Prompt Corrective Action (PCA) is a framework under which financially weak and mismanaged banks are put under watch by the RBI. RBI introduced PCA framework in 2002 as a structured early-intervention mechanism for banks that were suffering from poor asset quality, or were vulnerable due to loss of profitability.
Understanding Prompt Corrective Action (PCA)?
- Prompt Corrective Action is a qualitative tool introduced by the Reserve Bank of India under which direct action is taken on weak banks to ensure the financial health of a bank.
- Reserve Bank has specified certain regulatory trigger points, as a part of prompt corrective action (PCA) Framework keeping 4 parameters as base for initiation of certain structured and discretionary actions in respect of banks hitting such trigger points:
- Capital to risk weighted assets ratio (CRAR)
- Net non-performing assets (NPA)
- Return on Assets (RoA)
- Leverage Ratio
- The PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.
- PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble.
Need for Prompt Corrective Action
During the financial crisis of the 1980s and early 1990s, many banks and financial institutions suffered monetary loss around the globe. More than 1,600 commercial and savings banks were either collapsed or given financial assistance in the United States. The increasing losses suffered by them exceeded the US $100 billion.
The need for appropriate supervisory strategy (Prompt Corrective action) arose to avoid banks and financial institutions from such events.
In India, it was first introduced in 2002 during the period of Bimal Jalan as RBI governor and was tightened by RBI governor Urjit Patel in April 2017. It is applicable to all the Scheduled Commercial Banks (SCBs) except RRB. It also does not take into its ambit the payment banks, NBFCs and MUDRA banks.
Parameters for Prompt Corrective Action
Capital to risk weighted assets ratio (CRAR): It is a measure of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures which is used to protect depositors and promote the stability and efficiency of financial systems around the world.
- If CRAR is less than 9%, but equal or more than 6%: Bank to submit capital restoration plan; restrictions on RWA expansion, entering into new lines of business, accessing/renewing costly deposits and CDs, and making dividend payments; order recapitalisation; restrictions on borrowing from inter-bank market, reduction of stake in subsidiaries, reducing its exposure to sensitive sectors like capital market, real estate or investment in non-SLR securities, etc.
- If CRAR is less than 6%, but equal or more than 3%: In addition to actions in hitting the first trigger point, RBI could take steps to bring in new Management/ Board, appoint consultants for business/ organizational restructuring, take steps to change ownership, and also take steps to merge the bank if it fails to submit recapitalization plan.
- If CRAR is less than 3%: in addition to actions in hitting the first and second trigger points, more close monitoring; steps to merge/amalgamate/liquidate the bank or impose moratorium on the bank if its CRAR does not improve beyond 3% within one year or within such extended period as agreed to.
- If Net NPAs is over 10% but less than 15%: Special drive to reduce NPAs and contain generation of fresh NPAs; review loan policy and take steps to strengthen credit appraisal skills, follow-up of advances and suit-filed/decreed debts, put in place proper credit-risk management policies; reduce loan concentration
- If Net NPAs is 15% and above: In addition to actions on hitting the above trigger point, bank’s Board is called for discussion on corrective plan of action.
Leverage Ratio : The fourth parameter is total debt or leverage which measures the financial risk of the bank. If bank Tier-1 leverage ratio is between 3.5 to 4.0 percent then the bank is subjected to prompt corrective action.
- The first threshold on the prompt corrective action will be triggered if a bank if its leverage is over 25 times its Tier-1 capital.
- The second threshold on the prompt corrective action will be triggered if a bank if its leverage is over 28.6 times its Tier-1 capital.
New PCA Updates
- PCA framework applies to all banks operating in India, including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
- However, payments banks and small finance banks have been removed from the list of lenders where prompt corrective action can be initiated.
- These new provisions will be effective from January, 2022.
- Capital, Asset Quality and Capital-To-Risk Weighted Assets Ratio (CRAR), NPA ratio, Tier I Leverage Ratio, will be the key areas in the revised framework.
- However, revised framework excludes return on assets as a parameter that may trigger action under the framework.
Invocation of PCA:
- The breach of any risk threshold by the banks may result in the invocation of the PCA.
- Stressed banks may not be allowed to expand credit or investment portfolios.
- However, they are allowed to invest in government securities and other high-quality liquid investments.
- In the case of a default on the part of a bank in meeting the obligations to its depositors, possible resolution processes may be resorted to without reference to PCA matrix.
Power of RBI
- In governance-related actions, RBI can supersede the board under Section 36ACA of Banking Regulation Act, 1949.
- Amendment to Section 45 of Banking Regulation Act enables the Reserve Bank to reconstruct or amalgamate a bank, with or without implementing a moratorium, with the approval of Central government.
- RBI may also impose appropriate restrictions on capital expenditure, other than for technological upgradation within Board approved limits, under the revised PCA.
Withdrawal of PCA Restrictions:
Withdrawal of restrictions imposed will be considered if no breaches in risk thresholds in any of the parameters are observed as per four continuous quarterly financial statements.
PCA for NBFCs
- PCA Framework for NBFCs shall come into effect from 1st October 2022, based on the financial position of NBFCs on or after March 31, 2022.
- PCA Framework for NBFCs shall apply to
- All Deposit Taking NBFCs [Excluding Government Companies]
- All Non-Deposit Taking NBFCs in Middle, Upper and Top Layers
- PCA excludes:
- NBFCs not accepting/not intending to accept public funds
- Government Companies
- Primary Dealers
- Housing Finance Companies
Measures under PCA
Following measures can be taken under PCA:
- Restrictions on dividend distribution, branch expansion, and management compensation.
- Only in an extreme situation, would a bank be a likely candidate for resolution through amalgamation, reconstruction or winding up.
- RBI may place restrictions on credit by PCA banks to unrated borrowers or those with high risks, but it does not invoke a complete ban on their lending.
- RBI may also impose restrictions on the bank on borrowings from interbank market.
- Banks may also not be allowed to enter new lines of business.
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