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Reserve Bank of India (RBI) moves to combat evergreening of loans through AIFs

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The Reserve Bank of India (RBI) has recently issued a circular for the Regulated Entities (REs) such as Commercial Banks, NBFCs, HFCs etc., with respect to their investments in certain Alternative Investment Funds (AIFs).  

The investments in question pertained to transactions involving the substitution of direct loan exposure to borrowers by REs with indirect exposure through investments in AIF units. In order to address these concerns and prevent evergreening i.e., where lender extends or rolls over existing loans to borrowers, often without adequate repayment plans or resolution of the underlying financial issues the RBI in its Circular has issued the following directives:  

1. REs are prohibited from investing in any AIF scheme with downstream investments, either directly or indirectly, in a debtor company of the RE. The debtor company is defined as any company to which the RE currently has or previously had a loan or investment exposure in the preceding 12 months.  

2. If an AIF scheme, in which an RE is already an investor, makes a downstream investment in a debtor company, then the RE must liquidate its investment in the scheme within 30 days from the date of such downstream investment. If REs have existing investments in such schemes, the 30-day period for liquidation will start from the issuing date of this circular i.e., December 19, 2023. If REs cannot liquidate their investments within the prescribed time limit, they are required to make a 100 % provision on such investments.  

3. Investment by REs in subordinated units of any AIF scheme with a ‘priority distribution model’ is subject to a full deduction from RE’s capital funds.   The term ‘priority distribution mode’ refers to a distribution waterfall structure of AIFs where one class of investors share loss more than pro rata to their holding in the AIFs with respect to the other classes of investors / unit holders.  

The above issue seems to be a jointly shared concern by SEBI and the RBI. Several news reports started emerging last year where lenders were potentially utilising certain AIF structures to circumvent regulations pertaining to classification and provisioning of bad loans. SEBI in a consultation paper in May 2023 also highlighted the issue arising out of the waterfall distribution method (as opposed to pro rata method) of profits and loss between two classes of investors i.e. junior class and senior class.  

Back in May, the RBI Governor Mr. Shaktikanta Das had cautioned banks against evergreening of loans. More recently, a SEBI Whole-Time Member Mr. Ananth Narayan G had highlighted the same issue while urging the AIF industry to set up a self-regulatory organisation.  

A copy of the RBI circular is enclosed herewith and available on the RBI website.  

Readers are welcome to send their views to Regstreet Law Advisors at info@regstreetlaw.com

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