The Reserve Bank of India has introduced a transformative draft framework that allows domestic banks to participate in acquisition financing, marking a significant policy shift in India's corporate deal-making landscape. This carefully calibrated move is set to reshape competitive dynamics between traditional banks and private credit funds while creating a more diversified financing ecosystem for mergers and acquisitions.
Key Provisions of RBI's Acquisition Finance Framework
The central bank has established clear boundaries for bank participation in acquisition deals. Funding is restricted to Indian listed companies acquiring control in domestic or overseas entities, either directly or through special purpose vehicles. The transactions must serve strategic purposes and generate long-term value rather than facilitating short-term financial engineering.
Several important safeguards have been implemented to ensure responsible lending. Banks cannot finance more than 70% of the acquisition value, which must be supported by two independent valuations. Acquirers must contribute a minimum of 30% equity in cash, and post-transaction leverage is capped at a debt-to-equity ratio of 3:1.
Additionally, banks must operate within capital market exposure limits, with acquisition finance capped at 10% of their Tier 1 capital. This classification falls under direct capital market exposure, which overall cannot exceed 20% of Tier 1 capital.
Impact on Bank and Private Credit Dynamics
This regulatory change will not eliminate private credit's role but will fundamentally reorganize the acquisition financing field. The market is shifting from an exclusively private credit model for sponsor-driven acquisitions to a mixed architecture combining bank and private capital.
Banks are expected to re-enter large-cap acquisitions focusing on control deals led by listed corporations with strong profitability and governance records. With pricing determined by public benchmarks, these acquisitions will likely be more cost-effective than those financed solely through private credit.
Meanwhile, private credit will maintain its dominance in specific segments outside the RBI's framework, including deals involving unlisted acquirers, new acquisition platforms, non-control transactions, or structures requiring acquisition vehicles not backed by listed entities.
Hybrid financing arrangements are anticipated to become more common, with banks anchoring senior secured tranches against target shares while private credit provides second-lien financing, seller-deferred consideration funding, or customized facilities.
Practical Implications for Deal Structures
The RBI framework will visibly influence transaction mechanics in several important ways. The requirements for both listed and profitable acquirers will direct transaction flows toward established corporations rather than pure sponsor platforms.
Private equity sponsors may need to collaborate with listed companies for certain specialized acquisitions to access bank financing at the operational level, while using private credit to fund control premiums and holding company layers.
The 70% bank financing cap and 30% cash equity requirement will reduce dependence on stapled vendor financing or highly leveraged holding companies. The central bank has emphasized that security must be anchored in a pledge of the target's shares, though regulatory challenges remain since Indian banking laws restrict equity pledges to a maximum of 30% of a company's capital.
The framework's insistence on unrelated parties and independent valuations also limits opportunities for intra-group restructurings to access bank finance.
Areas for Potential Refinement
While the draft directions represent a pragmatic approach, several areas could benefit from further refinement. The exclusion of non-banking financial companies and alternative investment funds as acquirers prevents common market structures, which may be overly restrictive in today's market context.
The 3:1 post-acquisition debt-to-equity ratio might prove particularly tight for capital-intensive industries or sectors with stable cash flows. A more sector-calibrated approach could better serve diverse industry requirements.
The mandate for two independent valuations adds both time and cost to transactions, potentially creating challenges for competitive timelines, especially in cross-border deals. Additionally, the 30% equity pledge limit for banks requires regulatory modification to align with the new framework's objectives.
Despite these considerations, the RBI's draft framework represents a significant step forward. It will likely reduce financing costs and enable listed, profitable corporations to pursue strategic acquisitions more effectively, while preserving ample opportunity for private credit participation in the M&A landscape.
Even with current limitations, Indian acquisition finance is positioned to become deeper, more diversified, and more affordable for credit-worthy borrowers, with private credit remaining an essential component of the ecosystem. The shortcomings appear fixable through future regulatory adjustments, and their persistence would not diminish the framework's overall positive impact on market development.
