RBI Tightens Norms for Lenders Investing in AIFs: Key Points
- December 20, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
RBI Tightens Norms for Lenders Investing in AIFs: Key Points
Subject :Economy
Section: Monetary Policy
- Objective:
- The Reserve Bank of India (RBI) has tightened norms for lenders investing in Alternative Investment Funds (AIFs) to address concerns related to evergreening of stressed loans.
- Concerns Addressed:
- The central bank aims to curb transactions involving the substitution of direct exposure of lenders to borrowers with indirect exposure through investments in AIF units, which may conceal the true status of stressed loans.
- Restrictions on Downstream Investments:
- Lenders are prohibited from investing in any scheme of an AIF with downstream investments, either directly or indirectly, in a company that has borrowed from them in the preceding 12 months. If lenders have such investments, they must liquidate them within 30 days. Failure to do so requires them to make a 100% provision on such investments.
- Circular Applicability:
- The norms are part of the RBI’s circular on ‘Investments in AIFs,’ applicable to REs (Regulated Entities) i.e. commercial banks, urban cooperative banks, all-India financial institutions, and non-banking finance companies, including housing finance companies.
- Deduction from Capital Funds:
- Full deduction from the lender’s capital funds is prescribed if they have investments in the subordinated units of any AIF scheme with a ‘priority distribution model.’
- Priority Distribution Model:
- Under this model, certain AIF schemes have a distribution waterfall where one class of investors has priority in distribution over others, leading to a deduction from the lender’s capital funds.
- Background:
- The tightening of norms follows RBI Governor Shaktikanta Das’s mention of instances where lenders used innovative methods to conceal the actual status of stressed loans.
- Industry participants express concerns that the circular makes it virtually impossible for RBI-regulated entities, especially banks and NBFCs, to invest in AIFs, reducing the pool of investable assets for AIFs.
- Industry participants plan to seek further clarity from the RBI on the circular’s implications and requirements.
The RBI’s move aims to enhance transparency and prevent the misuse of AIF investments for concealing the true state of stressed loans by financial institutions.
Upstream and Downstream Investment in Foreign Direct Investment (FDI):
- Upstream Investment in FDI:Upstream FDI involves foreign investments in activities related to the early stages of the production process, such as exploration, extraction, and initial processing of raw materials or resources in a host country.Examples: A foreign company investing in the exploration and extraction of natural resources (oil, minerals, etc.) in another country. Investment in agricultural activities, including farming or cultivation of raw materials.
- Downstream Investment in FDI:Downstream FDI pertains to foreign investments in activities associated with the later stages of the production process, including processing, manufacturing, distribution, and marketing of finished products in a host country. Foreign investment in manufacturing plants for converting raw materials into finished goods. Investment in retail chains, distribution networks, or marketing activities in a host country.
About AIFs:
As per Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, AIFs refer to privately pooled investment funds, either from Indian or foreign sources, in the form of a trust, company, body corporate, or Limited Liability Partnership (LLP).
AIFs do not include funds covered under SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999, or any other regulations of the Board regulating fund management activities.
Categories of AIFs:
AIFs are classified into three categories based on their investment focus and activities.
Category I:
- Category I AIFs primarily invest in start-ups, small and medium-sized enterprises (SMEs), or sectors deemed economically and socially viable by the government.
Category II:
- Category II AIFs include private equity funds or debt funds that do not receive any specific incentives or concessions from the government or any other regulator.
Category III:
- Category III AIFs encompass hedge funds or funds aimed at making short-term returns, along with open-ended funds that do not receive any specific incentives or concessions from the government or any other regulator.
About Evergreening of Loans:
Evergreening of loans refers to the practice where banks or lenders provide additional funds or take other measures to artificially sustain a loan that is not being repaid as scheduled.
The primary objective is to avoid classifying the loan as a non-performing asset (NPA) which could necessitate setting aside more provisions for potential losses.
Purpose of Evergreening:
Evergreening is a temporary measure employed by banks to maintain the appearance of a performing asset, thereby safeguarding their profitability and financial stability.
Risk Associated:
While evergreening loans may temporarily alleviate the stress on a bank’s balance sheet, it can conceal the true extent of non-performing assets and potentially lead to a more significant financial crisis if not addressed effectively.
Classic Evergreening
Instances of non-bank lenders selling stressed loans to AIFs partially set up by the lender itself, with the fresh funds being used to repay the original debt to prevent the loans from turning bad, is “classic evergreening”.
Definition of Non-Performing Asset (NPA):
NPA refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest.
Categories of Non-Performing Assets:
Sub-standard Assets:
Sub-standard assets are those classified as NPAs for a period less than or equal to 12 months.
Doubtful Assets:
Doubtful assets are those that have been non-performing for a period exceeding 12 months.
Loss Assets:
Loss assets are considered uncollectible, with little or no hope of recovery, and require complete write-off from the bank’s books.