Section 20 of the Banking Regulation Act, 1949: Restrictions on Loans and Advances
Section 20 places statutory restrictions on lending by a banking company where conflicts of interest may arise. It prohibits loans or advances against the bank's own shares and restricts commitments to lend to directors and specified connected persons or entities.
- A bank cannot grant a loan or advance on the security of its own shares.
- A bank cannot enter into specified lending commitments to its directors or connected firms, companies and individuals.
- Existing prohibited advances are subject to statutory recovery requirements.
- Remission of covered loans requires previous RBI approval.
- If a question arises whether a transaction is a "loan or advance" for this section, the Reserve Bank of India decides the issue.
Meaning and scope of Section 20
Section 20 is intended to prevent a bank's funds from being used to provide preferential credit to persons who can influence the bank's management. The provision operates together with RBI directions on statutory and regulatory restrictions on loans and advances.
The current RBI formulation recognizes the exception for a company registered under Section 8 of the Companies Act, 2013, replacing the older reference to a Section 25 company under the Companies Act, 1956. Section 8 broadly concerns companies formed for charitable or other permitted not-for-profit objects, subject to the conditions laid down in that Act.
Section 20(1): Prohibited loans and commitments
(a) Security of own shares: A banking company shall not grant any loan or advance on the security of its own shares.
(b) Directors and connected persons: A banking company shall not enter into any commitment for granting a loan or advance to or on behalf of:
- any of its directors;
- any firm in which any of its directors is interested as partner, manager, employee or guarantor;
- any company, other than specified exempt categories, where the bank's director has the relationship or substantial interest contemplated by Section 20; or
- any individual in respect of whom any of the bank's directors is a partner or guarantor.
For the company category, RBI's current formulation identifies the excluded categories as a subsidiary of the banking company, a company registered under Section 8 of the Companies Act, 2013, and a Government company.
Section 20(2): Recovery of certain existing advances
Where an advance falls within the statutory category described in sub-section (2), the banking company must take steps to recover the amount due, together with interest if applicable, within the period stipulated when the advance was granted. Where no period was stipulated, the provision prescribes the statutory recovery period subject to the power of the Reserve Bank to grant the extension contemplated by the Act.
The sub-section also contains a proviso concerning the position where the director concerned ceases to hold office by death, retirement, resignation or otherwise.
Section 20(3): Remission requires prior RBI approval
A loan or advance referred to in sub-section (2), or any part of it, cannot be remitted without the previous approval of the Reserve Bank. A remission made without such approval is void and has no effect.
Section 20(4): Consequence of non-repayment by a director
Where a covered loan or advance is not repaid within the period specified in sub-section (2), and the borrower is a director of the banking company on expiry of that period, the statutory consequence provided by Section 20 applies to the director's office.
Explanation: "loan or advance" and "director"
The Explanation permits the Reserve Bank, having regard to the nature of the transaction, likely realization, depositor interests and other relevant considerations, to specify transactions that will not be treated as loans or advances for the purposes of Section 20.
The expression director is extended for this purpose to include a member of a board or committee in India constituted by a banking company to manage, or advise on the management of, all or any of its affairs.
Section 20(5): RBI decides classification disputes
If a question arises whether a transaction is a loan or advance for the purposes of Section 20, the question is to be referred to the Reserve Bank of India, whose decision under the section is final.
RBI guidance and practical application
RBI guidance treats Section 20 as a statutory conflict-of-interest restriction. It also explains categories of transactions that are not treated as loans and advances for this purpose and provides guidance on guarantees, letters of credit and similar facilities where liability could ultimately devolve on the bank.
Following the Banking Regulation (Amendment) Act, 2020, Section 20 also applies to urban co-operative banks, subject to the provisions governing co-operative banks.
Note: This page is an explanatory article and should be read with the current text of the Banking Regulation Act, 1949 and applicable RBI directions, circulars and notifications.