RBI is treading a careful path as it looks to pre-empt misadventures

The reserve bank of India (RBI) has found that co-operative banks are regularly flouting norms related to ‘loans and advances to directors, their relatives, and firms/concerns in which they are interested’. While instances of such lending are not prevalent among commercial banks, with the entry of non-banking financial companies (NBFCs) backed by corporate giants, India’s banking regulator seems unsure if the current regulations are sufficient to prevent any future misadventure. Incidentally, the RBI has always pooh-poohed the idea of allowing corporates to run commercial banks, citing their poor track record in upholding governance standards.

The regulator’s other big worry is the proliferation of fintech firms that are getting into co-lending tie-ups with banks and NBFCs. The entry of large corporates into the NBFC space, coupled with the growing fintech universe, has the potential to create complicated layers of lending, which may make it difficult for the regulator to track connected-party lending. Responding to the emerging situation, the RBI has now called for a comprehensive framework to govern such lending, which would apply uniformly to all regulated entities of the RBI.

M. Rajeshwar Rao, Deputy Governor of RBI, explained that connected lending refers to the act of providing loans to individuals or organisations who hold the power to control or influence a lender’s decisions. Nitin Purswani, Co-founder and CEO of debt management firm Medius AI, says the new framework should mandate transparent reporting of relationships between lenders and borrowers. “It should also impose limits on the amount of credit extended to connected entities and ensure that such lending is conducted at arm’s length and on commercial terms.”

Senior bankers say, the issue of connected-party lending is vast, and any new framework could cover directors and senior management of banks, who have relationships with or an interest in the borrowers. Further, there is a possibility of lenders having informal arrangements with their groups to fund the business activities of related parties, while avoiding any direct regulatory oversight. Anil Gupta, Senior VP at credit rating agency Icra, says there could be some harmonisation of regulations. “We will also watch out for any expansion in the definition of connected parties or connected lending,” he adds.

Then, there is the issue of co-lending tie-ups, where banks or NBFCs extend credit to fintech firms, which in turn lend to MSMEs. “There could be some [related-party lending] deals in such arrangements,” says a consultant, requesting anonymity.

But what has prompted the RBI’s move to cover all the regulated entities? The answer lies in the dynamic financial landscape, which has seen many big corporates—such as Reliance’s Jio

Financial Services, the Piramal Group’s Piramal Capital, The Poonawalla Group of Companies’ Poonawalla Fincorp, and the Godrej Group’s Godrej Capital, among others—enter via the NBFC route. Moreover, many of these players are eyeing the fast-growing MSME segment to gain a foothold. “NBFCs are already operating as conglomerates with business interests spread over multiple sectors like insurance, mutual funds and real estate. As such, the risks of the NBFC sector can be easily transmitted to the financial sector,” says Rishi Agrawal, Co-founder and CEO of TeamLease Regtech.

Further, the entry of large corporates into the sector can make it extremely tricky for the RBI to spot lending to connected parties, as they have complex organisational structures, a network of suppliers and dealers, and also promoters with relatives, who have their own business interests. In such a situation, there is a likelihood of suppliers and dealers, or connected entities, getting a loan on favourable terms when borrowing. “These companies (NBFCs) might have to re-evaluate and possibly restructure their lending practices to comply with stricter disclosure and conflict of interest norms,” says Purswani. “This could involve additional compliance costs and might limit their ability to leverage intra-group financial synergies.”

Which brings us to the question, is this a precursor to allowing corporates to enter the banking space? In 2020, a working group set up by the RBI and headed by Central Board Director P.K. Mohanty, had suggested that corporates and industrial houses might be permitted to become bank promoters only after the necessary amendments to the Banking Regulation Act, 1949. With the central bank’s track record of well-considered decisions, one thing is certain: Any decision by the RBI on the matter would be after careful scrutiny.

@anandadhikari