Lenders' investments in alternative investment funds are now limited to 20% as per the new regulations set by the Reserve Bank of India.
The Reserve Bank of India (RBI) has recently revised its regulations for lenders investing in Alternative Investment Funds (AIFs), effective from January 1, 2026. These changes aim to balance the expansion of investment opportunities with enhanced safeguards against hidden credit risks.
In a significant move, the RBI has increased the overall exposure cap for regulated entities (REs) from the initial proposed 15% to 20% of the scheme’s corpus. However, the individual RE's investment remains capped at 10% of the corpus.
One of the key changes includes the prohibition of investments in AIFs that have exposure to the investing lender’s existing or recent borrowers. Lenders must make 100% provisioning for investments in AIFs holding downstream investments in debtor companies to the extent of the exposure.
If an RE invests more than 5% in an AIF scheme that has indirect (downstream) non-equity investments in a debtor company of that RE, the RE must fully provision for credit risk proportionate to its indirect exposure, capped by its direct exposure to that debtor. Investments in subordinated units of such AIFs must be deducted entirely from the RE’s capital funds (Tier-1 and Tier-2) to maintain capital adequacy.
These new regulations, known as the RBI Investment in AIF Directions, 2025, replace earlier guidelines issued in December 2023 and March 2024. They strengthen risk management and due diligence to prevent hidden credit risks, including "evergreening" and circumvention through investments in stressed companies.
Meanwhile, the RBI has rejected the banking application of PE-backed Annapurna Finance for the second time. Separately, the Delhi High Court has issued an order that could potentially offer a significant tax relief to Category III AIFs.
It's also worth noting that SEBI has unveiled a settlement scheme for legacy Venture Capital funds that have transitioned to the AIF regime. Alternative investment funds are privately pooled funds investing in listed, unlisted, and other asset classes.
These developments underscore the RBI's commitment to fostering a robust and safe investment environment for lenders while maintaining stringent controls to mitigate potential risks.
- In line with these newly established regulations, lenders in the business sector will now face stricter provisions when investing in AIFs, as they must fully provision for credit risks associated with debtor companies.
- The banking industry will observe enhanced investment opportunities in the finance sector, especially for Category III AIFs, following a potential tax relief ordered by the Delhi High Court.
