Prudential Regulation of Capital Market Exposure under the Draft RBI Directions, 2025

Posted On - 4 May, 2026 • By - Siddartha Karnani

Introduction

The Reserve Bank of India (“RBI”) has issued the Draft Reserve Bank of India (Commercial Banks – Capital Market Exposure) Directions, 2025 (“Draft Directions”) under Sections 21 and 35A of the Banking Regulation Act, 1949.1

These Draft Directions seek to consolidate, harmonise, and modernise the existing regulatory framework governing capital market exposure (“CME”) of commercial banks. They replace a fragmented regime of circulars and guidelines with a principle-based, risk-aligned framework, reflecting evolving market structures, increased retail participation, and the growing role of institutional financing in capital markets.

The Draft Directions are proposed to come into effect from 1 April 2026, with an option for voluntary early adoption. While legacy exposures may run to maturity, all fresh or renewed exposures must comply with the revised framework.

Regulatory Scope and Applicability

The Draft Directions apply to commercial banks, excluding:

  • Small Finance Banks
  • Regional Rural Banks
  • Local Area Banks
  • Payments Banks

Importantly, the Directions operate in addition to, and not in derogation of, other applicable RBI frameworks governing credit, investments, large exposures, and capital adequacy.

The legal foundation derives from:

  • Section 21 (control of advances)
  • Section 35A (RBI’s power to issue directions)

of the Banking Regulation Act, 1949.

Conceptual Framework: What Constitutes Capital Market Exposure (CME)?

The Draft Directions retain a broad and substance-over-form definition of CME, covering both direct (investment) and indirect (credit) exposures.

1. Direct (Investment) Exposure

Includes:

  • Equity and preference shares
  • Convertible debentures/bonds
  • Units of equity-oriented mutual funds
  • Units of Alternative Investment Funds (AIFs)
  • Derivatives with capital market underlying

2. Indirect (Credit) Exposure

Includes:

  • Loans for investment in shares, IPOs, ESOPs, and non-debt instruments
  • Loans against shares or mutual funds
  • Financing to capital market intermediaries (CMIs)
  • Acquisition/leveraged buyout financing
  • Promoter contribution financing
  • Bridge loans against expected equity inflows
  • Underwriting and irrevocable commitments

A critical clarification is that where repayment is primarily dependent on capital market collateral, the exposure is treated as CME irrespective of additional security.

Prudential Limits on Capital Market Exposure

A key feature of the Draft Directions is the linkage of capital market exposure to Tier 1 capital, ensuring systemic stability.

1. Aggregate CME Limits

  • 40% of Tier 1 Capital (solo basis)
  • 40% of Tier 1 Capital (consolidated basis)

2. Sub-limits within CME

  • Direct CME (investments + acquisition finance): capped at 20% of Tier 1 capital
  • Acquisition finance: capped at 10% of Tier 1 capital

Banks are also required to define internal sub-limits, including for intra-day exposures.

Exclusions from CME Computation

Certain exposures are excluded to avoid double counting or undue restriction on core banking functions, including:

  • Investments in subsidiaries and joint ventures
  • Exposure to critical financial market infrastructure
  • Inter-bank instruments (CDs, Tier I/Tier II bonds)
  • Non-convertible debentures and debt mutual funds
  • Infrastructure SPV promoter share pledges (for project lending)

However, mark-to-market gains post-listing may be included, reflecting economic exposure.

Computation Methodology

  • Investments: measured at cost
  • Credit exposures: higher of sanctioned limit or outstanding
  • Term loans: may be reckoned at outstanding (if fully drawn)

Importantly, these are prudential ceilings, not targets. Banks are expected to adopt stricter internal risk limits where warranted.

General guidelines for credit exposure established by banks2

Banks can provide credit to clients based on the value of their collateral (eligible securities) based on their internal policy. This policy will include:

Lending Against Shares and Market Instruments (LAS Framework)

The Draft Directions significantly tighten and standardise Loan Against Securities (LAS) practices.

Key Policy Requirements

Banks must formulate board-approved policies covering:

  • Eligible collateral
  • Borrower concentration limits
  • Loan-to-Value (LTV) ratios
  • Margining and haircut frameworks
  • Valuation and mark-to-market frequency

Prohibited Collateral

  • Partly paid shares
  • Locked-in securities
  • Bank/NBFC-issued instruments
  • Indian Depository Receipts (IDRs)
  • Own shares of the lending bank

Loan-to-Value (LTV) Norms

Indicative LTV ceilings include:

  • Listed equity/convertible instruments: up to 60%
  • Non-debt mutual funds / ETFs / REITs / InvITs: up to 75%
  • Debt mutual funds: up to 85%
  • Listed debt securities / CPs: 75–85% (rating-based)

Collateral must be valued conservatively, typically based on the lower of historical average or current market price. Breaches of LTV limits must be rectified within 7 calendar days.

Retail Participation: IPO / ESOP Financing

Banks may finance individuals for IPOs, FPOs, and ESOPs subject to:

  • Cap of ₹25 lakh per individual
  • Maximum 75% funding (minimum 25% margin)
  • Mandatory lien/pledge post-allotment

A strict prohibition applies to financing purchase of the bank’s own shares, including via employee trusts.

Exposure to Capital Market Intermediaries (CMIs)

Banks may extend fully secured, need-based facilities to regulated CMIs for:

  • Margin trading
  • Settlement obligations
  • Market-making

Key safeguards

  • Lending only to regulated and compliant entities
  • No financing of proprietary speculative trading
  • Collateral must be borrower-owned
  • Prescribed haircuts (e.g., ~40% for equities)
  • Minimum 50% cash collateral for guarantees

Acquisition and Leveraged Financing

The Draft Directions introduce tight prudential discipline for acquisition financing:

  • Acquirer must have 3-year profitability track record
  • Target financials must be available for 3 years
  • Maximum bank funding: 70% (minimum 30% equity contribution)
  • Post-acquisition leverage capped (typically 3:1 debt-equity)
  • Mandatory pledge of target shares
  • Independent valuation and enhanced due diligence

Such exposures are included within direct CME limits and subject to the 10% Tier 1 cap.

Irrevocable Payment Commitments (IPCs)

Custodian banks may issue IPCs subject to:

  • Full collateralisation or control over settlement securities
  • Treatment as financial guarantees

Exposure reckoning:

  • 30% (intra-day)
  • 50% (overnight)

PSU Disinvestment Financing

Banks may finance participation in Government disinvestment programmes3, subject to:

  • Strong borrower credit profile
  • No restrictions on pledge enforcement
  • Classification as direct CME exposure

Disclosure and Regulatory Consolidation

Banks are required to disclose total CME in financial statements, enhancing transparency. A major reform objective is the repeal and consolidation of legacy RBI circulars, resulting in:

  • Reduced interpretational ambiguity
  • Improved compliance efficiency
  • Greater supervisory clarity

Key Regulatory Takeaways

For banks, NBFCs, and capital market participants, the Draft Directions signal:

  • Stricter capital allocation discipline for equity-linked exposures
  • Enhanced collateral governance and valuation rigor
  • Increased scrutiny of leveraged and structured financing
  • Alignment with risk-based supervision and Basel principles

For borrowers and intermediaries:

  • Reduced leverage availability in capital markets
  • Greater reliance on high-quality collateral and equity contribution
  • Tighter compliance expectations

Conclusion

The Draft RBI Directions, 2025 mark a significant shift from rule-based fragmentation to a unified prudential regime governing capital market exposure.

By linking exposures to Tier 1 capital, tightening LTV and collateral norms, and introducing clear limits on acquisition and intermediary financing, the RBI aims to strike a balance between:

  • Market development, and
  • systemic risk containment

From a regulatory standpoint, this framework reflects a maturing financial system where capital market financing is no longer peripheral but systemically relevant—necessitating robust, forward-looking prudential oversight.

  1. https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4762 ↩︎
  2. https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4762 ↩︎
  3. https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4762 ↩︎