How the Reserve Bank of India is looking to revive credit flow to India Inc

In 1989, at the height of what is considered the Japanese “bubble economy”, Sony Corporation acquired US-based Columbia Pictures in a multi-billion-dollar deal. The same year, another Japanese giant, Mitsubishi Estate, bought a controlling stake in US-headquartered Rockefeller Center, the crown of Manhattan’s skyline. These marquee deals, among many others across the globe, were hailed as symbols of Japan’s newfound financial might.

There was another aspect common to these mega deals—they were heavily backed by bank credit. Japanese banks lent aggressively to fund corporate acquisitions, and when asset prices collapsed in the early ’90s, it triggered an avalanche of bad debt. It took banks decades to repair their balance sheets.

The Japanese experience has come back into discussion after the Reserve Bank of India’s (RBI’s) big bang measures to improve credit flow to industry at the beginning of October.  

The RBI has allowed banks to fund mergers and acquisitions (M&As)—an activity they were banned from for decades. Banks’ foreign branches have been permitted to extend rupee-denominated loans to residents of neighbouring countries such as Nepal, Bhutan, and Sri Lanka. This is something Chinese banks have been doing of late. The RBI also announced relaxations in lending against volatile assets like shares, real estate investment trusts (REITs) and infrastructure investment trust (InvITs).

These are of a piece with other measures announced by the government, like the reduction in goods and services tax and income tax rates, and the RBI’s earlier decisions to cut interest rates. Together, these are expected to firm up domestic demand as India grapples with an increasingly uncertain external trade landscape amid fears of a growth slowdown in advanced economies next year because of US President Donald Trump’s tariff policies.

The RBI’s actions are rooted in a broader strategic vision. “The measures aim to support economic momentum amid global uncertainties, enhance the strength and competitiveness of Indian banks, align regulatory frameworks with global best practices, and deepen participation in India’s financial markets,” says Pratik Shah, Partner and National Leader (Financial Services) at EY India.

Vivek Iyer, Partner, and Financial Services Risk Leader at Grant Thornton Bharat, says many countries are focusing on economic growth through domestic drivers such as investment and consumption. “These thematic growth schemes can be accelerated through the right levers under fiscal policy and monetary policies,” he says.

These measures could also spark a shift in the lending space. In the last decade, the Indian banking sector has undergone a profound transformation—a clear shift towards retail or consumer lending and shifting of deposits to higher yielding equities and mutual funds.

A year ago, former RBI Governor Shaktikanta Das had admitted that households are increasingly turning to equity markets to park their surplus funds. The current Governor, Sanjay Malhotra, recently termed this shift “as a healthy trend”.

Measuring Up

Many see the RBI’s push to globalise the rupee by allowing banks to lend in rupees in select neighbouring countries as a bold move, but this is easier said than done. “While these initiatives enhance the rupee’s position in global trade and finance, they simultaneously raise credit and recovery risks—particularly when lending to countries with weaker banking oversight and capital controls,” warns Shah of EY India. Volatile economic and trade climate further compound credit risk for the bank.

Shah says if there are defaults, banks will face complex cross-jurisdictional enforcement challenges, further complicated by political and regulatory uncertainties in partner countries that may hinder contract enforceability. “Addressing these risks requires more than conventional risk management. Banks have to adopt country-specific exposure limits that account for sovereign risk and bilateral dynamics.”

Shah suggests that banks prioritise cross-border rupee loans with enforceable collateral—with liquid assets or guarantees from credible local institutions—to build stronger protection against these vulnerabilities.

Similarly, allowing banks to finance M&As comes with its own set of risks. First, there is the likelihood of concentration risk. If a takeover fails, banks will suffer. “This is even more challenging at a time when global trade rules are shifting, and disruptions from technology and AI are reshaping industries,” says an investment banker.

The key question is: do banks have the capabilities to truly assess risks in such fast-changing industry dynamics? “Such transactions are cyclical by nature and depend heavily on the financial strength of both the acquiring and target entities,” says Shah, adding that banks today are better prepared due to stronger regulatory oversight, advanced risk management practices, and conditional approach to acquisition finance.

A Black Swan event could upset those safeguards. Indian banks are well aware of this. In India’s own boom years between 2004 and 2008, several Indian companies made billion-dollar acquisitions. When demand cratered after the global financial crisis (GFC) in 2008, many of those deals failed to deliver, resulting in massive write-offs.

The RBI must set up a framework for acquisition financing balancing assets and liabilities management risks, governance risks for related parties and effective end-use of funds to make the product successful, advises Iyer of Grant Thornton Bharat.

While Iyer believes there is enough know-how within the country to assess M&A risks effectively, he adds that talent may not be equally available at all banks. Each bank will need to have an effective people and talent strategy to staff M&A credit teams.

Indian banks can draw parallels from leading global institutions by adopting scenario-based stress testing. This incorporates both macroeconomic and sector-specific shocks, including forming cross-functional teams with external advisors to conduct thorough due diligence on complex transactions. “Benchmarking against international deal structures and integrating advanced analytics and AI can strengthen risk assessments,” Shah says.

Credit Relaxations

There is now a danger of overexposure to large groups or conglomerates. Unlike in the past, these conglomerates are moving away from traditional sectors into newer areas that are both risk-prone and highly competitive.

Banks’ funds are likely to flow into riskier areas. “We have already seen in earlier cycles how large groups became over-leveraged in the steel and construction sectors,” says an analyst. Any reckless exposure could have serious implications for banks in terms of provisioning, capital adequacy, and may even trigger a chain reaction of defaults across the banking system.

There is a liquidity risk in lending against shares, REITs and InvITs. The latter two are traded on exchanges like equities. In the past, pledged shares have created havoc during sharp market crashes.

Similarly, the market prices of REITs and InvITs fluctuate daily based on the outlook for their underlying assets—typically commercial real estate or toll roads. If the value of these underlying assets falls, market prices of REITs and InvITs would decline, putting pressure on banks to seek additional margins from borrowers or liquidate their pledged holdings in the market.

Another measure requires banks to pay insurance premiums that reflect their individual risk levels. This is a good step but with a flip side. Depositors today go by brand names. “Tomorrow, they could shift to banks with higher interest rates without worrying about where the funds are being deployed,” says a banker.