Prompt Corrective Action Framework for Banks Released

The Reserve Bank of India (RBI) has come out with a revised prompt corrective action (PCA) framework for banks.

The revised norms have set out three thresholds.

The breach of the third one on capital would identify a bank as a likely candidate for resolution through tools like amalgamation, reconstruction, winding up etc.

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

The framework would be reviewed after three years.

The thresholds are based on capital, net non-performing assets, profitability and leverage ratio.

The breach of the first threshold will invite restriction on dividend distribution or require parents of foreign banks to bring in more capital. This will get triggered if capital adequacy ratio (including capital conservation buffer) falls below 10.25% or common equity tier-I (CET1) capital ratio falls below 6.75%. Breach of either CAR or CET1 would trigger corrective action. The trigger for net NPA is 6% and 4% for leverage ratio. Two consecutive years of negative return on assets (RoA) will also be classified in threshold one.

The breach of the second threshold will occur when the capital adequacy ratio falls below 7.75% or CET1 goes below 5.125%. The net NPA threshold is breach of 12% and leverage ratio below 3.5%. Three consecutive years of negative ROA will also trigger threshold two. Breach of threshold two will result in restrictions on expansion of branches and higher provisions.

The breach of the last threshold happens when CET1 falls below 3.625% and net NPA goes above 12%. Negative ROA for four consecutive years will also be considered as a breach of the third threshold vis-a-vis the profitability parameter. Restrictions, in addition to that of threshold one and two, will be put on management compensation and directors’ fees if the the third level is breached.

Corrective action that can be imposed on banks includes special audit, restructuring operations and activation of recovery plan.

Promoters of banks can be asked to bring in new management, or even can supersede the bank’s board, as a part of corrective action.