Prompt Corrective Action

Prompt Corrective Action
Prompt Corrective Action

What is Prompt Corrective Action

Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. It was initiated in 2002. The PCA framework deems banks as risky if they slip below certain norms on three parameterscapital ratios, asset quality and profitability
The scheme was revised in April 2017. Under the Revised PCA framework, apart from the capital, asset quality and profitability, leverage is to be monitored additionally. The PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.

Three Threshold Levels

It has three risk threshold levels (1 being the lowest and 3 the highest) based on where a bank stands on these ratios.
Threshold 1 - Banks with a capital to risk-weighted assets ratio (CRAR) of less than 9 per cent but equal or more than 6 per cent fall under threshold 1.
Threshold 2 - Those with CRAR of less than 6 per cent but equal or more than 3 per cent fall in the second threshold.
Threshold 3 - In case a bank’s CRAR of less than 3 per cent, it gets categorised under the third threshold level.
Banks that have a net NPA of 10 per cent or more but less than 15 per cent fall under threshold 1, and those with 15 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. ROA (Return on Assets) below 0.25% is considered as major trigger point.

Importance of PCA

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.
PCA does not really limit the normal lending operations of banks. 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.

Breach of Thresholds

RBI has set trigger points on the basis of CRAR (Capital To Risk Weighted Assets Ratio), NNPA (Net Non-Performing Assets) and ROA (Return on Assets). Based on each trigger point, the banks have to follow a mandatory action plan. Depending on the threshold levels, the RBI can place restrictions on banks.
There are two types of restrictions, mandatory and discretionary. Restrictions on dividend, branch expansion, director’s compensation, are mandatory while discretionary restrictions could include curbs on lending and deposit. 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.

Banks in PCA

In early 2018, there were 12 banks under PCA framework, implying that their financial conditions were weak. Out of these, 11 were Public Sector Banks (PSBs). Later, the government injected capital into the PSBs besides making several steps to improve their performance. As a result, as on March 9, 2019, there were only six banks (all PSBs) under the PCA framework.

Impact of PCA

Small and medium enterprises will have to bear the brunt due to this move by RBI. Since the PCA framework restricts the amount of loans banks can extend, this will definitely put pressure on credit being made available to companies especially the MSMEs. Large companies have access to the corporate bond market so they may not be impacted immediately. 
It has been predicted that if more state-owned banks are brought under PCA, it will impact the credit availability for the MSME segment. The PCA framework may soon be reviewed, as decided in the RBI board meeting. There could be some relaxation in the norms.

Source - RBI Report