RBI’s Regulatory Measures to Clamp Down on Loan Evergreening Through AIFs

##Introduction

The Reserve Bank of India (RBI), India’s central banking institution, has recently announced strict measures to clamp down on loan evergreening through Alternative Investment Funds (AIFs). These measures are significant as they aim to curb the prevalence of loan evergreening, which can pose serious risks to the stability of the financial system. This article discusses the concept of loan evergreening, the role of AIFs in enabling it, and the regulatory measures taken by the RBI to address this issue.

##Understanding Loan Evergreening

Loan evergreening is a practice in which lenders extend new loans to borrowers who are already struggling to repay their existing loans. This essentially provides the borrower with fresh funds to service their old debts, making it seem as though they are making timely payments. This practice can create a false sense of security and allow borrowers to continue their unsustainable borrowing behavior.

##The Role of AIFs

AIFs are privately pooled investment funds that raise money from investors for the purpose of investing in various assets. They operate as an investment vehicle for high net-worth individuals, institutional investors, and other qualified investors. AIFs have played a major role in enabling loan evergreening by acting as a channel for the infusion of fresh funds into struggling companies.

AIFs, particularly Category III AIFs, have been found to have invested in companies with high levels of debt, often to fund their existing loans. This led to an increase in the number of stressed accounts, which in turn increased the burden on the banking system. Additionally, borrowers continued to default on their existing loans, despite receiving fresh funds through AIFs, leading to a vicious cycle of loan defaults and evergreening.

##RBI’s Regulatory Measures

To address these concerns, the RBI has introduced regulatory measures to prevent AIFs from engaging in loan evergreening practices. These measures include the following:

###Limiting Exposure

The RBI has limited the exposure of AIFs to any single borrower to a maximum of 20% of the AIF’s corpus. This means that AIFs are now prohibited from investing more than 20% of their funds in a single borrower. This measure aims to prevent AIFs from becoming the sole source of funds for struggling companies and creating a dependency on them for fresh loans.

###Curtailing Multiple Structuring

The RBI has also put a cap on the number of times a loan can be restructured, at five. This means that if a loan is restructured more than five times, it cannot be further consolidated or restructured. This measure aims to prevent the evergreening of loans by limiting the number of times a borrower can receive fresh funds through loan restructuring.

###Implementing Arm’s Length Transaction Rules

The RBI has mandated that AIFs must conduct their transactions at arm’s length, meaning they must not engage in transactions with related parties. This measure aims to prevent AIFs from giving favorable terms to struggling companies in which they have an interest, thereby enabling loan evergreening.

###Requiring Asset Classification

The RBI has also mandated that AIFs must classify their investments in various categories, such as standard, sub-standard, doubtful, and loss assets, based on the quality of their assets and their repayment status. This measure aims to increase transparency and enable better monitoring of AIFs’ investments in stressed companies.

###Strengthening Reporting Requirements

The RBI has strengthened the reporting requirements for AIFs and has made it mandatory for them to report their investments on a quarterly basis. This will enable the RBI to monitor the activities of AIFs and take timely action in case of any deviations or irregularities.

##Conclusion

The RBI’s regulatory measures to clamp down on loan evergreening through AIFs are crucial as they aim to prevent the buildup of stressed accounts and mitigate the risks to the financial system. By limiting the exposure of AIFs, curbing multiple restructuring, and implementing arm’s length transaction rules, the RBI is taking important steps towards ensuring the stability of the financial system. It is essential for AIFs and other financial institutions to comply with these measures and ensure responsible lending practices to avoid any adverse consequences.