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Operational Risk Assessment for NBFCs : Understanding The Basics

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Simrat Singh | finserv@vinodkothari.com 

Operational risk, as defined by the Basel framework, refers to the possibility that a financial institution’s routine operations may be disrupted due to failures in processes, systems, people, or external events. While historically treated as secondary to credit and market risk, it has increasingly become a central focus of risk management, particularly for institutions with complex operations, heavy technology dependence, extensive outsourcing, and stringent regulatory obligations. Reflecting this shift, the RBI’s 2024 Guidance Note on Operational Risk Management and Resilience expands its expectations for operational risk management to all NBFCs. 

Having previously discussed the guidance note (refer here), this article now explains the fundamentals of operational risk assessment and outlines its process.

Operational Risk Management

Operational risk poses unique challenges because many of the events that cause losses arise from internal factors, making them difficult to generalise or predict. Large operational losses are often viewed as rare, which can make it difficult to get sustained management attention on the steady, routine work required to identify issues and track trends1. Operational risks typically stem from people, processes, systems and external events, ironically, the same resources essential for running the business. Unlike credit and market risk which are modelled and hedged, operational risks are often idiosyncratic, event-driven and subject to human, process and system failure.

Relevance For Financial Institutions

Financial institutions operate with complex processes, large transaction volumes, strict regulatory reporting requirements and often heavy dependence on technology, outsourcing arrangements and third-party service providers. Because of this, operational failures, such as system glitches, fraud, compliance breaches or breakdowns in business continuity, can result in substantial financial losses, regulatory sanctions, reputational harm and other disruptions to business operations. 

Given these risks, regulators have placed growing emphasis on the measurement and management of operational risk. Based on our experience, RBI has frequently raised queries regarding the operational risk frameworks of NBFCs during its supervisory inspections. Under Basel II, for instance, banks using the Advanced Measurement Approach were required to maintain strong, demonstrable operational risk management systems. Recognising the importance of operational risk, the Bank of England’s FSA0732 report, which is applicable on banks and large investment firms, requires firms to record the top ten operational risk loss events for each reporting year. This provides a clear view of what went wrong, where it occurred and the scale of the financial impact.

Operational Risk Assessment Process

In its guidance note for operational risk, RBI at many places underscored the importance for risk assessment. One such example is given below:

Principle 6: Senior Management should ensure the comprehensive identification and assessment of the Operational Risk inherent in all material products, activities, processes and systems to make sure the inherent risks and incentives are well understood. Both internal and external threats and potential failures in people, processes and systems should be assessed promptly and on an ongoing basis. Assessment of vulnerabilities in critical operations should be done in a proactive and prompt manner. All the resulting risks should be managed in accordance with operational resilience approach.

6.1 Risk identification and assessment are fundamental characteristics of an effective Operational Risk Management system, and directly contribute to operational resilience capabilities. Effective risk identification considers both internal and external factors. Sound risk assessment allows an RE to better understand its risk profile and allocate risk management resources and strategies most effectively.

Figure 1: Operational Risk Assessment Process

Risk identification

Risk identification means figuring out what exactly you need to assess. It involves recognising the different risk sources and risk events that may disrupt your business. A risk source is the underlying cause, something that has the potential to create a problem. A risk event is when that problem actually occurs. For example, a weak password is a risk source, while a data breach caused by that weak password is the risk event. 

As per the RBI’s Guidance Note, REs are expected to take a comprehensive view of their entire “risk universe”. This means identifying all categories of risks, traditional or emerging, that could potentially affect their operations. These may include insurance risk, climate-related risk, fourth- and fifth-party risks, geopolitical risk, AML and corruption risk, legal and compliance risks, and many others. The underlying expectation is simple: an RE should systematically identify everything that can go wrong within its business model, processes, people, systems, and external dependencies, and ensure that no material source of risk is overlooked.

There are many ways to identify risks. You may use questionnaires, self-assessments by business or functional heads, workshops with staff involved in risk management, or you may review past failures within the company. Industry reports, experiences of peers, and linking organisational goals to potential obstacles can also reveal important risks. You can even look at upcoming strategic initiatives and think ahead about the risks that may arise when these changes are implemented.

Every organisation has its own risk profile. A lender may worry about borrowers not repaying, untrained staff, biases in an AI underwriting model, IT system failures, employee fraud, or suppliers not delivering on time. These risks should be recorded in a risk register, but it is important that this register reflects your business. A company offering only physical loans may not face digital lending risks, and should not simply copy any generic list. The goal is to identify risks that genuinely matter to your day-to-day operations.

Assessment

Once you know which risks matter, the next step is to assess each of them. For every risk, ask yourself two basic questions: 

  1. What is the likelihood of this risk actually happening? This is simply the chance that the event might occur; You may assign parameters to determine the likelihood – for eg if the risk event is almost certain to occur in the next 1 year or is it likely to occur or it will occur only in remote situations?

Figure 2: Illustrative likelihood assessment criterias

  1. If it does happen, what impact will it have on my organisation? Will it hurt my reputation? Lead to financial loss? Negative feedback from customers? Cause a data leak? One can record the impact of the risk as High, medium or low based on its gravity

Figure 3: Illustrative impact assessment of risks

These two questions help you understand how serious the risk is inherently (inherent risk level) i.e, before considering whether you have any controls in place. Note that at this stage, you’re only interested in the natural level of risk that exists ignoring any controls you might already have. 

Evaluating Controls

Once the inherent risks are understood, the next step is to look at how these risks are currently being managed. These risk-reducing efforts are your controls or mitigation measures. Controls are simply the actions, checks, or processes already in place to lower the likelihood or impact of a risk. For example: Is your underwriting model checked for bias? Are board committees meeting regularly? Do you have proper maker–checker checks in your V-CIP process? Controls can take many forms such as policies, procedures, tools, system checks, reviews, or even day-to-day practices followed by employees. In essence, a control is any measure that maintains or modifies risk and helps the organisation manage it more effectively. 

Residual Risk

After evaluating the controls, you can determine the residual risk i.e. the level of risk that remains even after your mitigation measures have been applied. Residual risk shows whether the remaining exposure is acceptable or whether additional controls are needed. By definition, residual risk can never be higher than inherent risk. Generally, residual risk can be interpreted as follows:

  • Low Residual Risk: When the effectiveness of internal controls fully covers or even exceeds the inherent risk;
  • Medium Residual Risk: When controls reduce most of the risk, leaving only a small gap;
  • High Residual Risk: When controls address only part of the risk and a significant gap still remains;
CategoryRisk SourceRisk eventRoot causeLikelihoodConsequenceLevel of inherent riskControl EffectivenessLevel of Residual Risk
People RiskEmployees / StaffEmployee fraud, misappropriation, or collusionWeak internal controls, poor background checksHighly LikelyMediumHighWeakHIGH
Information Technology & Cyber RiskIT Infrastructure / SystemsSystem downtime or core platform failureServer outage, inadequate IT resiliencePossibleLowLowStrongLOW
Process & Internal Control RiskOnboarding / KYC ProcessesNon-compliance with KYC or onboarding proceduresInadequate verification, manual errorsPossibleHighHighAdequateMEDIUM
Legal & Compliance RiskOutsourcing / LSP ArrangementsNon-compliance in outsourcing / LSP arrangementsWeak SLA oversight, inadequate due diligenceUnlikelyLowLowAdequateLOW
External Fraud RiskBorrowers / External PartiesBorrower fraud – identity theft, fake borrowers, or collusionForged documents, weak KYCPossibleLowLowStrongLOW
Model / Automation / Reporting RiskData Aggregation / SystemsFailure in data aggregation across systems for regulatory returnsSystem inconsistencies, poor data governanceHighly LikelyMediumHighStrongLOW
Reputation Risk / Customer ExperienceCustomer Communication / Sales PracticesMiscommunication of terms or conditions to customersPoor training, unclear communication scriptsPossibleMediumMediumWeakMEDIUM

Figure 5: An illustrative Snapshot of Operational Risk Assessment

Understanding residual risk helps decide where further action is required and where the organisation may still be vulnerable.

Conclusion

The goal, therefore, is to move away from a simple “tick-box” approach and make the operational risk assessment truly tailored to the organisation. For ML and above NBFCs, the ICAAP requirement to set aside capital for operational risk is useful, but it covers only a narrow part of what operational risk really involves. A comprehensive assessment goes much further by examining the strength of the entity’s internal controls and how effectively they manage real-world risks. If the residual risk exceeds the organisation’s tolerance level, it should trigger a closer look at those controls and prompt corrective action. Ultimately, the focus should be on building a risk framework that is meaningful, proactive, and aligned with how the organisation actually operates. The ultimate goal is therefore to develop ‘operational resilience’ which as per Bank of England3 is the ability of firms and the financial sector as a whole to prevent, adapt, respond to, recover from, and learn from operational disruptions.

Our other resources on risk management:

  1. Analysing Banking Risk: World Bank ↩︎
  2. FSA073: Instruction ↩︎
  3. Operational resilience of the financial sector: Bank of England ↩︎

RBI Trade Relief Directions: How is your company impacted?

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– Team Finserv | finserv@vinodkothari.com

Call it Trump relief! The RBI announced relief measures on the 14th Nov to help the exporters of certain specified items, who may have availed export credit facilities from a regulated lender, whereby all regulated entities (REs) “may” provide a moratorium, from 1st September 2025 to 31st December, 2025. The grant of such a relief shall be based on a policy, consisting of the criteria for grant of the subject relief, and such criteria shall be disclosed publicly. Not only this, REs shall also make a fortnightly disclosure of the reliefs granted to eligible borrowers on a RBI format on Daksh portal.

The Reserve Bank of India (Trade Relief Measures) Directions, 2025 (‘Directions’) are applicable to NBFCs and HFCs as well. This is accompanied with amendment to Foreign Exchange Management (Export of Goods and Services) (Second Amendment) Regulations, 2025 for extension of the period for both realization/repatriation of export value (from 9 to 15 months) and the shipment of goods against advance payment (from 1 to 3 years).

Highlights:

  • Whether your company grants an export credit or not, if your borrower is the one who has availed export credit for export of specified goods or services, the borrower may approach you for the moratorium.
  • Are you bound to grant the moratorium? Answer is, no. However, basis a policy which is publicly hosted, you will consider the eligibility of the borrower. The relevant factors on which the eligibility will be examined may also form a part of the policy, and ideally, should include the extent of dependence on exports of specified items to the USA, tariff-based disruption in the cashflows, alternative markets and transitioning possibilities, etc.
  • Effective: Immediately. 
  • Actionables: (a) Framing of policy to consider the eligibility of affected borrowers; (b) Hosting the policy on public website; (c) Creating mechanism for receiving and transmission of borrower requests for the moratorium and giving timely responses to the same (d) RBI fortnightly reporting.

What is the intent?

To mitigate the disruptions caused by global headwinds, and to ensure the continuity of viable businesses.

Tariff impositions by the USA are likely to impact several exporters. There may be a ripple effect on penultimate sellers or other segments of the economy as well, but the intent of the Trade Relief Directions seems limited to the direct exporters only.

Which all regulated entities are covered?

The Directions are applicable to following entities:

  • Commercial Banks
  • Primary (Urban) Co-operative Banks, State Co-operative Banks and Central Co-operative Banks
  • NBFCs
  • HFCs
  • All-India Financial Institutions
  • Credit Information Companies (only with reference to paragraph 16 of these Directions).

Does it matter whether the RE in question is giving export credit facilities or not? In our view, it does not matter. The intent of the Directions is to mitigate the impact of trade disruptions. Of course, the borrower in question must be an exporter, must have an export credit facility outstanding as on 31st Aug 2025, and the same must be standard.

If these conditions are met, then the RE which holds the export credit, as also other REs (of course, the nexus between the trade disruption and the servicing of the credit facility will have to be seen) should consider the borrower for the purpose of grant of relief.

Relief may or may not be granted. 

Policy on granting relief

The consideration of the grant of relief will be based on a policy. 

Below are some of the brief pointers to be incorporated in the policy: 

  1. Purpose and Scope: define which loan products, sectors, or borrower categories are covered; effective period for granting relief
  2. Eligibility Criteria for borrowers
  3. Assessment criteria for relief requests received from the borrowers
  4. Authority responsible for approving such request
  5. Relief measures that can be offered to borrowers
  6. Impact on asset classification and provisioning
  7. Disclosure Requirements
  8. Monitoring and Review: Authority which is responsible for monitoring such accounts; periodicity of review

How is the assessment of eligible borrowers to be done?

In our view, the relevant information to be obtained from the candidates should be:

  • Total export over a relevant period in the past, say 3 years
  • Break up of export of “impacted items” and other item
  • Of the above, exports to the USA
  • Gross profit margin
  • Impact on the cashflows
  • Information about cancellation of export orders from US importers
  • Any damages or other payments receivable from such importers
  • Any damages or other payments to be made to the penultimate suppliers
  • Alternative business strategies – repositioning of markets, alternative buyer base, etc
  • Cashflow forecasts, and how the borrower proposes to pay after the Moratorium Period.

What sort of lending facilities are covered?

Please note the following from the preamble: “mitigating the burden of debt servicing brought about by trade disruptions caused by global headwinds and to ensure the continuity of viable businesses”. Therefore, clearly, the relief intended here is one where “trade disruptions” create such a burden on debt servicing, which may impact the viability of the business.

From this, it implies that the entity in question must be a business entity, and the loan in question should be a business loan. 

In our thinking, the following facilities seem covered:

  1. Export credits of all forms, including packing credit, funded as well as unfunded, letters of credit, etc.
  2. Buyer’s credit or facilities for inward acquisitions/purchases by an exporter
  3. Cash credits, overdrafts or working capital related facilities, intended for export business of impacted items.
  4. Term loans relating to an impacted business
  5. Loans against property, where the end use is working capital

Eligible and ineligible borrowers:

Eligible borrowers:

  • Borrowers who have availed credit for export
  • Borrower had an outstanding export credit facility from a RE as of August 31, 2025 (However, in case the borrower has a sanctioned facility pending disbursement as on Aug 31, the same shall not be eligible)
  • Borrower with all REs was/were classified as ‘Standard’ as on August 31, 2025

In our view, the following borrowers/ credit facilities are not eligible for the relief:

  • Individuals or borrowers who have not borrowed for business purposes
  • Home loans or loans against specific assets or cashflows, where the debt servicing is unconnected with the cash flows from an export business
  • Loans against securities or against any other financial assets
  • Gold loans, other than those acquired for business purposes
  • Car loans, loans against commercial vehicles or construction equipment, unless the borrower is engaged in export business and the cashflows have a nexus with such business
  • Borrower is engaged in exports relating to any of the sectors specified
  • Borrower accounts which were restructured before August 31, 2025
  • Accounts which are classified as NPA as on August 31, 2025

Consider a borrower who is not an exporter himself, but an ancillary supplier, supplying to a trading house. Will such a penultimate exporter be covered by the Relief Directions? In our view, the answer is negative, as the “eligible borrowers” are defined to mean an exporter.

Impacted items and impacted markets

The list of impacted items broadly covers a wide spectrum of manufacturing and export-oriented sectors, including marine products, chemicals, plastics, rubber, leather goods, textiles and apparel, footwear, stone and mineral-based articles, jewellery and precious metals, metal products, machinery, electrical and electronic equipment, automobiles and auto components, medical and precision instruments, and furniture and furnishing items.

Is it mandatory that the borrower shall be exporting to USA? While the Directions do not specifically mandate that the borrower shall be exporting to the USA, the concerned REs should, as part of their assessment, evaluate whether the borrower genuinely requires such relief measures and, in our view, should consider the extent to which the borrower depends on exports of the specified items to the USA.

Why have HFCs been covered?

Generally speaking, the servicing of home loans is not supposed to be based on business cashflows, and therefore, the impact of trade disruptions on servicing of a home loan does not seem easy to establish.

However, HFCs grant other credit facilities too, including LAP or business loans. Therefore, there is no carve out for HFCs as such. HFCs are also expected to prepare the policy referred to above and be sensitive to requests from impacted borrowers.

Is the moratorium retrospective?

Yes, clearly, the moratorium is retrospective, as it covers the period from 1st September to 31st December. This is the range over which the moratorium may be granted; of course, the decision as to how much moratorium, within the above maximum range, is warranted in the particular case, is that of the lender. Let us call the agreed moratorium as the Moratorium Period.

If the moratorium is granted from 1st Sept., then any payments which were due for the period covered by the Moratorium Period will  not be taken as having fallen due. This will have significant impact on the loan management systems:

  • Considering that we are already in the middle of November, the day count for any payments due during the part of the Moratorium Period will be set to zero. In other words, day count will stop during the Moratorium Period. Thus, if an account was showing a DPD status of 60 days as on Aug 31, 2025, the DPD count will remain at a standstill till the moratorium period is over.
  • However, in case a borrower has made payment during the moratorium period, will the DPD count decrease or will it remain the same? 

The RBI Directions state that the days past due (DPD) count during the moratorium period will be excluded. However, this does not imply that a borrower who makes payments during this period should be denied the corresponding benefit. In our view, if a payment is received from the borrower, the DPD count should accordingly be reduced.

  • Any payments already made during the part of the Moratorium Period already elapsed may be taken towards principal, or may be held to be adjusted against the future dues of the borrower, after the Moratorium Period. This should also, appropriately, be captured in the policy.
  • Further, for accounts for which the CIC reporting has already been done on or after Aug 31, 2025, and the lender decides to extend the moratorium benefit, it must be ensured that the DPD count is revised so as to reflect the status as on Aug 31, 2025. 

Do lenders have to necessarily grant moratorium, or grant partial interest/principal relief?

The RBI Directions do not mandate REs from granting such relief measures. Accordingly, the concerned RE will need to assess individual cases based on the sectors, the need for such relief and the extent to which such relief may be granted. 

Lenders may grant full moratorium during the Moratorium Period, or may grant relief as may be considered appropriate.

Do lenders take positive actions, or simply respond to borrower requests?

The lenders must establish a policy for granting such relief measures prior to extending any relief, as the authority to do so will be derived from this policy. As discussed above, the discretion to grant relief rests with the concerned RE; therefore, each request submitted by a borrower must be evaluated on an individual basis.

For this purpose, the following information must be obtained from the borrowers seeking relief:

  1. The concerned sector and how the same has been impacted necessitating such relief
  2. Information relating to the current financial condition of the business of the borrower
  3. Facilities taken and outstanding with other REs 

Non-compounding of interest during the Moratorium Period:

Para 9 (iii) provides that while interest will accrue during the Moratorium Period, but the interest shall be simple, that is, shall not be compounded.

This may require REs to tweak their loan management systems to stop the compounding of interest during the Moratorium Period. 

However, the actual population of affected borrowers for a particular RE may be quite limited. Hence, REs may do manual or spreadsheet-based adjustments for affected borrowers, instead of making adjustments to their LMS itself.

Recomputation of facility cashflows after Moratorium:

During the moratorium period, as per the RBI directive, the lender can only accrue simple interest. Accordingly, the IRR of the credit facility will have a negative impact unlike the covid moratorium where the compound interest loss was compensated by the central government. 

Further, it has also been provided that the accrued interest may be converted into a new term loan which shall however be repayable in one or more installments after March 31, 2026, but not later than September 30, 2026. Accordingly, the accrued interest should anyhow be received by September 30, 2026.

Similar moratoriums in the past

  • Moratorium on loans due to COVID-19 disruption: Refer to our write-up here.
  • Moratorium 2.0 on term loans and working capital: Refer to our write-up here.

Our write-ups on similar topics:

Referral or Representation? The Fine Line Between LSP, DSA and Referral Partner

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Simrat Singh & Sakshi Patil | finserv@vinodkothari.com

India’s lending landscape is evolving from traditional, branch-led lending to digital and now “phygital” models, involving multiple intermediaries connecting borrowers and lenders. For regulated entities (REs), three different terms referring to loan intermediaries are commonly seen: Lending Service Providers (LSPs), Direct Selling Agents (DSAs) and Referral Partners. 

At first glance, these roles may appear similar since all “bring in business.” But as far as the RBI is concerned, the difference determines how much regulatory oversight the lender must exercise over these participants. This article attempts to answer who’s who in this lending chain, and more importantly, where a simple referral ends and a regulated lending function begins.

The Lending Trio: LSPs, DSAs and Referral Partners

LSPs: The digital lending backbone

In the digital lending framework, the most central participant is the LSP who are engaged by the REs to carry out some functions of RE in connection with its functions on digital platforms. These LSPs may be engaged in customer acquisition, underwriting support, recovery of loan, etc. The RBI’s Digital Lending Directions, 2025 define an LSP as:

“An agent of a RE (including another RE) who carries out one or more of the RE’s digital lending functions, or part thereof, in customer acquisition, services incidental to underwriting and pricing, servicing, monitoring, or recovery of specific loans or loan portfolios on behalf of the RE, in conformity with the extant outsourcing guidelines issued by the Reserve Bank.”

The emphasis on the term “agent” is crucial since being an agent becomes a precondition to becoming an LSP. An agent is a person employed to act for another; to represent another in dealings with third persons within the overall authority granted and can legally bind the principal by their actions (more discussion on agency later). This distinguishes an agent from a mere vendor or service provider who delivers a contracted service but has no authority to affect the principal’s relationship with third parties and neither is subjected to a degree of control from the principal.

DSAs: The traditional middle ground

DSAs, though not formally defined by the RBI, their appointment, conduct and RE’s oversight on them is governed by Annex XIII of the SBR Directions (Instructions on Managing Risks and Code of Conduct in Outsourcing of Financial Services by NBFCs) for NBFCs and by Guidelines on Managing Risks and Code of Conduct in Outsourcing of Financial Services by Banks for Banks. DSAs operate largely in physical or “phygital” lending models, focusing on loan sourcing. They represent the lender while dealing with potential borrowers. However, their functions are narrower than those of an LSP. A DSA’s role typically ends with lead generation and preliminary documentation, without involvement in underwriting, servicing or recovery. While the DSA is an agent, it plays a more limited role in the lending value chain and has minimal borrower-facing obligations post origination.

Referral Partners: The nudge before negotiation

Referral Partners perform the most limited role. They simply share leads or basic borrower information with the lender and have no authority to represent or bind the lender. Their role is confined to referral i.e. the providing the first nudge to the lender. They are treated as independent contractors or service providers, not agents and operate under commercial referral agreements. The RE does not exercise control over their operations, nor is it responsible for their actions beyond the agreed referral activity. The distinction lies not in what they do (introducing borrowers) but in what they cannot do i.e. represent the lender or perform any of its lending functions.

Referral ≠ Representation: The Agency Test

The most important question then arises “How does one determine whether a person is an LSP, DSA, or a referral partner?”. All three may assist in borrower acquisition, but the answer might lie in distinguishing referring from representing. To be classified as an LSP (or even a DSA), the person must first be the agent of the RE, not just a vendor or service provider. The test of agency has been laid down in the Supreme Court’s decision in Bharti Cellular Ltd. v. Commissioner of Income Tax1. The Court, in para 8, observed that the existence of a principal–agent relationship depends on the following elements:

  1. The authority of one party to alter the legal relationship of the other with third parties;
  2. The degree of control exercised by the principal over the agent’s conduct (less than that over a servant, but more than over an independent contractor);
  3. The existence of a fiduciary relationship, where the agent acts on behalf of and under the guidance of the principal;
  4. The obligation to render accounts to the principal, and the entitlement to remuneration for services rendered.

Further, the Court clarified in para 9 that the substance of the relationship, not just its form, determines whether agency exists. If a person is neither authorised to affect the principal’s relationship with third parties nor under its control, and owes no fiduciary obligation, the person is not an agent, regardless of what the contract calls them. 

Similarly, in Bhopal Sugar Industries v. Sales Tax Officer2, the Supreme Court had observed that the mere word ‘agent’ or ‘agency’ is not sufficient to lead to the inference that parties intended the conferment of principal-agent status on each other. Mere formal description of a person as an agent is not conclusive to show existence of agency unless the parties intend it so hence, “the true relationship of the parties in such a case has to be gathered from the nature of the contract, its terms and conditions, and the terminology used by the parties is not decisive of the said relationship.”

On the aspect of supervision and control, the Supreme Court in para 40 of the Bharti Cellular ruling stated:

An independent contractor is free from control on the part of his employer, and is only subject to the terms of his contract. But an agent is not completely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent are fiduciary….The distinction is that independent contractors work for themselves, even when they are employed for the purpose of creating contractual relations with the third persons. An independent contractor is not required to render accounts of the business, as it belongs to him and not his employee.

In lending transactions, therefore, the relevant considerations to determine whether an agency exists or not may be:

  1. Does the agency have the authority, under a contract with the principal, to represent the principal to create any relationship with the borrower?;
  2. Does the agency have the authority to approach potential borrowers, representing that the agency can source a loan from the RE?;
  3. What is the role of the agency in the loan contract – is the loan contract established between the lender and the borrower through the agent?;
  4. Does the agency agreement control/regulate the manner of the agent’s dealings with the borrowers?;
  5. Effectively, is the agency the interface between the RE and the borrowers?

Paanwala and the Poster: Not everyone who sells a loan lead is an LSP

To illustrate the difference between LSP/DSA and Referral Partner, consider a simple example. You stop at your neighbourhood paanwala for your regular paan or pack of mints. Between the faded ads for mobile recharges and UPI QR codes, one new poster catches your eye “Need a personal loan? Look No Further ! Fast approvals”. Curious, you ask if the shopkeeper has joined the finance world. Smiling, he replies, “Arre nahi sahib, I just share numbers! You give me your name and phone number, I’ll send it to my guy. If your loan gets approved, I get a small tip!” No exchange of KYC documents, no app, no credit score. Now, does this make the paanwala an LSP under the Digital Lending Directions? He may appear as performing a part of the customer acquisition function of the lender so should he now comply with outsourcing norms, data protection protocols and grievance redressal requirements? Of course not.

The paanwala is a pure referral partner. His role ends with introducing a potential borrower to a contact connected to a lender. He does not represent the lender, verify or collect documents, underwrite, service, or recover loans, nor can he legally bind the lender through his actions. Mere referral, without agency and without performing a lending function, does not make one an LSP. Passing a phone number over a cup of chai does not amount to digital intermediation.

BasisReferral PartnerLSP
Scope of activityLimited to sharing leads with the lenderPerforms one or more of the lenders functions w.r.t in customer acquisition, services incidental to underwriting and pricing, servicing, monitoring, recovery
Access to prospective customer’s information and documentsOnly basic contact information necessary for the lender to approach the customer for the loan is sharedTo the extent relevant for carrying out its functions
RepresentationDoes not represent the RERepresents the RE
Agency & PrincipalNot an agentAppointed as an agent
DLGCannot provideCan provide (in case of Digital Lending and Co-lending)
Applicability of Outsourcing GuidelinesNot applicableApplicable
Mandatory due diligence  before appointmentNot applicableApplicable
Appointment of GRONo such requirementLSP having interface with borrower needs to appoint a GRO
Right to auditNo right of RERE has a right
Disclosure on the website of the lenderNot applicableApplicable

Table 1: Distinction between Referral Partner and LSP

Conclusion

As digital lending continues to expand in India, ensuring that every intermediary’s role aligns with its true legal character is essential. The key in determining the true nature of the relationship would ultimately rest on the contractual terms that must reflect the true nature of the relationship. Misclassifying these entities can expose lenders to compliance risks under RBI’s outsourcing and digital lending guidelines.

  1. [2024] 2 S.C.R. 1001 : 2024 INSC 148 ↩︎
  2. 1977 AIR 1275 ↩︎

Our resources on the same:

  1. Lending Service Providers for digital lenders: Distinguishing agency contracts and principal-to-principal contracts
  2. Principles of Neutrality for Multi-Lender Platforms
  3. Multi-lender LSPs – Compliance & Considerations
  4. Outsourcing (Direct Selling Agent) v. Business Correspondent route
  5. Resources on Digital Lending

Virtual Certificate Course on Grooming of Chief Compliance Officers of NBFCs

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Refer our other resources:

  1. Tech-driven compliance monitoring and validation of internal models
  2. Compliance-o-meter: From abstraction to structured granular assessment
  3. Compliance Risk Assessment
  4. Enhanced Corporate Governance and Compliance Function for larger NBFCs

Upfronting Uprooted: RBI puts an end to early profit booking in Co-lending

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Simrat Singh | Finserv@vinodkothari.com

Co-lending is an arrangement where two or more regulated entities (REs) jointly extend credit to a borrower under a pre-agreed Co-Lending Agreement (CLA). The CLA, signed before origination, defines borrower selection criteria, product lines, operational responsibilities, servicing terms and the proportion in which each lender will fund and share the loan. The aim is to combine the origination strength of a RE with the lower cost of funds of another RE, thereby expanding credit outreach.

Before the issuance of the RBI (Co-Lending Arrangements) Directions, 2025 (‘Directions’), there was no formal co-lending framework for non-PSL loans and for PSL loans, the CLM-2 ‘originate-and-transfer’ model was the most common structure. Under this model, the originating RE would book 100% of the loan in its books and, within a stipulated period, selectively transfer a portion to the funding partner. This post-origination discretion enabled ‘cherry-picking’ of loans. CLM-2 mirrored a loan sale under TLE framework but without any minimum holding period restrictions, making it a preferred route. It offered the economic and accounting benefits of transfer, including derecognition and upfront gain recognition without waiting for loan seasoning.  

Upon transfer, the originating RE would derecognise the transferred portion and book ‘upfront gains’. The upfront gain arose from the excess spread between the interest rate charged to the borrower and the yield at which the loan pool was transferred to the funding partner. For example, if the originating RE extended loans at 24% and sold down 80% of the pool at 18%, the 6% differential represented the excess spread. This spread, which would otherwise have been earned over the life of the loan, was discounted to present value and recognised as gain on transfer upfront, at the time of derecognition. This led to the originating RE recognising profits immediately despite not receiving any actual cash on the co-lent loans. This practice allowed originating REs to show higher profits upfront, even though no cash had actually been received on the co-lent loans.

The Directions fundamentally alter this framework as well as the prevalent market practice. They move away from originate-and-transfer and institute a pure co-origination model. It has been expressly stated that The CLA must now be executed before origination, with borrower selection and product parameters agreed ex ante. The funding partner must give an irrevocable commitment to take its share on a back-to-back basis as loans are originated. Importantly, the 15-day window provided under the Directions is only for operational formalities such as fund transfers, data exchange and accounting. It is not for evaluating or selecting loans after origination. If the transfer does not occur within 15 days due to inability, not discretion, the originating RE must retain the loan or transfer it under the securitisation route or as per Transfer of Loan Exposure framework. In short, post-origination cherry-picking is no longer permitted.

This change has direct accounting consequences. Under Ind AS 109, a financial asset is recognised only when the entity becomes a party to the contractual provisions and has enforceable rights to the underlying cash flows (see para 3.1.1 and B3.1.1). In a co-lending transaction under the Directions where co-origination is a must, each lender should recognise only its respective share of the loan at origination. The originating partner should not recognise the funding partner’s share at any stage, except as a temporary receivable if it disburses on behalf of the funding partner. Since the originating partner never recognises the funding partner’s share (except as a servicer), there is no recognition and therefore, there is no question of any subsequent derecognition and booking of any gain on sale. Income, if any, is limited to servicing fees or mutually agreed charges, not upfront profit.

By eliminating post-origination discretion, RBI has closed the upfronting route. Co-lending is now truly co-origination, joint funding from day one, with proportionate recognition and no accounting arbitrage.  The practice that once allowed REs to accelerate income has been uprooted.

Click here to see our other resources on co-lending

The Great Consolidation: RBI’s subtle shifts; big impacts on NBFCs

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Team Finserv | finserv@vinodkothari.com

In its recent consolidation exercise of the Master Directions applicable to NBFCs, the RBI has done a lot of clause shifting, reshuffling, reorganisation, replication for different regulated entities, pruning of redundancies, etc. However, there are certain places where subtle changes or glimpses of mindset may have a lot of impact on NBFCs. Here are some:

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Old Rules, New Book: RBI consolidates Regulatory Framework

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Team Finserv | finserv@vinodkothari.com

RBI Consolidation of Circulars (1)Download

Read our related resources:

RBI’s Regulatory Shelf gets a Pre-Diwali Dusting  

RBI’s Regulatory Shelf gets a Pre-Diwali Dusting  

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RBI releases plethora of draft regulations to consolidate existing regulations

Manisha Ghosh & Sakshi Patil | finserv@vinodkothari.com 

In 2021, RBI had set up an expert committee with the ideal objective of consolidating the multitude of separate notifications, Directions, circulars, and regulations applicable to various regulated entities. The aim was to create a comprehensive repository that such REs could easily refer to, streamlining compliance and reducing ambiguity.   

This consolidation exercise builds upon the groundwork laid by the Regulations Review Authority, which was tasked with reviewing regulations, circulars, and reporting requirements based on feedback from the public, banks and financial institutions, as highlighted in the press release dated April 15, 2021.

Ever since RBI was entrusted with the powers to regulate the financial sector entities, the RBI’s regulatory framework has steadily expanded, issuing numerous Directions under its statutory powers. While such evolution is natural, overlapping jurisdictions and a lack of clear supersession of older instructions have added complexity to the regulatory landscape.

In line with the above, the RBI has carried out a thorough consolidation of the regulatory instructions currently overseen by the Department of Regulation. On a prima facie review, it seems that this exercise has been carried out on an ‘as-is’ basis, with only minor editorial updates to clarify language or update terminology. There has been no substantive review of the instructions as such for any revisions or new additions. 

Under the consolidation exercise, more than 9000 circulars and Directions issued up to October 9, 2025, have been streamlined into 238 Master Directions, covering 11 specific categories of regulated entities across up to 30 functional areas. As a result, all these existing circulars, including various Master Circulars and Master Directions, administered by the Department of Regulation are proposed to be repealed.

Previously, a single circular often applied to multiple entities, with provisions scattered across different sections. This sometimes led to some confusion- for example, under the KYC Directions, 2016,  reference to “opening a small account” applied to banks, however, it created ambiguity about whether this shall be applicable to a borrower taking a loan in the case of NBFCs. 

It has been proposed that the regulatory framework shall be divided amongst regulated entities like commercial banks, payments banks, All India financial institutions, NBFCs, etc. Additionally, within each entity the provisions shall be separated into key areas such as, prudential requirements, interest on advances, asset liability management, valuation of investments, concentration risks, credit reporting, outsourcing, disclosures, etc. The aim is to ease out the compliance process by simplifying and arranging the regulations into identified key operational areas  applicable to a particular RE

While the intent of the consolidation exercise was refinement of the regulatory provisions and clarify any existing ambiguities, however, the segregation exercise requires a thorough review before being notified. Various provisions that were once uniformly applicable across all regulated entities have now been segregated based on the construct of respective REs, however, in ironing out one ambiguity, other creases may have surfaced! This underscores the need for a critical analysis of the implications of these provisions on individual regulated entities.

Drafts of these Master Directions have been circulated for comments to enable stakeholders to provide their views on this step taken towards ease of compliance. There could be uncertainties that would still persist post the streamlining process, and hence, warrants thorough review.

Read our detailed analysis of the consolidated regulations through here: Old Rules, New Book: RBI consolidates Regulatory Framework

For reference, RBI has made available on its website the following draft documents for public comments, with a focus on their completeness and accuracy:

Old Rules, New Book: RBI consolidates Regulatory Framework

Insure to Ensure Your Loan? 

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Manisha Ghosh, Executive | finserv@vinodkothari.com

Introduction 

It is quite common that whenever a borrower wishes to apply for a loan, lenders require the borrower to purchase an insurance policy, as a pre-condition for sanction. One may wonder if availing insurance can be a mandatory requirement for availing any loan? Insurance is not a regulatory requirement that is needed in loans, however, lenders prefer the same to safeguard their interest in the event of default. 

Lending institutions such as banks and NBFCs may also enter into insurance business in line with the Master Circular – allied activities- entry into insurance business, issue of credit card and marketing and distribution of certain products for Banks and the “Guidelines for Entry of NBFCs into Insurance” (Annex XVI of SBR Directions) for NBFCs. Generally, lenders try to solicit customers by marketing insurance to the borrowers who have applied for a loan by acting as commissioned corporate agents of the insurance companies under the supervision of IRDAI. 

In this article, the author examines the prevalent practice of lenders requiring borrowers to obtain insurance as a prerequisite for loan sanction and evaluates its permissibility within the regulatory framework.

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RBI’s Draft on Integrated and Internal Ombudsman

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Team Finserv | finserv@vinodkothari.com

In the Monetary Policy Statement dated October 1, 2025, the RBI Governor announced several measures to strengthen consumer protection. Some of the measures introduced for enhancing consumer protection are as follows:

The Draft IOS Scheme has enhanced the scope of the grievance redressal mechanism and introduced a more structured procedural framework for complaint processing. The Draft Internal Ombudsman Directions further strengthen grievance redressal, enhance procedural clarity, and improve transparency through reporting requirements. This write-up analyses the proposed changes.

Reserve Bank – Integrated Ombudsman Scheme, 2021 (“RB-IOS, 2021”) and Reserve Bank – Ombudsman Scheme, 2025 (“Draft Scheme”)

HeadsCurrent RequirementProposed Requirement/ChangeImplication 
Definition of Customer The term “Customer” is not definedDefined under Para 3(1)(j) as:
“Customer” means any person who engages, in a financial service /product or activity related thereto with a Regulated Entity, irrespective of whether such person has an account-based relationship with the Regulated Entity;		The scope of financial services included within the ambit of the Scheme has been widened.
For eg:All types of credit facilities extended by the borrower to the customer;Guarantees or other non-fund based facilities offered by RE to customer;Demand Draft facilities offered by Banks; Services by RE, acting as an LSP, to other REs;
Compensation CeilingsUp to ₹20 lakh for consequential loss ₹1 lakh for consolatory damagesIncreased to ₹30 lakh for consequential loss &  ₹3 lakh for consolatory damagesThere was no cap on the value of dispute that can be brought before the Ombudsman. The same has been retained. Increment in the compensation limits 
“Advisory” MechanismNot providedPara 14(4) empowers the Ombudsman to encourage settlement between parties through a written agreement, subject to the fact that all communications are documented.
Para 14(6) allows the Ombudsman to issue advisory for settlement as a measure for the resolution of complaints.
RBI Ombudsman can now help parties resolve disputes by settlement.Draft IOS Scheme 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.
Change in the Appellate AuthorityExecutive Director in charge of the Department of the Reserve Bank administering the Scheme;The Draft IOS Scheme clearly mentions that the executive  director in charge  of the Consumer Education and Protection Department (CEPD) is the Appellate AuthorityExplicitly mentions the independent department under the RBI to act as the Appellate Authority.
Guidance on filing of the complaint formGuidance was provided under the Scheme at several places, but not at one place, along with the formAdded under Part A of Annexure, along with the Complaint FormMinor edits in the complaint form with guidance to clarify the process for filing complaints and reduce errors.It will enable quicker allocation and segregation of complaints.The clear filing mechanism will improve ease and understanding for customers.Improved accessibility by the Launch of a 24×7 Contact Centre (#14448) with multilingual IVRS support.
Ombudsman ReportEarlier, the Ombudsman was required to submit an annual report to the Deputy Manager of the RBI; however, the RBI was not obligated to publish itUnder the Draft IOS Scheme, it has now been made mandatory for the RBI to publish an annual report on the functioning and activities carried out under the Scheme.It will enable the regulator to understand the issues raised under the complaints and assess the effectiveness of the measures introduced.
Addition of an RE as third party to proceedingsNot providedThe Ombudsman can make any other RE as a party to the proceedings.Expands the powers of the ombudsman to include connected REs as well (for instance, in the case of co-lending or TLE transactions) 
Power of CRPC to classify and close complaintsNot explicitly mentioned RBI Ombudsman and CRPC remain responsible for receipt and examination of complaints.The Complaints shall be treated as follows:Complaints in the nature of suggestions or queries shall be treated as  non – valid at the stage of CRPFFurther, Para 10 specifies certain grounds for non maintainability of complaints for complaints to be rejected by the RBI Ombudsman.However the grounds of non-maintainability under Para 10 shall be specifically provided by the Competent Authority.This clarifies the hierarchy for complaint handling and enables early elimination of frivolous or ineligible complaints before they reach the RE.

It may also be noted that the RBI has, vide notification dated 07th October 2025, extended the applicability of the existing RBI-IOS to include State Co-operative Banks and Central Co-operative Banks. 

Draft Master Direction – Reserve Bank of India (Internal Ombudsman for Regulated Entities) Directions, 2023

Particulars of the ProvisionCurrent RequirementsNew RequirementsImplication
Eligibility of the IO (Para 5) No such requirement prescribedIf the person is a serving officer, he/she is required to relinquish the same before assuming charge as IO.
The IO shall previously not have been employed, nor presently be employed, by the RE or a holding, associate or subsidiary company of the RE.		To ensure the IO’s independence and impartiality, in case the proposed IO is a serving officer, he/she must relinquish the existing position before assuming charge, enabling objective and credible grievance redressal within the RE.
Further, conflict of interest positions clarified by specifically defining the scope of Related Parties of the RE.
Same IO appointment in a number of entities No such clause restricting the number of REs. The IO can work in more than one RE simultaneously, with specific approval from the CEPDSuch approval shall be obtained by the appointing RE.However, the deputy IO cannot be appointed in more than one RE simultaneously IO (but not deputy IO) has been permitted to be appointed in more than one RE simultaneously, subject to the approval from CEPD. Approval to be obtained by the appointing RE.
Impact:To allow efficient deployment of an experienced IO across multiple REs under CEPD oversight, while ensuring sufficient focus at each entity so that the role and effectiveness are not compromised.
Terms of Appointment of IO No clause that specifies the minimum no of IOs or the responsibility of the Board or its Committees w.r.t assessing the need for multiple IOs or the factors to be considered when doing so. Every RE shall appoint at least one IO.
The Board or its committees shall, at least annually, determine the number of IO/ Dy. IO to be appointed. This  must be determined with due regard to the volume and complexity of the complaints received.		To ensure effective grievance redressal, clarity has been provided on the minimum number of IOs to be appointed and the annual assessment of the need for IOs.
Actionables for the REs:All REs shall appoint at least one IO The Committee of the RE shall be required to assess the need of the no of IOs at least once in a yearFactors to be considered include complexity of complaints, sufficiency of the time, diversity of experience etc
Auto-escalation of complaintsAll complaints that are partly or wholly rejected by the RE’s internal grievance redress mechanism shall be auto-escalated to the IO within 20 days of receipt for a final decision.Auto-escalation of partly resolved or wholly rejected complaints to the office of the IO  has been specified to be 25 days in case of CICs (Credit Information Companies)To ensure timely escalation of unresolved complaints, the draft directions require auto-escalation to the IO within 20 days, with a relaxed timeline of 25 days for CICs, balancing prompt redressal with operational feasibility for CICs.
Board oversight – rotation of IOsNo such clause to ensure rotation of IOs in REs with multiple IOs exists in the current directions.In REs having multiple IOs, a view shall be taken by the Board or Customer Service Committee / Consumer Protection Committee of the Board to have representation of more than one IO or having a system of rotation.Actionables for REs:To ensure diversity in perspectives in grievance handling, REs with multiple IOs should consider Board-approved rotation or representation of more than one IO, enhancing fairness and effectiveness in complaint resolution.
Complaint Management System (CMS)Under the current directions, REs do not have to provide specific categories in the CMS.The REs shall provide only three categories i.e. ‘Fully Resolved’, ‘Partly Resolved’ and ‘Wholly Rejected’ in its CMS for recording the decision on the complaints before escalation to the office of IO. RE shall be required to have in place a fully automated  Complaint Management System.  To standardise complaint recording, REs must limit CMS decision categories to ‘Fully Resolved’, ‘Partly Resolved’, and ‘Wholly Rejected’ before escalation to the IO, ensuring consistency and clarity in complaint tracking.
Procedure for Complaint Redress by IO / Dy. IOThe current directions allow the IO to only rely on documents that are furnished to it by the RE.The IO / Dy. IO may, if they find it necessary, seek written or oral submission (including additional information and documents) from the complainant. Strengthening the principle of hearing, enhances procedural transparency, and facilitates effective complaint redressal.
Reporting to Reserve Bank The current directions have different disclosure requirements pertaining to categorisation of complaints and periodicity of reporting.In addition to the existing details to be provided to the CEPD, the draft directions have included the additional details to be included such as Date of Birth and the Date of intimation to the Reserve Bank in its intimation to the CEPD.
Further an additional periodic reporting requirement on quarterly basis instead of the previously annual requirement has been introduced for the REs. 
These additional details enable the regulator to verify that the eligibility of the IO, as prescribed in the regulations, is being complied with specifically, ensuring the age limit of 70 years based on the date of birth and that the intimation to the RBI is duly sent.
Further, the quarterly reporting requirement allows the CEPD to track the status of complaints and the IOs reported, enabling the regulator to assess implementation and the overall compliance position of the entity.