Introduction
1. On December 19, 2023 the Reserve Bank of India ("RBI") issued a notification to all banks, non-banking financial companies and other regulated entities ("Regulated Entities") prescribing certain restrictions on investments by Regulated Entities in alternative investment funds ("AIFs").1 To address possible evergreening, Regulated Entities were not permitted to invest in AIFs which have downstream investments either directly or indirectly in a debtor company of the Regulated Entity. The notification also required a Regulated Entity to liquidate its investment in a scheme of an AIF ("AIF Scheme") in which it is already an investor and where the AIF Scheme has made a downstream investment in a debtor company. In the event a Regulated Entity could not liquidate such investment, then it was mandated to make a 100% (one hundred percent) provision on such investments.
2. Subsequently, the RBI issued another notification on March 27, 2024 providing certain limited relaxations.2 Regulated Entities were permitted to invest in an AIF Scheme which has downstream investments only in equity shares of the debtor companies of the Regulated Entity. However other investments, including investments in hybrid instruments, continued to be excluded. Further, the requirement of a Regulated Entity to provision the investment in the AIF was limited to the extent of the investment by the Regulated Entity in the AIF Scheme which has further invested in the debtor company, and not the entire investment by the Regulated Entity in the AIF Scheme.
3. RBI has now issued the RBI (Investment in AIF) Directions, 2025 ("RBI AIF Directions") vide notification DOR.STR.REC.43/21.04.048/2025-26 on July 29, 2025,3 repealing both the above-mentioned notifications, taking into account industry feedback, and prescribing regulatory guidelines in respect of investment by banks and other Regulated Entities in AIFs. These Directions shall be effective from January 1, 2026, or from any earlier date as decided by a Regulated Entity as per its internal policy.
4. This update summarizes the key changes introduced by the RBI AIF Directions.
New Investment Caps
1. The absolute bar on a Regulated Entity from investing in an AIF which has downstream investments either directly or indirectly in a debtor company of the Regulated Entity has been removed.
2. Investments of an individual Regulated Entity are capped to 10% (ten percent) of the corpus of an AIF Scheme.
3. Investments by all Regulated Entities in an AIF Scheme collectively, are capped at 20% (twenty percent) of the corpus of that AIF Scheme.
Provisioning Rules
1. RBI has relaxed the provisioning requirements for Regulated Entities having an investment in an AIF which in turn has an investment in a debtor company of the Regulated Entity.
2. A Regulated Entity is required to make a 100% (one hundred percent) provision, if the following 2 (two) conditions are satisfied:
a. the Regulated Entity contributes more than 5% (five percent) of the corpus of an AIF Scheme; and
b. such AIF Scheme also has downstream investment (excluding equity instruments) in a debtor company of the Regulated Entity.
3. This provisioning is limited to the extent of the Regulated Entity's proportionate investment in the debtor company through the AIF Scheme and is subject to a maximum of the direct loan and/ or investment exposure of the Regulated Entity to the debtor company. Notwithstanding what is stated above, if a Regulated Entity's contribution is in the form of subordinated units, then it is mandated to deduct the entire investment from its capital funds proportionately from both Tier-1 and Tier-2 capital (wherever applicable).
4. Thus, the key relaxations are as follows:
a. If the contribution of the Regulated Entity is less than or equal to 5% (five percent) of the corpus of an AIF Scheme, then the provisioning requirement does not apply.
b. Previously, the provisioning requirement did not apply where an AIF had a downstream investment in the equity shares of debtor companies of a Regulated Entity. However, now the exclusion has been broadened to also include compulsorily convertible preference shares and compulsorily convertible debentures. Thus, if an AIF has a downstream investment in equity shares, compulsorily convertible preference shares and compulsorily convertible debentures of a debtor company of a Regulated Entity which has invested in the AIF, then there shall be no requirement to provision the investment.
c. Previously, a company in which a Regulated Entity had any loan or investment exposure (excluding equity shares) at any time during the preceding 12 (twelve) months was included within the definition of a 'debtor company'. Now, investment in a company only in the form of equity instruments would not make the company a 'debtor company'.
d. The provisioning requirement is limited to the maximum of the direct loan and/ or investment exposure of the Regulated Entity to the debtor company.
Requirement to Include Suitable Provisions in the Investment Policy
The RBI AIF Directions provide a general requirement that a Regulated Entity's investment policy shall have suitable provisions governing its investments in an AIF Scheme, which is in compliance with the law.
Exemptions
1. The aforementioned limits are not applicable for outstanding investments or commitments made with prior RBI approval under the master direction on RBI (Financial Services provided by Banks) Directions, 2016.
2. Further, the RBI, in consultation with the Government of India, may exempt certain AIFs from the RBI AIF Directions. However, no exemption may be made in respect of the general requirement under paragraph 4.1. hereinabove.
Practical Impact
1. Regulated Entities should update their investment policies as per the new RBI AIF Directions. Regulated Entities also have to decide as to when they would adopt the new norms since the RBI AIF Directions shall be effective from January 1, 2026, or from any earlier date as decided by a Regulated Entity as per its internal policy.
2. Investments in AIF Schemes by a Regulated Entity which are outstanding as on July 29, 2025, where the Regulated Entity has fully honoured its commitment shall continue to be governed by the provisions of the previous notifications.
3. A Regulated Entity is required to follow the provisions of either the previous notifications or the RBI AIF Directions, in toto, if:
a. there is an investment made by a Regulated Entity in an AIF Scheme in terms of an existing commitment as on July 29, 2025; or
b. there is an investment made by a Regulated Entity in an AIF Scheme in terms of a new commitment entered into before the effective date of the RBI AIF Directions.
Footnotes
1 https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0
2 https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12639&Mode=0
3 https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12886&Mode=0
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