New PCA framework for banks from January

Stressed banks may be prohibited from expansion of credit portfolio and asked to restrict outsourcing activities, going by the Reserve Bank of India’s revised prompt corrective action (PCA) framework.

A bank prohibited from expansion of credit/investment portfolios under PCA will, however, be allowed to invest in government securities/other high-quality liquid investments.

As per the extant framework, the RBI can ask a bank under PCA to only restrict/reduce credit expansion for borrowers below certain rating grades, reduce exposure to unsecured borrowers, among others. But it does not prohibit expansion of credit/investment portfolios.

The RBI said it would monitor three key areas — capital, asset quality and leverage — in the revised framework and breach of any risk threshold may result in invocation of PCA. Under the extant framework, the RBI also monitors profitability, besides the aforementioned areas.

Exit from PCA

The provisions of the revised PCA framework, which will be effective from January 1, 2022, clearly specify the conditions under which the central bank will allow exit from PCA and withdrawal of restrictions under PCA.

Taking a bank out of PCA framework and/or withdrawal of restrictions imposed will be considered if no breaches in risk thresholds in any of the parameters are observed as per four continuous quarterly financial statements, one of which should be Audited Annual Financial Statement (subject to assessment by RBI).

Further, this will be based on the supervisory comfort of the RBI, including an assessment on sustainability of profitability of the bank.

The revised framework incorporates resolution of a PCA bank by Amalgamation or Reconstruction (under Section 45 of Banking Regulation/BR Act 1949).

This follows amendment to Section 45 of the BR Act, which enables the Reserve Bank to reconstruct or amalgamate a bank, with or without implementing a moratorium, with the approval of the Central government.

Per the extant framework too, a breach of ‘Risk Threshold 3’ of Common Equity Tier I capital by a bank would identify it as a likely candidate for resolution through tools like amalgamation, reconstruction, winding up, etc.

In the case of a default on the part of a bank in meeting the obligations to its depositors, possible resolution processes may be resorted to without reference to the PCA matrix.

The RBI, as part of its mandatory and discretionary actions, may also impose appropriate restrictions on capital expenditure, other than for technological upgradation within Board approved limits, under the revised PCA.

The current provisions relating to imposition of restriction on dividend distribution/ remittance of profits, promoters/owners/parent (in the case of foreign banks) being required to bring in capital, and restriction on branch expansion, domestic and/or overseas, will continue under the revised PCA framework.