Prelims Level
Mains Level
Prelims Syllabus : Economy Mains Syllabus : Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

In News:

  • After Reserve Bank of India (RBI) lifted restrictions under prompt corrective action (PCA) on three public sector banks last week of January 2019, Finance Minister said the government will try to help lift the restrictions on other public sector banks too.

Explained:

PCA Framework:

  • PCA framework was started in 2002 to regulate activities of the banking sector
  • Its objective is to facilitate banks to take corrective measures including those prescribed by RBI, in timely manner to restore their financial health. PCA framework is supervisory tool of RBI, which involves monitoring of certain performance indicators of banks to check their financial health as early warning exercise and to ensure that banks don’t go bankrupted. 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 PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs
  • PCA framework is invoked on banks when they breach any of three key regulatory trigger points (or thresholds).
  • They are capital to risk weighted assets ratio, net non-performing assets (NPA) and Return on Assets (RoA), Asset Quality, Profitability, Leverage – of the banks
  • It also provides opportunity to RBI to pay focused attention on such banks by engaging. With focusing more closely in those areas.
  • Depending on risk thresholds set in PCA framework, banks are put in two type of restrictions, mandatory and discretionary depending upon their placement in PCA framework levels. The mandatory restrictions are on dividend, branch expansion, director’s compensation while discretionary restriction include curbs on lending and deposits. At present, 8 weak PSBs out of the 21 State-owned banks are under the PCA, recently 3 (Bank of India, Bank of Maharashtra and Oriental Bank of Commerce) PSB got out of PCA framework making it to a total of 8

NEED For PCA Framework

  • Due to the adverse impact on the economy, medium sized or large banks are rarely closed and the governments try to keep them afloat for this PCA kind of framework needed
  • If banks are not to be allowed to fail, it is essential that corrective action is taken well in time when the bank still has adequate cushion of capital to minimize the losses. If these asset stressed banks are not properly taken care off then its bankruptcy will create a chain reaction in the economy setting off job losses, share market down and loss of credibility in public sector banks

What are the restrictions faced by banks in this Framework?

  • The PCA framework prescribes five levels of trigger points based on capital measures, i.e. total risk-based capital ratio,

The five PCA categories are

  • Well capitalized
  • Adequately capitalized
  • Undercapitalized
  • Significantly undercapitalized, and
  • Critically undercapitalized.
  • On bank reaching the levels of undercapitalized, or significantly undercapitalized, or critically undercapitalized, automatic restrictions, as per provisions of Section 38 of FDI Act, are placed on the concerned bank in respect of
  • Payment of capital distributions and management fees
  • The growth of assets
  • Requiring prior approval of certain expansion proposals
  • Requiring that the RBI monitor the condition of the bank, and
  • Requiring submission of a capital restoration plan.
  • In addition to the above restrictions and close monitoring, the significantly undercapitalized and critically undercapitalized banks are restricted to pay compensation to senior executive officers of the institution. The critically undercapitalized bank is, in addition to above, required to take prior approval from RBI in respect of – entering into any material transaction other than in the usual course of business, such as any investment, expansion, acquisition, sale of assets, or other similar action; extending credit for any highly leveraged transaction; amending the institution’s charter or bylaws; making any material change in accounting methods; paying excessive compensation or bonuses; paying significantly high interest on new or renewed liabilities; making any principal or interest payment on subordinated debt beginning 60 days after becoming critically undercapitalized; and engaging in any covered transaction. In addition, RBI may further restrict the activities of the critically undercapitalized bank.
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