RBI Game-Changer: Shocking Ban on Lenders! Unveiling the AIF Investment Saga – #1 Must-Know Revelation!

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Unveiling the RBI’s Prohibition on Lenders’ Investments in AIFs Tied to Borrower Companies

In a strategic move aimed at curbing the escalating trend of loan evergreening orchestrated by financial institutions, the Reserve Bank of India (RBI) issued a decisive directive on December 19. According to experts consulted by Moneycontrol, this timely intervention is poised to staunchly impede the perpetuation of loans through innovative financial maneuvers.

Unraveling the Veil: The Motive Behind RBI Directive

The intricate practice of evergreening, wherein banks strategically forestall loans from defaulting to a non-performing asset (NPA) status, prompted the central bank to enact this preventative measure. By extending fresh loans to borrowers for the settlement of existing debts, the illusion of financial robustness is sustained.

Jyoti Prakash Gadia, Managing Director of Resurgent India, elucidated, “AIF was being used for transactions that camouflaged the real status of some accounts by borrowing additional funds through the AIF to repay the existing debt of group concerns. Hence, the RBI was prompted to bring directives to prevent such hidden and indirect violations.”

Veena Sivaramakrishnan, Partner in Banking and Finance, as well as Insolvency and Bankruptcy Practice at Shardul Amarchand Mangaldas & Co., remarked, “Against the backdrop of evergreening, the existing structures in the market operated in a regulatory vacuum of not being prohibited and, in more instances than not, failed to pass the smell test on account of the spirit of the existing RBI regulations.”

Decoding the RBI Mandate

The RBI, on December 19, explicitly stated that lenders are prohibited from investing in Alternative Investment Funds (AIFs) directly or indirectly connected to companies that are borrowers from these lenders. Expressing regulatory concerns regarding specific AIF transactions by regulated entities, the RBI elucidated on the following guidelines:

1. Regulated entities (REs) must refrain from investing in any AIF scheme that has downstream investments, either directly or indirectly, in a debtor company of the RE.
2. Lenders are obligated to liquidate their investment in the scheme within 30 days if the AIF scheme, in which lenders are already investors, makes a downstream investment in any such debtor company.
3. If lenders have existing investments in schemes with downstream investments in their debtor companies, the 30-day liquidation period commences from the circular’s issuance date. Failure to comply within 30 days necessitates a 100 percent provision on such investments.

The circular also stipulates that investments by REs in the subordinated units of any AIF scheme employing a “priority distribution model” will be subject to full deduction from the RE’s capital funds.

Insights from RBI Governor Shaktikanta Das

Governor Shaktikanta Das, on May 29, shed light on instances of banks perpetuating loans. He underscored the need for vigilance, citing innovative methods concealing the actual status of stressed loans. The circular, Das emphasized, aims to deter such practices that compromise the broader interest.

The Landscape of India’s AIF Market

As per a November 2023 report by PMS Bazaar, the alternative investment industry in India, encompassing Portfolio Management Services (PMS) and AIF, is poised to burgeon to Rs 43.64 lakh crore in the next five years. Over the past five years (June FY19 to June FY24), the AIF and PMS industry exhibited a commendable Compound Annual Growth Rate (CAGR) of 26 percent, with assets under management reaching Rs 13.74 lakh crore by June FY24. AIFs, exhibiting a stellar CAGR of 36 percent, led the alternative investment domain.

Implications for Lenders

Sivaramakrishnan highlighted the imperative need for a comprehensive review of certain entities’ structures. She affirmed, “The RBI’s move does not come as a surprise as it has always been concerned with hidden NPAs and evergreening.” The priority/senior or junior structures employed by entities, she noted, fall within the purview of this circular, necessitating swift reassessment for alternative structuring.

Gadia contended that the directives, particularly the mandate for a 100 percent provision, could serve as a robust deterrent to irregularities in transactions. He remarked, “The need to make a 100 percent provision on such outstanding debt is likely to be a big deterrent to such irregularities in transactions.”