Keep the AIF baby, chuck the bathwater
RBI has closed a loophole in the discovery of dodgy loans by pulling bank lending out of investment pools that also feed the same borrowers. This is a genuine regulatory concern, voiced by Sebi, given the ballooning flow of capital through alternative investment funds (AIFs). RBI's directive to banks and NBFCs to liquidate their investments in AIFs that invest in their debtor companies is informed by previous instances of evergreening bad loans through shadow lending.
The central bank has moved with alacrity on Sebi's findings that AIFs were being structured for such purposes.
Questions over execution of the quarantine are of equal import — the intermediaries will themselves have to draw up processes to keep funding lines separate. Some solution will have to be arrived at for an orderly exit from current positions, particularly for Sidbi, which GoI uses to direct venture capital into small enterprises.
The move will affect long-term funding to the startup ecosystem, although the regulators are seeking better housekeeping and not a wholesale exit. Financial institutions could baulk at the compliance burden of investing in AIFs. The immediate fallout on valuations of startups and unlisted companies in receipt of venture capital funding may be significant given the scale of circumvention of the principle.
RBI's directive does not clarify about investments by group companies of banks and NBFCs. Yet, the regulatory intent over weeding out bad loans from the financial system is clear.
The regulatory intervention has been received well by the market, which has made minor adjustments in valuations of NBFCs that have disclosed their affected investments. Bank stocks have not faced investor action in the main on account of their
