The Reserve Bank of India (RBI) has expressed significant apprehensions regarding the utilization of Alternative Investment Funds (AIFs) in conjunction with stressed loans, primarily revolving around the practice known as "evergreening." This term refers to the strategy employed by lenders to perpetually postpone the categorization of loans as non-performing assets (NPAs) through a series of financial manoeuvres.
The mechanism of this practice entails several steps:
A borrower, encountering financial distress, holds a loan from a bank that is teetering towards classification as an NPA.
In response, the bank takes the initiative to establish an AIF and injects a portion of the stressed loan into it.
External investors also participate by contributing to the AIF, thereby augmenting its capital base.
Subsequently, the AIF employs the consolidated funds to reinvest in the same beleaguered borrower, temporarily alleviating their financial woes and, consequently, delaying the loan's reclassification as an NPA.
The RBI's concern is multifaceted, rooted in the potential ramifications of this practice:
Obscuring Borrowers' Financial Health: Evergreening creates a veil over the true financial status of borrowers, rendering it challenging to accurately evaluate the risk entailed in stressed loans. This opacity, in turn, poses difficulties in ascertaining the overall financial stability of banks and the broader health of the financial system.
Hindrance to Timely Resolution: By deferring the classification of loans as NPAs, banks are disincentivized to take prompt and necessary measures to recover the distressed debt, thereby prolonging the resolution process.
Risk to Investors: Investors who funnel funds into AIFs may not possess full awareness of the actual risks tied to the underlying investments, particularly when these funds are employed to evergreen stressed loans.
In response to these concerns, in June 2023, the RBI implemented more stringent regulations governing lenders' involvement in AIFs, aimed at rectifying the situation. These new directives expressly forbid lenders from:
Investing in AIFs that, in turn, hold investments in companies to which the lender itself is indebted.
Maintaining investments in AIFs that are engaged in investments in companies to which the lender has a debtor relationship.
In summation, the RBI's vigilance regarding the employment of AIFs stems from the potential misuse of this avenue to conceal the actual extent of bad loans within the Indian banking system. In order to mitigate these concerns, the RBI has taken proactive measures to bolster regulatory oversight of lenders' engagements with AIFs.
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