Here’s how RBI’s new circular on AIF investments may benefit banks

The Reserve Bank of India (RBI) has revised its circular on regulated entities’ (RE) investments in Alternative Investment Funds (AIFs). The modifications come after feedback and representations from stakeholders regarding the initial stringent requirements set by the central bank.

The original circular, issued in December 2023, raised concerns about the potential misuse of AIF investments for loan restructuring purposes, commonly known as evergreening.

Under the initial provisions, REs were required to make 100% provisioning against their entire

AIF investments, impacting their profitability.

However, following the recent revisions, the RBI clarified that provisioning would now be required only to the extent of the RE’s investment in the AIF scheme, specifically for investments directed towards the debtor company.

Additionally, the revised circular excludes investments in equity shares of the debtor company from downstream investments, providing relief to REs.

Furthermore, the RBI’s modifications exempt investments by REs in AIFs through intermediaries such as fund of funds or mutual funds from the scope of the circular.

Punit Shah, Partner, Dhruva Advisors, believes this relaxation will help the AIF as well as financial services industry, as maximum investment would be in the nature of equity investments by AIFs.

“The situation of hybrid instruments are not exempted. 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 adequate case for exempting CCPS investments as well,” Shah said.

Siddharth Shah, Partner at Khaitan & Co, added that relaxation should bring a sigh of relief both for AIFs and the banks/NBFCs.

“The carving out of equity investments from the applicability of the earlier circular should allow a large majority of venture capital funds (VCFs) and private equity (PE) funds to continue with the investments by REs as well as to go out and raise capital from REs. Secondly, limiting the provisioning to pro-rata exposure to underlying debtor company makes logical sense and should help dilute the adverse provisioning impact for REs linked to it’s entire exposure to an AIF,” he said.

Nikhil Aggarwal, Founder & CEO of Grip Invest said “The relaxation achieves SEBI’s original objective of disincentivising evergreening of loans extended by banks and NBFCs while also recognising that investments in equities, other debt investments should stand outside this purview.”

Aggarwal emphasized the importance of ensuring continued investment by banks and NBFCs in AIFs to foster a deeper market and provide access to capital to a diverse set of borrowers.

Rahul Gupta, Managing Partner & Founder of ValuAble, welcomed the recent announcement by the RBI, highlighting its positive impact on the financial landscape.

Gupta remarked, “This move allows banks to write back certain provisions, offering much-needed flexibility. However, clarifications around hybrid instruments and debt instruments are still awaited.”