Editorial. RBI eases banks’ investment in AIFs, with guardrails  

RBI: Easing funds flow
| Photo Credit:
DHIRAJ SINGH

In the recent monetary policy statement, Reserve Bank of India Governor Sanjay Malhotra drew attention to the fact that though the growth rate of bank credit had slowed down in FY25, credit flow from non-bank sources had helped offset the gap. Total flow of resources from non-bank sources increased by ₹4.3 lakh crore in FY25. In a bid to boost credit flow through the non-bank route, the RBI recently lifted the ban on banks and NBFCs’ investments in alternative investment funds (AIFs) — investment vehicles that attract funds for investment in private equity, venture capital, hedge funds and real estate.

The AIF directions can be counted among many recent moves to ease the regulatory tightening in order to improve the flow of credit to the economy. The regulations came into being in a certain context. Sharp growth in credit in the years following the pandemic was accompanied by rampant malpractices by lenders, including window dressing of accounts, evergreening of loans, and creating fake customer accounts. The nexus between banks and AIFs in evergreening loans was flagged by the Securities and Exchange Board of India; in December 2023, the RBI banned all investments of banks in AIFs with downstream exposures to bank debtors. Banks were found to be channelling funds through the AIFs to help debtors repay their loans. The rules were relaxed slightly in March 2024, when banks were allowed to invest in AIFs which had invested in equity instruments of the debtor company. The RBI has now completely lifted the ban on bank and NBFC investments in AIFs, regardless of the nature of exposure to the debtors, be it in equity, debt and other hybrid instruments. This, in fact, can be seen as a pragmatic step, as investment funds have made the necessary adjustments as stipulated by the RBI.

The central bank appears to have put up guardrails to ensure that the leeway is not misused, or the asset quality of banks compromised. This is being done by laying down that no lender should invest more than 10 per cent of the assets under management of the AIF and the total contribution of all lenders in an AIF should not exceed 20 per cent of the scheme’s AUM. If the investment of the lender exceeds these limits and the AIF has invested in any debtor of the lender, then full provision needs to be made for the exposure through the AIF. If any bank or NBFC invests in subordinate units of AIFs, which have invested in the debtor of the lender, the exposure needs to be adjusted from the capital of the lender.

The central bank has rightly expanded the definition of ‘equity’ under the AIF directions to include convertible preference shares and convertible debentures. With corporates using all kinds of instruments to raise funds from the market, it is important for the regulations to be in sync. The central bank has been nimble in adapting regulations to the current context. However, the impact of liquidity infusion on financial stability must be on its radar as well.

Published on August 10, 2025

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