Banks can now fund India Inc’s M&A drive

The Reserve Bank of India (RBI) on Wednesday met the long-standing demand of banks by allowing them to finance acquisitions by Indian companies, a move that also expands banks’ capital market lending in the country.

Illustration: Uttam Ghosh

“…to expand the scope of capital market lending by banks, it is proposed to provide an enabling framework for Indian banks to finance acquisitions by Indian companies,” said Sanjay Malhotra, governor, RBI.

Banks had made representations to the RBI to allow acquisition financing, particularly as credit to industry has slowed significantly, with corporates relying on alternative sources of funds for their capital expenditure activities.

In August, C S Setty, chairman, State Bank of India (SBI), had said that the Indian Banks Association will formally request the RBI to allow domestic banks to finance mergers and acquisitions (M&As) of Indian corporates, beginning perhaps with listed companies, where acquisitions are more transparent and approved by shareholders.

Indian banks are generally restricted from lending for mergers and acquisitions, as such financing can lead to over-leverage, promoter-level funding at the holding company level, and may not directly contribute to asset creation or growth.

As a result, companies often turn to non-banking financial companies, private equity firms, or foreign lenders to fund these deals.

“…allowing of M&A financing by Indian banks is growth accretive and will foster incremental credit flow from banks,” said Setty.

Allowing acquisition financing is a major positive move by the RBI, as most such financing has shifted to the private credit market where borrowing costs are significantly higher.

Banks can now tap into this space and capture a meaningful share of the acquisition financing.

In the near term, banks are expected to focus on smaller acquisitions by MSMEs, debt-free companies, and players in the pharmaceutical sector, said a senior banker at a state-owned bank.

According to a senior SBI executive, the move to allow acquisition funding by banks would certainly open up business opportunities.

“While the bank is best placed for opportunity with robust credit underwriting standards and an experienced team, M&A needs a separate skills set and approach.

“The lender is mulling to have the centre of excellence to groom and nurture talent and ecosystem for merger and acquisition,” he said.

An SBI Research report highlighted that M&A deals in FY24 were valued at over $120 billion, or Rs 10 trillion.

Assuming a debt component of 40 per cent of M&A and if 30 per cent of this will be financed by banks, this translates into a potential credit growth of Rs 1.2 trillion.

This comes at a time when corporate credit growth has been lackluster as increasingly corporates have moved to the equity capital market, debt capital market, and overseas capital market for their funding or capex needs.

Additionally, the huge cash pile they have accumulated by deleveraging their balance sheets is also helping them fund their immediate capex needs.

According to the latest RBI data, credit to industry recorded 6.5 per cent year-on-year (Y-o-Y) growth in August, compared to 9.7 per cent Y-o-Y growth in the corresponding period last year.

The Governor on Wednesday noted that other sources of funding are gradually but steadily increasing their footprint.

The total flow of resources from non-bank sources to the commercial sector rose by Rs 2.66 trillion in 2025-26 so far, more than offsetting the decline in non-food bank credit by Rs 48,000 crore.

For M&A loans, the interest rate is typically higher by one to two percent to compensate for the higher risk, said India Inc leaders.

“This will provide an excellent platform for strong Indian corporates seeking acquisition financing to acquire companies within their sector, which are otherwise available at attractive valuations.

“In many cases, the cash flows from the acquired entity can support the debt servicing obligations of the acquiring entity, thus making it a win-win situation,” said Srinivasan Vaidyanathan, operating partner, Essar Capital.

“Historically, the RBI has been reluctant to allow acquisition, based on the premise that it may lead to over-leverage, promoter-level funding at the holding company level, and may not necessarily contribute to asset creation or growth.

“Therefore, it is a welcome move to consider acquisition funding.

“As long as it is done with proper diligence and reserved for meritorious cases, it will be a positive development,” Vaidyanathan said.

However, experts cautioned that this move is fraught with risks as it can cause asset liability management mismatches for banks.

“A prudent approach would be to specify certain long-term funding sources that would be matched for the purpose of acquisition funding.

“This would enable the asset position to be matched to the liability position, reducing the ALM mismatch that would otherwise sit on the bank balance sheets.

“More simply put, RBI needs to consider the implications of interest rate risk in the banking book, as a result of allowing this acquisition funding for banks,” said Vivek Iyer, partner and financial services risk leader, Grant Thornton Bharat.