By Mahesh Nayak
The Reserve Bank of India (RBI) has proposed new guidelines for investments by regulated entities in Alternative Investment Funds (AIFs), aiming to mitigate potential risks and prevent overexposure.
According to the latest draft guidelines, the contribution of a single regulated entity, including all commercial and co-operative banks, financial institutions and non-banking financial companies’ (NBFCs) to any AIF scheme will be capped at 10% of its corpus. Meanwhile, a collective ceiling of 15% will be applied for investments by all regulated entities in an AIF scheme.
“Concerns for the RBI have been evergreening practices, which can distort asset values and lead to hidden losses in the financial system,” said an investment banker requesting anonymity.
The banker added that the financial system is currently on a solid footing with balance sheets of banks and financial institutions stronger than ever before and India standing tall compared to many economies due to its robust and vibrant banking and financial infrastructure. “Therefore, to avoid any mishap, the regulator is taking all possible measures to prevent future risk,” he said.
The revised directions will be applicable prospectively, with existing investments following extant norms. However, investments of up to 5% of the corpus of an AIF scheme will not be subject to restrictions. If a regulated entity’s investment exceeds 5% and the AIF scheme has a downstream debt investment in a debtor company of the regulated entity, it must make 100% provisions for its proportionate exposure.
The RBI may exempt certain AIFs set up for strategic purposes from these directions, subject to consultation with the government, recognising the potential benefits of AIFs in specific contexts. The RBI has invited comments on the draft directions until June 8, 2025, aiming to strike a balance between allowing regulated entities to invest in AIFs and ensuring prudent regulation.
The apex bank also acknowledged that the Securities and Exchange Board of India (Sebi) has issued its own guidelines: “Sebi has also issued guidelines requiring inter alia specific due diligence with respect to investors and investments of the AIFs, to prevent facilitation of circumvention of regulatory frameworks,” the central bank said.
In 2023, the RBI had barred REs from investing in any AIF scheme that had downstream investments — directly or indirectly — in companies to which the RE had a loan or investment exposure in the preceding 12 months. If an AIF later made such an investment, the RE was required to exit the fund within 30 days, failing which it had to make 100% provisioning. The circular also mandated full capital deduction for investments in subordinated units of AIFs with a priority distribution model.
However, in March 2024, the RBI softened its stand partially and said that downstream investments would exclude equity shares but include all other instruments, such as hybrids. It also clarified that provisioning would apply only to the portion of the RE’s investment linked to the debtor company exposure.
The proposed guidelines is another attempt by the banking regulator to rein in enthusiasm of the AIF industry and ensure that REs’ investments in these funds are responsible and risk-sensitive.