Editorial

Correcting PCA rules

| Updated on November 10, 2021

RBI’s revised rules on Prompt and Corrective Action for banks are a step in the right direction   -  REUTERS

There are welcome tweaks by the RBI to PCA rules but banks may resent the high exit bar

With India yet to devise a formal resolution mechanism for distressed banks, an early warning system is much needed to alert the regulator to slippage in bank performance for timely intervention. The Reserve Bank of India’s (RBI) Prompt Corrective Action (PCA) framework, devised to do this nearly a decade ago, has however proved only partly effective. In the case of a few private banks such as YES Bank, RBI was forced to supersede the bank’s Board even without reported numbers breaching PCA thresholds — management churn in such cases, offered better advance warning of stress. In the case of public sector banks, RBI has been criticised for sweeping too many of them under PCA based solely on their weak reported numbers, despite minimal risk of failure given their Government backing. RBI’s latest tweaks to the PCA framework, set to take effect from January 1, 2022, are to be seen in this context.

The revised rules propose changes on three fronts — the triggers to invoke PCA against a bank, the mandatory actions RBI may take after it and conditions for a bank to exit it. Rules currently allow RBI to invoke PCA, if a bank’s capital-to-risk weighted assets ratio and Tier 1 capital ratio, Return on Assets (ROA), net Non-Performing Assets and leverage fall well short of statutory thresholds. Under the new regime, a negative ROA (effectively, a reported loss) will no longer be a trigger for a bank to invite corrective action. This appears sensible because the accounting profit for a bank is the residual sum left over after provisioning for bad and doubtful loans. A bank that proactively provisions for possible NPAs and maintains high provision coverage may report losses, but is better protecting the interests of its stakeholders than a bank that skimps provisioning to show a profit. Some of the corrective actions to be taken by RBI once a bank falls under PCA, have been left to its discretion instead of being mandated. Today, PCA rules require RBI to enforce higher provisioning norms and cap management compensation. The new rules allow it to take a discretionary call, perhaps to avoid denting depositor confidence. The existing curbs placed by the RBI on PCA banks lending to lower-rated or unsecured borrowers have been diluted and replaced with more generic powers, which is welcome.

Overall, while the new framework rightly affords RBI greater flexibility in resolving stressed banks on a case-to-case basis, the roadmap it offers for a bank’s exit from PCA appears to run counter to this. While such exit was earlier left to RBI’s discretion, the new regime requires a bank to stay above mandated capital, NPA and leverage thresholds for four consecutive quarters to apply for exit. This may be a rather high bar. A troubled bank can mend its capital adequacy or leverage quickly with infusion from its promoter. But resolving legacy NPAs often requires it to pursue business growth or margin-improving strategies that may not be possible while its hands are tied by PCA.

Published on November 10, 2021

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