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What is prompt corrective action?

by Uddipana Gogoi

Prompt corrective action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. In 2002, The Reserve Bank of India introduced the Prompt corrective action framework for banks that become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability. It aims to alert the regulator as well as investors and depositors if a bank is heading for trouble. Under this mechanism, the RBI monitors key performance indicators of banks, and takes corrective measures accordingly to restore the financial health of a bank. This mechanism is applicable to

  • Commercial banks
  • Co-operative banks
  • Non-banking financial institutions

According to PCA mechanism, banks are considered as risky if they slip some trigger points – 

  • Capital to risk weighted assets ratio (CRAR)
  •  Net NPA
  • Return on Assets (RoA) 
  • Tier 1 Leverage ratio

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, the scheme was reviewed in 2017. 

Objectives of Prompt corrective action

The objective of the PCA Framework are-

  • Firstly, to enable Supervisory intervention at appropriate time and require the Supervised Entity.
  •  Secondly, to initiate and implement remedial measures in a timely manner, so as to restore its financial health. 
  • Thirdly, to act as a tool for effective market discipline. 
  • Fourthly, The PCA Framework does not preclude the Reserve Bank of India from taking any other action as it deems fit at any time, in addition to the corrective actions prescribed in the Framework.

Common menu for selection of Discretionary Corrective Actions

1. Special Supervisory Actions for Prompt corrective action

  • Firstly, Special Supervisory Monitoring Meetings (SSMMs) at quarterly or other identified frequency
  • Secondly, It inspections/targeted scrutiny of the bank
  • Further, Cause a special audit of the bank by the extant Supervisory mechanism and/or through external auditors
  • Finally, Resolution of the bank by Amalgamation or Reconstruction (Ref. Section 45 of Banking Regulation Act 1949)

2. Strategy related activities for Prompt corrective action

Moreover, RBI to advise the bank’s Board to:

  • Activate the Recovery Plan that has been duly approved by the Supervisor
  • Undertake a detailed review of business model in terms of sustainability of the business model, profitability of business lines and activities, medium and long-term viability, etc.
  • Review short term strategy focusing on addressing immediate concerns
  • Review medium term business plans, identify achievable targets and set concrete milestones for progress and achievement
  • Undertake business process reengineering as appropriate
  • Undertake restructuring of operations as appropriate

3. Governance related Actions

  • Firstly, RBI to actively engage with the bank’s Board on various aspects as considered appropriate
  • Secondly, RBI to recommend to Owners (Government/ Promoters/ Parent of foreign bank branch) to bring in new Management/ Board
  • Thirdly, RBI to remove managerial persons under Section 36AA of the BR Act, 1949 as applicable
  • Furthermore, RBI to supersede the Board under Section 36ACA of the BR Act, 1949/ recommend supersession of the Board as applicable
  • Moreover, RBI to require bank to invoke claw back and malus clauses and other actions as available in regulatory guidelines, and impose other restrictions or conditions permissible under the BR Act, 1949
  • Finally, Impose restrictions on directors’ or management compensation, as applicable.

4. Capital related Actions

  • Detailed Board level review of capital planning
  • Submission of plans and proposals for raising additional capital
  • Requiring the bank to bolster reserves through retained profits
  • Restriction on investment in subsidiaries/associates
  • Restriction in expansion of high risk-weighted assets to conserve capital
  • Reduction in exposure to high risk sectors to conserve capital
  • Restrictions on increasing stake in subsidiaries and other group companies
5. Credit Risk related Actions

  • Preparation of time bound plan and commitment for reduction of stock of NPAs
  • Preparation of and commitment to plan for containing generation of fresh NPAs
  • Higher provisions for NPAs/NPIs and as part of the coverage regime
  • Strengthening of loan review mechanism
  • Restrictions/reduction in total credit risk weight density (example: restriction/reduction in credit for borrowers below certain rating grades, restriction/reduction in unsecured exposures, etc.)
  • Reduction in loan concentrations; in identified sectors, industries or borrowers
  • Sale of assets
  • Action plan for recovery of assets through identification of areas (geography wise, industry segment-wise, borrower-wise, etc.) and setting up of dedicated Recovery Task Forces, Adalats, etc.
  • Prohibition on expansion of credit/ investment portfolios other than investment in government securities / other High-Quality Liquid Investments

6. Market Risk related Actions

  • Firstly, Restrictions on/reduction in borrowings from the inter-bank market
  • Secondly, Restrictions on accessing/ renewing wholesale deposits/ costly deposits/ certificates of deposits
  • Thirdly , Restrictions on derivative activities, derivatives that permit collateral substitution
  • Fourthly, Restriction on excess maintenance of collateral held that could contractually be called any time by the counterparty

7. HR related Actions

  • Firstly, Restriction on staff expansion
  • Secondly, Review of specialized training needs of existing staff

8. Profitability related Actions

  • Restrictions on capital expenditure, other than for technological upgradation within Board approved limits
  • Restrictions/reduction in variable operating costs

9. Operations related Actions

  • Firstly, Restrictions on branch expansion plans; domestic or overseas
  • Secondly, Reduction in business at overseas branches/ subsidiaries/ in other entities
  • Thirdly, Restrictions on entering into new lines of business
  • Fourthly, Reduction in leverage through reduction in non-fund based business
  • Furthermore, Reduction in risky assets
  • Moreover, Restrictions on non-credit asset creation
  • Further, Restrictions on undertaking businesses as specified.
  • Finally, Restriction/reduction of outsourcing activities
  • Restrictions on new borrowings

10. Other Actions

  • Any other specific action that RBI may deem fit considering specific circumstances of a bank.

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