By Sandeep Parekh, Managing partner, Finsec Law Advisors
Mergers and acquisitions (M&A) activity in India has entered a period of sustained strength. In 2024 alone, deal-making touched nearly $120 billion as Indian companies continued to acquire domestic businesses at a rapid pace. That momentum has carried into 2025, with another $50 billion in deals reported in the first half of the year.
Commercial banks in India, despite holding one of the country’s deepest pools of domestic capital, have largely remained spectators. This is largely attributable to the Reserve Bank of India (RBI) maintaining a conservative approach on permitting banks’ exposure to the capital markets. Under the provisions of the Banking Regulation Act, 1949 and the directives issued under the RBI Master Circular on Loans and Advances, banks are prohibited from granting loans or advances for acquiring shares of other companies, including financing corporate takeovers or management buyouts except to the extent of the infrastructure sector. The rationale behind this restriction is to ensure that banking funds, which are primarily public deposits, are not exposed to the inherent risks associated with volatile equity investments. But as M&A activity grows in scale, the RBI is rethinking these restrictions.
Historically, banks’ capital market exposures have been subject to tight prudential limits, and bank financing for the acquisition of shares has generally been prohibited. Against the backdrop of a more mature capital market and a stronger banking system, the RBI, through its Statement on Developmental and Regulatory Policies, has proposed a calibrated easing and rationalisation of these norms, including permitting acquisition finance, widening the scope of lending against securities, and moving towards a more principle-based framework for lending to capital market intermediaries. On October 24, the draft RBI (Commercial Banks – Capital Market Exposure) Directions, 2025 (Directions) were released, proposed to come into force from April 1, 2026. They apply to all commercial banks except small finance banks, regional rural banks, local area banks and payments banks.
Under the Directions, capital market exposure of banks shall include both their direct and indirect exposures, including investment and credit exposure. Investment exposure refers to banks’ direct or derivative exposure to equity-linked instruments including direct holdings in equity shares, preference shares, convertible securities, and units of equity mutual funds, and of alternative investment funds (AIFs). Credit exposure, however, stretches wider. It captures everything from acquisition finance to promoter funding, loans secured against marketable securities, bridge loans against anticipated equity infusions, and financing backed by mutual fund units (other than debt schemes). Over time, these categories developed through a patchwork of standalone circulars and context-specific directions; the Directions now consolidate them into a single, coherent, and principles-based framework.
One of the most significant components of the draft is the framework for acquisition finance, an area India has historically tiptoed around. While Indian companies often relied on overseas bank funding for cross-border acquisitions, domestic financing of acquisitions (apart from infrastructure) remained a grey area. The Directions provide a clear definition of ‘acquisition finance’, as funding extended directly to an acquiring company or its special purpose vehicle (SPV) for the purchase of all or a controlling stake in a target company’s shares or assets.
However, the RBI has not thrown caution to the wind. The Directions construct a high wall around who can borrow and how much. The RBI proposes eligibility filters at both ends of the transaction. The borrower must be a listed Indian body corporate with a satisfactory net worth and at least three years of profitability. The target must have three years of audited financials and must not be a related party. In substance, this ensures that acquisition finance flows to strategic, long-term transactions rather than promoter-level restructurings or intra-group self-deals. The emphasis on long-term value creation is a recurring theme throughout the Directions.
While the Directions permit banks to finance acquisitions involving controlling stakes often exceeding 51%, such financing remains subject to Section 19(2) of the Banking Regulation Act, which restricts banks from holding, whether as pledgee or absolute owner, more than 30% of a company’s paid-up share capital. Further, the Directions also permit the banks to take additional collateral, subject to their internal policies. Yet where the target is a public company, its ability to offer guarantees or other forms of security may be limited due to the Companies Act, 2013, which restricts financial assistance for the purchase of its own shares.
The prudential framework surrounding acquisition finance is deliberately tight. To contain systemic risk, the RBI has capped a bank’s aggregate exposure to this segment at 10% of its Tier 1 capital (bank’s core equity capital available to absorb losses). In terms of funding limits, a bank may fund only up to 70% of the acquisition value; the remaining 30% must come from the acquirer’s own equity, ensuring meaningful ‘skin in the game’. The Directions require banks to undertake regular monitoring, stress tests, early-warning assessments and valuation checks, creating a tightly controlled environment for acquisition financing.
Against this backdrop, the case for allowing banks to play a more direct role in acquisition financing becomes clearer. Financial sovereignty allows capital flows to be shaped domestically while reducing exposure to external shocks. This objective is advanced when long-term corporate growth is supported by domestic capital rather than offshore funding. Creating regulated pathways for banks to support strategic acquisitions therefore becomes essential, with acquisition finance emerging as the link that enables Indian corporates to execute complex transactions through stable, domestically anchored banking channels.
The Directions represent one possible regulatory response: opening the door to acquisition financing while surrounding it with tight safeguards to preserve systemic stability. While the framework signals a shift, its operational window remains narrow, with stringent eligibility, collateral, and prudential conditions limiting its applicability to a small segment of corporates. Even so, the direction of travel is clear. The RBI is cautiously laying the groundwork for banks to play a more constructive role in India’s expanding M&A landscape, with the final directions likely to determine how this balance between flexibility and restraint is ultimately struck. This will help with Indian companies achieving scale, without depending solely on foreign loans.