Context:
- The Reserve Bank of India (RBI) has released draft guidelines permitting banks to finance up to 70% of corporate acquisition (takeover) value, effectively ending a decades-long ban on acquisition financing.
- This move is a major reform in India’s corporate finance landscape, aimed at boosting mergers and acquisitions (M&As), deepening credit markets, and enhancing banking participation in corporate restructuring — while maintaining strong prudential norms and risk safeguards.
Key Highlights:
- New Financing Framework
- Banks can now lend up to 70% of the total acquisition value for corporate takeovers.
- The remaining 30% must be financed through equity by the acquiring entity.
- The acquirer must be a listed company with a profit record for at least three years.
- Risk Exposure and Capital Limits
- Banks’ aggregate exposure to acquisition finance must not exceed 10% of their Tier 1 capital.
- The total Capital Market Exposure (CME), including acquisition finance, should stay within 40% of Tier 1 capital (solo and consolidated basis).
- Loans must be secured primarily by shares of the target company, with additional collateral (such as promoter shares or guarantees) permitted for risk coverage.
- Eligibility and Restrictions
- The acquiring company or SPV must be a corporate entity, excluding NBFCs and Alternative Investment Funds (AIFs).
- The acquirer and target companies cannot be related parties, as defined under Section 2(76) of the Companies Act, 2013, ensuring transparency and arm’s-length transactions.
- The post-acquisition debt-to-equity ratio must remain within prudential limits, capped at 3:1.
- Risk Management and Governance
- Banks must formulate a comprehensive policy framework on acquisition finance covering risk management, monitoring, and internal approvals.
- Implementation of early warning systems, periodic stress-testing, and exposure reviews is mandatory.
- RBI expects banks to treat these loans as high-risk, high-return exposures, warranting strict internal oversight.
Relevant Mains Points:
- Economic Significance:
- Marks a paradigm shift from restrictive to enabling policy in corporate finance.
- Expected to deepen India’s M&A ecosystem, supporting corporate consolidation and economic efficiency.
- Encourages banks to diversify lending beyond traditional working capital and project finance.
- Governance and Risk Concerns:
- Prevents over-leveraging and connected lending through equity contribution requirements.
- Reinforces corporate governance norms via arm’s-length conditions and prudential ratios.
- Promotes transparency in bank exposure reporting under Basel III norms.
- Challenges and Risks:
- Potential for credit concentration in large corporate groups.
- Valuation and collateral volatility (especially share-backed loans).
- Need for robust credit assessment frameworks to avoid systemic risk.
- Way Forward:
- Banks should integrate AI-based risk monitoring tools for real-time exposure analysis.
- RBI could introduce a centralized acquisition finance registry for tracking large takeovers.
Encourage corporate bond market deepening to complement bank-based funding.