The Reserve Bank of India (RBI) has announced the tightening of conditions related to connected lending. As per the announcement, connected lending practices create moral hazards in lending. There is a need for a unified regulatory framework to create an arm’s length relationship between borrowers and lenders.
As per the statement issued by the RBI, “Connected lending or lending to persons who are in a position to control or influence the decision of a lender can be of concern, if the lender does not maintain an arm’s length relationship with such borrowers. Such lending can involve moral hazard issues leading to compromise in pricing and credit management. The extant guidelines on the issue are limited in scope and are not applicable uniformly to all regulated entities. It has accordingly been decided to come out with a unified regulatory framework on connected lending for all the regulated entities of the Reserve Bank. A draft circular in this regard will be issued for public comments.”
While making a statement, the RBI governor said, “The extant guidelines on connected lending are limited in scope. It has been decided to come out with a unified regulatory framework on connected lending for all regulated entities of the Reserve Bank. This will further strengthen the pricing and management of credit by regulated entities.”
Connected lending refers to the influence of people in controlling owner of a bank giving loans to himself or parties related to them and group companies at favourable terms and conditions. Due to their influence, they can get it easily with no questions asked if they have such control over the bank. A bank can give cheaper loans to risky projects to these people.
There has been news reports in the recent past where banks have given loans to many influential people without conducting through due-diligence.
Shivaji Thapliyal, Head of Research and Lead Analyst, Yes Securities says, “Connected lending pertains to lending to related parties within the same business group. While on the one hand, the RBI might be seeming to be somewhat more agreeable to allowing business conglomerates to own banking licences, it also feels it is important to, simultaneously, bolster regulations that would disallow conglomerate-owned banks from gaming the system.”
