Banks are increasingly selling retail loan accounts showing signs of incipient stress to Asset Reconstruction Companies (ARCs) in order to avoid the impact of provisioning on their bottomline should they turn non-performing down the line.

This is underscored by the fact that Crisil recently noted an increase in the proportion of low-vintage (or Special Mention Account/SMA) borrowers, as reflected in its rated Security Receipt (SR) portfolio, from 5 per cent in FY2023 to 25 per cent in FY2024. This is driving the recoveries up.

“For these (accounts), ARCs have seen recovery of the full principal outstanding (or POS), due to better accessibility and lower operational intensity for collections as compared to deep vintage borrowers,” the agency said.

It may be pertinent to note here that though RBI had permitted sale of all category of SMAs (accounts showing signs of igories of incipient stress) to ARCs by lenders in 2021, activity on this front was low-key for a couple of years.

Before a loan account turns into a Non-Performing Asset (NPA), a bank is required to identify incipient stress in it by creating three sub-categories under the SMA category.

The three sub-categories are – SMA-0 (principal or interest payment not overdue for more than 30 days, but account showing signs of incipient stress), SMA-1 (principal or interest payment overdue between 31-60 days) and SMA-2 (principal or interest payment overdue between 61-90 days).

Sale of stressed assets to ARCs is one of the channels for lenders to clean up their balance sheet. This is done either through a combination of cash payment and issue of security receipts (SRs) or all cash transaction.

Hari Hara Mishra, CEO, Association of ARCs in India, observed that for small loans up to ₹1 lakh, lenders do not have recovery mechanisms such as SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and DRT (Debt Recovery Tribunal).

Hence, sale to ARC gets preferred to in-house resolution, as once an account becomes non-performing, banks have to start making provision. In the case of an unsecured loan, after one year, when it is categorized as doubtful, it has to be provided 100 per cent.

“Early sale to ARCs is visible in the case of corporate loans accounts too. The overall age of NPAs sold to ARCs, including corporate loans, is progressively coming down,” Mishra said.

Restructuring to the fore

The changing composition of NPAs is now resulting in more recovery from restructuring rather than asset sales or settlement, which is a healthy sign of ARC functioning.

According to the Association’s data, during the first nine months (April-December 2024) of the current financial year, recovery by ARCs through restructuring was the highest at ₹11,692 crore, followed by settlement (₹9,399 crore) and asset sale (₹7,098 crore).

Mishra opined that globally, stressed assets migrate to market early, as value erosion in NPAs is fast and needs specialized attention of distressed debt professionals like ARCs.

“In the initial years of ARCs, not much restructuring was possible as most of the assets transferred were vintage class with dim prospects of revival. Now all ARCs have successful turnaround cases of various sizes across industries,” he said.

Published on March 30, 2025