Beyond SARFAESI: RBI’s Bold Step Toward Market-Based NPA Resolution

[Neeraj Kushawah and Abhishek Joshi are fourth year students at Gujarat National Law University]

Introduction

The Reserve Bank of India (RBI) released a draft direction for public comments on the securitization of stressed assets and Non-performing Loans (NPLs) in April 2025 titled “Reserve Bank of India (Securitisation of Stressed Assets) Directions, 2025”. These draft guidelines have not been notified yet.

In simpler terms, these directives would repackage stressed loans and Non-Performing Assets (NPAs) into tradeable securities through the process of Securitisation.  This will allow banks to offload their risky loans onto the market, and attracting investors who have a risk appetite. By doing so, banks would be able to reduce their exposure to high-risk loans, improving their financial health and liquidity ratios. Further, these directions go beyond the existing Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) while offering a border mechanism for regulated entities to deal with stressed loan exposures. This extended mechanism could help banks manage their NPAs better by offering flexibility in the manner in which these assets can be securitized, sold and resolved. Through this proposed framework, the RBI aims to supplement the existing frameworks and improve the financial conditions of banks, thus, creating an effective way of dealing with stressed assets in the financial system and making it easier for the banks to offload bad loans and bring them into the market as tradable securities, the RBI hopes to reduce the pressure on the banks and financial institutions.

In this article, the authors examine this proposed direction. Firstly, the article gives a brief introduction about the proposed framework. Secondly, it outlines the flaws in the current framework and lastly, concludes by analysing its implications on the market. 

Gaps in Existing Mechanism

Until 2024, only ARCs under the SARFAESI Act were allowed to acquire NPAs and there was no framework facilitating the acquisition of stressed assets NPAs and NPLs by banks. Firstly, under the current framework of the SARFAESI Act, only a limited class of entities those who are registered with RBI are allowed to acquire the asset. This creates a bottleneck in the secondary market for stressed assets, leading to delays in recovery and process. Secondly, SARFAESI allows ARCs to securitize loans or accounts that are flagged as fraud or even wilful defaulters. RBI Report on “The Committee to Review the Working of ARCs”, published in 2021, observed  that this could slow the process of recovery and dilute market interest, as investors would not be willing to buy such loans and reduce the marketability and valuation of such pools. Thirdly, there is an issue of low marketability of stressed assets where although ARCs are authorised to restructure and sell the distressed loans, many assets have limited value and market appeal and the authors opine that this might led to long-term difficulties for banks to recover loans as investors may not be interested in investing in such assets. Fourthly, under SARFAESI, there is no cap on the percentage of interest a bank could hold in a Special Purpose Vehicle (SPV) Originators (Original lenders, in this case, banks who owns the financial assets, are required to retain a minimum of 15% of the security receipt but there was no upper limit on their exposure. This can create a risk of moral hazard diminishing a genuine risk transfer and weakening the trust of investors in originators. Lastly, the current law does not mandate a full payment at origination. Under the SARFAESI the ARC can pay the bank via cash or security receipts which could add a contingency to the recovery of the loan.

To tackle the current gaps in the banking sectors the RBI’s draft directions on securitisation aims to create a more transparent and liquid market for the selling of NPA’s and stressed assets of the bank and by allowing the securitisation of NPLs, the central bank has intended to improve the flow of capital, broaden investor participation, and expedite the resolution of NPA’s, ultimately strengthening the Indian banking sector. 

Decoding the Draft Directions and its impacts on the market

1.     Assets Eligibility and Pooling Standards-

Under this framework, only homogeneous assets will be pooled, and it separates the retailers (retailers mean personal loans and micro-enterprise loans under 50 crores) and corporate exposure. The proposed framework explicitly restricts the inclusion of certain categories of high-risk accounts, such as those marked as fraudulent, wilful default, or under red flag review. This classification and clarity about assets and pooling standards can help reduce risk and prevent regulatory arbitrage. The authors opine that the eligibility of assets will ensure transparency and comparability in pricing, thereby enhancing investors' confidence.  

2.     Role of Resolution Managers (ReM)

The RBI introduced a new independent entity under the proposed framework called Resolution Managers (ReM). A ReM would be responsible for managing recovery and enforcement actions on the securitized pool. The ReM must be a regulated financial entity or an insolvency professional and should not be associated with the borrowers or Originator. This separation of control could help address conflict of interest concerns and professionalize the recovery process.  The duties and responsibilities of ReM include developing and executing recovery strategies, overseeing collections, remittances, and communications. Also, it must ensure all cash flows go to the SPE via an escrow account, maintaining clear separation from its own funds. With respect to reporting guidelines, ReMs must report to investors on a quarterly basis about asset performance, management. They are regulatorily required to report to the RBI at various stages and and fulfil disclosure requirements in offer documents and annual accounts.

3.     Risk Retention, Capital Charges, and Valuation Norms

The proposed framework relaxes the requirement of mandatory MRR and imposes strict exposure limits, treating any originator exposure above 10% would be considered as the “First Loss” tranche. It also introduces the conservation valuation mechanism which mandates uniform linear amortization-based provisioning of securitisation notes either over a period of 5 years or a expected resolution timeline, whichever is earlier. Additional, capital charges are to be assigned based on recovery rating.

4.      Enhancing Transactional Transparency through Structured Disclosures and Real-Time Monitoring

The proposed framework advances transactional transparency by mandating structured disclosures both at the time of issuance and throughout the lifecycle of securitisation notes. These disclosures include granular data on the performance of underlying assets, periodic valuation reports, details of any credit enhancement mechanisms, and the progress of the recovery process. Further, it requires Resolution Managers to provide quarterly performance reports to investors and regulatory filings to the RBI, thereby ensuring real-time visibility into asset performance. By institutionalising this continuous flow of information and mandating third-party reporting, the framework aims to align the interests of originators, investors, and resolution professionals, ultimately enhancing market confidence and accountability.

5.     Cash-Only Sale Requirement and Price Discovery

A significant safeguard introduced by the proposed framework is that it is a mandatory requirement that all transfer of stressed assets to the Special Purpose Entity (SPE) originator must be conducted on a 100% cash basis with the full sale consideration received by the originator at the time of transfer. The originator is required to obtain two independent and external valuation reports only for non-retail pools and has to adopt a transparent price discovery method as an internal policy framework. This step prevents off-balance sheet financial manipulation or abuses and ensures the transfer of assets reflects genuine transfer. These conditions will help remove the possibility of circular financing and collusive arrangements that may artificially hike the asset's values and the price discovery method ensures that the assets will be transferred in realistic market-aligned value.

 

Market Outlook and Investor Implications

This proposed framework could have a substantial impact on the market by creating a new way to deal with bad loans. It offers a fresh approach that may help reduce the burden of NPAs on Indian banks.

Firstly, this move is expected to attract Foreign Portfolio Investors (“FPI”) and private credit funds by offering high-yielded investment opportunities. In the fiscal year 2024-25, the volume of securitized standard loans rose by 25% to 2.3 trillion suggesting a growing market appetite for such entities. The growing participation of private credit in India underscores the relevance and timeliness of the RBI’s proposed framework. As private debt funds and institutional investors increasingly seek structured, high-yield opportunities, a transparent and regulated securitisation mechanism becomes essential to channel this capital effectively into stressed asset resolution.

For instance, the Shapoorji Pallonji group recently secured ₹298 billion through a zero-coupon bond issuance backed by global investors. Similarly, Shriram Finance raised ₹300 million via social bonds aimed at supporting securitisation. These examples demonstrate that when provided with clear structures and safeguards, foreign and domestic investors are willing to engage with India’s evolving credit ecosystem. The draft framework, by offering regulatory clarity, independent oversight, and credible valuation norms, can further facilitate such private capital flows into stressed asset markets.

On the other hand,  there are certain challenges that would prevail in the market. ARCs have expressed concerns about their roles within the proposed framework and aim to seek recognition of ARCs-sponsored trusts as qualified SPE.  This clarification is important as ARCs typically operate through such trusts to acquire and manage bad loans. In the absence of such recognition, their ability to participate in securitisation transactions may be limited, reducing their effectiveness in the stressed asset resolution process.

Additionally, markets are also concerned about the valuation complexities and potential hidden risks, basically about valuing stress assets is challenging because of uncertain cash flow and recovery prospects. The RBI’s discussion paper titled “Discussion Paper on Securitisation of Stressed Assets Framework (SSAF) ” states that including both NPAs and standard assets in securitization pools could lead to regulatory arbitrage and complicate valuation processes.

Filling the Gap in Indian Banks (Lessons from around the Globe)

Incorporation of cross-border NPA resolution

Countries such as the United States (US), the United Kingdom (UK), and Singapore have adopted the United Nations Commission on International Trade (UNCITRAL) Model Law on Cross-Border Insolvency, enabling resolute treatment of defaulted foreign assets. India can incorporate this by enabling foreign branches of Indian banks to securitise stressed assets with a global pedigree. Incorporating similar mutual recognition provisions into India’s SSAF could allow Indian banks to securitise distressed assets held abroad and facilitate smoother asset recovery.

For example, the UK’s Cross-Border Insolvency Regulation 2006 enable foreign representatives to access UK courts, typically completing recognition within 6–12 months. Likewise, the Eurobank “Cairo” deal in Greece led to securitisation of over €7.5 billion  in NPLs under the Hercules Asset Protection Scheme, aided by enforceable investor protections and structured recovery timelines. Such models highlight how India's adoption of cross-border standards could reduce legal delays and attract global investors to distressed Indian assets.

Early Warning Systems & Risk-based Supervision

Australia and Singapore use an AI-powered internal rating system, while the European Union and US banks implement validated risk-based loan monitoring models to spot stress early. India’s framework can integrate AI-driven EWS into its internal risk models, flagging loans for potential securitization under the new proposed draft on SSAF, supported by supervisory audits.

For instance, Australia’s Prudential Regulation Authority APRA uses predictive credit risk tools to enable proactive intervention, while the EU’s Supervisory Review and Evaluation Process (SREP) framework uses internal risk ratings to assign capital buffers. Integrating such systems would enable Indian banks to pre-emptively securitise stressed loans, improving recovery timelines and reducing provisioning needs, while supporting smarter RBI supervision.

By implementing these measures, this mechanism can do better and effectively deal with the NPA problem in India’s financial framework.

Conclusion

The RBI’s approach marks a progressive leap in the manner in which India aims to manage stressed assets. By introducing a transparent market-based securitisation framework, RBI enables banks and non-banking financing companies to de-risk their balance sheet while inviting diversified capital. The inclusion of independent resolution managers, strict valuation norms, and compulsory cash sales boosts investors’ confidence and market integrity. Ultimately, the proposed framework shows the way for a healthier and more resilient financial ecosystem and signals the RBI's proactive stance in strengthening India’s credit infrastructure.