Prompt corrective action for banks

Updated - May 21, 2017 08:57 pm IST

Published - May 21, 2017 08:34 pm IST - MUMBAI

The Reserve Bank of India has revised the norms for prompt corrective action in April 2017.

The Reserve Bank of India has revised the norms for prompt corrective action in April 2017.

As the financial health of banks had deteriorated over the last three years, the Reserve Bank of India (RBI) has revised the norms for prompt corrective action early last month, and has promptly imposed those norms on a couple of public sector lenders.

What is PCA?

PCA norms allow the regulator to place certain restrictions such as halting branch expansion and stopping dividend payment. It can even cap a bank’s lending limit to one entity or sector. Other corrective action that can be imposed on banks include special audit, restructuring operations and activation of recovery plan. Banks’ promoters can be asked to bring in new management, too. The RBI can also supersede the bank’s board, under PCA.

The provisions of the revised PCA framework will be effective April 1, 2017 based on the financials of the banks for the year ended March 31, 2017. The framework will be reviewed after three years.

When is PCA invoked?

The PCA is invoked when certain risk thresholds are breached. There are three risk thresholds which are based on certain levels of asset quality, profitability, capital and the like. The third such threshold, which is maximum tolerance limit, sets net NPA at over 12% and negative return on assets for four consecutive years.

What are the types of sanctions?

There are two type of restrictions, mandatory and discretionary. Restrictions on dividend, branch expansion, directors compensation, are mandatory while discretionary restrictions could include curbs on lending and deposit. In the cases of two banks where PCA was invoked after the revised guidelines were issued — IDBI Bank and UCO Bank — only mandatory restrictions were imposed. Both the banks breached risk threshold 2.

What next?

Some more lenders are expected to come under the corrective action framework as and when their asset quality worsens, putting profitability under pressure. Some public sector banks have breached the net NPA parameter as well as the profitability parameter. These banks are comfortable on the capital parameter, thanks to the government’s commitment to ensure the PSU banks are not starved of capital. However, as the government has its own commitment for maintaining fiscal discipline, it remains to been seen how long it can afford to infuse capital in these banks.

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