The Reserve Bank of India (RBI) has introduced new rules effective January 1, 2026, limiting how much banks, NBFCs, and other regulated entities (REs) can invest in Alternative Investment Funds (AIFs). Under these guidelines, the total investment by all REs together in any AIF scheme cannot exceed 20% of that scheme’s corpus, while each individual RE’s investment is capped at 10%. These measures are designed to reduce hidden credit risks that arise when AIFs invest in companies that owe money to the very banks and NBFCs funding those AIFs.
Earlier, regulated entities could invest large amounts freely, sometimes creating risky indirect exposures (“evergreening”) when AIFs funded their debtor companies. To counter this, RBI first banned such investments (except equity shares), requiring quick exit or full provisioning (setting aside funds to cover losses). Following industry feedback, RBI relaxed some rules in 2024 by allowing equity investments and requiring provisioning only for the portion tied directly to debtor companies, along with proportional capital deductions for subordinated units.
If a regulated entity invests more than 5% in an AIF scheme that also invests (excluding equity) in its debtor companies, it must provision fully for its share of that exposure, capped by its direct loan or investment to those companies. Equity investments are exempt from these provisioning requirements, reflecting a balanced approach between risk management and flexibility. Investments in subordinated units require full deduction from regulatory capital, split between Tier-1 and Tier-2 capital.
These new caps and provisioning rules will notably affect how AIFs operate. Restricted from relying heavily on a few regulated financial institutions, AIFs will need to broaden their investor base, seeking funds from diverse sources such as foreign investors, pension funds, and family offices. The stricter provisioning demands will push AIFs to enhance transparency and track where their money goes, helping their RE investors remain compliant. While this adds operational effort, it strengthens governance and risk controls. Overall, these rules reduce concentration risks and limit indirect funding of stressed borrowers, encouraging more diversified and transparent AIF structures that support sustainable growth of India’s alternative investment market.
RBI may exempt certain categories of AIFs in consultation with the government. Investments made before these new rules remain grandfathered, but all new or renewed investments after the effective date must comply fully. Overall, the regulations aim to promote a safer, more transparent financial system while supporting the responsible growth of the alternative investment ecosystem in India.
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