The RBI has implemented sweeping reforms to regulate investments by banks and financial institutions in Alternative Investment Funds, introducing stringent new norms that will take effect from January 2026.
These comprehensive regulations, replacing previous circulars from December 2023 and March 2024, aim to eliminate potential loopholes that allowed evergreening of stressed assets while bringing greater transparency to financial exposures. The revised framework applies across the banking sector – covering commercial banks, cooperative banks, financial institutions, and NBFCs including housing finance companies – and specifically targets situations where lenders might use AIF structures to indirectly support troubled borrowers.
Central to the new rules is a precise definition of “debtor companies” as firms where regulated entities had any loan or investment exposure (excluding equity instruments) in the preceding year. The regulations impose strict investment limits, capping individual institutional contributions to any AIF scheme at 10% of the corpus, with aggregate exposure from all regulated entities restricted to 20%.
More significantly, the norms introduce tough provisioning requirements – any investment exceeding 5% in an AIF that subsequently lends to the institution’s debtor company will trigger mandatory 100% provisioning on the proportionate exposure. The rules take an even stricter stance on higher-risk subordinated units, mandating full deduction from capital funds for such investments.
While existing approved investments are grandfathered, all fresh commitments after implementation must fully comply with the new regime. The RBI’s move specifically addresses concerns about evergreening practices where lenders could potentially use AIFs to refinance stressed borrowers and avoid recognizing bad loans. By enforcing higher provisioning and capital charges, the central bank aims to maintain financial system stability while discouraging regulatory arbitrage.
The banking sector now faces a critical transition period to review portfolios, strengthen due diligence processes, and realign investment strategies before the 2026 deadline. Though these measures may temporarily slow institutional participation in certain AIF segments, they ultimately align India’s regulatory framework with global best practices for transparency and risk management in alternative investments.
The RBI has retained some flexibility to grant exemptions for specific AIFs in consultation with the government, ensuring the regulations achieve their objectives without unnecessarily constraining legitimate investment activity. This comprehensive overhaul underscores the central bank’s unwavering commitment to preserving the integrity of India’s financial system while addressing evolving risks in the investment landscape.
Commenting on RBI notification Anil Gupta, Senior Vice President and CO-Group Head Financial Sector Ratings, ICRA Ltd.
