In a move to combat the practice of perpetually renewing stressed loans, the Reserve Bank of India (RBI) issued a circular instructing banks, non-banking financial companies (NBFCs), and other lenders to refrain from participating in any alternative investment funds (AIFs) schemes with downstream investments in a debtor company.

The term AIF refers to any fund established or incorporated in India that serves as a privately pooled investment vehicle. Such funds gather funds from sophisticated investors, whether Indian or foreign and invest them per a defined investment policy for the benefit of investors. Regulated entities (REs) typically invest in units of AIFs as part of their regular investment operations. However, the RBI highlighted specific transactions of REs involving AIFs that raise regulatory concerns. Evergreening of loans is a process whereby a lender tries to revive a loan that is on the verge of default or in default by extending more loans to the same borrower. The process of evergreening of loans is typically a temporary fix for a bank.

Prevention of evergreening

To address concerns relating to possible evergreening, the following guidance is provided –

1. REs are directed not to invest in AIF schemes that have any downstream investments either directly or indirectly in a debtor company of the RE. The debtor company of the RE, for this purpose, shall mean any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
2. If an AIF scheme, in which RE is already an investor, makes a downstream investment in any such debtor company, then the RE shall liquidate its investment in the scheme within 30 days from the date of such downstream investment by the AIF. If REs have already invested into such schemes having downstream investment in their debtor companies as on date, the 30-day period for liquidation shall be counted from the date of issuance of this circular. REs shall forthwith arrange to advise the AIFs suitably in the matter.
3. In case REs are not able to liquidate their investments within the above-prescribed time limit, they shall make 100 percent provision on such investments.

In addition, investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds. ‘Priority distribution model’ shall have the same meaning as specified in the SEBI circular SEBI/HO/AFD-1/PoD/P/CIR/2022/157 dated November 23, 2022.

By implementing specific measures to curtail the substitution of direct loan exposure with indirect exposure and mitigate the risks associated with potential evergreening, the RBI aims to enhance transparency and prudence in financial transactions. The strict guidelines regarding investments in AIFs and the imposition of provisions on delayed liquidation demonstrate the central bank’s commitment to fostering responsible lending practices and safeguarding the stability of the financial sector. These measures, enacted under the authority of relevant banking and regulatory acts, emphasize the importance of immediate compliance, signalling a critical step toward fortifying the integrity of the financial system.