INTRODUCTION

In a significant development, likely to change the face of corporate finance in India, the Reserve Bank of India (“RBI”) has taken a stance where it will allow banks to provide finance in the Merger and Acquisition (“M&A”) space. On 24^th October, 2025, RBI released the Draft RBI (Commercial Banks – Capital Market Exposure) Directions, 2025 (“Draft Directions”), and it represent, for the first time, a formal regulatory structure for bank-financed acquisitions, which has been largely prohibited before.

The Draft Directions comes just weeks after the RBI’s Statement on Developmental and Regulatory Policies issued on 1^st October, 2025, which proposed, among several things, to “provide an enabling framework for banks to finance acquisitions by Indian corporates”. The Draft Directions, which will take effect on 1^st April, 2026 or earlier, indicates the beginning of a new era for M&A in India, and closely aligns with rapidly developing global markets.

The article examines the provisions of the Draft Directions that specifically relate to bank-financed acquisitions. It also discusses the RBI’s traditionally cautious stance toward bank’s role in financing M&A transactions. Additionally, the article analyses the implications of this reform for India’s future M&A landscape.

HISTORICAL PROHIBITION ON BANK-FINANCED ACQUISITIONS

Debt Financing plays a vital role in M&A sector, as it allows entities to execute transactions without depleting their cash reserves upfront. A strategy or tool for such financing is Leveraged Buyouts (“LBO”). In LBO, the acquisition of a company is done largely through debt, which is secured by the assets and cash flows of the company being acquired. Most Indian LBOs are outbound (acquiring foreign companies), often by setting up foreign Special Purpose Vehicle (“SPV”) due to domestic constraints. Examples of such acquisitions are the Tata Tea acquisition (LBO) of UK-based Tetley in 2000 and the Hindalco’s acquisition of US-based Novelis. While the LBO model has fuelled consolidation and investment in Western markets, Indian regulators were often concerned that leveraged acquisitions would result in financial instability.

RBI has traditionally adopted a cautious approach toward permitting banks to take exposure in capital markets. As per paragraph 2.3.1.8 of RBI’s Master Circular on Loans and Advances – Statutory and Other Restrictions released on 1^st July, 2015 (“Master Circular”), banks are restricted from granting loans secured primarily by shares or debentures, except for working capital or other productive purposes. It rules out acquisition financing and thus creates a hurdle in using target company’s assets as collateral for acquisition-related financing. Similarly, paragraph 2.3.1.9 of the Master Circular prohibit banks from funding promoters’ equity contributions or providing loans to companies for acquiring shares of other companies. However, an exception (under paragraph 2.3.1.9(iii)) allows banks to finance overseas acquisitions viz. outbound LBOs while prohibiting domestic ones.

Moreover, RBI’s Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations released on 26^th March, 2019 (“Master Direction”) prohibits Indian companies from acquiring other Indian companies by using foreign debt to fund the share purchase or to structure a buyout. As per Part I (2.1) (viii) of the Master Direction, “Equity investment” and “investment in capital market” are prohibited end-uses, so no External Commercial Borrowings, whether in foreign currency or INR, can be used directly or indirectly to fund an acquisition of shares or to structure a buyout.

Collectively, the Master Circular and the Master Direction form a dual prohibition against bank-financed acquisitions in India, whether through domestic or external borrowing.

ACQUISITION FINANCE UNDER THE DRAFT DIRECTIONS

Definition and Scope

Under paragraph 8(i), the Draft Directions define “Acquisition Finance” as: “Providing finance to a company (‘acquiring company’), or to an SPV set up as a company by the acquiring company, for purchase of all or a controlling portion of another company’s (‘target company’) shares, or assets to gain control over the target company and its operations”.

This simple definition marks a turning point as it explicitly legitimizes the concept of bank-financed acquisitions, something that had previously existed only in a grey area. Moreover, paragraph 39 explicitly states that Acquisition Finance can be extended by banks to Indian companies for acquiring equity stakes in domestic or foreign companies as strategic investments. Banks may extend such financing either directly to the acquiring company or to a step-down SPV established by the acquirer.

Interestingly, Acquisition Finance is confined to transactions involving acquisition of “all or a controlling portion” of shares or assets. Therefore, non-controlling or minority stake acquisitions do not fall under this category, however, such transactions are not prohibited, but they are simply treated differently for regulatory classification. For instance, paragraphs 36 – 38 permit banks to extend loans to commercial entities against eligible securities for working capital or other productive purposes, provided funds are not used for speculative activity. Alternatively, if a bank itself invests in either equity or convertible instruments of a company, that exposure counts, as defined under paragraph 10(a), as direct investment exposure. It accounts towards the 20% direct Capital Market Exposure (“CME”) sub-limit, and towards the overall 40% CME limit.

Conditions and Limits

Detailed set of eligibility conditions and safeguards to govern such transactions are laid down in paragraph 42 of the Draft Directions. It states that only listed, profit-making companies with a history of profitability in the previous three years will be eligible borrowers, while financial intermediaries (such as NBFCs, AIFs, etc.) are specifically excluded from borrowing. The target company must have at least previous three years of annual returns available to ensure transparency and financial soundness. The parties must not be related party acquisitions within the meaning of Section 2(76) of the Companies Act, 2013.

Moreover, paragraph 42(viii) mentions that the acquisition finance must be fully secured by the shares of the target company as primary security. Assets of the acquirer or target company, or other securities held by the acquiring company, can be taken as collateral security as per the bank’s policy. This provision effectively formalizes what was earlier prohibited: allowing the target company’s shares and its assets to serve as security for the acquisition debt.

Significantly, banks can finance up to 70% of the acquisition costs with the acquirer contributing at least 30% of the funds themselves. This ensures adequate skin in the game. The post-acquisition debt-to-equity ratio of the acquirer or target must not exceed 3:1., ensuring that leverage remains within manageable bounds. In addition, there are quantitative limits: a bank’s total exposure to acquisition financing cannot exceed 10% of its Tier-1 Capital, and Acquisition Finance falls under Direct CME, which itself is capped at 20% of Tier-1 Capital.

POTENTIAL CONSTRAINTS AND UNINTENDED CONSEQUENCES

While the Draft Directions unlock significant opportunities, there are some risks and potential unintended consequences that could temper this optimism.

Firstly, the Draft Directions formally allows Acquisition Finance, however, the attached conditions, such as the 3:1 debt-equity limit after the acquisition, the requirement that both the acquirer and the target have three consecutive profitable years, and the 70% cap on bank financing, make the framework quite narrow and restricted. These requirements and filters exclude exactly the kinds of deals for which acquisition finance could have the greatest benefit, such as distressed assets, capital-heavy sectors, or high-growth companies that are still loss-making. As a result, this will likely end up benefitting only large, established corporates with stable profits, while limiting mid-market players and emerging sectors from using debt-driven acquisitions to scale or turn around businesses.

Secondly, the provision allowing the target company’s shares and its assets to serve as security for the acquisition debt appears, at first glance, critically close to what Section 67(2) of the Companies Act, 2013 prohibits because that provision prohibits a public company from giving, directly or indirectly, any financial assistance such as loan, guarantee, or security in connection with the purchase of its own shares. However, the key distinction lies in the fact that it is the acquirer or its SPV, not the target company itself, that pledges the shares of the target company after the acquisition to secure the loan. So while the shares of the target serve as principal security, the company issuing the shares remains a passive participant in the financing process. Therefore, such arrangements would likely fall outside the ambit of “financial assistance” under Section 67(2) of the Companies Act, ensuring legal compliance. However, in practice, post-acquisition operational integrations, cash flow sweeps, dividend upstreaming, or guarantees could blur these lines, inviting legal challenges. The RBI’s reliance on bank policies to manage collateral security indicates a potential enforcement gap that require very strong supervisory oversight.

Thirdly, the Draft Directions may unintentionally speed up market concentration. Big business groups, already meeting profitability and capital thresholds, are better positioned than their smaller counterparts to take advantage of Acquisition Finance, which could allow for further market dominance in sectors like telecom, ports, steel, and renewable energy. As a result, smaller players may find it even harder to compete, and highlights the need for coordinated oversight by both the RBI and Competition Commission of India to ensure that the competitive market structures are not negatively impacted.

CONCLUDING THOUGHTS

The Draft Directions come at an advantageous juncture for India’s M&A landscape: in the first quarter of 2025, India recorded US$29 billion worth of M&A transactions which the highest quarterly total in last three years. By enabling Acquisition Finance, the RBI seeks to equip Indian banks to catalyse this growth, creating a more dynamic, credit-backed M&A environment that is in tune with India’s economic ambitions. The public and stakeholders can submit their comments on the Draft Directions until 21^st November, 2025, after which the RBI is expected to finalize the framework. The RBI has now set the stage, and what comes next could very well mark the beginning of a new era in India’s M&A landscape.