Bank funding of corporate takeovers: RBI to cap lending at 70% of deal value, Pg15.

Key Highlights:

• The RBI has proposed draft guidelines allowing banks to finance up to 70% of corporate acquisition value, a shift from the previous prohibition.
• The acquiring company must fund the remaining 30% through equity and should be a listed company with a three-year profit record.
• Banks' aggregate exposure to acquisition finance should not exceed 10% of their Tier 1 capital.
• The acquisition finance should be secured by shares of the target company, with additional collateral security options available.
• The RBI has directed banks to establish comprehensive policies on acquisition financing, including risk management and monitoring mechanisms.

Detailed Insights:

• The RBI's move aims to deepen India’s credit market, improve liquidity for mergers and acquisitions (M&As), and enable banks to play a larger role in corporate restructuring.
• The acquiring company and any Special Purpose Vehicle (SPV) involved must be corporate bodies, excluding Non-Banking Financial Companies (NBFCs) and Alternative Investment Funds (AIFs).
• The acquiring and target companies should not be related parties as defined under Section 2(76) of the Companies Act 2013, ensuring an arm's length transaction.
• Post-acquisition, the debt-to-equity ratio at the acquiring company or SPV/target company level should remain within prudential limits set by the financing banks, with a maximum of 3:1.
• Banks must implement rigorous monitoring of acquisition finance exposures, including early warning systems and regular stress-testing, to manage risks effectively.
• The aggregate Capital Market Exposure (CME) of a bank should not exceed 40% of its Tier 1 Capital, both on a solo and consolidated basis, as of March 31 of the previous financial year.

Key Concepts Involved:

• Tier 1 Capital: The core capital of a bank, including equity capital and disclosed reserves.
• Special Purpose Vehicle (SPV): A subsidiary created by a parent company to isolate financial risk.
• Mergers and Acquisitions (M&As): Transactions involving the consolidation or acquisition of companies or assets.