When a bank's resolution framework fails and a loan cannot be restructured or recovered through normal channels, the asset has to go somewhere. In India, that somewhere is an Asset Reconstruction Company. ARCs exist for a single purpose: to buy bad loans from banks at a discount and recover whatever value remains. The mechanism through which they do this — the security receipt — is one of the more unusual instruments in Indian finance. The ARC does not pay cash upfront for the full acquisition price. It issues security receipts to the selling bank, backed by the expected recovery from the underlying asset. The bank exchanges a non-performing loan on its books for a tradeable instrument whose value depends on whether the ARC can actually collect.
This market did not emerge naturally. It was created by statute, because India's civil court system was too slow to enforce creditor rights on its own. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 — SARFAESI — gave two things simultaneously: it created the legal framework for ARCs to exist, and it gave banks (and by extension ARCs) the power to enforce security interests without going to court. Before SARFAESI, a bank that wanted to seize collateral from a defaulting borrower had to file a suit, obtain a decree, and execute it through the civil court system. That process took years. SARFAESI allowed banks to issue a 60-day notice to the borrower and, if the default was not cured, take possession of the secured asset, manage it, and sell it — all without judicial intervention.
The combination of these two powers — acquisition of distressed debt and non-judicial enforcement — makes ARCs the primary institutional mechanism for clearing NPAs from the banking system. But the framework has evolved considerably since 2002, shaped by two decades of regulatory intervention, a major committee review, and the November 2025 consolidation that rewrote the rulebook.
How ARCs Operate
An ARC registered with the RBI acquires financial assets from banks and financial institutions. The acquisition can cover both fund-based and non-fund based exposures, and the ARC can even acquire accounts classified as Special Mention Accounts — stress that has not yet become an NPA. Before bidding, an ARC must conduct due diligence:
"Before bidding for the stressed assets, an ARC may seek adequate time, of not less than two weeks, from the auctioning banks to conduct a meaningful due diligence of the account by verifying the underlying assets." — ARC Directions 2025, Para 27
Once acquired, the ARC has several recovery tools available under Section 9 of SARFAESI: enforcement of security interest (seizure and sale of collateral), takeover or change in management of the borrower's business, settlement with the borrower, or sale of the business as a going concern. The 2025 Directions also permit ARCs with a minimum net owned fund of Rs 1,000 crore to act as Resolution Applicants under the Insolvency and Bankruptcy Code — a significant expansion that lets the largest ARCs bid for distressed companies through the IBC process rather than relying solely on SARFAESI enforcement.
The minimum capital threshold itself has been ratcheted up. The 2025 Directions require every ARC to maintain a minimum net owned fund of Rs 300 crore on an ongoing basis. ARCs existing as of October 2022 were given until March 31, 2026 to comply. This consolidation pressure is deliberate — the reason is that the RBI wants fewer, better-capitalised ARCs rather than a fragmented industry of undercapitalised entities that lack the resources to pursue meaningful recovery.
Security Receipts and the Trust Structure
The financial engineering behind ARC acquisitions runs through trusts. When an ARC acquires assets, it typically sets up a trust under the Indian Trusts Act, 1882, and issues security receipts to the investors in that trust — usually the selling bank itself, but potentially other qualified institutional buyers. The security receipts represent an undivided beneficial interest in the trust's assets (the acquired loans). Recovery proceeds flow back to SR holders based on the terms of the trust deed.
"With the issue of these Directions, the existing Directions, instructions, and guidelines relating to ARCs stand repealed." — ARC Directions 2025, Para 167
That single sentence in the November 2025 Directions wiped out years of accumulated circulars, amendments, and piecemeal guidance. The RBI's April 2021 Committee on ARC functioning, whose report was released for public comment in November 2021, had recommended a comprehensive overhaul. The 2025 Directions implement that vision — a single, consolidated Master Direction covering registration, governance, acquisition, recovery, security receipt management, and prudential norms, replacing everything that came before.
The Securitisation Framework
Securitisation of standard assets — the pooling of performing loans into tradeable securities — runs on a parallel track. The Reserve Bank of India (Commercial Banks – Securitisation Transactions) Directions, 2025 replaced the earlier Securitisation of Standard Assets Directions, 2021 (since withdrawn). The framework imposes two key structural requirements on originators.
The Minimum Holding Period (MHP) requires the originating bank to hold loans on its books for a specified period before they can be securitised. The reason for this requirement is to ensure the bank has skin in the game and does not originate loans solely for the purpose of selling them — the same originate-to-distribute problem that triggered the 2008 global financial crisis. The Minimum Retention Requirement (MRR) requires the originator to retain a portion of the securitised pool, aligning the originator's interests with those of the investors. Re-securitisation — securitising already-securitised exposures — is prohibited outright, as are structures involving short-term instruments like commercial paper.
The Transfer of Loan Exposures Directions, 2021 (also since withdrawn into the 2025 framework) governed direct bilateral loan sales. Together with the securitisation framework, these directions create the full architecture for moving credit risk off bank balance sheets — whether the loans are performing or not.
The RBI also released a Discussion Paper on Securitisation of Stressed Assets Framework (SSAF) in January 2023, proposing a framework for securitising NPAs — not just standard assets. This was prompted by the recognition that the ARC route alone was insufficient to clear the volume of distressed debt in the system. A secondary market for stressed assets would allow a broader set of investors to participate in NPA resolution, because international experience — particularly in Europe and the United States — had shown that deeper investor pools drove better price discovery and faster resolution.
The Enforcement Architecture
SARFAESI enforcement remains the backbone. A secured creditor holding at least 60% of the outstanding debt can issue a Section 13(2) notice to the borrower, demanding repayment within 60 days. If the borrower does not comply, the creditor can take possession of secured assets under Section 13(4), manage or sell them, and apply the proceeds to the outstanding debt. The borrower's recourse is to the Debt Recovery Tribunal under Section 17 — not the civil courts. The reason Parliament channelled disputes to the DRT rather than civil courts was to ensure that enforcement was not delayed by the procedural backlog that had historically made loan recovery a decade-long process.
This power extends to ARCs that acquire the debt. When an ARC buys a non-performing loan and the associated security interest, it steps into the shoes of the original secured creditor for enforcement purposes. The 2025 ARC Directions also codify the power of management takeover — an ARC can, after due process including a 30-day notice period, take over the management of the borrower's business for the purpose of realising its dues.
Governing Master Direction: Reserve Bank of India (Asset Reconstruction Companies) Directions, 2025 (RBI_MD_12930)
Companion articles:
- What Happens After a Loan Goes Bad
- How SARFAESI Gave Banks Power
Last updated: April 2026