Bank financing of M&As will be like any other business and only needs guardrails, report Raghu Mohan, Ishita Ayan Dutt and Abhijit Lele.
Recently, State Bank of India chairman C S Setty lifted the veil on a subject long spoken of in corporate corridors: Why can’t our banks finance mergers and acquisitions (M&As)?
Change is in the air: Indian Banks’ Association (of which Setty is the chairman) is to “make a formal request” to Mint Road to make way for it.
Thus far the exclusive turf of foreign banks even though its funding remains offshore — as in, it’s not on these entities rupee-book (and a few select shadow banks) — a most lucrative segment in the investment banking suite, M&As, will be homeward-bound.
Business Standard reached out to Setty for his views on the guardrails which need to be in place before Indian banks foray into this business; the revisions or changes in regulations which would be in order; and the treatment of capital markets exposure defined as one of the “sensitive sectors” by the Reserve Bank of India (RBI), the others being commodities and realty.
Setty did not respond but his predecessor at SBI, D K Khara, explained why the oft-trotted reasons for disallowing M&A financing may not hold anymore.
Take the adequacy (or lack) of safeguards. Stockbrokers have margin calls but banks are more regulated and follow stringent risk management and capital adequacy norms.
Banks will anyway subject M&A proposals to credit underwriting norms, align with compliance standards and adhere to exposure limits.
As for concerns relating to concentration (monopolistic) emanating from M&As, you have the Competition Commission of India.
The point being made is hygiene measures and sundry modalities will unfold; we are after all, just getting started.
‘Lost opportunity’
As to why M&A financing should be allowed, Khara’s case is first, “it’s prudent to give a product that Indian companies want rather than pushing loans which may not meet their requirements.”
Second, given foreign banks are already in the game via their international networks, “our banks are losing out on this opportunity”.
And third, for us to become developed, “such funding within India and for select international transactions (to acquire companies with technology, say in the defence sector) should be allowed”.
As Hitendra Dave, chief executive officer (CEO) of HSBC India, put it: “We want Indian companies to be at the forefront of international M&A activity and having banks to back their ambition is the need of the hour.”
That said, “this is an area which requires specialists and specialisation and banks which want to enter this activity will need to build the required expertise.”
Why did bank financing of M&As become a no-go area?
The 1991 securities blowout is usually seen as a trigger for RBI’s clampdown but there’s nothing in its circulars which specifically frowns upon it.
Senior bankers surmise its roots are in the thinking that it’s “unproductive” in nature.
The logic driving it, they say, is as follows. When Firm A acquires Firm B, there’s no incremental addition to productive capacity in the economy even though it holds true for the merged entity — you have merely financed the purchase of shares.
Indian promoters were also covertly against such financing lest they become victims of hostile takeovers.
As an aside, given that the issue of hostile takeovers is sure to crop up in the ongoing debate on M&A financing, it would be worthwhile to define the term “hostile” — to the promoter/s or shareholders’ interest.
There are other fault-lines on the regulatory front.
Banks can’t get into M&A financing but non-banking financial companies (NBFCs) can. This even as NBFCs source credit from banks.
It amounts to banks financing M&As, a step removed — buffered by another set of regulated entities or REs’ (read NBFCs) equity capital.
Or inter-connected lending by RBI’s REs. This can lead to a situation where an acquiring firm floats bonds which are subscribed to (partly or fully) by NBFC/s (funded by banks), the proceeds of which finance an acquisition.
Banks cannot cavort likewise — be it by giving loans (even if it is a general-purpose line without end-use restrictions) or by subscription to bonds.
With newer sources of funding emerging (even for M&As) — alternate investment funds and family offices — it gets to be even more opaque and complicated.
Now let’s take stock of banks’ exposure to sensitive sectors.
According to RBI’s ‘Report on Trend and Progress of Banking in India (2023-24)’, this stood at 22.1 per cent of total loans and advances at Rs 2,098,358 trillion (marginally higher than the 21.7 per cent a year ago).
But during this period, the share of capital market exposure soared to 31.3 per cent to Rs 243,321 crore (up from 20.2 per cent).
The central bank cites a “merger” as the reason for the increase to the sensitive sectors in general (a reference to the HDFC Ltd and HDFC Bank transaction) but this still does not explain the jump in banks’ capital market exposures.
Again, it’s not clear whether these numbers take into account bank funding to NBFCs that finds its way to the sensitive sectors.
“Financing M&As is not very different from any other lending risk that depends on a company’s future cash flows,” says Sunil Sanghai, founder and CEO of NovaaOne Capital.
He is the chair of the Federation of Indian Chambers of Commerce and Industry’s National Committee on Capital Markets and believes that “in the case of M&As, it is linked to cash flows of the new entity created through the transaction. Denying this option to local banks and companies puts them at a disadvantage.”
Seshagiri Rao, JSW Group’s chief financial officer, mirrors Sanghai: “Banks can fund acquisitions in infrastructure projects and even take up to 50 per cent equity, but in non-infrastructure deals, this is barred due to concerns around capital market exposure.”
Even as he concedes “banks should not have too much capital market exposure — guardrails are necessary. But a blanket ban shuts off a crucial source of funding, making M&As more expensive for Indian companies.”
Time to move ahead
And did you know of this? The RBI permits banks to finance investments and acquisitions by Indian companies in their offshore joint ventures or subsidiaries though not from their local books but from banks’ offshore offices.
This has other ramifications: any mess in these transactions and its impact on offshore offices — be it branches or representative offices — has a bearing on the Indian parent bank.
Be as it may, “Having opened this window, it can be considered for onshore deals also,” points out Ameya Khandge, partner at Trilegal (and national head of the banking and finance practice groups).
As for guardrails, he notes that the RBI could, as a start, limit these deals to tangible real-sector assets; not to intangibles or valuations that go beyond asset value to aspects like non-compete fee, etc; and mandate strict concentration and sectoral exposure limits.
“Plus, use a combination of both cash-flow-based lending and real asset collateral and allow it only for non-hostile deals and in cases under the Insolvency and Bankruptcy Code (IBC, 2016) where there is consensus on what is to be done.”
The move will also help give a fillip to capacity expansion by India Inc through the inorganic route, especially when IBC cases are involved.
Again strangely, Indian banks actively finance the acquisition of targets through the corporate insolvency resolution process (CIRP) under the IBC.
This is because, in an acquisition under CIRP, bank financing is not utilised for funding acquisition of shares but for repaying existing lenders of the target company.
In the context of the move to fine-tune the IBC (and bank funding of M&As), it is also worthwhile to take on board former RBI governor Shaktikanta Das’ observation on group insolvency. Speaking on ‘Resolution of stressed assets and IBC - Future Road Map’, organised by the Centre for Advanced Financial Research and Learning, Mumbai, 11 January 2024) he noted that while the insolvency mechanism has been graduating towards a zone of stability through various concerted measures, one visible impediment seems to be the absence of a clear framework for group insolvency.
“…in the absence of a specified framework, the group insolvency mechanism has been so far evolving under the guidance of the courts. Perhaps the time has come for laying down appropriate principles in this regard through legislative changes.”
We are just getting started on the road to bank M&A financing.
The RBI already has a number of prudential lending frameworks in place that can be tweaked to address some of these risks.
As for misgivings, “indicatively, single/group borrower exposure caps could be set at lower threshold of Tier-I capital, higher risk weights could apply for M&A loans, robust end-use norms to avoid fund diversion, separate disclosure norms for such loans for increased transparency, among others,” says Rohan Lakhaiyar, partner (financial services-risk), Grant Thornton Bharat.
“While guardrails may provide prudential limits to the banks, nothing can replace banks’ independent due diligence processes and risk management practices for funding M&A deals,’ he adds.
M&A financing by banks is like any other business; and unlike too.
Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd.
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