Too Big to Lend? RBI’s New Exposure Directions Under the Scanner

CCL NLUO
22 hours ago
9 min read

Third year law student at OP Jindal Global University, Sonipat

I. Introduction

In India’s modern banking history, the greatest systemic threat has not been volatility, but the concentration of credit with dominant corporates. The collapse of the IL&FS group in 2018 revealed how intra-group cross-guarantees and opaque funding can end an entire financial conglomerate and transmit shockwaves into bank balance sheets. The PMC Bank–HDIL scandal of 2019 revealed how a single corporate group could consume significant credit through falsified accounts and concealed intra-group lending. Years earlier, the Kingfisher Airlines defaults exposed how banks continued to extend concentrated credit into a visibly insolvent corporate group in the hopes of good-will recovery and political insulation.

These episodes are not isolated, outlier failures of judgment, but highlight a structural flaw in India's treatment of the concentration risk associated with large borrowers. Against this backdrop, The Reserve Bank of India’s 2025 Concentration Risk Directions and the subsequent Amendment seek to modernize exposure regulations. While the Directions retained the Large Exposures Framework (Chapter III), the Chapter IV market-mechanism/NPLL overlay was repealed. Although the framework was designed to supervise credit lending, it eliminated market-based credit alternative options without redressal, removed penalties for lending beyond permissible NPLL and permitted significant intra-group exceptions.

This article argues that, despite its reformist appearance, India's amended exposure regime raises concerns regarding the adequacy of safeguards to address concentration risk posed by ultra-large borrowers.

II. A Snapshot of the Existing Domestic Framework

Since November 2025, India’s concentration risk regime has been anchored by a two-pillar framework. The quantum of capital risk that a bank may assume is primarily governed by the RBI (Commercial Banks – Prudential Norms on Capital Adequacy) Directions, 2025, while the distribution and diversification of that risk is regulated through the RBI (Commercial Banks – Concentration Risk Management) Directions, 2025. Prior to the 2025 framework, India formally adopted the Basel Large Exposures (LEX) Framework in 2019 for SCBs. The 2025 Directions reorganise this structure through a governance-centric model.

In November 2025, RBI consolidated numerous prior circulars into comprehensive Master Directions, reorganising the concentration-risk framework. Shortly thereafter, on 4 December 2025, RBI introduced consequential amendments signalling a deliberate policy shift. The Concentration Risk Amendment repealed the market-discipline architecture for large borrowers that sought to reaccommodate their needs via market instruments, left major discretion with the banks and retained major exemptions. In parallel, the Capital Adequacy Amendment deleted the additional penal risk-weight for exposures beyond NPLL, rendering it as only a soft reference number in lieu of binding ceilings.

Together, these amendments substantially reorient how large-borrower risk is absorbed and monitored.

III. Key Observations Regarding the 2025 Exposure Framework

A. Structural Dilution of Safeguards

The December 2025 Amendment repealed Chapter III of the original Concentration Risk Directions, titled “Enhancing Credit Supply for Large Borrowers through Market Mechanism” in its entirety effective from January 1, 2026. This chapter originally functioned as an NPLL-linked behavioural lever that is it did not ban bank credit, but imposed prudential disincentives on incremental exposures beyond the NPLL to shift ultra-large borrowers’ marginal funding choice. After a draft repeal in October 2025, the RBI withdrew the market-mechanism overlay as implementation-heavy and ineffective in pushing migration to bonds. RBI’s ‘ineffectiveness’ rationale is itself evidence of the deeper problem that India’s bond market still cannot absorb the funding the mechanism sought to redirect. India’s corporate bond market remains shallow and segmented (around 15–16% of GDP as of March 2025), dominated by private placements (~98%) and top-rated issuers, leaving lower-rated or disclosure-sensitive firms reliant on bank loans. That matters because a segmented bond market cannot reliably absorb the incremental funding that the NPLL mechanism tried to divert away from banks. In practice, the repeal therefore weakens the only explicit incentive for ultra-large borrowers to diversify funding sources, making continued bank dependence (and concentration risk) the default outcome. It also collapses the intended two channel discipline (bank exposure limits / bond market funding) into reliance on the LEF and bank governance; but LEF is a loss containment exposure cap, not a mechanism to shift borrowers toward bond-market funding. The burden of concentration management therefore falls back on bank balance sheets and supervisory oversight, rather than a scalable market alternative.

At the same time, Deleting Paragraph 78 via the Capital Adequacy Amendment 2025, removed the NPLL linked 75 percentage-point additional risk-weight on lending beyond NPLL, taking away an automatic, rule-based capital penalty that made extra exposure to ultra-large borrowers more costly. Safeguards do remain: banks are still constrained by LEF exposure limits and the December amendments strengthen Board level monitoring of ultra large borrowers. But the shift is substantive from a clear capital cost (which works automatically) to reliance on caps and internal governance (which depends on enforcement and supervision). Because higher risk-weights increase the capital a bank must allocate to that exposure, they tend to show up in lending terms such as higher loan rates and wider spreads, which makes a capital add-on a more immediate brake on incremental exposure build up. Without that automatic capital friction, banks can add incremental exposure up to the LEF cap with fewer pricing disincentives, so borrowers face less push to shift marginal funding to bonds.

B. Board-Level Discretion Weakens Regulatory Uniformity

A notable feature of the 2025 Concentration Risk Directions is the degree of discretion conferred upon bank Boards in areas that, in certain other jurisdictions, are determined through uniform rules. Under Paragraph 6 of the Directions, Boards may design and approve the bank’s policies for:

Setting sectoral exposure limits;
Determining thresholds for unsecured credit;
Approving exceptions to single-counterparty exposure limits above the base cap of 20%, as per undefined “exceptional circumstances” amongst other aspects.

This shift is consistent with RBI’s broader move toward governance-based regulation, which places primary responsibility on Boards to internalise supervisory expectations through policy, risk appetite, and oversight. However, a principles based, Board led model also raises predictable implementation risks, especially where governance capacity is uneven across banks. International evidence cautions that greater discretion can produce uneven supervisory outcomes, differences in supervisory strictness lead to inconsistent enforcement and can delay corrective action, supporting concerns about lender shopping and slow ex post intervention. First, excessive discretion undermines uniformity, leaving room for uneven supervisory outcomes and ‘lender-shopping’. Second, Board discretion can be distorted by internal governance asymmetries. Boards with weaker oversight culture may be inclined to relax exposure norms in favour of influential borrowers. Third, the framework relies on ex post supervisory intervention rather than ex ante uniformity. RBI retains supervision; however, this supervisory remedy is slow relative to the speed at which concentration risk can build.

Board Policy Parameters as Prudential Escape Valves

While the RBI does lay down hard, non-negotiable LEF limits, the 2025 Directions are simultaneously threaded with Board policy parameters and governance requirements that operate, in effect, as escape clauses capable of diluting uniform prudential discipline in practice. Even within the single counterparty architecture, the framework permits the Board, in “exceptional cases,” to allow an additional 5% exposure subject to a Board-approved policy yet the trigger remains under specified, leaving the relaxation heavily dependent on internal judgment and supervisory follow-through. The Basel Committee’s RCAP assessment flags this problem that there is no regulatory guidance on what counts as “exceptional,” so the 20% to 25% relaxation is left to full Board discretion, creating scope for uneven application across banks. The same pattern repeats across other calibration points: from setting sectoral concentration ceilings, to evaluating interconnectedness between parties, to determining the treatment and limits around unsecured consumer credit, multiple safeguards can be softened, stretched, or selectively applied through Board level discretion

Intra-group Exemptions Create Blind Spots

Despite a longstanding history of inadequate intra-group concentration prevention as the primary cause of global bank failures, the recent amendment fails to address the overarching exemptions granted by the existing framework for the same. While excessive intra-group credit warrants reporting requirements to RBI, the determination of what qualifies as ‘intra-group’ is loosely regulated.

The amendments clarified methodological aspects of LEF and intra group/interbank exposure treatment and strengthened reporting-oriented supervision. However, although the Amendment recognises overseas branch exposures within the intra-group reporting framework, it continues to exclude them from the Large Exposure limits, preserving a significant cross-border intra-group blind spot. Second, Paragraphs 119–121 largely leave it to the bank’s internal board policy to decide whether parties are “connected.” Banks can treat exposures as not connected based on their internal assessment, with discipline largely crystallising through ex post supervisory review by RBI. Third, while disclosure expectations have been strengthened, critical calibrations, risk assessment thresholds, monitoring intensity, and the practical content of transparency remain substantially governance-driven under Chapter VI, making outcomes dependent on Board capability and supervisory follow through rather than uniformly triggered constraints

This stands in sharp contrast to international practice. Under the EU CRR, part 4, and UK’s PRA intra-group large exposures are subject to mandatory identification, continuous reporting, and strict limits, with exemptions permitted only in narrowly defined circumstances.

IV. Comparison with International Practice

Basel’s LEF applies uniform, non-negotiable definitions of connectedness and exposure measurement. India’s structure, by contrast, allows Board policies to shape these determinations. To be clear, India’s headline LEF caps are not weaker than Basel’s, Basel sets a 25% Tier 1 limit, whereas India prescribes a 20% single-counterparty cap (with a narrow uplift in exceptional cases) and a 25% group cap. The concern, therefore, is not the numerical strictness of the cap but the operational space for Board led interpretation in connectedness and exposure measurement, which can generate uneven application even under conservative headline limits particularly in a system where governance capacity and supervisory intensity vary across banks. EU Capital Requirements Regulation (CRR) Framework mandates a single, binding definition of “group of connected clients” under Article 4(1)(39). Banks have no discretion to dilute or reinterpret connectedness, and exposure limits apply automatically. The UK Prudential Regulation Authority (PRA) under the PRA Rulebook – CRR Firms – Large Exposures Instrument treats large-exposure rules as hard prudential standards. Any deviation requires explicit supervisory approval. Board-level flexibility of the kind present in the Indian directions is therefore atypical in mature regimes.

IV. Considerations and Observations

Non-discretionary recognition of Intra-group and connected parties –

To preserve the effectiveness of the LEF’s non-negotiable hard caps, RBI should reduce variability in identifying “connected counterparties” by moving from largely Board-mediated classification to a standardised, indicator based presumption of aggregation. This practice is in consonance with the EU CRR which prescribes a mandatory definition for ‘groups of connected clients’ under Article 4(1)(39) and with Basel’s Large Exposures standard likewise applies the limit to a single counterparty or a group of connected counterparties and requires treating such a group as one exposure unit, with connectedness grounded in control and economic interdependence (LEX 10.1, 10.8, 10.10, 10.11). RBI should hard code minimum aggregation triggers, allow only narrow rebuttals, and require reporting of rebuttals for supervisory challenge.

2. Host Supervisors for Intra Group Cross Border Exposures –

Under Basel LEF, paragraph 12 (1991), while intra-group exposures are ordinarily subject to consolidated home-country supervision, host supervisors (the supervisory authorities of the foreign jurisdiction) are expressly empowered to apply independent safeguards and restrictions where the effectiveness of consolidated supervision is in doubt. This principle reflects global consensus that cross-border intra-group exposures are not risk-neutral. At present, while the 2025 amendment allows for its formal recognition as part of ‘intra group exposures’, it is yet to be included under the large exposure framework (LEF). While the Amendments have strengthened reporting and disclosure, transparency alone does not close this gap unless it is tied to clear supervisory escalation triggers and consequences (including Pillar 2 capital add-ons or bank specific limits) when cross border intra group concentrations rise.

3. Defining Board policy parameters and supervisory exceptions –

RBI’s Directions retain hard LEF caps, but they also permit Board-approved exceptions without defining what qualifies as “exceptional,” as earlier discussed. RBI should therefore define the circumstances and objective criteria for such exceptions and require supervisory sign off for material departures from baseline limits. This is closer to the UK approach in which the UK PRA Rulebook (Large Exposures) vests all material exceptions squarely within the domain of the supervisory authority, not internal management.

4. Reintroduction of Penal Consequences for Exceeding Permissible Credit Limits -

RBI’s recalibrated approach keeps hard LEF caps, stronger Board oversight, better reporting, and Pillar 2 powers to impose bank specific capital add ons where concentration risk is found. But the repeal of the penalty removed an automatic financial consequence that discouraged incremental lending to ultra large borrowers before banks hit the LEF ceiling. To retain deterrence in a governance led regime, RBI should pair Pillar 2 discretion with a clear penalty ladder for defined triggers (e.g., repeated approaches to LEF caps, frequent “exceptional case” relaxations), such as preset capital surcharges, provisioning add ons, or temporary lending restrictions.

IV. Conclusion

India's 2025 exposure framework, as amended in December 2025, represents a significant regulatory evolution. The historical failures of IL&FS, PMC Bank–HDIL, and Kingfisher Airlines demonstrated the consequences of inadequately managed concentration risk. The regulatory approach reflects a broader international trend toward governance-based banking supervision, as seen in the RBI's comprehensive Master Directions framework issued in November 2025.

Note: This article has been reviewed by Mr. Abir lal dey (Partner, Saraf and Partners), at the Tier II Stage.