What is Prompt Corrective Action?
Prompt Corrective Action is a measure to maintain the financial health of banks. Also involves monitoring of certain performance indicators as an early warning exercise. The PCA framework deems banks as risky if they slip below certain norms on three parameters — capital ratios, asset quality and profitability.
Why the need for PCA
The 1980s and early 1990s were a period of great stress and riot for banks and financial in institutions all over the globe. In USA, more than 1,600 commercial and savings banks insured by the Federal Deposit Insurance Corporation (FDIC) were either closed or given financial assistance during this period. The cumulative losses provoked by the failed institutions exceeded US $100 billion.
What does the RBI stipulate?
- 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) of 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 second threshold. In case a bank’s common equity Tier 1 (the bare minimum capital under CRAR) falls below 3.625 per cent, it gets categorised under the third threshold level.
- 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.
Based on each trigger point, the banks have to follow a mandatory action plan. Apart from this, the RBI has permissive action plans too. The rationale for classifying the rule-based action points into “mandatory“ and “non-mandatory“ is that some of the actions are essential to restore the financial health of banks while other actions will ..
What will a bank do if PCA is triggered?
Banks are not allowed to renew or access costly deposits or take steps to increase their fee-based income. Banks will also have to launch a special drive to reduce the stock of NPAs and contain generation of fresh NPAs. They will also not be allowed to enter into new lines of business. RBI will also impose restrictions on the bank on borrowings from inter bank market.
Benefits of PCA
If banks undergo Prompt Corrective Action, it will not affect their performance it will only improve the internal controls.
Only five PSU banks—United Bank of India, UCO Bank, Central Bank of India, Indian Overseas Bank, Dena Bank—now under RBI PCA framework