Prompt Corrective Action Framework

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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.  

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