RBI notifies restrictions on investments by regulated entities in AIFs’
In a decisive move to recalibrate institutional investments and fortify the financial ecosystem, the Reserve Bank of India (RBI) has released the RBI (Investment in AIF) Directions, 2025. These comprehensive guidelines overhaul the existing framework governing how regulated entities (REs) such as banks, NBFCs, and other financial institutions allocate capital to Alternative Investment Funds (AIFs). With stricter exposure caps, mandatory provisioning requirements, and sharper focus on investment-linked risk, the Directions signal a more cautious regulatory stance—aimed at mitigating systemic vulnerabilities and curbing potential misuse of AIF structures. This blog unpacks the key provisions, their far-reaching implications, and the strategic shifts mandated for REs.
Background
The Reserve Bank of India (“RBI”) issued the RBI (Investment in AIF) Directions, 2025 (“RBI Directions”), on July 29, 2025revising the permissible exposure limits of its regulated entities in alternative investment funds (“Bribe”). This regulatory shift follows the draft guidelines circulated earlier this year, which proposed curbing capital infusion by RBI-regulated institutions into AIFs, signalling a more stringent oversight regime.
RBI has mandated that the following regulated entities (“REs”) comply with the RBI Directions pertaining to their investments in AIF: (a) Commercial Banks, including Small Finance Banks, Local Area Banks, and Regional Rural Banks; (b) Primary (Urban), State, and Central Co-operative Banks; (c) All-India Financial Institutions; and (d) Non-Banking Financial Companies (NBFCs), including Housing Finance Companies.
The RBI Directions will come into effect from January 1, 2026or earlier, subject to each RE’s internal policy (“Effective Date”). This paper provides an analytical overview of the key provisions and implications of the RBI Directions.
Limitations on RE exposure
Under the RBI DirectionsREs are now subject to enhanced investment thresholds for AIFs. Specifically:
- At an individual RE levelinvestment in a single AIF is capped at 10% of the fund’s corpus.
- At the AIF levelcumulative investment from all REs cannot exceed 20% of the fund’s corpus.
Historically, such investment caps were applicable primarily to banks, restricting their contributions to 10% of paid-up/ unit capital in Category I and II AIFs — subject to prior RBI approval. The revised RBI Directions extend these constraints to other financial institutions, notably Non-Banking Financial Companies (NBFCs)reflecting RBI’s intent to limit AIFs’ dependence on institutional capital from such entities.
This move is likely to considerably alter the prevalent industry practice of AIFs being anchored or substantially capitalised by banks and NBFCs.
Requirement of Provisioning
As per the RBI Directions, if an RE contributes more than 5% of the corpus of an AIF that subsequently holds investments (other than equity instruments) in a debtor company of the RE, the RE is obligated to make a 100% provision — limited to its proportionate exposure through the AIF, subject to the maximum of its direct credit or investment exposure in the debtor company.
For regulatory purposes, the term ‘debtor company’ includes any entity to which the RE has extended (or had extended) loans or non-equity investments within the preceding 12 months.
The RBI Directions explicitly define ‘equity instruments’ to comprise – (a) equity shares; (b) compulsorily convertible preference shares (“CCPS”); and (c) compulsorily convertible debentures (“CCDs”).
Additionally, when an RE’s contribution is made via subordinated units, the entire investment must be deducted from the RE’s capital funds, split proportionately between Tier-I and Tier-II capital, as applicable. Such subordinated exposure have often been used to facilitate AIF-led acquisition of distressed assets and to attract third-party capital through senior unit issuance — a structure that aligns with the RBI’s earlier caution against ‘evergreening’, as highlighted in its December 2023 notification.
Exemptions
The RBI, in consultation with the Government of India, by a notification, may exempt certain AIFs from the scope of the RBI Directions (except the general requirement as stated below).
This exemption may apply to government-backed AIFs that are considered strategically important.
General Requirement: Applicable to all REs
All REs must now incorporate appropriate provisions within their respective investment policies to govern their AIF participations. These provisions must ensure full compliance with the applicable laws, regulations, and the RBI Directions.
Repeal provisions
- Legacy Investments: Outstanding investments by an RE in an AIF where entire commitments have been honoured as on the date of issuance of the RBI Directions, shall continue to be governed by the provisions of the earlier circulars (dated December 19, 2023, and March 27, 2024, – “RBI Notifications”).
- Investments Under Existing or Pre-Effective Date Commitments: For investments made pursuant to an existing commitment as on the date of the RBI Directions, or a new commitment entered into prior to the Effective Date (i.e., January 1, 2026, or earlier, per RE’s internal policy), the RE must adhere fully to either the previous RBI Notifications or the newly issued RBI Directions, in their entirety.
- Investments Post-Effective Date: Any fresh commitment to an AIF by an RE post January 1, 2026, shall be governed exclusively by the provisions of the RBI Directions, 2025.
Conclusion
The RBI has extended a measure of regulatory relief (by carving out REs having equity exposure in debtor companies via its new directions) compared to its earlier notifications, which had categorically barred REs from investing in AIF schemes with direct or indirect downstream exposure to debtor companies. Furthermore, the RBI’s provision of optionality allows REs with existing investments in AIFs to choose between complying with the previous notifications or adopting the newly issued directions, offering a welcome flexibility and relief to these REs.