RBI Eases Rules on Regulated Entities Investing in Alternative Investment Funds (AIF)

In a significant development, the Reserve Bank of India (RBI) has revised its guidelines concerning investments by regulated entities (REs) in Alternative Investment Funds (AIFs). This adjustment, announced on Wednesday, comes in response to feedback from various stakeholders expressing concerns about the initial requirements outlined in a circular released in December 2023.

The original guidelines were introduced amid apprehensions that the investment channel into AIFs was being utilized for the ‘evergreening’ of loans, a practice where new loans are used to repay old ones, thus avoiding classifying them as non-performing. Specifically, there was worry that REs’ investments in AIFs served indirectly to support borrowers of the banks, possibly masking underlying financial distress.

However, the revised circular provides clarifications that aim to address these concerns while ensuring a consistent implementation framework across all REs. One notable amendment is the provision requirement, which now mandates that provisioning is necessary only for the portion of the RE’s investment in the AIF that is subsequently invested in the debtor company, rather than the entire investment in the AIF.

Additionally, the RBI has refined the definition of ‘downstream investments’ to exclude investments in the debtor company’s equity shares while including all other forms of investments, such as hybrid instruments. This clarification is expected to provide more leeway in how REs manage their investment portfolios.

The updated guidelines also specify that any deductions from an RE’s capital, necessitated by investments in AIFs, should be equally divided between Tier-1 and Tier-2 capital. Furthermore, investments made by REs into AIFs through intermediaries, like mutual funds or funds of funds, fall outside the scope of this circular, providing additional flexibility to REs in their investment strategies.

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The clarifications have been well-received within the financial sector, with Gopal Srinivasan, Chairman of TVS Capital Fund, expressing particular approval. The original requirement for REs to provision 100% against their AIF investments had previously led to significant profit impacts for many entities, an issue this revision aims to mitigate.

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