RBI Tightens Rules on AIF Investments to Curb Evergreening: What You Need to Know

In a significant move to prevent the evergreening of stressed loans, the Reserve Bank of India (RBI) has issued directives barring banks, non-banking financial companies (NBFCs), and other lenders from investing in alternative investment funds (AIFs) with downstream investments in debtor companies. This action aims to address regulatory concerns arising from certain transactions of regulated entities (REs) involving AIFs. The RBI's notification emphasizes the potential risks associated with the substitution of direct loan exposure with indirect exposure through AIF investments, shedding light on the broader issue of evergreening in the banking sector.

Understanding the RBI's Directive:

The RBI's directive is rooted in the concern over evergreening, a practice where lenders attempt to revive near-default or defaulted loans by extending additional loans to the same borrower. The circular outlines that REs should refrain from investing in AIF schemes with downstream investments directly or indirectly tied to debtor companies of the RE. Downstream investments refer to AIFs investing in companies using funds raised from investors.

Key Points of the RBI Notification:

Evergreening Concerns: The RBI's move is motivated by the need to curb evergreening practices, offering a temporary fix that can pose risks to the stability of the banking system.

Debtor Company Definition: The circular defines debtor companies as those to which REs currently have or had loan or investment exposure in the preceding 12 months.

Liquidation Timeline: If an AIF scheme, where an RE is an investor, makes a downstream investment in a debtor company, the RE must liquidate its investment within 30 days. Failure to do so requires a 100 percent provision on the investment.

Industry Insights:

Veena Sivaramakrishnan, Partner at Shardul Amarchand Mangaldas & Co, notes that the RBI's focus on the exposure of regulated entities to other entities aligns with prudential concerns. The amendments provide regulatory oversight on the investment activities of REs in AIFs, outlining principles to prevent certain actions when an RBI-regulated entity is an AIF unitholder.

What's Next:

As of December 19, there were 1,220 AIFs registered with the Securities and Exchange Board of India (SEBI), showcasing the significance of this segment in the financial landscape. Investors, lenders, and financial institutions will need to adapt to these new guidelines, ensuring compliance with the RBI's regulatory framework.

Stay tuned for updates on how these changes may impact the investment landscape and contribute to the overall financial stability.