RBI's 10% Tier-I cap on acquisition financing restrictive, say bankers

Experts suggest 30% equity contribution should include preference shares as well as convertible instruments

- ANJALI KUMARI

The Reserve Bank of India’s proposal to cap acquisition financing exposure of banks at 10 percent of their Tier-I capital is restrictive, and the caveat that the acquiring firm has to put in 30 percent equity towards the deal should also be expanded to include equity and other capital instruments, which could be in the form of preference shares, convertible securities etc said bankers.

The RBI on October 24, in a draft circular, proposed allowing banks to finance Indian companies’ acquisition of full or controlling stakes in domestic or overseas firms, provided such investments create long-term strategic value rather than serve short-term financial restructuring goals.

Under the proposal, banks can fund up to 70 per cent of the acquisition cost, with the acquirer contributing the remaining 30 percent through equity. The acquiring company must be a listed entity with satisfactory net worth and at least three years of profitability. The RBI also proposed capping a bank's total exposure to such financing at 10 per cent of its Tier-I capital. “The 10 per cent cap (on Tier I capital) is too low,’ said a senior executive at a state-owned bank. “The 30 percent contribution shouldn't be restricted to pure equity; it should include a combination of equity and other eligible instruments”, he said. “The RBI could consider raising the limit to around 30 per cent (of Tier I capital) without compromising prudence,” said another senior executive at a state-owned bank. However, experts said that the central bank’s cautious stance is justified given the risks associated with acquisition financing.