RBI unveils PCA framework for NBFCs effective Oct 2022

The Reserve Bank of India (RBI) has decided to put in place a prompt corrective action (PCA) framework for troubled non-banking finance companies to restore their financial health. Until now, the RBI had imposed PCA only on banks.

The move comes in the wake of large NBFCs such as IL&FS, DHFL, SREI Group and Reliance Capital getting into financial trouble over the last few years.

Referring to the mushrooming of NBFCs and their links to other segments of the financial system, the RBI said the PCA framework will further strengthen the supervisory tools.

The PCA framework for NBFCs comes into effect from October 1, 2022, based on their financial position on or after March 31, 2022. The framework will apply to all deposit-taking NBFCs, excluding government companies, and all non-deposit taking NBFCs in the middle, upper and top layers.

Tracking indicators

The central bank will track three indicators — capital to risk-weighted assets ratio (CRAR), Tier I ratio and net non-performing assets (NNPAs), including non-performing investments (NPIs).

In the case of core investment companies (CICs), the RBI will track adjusted net worth/aggregate risk weighted assets, leverage ratio and NNPAs, including NPIs.

A breach in any of the three risk thresholds under the above mentioned indicators could result in invocation of PCA.

Sectoral growth to be hit

AM Karthik, Vice President and Sector Head, Financial Sector Ratings, ICRA, said, “The thresholds around total capital adequacy and Tier-I capital for classification of an NBFC in the PCA category are liberal; however some entities could breach the net NPA criterion of more than 6 per cent, if the asset quality does not improve.”

Among the large NBFCs (asset size more than ₹25,000 crore), ICRA notes that about three entities are in breach of the net NPA criterion as of September 2021. However, all of them have an established parentage.

Karthik said that as PCA guidelines are applicable from October 2022, entities are expected to bring the NPA levels under control by improving provisions or effecting write-offs.

However, in view of the above regulatory changes, ICRA expects the sectoral growth to be impacted in the near term, as entities tighten their credit norms and operational focus shifts towards collections.

Corrective actions

Based on the risk threshold, the RBI may prescribe mandatory corrective actions such as restriction on dividend distribution/remittance of profits, requiring promoters/shareholders to infuse equity and reduce leverage, and restriction on issue of guarantees or taking on other contingent liabilities on behalf of group companies (only for CICs).

Further, the central bank may also restrict branch expansion, impose curbs on capital expenditure other than for technological upgradation within board approved limits and restrict/ directly reduce variable operating costs.

“This is a welcome move as it will stop bad lenders from going worse rather than brushing the issue aside. Ultimately, since NBFCs are now more closely integrated with the banking system than ever before, safer NBFCs also translate to a safer overall financial system,” said Jaya Vaidhyanathan, CEO, BCT Digital, a fintech offering risk management products. Under discretionary corrective actions, the RBI may undertake resolution of NBFC by amalgamation, reconstruction, splitting; file insolvency application under the Insolvency and Bankruptcy Code and issue show-cause notice for cancellation of certificate of registration and winding up of the NBFC.

The RBI may also recommend to promoters/shareholders to bring in new management/board; remove managerial persons under the RBI Act, as applicable; seek removal of director and/or appointment of another person as director in his place; supersede the board under the RBI Act and appoint an administrator, among others.

The central bank said the PCA framework for NBFCs will be reviewed after three years.

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