Simply, Prompt Corrective Action can be referred to as penalties on the banks when they do not comply with the regulator’s (The Reserve Bank of India here in India) guidelines.
To ensure that banks don’t collapse at any point, RBI has put some threshold limits on activities according to which RBI monitors the banks’ working and then take corrective actions on banks which are weak and troubled. So this process of taking such actions is called Prompt Corrective Action, or PCA.
The banking regulator has powers to deal with such problems. The norms for PCA allow RBI to put certain restrictions on banks such as halting branch expansion and stopping dividend payment, etc. It can even limit a bank’s lending limit (loan limit) to anyone.
PCA framework for banks was started in 2002 and has been modified recently in 2017 and the provisions of the revised PCA framework will be effective April 1, 2017 based on the financials of the banks for the year ended March 31, 2017. The framework will be reviewed after three years.
The PCA framework would apply without exception to all banks operating in India including small banks and foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
The framework allows RBI
- to remove managerial persons under Section 36AA of the Banking Regulation (BR) Act 1949 as applicable;
- to supersede the Board under Section 36ACA of the BR Act 1949, among others
How it all started?
In the 1980s and the early 1990s, the banks around the globe were in financial stress. Even in the US, many banks were closed or given financial assistance by its Central Bank. So these events led to take some corrective actions to avoid bank failures as they can have a devastating effect on the country’s economy.
Also, the closure of the medium or large banks can have adverse effects on the economy so the government tries to keep them out of debt or difficulty. One of the options is banks’ mergers rather than the banks’ closures.
How does the RBI choose bank for PCA?
RBI has set 3 trigger points and then based on these (when the banks breach the risk thresholds), one of the two actions are taken.
The trigger points are: CRAR (Capital to Risk (Weighted) Assets Ratio), NPA (Non-Performing Asset) and ROA (Return on Assets).
The 2 restrictions are either mandatory or discretionary actions.
- Mandatory restrictions are restrictions on dividend, branch expansion, directors compensation while discretionary restrictions could include curbs on lending and deposit.
In the cases of two banks (IDBI Bank and UCO Bank) where PCA was invoked recently — only mandatory restrictions were imposed.
What happens next?
The RBI imposes various restrictions on banks like borrowings from interbank market, not allowed to enter into any new business, etc. Banks will have to reduce their NPAs by launching special drives, etc.
And this is not all; RBI may use the PCA framework to identify weak banks as candidates for mergers in future. The stronger and the well-managed banks will grow. The new PCA framework will be invoked on the basis of the banks’ FY17 (2016-17) financials.
So, the Prompt Corrective Action step by RBI is a welcome step which will improve country’s banking sector and hence the economy.
* Information taken from RBI’s website, The Hindu and The Economic Times