Funding M&As: RBI’s Relaxation on Indian Banks’ Lending Activities

Introduction

The Reserve Bank of India (“RBI”) on October 02, 2025, had announced that Indian banks will now be permitted to finance acquisitions and takeovers by Indian corporates^[1]. Prior to the announcement, Indian banks were barred from financing acquisitions and takeovers, while allowing the non-bank lenders or non-banking financial institutions or offshore entities^[2]. Furthermore, on October 24,2025, the RBI has released the draft - Reserve Bank of India (Commercial Banks- Capital Market Exposure) Directions, 2025^[3] (“Draft Directions”) for public comments. This article explores the key highlights of the Draft Directions and key considerations to be addressed by the RBI in the Draft Directions.

Historic Apprehension of RBI

The limitation on financing acquisitions was a consequence of the RBI’s prudential circular dated August 28, 1998. The circular stated that promoters' contribution towards the equity capital of a company should come from their own resources, and the bank should not normally grant advances to take up shares of other companies^[4]. Although RBI had relaxed this restriction in a subsequent circular^[5], the relaxation was only for companies implementing or operating an infrastructure project in India, subject to additional conditions. While the restriction on other sectors may have caused impediment to growth, the rationale for the restriction was to prevent speculative use of depositors’ funds, avoid leveraged buyouts that could threaten banking system stability, and avoid takeovers requiring significant debt^[6].It is pertinent to note that there is a significant amount of risk involved in funding acquisition transactions, especially listed entities as capital market exposures are inherently volatile and uncertain. In contrast the traditional banking activities such as advancing loans for projects carried relatively lessor market risks compared to Investment in equity shares tied to acquisitions and takeovers.

Draft RBI (Commercial Banks - Capital Market Exposure) Directions, 2025

While the erstwhile regime was restrictive and often unclear, the Draft Directions provides a clear and flexible framework for banks to participate in the capital markets with an aim to promote responsible lending for activities like corporate acquisitions, without exposing banks to unwanted risk. The Draft Directions will apply to capital market exposures of commercial banks (excluding small finance banks, regional rural banks, local area banks and payment banks). Capital Market Exposure can occur in two ways(i) direct exposure: where banks directly invest in shares, convertible bonds, mutual fund units or venture capital funds and (ii) indirect exposure: where banks lend money against securities or finance intermediaries such as brokers or custodians.

The RBI has taken a balanced approach under the Draft Directions where It has allowed banks access to capital market investment opportunities while at the same time introducing a prudential limit on investments to mitigate risks. The bank's total capital market exposure, which includes both direct investments and indirect credit exposure, cannot exceed40% of its Tier 1 capital^[7]. Within this umbrella threshold, direct exposure such as investments in equities, underwriting, or acquisition financing, is capped at 20% of Tier 1 capital^[8] and banks may finance up to 70% of an acquisition's value, with the remainder contributed by the acquirer. By introducing a strict exposure threshold and participation rules, RBI aims to navigate a middle ground between market innovation and market safety. However, it may be noted that over the years, acquisition finance has grown significantly^[9] and Indian banks have improved their regulatory compliance standards and set internal ceilings on exposure to each segment^[10]. Restricting banks’ exposure towards acquisition finance at 10% of their Tier-I capital may not make any meaningful change^[11].That being said, RBI may consider increasing the exposure limit with respect to the Tier-I capital.

Under the Draft Directions, the Acquirer must be a listed company with positive net worth and have profit for the preceding three financial years, while the target company’s financials must be available for the preceding three financial years^[12] and the value of the acquisition must be determined by two independent valuers and must align with the SEBI norms^[13]. While this may be necessary in the RBI’s point of view, the central bank may consider allowing banks to finance acquisitions of well-run unlisted entities, as various small-size listed entities have seen governance issues in the past^[14]. Not all well-managed companies choose to list, and listing status alone doesn't guarantee good governance. While the RBI may have decided to allow only listed entities, it is important to note that listed entities have significantly higher disclosure and reporting standards compared to unlisted entities, reducing information risk for lenders. Other provisions under the Draft Directions include mandating banks to maintain separate sub-limits for intra-day exposures^15], ensuring that for the time being, high-value market transactions remain within control. If an acquisition is being financed by a bank, the acquirer and the target company cannot be related parties^16] as defined under the Companies Act,2013^[17].

Conclusion

Since the Draft Directions relaxed the earlier restriction on all the sectors for acquisition finance, this may certainly reduce the dependence on offshore financing for acquisitions and takeovers by Indian corporates and promote domestic borrowing. With the RBI’s announcement, Indian banks now have access to not just the infrastructure sector but all the sectors, while the companies have a new destination to fund their corporate acquisitions, subject to the restrictions set out under the Draft Directions. While RBI may rethink its restrictions under the Draft Directions in lieu of the views expressed by various industry leaders and general public, RBI may for the time being test the current restrictions and, in the future, strive to relax the restrictions while keeping in mind the risks of using depositors’ money.

Reference

[1] RBI to permit banks to fund merger &acquisition activity by Indian corporates, Press Trust of India. Available at: https://www.ptinews.com/story/business/rbi-to-permit-banks-to-fund-merger-acquisition-activity-by-indian-corporates/2966395.

[2] Mathew, G. (2025) RBI allows banks to fund M&As, lend in rupee to residents of India’s neighbours, The Indian Express. Available at: https://indianexpress.com/article/business/rbi-allows-banks-to-fund-mas-lend-in-rupee-to-residents-of-indias-neighbours-10283012/(Published on October 02, 2025).

[3] Bank of India (Commercial Banks - Capital Market Exposure) Directions, 2025 – Draft for Comments, Reserve Bank of India. Available at: https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4763.

[4] Bank Finance against shares and debentures- Master Circular, Reserve Bank of India: DBOD. No. Dir.BC.90/13.07.05/98-99.

[5] Master Circular- Loans and Advances –Statutory and Other Restrictions DBR. No. Dir.BC.10/13.03.00/2015-16.

[6] (2025) Indian banks want a shot at funding business takeovers. Available at: https://thedailybrief.zerodha.com/p/indian-banks-want-a-shot-at-funding.

[7] Supra Note 3

[8] Supra Note 3

[9] Acquisition Finance 2025, Chambers and Partners. Available at: https://practiceguides.chambers.com/practice-guides/acquisition-finance-2025/india/trends-and-developments.

[10] Shukla, P. (2025) Banks urge RBI to raise exposure limit for M&A financing, The Hindu -Business Line. Available at: https://www.thehindubusinessline.com/money-and-banking/banks-seek-higher-exposure-limit-for-acquisition-finance/article70240838.ece.

[11] Ibid

[12] Supra Note 3

[13] Supra Note 3

[14] Supra Note 10

[15] Supra Note 3

[16] Supra Note 3

[17] Section 2(76) under the Companies Act, 2013

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