Recovery channels: DRTs, SARFAESI, securitisation, ARCs and the bad bank

Detail

Why recovery channels matter

• Non-Performing Asset (NPA): a loan on which the borrower has stopped paying interest or principal for a set period. The bank is no longer earning from it.
• The problem with ordinary courts:
• Ordinary civil suits took years.
• Collateral lost value during the wait, so banks recovered very little.

• Money stuck in bad loans could not be lent again, so credit to the economy slowed.

• The answer: Parliament built special channels step by step:

• Lok Adalats first, then DRTs (1993), then SARFAESI (2002).

• The IBC came later, in 2016.

• Scale: Government and RBI measures helped scheduled commercial banks recover an aggregate Rs 10,16,617 crore over the nine financial years to 2022-23 [7].

The pre-IBC toolkit

Channel	Law and year	Mechanism	Best suited for
Lok Adalats	Legal Services Authorities Act	Settlement by agreement (compromise)	Small-value loans
Debt Recovery Tribunals (DRTs)	RDDBFI Act 1993 (Recovery of Debts Due to Banks and Financial Institutions)	Special tribunals that hear only bank and FI dues	Mid and large dues
SARFAESI	2002	The lender enforces its security without going to court	Secured loans

• Lok Adalat ("people's court"): a forum where both sides agree to a settlement. It is quick and cheap, but it works only when the borrower is willing to settle.
• DRT: a tribunal set up only for debts owed to banks and financial institutions.
• It is faster than a civil court because it handles nothing else.
• Over time, however, DRTs also built up large backlogs.

SARFAESI — enforcement of security interest

• Full name: Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
• Security interest: the lender's legal right over an asset (land, plant, machinery) that the borrower pledged when taking the loan.
• Step-by-step process:
• The loan becomes an NPA, and the secured lender issues a 60-day demand notice under s.13(2).
• If the borrower still does not pay, the lender takes possession under s.13(4). It can take over the asset or its management.
• The lender then sells the asset and recovers its dues.

• No court is needed at any point.

• Coverage: the Act first covered banks and was later extended to larger NBFCs. The current NBFC asset-size threshold could not be verified from the sources here.

• The same Act does three jobs:
• It gives the enforcement power described above.
• It provides the legal base for securitisation.
• It provides the legal base for ARCs.

Securitisation

• Definition: pooling illiquid loans (loans that cannot easily be sold) and turning them into tradable securities that are sold to investors.
• Why banks do it:
• The bank sells the loan pool and gets cash now.
• The loans leave its balance sheet, so capital tied up against them is freed.

• The bank can lend that capital again.

• Worked example:

• A bank holds 1,000 home loans worth Rs 500 crore in total.
• It pools them and sells securities worth Rs 500 crore to investors.
• Borrowers' EMIs now go to the investors.

• The bank has Rs 500 crore of fresh cash to lend.

• Rules: the RBI Master Directions 2021 cover securitisation of standard assets (healthy loans) and transfer of loan exposures.

• Minimum Retention Requirement (MRR): the originator (the bank that made the loans) must keep part of the risk. This is its "skin in the game".

• If the originator keeps some of the loss, it has a reason to lend carefully in the first place.

• Contrast with the US subprime crisis (2007-08):

• In the MBS/CDO chain, originators kept no risk.
• So they gave loans to weak borrowers and sold them straight on.
• When the loans went bad, investors and the whole financial system were hit (see the parent note, Section 10).

Asset Reconstruction Companies (ARCs)

• Definition: an ARC is a specialised company that buys bad loans from banks at a discount. It then tries to recover the money through restructuring, settlement or sale of collateral.
• Registration: ARCs are registered with the RBI under SARFAESI.
• How an ARC pays the bank:
• Part of the price is paid in cash.
• The rest is paid in security receipts (SRs).

• SR: an instrument that gives its holder a share of whatever the ARC later recovers from the loan. The bank gets paid in full only if the recovery is good.

• Minimum Net Owned Fund (NOF): NOF is the owners' own capital, after losses and intangible items are removed.

• The minimum was raised from Rs 100 crore to Rs 300 crore by an RBI circular of 11 October 2022 [4].
• New ARCs cannot start business without Rs 300 crore [4].

• Existing ARCs got a glide path (a step-by-step timeline): Rs 200 crore by 31 March 2024 and Rs 300 crore by 31 March 2026 [4].

• Skin in the game for ARCs: the ARC must invest in SRs at the higher of [4]:

• 15% of the transferors' investment in SRs (the transferors are the selling banks), or
• 2.5% of total SRs issued.

• The rule applies to each class of SRs in each scheme, on an ongoing basis until the SRs are redeemed (paid off) [4].

• Worked example:

• An ARC buys a loan of Rs 1,000 crore (book value) for Rs 300 crore.
• It pays in SRs worth Rs 300 crore. The bank holds Rs 255 crore of these and the ARC holds Rs 45 crore.
• Rule 1: 15% × 255 = Rs 38.25 crore.
• Rule 2: 2.5% × 300 = Rs 7.5 crore.

• The required holding is the higher figure, Rs 38.25 crore. The ARC holds Rs 45 crore, so it complies.

• Governance (October 2022 framework) [4]:

• The Board Chair must be an independent director.
• At least half of the Board must be independent directors.

• An MD/CEO or whole-time director can serve at most 5 years per term and 15 years in a row. The age limit is 70 years.

• Review: the Sudarshan Sen Committee (2021) reviewed the working of ARCs. RBI's October 2022 revised framework came after a comprehensive review of ARC regulation [4].

• Weakness — low recovery rates:
• Banks often transferred loans to ARCs mainly for SRs, so the ARC put in little cash of its own.
• Many ARCs were too small to revive large companies.
• As a result, a lot of the risk stayed with the banks, only in the form of SRs.

The bad bank

• Definition: a bad bank is an entity that takes over stressed assets from banks.
• The banks' balance sheets become clean, so they can focus on fresh lending.

• Recovery is handled separately by specialists.

• Global models:

Country	Entity	Year	Context
USA	Resolution Trust Corporation	1989	Savings-and-loan crisis
Sweden	Securum	1992	The classic success story
Malaysia	Danaharta	1998	East Asian crisis
Ireland	NAMA	2009	Property-bubble collapse

India's bad bank: NARCL-IDRCL

• How the idea developed:
• The Economic Survey 2016-17 proposed PARA (Public Sector Asset Rehabilitation Agency).
• The idea came back in the Budget 2021-22 announcement.

• The Cabinet approved the government guarantee in September 2021 [2].

• Two-entity structure: both NARCL and IDRCL were set up by banks [3].

• NARCL (National Asset Reconstruction Company Ltd): set up in 2021 and majority-owned by PSBs. It buys and holds the loans.

• IDRCL (India Debt Resolution Company Ltd): majority private. It manages and resolves the loans, acting like a debt manager.

• Why this helps: a big company's debt is usually spread across many lenders.

• NARCL-IDRCL brings that debt together in one place.

• This gives faster, single-point decisions, including through IBC processes where they apply [3].

• Target: NARCL plans to acquire stressed assets of about Rs 2 lakh crore, in phases, within RBI rules [2].

• 15:85 structure: 15% paid in cash, 85% in SRs [2].
• Government guarantee: the SRs are backed by a guarantee of up to Rs 30,600 crore, valid for 5 years [2].
• It covers the shortfall between the SR's face value and the amount actually realised from the asset.

• The Rs 30,600 crore limit is an overall ceiling [2].

• Worked example:

• A loan with a book value of Rs 1,000 crore is bought for an agreed value of Rs 400 crore.
• The bank gets Rs 60 crore in cash (15%) and Rs 340 crore in SRs (85%).
• The asset is later sold for only Rs 250 crore.

• Shortfall on the SRs = 340 − 250 = Rs 90 crore. The government pays this, within the Rs 30,600 crore ceiling and the 5-year window.

• Progress so far:

• An earlier PIB update reported that NARCL had acquired 22 accounts with an exposure of Rs 95,711 crore [6].
• After NARCL made offers, banks themselves resolved 28 accounts with an exposure of Rs 1.28 lakh crore. This is an indirect effect: NARCL's offer pushed other solutions forward [6].
• NARCL realised Rs 4,364 crore in FY 2025-26, about 70% of its cumulative recoveries so far [5].
• For comparison, the planned pipeline was about Rs 2 lakh crore [2]. Acquisition has therefore been slower than planned.

Prelims Hooks

• DRTs were created under the RDDBFI Act 1993. SARFAESI is a 2002 Act. Lok Adalats work under the Legal Services Authorities Act.
• SARFAESI: a 60-day notice under s.13(2), then possession under s.13(4), with no court involvement.
• ARCs are registered with the RBI under SARFAESI. They are not registered with SEBI or under the Companies Act alone.
• The minimum NOF for ARCs is Rs 300 crore (circular of 11 October 2022). Existing ARCs had to reach it by 31 March 2026 [4].
• ARC skin in the game = the higher of 15% of transferors' SR investment or 2.5% of total SRs [4].
• NARCL buys and holds the loans and is majority PSB-owned. IDRCL manages and resolves them and is majority private. Exams often swap the two roles.
• NARCL pays 15% in cash and 85% in SRs. The SR guarantee is up to Rs 30,600 crore for 5 years and covers the shortfall between face value and realisation [2].
• Match the bad bank to its country: Securum – Sweden (1992), Danaharta – Malaysia (1998), NAMA – Ireland (2009), RTC – USA (1989).
• The Minimum Retention Requirement in securitisation is meant to prevent the "originate-to-distribute" behaviour behind the US subprime crisis.
• The PARA idea first appeared in the Economic Survey 2016-17.

Mains Points

• Speed versus fairness in recovery:
• SARFAESI lets lenders act without a court, which is fast.
• But borrowers need protection against arbitrary seizure.

• Clogged DRTs show that special forums also fail without enough judges and good infrastructure.

• Aligning incentives is the key design principle:

• This covers the MRR in securitisation, ARC investment in SRs (at least 15% / 2.5%) [4], and IDRCL's private majority.

• The idea is that whoever decides on a loan should share its loss. This is the lesson of the US subprime crisis.

• The bad-bank debate:

• For: clean bank balance sheets, a single point of decision across many lenders [3], and a sovereign guarantee that gives comfort on value [2].
• Against: moral hazard (banks may lend carelessly if they expect a bailout), a contingent liability for the government (a cost that appears only if the guarantee is used), and slow acquisition.

• Acquisitions of Rs 95,711 crore [6] fall well short of the Rs 2 lakh crore target [2]. Sweden's Securum worked because of speed and independence.

• The toolkit evolved in layers:

• Each channel shows the limits of the one before it: Lok Adalats → DRTs → SARFAESI and ARCs → IBC 2016.
• Today these channels work alongside the IBC.
• Aggregate recoveries of about Rs 10.17 lakh crore over the nine years to 2022-23 show their combined effect [7].