Context: Recently, Reserve Bank of India (RBI) has decided to put in place a prompt corrective action (PCA) framework for troubled non-banking finance companies to restore their financial health.
What is the PCA framework?

• Prompt Corrective Action Framework refers to the central bank’s watchlist of weak banks.
• The regulator imposes restrictions like curbs on lending on such banks.
• The PCA Framework applies only to commercial banks and does not cover cooperative banks and non-banking financial companies.

When was PCA introduced?

• The RBI’s PCA Framework was introduced in December 2002 as a structured early intervention mechanism along the lines of the US Federal Deposit Insurance Corporation’s PCA framework.
• The last PCA Framework was issued by the RBI on April 13, 2017, and implemented with respect to banks’ financials as of March 31, 2017.

Objective: Prompt Corrective Action or PCA is a framework under which financial institutions with weak financial metrics are put under watch by the RBI.

• Until now, the RBI had imposed PCA only on banks. This is the first time PCA framework is extended to NBFCs.
• The move comes in the wake of large NBFCs such as IL&FS, DHFL, SREI Group and Reliance Capital getting into financial trouble over the last few years.

Applicability: The PCA framework for NBFCs comes into effect from October 1, 2022, based on their financial position on or after March 31, 2022.

• The framework will apply to all deposit-taking NBFCs, excluding government companies, and all non-deposit taking NBFCs in the middle, upper and top layers.

Implications - This is a welcome move as it will stop bad lenders from going worse rather than brushing the issue aside.

• Safer NBFCs will translate to a safer overall financial system.
• The PCA framework for NBFCs will be reviewed after 3 years.

What are the tracking indicators?
The central bank will track three indicators

• Capital To Risk-Weighted Assets Ratio (CRAR): It is bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures.
• Tier I leverage ratio: It is the relationship between a banking organization's core capital and its total assets.
• Net Non-Performing Assets (NNPAS) Including Non-Performing Investments (NPIS). NPA are loans for which the principal or interest payment remained overdue for a period of over 90 days

In the case of core investment companies (CICs), the RBI will track

• Adjusted Net Worth/Aggregate Risk Weighted Assets.
• Leverage Ratio
• NNPAs, including NPIs.

A breach in any of the three risk thresholds under the above mentioned indicators could result in invocation of PCA.
Significance of PCA

• The financial health of a bank: Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.
• Averting a crisis: PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble. The idea is to head off problems before they attain crisis proportions.