News Analysis

What the RBI’s corrective action on Bank of India means for depositors

Radhika Merwin | Updated on January 09, 2018 Published on December 20, 2017

There’s no reason for panic; the action is intended to strengthen the bank over the long run and protect depositors’ interests

With the RBI invoking Prompt Corrective Action (PCA) on Bank of India — one of the largest public sector banks — depositors are sure to be rattled.

But if you are worried about your deposits being frozen or your bank going bust, rubbish such thoughts right away. The RBI’s PCA involves monitoring certain key performance indicators of banks, and taking corrective measures, if need be, to restore their financial health.

But that is not to say that depositors can completely disregard the RBI’s action. It can offer some cues on the critical financial parameters that determine the health of your bank.

The PCA framework has three risk threshold levels (one being the lowest and three the highest); and breach of capital, asset quality and profitability levels lead to banks being bucketed in one of the three threshold levels.

Current norms under Basel III require banks to maintain a minimum capital adequacy ratio (CRAR) of 9 per cent (plus 1.25 per cent of counter-cyclical buffer).

Under PCA, banks with total CRAR of less than 10.25 per cent but more than 7.75 per cent will fall under threshold one. Those with CRAR of more than 6.25 per cent but less than 7.75 per cent will 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 bucketed under the third threshold level.

The second parameter, to gauge the health of a bank is its level of bad loans. Hence, based on the level of net NPAs, banks can again be bucketed in one of the three threshold levels.

Also, banks with negative return on assets (ROA) for two, three and four consecutive years fall under threshold 1, threshold 2 and threshold 3, respectively.

High net NPA and negative ROA had led the RBI to invoke PCA against, among others, Dena Bank, UCO Bank, and Central Bank of India. For Bank of India, RBI’s action was additionally on account of insufficient capital.

Contrary to some reports, the corrective action does not limit the normal operation of the banks. Depending on the threshold levels, the RBI can place restrictions on dividend distribution, branch expansion, and management compensation.

Only an extreme situation — breach of the third level of threshold — would identify a bank as a likely candidate for resolution through tools, such as amalgamation, reconstruction, and winding up.

So, just because the RBI has drawn out a corrective action for your bank, does not mean your bank’s operations are constrained.

Many other banks have high NPAs and can result in the RBI invoking corrective action. Remember not to press the panic button.

The RBI’s corrective measures are intended to strengthen the banking system over the long run and protect depositors’ interests.

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Published on December 20, 2017
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