RBI's Groundbreaking Proposal for Bad Loans

In a significant move to revitalize the banking sector, the Reserve Bank of India (RBI) has proposed a novel pathway for banks and Non-Banking Financial Companies (NBFCs) to offload their bad loans. This initiative allows financial institutions to bundle and sell stressed assets directly to investors through special purpose entities established by regulated financial firms, marking a departure from the traditional reliance on Asset Reconstruction Companies (ARCs).

Key Features of the New Framework

The proposal introduces resolution managers, independent of the originating lenders, tasked with maximizing recovery from the underlying assets. These managers can be RBI-regulated entities, insolvency professionals, or other qualified institutions. Lenders are required to provision for the securitized notes over a five-year period, with capital requirements adjusted according to recovery ratings, favoring senior tranches.

Impact on ARCs and the Market

This new framework is set to diversify the market for distressed debt, potentially reducing the dominance of ARCs. With larger cases already being directed to the National Asset Reconstruction Company Limited (NARCL), the RBI's latest move enables lenders to bypass ARCs for mid-sized and retail loans. Additionally, ARCs are mandated to increase their net owned fund to Rs 300 crore by the fiscal year 2026, a challenge for many in the sector.

The RBI's initiative underscores its commitment to preventing defaulters from regaining control of their assets through indirect means, reinforcing the integrity of the financial system.