Banks’ exposure to AIFs: Group-wide limits introduced

– Simrat Singh | Finserv@vinodkothari.com

The RBI has long been stitching up the seams where AIF structures threatened to pull at the fabric of Banking regulation. The latest amendment to the Reserve Bank of India (Commercial Banks – Undertaking of Financial Services) Directions, 2025 is another careful thread in that ongoing work. The provisions apply not only to banks directly but also to exposures routed through their group entities (meaning subsidiary, JV or associate of the bank). Banks (and their group entities) may still participate in AIFs but only within closely drawn boundaries. The message is unambiguous: the AIF route cannot be used to skirt evergreen exposures or manufacture regulatory arbitrage. 

Limits on investment in AIF schemes

For Category I and Category II AIFs, limits apply at both the individual bank level and at the group level.

• At the bank level, no bank may contribute more than 10% of the corpus of any AIF scheme;
• At the bank group level, investments are permitted within a corridor:
  • Less than 20% of the corpus of Cat I or Cat II AIFs may be invested without prior approval, provided the parent bank continues to meet minimum capital requirements and has reported net profit in each of the preceding two financial years. This means even the AMC along with the bank cannot hold more than 20%;
  • Between 20% and 30% of the corpus may be invested with prior RBI approval.

A systemic cap overlays this: contributions from all regulated entities  – banks, NBFCs, co-operative banks and AIFIs etc. – cannot collectively exceed 20% of any AIF corpus. Similarly investment in the unit capital of REITs and InvITs is capped at 10%, within the overall ceiling of 20% of net worth for equity, convertible instruments and AIF exposures. 

A question may arise on whether such limits, as applicable to investments in AIFs, would also be applicable to making investments in FMEs operating in IFSC? Practically, Indian banks are unlikely to invest in FMEs, because such investments would cause the FME to lose its tax benefits. For an FME to qualify as a “specified fund”, all its units must be held by non-residents, except those held by the sponsor. When this condition is met, the income of the fund is exempt under Section 10(4D) and the income received by non-resident investors is exempt under Section 10(23FBC) of the Income Tax Act. 

No circumvention of regulations through investments in AIFs 

Banks shall ensure that their exposure in an investee company through their investments in AIF schemes does not result in circumvention of any regulations applicable to banks. (see para 38D). This would mean that where a bank is restricted from having any exposure in an investee company (this may include restrictions on account of the end-use of funds, or restrictions in terms of limits to exposures etc), such exposures cannot be made indirectly through making investments in AIF schemes, which, in turn, leads to the bank’s exposures to such investee companies. 

Prohibition on Category III AIFs

The clearest prohibition concerns Category III AIFs. Banks are not permitted to invest in their corpus at all. If a subsidiary is a sponsor, it may hold only the minimum contribution required under SEBI’s regulations (which currently is lower of 5% of the corpus or ₹10 Crore as per proviso to Regulation 10(d) of the SEBI AIF Regulations, 2012). Highly traded, leveraged or long-short strategies are thus kept outside the perimeter of bank funding in a deliberate effort to insulate bank balance sheets from hedge-fund-type risk.

Globally, regulators have taken a different, more permissive route. In the United States, banks are not barred from investing in hedge-fund-type vehicles. Instead, the Volcker Rule restricts ownership to de-minimis levels, generally up to 3% of a fund and 3% of Tier 1 capital in aggregate.¹

Under Basel’s CRE 60 framework, investments in funds are permitted, however, discipline lies in capital treatment:

• If the bank can look-through to underlying exposures, risk weights are based on the underlying assets²;
• Where transparency is not available, risk weights can rise to punitive levels, up to 1,250% –  making opaque fund exposures extremely capital-intensive.

Recently, IMF in its October 2025 Financial Stability Report has highlighted that banks’ exposures to non-banks, including private-credit and private-equity funds, have grown materially, raising concerns about concentration and potential spill-over risks.

India therefore stands apart. Where other jurisdictions rely on expensive capital and other constraints to manage hedge-fund-type exposures, the RBI has chosen to keep such structures outside the banking perimeter altogether. 

Provisioning and Capital Treatment

Capital consequences have also been tightened. Where a bank holds more than 5% of the corpus of an AIF that subsequently invests – other than in equity instruments³ – into a debtor company of the bank, a 100% provision must be created for the bank’s proportionate exposure (See our write-up on the same here). This directly addresses the risk that AIFs could become conduits for evergreening or indirect refinancing of stressed loans.

Overall Perspective

The Amendment Directions extend the guardrails on AIF participation to the bank group, as against the previous approach of regulating only the bank’s exposures. Guardrails are numerical and backed by provisioning and capital consequences. Any breach in the limits require reporting to RBI, with clear reasons and plan for corrective actions. For existing investments, banks are required to provide an action plan by 31st March, 2026 – ensuring the compliances within a maximum of 2 years, viz., 31st March 2028. 

RBI’s stance is more conservative than many international regimes, but the regulatory intent is unmistakable: prudential norms are not to be diluted simply because exposure is packaged through an AIF.

1. See Section 619 of Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010 ↩︎
2.  CRE 60 offers three routes for capital treatment – look-through, mandate-based and fall-back – chosen according to how much visibility the bank has into the fund’s underlying assets. ↩︎
3. Equity instruments means equity shares, compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCDs) ↩︎

See our other relevant resources:

1. Bank group NBFCs fall in Upper Layer without RBI identification
2. Group-level regulation: RBI brings major regulatory restrictions on banks and group entities
3. RBI norms on intra-group exposures amended
4. New NBFC Regulations: A ready reckoner guide