RESERVE BANK OF INDIA (INVESTMENT IN ALTERNATIVE INVESTMENT FUNDS) DIRECTIONS, 2025

The Reserve Bank of India (“RBI”) has promulgated the Reserve Bank of India (Investment in Alternative Investment Funds) Directions, 2025 vide notification dated July 29, 2025, as amended from time to time (“Directions”). The Directions shall come into operation with effect from January 1, 2026, though regulated entities (RE) retain the discretion, subject to internal policy to implement them at an earlier date.

These Directions mark a long-anticipated regulatory response to concerns that had persisted notwithstanding earlier circulars, particularly the risk of indirect exposure to high-risk assets through layered investment structures. The RBI’s approach seeks to reinforce credit discipline and prevent the circumvention of prudential norms through AIF channels while still permitting calibrated participation by financial institutions in India’s growing alternative investment ecosystem.

APPLICABILITY AND REGULATORY PERIMETER

The Directions apply to all investments made by the following REs in units of AIF schemes, irrespective of the mode or structure of acquisition:

1. Commercial banks, including small finance banks, regional rural banks, and local area banks.
2. Primary (urban) co-operative banks, state co-operative banks, and central co-operative banks.
3. All-India Financial Institutions (AIFIs).
4. All categories of Non-Banking Financial Companies (NBFCs).
5. Non-banking financial companies classified as housing finance companies.

INTERNAL INVESTMENT POLICY REQUIREMENTS

The Directions mandate that every RE update its internal investment policy to incorporate suitable provisions relating to AIF investments. Such policy revisions must ensure compliance with the Directions, the extant prudential norms applicable to the particular category of RE, and any additional sector-specific or board-mandated risk controls.

LIMITS ON INVESTMENTS AND PROVISIONING NORMS

The Directions prescribe quantitative and qualitative restrictions governing RE contributions to AIF schemes:

Individual contribution limit

No RE may contribute more than 10% of the total corpus of an AIF scheme.
This ceiling is intended to prevent any single RE from assuming a disproportionate exposure to a fund’s investment strategy or becoming a dominant capital provider capable of influencing investment decisions.

Aggregate contribution limit

The cumulative contribution by all REs collectively to a single AIF scheme shall not exceed 20% of the scheme’s corpus. This ensures that risks originating within the regulated financial system are not excessively channelled into the same AIF vehicle, mitigating systemic contagion.

Provisioning triggered by downstream exposure

Where an RE contributes more than 5% of the corpus of an AIF scheme, and the AIF has downstream exposure (other than equity instruments) to a company that is also a debtor of the RE, the RE must create a 100% provision limited to the RE’s proportionate share of the AIF’s investment in the debtor company and capped at the RE’s total direct loan and investment exposure to the same debtor.

This provision serves as a prudential buffer against credit enhancement risks that arise when an RE indirectly supports entities to which it is already exposed. By carving out equity instruments, the RBI preserves flexibility for AIFs that hold only passive equity stakes in borrower companies.

Treatment of subordinated units

Where the RE’s contribution to the AIF is in the form of subordinated units, the RE must deduct the entire value of such investment from its capital funds. The deduction is to be applied proportionately to Tier 1 and Tier 2 capital, where applicable.

This stringent treatment reflects the higher risk of subordinated units, which absorb losses ahead of senior tranches and therefore possess characteristics akin to equity or mezzanine capital. Capital deduction ensures transparent recognition of risk and prevents overstatement of regulatory capital adequacy.

LEGISLATIVE INTENT AND POLICY IMPACT

The framework:

enforces risk alignment between direct and indirect exposures;

curtails regulatory arbitrage through structured finance;

strengthens systemic oversight over the AIF ecosystem; and

preserves the developmental role of AIFs without undermining financial stability.

By imposing provisioning norms, investment caps, and governance obligations, the Directions seek to strike a balance between encouraging capital formation through AIFs and safeguarding the soundness of regulated financial institutions.