[Rudraksh Misra is a 3rd Year B.A.LL.B. (Hons.) Student at Hidayatullah National Law University, Raipur]
In October 2025, the Reserve Bank of India (‘RBI’) issued the draft RBI (Commercial Banks – Capital Market Exposure) Directions, 2025 (‘RBI Draft Directions’) proposing to allow banks to finance corporate takeovers, a marked departure from decades of regulations that effectively barred banks from funding such acquisitions. Under the proposal, banks could lend up to 70% of a deal’s value (the acquirer providing at least 30% equity), subject to stringent conditions, viz., the borrower must be a listed company with strong net worth and three years of profitability, and the loan must be fully secured by shares of the target. At the same time, the RBI would cap bank exposures to acquisition loans at 10% of Tier-1 capital and generally limit a bank’s total capital-market exposure to 40% of Tier-1 capital.
This framework is aimed at broadening the scope for capital market lending by banks and other regulated entities, rather than an unchecked private credit. As the Indian corporate sector and deal lawyers digest these proposals, it is critical to examine how debt-funded mergers and acquisitions (‘M&A’) work in theory and in practice, both internationally and in India’s legal setting, and to surface the core governance, disclosure, and enforcement issues that will arise if bank-financed takeovers become common.
This post analyses the RBI Draft Directions, in a three-pronged manner. Firstly, it deals with the international evidence on the certification benefits and leverage risks of bank-funded takeovers. Secondly, it goes over three legal fault-lines: how banks and acquirers would tackle disclosure norms prescribed by the Securities and Exchange Board of India (‘SEBI’); the position of banks as pledgee of shares in the Indian insolvency framework; and governance risks arising from potential conflicts between banks and acquirers. Lastly, it offers suggestions to regulators to overcome implementation challenges, which would allow the Indian M&A environment to flourish to its full extent.
Analysing Bank-Financed Takeovers: Global Evidence on Benefits and Risks
Financial economists have long studied the role of debt finance in takeovers. On the one hand, lenders can play a certifying and monitoring role. A bank’s decision to underwrite a takeover effectively signals that the deal has been vetted and is creditworthy. A firm’s value may be considered enhanced through the certification effect of bank lending, where investors infer from a bank loan that the deal is sound. In a study of bidding shareholders, it was recorded that acquisitions financed by bank loans tend to observe higher stock-market returns at announcement than those financed by internal cash. This well-documented effect, that the existence of a bank’s money behind an acquisition often certifiesthat the target is not overvalued, is what the market rewards. In practice, banks routinely use covenants and reporting requirements to constrain managerial risk-taking.
Further, bank covenants tend to constrain borrower risk taking, which gives banks the leverage over the debtor’s corporate policy. While firms with heavy bank debt often experience improved discipline, the extent of lender influence in public companies goes to suggest that loan covenants may in some cases even substitute shareholder-centred corporate governance mechanisms.
At the same time, leverage brings along its own perils. High debt loads raise default risk, potentially forcing even viable projects to be abandoned if cash flows fall short, an underinvestment problem under heavy debt. The agency‐cost-of‐debt theory warns that shareholders may engage in risky behaviour in distress, and cumbersome debt can impose costly cash flow constraints. In leveraged buyouts (‘LBO’) overseas, for example, if financial projections prove too optimistic, banks can face substantial losses. Consequently, leveraged-lending regulators in the United States (‘U.S.’) and European Union (‘E.U.’) insist on strong covenants and capital buffers for such deals. While bank monitoring may generally benefit firms, the rise of covenant-lite loans in recent years has alarmed U.S. regulators. These loans provide excessive leverage to borrowers, followed by loose loan terms, making loans very attractive for large firms. Since too much leverage without constraints can undermine lender protection, regulators have urged banks to give out loans on tighter terms, leading to a fall in the numbers of debt-driven acquisitions in the U.S. In the Indian context, overly aggressive loan terms could lead to borrower distress and a rise in non-performing assets. Thus, the RBI Draft Directions have proposed a prerequisite for the banks to set post-deal leverage limits with a cap to the debt/equity ratio at 3:1, and conduct ongoing stress-testing of the acquisition loans.
The experience abroad illustrates how law and institutions manage these trade‐offs. In the U.S. and E.U., banks commonly finance M&A, but with extensive structuring. Lenders secure broad packages of collateral (assets, receivables, and in some cases pledged shares) and negotiate covenants that limit dividend payments, additional borrowing, or changes in business strategy. Disclosure regimes also play a role, where takeover rules typically require acquirers to demonstrate funding commitment, such as in the U.K. or U.S.; a bidder may need bank guarantees or escrowed cash when launching a mandatory offer. For example, in India too, the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘SEBI SAST’) in India already require an acquirer to fund an escrow with cash, bank guarantee or liquid securities for a compulsory open offer.
Moreover, regulators impose capital and concentration limits: U.S. regulators have in practice an interagency leveraged lending guidance urging banks to maintain strict credit quality and appropriate capital for high-leverage deals, and the European Banking Authority monitors bank concentration in syndicated loans. The RBI’s new exposure caps (acquisition loans limited to 10% of Tier-1 capital) mirror these global precautions. On the debtors’ side, corporate laws in developed markets treat pledged stock as ordinary collateral; a lender who forecloses can usually sell the shares on the open market. Bank entries into shareholding are permitted, though regulators in India such as SEBI will soon scrutinize any bank-owned shares for related-party rules. However, looking at all the precautions taken RBI Draft Directions, some clarifications are yet to be provided by the regulator with regard to the following challenges outlined herein.
Legal and Institutional Challenges and Plausible Solutions
India’s situation, however, has particular wrinkles. Until now, Indian banks were largely barred from any takeover financing. By law, a promoter’s own contribution to an acquisition could not be bank-funded, and banks could not lend to buy equity of an Indian company except in ‘exceptional cases’. As a result, ambitious takeovers have so far been structured through capital market financing, and more recently via private credit funds. Lending by non-banking financial companies (‘NBFCs’) have flourished with fewer constraints, raising concerns about opacity and risk which the RBI draft proposal attempts to fill as a long-standing gap, channelling some deal finance into banks.
SEBI Disclosure Rules
One immediate issue would be how SEBI’s disclosure rules will apply. Under the SEBI SAST, an acquirer must demonstrate ‘financial arrangements’ for an open offer. If a bank loan is part of that arrangement, the acquirer’s merchant banker must be satisfied that the financing is available before launching a mandatory bid. Banks will therefore effectively vouch for the bid, and regulators will want proof for record, which may be submitted in the form of escrow receipts. Crucially, SEBI treats share pledges as akin to acquisitions when reporting, as any corporate shareholding taken as collateral by a bank is an encumbrance that must be disclosed if it crosses disclosure thresholds.
In a case where a bank lends against target shares, SEBI requires the company to file compliance certificates whenever shares are pledged or released. In practice, this means banks and acquirers must coordinate with the stock exchanges; the target’s share registry will show the bank as a pledge-holder, possibly flagging the transfer of voting rights. The RBI Draft Directions have barred related-party lending, requiring the acquirer and target to be unrelated parties, precluding round-tripping by a promoter using its own bank to buy its stock.
Share Pledges in Insolvency
By design, the RBI allows banks to take target shares as security. This means that on default a bank can foreclose and get title to the shares. But under India’s insolvency framework, pledged equity has an uncertain status. The Supreme Court of India has in Phoenix ARC Private Limited v. Ketulbhai Ramubhai Patel recognised that, contingent on terms of the agreement, a pledgee of shares may not be a financial creditor under the Insolvency and Bankruptcy Code, 2016 (‘IBC’) unless money was disbursed directly to the pledgor; instead the pledgee is treated as a secured creditor of the borrower and has limited rights in resolution. In practical terms, this meant a lender who had only taken a subsidiary’s shares as collateral and lent to the holding company, lost out in the priority waterfall. The resolution plan was confirmed without paying the pledgee, and the shares went to the new owner. To their credit, courts in recent rulings have signalled that pledgees deserve better treatment going forward, suggesting that if a pledged asset is sold in insolvency, the pledgee should get the sale proceeds up to the value of its debt. However, the area remains unsettled as of now. If a bank funds an acquisition by taking the target’s shares as collateral, and then the target itself falls into bankruptcy, the bank faces exactly this ‘pledgee’ dilemma, which the RBI Draft Directions regime fails to address. Thus, Indian banks entering takeover finance would want clarity; additionally, banks as pledgees of such corporate shares may even demand a priority status in insolvency proceedings.
If instead the acquirer defaults, the bank is an ordinary secured financial creditor of the borrower, albeit with a first charge on the target’s stock. Under the IBC, the bank can be part of the committee of creditors and bid in insolvency. However, if the acquirer goes insolvent before completing the takeover, the fate of the pledged shares is murkier. Since the bank cannot compel the target to repay on behalf of the acquirer, it would only be able to confiscate its security, leaving the bank with just one recourse: selling the pledged shares via the stock market or to a new buyer, resulting in market turmoil when large stakes flood the exchange at once. To avoid such a situation, banks as the pledgee of target shares would have to be recognised higher up in the hierarchy of creditors in the insolvency process. Further, an issue that arises in such situations is the lack of standardised loan agreements, a hindrance highlighted in U.S. acquisition finance. Regulators could provide for standardised documentation and loan agreements, exactly to avoid such conundrums while providing further clarity on the status of banks as pledgee of shares.
Governance and Systemic Risks
The RBI Draft Directions give rise to a multitude of institutional implications such as corporate governance and disclosure concerns, that acquirers and banks would have to get ahead of. First, permitting banks into acquisition finance shifts risk to the formal banking system. Banks will now be lending on deals that previously were financed by aggressive NBFC and private credit funds. The upside is that banks are better regulated, with capital requirements, risk-management protocols and recourse to RBI oversight. The RBI Draft Directions even extends beyond M&A loans to cap all capital-market exposure and continues forcing banks to maintain margin on loans. While this move is intended to reduce the blind enthusiasm of unregulated credit, however, the downside is that if a wave of takeovers soars, banks’ balance sheets could absorb heavy losses, possibly even undercutting deposit confidence. Regulators have recognised this, hence enforcing the 10% Tier-1 cap and stress-testing mandates.
Second, corporate governance must adapt in cases where banks holding collateral shares demand de facto voting power. The RBI’s draft does not explicitly bar banks from voting pledged stock, but it does limit loans to public companies only and requires separate purchase vehicles, suggesting that direct bank ownership of non-financial enterprises is not intended. However, prolific scholarship and evidence exist internationally, demonstrating that banks do in fact gain numerous de facto rights once the borrower defaults. In any event, banks are generally barred from acquiring more than 10% of any company under banking regulations, so a lender will likely liquidate shares as soon as feasible. In any case, firms should anticipate potential conflicts, since in a situation where promoter-backed bid is funded by a bank, minority shareholders may question whether the bank and promoter are coordinating.
Third, transparency and disclosure will become crucial. Unlike a stock acquisition or share swap, a loan agreement is not public. If SEBI and the RBI want the market to be aware of big leveraged deals, they may need to consider reporting requirements. For instance, a 70% acquisition loan above a threshold could be disclosed in stock exchange filings or by the acquirer’s board, with the RBI encouraging banks to issue brief announcements upon funding a takeover, analogous to how private placements must be disclosed. This suggestion leads to information symmetry within the market, supported by the co-ordination between regulators.
Lastly, there is a question of whether debt-heavy bids serve the Indian economy’s interests. The opening of the credit markets has been widely accepted as a welcome change; but while it is true that leverage can discipline management and improve efficiency, it is only in the case when cash flows truly support the debt. In India’s volatile economy, a cyclic or regulatory shock could turn a deal risky overnight. Banks will need to price that risk, possibly charging higher spreads or requiring equity cushions. From a policy angle, regulators might restrict such finance to long‐term strategic acquisitions rather than hostile or roll-up deals.
Conclusion
The RBI’s Draft Directions are a bold move that acknowledges the realities of India’s M&A market; private credit is booming, and banks have the balance-sheet heft to underwrite large deals. The academic and global experience suggests there are real benefits to bank-monitored takeovers, such as the certification effect, better governance, and lower financing costs, but only if institutional safeguards are in place. For India, this means integrating the banking and corporate law regimes more closely, beginning with ensuring that the SEBI SAST aligns with the new bank-funding channel, clarifying the status of share pledges in insolvency, and maintaining capital and disclosure rules to prevent overreach. Equally, bank risk management must evolve to treat acquisition loans as a distinct asset class as regulators in the U.S. and E.U. have already done. With these guardrails in place, India would be able to reap the upside of leveraging its banks for growth while avoiding the pitfalls of unchecked leverage.
– Rudraksh Misra
Leave a comment