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.

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.

“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.