RBI’s Draft Circular To Tighten Rules On Bank Investments And Group Businesses: CareEdge

The Reserve Bank of India's (RBI) newly proposed draft circular, Forms of Business and Prudential Regulation for Investments, is set to reshape how banks operate and manage their investments. According to CareEdge Ratings, the circular introduces stringent guidelines to ringfence banks' core operations and curb overlaps between lending and non-core businesses, such as insurance and mutual fund services, across bank groups. The circular aims to enhance transparency, reduce risks, and drive structural realignments within banks.

Under the draft guidelines, banks will be required to focus solely on their core functions—deposit-taking and lending—while conducting non-core activities such as insurance, mutual fund, and investment advisory services through separate group entities. Banks will no longer be allowed to have multiple entities within their group providing the same financial services or licences.

The RBI's circular outlines specific conditions for both forms of business and prudential regulations for investments, aimed at preventing risks associated with non-banking ventures and cross-entity overlaps.

Core Banking And Group Business Rules: The draft circular mandates that the bank's core operations—acceptance of deposits and lending—must be executed by the bank itself. Other business activities such as credit card issuance, factoring, and housing finance may be undertaken either directly by the bank or through a separate group entity, provided that relevant regulatory conditions are met.

Non-core businesses, such as mutual funds, insurance, and pension fund management, must be conducted by separate entities within the bank group. There will also be strict measures to prevent multiple group entities from offering the same services, and the circular prohibits overlap in lending activities between banks and their group entities, such as non-banking financial companies (NBFCs) and housing finance companies (HFCs). NBFCs and HFCs will now be regulated under norms applicable to Upper Layer NBFCs, aligning them with banks' restrictions on loans and advances.

Investment Limits For Banks: Banks will be subject to stringent prudential limits on equity investments in financial and non-financial companies. For instance, no individual equity investment by a bank in any company shall exceed 10 per cent of the bank’s paid-up capital and reserves. Additionally, aggregate equity investments must not exceed 20 per cent of the bank’s total paid-up capital and reserves.

Investments held under certain categories, such as Held for Trading, and those exceeding 10 per cent in non-financial companies acquired through restructuring will be excluded from these aggregate limits. Furthermore, banks will be restricted from holding more than 10 per cent of the equity capital of a deposit-taking NBFC or more than 20 per cent in any non-financial services company.

Banks will also be prohibited from investing in Category III Alternative Investment Funds (AIFs) and limited to sponsoring only one Asset Reconstruction Company (ARC), with the shareholding capped at 20 per cent of the ARC’s equity.

Prior Approval From RBI Required For Large Investments: For equity investments exceeding 20 per cent in financial services companies or non-financial companies, banks must seek prior approval from the RBI’s Department of Regulation. This applies to both direct investments and collective investments made by group entities, including mutual funds controlled by the bank.

However, prior approval will not be required for investments where the aggregate shareholding is less than 20 per cent of the company's equity capital, provided the bank meets certain conditions, including maintaining minimum prescribed capital and reporting net profits for the last two years.

“These measures will help curb regulatory arbitrage, reduce operational risks, and streamline investments across banks and their subsidiaries. However, the new rules may require banks to overhaul their group structures and manage compliance more tightly,” said Kinjal Shah, Senior Vice President, CareEdge Ratings.

The RBI’s proposed framework is expected to tighten governance in the banking sector, ringfence core banking operations, and limit the risks associated with banks' involvement in non-core businesses. With these regulations, banks will need to make significant adjustments to their investment and business strategies to comply with the new rules, while balancing profitability with stricter oversight.