RBI Draft Circular: Limits on Bank Lending to Capital Markets & Corporate Acquisitions
Background
The Reserve Bank of India (RBI) issued a draft circular (October 2025) to regulate banks’ exposure to capital markets and acquisition financing.
Aim: To prevent concentration risk, ensure financial stability, and maintain prudential lending norms after recent relaxations.
Key Highlights
1. Exposure Caps
Direct exposure to capital markets + acquisition finance:
➤ Capped at 20% of Tier 1 capital.Aggregate capital market exposure (direct + indirect, incl. funds, guarantees, etc.):
➤ Capped at 40% of Tier 1 capital.Exposure specifically to acquisition finance:
➤ Not to exceed 10% of Tier 1 capital.
2. Definition of Tier 1 Capital
Represents the core strength of a bank.
Includes:
Equity capital
Retained earnings
Certain loss-absorbing instruments
Acts as the first line of defence during financial stress.
3. Acquisition Financing Norms
Banks may finance up to 70% of an acquisition deal value.
➤ Remaining 30% must be funded by the acquiring company.Lending allowed only to listed entities with:
Satisfactory net worth, and
Profit record of at least 3 years.
Loans must be fully secured by shares of the target company.
4. Recent Policy Relaxations
RBI earlier:
Allowed banks to fund mergers and acquisitions (M&A).
Raised IPO financing limit from ₹2 million → ₹20 million.
Permitted unrestricted bank lending against listed debt securities.
5. NBFCs – Revised Risk Weights
RBI also proposed revised risk-weight norms for NBFC infrastructure loans.
Objective: Reduce capital requirements and promote infrastructure lending.
Objectives of the Move
🔸 Maintain prudential exposure limits for banks.
🔸 Prevent over-leverage in capital markets.
🔸 Encourage responsible financing for corporate acquisitions.
🔸 Strengthen systemic risk management.
🔸 Support domestic M&A activity without destabilizing credit quality.
Tier 1 Capital – Explained
Meaning
Tier 1 Capital is the core capital of a bank — the most reliable and permanent source of funds.
It represents the bank’s capacity to absorb losses while continuing operations.
It forms part of the Basel III capital adequacy framework followed by RBI.
Components of Tier 1 Capital
1. Common Equity Tier 1 (CET1)
This is the highest quality capital and forms the major part of Tier 1.
Includes:
Paid-up equity share capital
Share premium (reserves)
Statutory reserves and retained earnings (profits not distributed as dividends)
Other disclosed free reserves
Capital reserves representing realized gains
Goodwill, intangible assets, and accumulated losses are deducted from Tier 1 capital
💡 Purpose: CET1 provides a permanent buffer that can absorb losses directly.
2. Additional Tier 1 (AT1) Capital
This is perpetual debt-like capital that can also absorb losses when needed.
Includes:
Perpetual Non-Cumulative Preference Shares (PNCPS)
Perpetual Debt Instruments (PDIs) (e.g., Basel III compliant bonds)
These do not have maturity and can be written down or converted to equity in stress situations.
💡 Purpose: Strengthens the bank’s resilience during financial shocks.
Prelims Practice MCQ
Q. Consider the following statements regarding Tier 1 Capital under Basel III norms:
It includes equity share capital and disclosed reserves.
Goodwill and other intangible assets form a part of Tier 1 capital.
It is designed to absorb losses while the bank remains a going concern.
Which of the statements given above are correct?
(a) 1 and 3 only
(b) 2 and 3 only
(c) 1 and 2 only
(d) 1, 2 and 3
✅ Answer: (a)
Explanation:
Statement 1 - Correct (core components).
Statement 2 - Incorrect (they are deducted, not included).
Statement 3 - Correct; Tier 1 capital absorbs losses during ongoing operations.
Q. Consider the following statements regarding the RBI’s recent measures to boost bank lending:
RBI has allowed banks to finance corporate acquisitions, a function previously limited mostly to NBFCs and foreign lenders.
The new framework allows banks to lend up to 70% of the acquisition value.
The acquiring company must fund at least 40% of the deal value from its own sources.
Which of the statements given above is/are correct?
A. 1 and 2 only
B. 2 and 3 only
C. 1 and 3 only
D. 1, 2 and 3
✅ Answer: A. 1 and 2 only
Explanation:
The acquiring company must contribute at least 30%, not 40%.
Banks may finance up to 70% of the total deal.
This policy shift opens new opportunities for domestic banks in the corporate acquisition space.