On December 19, 2023, the Reserve Bank of India (RBI) issued a circular restricting certain Regulated Entities (Commercial Banks, Co-operative Banks, All India Financial Institutions, and Non-Banking Financial Companies (REs) from making investments in Alternative Investment Funds (AIFs) with immediate effect (Circular).
The Circular provides for the following:
- REs must not invest in AIFs having indirect/direct downstream investment in such RE’s debtor company (i.e., companies in which REs currently have or have had anytime during the preceding 12 months loan/investment exposure).
- On and from the date of the Circular, if an AIF, in which an RE is invested, makes a downstream investment in such RE’s debtor company, then such RE must liquidate its investments in such AIF within 30 days of such downstream investment by the AIF.
- If, as on the date of the Circular, if an AIF, in which an RE is invested, already holds downstream investment in such RE’s debtor company, such RE must liquidate its investments in such AIF, within 30 days of this Circular.
- REs failing to comply with the provisions of the Circular must make 100% provision on such investments.
Additionally, the Circular also stipulates that RE’s investments in subordinated units of AIFs having a priority distribution model shall be subject to full deduction from such RE’s capital funds.
This is, evidently, a step towards addressing and alleviating concerns of ‘evergreening of loans’, aligned with the RBI governor’s earlier warning against innovative practices in loan evergreening. That said, though well intentioned, the Circular does throw open a few challenges in its wake. The time period for REs to liquidate their investments has been too short to implement effective change that is not commercially unviable. With the funding winter still to relent, the changes expose AIFs to further funding crunch. The heightened provisioning requirements may result in certain Non-Banking Financial Companies shutting shops for want of funding.