The Securities and Exchange Board of India (SEBI) has expanded the pool of non-banking finance companies (NBFCs) eligible to invest in security receipts (SRs) issued by asset reconstruction companies (ARCs).
This decision now includes all NBFCs regulated by the Reserve Bank of India (RBI), including housing finance companies (HFCs), as qualified buyers.
Before this change, only non-deposit-taking NBFCs with an asset size of at least ₹50 crore were allowed to invest in these financial instruments. Now, the rule change could mean more NBFCs entering the market, potentially increasing demand and liquidity for SRs.
ARCs play a key role in handling bad loans. They buy stressed assets (bad loans) from banks and other financial institutions—usually at a discount, known as a ‘haircut’—and then issue security receipts to investors. These SRs represent a stake in the recovery process of those distressed loans. The better the ARC manages to recover from the bad loan, the more valuable the SRs become.
The regulator seems keen on broadening the investor base in this market, which could lead to a more dynamic and liquid secondary market for stressed assets. Greater participation may help in price discovery—determining a fair value for bad loans—and could encourage banks to sell stressed assets earlier, rather than waiting until they become a bigger problem.
This isn’t a free-for-all, though. SEBI has laid down some ground rules.
NBFCs investing in SRs must ensure that defaulting promoters—the original owners of the bad loans—don’t regain control of the secured assets through the backdoor.
They must also follow any additional rules that RBI may impose from time to time.
The broader investment pool could lead to increased liquidity in the stressed asset market. In simpler terms, more buyers could mean an easier and quicker resale process for security receipts, which could ultimately benefit banks looking to clean up their balance sheets.
A report by the RBI’s Committee to Review the Working of ARCs (2021) highlighted the need for a vibrant secondary market for SRs. A stronger market would make it easier for investors to exit their investments when needed and could attract more participation in the long run.
