The Reserve Bank of India (RBI) recently released the Central Bank of India (CBI) from its Prompt Corrective Action Framework (PCAF). The RBI had initially placed CBI under these regulations due to a high net Non-Performing Assets (NPA) and Negative Return of Assets (RoA). However, after showing marked improvements in various financial areas, including regulatory capital and Net NPAs, CBI has been removed from this framework.
Understanding the PCA Framework
In 2002, the Reserve Bank of India developed the PCA framework as a structured early-intervention mechanism to monitor banks with poor asset quality or profitability issues. The framework was revised in 2017, following recommendations by the Financial Stability and Development Council and the Financial Sector Legislative Reforms Commission.
Parameters and Objectives of PCA Framework
The PCA framework uses three primary indicators: Capital to Risk Weighted Assets Ratio (CRAR), Net Non-Performing Assets (NPA), and Return on Assets (RoA). These are designed to ensure early supervisory intervention, encouraging supervised entities to implement timely remedial measures and restore financial health. This framework is particularly critical for addressing the Non-Performing Assets (NPAs) issue in the Indian banking sector.
Audited Annual Financial Results and the PCA Framework
The application of the PCA framework is generally based on a bank’s audited annual financial results and an ongoing supervisory assessment conducted by the RBI. In 2021, the framework was revised to focus on capital, asset quality, and leverage, deviating from the prior focus on asset quality and profitability.
Understanding Non-Performing Assets and their Classification
A non-performing asset (NPA) is a loan or advance where the principal or interest payment remains overdue for at least 90 days. Banks must further classify NPAs into Substandard, Doubtful, and Loss assets.
Understanding Capital Adequacy Ratio (CAR)
The CAR is a measurement ratio that gauges a bank’s capacity to absorb losses. It expresses available capital as a percentage of risk-weighted credit exposures. The Capital Adequacy Ratio or CRAR is instrumental in protecting depositors and promoting worldwide financial system stability and efficiency.
Defining Return on Assets (RoA)
The RoA is a profitability ratio measuring how much profit a company can generate from its assets. A high RoA indicates efficient management, resulting in profit generation with fewer assets. Conversely, a low RoA suggests more assets are required to generate profits. The RoA is most useful when comparing similar companies.
Governance of Public Sector Banking in India
India’s government has been infusing capital into public sector banks for various purposes, such as facilitating credit expansion and aiding loss coverage due to non-performing asset provisions. However, this trend hasn’t followed a particular path, with both increases and decreases in recent years. In 2017, the government approved a merger of five associate banks along with the Bharatiya Mahila Bank with the State Bank of India (SBI). This merger aimed to rationalize public bank resources, reduce costs, improve profitability, decrease the cost of funds, provide better interest rates for the public, and enhance productivity and customer service.