Banks' Non-Compliance Likely Sparked Connected Lending Revisions

The revision of connected lending guidelines by the Reserve Bank of India (RBI) might have stemmed from observed instances of lenders not adhering to regulations concerning loans to corporations, suggest experts.

According to bankers, creative structuring of loans might have led to breaches in regulations. They note that numerous business conglomerates operate non-banking financial companies (NBFCs), facilitating the flow of credit within corporate groups. This setup potentially allows for reciprocal deals, with one NBFC extending credit to another and vice versa, considering most NBFCs transact with multiple banks.

Sanjay Agarwal, senior director at CAREEdge Ratings, views connected lending revisions as part of a reinforcing process aimed at preventing scenarios where lending and credit risk decisions are influenced by parties external to the business team.

An official from the State Bank of India highlights the scrutiny involved when lending to corporate groups, emphasising that while they assess certain transactions, there might be others beyond their scrutiny due to practical limitations.

Similarly, a senior official from Union Bank of India suggests that the RBI might have encountered instances where lending guidelines were being breached, leading to credit disbursal without proper risk assessment.

The RBI's connected lending guidelines are designed to prevent conflicts of interest in financial institutions' lending operations. For instance, financial institutions are prohibited from offering loans against their own shares as security to directors or firms where directors hold interests. Additionally, lending to companies where directors hold substantial interests is restricted.

Notably, the RBI took action in cases like the Punjab and Maharashtra Cooperative (PMC) Bank in 2019, where a substantial portion of loans was extended to a realty firm, and a more recent event involving ICICI Bank, which was fined for loans extended to companies where two directors held positions.