The Reserve Bank of India has proposed norms for regulated entities (mostly banks and non banking financial companies) to invest up to 15% in an Alternative Investment Fund (AIF).
Category 1 AIF has been a key investment vehicle for domestic venture capital firms, mobilising money from Indian investors for early-stage investments. A lot of angel investors and seed funds institutionalised and redirected their personal investments through AIFs over the last few years.
“This move by the RBI is significant to rupee capital formation through AIFs. Banks and NBFCs are important institutional investors in AIFs,” said Siddarth Pai, founding partner of 3One4 Capital, a domestic VC firm.
The RBI’s move comes after the market regulator Sebi’s discussions with the industry, after which the latter issued specific due diligence guidelines, which address some of the concerns.
Last December, the financial sector regulator asked banks and NBFCs to stop investing in AIFs and also make full provisioning for the investments made in AIFs. This has set panic among RBI-regulated entities, who have stopped AIF investments.
The primary concern emerged after the RBI found that certain financial institutions were evergreening their loans and investments in AIFs. The practice was sometimes used when some AIFs did not make a profit within their stipulated lifespan and were forced to extend their fund life beyond the limit set by Sebi.
Progressive regulation is transformative
“Governor Sanjay Malhotra’s bold recalibration paves the way for capital from RBI-regulated entities to fuel AIFs — a transformative boost for India’s entrepreneurial landscape,” said Gopal Srinivasan, chairman and managing director of TVC Capital Funds, an investment firm.
Since the RBI notice to financial institutions, the industry has been in talks with the regulators, and the circular is a relaxation of the earlier stand RBI took on the matter.
Among the key asks of AIFs has been that banks and NBFCs should not be asked to provision for AIF investments in equity-linked instruments such as CCDs and CCPS.
Startups raise money through CCD (Compulsory Convertible Debenture) and CCPS (Compulsory Convertible Preference Share).
The Indian AIF industry is around Rs 13.5 lakh crore in capital commitments as of March 31, 2025. The industry's aim is to reach at least Rs 30 lakh crore by 2030.
“To reach this target, the simplification of regulation and the removal of artificial regulatory barriers to investing in alternatives is key,” Pai added.
15% cap is restrictive
While the RBI announcement has come as a positive surprise to many in the industry, VCs said that they will press the RBI and Sebi for a cap of 20-25 percent, rather than 15 percent.
“There is no basis for a 15 percent cap. We will make a representation again,” said one of the VC investors.
According to another investor, if multiple banks and NBFCs are making an investment in a particular AIF, the risk is mitigated.
AIFs are considered riskier assets as the certainty of returns is not expected to match the current NPAs of banks’ lending division. However, the likelihood of outsized returns is also much greater.
“RBI has always been conservative when it comes to risk, but progressive when it comes to regulation and technology. This is a first step, and the regulator is likely to raise the cap gradually over the next few years,” said a senior banking consultant who works with the RBI and other government agencies.
“This is a positive surprise. It is good to have Indian banks and NBFC entities allowed to invest in AIFs,” said Karthik Reddy, managing partner of Blume Ventures.
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