The Reserve Bank of India (RBI) on July 29, 2025, issued the RBI (Investment in AIF) Directions, 2025, redefining the regulatory framework for investments by regulated entities (REs)—banks and NBFCs—into Category I and II Alternative Investment Funds (AIFs) The new rules replace the earlier blanket prohibition on investments in AIFs that finance borrowers of these REs, offering a more flexible yet prudential structure.
Under the new norms:
If an RE invests over 5% in an AIF that has downstream investments in debtor companies of that RE (excluding equity or convertible instruments), the RE must provision 100% on its proportionate exposure—capped at its direct loan/investment exposure to the debtor company
Equity instruments—including equity shares, compulsory convertible preference shares (CCPS), and compulsory convertible debentures (CCDs)—are now excluded from provisioning requirements and from “debtor company” definition
Investment in subordinated units of an AIF now requires full capital deduction from both Tier‑1 and Tier‑2 capital, proportionately—strengthening capital adequacy and reducing hidden leverage
The directions are effective from January 1, 2026, though REs may adopt them earlier per their internal policies. Investments made or commitments honored before the effective date may continue under older circulars, or choose to follow the new regime
These directions strike a balance between safeguarding the financial system and promoting market development. By limiting exposure and ensuring provisioning, RBI mitigates risks such as evergreening, where stressed assets may get recycled via AIFs to mask financial weaknesses
Relaxing the outright ban while imposing limits allows banks and NBFCs to gradually return to investing in AIFs, especially equity-focused ones. This regulatory clarity is expected to enhance liquidity for startup and private credit ecosystems, benefitting economic growth and employment sectors such as infrastructure, fintech, and NBFCs themselves
Students preparing for exams like IAS, PSCS, Railways, Banking, Defence, Teacher and Police services should note:
In December 2023, RBI had imposed a blanket ban on AIF investments by REs if the AIF held exposure to the lender’s borrowers. This was triggered by alarming cases of evergreening, where banks masked stressed assets through structured investments. The March 2024 follow‑up clarified that pure equity investments were excluded from the ban, though restrictions remained tight with compulsory provisioning
In May 2025, RBI issued draft guidelines proposing a 15% collective cap, 10% individual cap, and 5% provisioning threshold—but still limited in flexibility
After stakeholder consultation—especially via industry bodies like IVCA—RBI finalized its August 2025 norms, increasing the collective limit to 20%, expanding exempt instruments, and formalizing transition regimes. These reflect RBI’s calibrated shift from rigid safeguards toward risk-based rules
An AIF is a privately pooled investment vehicle, which collects funds from investors to invest according to a defined investment policy. It includes hedge funds, private equity, and venture capital funds.
RBI has allowed individual regulated entities (REs) to invest up to 10% and collectively up to 20% of a scheme’s corpus.
REs must make 100% provisioning on their exposure if they invest more than 5% in an AIF that has downstream non-equity exposure to their own borrowers.
Because equity investments (like shares, CCPS, CCDs) are considered long-term and not structured for evergreening, hence less prone to misused debt recycling.
These are junior tranches that absorb losses first. RBI mandates capital deduction from Tier 1 or Tier 2 capital for such units.
The new directions will be effective from January 1, 2026, with optional early adoption.
To prevent evergreening of loans and increase transparency in financial markets while still promoting institutional participation in AIFs.
The news covers topics from financial regulations, RBI policies, banking sector reforms, and capital market oversight—all commonly asked in UPSC, Banking, and SSC exams.
Yes, for investments made or commitments honored before January 1, 2026, earlier circulars apply, unless they choose to adopt the new framework early.
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