Context: Recently, the Reserve Bank of India (RBI) introduced regulations to prevent banks and non-banking financial companies (NBFCs), utilizing alternate investment funds (AIFs) route to ‘evergreen’ their loans. 

RBI Tightens Norms for Lenders Investing in AIFs

• Tightening of norms: The move seeks to draw the attention of bank directors towards lenders using innovative methods to conceal the real status of stressed loans.
• These methods include:
• • Bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments.
  • Good borrowers are persuaded to enter into structured deals with a stressed borrower to conceal the stress.
  • Use of Internal or Office accounts to adjust borrower’s repayment obligations.
  • Renewal of loans or disburse new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans.
• Prevent Artificial Sustaining Of Loans: RBI’s move aims to stop banks and NBFCs from using the AIF channel to sustain the life of their loans artificially.
• Stressed loans: The Central bank highlighted that Regulated Entities (REs) use AIFs as part of their regular investment operations, substituting direct loan exposures with indirect exposures, leading to concealment of the real status of stressed loans.
• Process of Loan  Evergreening:
  • RE creates an AIF structure to fund its borrower, which is likely to become an NPA.
  • The AIF, created by the RE and other investors, invests in the stressed company, which uses the same money to repay the lender.
• AIFs Investment commitment: As of now, there were 1,220 AIFs registered with the Securities and Exchange Board of India (SEBI), with total investment commitment raised by AIFs stood at Rs 8.44 lakh crore as of June 30, 2023, and total funds raised by the AIFs as of end June 2023 quarter was Rs 3.74 lakh crore

RBI’s Recent Norms For Lenders Investing In AIFs

• Liquidation time
  • Lenders investment in AIFs have 30 days to liquidate them. Failing to liquidate, they must make 100 per cent provision on such investments.

• • 100% deduction: RBI prescribes full deduction from lender’s capital funds if they have investments in the subordinated units of any AIF scheme with a ‘priority distribution the model’.
• Regulation for Investments
  • REs shall not make investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE
• Evergreening modus operandi
  • Debtor company due to repay a loan or instalment, can give a list of mutual funds/fund houses, investing either in their equity or debts through AIFs to the lender. 
  • The List can also include AIFs not yet invested in the debtor company, but the company is eligible for an investment from them.

Reaction from AIFs industry

• Reduction in the pool of investable assets for AIFs:
  • Banks invest into AIFs, and if that AIF invests in a listed company, that listed company for a period of 12 months prior cannot do business with the bank leading to reduction in investible assets.
• Limits their ability:
  • Lenders must set aside 100% of the invested money in their books, which limits their ability to use the specified amount for any other type of financing.
• Significant reduction in the value of their initial investment:
  • Lenders required to liquidate their investments in the AIF within the 30-day redemption period outlined in this circular will have to redeem it based on the prevailing Net Asset Value (NAV) of the AIF leading to a significant reduction in the value of their initial investment.

News source: Indian Express