Asset Reconstruction Companies (ARCs) – Business Model
Banks are financial institutions primarily engaged in lending and borrowing money. Given their large customer base, lending activities always involve credit risk. When borrowers fail to repay loans and those loans turn into Non-Performing Assets (NPAs), banks face pressure on profitability and balance sheets.
Although banks can initiate legal recovery proceedings, it is not always economically viable or time-efficient. In such cases, instead of pursuing prolonged recovery action, banks may sell stressed assets to an Asset Reconstruction Company (ARC).
What is an Asset Reconstruction Company (ARC)?
An Asset Reconstruction Company (ARC) is a specialized financial institution that purchases non-performing loans (NPAs) from banks and financial institutions at an agreed value and then attempts to recover the dues or enforce associated securities.
In India, ARCs are:
- Registered with the Reserve Bank of India
- Regulated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002)
ARCs are permitted to undertake:
- Asset reconstruction
- Securitisation
- Or both
When a bank sells an NPA to an ARC, all legal rights related to that loan are transferred from the bank to the ARC.
How the ARC Business Model Works
The business model of ARCs revolves around:
- Acquiring distressed assets from banks at a discount
- Recovering more than the purchase price
- Generating profit from the recovery difference
ARCs raise funds primarily from Qualified Buyers (QBs) to purchase such stressed assets.
1️⃣ Asset Reconstruction
Asset reconstruction refers to:
Acquisition of rights or interests of banks/financial institutions in loans, advances, debentures, bonds, guarantees, or other credit facilities for the purpose of recovery.
These instruments are collectively referred to as financial assistance.
After acquiring the asset, the ARC may:
- Restructure the loan
- Change repayment terms
- Enforce security interests
- Take possession of secured assets
- Sell collateral
- Convert debt into equity
The goal is to maximize recovery value.
2️⃣ Securitisation
Securitisation involves acquiring financial assets and issuing Security Receipts (SRs) to Qualified Buyers.
Key features:
- Security Receipts represent an undivided interest in the acquired financial assets.
- Investors (QBs) share recovery proceeds proportionally.
- The ARC manages recovery and distributes proceeds accordingly.
This allows ARCs to reduce their own capital exposure while sharing risk with investors.
3️⃣ Qualified Buyers (QBs)
ARCs can raise funds only from Qualified Buyers.
Qualified Buyers include:
- Banks
- Financial Institutions
- Insurance Companies
- State Financial Corporations
- State Industrial Development Corporations
- Trustees
- ARCs registered under SARFAESI
- Asset Management Companies registered under SEBI
- Pension funds
- Foreign Institutional Investors (FIIs)
These investors subscribe to Security Receipts issued by ARCs.
Working of an Asset Reconstruction Company (ARC)
The functioning of an Asset Reconstruction Company (ARC) follows a structured legal and financial process under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002).
An ARC can commence business only after:
- Obtaining a registration certificate under Section 3 of SARFAESI
- Meeting the minimum Net Owned Funds (NOF) requirement of ₹100 crore (as prescribed under the Reserve Bank of India regulations)
Step-by-Step Working of an ARC
Although often shown in diagram form, the working of an ARC can be understood in the following stages:
1️⃣ Acquisition of NPAs from Banks
- Banks identify stressed loans (Non-Performing Assets).
- The ARC evaluates the recoverable value of these assets.
- A purchase agreement is signed at a mutually agreed discounted price.
- The bank transfers all rights related to the loan to the ARC.
The ARC may pay:
- Partly in cash
- Partly through Security Receipts (issued to Qualified Buyers)
2️⃣ Raising Funds
To purchase such assets, ARCs raise funds from Qualified Buyers (QBs) by issuing Security Receipts representing an undivided interest in the financial assets.
3️⃣ Asset Reconstruction / Recovery Process
The ultimate goal of acquiring NPAs is recovery. However, recovery is complex and may require strategic intervention.
ARCs have several legal and operational options:
A. Change or Takeover of Management
If the borrower’s management is inefficient or responsible for default:
- ARC may replace management
- Take control of business operations
- Appoint new directors or administrators
This improves operational efficiency and recovery prospects.
B. Sale or Lease of Business
The ARC may:
- Sell the borrower’s business as a going concern
- Lease the business to generate income
- Sell divisions or assets separately
This helps unlock value from stressed enterprises.
C. Rescheduling / Restructuring of Debt
Instead of enforcing security immediately, ARCs may:
- Extend repayment timelines
- Reduce interest burden
- Offer settlement schemes
- Rework repayment structures
This improves the borrower’s ability to repay while maximizing recovery.
D. Enforcement of Security Interest
Under SARFAESI, ARCs can:
- Enforce secured assets without court intervention (subject to legal provisions)
- Initiate recovery proceedings
This is a powerful tool for faster resolution.
E. Taking Possession of Secured Assets
If default continues, the ARC may:
- Take physical or symbolic possession of collateral
- Auction assets
- Recover dues from sale proceeds
F. Conversion of Debt into Equity
ARCs may:
- Convert part of the outstanding debt into shares
- Become shareholders in the borrower company
This aligns the ARC with business revival and future value appreciation.
Types of Debts an ARC Can Take Over
An Asset Reconstruction Company (ARC) can acquire only specific types of debts under the framework of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002).
1️⃣ Only Secured Debts
ARCs are permitted to take over:
- Secured debts
- Which have been classified as Non-Performing Assets (NPAs)
This means:
- The loan must be backed by collateral (e.g., property, plant & machinery, inventory, receivables).
- The borrower must have defaulted in repayment as per regulatory norms.
Unsecured loans generally do not fall within the standard acquisition scope of ARCs under SARFAESI.
2️⃣ Special Case: Debentures / Bonds
If debentures or bonds remain unpaid:
- The beneficiary of the security must issue a 90-day notice
- Only after expiry of this notice period can the asset qualify to be taken over by the ARC.
This ensures procedural fairness before enforcement or acquisition.
Understanding Non-Performing Assets (NPAs)
Banks and financial institutions classify their loan assets into four categories based on performance and recoverability norms prescribed by the Reserve Bank of India (RBI).
Classification of Bank Assets
1️⃣ Standard Assets
- Performing loans
- Regular repayment of principal and interest
- No significant credit risk
2️⃣ Sub-Standard Assets
- Assets that have remained NPA for up to 12 months
- Higher credit risk
- Weakening financial position of borrower
3️⃣ Doubtful Assets
- Assets that have remained in the sub-standard category for 12 months or more
- High probability of loss
- Recovery is uncertain
4️⃣ Loss Assets
- Assets identified as uncollectible
- Considered irrecoverable by the bank or auditors
- Minimal salvage value
Which Categories Qualify as NPA?
Out of the four categories:
- Sub-standard
- Doubtful
- Loss
These three categories are considered Non-Performing Assets (NPAs).
Standard assets are not eligible for takeover by ARCs because they are performing loans.
Why Only NPAs?
The purpose of ARCs is to:
- Resolve stressed assets
- Recover bad loans
- Clean bank balance sheets
Therefore, only loans that have already defaulted and been classified as NPAs are eligible for transfer.
FAQ’s
1. What is an Asset Reconstruction Company (ARC)?
An Asset Reconstruction Company (ARC) is a financial institution registered with the Reserve Bank of India (RBI) that acquires Non-Performing Assets (NPAs) from banks and financial institutions to recover dues and improve financial stability.
2. Under which law are ARCs regulated in India?
ARCs operate under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002) and are regulated by the RBI.
3. How do ARCs make money?
ARCs generate revenue through:
- Recovering dues from borrowers
- Restructuring stressed loans
- Selling underlying assets
- Charging management fees
- Earning upside through Security Receipts (SRs)
4. What is the typical business model of an ARC?
The ARC purchases stressed assets from banks at a discounted value and issues Security Receipts (SRs) to investors. The ARC then manages recovery and shares proceeds with SR holders after deducting fees.
5. What are Security Receipts (SRs)?
Security Receipts are financial instruments issued by ARCs to Qualified Institutional Buyers (QIBs), representing an undivided interest in the acquired financial assets.
6. Who can invest in ARCs?
Investors typically include banks, financial institutions, mutual funds, Alternative Investment Funds (AIFs), and other Qualified Institutional Buyers (QIBs).
7. How do ARCs help banks and financial institutions?
ARCs help by:
- Reducing NPAs from bank balance sheets
- Improving liquidity
- Enhancing capital adequacy ratios
- Allowing banks to focus on core lending activities
8. What is the 15:85 structure in ARCs?
Under RBI guidelines, ARCs typically pay 15% of the asset value upfront in cash and issue 85% as Security Receipts to banks or investors.
9. What recovery methods do ARCs use?
ARCs may:
- Restructure loans
- Take possession of secured assets
- Sell collateral
- Convert debt into equity
- Initiate recovery proceedings under SARFAESI
10. What are the risks in the ARC business model?
Risks include:
- Lower-than-expected recovery
- Legal delays
- Asset valuation challenges
- Market volatility affecting asset resale
11. How is an ARC different from a bank?
A bank provides loans and financial services, while an ARC specializes in purchasing and resolving stressed or non-performing assets.
12. Are ARCs profitable in India?
Profitability depends on asset quality, recovery efficiency, market conditions, and regulatory changes. Successful asset turnaround strategies significantly impact returns.
