RBI eases regulations for banks' investments in AIFs; here is what experts say

The Reserve Bank of India (RBI) modified its circular on regulated entities' (RE) investments in alternative investment funds (AIFs) on Wednesday, March 27. The step was taken to ensure uniformity in implementation among the regulated entities (REs) and to address the concerns flagged in various representations received from stakeholders.

Regulated entities include banks, primary cooperative banks, non-banking financial companies, credit information companies, and also institutions such as EXIM Bank, NABARD, NaBFID, the National Housing Bank ('NHB'), and the Small Industries Development Bank of India ('SIDBI').

What modifications have been made? 

As per the new ruling, the equity investments in the debtor company (of the bank) have been excluded from the scope of the guidelines, while other forms of investments that are likely to be used as a means of evergreening have been specifically included.

Further, investments by regulated entities in AIFs through intermediaries such as fund of funds or mutual funds are not included.

Experts have mixed views on the RBI's modification of AIF investments. Punit Shah, Partner, Dhruva Advisors, believes that this relaxation will certainly help the AIFs and the financial services industry, as the maximum investment would be like equity investments by AIFs. 

Also read: RBI modifies circular on AIF investments by regulated entities

"The situation of hybrid instruments is not exempt. This would include investment in Compulsorily Convertible Preference Shares (CCPS) by the AIFs; this may not be intended as CCPS are quasi-equity and not a debt instrument. There is also an adequate case for exempting CCPS investments," said Shah. 

Note, CCPS carries certain terms—if an early investor has CCPS, they can have more rights than other investors who come in later at a higher valuation.

Meanwhile, Atul Parakh, CEO of Bigul, believes the move will open up a new revenue stream for banks. He added that the ruling provides not only opportunities for banks to leverage their credit expertise but also regulatory compliance challenges. Its impact on the financials of banks will depend on their ability to successfully manage the risks and capitalise on the fee-based income potential from sponsoring AIFs.

However, he said banks will need to ensure robust governance and risk management frameworks for their AIF operations. 

On the other hand, Mukesh Kochar, National Head of Wealth at AUM Capital, believes it will harm banks and AIFs as there is the possibility that one defaulted debtor of the bank is getting funds from an AIF in which banks have also invested.

"This restriction does not give any relief to a performing bank debtor seeking funding through AIF, which is detrimental. Most of the banks have a good amount of investment in AIFs and will be in a difficult situation," said Kochar. 

The relaxation in the norm comes after, in December 2023, the RBI issued a circular governing investments by banks, non-bank lenders, and other REs in the AIF sector, following concerns about the route being used for the evergreening of loans.

As per the initial concerns, REs' investments in AIFs were used as a route to repay loans that would otherwise have to be classified as non-performing, wherein the AIF gives succour to a bank's borrower.

Following the central bank's clarification, provisioning will be required only to the extent of investment by the RE in the AIF scheme, which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme.

The central bank said the revisions have been made to ensure "uniformity in implementation among the REs and to address the concerns flagged in various representations received from stakeholders."

What are AIFs? 

As per market regulator Sebi's official website, an alternative investment fund, or AIF, means any fund established or incorporated in India that is a privately pooled investment vehicle that collects funds from sophisticated investors, whether Indian or foreign, for investing under a defined investment policy for the benefit of its investors.

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