A New Disguise for Bad Loans? Analyzing the Risks in Acquisition Finance

[Gaurav and Vedant are students at Hidayatullah National Law University.]

With Indian corporates increasingly pursuing large domestic and cross-border buyouts, the Reserve Bank of India (RBI) has proposed a new framework that allows banks to finance mergers and acquisitions in accordance with its recent policy shift. The Reserve Bank of India (Commercial Banks - Capital Market Exposure) Directions 2025 (Draft Circular), released on 24 October 2025, seeks to regulate acquisition financing by banks.

Banks will now be able to extend loans to Indian companies for acquiring control in domestic or foreign firms as ‘strategic investments’, effective from 1 April 2026. The Draft Circular introduces prudential safeguards, including a 70% loan-to-value cap, compared to USA’s 50% loan-to-value cap and a 3:1 debt-to-equity limit, which diverge from the EBITDA-based approach in the USA and leveraged lending limits in the UK.

However, critical questions remain unanswered. The definition of ‘strategic investments’ is unclear, and banks retain broad discretion. These gaps raise concerns that banks may bypass the rules or continue engaging in evergreening of loans, a long-standing issue in the Indian banking system. The authors will analyze the Draft Circular with this focus, and provide recommendations to strengthen RBI’s policy shift.

Rationale for the Policy Change

Acquisition financing has often been viewed as inherently risky, as it is usually secured by the shares of the acquired company. Financers face losses if valuations fall or expected synergies fail to materialize. Thus, in the past, the RBI has aimed to prevent aggressive funding of high-profile takeovers from translating into systemic stress.  

However, as Indian markets mature, the RBI now sees value in allowing banks to finance acquisitions. This shift coincides with India’s private credit market deploying USD 8 billion across 79 deals in H1 2025, a 53% year-on-year increase, with about 35% linked to acquisition finance.

By creating a standard framework for bank participation, the RBI aims to balance corporate growth with financial stability. Expanding capital sources is essential for business expansion, and allowing banks into this space brings more regulated credit alongside private capital.

Why do Vague Definitions Threaten RBI’s Draft Circular?

The new policy, while a positive step for Indian markets, is accompanied by a Draft Circular with several unaddressed uncertainties and loopholes that need refinement.

Ambiguity in defining ‘strategic investments’ under Clause 39

Clause 39 allows acquisition finance only for ‘strategic investments’, described as those creating long-term value through synergies rather than short-term gains. However, the Draft Circular provides no measurable criteria for assessing ‘long-term value’, ‘synergies’, or any indicative time frame.

Previously, the RBI has used the phrase ‘strategic investments’ in the Master Circular on Loans and Advances 2015 in the context of financing overseas acquisitions. The only characterization provided there was that the investment should be ‘beneficial to the company and the country,’ but without any tangible test.

The RBI’s use of ‘strategic investments’ as a qualifier is akin to the model adopted by Chinese banks in acquisition financing. Thus, the downfall of the HNA group becomes noteworthy. Encouraged by the ‘go-out’ policy, it completed its ‘strategic’ acquisitions by taking massive loans from the state-owned Chinese banks. Once it became clear that the company lacked a coherent business model, it was forced into bankruptcy, revealing a significant debt.

In effect, Clause 39 continues the RBI’s reliance on intent over evidence. For instance, the RBI has used ‘intent’ as a criterion for classifying securities acquired by a financial institution. While unrelated to the topic at hand, transposing such a principle in our context risks blurring the boundary between bona fide strategic acquisitions and speculative, financially engineered deals. For instance, leveraged bets like short-dated exit options or transactions with limited operational integration may be packaged as a ‘strategic’ or a ‘synergy-driven’ acquisition, based on narrative rather than substance.

To preserve prudential integrity, the authors suggest that the RBI should establish objective criteria, such as synergy documentation and holding-period requirements, that would help ensure ‘strategic investment’ becomes a verifiable category.

Undefined threshold for ‘satisfactory net worth’

Clause 42(ii) of the Draft Circular says that the acquiring company should be ‘a listed entity, having a satisfactory net worth and profit-making for the last three years.’ The idea is to ensure that only financially stable companies receive acquisition finance. The authors suggest that ‘satisfactory net worth’ should be understood to mean that the acquiring company has a net worth of at least 25–30% of its total assets and that its total debt does not exceed about 60–70% of total assets. This is consistent with international leveraged lending guidance which treats borrowers with very high leverage as higher risk. Comparable frameworks in the US and EU prescribe explicit leverage thresholds and stress-testing standards.

Despite the prudential safeguards in foreign jurisdictions, the 2019 example of Diamond Sports Group shows how weak assessments of an acquirer’s creditworthiness can be disastrous. An underestimation of the ‘cord-cutting’ trend led to banks taking massive haircuts on a debt of over USD 8 billion. In the Indian context, the insolvency of Reliance Communications (Rcom) becomes relevant, where RCom had amassed over INR 45,000 crore in debt to fund spectrum and infrastructure based on voice-revenue projections. 

However, the sectoral shift to data-driven models rendered those projections obsolete, forcing banks to take haircuts exceeding 50%. Additionally, heavily leveraged power and infrastructure assets, forcing banks to take deep haircuts under IBC, are also relevant here because they are Indian banks’ clearest experience of funding large, long‑gestation projects based on optimistic sectoral projections and weak borrower credit assessment.  Given that RBI is cautiously opening acquisition finance for banks, an undefined ‘satisfactory net worth’ grants excessive discretion, undermining prudence.

Monitoring and stress testing: A framework built on discretion

Clause 42(ix) of the Draft Circular requires banks to ensure ‘rigorous and continuous monitoring’ of acquisition finance exposures. However, this principles-based drafting lacks defined metrics, risking weak enforcement and regulatory arbitrage.

The clause mentions ‘regular stress testing’ but provides no guidance on scenarios, severity, or what counts as pass or fail. As a result, banks may conduct minimal tests only to show compliance rather than continuously monitor risks. Without clear rules for responding to warning signs, banks can ignore them as temporary issues, leading to renewed forbearance and evergreening.

If we look at other systems like the Basel Principles (2018) or the U.S. Federal Reserve’s stress testing standards, they clearly specify which stress cases to use, which numbers to check, and how to conduct a supervisory review. The RBI’s silence opens the rule to interpretation and each bank can follow its own method. 

The authors recommend adopting fixed monitoring time gaps, standard test patterns, and a compulsory response mechanism. Otherwise, as discussed above, clause 42(ix) may be only a box-ticking exercise instead of a genuine risk-management tool.

Acquisition Finance: A New Disguise for Evergreening?

Indian banks have been infamous for devising innovative methods to evergreen loans. Evergreening is a practice where banks conceal the actual status of stressed loans to project an artificial clean image of the asset. It has long been a structural vulnerability in Indian banking. The Draft Circular may create new avenues for evergreening. The combination of broad discretion to determine ‘strategic investments,’ undefined thresholds for ‘satisfactory net worth,’ and unstandardized monitoring could transform acquisition loans into sophisticated refinancing tools for stressed borrowers. Promoter groups can structure acquisitions through related entities to recycle liquidity. A ‘healthy’ affiliate seeks financing from banks for an acquisition, routes part of the proceeds to the group’s stressed entity, which then repays its old bank loan. On paper, this appears to be a legitimate ‘strategic investment’; however, in substance, it shows the refinancing of existing stress, allowing the bank to avoid NPA recognition.

Additionally, a borrower with an underperforming acquisition loan seeks further financing for ‘synergistic’ follow-on acquisitions. Take the example of Serta Simmons Bedding LLC ,whose acquisition was financed by US banks. Despite the distress of the pandemic, the acquirer was able to raise new financing as part of a larger restructuring. Due to the agreement’s liberal language, few lenders were able to syphon valuable collateral from existing loans to secure new loans through so-called “liability management” transactions. ICICI Bank and Videocon form India’s own ‘Serta Simmons’ experience, where Videocon was already in debt.

Nevertheless, ICICI Bank provided ‘follow-on’ finance to the company. The money was then siphoned to sell a Videocon entity to a company owned by the husband of the then-CEO of ICICI Bank. Given that acquisition finance is new in India, the RBI could explore ring-fenced reporting for such loans, keeping them separate from the wider loan book to prevent misuse.

Conclusion

The RBI’s decision to allow banks to fund corporate acquisitions has been hailed as a sign of financial maturity. Yet, beneath the optimism lie significant prudential and synergistic concerns.

Indian banks, especially public-sector banks, are not well equipped to handle such complex commercial risks. In developed countries, banks mostly deal with retail and SME borrowers, but in India, the banking system still leans heavily toward corporate lending. This reform may deepen that imbalance. Additionally, Indian bankers work under heavy post-facto checks, and they do not always have deep cross-industry knowledge. Thus, they prefer to make safer decisions instead of those that are actually good for business. Expecting them to underwrite significant acquisition risks may threaten financial stability. India’s banking credibility rests on prudence; in this reform restraint itself must remain the accurate measure of progress.