Connected Lending

Connected lending refers to the practice whereby banks and financial institutions extend credit to parties that are directly or indirectly related to the institution’s owners, directors, senior management, or affiliated entities. These related parties may include promoters, group companies, subsidiaries, associates, relatives of key managerial personnel, or firms in which influential insiders have a substantial interest. In banking and finance, connected lending is a critical governance and prudential concern because it can undermine credit discipline, distort resource allocation, and threaten financial stability. In the context of the Indian economy, connected lending has historically been associated with episodes of banking stress and remains a key focus of regulatory oversight.
The core risk of connected lending lies in the potential conflict of interest, where lending decisions are influenced by relationships rather than objective credit assessment.

Concept and Meaning of Connected Lending

Connected lending arises when the borrower and the lender share a relationship that goes beyond a normal arm’s length commercial transaction. While not all connected lending is inherently illegal, it becomes problematic when it bypasses standard credit appraisal, pricing, collateral requirements, or exposure limits.
Such lending often involves:

• Preferential loan terms or relaxed repayment conditions
• Inadequate risk assessment and monitoring
• Suppression or delay in recognising loan stress
• Concentration of credit within a corporate or business group

Internationally, connected lending is viewed as a governance risk that can magnify credit risk and concentration risk within the banking system.

Forms of Connected Lending

Connected lending can take multiple forms in banking and finance, particularly in economies with closely held corporate structures.
Promoter-related lending involves loans granted to companies owned or controlled by the promoters of a bank or financial institution.
Director and management-related lending includes credit extended to directors, senior executives, or entities in which they have significant influence.
Group and affiliate lending refers to exposure to subsidiaries, associate companies, or firms within the same corporate group, often routed through complex ownership structures.
Indirect connected lending occurs when loans are channelled through intermediaries or special purpose vehicles to disguise the ultimate beneficiary.
These forms are especially relevant in India, where business groups often operate across diverse sectors with intricate cross-holdings.

Connected Lending in the Indian Banking System

The Indian banking system comprises public sector banks, private sector banks, co-operative banks, and non-banking financial companies. Historically, connected lending concerns have been more prominent in closely held private banks and co-operative banks, though public sector banks have also faced challenges through politically influenced or group-based lending.
Weak governance and inadequate checks on insider influence have, in some cases, resulted in excessive exposure to related parties. This has contributed to asset quality deterioration, capital erosion, and loss of depositor confidence.
The Reserve Bank of India has repeatedly emphasised that connected lending poses systemic risks by weakening credit culture and encouraging moral hazard within banks.

Regulatory Framework in India

India has established a detailed regulatory framework to prevent abuse arising from connected lending. Prudential norms restrict lending to directors, their relatives, and entities in which they have significant interest. Banks are required to disclose related-party transactions and ensure that such exposures are conducted strictly on an arm’s length basis.
Key regulatory measures include:

• Limits on loans and advances to directors and related entities
• Mandatory board and audit committee oversight
• Enhanced disclosure requirements in financial statements
• Fit and proper criteria for bank promoters and directors

These norms are aligned with international best practices and standards influenced by Basel III, which stress governance, transparency, and risk containment.

Impact on Banking Stability and Financial Health

Connected lending can significantly impair banking stability. Loans granted on non-commercial considerations often exhibit higher default rates and weaker recovery prospects. When such exposures turn non-performing, banks face capital erosion and reduced lending capacity.
At a systemic level, widespread connected lending can:

• Distort credit allocation across the economy
• Increase non-performing assets
• Undermine depositor and investor confidence
• Create contagion risks within interconnected corporate groups

These effects can constrain the banking sector’s ability to support economic growth.

Implications for the Indian Economy

For the Indian economy, connected lending has broader macroeconomic consequences. Credit misallocation towards connected entities can crowd out productive sectors such as small enterprises, agriculture, and innovation-driven industries. This reduces overall economic efficiency and employment generation.
Additionally, banking stress arising from connected lending often necessitates regulatory intervention or public recapitalisation, imposing fiscal costs. Persistent governance weaknesses can also deter foreign investment by raising concerns about transparency and financial integrity.

Risk Management and Governance Practices

Effective mitigation of connected lending requires strong internal governance and risk management frameworks. Indian banks are expected to implement robust related-party identification systems, independent credit committees, and regular audits.
Key governance practices include:

• Clear segregation between ownership, management, and credit approval
• Independent directors with strong oversight roles
• Stringent internal controls and compliance mechanisms
• Regular supervisory inspections and stress assessments