RBI Revises Regulations for Bank Investments in Alternative Investment Funds

In December 2023, the Reserve Bank of India (RBI) imposed constraints on banks and NBFCs, prohibiting them from investing in AIFs with downstream investments in debtor companies. These financial institutions were instructed to either liquidate their holdings within 30 days or make 100% provisions against them.


However, in its circular dated March 27, 2024, the RBI announced a revision, stating that banks are now only required to reserve provisions based on their investment in the AIF scheme, rather than the entire investment in the debtor company. For example, if the RE has a total investment of Rs 100 crore in an AIF scheme, but only Rs 10 crore of it is allocated to the debtor firm by the AIF, then under the revised regulations, provisioning is necessary only for Rs 10 crore, compared to the earlier requirement of provisioning for the entire Rs 100 crore.


This action would alleviate the pressure on NBFCs, which had fully provisioned for all investments in AIFs following the lapse of the 30-day period given by the RBI to liquidate these assets. Given that certain entities have already made provisions, there may be a reversal of provisions in the current quarter.


Equally noteworthy, the RBI has excluded investments in equity shares of debtor companies from the definition of “downstream investments,” allowing banks and NBFCs to invest in AIFs even if the scheme includes equity investments in companies they have already lent to.


While this exclusion applies to investments in listed companies, it overlooks Private Equity & Venture Capital investments, often in the form of compulsory convertible instruments like CCPS and CCDs. Furthermore, the RBI has exempted investments made through intermediaries such as fund of funds and mutual funds.


This circular is expected to ease the burden on both AIFs and banks/NBFCs. By excluding equity investments from the earlier circular’s scope, numerous VCFs and PE funds should be able to maintain their investments and seek additional capital. Moreover, limiting provisioning to pro-rata exposure to the debtor company should mitigate negative provisioning impacts for REs associated with their AIF exposure. Finally, the clarification regarding the non-applicability of the December 19 circular to fund of funds is likely to benefit development financial institutions like SIDBI, NABARD, and NIIF.


These guidelines apply to all commercial banks, including Small Finance Banks, Local Area Banks, and Regional Rural Banks, as well as all Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, All-India Financial Institutions, and Non-Banking Financial Companies, including Housing Finance Companies.