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Alternative investment funds have urged the banking regulator to ease rules after the central bank capped combined investment by banks, non-bank lenders and other regulated entities into such vehicles, according to four people with knowledge of the development.

The Reserve Bank of India (RBI) last week issued a circular introducing an overall cap, barring entities regulated by it from investing more than 15% in alternative investment funds (AIFs). In case of a ₹100 crore fund, banks, cooperative banks, financial institutions and non-bank financial companies (NBFCs) put together cannot invest more than ₹15 crore. That’s a setback for the ecosystem, which has so far depended on domestic financial institutions to raise the bulk of its capital.

AIFs include private equity, venture capital, hedge funds, and other vehicles that invest in alternative assets, such as real estate, startups, and infrastructure.

Also read: Why AIFs need regulatory innovation for next phase of growth

The AIF industry has asked the RBI to either make it a group-wise ceiling or to relax it to 25%, the people said on the condition of anonymity.

Apart from reviewing the ceiling, the industry has also urged the RBI to relook “applying this circular retrospectively", said Siddarth Pai, cofounder 3one4 Capital, an early-stage venture capital firm. “We hope to see some relaxations being made to this."

The Indian AIF industry had capital commitments worth around ₹13.5 trillion as of 31 March. It aims to at least double it to ₹30 trillion by 2030. Most of these venture capital, venture debt and private equity firms raise capital from domestic high-net-worth individuals, family offices, banks and other financial institutions, mutual funds, insurance companies and corporates.

“The aggregate ceiling of 15% being too low… would severely impact the access that the domestic fund management industry has to an important stream of institutional capital," said Swapneil Akut, partner-investment funds & securities law at S&R Associates, a law firm. “If one RE (regulated entity) invests up to its entitlement of 10%, then only 5% is left for other REs."

On 19 May, however, RBI said banks, non-bank lenders and financial institutions may get to invest up to 10% in the corpus of AIFs, in a relief for the sector that faced a central bank clampdown in December 2023.

There will be no restriction on regulated entities such as banks for investing up to 5% in the AIF scheme's corpus, RBI proposed. However, if the AIF scheme invests in a company that has borrowed from the bank, then the regulated entities must make full provision to the extent of its proportionate exposure, the draft circular said.

Also Read: Managing market volatility: How AIFs turn risk into opportunity

Fund managers are also looking at ways to raise capital outside of the domestic institutions to mitigate the regulatory risks.

“We hope to shift the bulk of our fund-raise focus overseas and hope to work under GIFT City jurisdiction. Indian regulations have sadly not been conducive to ease of business for AIFs," said Anand Lunia, founding partner, India Quotient, a homegrown early-stage venture capital firm. “The government reduced capital gains tax, which is such a positive step. But there are sections in regulations that perhaps intrinsically believe AIFs are out to scam."

India Quotient is currently raising its fifth $130 million ( ₹1,000 crore) VC fund.

Investments by banks, NBFCs and other financial services companies in AIFs have been under the banking regulator’s scrutiny.

On 19 December 2023, RBI asked lenders not to invest in AIFs that have direct or indirect downstream investments in companies that were borrowers in the last 12 months. Such existing investments were required to be liquidated or fully provided for within 30 days. This prompted several large private banks to make significant provisions against these investments in their financials for the last two quarters of FY24.

These guidelines were aimed at preventing instances of evergreening by using the AIF route to repay existing, potentially distressed loans.

In March this year, however, the regulator clarified that these investments would exclude equity shares, compulsorily convertible preference shares and compulsorily convertible debentures. It also said the provisioning will be required only to the extent of investment by the regulated entity in the AIF scheme, which is further invested by the AIF in the debtor company, and not on the entire investment of the entity in the AIF scheme.

In Monday’s circular, RBI said the regulatory measures have brought “financial discipline among the REs regarding their investment in AIFs".

Also Read: Do AIF investors need easier accreditation?

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