The private sector Asset Reconstruction Company (ARC) model in India, once touted as the ideal route to relieve lenders of their stressed assets and expedite resolution, seems to be floundering. A recent Reserve Bank of India (RBI) directive against Edelweiss ARC, the largest private sector ARC, asked it to cease and desist from acquiring any financial assets including Security Receipts (SRs). Though resolution efforts can continue, the directive is likely to pose challenges to its ability to carry on business as usual and raise capital.

The supervisory action against Edelweiss ARC comes at a time when its peer JM ARC is facing capital shortfalls after providing for credit losses. Most other private sector ARCs are said to be struggling to meet RBI’s minimum net worth requirement of ₹300 crore by the March 2026 deadline. RBI’s latest regulatory action is bound to hobble the sector. But it really had little choice in the matter having given a fairly long rope to Edelweiss ARC to fall in line. The RBI alleges that it found Edelweiss ARC evergreening stressed assets of group company ECL Finance, by entering into structured transactions with it. It is also said to have taken over loans from non-lending institutions using ECL Finance as a conduit, incorrectly valuing SRs and sharing non-public information on clients with group entities. Though RBI issued a letter highlighting such deficiencies in 2021-22, Edelweiss ARC failed to bring this to the notice of its Board. RBI issued the cease-and-desist order only after fruitless attempts to engage with the Edelweiss senior management and auditors for over two years.

It is disturbing that such infractions persist despite RBI issuing specific guidelines in October 2022. These had recommended a Board-managed structure that required ARCs to have an independent director as Chairperson, with active Audit and Nomination and Remuneration committees. Deals for one-time settlement were to be vetted by an independent panel. These were in addition to existing rules requiring transactions between ARCs and lenders to be conducted on a transparent, arm’s length basis. It has been over two decades since policymakers placed their faith in private sector ARCs as an efficient means to stressed asset resolution. Despite 29 ARCs springing up, they have largely failed to deliver on this objective.

Apart from struggling to raise capital and notching up a patchy record on resolution, some of them have also been accused of practices such as buying out stressed assets from banks at unrealistically low prices, getting into a nexus with defaulting borrowers and selling assets back to promoters barred under the Insolvency and Bankruptcy Code. Given these factors, RBI must not backtrack from strictly enforcing its tighter net worth or governance norms on the sector. With the government-backed National Asset Reconstruction Company up and running, the sector will have a viable alternative even if large private players fall prey to a shakeout.