does not remove the lender's right to see its security protected. Expect these requirements to stay in sanction letters whatever the final rules say.

Insurance on charged assets

Hypothecated stock, book debts where relevant, plant and machinery financed by the term loan, and mortgaged buildings will still need cover against the perils in the sanction terms, usually fire and allied perils, often with burglary for stock. The lender can reasonably specify minimum cover: sum insured at least equal to the asset value or the outstanding limit, named perils, and a policy period that does not lapse during the loan.

Bank clause and loss payee

The lender will still want its interest recorded on the policy. In practice this is done through an endorsement naming the bank as hypothecatee or mortgagee, commonly called the bank clause or loss payee clause. Its effect is that claim payments for the charged assets go to the bank, or are paid with its consent, so the bank can apply the money to the loan or release it for reinstatement. Some lenders also ask for notice of cancellation or non-renewal.

None of this depends on who sold the policy. A policy you buy from any insurer, directly or through your own broker, can carry the same bank clause. That is the practical point of the draft: the security requirement and the distribution choice come apart.

If you want to use your own insurer or broker, whether now under existing sanction terms or later if the draft is adopted, the process is short. What matters is giving the credit or operations team a file they can tick off without discretion.

1. Read the insurance covenant in the sanction letter. Note the assets to be covered, perils, minimum sum insured, and any wording on bank clause, renewal reminders or the lender's right to insure at your cost if you fail to.
2. Instruct your broker or insurer to match it. Ask for the bank's name as hypothecatee or mortgagee to be endorsed on the schedule, with the correct branch and loan reference.
3. Align the sum insured with the stock statements. The stock value you declare to the bank in monthly drawing power statements and the sum insured on the policy should tell the same story. A large gap invites questions from both the bank's auditor and the insurer's surveyor.
4. Submit the policy schedule and premium receipt. Lodge them with the branch before the existing cover expires, and ask for written acknowledgment that the covenant is met.
5. Diarise renewal. A lapsed policy is the most common reason banks force-place cover. Renew early and resend the schedule each year.

If your branch refuses an outside policy that meets every stated requirement, ask for the refusal and the reason in writing. That record is useful with the bank's grievance process today, and more so if the draft becomes binding.

Most MSMEs reading this already have a bank-arranged policy in force. Whether or not you switch at renewal, check it now. Bank-arranged covers are often bought quickly against the sanction amount rather than the actual risk, and the gaps show up only at claim time.

Sum insured against real values

The sum insured is frequently set at the loan limit, not at the value of the assets. If your stock regularly runs above the limit, or your machinery's replacement cost is higher than the term loan, you are underinsured, and the average clause will cut any claim proportionately. Check whether the building and machinery are on reinstatement value basis or market value. Market value cover pays depreciated amounts.

Stock declarations

If stock is covered on a declaration or floating basis, the policy will require periodic declarations of stock values, usually monthly. Missed or understated declarations can reduce a claim even when the overall sum insured looks adequate. Ask who is filing them: the bank, the insurer's partner, or nobody. If you do not know, assume nobody. Our note on stock declaration underinsurance when prices jump walks through how quickly a declaration gap turns into a short claim.

Add-ons and exclusions. Check what was actually bought. Common gaps include no cover for stock at other locations or in transit, no burglary section for stock, earthquake or STFI perils not selected, and no business interruption cover. Equally, check for add-ons you did not ask for and do not need, which push up premium. The schedule, not the relationship manager's summary, is what governs.

The draft's approach to incentives is worth understanding, because it shapes what lenders are likely to do next.

Banning compulsory bundling alone would leave the sales pressure intact: staff with volume targets would still push the bank-arranged policy as the easy option. Showing the rate with and without insurance exposes any price penalty for declining. Banning volume- or reward-linked incentives for bank and NBFC staff removes the reason to push in the first place (Medianama; BusinessToday). The three measures work as a set.

The group policy carve-out gives lenders a clean alternative. A lender that wants certainty that its security is insured can buy a portfolio-level policy and pay the premium itself (Mondaq/Tuli & Co). The borrower is then not charged, and the lender carries the cost of its own risk preference.

For an MSME, the group policy route has two implications to watch if it is adopted:

• It protects the lender, not necessarily you. A portfolio policy sized to protect loan exposure may not cover your full asset value, your uncharged assets, or your business interruption loss. You may still need your own cover.
• Cost can reappear elsewhere. A lender bearing premium as its own expense can price it into processing fees or rates. The with-and-without disclosure is what lets you spot that.

Fintech and NBFC lenders face the same questions on embedded borrower cover; we discussed their side in how fintech lenders should think about borrower insurance.

The draft is not final, and banks and NBFCs also answer to the RBI on lending conduct. A sensible owner does not wait for the final rules to act on the parts that are already within their control.

• Pull every policy linked to your loans and match each schedule against the sanction letter and the latest stock statement. Fix sum insured and declaration gaps before the next renewal, not after a loss.
• Get an independent quote at renewal on the same specification as the bank-arranged cover. Even if you stay with the bank's partner, you will know what the bundled policy costs.
• Ask your branch in writing whether an external policy with the bank clause endorsed is acceptable. Some banks already accept it under existing terms; the conversation is simply rarely started.
• Keep records of how insurance was presented at sanction, including any statement that it was mandatory or that the rate depended on it. If the rules change, that record matters.
• Watch for the final IRDAI regulations and any RBI direction. The scope of the IDE conduct rules, timelines, and whether existing loans are covered will decide how much changes in practice.

For a broader view of how IRDAI and government policy have treated MSME cover, see our earlier piece on the MSME insurance regulatory push. Insurance on hypothecated assets is meant to protect both the lender and the business. Getting the cover right matters more than who sold it.