RBI Strengthens Norms for Lenders in AIFs

• 21 Dec 2023

Source: IE

Why in News?

In a move aimed at curbing evergreening of stressed loans, the Reserve Bank of India (RBI) recently directed Regulated entities (REs) like banks, non-banking financial companies (NBFCs) and other lenders not to invest in any scheme of alternative investment funds (AIFs) which has downstream investments in a debtor company.

• Regulated entities (REs) make investments in units of AIFs as part of their regular investment operations. RBI, however, stated that certain transactions of REs involving AIFs, raise regulatory concerns.

What are the Recent RBI’s Directives to REs Related to AIFs?

• RBI emphasized “replacing direct loans given to borrowers with investments in AIF units by REs, which indirectly links to the borrowers. This raised concerns about the practice of loan evergreening to avoid marking them as defaults.
  • Evergreening of loans is a process whereby a lender tries to revive a loan that is on the verge of default or in default by extending more loans to the same borrower.
• RBI's directive explicitly prohibits REs from investing in AIFs schemes with downstream investments in debtor companies related to the RE.
  • According to the directive, in instances where an AIF in which an RE is already an investor makes downstream investments in debtor companies, the RE must liquidate its investment within 30 days.
  • In case the REs are not able to liquidate their investments within the prescribed time limit, they will have to make a 100% provision on such investments.
    • A provision is an amount set aside or reserved by a company or financial institution to cover anticipated future expenses or losses.

Note

• Downstream investments refer to the actual investments made by AIFs in companies using raised funds from investors.

What is an Alternative Investment Fund?

• About: An AIF refers to a fund established or formed in India, serving as a privately pooled investment mechanism.
  • It gathers funds from sophisticated investors, whether domestic or international, with the aim of investing according to a specific investment policy, ultimately benefiting its investors.
  • These investment vehicles adhere to the SEBI (Alternative Investment Funds) Regulations, 2012.
    • As of December, 2023, 1,220 AIFs were registered with the Securities and Exchange Board of India (SEBI).
• Types of AIFs in India: SEBI has classified AIFs into three main categories:
  • Category I: AIFs that invest in startups, early-stage ventures, social initiatives, SMEs, infrastructure, or sectors deemed socially and economically beneficial by authorities.
    • This includes venture capital, social venture funds, infrastructure funds, and any other specified Alternative Investment Funds.
  • Category II: AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements.
    • These include real estate funds, private equity funds (PE funds), distressed asset funds, and similar types.
  • Category III: AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.
    • Various types of funds such as hedge funds, PIPE (private investment in public equity) Funds, etc. are registered as Category III AIFs.
• Legal forms: An AIF can be established in the form of a trust or a company or a limited liability partnership or a body corporate.
  • Most of the AIFs registered with SEBI are in trust form.