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India's central bank and market regulator are considering exemptions to recently tightened rules for bank investments in alternate investment funds (AIFs) due to their unintended consequences, three sources with direct knowledge of the matter said.

Last month, the Reserve Bank of India (RBI) ruled that banks and non-bank lenders cannot invest in AIFs with holdings in the banks' current or recent borrowers, to avoid cases of "evergreening" bad loans, and asked lenders to sell existing investments within a month, or provision against them.

However, the industry says the new norms would stymie growth. These rules impact about $8-10 billion worth of investments, according to the Indian Venture and Alternate Capital Association (IVCA), a lobby body for AIFs.

"The inadvertent impact of the RBI circular is that banks and non-bank finance lenders will stay away from investing in AIFs fearing that they may run afoul of the regulations," said Srini Srinivasan, managing director, Kotak Investment Advisors, one of India's largest alternate asset managers.

Hence, the regulators are considering suitable exemptions to some of the valid concerns, said the sources, who declined to be identified as they are not authorised to speak to the media.

Reuters learnt of two such exemptions being sought by lenders and funds. The first is for AIFs set up specifically to invest in distressed assets, two of the sources said.

For example, two large funds run by State Bank of India -- one that invests in stressed and stalled residential projects and one in small enterprises -- are impacted as they have direct or indirect exposure to companies that are existing borrowers of SBI, said a source.

"It is under active consideration whether certain categories of funds such as the ones investing in distressed companies should be exempted," one source said.

Emails sent to SBI, RBI and the market regulator Securities and Exchange Board of India (SEBI) were not answered.

Banks have also asked that they should be given more time to exit such investments or allowed to stagger provisions they need to make, two sources said.

"The 30-day deadline to either provide for or exit the investments is unrealistic as the haircuts are going as high as 80% of the net asset value due to the regulatory diktat," said Siddarth Pai, co-chair of IVCA's regulatory affairs committee.

A haircut in finance parlance is the difference between the fair value of an asset and how a lender can recover via a sale.

Pai said the industry is looking for at least one year to exit.