The phrase “arm’s length” appears frequently in related-party transaction policies, board papers and financial statements. Too often, however, it is used as a conclusion rather than demonstrated through evidence. A transaction is not arm’s length merely because management says the price is reasonable or because an external valuer has been engaged.
The supervisory task is to determine whether the regulated institution acted as an independent, commercially rational counterparty would have acted in comparable circumstances. That requires an assessment of the entire transaction package, the decision process and the allocation of risk—not only the headline price.
“Arm’s length is an outcome supported by evidence, not a label attached to an approval paper.”
What arm’s length should mean in practice
Basel Principle 20 expects related-party transactions to be undertaken on terms no more favourable than comparable transactions with unrelated parties. The comparison extends to credit assessment, tenor, rates, fees, amortisation, collateral and other contractual terms. OECD corporate-governance principles similarly emphasise proper conflict management and protection of the company and its shareholders.
A robust assessment should consider three dimensions: economic terms, decision-process independence and enforceability in practice.
The eight-part supervisory test
- Commercial rationale: Is there a genuine business need and benefit for the regulated institution?
- Counterfactual: Would the institution undertake the transaction with an unrelated party, and were alternatives considered?
- Pricing evidence: Is the price supported by comparable market data, competitive bids, an independent valuation or a transparent cost methodology?
- Non-price terms: Are tenor, fees, collateral, covenants, settlement, termination rights and indemnities commercially balanced?
- Risk assessment: Was the related party subjected to the same credit, conduct, operational and prudential standards as an independent counterparty?
- Process independence: Were conflicted persons excluded from initiation, negotiation, valuation, recommendation and approval?
- Approval timing: Was approval obtained before commitment, and did the decision-maker receive complete information?
- Ongoing behaviour: Are payments, monitoring, exceptions, restructurings and enforcement handled as they would be for an unrelated party?
Price is only one component
A transaction can be priced within a market range and still be non-arm’s length. Examples include granting an unusually long payment period, accepting weak collateral, waiving default interest, assuming environmental liabilities, providing a free guarantee or allowing the related party to terminate without equivalent rights for the institution.
| Dimension | Evidence expected |
| Price / rate | Market quotes, comparable transactions, valuation model and sensitivity analysis. |
| Credit quality | Independent credit assessment, risk grade and approval conditions. |
| Security | Collateral valuation, legal enforceability, margins and release conditions. |
| Tenor / settlement | Comparison with standard practice and explanation for deviations. |
| Covenants / rights | Balanced protections, default triggers and termination provisions. |
| Fees / expenses | Allocation consistent with benefits received and market practice. |
| Post-approval conduct | Normal monitoring, collection, impairment and enforcement. |
Independent valuation: useful , not conclusive
An independent valuation can strengthen the evidence, especially for land, unlisted securities, intellectual property or complex services. Supervisors should nevertheless examine who appointed the valuer, the information supplied, assumptions used, valuation date, conflicts, range of outcomes and whether management selected the most favourable point in the range.
Valuation also does not answer the broader question of whether the institution should enter the transaction. A fair price for an unnecessary, illiquid or strategically unsuitable asset may still produce a poor prudential outcome.
Approval and recusal
Interested persons should not participate in negotiation or recommendation and then simply abstain from the final vote. Effective recusal removes influence throughout the decision chain. Minutes should identify the conflict, record the person’s absence and document the independent basis for approval.
Supervisory documentation request
- Original proposal and commercial rationale.
- Alternative options or evidence that the market was tested.
- Valuation reports, quotations, pricing models and source data.
- Credit, risk, compliance, finance and legal assessments.
- Conflict declarations and recusal records.
- Approval papers and minutes, including approval date.
- Executed contracts, side letters and subsequent amendments.
- Accounting entries, settlement evidence and ongoing performance records.
Annex: Hypothetical assessment scenarios
| Scenario | Initial view | Key supervisory assessment |
| 1. Office building purchase from the parent | High-risk | Test independent valuation, strategic need, alternatives, liabilities transferred and settlement terms. |
| 2. Shareholder loan to the bank | Potentially acceptable | Compare rate, subordination, maturity, conversion rights and regulatory-capital treatment with market funding. |
| 3. IT services from a sister company | Depends on evidence | Assess competitive tender, service levels, data risk, exit rights, cost allocation and dependency. |
| 4. Property lease from a director-controlled entity | Conflict-sensitive | Check market rent, lease incentives, duration, renewal options and full recusal. |
| 5. Credit facility to a group company | Prudentially significant | Apply ordinary underwriting, collateral, covenants, limits, impairment and collection standards. |
| 6. Securities sale to a related investment vehicle | Valuation-sensitive | Test market price, liquidity, trade timing, beneficial ownership and whether losses were avoided. |
| 7. Asset disposal shortly before year-end | High red flag | Review cut-off, control transfer, valuation, gain recognition, settlement and approval chronology. |
| 8. Routine procurement from a related supplier | Potentially ordinary course | Confirm standard terms, price benchmarking, cumulative spend and ongoing conflict management. |
| 9. Guarantee issued for the parent | Potentially non-arm’s length | Value the guarantee, assess fees, exposure, capital impact, legal limits and likelihood of support. |
| 10. Intra-group outsourcing | Operational and contagion risk | Assess due diligence, resilience, audit rights, data location, concentration and exit feasibility. |
A genuine arm’s-length conclusion requires more than market pricing. The institution must demonstrate independent purpose, balanced terms, normal risk standards, conflict-free decision-making and consistent post-approval treatment. Where transaction evidence contradicts the policy or board paper, the evidence should prevail.
Reference sources
Basel Committee on Banking Supervision. (2024). Principle 20: Transactions with related parties. Basel Framework. https://www.bis.org/basel_framework/chapter/BCP/40.htm
Basel Committee on Banking Supervision. (2025). Principles for the management of credit risk. Bank for International Settlements. https://www.bis.org/bcbs/publ/d595.pdf
IFRS Foundation. (2025). IAS 24 Related Party Disclosures. https://www.ifrs.org/content/dam/ifrs/publications/html-standards/english/2025/issued/ias24.html
Organisation for Economic Co-operation and Development. (2023). G20/OECD Principles of Corporate Governance 2023. OECD Publishing. https://doi.org/10.1787/ed750b30-en
Basel Committee on Banking Supervision. (2015). Corporate governance principles for banks. Bank for International Settlements. https://www.bis.org/bcbs/publ/d328.htm
European Banking Authority. (2021). Guidelines on internal governance under Directive 2013/36/EU (EBA/GL/2021/05). https://www.eba.europa.eu/sites/default/files/document_library/Publications/Guidelines/2021/1016721/Final%20report%20on%20Guidelines%20on%20internal%20governance%20under%20CRD.pdf
Financial Conduct Authority. (2026). UKLR 8.2: Requirements for related party transactions. FCA Handbook. https://handbook.fca.org.uk/handbook/UKLR/8/2.html
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