The Reserve Bank of India has tightened norms for lenders relating to making investments in units of Alternative Investment Funds (AIFs).
This is being looked at the central bank addressing concerns related to possible evergreening of stressed loans.
An AIF is a privately pooled investment vehicle, which collects funds from investors, for investing it in accordance with a defined investment policy.
How does evergreening work?
A debtor company due to repay a loan or instalment, but in a stressed liquidity situation, can give a list of mutual funds/fund houses, which have invested either in their equity or debts through AIFs, to the lender.
This list can also include AIFs, which have not invested in the debtor company so far, but the the company is eligible for an investment from them.
The lender invests in the AIF with an understanding that the money will in turn be invested partly or fully in its debtor company.
The debtor company then uses the funds received from AIF (mostly as debt) and repays the lender on due date. The company then can avail additional finance from the lender after clearing old dues.
The RBI is seeking to put a stop to such transactions that entail substitution of direct loan exposure of lenders to borrowers as this could lead to ‘concealment of the real status’ of stressed loans.
The tightening of norms comes in the wake of RBI Governor Shaktikanta Das, in a May 2023 speech, drawing the attention of bank directors to central bank supervisors, to instances of such concealment.
‘To mention a few, such methods include bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments; good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress; use of Internal or Office accounts to adjust borrower’s repayment obligations; renewal of loans or disbursement of new / additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans;…,’ Das said.
The RBI said lenders cannot make investments in any scheme of AIFs, which has downstream investments either directly or indirectly in a company that has borrowed/ debtor company (currently has or previously had a loan or investment exposure anytime during the preceding 12 months) from them.
Liquidation notice and investment value
In case lenders have this kind of exposure, they have 30 days to liquidate them. Further, if lenders are not able to liquidate their investments within this time limit, they have to make 100 per cent provision on such investments.
RBI’s circular on ‘Investments in AIFs’ applies to commercial banks, urban co-operative banks, all-India financial institutions and non-banking finance companies (NBFCs), including housing finance companies.
Any lender which is required to liquidate its investment in the AIF within the 30-day redemption period outlined in this circular will have to redeem it based on the prevailing Net Asset Value (NAV) of the AIF. Alternatively, lenders must allocate 100 per cent provision in their books for the invested amount, thereby restricting their capacity to utilize their funds elsewhere.
The central bank prescribed full deduction from lenders’ capital funds if they have investments in the subordinated units of any AIF scheme with a ‘priority distribution model.’
Under priority distribution model, certain schemes of AIFs have a distribution model such that one class of investors share loss more than pro rata to their holding in the AIF vis-à-vis other classes of investor, since the latter has priority in distribution.
Analysts fear investors might face a significant reduction in the value of their initial investment, due to these norms, also lead to reduction of the pool of investable assets for AIFs.
Industry participants plan to reach out to RBI for more clarity.