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The Swap that does it all: RBI introduces total return swaps on corporate bonds

February 9, 2026/0 Comments/in Bond Market, Capital Markets, Financial Services, RBI /by Staff

– Dayita Kanodia & Siddharth Pandey | finserv@vinodkothari.com

Budget 2026 proposed to introduce Total Return Swaps (TRS) for corporate bonds, purportedly as a measure for synthetic trading in corporate bonds. However, given the very slow pick up of credit default swaps, the much easier and globally prevalent version of credit derivatives, will the more esoteric TRS really make a difference? We explain what TRS is, how it differs from a CDS, give a sense of the global data on TRS as a part of OTC credit derivatives, and discuss how much the new measure will impact India’s bond market.

On February 6, RBI, in furtherance of the announcement in the Statement on Developmental and Regulatory Policies dated February 6, 2026, issued the draft revised Master Direction – RBI (Credit Derivatives) Directions, 2022. (‘Draft CD Directions’). The Draft CD Directions permit TRS to be issued to eligible persons.

Background

India’s credit derivatives market has historically remained shallow, with hardly any transanctions involving credit default swaps. This has resulted in limited hedging options focused only on default risk and an absence of tools for transferring market and price risk.

This contrasts sharply with global trends. As of mid-2025, the notional outstanding volume of OTC derivatives exceeded USD 840 trillion, with credit derivatives, despite being smaller in absolute size than interest rate or FX derivatives, recording the fastest year-on-year growth at approximately 23%.

It may be noted that as of 1996, which is when credit derivatives had almost started emerging and gaining strength, TRS transactions were significant and took up almost 32% of the market share. However, the percentage of TRS dropped. Over time, CDSs overtook the position because CDSs are more definitive and limit the risks of the protection seller. In 2025, as per 118th edition of the OCC’s Quarterly Report on Bank Trading and Derivatives Activities based on call report information provided by all insured U.S. commercial banks and others, the TRSs had become a smaller segment representing 4.9 per cent of the credit derivative market.

Meaning of TRS

In simple terms, a TRS swap transfers the entire volatility of returns of a reference asset from one party to another. TRS is a kind of derivative contract wherein the protection buyer agrees to transfer, periodically and throughout the term of the contract, the actual returns from a reference asset to the protection seller (“floating returns”), and the latter, in return, agrees to transfer returns calculated at a certain spread over a base rate (“fixed returns”) Total returns include the coupons, appreciation, and depreciation in the price of the reference bond. On the other hand, the protection seller will pay a certain base rate, say, risk free rate, plus a certain spread. The protection seller in the case of a TROR swap is also referred to as the total return receiver, and the protection buyer is similarly called the total return payer. The figure below illustrates the essential mechanics of a total return swap.

Impact of TRS
TRS swaps originate from synthetic equity structures, where economic returns of an asset are transferred without any actual investment in the underlying. The structure separates economic exposure from legal ownership. In a TROR swap, the economic impact is such that the total return receiver assumes the position of a synthetic lender to or investor in the bonds of the reference obligor, while the total return payer becomes a synthetic lender to the counterparty. Consider the illustration below:

Party PB invests in the unsecured bonds of entity X carrying a fixed coupon of 9.5 per cent.
PB then enters into a TROR swap with PS, under which PB agrees to transfer the actual returns from the bonds of X and, in return, receive MIBOR plus 100 basis points.
Under the terms of the swap, PB periodically transfers the coupon income, plus any market price appreciation minus any market price r depreciation in the bonds, while PS periodically pays MIBOR plus 100 basis points.
Although PB technically holds the bonds of X, in substance PB has neither exposure to X nor to the returns generated by X. Instead, PB is economically exposed to PS at MIBOR plus 100 basis points, which is equivalent to having invested in PS at that rate.
Conversely, PS, despite not holding the bonds of X, is economically exposed to the actual returns from X’s bonds (net of MIBOR plus 100 basis points). The effect of the TROR swap is therefore to synthetically create a fully refinanced investment in the bonds of X, giving a return equal to the actual returns in the bonds, and having a funding cost equal to MIBOR plus 100 basis points.

Thus, the true impact of a TROR swap is the synthetic replacement of exposures. Consequently, the advantages of a TRS can be:

Off-balance sheet exposure: TRS creates synthetic assets without recording loans or bonds on balance sheets improving leverage ratios and capital efficiency.
Regulatory Arbitrage: TRS has been used to bypass investment or lending restrictions, such as exposure norms, concentration limits, etc.
Provides very high leverage: In the above illustration, the synthetic investment made by the O in the bond is highly leveraged, assuming no margin has been put by the PS.
Alternative to a Repo: Assume PB holds a bond and is looking at having it funded. It sells the bond to Q and simultaneously enters into a TRS transaction, paying MIBOR + spread and receiving the actual returns of the bond. Hence, PB continues to have an economic stake in the bond whereas for accounting purposes, the bond may be removed from the balance sheet of PB.

TRS structures have been used globally across a wide range of asset classes, including equities, bonds, loans, real estate and property interests, credit-linked notes, and portfolios or indices of such assets. Hence, a TRS is a credit derivative only when the reference asset is a credit asset, otherwise it is a generic total return derivative. The Draft CD Direction framework deliberately confines TRS usage to specified debt instruments in order to prevent synthetic funding and balance-sheet arbitrage.

CDS Vs TRS

Aspects	CDS	TRS
Basic Definition	A credit derivative contract where a protection seller commits to pay the buyer in the event of a credit event.	A credit derivative contract where a payer transfers the entire economic performance of an asset to a receiver (protection seller).
Risk Transferred	Transfers only the credit risk associated with a specific obligation. The protection seller is only concerned with the risk of default or increase in credit spreads of the asset. That is, the reference transaction only shifts the risk of credit spreads	Transfers the total volatility of returns, including credit risk, interest rate risk, and market risk. The receiver gains exposure to all gains and losses (coupons, appreciation, and depreciation).
Cash Flow Mechanics	The buyer makes periodic premium payments to the seller until maturity or a credit event	Involves a periodic exchange of cash flow, the payer gives returns and appreciation; the receiver gives a benchmark rate + spread and depreciation. No fixed premium; the premium is inherent in the difference between actual returns and the agreed-upon spread
Synthetic Impact	Used primarily for credit insurance or hedging against specific default.	Used to synthetically replace the entire exposure of the parties, causing the receiver to assume the position of a synthetic lender to the reference obligation.

Types of TRS

Total Return Swaps can be categorized into several types based on their underlying assets and funding structures:

Index-Based TRS: Instead of a specific bond, the returns are linked to a diversified index (e.g., a broad-based index of 100 high-yield corporate bonds). The RBI specifically allows these if the index is composed of eligible debt instruments and published by an authorized administrator.
Equity Swaps: A type of TRS where the reference asset is one or more equity securities. Here, the total return payer pays the return from the equity or the portfolio, and in turn, receives a base rate spread.
Property Derivatives: The TRS methodology has been applied to swapping the returns of property investments also, allowing investors to synthetically invest in properties or property indices.
Structured TRS: Here, the reference assets would be a pool of loans or bonds. The transaction will make uses of the credit-linked notes.

See further details on TRS in the book on Credit Derivatives and Structured Credit Trading by Mr Vinod Kothari

Regulatory framework for TRS

The Draft CD Directions permit the use of TRS while adding multiple safeguards to ensure that TRS functions strictly as a credit risk transfer instrument and not as a means of synthetic funding, balance-sheet arbitrage, or regulatory circumvention. The regulatory framework governs four key aspects:

Eligible participants,
Permissible reference assets,
Permitted purposes for which these instruments may be used, and
Prudential safeguards.

Eligible participants for TRS

Para 4.1.2(iii) of the revised Directions stipulates that at least one counterparty to every credit derivative transaction must be a market-maker. For this purpose, market-makers are defined to include

Scheduled Commercial Banks,
Large NBFCs (including HFCs and SPDs) with a minimum net owned fund of ₹500 crore, and
Specified financial institutions such as NABARD, SIDBI, and EXIM Bank.

This requirement ensures that TRS transactions are intermediated by regulated entities with adequate risk management capabilities.

In alignment with this overarching requirement, the Draft CD Directions prescribe the following specific eligibility conditions for TRS:

TRS may be offered only by market-makers, ensuring that such transactions are undertaken by regulated entities with adequate risk management capabilities.
Residents (other than individuals) may enter into TRS without any restriction on the purpose, allowing both hedging and non-hedging purposes.
Persons resident outside India may enter into TRS only for the purpose of hedging, and such TRS may be offered to them exclusively by market-makers.

Reference entities and reference assets for TRS

In addition to prescribing eligible participants, the Draft CD Directions impose strict controls on the nature of reference entities and assets that may be used for TRS transactions. These controls are intended to ensure transparency, prevent regulatory arbitrage, and avoid the creation of complex or opaque synthetic exposures.

Reference entity:

A reference entity refers to the issuer whose credit risk and economic performance form the basis of the TRS contract. For TRS, the reference entity shall be a indian resident entity that is eligible to issue Reference assets under the Draft CD Directions.

By limiting reference entities to domestic issuers of eligible debt instruments, the framework ensures that TRS activity remains in the Indian corporate debt market, which was also the regulatory intent.

Reference assets:

A reference asset refers to the underlying corporate bond or debt instrument issued by the reference entity or an index of underlying debt instruments specified in a total return swap contract. The Draft CD Directions specify the following as eligible reference assets for TRS:

Money market debt instruments;
Rated INR-denominated corporate bonds and debentures;
Unrated INR-denominated corporate bonds and debentures issued by Special Purpose Vehicles (SPVs) set up by infrastructure companies; and
Bonds with call and/or put options.

At the same time, the Directions expressly prohibit TRS on certain instruments, including asset-backed securities, mortgage-backed securities, credit-enhanced or guaranteed bonds, convertible bonds, and other hybrid or structured obligations. This exclusion reflects regulatory caution against layering derivatives on complex or credit-enhanced products that could obscure risk transfer.

Index-based reference assets

The Draft CD Directions also permit a TRS to reference an index, provided that:

The index comprises only eligible debt instruments as specified above; and
The index is published by a financial benchmark administrator duly authorised by the RBI under the Reserve Bank of India (Financial Benchmark Administrators) Directions, 2023

Although such index based reference asset has been introduced for CDS and TRS, no such index for debt securities exists currently. Accordingly, such an index must be developed.

Preventing Regulatory circumvention:

Para 4.5.1(ii) of the Draft CD Directions expressly provides that market participants shall not undertake credit derivative transactions, including Total Return Swaps, involving reference entities, reference obligations, or reference assets where such transactions would result in exposures that the participant is not permitted to assume in the cash market, or where they would otherwise violate applicable regulatory restrictions. This provision prevents the use of TRS to bypass exposure limits, concentration norms, sectoral caps, or investment restrictions applicable to the participants.

Additional safeguards for TRS used for hedging

Where a TRS is entered into for the purpose of hedging, the market-maker is required to ensure that the user satisfies the following conditions:

The user has an existing exposure to the relevant reference asset
The notional amount of the TRS does not exceed the face value of the reference asset held by the user, and
The tenor of the TRS does not extend beyond:
- The maturity of the reference asset held by the user, or
- The standard TRS maturity date is immediately following the maturity of the reference asset.

These safeguards reinforce the principle that hedging-oriented TRS must remain strictly co-terminous and proportionate to the underlying exposure, thereby avoiding over-hedging or speculations. Further, the Draft CD Direction specify that the settlement rules and standard documentation will be specified by shall be specified by the Fixed Income Money Market and Derivatives Association of India (FIMMDA), in consultation with market participants. However, the market participants are allowed to, alternatively, use a standard master agreement for credit derivative contracts.

Will it impact the bond markets in India?

Will this new instrument have an impact on bond markets in India? The first instance of guidelines on credit derivatives was issued in 2011; this failed to have any impact at all. Then, after the report of the Working Group, new Credit Derivatives Directions were issued in 2022. These also, at least based on anecdotal market information, have not had any significant traction at all.

CDS is much more standardised than TRS; as we have noted above, TRS is only 4.9% of the global credit derivatives market. Will the Indian market, which has not yet picked up credit spread trading in the form of CDS, delve into a far more esoteric TRS trade? Was it based on any reasoned or surveyed market feedback that this regulatory change was inspired? These questions, a priori, are difficult to answer. However, like a new flavour of ice cream, you never know until you try it.

Other Resources:

The NBFC that doesn’t have to be: CICs and Principal Business paradox

February 7, 2026/0 Comments/in Financial Services, NBFCs, RBI, Uncategorized /by Staff

– Dayita Kanodia, Assistant Manager | finserv@vinodkothari.com

Holding Companies whose primary intent is to invest in their group companies have lately faced a paradox with respect to the requirement of registration as a Core Investment Company (CIC).

CICs are entities whose principal activity is the acquisition and holding of investments in group companies, rather than engaging in external investments or lending exposure outside the group. Para 3 of the Reserve Bank of India (Core Investment Companies) Directions, 2025 (‘CIC Directions’) prescribes the quantitative thresholds for classification of an NBFC as a CIC. In terms thereof, an NBFC that holds not less than 90% of its net assets in the form of investments in group companies, of which at least 60% is in equity instruments, is classified as a CIC and is required to obtain registration from the RBI, unless exempted.

Conceptually, a CIC is a sub-category of a Non-Banking Financial Company (NBFC) (para 3 of the CIC Directions), just like Housing Finance Companies, Micro Finance Institutions, etc. The threshold criteria that NBFCs are required to satisfy is the principal business criteria (PBC), pursuant to which at least 50% of the total assets of the entity must consist of financial assets and at least 50% of its total income must be derived from such financial assets.

The PBC has historically served as the foundational threshold for determining whether an entity is an NBFC. Once the entity satisfies this principal requirement of carrying out financial activity, the sub-category is to be determined based on its line of business, which, lately, has seen quite a varietty – fron tradtional variants such as investment and lending activities (ICC), to housing finance (HFC), to financing of receivables (Factoring companies), the more recent inclusions are account aggregators (AA), mortgage guarantee companies (MGCs), infrastructure finance compaies (IFC), etc. Each of these NBFCs first, and then they fall in their respective class. For instance, HFCs are a type of NBFCs that primarily focus on extending housing loans and hence, must have a minimum housing loan portfolio of 60% and an individual housing loan of 50%.

Accordingly, all categories of NBFCs must first be ascertained to be carrying out financial activities as their primary business, and thereafter, the specific product helps to determine the category. Consequently, holding companies or CICs should ideally also adhere to the 50-50 criteria first and thereafter meet the 90-60 criteria for CIC classification.

However, there is a common perception among the market participants that CICs, irrespective of meeting such PBC, in case they reach the 90-60 criteria, will be required to obtain registration as a CIC. Several news reports also note this perception.

This perception among the market participants that CICs are not required to adhere to the PBC criteria stems from para 17(3) of the CIC Directions, which explicitly provides that:

“CICs need not meet the principal business criteria for NBFCs as specified under paragraph 38 of the Reserve Bank of India (Non-Banking Financial Companies – Registration, Exemptions and Framework for Scale Based Regulation) Directions.”

It may be noted that the above-quoted provision, which has recently been made a part of the CIC Directions pursuant to the November 28 consolidation exercise, was earlier included in the FAQs released by RBI on CICs. FAQs are RBI staff views; whereas Directions or Regulations are a part of subordinate law; however, in the consolidation exercise, a whole lot of FAQs and circulars became a part of the Directions.

Going by the intent of the NBFC classification and categorisation, the above-quoted provisions seem more relevant for registered CICs, implying that CICs once registered need not meet the PBC on an ongoing basis. CICs predominantly hold investments in group companies and therefore satisfy the 90–60 thresholds, but often do not derive any financial income from such investments. Group investments, being strategic in nature, are rarely disposed of, and the dividend income from such investments depends on the dividend/payout ratio, which may be quite low. In several cases, such entities continue to earn income, say, by way of royalty for a group brand name. Even the slightest of non-financial income will seem to breach the PBC criteria, which may challenge the continuation of registration of the CIC as an NBFC. In order to redress this, the provision under para 17(3) of the CIC Directions provides that CICs need not meet the PBC criteria on an ongoing basis.

What is the basis of this argument? The definition of a CIC comes from para 3, which says as follows: “These directions shall be applicable to every Core Investment Company (hereinafter collectively referred to as ‘CICs’ and individually as a ‘CIC’), that is to say, a non-banking financial company carrying on the business of acquisition of shares and securities, and which satisfies the following conditions.” Para 17 (3) is a note to Para 17, which apparently deals with conditions of continued registration.

Given that CIC is a category of NBFC, it would be counter-intuitive to say that the regulatory requirement requires holding companies to go for registration as a CIC even if they do not meet the PBC for an NBFC. In fact, if an entity is not an NBFC because it fails the principality of its business, it would not even come under the statutory ambit of the RBI by virtue of section 45-IC.

Accordingly, without going by just the text of the regulations, in our view, considering the regulatory intent, the following could be inferred:

If there are group holding companies which have intra group investments, but also have operating income from one or more sources, such that the operating income is more than finanical income, these companies are not NBFCs at all. If they are not NBFCs, they cannot be CICs irrespctive of the extent of investment/loans as a part of their asset base. As we say this, we emphaise that the operating income shoudl be substantive and should be indicating a strategic business intent, rather than a pure one-off or passive income.
CICs are a type of NBFC.
Holding companies will be classified as a CIC in case they first meet the 50-50 criteria for NBFC and thereafter the 90-60 criteria as well. The registration requirement may then be ascertained based on the asset size and access to public funds by the CIC.
A CIC (registered or unregistered) need not meet the PBC criteria on an ongoing basis.

Other Resources:

Representation with respect to NBFC-related Regulatory Issues

January 30, 2026/0 Comments/in Financial Services, NBFCs, RBI /by Staff

– Team Finserv | finserv@vinodkothari.com

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RBI Integrated Ombudsman Scheme 2026 – Key Changes

January 17, 2026/0 Comments/in Financial Services, NBFCs, RBI /by Staff

– Chirag Agarwal & Siddharth Pandey | finserv@vinodkothari.com

Background

The framework for Integrated Ombudsman Scheme (IOS) constitutes a cornerstone of the RBI’s customer protection and grievance redressal mechanism across the financial sector. With the objective of providing customers a single, unified and accessible platform for redressal of complaints against Regulated Entities, the RBI introduced the Integrated Ombudsman framework.

The RBI has now introduced the Reserve Bank – Integrated Ombudsman Scheme, 2026 (“IOS 2026”), which supersedes the earlier Reserve Bank – Integrated Ombudsman Scheme, 2021 (“IOS 2021”). The new Scheme shall come into force with effect from July 1, 2026.

Key Changes

The IOS 2026 seeks to refine and reinforce the existing mechanism by expanding the scope of coverage, strengthening the powers of the Ombudsman, tightening procedural timelines, enhancing disclosure and reporting. The table below highlights and analyses the key changes introduced under IOS 2026 as compared to the IOS 2021, to enable stakeholders to assess the regulatory and operational impact of the revised framework.

Provision	IOS 2021	IOS 2026	Analysis / Impact
Definition of “Customer” & “Deficiency in Service”	The term “Customer” was not defined. Limited definition for ‘Deficiency in Service’, largely linked to users/applicants of financial services.	‘Customer’ means a person who uses, or is an applicant for, a service provided by a Regulated Entity. (Para 3(1)(h)) ‘Deficiency in Service’ now applicable across all services provided by Regulated Entities and not just restricted to financial services. (Para 3(1)(i))	Broadens the scope of protection by covering all services offered by Regulated Entities, not just financial services.
Definition of “Rejected Complaints”	Not expressly defined	New definition introduced – complaints closed under Clause 16 of the Scheme. (Para 3(1)(o))	Clarificatory in nature; definition is not used elsewhere in the Scheme
Power to Implead Other Regulated Entities	No explicit power	Ombudsman empowered to make other Regulated Entities a party to the complaint if such Regulated Entity has, by an act, negligence, or omission, failed to comply with any directions, instructions, guidelines, or regulations issued by the RBI. (Para 8(6))	Expands investigative and adjudicatory powers of the RBI Ombudsman
Annual Report on Scheme Functioning	The Ombudsman was required to submit an annual report to the Deputy Manager of the RBI; however, the RBI was not obligated to publish it.	It has now been made mandatory for the RBI to publish an annual report on the functioning and activities carried out under the Scheme. (Para 8(7))	Enhances transparency and public accountability of the Ombudsman framework
Interim Advisory	No express provision	Ombudsman expressly empowered, if deemed necessary and based on the circumstances of the complaint, to issue an advisory to the RE at any stage to take such action as may lead to full or partial resolution and settlement of the complaint. (Para 14(6))	Enables interim reliefs/directions and more effective complaint handling. This would help in resolving disputes by settlement at any stage. IOS permits advisories i.e., communications from the Ombudsman advising REs to take actions for full or partial complaint resolution. Advisories are non-binding and serve as a pre-award tool to facilitate quicker settlements.
Principal Nodal Officer (PNO) – Change Reporting	Reporting obligation not specified	Any change in appointment or contact details of PNO must be reported to CEPD, RBI (prior to change or immediately post-change) (Para 18(2))	Additional intimation requirement for regulated entities
Compensation – Consequential Loss	Capped at ₹20 lakh	Enhanced to ₹30 lakh (Para 8(3))	Increases the limit of potential financial risk for Regulated Entities
Compensation – Harassment & Mental Anguish	Consolatory damages capped at ₹1 lakh	Increased to ₹3 lakh (in addition to other compensation) (Para 8(3))	Compensation limit tripled
Limit on Amount in Dispute	No monetary cap	No change – still no limit (Para 8(3))	Ombudsman continues to have wide jurisdiction irrespective of dispute value
Timeline for Filing Complaint	1 year from RE’s reply; or 1 year + 30 days if no reply from RE	Complaint must be filed within 90 days from the expiry of the RE’s response timeline (30 days) or last communication, whichever is later. (Para 10(1)(g))	Considerably tightens timelines; this would mean the customers must act swiftly
Guidance on Complaint Filing	Dispersed across the Scheme	Consolidated guidance provided in Part A of the Annexure along with Complaint Form. (Annex)	The guidance merely reiterates the points from the scheme that relate to admissibility of a valid complaint, but this is useful for the complainant as he will be aware of the complaint filing requirements and shall not be required to be thorough with the scheme itself
Modes of Filing Complaint	Specified the options to file a complaint through portal, email, or courier at CRPC.	Explicitly specified the email-ID of CRPC, and the address at which the complaint shall be couriered. (Para 6(2))	Specification of the details for filing complaint
Data Consent in Complaint Form	No explicit consent requirement	Explicit consent for use of personal data mandatory. (Annex)	Aligns complaint process with evolving data protection and privacy standards
Categorisation of Complaints in complaint form	Limited classification	Detailed categorisation of complainant type and nature of complaint. (Annex)	Enables better routing, analytics, and faster resolution
Maintainability Check in Complaint Form	No upfront maintainability warning	Explicit note stating non-maintainable scenarios (court pending, advocate filing, etc.). (Annex)	Reduces frivolous filings and early-stage rejections
Appellate Authority	Executive Director in charge of concerned RBI department	Executive Director in charge of Consumer Education and Protection Department (CEPD) explicitly designated. (Para 3(1)(a))	Clarificatory in nature
Introduced system-based validation	No such provision	Complaints received via portal, will undergo a system-based validation/check and will be rejected at the outset for being non-maintainable complaints. For the complaints received via e-mail and physical mode, CRPC will assess their maintainability under the Scheme. (Para 12(1))	This would enhance the “gatekeeping” responsibility of the CRPC, which should speed up the process for valid complaints by weeding out inadmissible ones.

Actionables for REs:

REs should review and align their internal grievance handling and escalation processes to ensure all service-related complaints are covered.
REs shall provide prior intimation to the CEPD, RBI for any change in the appointment or contact details of the Principal Nodal Officer (PNO)
REs shall take note of the enhanced compensation limits under the Scheme and accordingly reassess potential liabilities, update grievance redressal frameworks, and sensitize relevant teams to ensure compliance with revised thresholds.
Para 18, as in the earlier Scheme, requires REs to display the salient features of the Scheme, a copy of the IOS 2026, and the updated contact details of the Principal Nodal Officer on their website and at their branches/places where the business is transacted.

Other Related Resources:

Lending to your own: RBI Amendment Directions on Loans to Related Parties

January 6, 2026/0 Comments/in Financial Services, NBFCs, RBI, Related Party Transactions /by Staff

-Team Finserv | finserv@vinodkothari.com

On January 5, 2026, the RBI issued the Amendment Directions on Lending to Related Parties by Regulated Entities. Pursuant to this, changes were introduced to Reserve Bank of India (Non-Banking Financial Companies – Credit Risk Management) – Amendment Directions, 2026 (CRM Amendment Directions) and Reserve Bank of India (Non-Banking Financial Companies – Financial Statements: Presentation and Disclosures) Directions, Amendment Directions, 2026. Previously, Draft Directions were also issued on the subject. Our write-up on the draft directions can be accessed here.

Highlights

Applicability and Effective Date

The amendments under CRM Directions shall apply to all NBFCs, including Housing Finance Companies (HFCs) with regard to lending by an NBFC to its ‘related party’ and any contract or arrangement entered into by an NBFC with a ‘related party’. However, Type 1 NBFCs and Core Investment Companies shall not be covered under the applicability.

These amendments shall come into force on 1 April 2026. NBFCs may, however, choose to implement the amendments in their entirety from an earlier date.

In addition to complying with the provisions of the Amendment Directions, listed NBFCs shall continue to adhere to the applicable requirements of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended from time to time.

Grandfathering of existing arrangements: Existing RPTs that are not compliant with these amendments may continue until their original maturity. However, such loans, contracts, or credit limits shall not be renewed, reviewed, or extended upon expiry, even where the original agreement provides for renewal or review.

Any enhancement of limits sanctioned prior to 1st April 2026 shall be permitted only if they are fully compliant with these amendments.

Relevant Definitions

Related Party

RPs under Amendment Directions	Whether covered in the Present Regulations
(A) Related Persons: These can be non-corporate
a promoter, or a director, or a KMP of the NBFC or relatives of the said (natural) person	All other persons except the promoter was covered
Person holding 5% equity or 5% voting rights, singly or jointly, or relatives of the said (natural) person	No
Person having the power to nominate a director through agreement, or relatives of the said (natural) person	No
Person exercising control, either singly or jointly, or relatives of the said (natural) person	Yes
(B) Related Parties: These can be any person other than individual/HUF, and cover Entities where (A)	Covered Partially
is a partner, manager, KMP, director or a promoter	Promoter not covered
hold/s 10% of PUSC	Holds lower of (i)10% of PUSC and (ii)₹5 crore in PUSC
has single or joint control with another person	Yes
controls more than 20% of voting rights	No
has power to nominate director on the Board	No
are such on the advice direction, or instruction of which the entities are accustomed to act	No
is a guarantor/surety	Yes
is a trustee or an author or a beneficiary (where entity is a private trust)	No
Entities which are related to (A) as subsidiary, parent/holding company, associate or joint venture	Yes

The definition of “Related Party” remains unchanged from that provided under the Draft Directions.

Further, a clarification have been added where an entity in which a related person has the power to nominate a director solely pursuant to a lending or financing arrangement shall not be regarded as a related party.

Related Person

Under the Draft directions, the definition of a “related person” included group entities. However, pursuant to the Amendment Directions, group entities have been expressly excluded from the scope of “related person.” The provisions are specific for lending to directors, KMPs and their related parties. In the case of lending to entities such as subsidiaries and associates, the NBFC must adhere to the concentration norms as prescribed under the CRM Directions.

Specified Employees

The definition of “Senior Officer” as provided under the erstwhile regulations (Para 4(1)(vii) of the Credit Risk Management Directions) has been omitted and, in its place, the concept of “Specified Employees” has been introduced. “Specified Employees” has been defined to mean all employees of an NBFC who are positioned up to two levels below the Board, along with any other employee specifically designated as such under the NBFC’s internal policy.

Under the erstwhile regulations, the term “Senior Officer” was given the same meaning as defined under Section 178 of the Companies Act, 2013. Thus, the terms Senior Officer included the following:

Members of the core management team,
All members of management who are one level below the Executive Directors,
Functional heads

Practically, this change implies that one additional hierarchical level would now need to be designated as “Specified Employees”. Further, the specific inclusions that earlier applied under the Companies Act and the LODR Regulations i.e., functional heads under the Companies Act and CS and CFO under the LODR will no longer be automatically covered, unless they fall within two levels below the Board or are specifically designated as such under the NBFC’s internal policy.

Meaning of “Lending”

‘Lending’ in the context of related party transactions would include funded as well as non-fund-based credit facilities to related parties. It may further be noted that investments in debt instruments of related parties are specifically included within the ambit of lending. Accordingly, the scope is not just restricted to loans and advances but includes all fund based and non-fund based exposures as well as investment exposures.

Principles to be followed while lending to a related party

While lending to related parties, the following principles and provisions are to be followed by NBFCs:

Credit Policy

The credit policy of the NBFC must contain specific provisions on lending to RPs. Mandatory contents of such policy will include:

Definition of RPs and Specified Employees
Safeguards to address the risks emanating from lending to related parties
Provisions relating to lending to ‘specified officers’ of the NBFC and their relatives
Provisions related to a suitable whistleblower mechanism for employees to raise concerns over irregular and unethical loans to RPs. Any kind of quid pro quo arrangements should also be prohibited.
Materiality Thresholds for sanctioning of the loans
Interested parties to recuse themselves
Limits for lending to RPs, including sub-limits for lending to a single related party and a group of related parties
Monitoring mechanism for such loans to RPs. This would include the designation of a specified authority for monitoring as well as reporting to the Board/Board committee. Further, procedure in case of deviation from the policy must also be prescribed.

Earlier, the policy requirement was specifically applicable in case of base layer NBFCs, but now the same has been made applicable for all NBFCs.

Board approved limits for lending to RPs

The CRM Amendment Directions also mandate prescribing board-approved limits for lending to RPs. Further, sub-limits will also have to be prescribed for lending to a single RP and a group of RPs. Here, a question may arise on what basis will the NBFC prescribe such limits? Such limits may be prescribed after considering the ticket size of the loans generally offered by the Company, to ensure the loans to RPs are aligned with the loan products for general customers. The limit may be specified as a percentage of the NOF of the NBFC, similar to the credit concentration limits.

Materiality Thresholds

NBFCs may extend credit facilities to related parties in accordance with their Board-approved credit policy. Any such lending must be within the board-approved limit prescribed for lending to RPs (including a single RP and a group of RPs).

Further, under the Amendment Directions (Para 13G of the CRM Amendment Directions), RBI has now clearly laid down materiality thresholds for such lending to related parties, including those to directors, senior officers, and their relatives. Lending above the prescribed materiality threshold should be sanctioned by the Board/Board Committee of the NBFC. (other than the Audit Committee).

It may be noted that earlier, for middle and upper layer NBFCs, any loans aggregating to ₹ 5 Crore and above were to be sanctioned by the Board/Board Committee. The materiality thresholds prescribed under the Amendment Directions are based on the layer of the NBFC, as follows:

Category of NBFCs	Materiality Threshold
Upper Layer and Top Layer	₹10 crore
Middle Layer	₹5 crore
Base Layer	₹1 crore
Layer of the NBFC shall be based on the last audited balance sheet.For loans, materiality threshold shall apply at individual transaction level

Can the power to sanction loans be delegated to the Audit Committee?

The CRM Amendment Directions have defined the Committee on lending to related parties which will mean a committee of the Board of the NBFC entrusted with sanctioning of loans to related parties. NBFCs may also identify any existing Committee, other than the Audit Committee, for this purpose.

Further, para 13I provides that,

However, a NBFC at its discretion, may delegate the above powers of lending beyond the materiality threshold to a Committee of the Board (hereafter called Committee) other than the Audit Committee of the Board

Accordingly, on a reading of the above, it seems that the power to sanction loans cannot be provided to the Audit Committee of the Board.

Monitoring and Reporting Mechanism

NBFC shall maintain and periodically update the list of all related persons, related parties, and loans sanctioned to them. This will be in addition to the list of related parties of the NBFC, which comes from the Companies Act, 2013, LODR and Accounting Standards.
The list shall be reviewed at regular intervals to ensure accuracy and compliance.
Credit facilities sanctioned to specified employees and their relatives shall be reported to the Board annually.
Any deviation from the lending policy on related parties, along with reasons, shall be reported to the Audit Committee or to the Board where no Audit Committee exists.
Products/structures circumventing these Directions (reciprocal lending, quid pro quo) shall be treated as related party lending.

5. Quid Pro Quo Arrangements

The CRM amendment directions also provide that any arrangements which aim at circumventing the Amendment Directions will be treated as lending to RPs. Accordingly, any such arrangements involving reciprocal lending to related parties shall be subject to all the provisions of this direction.

Refrain from participation

Para 13J requires that Directors, KMPs and specified employees must recuse themselves from any deliberations or decision-making on loan proposals, contracts or arrangements that involve themselves or their related parties. This obligation also applies to all subsequent decisions involving material changes to such loans, including one-time settlements, write-offs, waivers, enforcement of security and implementation of resolution plans, to ensure independence and avoid conflicts of interest.

Financial Statements Disclosures

Details of exposure to related parties as per these Directions shall be disclosed in the Notes To Accounts pursuant to para 21(9A) of the Reserve Bank of India (Non-Banking Financial Companies – Financial Statements: Presentation and Disclosures) Directions, 2025 in the following format:

(Amt in ₹ Crore)
Sr. No	Particulars	Previous Year	Current Year
Loans to Related Parties
1	Aggregate value of loans sanctioned to related parties during the year
2	Aggregate value of outstanding loans to related parties as on 31st March
3	Aggregate value of outstanding loans to related parties as a proportion of total credit exposure as on 31st March
4	Aggregate value of outstanding loans to related parties which are categorized as:
	(i) Special Mention Accounts as on 31st March
	(ii) Non-Performing Assets as on 31st March
5	Amount of provisions held in respect of loans to related parties as on 31st March
Contracts and Arrangements involving Related Parties
6	Aggregate value of contracts and arrangements awarded to related parties during the year
7	Aggregate value of outstanding contracts and arrangements involving related parties as on 31st March

Comparison at a Glance

Parameters	Existing Guidelines	Amendment Directions
Applicability	NBFC-BL- only policy requirement was prescribedNBFC-ML and above – threshold, approval and reporting was applicable	NBFCs in all layers, except Type 1 and CICs
Materiality Threshold/ Threshold for seeking board approval	NBFCs-BL- As per the PolicyNBFCs-ML- Rs. 5 croreNBFCs-UL- Rs. 5 crore	NBFCs-BL- Rs. 1 croreNBFCs-ML- Rs. 5 croreNBFCs-UL- Rs. 10 crore. Lending beyond the MT requires board or board committee approval (other than AC).
Board approved limits for lending to RPs	No such limit was required to be prescribed	Policy shall specify aggregate limits for loans towards related parties. Within this aggregate limit, there shall be sub-limits for loans to a single relatedparty and a group of related parties.Lending beyond the board approved limit, requires ratification by the Board/AC.
Monitoring	Loans and Advances to Directors less than ₹5 crores shall be reported to the Board. Further, all loans and advances to senior officers shall be reported to the Board.	Para 13K: Maintain and periodically update list of related persons, related parties, and loans to them. Para 13L: Annually report credit facilities to specified employees and relatives to the Board. Para 13M: Quarterly or shorter internal audit reviews on adherence to related party guidelines. Para 13N: Report deviations and reasons to the Audit Committee or Board. Para 13O: Products/structures circumventing Directions (reciprocal lending, quid pro quo) shall be treated as related party lending.
Policy Requirement	Only for NBFC-BL. NBFCs were required to prescribe a threshold beyond which the loans shall be required to be reported to the Board	Applicable for all NBFCs.
Recusal by interested parties	Directors who are directly or indirectly concerned or interested in any proposal should disclose the nature of their interest to the Board when any such proposal is discussed	Interested parties, including specified employees to recuse themselves
Disclosure under FS	Related Party Disclosure were specified as per format prescribed under Para 21(9) of Financial Statement Disclosures Directions	In addition to the earlier requirement, another format has been prescribed under Para 21(9A) with respect to details of exposures to related parties
Power to sanction loans to RPs	For NBFCs-BL: Only reporting is required; no board approval For NBFCs-ML and above: Board approval required for loans above the threshold.	For all NBFCs:Loans above materiality threshold shall be sanctioned by Board or delegated Committee (not Audit Committee) Loans below the threshold shall be sanctioned by appropriate authority as defined under the Policy.

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Banking group NBFCs: Need to map businesses to avoid overlaps with the parent banks

December 6, 2025/0 Comments/in Banks, Capital Markets, Financial Services, NBFCs, RBI, Securitisation /by Staff

– Vinod Kothari | finserv@vinodkothari.com

The new dispensation implemented from 5th December 2025 implies that lending business, obviously carried in the parent bank, needs to be allocated between the bank and the group entities so as to avoid overlaps. The bank will have to take its business allocation plan, at a group level, to its board, by 31st March 2026.

The RBI’s present move has certain global precedents. Singapore passed an anti-commingling rule applicable to banking groups way back in 2004, but has subsequently relaxed the rule by a provision referred to as section 23G of the Banking Regulations. However, the approach is not uniformly shared across jurisdictions.

We are of the view that as the decision works both at the bank as well as the NBFC/HFC level, the same has to be taken to the boards of the respective NBFCs/HFCs too.

Businesses which currently overlap include the following:

Loans against properties
Housing finance
Loans against shares
Trade finance
Personal loans
Digital lending
Small business loans
Gold loans
Loans against vehicles – passenger and commercial, or loans against construction equipment

In our view, banks will have serious concerns in meeting their priority sector lending targets, unless they decide to keep priority sector lending business in the bank’s books. Priority sector lending is quite often much less profitable, and the NBFCs in the group are able to create such loans at much higher rates of return due to their delivery strengths or customer franchise. As to how the banks will be able to originate such loans departmentally, will remain a big question.

There are other implications of the above restrictions too:

If a bank is engaged, for example, in MSME lending, but auto loans are done at the group entity, the bank cannot be a co-lender with its group entity, nor can it acquire auto loans originated by its group entity.
Extending the same argument, if the banking group is carrying auto loan activity in its group NBFC, it cannot buy auto loans either by way of a direct assignment or co-lending, originated by other banks or other independent NBFCs. The reason for this is obvious – if the bank has decided to carry auto lending activity in its group entity, it should stay away from that exposure, even if originated by other entities.
The decision to keep particular loan products with group entities – can it be stretched to the extent that bank will not have indirect exposure in such products, for example, by way of giving a loan to its group entity for on-lending for a product which the bank does not undertake departmentally? One of the reasons that may have prompted the Mohanty Group report in 2020 to segregate products between the bank and its group entities was contagion risk. If contagion is at the core of the present restriction, then that risk is still there even if the bank lends to a group entity for on-lending for a product. However, in our view, the present restriction is primarily aimed at avoiding regulatory arbitrages, and cannot be expected to require a completely independent financing of the loan products that a subsidiary finances, and not the bank.
Therefore, in our view, a bank may not only on-lend to its group entities (of course, on the basis of an arm’s length lending approach), but it may also buy the asset-backed securities arising from such loan portfolios as sit with its group entities.

Factors to decide loan product allocation

In case of several non-lending products such as securities trading, demat services, etc., the approach may be easier. However, lending services constitute the bulk of any bank’s financial business, and group NBFCs and HFCs are also evidently engaged in lending. Hence, there may be a delicate decisioning by each of the boards on who does what. Note that this choice is not spasmodic – it is a strategic decision that will bind the entities for several years.

The factors based on which banks will have to decide on their business allocation may include:

Delivery mechanisms – Mostly, branch and team strengths are sitting in group entities. Therefore, the loan products that entail last mile customer outreach, geographical access, etc are naturally housed in entities which possess those abilities.
Technology strength: Some of the products are based on fintech or similar technology strength, which may be sitting with respective entities.
Recovery mechanisms – Group entities are typically more nimble than banks. Hence, while banks may keep loans on their books, but they may engage group entities for recovery purposes.
Priority sector requirements-: This will be a very important factor in deciding business allocation. Banks are mandated to invest 40% of their ANBC in qualifying priority sector loans – not NBFCs. Hence, for such loans as qualify as priority sector, the option may be to house the portfolios with the bank, or to invest in pass through certificates.

Securitised notes: whether investment in group entities?

Talking about pass through certificates, there is a complicated question as to whether the investment limits imposed by the 5th Dec. 2025 amendment on aggregate investments in group entities will include investment in pass through certificates arising out of pools originated by group entities. In our view, the answer is in the negative, as the investment is not originator, but in the asset pools. However, if the bank makes investment in the equity tranche or credit enhancing unrated tranches, the view may be different.

Conclusion

Banks are heading shortly in the last quarter of a year which is laden with strong headwinds. In this scenario, facing business allocation decisions, rather than business expansion or risk management, may be more challenging than it may seem to the regulators.

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Bank group NBFCs fall in Upper Layer without RBI identification

December 6, 2025/0 Comments/in Banks, Banks, Financial Services, NBFCs, RBI /by Staff

– Dayita Kanodia | finserv@vinodkothari.com

RBI on December 5, 2025 issued RBI (Commercial Banks – Undertaking of Financial Services) (Amendment) Directions, 2025 (‘UFS Directions’) in terms of which NBFCs and HFCs, which are group entities of Banks and are therefore undertaking lending activities, will be required to comply with the following additional conditions:

Follow the regulations as applicable in case of NBFC-UL (except the listing requirement)
Adhere to certain stipulations as provided under RBI (Commercial Banks – Credit Risk Management) Directions, 2025 and RBI (Commercial Banks – Credit Facilities) Directions, 2025

The requirements become applicable from the date of notification itself that is December 5, 2025. Further, it may be noted that the applicability would be on fresh loans as well as renewals and not on existing loans. The following table gives an overview of the compliances that NBFCs/HFCs, which are a part of the banking group will be required to adhere to:

Common Equity Tier 1	RBI (Non-Banking Financial Companies – Prudential Norms on Capital Adequacy) Directions, 2025	Entities shall be required to maintain Common Equity Tier 1 capital of at least 9% of Risk Weighted Assets.
Differential standard asset provisioning	RBI (Non-Banking Financial Companies – IncomeRecognition, Asset Classification and Provisioning) Directions, 2025	Entities shall be required to hold differential provisioning towards different classes of standard assets.
Large Exposure Framework	RBI (Non-Banking Financial Companies – Concentration Risk Management) Directions, 2025	NBFCs/HFCs which are group entities of banks would have to adhere to the Large Exposures Framework issued by RBI.
Internal Exposure Limits		In addition to the limits on internal SSE exposures, the Board of such bank-group NBFCs/HFCs shall determine internal exposure limits on other important sectors to which credit is extended. Further, an internal Board approved limit for exposure to the NBFC sector is also required to be put in place.
Qualification of Board Members	RBI (Non-Banking Financial Companies – Governance)Directions, 2025	NBFC in the banking group shall be required to undertake a review of its Board composition to ensure the same is competent to manage the affairs of the entity. The composition of the Board should ensure a mix of educational qualification and experience within the Board. Specific expertise of Board members will be a prerequisite depending on the type of business pursued by the NBFC.
Removal of Independent Director		The NBFCs belonging to a banking group shall be required to report to the supervisors in case any Independent Director is removed/ resigns before completion of his normal tenure.
Restriction on granting a loan against the parent Bank’s shares	RBI (Commercial Banks – Credit Risk Management) Directions, 2025	NBFCs/HFCs which are group entities of banks will not be able to grant a loan against the parent Bank’s shares.
Prohibition to grant loans to the directors/relatives of directors of the parent Bank		NBFCs/HFCs will not be able to grant loans to the directors or relatives of such directors of the parent bank.
Loans against promoters’ contribution	RBI (Commercial Banks – Credit Facilities) Directions,2025	Conditions w.r.t financing promoters’ contributions towards equity capital apply in terms of Para 166 of the Credit Facilities Directions. Such financing is permitted only to meet promoters’ contribution requirements in anticipation of raising resources, in accordance with the board-approved policy and treated as the bank’s investment in shares, thus, subject to the aggregate Capital Market Exposure (CME) of 40% of the bank’s net worth.
Prohibition on Loans for financing land acquisition		Group NBFCs shall not grant loans to private builders for acquisition and development of land. Further, in case of public agencies as borrowers, such loans can be sanctioned only by way of term loans, and the project shall be completed within a maximum of 3 years. Valuation of such land for collateral purpose shall be done at current market value only.
Loan against securities, IPO and ESOP financing		Chapter XIII of the Credit Facilities Directions prescribes limits on the loans against financial assets, including for IPO and ESOP financing. Such restrictions shall also apply to Group NBFCs. The limits are proposed to be amended vide the Draft Reserve Bank of India (Commercial Banks – Capital Market Exposure) Directions, 2025. See our article on the same here.
Undertaking Agency Business	Reserve Bank of India (Commercial Banks – Undertaking of Financial Services) Directions, 2025	NBFCs/HFCs, which are group entities of Banks can only undertake agency business for financial products which a bank is permitted to undertake in terms of the Banking Regulations Act, 1949.
Undertaking of the same form of business by more than one entity in the bank group	UFS Directions	There should only be one entity in a bank group undertaking a certain form of business unless there is proper rationale and justification for undertaking of such business by more than one entities.
Investment Restrictions	UFS Directions	Restrictions on investments made by the banking group entities (at a group level) must be adhered to.

Read our write-up on other amendments introduced for banks and their group entities here.

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The will of the borrower: Do Balance Transfers Count as Loan Transfers?

December 2, 2025/0 Comments/in Financial Services, NBFCs, RBI /by Staff

-Dayita Kanodia & Chirag Agarwal | finserv@vinodkothari.com

The RBI, as part of its recent consolidation exercise, has consolidated various instructions applicable to NBFCs and issued 34 Master Directions. Our analysis of these can be accessed here.

Loan transfers are now governed by the RBI (Non-Banking Financial Companies – Transfer and Distribution of Credit Risk) Directions, 2025 (‘Transfer Directions’), which assimilates the erstwhile TLE and Co-lending Directions.

One notable change (which was not there in the Draft) appears in the provisions relating to transfer of loan exposures. Para 31 of the Directions provides a carveout for items which will be excluded from the purview of the Directions. One of the exclusions, which has existed since the 2012 Guidelines, is the exclusion for balance transfers. That exclusion has now been removed.

This change raises the question of whether NBFCs are now required to comply with the provisions of the Transfer Directions, even in cases where it is the borrower who requests the transfer of its loan account.

Case of Balance Transfer

Balance transfer is an arrangement where a borrower who has already availed credit from a particular RE identifies another lender willing to offer a loan at a lower interest rate. In such cases, the borrower requests the existing lender to pre-close the loan account using the funds provided by the new lender. The essence is that the transaction happens at the instance of the borrower.

While BTs can take place for a number of reasons, it generally happens when the borrower finds another lender offering loans at a lower interest rate. Other common BT causes include:

Better Loan Terms: More flexible repayment schedules, lower processing fees, reduced foreclosure charges, or longer tenure options.
Top-Up Loan Facility: The new lender may offer a top-up loan along with the transfer at attractive rates.
Improved Customer Service: Borrowers often move due to dissatisfaction with the existing lender’s service quality, delays, or poor communication.
Switching from Floating to Fixed (or vice versa): A borrower may want to change the interest type depending on market outlook or personal preference.
Consolidation of Loans: Borrowers might transfer in order to consolidate multiple loans under one lender for easier management.

BTs typically take place in longer-term loans such as housing loans and LAP.

Typically, the borrower is also charged a prepayment penalty when the existing lender pre-closes the loan account.

Is BT a case of Transfer?

As discussed above, balance transfer is not, per se, a transfer of the loan account between lenders; rather, it is a situation in which one lender effectively steps into the place of another at the request of the borrower.

It may also be noted that the Directions recognise only three modes of transfer of loan accounts:

Assignment
Novation
Loan participation

BT, however, does not fall under any of the above modes.

Further, the introduction to the Transfer Directions states:

Loan transfers are essential to the development of a credit risk market, enabling diversification of credit risk originating in the financial sector and ensure the availability of market-based credit products for a diversified set of investors having commensurate capacity and risk appetite.

BT, on the other hand, does not achieve any credit-risk redistribution. The incoming lender is not purchasing risk, but issuing a fresh loan directly to the borrower. In essence, a balance transfer is not a credit risk transfer; rather a refinancing transaction driven by the borrower’s choice, without any movement of the underlying asset.

Situation for Banks

It may be noted that, in the case of banks, a specific exclusion has been provided for situations where the transfer of a loan account occurs at the instance of the borrower. In such cases, banks are required to comply with the provisions set out under Chapter III of Part C of the Reserve Bank of India (Commercial Banks- Transfer and Distribution of Credit Risk) Directions, 2025.

However, for banks, the concept of inter-bank transfer of loan accounts exists, whereas for NBFCs, there is only a pre-closure of the loan account by one lender using funds obtained from another lender.

Conclusion

Accordingly, in our view, the position for NBFCs in respect of balance transfers remains unchanged, and there is no requirement to comply with the provisions of the Transfer Directions. It must, however, be ensured that such borrower-initiated transfer requests are responded to by the concerned NBFC within 21 days, as required under Para 19 of Reserve Bank of India (Non-Banking Financial Companies – Responsible Business Conduct) Directions, 2025.

Our Other Resources

2025 RBI (Commercial Banks – Governance) Directions – Guide to Understanding and Implementation

December 2, 2025/0 Comments/in Financial Services, RBI /by Staff

RBI Guidelines on Governance in Banks_2025 Download

Private Credit AIFs: Lenders of Last Resort?

December 2, 2025/0 Comments/in Alternate Investment Fund, Alternative investment Vehicles, Capital Markets, Financial Services, RBI /by Staff

Updated as on 7th January, 2025

Simrat Singh | Finserv@vinodkothari.com

Private credit is becoming a new force in India’s lending ecosystem. As traditional banks and NBFCs operate under the strict regulations on capital, exposure and asset quality norms, they are often unable, or unwilling to cater to certain borrowers. In addition, for banks in particular, what kind of lending opportunities can be tapped is often a matter of having typecast lending products, policies and procedures. This leaves occasional, however, lucrative gaps in funding needs which are not serviced by regulated lenders. Into these gaps step in Private Credit AIFs (in India), Business Development Companies (BDCs) and Private Collateralized Loan Obligations (CLOs) (in the USA and Australia), these funds can structure deals creatively, customise financing to borrower needs and capture higher-yield opportunities that conventional lenders must pass over. What is emerging is a parallel channel of credit, one that is nimble, agile and focused.

Globally, this shift hasn’t gone unnoticed. Policymakers and institutions like the IMF have flagged the risks tied to private credit markets, especially around opacity, leverage and borrower quality (see below). Yet in India, the momentum continues to build. Tight constraints on banks, the rise of alternative asset managers and the unmet capital needs of businesses beyond the traditional credit universe are all fuelling rapid expansion.

This article examines what private credit is, why it is growing in India, the risks associated with this market and whether their growth creates regulatory arbitrage relative to banks and NBFCs.

What is Private Credit?

As per an IMF paper¹, private credit is defined as “non-bank corporate credit provided through bilateral agreements or small “club deals” outside the realm of public securities or commercial banks. This definition excludes bank loans, broadly syndicated loans, and funding provided through publicly traded assets such as corporate bonds.

Simply, private credit is the lending by non-bank and non-NBFCs. The sector predominantly involves alternative asset managers² who raise capital from institutional investors using closed-end funds and lend directly to predominantly middle-market firms³.

How is it Different From Normal Credit?

Unlike traditional credit, private credit is typically tailored to the specific needs of each borrower. Repayment terms can, for instance, be aligned with the timing of a funding round or disbursements can be structured to match capital expenditure plans. Interest rates may also be designed on a step-up basis, linked to the borrower’s turnover. Many elements that are otherwise rigid under RBI-regulated lending can be flexibly structured in private credit (see table 2 below). This flexibility is especially valuable for start-ups and small businesses, which often require customised financing solutions that traditional lenders may be unable to provide.

Parameter	Private Credit	Traditional Credit
Source of Capita	Private debt funds (Category II AIFs), investors like HNIs, family offices, institutional investors	Banks, NBFCs and mutual funds
Target Borrowers	Companies lacking access to banks; SMEs, mid-market firms, high-growth businesses	Higher-rated, established borrowers.
Deal Structure	Bespoke, customised, structured financing	Standardised loan products
Flexibility	High flexibility in terms, covenants, and structuring	Restricted by regulatory norms and rigid approval processes
Returns	Higher yields (approx. 10–25%)	Lower yields (traditional fixed-income)
Risk Level	Higher risk due to borrower profile and limited diversification	Lower risk due to stronger credit profiles and diversified portfolios
Regulation	Light SEBI AIF regulations; fewer lending restrictions	Heavily regulated by RBI and sector-specific norms
Liquidity	Closed-ended funds; limited exit options	More liquid; established repayment structures; some products have secondary markets
Diversification	Limited number of deals; concentrated portfolios	Broad, diversified loan books
Role in Market	Fills credit gaps not served by traditional lenders	Core credit providers in the financial system

Table 1: Differences between private credit and traditional credit

How Much of it is in India?

Global private credit assets under management have quadrupled over the past decade to US$2.1 trillion in 2023⁴. Compared with the rest of the world, the private credit market in India is very small, with estimated assets under management of $25 billion to $30 billion as of March 31, 2025, representing about 0.6% of India’s GDP and 30-35% of the total investments made by AIFs in India.⁵

Figure 1: Private credit share (1%) as a part of overall corporate lending. Source: RBI, AMFI

Figure 2: Size of Private Credit Market. Source: RBI

Reasons for Rise in Private Credit?

Private credit is expanding rapidly because it steps in where traditional banks hesitate. It provides capital for last-mile project completion, cost overruns and promoter equity infusion; areas that fall outside the comfort zone of regulated lending. The asset class has also delivered consistently higher risk-adjusted returns, a compelling draw for global and domestic investors, especially through long phases of low interest rates.⁶

A key advantage lies in its flexibility. Private lenders can tailor covenants⁷, link returns to cash flows and restructure repayment terms during stress, offering a level of customisation that conventional bank credit cannot match. For investors, this translates into both diversification and access to high-growth segments that remain beyond the scope of mainstream credit markets.

Sector specific regulatory gaps: There is a concern that tighter bank regulation will continue to encourage the migration of credit from banks to private credit lenders⁸. Certain regulatory restrictions on banks directly push borrowers toward private credit:

Real estate: Banks cannot lend for land acquisition (Para 3.3.1, Master Circular – Housing Finance), leading to real estate becoming a major private-credit segment, accounting for about one-third of all private credit deals.⁹

Mergers & acquisitions: Banks are not expected to lend to promoters for acquiring shares of other companies (Para 2.3.1.6, Master Circular – Loans and Advances). Consequently, 35% of private credit deals involve M&A financing. However, RBI’s Draft Directions on Acquisition Finance proposes to somewhat ease this restriction.¹⁰

Apart from the above, The IBC significantly strengthened creditor rights and recovery prospects, boosting confidence among lenders and supporting the growth of private credit. At the same time, many borrowers, particularly smaller firms, those with weak earnings, high leverage or insufficient collateral, struggle to access bank loans making private credit a natural alternative¹¹. This shift was further accelerated by an extended period of low global interest rates, which pushed investors to seek higher-yielding opportunities and increased capital flows into private credit strategies.

The most common structure for channelising private credit is an AIF – more specifically, a Category II AIF. A ‘Private Credit AIF’ is essentially an AIF whose primary investment strategy is direct debt financing (by investing in debt instruments) to borrowers outside the conventional banking/syndicated loan market. Since AIFs are not subject to the same regulatory framework as traditional lenders (for example, no deposit-taking, no CRR/SLR requirements etc.), they can offer tailor-made structures such as step‐up interest rates, bullet repayments, equity warrants, convertible features, etc.

A private credit fund requires long-term, stable capital, and frequent redemption demands can disrupt lending strategy. A closed-ended Category II AIF structure suits this model well, as it locks in investor capital for the fund’s life and prevents premature withdrawals. Private credit deals are idiosyncratic and difficult for outside parties to value or trade, lenders typically rely on long-term pools of locked-up capital for financing. One advantage AIFs have over mutual funds is that mutual funds are restricted to investing only up to 10% of their debt portfolio in unlisted plain vanilla NCDs.

Compared to private equity or venture capital, where performance depends heavily on market conditions and timing exits, private credit offers returns that are largely predetermined by contract. The trade-off, however, is that like most AIFs, these investments typically come with multi-year lock-ins and fewer exit opportunities, underscoring their inherently illiquid nature. Typically, investors which can commit long term capital are well-suited to invest in such AIFs – such as pension funds and sovereign wealth funds etc.

Rise of Business Development Companies

A Business Development Company (BDC) is a U.S. investment vehicle designed to channel capital to small and mid-sized businesses that lack easy access to traditional bank financing or public capital markets. BDCs were created by the U.S. in 1980, through amendments to the Investment Company Act of 1940 (see sections 2(48), 54 and 55), with a clear policy objective: to allow retail investors to participate in private credit and growth capital, an area previously accessible only to institutional investors.

As per a Federal Reserve Paper: BDCs are a way for retail investors to invest money in small and medium-sized private companies and, to a lesser extent, other investments, including public companies. BDCs are structured in different ways. Public BDCs refer to those with shares traded on national securities exchanges, and those whose shares are not traded on national securities exchanges but placed through SEC-registered or private placement offerings are non-publicly traded BDCs. BDCs typically finance middle-market firms—companies with EBITDA between $5 to $100 million, which historically have had limited access to funding from commercial banks and public debt markets. They also provide finance to development-stage companies in sectors such as technology, life science, healthcare information and services and sustainability industries, and private-equity owned or sponsored companies.
Structure and regulatory framework: Legally, a BDC is an unregistered closed-end investment company (fund). To qualify as BDC, a company must invest at least 70% of its assets in ‘eligible portfolio companies’ i.e. firms with market values below $250 million and provide ‘significant managerial assistance’ to its portfolio companies [see section 2(48) of the Investment Company Act, 1940]. These companies are often private, thinly traded public firms, or businesses undergoing financial stress. To avoid corporate-level taxation, they must distribute at least 90% of their taxable income to shareholders each year (like REITs and InvITs in India). BDCs are also permitted to use leverage (up to 2x the amount of assets).

BDCs raise capital through IPOs, follow-on equity issuance, corporate bonds or hybrid securities. While many BDCs are publicly traded on stock exchanges (50 in number), offering daily liquidity to investors, some exist as non-traded BDCs with limited liquidity (47 in number) and yet some as private BDCs (50 in number).¹²

Investment mix: Although BDCs are permitted to invest in both equity and debt, their portfolios are majorly debt-focused. In practice, 60–85% of a typical BDC portfolio is invested in debt instruments, such as senior secured loans, second-lien loans, or mezzanine debt. Equity investments usually comprise 15–30% of assets.¹³ Because of this allocation, interest income from loans is the primary driver of BDC earnings. This income tends to be steady and predictable, which aligns well with the BDC structure. For example, Ares Capital, one of the largest BDCs, allocates roughly 78–83% of its portfolio to debt (primarily first-lien loans) and about 17% to equity.

How BDCs generate returns: BDCs generate returns through multiple channels:

Interest income from loans to portfolio companies (the dominant source)
Dividends from preferred or common equity holdings
Capital gains from selling equity stakes or converting and exiting convertible securities

Many BDC loans are floating-rate, which provides partial protection in rising interest rate environments. However, most BDC investments are below investment-grade or unrated and equity positions are often in privately held or financially stressed companies, introducing credit and valuation risk.

Comparison with venture capital, private equity AIFs and Mutual Funds: BDCs are often compared with venture capital and private equity funds because all three invest in private, illiquid companies and may provide strategic or managerial support. The key distinction lies in investor access and structure. Venture capital and private equity funds are privately placed vehicles, restricted to institutions and wealthy investors, with long lock-ups and limited transparency. BDCs, by contrast, are designed to be accessible to retail investors and trade on public exchanges.

This distinction becomes especially relevant when comparing BDCs with AIFs in India, particularly private credit AIFs. Economically, BDCs resemble private credit AIFs; both lend to mid-market companies and rely heavily on interest income. The crucial difference lies in retail participation. In India, AIFs exclude retail participation by making the minimum investment amount of Rs. 1 Crore and prohibiting public issuances. In the U.S., BDCs were created to enable retail participation therefore there are no minimum investment norms and public issuances are allowed for BDCs. In this sense, BDCs can be thought of as private credit AIF-like strategies wrapped in a publicly traded structure, placing them between mutual funds (fully liquid public-market vehicles) and AIFs (illiquid private-market vehicles) on the investment spectrum.

From an Indian regulatory perspective, mutual funds offer the closest structural comparison to BDCs, albeit with important distinctions. Indian mutual funds are not permitted to employ leverage as part of their investment strategy and may borrow only to meet temporary liquidity requirements, capped at 20% of net assets (see Regulation 44 of the SEBI Mutual Fund Regulations). In addition, mutual funds face strict asset-side constraints, including a limit of 10% of the debt portfolio in unlisted plain-vanilla non-convertible debentures (see paragraph 12.1.1 of the SEBI Master Circular on Mutual Funds). These restrictions constrain exposure to illiquid private credit, making a BDC-like structure regulatorily infeasible in India under the mutual fund framework.

Global context: No other major market has created a true equivalent of the BDC. While regions such as Europe, Canada, and Australia have listed private credit funds, specialty finance vehicles, or credit income trusts, these structures typically limit or discourage retail participation.
Risk considerations: While BDCs may have stable and regular income, they carry elevated risks. Their portfolios consist largely of non-investment-grade debt and equity in small or distressed companies, often with limited public information. Credit losses, economic downturns or excessive leverage can materially impact returns.

Regulatory Concerns with Growth of Private Credit?

IMF in its 2024 Global Financial Stability Report highlighted risks w.r.t rise in private credit since its growth comes with several structural weaknesses that make the market vulnerable, especially in a downturn. Its rapid expansion is happening largely outside traditional regulatory oversight and because the market has not been stress-tested, the true scale of risk remains unclear. Borrowers tend to be smaller and more leveraged and with most loans being floating-rate, repayment stress can escalate quickly when interest rates rise. Although private credit funds’ leverage appears low compared with other lenders, end borrowers tend to be more highly leveraged than those in public markets, increasing the risks to financial stability.¹⁴

The increased complexity and the interconnections with leveraged financial entities create more channels through which unexpected losses in private credit could spread to the broader financial system¹⁵

Instruments such as PIK interest¹⁶ only defer the problem, increasing loss severity if performance deteriorates. Liquidity is another pressure point since private credit funds are inherently illiquid. Risk is further amplified by layers of hidden leverage, at the borrower, SPV, investor and fund level making contagion hard to track. Layers of leverage are created by the AIF lending against equity to a holding entity, which infuses the equity into an operating company, and the operating company borrowing against such equity.

Because loans are private, unrated and rarely traded, valuation is opaque and losses may remain masked until too late. Growing competition also risks weakening underwriting standards and covenant discipline, particularly as larger banks participate in private deals.

Practical challenges add to this vulnerability. Collateral enforcement may not always hold up legally, say due to restrictions on transferability of collateral (say, shares of a private company). Equity-linked security is volatile as well, and during distress, equity tends to lose its value almost completely. In essence, private credit offers flexibility and returns, but its opacity, leverage, illiquidity and weaker borrower profiles create risks that could surface sharply in stress conditions. Private credit certainly warrants closer attention. Nonbank lenders, especially private credit funds, have grown rapidly in recent years, adding to financial stability risks because they are less transparent and not as firmly regulated.

Do private credit AIFs create any regulatory arbitrage?

What you cannot do directly, you cannot do indirectly – the age-old maxim might apply in case a RE which is otherwise barred by RBI for an object, uses the AIF route to achieve that object. Below we examine some of the distinctions in the regulatory oversight:

Function	Private Credit AIFs	RE
Credit & Investment rules
Credit underwriting standards	No regulatory prescription	No such specific rating-linked limits. However, improper underwriting will increase NPAs in the future.
Lending decision	Manager-led Investment Committee under Reg. 20(7) may decide lending Manager controls composition of IC; IC may include internal/external members; IC responsibilities may be waived if investor commitment ≥₹70 Cr w/ undertaking Primarily i.e. the main thrust should be in: – Unlisted securities; and/or – Listed debt rated ‘A’ or below	Lending decisions guided by Board-approved credit policy
Exposure norms	Max 25% of investible funds in one investee company.	Exposure is limited to 25% of Tier 1 Capital per borrower and 40% per borrower group for NBFC ML; No such limit for NBFC BL. Banks can lend maximum upto 15% of their Tier 1 + Tier 2 capital to a single borrower. Large exposure norms may apply in case of banks and Upper Layer NBFCs
End-use restrictions	None prescribed under AIF Regulations, results in high investment flexibility	Banks cannot lend for land acquisition or for funding a M&A deal [refer ‘sector-specific regulatory gaps’ above] NBFCs do not have any such restrictions. They do have internal limits on sensitive sector exposures which includes capital market and commercial real estate [See Para 92 of SBR]
Related party transactions	Need 75% investors consent [reg 15(1)(e)]	Board approval mandatory for loans ≥₹5 Cr to directors/relatives/interested entities; Disclosure + abstention from decision-making;Loans to senior officers requires Board reporting [See para 93 of SBR]
Capital, Liquidity & Leverage Requirements
Capital requirements	No regulatory prescription as the entire capital of the fund is unit capital	Minimum net owned funds of ₹10 Cr, CRAR 15% for NBFC-ML and above [See para 133.1 of SBR]9% CRAR in case of banks,
Liquidity & ALM	Uninvested funds may be parked in liquid assets (MFs, T-Bills, CP/CDs, deposits etc.) [15(1)(f)]	NBFC asset size more than 100 Cr. have to do LRM [Para 26]
Leverage limits	No leverage permitted at AIF level for investment activities Only operational borrowing allowed	Leverage ratio of BL NBFC cannot be more than 7 No restriction on NBFC ML however, CRAR of 15% makes results into leverage limit of 5.6 times For Banks, in addition to CRAR, there is minimum leverage ratio is 4%
Monitoring, Restructuring and Settlements
Loan monitoring	No regulatory prescription	RBI-defined SMA classification, special monitoring, provisioning & reporting.
Compromise & settlements	No regulatory prescription	Governed by RBI’s Compromise & Settlement Framework
Governance, Oversight & Compliance
Governance & oversight	Operate in interest of investors Timely dissemination of info Effective risk management process and internal controls Have written policies for conflict of interest, AML. Prohibit any unethical means to sell/market/induce investors Annual audit of PPM termsAudit of accounts 15(1)(i) – investments shall be in demat form Valuation of investments every 6 months	A Risk Management Committee is required for all NBFCs. [See para 39 of SBR] AC [94.1], NRC [94], CRO [95] ID and internal guidelines on CG [100] required for NBFC-ML and above
Diversity of borrowers	Private credit AIFs usually have 15-20 borrowers.	Far more diversified as compared to AIFs
Pricing	Freely negotiated which allows for high structuring flexibility	Guided by internal risk model

Table 2: Differences in regulatory oversight between AIFs and Regulated Entities (REs)

The core difference between private credit AIFs and RBI-regulated lenders lies in regulatory intent. SEBI is a disclosure-driven market regulator, it relies on transparency, governance and informed investor choice. RBI is a prudential regulator tasked with protecting systemic stability, and therefore imposes capital buffers, exposure limits and stricter supervision. Private credit AIFs operate within SEBI’s lighter, disclosure-based approach, while banks and NBFCs function under RBI’s risk-averse framework. This does not always create arbitrage, but it does allow credit activity to grow outside the prudential perimeter. As private credit scales, a coordinated SEBI-RBI framework may be necessary to preserve flexibility without compromising financial stability.

It is important to recognise that Category I and Category II AIFs are prohibited from taking long-term leverage. As a result, any loss arising from their lending or investment exposures does not cascade into the wider financial system. Therefore, concerns around applying capital adequacy requirements to these AIF categories are largely unwarranted.

Conclusion

Though still a small fragment of India’s wider corporate lending landscape, private credit AIFs are steadily gaining ground reaching those nooks and crannies of credit demand that banks and NBFCs often cannot, or would not, serve. Their ability to operate beyond the traditional comfort zone of regulated lenders is what makes this segment structurally relevant and increasingly attractive to borrowers and investors alike.

At the same time, rapid expansion brings the potential for regulatory arbitrage. The RBI has already acknowledged this risk, most notably through its actions on evergreening via AIF structures, ultimately resulting in exposure caps of 10% for individual regulated entities and 20% collectively, along with mandatory full provisioning where exposure exceeds 5% in an AIF lending to the same borrower. These measures serve as guardrails to prevent private credit vehicles from functioning as an indirect tool for evergreening of loans.

IMF Global Financial Stability Report 2024 ↩︎
Ibid ↩︎
A middle-market firm is a firm that is typically too small to issue public debt and requires financing amounts too large for a single bank because of its size and risk profile. The size of middle-market firms varies widely. In the United States, they are sometimes defined as businesses with between $100 million and $1 billion in annual revenue. ↩︎
IMF Global Financial Stability Report 2024 and Federal Reserve Note dated May 23, 2025 ↩︎
India’s private credit market is coming of age: S&P Global and SEBI Data ↩︎
RBI’s Financial Stability Report June 2024 ↩︎
Customized lending terms can include, for example, the option to capitalize interest payments (that is, pay in kind) in times of poor liquidity ↩︎
Cai and Haque 2024 ↩︎
India’s private credit market is coming of age: S&P Global ↩︎
See our article ‘Draft RBI Directions: Banks may finance Acquisitions’ ↩︎
Chernenko, Erel, and Prilmeier 2022 ↩︎
Source: https://sbia.org/bdc-council/ (Numbers are as on Q4 2024). ↩︎
Source: S&P Global ↩︎
Growth in Global Private Credit: Reserve Bank of Australia ↩︎
From the speech of Fed Reserve Governor Lisa D. Cook on financial stability ↩︎
Payment-in-kind (PIK) is noncash compensation, usually by treating accrued interest as an extension of the loan. ↩︎

See our other resources of Alternative Investment Funds here

Background

Meaning of TRS

CDS Vs TRS

Types of TRS

Regulatory framework for TRS

Eligible participants for TRS

Reference entities and reference assets for TRS

Preventing Regulatory circumvention:

Will it impact the bond markets in India?

Background

Key Changes

Actionables for REs:

Highlights

Applicability and Effective Date

Relevant Definitions

Related Party

Related Person

Specified Employees

Meaning of “Lending”

Principles to be followed while lending to a related party

Financial Statements Disclosures

Comparison at a Glance

Factors to decide loan product allocation

Securitised notes: whether investment in group entities?

Conclusion

Case of Balance Transfer

Is BT a case of Transfer?

Situation for Banks

Conclusion

Our Other Resources

What is Private Credit?

How is it Different From Normal Credit?

How Much of it is in India?

Reasons for Rise in Private Credit?

Rise of Business Development Companies

Regulatory Concerns with Growth of Private Credit?

Do private credit AIFs create any regulatory arbitrage?

Conclusion

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