RBI Revised PCA Framework

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• The Reserve Bank of India (RBI) has revised the Prompt Corrective Action (PCA) Framework for scheduled commercial banks. 
  • The provisions of the revised framework will come into effect from January 01, 2022.

About 

• Earlier framework mechanism: The leverage was also monitored additionally as part of the PCA framework, but profitability was the key.
  • Under profitability, the return on assets (ROA) was closely monitored. A negative ROA for two consecutive years was used to trigger the RBI’s Risk threshold for restriction on banking operations.
• New proposed mechanism: While the capital, asset quality and profitability were the key areas for monitoring in 2017’s framework, this time round capital, asset quality and leverage will be key areas.

When exactly does a bank fall into this list?

• The RBI has specified certain regulatory trigger points with respect to three parameters, i.e., capital-to-risk weighted assets ratio (CRAR), net non-performing assets (NPA) and return on assets (RoA) for the initiation of the process.
  • CRAR: There are various stages. If CRAR falls to less than 9 per cent, the RBI asks banks to submit a capital restoration plan, restricts new businesses and dividend payments. If CRAR is less than 6 per cent but equal to or more than 3 per cent, the RBI could take additional steps if the bank fails to submit a recapitalisation plan.
  • NPAs: If net NPAs rise beyond 10 per cent but are less than 15 per cent, a special drive to reduce bad loans and contain the generation of fresh NPAs begins. The RBI reviews the bank’s loan policy and takes steps to strengthen credit-appraisal skills.
  • RoA: If RoA is less than 0.25 per cent, restrictions on accessing/renewing costly deposits and CDs kick in and the RBI bars the bank from entering new lines of business. The bank’s borrowings from the inter-bank market, making dividend payments and increasing staff will be restricted.

Provisions of the revised framework

• Exclusion: The revised framework excludes return on assets as a parameter that may trigger action under the framework.
• Removal from the list: Payments banks and small finance banks (SFBs) have also been removed from the list of lenders where prompt corrective action can be initiated.
• Key areas for monitoring: Capital, asset quality and leverage will be the key areas for monitoring in the revised framework.
  • Indicators to be tracked for capital, asset quality and leverage would be CRAR/ common equity tier I ratio, net NPA ratio and tier I leverage ratio, respectively.
• Governance related actions: the RBI can supersede the board under Section 36ACA of the BR Act, 1949.
• Revision in CAR Ratio: RBI has also revised the level of shortfall in total capital adequacy ratio that would push the lender to ‘risk threshold three’ category.

What is the Prompt Corrective Action (PCA) Framework?

• Introduction: The RBI’s PCA Framework was introduced in December 2002 as a structured early intervention mechanism along the lines of the US Federal Deposit Insurance Corporation’s PCA framework.
• Banks under this framework: In the past, IDBI Bank, Indian Overseas Bank and Central Bank of India were put under the PCA framework. The first two banks are out of PCA, while the Central Bank of India is still under the watch of the RBI.  
• Objectives: The objective of the PCA Framework is to enable Supervisory intervention at the appropriate time and require the Supervised Entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.
  • The PCA framework is also intended to act as a tool for effective market discipline.
  • It refers to the central bank’s watch list of weak banks.
  • PCA entails curbs on high-risk lending, setting aside more money on provisions and restrictions on management salary.
• Does not preclude the Reserve Bank of India: The PCA Framework does not preclude the Reserve Bank of India from taking any other action as it deems fit at any time, in addition to the corrective actions prescribed in the Framework.
• Application: The PCA Framework would apply to all banks operating in India including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
• Assessment: A bank will generally be placed under the PCA framework based on the Audited Annual Financial Results and the ongoing Supervisory Assessment made by RBI.
• Time period: RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances warrant.

If a bank is under the PCA framework then there will be three risk thresholds

• Firstly, restrictions on dividend distribution/remittance of profits. Also, restrictions will be there on Promoters/Owners/ to bring in capital.
• In the second risk threshold, restrictions will be there on branch expansion; domestic and/or overseas.
• In the third risk threshold, appropriate restrictions on capital expenditure, other than for technological up-gradation within Board approved limits.

Issues/challenges with PCA framework

• Lack of capital: PCA framework applies to banks whose capital slips below the minimum regulatory threshold of 9 per cent. These PCA banks have been starving for funds for a long because of inadequate capital as government finances are too tight. These banks are not in a position to raise capital on their own.
• No let-up in deteriorating asset quality: Higher NPAs are not good for the health of a bank as it reflects poor credit standards and failure to recover loans through collateral. These banks need higher provisioning from profits to provide for any future losses before kick-starting any fresh loans. The SME or the MSME segment is too risky to lend at these times.
• Balance sheet clean-up drive is already underway: This is a good long-term exercise along with a good recovery and restructuring mechanism of bankruptcy code. These measures would stabilise with some short-term pain. Any relaxation of the PCA framework at this stage will derail the process, which may have longer-term negative implications.
• Not much on the governance or reform front: There is a bigger issue of governance reforms in PSBs. There are some half-hearted measures like the Bank Board Bureau (BBB), but it doesn’t have many powers. The next logical step of having an investment holding company for all the PSBs also does not look insight.

Benefits of PCA framework

• Maintains capital: As most bank activities are funded by deposits that need to be repaid, it is imperative that a bank carries a sufficient amount of capital to continue its activities.
• Alert mechanism and a regulator: PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble.
• Checks NPA: It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
• Rectify the bank’s mistakes: The aim of PCA is to rectify the bank’s mistakes before they attain crisis proportions.
• Regulation: RBI will regulate loan disbursals/ credit by PCA banks to unrated borrowers or those with high risks; however, it will not place a complete ban on the bank’s lending.
• Restoring the financial health of a bank: Basically, PCA helps RBI in restoring the financial health of a bank by monitoring key performance indicators of banks and taking corrective measures on the same.
• Strengthening the financial core of the institution: It may also stop banks from entering new lines of businesses, thereby strengthening the financial core of the institution.

Source: TH