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I. Introduction
The Reserve Bank of India (RBI) released the Draft Reserve Bank of India (Commercial Banks – Capital Market Exposure) Directions, 2025 on October 24, 2025, representing a watershed moment in India's acquisition financing landscape 1.
This follows the RBI Governor's announcement on October 1, 2025, in the Statement on Developmental and Regulatory Policies, where the central bank proposed an enabling framework for commercial banks to finance mergers and acquisitions (M&A) by Indian corporates2.
For over seven decades, Indian commercial banks operated under a categorical prohibition against financing corporate acquisitions, a restriction rooted in prudential concerns regarding the speculative nature of equity investments and the risk to public deposits3.
The Draft Directions consolidate and repeal more than 50 circulars issued since 1986, replacing them with a unified, modern regulatory framework that balances market liberalization with stringent prudential safeguards.
This article examines the salient features of the Draft Directions, their eligibility criteria, structural requirements, security frameworks, and prudential limits, whilst also assessing the implications of this transformative policy shift for India's corporate financing ecosystem.
II. Historical Context and Policy Rationale
For decades, the RBI's regulatory stance on acquisition financing remained fundamentally prohibitive. The Banking Regulation Act, 1949, and the RBI Master Circular on Loans and Advances, dated July 1, 2015, explicitly barred commercial banks from extending loans or advances for the purpose of acquiring shares of other companies, including financing corporate takeovers or management buyouts, with limited exceptions confined to the infrastructure sector.
The underlying rationale for this restriction was the protection of public deposits from the inherent risks associated with equity and speculative investments, as well as concerns that promoters might misuse borrowed funds to gain control of companies rather than invest in genuine business expansion4.
However, in recent years, the RBI had permitted limited exceptions, primarily for acquisitions conducted under the Insolvency and Bankruptcy Code (IBC), 2016 process5.
The policy recalibration announced in October 2025 reflects a fundamental shift in the RBI's assessment of the Indian banking system's maturity and regulatory sophistication. Years of reform initiatives, including the clean-up of legacy bad loans following asset quality reviews, recapitalization of public sector banks, and robust governance reforms post-IBC, have restored credibility to bank balance sheets.
Additionally, India's capital market has deepened significantly, with increasing participation of institutional investors and sophisticated market participants. Recognizing these developments, the RBI determined that the banking sector could now prudently participate in acquisition financing whilst maintaining robust risk controls and regulatory oversight.
III. Scope, Applicability, and Effective Date
The Draft Directions apply exclusively to commercial banks, as defined in the Banking Regulation Act, 1949. Notably, they exclude Small Finance Banks, Regional Rural Banks, Local Area Banks, and Payment Banks from the ambit of acquisition finance provisions6 .
This selective approach reflects the RBI's calibrated stance, limiting this relatively higher-risk asset class to banks with greater capital buffers, stronger governance frameworks, and more sophisticated risk management capabilities.
The Draft Directions will come into effect from April 1, 2026, or on such earlier date as may be voluntarily adopted by a bank in its entirety. Significantly, the Directions apply only to fresh loans or guarantees made available after the effective date, and do not apply with respect to any outstanding loans or guarantees up to the effective date; such outstanding exposures are permitted to continue until their respective maturity.
Public comments on the Draft Directions were invited by the RBI through the 'Connect2Regulate' section of its website, with a deadline of November 21, 20257. This consultation process enables stakeholders, including banks, financial institutions, industry bodies, and legal practitioners, to provide feedback before the final Directions are issued.
IV. Eligibility Criteria and Borrower Requirements
The Draft Directions establish a tiered eligibility framework, distinguishing between requirements applicable to acquiring companies and those for Target Companies. These requirements reflect the RBI's intent to restrict acquisition financing to entities with sound financial positions and transparent governance structures.
1. Eligibility Criteria for Acquiring Companies
The Acquiring Company must satisfy several key conditions.
First, it must be a listed entity on a recognized stock exchange in India. The listing requirement ensures transparency, regulatory oversight, and market discipline, as listed companies are subject to continuous disclosure obligations and corporate governance standards prescribed by the Securities and Exchange Board of India (SEBI).
Second, the Acquiring Company must have satisfactory net worth and must have been profit-making for the immediately preceding three financial years. This requirement ensures that the borrower possesses adequate financial buffers and a demonstrated capacity to service debt obligations. The reference to "profit-making" implies that the company must have recorded positive net profits, thereby excluding companies with losses, turnaround situations, or start-ups, however promising8.
The Acquiring Company or Special Purpose Vehicle (SPV) established by it must be a body corporate, thereby explicitly excluding Limited Liability Partnerships (LLPs), trusts, funds, and foreign-owned and controlled companies from the scope of acquisition financing9.
Furthermore, the Acquiring Company cannot be a financial intermediary such as a Non-Banking Financial Company (NBFC), Alternate Investment Fund (AIF), mutual fund, or any other entity whose primary business is financial intermediation10. This restriction prevents the channeling of acquisition financing to entities that primarily engage in financial restructuring and speculation rather than operational control and strategic integration.
2. Eligibility Criteria for Target Company
The Target Company must not be a related party of the Acquiring Company, as defined in Section 2(76) of the Companies Act, 2013. The related party restriction prevents acquisitions between entities with common ownership, control, or significant influence, thereby ensuring that the acquisition represents a genuine business combination rather than a restructuring of related group entities.
Additionally, the annual returns of the Target Company must be available for at least the previous three financial years, enabling the financing bank to conduct comprehensive financial due diligence and assess the historical earnings capacity and cash flow generation of the Target entity11.
V. Acquisition Finance: Structure, Limits, and Security Requirements
1. Financing Structure and Quantu
The Draft Directions prescribe that a bank may finance at most 70% of the acquisition value, with the Acquiring Company required to fund at least 30% of the acquisition value in the form of equity using its own funds12.
This 70:30 financing structure serves multiple regulatory objectives: it aligns the interests of the borrower and lender by ensuring meaningful "skin-in-the-game" by the acquirer, reduces the bank's loss-given-default exposure by ensuring an equity cushion, and promotes financial discipline by limiting excessive leverage.
The determination of acquisition value shall be based on two independent valuations, as prescribed by SEBI under the Substantial Acquisition of Shares and Takeovers (SAST) Regulations, 201113.This dual-valuation requirement mitigates valuation risk and ensures that the purchase price is grounded in objective, professional assessment rather than subjective or inflated valuations.
2. Post-Acquisition Debt-to-Equity Ratio
The credit assessment for acquisition finance shall be based on the combined balance sheet of the Acquiring Company and the Target Company, reflecting a consolidated view of the merged entity's financial position.
Critically, the post-acquisition debt-to-equity ratio at the level of the Acquiring Company, or the SPV, or the Target Company, as applicable shall not exceed 3:1. This threshold is imposed as a prudential limit and represents the maximum leverage permissible post-acquisition.
The 3:1 ratio is substantially more conservative than leverage ratios typically observed in leveraged buyouts globally, reflecting the RBI's cautious approach to risk management and its concern regarding the capacity of Indian corporate borrowers to service high leverage14.
3. Nature of Acquisition
The acquisition finance shall be provided solely for the purpose of acquiring "all or a controlling portion" of the Target Company's shares, or assets to gain control over the Target Company and its operations15.
The requirement for "strategic investments" rather than "financial restructuring for short-term gains" further underscores the RBI's intention to support genuine business combinations driven by the core objective of creating long-term value for the acquirer through potential synergies16.
4. Security and Collateral Framework
The acquisition finance shall be fully secured by shares of the Target Company as primary security. This requirement ensures that the bank holds a direct interest in the primary asset being acquired, providing a first line of recourse in the event of default.
The pledge of Target Company shares as security also aligns the bank's interests with the success of the acquisition, as the value of the security is intrinsically linked to the operational and financial performance of the Target Company post-acquisition.
In addition to the primary security, assets of the Acquiring Company and/or Target Company, or other securities held by the Acquiring Company, may be taken as collateral security as per the bank's policy.This provision permits banks to implement layered security structures, supplementing share pledges with tangible assets, receivables, intellectual property, or other financial instruments, subject to the bank's internal policies and the borrower's asset composition17.
VI. Prudential Limits and Exposure Caps
The Draft Directions establish a hierarchical structure of prudential limits to ensure sound risk management and prevent excessive concentration of acquisition finance exposures across the banking system.
1. Aggregate Capital Market Exposure Limit
The aggregate capital market exposure of a bank, on a consolidated
and solo basis, shall not exceed 40% of its consolidated and
individual Tier 1 capital, respectively, as on March 31 of the
previous financial year18.This overarching limit
encompasses all capital market exposures undertaken by the bank,
including equity investments, lending against securities, venture
capital exposures, bridge financing, and acquisition finance. The
40% ceiling reflects a cautious stance toward capital market
activities whilst maintaining meaningful participation in the
equities ecosystem.
2. Direct Capital Market Exposure Limit
Direct capital market exposure, comprising investment exposures
and acquisition finance exposures, shall not exceed 20% of solo and
consolidated Tier 1 capital19.This provision creates a
distinct sub-ceiling within the 40% aggregate limit, ensuring that
the bank's direct exposures (i.e., those where the bank bears
the primary credit and market risk) remain within a prudent
band.
3. Acquisition Finance-Specific Exposure Cap
Most significantly, the aggregate exposure of a bank towards acquisition financing is capped at 10% of its Tier 1 capital20.
This sector-specific ceiling is substantially more restrictive than the broader capital market exposure limit, reflecting the RBI's heightened concerns regarding acquisition finance risk. For a large commercial bank with Tier 1 capital of ₹5,000 crore, the acquisition finance limit would be ₹500 crore, demonstrating the material constraints imposed on the scale of individual transactions and the aggregate portfolio size. This cap will shape the strategic choices of banks, potentially limiting support for mega-deals and directing acquisition financing primarily toward mid-sized transactions.
VII. Risk Management and Regulatory Requirements
The Draft Directions mandate that banks proposing to undertake acquisition financing transactions establish comprehensive lending policies governing acquisition finance activities21.
These policies must clearly define the overall exposure limits, terms and conditions for borrower eligibility, security and margin requirements, risk management frameworks, monitoring mechanisms, and provisions for addressing deterioration in portfolio quality.
Banks are required to implement rigorous and continuous monitoring of acquisition finance exposures to manage risks effectively, including the establishment of early warning systems capable of detecting incipient stress signals within the portfolio.
Regular stress testing of acquisition finance exposures is mandatory, particularly under adverse macroeconomic scenarios (such as sharp declines in equity valuations, increased interest rates, or sectoral downturns) that might impair the borrower's capacity to service debt or maintain adequate margins on pledged securities.
Additionally, the credit assessment process must incorporate evaluation of the borrower's financial position, the structure and terms of the acquisition deal, the adequacy of security, and the operational and financial synergies anticipated post-acquisition.
The monitoring framework should track covenant compliance, equity cushion maintenance, and deterioration in the Target Company's financial performance, with clearly defined trigger points for escalation and remedial action.
VIII. Implications and Conclusion
The RBI's Draft Directions on acquisition finance represent a carefully calibrated liberalization of India's capital market financing landscape. By opening the door to bank-financed acquisitions, the RBI acknowledges the maturity of India's financial system and the deepening of corporate financing markets.
The policy is expected to expand funding options for corporate acquirers, reduce reliance on foreign portfolio investors, alternative investment funds, and NBFCs as primary sources of acquisition financing, and foster greater price competition in the market for acquisition capital, thereby reducing financing costs for eligible borrowers.
However, the extensive qualifying criteria, conservative leverage ratios, and restrictive exposure caps demonstrate the RBI's cautious and risk-averse approach. The requirement that acquiring companies be listed, profitable, and have three years of track record, combined with the prohibition on financial intermediaries and related party transactions, significantly constrains the universe of potential participants.
The 10% Tier 1 capital cap on acquisition finance, whilst prudent, may limit the scale of transactions that individual banks can support and could necessitate consortium or syndicated lending arrangements for larger transactions.
The tentative effective date of April 1, 2026, provides a transition period for banks to build institutional capabilities, refine credit assessment frameworks, establish monitoring systems, and formulate board-approved policies.
The consultation process, with comments due by November 21, 2025, will likely yield refinements to the Draft Directions before they are finalized.
Overall, the RBI's Draft Directions mark a pivotal moment in India's regulatory journey, demonstrating the central bank's commitment to enabling bank-based financing of domestic corporate acquisitions whilst maintaining prudential safeguards against excessive risk-taking and systemic fragility.
The successful implementation of the Directions will depend critically on banks' adherence to sound credit practices, robust governance, and effective risk management areas where regulatory oversight and supervisory enforcement will be essential.
Footnotes
1. Database – Historical Data- Reserve Bank of
India
2. Database – Historical Data- Reserve Bank of India
3. ERGO – RBI – Draft Directions – 5 November
2025.pdf
4. The Debt Shift: How the RBI is Quietly Reshaping India's
M&A and Competition Landscape – IndiaCorpLaw
5. RBI to cap bank lending for corporate takeovers at 70% of deal
value | Business News – The Indian Express
6. ERGO – RBI – Draft Directions – 6 November
2025.pdf
7. RBI Releases Draft Directions on Capital Market Exposure and
NBFC Regulations
8. RBI draft norms say acquisition finance only for listed
entities, bank exposure not to exceed 10% of Tier 1 – The
Economic Times
9. ERGO – RBI – Draft Directions – 6 November
2025.pdf
10. RBI Opens the Doors to Bank-Funded M&A's: Boosting
Domestic Acquisition Financing – Obhan & Associates
11. Acquisition finance under rbi's draft capital market norms
| Desai & Diwanji
12. RBI proposes 70% cap on financing for acquisitions –
Banking & Finance News | The Financial Express
13. RBI draft norms say acquisition finance only for listed
entities, bank exposure not to exceed 10% of Tier 1 – The
Economic Times
14. ibid
15. ERGO – RBI – Draft Directions – 6 November
2025.pdf
16. RBI issues draft norms to enable banks to fund acquisitions
– Quatro Hive
17. RBI draft norms say acquisition finance only for listed
entities, bank exposure not to exceed 10% of Tier 1 – The
Economic Times
18. RBI Proposes Stricter Norms for Bank Funding of Mergers and
Acquisitions | Whalesbook
19. ibid
20. RBI to cap bank lending for corporate takeovers at 70% of deal
value | Business News – The Indian Express
21. RBI issues draft norms to enable banks to fund acquisitions
– Quatro Hive
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