Draft Circular on Business Forms and Investments Released

In a significant step aimed at strengthening the regulatory landscape for Indian banks, the Reserve Bank of India (RBI) has issued a draft circular outlining amendments to the prudential regulation framework. These changes target the operational and investment practices of Scheduled Commercial Banks (excluding Regional Rural Banks), Non-Banking Financial Companies (NBFCs) associated with banks, and Non-Operative Financial Holding Companies (NOFHCs).

The draft circular emphasizes stringent regulations for permissible business activities and investments to protect public interests and bolster banking stability.

Key Regulatory Changes Proposed:

• Revised Business Structure for Banks and Group Entities

i) Under Section 6(1) of the Banking Regulation Act, banks can engage in non-core business activities beyond traditional banking, either within bank departments or through subsidiary or group entities. However, the RBI has introduced amendments aimed at “ring-fencing” the core business of banking—primarily deposit-taking and lending—from higher-risk business ventures.

ii) Only a single entity within a banking group will be allowed to operate specific business lines to avoid operational overlaps. This includes activities such as primary dealership, credit card issuance, housing finance, and leasing, which may now be handled either by the bank or its group entities but not both.

iii) High-risk businesses, including mutual fund management, insurance, portfolio management, and broking services, are to be restricted to group entities rather than the bank’s main structure, ensuring the core banking operations remain insulated from potential financial volatility in these sectors.

• Prudential Investment Regulations for Banks

i) The draft circular proposes capped limits on equity investments in various sectors. A bank’s investment in any company, including group entities, will be restricted to 10% of its paid-up share capital and reserves, while aggregate investments in multiple entities will not exceed 20%.

ii) Restrictions on NBFCs include a 10% cap on bank holdings in deposit-taking NBFCs, while non-financial companies could see investment limits of up to 30% under specific conditions, such as debt restructuring to protect the bank’s interests.

iii) Banks will also be prohibited from making direct or indirect investments in certain Alternative Investment Funds (AIFs), including Category III AIFs, to manage potential exposure risks. Additionally, no bank group will be permitted to control more than one Asset Reconstruction Company (ARC) simultaneously.

• Approval Process for New Business Activities

i) Banks will be required to secure prior approval from the RBI before launching any new group entities or undertaking novel business activities that have not been previously sanctioned. NOFHCs, similarly, must obtain prior approval from the Department of Regulation for activities beyond those traditionally listed in the circular.

ii) Notably, banks under the NOFHC structure are temporarily barred from establishing new entities for three years from the business commencement date, signalling RBI’s cautious approach to rapid business expansion in the sector.

The draft circular specifies that key provisions will take effect two years from the release date of the final circular. Banks are required to report their current compliance status and outline their plans to align with the new framework within two months from the date of the final circular. The circular will apply universally to all Scheduled Commercial Banks (excluding Regional Rural Banks), NOFHCs, and applicable NBFCs, including housing finance companies connected to banking groups.

The RBI’s proposed amendments seek to establish a uniform playing field across India’s banking landscape, reducing the overlap between banks and their group entities while minimizing systemic risks associated with non-core activities.