Introduction
The RBI created the Prompt Corrective Action (PCA) framework in 2002 as a structured early-intervention method for banks that had grown undercapitalized or fragile as a result of a decline in profitability. The PCA framework is used by the RBI to monitor banks with subpar financial performance. Beginning on October 1, 2022, the Non-Banking Financial Company is subject to the PCA framework. Learn about the PCA framework's definition, the criteria that determine whether a financial institution is subject to it, its trigger points and risk thresholds, as well as the steps the RBI takes when a financial institution is subject to it, in this article.
Framework For PCA
• The PCA framework is used by the RBI to monitor banks with subpar financial performance.
• The RBI introduced the PCA framework in 2002 as a planned early-intervention mechanism for banks that had grown weak or undercapitalized as a result of a decline in profitability.
• Its objective is to deal with the non-performing assets (NPAs) problem in India's banking system.
• The framework was reviewed in 2017 in accordance with the suggestions of the Financial Sector Legislative Reforms Commission and the Working Group on Resolution Regimes for Financial Institutions in India of the Financial Stability and Development Council.
• In the event of a bank crisis, PCA is required to notify the regulator, investors, and depositors.
• The intention is to keep issues from escalating into crises.
• Basically, PCA works with RBI to monitor banks' key performance indicators and take remedial action as necessary to get their financial health back on track.
Components of The PCA Framework
Capital adequacy ratio (CAR)
• The CAR measures the proportion of a bank's risk-weighted credit exposures to its available capital.
• The capital-to-risk-weighted-assets ratio (CRAR), also referred to as the capital-adequacy ratio, is utilized globally to safeguard depositors and advance the stability and effectiveness of the financial system.
CET 1 Ratio
• the proportion of common equity capital to all risk-weighted assets as specified by
RBI Basel III criteria after deducting regulatory adjustments.
NPA (non-performing asset)
• It refers to a loan or advance for which the principal or interest payment is more than 90 days past due.
• Banks must categorize NPAs as Substandard, Doubtful, or Loss assets.
Tier 1Leverage ratio
• It alludes to the relationship between a bank's total assets and core capital.
• The tier 1 leverage ratio is calculated by dividing a bank's total average consolidated assets by its total average off-balance sheet exposures.
• One of the many financial indicators used to assess a company's ability to meet its financial obligations is the leverage ratio.
• Here are a few illustrations:
o Equivalent Ratio The whole total of the owners' financial investments is shown in this number.
o Debt Ratio: This number reflects all of the company's leverage.
o Ratio of Debt to Equity This ratio examines the relationship between a company's debt and equity.
Trigger Points and Risk Thresholds for PCA framework
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PCA Matrix – Parameters, Indicators and Risk Thresholds
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Parameter
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Indicator
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Risk Threshold 1
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Risk Threshold 2
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Risk Threshold 3
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(1)
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(2)
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(3)
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(4)
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(5)
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Capital (Breach of either CRAR or CET 1 Ratio)
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CRAR - Minimum regulatory prescription for Capital to Risk Assets Ratio + applicable Capital Conservation Buffer (CCB) and/or Regulatory Pre-Specified Trigger of Common Equity Tier 1 Ratio (CET 1 PST) + applicable Capital Conservation Buffer (CCB)
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Upto 250 bps below the Indicator prescribed at column (2) Upto 162.50 bps below the Indicator prescribed at column (2)
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More than 250 bps but not exceeding 400 bps below the Indicator prescribed at column (2) More than 162.50 bps below but not exceeding 312.50 bps below the Indicator prescribed at column (2)
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In excess of 400 bps below the Indicator prescribed at column (2) In excess of 312.50 bps below the Indicator prescribed at column (2)
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Breach of either CRAR or CET 1 ratio to trigger PCA
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Asset Quality
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Net Non-Performing Advances (NNPA) ratio
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>=6.0% but <9.0%
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>=9.0% but < 12.0%
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>=12.0%
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Leverage
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Regulatory minimum Tier 1 Leverage Ratio
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Upto 50 bps below the regulatory minimum
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More than 50 bps but not exceeding 100 bps below the regulatory minimum
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More than 100 bps below the regulatory minimum
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Actions taken by RBI
Actions taken by RBI under PCA
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Mandatory and Discretionary Actions
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Specifications
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Mandatory actions
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Discretionary actions
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Risk Threshold 1
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- Restriction on dividend distribution/remittance of profits.
- Promoters/Owners/Parent (in the case of foreign banks) to bring in capital
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Common menu
- Special Supervisory Actions
- Strategy related
- Governance related
- Capital related
- Credit risk related
- Market risk related
- HR-related
- Profitability related
- Operations/Business related
- Any other
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Risk Threshold 2
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In addition to mandatory actions of Threshold 1,
- Restriction on branch expansion; domestic and/or overseas
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Risk Threshold 3
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In addition to mandatory actions of Threshold 1 & 2,
- Appropriate restrictions on capital expenditure, other than for technological up-gradation within Board approved limits
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• As seen in the table above, the RBI puts a few required restrictions on each threshold zone, including limitations on capital infusion from promoters, branch development, and dividend payout.
• The RBI may conduct Common Discretionary Actions for any of the three risk threshold zones.
Prompt Corrective Action - Issues
• PCA is a distinctive action that affects both consumer confidence and the bank's rating. Long-term harm results from this since it undermines the bank's credit history and casts doubt on its management.
• The public sector banks' position in the financial system may worsen as a result of PCA, perhaps speeding up the loss of market share and favoring private and foreign banks.
• The government wants lending restrictions to be friendlier by lowering PCA requirements and bringing them in line with international standards since it sees PCA as a roadblock to economic progress.
• India's reputation as an investment destination could be harmed by the dispute between the government and the RBI.
Conclusion
The underlying causes of the governance issues in the banking sector should be addressed by the government. A formal organization like the Public Sector Asset Rehabilitation Agency (PARA) can be established to deal with big bad debt situations; East Asian nations adopted this action after being confronted with huge TBS issues in the 1990s. The Insolvency and Bankruptcy Code (IBC) procedure must be modernized to adhere to international norms, and this requires active engagement by the executive branch, regulatory agencies, lenders, borrowers, and the judiciary.
