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To curb the evergreening of loans by banks and non-banking finance companies (NBFCs), the Reserve Bank of India tightened the rules of institutional investments in Alternative Investment Funds. Shilpy Sinha explains the impact of the central bank curbs.

What are AIFs? Who are the investors?
Alternative Investment Funds are privately managed funds with just a few investors, usually wealthy family offices, banks, NBFCs and other institutions and even corporate treasuries. These funds usually invest in high-yielding debt instruments and structure transactions in a complex way that helps hide the genuine nature of the financial strength of the borrower.

What is the RBI’s suspicion on the nexus between NBFCs/banks and the AIFs?
The regulator suspects that some NBFCs and banks were using these AIFs to hide their bad loans. There is a suspicion that lender-investors in AIFs used their investments to sell their troubled loans so that it was taken off their books but at the same time, their funds were owning the same loans through the AIFs.

How did these transactions work?
Banks and NBFCs lend money to companies, but when these borrowers were facing financial strain, regulators noticed them getting involved in “evergreening”. Here, the lending institution, either a bank or NBFC, bought units of AIFs. The AIFs then utilised this capital to lend to the struggling borrowing company, which, in turn, repaid the original lender.

Which is the sector that is in focus AS A RESULT OF THIS MOVE?
Several non-banking finance companies (NBFCs) in the past few years were found to have transferred their real estate and other wholesale loans to newly established AIFs, as reported by ET first on August 16, 2022. This was done along with private equity (PE) firms and asset managers.

How did these deals put lenders at a disadvantage?
The loan would be transferred under a ‘senior-junior tranche’ structure with the PE securing a ‘senior’ status. This gave the PE investor priority in receiving returns generated from the AIF’s investments. Only after the PE fund made money, the AIF proceeded to distribute the remaining balance to the NBFC, situated in the ‘junior tranche’ with a second lien. The apprehension of the regulator was that the bank/NBFC was not providing for potential losses on the restructured accounts.

What has the RBI done now?
If a bank or NBFC invests in AIF units that have also lent to a company borrowing from the same bank or NBFC, the RBI insists on the divestment of the lending institution’s stake in the borrowing company within 30 days. Moreover, if the bank or NBFC has invested in an AIF that subsequently lends to its own borrowing company, the entire amount involved must be provisioned for.

Who will be affected by the new norms?
Some banks, NBFCs and finance institutions like SIDBI and NIIF may be affected due to the provisioning rules, especially if the AIF’s investment involves stressed loans of the investee NBFCs or banks. If a bank, also a working capital provider to a performing company, is an investor they may be compelled to sell the units of the fund.

How much have banks/ NBFCs invested in AIFs?
According to Sebi data, funds raised by AIFs have risen to ₹3.74 lakh crore from ₹2.30 lakh crore in FY20. Of this, 70-80% is expected to be from global funds. The remaining 20-30% includes family offices, ultra-high net worth individuals, banks, NBFCs and others, according to market experts. Banks are not permitted to invest more than 10% of paid-up capital in Category I and Category II AIFs.

  • Published On Dec 21, 2023 at 12:46 PM IST

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