The Reserve Bank of India (RBI) on Tuesday, December 19, introduced regulations to prevent banks and non-banking financial companies (NBFCs) from utilising the alternative investment fund (AIF) route to 'evergreen' their loans. This move aims to tackle concerns regarding the substitution of direct loan exposures with indirect exposures through investments in AIFs.
"Regulated entities (REs) make investments in units of AIFs as part of their regular investment operations. However, certain transactions of REs involving AIFs that raise regulatory concerns have come to our notice," the central bank said.
What this means?
The RBI's move is aimed at stopping banks and NBFCs from using the AIF channel as a way to artificially sustain or extend the life of their loans.
‘Evergreening’ refers to a practice where financial institutions extend new credit to cover old debts, essentially masking the true status of those loans.
Decoding RBI's regulation
The central bank has advised REs against investing in any AIF scheme that has downstream investments (investments made by the AIF) in companies to which the REs have had financial dealings, such as providing loans or making investments, within the past 12 months.
Additionally, if an AIF scheme, in which an RE is already an investor, goes on to make downstream investments in any of the debtor companies associated with the RE (companies that have borrowed from or received investments from the RE), the RE is required to sell off its investments in that AIF scheme within a timeline of 30 days from the date of the downstream investment.
Failure to comply within this timeframe will result in the RE being obligated to make a full 100% provision on those investments, RBI said.
Further, the circular issued by the RBI specifies that investments made by REs in the subordinated units of any AIF scheme operating on a 'priority distribution model' will be subject to complete deduction from the RE's capital funds.
