Whether private NBFCs-ML are required to appoint IDs?
– Neha Malu, Associate | finserv@vinodkothari.com
Independent directors have long been regarded as critical instruments of corporate governance. They bring fresh perspectives, specialized knowledge and most importantly, an element of unbiased oversight to board deliberations. Think of them as neutral referees who ensure fair play in business operations and uphold the integrity of boardroom decisions. Their presence helps reduce conflicts of interest, curb excessive promoter influence and encourage more balanced and professionally informed decision-making.
Under the Companies Act, 2013, section 149 read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014 lays down the categories of companies that are mandatorily required to appoint independent directors[1]. These categories do not include private companies. The rationale is intuitive: private companies, by their very nature of being closely held, are presumed to function under greater internal control, thereby reducing the perceived need for external board oversight. The whole basis of “privacy” of a private company will be frustrated if there are independent persons on its board.
Further, wholly owned subsidiaries are explicitly exempted from the requirement to appoint independent directors under rule 4(2), regardless of their nature or size.
And accordingly, a point of regulatory discussion arises in the case of (i) private NBFCs and (ii) NBFCs that are wholly owned subsidiaries, classified in the middle layer or above under the SBR Master Directions. While the Companies Act, 2013 does not mandate the appointment of independent directors for private companies and explicitly exempts WOS from such requirement, the corporate governance provisions under the SBR Master Directions require the constitution of certain committees, the composition of which hints towards the presence of independent directors.
This gives rise to a key question: Does a private NBFC or a wholly owned subsidiary, solely by virtue of its classification under the middle layer or above, become subject to an obligation to appoint independent directors?
Committees for NBFC-ML and above, the composition of which includes IDs
Upon classification as an NBFC-ML or above, conformity with corporate governance standards becomes applicable. Below we discuss specifically about the committees, the composition of which also includes IDs:
Audit Committee, consisting of not less than three members of its Board of Directors. If an NBFC is required to constitute AC under section 177 of the Companies Act, 2013, the Committee so constituted shall be treated as the AC for the purpose of this para 94.1.
As per section 177, an AC shall comprise a minimum of three directors, with Independent Directors forming a majority. Hence, in case the NBFC is not covered under the provisions of section 177, the same may be constituted with any three directors, not necessarily being independent directors.
Composition will be as per section 178 of the Companies Act, 2013.
The provisions indicate that the NRC shall have the constitution, powers, functions and duties as laid down in section 178. In this context, Companies Act requires every NRC to consist of at least three non-executive directors, out of which not less than one-half should be independent directors.
The Committee shall be a Board-level IT Strategy Committee (a) Minimum of three directors as members (b) The Chairperson of the ITSC shall be an independent director and have substantial IT expertise in managing/ guiding information technology initiatives (c) Members are technically competent (d) CISO and Head of IT to be permanent invitee
Chairperson of the Committee is required to be an ID.
The Composition of the Committee shall be as follows: The MD/ CEO as chairperson; and Two independent directors or non-executive directors or equivalent officials serving as members.
Where the NBFC has not appointed IDs, NEDs or equivalent officials to serve as members of the Committee.
Divergent Market Practices
With respect to appointment of IDs on the Board and induction in the Committees, two interpretations are seen in practice in the case of private companies and WOS:
First, since the Companies Act does not mandate the appointment of independent directors in the case of private companies and explicitly exempts WOS, private NBFCs and WOS often rely on these statutory exemptions. The SBR Master Directions make a general reference to the Companies Act without distinguishing between company categories, which further supports the view that these entities constitute the relevant committees without appointing independent directors.
Second, given that NBFCs in the middle layer or above have crossed the ₹1,000 crore asset threshold and fall under enhanced regulatory scrutiny, some take the view that such entities should align with the intended governance standards and appoint independent directors, even if not required under the Companies Act.
Closing thoughts
The SBR Framework takes into account the systemic concerns associated with different NBFCs and thus classifies them into different layers. The corporate governance norms are applicable to ML, UL and TL NBFCs, which, given their asset sizes, are expected to operate at huge volumes and carry a great magnitude of risks. Such NBFCs may have access to public funds (by way of bank borrowings, debenture issuance etc.), wherein large lenders or public would have exposures and consequent high systemic risks. Hence, looking at the constitution (that is whether the NBFC is a private limited or public limited) becomes less important, and looking at the size, activity and function becomes more important.
Thus, it may not be right to conclude that NBFCs registered as private companies and WOS can do away with the mandatory composition prescriptions merely due to the constitutional form of their entity. Looking at the intent and idea of SBR Framework, the applicable NBFCs may be required to appoint independent directors irrespective of the form of their constitution. The scale-based regulation emanates from the idea that NBFCs having high risk should be effectively monitored. Thus, the regulations should be followed in spirit to effectively mitigate the risks arising in the course of the NBFC’s functioning.
[1] Pursuant to the provisions of section 149(4) of the Companies Act read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014, following companies are mandatorily required to appoint independent directions: listed companies, public companies having paid up share capital of ten crore rupees or more; or turnover of one hundred crore rupees or more; or having in aggregate, outstanding loans, debentures and deposits, exceeding fifty crore rupees as per the latest audited financial statements.
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In our previous article, we discussed the expectations of the regulator along with a probable approach for NBFCs towards ICAAP. Notably, while ICAAP is applicable to banks as well as NBFCs (middle and upper layer), our present write-up focuses on ICAAP in the context of NBFCs. The inclusion of ICAAP for NBFCs marks a significant shift, from a one-size-fits-all capital adequacy regime, towards a more tailored, risk-sensitive approach that reflects the unique risk profile of each NBFC.
While RBI has not mandated a rigid format or methodology for ICAAP, it has emphasised the need for internal capital assessments that are proportional to the nature, scale, and complexity of operations. The challenge, however, lies in the absence of detailed guidance or templates. Unlike banks that have had years to mature their ICAAP practices, most NBFCs are at the beginning of this journey.
This article attempts to fill that gap. As a sequel to our previous overview, it delves further into how different elements & each category of risk—credit, market, operational, liquidity, concentration, and others—should be considered for ICAAP.
It may be noted that while the RBI has not issued specific guidelines for NBFCs to undertake ICAAP, they are instructed to be guided by the Master Circular – Basel III Capital Regulations to the extent applicable.
Need of ICAAP for NBFCs
The goal of ICAAP is not merely compliance, it is an internal assessment to ensure that the capital maintained by the NBFC is adequate, not just by regulation, but by the realities of its risk environment.
The risk weights prescribed for computing the minimum capital adequacy are based on the general experience of the regulators with respect to the respective asset classes. However, risks associated with the assets also depend on the credit underwriting qualities of the originator, the geography in which it operates, concentricity, borrower composition, nature of underlying collateral, etc. As a result, regulatory risk weights may not always reflect the true risk. This is where ICAAP comes in.
ICAAP helps NBFCs assess whether they hold enough capital based on their specific risk profile, going beyond the regulatory minimum. This self-assessment often goes beyond the basic rules. For example, an NBFC might consider capital required for additional risks, such as market risk, reputational risk, operational risk, etc, even though these aren’t always covered by the minimum capital requirements set by regulators. It might also use its own methods to evaluate more common risks like credit, market, or operational risks.
Apart from these risks, there are several other factors that are often overlooked but are essential to consider under ICAAP. These include off-balance sheet exposures, the NBFC’s future strategic plans, its compensation practices, etc.
NBFCs approach to ICAAP
An NBFC should not treat ICAAP as a mere compilation of regulatory templates such as capital adequacy, liquidity, or other prescribed formats. Doing so would reduce ICAAP to a regulatory compliance exercise, rather than a genuine internal assessment of how capital relates to the NBFC’s inherent risks.
In addition to serving as an assessment of capital adequacy, ICAAP also functions as a key decision making tool for the management. For instance, it helps evaluate whether the company’s existing capital levels are sufficient to support proposed business plans, assess the potential adverse impact of riskier asset classes on business continuity, and determine if planned growth would require capital infusion alongside debt raising. It also allows the company to assess whether its current trajectory is sustainable. In this manner, ICAAP effectively serves as a business continuity check for NBFCs.
Considering the above, the framework of ICAAP should be robust enough to assist management sufficiently. Accordingly, we discuss key elements of ICAAP in the subsequent section.
Key Elements under ICAAP
ICAAP consists of various elements. The detailed discussion on each element is discussed in subsequent sections. The various elements under ICAAP are as follows:
Listing and Assessment of Key Risk
The most critical element of ICAAP is the assessment of risks faced by the NBFC. It is important to note that there are two possible approaches: one, to consider only material risks, and the other, to consider all risks faced by the NBFC. The former approach is for NBFCs with simpler operations, while the latter is more appropriate for NBFCs with moderately complex operations, based on the management’s assessment.
Based on this assessment, a comprehensive list of risks should be identified and categorised as follows:
Quantitative Risks: Risks that can be measured and quantified reliably should be assessed using the best available data, tools, and methodologies. The methods employed will naturally differ across NBFCs, depending on their risk profile, operational scope, and internal systems. NBFCs are exposed to various types of risks, including credit risk, market risk, operational risk, interest rate risk, credit concentration risk, etc.
Qualitative Risks: While the aforementioned risks can be quantified, there are certain other risks which cannot be quantified such as reputational risk and business or strategic risk, and may be equally important for an entity and, in such cases, should be given same consideration as the more formally defined risk types. For example, an entity may be engaged in businesses for which periodic fluctuations in activity levels, combined with relatively high fixed costs, have the potential to create unanticipated losses that must be supported by adequate capital. Additionally, an entity might be involved in strategic activities (such as expanding business lines or engaging in acquisitions) that introduce significant elements of risk and for which additional capital would be appropriate.
Other key elements under ICAAP
Off-Balance Sheet Items: Off-balance sheet items represent potential obligations that do not appear directly on the institution’s balance sheet but can lead to substantial future liabilities. Examples include loan commitments, letters of credit, derivatives, securitizations, and guarantees.
While these exposures may not currently affect a firm’s capital or liquidity metrics, they carry contingent risks that can materialize under stress conditions. If not adequately monitored and incorporated into risk assessments, off balance sheet items may result in underestimated capital needs, particularly under adverse scenarios.
ICAAP Implications:
Institutions must employ robust risk identification frameworks to capture the nature, size, and likelihood of off-balance sheet exposures becoming on-balance sheet liabilities.
Stress testing should simulate adverse market or credit conditions to evaluate how these contingencies might impact capital adequacy.
Capital buffers should be calibrated to reflect not just current exposure, but also potential future liabilities from these items under both baseline and stressed conditions.
Compensation Practices: Compensation structures have a direct influence on employee behavior and, by extension, the institution’s risk culture. When short-term incentives are misaligned with long-term stability goals, they may encourage excessive risk-taking, leading to undesirable financial outcomes and reputational damage.
ICAAP Implications:
The capital adequacy framework must consider how incentive structures align with the institution’s risk appetite. Compensation policies should be reviewed to ensure they do not drive behaviors that conflict with prudent risk management.
NBFCs should establish compensation deferral mechanisms (e.g., clawbacks, performance-based vesting) and ensure these are factored into risk planning to reinforce sound decision-making.
Future Strategic Plans: Strategic initiatives such as geographic expansion, launching new products, or entering new markets often involve heightened or novel risks. These initiatives may expose the institution to unfamiliar regulatory environments, new credit or operational risks, or increased competition.
ICAAP Implications:
Future business plans must be embedded into capital planning and risk modeling. This includes estimating the impact of new initiatives on capital demand, funding needs, and operational capacity.
Scenario analysis should test how strategic changes could affect capital ratios under both expected and stressed conditions, especially when entering volatile or unfamiliar sectors.
Management must ensure that adequate risk mitigation strategies are in place, and that the institution holds sufficient capital to support growth without compromising its resilience.
Stress Testing: As part of the ICAAP, NBFCs must, at a minimum, conduct periodic stress tests, with a focus on material risk exposures. These tests are designed to assess the institution’s vulnerability to unlikely but plausible adverse events or significant changes in market conditions that could negatively impact its financial position. By implementing a structured stress testing framework, management gains a deeper understanding of the entity’s potential exposures under extreme but realistic scenarios—thereby improving preparedness and resilience. But what exactly is stress in this context? In ICAAP, stress refers to adverse deviations from the base case or normal operating conditions. It could be in the form of macroeconomic shocks, sector-specific downturns, or internal events—such as operational breakdowns or large-scale defaults. The purpose of stress testing is not to predict the future but to examine what could happen if things go wrong.
There is no fixed threshold for the severity of stress scenarios. However, the scenarios should be severe enough to test the NBFC’s capital and liquidity buffers, yet plausible enough to remain relevant. For example:
Interest rate shock of +250 basis points
30% increase in delinquency rates
Sudden collapse in collateral valueNBFCs should ideally run multiple stress levels—mild, moderate, and severe—to observe performance across a range of conditions.
Adverse regulatory action halts lending in a key segment.
Widespread borrower fraud in a key region.
Natural disaster (e.g., flood or earthquake) affecting multiple branches, etc
Quantitative Risks
Credit Concentration Risk
Credit concentration risk arises when a financial institution’s exposures are not well-diversified—either across counterparties, sectors, geographies, asset classes, or even business models. In simple terms, it is the risk of putting too many eggs in one basket. Risk concentrations are arguably the single most important cause of major problems in entities. Credit risk concentrations, by their nature, are based on common or correlated risk factors, which, in times of stress, have an adverse effect on the creditworthiness of each of the individual counterparties making up the concentration. The credit concentration risk calculations shall be performed at the counterparty level (i.e., large exposures), at the portfolio level (i.e., sectoral and geographical concentrations) and at the asset class level (i.e., liability and assets concentrations). There could be several approaches to the measurement of credit concentration in the entity’s portfolio. One of the approaches commonly used for the purpose involves the computation of Herfindahl-Hirschman Index (HHI). Under the HHI approach, an entity first decides what level of portfolio diversification it considers to be ideal—this is called the target HHI. The HHI for the actual credit portfolio is then calculated and compared with the target HHI. If the actual HHI is higher than the target, it indicates that the portfolio is more concentrated (i.e., riskier) than desired.
To compensate for this additional concentration risk, the NBFC needs to hold extra capital. The amount of additional capital is determined by using a multiplier. This multiplier increases in proportion to how far the actual HHI exceeds the target. The multiplier is the interpolated value of Loss given Default at the current HHI level where the minimum LGD is at the target HHI level and the maximum LGD occurs at the highest possible HHI level i.e. 1. Essentially, the more concentrated the portfolio is, the higher the capital buffer required.
Stress Testing: Stress scenarios for concentration risk can involve:
Counterparty default stress, where the largest or top 20 borrowers default simultaneously.
Sectoral collapse, where an entire sector (e.g., real estate or microfinance) underperforms.
Geographic shocks, like drought or political disruption in a key operating region.
The stress scenarios would result in higher Loss Given Defaults and consequently higher capital requirements for stress scenarios.
Credit Risk
Credit Risk is the most important component of capital required for lending institutions. Despite implementing the most rigorous credit underwriting processes, it is impossible to completely eliminate the possibility of credit defaults. This is because certain factors can evolve over time, potentially leading to heightened strain within the portfolio. Companies use Expected Credit Loss (ECL) models to estimate credit risk. However, it’s important to understand that ECL models are designed to capture only the ‘expected’ portion of credit losses—those that are likely to occur based on current conditions and historical data. Hence, entities should also consider using additional models or approaches to estimate the capital required to cover unexpected losses—those rare, extreme events that could have a significant financial impact but are not captured by ECL models. NBFCs may apply stress scenarios to the probability of default and loss given default parameters in their Expected Credit Loss models, beyond what is assumed in the base case, in order to capture potential unexpected losses.
Stress Testing: To stress credit risk, NBFCs can alter the assumptions used in their ECL models or conduct additional simulations to capture unexpected losses. Examples include:
Increasing default rates by 50% to 100% over historical averages.
Reducing recovery rates by 20% to simulate distressed recoveries.
Assuming sector-specific shocks, such as stress in MSME lending or rural portfolios.
Market Risk
An entity should be capable of identifying risks arising from trading activities due to movements in market prices. This assessment should take into account factors such as instrument illiquidity, concentrated exposures, one-way market conditions, non-linear or deep out-of-the-money positions, and the likelihood of substantial changes in correlations. Stress testing exercises incorporating extreme events and market shocks should be specifically designed to highlight key vulnerabilities within the portfolio in relation to relevant market developments.
Stress Testing: For market risk, NBFCs should simulate movements in interest rates, exchange rates, and asset prices. Examples of stress scenarios include:
A 250–300 bps rise in interest rates, increasing cost of funds and decreasing bond portfolio values.
Drop in collateral prices (e.g., gold or real estate) by 20%–30%.
Liquidity contraction in trading instruments, rendering assets difficult to exit.
The idea is to identify exposures where market volatility could result in valuation losses or income shocks.
Operational Risk
An entity should be equipped to evaluate potential risks arising from deficiencies or failures in internal processes, personnel, and systems, as well as from external events. This assessment should also consider the impact of extreme events and shocks associated with operational risk. Such events may include a sudden surge in process failures across multiple business units or a major breakdown in internal controls. As a general practice, companies often use the Business Indicator Component Model for computing the capital requirement for operational risk. In this model, the risk is computed by multiplying the average income of the entity with a prescribed factor.
Stress Testing: Stressing operational risk requires assumptions about adverse internal or external events. For instance:
Simulating a cyberattack that shuts down core systems for 5–10 days.
Widespread process failures during a system migration or staff shortage.
Vendor risk, where a critical third-party service fails.
Qualitative Risks
Compliance Risk
NBFCs in India operate within a highly regulated environment. NBFCs usually are regulated by multiple regulators, and non-compliance with applicable norms would not only result in imposition of penalties/fines but in few cases may even threaten the continuity of operations of the business. Compliance risk may further act as a trigger factor for other risks faced by the Company, as non-compliance may threaten reputation, operations, profitability as well as other aspects of the Company’s operations. Accordingly, compliance risk is considered as a significant risk for the NBFCs. For ICAAP purposes, entities may begin by identifying the sources of risk and evaluating the internal controls and mitigation measures already in place. Based on this assessment, they can then determine the residual risk—the portion of risk that remains unaddressed—and accordingly estimate the capital required to cover it.
IT Risk
In the current business environment, almost all the businesses, including that of the NBFCs, are assisted by information technology infrastructure, while these assets assist entities in streamlining its processes and reducing risk due to human errors it also poses a significant risk, due to possibility of malfunctioning and downtime.
Off-balance sheet items
An entity may have various contingent liabilities and on occurrence of certain events if these liabilities were to materialize, they could lead to expenses / losses for the entity.
Hence, despite the uncertainty surrounding these arrangements, it is essential that the entity maintains sufficient capital considering the likelihood of happening of these events.
Compensation practices
An effective compensation framework plays a critical role in aligning employee behaviour with the long-term objectives of the organization to manage human resource risk. It shall be ensured that the compensation policy does not inadvertently prioritize short-term gains for senior management over the long-term interests of the organization. These measures are designed to prevent compensation practices that may incentivize excessive risk-taking or compromise the Company’s long-term goals in pursuit of short-term performance.
To strike the right balance between performance incentives and long-term business objectives, the entity shall maintain an appropriate mix of variable and fixed pay for its employees. This approach aims to encourage improved performance while safeguarding the Company’s overall long-term interests.
These practices fosters a culture of responsible decision-making and ensures that the employees are motivated to achieve sustainable success and growth, aligning individual performance with the broader objectives of the organization.
Future projections
In ICAAP, making future projections is important to check if the institution will have enough capital to stay strong in the coming years, even if things go wrong. These projections usually cover the next 3 to 5 years and include key numbers like expected CRAR (capital to risk-weighted assets ratio), future income, asset growth, and risk levels. The CRAR should be estimated by looking at how much capital the institution will earn and keep, how much new capital it might raise, and how much its risk-weighted assets are likely to grow. Income should be projected based on how much the institution expects to earn from interest, fees, and other sources, while also considering possible loan losses and other costs. The growth in assets should reflect the business plans and also think about where and to whom loans will be given. Based on this, the risk-weighted assets should also be estimated to understand how risky the future asset base might be.
Conclusion
ICAAP represents more than just a regulatory formality—it is a critical framework for NBFCs to understand and manage their unique risk landscape. By systematically identifying, assessing, and planning for both quantifiable and unquantifiable risks, and by applying stress testing to challenge their assumptions, NBFCs can ensure they are adequately capitalised for both expected and unexpected events. A well-executed ICAAP also considers various “blind spots” which often gets overlooked which includes off balance sheet items, compensation practices, future projections, etc. ICAAP not only strengthens financial resilience but also fosters a risk-aware culture, enabling NBFCs to navigate uncertainty with greater confidence and strategic clarity.
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On June 09, 2025, the Tamil Nadu Money Lending Entities (Prevention of Coercive Actions) Act, 2025 was notified (hereafter referred to as ‘Act’). The Act aims to protect vulnerable groups from the coercive recovery practices perpetrated by microfinance institutions, money-lending agencies, and organisations operating in the state of Tamil Nadu. Violations of the Act are subject to penalties, including imprisonment and fines.
While the Act is not generally applicable to RBI-regulated entities, certain provisions on coercive recovery practices (Sections 20 – 26), are made applicable upon NBFCs functioning in Tamil Nadu. The term “functioning” is quite broad, and would appear to include in its ambit entities with branches, and also those conducting business in the state.
Non-compliance with these provisions can also result in the concerned persons of the NBFCs being punished with imprisonment and fines.
What is curious, however, is the differentiation made between banks and NBFCs. The said provisions are not made applicable to banks, but apply to NBFCs. This is notwithstanding the fact that NBFC recovery practices are just as heavily regulated by the RBI, as those of banks, and borrowers already have recourse available to them through the RBI ombudsman, and consumer protection courts.
Indeed, such recourse may be more speedy, and efficacious (as those bodies specialise in such matters), as compared to the police machinery and criminal procedure (which are already burdened with backlogs and heavy case-load). The provisions are also quite subjective and ambiguous in their interpretation (as will be outlined below), and there is certainly a risk that this will result in a slew of complaints by delinquent borrowers, which will serve to stall recoveries further.
Hence, one is at the outset unable to trace the rational nexus behind the differential classification/treatment (between the banks and NBFCs), and the object sought to be achieved[1].
Unpacking the applicable provisions
NBFCs functioning in the state of Tamil Nadu would need to ensure that “no borrower or any of his family members shall be subject to coercive recovery action by a money lending agent, or its agents while recovering a loan from the borrower”. It is to be noted that “coercive recovery action” is nowhere defined in the Act. Section 3(a) states that “coercive actions” are as understood under Section 20, and Section 20 gives only an indicative list of what such coercive actions may be.
Hence, what is “coercion” is only understood by inference, however reference may also be made to the definition of coercion under Section 15 of The Indian Contract Act, 1872, where coercion is the “the committing, or threatening to commit, any act forbidden by the Indian Penal Code (45 of 1860) or the unlawful detaining, or threatening to detain, any property, to the prejudice of any person whatever, with the intention of causing any person to enter into an agreement. “
Under Section 20(2) of the Act, the following may be flagged as coercive, and hence, NBFCS would need to take note of the same:
Coercive actions under Section 20(2) of the Act
Provision: Obstructing/using violence to, or insulting, or intimidating the borrower or any of his family members Punishment for contravention: Imprisonment for a term which may extend to three years / fine of five-lakhs / or both.
Provision: Persistently following the borrower or any of his family members from place to place, or interfering with any property owned or used by them, or depriving them of or hindering them in the use of, any such property Punishment for contravention: Imprisonment for a term which may extend to three years / fine of five-lakhs / or both. Our comments: Sticky borrowers may be reluctant to repay unless persistently followed up with, particularly when the borrowers themselves are moving “from place to place” to avoid repaying amounts due. However what seems to be prohibited here is “stalking” the borrower, and obstructing their daily activities. As regards hindering the borrower in the use of “any property”, in our view, the property here should not be understood to mean the collateral provided by the borrower, or the primary security created out of the disbursed funds. Such an interpretation would cast a chilling effect on the basic assurances available to lenders in secured lending.
Provision: Frequenting the house or other place where the borrower resides or works, or carries on business, or happens to be, with an intention of taking coercive action Punishment for contravention: Imprisonment for a term which may extend to three years / fine of five-lakhs / or both. Our comments: Frequenting the borrower’s house or workplace may be inevitable in cases of high DPDs, and persistent defaults. However, whether or not there was an “intention of taking coercive action” is an entirely fact-sensitive matter, which would require analysis by the courts. Such subjectivity may become an avenue for frivolous complaints by defaulting borrowers.
Provision: Using the service of private or outsourced or external agencies, to negotiate or urging the borrower to make payment using coercive and undue influence; Punishment for contravention: Imprisonment for a term which may extend to five years / fine of five-lakhs / or both. Our comments: What appears to be restricted here is not the mere use of business correspondents or outsourced agents for recovery, but rather using them as an instrumentality for the coercive recovery. Essentially, even if the coercive recovery is not directly done by the lenders themselves they will still be held accountable for the same.
Provision: Seeking to take forcibly any document of the borrower which entitles him to a benefit under any Government programme, any other vital documents, articles or household belongings Punishment for contravention: Imprisonment for a term which may extend to five years / fine of five-lakhs / or both. Our comments: Refer to comments under Row 2, specifically with regards to collateral property and security.
Who would be punished?
In case of NBFCs, the punishment may be imposed on the following persons (See Section 26 of the Act):
Every person who, at the time of the offence being committed, was in charge of and responsible for the business of the Company. Provided that, such persons shall not be liable to punishment if: (i) they prove the offence was committed without their knowledge; and (ii) all due diligence was exercised to prevent the commission of the offence.
In addition to the above, the director, manager, secretary, or other officer, due to whose consent/connivance/neglect/ the offence had been committed, shall also be liable to be proceeded against and punished accordingly.
Should it apply to RBI regulated entities?
Notwithstanding the noble sentiments around protecting borrowers from Shylockian lending, the question here is, can/should such a state money-lending enactment also apply to RBI-regulated entities? Especially considering that there are already exhaustive regulations around the recovery practices (including for MFIs, the concerns around which the Act purports to address).
The Apex Court had ruled on this in Nedumpilli Finance Company Ltd. v. State of Kerala. Here, the Court held that because the RBI Act and control over NBFCs are traceable to entries under List I of the Seventh Schedule of the Constitution, Article 246(1) of the Constitution would come into play. This grants parliament exclusive law-making power over the said entries. Further, Section 45Q of the RBI Act provides an overriding effect to Chapter III of the RBI Act and regulations made thereunder (which are of a statutory nature).
Hence, it is understood that such state money lending enactments cannot apply to NBFCs. For interested readers, we have written on this judgment here, and have also covered the constitutional analysis from an earlier judgment by the Gujarat HC, here.
In the final analysis, the RBI (already) regulates NBFCs from “cradle to grave”. As observed by the Hon’ble Supreme Court, unlike state enactments, which have a one-eyed approach of borrower protection, the RBI Act takes a holistic approach to lending business. And, “all activities of NBFCs automatically come under the scanner of the RBI. As a consequence, the single aspect of taking care of the interest of the borrowers, which is sought to be achieved by the State enactments, gets subsumed in the provisions of Chapter IIIB”.
[1] Referring to the doctrine of reasonable classification under Article 14 of the Constitution.
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Probably the first in India, green securitisation has finally found an entry with the recent issuance of pass-through certificates backed by residential rooftop solar loan receivables in India. The loans were originated by a ‘green-only’ NBFC focussed on climate-positive lending. The present issuance is in the form of green collateral securitisation – since the securitised receivables qualify as ‘green’. Further, given the activities of the originator, it seems that the same may qualify to be a green capital securitisation, with the freed capital of the originator being utilised towards creation of green assets.
Notably, as per a recent publication of Climate Policy Initiative, the Global Landscape of Climate Finance 2025, India has been ranked as the leading country in the South Asia region in terms of mobilisation of climate finance (as per the data for 2023). Green securitisation may act as a catalyst to the growth of green finance in India. See a whitepaper on the same here.
A broader concept in the context of climate finance is sustainable securitisation, our whitepaper on the same can be accessed here. The recent guidelines of SEBI also permits the issuance and listing of sustainable securitised debt instruments, based on the recommendations of the Working Group constituted for the review of SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008, chaired by Mr. Vinod Kothari. An article on the concept of sustainable SDIs may be accessed here.
The evolution of Electronic Trading Platform (‘ETPs’) is rooted in the market’s need for speed, efficiency, and enhanced transparency in dissemination of trade information. Traditional floor based trading methods struggled with sluggish processes, limited data dissemination, and inefficiencies that couldn’t pace with a global financial landscape. In response, industry players and regulators recognised the need for a digital overhaul, a system that could streamline trade execution, provide real-time market data, and foster a more accurate price discovery mechanism. This led to the emergence of specialised platforms, such as those designed for government securities trading, where primary dealers are entrusted with membership and operations. One such platform is ETP.
An ETP is a computarised system that facilitates the buying, selling and management of a wide range of financial instruments (listed down below). These platforms enable real-time market data dissemination, order execution, and efficient trade processing. For instance, in India, platforms such as the NDS-OM (Negotiated Dealing System – Order Matching) are well-known examples that specialize in government securities (g-sec) trading. Other entities include various bank-operated ETPs such as BARX operated by Barclays Investment Bank (international) and proprietary systems developed by financial institutions such as 360TGTX operated by Three Sixty Trading Networks (India) Pvt. Ltd.
Entities operating ETPs facilitating transactions in eligible instruments,under the New ETP Directions,
Grandfathering clause:
Any entity already authorised under the Erstwhile ETP Directions shall deemed to have been authorised under the New ETP Directions, or
any action already taken under the Erstwhile ETP Directions “shall be deemed to have been taken” under the New ETP Directions.
In practical terms, operators need not re-submit applications, seek fresh authorisations or revisit past actions as long as compliant under the Erstwhile ETP Directions.
Effective Date:
Effective immediately i.e. from June 16, 2025.
All about Electronic Trading Platforms (‘ETPs’)
Before going ahead to analyse the changes let us understand what ETPs are. ETPs are electronic systems, other than recognised stock exchanges, on which transactions in eligible instruments are contracted. But why would someone prefer trading on ETP rather than other exchanges/ platforms such as stock exchanges? ETPs offer eligible entities multi-instrument trading platforms (dealing with money-market, G-Secs, FX, swaps etc.) with tailored tenures and faster settlement process while stock exchanges cater to listed equities and futures with standardised contracts, retail participation and fixed trading hours.
Who operates these electronic systems?
Any entity as defined in the New ETP Directions incorporated in the form of a company and authorised by the RBI in this regard can operate an ETP. Currently, there are 12 authorised ETP operators under the Erstwhile ETP Directions who shall continue to operate under the New ETP Directions.
Types of ETP: Single Dealer Platform v. Multi-Dealer Platform
Basis
Single Dealer Platform
Multi-Dealer Platform
Seller
A single bank or financial institution
Several banks and financial institutions
Pricing
Tailored pricing from one provider.
Competitive pricing with options from several liquidity providers.
Liquidity
Low
High
Liquidity source
Provided by a single bank or institution.
Aggregated liquidity from multiple banks/institutions.
Customisation
Tailored interfaces and services designed for specific clients.
More standardized interfaces across multiple dealers; less tailored.
Execution quality
Stable and consistent execution within one controlled environment
Best execution can be sought across multiple quotes and providers
Suitability
Clients who value a close banking relationship and prefer a dedicated, controlled trading environment
Clients who want to compare and execute trades across a range of prices and liquidity providers
Example
NDS-OM, operated by Clearcorp Dealing Systems (India) Ltd., provides a secondary market platform for government securities owned by RBI
360TGTX, operated by Three Sixty Trading Networks (India) Pvt. Ltd., provides a platform for trading in FX Spot, Forwards, Swaps and Options
Players on ETP
Primary Dealers- In 1995, the RBI introduced the system of PDs in the Government Securities (G-Sec) Market. The objectives of the PD system are to strengthen the infrastructure in G-Sec market, development of underwriting and market making capabilities for G-Sec, improve secondary market trading system and to make PDs an effective conduit for open market operations (OMO).
The RBI currently extends various facilities to the PDs to enable them to fulfill their obligations, including memberships of electronic dealing, trading and settlement systems (NDS platforms/INFINET/RTGS/CCIL).
PDs are classified as below:
Standalone Primary Dealers- NBFC-ML
Bank Primary Dealers- Scheduled Commercial Banks and Central Banks- National and International
Basis
Standalone Primary Dealer
Bank Primary Dealers
Entity Structure
Operate as independent legal entities, often registered as NBFCs or as dedicated subsidiaries/joint ventures.
Operate as a departmental function within a scheduled commercial bank (or its branch, including foreign banks).
Regulatory Framework
RBI guidelines
RBI Guidelines and bank specific norms
Business focus
Primarily focused on government securities trading and related activities, often with more flexibility to diversify (e.g., underwriting, trading derivatives).
The primary dealer function is one element of a larger suite of banking services and is more integrated with the bank’s overall operations.
Operational Independence
Greater operational autonomy, being solely focused on the government securities market
Functions as an integral part of the bank’s operations, with decisions influenced by the broader business strategy of the bank
PDs registered with RBI
SBI DFHI Limited
Bank of Baroda, Bank of America
Traders
Analysis of Change
Having understood the nomenclature, we may proceed to analyse the changes and what they mean for Regulated Entities. The primary change and intent of the Draft Directions was to curb unregulated entities and platforms, specifically offshore platforms dealing with foreign exchange trading involving inshore/ domestic investors. Please note that foreign exchange instruments have been a part of eligible instruments, however, due to not being defined, the question whether such offshore ETPs would be covered, was always a question. The Draft Directions recommended certain changes, however, the major change was bringing offshore ETPs under the domain of RBI. However, the finalised New ETP Directions do not deal with this aspect.
While the RBI largely accepted the foundational architecture proposed in the draft, it has revised certain provisions to provide clarity in many areas, especially around risk and operational aspects which are now expressed in more precise terms along with addition of new provisions around enforcement and transitional mechanisms.
Highlights of Major Changes:
Expanded applicability to include outsourcing entities under the purview of the New ETP Directions in essence
Carve out to single dealer banks and Standalone Primary Dealer (‘SPD’)
Transition to an electronic application process: Moving away from physical submission, the application process is now streamlined through the PRAVAAH portal
Quarterly and annual reporting requirements for the operators introduced mandating regular updates thereby tightening regulatory oversight
Framework for data preservation and sharing post-authorisation
Comparison at a Glance:
Area
Erstwhile ETP Directions
New ETP Directions
Implications
Application process for authorisation
Physical submission
Through PRAVAAH Portal of RBI
Streamlining the process, enhancing accessibility, efficiency, and real-time tracking for applicants as well as regulators
Quarterly reporting
No such requirement
Quarterly reporting on functioning of ETPs by Operators (details covered below)
Operators to provide periodic updates on operational performance, ensuring regulatory oversight
Annual Reporting
No such requirement
Annual reporting on compliance of the New ETP Directions and terms and conditions prescribed (details covered below)
Operators to yearly confirm their adherence to updated regulatory guidelines and contractual conditions
Eligibility Criteria
Did not apply to ETPs operated by SCBs
Apply to all the entities including SCBs operated ETPs (except exemption covered below)
Banks must now play by the same rulebook as other operators, additionally Public Sector Banks shall have to incorporate (or spin off) a Companies Act vehicle, infuse requisite capital and adhere to technological standards. Until now, Public Sector Banks that operate an ETP slipped neatly around the RBI’s “company‐only” eligibility gate. The New ETP Direction takes away that privilege. From the day the change takes effect, every ETP, bank-owned or not must meet the same bar
Preservation, access and use of data
Did not have a provision for treatment of data in the event of cancellation of authorisation
Specifies the requirement to share data, along with form and manner, with the RBI or any agency in the event of cancellation of authorisation as may be called upon by the RBI or any other agency.
Enhanced regulatory oversight and post-termination accountability on operators
Definition of ‘Entity’
“….an agency formed as a ‘company’ and incorporated under the Companies Act, 2013 (or earlier acts)”
“….any person, natural or legal.”
Language of the New ETP Directions seems to widen the scope of entity, however reading the impact along with para 6(f)(iii), it only brings the outsourcing entities under the widened scope
Grandfathering Rule
Not needed (first issue)
All licenses/actions under Erstwhile ETP Directions shall be treated as valid
No fresh registration required
Exemption
ETPs operated by banks for their customer on a bilateral basis as long as no market is being created for the securities
Carve out to SCBs (including branches of Foreign Banks operating in India) and SPDs wherein the bank or the SPD operating the electronic system is the sole quote/price provider and a party to all transactions contracted on the system.
Banks and SPDs can operate proprietary trading platforms without the full weight of the standard compliance requirements set for multi-dealer platforms. This can streamline their internal processes and reduce regulatory and technological burdens.Acting as the sole quote provider makes these institutions both the operator and counterparty. This can improve execution speed and reduce inter-dealer friction.A single market maker model may lead to faster execution but can constrain competitive pricing, potentially resulting in wider spreads if the operator does not face rival pricing pressures from other dealers.While banks and SPDs gain efficiency due to lesser compliances, they must remain vigilant about disclosure and transparency requirements to avoid any adverse effects on market integrity.Banks and SPDs may develop more tailored platforms, exclusive systems to capture niche market segments.Synchronization with global norms that treat single-dealer platforms as an extension of the dealer’s book and not that of an exchange.
Reporting Requirements:
These new requirements shall have to be complied with along with the existing reporting requirements under the Erswhile ETP Directions from the effective date of the New ETP Directions. Accordingly, the first quarterly report shall be required to be submitted on or before 15th July, 2025 and the annual report shall be submitted on or before 30th April, 2026. The manner of reporting by ETP operators as per the New ETP Directions has been listed below:
Reporting Requirement
Reporting Authority
Frequency
Format
Timeline
New
Functioning of the platform, including but not limited to the following points:Events resulting in disruption of activities, during the quarter, if anyInstances of market abuse, during the quarter, if anyDetails about any material change in trading procedure or technology carried out during the quarter
On or before 15th day of the month following the quarter
Compliance with the New ETP Directions and terms and conditions prescribed at the time of authorisation
RBI
Annually
Not specified
on or before the 30th of April of the succeeding financial year
Data relating to activities on the ETP
RBI
Post cancellation of authorisation
As may be prescribed
As may be prescribed
Existing
Transaction information
Trade repository or trading platform
As may be prescribed
As may be prescribed
As may be prescribed
Other report, data and/or information as required by RBI
RBI
As may be prescribed
As may be prescribed
As may be prescribed
Data/information
Any agency as required by Indian Laws
Not specified
Not specified
Not specified
Event resulting in disruption of activities or market abuse
RBI
Event-based
Not specified
Not specified
Conclusion:
By introducing defined protocols for risk management, data governance and reporting, the updated framework seeks to close existing regulatory gaps. Key provisions of the New ETP Directions include, amongst others, a clear exemption for single–dealer platforms and a streamlined application process via the PRAVAAH portal. These measures ensure legal continuity. Ultimately, this transformative framework not only reinforces the integrity of the trading ecosystem but also cultivates an environment conducive to innovation.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-06-23 19:18:342025-06-23 19:33:47Master Direction on ETPs: Key Changes & Compliance Guide
Project loans, used to finance large infrastructure and industrial ventures like highways, power plants and railways etc., are fundamentally different from regular business or personal loans. Unlike typical loans that are repaid from either the borrower’s existing operations and balance sheet (in case of the former) or the borrower’s own credit worthiness (in case of the latter), project loans are forward-looking: they primarily rely on cash flows of the project, generated onlyafterthe project becomes operational. Because of this, delays in project completion due to various factors such as land acquisition issues and regulatory delays which may be beyond the control of the developer are common. These may arise from. Such delays, though being routine and not necessarily indicating borrower’s stress, triggered adverse asset classifications under the existing rules.
When the RBI introduced its 2019 prudential framework to enable early recognition and time bound resolution of stressed assets, it excluded such project loans from its scope (see para 25). As a result, these continued to be governed by old norms, specifically para 4.2.5 of the 2015 IRCAP and later, para 3 of Annex III under the RBI SBR Directions. However, these norms did not reflect the unique risks faced by project finance especially during the construction phase.
To address these issues, the RBI released the Draft Project Finance Directions in May 2024, proposing a dedicated regulatory framework tailored to project loans. The Project Finance Directions(‘Directions’) have been issued on 19 June, 2025. This article explores the need for such a framework, the changes brought in the regulatory regime, and their impact on borrowers and lenders.
Project finance vs other kinds of finance
In corporate lending, credit decisions are primarily based on the borrower’s balance sheet strength, existing cash flows and overall financial health. where the lender primarily assumes credit risk
In contrast, in project finance, repayments as well as the primary security depend primarily on the successful implementation and projected cash flows of a specific project, rather than the borrower’s overall financial position. Accordingly, the lender takes two different risks:
Project riski.e. the risk that the project may face commencement delays due to factors like regulatory bottlenecks, land acquisition issues or construction delays and;
Credit riski.e. the risk of inadequacy of cashflows to make the scheduled contractual payouts.
Importantly, in project finance, delays in cashflows often happen due to non-credit factors linked to project execution, mainly project delays. As a result, automatic downgrading of classification due to any project delay may not only fail to provide a true risk profile of the loan but also cause increased provisioning burden on the lender.
Overview of the Directions
The Directions deal with the following broad aspects:
Classification of projects and project finance;
Prudential requirements for extending project loans including:
Provisioning requirements;
Conditions for sanction, disbursement and monitoring.
Resolution and restructuring of project loans
Either due to stress;
Extension/ delays in DCCO.
Applicability
Classification of ‘project’ and ‘project finance’
Under the Directions, a project is defined as to involve capital expenditure for the creation, expansion or upgradation of tangible assets or facilities, with the expectation of long-term cash flow benefits [see para 9(l)], with the following features:
Project finance is a method of funding where the project’s cash flows/ revenue own revenues are the primary source of repayment as well as the and security for the loan [see para 9(m)].
It can be:
Greenfield (new project);
Brownfield (existing project enhancement).
To qualify as project finance under the Directions:
Note: Loan terms can differ across lenders if agreed by all parties
The earlier definition of project finance under the SBR Directions was generic and vague, referring merely to a “project loan” as any term loan extended for setting up an economic venture. The Directions have provided more clarity on what would be considered as project finance and have linked it to the definition of project finance under the Basel Framework, while also providing a quantitative threshold of 51%.
Project finance envisages the lender’s exposure in a project, which is typically in the process of being set up. The repayment will be from the project cashflow i.e. the payout structure is connected with the commencement of commercial operations of the project. The lending is based on the projected cash flows of the project rather than the balance sheet of the developer. It is distinct from asset finance, where loans are backed by existing assets generating income. Further, project finance differs from a working capital loan/general corporate purpose loan where the latter is towards financing the working capital needs of the developer entity based on the overall health of the entity.
Would it mean that project loans cannot have any other collateral and must solely rely on the project as the security? The answer is negative since the threshold specified allows to have other/ additional collateral, say, personal guarantee of the developer etc., however, the primary security shall be the project cashflows.
Other important terminology
DCCO
The Date of Commencement of Commercial Operations (DCCO) is a key milestone in project finance, marking the transition from construction to operational phase when a project begins to generate revenue.The Directions recognises three forms of DCCO. [see Para 9(e) to (m)]
CRE and its sub-category CRE-RH
Defined in Directions on Classification of Exposures as Commercial Real Estate Exposures, CRE refers to loans or exposures where repayment primarily depends on income generated by the real estate asset itself. This typically includes office spaces, malls, warehouses, hotels and multi-family housing complexes that are leased or sold in the open market. Since CRE is a sub-head of project finance, it also follows similar characteritics of project finance i.e.both repayment of the loan and recovery in case of default are closely tied to the cash flows from the real estate asset such as rental income or sale proceeds. [see para 9(b)]. The definition is aligned with the definiton of income-producing real estate (IPRE) under Basel norms. Our article discussing CRE can be assessed here. https://vinodkothari.com/2023/04/commercial-real-estate-lending-risks-and-regulatory-focus/
Commercial Real Estate – Residential Housing (CRE-RH) [see para 9(c)]
Since residential housing projects generally pose lesser risk and volatility compared to commercial properties, the RBI created a distinct sub-category within CRE called CRE-RH vide notification dated June 21, 2013. CRE-RH includes loans given to builders or developers for residential housing projects meant for sale.To classify as CRE-RH, the project must be predominantly residential and commercial components like shops or schools should not exceed 10% of the total built-up area (FSI). If the commercial area crosses this 10% threshold, the entire project will be CRE. This distinction isn’t just semantic, it has regulatory benefits. Since CRE-RH are subject to lower risk due to various reasons such as diversified cash flows and lower dependency on a single occpnt, RBI has assigned lower capital risk weights i.e. 75% to CRE-RH compared to standard CRE 100% and lower provisioning provisioning requirements (0.75% vs. 1%).
Prudential requirements
Provisioning requirements
In the context of project finance, where risks vary across different phases of a project’s lifecycle, a one-size-fits-all provisioning approach throughout the project life may not be relevant. .
Under the SBR, provisioning norms made no distinction between the construction and operational phases of a project. A uniform provisioning rate was applied i.e. 0.75% for CRE-RH and 1% for CRE while other loans were provisioned at 0.4% irrespective of whether the project was just starting construction or had already begun generating revenue. This approach, while simple, failed to reflect the heightened risks associated during the construction phase , such as delays, cost overruns, or regulatory hurdles.
To address this gap, the Draft Directions, proposed a conservative approach calling for a 5% provision during the construction phase and 2.5% during the operational phase, with the operational rate reducible to 1% if following conditions were met:
the project demonstrated positive net operating cash flows sufficient to service all current repayment obligations, and
there was a minimum 20% reduction in long-term debt from the level outstanding at the time of achieving DCCO.
These draft norms were considered overly harsh, particularly for long-gestation infrastructure projects where cash flows stabilise gradually.
Taking stakeholder feedback into account, the Directions adopted a more balanced g structure as follows:
Project type
Construction Phase
Operational phase – after commencement of repayment interest and principle
Commercial real estate (CRE)
1.25%
1%
CRE – Residential Housing
1%
0.75%
Other projects
1%
0.40%
DCCO deferred projects:
Additional provisioning to be maintained depending on the type of project:0.375% per quarter for infra projects0.5625% per quarter for non-infra projects
NPA project finance accounts
As per extant instructions
Provisionig for existing projects
Continued to be governed by extant norms;If resolution is done for any fresh credit event or change in terms occur after the effective date of these directions, then provisioning as per these Directions
RBI’s draft proposal for lower risk-weights for high quality infrastructure projects
The RBI has issued a draft amendment to the Scale Based Regulations, 2023 on 27th October, 2025, proposing a lower risk weight framework for ‘High-Quality Infrastructure Projects’. Once finalised, the provisions would be applicable from April 1, 2026, or from an earlier date when adopted by an NBFC in entirety. The intent of the amendment is to recognise and incentivise lending to stable, well-performing infrastructure projects by prescribing reduced risk weights for such exposures. Under the draft, “High-Quality Infrastructure Projects” are defined as infrastructure projects meeting all of the following conditions:
The project has completed at least one year of satisfactory operations post achievement of the actual DCCO;
The exposure is classified as ‘standard’ in the books of the lender;
The obligor’s revenue depend on one main primary counterparty, which shall be the Central Government or a Public Sector Entity, and the contractual terms ensure certainty of payment, such as through availability-based1 or take-or-pay arrangements2;
The contractual provisions offer strong creditor protection such as escrow of cash flows, legal first charge on project assets and other appropriate safeguards in case of early termination;
The obligor has adequate internal or external funding arrangements to meet current and future working capital or other funding needs, as assessed by the lender;
The obligor is restricted from undertaking actions detrimental to creditors, such as raising additional debt secured by the project’s cash flows or assets without lender’s consent.
Projects meeting all of the above criteria will qualify as high-quality infrastructure assets and will attract lower risk weights, as follows:
50%, where the obligor has repaid at least 10% of the sanctioned amount;
75%, where the obligor has repaid at least 5% but less than 10% of the sanctioned amount.
If a project subsequently fails to meet any of the qualifying conditions, it will cease to be treated as a high-quality asset and will instead attract the standard risk weight of 100% applicable to regular infrastructure exposures.
Conditions of project finance
The onus is on the lender to ensure that the following conditions are met before extending any project finance. These conditions will ensure that the facility is structured prudently and is aligned with the implementation as well as cash flows of the project, thereby mitigating both credit as well as project risk. The requirements are more or less similar to the earlier Directions.
Repayment schedule during operational phase is designed to factor initial cash flows
Repayment tenor, including the moratorium period, if any, shall not exceed 85% of the economic life of a project.
This means there is a mandatory 15% tail period i.e. if the project has an economic life of 20 years and the loans are to be repaid in 17 years, the last 3 years are the tail period.Tail period gives comfort to the lender that in case of any default or delay in repayment by the time of maturity, there is still some period left to recover dues from the project cash flows after the scheduled loan maturity.
Would this mean that a borrower cannot obtain a top-up loan after the expiry of 85% of the loan tenure?
The requirement applies to loans with all kinds of tenures, either short or long.
One borrower, multiple lenders
If a project is financed by more than one lender, RBI mandates that the DCCO, whether original, extended or actual, shall be the same across all lenders. This will ensure that:
DCCO is uniform across all lenders
Project progress as well as any delays are uniform across all lenders
Uniform asset classification, preventing any lender from having a different provisioning status.
To ensure balanced risk sharing, the Directions have put consortium lending limits (Para 15): Where projects are under-construction:
Aggregate exposure of all lenders is ≤ ₹1,500 crore: each lender shall hold at least 10% of total exposure;
For projects with exposure > ₹1,500 crore: each lender must hold at least 5% or ₹150 crore, whichever is higher.
These caps essentially require participating lenders to hold sufficient skin in the game and thereby promote responsible credit appraisal as well as avoid risk from being concentrated in a few lenders, especially where other lenders have negligible exposure and hence, less incentive to ensure monitoring.
Inter-lender transfer
These minimum exposure norms will not apply to operational phase projects;
In design or construction phase, lenders are permitted buy/sell exposure only under syndication arrangements as per TLE, and within the exposure limits
In operational phase, exposures can be freely transferred as per TLE norms.
This may be because construction and pre-operational stages are inherently more uncertain and riskier, and therefore, the regulator requires lenders who are willing to remain committed and not exit easily to avoid creating instability.
Project lifecycle – 3 different phases
A project has been divided into 3 phased viz Design, Construction and Operational.
Why does this classification matter?
The regulatory framework treats each phase differently for various risk, compliance and prudential reasons.
Disbursement discipline (Para 21)
Disbursal of funds must be linked to project completion milestones i.e. completion of phases.
Lenders must also track progress in equity infusion and other financing sources as agreed at financial closure
Asset classification (Para 22 & 29)
In design and construction phases, loans can be classified as NPA based on recovery performance, as per IRACP norms.
Once an account is classified as NPA, it can only be upgraded after demonstrating satisfactory performance during the operational phase
Resolution trigger (Para 23)
If any credit event (e.g., default) occurs with any lender during the construction phase, a collective resolution process is triggered
Provisioning norms (Para 32)
Provisioning rates are higher for projects under construction
Once the project enters the operational phase, provisioning reduces, reflecting lower credit risk.
Mandatory requirements before sanctioning a project finance loan: (13)
Achievement of financial closure and documentation of original DCCO;
Project specific disbursement schedule vis a vis stage of completion is included in loan agreement
Post DCCO repayment schedule designed to factor initial cash flows
Prudential conditions related to disbursement and monitoring:
Lender to ensure the following:
Clearances are obtained by the lender:
All requisite approvals/clearances for implementing/constructing the project are obtained before financial closure.(examples: environmental clearance, legal clearance, regulatory clearances, etc.)
Approvals/clearances contingent upon achievement of certain milestones would be deemed to be applicable when such milestones are achieved.
Availability of sufficient (prescribed) minimum land/right of way with the lender before disbursal of funds
This would mean that lender must ensure that the builder executing the project has either:
Ownership of the land (through purchase, lease etc.) or
Legal rights to use/access the land i.e. Right of Way.
For PPP projects, disbursal of funds to occur only after declaration of the appointed date.
Except where non-fund based facilities are mandated by the concessioning authority as a pre-requisite for declaration of the appointed date itself;
Disbursal to be proportionate
To stages of completion of project, infusion of equity or other sources of finance and receipt of clearances
Lender’s Independent Engineer/Architect to certify the stages
Creation and maintenance of a project finance database (see para 37):
Every lender to capture and maintain, on an ongoing basis, project specific information relating to:
Debtor and project profile;
Change in DCCO;
Credit events other than deferment of DCCO;
Specifications of project
Any updation shall be made within 15 days from any change in information;
Necessary systems to be placed within 3 months from the effective date ie by 1st January, 2026
Resolution of Project Loans
Prudential norms for resolution
Lender to monitor performance of project on on-going basis;
Expected to initiate a resolution plan well in advance.
Collective resolution to be initiated by the lenders in case credit event happens with any one lender
In case of any credit event;
Lender to report the same:
to the Central Repository of Information on Large Credit and;
to all other lenders, in case of consortium lending.
Lender to take a review of debtor account within 30 days.
Inter creditor agreement and decision to implement a resolution plan may be done during this period.
Implement the resolution plan within 180 days from the end of the review period.
Resolution plans involving extension of DCCO
Paragraphs 26 to 28 provide a structured framework under which project loans may continue to be classified as ‘standard’ despite delays in project completion, provided specific conditions are met. The objective is to offer flexibility to lenders and borrowers in addressing genuine project delays or cost escalations, without triggering an immediate downgrade to NPA so long as the resolution is timely and prudently implemented.
Permitted DCCO deferment
The DCCO may be deferred, with a corresponding adjustment in the repayment schedule. However, such deferment is subject to the following maximum limits:
Up to 3 years for infrastructure projects
Up to 2 years for non-infrastructure projects (including commercial real estate)
Cost overrun associated with the DCCO deferment:
A cap of 10% of the original project cost, over and above Interest During Construction (IDC)
The overrun must be financed through a Standby Credit Facility sanctioned at the time of financial closure
Post-funding, key financial metrics such as the Debt-Equity ratio and credit rating must remain unchanged or show improvement in favour of the lender
Deferment in DCCO associated with change in scope and size
Rise in project cost (excluding cost overrun) is at least 25% or more of the original project outlay
Reassessment of project viability by the lender before approving the revised scope and DCCO
If the project has an existing credit rating, the new rating must not deteriorate by more than one notch; if unrated and aggregate lender exposure is ₹100 crore or more, the revised project must obtain an investment-grade rating
This benefit of maintaining ‘Standard’ classification due to a change in scope can be availed only once during the project’s life
Resolution plan (‘RP’) deemed successfully implemented only if:
Necessary documentation completed within 180 days from the end of the Review Period and;
Revised capital structure and financing terms are duly reflected in the books of both the lender and the borrower.
Immediate downgrading to NPA if the resolution plan is not implemented within the timeline and conditions above
Once NPA, account can be upgraded only after:
Satisfactory performance post actual DCCO, in case of non-compliance with conditions of resolution plan;
Successful implementation of resolution plan, in case of non-implementation of RP within the specified time.
See a detailed PPT on the Project Finance Directions here
A contractual model where the project earns fixed payments from the counterparty based on the asset’s availability and performance, irrespective of actual usage or demand ↩︎
A contract under which the buyer agrees to pay for a specified quantity of output (e.g., power, gas, water) whether or not it actually takes delivery, ensuring predictable cash flows for the project. ↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-06-23 16:44:502025-10-28 18:11:30Balancing flexibility and discipline: Analysis of RBI’s Project Finance Directions, 2025
Loan write-offs in case of banks has been a consistent practice, and has been sharply criticized in several forums. Loan write-offs constitute a significant amount: Between FY 2015 and FY 2024, Scheduled commercial banks wrote off loans worth ₹12.3 lakh crore, with a ₹9.9 lakh crore written off in just the last five years (FY 2020 to FY 2024).
Year
Amount (in INR Crore)
2023-24
1,70,270
2022-23
2,08,037
2021-22
1,74,966
2020-21
2,02,781
2019-20
2,34,170
Total
9,90,224
Table 1: Loan write-offs by banks in the last 5 years (FY 20 – 24)
On the other hand, global supervisors and developmental bodies have always advocated a sound loan write-off policy for uncollectable loans. In its 2014 paper, IMF says:
“Banking supervisors should have a general policy requiring timely write-off of uncollectible loans and assist banks in formulating sound write-off criteria. The benefits of timely write-offs of uncollectible loans are numerous … A bank should write off a loan or portion of a loan when it is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This does not have to be preceded by exhausting all legal means and giving up contractual rights on cash flows. This also does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this essentially worthless asset even though partial recovery may be realized in the future.”
The IMF paper also discusses the potential downside of the write-off – that the reported NPLs would be lower, however, it argues that the write-off gives a better picture of the provision coverage.
European regulators have also extensively recommended loan-write off policy. In a 2017 paper1, European Central Bank says:
“An entity should write off a financial asset or part of a financial asset in the period in which the loan or part of the loan is considered unrecoverable. For the avoidance of doubt, a write-off can take place before legal actions against the borrower to recover the debt have been concluded in full. A write-off does not involve the bank forfeiting the legal right to recover the debt; a bank’s decision to forfeit the legal claim on the debt is called “debt forgiveness”.
The World Bank in a 2019 paper2 has, likewise, given several benefits of a write-off as compared with provisioning:
“An ambitious NPL write-off policy provides several benefits for banks and the financial system.
Firstly, by resolving NPLs banks can focus on core business (i.e., financial intermediation) in terms of time and resources. By efficiently dealing with NPLs, including writing off, the bank can allocate its productive resources to new lending, instead of becoming an asset management company of “bad assets”.
Secondly, while the main aim is the liquidation of assets with low recovery prospects, the consequence of an NPL write-off typically is a decrease of the NPL ratio in banks. Country experience shows that this is a particularly efficient way to decrease the NPL ratio quickly …
Thirdly, there are no negative effects on financial statements, provided that loans are already fully provisioned and losses already recorded in the P&L statements. Fourthly, a decrease in NPL ratio should improve a ratings agency assessment of credit risks in the bank or in the financial system.”
IFRS 9 (Indian version Ind AS 109) specifically permits write-off, though its precursor, IAS 39 did not have a specific provision.
Originally, write-off in India seems to have been inspired by tax considerations, as a mere provisioning qualifies for a conditional and limited tax deduction under sec. 43D of the Income-tax Act. On the contrary, write-off as a bad debt can be fully claimed. Therefore, as back as in 2009, the RBI advised:
“Therefore, the banks should either make full provision as per the guidelines or write-off such advances and claim such tax benefits as are applicable, by evolving appropriate methodology in consultation with their auditors/tax consultants. Recoveries made in such accounts should be offered for tax purposes as per the rules.”
Similar paras appear in the Prudential circular of 2007 and 2008 too.
What is the genesis of the word “technical write-off”? Is it coming from global jurisdictions? It does not seem so. As per our research, the 2009 circular of the RBI (cited above) permitted banks to write off advances at HO level, even though they are outstanding at the branch level [this, in present day parlance would mean, write-off in books of account, though still outstanding in the customer’s MIS LAN).
The RBI stated:
“Banks may write-off advances at Head Office level, even though the relative advances are still outstanding in the branch books. However, it is necessary that provision is made as per the classification accorded to the respective accounts. In other words, if an advance is a loss asset, 100 percent provision will have to be made therefor.”
This write-off, done at HO level but not at branch level, has been referred to as prudential or technical write off, that is written-off technically, but not written-off really. In the forms appended to Master Circulars of 2011 onwards, the word “technical write off” appears with the meaning referring to advances which are written off at HO level.
FAQs on Write off
Below are some of the pertinent questions on write-offs:
Para 4.1.3 of the IRACP Circular defines a loss asset as follows:
“A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection, but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.”
This loss asset has been placed as a category under NPAs.
The Technical Write-off Framework states:
“Technical write-off for this purpose shall refer to cases where the non-performing assets remain outstanding at borrowers’ loan account level, but are written-off (fully or partially) by the RE only for accounting purposes, without involving any waiver of claims against the borrower, and without prejudice to the recovery of the same.”
The Prudential Circular provides that loss assets are either to be written off, or to be fully provided for. On the other hand, the Compromise Framework clearly refers to full or partial write off.
The intent of the two is the same – to write down what is worthless. However, the Prudential Circular is referring to the degradation of an NPA – from substandard, to doubtful, to loss, where it comes to a stage where there is a trivial recovery value. The end result is the same – the first one is a mandatory prudential requirement; under the Technical Write-off Framework, accounting write-off is purely optional.
Can a lender do a partial write off? Or write off means the entire amount due from the borrower needs to be written off?
Response:
Very clearly, the technical Write-Off Framework provides the option for a partial write-off. Further, in terms of para 5.4.4 of Ind As 109
“An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off constitutes a derecognition event [see paragraph B3.2.16(r)].“
Further, para B3.2.16(r) provides that,
“The following examples illustrate the application of the derecognition principles of this Standard- (r) Write-off. An entity has no reasonable expectations of recovering the contractual cash flows on a financial asset in its entirety or a portion thereof.“
Therefore, accounting norms also allow for partial write offs and to the extent the loan has been written off, the lender can derecognise the loan asset from their books.
What is the approach towards write off? In case of secured loans, and in case of unsecured loans?
Response:
The key to determination of write-off is the extent of recovery in an impaired loan. That is, what is considered not recoverable is written off. So, the task is to recognise (a) an impaired loan; (b) make a fair estimate of recoverable amounts from the loan; (c) apply a suitable discounting factor; and thus, find the fair value of the loan. The difference between the POS and such fair value becomes the amount of the write-off.
In case of secured loans, the focus is on the value of the collateral, the haircut on its valuation due to sale of repossessed collateral, legal expenses and costs on recovery, the time taken, etc.
What is the stage of write off – only when the asset turns an NPA or can the write off be done before it is recognised as NPA?
Response:
The Technical Write-off Framework refers to technical write off in case of NPAs. The IRACP Circular (applicable upon Banks) also refers to a loss asset as a sub-category of NPAs. However, under the SBR Directions (relevant for NBFCs), loss asset is not a sub-category of NPA but is defined as a separate asset class:
(i) an asset which has been identified as loss asset by the NBFC or its internal or external
auditor or by the Reserve Bank during the inspection of the applicable NBFC, to the extent it is not written off by the applicable NBFC; and
(ii) an asset which is adversely affected by a potential threat of non-recoverability due to
either erosion in the value of security or non-availability of security or due to any fraudulent act or omission on the part of the borrower.
That, however, does not imply that a lender cannot have a policy of recognition of impairment before an asset turns NPA. This will depend on the nature of the asset. For example, in case of personal loans, if a lender recognises a loan as impaired after 60 DPD, the lender may do a write off. Of course, there is no justification to do a write off if the loan is not considered impaired, on the basis of the parameters that may be applicable to the said loan.
There are two facilities to a borrower – can one be written off while the other one continues? What will be the basis for the same?
Response:
Yes. It is possible that one loan is backed by a tangible collateral, say, home loan or gold loan, while the other loan is unsecured. While the borrower may default on the unsecured loan, he may be maintaining performance on the secured loan, in order not to lose the collateral. If the value of the collateral, on the basis of principles discussed above, is good, it is possible to conclude that no write-off is required in case of the secured loan, while write-off may be done in case of the unsecured one.
If one facility to a borrower is written off, can the other continuing facility, which is not in default, be treated as performing/standard?
Response:
Even though one loan (having a DPD status of 90+ days) is written off, the borrower’s liability to pay and the lender’s right to recover continue. The borrower is a defaulter. NPA classification is based on borrower, and not on facility. Hence, the other facility will remain NPA.
After write-off, can the lender give a fresh loan to the borrower?
Response:
We find it quite difficult to justify giving a fresh credit facility to a borrower who caused a write-off. However, para 12 of the Technical Write-off Framework allows giving of new loans to a borrower whose account has been written off after a minimum cooling period decided in accordance with the lender’s Board-approved policy.
In case a borrower has been written off by a particular lender, can another lender extend a fresh loan to such borrower? Would the cooling period provision be applicable in such a scenario?
Response:
The response to this seems affirmative, as the language of the Technical Write-off Framework suggests that bar on taking fresh exposure during the cooling off period is on the RE involved in the arrangement, however, it does not suggest any prohibition on other lenders to take fresh exposure during this period.
Of course, other lenders will have to take their own informed credit call and carry out the credit assessment in view of the impaired credit history of the borrower.
What is the difference between:
write off and waiver
Write off and restructuring
Response:
Waiver is the exhaustion of all rights to recoverability of the loan amount as compared to write offs where the lender writes off the amount only for accounting reasons but retains the legal right to recover money.
What should be the contours of the write-off policy? If there is an SOP for write off, what will the SOP contain?
Response:
The write off policy must contain the following aspects:
Condition precedent for write offs – this may include:
Efforts taken for a one-time settlement;
death of the borrower with absence of insurance;
achievement of a certain number of days past due before writing off);
Deterioration in the collateral value
a stipulation that if the monthly recovery drops below a certain % of the loan outstanding only then will the loan be written-off;
untraceability of borrower;
absence of guarantor support;
minimum time elapsed since last recovery;
exhaustion of all possible legal remedies etc.
Approval authority for the write-off – an approval matrix should be drawn for this purpose based on:
Size
Nature of loan
DPD status
Determining the write off amount – this will be based on the extent of security available, recovery efforts already taken, recovery costs associated etc.
Reporting Mechanism for write offs – to the board and CICs
The SOP on the other hand should provide for the following:
Recovery efforts taken and exhausted before arriving at the write off decision
Determination process of the write off amount
Recovery efforts to be taken after write off etc.
Who should approve the write off?
Response:
The delegation of powers for approving write-offs should be clearly articulated in the Policy (Para 5 of Annex to the technical Write off Framework). To ensure objectivity and avoid any potential conflict of interest or a ‘judge in its own case’ scenario, the write-off should, as a general principle, be approved by an authority which is at least one-level higher than the sanctioning authority of the original exposure. The approving authority should be determined based on factors such as the size of the exposure/write-off, the nature and duration of the borrower relationship. The policy should provide adequate flexibility while maintaining robust checks and balances.
What evidence of uncollectability is required to be put on record for write-off action?
Response:
The assessment will be borrower-specific. A detailed record of all the recovery actions taken, outcomes, and reasoned justification that all reasonable recovery measures have been exhausted, and further recovery is impractical, shall be maintained. This shall include reminders, follow-ups, legal notices, enforcement actions, and other efforts undertaken.
An aggressive lending policy, backed by an aggressive write off policy – what implications does it have for the lender, or for the system? In a situation where the lender is witnessing high levels of write off, is there a need to revisit the lending policy ?
Response:
Lending has to be responsible, that is, lenders have to assess the prospects of recovering the loan in view of the borrowers’ cashflows. Lenders determine their lending spreads based on expected losses of the portfolio. Therefore, the cost of defaults is charged on the borrowers. Aggressive lending, in a way, involves the cost of the defaults being passed on to those who mean to pay. The assessment of the borrowers’ ability to pay is not merely an ex ante assessment – it is also benefited by the feedback from performance of the existing pools. Therefore, if a pool is having significant and excessive write off, lenders need to reexamine their lending practices.
Reporting
When the lender writes off the loan, is the lender required to notify the same on the CIC portal?
Response:
Yes, as per the data formats laid down in Annex IV of Master Direction – Reserve Bank of India (Credit Information Reporting) Directions, 2025, a credit institution is required to report written-off amount (total and principal). When an account is reported as written-off and the borrower makes the complete payment, i.e., through settlement or otherwise, the ‘Credit Facility Status’ field in CIC reporting shall be reflected as ‘Post Write Off Closed’.
How long will a lender be required to report write offs to CICs ?
Response:
It may be operationally challenging for lenders to report write-off cases indefinitely. However, considering that the idea of CIC reporting is borrower behaviour, the borrower continues to be a defaulter. Therefore, merely because a loan is written off in accounting books should not mean it should be taken off CIC records.
Accounting
Is there accounting guidance on how the amount of write off/partial write off is to be computed?
Response:
As per Paragraph B5.4.9 of Ind AS 109,
“a financial asset, or a portion thereof, is required to be written off when there is no reasonable expectation of recovering the contractual cash flows. The standard allows for partial or full write-offs, depending on recoverability assessments. For example, if 30% is expected to be recovered via collateral and no further recovery is reasonably expected, then the remaining 70% is to be written off.”
However, Ind AS 109 does not prescribe a specific methodology for computing the amount to be written off, nor does it provide distinct guidance for unsecured lending. In such cases, since no collateral is involved, the amount can be determined based only on how much recovery is reasonably expected from the borrower. For this purpose, the lenders must have a SOP in place which will determine the write off amount based on the expectation of recovery, cost of recoveries, DPD status, borrower history etc.
When an asset is written off, what happens to the specific provision made against the asset, which is outstanding?
Response:
When a loan is written off, the entire amount that is being written off is charged to P/L
When a loan is written-off, the gross carrying amount of the loan is reduced to zero. The specific provision already created against it is utilised (i.e. reversed) against the carrying amount. In other words, as the loan is written off, so is the specific provision against such loan.
What is the impact of write off on the impairment for ECL?
Response:
A write off is a case of incurred loss, whereas ECL is made for expected loss. Expected loss should precede incurrence of the loss, since ECL is forward looking. Therefore, the extent of write off should force a lender to re-examine and calibrate the ECL estimation, such that a write off does not exceed the ECL against such assets..
Is it justifiable to say that there was no SICR and the asset was written off?
Response:
Sans any Significant Increase in Credit Risk (SICR), a financial asset remains in Stage 1 under Ind AS 109. It is generally not prudent to write off a Stage 1 asset, as a write-off requires the lender to have no reasonable expectation of recovering the asset, in whole or in part, a condition that ordinarily implies the asset is credit-impaired and therefore classified under Stage 3. That said, as discussed in above, a write-off before an asset turns to NPA may still be possible, provided there is objective evidence of impairment based on the lender’s internal credit risk assessment, particularly in cases such as short-tenure personal loans or unsecured retail loans, where credit deterioration may manifest earlier than 90 DPD.
What will be the accounting treatment for the recoveries received after an account has been written off?
Response:
Any amount received (principal or interest) after a loan account has been written off will be shown as income in the P/L.
Tax treatment
What will be the tax treatment for write off in the books of the lender?
Response:
For Banks and NBFCs, the tax treatment of loan write-offs is primarily governed by Sections 36(1)(vii) of the Income Tax Act, 1961 (‘IT Act, 1961’). As per Section 36(1)(vii), these entities can claim a tax deduction for bad debts or parts thereof that are actually written off as irrecoverable during the financial year. There are conditions as evidence of the amount having been taken in computation of income, as also reference to accounting standards – ICDS – under sec. 145 (2).
In addition, deduction is allowed for provision, upto limits, under Section 36(1)(viia).
Hence, if there is a write off, the same is deductible against income. However, if the write off was preceded by a provision, and the entity has claimed the benefit of the provision u/s 36 (1) (viia), then the write off should be first adjusted against such provision.
Further, in terms of Section 43D of the Income tax Act, an amount which has already been written off and subsequently recovered will be chargeable to tax in the previous year in which it is credited by the lender to its P/L account or in the year it is actually received, whichever is earlier.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-06-06 17:15:452026-03-12 13:24:18Gone but Not Forgotten: FAQs on Loan Write-offs
Consider this: you’re out shopping on a Saturday afternoon for a perfect pair of jeans. You stop by a store that retails multiple brands and boasts the best variety. With a salesperson to guide you, you make your pick after careful diligence and comparison, and finally check out. Hours later, however, you discover that certain brands were selling better trousers at a lower price point, in the very same store, but these were deliberately obscured from your vision. Now, you feel duped, hurt and confused.
It’s still the same product. However, what has changed is your ability to make an informed choice. What’s worse, indeed, is that you were made to believe that you had an informed choice.
A sincere consumer, shopping for trousers from a multi-brand store.
Multi-lender LSPs (MLLs)
Drawing parallels from the above, in the lending space, a similar tale unfolds. There is an emerging class of platforms that operate as Multi-lender LSPs (MLLs). These MLLs undertake the sourcing function for multiple lenders against a given product. For instance, Partner ‘A’ may act as a sourcing agent via its platform for unsecured personal loans offered by Lenders X, Y, and Z.
In this case, the consumer may be onboarded onto the platform and be under the impression that they are making an informed choice, and receiving an impartial display of all options for the given loan product. If this is indeed the case, then there is no issue. However, it is possible that due to factors including (a) certain Lender-LSP Arrangements, and (b) differences in the commission received from various lenders, the loan product of a particular lender may be pushed to the borrower. The borrower may also be influenced towards making a particular selection through the use of deceptive design practices designed to subvert their decision-making process (Dark Patterns – for more, see our resource here).
Here, the lack of choice and transparency, and insufficient disclosure in the sourcing process would be an unfair lending practice. And unlike a simple pair of trousers, here the consumer’s hard-earned money and personal finances are at stake.
A similar tale unfolds on a multi-lender platform.
Requirements for REs under the Digital Lending Directions, 2025
Para 6 of the DL Directions
In order to protect the borrower and their right to choose, the RBI vide the Digital Lending Directions, 2025 (‘DL Directions’) has prescribed additional requirements upon REs contracting with such MLLs (refer to our article on the DL Directions here).
These requirements under Para 6 of the DL Directions are applicable upon “RE-LSP arrangements involving multiple lenders”, and pertain to:
The borrower being provided a digital view of all the loan offers which meet the borrower’s requirements.
A view of the unmatched lenders as well.
The digital view would have to include the KFS, APR, and penal charges if any of all the lenders, to display terms in a comparable manner.
The content displayed should be unbiased and objective, free from the influence of any dark patterns or deceptive design practices designed to favour a given product.
The RBI’s annual report for FY 2024-2025 also reveals that the rationale behind these additions was to mitigate risks arising out of LSPs that display the loan offers in a discretionary way, and “which seldom display all available loan offers to the borrower for making an informed choice”. These requirements were, of course, first published via the Draft Guidelines on ‘Digital Lending – Transparency in Aggregation of Loan Products for Multiple Lenders’ (our team’s views on the same may be found here).
Multi-lender LSP v. LSP working for multiple lenders – Is there a difference?
Although this may not be immediately apparent from the language, the “RE-LSP arrangements involving multiple lenders” being contemplated here (in our view) are not RE-LSP arrangements where a single LSP is contracting with multiple REs, each for a separate product, but rather the MLLs described above.
For example, consider a scenario where the LSP works with Lender ‘A’ for vehicle loans, Lender ‘B’ for personal loans, Lender ‘C’ for gold loans and so on. Would this then be considered a Multi-lender LSP requiring compliance under Para 6 of the DL Directions? In our view, no.
Here, because each borrower has only a single lender for a particular product, there is no question of their ability to choose being prejudiced, or there being a need to draw a comparison between the terms offered by multiple lenders. Hence, the requirements under Para 6 of the DL Directions would not be applicable upon REs contracting with such LSPs.
Such requirements would only become relevant in the case where the LSP is undertaking sourcing for multiple lenders against a particular product. In such a case, because the borrower is under the impression that they have a choice, it becomes crucial to protect the borrower’s ability to make that choice (in an informed, transparent, and non-discriminatory manner).
Consumer Protection Act, 2019
Additionally, with reference to the above scenario, under Section 2(9) of the Consumer Protection Act, the following (amongst others) have been recognised as consumer rights (upon violation of which the consumer can seek redressal):
Right to be informed: “the right to be informed about the quality, quantity, potency, purity, standard and price of goods, products or services, as the case may be, so as to protect the consumer against unfair trade practices”
Access to competitive prices: “the right to be assured, wherever possible, access to a variety of goods, products or services at competitive prices”.
In our view, with respect to MLLs, this may be interpreted to mean that the borrower has a right to be informed of the comparable options and to receive an impartial, unbiased, and competitive display of the terms to enable their decision-making.
Finally, it is to be noted that such MLLs, would also qualify as “E-Commerce Entities” under the Consumer Protection (E-Commerce) Rules, and the said rules inter alia cast a duty upon such entities to ensure that they do not adopt any unfair trade practice, whether in course of business on its platform, or otherwise [Rule (4)(2)]. Under the E-commerce Rules, a “marketplace e-commerce entity” is an e-commerce entity providing an information technology platform to facilitate transactions between buyers and sellers. Marketplace e-commerce entities are required to ensure that:
All the details about the sellers necessary to help the buyer make an informed decision at the pre-purchase stage are “displayed prominently in an appropriate place on its platform”
To the extent MLLs would meet this definition, they would also need to ensure the same.
RBI has recently been directing NBFCs to compute ECL without factoring in the impact of DLGs obtained1. This stance appears to stem from the regulator’s perception that fintech-issued guarantees carry inherent risk and may expose NBFCs to potential losses.
As per Ind AS 109, Expected Credit Loss (ECL) model is used for the recognition and measurement of impairment on financial assets. ECL is a forward-looking approach that requires entities to recognize credit losses based on expectations of future defaults.
The Default Loss guarantee Guidelines (‘DLG Guidelines’) allow LSPs, (both regulated and unregulated) to provide DLG to the extent of 5% of the portfolio amount to the lender. The DLG Guidelines specify the forms in which such DLG can be obtained.
In terms of para 22 of the DL Guidelines,
“RE can accept DLG only in one or more of the following forms:
Cash deposited with the RE;
Fixed Deposit maintained with a Scheduled Commercial Bank with a lien marked in favour of the RE;
Bank Guarantee in favour of the RE”
Accordingly, DLGs can only be obtained in fully funded forms thus eliminating any question of incurring credit loss on such guarantee.
RBI Directive to NBFCs
RBI has directed NBFCs to maintain ECL without giving effect to the DLGs obtained in accordance with the DLG Guidelines. In this respect, the following should be taken into consideration:
A regulatory prescription, without a regulatory backing, and in fact, going against the regulation:
There is a well-laid process for the RBI coming with a regulation, and in fact, now, the RBI has decided to come up with a consultation process, impact assessment etc before coming with a regulation.
Dictating a certain treatment with respect to ECL is nothing short of a regulation – if this sort of generic requirements keep coming from the supervisors, then the very dividing line between supervision and regulation is lost.
Let accounting standards prevail; auditors and accountants know what ECL to provide:
Annex II of the SBR Directions provides that NBFCs shall follow applicable accounting standards. The ECL provisioning, known as impairment loss, comes from para 5.5.13 of Ind AS 109. The detailed requirements of how ECL is to be estimated has been laid in that standard.
Admittedly, whether and how much ECL write down is required, and whether such ECL estimation does or does not give effect to a fully-funded guarantee, is a matter for the accountants and auditors to deal with. We find little reason for the regulator to step into what is clearly an accounting standard domain.
If there is a funded guarantee, how can losses met by such guarantee be disregarded?
As per DLG guidelines, the guarantee has to be either fully funded, or fully backed by bank guarantee. It is true that even if a credit loss is backed by a guarantee, it is merely shifting of the exposure – from the borrower to the guarantor. But in this case, the guarantee is equivalent to cash. If the lender has a cash collateral to back up the guarantee, there is no reason to not give the benefit of the same in ECL estimation.
For example, if for a certain loan pool, the ECL estimation is 3.8%, and the lender has a guarantee of 5% backed by fixed deposits lien-marked to the lender, will the lender have any expected loss? The answer is negative. If the ECL estimation was, say, 6.8% and the guarantee is 5%, clearly the lender’s ECL will be 1.8%. Thus, there is no reason to disregard the funded guarantee while estimating ECL.
If a company cannot incur loss to the extent of the guarantee, and it still creates an impairment loss, it is actually creating a reserve and not a provision, and therefore, compromising its true and fair view:
The RBI expects lenders to disregard the guarantee and create ECL as if the guarantee did not exist. This will be like creating a loss where the losses actually cannot hit the lender. Therefore, the ECL becomes a reserve, and given that the entity is hitting the P/L with a loss that will not hit the lender, the entity is compromising its true and fair view.
The RBI has reasons to have no trust on the fintechs for the guarantee they give, but it is fully funded.
In light of this, the RBI’s emails sent to various lenders are objectionable, and such emails create a precedent of creating a regulation without going through the regulatory process.
Accordingly, in our view, NBFCs should be allowed to follow their applicable accounting standards while computing the ECL provisions.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-05-30 13:17:352025-05-30 15:38:59Cash in Hand, But Still a Loss?
The RBI has issued Draft Reserve Bank of India (Investment in AIF) Directions, 2025 (‘Draft Directions’), vide Press Release dated 19th May, 2025, marking a significant revision to the existing regulatory framework governing investments by regulated entities (REs) in Alternative Investment Funds (AIFs). These new directions, once finalised, will replace the existing circulars dated December 19, 2023 (“2023 Circular”), and March 27, 2024 (“2024 Clarification”) (collectively, referred to as “Existing Directions”), which currently govern such investments.
The Existing Directions prohibit REs from making investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE. In case of any such investment full provision is required to be maintained by the RE. Such prohibition is imposed to address the concerns of evergreening while making investments by an RE. See our analytical article on the same here.
However, the Draft Directions now propose to allow investment by the RE in such AIF upto 5% of the corpus of the AIF scheme. Any investment exceeding this 5% limit will require full capital if AIF has made debt investments in the debtor company. Note that these norms are entirely directed towards debt or debt instruments (whether at the RE level or the AIF level), as all sorts of equity instruments (equity shares, compulsorily convertible preference shares and compulsorily convertible debentures) are excluded – detailed discussion follows.
Comparison of Existing and Draft Directions
Below is a snapshot of what is going to change once the Draft Directions are finalised and notified, and certain important implications are discussed further:
Particulars
2023 Circular read with 2024 clarification
Draft Directions
Investment by REs in scheme of AIF
RE completely prohibited from investing in any scheme of AIF which has downstream investments in debtor company of the RE.Any investment already made had to be liquidated within 30 days of the issuance of the Circular. Similarly, where the RE had already invested, but AIF makes investment in a debtor company of RE, RE shall liquidate investments in AIF within 30 days.
To be allowed subject to individual and collective limits:Max. contribution of single RE to an AIF scheme – 10% of its corpusMax. contribution of multiple REs – 15% of its corpusSee illustrations later in this article.
Debtor company
Shall mean any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
Shall imply any company to which the RE currently has or previously had a loan or investment exposure (excluding equity instruments) anytime during the preceding 12 months.
Provisioning requirements
Inability to liquidate investments within 30-day liquidation period would entail 100% provisioning against such investments.
Investment by the RE in such AIF allowed upto 5% of the corpus of the AIF scheme, without looking into the form of downstream investments made by AIF. Hence, no provisioning required. If investment by RE exceeds 5%, it will require full capital, if downstream investments by AIF in debtor company are not permissible investments (see below). See illustrations later in this article
Provisioning required proportionately and not on entire investments
Provisioning is required only to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme
Norms remain the same – RE shall be required to make 100 per cent provision to the extent of its proportionate investment in the debtor company through the AIF Scheme
Permissible forms of investments by AIF scheme in debtor company
Investment in equity shares (by AIF scheme in debtor company) were excluded from the prohibition by 2024 clarification. However hybrid instruments were still included.
All forms permitted, if investment by RE does not exceed 5%. Therefore, even debt investments by AIFs are permissible.Only equity shares, CCPS, and CCDs allowed, if investments by RE exceeds 5%. If AIF makes other forms of investments in debtor company, RE will have to provide for full capital.Note that, irrespective of the form of downstream investments by AIF in the debtor company, RE can take a maximum exposure of 10% in an AIF.
Priority distribution model
investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds. Deduction shall be made from Tier I and II equally.
Norms remain the same.
Investment policy
No specific requirement
Investment policy to have suitable provisions to ensure that investments in an AIF Scheme comply, in letter and spirit, with the extant regulatory norms. In particular, such investments shall be subject to the test of evergreening.
Exemption by regulator
No specific enabling provision
Exempted category to be decided by RBI in consultation with GoI.
Illustrations on investment limits by RE
Below are certain illustrations to explain the implications of the investment thresholds under Draft Directions:
Scenarios
Implications under Draft Directions
Investment of Rs. 10 Crores by an RE in an AIF scheme having corpus of 50 crores
Cannot make since the threshold limit of 10% will be breached.
Investment of Rs. 5 Cr by an RE in an AIF scheme having corpus of 50 crores with other REs contributing Rs. 15 Cr
While the investment by the RE individually is within the limit of 10%, the collective investment is more than 15%. Hence, such an investment cannot be made by the concerned RE. Further, since the total investment of 15 cr by other REs will also breach the threshold of 15%, the investments will not be possible.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE.
Cannot be made since the limit of 5% will be breached.
Investment of Rs. 1 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE.
This constitutes only 2% of the corpus of the AIF scheme. Hence, permissible – even when the downstream investment of the AIF is a debt investment.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream equity investment in a debtor company of the RE.
Can be made as the downstream investment of the AIF is in equity of the debtor company. However, the maximum cap of 10% would apply to the RE.
Certain points of discussion/implications
Prospective applicability: The Draft Directions, once notified, will be applicable prospectively. It says, “These Directions shall come into force from the date of final issue (‘effective date’), substituting the existing circulars. Provided that, all outstanding investments as on the effective date, or subsequent drawdowns out of commitments made prior to the effective date, shall continue to be guided by the provisions of the existing circulars.” Therefore, no relaxations would be available to the existing investments/commitments by REs. If the same had not been liquidated so far – those will require to be liquidated. The Draft Directions will apply only to fresh investments by REs.
Maximum cap on investments by RE in AIF: Under Existing Directions, there is a blanket prohibition on RE to invest in AIF scheme which has invested in a debtor company. However, if such downstream investment is in equity shares, such prohibition would not apply. As such RE could invest in the said AIF without any limits. However, now, even if the AIF has invested only in equity instruments of the debtor company (equity shares, CCPS and CCDs), RE can only invest upto 10% of the corpus of the AIF scheme. Hence, to that extent, the Draft Directions are more restrictive than the Existing Directions. Note that, SEBI Circular on specific due diligence with respect to investors and investments of the AIFs does not provide any carve out for equity investments.
Exclusion of equity instruments (equity shares, CCDs and CCPS) from investment exposure of REs in the debtor company: Such exclusion is not explicitly there in the Existing Directions; which might have led to a possible interpretation that investment would include any nature of investment, including equity. Although, it was evident from the use of terminology that a debtor company would only mean a company where RE has extended only debt. The Draft Directions has clarified the same through explicit exclusion. Therefore, the directions will be applicable only where RE has investment in debt/debt instruments of the investee company.
Investments in AIF through intermediary funds: Existing directions exclude investments by REs in AIFs through intermediaries such as fund of funds or mutual funds from the scope of the directions. However, Draft Directions are silent on the same. We are of the view that such exclusion should continue to apply – as funds such as mutual funds are required to be well-diversified in terms of the SEBI Regulations, and investment decisions are taken by an independent investment manager.
Closing Remarks
We had earlier indicated that the Existing Directions may need to be reviewed and softened. The Draft Directions take a step in the same direction – however, a few concerns may still remain open. For instance, the Draft Directions retain the outreach of these restrictions to all AIFs, and not only affiliated AIFs. In our previous article, we had discussed how the concerns as to evergreening, etc. would arise mostly in cases involving affiliated AIFs, and not those AIFs which are completely unrelated to the RE..Further, no distinction has been made between various categories of AIF – therefore, investments in any AIF (Cat I, II, III) would be governed by these directions.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-05-22 18:04:552025-05-22 18:07:20Capital subject to “Caps”: RBI relaxes norms for investment by REs in AIFs, subject to threshold limits
