Evergreening of loans – Is RBI justified in its actions? 

Many companies have been raising funds through external commercial borrowings (although rates abroad have also risen) to retire more expensive Indian loans.

Recently, the Reserve Bank of India (the “RBI”) issued a circular restricting Regulated Entities (“REs”), including banks and Non-Banking Financial Companies (“NBFCs”), from making investments in Alternative Investment Funds (“AIFs”) that, in turn, have investments in debtor companies. A debtor company is one in which the RE currently has or, during the preceding 12 months, had a loan or investment exposure. The circular aims to address concerns relating to the possible evergreening of loans to borrowers through AIFs.

Evergreen loans simply refer to endless loans.   In some cases, REs have been taking minority stakes in AIFs, and AIFs have used the invested capital to subscribe to debentures or other instruments of debtor companies. The funds so received by the debtor companies are used to repay the earlier unpaid loans of REs. This helps REs show a lower percentage of Non-Performing Assets in their books.

Some of the key and onerous aspects of the circular are:

1] REs must not make an investment in any scheme of an AIF, which plans to make or has made downstream investments either, directly or indirectly, in a debtor company of the RE.

2] If an AIF scheme, in which an RE is already an investor, makes a downstream investment in any debtor company, then the RE must liquidate its investment in the scheme within thirty (30) days from the date of the downstream investment by the AIF.

Read: RBI bars lenders from investing in AIFs linked to borrowing companies

3] If the RE is unable to liquidate its investment in such AIF scheme within thirty (30) days, it must make a 100% provision on such investment in its books of accounts.

4] An investment by an RE in subordinated units of an AIF scheme with a “priority distribution model” will lead to a full deduction from the RE’s capital. “Priority distribution model” refers to an AIF’s adoption of a distribution waterfall that allows a class of investors to share losses more than pro rata to their holdings in the AIF when compared to other investors.

Following the circular, many NBFCs have started to make the necessary provisions in their books. Moreover, funding to NBFCs is also being scrutinised in more detail, and there are fears that some NBFCs may have to shut shop as funding may dry up.

Although the circular aims at curbing evergreening of loans, it seems to be painting all debtor companies with one broad brush stroke. Companies often seek to retire higher interest loans with lower interest ones in order to reduce their interest outflow. Many Indian companies have been raising funds through external commercial borrowings (although rates abroad have also risen) to retire more expensive Indian loans. Although the RBI’s move is well intended and seeks to eliminate fraudulent transactions, prohibiting any exposure by REs to AIFs invested in “debtor companies” will result in collateral damage for AIFs in general.  AIFs are already seeing a funding crunch on this count.

Further discussion needs to be had with the stakeholders and more precise guard rails need to be put in place by the RBI. Rather than have a carte blanche ban, the audit committees of the REs should be tasked with assessing whether an investment in an AIF is for bona fide business purposes or to evergreen a loan. Adequate disclosures should be made to the stock exchanges if loans are being taken by debtor companies from AIFs to ensure transparency and integrity of the financial system. A collaborative approach rather than a ban will aid the debt markets significantly.

Akil Hirani is Managing Partner, Majmudar & Partners, India. Views are personal, and do not represent the stand of this publication.