RBI Eases Investment Rules, Sets 20% Cap for Banks and NBFCs in AIFs

The Reserve Bank of India (RBI) has significantly relaxed investment norms for banks and non-banking financial companies (NBFCs) in Alternative Investment Funds (AIFs) to boost capital flows into alternative investment vehicles and spur growth in long-gestation sectors.

The latest regulatory update seeks to balance growth in capital markets with prudential safeguards. These directions will come into force from January 1, 2026 or on any date decided by the RE (Regulated Entities) like banks, NBFCs.

RBI Relaxes AIF Investment Norms for Banks and NBFCs

On July 26, 2025, the RBI issued a circular revising its earlier framework, allowing banks and NBFCs to invest in AIFs with greater flexibility. The amendment is being seen as a positive shift, enabling deeper institutional participation in India’s fast-growing private capital ecosystem.

This relaxation will encourage flow of funds into sectors like infrastructure, start-ups, and small businesses, all of which are commonly financed by AIFs.

Revised Limit: Exposure Now Capped at 20% of AIF Corpus

Under the revised norms, the RBI has capped investment by any bank or NBFC at 20% of the total corpus of an individual AIF scheme. 

This replaces the earlier limit of 10% of the institution’s owned funds, providing much more leeway for larger institutions with significant capital bases.

Comparison of Old vs New Investment Norms
 

This change allows entities with larger balance sheets to meaningfully invest in more than one scheme without breaching regulatory ceilings.

Entity-Level Cap Replaced with Scheme-Level Restriction

Previously, the cap was applied at the entity level, meaning banks and NBFCs had to ration their total exposure across all AIF schemes. This often led to underutilisation of capital and discouraged participation in smaller or sector-specific funds.

Now, with a scheme-specific cap, each AIF is treated as a separate exposure unit, a move that brings India in line with international best practices.

Broader Access Expected to Deepen Capital Markets

The RBI’s decision is expected to help AIFs attract long-term institutional capital, vital for sectors underserved by conventional bank credit. These include early-stage technology firms, renewable energy projects, and distressed asset markets.

Fictional Example:

Take the case of Arka Capital, a mid-sized NBFC with ₹2,000 crore in owned funds. Under the previous rule, it could invest only ₹200 crore in total across all AIFs. Now, under the new norms, Arka can invest up to ₹100 crore in each AIF scheme, opening up multiple avenues across infrastructure, healthcare, and fintech funds — thus reducing concentration risk while improving capital allocation.

Investments Must Remain Unleveraged and Unrelated

However, RBI has made it clear that investments must adhere to prudential standards. Banks and NBFCs are prohibited from investing in leveraged AIFs or schemes that provide indirect credit intermediation. This is to prevent regulatory arbitrage and systemic risk.

Moreover, such institutions must conduct due diligence to ensure the AIFs they invest in are not exposed to entities linked to the lender’s existing loan book.

AIFs with Lending Exposure to Parent Institutions Still Barred

To avoid conflict of interest and ensure ring-fencing of exposures, RBI retains the ban on investments in AIFs that have downstream exposure to entities that have borrowed from the investing bank or NBFC. The objective is to prevent indirect evergreening of bad loans through AIF structures.

Permissible vs Prohibited AIF Investments
 

Regulatory Objective: Balancing Growth with Prudence

The RBI has taken a calibrated approach—liberalising investment rules while maintaining strict boundaries against potential risk channels. By shifting the cap from the lender’s capital to the scheme’s size, the RBI has empowered financial institutions without weakening safeguards.

The approach resonates with the regulator’s broader agenda of sustainable financial sector development and deeper institutional intermediation.

Industry Response: Greater Scope for Portfolio Diversification

Industry players have largely welcomed the move, stating that it allows for better portfolio diversification and encourages innovation in financial products. Fund managers believe the change will result in more co-investment opportunities, stronger fund pipelines, and improved governance as institutional investors enter the fray.

Ravi Mehta, CEO of a leading mid-market private equity firm, noted:

“This decision will catalyse domestic institutional participation in a space traditionally dominated by foreign capital. It’s a huge step toward Atmanirbhar financial markets.”

Conclusion

The RBI’s revised stance on AIF investments reflects a maturing financial ecosystem — one where flexibility and risk management are not seen as contradictory but complementary. While the enhanced limits open the door for greater capital flows into key sectors, the checks around borrower linkages and leverage ensure the stability of the system isn’t compromised.

As India charts a high-growth trajectory, these nuanced reforms will play a crucial role in aligning regulatory intent with market realities.
 

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