Unveiling the Strategy: RBI's Fresh Strategic Approach for Regulated Entities to Invest in Alternative Investment Funds
The Reserve Bank of India (RBI) has introduced the RBI (Investment in AIF) Directions, 2025, which impose stricter regulations on regulated entities (REs) such as banks, financial institutions, and co-operative banks when investing in Alternative Investment Funds (AIFs).
Key Changes from the Old Circulars
The new Directions have a broader applicability, explicitly including various REs, such as commercial banks, co-operative banks, and all-India financial institutions. The investment caps have been tightened, with no single RE allowed to invest more than 10% of an AIF’s corpus, and collectively, REs cannot exceed 15%.
Investments exceeding 5% require full provisioning if the AIF invests downstream in the RE’s debtor companies, especially in non-equity instruments. The new Directions also aim to prevent "evergreening" and credit risk masking, tightening rules to avoid the use of AIFs for extending or masking credit risks related to the regulated entities’ borrowers.
Capital Impact of Subordinated Units
Investments through subordinated units must be deducted fully from the RE’s capital funds, split between Tier-1 and Tier-2 capital, reflecting a more conservative treatment not explicitly mandated earlier.
Alignment with SEBI Regulations
The new Directions incorporate the latest Securities and Exchange Board of India (SEBI) regulations, such as limitations on priority distribution and permission to invest in junior/subordinate units, reflecting a harmonized regulatory approach.
Implementation and Effective Date
The Directions will come into mandatory effect from January 1, 2026, with an option for early adoption, replacing earlier circulars issued in 2023 and 2024. The phased implementation approach allows REs sufficient time to adjust their investment strategies to the new requirements.
Addressing Systemic Risks and Misuse
The new Directions reflect a shift towards cautious oversight of RE investments in AIFs to mitigate systemic risks and misuse. The key concern behind these moves is the potential use of AIF structures for evergreening of loans and masking true credit risk.
Implications for REs
The cap on RE investments may create a sense of urgency for REs to participate in AIFs before the available headroom is exhausted. The Directions establish a three-tier framework for determining which regulatory regime applies. The phased implementation of the Directions may trigger greater competition amongst REs for participation in high-quality AIFs.
Sources
- RBI, Investment in AIF, 2025, July 29, 2025.
- SEBI, Master Circular on Investment by Mutual Funds in Debt Securities, July 14, 2025.
- IC RegFin Legal, RBI Issues Directions on Investment in AIFs, August 1, 2025.
- Business Standard, RBI Tightens Norms for RE Investments in AIFs, August 2, 2025.
- Financial Express, RBI's New Directions for AIF Investments: What They Mean for REs, August 3, 2025.
This article was written by Leelavathi Naidu, Harsh Dilip Kothari, and Siddhanth Sharma from IC RegFin Legal. Please note that the opinions expressed in the article are those of the authors and may not reflect the views of Bar & Bench. The article is intended for general consumption and should not be considered as legal advice or opinion. The article does not represent advertisements or press releases.
The article was published to curb risks associated with investments by regulated entities in Alternative Investment Funds. The RBI issued the Directions on Investment in AIF, 2025 on July 29, 2025, and applies to Commercial Banks, Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, All-India Financial Institutions, NBFCs, and Housing Finance Companies.
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