When the Reserve Bank of India announced allowing banks to finance corporate acquisitions, the move was hailed by some as a sign of confidence in the maturing sophistication of Indian banking. Many have celebrated it as the long-overdue step that would place banks at the centre of India’s corporate growth story – as if the missing ingredient in our economic ambition was merely the ability of banks to underwrite big takeovers.
Why now?
Yet beneath this chorus of approval lies a deeper unease. Acquisition financing, by its nature, is not ordinary lending. It is a bet on projected synergies, on integration that has not yet happened, and on management execution that may never fully materialise.
One wonders if this regulatory shift also reflects a quiet unease about the rapid expansion of the private credit industry – currently lightly regulated by SEBI. Or is it the persuasive whisper of industrial houses, seeking access to the deep-well of bank liquidity, especially since the central bank has rightly refused to let corporate groups own banks?
Banking in India is not same as banking in developed markets
Banks, by contrast, are designed to be conservative institutions, meant to lend against cash flows that exist. They must balance the assets they finance with the tenor and stability of the liabilities they hold. Every loan is, in essence, a wager made with public deposits. This is fundamentally different from the private credit, private equity or venture-debt world, where investors knowingly bear the risks of long-duration, high-yield exposures. Banks’ core strength lies in managing collateral, monitoring repayments, and absorbing shocks within a prudential framework built on predictability.
Those who argue that this move simply aligns India with global practice miss the fundamental nature of that comparison. Banks in advanced economies focus primarily on retail and small business lending, while large corporates fund their normal business and even mergers and acquisitions through bond markets, private credit, or syndicated instruments and specialised banking units.
In India, however, the story has long been the reverse. Our banks have been disproportionately skewed towards corporate lending, while retail and SME segments remain under-served despite the visible growth numbers. Even today, a large proportion of bank balance sheets are dominated by exposure to corporate credit. We won’t be far off in calling it a kind of lazy banking — a comfort in lending only to the AAA or AA-rated, while neglecting the harder, risk-pricing work of developing differentiated credit capabilities. To suggest that this new rule will bring Indian banks “on par” with their global peers is therefore both inaccurate and misleading. We are, in fact, amplifying an existing imbalance rather than correcting one.
Credit underwriting is dissimilar to commercial decision making
Banks are experts in credit underwriting; not so, in commercial decision-making. Credit is about assessing the ability and willingness to repay; commercial decisioning is about judging the future potential of a business, a market, a technology, or a synergy. Acquisition finance lives firmly in the latter space. Except for low single-digit Indian banks, others don’t have such exposure to commercial decisions at all.
Organisational culture matters
A similar behavioural constraint would haunt acquisition financing. The incentive for any banker to take a commercial call, particularly in public sector institutions, is heavily loaded against them. The fear of post-facto scrutiny – by auditors, vigilance bodies, or investigative agencies – ensures that no officer wants to be “bold”. Every loan decision is taken defensively, framed by what will be defensible later, not necessarily what is economically sound now.
The western banking systems that some supporters of this reform invoke do not operate under such behavioural ceilings. Their bankers are empowered to make commercial calls, protected by governance systems that distinguish between bad luck and bad intent.
In India, that distinction is often lost in hindsight. In such an environment, expecting bankers to underwrite acquisition risk is unfair to them and unsafe for the system.
Who is expected to gain?
Proponents of this new regulatory thinking have claimed that the move will modernise India’s financial architecture, integrate banks into the corporate finance ecosystem, and perhaps even lower the cost of capital. But one must ask: lower for whom?
Imagine, for instance, a bank being asked to finance an acquisition in an electric vehicle venture or a green technology or an emerging-technologies based value-chain venture. These are businesses where cash flows are uncertain, market acceptance is evolving, raw materials unstable and regulatory frameworks are fluid. Assessing their viability demands a deep commercial, technical, regulatory understanding of the underlying industry and entire value chain. If such skills and sectoral confidence truly existed within Indian banking, our climate finance and green technology sectors would already have witnessed far greater institutional participation than they do today.
Even if banks were to develop such capabilities, one must ask whether they should — and at what opportunity cost. Would their limited management bandwidth and capital not be better used to deepen credit access for the broader economy?
Lagging private capex tells its own story
One should also remember that Indian private-sector capex has yet to catch up with, let alone surpass, the scale and pace at which the government has been leading from the front over the past few years. Despite the rising profitability of Indian corporates and the strengthening of their balance sheets, much of this financial muscle has been channelled into share buybacks, balance sheet consolidation, or overseas expansion – not into domestic capacity creation.
The function of a bank is not to act as a proxy venture capitalist. Its role in the economy is to channel savings into stable, productive use. Every time Indian banking has drifted from this principle, the outcome has been painful. The infrastructure lending boom of the mid-2000s was justified in the same language of national ambition and financial modernisation. When those dreams turned to non-performing assets, the same institutions were accused of reckless optimism.
Don’t overlook the political economy of credit
Moreover, the governance challenge cannot be overstated. If banks begin funding acquisitions, they inevitably influence patterns of ownership and control in corporate India. They become participants – however indirectly – in shaping who acquires whom.
That is a profound shift in the political economy of credit. For public sector banks, it opens up a minefield of potential conflicts and perceptions. For private banks, it risks concentration of risk in a few large clients.
Restraint is ma form of reform
It would be prudent for the RBI, in its implementation phase, to introduce tighter exposure norms linked to each bank’s balance sheet capacity and risk appetite. It could also use its annual supervisory assessments to set acquisition-financing limits, ensuring that no herd mentality emerges — a phenomenon all too familiar in Indian banking, where smaller institutions mimic the strategies of their larger peers.
After all, India’s banking system has faced many crises with resilience and earned public trust through decades of prudence – a legacy shaped as much by the Reserve Bank’s steady hand as by institutional discipline. As this new proposal unfolds, the RBI’s hallmark prudence will be key to ensuring that ambition and stability continue to move in step — because, in the end, restraint may well be the most enduring form of reform.
(Srinath Sridharan is Author, Policy Researcher & Corporate Advisor, Twitter: @ssmumbai.)
Views are personal, and do not represent the stand of this publication.
