The Reserve Bank of India (RBI), through its latest directive issued on July 29, 2025, has introduced a critical shift in the way regulated entities (REs) such as banks and NBFCs can invest in Alternative Investment Funds (AIFs). As per the new guidelines, the RBI has capped the total contribution of all REs in any AIF scheme at 20% of the scheme’s total corpus. Additionally, no single RE will be allowed to contribute more than 10% of the corpus of a particular scheme.
These directions will come into effect from January 1, 2026, or from an earlier date if decided internally by a regulated entity. The move is being positioned as a decisive step towards better risk management, increased transparency, and alignment with SEBI’s due diligence and investment norms.
In this blog, you’ll learn what these guidelines mean, why they were issued, and what impact they may have on the financial ecosystem and on the functioning of AIFs in India.
The New Guidelines at a Glance
Here’s what the circular issued by the RBI outlines:
- Individual Cap: A single regulated entity cannot contribute more than 10% of the corpus of an AIF scheme.
- Collective Cap: The total contribution of all REs in an AIF scheme must not exceed 20% of its corpus.
- Downstream Investment Provisioning: If an RE contributes more than 5% to an AIF scheme that in turn has downstream investments (excluding equity instruments) in a company already classified as the RE’s debtor, the RE must make 100% provision on its proportionate investment in that debtor, subject to the extent of the direct loan or investment exposure.
- Subordinated Units: If the RE’s investment in the AIF is in the form of subordinated units, it must deduct the entire investment from its capital funds, distributed proportionately between Tier-1 and Tier-2 capital, wherever applicable.
These directions apply to:
- Commercial Banks (including Small Finance Banks, Local Area Banks, and Regional Rural Banks)
- Primary (Urban) Co-operative Banks
- State and Central Co-operative Banks
- All-India Financial Institutions
- NBFCs (including Housing Finance Companies)
Why RBI Introduced These Guidelines
The RBI’s motivation behind this move is grounded in regulatory tightening and risk mitigation.
At the core of this revision lies the growing concern around the misuse of the AIF route for the evergreening of loans. In several instances, REs were indirectly funding troubled borrowers through AIFs – effectively using pooled vehicles to avoid direct provisioning or downgrade triggers. This loophole allowed some financial institutions to maintain cleaner books without truly addressing underlying asset quality issues.
By enforcing a 10% individual limit, RBI aims to decentralise exposure and limit concentration risk. AIFs, by nature, are meant to be risk-managed diversified investment vehicles, not tools for regulatory arbitrage. The new 20% collective ceiling further ensures that the AIF scheme remains independent of being overtaken by regulated entities’ interests.
Provisioning and Capital Treatment: The Fine Print
One of the most critical components of the circular relates to provisioning requirements for downstream investments.
If a regulated entity holds more than 5% of the corpus in an AIF, and that AIF has made downstream investments (excluding equity) in a company that is already a debtor to the RE, the RE will now be required to provision 100% of its proportionate exposure to that company – capped at the RE’s direct exposure.
This clause directly targets the mechanism of using AIFs to bypass income recognition and asset classification norms (IRAC). By introducing steep provisioning, the RBI is effectively discouraging REs from investing in AIFs that redirect funds to existing stressed or delinquent borrowers.
Similarly, if the contribution to the AIF is made in subordinated units, which rank below other claims in a liquidation event, the RE must deduct the entire investment from its capital base. This ensures that capital adequacy metrics are not inflated through high-risk indirect exposures masked as investments.
These measures make it significantly costlier, both from a capital and accounting perspective, for REs to engage in indirect lending through AIFs, especially to borrowers already on their books.
Implications for Regulated Entities
For banks and NBFCs, this circular marks a strategic inflection point. AIFs have, in recent years, served as tools for diversification, higher yield generation, and in some cases, backdoor lending. But the revised guidelines narrow the leeway for such activities.
Some likely implications include:
- Tighter Internal Compliance: REs will now need to monitor AIF investments more rigorously to ensure they remain within the caps.
- Reduction in Concentrated Bets: Institutions with significant exposure to single AIFs will need to rebalance portfolios.
- Capital Recalibration: Investments via subordinated units will now directly affect the capital adequacy position, pushing REs to reconsider such instruments.
- Provisioning Buffer Impact: In cases where downstream exposure overlaps with existing debtor relationships, 100% provisioning can heavily dent quarterly earnings, thereby discouraging such overlaps.
These changes are likely to trigger internal risk audits, capital planning reviews, and changes to AIF investment strategy within financial institutions.
Implications for AIFs and Fund Managers
From the perspective of AIFs and their fund managers, the circular may limit the quantum of funds raised from banks and NBFCs. Historically, regulated entities have been a significant investor category in AIFs, particularly in Category II and Category III funds focused on debt or hybrid instruments.
Some expected effects include:
- Diversified Investor Base: Fund managers will now need to increase participation from HNIs, family offices, and institutional investors not governed by RBI norms.
- Stronger Governance Mechanisms: With the RBI’s focus shifting to indirect exposures, AIFs may see increased scrutiny on where and how capital is deployed, especially in debt-heavy schemes.
- Cautious Downstream Lending: AIFs will need to evaluate their downstream portfolios more conservatively, especially when accepting RE investments exceeding 5% of corpus.
This could also result in better transparency and alignment of AIF investment strategies with both SEBI and RBI frameworks.
Alignment with SEBI and the End of Arbitrage
Another key highlight is that the RBI’s revised directions bring RE-related AIF investments in alignment with SEBI’s existing guidelines on due diligence and risk assessment. This ensures consistency across India’s financial regulators, plugging regulatory gaps that may have allowed exploitation through layered structures.
Arbitrage between RBI and SEBI regulations may have created avenues for AIFs to be used for indirect lending practices that didn’t fully align with prudent banking norms. These revised guidelines aim to close that window and ensure greater regulatory consistency.
The Bottom Line
The RBI’s July 2025 circular is a landmark move in India’s journey toward strengthening financial sector stability. By limiting both individual and collective exposure of regulated entities in AIF schemes, the central bank appears to be sending a clear message – that risk-taking should be backed by responsibility, transparency, and capital discipline.
From 2026 onward, banks, NBFCs, and other regulated players will need to treat AIF investments not just as opportunistic alpha generators but as exposures requiring strategic evaluation and robust risk controls.
For fund managers, the next 12 months will be crucial. The challenge lies in diversifying investor pools, enhancing governance, and aligning with the new expectations of India’s financial regulators. In a landscape where compliance is becoming non-negotiable, these revised directions set the tone for a more resilient and responsible investment ecosystem.
At BeFiSc, we’re helping financial institutions and asset managers stay ahead of these evolving regulations through intelligent APIs and compliance-driven data infrastructure. From investor onboarding to risk checks and entity validation, our tools are built to ensure your AIF operations remain future-ready and regulator-aligned.
