Prompt Corrective Action (PCA)

• 10 Dec 2018

Last Updated: September 2022

For Prelims: Prompt Corrective Action, Reserve Bank of India (RBI), Non-Performing Asset, Tier 1 Leverage Ratio, Capital Adequacy Ratio (CAR).

For Mans: Prompt Corrective Action: Role of RBI, Challenges and Issues, Steps that can be taken.

What is PCA? 

• About: 
  • Prompt Corrective Action (PCA) is a framework under which banks with weak financial metrics are put under watch by the Reserve Bank of India (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.
  • It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
    • 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.
  • 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.
• Revised Framework:
  • Applicability:
    • The PCA framework was earlier applicable only to commercial banks.
    • The revised 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 were applicable 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.

What is A Non-Performing Asset?

• A non-performing asset (NPA) 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.

What is 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.

What is 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.

What is the Role of RBI in PCA Framework?

• In governance-related actions, the RBI can supersede the board under Section 36ACA of the Banking Regulation (BR) 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.

What are the Challenges and Issues Regarding PCA?

• PCA is an exceptional action and impacts the rating of the bank as well as consumer confidence. This is detrimental in the long run as it impacts the credit history of the bank and raises questions about its management.
• PCA can accelerate the loss of market share and cause further decline of the position of the public sector banks in the financial system in favour of private banks and foreign banks.
• PCA is seen by the government as hindering economic growth therefore is arguing for easier lending policies by relaxing the PCA norms and aligning them to global norms.
• The tussle between RBI and government can negatively impact the image of India as an investment destination.

What can be the Way Forward?

• Narasimham Committee (1998) on structural reforms recommended the merger of Indian banks, a consolidated banking industry will be able to better deal with NPA crisis.
• Government should address the core issue of Governance impacting the Banking Sector.
• A formal agency such as Public Sector Asset Rehabilitation Agency (PARA), can be instituted to resolve the large bad debt cases, this step was taken by East Asian countries after they were hit by severe Twin Balance Sheet (TBS) problems in the 1990s.
• The Insolvency and Bankruptcy Code (IBC) mechanism needs to be strengthened to meet global standards with active involvement of the government, regulators, lenders, borrowers and the judiciary.