Markets regulator and its central bank are investigating about a dozen cases of alternate investment funds (AIFs) allegedly being used to circumvent regulations, including the "evergreening" of stressed loans, according to three sources with direct knowledge of the matter.

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The investigations could lead to increased disclosures and greater scrutiny for an investment category including private credit funds that have drawn billions of dollars from local and global high net-worth investors because of the flexibility they offer and liberal regulations.

The Securities and Exchange Board of India (SEBI) has detected at least a dozen cases involving 150 billion to 200 billion Indian rupees ($1.8 billion to $2.4 billion) where AIFs have been misused to circumvent rules of other financial regulators including the Reserve Bank of India (RBI), one of the sources said.

The sources declined to be identified because they are not authorised to speak to media. SEBI and RBI did not respond to requests for comment.

While the amount is small in comparison to the 8.4 trillion rupees managed by AIFs, the number of cases of misuse detected are "material", the second source said.

The cases under investigation include instances of non-bank lenders selling stressed loans to AIFs partially set up by the lender itself, with the fresh funds being used to repay the original debt to prevent the loans from turning bad, according to the second source.

This is "classic evergreening", the source added.

The central bank has initiated enquiries into these cases, according to the first and third sources. If proven, such instances of misuse of AIFs could eventually result in penalties or restrictions on business in extreme cases.

In other cases under investigation, AIFs have been used to evade caps on foreign investment in certain sectors, the first and third sources said. Some cases where insolvency regulations are being evaded using AIFs are also under investigation, they added.

"We have found various cases of AIF structures are being used to circumvent other regulations," SEBI wholetime member Ananth Narayan said at a conference in Mumbai last week. "These cases do bother us even when we want the industry to grow."

The market regulator has asked AIFs to report both assets and liabilities via India's share depositories starting at the end of this month, according to a circular issued in June.

It is also asking the industry to self-regulate and put in place a code of conduct for its members.

A proposal made in June to stop priority payouts to investors in credit funds, however, has been put on hold after pushback from the industry, the first and second sources said.

Priority payouts are when an investment is split into senior and junior tranches based on the risk and priority of payout.