RBI green lights acquisition finance: Two decades after barring banks from funding corporate takeovers, the RBI has reversed course — opening the door for lenders to play a larger role in India’s M&A boom. Its draft framework now allows banks to fund mergers, acquisitions, and management buyouts — activities from which they were long barred. The restriction, rooted in fears of exposing depositors’ money to the volatility of equity markets, had pushed Indian acquirers toward non-bank lenders, private-credit funds, or overseas financiers.
The new framework reverses that stance. Banks can now finance up to 70 per cent of an acquisition’s value, provided the acquirer contributes at least 30 per cent equity. Exposure to such loans is capped at 10 per cent of Tier-1 capital, and total capital-market exposure (direct and indirect) at 20–40 per cent. Only profitable, listed companies with a sound net worth qualify.
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Each deal will require two independent valuations and must be demonstrably strategic. Boards must approve policies governing these loans, monitor leverage (a proposed debt-equity ceiling of 3:1), and secure collateral—usually pledged shares of the target company.
The legal plumbing and prudential design
This is not a regulatory free-for-all. The draft framework is issued under Sections 21 and 35A of the Banking Regulation Act, dovetailing with the Large Exposure Framework and Basel III capital norms. RBI proposes higher risk weights and provisioning buffers to reflect the greater volatility of acquisition finance. Loans backed by shares will remain subject to the SARFAESI Act but may face recovery delays if collateral prices plunge.
Promoter financing and intra-group acquisitions remain restricted to prevent circular lending. The framework also bars evergreening through upstream guarantees or connected lending within conglomerates.
Redistribution of market power
India’s M&A market, valued at nearly US $150 billion in 2023, has been expanding at double-digit rates. Yet banks earned little from this surge because of the prohibition. Their entry could deepen domestic credit markets and reduce dependence on offshore loans and private-credit funds.
The reform also redistributes market power. NBFCs and AIFs, which had dominated leveraged financing, will face stiffer competition from banks able to price loans more cheaply due to access to retail deposits. That said, sophisticated borrowers may still prefer private credit for faster execution and covenant flexibility.
The new rules could spur syndicated-loan markets and securitised instruments akin to CLOs, creating secondary liquidity—something India’s debt market sorely lacks.
Opportunity meets risk
Acquisition financing is inherently complex. A deal’s success rests on post-merger integration, synergy realisation, and market conditions—all difficult to model. When banks fund such deals, they bet on management execution as much as on numbers.
The RBI’s prudential caps—10 per cent of Tier-1 for acquisition finance and 20–40 per cent for overall capital-market exposure—are designed to prevent overreach. Yet concentration risk looms large. If several banks chase the same large industrial groups or sectors, systemic vulnerabilities can build unnoticed.
RBI would do well to maintain a sector-wise heat-map of acquisition-finance exposure and require quarterly stress-testing. A sensitivity of just 150 basis points in interest rates or a 20 per cent EBITDA shortfall could tip many leveraged deals into distress.
Sectoral implications
Manufacturing, infrastructure, and renewables—the government’s priority sectors—are capital-intensive and ripe for consolidation. Acquisition financing could help create scale economies and globally competitive champions.
But these sectors also face cash-flow cyclicality and policy risk. Renewable-energy projects, for instance, depend on long-term power-purchase agreements; delayed payments or tariff revisions could erode debt-service capacity. In contrast, mid-market buyouts in technology or services may have stronger cash flows but carry valuation risk.
A clear policy on foreign acquisitions under FEMA is also required. RBI will need to define whether rupee loans can fund overseas takeovers or must be blended with external-commercial borrowings—and to impose strict hedging ratios where FX exposure exists.
Governance, disclosure, and competition
Governor Sanjay Malhotra has cleared that “no regulator can substitute board-room judgement.” The burden of discipline rests squarely on bank boards. They must vet each transaction’s strategic logic, approve detailed covenant packages, and link management incentives to long-term deal outcomes, including clawbacks for underwriting failures.
Listed acquirers should disclose post-deal leverage, debt-service ratios, and covenant compliance in quarterly filings. Meanwhile, the Competition Commission of India must ensure that leveraged consolidation does not harden oligopolies in key industries.
India’s credit-to-GDP ratio, below 60 per cent, is among the lowest in major economies—China’s stands near 180 per cent and the US at 150 per cent. The potential for financial deepening is enormous, but history cautions against exuberance. Rapid credit expansion without governance discipline once led to twin balance-sheet stress.
If implemented with prudence, the RBI’s move could become a foundation of India’s next investment cycle. It will allow banks to fund scale, foster domestic champions, and reduce reliance on external capital. But if boards chase short-term profit or weaken underwriting, the same reform could sow the seeds of another bad-loan cycle. In the end, the reform’s success will rest not on new freedoms, but on old virtues—prudence, transparency, and accountability.