Purchase of Banks’ Bad Loans Jumps 50% Worth ₹15,000 Crore in Q1

Banks in India are increasingly turning to asset reconstruction companies (ARCs) to offload stressed loans, with purchases of bad-loan portfolios rising sharply in the June quarter. The increase comes even as the banking sector’s overall asset quality remains relatively strong, suggesting that lenders are becoming more proactive in cleaning up emerging pockets of stress rather than waiting for bad loans to accumulate.

Banks put around ₹15,000 crore of fresh non-performing assets (NPAs) up for sale to ARCs in Q1 FY27, with retail loans accounting for the bulk of the assets offered, according to data reported in July. Including these fresh additions, the stock of bad loans available for acquisition by ARCs stood at around ₹50,000 crore.

The increase in loan sales is significant because India’s banking sector has spent several years repairing balance sheets and reducing the stock of stressed assets. Banks have used write-offs, recoveries, insolvency proceedings, settlements and sales to ARCs to bring down their reported bad-loan ratios.

The latest trend suggests that the focus is increasingly shifting toward smaller-ticket retail and MSME loans. About one-fifth of the fresh NPAs put up for sale in the June quarter comprised loans to smaller corporate borrowers, including micro, small and medium enterprises, while retail loans made up the largest portion.

The changing composition of stressed assets is important because India’s earlier bad-loan cycle was dominated by large corporate accounts, particularly in infrastructure, power, steel and other capital-intensive industries. Banks are now dealing with a different kind of stress, with smaller borrowers and unsecured retail segments becoming more prominent.

Asset reconstruction companies play a specialised role in this process. They acquire distressed loans from banks, generally at a discount to their outstanding value, and then attempt to recover the money through restructuring, settlements, asset sales or legal proceedings.

For banks, selling an NPA can provide several benefits. It allows lenders to remove stressed assets from their balance sheets, reduce the resources required for recovery and focus on originating new loans. It can also provide greater clarity about potential losses instead of leaving troubled accounts unresolved for extended periods.

The rise in sales does not necessarily mean India’s banking system is facing a fresh systemic bad-loan crisis. In fact, the sector’s overall asset-quality indicators have remained considerably stronger than during the previous NPA cycle.

Private-sector banks, for example, wrote off nearly half of their bad loans in FY26, particularly targeting unrecovered exposure in unsecured microfinance and consumer-credit segments. Across the banking sector, more than ₹1.28 lakh crore of bad loans were written off during the financial year.

The clean-up has helped push the banking system’s bad-loan ratio to multi-year lows. But the continued sale of new NPAs indicates that fresh stress is still emerging even as banks resolve older problem loans.

Retail credit is one area receiving particular attention.

The rapid expansion of unsecured personal loans, consumer credit and microfinance in recent years created a large pool of relatively small loans. While diversification away from large corporate borrowers can reduce concentration risk, unsecured retail lending can also experience rapid deterioration when household cash flows come under pressure.

The increase in bad-loan sales therefore provides an early indicator that lenders and ARCs are paying closer attention to pockets of retail stress.

The MSME segment is another important area. Smaller businesses can be particularly vulnerable to changes in demand, input costs, interest rates and working-capital conditions. Their loans are generally smaller than large corporate exposures, but thousands of individual accounts can collectively create a sizeable recovery challenge for banks.

Selling such portfolios to ARCs allows lenders to transfer the recovery process to specialised investors.

The increased supply of bad loans could also create a larger opportunity for India’s distressed-asset industry. ARCs can potentially purchase loan pools at attractive prices if they believe the underlying borrowers have recoverable businesses or assets.

However, buying distressed loans is not without risk. ARCs need to accurately assess recovery values, legal timelines and borrower willingness to settle. Recoveries can take years, particularly when assets are tied up in litigation or insolvency proceedings.

Pricing is therefore critical.

Banks may want to sell loans at prices that minimise their losses, while ARCs need to purchase them cheaply enough to generate attractive returns after accounting for recovery costs and the time value of money.

This gap can sometimes make transactions difficult to complete.

The government is also considering changes to the ARC ecosystem. One proposal under discussion involves the potential merger of ASREC Asset Reconstruction Company with the National Asset Reconstruction Company (NARCL) to strengthen the functioning of state-sponsored bad-loan resolution efforts.

Greater consolidation in the ARC sector could potentially create larger platforms capable of handling bigger and more diverse stressed-asset portfolios.

The banking system’s improved asset quality also gives lenders more flexibility to deal with emerging stress early.

During the previous NPA crisis, banks often carried large stressed accounts for years before recognising the full extent of the problem. The resulting clean-up required substantial provisions and capital, putting pressure on profitability and lending capacity.

The current approach appears more proactive.

Banks can recognise stressed accounts, make provisions and then use multiple resolution mechanisms, including ARC sales and insolvency proceedings, rather than allowing bad loans to remain unresolved.

The Insolvency and Bankruptcy Code has also become an important tool for recovering large stressed corporate loans. State Bank of India, for example, had referred 1,247 cases to the National Company Law Tribunal as of March 31, 2026, with 293 cases receiving approved resolution plans and 549 cases resulting in liquidation orders.

For smaller loans, however, traditional insolvency proceedings may not always be economical. Portfolio sales to ARCs can provide a more practical mechanism for dealing with thousands of smaller accounts.

The changing nature of bad loans is also reflected in the broader credit market. Consumer lending has continued to grow rapidly, while gold loans and other retail credit segments have expanded significantly.

RBI data showed loans against gold jewellery rising nearly 70% year-on-year to ₹3.29 lakh crore in May 2026, highlighting the rapid expansion of certain forms of secured retail lending.

At the same time, consumer financing has reached record levels in some categories, including electronics and other consumer durables.

Rapid credit growth is not inherently negative. A growing economy requires greater access to credit, and higher lending can support consumption, investment and entrepreneurship.

The concern arises when lending expands faster than borrowers’ ability to repay.

Banks therefore need to balance growth ambitions with underwriting standards and collection capabilities.

The increase in bad-loan purchases could actually be a sign that this discipline is strengthening. Instead of allowing stressed accounts to remain on their books, lenders are increasingly willing to recognise problems and transfer them to specialised recovery platforms.

For investors in banks, this distinction is important.

A rise in bad-loan sales may initially appear negative because it highlights stress in the loan book. But if banks have already made adequate provisions and can sell the assets without significant additional losses, the transactions can ultimately improve balance-sheet quality.

The more important indicators are fresh NPA additions, credit costs, recoveries, provisioning coverage and the performance of the underlying loan book.

If fresh slippages continue rising sharply, the increase in NPA sales could signal broader deterioration in borrower health. If fresh stress remains contained while banks continue resolving legacy and emerging problem loans, the trend would be more consistent with proactive balance-sheet management.

The current data appears closer to the latter scenario, although the growing share of retail and MSME stress warrants monitoring.

The broader industry impact is that India’s bad-loan market is entering a new phase. The large corporate NPA cycle that dominated the previous decade has largely receded, while smaller retail and MSME exposures are becoming more important sources of stressed assets. Banks are responding by increasingly using ARCs, write-offs, settlements and other resolution mechanisms.

For India’s banking sector, the key challenge will be preventing pockets of retail and MSME stress from developing into a broader deterioration in asset quality. Strong capital buffers and lower overall NPA ratios give banks greater room to manage the problem, but rapid growth in unsecured and consumer credit means underwriting and collection standards will remain crucial.

For ARCs, meanwhile, the growing supply of distressed loans could create a larger investment opportunity. The companies that can accurately value portfolios and recover assets efficiently are likely to benefit most as banks become more willing to clean up their books.

The latest rise in bad-loan purchases therefore represents both a warning and a sign of maturity: stress is emerging in parts of the credit system, but banks are increasingly acting early rather than allowing problem loans to build up unchecked.