RBI’s 10% Tier-I Cap on Acquisition Financing Seen as Restrictive

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