Asset Reconstruction Companies (ARCs)

Asset Reconstruction Companies are specialized financial institutions that focus on buying bad loans (NPAs) from banks and financial institutions and recovering or restructuring them. The concept of ARCs in India was introduced by the SARFAESI Act, 2002, which provided a legal framework for securitisation and asset reconstruction. The first ARC in India, ARCIL (Asset Reconstruction Company India Ltd.), was established in 2002 by major banks (SBI, ICICI Bank, PNB, and IDBI) as a joint initiative to tackle NPAs. Since then, numerous ARCs have been set up; they are regulated by RBI and need to be registered under the SARFAESI Act.

Role and Business Model

An ARC essentially takes over NPAs from a bank at a mutually agreed discounted price and then tries to recover as much as possible from those assets. When an ARC buys a bad loan, all rights that the bank had (to recover, to enforce collateral, etc.) are transferred to the ARC. The ARC then steps into the shoes of the lender and works to maximize recovery. ARCs have a few strategies to realize value from bad loans:

• Restructuring the loan: They may renegotiate terms with the borrower, extend repayment schedules, or cut interest rates to enable the borrower to repay.
• Enforcing security: Using powers under SARFAESI, ARCs can seize and sell the collateral (e.g., auctioning a defaulting company’s property or assets) to recover dues.
• Asset sale or management change: They might sell the entire business or assets of the borrowing company or even take over management to turn it around. Converting debt to equity is another tool – the ARC can take equity in the defaulting company, hope to revive it, and later sell the stake if the company recovers.
• Securitisation: A key method ARCs use is to bundle the bad loans and issue Security Receipts (SRs) to raise funds. Security Receipts represent an undivided right in the ARC’s pool of assets (the NPAs it bought). They are issued to Qualified Buyers (QBs) – typically financial institutions, banks, insurance companies, etc., who invest money expecting returns from future recoveries. For example, if an ARC buys a bad loan for ₹50 crore, it may finance this by issuing SRs of ₹50 crore to investors (often the same bank sells the NPA takes a portion of these SRs). As the ARC recovers money over time, it pays back the SR holders. If recoveries fall short, SR investors bear the loss.

Funding and Regulations

To operate, ARCs need capital and RBI’s permission. RBI mandates a minimum Net Owned Fund (capital) for ARCs – originally ₹100 crore, which was later increased to ₹300 crore (with existing ARCs given time until March 2026 to comply).

This ensures ARCs are adequately capitalized and have “skin in the game.” In fact, RBI also requires ARCs to invest a minimum portion of the SRs themselves (earlier 15%), so that they have incentive to maximize recoveries. ARCs are supervised by RBI through reporting requirements and guidelines (e.g., on conduct, valuation of assets, etc.).

ARCs do not take deposits like banks. Their profit comes from the difference between what they pay for an NPA and what they eventually recover. For instance, a bank might sell an NPA of ₹100 crore to an ARC at ₹40 crore. If the ARC manages to recover ₹50 crore over time, it earns a profit (minus expenses and payments to SR holders).

If it recovers only ₹30 crore, it incurs a loss. Therefore, ARCs bring in focused recovery expertise: they specialize in extracting value from bad loans, which may involve legal action, restructuring, or finding buyers for stressed assets.

ARC Regulations

ARCs in India operate under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002. They must obtain a Certificate of Registration from RBI under this Act to commence business. RBI’s Master Directions for ARCs outline their scope of activities, investment conditions, and corporate governance.

ARCs can only deal with financial assets (loans, debentures, etc.) that are NPAs. They cannot take over a loan that is still standard.

Importantly, ARCs can only buy secured loans – there must be some security interest for enforcement; unsecured loans are less attractive unless bundled with others. Over the years, RBI has strengthened the ARC framework – e.g., increasing capital requirements to ₹300 crore, allowing ARCs to become resolution applicants under IBC (so they can bid for companies), and setting timelines for ARCs to deploy funds and resolve assets. A committee (Sudarshan Sen Committee, 2021) also suggested measures to improve ARC effectiveness.

Progress

Despite being around for two decades, ARCs had a mixed record. They worked well for smaller loans, but were less effective for large corporate NPAs (one reason the NARCL “bad bank” was needed). However, ARCs remain an important tool in the NPA management toolkit. They provide an avenue for banks to offload troublesome loans and get some cash upfront. As of mid-2020s, India has more than 25 ARCs. With improved regulations and the advent of NARCL, the ARC model is expected to play a complementary role in resolving distressed assets, especially mid-sized and retail loans.