RBI’s New Playbook for AIF Investments: Stronger Rules to Prevent “Evergreening”

Posted On - 23 June, 2025 • By - Asha Kiran Sharma

The Reserve Bank of India (RBI) has released new draft Directions on how banks and other regulated financial companies (REs) can invest in Alternative Investment Funds (AIFs). These proposed changes, opened for public feedback till June 8, 2025, representing a significant step in the RBI’s ongoing efforts to enhance financial discipline and mitigate potential risks, particularly the practice of “evergreening” within the financial system.1

Evolution of Regulatory Scrutiny

The journey towards these revised directions began with the RBI’s initial guidelines on December 19, 20232. The primary objective of these earlier measures was to address concerns surrounding the potential use of AIFs as a conduit for evergreening. This practice involves masking stressed assets by giving new loans to a struggling borrower just so they can pay back an old one, making the problem seem to disappear without actually fixing it – much like putting a fresh coat of paint on a rusty car without dealing with the rust underneath.

The December 2023 circular specifically prohibited REs from investing in AIF schemes that had direct or indirect downstream investments in a debtor company of the RE – meaning a company that had a loan or investment exposure from the RE within the preceding 12 months. If such a situation arose after an RE had already invested, the RE was required to liquidate its investment within 30 days or make a 100% provision on it. Furthermore, investments by REs in “subordinated units” of AIF schemes using a “Priority Distribution Model” (PDM) – where certain investors take losses before others—were subject to full deduction from the RE’s capital funds, ensuring robust capital buffers against these riskier instruments.

Following feedback from stakeholders, the RBI issued important clarifications on March 27, 20243. These clarifications specified that the prohibition on downstream investments would exclude investments in equity shares of the debtor company, focusing the restriction primarily on debt-like investments. The 100% provisioning requirement was also refined, mandating provisioning only to the extent of the RE’s investment in the AIF scheme that was specifically linked to the downstream investment in the debtor company, rather than the entire AIF investment. Additionally, the strict capital deduction rule for subordinated units under PDM was clarified to apply only when the AIF did not have any downstream exposure to a debtor company of the RE, and the deduction would be equally split between Tier-1 and Tier-2 capital. These previous regulatory interventions have reportedly fostered greater financial discipline among REs regarding their AIF exposures. Concurrently, the Securities and Exchange Board of India (SEBI) has also introduced its own guidelines, notably through its Alternative Investment Funds Regulations, 2012 (last amended on August 06, 2024), which mandate specific due diligence for investors and investments within AIFs, ensuring transparency and accountability4. This concerted effort by both regulatory bodies underscores a unified approach to prevent the circumvention of established regulatory frameworks.

Key Proposals

The new draft Reserve Bank of India (Investment in AIF) Directions, 2025, builds upon these foundations with several critical proposals. First, it introduces clear investment limits. No single RE shall contribute more than 10% of an AIF scheme’s total size (corpus). Collectively, all REs investing in any AIF scheme shall be capped at 15% of its corpus. These limits are designed to prevent excessive concentration of any single RE’s exposure in an AIF and promote a broader investor base.

Second, a significant change is introduced regarding provisioning for downstream debt investments. While investments by an RE up to 5% of an AIF scheme’s corpus are allowed without specific restrictions, if the investment exceeds this threshold and the AIF scheme has a downstream debt investment (excluding equity instruments like shares or compulsorily convertible debentures/preference shares) in a debtor company of the RE, the RE will be required to make a 100% provision on that proportionate exposure. This particular measure is a direct and potent tool against evergreening, making it financially prohibitive for REs to use AIFs to indirectly fund their own struggling borrowers. This compels them to recognize and account for the true risk of such hidden exposures. Furthermore, if an RE’s contribution is in the form of subordinated units under the Priority Distribution Model, the entire investment must be deducted from its capital funds—equally from both Tier-1 and Tier-2 capital. This stringent requirement acknowledges the higher risk profile of these instruments, ensuring REs maintain adequate capital to cover potential losses.

Applicability and Transition

The RBI has also provided for the power to exempt certain AIFs from the directions by consultation with the Government of India, considering that these AIFs may be set up for strategic purposes to serve a national need, in which case different regulatory treatment is necessary. The revised Directions will apply to any tax or legal obligations to be implemented prospectively from the effective date. All investments whether existing investments as of the effective date or subsequent amounts withdrawn out of previous commitments as of the effective date will be governed by the conditions of existing circulars and other conditions of the AIFs, such that it enables an easy transition without jeopardizing, for example, the current portfolios.

In principle, these Directions are applicable to the investment by any RE, into the units of AIF Schemes. A few examples of these REs include Commercial Banks (such as Small Finance Banks, Local Area Banks, and Regional Rural Banks), Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, All-India Financial Institutions and Non-Banking Financial Companies (including Housing Finance Companies). For specificity, the Directions define a ‘debtor company’ to be any company to whom the RE has now or has had loan or investment exposure (not equity instruments) at any time during the preceding 12 months. ‘Equity instruments’ are defined to be equity shares, compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCD), distinguishing them from the debt instruments that trigger the strict provisioning rules.

Conclusion

In conclusion, the revised draft Directions on RE investment in AIFs represent a proactive and analytically informed regulatory measure by the RBI. By imposing clear investment limits, introducing stringent provisioning requirements for downstream debt exposures, and maintaining a clear focus on preventing evergreening, the RBI aims to further strengthen the financial system’s resilience and plug potential loopholes. The prospective application and the transparent consultation process demonstrate a balanced approach to implementing these crucial changes, ultimately contributing to a more stable and disciplined financial landscape in India.

  1. https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=4646 ↩︎
  2. Reserve Bank of India – Notifications ↩︎
  3. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12639&Mode=0 ↩︎
  4. https://www.sebi.gov.in/legal/regulations/aug-2024/securities-and-exchange-board-of-india-alternative-investment-funds-regulations-2012-last-amended-on-august-06-2024-_85618.html ↩︎