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PROMPT CORRECTIVE ACTION (PCA)

Written by Talent KAS

Related Topics: Banking Sector, Non Performing Asset (NPA)

News

  • The Reserve Bank of India (RBI) has placed Lakshmi Vilas Bank under Prompt Corrective Action (PCA) framework due to high bad loans and insufficient capital.
  • RBI has also advised the bank on the restrictions put in place and the actions to be taken, which the bank has taken note of for necessary compliance, with progress to be reported every month to RBI.

What is Prompt Corrective Action (PCA)?

  • RBI PCA framework was introduced in December 2002 as a structured early-intervention mechanism along the lines of the US Federal Deposit Insurance Corp.’s PCA framework.
  • The framework was reviewed based on the recommendations of the working group of the Financial Stability and Development Council on Resolution Regimes for Financial Institutions in India and the Financial Sector Legislative Reforms Commission in 2017.
  • It is a framework under which banks with weak financial metrics are put under watch by the RBI.
  • Under PCA, banks are mandated to cut lending to corporates and focus on reducing concentration of loans to certain sectors.
  • They are also restricted from opening new branches and paying dividends.

Trigger Points

The PCA framework specifies the trigger points or the level after which the RBI will intervene with corrective action. The trigger points are set by considering three financial indicators of that bank:

  • Capital to Risk weighted Asset Ratio (CRAR)
  • Net Non-Performing Assets (NPA) and
  • Return on Assets (RoA)

Threshold Levels

  • 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) 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 threshold 2.
  • In case a bank’s common equity Tier 1 (the bare minimum capital under CRAR) falls below 3.625 per cent; it gets categorized under threshold 3.
  • 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 PCA is 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.
  • 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.

[Source: The Hindu, Livemint]

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