Source: BS
Context:
The Reserve Bank of India (RBI) released a draft circular on October 24, 2025, proposing guidelines to allow banks to finance corporate acquisitions. This is a major policy shift, since Indian banks were earlier barred from lending for mergers and acquisitions due to risks of over-leverage and promoter-level funding. Under the new proposal, banks may fund corporate acquisitions—domestic or overseas—only if they create long-term strategic value and not merely support financial restructuring.
Key Provisions of RBI’s Draft Norms
- Banks may finance up to 70% of the acquisition cost.
- Acquirer must bring 30% equity from its own resources.
- Only listed companies with strong net worth and at least 3 years of profitability are eligible.
- A bank’s total exposure to acquisition financing is capped at 10% of Tier-I capital.
Why Banks Find the 10% Cap Restrictive
Bankers argue that:
- A 10% limit of Tier-I capital is too low and reduces the ability of large banks to support meaningful M&A deals.
- The 30% equity contribution should not be limited to “pure equity.”
They suggest including:- Preference shares
- Convertible instruments
- Other eligible hybrid capital instruments
Some executives believe the exposure cap could be raised to around 30% of Tier-I capital for well-governed banks.
Why RBI Is Being Cautious
Experts say the central bank’s conservative limits reflect genuine risks:
1. Uncertain outcomes of acquisitions
Not all M&A deals succeed. If a bank funds a deal based on optimistic projections and the acquisition fails, it can turn into a bad loan.
2. Asset–Liability Mismatch (ALM)
- Acquisition loans are long-term.
- Banks often raise short-term funds, leading to liquidity risks if the loan turns bad.
Banks will therefore need stronger credit underwriting and dedicated long-term funding structures.
Need for Strong Internal Frameworks
Experts advise banks to:
- Strengthen credit underwriting capabilities
- Build robust risk assessment structures
- Establish dedicated acquisition finance teams
- Develop internal guardrails before seeking regulatory relaxations
Analysts add that banks must first build a high-quality acquisition finance book, especially through mid-market deals, before asking RBI for softer rules.
Inclusion of Mid-Market & Family-Owned Firms
EY notes that restricting eligibility only to listed companies excludes:
- Profitable unlisted mid-market firms
- Family-owned businesses
These segments drive a major share of India’s industrial expansion.
A calibrated expansion of eligibility may be required later.
Why Banks Want the Norms Liberalised
Bank credit growth to corporates has slowed as companies rely increasingly on:
- Bond markets
- Overseas loans
- Equity markets
Bankers believe acquisition financing could develop similarly to infrastructure financing, where:
- A few large banks build strong expertise
- Smaller banks piggyback by taking smaller participations
Key Risks Identified
- Asset–liability mismatch due to long-tenure loans
- Credit underwriting challenges due to unpredictable acquisition outcomes
- Need for dedicated long-term funding
- Risk of over-exposure if norms are liberalised prematurely
