Budget 2026: North Block is crafting a grand plan to smooth the debt recovery road
The government may announce plans to tweak SARFAESI and DRT rules in the upcoming budget to reduce litigation in debt recovery tribunals.
NEW DELHI : The Centre is preparing a major overhaul of debt recovery laws in the upcoming Union budget to accelerate recoveries and clear a mounting backlog of cases that has clogged its specialized tribunals, two people aware of the matter said.
The finance ministry is working to harmonize various laws governing loan recovery, at a time debt recovery tribunals (DRTs) are overburdened with annual inflows of nearly 60,000 new cases outpacing disposals of 30,000-40,000. The proposed changes aim to prevent errant borrowers from selling secured assets, classify special situation funds as financial institutions, and allow banks to withdraw recovery proceedings without borrower consent, the people said on condition of anonymity.
A key proposal is to align three major laws on debt resolution in India -- the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, 2002; the Recovery of Debts and Bankruptcy Act, 1993; and the Insolvency and Bankruptcy Code, 2016. The changes aim to prevent these laws from working at cross-purposes, the people said.
Special situation funds, which step up in specific, one-time corporate events such as mergers and bankruptcies, may be among the beneficiaries of these changes.
“The annual financial statement may classify special situation funds -- a new class of alternative investment funds -- as financial institutions for debt resolution, and give banks greater autonomy by removing the clause that requires borrowers’ approval to withdraw debt recovery proceedings," one of the two people said.
Another proposal is to amend Sarfaesi rules to bar borrowers from redeeming secured assets after a creditor finalizes a sale, addressing a key source of litigation. Borrowers' redemption rights have fuelled delays, with approximately 178,000 cases pending across 39 Debt Recovery Tribunals (DRTs) and five Debt Recovery Appellate Tribunals as of late 2025, including about 67,000 Sarfaesi-related applications, according to finance ministry data.
The government may also accord full legal sanctity to electronic notices and communications sent under the Sarfaesi Act.
"The proposed changes to the rules governing debt recovery procedures have been under discussion for some time and are being considered for mention when the budget proposals for 2026-27 are announced in February," the second person said.
The finance ministry didn't respond to requests for comment.
The trigger
The moves follow a September 2025 Supreme Court ruling that questioned the 30-day gap between a Sarfaesi sale notice and the auction, highlighting risks of uncertainty and litigation if redemption rights persist during the period. The government formed a committee to review the issue, and its recommendations could become law, potentially by reconciling redemption timelines with notice periods or extending borrower windows for greater certainty, the second person said.
"With expected credit loss (ECL) provisioning in place, banks need to minimize loss-given-default to control provisions," said Vivek Iyer, partner and financial-services risk leader at Grant Thornton Bharat. "Sarfaesi and DRT reforms are essential to maximize recoveries and mitigate ECL impacts."
Under ECL provisioning, banks must set aside money to cover potential future loan defaults before they actually happen, based on historical data and economic forecasts. The Reserve Bank of India has proposed to implement ECL provisioning in phases beginning 1 April, 2027.
Iyer added that procedural hurdles in DRTs and Sarfaesi often erode security value and bank profitability, calling for clearer accountability in tribunals and streamlined rules, especially for smaller loans. The reforms aim to bolster out-of-court recoveries, which have lagged despite the IBC's success in restoring discipline for large corporate defaults.
The rationale
Reforms to the Sarfaesi Act are crucial because they address long-standing systemic bottlenecks that have historically hindered out-of-court debt recovery, making it slow and unpredictable. The reforms can strengthen balance sheets and liquidity through faster resolution, freeing capital, and reducing provisioning, reduce judicial backlogs, improve operational efficiency, bring in SSFs and create a level-playing field for non-banking financial companies, and enhance overall market discipline and confidence.
Weaknesses in Sarfaesi have pushed lenders toward costlier IBC proceedings as a last resort, said Nitin Jain, partner for strategy and transactions at EY India.
"Inherent gaps in the Sarfaesi framework have weakened recovery for smaller borrowers, including retail and MSMEs, raising credit costs and caution in lending," Jain said. Strengthening Sarfaesi and DRTs would create a more efficient ecosystem, he added.
Experts also urge faster judicial appointments, strict timelines for high-value cases, and penalties for unwarranted delays, according to Prateek Kumar, partner at Khaitan & Co. Separately, the government is exploring incentives for banks to withdraw low-value claims—over 75% of pending DRT cases involve amounts between ₹20 lakh and ₹1 crore—to resolve them via Lok Adalats or bilateral settlements, easing tribunal loads.
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