Type: Prelims Only

The RBI has issued a revised Prompt Corrective Action (PCA) framework for banks to enable supervisory intervention at “appropriate time” and also act as a tool for effective market discipline.

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.

Latest PCA norms

• The revised PCA framework will be effective from January 1, 2022.
• Capital, asset quality and leverage will be the key areas for monitoring in the revised framework.
• That apart, RBI has also revised the level of shortfall in total capital adequacy ratio that would push the lender to “risk threshold three” category.

When exactly does a bank fall into this list?

• The RBI has specified certain regulatory trigger points with respect to three parameters for the initiation of the process:
• Capital-to-risk weighted assets ratio (CRAR): It is a measure of a bank’s capital to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements.
• Net Non-Performing Assets (NPA)

• Return on assets (RoA): It is an indicator of how well a company utilizes its assets in terms of profitability.

What are the trigger points on capital and how does a breach invite action?

1. CRAR

• If CRAR falls to less than 9 percent, the RBI asks banks to submit a capital restoration plan, restricts new businesses and dividend payments.
• The RBI also orders recapitalisation, restrictions on borrowings from the inter-bank market, reduction of stake in subsidiaries and reduction of exposure to sensitive sectors.
• Such sectors include the capital markets, real estate or investments in non-statutory liquidity ratio securities.
• If CRAR is less than 6 percent but equal to or more than 3 percent, the RBI could take additional steps if the bank fails to submit a recapitalisation plan.

2. NPA levels

• If net NPAs rise beyond 10 percent but are less than 15 percent, a special drive to reduce bad loans and contain the generation of fresh NPAs begins.
• The RBI reviews the bank’s loan policy and takes steps to strengthen credit-appraisal skills.

3.Return on assets

• If RoA is less than 0.25 percent, restrictions on accessing/renewing costly deposits and CDs kick in and the RBI bars the bank from entering new lines of business.
• The bank’s borrowings from the inter-bank market, making dividend payments and increasing staff will be restricted.

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.