RBI Wants M&A Deals Funded by Cash Flow, Not Pledged Shares

A practice many acquirers resort to in M&A deals is to “pledge the target to buy the target.” For years, control transactions and creeping acquisitions were stitched together through a patchwork of bank lines of credit, NBFC loans, and offshore structures, held together by high pledge ratios on the shares being accumulated.

Such a structure can hold together in calm markets, yet it can crumble quickly when the share price falls and lenders demand additional collateral. The Reserve Bank of India has now placed curbs on such structures, even as it opens a new bank-backed route for mergers, acquisitions, and leveraged buyouts. This will change who gets funded, on what terms, and where leverage sits when markets wobble.

What has changed is simple in principle but complicated for dealmakers in practice. The RBI has clarified who can borrow for acquisitions, how much they can borrow, and how banks must classify and secure these loans. Banks will have to assess the acquirer and the target together as one combined business, not as two separate companies. Banks may fund up to 75% of the acquisition value in qualifying cases, subject to caps tied to Tier 1 capital, with the remaining 25% coming from the acquirer’s own funds, including internal accruals or fresh equity, shrinking the room for pledge-heavy ‘equity-by-proxy’ structures.

This is a significant development, as the rules require boards, risk committees, and regulators to see the whole exposure at once, rather than bits and pieces spread around. It also means investment bankers cannot be sanguine about financing a deal based purely on relationship logic.

The RBI has set a higher bar for eligibility. Acquisition finance is aimed at financially sound acquirers, typically with a minimum net worth of ₹5 billion, a record of profitability, and the ability to maintain a consolidated debt-to-equity ratio of about 3:1 after the deal closes.

The bigger change is in how banks appraise these deals. The RBI is signalling that banks should focus more on the merged entity’s ability to generate cash and service debt than on the market value of pledged shares. In practice, the guidance makes equity collateral a backstop rather than the mainstay.

That weakens the “pledge the target to buy the target” model, where risk could sit outside bank books even when it ultimately leans on bank liquidity. It could also leave minority investors exposed when a falling stock triggers margin calls and forced selling.

Under the revised RBI guidelines, banks must ensure loans fall within recognised acquisition finance or capital market exposure norms. On the plus side, Indian banks can fund more acquisitions in rupees, reducing reliance on offshore private credit and complex NBFC structures that add currency and refinancing risks. On the downside, banks will price deals around strict leverage caps and repayment buffers that must remain sound through a downturn, not just look fine on signing day.

The first to feel the shift will be promoters and sponsors who use high pledges as a control amplifier. Since acquisition finance and other capital market exposures compete within a fixed slice of Tier 1 capital, lenders have every incentive to reserve that capacity for deals with meaningful equity, diversified earnings, and clear governance protections. Transactions that lean heavily on volatile or illiquid stock, without real operating strength and equity depth, will look uncompetitive next to cleaner structures and will either be repriced sharply or struggle to clear credit committees.

The RBI’s parallel tightening around bank credit to stockbrokers and other capital market intermediaries completes the picture. By insisting on fully secured funding, steeper haircuts on equity collateral, and a bar on bank finance for proprietary trading, the central bank is signalling that it wants leverage to sit on supervised corporate balance sheets rather than flow through intermediary channels that can transmit shocks quickly.

India is allowing more predictable, bank-led acquisition loans for solid, cash-flow-backed deals while leaving less space for pledge-heavy structures that try to substitute for equity. If buying control is the goal, the real test will be steady cash generation, not a strong share price.