RBI finalises its new rules for investments in AIFs by Banks and NBFCs

Two months ago, the Reserve Bank of India (“RBI”) issued a draft notification dated May 19, 2025 (the “May 2025 Draft Directions”) proposing various changes to previous regulations issued in December 2023 and March 2024 (“Old Regulations”) which had prohibited banks and other entities regulated by the RBI (“Regulated Entities”) from investing in any scheme of an alternative investment fund (“AIF”) which has downstream investments either directly or indirectly in a debtor company of such Regulated Entity. The RBI has now issued a notification dated July 29, 2025 (the “July 2025 Final Directions”) which is primarily based on the May 2025 Draft Directions, with a few crucial differences.

The key features of the new regime introduced by the July 2025 Final Directions are as follows:

• The July 2025 Final Directions shall come into force on January 1, 2026. However, any Regulated Entity may implement the July 2025 Final Directions from an earlier date, if it so wishes.
• The July 2025 Final Directions shall apply to all Commercial Banks, Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, All-India Financial Institutions, NBFCs and Housing Finance Companies.
• No Regulated Entity shall individually contribute more than 10% of the corpus of an AIF Scheme. The aggregate contribution by all Regulated Entities in any AIF Scheme shall not be more than 20% of the corpus of that scheme.
• If a Regulated Entity contributes more than 5% of the corpus of an AIF Scheme, which also has downstream investment (excluding equity instruments) in a debtor company of the Regulated Entity, then the Regulated Entity shall be required to make 100% provision to the extent of its proportionate investment in the debtor company through the AIF Scheme, subject to a maximum of the direct loan and/ or investment exposure of the Regulated Entity to the debtor company.
• If a Regulated Entity’s contribution to an AIF is in the form of subordinated units, then it shall deduct the entire investment from its capital funds – proportionately from both Tier-1 and Tier-2 capital (wherever applicable), even if the Regulated Entity has contributed less than 5% of the corpus of an AIF Scheme.
• The Old Regulations stand repealed with effect from January 1, 2026. Any new commitment by a Regulated Entity for contribution to an AIF scheme, made after January 1, 2026, shall be governed by the July 2025 Final Directions. However, any outstanding investment by a Regulated Entity, on the date of issuance of the July 2025 Final Directions (that is on July 29, 2025), in an AIF Scheme in which it has fully honoured its commitment, shall be governed by the provisions of the Old Regulations. Further, if any investment is made by a Regulated Entity in an AIF Scheme at any time pursuant to a commitment existing as on July 29, 2025, or in terms of a new commitment entered into before January 1, 2026, the Regulated Entity has the option to follow, in toto, either the Old Regulations or the July 2025 Final Directions.

• The most important difference between the July 2025 Final Directions and the Old Regulations is that under the Old Regulations, there was no cap on a Regulated Entity’s investment in an AIF scheme which has invested in a debtor company of the Regulated Entity as long as the Regulated Entity made provisions for its investment in the AIF to the extent of the Regulated Entity’s investment in the AIF scheme. Under the July 2025 Final Directions, there is an absolute prohibition on any investment by a Regulated Entity in an AIF exceeding the prescribed caps, namely an individual cap of 10% of the corpus of the AIF Scheme and an aggregate cap of 20% of the corpus for all Regulated Entities in any AIF Scheme. Even if the AIF’s investment in the underlying debtor company is in the equity of such company, these caps cannot be exceeded. The Old Regulations imposed a provisioning requirement only if the AIF invests in the debt securities of a debtor of the Regulated Entity. It is likely that the limits under the July 2025 Final Directions will affect the operations of various AIFs which depend on funding from Banks and NBFCs for their underlying investments.

• Paragraph 8(b) of the July 2025 Final Directions sets out crucial rules for the switch from the Old Regulations to the July 2025 Final Directions and its language could cause some confusion. Paragraph 8(b) states as follows:

Notwithstanding the above repeal provisions:

1. Outstanding investment by a RE, on the date of issuance of these Directions, in a AIF Scheme in which it has fully honoured its commitment, shall be governed by the provisions of the existing circulars.
2. In respect of any investment made by a RE in a AIF Scheme in terms of an existing commitment as on the date of these Directions, or in terms of a new commitment entered into before the effective date, the RE shall follow, in toto, the provisions of either the existing circulars or the revised Directions.”

On a strict reading of sub-paragraph (i) of Paragraph 8(b), it can be inferred that if a Regulated Entity has made a capital commitment to an AIF and such capital commitment has been fully drawndown, investments in the AIF from which the Regulated Entity has not exited will be governed by the Old Regulations. So, if a Regulated Entity has made a capital commitment to an AIF and such capital commitment has not been fully drawndown, investments by the Regulated Entity in the AIF made prior to July 29, 2025, will not be mandatorily governed by the Old Regulations. However, sub-paragraph (ii) of Paragraph 8(b) (which gives Regulated Entities the option to follow, in toto, either the Old Regulations or the July 2025 Final Directions in respect of investments covered by sub-paragraph (ii)) seems to apply only to investments made after July 29, 2025, though it doesn’t say so in as many words. Further, the situation detailed in this paragraph is not covered by the lead statement in Paragraph 8(a) of the July 2025 Final Directions which states that “any new commitment by a RE for contribution to an AIF scheme, made after the effective date, shall be governed in terms of the revised Directions. Therefore, it may be possible to take the view that a Regulated Entity could take advantage of the option provided by sub-paragraph (ii) of Paragraph 8 with respect to any investment made prior to July 2029, provided the Regulated Entity’s capital commitment to the AIF was not fully drawndown on July 29, 2025.

1. 1. • The key differences between the July 2025 Final Directions and the May 2025 Draft Directions are as follows:
   2. • The May 2025 Draft Directions did not expressly repeal the Old Regulations. They also stated that, all outstanding investments as on January 1, 2026, or subsequent drawdowns out of commitments made prior to January 1, 2026, shall continue to be guided by the provisions of the Old Regulations. The July 2025 Final Directions have expressly repealed the Old Regulations. However, the July 2025 Final Directions provide that outstanding investments by a Regulated Entity shall continue being governed by the Old Regulations, provided the Regulated Entity has fully honoured its commitment to the AIF scheme. The July 2025 Final Directions also permit a Regulated Entity to choose between the Old Regulations and the July 2025 Final Directions with respect to investments made by the Regulated Entity in any AIF Scheme pursuant to a commitment existing as on July 29, 2025 or in terms of a new commitment entered into before January 1, 2026. This flexibility offered by the July 2025 Final Directions allows Regulated Entities to assess which framework best aligns with their current operations and avoid disruption in their ongoing transactions.
   3. • The ‘General Requirements’ clause of the May 2025 Draft Directions state that all investments made by a Regulated Entity under this framework shall be subject to the ‘test of evergreening’. This language is not present in the July 2025 Final Directions, possibly because the July 2025 Final Directions have expressly repealed the Old Regulations.
   4. • The July 2025 Final Directions has fixed the overall limit on investments by Regulated Entities in a single AIF scheme at 20%. This limit was 15% in the May 2025 Draft Directions.
   5. • Under the May 2025 Draft Directions, if a Regulated Entity contributed more than 5 % to the AIF scheme’s corpus and the AIF had downstream investments (excluding equity instruments) in a debtor company of the Regulated Entity, the Regulated Entity was required to make a 100% provision of its proportionate exposure through the AIF scheme in the debtor company. The July 2025 Final Directions have placed a cap on the provisioning requirement which is to the extent of the Regulated Entity’s direct loan and/or investment exposure to that debtor company. For example, if a Regulated Entity has invested Rs. 10 crore in an AIF, which has a total corpus of Rs. 100 crore and the AIF has invested Rs. 20 crore in a Tech company and the Regulated Entity has lent Rs. 1.5 crore to the same Tech company, under the May 2025 Draft Directions, the Regulated Entity would have to make a provision of Rs. 2 crore which is the Regulated Entity’s proportionate exposure through the AIF scheme in the debtor company. Under the July 2025 Final Directions, the Regulated Entity would have to make a provision of Rs. 1.5 crore which is the Regulated Entity’s direct loan exposure to the debtor company.

The May 2025 Draft Directions can be found here.

The July 2025 Final Directions can be found here.

The December 19, 2023, notification can be found here.

The March 27, 2024 notification can be found here.

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Vinod Joseph, Partner – Email – vinodjoseph@elp-in.com

Zaynali Badami, Associate – Email – zayanalibadami@elp-in.com