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All you wanted to know about Prompt Corrective Action

Radhika Merwin | Updated on February 20, 2019 Published on December 03, 2018

If you had just got a handle on the NPA animal after all the noise around it in the last two or three years, the recent bickering between the Centre and the RBI over PCA may have stumped you all over again. While the Centre maintains that it is the RBI’s more stringent PCA norms that have led to a large number of public sector banks being under its watch, thus crimping credit growth, the central bank has been reluctant to relax its PCA norms. At the RBI board meeting last month, it was agreed that the Board for Financial Supervision would look into the banks’ PCA framework.

What is it?

Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. The PCA framework deems banks as risky if they slip below certain norms on three parameters — capital ratios, asset quality and profitability.

It has three risk threshold levels (1 being the lowest and 3 the highest) based on where a bank stands on these ratios. Banks with a capital to risk-weighted assets ratio (CRAR) of less than 10.25 per cent but more than 7.75 per cent fall under threshold 1.

Those with CRAR of more than 6.25 per cent but less than 7.75 per cent fall in the second threshold. In case a bank’s common equity Tier 1 (the bare minimum capital under CRAR) falls below 3.625 per cent, it gets categorised under the third threshold level.

Banks that have a net NPA of 6 per cent or more but less than 9 per cent fall under threshold 1, and those with 12 per cent or more fall under the third threshold level.

On profitability, banks with negative return on assets for two, three and four consecutive years fall under threshold 1, threshold 2 and threshold 3, respectively.

Why is it important?

As most bank activities are funded by deposits which need to be repaid, it is imperative that a bank carries a sufficient amount of capital to continue its activities. 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. Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.

On breach of any of the risk thresholds mentioned above, the RBI can invoke a corrective action plan. Depending on the threshold levels, the RBI can place restrictions on dividend distribution, branch expansion, and management compensation. Only in an extreme situation, breach of the third threshold, would identify a bank as a likely candidate for resolution through amalgamation, reconstruction or winding up.

Owing to the sharp deterioration in finances of state-owned banks on the back of rising NPAs, 11 public sector banks were put under PCA last year. Based on FY18 financials of the 21 PSBs, 17 can fall under PCA based on net NPA threshold alone and nine on ROA alone (negative for two consecutive years).

Why should I care?

If a bank in which you hold deposits falls under PCA, don’t press the panic button. The RBI’s corrective measures may bode well for your bank. But do keep a watch on the RBI’s PCA announcements, as they can offer vital cues on the performance of your bank.

Contrary to the perception, PCA does not really limit the normal lending operations of banks. Arguments that so many banks slipping into PCA has stifled credit growth are overdone. While the RBI has placed restrictions on credit by PCA banks to unrated borrowers or those with high risks, it hasn’t invoked a complete ban on their lending.

The PCA framework may soon be reviewed, as decided in the RBI board meeting. There could be some relaxation in the norms.

The bottomline

In banking, a stitch in time may save ninety.

Published on December 03, 2018

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