AIF Circular Concerns: Get lenders dressing up loans to cut exposure, AIFs tell RBI

Stunned by a volley of harsh new rules, alternative investment funds (AIFs) in India have put their cards on the table.

A fund lobby has told RBI it would accept a directive that forces lenders which have used AIFs to ‘evergreen’ loans to slash exposure to 10% of a fund corpus within six months from the date of RBI’s circular. It has also mooted a limit on investment by a non-banking finance company (NBFC) in an AIF.

Bona fide investments
The AIF industry, it is learnt, is ready to function under a regulatory framework that imposes such a cap – as exists for banks. While a bank’s investment in an AIF is typically restricted to 10% of the size of the fund, no such rule exists for NBFCs.

These are among the key proposals made by the fund industry body in its representation to the Reserve Bank of India (RBI) in the wake of the central bank’s sweeping measures, a person familiar with the subject told ET.

The strict dos and don’ts imposed by RBI in a circular on December 19 are aimed at restraining lenders from using AIFs to move funds to help near-delinquent borrowers and hide the stress on loan books.

But since the RBI directive covered all banks and AIFs – irrespective of the size and nature of the deals – it rattled several wholesale lenders, as well as fund managers who now fear investments by banks and NBFCs into AIFs could virtually dry up.

Thus, while the AIF industry is willing to embrace regulatory steps that would curb practices such as loan evergreening, it has reached out to RBI to protect bona fide transactions.

What the industry’s saying
First, according to the fund body, development finance institutions such as Sidbi, Nabard, Exim Bank should be spared the new, broad-brush RBI rules on grounds of their governance standards and the specific role played by many of these in fulfilling the government’s initiatives on AIFs.

Second, banks whose investment in an AIF is within the regulatory stipulated level of 10% of the paid-up capital of the fund should be exempt from the new rules. “Technically, a bank can exceed the 10% level with RBI’s permission. However, there is no bank I know which has done this,” said a banker.

Third, it wants a decision on an exposure limit for NBFCs – say, at 10%, as for banks – and for the regulator to keep NBFCs whose investments are within this limit outside the purview of the new rules.

RBI strictures
Last week’s rules ban a bank or NBFC from investing in any AIF which, in turn, has invested in a company that has borrowed from the investing bank or NBFC. In cases where such investments already exist, lenders have to either liquidate the investment in 30 days (from the date of issuance of the circular) or make 100% provisioning on such investment.

“AIFs are typically close-ended. On one hand, it is impossible to exit without a heavy loss within a month; on the other hand, provisioning would hurt the financials of all entities which have put money in the AIFs,” said a person aware of the matter. “Under the circumstances, this 30-day timeline should be extended to a realistic period. This is essential to safeguard the interests of banks and NBFCs that have not used AIFs to evergreen loans.”

The most pertinent point in RBI’s note states, “Investment by REs (regulated entities, that is, banks and NBFCs) in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds.”

Such transactions – which, in all likelihood, triggered the new RBI rules – entail a lender (typically an NBFC) cutting a deal with a foreign credit fund to invest in a 30:70 or 40:60 ratio to set up a local AIF that makes downstream investments in debentures issued by distressed borrowers of the NBFC.

These borrowers then use the new debt money from the AIF to pay off the NBFC, while the AIF issues senior units to the foreign investor (which has the first claim on repayments by debenture issuers) and junior units to the NBFC (which is paid only after the foreign partner is paid).

It was an evergreening technique perfected by less than a dozen NBFCs to delay defaults hitting their asset books. This was done without technically breaking any rules.

“The AIF industry understands what drove RBI. So, it thinks such NBFCs should be mandated to cut their exposures to AIFs below 10% within six months,” said another person in the know. “Since such evergreening requires an NBFC to put in 40% of the AIF capital, the transaction will not work if the NBFC can’t invest above 10%.”

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