RBI Proposes Relaxed Investment Norms for Banks in AIF Schemes
| 2025-05-19
Reserve Bank of India (RBI)
India’s central bank proposes easing rules on lender investments in Alternative Investment Funds, capping exposure while allowing strategic exemptions.
India’s central bank on Monday issued revised draft guidelines on investment in Alternative Investment Funds (AIFs) by regulated entities, including banks and non-banking financial companies (NBFCs). The proposals follow earlier regulatory interventions that restricted such investments over concerns about financial risk and regulatory circumvention.
The new framework seeks to allow more flexibility, while maintaining oversight. According to the draft, the contribution by a single regulated entity to any AIF scheme will be capped at 10 percent of the scheme’s total corpus. Collectively, all regulated entities together will be limited to a maximum 15 percent contribution to a given scheme.
Lenders will be allowed to invest up to five percent of an AIF scheme’s corpus without restriction. However, if this threshold is exceeded, and if the AIF holds downstream debt exposure to a borrower of the investing entity, the regulated entity must make a 100 percent provision for its proportionate exposure.
These rules are part of a broader effort by the RBI to mitigate risks in financial intermediation through alternative investment routes. In December 2023, the central bank had prohibited investments by lenders in AIFs that held exposures to the lender's own borrowers, either existing or recent. This was in response to findings by the Securities and Exchange Board of India (SEBI) that some AIF structures were being used to mask non-performing assets and circumvent regulations—a practice often referred to as "evergreening" of loans.
Following industry feedback, the RBI eased some provisions in March 2024. The current draft builds on that momentum, proposing a middle path between strict restrictions and market flexibility.
In its statement, the RBI noted that “regulatory measures undertaken by the Reserve Bank have brought financial discipline among the REs regarding their investment in AIFs.” It added that SEBI has issued its own set of due diligence requirements aimed at ensuring transparency in AIF investor and investment profiles.
Industry Reactions and Legal Observations
Industry experts have welcomed the RBI’s revised stance, though some have expressed concerns about the practical impact of the proposed caps.
“This is a more palatable approach as compared to a blanket ban. However, the proposed limits seem overly restrictive, particularly for collective exposure of all regulated entities being limited to 15 percent,” said Nandini Pathak, a partner at Bombay Law Chambers.
She added that further exemptions should be considered, especially for fund-of-funds structures that play a different role in the investment ecosystem.
Siddarth Pai, co-chair of the Regulatory Affairs Council at the Indian Venture and Alternate Capital Association (IVCA), also commented positively on the shift. “This move by the RBI is significant to rupee capital formation through AIFs,” he said. “Banks and NBFCs are important institutional investors in AIFs, and this relaxation is a direct result of industry engagement and SEBI’s intervention.”
Strategic Exemptions and Consultation Period
The RBI has also stated that certain AIFs, especially those set up for strategic purposes, may be exempt from these restrictions. Such exemptions would be granted in consultation with the central government.
The revised guidelines will apply prospectively, meaning that existing investments or prior commitments made by lenders will continue to be governed by current rules.
Stakeholders have until 8 June to submit comments or suggestions before the central bank finalises the guidelines.
Context Section: The Role of AIFs in Indian Capital Markets
Alternative Investment Funds are privately pooled investment vehicles that cater to high-net-worth individuals and institutional investors. They typically operate outside the conventional regulatory frameworks that govern mutual funds and other public market instruments.
In India, AIFs have played a growing role in channeling capital into infrastructure, start-ups, and distressed assets—areas not typically served by traditional banking. However, their opaque structures and occasional regulatory loopholes have attracted scrutiny from both the RBI and SEBI.
The evolving regulatory approach highlights the balancing act between encouraging capital flow and preventing financial risk. With the latest proposal, the RBI appears to be responding to market needs while reinforcing safeguards that ensure accountability.
Conclusion
The RBI’s proposed guidelines mark a significant shift in its regulatory stance on AIF investments by banks and NBFCs. While maintaining caution through caps and provisioning rules, the draft also signals a greater willingness to accommodate strategic investment frameworks. The final contours of the policy will depend on industry feedback in the coming weeks.
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