Context: Recently, the Reserve Bank of India (RBI removed Central Bank of India from its Prompt Corrective Action Framework (PCAF) after the lender showed improvement in various financial ratios, including minimum regulatory capital and net non-performing assets (NNPAs).

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.

About Prompt Corrective Action Framework (PCAF)

• 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.

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

• While some banks have the capacity to withstand challenging phases of operations, others not so much. This is where RBI steps in through the PCA framework, essentially providing an opportunity for the banks to clean their operations. It can benefit both banks and depositors of the banks.

• In short the PCA framework for banks enables supervisory intervention and also acts as a tool for effective market discipline.