A Director's Guarantee and a Loan That Should Not Be Sanctioned
Uma Co-operative Bank has deposits of Rs 1,200 crore. Its director, Mr Ramesh Patel, has given a personal guarantee for a Rs 3 crore term loan sought by Patel Logistics LLP, a firm in which his brother is the managing partner. Mr Patel is also a member of the bank's credit committee. The proposal is otherwise commercially attractive: debt-equity of 1.4:1, collateral of a commercial property valued at Rs 4.5 crore, and projected DSCR of 1.6. The branch has recommended the proposal, and the file notes that 'the director has no financial interest in the borrower'. Mr Patel has not disclosed the guarantee in his annual fit-and-proper declaration. The bank's existing exposure to the Patel group is Rs 8 crore, and capital funds are Rs 70 crore. The board is scheduled to approve the loan next week.
1. Identify the regulatory, exposure and governance issues in this proposal.
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The central issue is not the borrower's financial ratios but the director's connection. Under Section 20 of the Banking Regulation Act, 1949, as applied to co-operative societies, a bank cannot grant a loan to a firm in which a director is interested as partner, manager, employee or guarantor. Mr Patel has given a personal guarantee, so the firm falls within the prohibited category. The statement in the file that he has 'no financial interest' is therefore wrong.
There is also a fit-and-proper failure: a guarantee is a material commitment that should have been disclosed in the annual declaration. The credit committee is conflicted because Mr Patel sits on it. On exposure, the bank must calculate the borrower-wise and group-wise limits against capital funds. If the Rs 3 crore is added to existing facilities of the same borrower, the single-borrower exposure may exceed the prescribed percentage of capital funds; group exposure must be computed separately and not netted. Commercial viability cannot cure a statutory prohibition. The board's fiduciary duty is to the institution and its members, not to a director's family firm.
2. What should the board do with the proposal and with Mr Patel?
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The board should reject the proposal in its present form. Mr Patel must recuse himself from the credit committee and from the board discussion, and the recusal must be recorded. The board should refer the matter to its nomination and remuneration committee or an independent committee for a fit-and-proper review, because the undisclosed guarantee breaches the declaration and the bank's code of conduct. The RBI should be informed in the appropriate return or communication, and the bank's exposure to the Patel group should be reviewed to ensure no other prohibited or excess exposure exists.
If the bank still wishes to lend to the firm, the only lawful route is for the guarantee to be withdrawn and for the director to have no interest as partner, manager, employee or guarantor, followed by a fresh appraisal and approval by a committee of which he is not a member. Even then, the transaction should be on arm's-length terms, documented, and disclosed as a related-party transaction. The board should not approve a loan merely because the collateral is adequate; legal eligibility comes first.
3. Suppose the loan was already disbursed last month. What immediate remedial steps are required?
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The bank cannot leave a prohibited advance on the books. It should immediately place the account under heightened monitoring, stop further disbursement, and issue a demand for repayment under the sanction terms. The board must be informed at the next meeting, and the minutes should record the contravention, the persons responsible, and the corrective action. The bank should report the matter to the RBI and take advice on whether any further disclosure or regulatory approval is needed. If the director or officials misrepresented the guarantee, the bank should also consider disciplinary action and, where there is evidence of dishonesty, a police complaint.
Provisioning should follow the actual asset classification: if the account is servicing normally, it may remain standard, but the legal defect and recovery risk must be assessed. The bank should not automatically classify it as fraud without evidence. The audit committee should review how the file recorded 'no financial interest' and why the guarantee was not detected. The fit-and-proper status of the director should be reconsidered, and the bank should strengthen its related-party declaration and screening process before the next board meeting.