Significant Investments of AIFIs – Basel III

Significant Investments of AIFIs – Basel III

Prudential limits for investments by AIFIs

AIFIs need to develop investment policies approved by their Board. These policies should address investments in financial entities, considering the limits set in the Large Exposure Norms. The policies should specify limits on investments as a percentage of the AIFI’s paid-up capital and reserves, based on the most recent audited balance sheet. These limits apply to investments in:

  • The equity of a single financial services entity not affiliated with the AIFI.
  • The total equity in all non-affiliated financial services entities.
  • The total equity in all financial services entities, including affiliates.
  • Equity investments in factoring subsidiaries and companies.
  • The equity of a single deposit-taking non-banking financial company (NBFC).
  • Equity or units in certain types of Alternative Investment Funds (AIFs), as long as this is legally allowed.

Regarding the Reserve Bank’s approval, AIFIs must get prior permission for certain investments. These include investments in subsidiaries and non-subsidiary financial services companies. However, approval isn’t needed if the investment meets specific criteria, like being in a financial services company, the AIFI having sufficient capital and recent profits, and the investment not exceeding 10% of the investee company’s paid-up capital. Also, if the AIFI’s total shareholding, including its controlled entities, is less than 20% of the investee’s capital, prior approval isn’t necessary. Investments held for trading purposes for less than 90 days also don’t require approval.

AIFIs are also restricted from investing more than 10% in non-financial companies or in certain categories of AIFs. Investments in Category III AIFs are prohibited, and any subsidiary investments in these funds must comply with regulatory minimums set by SEBI.

AIFIs must evaluate the risks associated with equity investments in AIFs, whether made directly or through subsidiaries. This evaluation should be part of their Internal Capital Adequacy Assessment Process (ICAAP). The additional capital required for these investments will be reviewed during the Supervisory Review and Evaluation Process.

Procedure for seeking approval of the Reserve Bank:

When an All India Financial Institution (AIFI) plans to make an investment that needs the Reserve Bank’s prior approval, there’s a specific process to follow. The AIFI should submit an application detailing its proposed investment. This application must include several key pieces of information:

  • The amount of equity the AIFI intends to contribute to the subsidiary, financial, or non-financial services company.
  • A Board Note and a Resolution that show the AIFI’s Board has approved the proposed investment.
  • Information about the AIFI’s current equity contributions in its subsidiaries and other financial and non-financial services companies.

This application should be sent to the Department of Regulation at the Reserve Bank’s Central Office in Mumbai. This process ensures that the Reserve Bank can review and approve the investment, maintaining financial stability and compliance with regulatory standards.

Relationship with subsidiaries

In managing their relationships with subsidiaries, parent or sponsor All India Financial Institutions (AIFIs) must maintain an “arm’s length” approach. This means they should interact with their subsidiaries as if they were independent entities. To ensure this, several supervisory strategies should be in place:

  • The Board of the parent or sponsor AIFI needs to regularly review how the subsidiaries are performing.
  • The parent or sponsor AIFI should conduct inspections or audits of the subsidiaries’ financial records periodically.
  • A subsidiary must not start another subsidiary, promote a new company, or begin a new business without the Reserve Bank’s prior approval. However, expanding into an existing line of business that’s already approved doesn’t count as a ‘new business.’
  • A subsidiary should not invest in another company to gain controlling interest without the Reserve Bank’s prior approval. This rule doesn’t apply to investments made by Category I and II Alternative Investment Funds established by a subsidiary.
  • A subsidiary cannot directly access customer accounts held with the AIFI. Information can be shared between an AIFI and its subsidiary, but they must keep their relationship at arm’s length.
  • The AIFI is not allowed to give unsecured loans to its subsidiary without the Reserve Bank’s prior approval.
  • All transactions between an AIFI and its subsidiary should be conducted as if they were between independent parties. The subsidiary should not receive any preferential treatment compared to other parties with similar risk profiles.

These guidelines help maintain transparency and fairness in the financial system, ensuring that subsidiaries operate independently and responsibly.