Investment of Banks in Alternative Investment Funds (AIFs) now less restricted by RBI, albeit with safety measures in place

Investment of Banks in Alternative Investment Funds (AIFs) now less restricted by RBI, albeit with safety measures in place

The Reserve Bank of India (RBI) has announced new regulations, the RBI (Investment in AIF) Directions, 2025, effective from January 1, 2026. These guidelines aim to prevent the use of Alternative Investment Funds (AIFs) for loan evergreening and improve transparency around credit risks.

In a significant move, the RBI has lifted the ban on banks and Non-Banking Financial Companies (NBFCs) investments in AIFs. However, the new regulations impose specific limits and prudential norms on these investments.

No single regulated entity, including banks and NBFCs, can invest more than 10% of the AIF scheme’s total corpus. Collectively, all regulated entities’ investments in a single AIF scheme cannot exceed 20% of the scheme’s total corpus.

The regulations also prohibit investments in any AIF scheme that invests downstream in the RE’s own debtor companies without stringent safeguards. If an RE invests more than 5% in an AIF that, in turn, invests in its own debtor company (except in equity instruments), it must make 100% provisioning against that portion of investment, limited to its direct exposure to that debtor.

The new guidelines apply broadly to commercial banks, primary urban, state and central cooperative banks, all-India financial institutions, and NBFCs, including housing finance companies.

These updated guidelines supersede earlier circulars from December 2023 and March 2024. The RBI’s measures align with the Securities and Exchange Board of India’s actions on AIF structures, especially regarding subordinate/junior units and priority distribution models.

Investments in higher-risk subordinated units require full deduction from capital funds, reinforcing the prudential regulation of riskier exposures.

The RBI’s move to ease regulations is aimed at improving the flow of credit to the economy. The central bank has been adaptive in updating regulations to match the current market context.

If a lender’s investment in an AIF exceeds these limits and the AIF has invested in any debtor of the lender, full provision needs to be made for the exposure through the AIF. Similarly, the central bank has accounted for investments in subordinate units of AIFs: If a bank or NBFC invests in such units that have invested in the debtor of the lender, the exposure needs to be adjusted from the capital of the lender.

These new regulations come amidst a sharp growth in credit in the years following the pandemic, which was accompanied by rampant malpractices by lenders. The Reserve Bank of India Governor, Sanjay Malhotra, highlighted a slowdown in the growth rate of bank credit in FY25. The central bank has also flagged a nexus between banks and AIFs in evergreening loans.

The impact of liquidity infusion on financial stability should be monitored by the central bank. The RBI's move to ease regulations is a step towards improving transparency and mitigating risks in the financial sector.

This article was published on August 10, 2025.

1. The Reserve Bank of India (RBI) has announced new regulations, the RBI (Investment in AIF) Directions, 2025, effective from January 1, 2026, which aim to prevent the use of Alternative Investment Funds (AIFs) for loan evergreening and improve transparency around credit risks.
2. In a significant move, the RBI has lifted the ban on banks and Non-Banking Financial Companies (NBFCs) investments in AIFs, nevertheless, the new regulations impose specific limits and prudential norms on these investments.
3. No single regulated entity, including banks and NBFCs, can invest more than 10% of the AIF scheme’s total corpus. Collectively, all regulated entities’ investments in a single AIF scheme cannot exceed 20% of the scheme’s total corpus.
4. The regulations also prohibit investments in any AIF scheme that invests downstream in the RE’s own debtor companies without stringent safeguards. If an RE invests more than 5% in an AIF that, in turn, invests in its own debtor company (except in equity instruments), it must make 100% provisioning against that portion of investment, limited to its direct exposure to that debtor.
5. The new guidelines apply broadly to commercial banks, primary urban, state and central cooperative banks, all-India financial institutions, and NBFCs, including housing finance companies.
6. These updated guidelines supersede earlier circulars from December 2023 and March 2024. The RBI’s measures align with the Securities and Exchange Board of India’s actions on AIF structures, especially regarding subordinate/junior units and priority distribution models. In addition, investments in higher-risk subordinated units require full deduction from capital funds, reinforcing the prudential regulation of riskier exposures.

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