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Recently, the Reserve Bank of India (RBI) removed the Central Bank of India from its Prompt Corrective Action Framework (PCAF).
Key Points
- Background:
- The RBI had imposed the PCA norms on the Central Bank of India in June 2017 due to its high net NPA and negative return of assets (RoA).
- This is the last bank which has been removed from the PCA norms by the RBI.
- Reason of Removal:
- The Bank showed improvement in various financial ratios, including minimum regulatory capital and net non-performing assets (NNPAs).
- The bank has provided a written commitment that it would comply with the norms of minimum regulatory capital, net NPA and leverage ratio on an ongoing basis.
Prompt Corrective Action Framework (PCAF)
- About:
- The RBI’s PCA Framework was introduced in 2002 as a structured early intervention mechanism along the lines of the US Federal Deposit Insurance Corporation’s PCA framework.
- It is a supervisory tool and is imposed when a bank breaches certain regulatory thresholds on capital to risk weighted assets ratio (CRAR), net NPAs and return on assets (RoA).
- It refers to the central bank’s watch list of weak banks.
- Objectives:
- 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.
- Intended to act as a tool for effective market discipline.
- PCA entails curbs on high-risk lending, setting aside more money on provisions and restrictions on management salary.
- 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.
- Banks under this framework:
- RBI had placed 11 state-run banks under PCA framework after they breached the risk thresholds:
- Allahabad Bank,
- United Bank,
- Corporation Bank,
- IDBI Bank,
- Uco Bank,
- Bank of India,
- Central Bank of India,
- Indian Overseas Bank,
- Oriental Bank of Commerce,
- Dena Bank and
- Bank of Maharashtra.
- Of the 11 lenders, five PSBs were placed under PCA restrictions in the quarter ended June 2017; another five in the quarter ended December 2017 and one PSB in the quarter ended March 2018.
- The first two banks are out of PCA, while the Central Bank of India is still under the watch of the RBI.
- RBI had placed 11 state-run banks under PCA framework after they breached the risk thresholds:
Corrective actions under PCA
- When a bank is placed under PCA, one or more of the following corrective actions may be prescribed:
- Restriction on dividend distribution/remittance of profits.
- Promoters/shareholders to infuse equity and reduction in leverage;
- Restriction on issue of guarantees or taking on other contingent liabilities on behalf of group companies (only for CICs)
- Restriction on branch expansion; domestic and/or overseas
- Appropriate restrictions on capital expenditure, other than for technological upgradation within Board approved limits
- Appropriate restrictions on capital expenditure, other than for technological upgradation within Board approved limits
- Restrictions/reduction in variable operating costs
Significance
- 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.
Challenges
- Lack of Capital: The PCA banks have been starving for funds for a long time because of inadequate capital as government finances are too tight. These banks are not in a position to raise capital on their own.
- Need of Provisioning: These banks need higher provisioning from profits to provide for any future losses before kick-starting any fresh loans.
- Avoid Relaxation: Any relaxation of the PCA framework at this stage will derail the process, which may have longer-term negative implications.
Conclusion
- The PCA framework for banks enables supervisory intervention and also acts as a tool for effective market discipline.
Source: IE
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