To prevent possible evergreening of loans through investments in schemes of alternative investment funds (AIFs), the Reserve Bank of India (RBI) tightened lending standards on Tuesday.
While regulated entities (REs) engage in units of AIFs as part of their regular investing operations, the RBI has discovered that certain transactions were not in accordance with regulatory standards. As a result, "in order to address concerns about possible evergreening via this route," it said that REs shall not participate in any scheme of AIFs that involves downstream investments — either directly or indirectly — in a debtor firm of the particular RE.
In this case, a debtor company is any company to whom the RE has now or previously extended a loan or had investment exposure during the prior 12 months.
All commercial banks, including small financing banks, local area banks, regional rural banks, co-operative banks, non-banking financial firms (NBFCs), and financial institutions, are subject to the rules.
According to Veena Sivaramakrishnan, partner at Shardul Amarchand Mangaldas & Co, while the RBI calling out specific structures is unusual, it does not come as a surprise because the central bank has always been concerned with concealed bad loans and evergreening as a principle.
"The priority/senior — junior structures adopted by certain entities would fall squarely within the purview of this circular and given the timelines prescribed, they would need to be quickly relooked for alternative structuring," she went on to say.
Separately, the RBI stated that if an AIF scheme already has a RE as an investor and continues to make a downstream investment in any bankrupt company of the RE, the RE must liquidate their position in the scheme within 30 days after the AIF's downstream investment.
"If REs have already invested in such schemes with downstream investment in their debtor companies as of today, the 30-day liquidation period shall begin on the date of issuance of this circular." "REs shall promptly arrange to advise the AIFs appropriately in the matter," it stated.
If REs are unable to liquidate their investments within the time frame specified, they must make a full provision for such investments. The RBI further stated that RE investments in subordinated units of any AIF scheme with a 'priority distribution model' will be fully deducted from the RE's capital funds.
According to Jyoti Prakash Gadia, MD of Resurgent India, the decision is timely and will prohibit money from being used for the evergreening of debt of group enterprises or connected parties. "The AIF is invested in riskier debt and other unquoted instruments that have lesser transparency, and there is a likelihood of it being used for payment of existing stressed loans earlier given by the banks," the finance minister added.
Furthermore, the regulation aims to close the loophole of improper use of additional borrowed money via the AIF route to avoid the rules governing advance restructuring and NPA disclosure. REs will now be required to make a 100% provision for such outstanding debt, which he believes will be a significant deterrent to irregularities.
According to Reuters, Kotak Mahindra Bank Group has announced that it will combine its alternate fund management and investment advice operations into an entity with $18 billion under management. The organisation, known as Kotak Alternate Asset Managers (KAAM), would feature $8.9 billion in alternative investment funds and a $9.1 billion consulting business.
