The Reserve Bank of India (RBI) has provided a sigh of relief to banks and non-banking financial companies (NBFCs) by relaxing its recent regulations on investments in Alternative Investment Funds (AIFs). These changes, announced in March 2024, address concerns raised by the financial industry regarding the initial strictness of the rules.
Background: Addressing Evergreening Concerns
In December 2023, the RBI implemented stricter norms for bank investments in AIFs. The primary aim was to curb the practice of “evergreening” loans. This occurs when banks disguise bad loans by transferring them to AIFs, keeping them off their books and maintaining the appearance of healthy financial performance.
Under the initial regulations, banks and NBFCs were restricted from investing in AIFs that had any involvement with companies they already lent money to (debtor companies). Additionally, they were required to make a 100% provision against the entire AIF investment if such exposure existed.
The Revised AIF Investment Framework
The RBI’s recent changes offer a more nuanced approach:
- Reduced Provisioning: Now, banks only need to set aside provisions for the portion of their AIF investment that goes directly towards existing borrowers, not the entire investment. This significantly reduces the financial burden on banks compared to the initial 100% provisioning requirement.
- Equity Carve-out: Investments in a borrower’s equity shares are excluded from the restrictions. This allows banks to participate in equity financing rounds of their existing borrowers through AIFs without triggering provisioning requirements.
- Intermediary Exemption: Banks investing in AIFs through intermediaries like fund-of-funds or mutual funds are not subject to these new regulations. This offers banks greater flexibility in their investment strategies.
Benefits and Broader Impact
The RBI’s revised AIF rules are expected to benefit banks and NBFCs by:
- Lowering Capital Requirements: Reduced provisioning requirements free up capital that banks can use for other purposes, such as lending to new borrowers.
- Increased Participation in AIFs: The revised framework encourages greater participation by banks in the AIF market, promoting diversification and potentially boosting overall investment activity.
However, some experts caution that the long-term impact of these changes needs to be monitored. While they address immediate concerns, ensuring that AIFs are not misused for evergreening practices remains crucial.
The RBI’s move reflects a willingness to strike a balance between promoting financial stability and facilitating investment activity. The revised AIF framework provides banks with more flexibility while aiming to maintain a robust regulatory environment.
