RBI move on M&A funding likely to revive corporate credit demand

Also enable corporate sector to capture sizeable share of acquisition financing mkt

Domestic banks are hopeful that the Reserve Bank of India’s (RBI’s) decision to allow them to fund acquisitions by Indian companies will not only boost credit demand from the corporate sector, but will also enable them to capture a sizeable share of the acquisition fina­ncing market, which so far has been dominated by non-banks, pr­i­vate credit funds, and foreign ba­n­ks, as banks have a lower cost of funds. 

It also comes at a time when the share of bank credit to corporates has declined significantly. 

Last week, RBI Governor Sanjay Malhotra announced 22 measures aimed at boosting credit flows to the real economy and promoting ease of doing business while lowering banks’ costs. These include a nod for banks to fund acquisitions of Indian non-financial sector companies. 

This has been a long-standing demand of the banking sector, especially as corporates are increasingly turning to alternative sources of funds, including the domestic and overseas debt capital markets, and the equity market, for their capex needs, leading to an overall slowdown in credit growth in the system. 

Indian banks have been historically restricted from lending for mergers and acquisitions, as such financing can lead to over-leverage, promoter-level funding at the holding company level, and may not directly contribute to asset creation or growth.

Meanwhile, bankers feel acquisition financing could follow the path of infrastructure financing, where a few large banks develop expertise, and smaller banks piggyback on their capabilities by taking smaller exposures. 

“Our stance is that we are funding the same corporates. We know the corporates; we have done the risk assessment otherwise, so why should we not be allowed to do a part of the business that the foreign banks and the NBFCs do and charge much more heavily to the corporates? Even if it is an opportunity of, let’s say, ₹60,000 crore –₹80,000 crore, it is still a large opportunity for banks in the corporate credit space,” said a senior banker at a state-owned bank, adding that banks’ cost of funds is lower than that of NBFCs, private credit players, foreign funds, and bonds, so that will give the banks an advantage to corner some part of the market. 

“Allowing M&A financing will certainly boost credit demand. How much, we don’t know yet. We are not seeing too much demand from corporates because there is a lot of uncertainty regarding the tariffs. I don’t see a very large pickup so far, but now with the GST cuts, we are seeing a pickup in sales on the retail side, and that might lead to an increase in corporate demand for credit to increase capacity. But we will have to wait and see,” he said. 

According to experts, the regulator will put some restrictions on M&A financing like limiting such activities only for listed entities, and excluding the financial sector from availing bank finance for acquisitions.  

“What RBI obviously doesn’t want is general access. The reason to have limits is to prevent bank funding going in for speculator activity. You don’t want to create a capital market, stock market bubble using bank funding,” said Kanchan Jain, head of Ascertis Credit — a Singapore-based private credit player. 

According to Jain, apart from the US, where it is not very restrictive, other geographies like EU, UK, even in Asia, there are usually some restrictions from the central bank. The restrictions are in terms of how much exposure a bank can take, in terms of their net worth or Tier-I capital, among others. 

Jain also said this move will boost M&A activities in India with banks bringing significant capital. 

“It will spur M&A activity. It will create collaboration between various types of participants. Because different participants bring different strengths to the table. For example, private credit funds have the structuring expertise. They have the ability to look at complex structures. Banks have the ability to bring significant capital. Banks can also then take a part in that structuring and pick a part of the capital structure that’s better suited to its requirements,” Jain told Business Standard during an interaction.

An SBI research report has pegged the potential credit growth — because of the RBI decision to allow banks to fund acquisition of corporates — at ₹1.2 trillion. 

Since banks were not allowed to fund such activities earlier, they may currently lack the required capabilities. However, bankers are confident that once the final guidelines are put in place by the RBI, they will be able to develop the necessary expertise, as they already fund these corporates and have conducted risk assessments on them in their normal course of funding. 

“Most of the banks may have to do some primer on acquisition finance. It is only the specifics of the acquisition part that people have to be trained on. I am sure we can develop those skills,” the state-owned banker quoted above said, adding that whichever sectors the banks are otherwise comfortable financing are the same sectors whose acquisitions they will be comfortable financing. 

“We have to wait for the final guidelines to come, and every bank will create its policies and SOPs and the way to assess and underwrite such transactions. It may take some time. Immediately, I don’t think anybody will start jumping into it. But at least they will start working on it,” he said. 

According to Madan Sabnavis, chief economist, Bank of Baroda, the RBI’s decision has the potential to open the doors to an industry which market sources value at around $40 billion or ₹3.5 trillion. 

“Clearly this adds a fresh dimension to the scope of banking in India and comes at a time when this activity has hitherto been funded by non-banking sources. Also given the pace of M&A activity in the country, the potential for growth is significant.

Given that the RBI has also rolled back the 2016 regulation on large exposures for banks, the scope to fund M&A involving large corporates open further,” he said, adding that presently growth in credit to large manufacturing is muted at 1.8 per cent while that to medium is at 13.1 per cent. 

“There is scope for these numbers to improve as most of the M&A activity would involve the medium to large companies. As most of these companies already have loans from the banking system, evaluating their creditworthiness in the context of new M &A activity would be an extension. These companies would be more on the radar of banks in the first phase,” he further said. 

 

Meanwhile, experts have also cautioned on the risks of allowing banks to finance acquisition of Indian corporates.

 

According to Vivek Iyer, partner and Financial Services Risk Leader, Grant Thornton Bharat, acquisition financing by banks is subject to risks on account of the ALM mismatches that acquisition financing as a large exposure and long tenor credit product brings. Not all acquisitions are going to be successful and hence the banks would need to be cognisant of the risk assessments that they would undertake with respect to corporates seeking for such funds. 

“Ideally the regulator should consider making fund raising for such banks via long term bonds mandatory who propose to enter into acquisition financing. This will help reduce the inherent ALM mismatches that large long tenor credit exposures to corporates can bring. Balancing systemic risk without creating a credit bubble is the key parameter for any regulatory change and the same would apply to acquisition financing,” he said.