The Reserve Bank of India released a draft regulatory framework on lending to related parties and connected persons, proposing a unified set of norms applicable to all categories of regulated entities including commercial banks, cooperative banks, small finance banks, and non-banking financial companies (NBFCs). The proposed framework seeks to harmonise the existing fragmented regulations on connected lending and establish enhanced disclosure, threshold-based approvals, and board-level oversight requirements for loans extended to parties with close connections to the lending institution.
Background
Connected lending — the practice of regulated entities extending credit to persons or entities with whom they share directorial, managerial, or significant ownership connections — has been a longstanding area of regulatory concern in the Indian financial system. The existing regulatory framework consisted of disparate provisions spread across multiple master directions, sector-specific guidelines, and circulars, resulting in inconsistent application across different categories of financial institutions.
The RBI had flagged this regulatory gap in its Statement on Developmental and Regulatory Policies dated 8 December 2023, announcing its intention to develop a comprehensive and unified framework. The stated objectives were to prevent conflicts of interest, curtail self-dealing, and ensure that connected lending decisions are made at arm's length with adequate institutional safeguards. The proposed directions represent the culmination of this regulatory initiative.
Key Provisions
The draft framework on connected lending proposes the following:
Expanded definition of related parties: The framework broadens the definition of "related persons" to include directors of the regulated entity, their relatives, entities in which directors hold significant influence, senior management personnel, and significant shareholders. The definition aims to capture both direct and indirect connections that could influence lending decisions.
Materiality thresholds for board approval: Connected lending transactions above specified materiality thresholds require prior approval of the Board of Directors or a designated Board Committee. The thresholds are calibrated on a scale-based approach linked to the asset size of the regulated entity.
Mandatory disclosure requirements: All regulated entities must maintain comprehensive records of connected lending transactions and make supervisory disclosures to the RBI. Public disclosure of aggregate connected lending is also proposed to enhance market discipline and transparency.
Arm's length pricing: All lending to related parties must be conducted on terms no more favourable than those extended to comparable unconnected borrowers. The framework requires documented evidence of arm's length pricing for each connected transaction.
Aggregate exposure limits: The draft proposes aggregate limits on total lending to all connected parties as a proportion of the regulated entity's capital funds, preventing excessive concentration of credit exposure within the connected universe.
Independent director exclusion: Independent directors serving on the boards of other regulated entities are proposed to be excluded from the definition of related persons, encouraging independent director participation without creating artificial conflict-of-interest barriers.
Implications for Practitioners
The proposed framework, if finalised, would represent the most comprehensive overhaul of connected lending regulation in India's banking sector. Compliance teams at banks and NBFCs should initiate a gap analysis of existing related party lending portfolios against the proposed definitions and thresholds.
Legal practitioners advising financial institutions should note that the expanded definition of related parties may capture transactions that were previously outside the regulatory perimeter. Corporate law practitioners dealing with group structures involving banking entities will need to reassess intra-group lending arrangements for compliance.
The board-level approval requirements will necessitate changes to governance frameworks, committee charters, and delegated authority structures at regulated entities. Institutions should evaluate whether their current board committee architecture adequately supports the oversight requirements contemplated by the draft directions.