1. Introduction:
The Reserve Bank of India (RBI) has released the much-anticipated “Reserve Bank of India (Investment in AIF) Directions, 2025”, which replaces the restrictive 2023 circular with a more nuanced and risk-based regulatory framework. These updated rules mark a significant shift in how Regulated Entities (REs)—such as banks and NBFCs—can participate in Alternative Investment Funds (AIFs).
Let’s delve into what these new directions entail, how they differ from the older ones, and what they mean for India’s financial and investment landscape.
2. What Are AIFs?
Alternative Investment Funds are privately pooled investment vehicles that collect funds from investors to invest in private equity, venture capital, real estate, infrastructure, and distressed assets. These are regulated by SEBI and classified into three categories:
- Category I: Startups, SME funds, infrastructure funds, etc.
- Category II: PE funds, debt funds, etc.
- Category III: Hedge funds, complex strategies
3. Key Highlights: RBI (Investment in AIF) Directions, 2025
Released on July 29, 2025, and effective from January 1, 2026 (or earlier if voluntarily adopted by REs), the new directions aim to:
i. Investment Caps
| Criteria | New Direction (2025) |
| Per RE Limit | Max 10% of the AIF scheme’s corpus |
| Aggregate RE Limit | Max 20% (all REs combined) |
This ensures that no single RE or group of REs dominates a fund’s ownership.
ii. Provisioning Norms for Downstream Exposure
The 2025 guidelines introduce a tiered provisioning model based on the extent of exposure:
| Scenario | Provisioning Requirement |
| Investment ≤ 5% of AIF corpus | No provisioning, regardless of downstream debt exposure |
| Investment > 5%, and AIF has downstream debt to RE’s borrower | 100% provision on RE’s proportional share |
| Investment in subordinated units (in priority distribution model) | Exposure deducted from Tier-1/Tier-2 capital |
| Investment in equity instruments (shares, CCPS, CCDs) | Exempt from provisioning rules |
This framework strikes a balance between regulatory oversight and investment flexibility.
iii. Equity vs Debt Distinction
Unlike the previous norms, the new directions draw a clear line between debt exposures (risky and subject to provisioning) and equity-type instruments (exempt). This benefits AIFs focused on startup equity or long-term capital, aligning RBI policy with SEBI’s fund classification.
iv. Capital Adequacy Implications
If an RE subscribes to subordinated units in AIFs with a priority distribution structure (e.g., waterfall models), such exposures are treated as first-loss positions and must be deducted from regulatory capital.
This step is consistent with international Basel norms on capital treatment of high-risk exposures.
4. Comparison with Previous Frameworks
Let’s contrast the 2025 Directions with RBI’s 2023 Circular and the 2024 transitional clarification:
A. December 2023 Circular (Highly Restrictive)
- Prohibited REs from investing in AIFs with downstream exposure to RE’s borrowers.
- Mandated REs to liquidate such investments within 30 days, or provision 100%.
- Applied even to minor exposures.
- No distinction between equity and debt.
√ Impact: Widespread disruption. Many AIFs had to return capital. Banks and NBFCs pulled back sharply.
B. March 2024 Clarification (Partial Relief)
- Allowed investment but required 100% provisioning if exposure to RE’s own borrowers existed.
- If the investment was in subordinated units, capital deduction was required.
- Still no relief for small investments or equity-only exposures.
√ Impact: Offered a bridge, but did not revive investor confidence fully.
C. July 2025 Final Directions (Balanced and Risk-Based)
- Introduces threshold (5%) below which no provisioning is needed.
- Differentiates between debt and equity exposure.
- Increases aggregate RE limit to 20%.
- Maintains capital deduction for subordinated units, aligning with risk principles.
√ Impact: Industry sees it as a rational, calibrated framework that safeguards REs without stifling capital formation.
5. Key Provisions: 2025 Directions vs Earlier Framework
| Provision/Feature | Dec 2023 / Mar 2024 | Draft May 2025 | Final Directions July 2025 |
| Individual RE limit | Not specified (subject to complete ban/exit) | Proposed 10% corpus cap per RE | 10% per RE, effective Jan 1, 2026 |
| Aggregate RE limit | Not specified | Proposed 15% aggregate cap for all REs | Final 20% aggregate cap |
| Safe investment threshold | No safe threshold | Up to 5% corpus allowed without restrictions | Same: ≤ 5% with no provisioning |
| Provisioning beyond the threshold | 100% on the entire AIF investment | 100% on proportional downstream exposure | 100% provision if >5% and AIF has downstream debt exposure |
| Equity carve-out | Not clearly exempted | Equity is excluded from the downstream scope | Equity instruments (shares, CCPS, CCDs) are exempted |
| Subordinated units treatment | 100% capital deduction required | Same, with more clarity | Deduction from Tier‑1 & Tier‑2 capital if subordinated units |
| Strategic exemption clauses | Not discussed | Proposed possibility | RBI may exempt strategic AIFs after the government consults |
| Transition rules for existing investments | Investors had to exit or provision immediately | Draft allowed grandfathering of existing commitments | Existing investments may follow previous norms until Jan 2026 |
6. Objectives Behind the New Framework
The 2025 Directions aim to achieve:
a. Prevent “Evergreening” of Loans
Some REs was indirectly refinancing distressed borrowers by investing in AIFs that later lent to those borrowers. This regulation shuts that loophole.
b. Promote Financial Stability
By controlling exposure to interconnected entities, the framework reduces systemic risk.
c. Encourage Long-Term Capital Formation
AIFs, particularly those focused on equity, play a crucial role in funding startups and infrastructure. The rules support these while insulating the financial system from credit risks.
7. Industry Response
√ Disclaimer for AIFs: The 5% safe threshold provides breathing room for equity-oriented or early-stage funds without counterparty risk triggering.
√ Capital Planning: The robust treatment of subordinated unit exposures forces a more cautious approach to PDM structures.
√ Exemptions & Strategic Funds: Particularly relevant for socially‑important funds like SWAMIH, though exemptions will be granted judiciously, considering parity with foreign sovereign funds.
√ Alignment with SEBI: The RBI’s framework now dovetails with SEBI’s due diligence mandates for large investors and cross-border regulatory oversight, reinforcing a united regulatory front.
8. Conclusion
The RBI Directions, 2025, mark a significant regulatory maturation—from outright prohibition to calibrated, risk‑based governance. By introducing defined caps, a safe harbour, differential treatment for equity, and capital treatment consistency, the RBI has crafted a framework that supports responsible investment in AIFs while guarding against systemic risks.
As the guidelines roll out in 2026, REs and AIFs will need to update their internal policies, monitoring mechanisms, and capital-planning tools to stay compliant and seize new opportunities.
Disclaimer: –
The information provided is for educational purposes and should not be considered as professional advice. The author shall not be liable for any direct, indirect, special, or incidental damage resulting from, arising out of, or in connection with the use of the information.
References:
1. RBI Official Circular (2025)
2. Business Standard Report (July 29, 2025)
3. SEBI Regulations on AIFs
4. Reuters: RBI Caps RE Investment in AIFs
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