The RBI uses the PCA framework to keep track on banks with poor financial performance. The PCA framework was introduced by the RBI in 2002 as a structured early-intervention mechanism for banks that have become undercapitalized or fragile due to a loss of profitability. Based on the recommendations of the Financial Stability and Development Council’s working group on Resolution Regimes for Financial Institutions in India and the Financial Sector Legislative Reforms Commission, the framework was reviewed in 2017.
Need for PCA
- The PCA framework’s goal is to allow supervisory involvement at the right moment and to require the supervised entity to undertake and implement corrective actions as soon as possible in order to restore its financial health.
- Its goal is to address the issue of non-performing assets (NPAs) in India’s banking system.
- Its purpose is to enable the regulator, as well as investors and depositors, know when a bank is in difficulty.
- The goal is to prevent problems from reaching crisis proportions.
- Annual Financial Results (Audited): The PCA framework will normally be applied to a bank based on its audited annual financial results and the RBI’s continuing supervisory evaluation.
Recent amended PCA rules
- A breach of any risk threshold could result in the PCA being activated. Banks in distress may not be permitted to increase their lending and investment portfolios.They are, however, permitted to invest in government securities and other high-quality liquid assets. In the event of a bank’s failure to meet its responsibilities to its depositors, potential resolution mechanisms may be used without consulting the PCA matrix.
- The RBI has the authority to supersede the board in governance matters under Section 36ACA of the Banking Regulation Act, 1949. With the permission of the Central government, an amendment to Section 45 of the BR Act allows the Reserve Bank to reconstruct or amalgamate a bank, with or without instituting a moratorium.
- Under the new PCA, the RBI may impose appropriate restrictions on capital spending, other than for technological upgradation within Board-approved limits, as part of its mandated and discretionary actions.
- Based on the breach of risk thresholds of selected indicators, the framework applies to all banks operating in India, including international banks operating through branches or subsidiaries. Payments banks and small financing banks (SFBs) have been removed from the list of lenders who can be subjected to immediate corrective action. The new rules will go into force in January 2022.
- If no violations in risk thresholds in any of the parameters are observed over the course of four consecutive quarterly financial statements, the limitations will be lifted.
- The updated approach will focus on capital, asset quality, and the Capital-to-Risk Weighted Assets Ratio (CRAR), as well as the NPA ratio and Tier I Leverage Ratio. Return on assets, on the other hand, is no longer a measure that can prompt action under the amended framework.
- While the new framework rightly affords RBI greater flexibility in resolving stressed banks on a case-to-case basis, the roadmap it offers for a bank’s exit from PCA appears to run counter to this.
- While such exit was earlier left to RBI’s discretion, the new regime requires a bank to stay above mandated capital, NPA and leverage thresholds for four consecutive quarters to apply for exit. This may be a rather high bar.
- Resolving legacy NPAs often requires it to pursue business growth or margin-improving strategies that may not be possible while its hands are tied by PCA.
With India yet to devise a formal resolution mechanism for distressed banks, an early warning system is much needed to alert the regulator to slippage in bank performance for timely intervention.
How to structure:
- Give an intro on PCA
- Write the importance of it in dealing the NPA crisis
- Discuss the recently revised PCA rules
- Suggest any further measures to improve it