The Reserve Bank of India (RBI) recently permitted domestic banks to finance acquisitions by Indian companies. This move aims to boost credit demand in the corporate sector and enable banks to capture a larger share of acquisition financing. Traditionally dominated by non-banks, private credit funds, and foreign banks, this market is now open to banks with their lower cost of funds. The announcement comes amid a decline in bank credit to corporates and a broader effort by RBI to support the real economy.
RBI’s New Measures to Boost Credit Flow
RBI Governor Sanjay Malhotra introduced 22 measures to enhance credit availability and ease business operations. Among these, allowing banks to fund acquisitions of Indian non-financial companies is step. This change addresses the long-standing demand from banks to participate in acquisition financing, which was earlier restricted due to risks of overleverage and limited asset creation.
Impact on Corporate Credit and Acquisition Financing
The decision is expected to increase credit demand from corporates. Banks have a cost advantage over non-banks and foreign lenders, potentially enabling them to offer better terms. However, initial demand remains uncertain due to tariff uncertainties and market conditions. The recent GST cuts have improved retail sales, which may indirectly stimulate corporate credit needs for capacity expansion.
Restrictions and Regulatory Safeguards
RBI plans to impose limits on acquisition financing. Funding will likely be restricted to listed non-financial companies and exclude the financial sector. These measures aim to prevent speculative use of bank funds and avoid creating asset bubbles in capital markets. Similar restrictions exist in other regions like the EU and UK, ensuring controlled exposure by banks.
Development of Bank Expertise in Acquisition Finance
Banks currently lack deep expertise in acquisition financing. However, they already have experience in assessing credit risk for corporates. With proper training and guidelines, banks expect to develop capabilities similar to those in infrastructure financing. Banks will focus on sectors they are familiar with and gradually build policies and procedures for acquisition lending.
Market Potential and Economic Significance
Experts estimate the acquisition financing market in India at around $40 billion (approximately ₹3.5 trillion). The RBI’s rollback of 2016 large exposure regulations further expands banks’ capacity to fund large corporate deals. Growth in credit to medium and large manufacturing firms is currently low but expected to rise with increased M&A activity. Banks’ existing relationships with these companies will ease credit evaluation for acquisition loans.
Collaborations Between Banks and Other Credit Providers
The move could encourage collaboration between banks, private credit funds, and foreign lenders. Each participant brings unique strengths. Private funds offer structuring expertise, while banks provide substantial capital. This synergy may improve financing options and support complex acquisition deals in India’s growing corporate sector.
Questions for UPSC:
- Discuss in the light of recent RBI reforms, how financial sector regulations impact credit availability and economic growth in India.
- Analyse the role of mergers and acquisitions in corporate growth and how bank financing can influence this process, taking examples from global markets.
- Examine the challenges and opportunities in developing specialised financial services within traditional banking systems, with reference to acquisition financing.
- Critically discuss the effects of regulatory restrictions on banking operations and their implications for financial stability and market development.
