Section 20 Banking Regulation Act: Loans to Directors and Lending Limits

A bank may lend, but not to anyone and not on any terms. The Banking Regulation Act confines banks to a list of permitted businesses, keeps them out of trade and property, limits what they may own in other companies, forbids them altogether to lend to their own directors and the firms those directors are mixed up with, and gives the Reserve Bank power to direct the purposes and terms of lending generally. Behind every one of these rules is the same fact: the money being lent belongs to depositors.

The outer limits of what a bank may do and hold

Figure 1: The outer limits of what a bank may do and hold

1. Permitted and Prohibited Business

The list (Section 6(1)): in addition to banking, a banking company may engage in the businesses listed in the section, which include the borrowing and lending of money with or without security, the discounting of bills, the issue of letters of credit and travellers cheques, the buying and selling of foreign exchange, acting as agent for a Government or a customer, safe deposit vaults, guarantees and indemnities, the acquisition and disposal of property charged to the company, and the doing of all such things as are incidental or conducive to the promotion of its business.
Nothing else (Section 6(2)): a banking company may not engage in any form of business other than those referred to in sub-section (1). The list is exhaustive, which is why new activities such as insurance distribution or mutual fund business require either a reading within the list or a separate subsidiary.
No trading (Section 8): a banking company may not directly or indirectly deal in the buying or selling or bartering of goods, except in connection with the realisation of security given to it, nor engage in any trade or buy, sell or barter goods for others, otherwise than in connection with bills of exchange received for collection or negotiation.
No non banking assets (Section 9): a banking company may not hold any immovable property, howsoever acquired, except such as is required for its own use, for any period exceeding seven years from acquisition, and must dispose of it within that period. The Reserve Bank may extend the period by up to five years in the interests of the depositors.

⚠ Note

Section 8 and Section 9 do the same work from different directions. The first keeps a bank out of the goods market, the second out of the property market, and both carry an exception for assets taken as security and then enforced. A bank that has sold up a defaulting borrower's factory is not thereby in the property business, provided it sells within the statutory period.

2. Holdings in Other Companies

Subsidiaries (Section 19(1)): a banking company may form a subsidiary only for the permitted purposes, which include the undertaking of banking business outside India, the carrying on of business of the nature described in Section 6(1), and such other business as the Reserve Bank may consider conducive to the spread of banking in India or otherwise useful or necessary in the public interest.
The thirty per cent rule (Section 19(2)): a banking company may not hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding thirty per cent of the paid-up share capital of that company or thirty per cent of its own paid-up share capital and reserves, whichever is less. Holdings in a permitted subsidiary under Section 19(1) fall outside this limit.
Companies with a common manager (Section 19(3)): a banking company may not hold shares, whether as pledgee, mortgagee or absolute owner, in any company in the management of which any managing director or manager of the banking company is in any manner concerned or interested.
Why the limit: a bank holding a controlling stake in a borrower has an interest in concealing that borrower's distress, and a bank owning equity is exposed to a loss that is not the ordinary credit risk it is equipped to price. The words whichever is less make the limit bite on both the investee and the investor.

3. Connected Lending

The bar on lending to directors and their interests

Figure 2: The bar on lending to directors and their interests

Section 20(1), Banking Regulation Act, 1949

Notwithstanding anything to the contrary contained in section 77 of the Companies Act, 1956, no banking company shall,

(a) grant any loans or advances on the security of its own shares, or

(b) enter into any commitment for granting any loan or advance to or on behalf of (i) any of its directors, (ii) any firm in which any of its directors is interested as partner, manager, employee or guarantor, or (iii) any company (not being a subsidiary of the banking company or a company registered under section 25 of the Companies Act, 1956, or a Government company) of which, or the subsidiary or the holding company of which any of the directors of the banking company is a director, managing agent, manager, employee or guarantor or in which he holds substantial interest, or (iv) any individual in respect of whom any of its directors is a partner or guarantor.

Absolute in form: the words are no banking company shall, and the bar extends to entering into any commitment, not merely to disbursing. A sanction that is never drawn is still a contravention.
Own shares: lending against the security of the bank's own shares is barred because it is a circular transaction in which the bank finances the purchase of its own capital.
Four classes: the director himself; any firm in which he is partner, manager, employee or guarantor; any company in which he is a director, manager, employee or guarantor or holds substantial interest, along with its subsidiary or holding company; and any individual for whom he is a partner or guarantor. Guarantee alone is enough.
Exceptions: a Government company, a company registered under the charitable companies provision, and a subsidiary of the banking company fall outside clause (iii), as do certain advances such as those against Government securities, life policies or fixed deposits, and loans to a director as an employee before he became a director, in accordance with the Reserve Bank's circulars.
Substantial interest raised: a director holds substantial interest in a company where his beneficial shareholding, with his spouse and minor children, exceeds a rupee figure or ten per cent of its paid-up capital, whichever is less. The Banking Laws (Amendment) Act, 2025 raised that figure from ₹5 lakh, fixed in 1968, to ₹2 crore with effect from 1 August 2025, so fewer companies are now caught by clause (iii) on this ground.
Existing advances (Section 20(2) and (3)): where an advance of a prohibited kind was already outstanding when the prohibition took effect, the bank had to recover it within the stipulated period or such extended period as the Reserve Bank allowed, failing which the director concerned is deemed to have vacated office.
Remission of debts (Section 20A): no banking company may, except with the prior approval of the Reserve Bank, remit in whole or in part any debt due to it by a director, by a firm or company in which a director is interested, or by an individual for whom a director is a partner or guarantor. A remission without approval is void and of no effect.

4. Control of Advances

The power (Section 21(1)): where the Reserve Bank is satisfied that it is necessary or expedient in the public interest, in the interests of depositors or in the interests of banking policy, it may determine the policy in relation to advances to be followed by banking companies generally or by any banking company in particular, and every banking company is bound to follow that policy.
What may be directed (Section 21(2)): the purposes for which advances may or may not be made; the margins to be maintained in respect of secured advances; the maximum amount of advances or other financial accommodation which, having regard to the paid-up capital, reserves and deposits of the banking company and other relevant considerations, may be made to any one company, firm, association of persons or individual; the maximum amount of guarantees that may be given; and the rate of interest and other terms and conditions on which advances or other financial accommodation may be made or guarantees given.
Binding force: a direction under Section 21 is binding, and contravention attracts penalty under Sections 46 and 47A. It is the statutory foundation of priority sector targets, exposure norms and every circular on lending terms.
Interest not justiciable (Section 21A): notwithstanding anything contained in the Usurious Loans Act, 1918, or any other law relating to indebtedness in force in any State, a transaction between a banking company and its debtor shall not be reopened by any court on the ground that the rate of interest charged is excessive.

📖 Central Bank of India v. Ravindra, (2002) 1 SCC 367

Facts: A Constitution Bench of five judges, deciding on 18 October 2001, considered whether a bank may charge interest on interest by capitalising unpaid interest at periodical rests, and whether the amount so arrived at may be treated as the principal sum adjudged on which the court may award interest under Section 34 of the Code of Civil Procedure.

Held: Subject to a binding contract or an established banking practice, interest may be charged at periodical rests and capitalised, and once capitalised it ceases to be interest and becomes part of the principal. The principal advanced together with interest so capitalised up to the date of the suit may be adjudged as the principal sum, on which pendente lite and future interest may be awarded under Section 34. Penal interest may not be capitalised, since that would be opposed to public policy, and no interest may be claimed on penal interest.

Ratio: Directions issued by the Reserve Bank under Sections 21 and 35A have statutory force and bind the banks to which they apply; where they do not squarely apply, they serve as a benchmark for deciding whether a rate is excessive, usurious or opposed to public policy. Interest charged or capitalised in breach of those directions is disallowed. The court retains a judicial discretion under Section 34 to reduce or refuse interest where the interest component is disproportionate, and a bank suing on an account must plead and prove compliance with the directions and file a statement of account.

5. Assets in India and Liquid Assets

Cash reserve for non-scheduled banks (Section 18): a banking company which is not a scheduled bank must maintain in India, by way of cash reserve with itself or in a current account with the Reserve Bank or a notified bank, a sum equal to such percentage of its total demand and time liabilities in India as the Reserve Bank specifies.
Liquid assets (Section 24): every banking company must maintain in India assets of a value not less than such percentage, not exceeding forty per cent, of its total demand and time liabilities in India, in cash, gold or unencumbered approved securities, with penal interest of three and then five per cent above the bank rate on a shortfall.
Assets in India (Section 25): the assets in India of every banking company at the close of business on the reporting date of every quarter must not be less than seventy five per cent of its demand and time liabilities in India, and a quarterly return must be submitted to the Reserve Bank. The Banking Laws (Amendment) Act, 2025 replaces the last Friday of the quarter with the last day of the quarter as that date.
Why Section 25 matters: it is aimed principally at foreign banks, ensuring that money raised from Indian depositors is deployed in India and remains within the reach of Indian insolvency law if the parent fails.

6. Questions Arising

Is a loan granted in breach of Section 20 recoverable?

The contravention is of a statutory prohibition addressed to the bank, and the Act's response is penalty under Sections 46 and 47A, the vacation of office by the director, and supervisory action. It does not follow that the borrower keeps the money. A bank would ordinarily recover the advance, if not on the contract then on restitution under the principles of unjust enrichment, since the policy of Section 20 is to protect depositors and would be defeated by allowing the borrower to retain the funds.

Does Section 21A mean a borrower can never complain about interest?

No. Section 21A only bars reopening a transaction on the ground that the rate is excessive under the Usurious Loans Act or State debt relief legislation. It leaves untouched a complaint that the interest was charged contrary to the contract, contrary to a Reserve Bank direction, or by a method the law does not permit, such as capitalising penal interest. Central Bank of India v. Ravindra confirms that the court retains a discretion under Section 34 of the Code of Civil Procedure over interest pendente lite and after decree.

⚠ Key point

Section 6(1) lists the business a bank may do and Section 6(2) bars everything else. Section 8 forbids trading in goods and Section 9 the holding of immovable property other than for its own use beyond seven years, extendable by five. Section 19(2) limits shareholding in any company to thirty per cent of that company's paid-up capital or thirty per cent of the bank's own paid-up capital and reserves, whichever is less. Section 20 absolutely bars advances on the security of the bank's own shares and any commitment to lend to a director, a firm in which he is partner, manager, employee or guarantor, a company in which he is a director or holds substantial interest, or an individual for whom he is partner or guarantor. Section 20A makes remission of such a debt void without the Bank's prior approval. Section 21 lets the Bank determine the policy on advances, including purposes, margins, maximum amounts, guarantees and the rate of interest, and Section 21A bars a court from reopening a transaction on the ground that the rate is excessive. Section 25 requires assets in India of at least seventy five per cent of demand and time liabilities in India.

7. Quick Revision

✦ Points worth fixing

Section 6(1) permits, Section 6(2) prohibits the rest, Section 8 bars trading in goods and Section 9 bars holding property.

Seven plus five is the life of a non banking asset under Section 9.

Thirty per cent of the company's capital or thirty per cent of the bank's own capital and reserves, whichever is less. Section 19(2).

Director, firm, company, individual. The four heads of Section 20, and guarantor appears in three of them.

Section 20A makes a remission void without prior approval.

Purposes, margins, maximum advances, maximum guarantees and the rate of interest are the matters Section 21 can fix.

Section 21A protects the rate, not the method. Capitalising penal interest is still bad.

Seventy five per cent in India under Section 25, aimed at foreign banks.

Capitalised interest becomes principal; penal interest never does. That is Ravindra.

8. Frequently Asked Questions

Can a bank lend to its own directors?

No. Section 20 forbids a banking company to enter into any commitment for granting a loan or advance to or on behalf of any of its directors, any firm in which a director is partner, manager, employee or guarantor, any company in which he is a director or holds substantial interest, or any individual for whom he is a partner or guarantor. Limited exceptions exist for Government companies, subsidiaries and certain fully secured advances.

How much may a bank hold in the shares of another company?

Under Section 19(2), not more than thirty per cent of the paid-up share capital of that company or thirty per cent of the bank's own paid-up share capital and reserves, whichever is less. The limit applies whether the bank holds as pledgee, mortgagee or absolute owner.

What does Section 21A of the Banking Regulation Act do?

It provides that a transaction between a banking company and its debtor shall not be reopened by any court on the ground that the rate of interest charged is excessive, notwithstanding the Usurious Loans Act, 1918 or any State law on indebtedness. It protects the rate, not every aspect of the charging of interest.

Can a bank charge interest on interest?

Yes, within limits. Central Bank of India v. Ravindra, (2002) 1 SCC 367 held that where there is a binding contract or an established banking practice, interest may be charged at periodical rests and capitalised, after which it becomes part of the principal. Penal interest may not be capitalised, which would be opposed to public policy, and no interest may be charged on penal interest.

Why must a bank keep seventy five per cent of its assets in India?

Section 25 requires it so that money raised from Indian depositors is deployed in India and remains within the reach of Indian law. The provision bears most heavily on foreign banks operating through branches, whose assets might otherwise be moved to the parent and placed beyond the reach of Indian depositors if the parent failed.

9. Related Topics and Provisions

Management of banking companies
Instruments of monetary control
Priority sector lending
Capital, reserve fund and shareholding in banking companies
Inspection, directions and penalties
Non-performing assets and the recovery statutes