RBI’s 10 % Tier‑I Cap on Acquisition Financing: Banks Seek More Flexibility

The Reserve Bank of India (RBI) has stirred the financial sector with a draft proposal allowing banks to finance corporate acquisitions—domestically and internationally. While this marks a significant policy shift aimed at enabling Indian companies to scale strategically, the framework has triggered debates. With a cap on acquisition financing exposure set at 10% of a bank’s Tier-I capital, and a 30% equity contribution mandate from the acquiring firm, many bankers believe the proposed limits may hinder the very intent of driving bold mergers and acquisitions.

What is the New Framework?

The RBI’s draft circular opens a formal path for banks to finance Indian firms acquiring controlling stakes in other companies, with strict guidelines in place,

• Banks may fund up to 70% of the acquisition deal, provided the acquiring company contributes 30% in equity.
• The acquiring firm must be listed and profitable for three years, with a satisfactory net worth.
• Bank exposure for acquisition financing is capped at 10% of Tier-I capital, maintaining conservative lending norms.
• Overall capital market exposure is also limited: 20% for direct, and 40% for combined (direct + indirect) exposures.
• Valuation safeguards, debt-equity ratio caps (3:1), and secure collateral (usually the target company’s shares) are mandated.

Why Bankers Say the 10% Cap is Restrictive

While the initiative is widely welcomed, several industry insiders suggest the regulations may limit actual execution on large or strategic deals,

• 10% of Tier-I capital could prove too tight for large banks involved in major infrastructure or overseas acquisitions.
• The requirement that 30% equity must be contributed by the acquiring company is seen as restrictive if only common equity is accepted.
• Bankers suggest that other capital instruments—preference shares, convertible debentures, and hybrid securities—should also count as equity to ease structuring.
• Without broader recognition of such instruments, many large deals may look elsewhere for funding, including overseas private equity or NBFCs.

Opportunities

• Banks can now directly participate in M&A financing, driving deeper engagement with corporate clients.
• Offers corporates a regulated route to raise acquisition funds without depending heavily on offshore or shadow banking.
• Expands bank credit books into higher-margin segments with strategic relevance.

Challenges

• M&A deals are complex—valuation risks, post-deal integration, and cash flow uncertainties remain key concerns.
• A narrow definition of “equity” may reduce transaction flexibility and slow approval processes.
• Conservative exposure caps could delay India’s ambitions to create global-scale conglomerates.

Relevance for Policy Watchers

The new proposal is highly relevant for aspirants preparing for competitive exams, particularly in economics, banking, and governance,

• It marks a paradigm shift in RBI’s stance on M&A financing, which had been restricted since 2006.
• Expected to be finalized and implemented from April 1, 2026.
• Requires understanding of key financial terms like Tier-I capital, capital market exposure, acquisition leverage, and hybrid capital instruments.