PCA Framework Revised

• 05 Nov 2021

Why in News

Recently, the Reserve Bank of India (RBI) has announced a revised Prompt Corrective Action (PCA) framework.

• The PCA framework enables supervisory intervention of RBI over Banks at an appropriate time and ensures effective market discipline.

Key Points

• Revised Framework:
  
  • Applicability:
    
    • The 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 (SFBs) have been removed from the list of lenders where prompt corrective action can be initiated.
      
      • The new provisions will be effective from January, 2022.
  • Monitored Areas:
    
    • Capital, Asset Quality and Capital-To-Risk Weighted Assets Ratio(CRAR), NPA ratio, Tier I Leverage Ratio, will be the key areas for monitoring in the revised framework.
    • However, the 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 may result in the invocation of the PCA. Stressed banks may not be allowed to expand credit/investment portfolios.
      
      • However, they are allowed to invest in government securities/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 the PCA matrix.
  • RBI’s Powers:
    
    • In governance-related actions, the RBI can supersede the board under Section 36ACA of the Banking Regulation Act, 1949.
    • Amendment to Section 45 of the BR Act enables the Reserve Bank to reconstruct or amalgamate a bank, with or without implementing a moratorium, with the approval of the Central government.
    • The RBI, as part of its mandatory and discretionary actions, 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.
• Prompt Corrective Action:
  
  • Background: PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.
    
    • The RBI introduced the PCA framework in 2002 as a structured early-intervention mechanism for banks that become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability.
    • The framework was reviewed in 2017 based on the recommendations of the working group of the Financial Stability and Development Council on Resolution Regimes for Financial Institutions in India and the Financial Sector Legislative Reforms Commission.
  • Objective: The objective of the PCA framework is to enable supervisory intervention at an appropriate time and require the supervised entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.
    
    • It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
    • It 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.
  • Audited Annual Financial Results: A bank will generally be placed under the PCA framework based on the audited annual financial results and the ongoing supervisory assessment made by the RBI.

Non Performing Asset:

• It is a loan or advance for which the principal or interest payment remains overdue for a period of 90 days.
• Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.

Capital Adequacy Ratio (CAR):

• The CAR is a measure of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures.
• The Capital Adequacy Ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to protect depositors and promote the stability and efficiency of financial systems around the world.

Tier 1 Leverage Ratio:

• It is the relationship between a banking organization's core capital and its total assets.
• The tier 1 leverage ratio is calculated by dividing tier 1 capital by a bank's average total consolidated assets and certain off-balance sheet exposures.
  
  • A leverage ratio is any one of several financial measurements that assesses the ability of a company to meet its financial obligations.Some of the examples are :
    
    • Equity Ratio: This ratio indicates total owner contribution in the company.
    • Debt Ratio: This ratio indicates total leverage used in the company.
    • Debt To Equity Ratio: This ratio indicates total debt used in the business in comparison to equity.

Source: IE