Prompt Corrective Action

BE/RBI NOTE/53/2018

What is Prompt Corrective Action and what is the recent development related to the differences between the Central Government and the Reserve Bank of India?   Here are the important points one should know to under the concept clearly.

1. Centre contends that because of RBI’s stringent PCA norms that several of the PSU Banks have come under the watch of RBI, which in turn has resulted in a constrained Credit growth of the banks.
2. In the last month’s meeting, it was decided that the Board for Financial Supervision would look into the Banks’ PCA structure.

Prompt Corrective Action:

1. Here the weak financial metrics of the banks will be put under a framework and would be RBI’s watch.

2. Three parameters have been framed and it is felt that if banks slip below these parameters, the banks would be considered to be risky. These are :

• Capital Ratios,
• Asset Quality and
• Profitability

3. The threshold levels are numbered three where 1 is the lowest and 3 is the highest and banks stand on these three Threshold levels.

Capital Ratios:

• Banks with a Capital to Risk Weighted Assets Ratio (CRAR) of less than 10.25% but more than 7.75% fall under Threshold 1
• Banks with a CRAR of more than 6.25% but less than 7.75% per cent fall in the Threshold 2.
• If a bank’s Tier 1 Capital which is the bear minimum capital under CRAR falls below 3.625% it will get categorized under Threshold 3.

Asset Quality:
Here, banks with an NPA of 6% or more but less than 9% fall under Threshold 1 and those with 12% or more fall under Threshold 3.

Profitability:
On Profitability, banks with a negative return on assets for 2, 3 and 4 consecutive years fall under Threshold 1, Threshold 2 and Threshold 3 respectively.

4. Banks hold sufficient capital in order to continue its activities which are funded by Deposits from customers which is required to be repaid.

5. Hence PCA is framed so that both the Regulators and the Investors as also the Deposits are put on alert when a bank tends to be in troubled waters.

6. This is mainly intended to ward off any crisis before they could become alarming.

RBI and PCA:

• PCA mainly helps RBI in monitoring the key performance indicators and to take necessary corrective steps which in turn will reveal the financial health of a bank.
• In the event of breach of any of the Threshold levels mentioned above, RBI has the right to invoke a correction action.
• RBI depending upon the Threshold levels, will place restrictions on Dividend Distribution, Branch Expansion and Management compensation of these banks.
• Under extreme circumstances, when Threshold 3 is breached, RBI would classify a bank as one earmarked for amalgamation, reconstruction or winding up.
• Due to the Owing to the severe decline in the financial position of the PSU Banks, RBI was compelled to categorize 11 Public Sector Banks, under PCA category.
• Based on the Financial levels of 21 PSBs in 2018, 17 can fall under PCA based on net NPA on the basis of their Threshold levels and 9 on ROA (Return on Assets) level, since they showed negative figures for two consecutive years.

Customers and PCA:

Why should a Customer worry about PCA?

• If a Bank in which a customer holds deposits falls under PCA, don’t press the panic button.
• RBI’s corrective measures will promise well for the said bank.
• However, a Customer is advised to keep a watch on the RBI’s PCA announcements, since these announcements would provide vital clues on the performance of such banks
• In contrast, PCA does not really restrict the lending operations of Banks.
• Several arguments in this area, about banks slipping into PCA, have brought panic all along.
• RBI has placed limitations on credit by PCA banks to unrated borrowers or those with high risks.
• However, RBI has not brought a total ban on their lending.
• It is likely that the PCA framework would soon be reviewed, in line with the recent RBI Board meeting and thus, some relaxation in the norms are expected.

However, the Dictum PREVENTION IS BETTER THAN CURE ofcourse stands.