Summary of this article
RBI caps bank and NBFC investments in AIFs to limit risks.
New rules curb indirect exposure to existing borrowers via AIFs.
Move aims to improve transparency and protect financial system integrity.
The Reserve Bank of India (RBI) has issued fresh guidelines to limit how much banks and non-banking financial companies (NBFCs) can invest in alternative investment funds (AIFs). These rules, which will come into effect from January 1, 2026, aim to curb indirect exposure to the banks’ and NBFCs’ borrowers and strengthen trust in the financial system. The directions follow concerns about some lenders using indirect routes, such as AIFs, to finance companies that have already borrowed from them.
What Is an AIF and How Does It Work
An AIF is a privately-pooled investment vehicle that collects money from investors and invests it in areas not covered by traditional instruments, such as stocks or bonds. These include start-ups, private equity, real estate, and infrastructure.
AIFs are classified into three categories. Category I includes investments in start-ups and infrastructure, Category II includes private equity and debt funds, and Category III covers hedge funds and other high-risk strategies.
Banks, NBFCs, and financial institutions sometimes invest in these funds to earn higher returns and diversify their portfolios. However, this can become risky when an AIF, backed by a bank, invests in a company that also owes money to the same bank. That leads to a double exposure, both direct and indirect, to the same borrower and poses risk to the bank as well.
What the New RBI Rules State
The new directions, titled Reserve Bank of India (Investment in AIF) Directions, 2025, apply to all scheduled commercial banks, cooperative banks, NBFCs, and All-India Financial Institutions. They replace the older circulars issued in December 2023 and March 2024.
The key changes are:
A single bank or NBFC cannot invest more than 10 per cent of the total corpus of any AIF.
All regulated entities together cannot invest more than 20 per cent of the corpus of any AIF.
If a bank or NBFC holds more than five per cent of an AIF and the fund then invests (excluding equity) in a borrower company of that bank or NBFC, the entity must make 100 per cent provision for its indirect exposure.
If the investment is in a subordinated unit (riskier tranche), the entire amount must be deducted from capital.
This directive by the RBI essentially discourages banks and NBFCs and other lenders from routing funds to their own borrowers through AIFs, a practice that had drawn regulatory attention, of late.
Why RBI Felt the Need for Stricter Rules
These measures come at a time when the RBI has been voicing concerns about some financial institutions prioritising short-term performance over ethical practices. RBI Deputy Governor Swaminathan J also recently cautioned banks and NBFCs against pursuing these practices.
“Driven by intense competitive pressures and a desire to project short-term success, the management of certain banks and NBFCs appears to believe that the ends justify the means,” Swaminathan said at Karur Vysya Bank’s foundation day event in Tamil Nadu last week.
He said: “Some lenders are resorting to practices such as creative accounting and liberal interpretations of regulations… which lead to supervisory interventions. It is important to pursue growth with systems, people, and processes that are aligned and rooted in ethical practices, from the boardroom to the branch. Every rupee must carry intent, not just interest.”
He added that growth must be pursued within the boundaries of governance and integrity, and financial decisions must serve a purpose beyond just profit.
How Will This Impact the Financial Sector
For banks and NBFCs, the rules may lead to a more cautious approach when it comes to investing in AIFs. They will now need to check whether an AIF is planning to invest in a borrower they have already lent to. For AIFs, this might mean a dip in fundraising from regulated entities, especially if their investment strategy includes sectors with high levels of existing bank credit.
For the financial system as a whole, the move is expected to improve transparency and reduce the risk of hidden exposures.
Will This Impact Consumers?
While individual consumers won’t feel any direct change, the new rules support a more stable financial environment. Tighter regulation will reduce the chance of unexpected risks affecting the system, thereby also protecting depositors and borrowers.
