RBI May Rethink Banks’ Exposure to ‘Sensitive Sectors’ to Enable M&A Financing

The Reserve Bank of India (RBI) is considering a review of banks’ exposure limits to ‘sensitive sectors’ — capital markets, real estate, and commodities — to pave the way for permitting them to finance mergers and acquisitions (M&As) in India.

About Sensitive Sectors

• As per RBI, sensitive sectors include capital markets, real estate, and commodities — areas prone to asset price volatility and systemic risk.
• Exposure Limit: Banks’ exposure to these sectors in a financial year is capped at 5% of total deposits at the end of the previous financial year.
• Current Exposure:
  • FY24 exposure stood at ₹46.62 trillion, accounting for 27.2% of total loans and advances — up 34.1% year-on-year.
  • Within this, capital market exposure was ₹2.43 trillion (1.4%), up 31.3% over FY23.

Existing Restrictions

• Banks are not permitted to directly finance M&A transactions.
• NBFCs, however, are allowed to fund M&As and often source such credit from banks — creating an indirect exposure.
• Foreign banks can finance M&As through their offshore offices.
• Under the Insolvency and Bankruptcy Code (IBC), 2016, banks can fund acquisitions via CIRP, but only for repayment of lenders, not share purchases.

Regulatory Developments

• The RBI’s draft framework on Capital Market Exposure (CME) (released last week) proposes that:
  • A bank’s aggregate CME should not exceed 40% of its Tier-1 capital (solo basis).
  • On a consolidated basis, the limit remains 40% of consolidated Tier-1 capital.
• The draft does not explicitly address exposure to sensitive sectors, though bankers believe it will influence future reforms.

Banking Sector Concerns

• Senior bankers argue that the 5% exposure ceiling could hinder M&A financing, as such deals typically require large credit commitments.
• Even expanding the capital markets sub-limit within sensitive sectors may prove insufficient for major acquisition financing.

Significance

• A review of exposure norms could enhance credit flow for corporate restructuring and stimulate investment activity.
• Aligns with efforts to liberalize banking participation in strategic financing while maintaining prudential safeguards.
• Would help level the field with NBFCs and foreign banks, promoting efficient capital formation in India.