RBI To Ease Investment Caps In AIFs For Banks, NBFCs

However, the AIFs want more. "They are urging the RBI to further relax the cap on the combined investment by banks, non-bank lenders, and other REs in those funds. We are studying the issue. The danger is that too much fund deployment in AIFs can also prove risky for these banks and NBFCs," said Finance Ministry officials.

AIFs are privately pooled investment vehicles that collect funds from domestic and foreign investors to invest in company-related assets like private equity, venture capital, hedge funds, real estate, and infrastructure funds.

Officials point out that in the past, huge investments in real estate and infrastructure went bust as bubbles were created. "We have to look at possible risks," they added.

Apart from banks and NBFCs, housing finance companies, credit information companies, asset reconstruction companies, small finance banks, payment banks, and all-India financial institutions also come under the category of the regulated entities (REs) that are regulated by the RBI.

In the circulated draft, the RBI is proposing a slightly relaxed 15 per cent cap for total investment by REs in AIFs. In a December 2023 circular, the apex bank, as regulator, had barred any RE from investing in any AIF scheme with downstream investments, directly or indirectly, in a debtor company of that particular RE.

2023 AIF Investment Restriction To Stop ‘Evergreening’

Officials pointed out that the central bank was alarmed by the reported cases of “evergreening of loans” — a phenomenon in which banks and NBFCs utilised the AIF route to hide bad loans by cycling funds through these alternate investment funds.

As a result, domestic capital sources, at least in parts, dried up for companies, particularly the startups, many of which are funded by these AIFs.

"In simple words, due to the fraudulent practices of a few, the entire investment cycle was negatively affected. Which is why the Securities Exchange Board of India (SEBI) was brought in to close the loopholes," officials said.

The new RBI proposal stipulates that a single RE (bank or NBFC) can now invest up to 10 per cent of an AIF’s total corpus. Combined investment of all kinds of REs can now go up to 15 per cent of the total corpus, while investments up to 5 per cent of the total corpus will have no restrictions or scrutiny.

If any regulated entity (RE) contributes more than 5 per cent of the corpus, and if that particular AIF is lending to a company that owes money to that RE (bank or NBFC), then the lender RE has to make a 100 per cent provision for the amount lent. This is proposed to prevent ‘evergreening’ of loans.

Fund Managers Happy, But Want More

Venture capitalists and fund managers have indicated they are "not unhappy" with this latest development, but would have preferred more investment flows and fewer checks.

"We would like the RBI to introduce global norms, which will allow more funds to be poured into such alternate investment funds, which can assure foreign capital inflow in these AIFs," said B Ganguly, a fund manager in a global hedge fund.

The AIF segment of India currently has a total of around Rs 13.5 lakh crore commitments to different companies. The AIF industry strives to hit the Rs 30 lakh crore milestone by 2030. The RBI possibly wishes to trigger this journey with this norm relaxation.

Some fund managers feel that the RBI’s conservatism can subdue the flow of investment and thereby stifle growth. They would prefer the RE investment to be increased to the range of 20 to 25 per cent of the total corpus. 

The RBI has set a deadline of June 8, 2025, to provide feedback on the draft. The regulator wants to make sure that the pursuit of growth does not come at the cost of financial instability.

Everybody wants the capital market to be business-friendly, but the apex regulator has to keep the financial system away from risks and fraud.