The government has asked the Reserve Bank of India (RBI) to consider diluting the Prompt Corrective Action (PCA) framework, to ensure that regulatory sanctions against public sector banks
(PSBs) are lifted swiftly. The framework is aimed at maintaining sound financial health of banks.
The government feels the RBI’s decision last year to tighten PCA norms put additional burden on PSBs, which had already been reeling from the increased provisioning for bad loans on their books due to the regulator’s asset quality review in 2015-16, a senior government official said.
The Centre has asked the RBI to review all three aspects of the PCA framework — minimum capital requirement, net non-performing assets, and profitability criteria.
Currently, any of the three scenarios — banks
registering net NPA level of 6 per cent, two consecutive years of negative return on assets, defined as a percentage of profit to average total assets, or the capital adequacy ratio (CAR) falling below the regulatory requirement — can prompt the RBI to put a bank under the PCA.
According to the government’s request, banks showing profitability in a single year should be a criterion for taking them out of the PCA, against the current requirement of two consecutive years.
“Further, NPA requirement should be revised to ensure that banks that have done full provisioning for their bad loans are out of the PCA. Banks have started setting aside more funds to cover anticipated losses arising out of bad loans,” the official quoted above said. The provision coverage ratio (PCR) of PSBs stood at 63.8 per cent in the first quarter of this financial year, 6.3 percentage points higher than a PCR of 57.5 per cent in 2014-15, a year before the RBI initiated its asset quality review. The PCR refers to the proportion of bad assets that has been provided for.
Sources said the government had also told the central bank to relax the minimum capital norms for banks. Banks are required to maintain a minimum capital, in terms of capital to risky asset ratio (CRAR) and common equity tier (CET)-1, to ensure they do not lend all the money they receive as deposits and keep a buffer to meet future risks.
According to the RBI, the CET-1 of banks must be at least 5.5 per cent of its risk-weighted assets (RWAs). However, the government feels that the RBI should prescribe banks to keep CET-1 at 4.5 per cent of their assets, which was stipulated by the Basel Committee on Banking Supervision while releasing its report on Basel-III norms in December 2010, according to the official. Banks will have more funds in hand to meet their growth requirements as a result of this move, the official said.
“Moving to the original Basel-III norms will ensure that the RBI will re-tune the minimum capital requirement under the PCA framework,” another official said.
Basel-III, an international regulatory framework for banks, is being implemented in India in phases since April 2013, and will be fully implemented by March 2019.
On Thursday, Department of Financial Services Secretary Rajiv Kumar expressed confidence that PSBs would come out of the PCA this fiscal year. Kumar said, “Cleaning of balance sheets has put the worst behind. Banks have made recovery of ~365 billion during the first quarter, registering 49 per cent growth over the last fiscal…I am sure banks will come out of the PCA this fiscal.”
The RBI uses the PCA as an early warning tool, to maintain sound financial health of banks, initiated once the thresholds related to capital, asset quality and non-performing assets are breached.
The PCA framework has been in place since 2002 but was revised and tightened by the RBI in 2017. Under the old rules, the net NPA ratio of banks had to breach the 10 per cent level to trigger the PCA as against the current requirement of 6 per cent. The RBI said it would revise the PCA framework in 2020.
Currently, 11 of the 21 public sector banks are under the PCA framework. These are Central Bank of India, IDBI Bank, Indian Overseas Bank, Corporation Bank, Bank of India, United Bank of India, Dena Bank, Bank of Maharashtra, UCO Bank, Oriental Bank of Commerce, and Allahabad Bank. IDBI Bank was the first one to be brought under the PCA following the RBI’s revised guidelines of 2017.
In fact, the RBI has put restrictions on all fresh lending by Dena Bank, while restricting lending to risky assets and raising high-cost deposits for Allahabad Bank after further deterioration in their performance in 2017-18.
Under the PCA, banks face severe restrictions for breaching the three risk thresholds, including curb on dividend distribution, branch expansion and management compensation. In the worst case scenario, the RBI may ask a weak bank to merge with others or wind up.