RBI has become very cautious regarding commercial bank’s capital market exposure in order to protect depositor funds and ensure financial stability. So, what is a bank’s capital market exposure? Capital Market Exposure is the total amount of capital of a bank that is tied to shares, securities, bonds including loans against them. This also includes how much a bank has lent to companies to carry out their acquisition activities. In short it is a way to measure how much a bank’s financial health is dependent on the performance of stocks and bonds in the share market.
What are the current and new CME limits?
Prior to this new proposal, the commercial banks were exposed to high risk of market fluctuations. In fact, the rules for Mergers and Acquisitions were vague that the companies looking for financing their acquisition activities often turn towards foreign lending institutions.
According to the new rules, the banks can finance upto 70% of a company’s total acquisition cost in buying another company, provided the company bears the remaining 30% of the cost and the company should be financially profitable and stable.
What does new proposal envisions?
This new proposal by the RBI further tightens the limits. It basically focuses on Lending against stocks and bonds (capital market) as well as Loans for mergers and acquisitions (M&A). India’s merger and acquisition activity has shown remarkable resilience, with deal values reaching up to US$50-60 billion in the first half of 2025 alone. Previous financing constraints forced Indian corporates to depend upon more expensive alternatives, putting them at a competitive disadvantage at both the levels i.e domestic and cross border M&A scenarios.
Why new proposal and more restrictions?
Extreme fluctuations in stock and bond prices poses a great risk for these assets leading to potential losses. Apart from this as many firms borrow funds for acquisition without guaranteed returns have led to default in the past, so large scale exposure to a few capital market entities can threaten the stability of the system. Moreover central banks around the globe have already learned regarding uncertain global financial conditions.
Issues and challenges in acquisition funding
Companies more often borrow to finance takeovers leading to increase in debt burden. Success of an acquisition depends on integration and market performance which is unpredictable at the core. Moreover banks often accept the company’s shares as collateral which may lose value in case of failure of acquisition. In recent past cases like IL&FS crisis, aggressive funding and loose monitoring led to cascading financial distress across the institutions. RBI’s proposal aspires to avoid such recurrence in future.
Importance and need for the move
By limiting exposure, RBI is trying to decrease the chance of contagion from one default spreading across the system. It also discourages speculative loans and ensures funds towards less risky and productive economic use. It also stabilises the banking system leading to attraction of investments from domestic and foreign sources. Moreover the proposal aligns with RBI’s broader strategy to promote sustainable credit growth while minimizing systemic vulnerabilities.
The proposal of RBI reflects a proactive approach to impose a limit on bank’s capital market exposure and acquisition funding in order to safeguard financial stability. It is going to strengthen India’s banking ecosystem in the long run by curbing excessive risk taking and ensuring balanced credit growth, although this may seem to restrict bank’s freedom to lend with aggression as of now.
