M&As funded by local banks will serve the economy well

Amid the torrent of regulatory notifications from the Reserve Bank of India (RBI) after its last monetary policy meeting, one of the pleasant surprises was its green-lighting of the financing of mergers and acquisitions (M&As) by domestic banks, placing them at par with their global peers.

- SOUMYA KANTI GHOSH

This move is likely to foster innovation and nudge stronger banks to adopt best global practices even as they work on a best-fit model to serve corporate clients along their entire financial life-cycle. It is rather surprising that the M&A sphere was not open to public sector banks earlier.

RBI's draft circular outlines guardrails for acquisition finance by banks to listed Indian corporates for acquiring equity stakes in domestic or foreign companies as strategic investments: it limits such exposures to 10% of a bank’s Tier I capital, with funding for each deal capped at 70% of the acquisition value, and prescribes robust eligibility, security, margin, monitoring and disclosure norms as mandatory safeguards.

In principle, M&As let firms grow inorganically by acquiring companies that offer complementary business opportunities. M&A benefits can range from product diversification and supply chain de-risking to forward or backward integration, among others. Mergers can also be justified on the grounds of creating economies of scale, so that the newly combined entity has lower average costs. While the economic rationale of M&As is well laid out, divergences exist in how the acquirer must finance the acquisition of its target. M&A activity can be financed using a range of methods from cash deals to debt financing and the use of equity as a currency. Further, the level of cash available with the acquirer and time involved could determine the success of a merger.