Rules of Restraint: RBI proposes revised norms on Related Party Lending and Contracting

– Team Finserv, finserv@vinodkothari.com

In its current hectic phase of revamping regulations, the RBI has issued Draft Directions for lending and contracting with related parties. Separate sets have been issued for commercial banks, other banks, NBFCs and financial institutions. 

The definition of “related party” is more rationalised and improvised over the existing definitions in Companies Act or LODR Regulations. Loans above a “materiality threshold” [which is scaled based on capital in case of banks, and based on base/middle/upper layer status in case of NBFCs] will require board approval, and nevertheless, will require regulatory reporting as well as disclosure in financial statements. In case of contracts or arrangements with related parties, with the scope of the term derived from sec 188 (1) of the Companies Act, there are no approval processes, but disclosure norms will apply. In the case of banks, trustees  of funds set up by banks are also brought within the ambit of “related persons”.

The new Directions, which are expected to be effective from 1st April, 2026, will cover existing lending transactions too, which will be brought into conformity within maximum 1 year of the effective date.

Credit policies of banks as well as NBFCs will eliminate quid pro quo arrangements, that is, a reciprocal lending arrangement with another lender. 

These norms, as clarified in the draft Directions, will be in addition to the discipline of the LODR Regulations, where applicable.  

Highlights:

• The scope of the draft Directions is wider than the existing Master Circular- Loans and Advances – Statutory and Other Restrictions dated July 1, 2015 read with Loans and Advances – Regulatory Restrictions dated July 23, 2021 for Banks and RBI Circular on Loans and Advances – Regulatory Restrictions – NBFCs dated April 19, 2022 for NBFCs.
• Directions  are expected to  take effect from 1st April, 2026.
  • For existing loans, may continue till one year from issuance of the Directions or run-off till maturity, whichever is earlier
    • Includes restriction on renewal or enhancement of limits by Banks unless in compliance with these Directions.
• Definition of “related party” significantly different from that under the Companies Act or Listing Regulations – will force entities to have multiple lists to meet differential regulatory requirements. 
• Contracts or arrangements enumerated in sec. 188 (1) of Companies Act also covered, though, apparently, there are no operating provisions for the same. Disclosures and regulatory reporting requirements apply
• The preamble talks about “indirect” lending – while there do not seem to be provisions having the “purpose and effect” test, but reciprocal lending or quid pro quo arrangements are covered by the Directions. 
• Lending to “senior officers” to be governed by provisions under the Credit Policy of the Bank/NBFC. 
• “Materiality threshold” for lending to related parties scales up
  • based on the capital of the bank – from Rs 5 crores to Rs 50 crores [at present, it is Rs 5 crores]; lending over the materiality threshold requires board approval. 
  • In case of NBFCs the limit is Rs. 1 crore in case of BL, Rs 5 crores in case of ML, and Rs 10 crores in case of UL entities 
• Either the Board or a Board Committee to specifically deal with lending to related parties. 
• Statutory auditors to specifically check all exposures to “group entities” (it seems the definition will be imported from  Para 2.3 of Guidelines on Management of IntraGroup Transactions and Exposures dated February 11, 2014, in case of banks, and Para 5.1.4 of SBR Directions in case of NBFCs); all other related party lendings to be checked on sample basis
• Internal auditors to review, on a quarterly or shorter intervals, adherence to the guidelines and procedures in relation to related party lendings

• Meaning of Related Party: 

• Related persons and relatives thereof
  • promoter, or a director or a KMP of the NBFC or Bank
    • Promoter is not covered within the meaning of RP under CA, 2013
  • holds >5% of paid-up equity share capital or voting rights
    • Reg 2(1)(zb) of LODR requires holding of 10% or more to be classified as RP 
  • can, through an agreement with the NBFC or Bank, nominate a director to its Board;
    • Such rights are ordinarily provided for in lending agreements/ debenture trust deeds as well, apart from under specific shareholder agreements etc. A carve-out should be provided for the same. 
  • Singly or jointly in control of the NBFC or Bank
  • Group entity of the NBFC or Bank
    • Should refer to the meaning of group under
      • Para 2.3 of Guidelines on Management of IntraGroup Transactions and Exposures dated February 11, 2014, in case of banks, and 
      • Para 5.1.4 of SBR Directions in case of NBFCs
  • In case of Banks: a director (excluding independent directors) of other commercial banks, AIFIs, scheduled cooperative banks, subsidiaries of commercial banks, and trustees of MFs and AIFs established by such REs.
    • Coverage similar to that under Para 2.2.1. of the Master Circular- Loans and Advances – Statutory and Other Restrictions
• Entity (including partnership firms) in relation to related persons, where the related person or a relative thereof
  • is a partner, manager, director, KMP or promoter
  • holds >10% of paid up equity share capital or Rs. 5 Cr, whichever is lower
  • Is having control, whether singly or jointly 
  • holds >20% of voting powers
  • power to nominate director on its Board
  • is a guarantor or a surety
    • Whether bank guarantees obtained in the normal course of business also get covered? 
  • is a trustee, author or beneficiary (for entities incorporated as a private trust)
• Entity which is accustomed to act on the advice, directions or instructions of the related person or a relative thereof 
• Entity which is a subsidiary or a parent company or a holding company or an associate or a joint venture of the related person 
• Exclusion – common ownership or control of Government does not result in government owned entities becoming RP to a government-owned bank 
• To include any product, entity or structure formed with the objective of circumventing these Directions through various means and identified as such by the auditors of the lender or by the supervisory authorities
  • This covers “purpose & effect” test
• Meaning of Group entity
  • Directions define as ‘Group entity’ of a bank shall have the same meaning as assigned to it under extant regulatory guidelines, or applicable accounting standards.  

• Statutory Restrictions for Banks 
  • Restrictions as given under Section 20(1)(b) of the BR Act, 1949 shall continue to apply with the following exclusions:
    • Loans or commitments made to a company where a bank’s director has substantial interest are allowed if made before the director’s appointment; however, such loans cannot be renewed, enhanced, or modified thereafter unless the director resigns from either the bank or the company.
    • Advances to a public trust, where a trustee is also a director of the lending bank
    • Loans to directors fully secured by government securities, life insurance policies, or fixed deposits, with loan-to-value not exceeding 100% of their realisable value, are permitted.
    • Personal loans to an employee director which he/she would have been eligible to borrow as an employee
    • Personal loans and advances to Chairman/ MD/ CEO/ director of the banking company subject to applicable prudential limits
    • Non-fund based facility to a director or his related party which are fully secured by cash collateral of equivalent or higher value
    • Line of credit or overdraft facilities granted by settlement banks to a licensed and regulator-approved qualifying central counterparty (QCCP) are permitted.
    • Loans or advances by a promoter bank to a Deemed Government Company promoted by it under Sections 139(5) or 139(7) of the Companies Act, 2013, and audited by the CAG, are permitted.
    • A foreign bank branch in India cannot lend to a firm or company if any of its foreign board directors has an interest in that entity or its parent company.
• Policy on lending to Related Parties
  • as a part of the Credit Policy 
  • prescribe additional safeguards to address the risks emanating from lending to related parties
  • include provisions for lending to senior officers and their relatives
  • whistleblowing arrangements for employees 
  • eliminate quid pro quo arrangements 
  • Aggregate limits for loan to RPs
    • Sub-limits for loans to a single RP and a group of RP  subject to prudential norms
• Materiality of loans to Related Parties  
  • Thresholds to be set up by NBFCs subject to:
    • UL and TL – Rs. 10 crore 
    • ML – Rs. 5 crore 
    • BL – Rs. 1 crore 
  • Thresholds to be set up by Banks are as follows:
    • Asset size <₹1,00,000 crore – ₹5 crore
    • Asset size between ₹1,00,000 crore and ₹10,00,000 crore – ₹10 crore
    • Asset size >₹10,00,000 crore – ₹50 crore
  • May vary for different categories of loans 
  • Does not include following under the meaning of loans and advances:
    • to a director and a KMP against government securities, life insurance policies or fixed deposit
    • Personal loans to an employee director which the employee director would have been eligible to borrow as an employee
  • To be sanctioned by Board of Directors (can be delegated to board level committee)
    • Below materiality thresholds, to be sanctioned by appropriate authorities 
• Recusal of interested parties
  • Having a direct/ indirect interest in loans to RPs
    • deliberations and decision-making processes involving sanction, disbursal and management of loans to related parties, including one-time settlements, write-offs, waivers, enforcement of security, implementation of resolution plans, etc.
• Monitoring of loans to RPs
  • Mechanism for periodic updation of RP list 
  • Quarterly or shorter reviews by internal auditors w.r.t. adherence to the guidelines 
  • Deviation from policy to be reported to AC
• Role of statutory auditors
  • Examine representative samples to satisfy compliance with the Directions 
  • All exposures to related parties which are group entities of the NBFCs or Banks shall invariably be examined by the statutory auditor
• Annual declaration by directors and KMPs
  • For loans availed by them and their associated entities from the respective NBFCs or Banks or its group entities.
• Reporting and disclosures 
  • NBFCs and Banks shall be required to  report to RBI through DAKSH Portal on half-yearly basis:
    • Details of loans sanctioned and contracts awarded to and arrangements made with related parties in the prescribed format including details like purpose of loan, type of exposure, collateral value, credit rating, classification, etc. 
    • any non-compliance of these Directions.
  • Under para 27.2 read with Annex VII of the SBR Direction NBFCs are required to make additional disclosures of Related Party Transactions in their financial statements through the Notes to Accounts. At present, only the amount outstanding at the year end and the maximum during the year of borrowings, advances, investments to RPs are required to be disclosed. However, the draft directions mandate more granular disclosures on loans to related parties including details of contract and arrangement for the last 2 financial years. The additional details introduced through the draft, which are also applicable to Banks, are as follows:
    • the aggregate value of outstanding loans to RPs;
    • the outstanding loans to RPs as a proportion of total credit exposure;
    • the aggregate value of outstanding loans to RPs which are categorized as SMAs and NPAs;
    • the outstanding loans to related parties which are categorized as SMAs and NPAs as a proportion of total SMAs and NPAs and amount of provisions held in respect of loans to related parties;
    • Top 10 exposures to related parties, where exposure shall include loans and advances, non-fund-based facilities, investments and positive Mark-To-Market (MTM) values of derivative and values of contracts and arrangements with the related party.