Alternate Investment Funds Not Convinced With RBI Clarifications On Lender Investments

The Reserve Bank of India issued a revised framework for investments by lenders into alternate investment funds or AIFs on Wednesday. But, industry players are wishing for more leeway.

"The recent RBI circular does provide some operational and regulatory clarity but also raises new questions," said Siddarth Pai, co-chair of Regulatory Affairs Committee at Indian Venture and Alternate Capital Association.

Contrary to the RBI's earlier circular on AIF regulations released in December, the central bank clarified that downstream investments by AIFs shall not apply to investments in equity shares of the debtor company of the lender.

According to the RBI's definition, debtor firms are those which have either borrowed or received investments from the same banks or NBFCs in the last 12 months.

All the other investments including hybrid instruments will come under the purview of the circular.

Pai pointed at a debate in the industry that whether AIFs would need to convert their hybrid instruments into equity. This, against the backdrop of no mention of how investments from private equity and venture capital funds will be treated, will be crucial, according to Siddharth Shah, partner at Khaitan & Co believes.

Private equity firms and venture capital make investments in companies already existing in lenders' books through compulsorily convertible instruments, which includes preference shares and debentures.

"This circular look to essentially cover credit funds, which are more prone to be used for evergreening," Shah said.

Industry players are likely to seek clarity on applicability of the revised norms on private equity and venture capital funds, as they prefer convertible instruments to protect themselves in case a company winds down its business, Shah added.

Another concern is that whether lenders who have existing capital commitments to AIFs can still honour capital calls to funds who do not meet the specific criteria in the revised circular.

Dipen Ruparelia, head of products at Vivriti Asset Management believes banks and development financial institutions should be exempted from the circular.

The RBI stated that AIF investments by lenders through intermediaries such as fund of funds or mutual funds are excluded from the aforementioned restrictions.

Under the prudential norms, banks cannot invest more than 10% of the AIF's corpus without approval from the central bank. However, there is no such cap on NBFCs.

"If a regulated entity has a capital commitment in an alternative investment fund, which has made an investment in a debtor company of the RE, post the RBI's revised circular, the regulated entity may still not be in a position to honor the undrawn capital commitments. This can have some resulting impact for the AIF, depending on the extent of such commitment." Ruparelia said.

Ball In Lenders' Court

The RBI directed banks and non-bank lenders to provide for the extent of investment in the AIFs, instead of providing for the entire investment of the lender in the AIF scheme.

Moreover, this provisioning can be deducted from tier-1 and tier-2 capital base equally. Setting aside funds from only tier-1 capital would erode net worth of the bank, Shah of Khaitan & Co. said.

In December quarter, five private banks made provisions of Rs 2,573 crore against their AIF portfolios. While HDFC Bank had the maximum provisions of Rs 1,220 crore, ICICI Bank set aside Rs 627 crore against AIF exposure.

Several banks had made 100% provisions against their investments in AIFs, which is not required now under the revised circular and some of these provisions may need to be written-off in the March quarter, Shah said.

"This clarification may lead to partial reversal of AIF investments hit taken by lenders in Q3," Citigroup said in a research note on Thursday.

With this relaxation, banks may be able to honour their capital commitments to AIFs as the impact on capital base would soften in the coming quarters, according to Shah.

"Practically, to the extend that a bank is adversely affected by the circular, the manager may offer a bank contributor an option to curtail their commitment drawdown and get excused from further drawdown to their capital commitments," Shah said.

"What has been already put in, they may do a LP secondary sale...However, with this circular, provisioning norms seem fairly achievable, so some of them may end up making provisions and continue with their commitment as it has been," he added.