The Reserve Bank of India (RBI) has revised its Prompt Corrective Action (PCA) framework. Banks in India, including foreign ones operating through branches or subsidiaries, are subject to this framework based on the risk thresholds of identified indicators. The PCA aims to enable timely supervisory intervention by the RBI and ensure effective market discipline. However, as per the new provisions set to take effect from January 2022, payments banks and small finance banks (SFBs) have been exempted from the scope of this framework.
Changes to the PCA Framework
The revised PCA framework will surveil key areas such as capital, asset quality, capital-to-risk-weighted assets ratio (CRAR), non-performing assets (NPA) ratio, and tier I leverage ratio. Notably, it excludes return on assets as a parameter that might trigger action under this framework.
The breach of any risk thresholds could invoke the PCA. Affected banks may face restrictions on expanding their credit or investment portfolios. However, they can still invest in government securities or other high-quality liquid investments. Should a bank fail to meet its obligations to depositors, the resolution processes may be adopted without referencing the PCA matrix.
Powers of the RBI under the PCA Framework
Governance-related actions allow the RBI to supersede a bank’s board under Section 36ACA of the Banking Regulation Act, 1949. An amendment to Section 45 of the same act further empowers the RBI, with the central government’s approval; to reconstruct or amalgamate a bank, even without implementing a moratorium. As part of its mandatory and discretionary actions, the RBI may impose reasonable restrictions on capital expenditure, barring technological upgradation within board-approved limits.
Withdrawal of PCA Restrictions
Restrictions imposed under the revised PCA will be withdrawn if no breaches are observed in risk thresholds across any parameters as per four successive quarterly financial statements.
A Brief Background on PCA
The PCA framework came into effect in 2002 as an early intervention mechanism for banks. It was designed to supervise banks having weak financial metrics and has been reviewed in 2017 based on certain recommendations.
The intent of the PCA framework is to facilitate supervisory intervention at an appropriate time and require the affected entity to initiate and implement remedial measures promptly. This helps restore the bank’s financial health, checks the problem of non-performing assets (NPAs), alerts regulators, investors, and depositors about potential troubles, and prevents a crisis.
Placing a Bank under the PCA Framework
A bank’s audited annual financial results and ongoing supervisory assessment by the RBI are primarily what determine its inclusion in the PCA framework.
Understanding Non-Performing Assets
A non-performing asset (NPA) refers to a loan or advance where the principal or interest payment has been overdue for 90 days. Banks classify NPAs into Substandard, Doubtful, and Loss assets.
Capital Adequacy Ratio (CAR)
The CAR measures a bank’s capital as a percentage of its risk-weighted credit exposures and it protects depositors while promoting stability and efficiency in financial systems globally.
Tier 1 Leverage Ratio
The tier 1 leverage ratio is the relationship between a banking organization’s core capital and its total assets. It is calculated by dividing tier 1 capital by a bank’s average total consolidated assets and certain off-balance sheet exposures. A bank’s ability to meet its financial obligations is assessed using this financial measurement. Some examples include Equity Ratio, Debt Ratio, and Debt to Equity Ratio.
