RBI shuts down ‘evergreening’ tactics in year-end cleanup

The Pattern #134

RBI shuts down ‘evergreening’ tactics in year-end cleanup

Mayank Jain

Head - Marketing and Content

Dec 22, 2023

Hello everyone,

Welcome to the 91st edition of The Pattern, a weekly newsletter where we dissect and dive into the rumblings in finance, economy, and technology. Let’s get started.

Sense and sensibility

The Reserve Bank of India has always had a reputation for being one of the toughest banking regulators. It is now leaning into it.

On Tuesday, the RBI released a rather innocently titled circular ‘Investments in Alternative Investment Funds (AIFs). However, the message isn’t as innocent as the title - especially when it comes to large lenders with large loan exposures to large corporates.

The RBI has effectively told lenders that they can no longer continue to park their money in AIFs - heavily managed funding vehicles - which go on to fund their not-very-merry borrowers downstream.

“Regulated entities (REs) make investments in units of AIFs as part of their regular investment operations. However, certain transactions of REs involving AIFs that raise regulatory concerns have come to our notice. These transactions entail substitution of direct loan exposure of REs to borrowers, with indirect exposure through investments in units of AIFs,” the bank said in the notice.

This is expected to put brakes on the alleged ‘evergreening’ practices by barring lenders from handing out more credit lifelines through these funds/vehicles.

“Since rules prohibit lenders from doing this blatantly, some of them, mostly non-banking companies, had figured out a different way some years ago. They cut special deals with foreign credit funds, which bet on comparatively lower-rated bonds, to set up local alternative investment funds (AIFs). These AIFs (an umbrella term for PE, VC, infra, special situation funds etc) became the new conduits for half a dozen non-banking finance companies (NBFCs) to evergreen their loans,” ET wrote in an analysis.

The kind of deals and structuring of such investments can often be loopy enough to confound even the best accountants and finance professionals.

The RBI seems to want to assess the true extent of stress in the lending books of the industry, and at the same time, ensure that none of this stress builds up in the dark to one day explode in our faces.

And just like its recent insistence on increased risk weights to stem personal unsecured lending, the AIF missive seems to be working.

Reports suggest that large lenders, including Piramal Enterprises, are planning to set aside provisioning funds to cover their investments in AIFs.

The RBI has mandated that wherever the lenders cannot liquidate their AIF investments that downstream fund borrowers, they should make 100% provisions for them.

“In case REs are not able to liquidate their investments within the above-prescribed time limit, they shall make 100 percent provision on such investments,” the RBI said in its notice.

In a filing, Piramal Enterprises said that it’ll look to provision for Rs 31.64 billion for its investments while its total AIF exposure is closer to Rs 38.17 billion.

This isn’t all - other NBFCs and banks are following in lockstep and curbing their AIF exposure or increasing provisioning coverage.

But this isn’t just going to be about the bad loans. AIFs have been gaining popularity for banking institutions as a vehicle for hedging, alternate value investing and higher-than-market returns on capital. The regulatory checks and balances might reduce the overall interest in AIFs and eventually make them seem obsolete or unnecessary even as lenders would be hard-pressed to find other investment vehicles or models to achieve their objectives.

It’s clear that whatever macro picture emerges next, the RBI will be there at ground zero - ensuring that nothing shaky is ever allowed to take off the ground.

This is all from me this week. Have a Merry Christmas and a great new year. We’ll be on a break starting today and we’ll be back in the first week of January.

Reading list

Between the digits