Banking News

loan renewals: Banks want boards kept out of loan renewals in ‘related party’ cases


Mumbai: Spotting a brother, the in-laws, or even a stepsister, of a director on a borrower’s board can be maddening for bankers. Still, they can’t disregard the links – lending to companies (where a bank’s director has a ‘connection’) without the clearance or knowledge of the bank’s board is breaking the law.

Mapping these links, though, is turning into an administrative nightmare for many high-street banks, thanks to an explosion of businesses over the years, a dearth of credible names for board berths, and overlapping directors.

Now, lenders want the regulator to tweak the age-old rule. “We have told the Reserve Bank of India (RBI) to modify the regulation so bank boards are not involved in proposals on renewal of loans when there is a ‘related party’ issue,” a senior banker told ET.

“There are so many cross-directorships, which put a burden on boards. Strictly, it’s not the boards’ job. Boards should focus on policy issues.”

The hassles of tracking related parties were discussed among chief executives of banks at a meeting a few weeks ago.

The consensus was, if there are no changes in the rate of interest on a loan, its tenor or other terms, there is no reason why hundreds of loan renewal decisions should be referred to the board or the board committee.


Where it Began
The maze of dos and don’ts by banks on ‘connected lending’ owes its origin to the Banking Regulation Act, 1949. Under the regulation, unless sanctioned by the board of directors or management committee, a bank should not lend beyond Rs 5 crore to a company where a ‘relative’ of any of the bank’s directors is on the board of the borrower, or is a partner, guarantor, a major shareholder or in control of the borrowing company.

In such related party cases, the bank’s audit committee also certifies whether the transaction was done at arm’s length principle so market-related interest was charged on the loan.

The term ‘relative’ is comprehensive, covering spouse, father, mother (including stepmother), son (or stepson), son’s wife, daughter (stepdaughter), daughter’s husband, brother (stepbrother), brother’s wife, sister (stepsister), sister’s husband, brother (stepbrother) of the spouse, and sister (stepsister) of the spouse.

Encompassing Rule
“The regulation does not distinguish between fresh loan sanctions and renewals of existing loans for following the board process in connected and related party loan proposals. So, for all annual renewals of companies’ working capital limits, prior approval or knowledge of the boards are taken. This is not necessary, and should change,” said another person.

Banks also refer to the board when lending to a company having a director who is also on the board of another bank or its subsidiary. Once a director of a borrowing company joins the board of the lending bank, the latter cannot increase its exposure to the borrower in question, or charge a lower interest rate.

The rationale behind these regulations, as spelt out in an old RBI circular, is: “There have been instances where certain banks have developed an informal understanding or mutual/reciprocal arrangement among themselves for extending credit facilities to each other’s directors, their relatives, etc.”

“By and large, they did not follow the usual procedures and norms in sanctioning credit limits to borrowers, particularly those belonging to certain groups or directors, their relatives, etc. Facilities far in excess of the sanctioned limits and concessions were allowed in the course of operation of individual accounts of the parties,” the circular said. “Although, there is no legal prohibition on a bank from giving credit facilities to a director of some other bank, or his relatives, serious concern was expressed in the Parliament that such quid pro quo arrangements are not considered to be ethical. (sic)”

Till date, there has been very little change made to the regulation.


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