Prompt Corrective Action (PCA) framework

Context:

  • The Reserve Bank of India (RBI) had placed 11 public sector banks (PSBs) out of 21 State-owned banks under its Prompt Corrective Action (PCA) framework because of deteriorating performance.
  • Currently, five PSBs which includes United Bank of India, UCO Bank, Central Bank of India, Indian Overseas Bank and Dena Bank still remain under the PCA framework.

What is Prompt Corrective Action (PCA) framework?

  • PCA is a process or mechanism to ensure that banks don’t go bust.
  • Under it, RBI has put in place some trigger points to assess, monitor, control and take corrective actions on banks which are weak and troubled.
  • It was first introduced after global economy incurred huge losses due to failure of financial institutions during 1980s-90s.
  • According to latest PCA framework, banks to be placed under it are assessed on three parameters viz. Capital ratios, Asset Quality and Profitability.
  • Indicators to be tracked for these three parameters are CRAR (Capital to Risk weighted Assets Ratio)/Common Equity Tier I ratio, Net NPA (non-performing assets) ratio and Return on Assets (RoA) respectively.
  • If banks breach of any risk threshold mentioned above, it results in invocation of PCA against them.
  • RBI enforces these guidelines to ensure banks do not go bust and follow prompt measures to put their house in order.
  • It had tightened its PCA framework in April 2017 to turn around lenders with weak operational and financial metrics,
  • Depending on the risk thresholds set in PCA rules, banks placed under it are restricted from expanding number of branches, staff recruitment and increasing size of their loan book.
  • Other restrictions include higher provisions for bad loans and disbursal only to those companies whose borrowing is above investment grades.

Key Facts

  • Since PCA framework restricts amount of loans banks can extend, placing PSBs under it will put pressure on credit being made available to companies especially MSMEs.
  • Large companies have access to corporate bond market so they may not be impacted immediately.
  • These banks may take at least another 6-9 months before they report any noticeable improvement in key regulatory indicators, which will help them come out of PCA.

Impact of PCA:

  • Operational performance of PSBs has improved in April-June 2018 quarter, with steep reduction in net losses, increase in recoveries and significant improvement in provision coverage ratio.
  • Besides, government is also providing PSUs adequate capital when required.  
  • Some of capital already has been given, as recoveries is taking place and there is possibility that some banks will not need it.
  • 6 banks have been pulled out of PCA since then.

Why there is a proposal for providing relaxation now?

After several measures taken for capital infusion in the Public Sector Banks, the Banks are well-capitalised. Banks have not only shown improvement on recoveries but have further de-risked their portfolios. The relaxation would aid banks in exiting the PCA framework.

The Parliamentary Committee on Finance had observed that “It is not clear as to how these banks will turn around their operations with the existing curbs on lending and even deposit-taking in the case of some. This could trigger a vicious cycle in the banking sector and the economy at large”. The committee had recommended reviewing the PCA framework.

PCA: Bone of Contention

  • The PCA framework had become a bone of contention between the government and the RBI.
  • In India, PCA kicks in when banks breach any of the three key regulatory trigger points namely
    • capital to risk-weighted assets ratio,
    • net non-performing assets (NPA) and
    • return on assets (RoA)
  • Globally PCA kicks in only when banks slip on a single parameter of capital adequacy ratio.
  • The government and independent directors of the RBI board, like S Gurumurthy, are in favour of this practice being adopted for the domestic banking sector as well.

 

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