RBI’s New Acquisition Finance Guidelines: The One-Size-Fits-All Problem of Rigid Leverage Caps?

This post is authored by Raghav Gupta and Ahan Garg, 3rd Year, B.B.A. LL.B (Hons.) students at National Law University, Jodhpur.

1. Introduction

For decades, India restricted acquisition finance by effectively preventing banks from funding equity acquisitions. Paragraph 2.3.1.9 of the RBI Master Circular on Loans and Advances - Statutory and Other Restrictions stipulates that the promoters' investment in the equity capital of a company should be funded by their resources, and the banks should not generally be granted advances for the purchase of shares of other companies. Acquirers had little choice but to rely on retained profits, promoter funds or elaborate offshore structures to fund acquisitions. Although it reflected a sound, prudent policy, it caused a fundamental structural disability to the companies, since leveraged acquisitions are a key driver of growth and consolidation of businesses.

The Reserve Bank of India’s recent reform marks a significant turning point. Domestic banks may now participate in the acquisition finance and finance as much as 75% of the acquisition value, with the acquirers required to fund the remaining 25% with their own money, subject to maintaining a 3:1 post-acquisition debt-to-equity ratio.

The policy intention is twin-fold: enabling Indian credit to play a part in M&A activity to develop deep capital markets; and macro-financial stability with quantitative limits on leverage, borrowers’ contribution and exposures. Simultaneously, the RBI gets an implicit say in interest rates and the terms & conditions of lending in the M&A space instead of relying solely on external, offshore sources of funding.

The commercially driven incentives for banks in this transaction are clear, as banks must be allowed to deploy capital in profitable opportunities, and an acquisition is one such opportunity providing risk-adjusted returns. However, the critical factor is the actual on-ground implementation. The regulation might succeed in lifting the prohibition, but it remains to be seen whether the ecosystem it created will be commercially viable, given the implicit conditions that could constrain its usefulness.

This blog analysis whether caps of strict uniform leverage and corresponding covenants under the new regime lead to a workable domestic acquisition-finance market and risk constraining the participation of bank financiers, spawning regulatory arbitrage, and resulting in the under-serving of strategically significant transactions, through an investigation of the practical implications of the 3:1 limit, the 25% equity investment requirement and, as a result, the incentives to use an offshore structure or non-bank financiers. The analysis is necessary because, while the reform correctly lifts a long-standing prohibition, its one-size-fits-all design may ultimately undercut the very objective of developing a deeper, more transparent domestic deal-financing market.

2. Practical Limitations of the Framework

(a) Uniform D/E Caps in a Heterogeneous Market

The debt-to-equity [“D/E”] ratio measures the proportion of financing that comes from debt relative to shareholders’ equity. It enhances returns on capital, but it places further fixed demands for repayment on the company and increases exposure to financial risk. Acquisition financing usually tailors leverage amounts to the target company’s cash flows and is inherently specific to the situation. Financially stable, cash-generating companies can support more debt financing than unstable or start-up companies can manage. Against this backdrop, a rigid, absolute ceiling of 3:1 seems excessively cautious.

A uniform D/E ratio ceiling becomes too restrictive as different industries have different factors affecting their Debt-Equity ratio. Capital-intensive sectors like infrastructure, cement and energy companies rely heavily on stable cash flows for debt, whereas tech companies/start-ups are mostly equity-dependent. This ongoing obligation adds significant rigidity. Any future increase in debt or decline in equity, whether from losses, new capex or market conditions, risks a technical breach even if the underlying cash flows remain healthy enough to service the debt.

Importantly, international leveraged finance markets rely primarily on EBITDA multiples often in the 4x to 7x range for leveraged buyouts rather than a fixed balance-sheet D/E ratio. These cash-flow-based metrics allow lenders to tailor leverage more flexibly to the target’s actual debt-servicing capacity. While a D/E ceiling can be useful for assessing overall capital structure and long-term financial stability, particularly where EBITDA is low, volatile or negative, it is less responsive to the specific cash-generation profile of the business being acquired.

The result is a distortion where Indian acquirers must operate under tighter constraints on the price they can pay for targets and how the transaction can be financed through domestic bank debt. Foreign PE-backed or global investors, by contrast, often have greater flexibility to structure higher leverage in segments of the market that still expect elevated debt levels. While the February 2026 liberalisation of the External Commercial Borrowings [“ECB”] framework now permits Indian companies to raise offshore funds for control acquisitions, practical frictions, including hedging costs, currency risk, tenor mismatches and availability, mean that ECBs do not fully neutralise the relative disadvantage. A framework that appears aimed at boosting Indian acquiring power may, over time, still subtly suppress domestic institutional participation in certain key deals.

(b) Incentivization of Regulatory and Structural Arbitrage

There is an obvious risk of regulatory arbitrage. Where domestic bank financing is limited in terms of scope, an acquirer may engage in structural techniques such as using offshore SPVs or layered structures, hybrid securities or any other alternative forms of financing not directly within bank credit guidelines. Such strategies are not new in acquisitions, but they might gain additional traction with persistent domestic regulatory restrictions on leveraging. As such, domestic bank financing would not be the cheapest available financing, even though it may be available; domestic acquirers may, as now, resort to overseas or non-bank routes to finance acquisitions, defeating the stated objective of domesticating the financing function.

(c) Misalignment Between Regulatory Intent and Market Function

Whilst the framework intends to internalise and regulate acquisition financing, the rigid nature of the leverage ceilings may lead to only marginal bank participation. The ceilings and thresholds effectively limit bank finance to well-capitalised entities acquiring stable, cash-generating businesses. Growth-stage companies or those pursuing strategically important but less predictable deals often cannot meet the continuous 3:1 requirement or the expectation of steady cash flows. As a result, these acquirers continue to turn to private credit, NBFCs or offshore routes. The framework therefore succeeds in formally opening the door for banks, yet leaves a significant portion of the market, precisely the segment that most needs flexible domestic financing, still underserved.

(d) Constraints Imposed by the 25% Equity Contribution Rule

The minimum 25% own-fund requirement will itself make it practically challenging for many deals and is likely to lead to asset sales, drain internal cash flows, or result in equity dilution. All of which carry their own trade-offs in terms of risk and value, and for a particular transaction may prove the ultimate barrier even for otherwise well-capitalised acquirers. While the 25% contribution is a deliberate “skin-in-the-game” safeguard that ensures the acquirer absorbs real risk, a modest degree of flexibility, for example, permitting a limited portion of that contribution to be met through subordinated or quasi-equity instruments that remain junior to bank debt, could improve practical utility without fully eroding the prudential cushion the rule is intended to provide.

3. A Global Take on Acquisition Financing through a Comparative Study of Leverage Financing in the United States and the UK

The 2013 Leveraged Lending Guidance regulates acquisitions in the US. Under this guidance (issued by the Federal Reserve, OCC, and FDIC), there are no hard caps, but banks are obligated to demonstrate that their lending is based on cash flow generation and repayment capacity, backed by solid underwriting practices. This means regulators don’t prevent deals in advance; instead, they assess a bank’s portfolio via systems like the Shared National Credit Program and intervene only in the event of any risk to financial health.

The current US framework is not best suited for India, as it relies on inter-agency surveillance that entails a coordinated monitoring infrastructure, which is difficult for India’s PSB-dominated banking system to adopt. India can, however, explore the option of cash-based underwriting even without engaging in SNC-style surveillance by adapting the RBI’s existing large exposure framework to require lenders to provide documents of repayment capacity assessments.

The Prudential Regulation Authority and the Financial Conduct Authority are tasked with the regulation of financial lending activities in the UK. The banks in the UK are permitted to finance as high as 80-90% of the acquisition, as there are no statutory limits on debt. The regulation is affected through analysis of stress tests, capital requirements and supervision; therefore, the regulation is intervention-based and not rule-based. Understandably, the RBI cannot resort to this approach for the Indian markets because this requires real-time monitoring capacity, which is very difficult to implement because India has a much larger and more heterogeneous banking system. However, what India can really adopt from this is targeted stress testing of potentially large exposure accounts to check whether the cash flows of the borrower can still finance the debt under stress or not; this will help assess the deal’s deterioration after origination and supplement existing caps.

On the other hand, the UAE and Singapore follow different prudential architectures. As per the MAS Notice 656, para 7 and 8(b) and the CBUAE Large Exposures Regulation article 3.1, respectively, generally a 25% Tier 1 capital limit is imposed upon a bank’s exposure to a single counterparty or a group. The banks have the discretion to determine the leverage, pricing, security and facility structure within this limit, subject to the jurisdiction’s broader credit risk management through their own underwriting framework.

For India, this is more suitable to adopt; it avoids supervising every transaction and is well within the RBI’s supervisory bandwidth; however, it cannot be adopted wholesale because India’s PSB-dominated system faces challenges like weaker credit discipline, political influence, etc. Therefore, nascent leveraged finance markets coupled with enforcement risks make it difficult to implement the above model.

4. Filling the gap: Suggested Reforms

In an effort to create a functioning acquisition finance regime, the framework needs to incorporate an element of flexibility to accommodate less risky situations without sacrificing prudent regulation. Some of the reforms one can include are:

a) A calibrated “safe harbour”: A higher D/E ceiling should require an independent RBI-empanelled certification by an auditor of pro forma interest coverage and debt service coverage ratio, with the certificate becoming void ab initio in cases where the filings are inaccurate; this triggers immediate reversion to the standard cap and mandatory reporting, as loans that are disbursed once cannot be unwound. This shall be piloted with large rated acquirers before subsequent wider rollout.

b) Sector-specific Leverage relief: Instead of pursuing a rigid 3:1 ratio across all sectors, the RBI should formulate sector-specific leverage ceilings after engaging in industry-wide consultations. The ceiling can be calibrated to suit cash-flow stability, asset intensity and default history of the various sectors and can be adjusted periodically to preserve prudential safeguards.

c) Distinguish between strategic and financial bidders: Being more forgiving to strategic bidders/acquirers who will use the assets for a long time, instead of short-term financial investors, would be a wise approach for risk assessment. To prevent misuse of 170A, banks must obtain a board resolution and a brief synergy note from the acquirer to abstain from an early exit before a three-year holding period, breach of which may trigger step-up risk weights with carve-outs for cases involving RBI- or IBC-recognised stress.

d) Flexible approach to bridge financing: The 180-day window for bridge financing can be retained and an extension for regulatory delay can be capped at 90 days. Refinancing through a second bridge facility can be prohibited and it can be enforced via imposition of mandatory disclosure to RBI’s large exposure repository. This can be effected via a published timeline for processing such disclosures and a dedicated nodal desk which can flag inconsistent exposure reporting by the same lender groups across the RBI’s repository. Since CCI & SEBI cannot be bound by directives of RBI, this mechanism ensures that RBI’s enforcement does not cross its bounds and a streamlined process is adopted.

Conclusion

Undoubtedly, this RBI reform marks a meaningful shift towards enabling domestic acquisition finance, but its uniform leverage imposition risks limiting the very market it seeks to develop. The objective shall shift from a strict rule-based approach to calibrated flexibility: to allow greater leverage where cash flows and transaction economics justify it, while preserving prudential safeguards. Such an approach will reconcile financial stability and commercial realities in the market. Sustained evolution is necessary to ensure a competitive, efficient and prudentially sound acquisition financing landscape.