In a historic move with far reaching consequences in the days to come, the Reserve Bank of India (RBI) has now paved the way for Indian banks-led onshore and offshore acquisition financing for Indian corporates. Permitting acquisition finance as a move by RBI has been on the anvil for a long time, especially against the backdrop of proposed amendments to the external commercial borrowings (ECB) regime, which intends to permit acquisition by Indian corporates as an end use for ECBs.

Any Indian professional linked to the banking sector has used the line ‘Indian banks are not permitted to lend for acquisition finance’ for decades. This restriction led to NBFCs, AIFs, FPIs and other private credit players taking centre-stage for acquisition finance by Indian corporates. A large part of the deal-making when it came to leveraged buyouts was conceptualised and executed offshore. Indian banks and corporates were never at the centre stage. With RBI now permitting commercial banks in India to fund strategic acquisitions, there is a level playing field set out for financiers across the spectrum.

Even from the perspective of Indian corporates as borrowers, they significantly relied on comparatively higher price debt for their acquisition objectives or had to redesign acquisition finance deals to fit the onshore or offshore debt capital markets playbook, which came with its own challenges. This is set to change.

RBI’s framework is fairly water-tight on what is permitted. Firstly, the borrower has to be a corporate entity or an SPV in the non-financial space, with the objective for finance being strategic long-term investment and not financial restructuring. While refinancing of target debt is permitted, such refinancing has to be integrally tied to the acquisition. Second, RBI has also laid down additional criteria for net worth, listing, credit rating, and valuation based on the nature of the borrower. RBI has taken industry feedback into account and not restricted this avenue to only listed acquirers as was contemplated in the draft regulations, signalling its confidence and trust on the maturity on the market participants. Last but not the least, the acquirer is required to have skin in the game of at least 25% of the acquisition value, permitting only 75% to be leveraged—with the exception for listed companies to avail bridge finance for the 25% with stringent fetters for such bridge financing being stipulated. RBI has also contemplated a total debt-to-equity ratio.

Collateral and credit comfort is mandatory for acquisition financing. Along with the pledge of acquired shares (subject to a cap of 30%), corporate guarantee of the acquiring company is a must. Additional security, though encouraged, would practically seem essential, given the general stipulations of credit committees of Indian banks. Indian banks are free to offer these services as soon as they have adopted a board-approved policy suitably incorporating the underwriting benchmarks according to the new regulations. FY27 will therefore see significant activity in bank-led financing in the M&A space in India.

In the interim, especially as Indian banks frame their policies to adopt acquisition finance as a line of business, certain key considerations would include (a) strategic investment being defined in a manner that can be fact-dependent; (b) escrow mechanisms especially for secondary acquisition finance to ensure that the pledge release and creation mechanics are seamless; (c) borrower set being defined in a manner that portfolio companies of private equity players are covered; (d) bridge finance meeting the fetters prescribed; (e) stringent measures for monitoring of debt-equity ratio as entities that raise acquisition finance may not necessary have enough headroom for raising growth capital or availing working capital. Once these are defined, banks and corporates would probably reach a conclusion that it would be necessary to identify the right entity to avail the finance given the aforementioned restrictions and SPV structures may inevitably get encouraged. Consequently, ensuring bankruptcy remoteness and seamless access to corporate guarantee could also become critical credit evaluation measures.

As this change gets implemented, Indian banks and foreign banks in India would set the stage for overall M&A growth in the Indian and offshore market. Even with the stipulated conditions, which isn’t surprising as RBI has always been a cautious regulator, it is quite obvious that the Indian corporate sector will go back to the drawing board to rewrite their M&A objectives, as access to debt capital for M&A activities from the Indian banking sector will prove to be the required boost for their growth trajectory.

 (Sivaramakrishnan is Partner & Co-head, Banking & Finance Practice, Shardul Amarchand Mangaldas & Co; Garg is Partner, Shardul Amarchand Mangaldas & Co. Views are personal.)