RBI's nod for banks' M&A funding may force tweak to sensitive sector norms

Bankers say that given the substantial exposures banks will have to take for M&A financing, the current ceiling for banks' exposure to the sensitive sectors is likely to be a hurdle

A rethink of banks’ exposure to so-called 'sensitive sectors' may have to be considered to ease the path of a proposed move to allow them to finance mergers and acquisitions (M&As) in the country.

 

The Reserve Bank of India (RBI) defines capital markets, real estate, and commodities as 'sensitive sectors' in view of the risks inherent in fluctuations in asset prices. The current ceiling for banks’ exposure to the sensitive sectors in a given financial year is set at five per cent of total deposits at the end of the previous financial year. 

According to the RBI’s 'Report on Trend and Progress of Banking in India 2023-24', banks’ exposure to the sensitive sectors stood at Rs 46.62 trillion in FY24, accounting for 27.2 per cent of their loans and advances, a 34.1 per cent increase over FY23. The figures for the sub-segment of capital markets were Rs 2.43 trillion, or 1.4 per cent of banks’ loans and advances, higher by 31.3 per cent over FY23. 

Under existing norms, banks are not allowed to finance M&As, something non-banking financial companies (NBFCs) are allowed to do, even as the latter source credit from the former. This is tantamount to banks financing M&As, albeit a step removed, and buffered by another set of regulated entities or REs’ (read NBFCs) equity capital. Foreign banks, however, are permitted to finance M&As through their offshore offices. 

Another fault line lies in the Insolvency and Bankruptcy Code (2016), wherein banks finance the acquisition of targets through the corporate insolvency resolution process (CIRP). This is because in an acquisition under CIRP, bank financing is not utilised for acquisition of shares but only for repaying existing lenders of the target company.

 

Senior bankers said given the substantial exposures banks will have to take for M&A financing, the current ceiling for banks’ exposure to the sensitive sectors will be a hurdle. Even if the sub-segment for capital markets within the sensitive sectors were to be given more space, it will likely be inadequate.

 

The RBI’s draft for comments on commercial bank’ capital market exposure (CME) released last week did not refer to sensitive sectors exposures, but said the aggregate CME of a bank, on solo basis, should not exceed 40 per cent of its Tier-1 capital at the end of the previous financial year. It also said aggregate CME during the same period on a consolidated basis should not exceed 40 per cent of its consolidated Tier-1 capital. 

 

• The RBI defines capital markets, real estate and commodities as 'sensitive sectors' in view of the risks inherent in asset price fluctuations
• The current ceiling for banks’ exposure to sensitive sectors in a financial year is set at five per cent of the deposit at the end of the previous fiscal year
• Bankers say current ceiling for banks’ exposure to the sensitive sectors will be a hurdle