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RBI Tightens Norms For Banks, NBFCs Investing In Alternative Investment Funds AIFs

As of the latest available data on December 19, the Securities and Exchange Board of India (SEBI) reported 1,220 registered Alternative Investment Funds (AIFs) with a substantial investment commitment of Rs 8.44 lakh crore as of June 30, 2023. This reflects a notable increase from Rs 6.94 lakh crore recorded at the end of June 2022, according to SEBI's records. The funds raised by AIFs reached Rs 3.74 lakh crore by the end of the June 2023 quarter, with Rs 3.5 lakh crore invested by the conclusion of the first quarter.


However, concerning trends in the Indian banking sector have prompted regulatory action by the Reserve Bank of India (RBI). On December 19, 2023, the RBI issued notice 2023-24/90, directing regulatory measures aimed at overseeing the investment practices of AIFs. This directive is applicable to Commercial Banks, Financial Institutions, and Non-Banking Financial Companies.


The regulatory focus is primarily on mitigating the practice of "evergreening" loans through the AIF route. This involves a scenario where Real Entities (REs), including Non-Banking Financial Companies (NBFCs), engage in structures where they invest in AIFs, which subsequently invest in non-convertible debentures (NCDs) of the debtor company associated with the RE. This allows the debtor company to utilize the funds obtained through NCD issuance to repay overdue loans from the RE, creating an appearance of debt resolution while maintaining exposure through AIF investments.


The RBI's circular aims to address potential evergreening structures, recognizing the need for caution without imposing a blanket ban on AIF investments. However, there are potential unintended consequences, such as misclassifying all AIF investments as associated with evergreening, increased due diligence requirements for REs and AIFs, and the possibility of discouraging domestic institutional investment compared to foreign counterparts.


To address the concerns and potential evergreening, the RBI advises the following:

  • REs should refrain from investing in any AIF scheme that has downstream investments, either directly or indirectly, in a debtor company of the RE. A debtor company refers to any entity to which the RE currently has or previously had a loan or investment exposure within the past 12 months.

  • If an AIF scheme, in which an RE is already an investor, makes a downstream investment in a debtor company, the RE must liquidate its investment in the scheme within 30 days from the date of such downstream investment. If an RE has already invested in such schemes at the time of the circular issuance, the 30-day liquidation period starts from the circular's date. REs are required to promptly inform the AIFs involved.

  • If REs are unable to liquidate their investments within the prescribed time limit, they must make a 100 per cent provision on such investments.

  • Additionally, investments by REs in the subordinated units of any AIF scheme with a 'priority distribution model' will be subject to a full deduction from RE’s capital funds. These instructions have been issued by RBI in accordance with the powers conferred by various sections of the Banking Regulation Act, of 1949, the Reserve Bank of India Act, 1934, and the National Housing Bank Act, of 1987. 


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