RBI Puts Banks on a Short Leash with Prompt Corrective Action (PCA)

The Reserve Bank of India (RBI): India's central banking institution have just come up with a notification that is sure to give a spine-chilling effect to every member of a bank's board across all banks.

What has been introduced?

The RBI on Thursday very categorically put forth a revised Prompt Corrective Action (PCA) framework on which the banks would be monitored.

According to the latest Prompt Corrective Action (PCA), the banks will be monitored on three parameters, and they are:
  • Capital 
  • Asset Quality 
  • Profitability 
The above-mentioned parameters would form the basis on which PCA will analyse a bank's performance.

The Three Risk Thresholds:

The RBI has classified the risk thresholds into three categories and the PCA depends on the type of risk threshold that was breached.
The three categories of risk thresholds can be understood from the picture below:

What would happen in the case of a risk threshold breach?

The RBI in its notification stated that the mandatory action that would be taken when a bank breaches the risk threshold includes:
  • Restriction on dividend payment/remittance of profits 
  • Restriction on branch expansion 
  • Higher provisions 
  • Restriction on management compensation and director's fees 

For instance,
If a bank’s capital adequacy is less than 10.25% but greater than or equal to 7.75%, it will be classified as risk threshold 1; if CRAR is less than 7.75% but greater than or equal to 6.25%, it will be classified as risk threshold 2 and if it is below 3.625%, the bank will be risk threshold 3. At present, minimum capital requirement stands at 10.25% (9% minimum total capital plus 1.25% of CCB as on March 31, 2017).
Similarly, if NNPAs are less than 9%, but greater than or equal to 6%, the bank will be risk threshold 1; less than 12% but greater than or equal to 9% will fall under risk threshold 2 and 12% and above will be classified as risk threshold 3.
In case of a breach of "Risk Threshold 3' of CET 1 (common equity tier 1)
As per the RBI- The breach of 'Risk Threshold 3' of CET 1 (common equity tier 1) by a bank would identify a bank as a likely candidate for resolution through tools like: 
  •  Amalgamation 
  • Reconstruction 
  • Winding up and others 

Who would come under the PCA's ambit?

The PCA framework would apply without exception to all banks operating in India including small banks and foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators", the RBI said.
RBI will also shower its words of wisdom
RBI in its discretion will also advise a bank's board to:
Activate the recovery plan that has been duly approved by the supervisor.
  • Undertake a detailed review of business model in terms of sustainability of the business model, profitability of business lines and activities, medium and long term viability, balance sheet projections and others. 
  • Review short term strategy focusing on addressing immediate concerns. 
  • Review medium term business plans. 
  • Identify achievable targets and set concrete milestones for progress and achievement and undertake restructuring of operations as appropriate. 
  • The banking regulator will also recommend to the bank owner (government/promoters/parent of foreign bank branch) to bring in new management/board. 
With this, it is safe to assume that banks will work far more rigorously to increase their profitability and bring down the NPA's to a justifiable level. As at the end of the day, the banking sector is a barometer of economic growth and development.

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