Introduction
The Reserve Bank of India (“RBI”) has historically been very conversative in permitting banks to make available acquisition finance. However, the RBI has recently proposed amendment to the restrictive regime through the release of two landmark draft frameworks: the Draft RBI (Commercial Banks – Capital Market Exposure) Directions, 2025, (“Draft Capital Market Exposure Directions”) and the Draft Foreign Exchange Management (Borrowing and Lending) (Fourth Amendment) Regulations, 2025 (“Draft FEMA Borrowing and Lending Amendment Regulations”).
While Draft Capital Market Exposure Directions is proposed to come into force from April 01, 2026, there is no separate effective date of Draft FEMA Borrowing and Lending Amendment Regulations and therefore will come into force as soon as Draft FEMA Borrowing and Lending Amendment Regulations are brought into force.
This note provides an analysis of the proposed regulatory changes in acquisition financing through amendment proposed in Draft FEMA Borrowing and Lending Amendment Regulations and Draft Capital Market Exposure Directions.
Current approach to acquisition finance
The (Indian) Companies Act, 2013 (“Companies Act”), prevents companies from providing any form of assistance for the purchase of its own securities and thereby prevents a key security / collateral that can be used for raising acquisition finance. Further, there is a restriction under the (Indian) Banking Regulation Act, 1949 (“BR Act”) which prevents banks from holding (whether as owner or pledgee) more than 30% of the share capital of a company , which also restricts the ability of banks to fund acquisition finance using the shares of the target company being acquired as collateral. Additionally, a foreign owned or controlled company (“FOCC”) cannot avail finance in the Indian market for acquisition of shares , which restricts the ability of foreign investors to use domestic leverage for acquisitions.
In addition to the statutory restrictions highlighted above, the RBI has discouraged banks from participating in any acquisition finance transaction, save and except in certain limited circumstances like capital infusion for infrastructure projects.
The RBI (Commercial Banks – Credit Facilities) Directions, 2025 (as amended from time to time) (“RBI CB Credit Facilities Direction”) provides the key restrictions applicable to banks in connection in making available loans and advances, including in connection with capital market exposures. Under the said master directions, the gamut of permitted capital market exposures for banks were limited and largely covered loans to individuals for purchasing small stakes or employees subscribing to Employee Stock Ownership Plans (ESOPs) up to ₹20 lakh. These directions call out the fact that banks are generally not allowed to finance promoters’ contribution towards the equity capital of a company.
However the RBI CB Credit Facilities Direction makes an exception for financing acquisition of the promoters’ shares in an existing company, which is engaged in implementing or operating an infrastructure project in India. This exception was made keeping in view the importance attached to the infrastructure sector. The RBI CB Credit Facilities Direction also creates exception for banks to extend loans to corporates against the security of shares held by them to meet the promoters’ contribution to the equity of new companies in anticipation of raising resources. Additionally, the RBI CB Credit Facilities Direction allows banks to provide finance to fund successful bidders to acquire shares of PSU under the PSU disinvestment program of the Government.
While the above restrictions apply in the context of bank participation in domestic capital markers, Indian banks were always allowed to extend financial assistance to Indian companies for acquisition of equity in overseas joint ventures / wholly owned subsidiaries or in other overseas companies as strategic investment.
The consequence of these restrictions is that domestic acquisition transactions were typically funded through financing made available by non-banking financial companies (“NBFCs”) / Foreign Portfolio Investors (“FPIs”). This also meant that the cost of raising finance for meeting acquisition funding requirements in India was significantly higher as the cheaper form of funding, being bank funding, was not available for the same.
Proposed Changes for Domestic Lenders
RBI now proposes to allow domestic banks to participate in acquisition financing through Draft Capital Market Exposure Directions. The proposal is not to open up bank finance for any acquisition but only for acquiring a controlling stake and therefore funding of acquisition of non-controlling stakes will still remain the playground for foreign portfolio investors. Further, the RBI has stated that the finance shall be utilized only for acquisition of equity stakes in domestic or foreign companies as strategic investments whose core objective shall be creation long-term value rather than mere financial restructuring for short-term gains.
1. Borrower’s Eligibility
A defining feature of Draft Capital Market Exposure Directions is the eligibility criteria for the acquiring company. It is explicitly stated that the acquiring company shall be a ‘listed entity, having satisfactory net worth and profit making for last three years’. It appears that the rationale for this is grounded in governance transparency as listed companies are subject to the rigorous disclosure norms of the Securities and Exchange Board of India (“SEBI”) which ostensibly results in lower credit risk. This necessarily means that acquirers who are not public companies will continue to rely on more expensive funding where leverage is being sought.
2. Target Company
The regulator proposes to make available the acquisition finance under the new regime only for target companies who meet certain identified conditions. The target company should have annual returns for at least the previous three financial years , which effectively filters out the early-stage start-ups or opaque shell companies. Further, debt to equity ratio at the acquirer level as well as the target company level, as applicable, shall be within prudential limits set by financing banks, subject to a maximum of 3:1.
3. Ceilings
Each bank is expected to keep their capital market exposure limit to 40% of the bank’s net worth, and within the said limit: (i) direct capital market exposure (which would include acquisition finance), should not exceed 20% of the net worth of the bank; and (ii) acquisition finance alone should not exceed 10% of the tier 1 capital of the bank.
Further a bank may finance at most 70% of the acquisition value and 30% of the acquisition value must come from the acquirer’s ‘own funds’.
4. Other Conditions
(a) The acquisition value of the target company is to be determined by two independent valuations as prescribed in the SEBI regulations to avoid acquisitions at cheap or overvalued valuation.
(b) The acquiring company and the target company shall not be related parties as per Companies Act.
(c) Acquisition finance must be fully secured by the shares of the target company as primary security, however, banks are permitted to take additional collateral over the acquirer’s other assets.
Proposed Changes for Offshore Lenders
Under the current Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 (“FEMA Borrowing and Lending Regulations”), Indian companies are allowed to raise external commercial borrowings (“ECB”), however, the ECB funding is subject to negative end-use list as notified in RBI Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations, 2019 (“RBI ECB Master Directions”). This list bars investment in capital market through the use of the ECB proceeds. Therefore, the main source of foreign funding for the domestic acquisition is from FPIs via subscribing non-convertible debentures (“NCDs”) issued by acquiring company.
The Draft FEMA Borrowing and Lending Amendment Regulations has introduced Regulation 3A, which specifically carves out an exception to this prohibition, which would permit offshore financing to be used for funding mergers, amalgamations, arrangements, or acquisition in accordance with the Companies Act, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, and Insolvency and Bankruptcy Code, 2016.
1. Amendment to RBI ECB Master Directions
However, prior to giving effect to the Draft FEMA Borrowing and Lending Amendment Regulations, the RBI ECB Master Directions will also have to be amended as the RBI ECB Master Directions does not have this relaxation for end use as envisaged under the Draft FEMA Borrowing and Lending Amendment Regulations. There is a possibility that the authorities may decide that any acquisition finance will be permitted only under the approval route, in which case the RBI ECB Master Directions may not be amended, however, we have not come across anything to indicate that this is the case.
2. Meaning of Acquisition
The Companies Act, 2013 does not define “acquisition”, however it does provide for merger, amalgamation and arrangement in section 230-232 of Companies Act. If the usage of the term ‘acquisition’ under the Draft FEMA Borrowing and Lending Amendment Regulations was to be interpreted on the basis of the ejusdem generis principle, for a permitted funding of ‘acquisition’, the acquisition itself would have to be completed via tribunal-approved schemes, like that of merger, amalgamation and arrangement as per Companies Act.
Concluding Thoughts
1. The ‘Unlisted’ Conundrum
The Draft Capital Market Exposure Directions does not permit banks to finance acquisitions by unlisted companies. By mandating that the acquiring company must be a ‘listed entity’, the RBI effectively locks out unlisted entities, namely private equity portfolio companies (PE firms operating through unlisted special purpose vehicles), unicorns / startups and family offices, etc. to avail funds from domestic banks for acquisition finance. This significantly reduces the ability of funds to leverage (using bank funds) their portfolio companies and this will continue to remain a market crowded by the NBFCs, Alternative Investment Funds (AIFs), foreign banks operating via FPI books and post the ECB amendments, foreign lenders.
2. Timing
The timing of these regulatory interventions seems coincidental at a moment when Indian corporate balance sheets are uniquely positioned to deploy capital. Estimates suggest that the top listed companies in India hold cash and cash equivalents exceeding Rs 14.19 lakh crore at the end of September 2025. The cash pile attributes that the companies have improved financial performance and had a big jump in other income . The pharma companies alone have amassed over ₹48,000 crore in cash, a 120% increase from FY20 levels, signaling imminent outbound M&A activity to acquire new molecules or market access . The ‘dry powder’ will likely be used as the 30% equity contribution mandated by the new banking norms, while the remaining 70% of the deal value is leveraged through the newly available bank financing.
3. More Regulatory Change
While the changes to bank funding and the ECB regulations are very welcome, the regulators should also consider making changes to the BR Act (which restricts ability of banks to take security over more than 30% of the share capital of the Company), the Companies Act (which restricts the ability of a target to use its assets for any acquisition finance) and the RBI regulations governing FOCC (which prevents FOCC’s from availing domestic finance for downstream investment). Without these additional changes we feel that the true opportunity of unlocking bank finance for acquisitions will remain unlocked.