For borrowers and lending desks
The Agreed Bank Clause, and what your lender is actually asking for
Your sanction letter says the charged asset must be insured and the bank named on the policy. This is what that clause does, what it asks of you and of the bank, and the four things that most often go wrong on a hypothecation file.
What the clause is
Where property is mortgaged, hypothecated or otherwise charged in favour of a bank, the bank's name appears in the policy schedule under the heading Agreed Bank Clause. If the charge is created after the policy was issued, it is added during the period by endorsement rather than by taking a new policy.
In the clause, the word ‘Bank’ includes any financial institution, so an NBFC lending against the same security stands in exactly the same position as a bank.
Who gets paid when there is a claim
Claim monies are paid to the bank. The bank receives them for its own demand and, for anything beyond its own interest, as agent for the other parties insured — which in practice means you.
The bank's receipt is a complete discharge of the insurer, and it binds every party named as insured on the policy. That is worth understanding before a loss rather than after: the insurer's obligation ends when the bank is paid, and what happens next is between you and the bank under your loan agreement.
Why a bank insists on this particular clause
Being named as a payee is not the same as being protected. The provision that matters is that the policy is not invalidated as against the bank by an act or omission of another insured party which increases the risk, provided the bank has not itself committed the breach.
So if the borrower does something that would otherwise prejudice the policy, the bank's interest survives it. That is the whole reason a lender asks for this clause by name rather than accepting a certificate that merely mentions them.
What the clause asks of the bank in return
It is not one-sided. The bank undertakes to notify the insurer of any change of ownership, alteration or increase of hazard that comes to its knowledge, and to pay any additional premium arising from it.
A branch that learns something at a site visit and never passes it on is not using the protection it holds. Unreported changes are among the first things an insurer will point to when a large claim is examined.
The four errors that cost the most
1. The sum insured is set to the loan, not to reinstatement value. This is the commonest and the most expensive. A sum insured pegged to the outstanding loan is almost always below what it would cost to rebuild or replace the asset, and where the policy carries an average condition the shortfall reduces every partial claim in the same proportion. The borrower recovers less than expected, and so does the bank.
2. The bank is on the certificate but not in the schedule. The certificate is a summary. The schedule is the operative document, and if the clause is not there the bank has no protected interest whatever the sanction letter says.
3. The property described is not the property charged. Stock hypothecated at one godown and a policy describing another is not a technicality; a policy answers for the property it describes.
4. The policy lapsed and nobody noticed. An expired policy still looks like a certificate in a file. Somebody has to hold the renewal date.
What is not covered by the fire policy your bank asked for
A standard fire policy answers for the named perils on the property it describes. It is not theft cover, it does not follow goods once they are on a lorry, it does not answer for machinery that fails electrically or mechanically, and it does not replace the profit lost while the business is stopped.
Where the security itself moves — stock in transit to a buyer, for instance — that needs marine or inland transit cover, which is a separate policy. A lender relying on moving stock as security should know which of the two it actually has.
Frequently asked questions
Can the bank be added to a policy that has already been issued?
Yes. Where a charge is created after the policy incepted, the bank is added during the policy period by endorsement. It does not require a fresh policy.
Does the Agreed Bank Clause mean the bank owns the claim?
The bank is paid, and it receives the money for its own demand and as agent for the other parties insured for anything beyond that. What it keeps is governed by your loan agreement, not by the insurance policy.
Should the sum insured match the loan amount?
No. It should reflect what it would cost to reinstate the asset today. A sum insured set to the loan is usually short of that, and under-insurance reduces a partial claim proportionately, which leaves both the borrower and the bank recovering less.
Does this apply to an NBFC as well as a bank?
Yes. In the clause the word 'Bank' includes any financial institution.
Who should hold the renewal date?
In practice the branch is better placed than the borrower, because the file is reviewed on a cycle. But somebody has to own it, and an expired policy in a hypothecation file is one of the most common findings in a cover review.
Related: insurance checklists by trade · fire and burglary cover · marine and transit cover
When the loss happens, the clause decides who is paid and the file decides how much: what a fire claim needs, and where these are cut.