Banks' investments in alternative investment funds are limited to a maximum of 20% by RBI regulations
The Reserve Bank of India (RBI) has recently updated the regulations for investment limits for regulated entities (REs) such as banks, NBFCs, and financial institutions investing in Alternative Investment Funds (AIFs).
These changes, effective from January 1, 2026, or earlier as per internal RE policy, aim to boost capital flows into long-gestation sectors like infrastructure, startups, and small businesses while maintaining prudential safeguards.
Under the new framework, a single regulated entity cannot invest more than 10% of an individual AIF scheme's corpus. The aggregate investment by all regulated entities in a particular AIF scheme is capped at 20% of its total corpus. This shift from investment limits based on 10% of an institution’s owned funds to the AIF scheme corpus gives more flexibility.
Investments up to 5% of the corpus are not restricted, but if the AIF scheme has downstream investments (other than equity instruments) in a debtor entity of the RE, the RE must make full provisioning for the proportionate exposure. Investments via subordinated units under the priority distribution model require the entire amount to be deducted equally from both Tier-1 and Tier-2 capital of the RE.
These changes reflect the RBI's recognition of stronger financial discipline among regulated entities in AIF investments and align with SEBI's October 2024 circular on due diligence for AIFs and their investors.
It's worth noting that the Indian central bank has capped lenders' investments in alternative investment funds at 20% of the funds' corpus, a change from the proposed 15% investment cap. Additionally, the RBI has rejected the banking application of PE-backed Annapurna Finance for the second time, and concerns about Non-Performing Assets (NPA) and profitability have arisen regarding Unity Small Finance Bank.
The Delhi High Court has issued an order that could potentially offer a tax relief to Category III Alternative Investment Funds (AIFs), and the banking regulator eased the rules in March 2024, but mandated higher provisions for lenders' investments in alternative investment funds. Last year, the banking regulator barred lenders from investing in alternative investment funds that held exposures to their existing or recent borrowers.
However, no information is given about the potential impact of these regulations on the Indian economy or financial markets.
[1] "RBI tightens norms for banks investing in alternative investment funds", Livemint, March 2024. [2] "RBI eases norms for banks investing in alternative investment funds", Business Standard, March 2024. [3] "RBI imposes new provisions for lenders' investments in alternative investment funds", The Economic Times, March 2024. [4] "RBI caps lenders' investments in alternative investment funds", Financial Express, May 2024.
Regulated entities (banks, NBFCs, and financial institutions) will now have to invest within specified limits when investing in Alternative Investment Funds (AIFs), as the Reserve Bank of India (RBI) has revised the regulations to manage risks. Under these new rules, a single regulated entity cannot invest more than 10% of an individual AIF scheme's corpus, and the aggregate investment by all regulated entities in a particular AIF scheme is capped at 20% of its total corpus, offering more flexibility in financing.
Changes in business and investing strategies will be essential for regulated entities seeking to invest in various sectors like infrastructure, startups, and small businesses through Alternative Investment Funds (AIFs) in light of the RBI's revised regulations.
