What is PCA in banking
PCA is an important component of India’s economy. The full form of PCA is prompt corrective action. The PCA framework is applied by RBI to other banks. So the question is What is PCA in banking and why does RBI put the PCA framework on the bank? Or which banks come under this PCA framework? You will find the answers to these questions in this article.
When we look at the history of any country, we realize that a recession in a country occurs only when the banks of that country expand their operations or the banks go bankrupt. So whether it is the position of the bank, whether the banks are in profit or in loss, it is RBI’s job to wear it.
RBI keeps an eye on all banks. Banks that are in LOSS, a bank that is in a financial crisis, or a bank whose banking operations are not in order, are put in the rbi PCA framework.
In a nutshell, this means that the RBI gives the bank an opportunity to improve its operations, or the bank is given notice that you have to streamline its banking operations.
When Does The Bank Come into the PCA Framework?
After understanding What is PCA in banking now we can learn about When does the bank come into the PCA framework?
When the RBI feels that a bank does not have sufficient capital to cope with the risk, is not making a profit from the money lent, and is not making a profit, then the RBI puts that bank in ‘PCA’. So that immediate steps can be taken to improve his financial condition.
To know when a bank is going through this situation, RBI has fixed some indicators, in which fluctuations show it.
What Happens with The Bank
we understand what happens with the bank When a bank is added to the PCA framework?
- Such a bank cannot be considered a dividend to its shareholders.
- Banks cannot expand new branches.
- The bank cannot give the loan or the loan is partially or completely banned.
- RBI may also take action to merge, restructure or close these banks.
- RBI may impose restrictions on management compensation and directors’ fees of these banks.
Points to get into PCA Framework-
CRAR, NPA, and RETURN ON ASSETS. These parameters are called Trigger Points. If a bank crosses TRIGGER POINTS. So it automatically falls within the scope of this PCA Framework.
The CRAR i.e. ‘Capital to Risk Asset Ratio’ for banks is currently fixed at nine percent. CRAR shows whether a bank has sufficient capital to cope with the risk. It is calculated in proportion to the risky loan given by the bank.
If the CRAR of a bank is less than this then the financial health of that bank is considered bad. Thus CRAR is one of the three tiger points in which it is decided to put the bank in PCA in case of fluctuations.
Another reason for putting the bank in PCA is the increase in net NPAs. When a customer is unable to repay the three monthly installments of the loan taken from the bank, the loan becomes NPA.
Thus the occurrence or increase of NPAs is an indication of how much risk there is in the amount lent by the bank. If the net NPA of a bank exceeds six percent of the amount lent by it, then RBI classifies that bank as PCA.
Return on Asset
The third important tiger is ‘Return on Asset’. This means how much return a bank is getting on the money it has lent or invested somewhere. Fluctuations in this indicate whether the bank is in profit or in loss.
If the return on assets remains negative for two consecutive years, then the bank is put in PCA.
It expresses the relationship between the core capital of a banking organization and its total assets.
The tier-1 leverage ratio is calculated by dividing the Tier-1 capital by the bank’s average total consolidated assets and exposure apart from the balance sheet.
The leverage ratio is one of the many financial measures that assess a company’s ability to meet its financial obligations. Here are some examples:
Equity Ratio: This ratio reflects the total contribution of the owner to the company.
Debt ratio: This ratio reflects the total leverage used in the company.
- Debt to equity ratio: This ratio refers to the total debt used in the business as compared to equity.
Key points about What is PCA in banking
This framework applies to all banks operating in India, including foreign banks operating through branches or subsidiaries.
However, payment banks and ‘small finance banks (SFBs) have been removed from the list of lenders, where prompt corrective action may be initiated by the Reserve Bank.
The new provisions will take effect from January 2022.
o Surveillance area:
- Capital, asset quality, and capital-to-risk weighted asset ratio (CRAR), NPA ratio, and Tier I leverage ratio will be key areas for monitoring in this revised framework.
However, return on assets is not included as a parameter in this revised framework.
o Implementation of PCA
PC PCA may be applied as a result of any risk limit violation. Pressured banks will not be allowed to expand their loan/investment portfolio.
However, they are allowed to invest in government securities / other high-quality liquid investments.
In case of default on the part of the bank in fulfilling its obligations to its depositors, possible solution procedures can be resorted to without the PCA matrix.
o Powers of the Reserve Bank
- In governance matters, the Reserve Bank of India may replace the Board under Section 36ACA of the Banking Regulation Act, 1949.
Amendment to Section 45 of the Banking Regulation Act enables the Reserve Bank to implement a moratorium with the approval of the Central Government or to reconstitute or merge a bank without it.
The Reserve Bank may, as part of its mandatory and discretionary actions, impose appropriate restrictions on capital expenditure in addition to technical upgrades within the limits approved by the Board under the revised PCA.
o Eliminate PCA restrictions:
Withdrawal of imposed sanctions will be considered only if no violation of the risk limit has been observed in any of the parameters as per the four consecutive quarterly financial statements.
Quick corrective action:
PCA is a framework under which banks with weak financial metrics are monitored by the Reserve Bank.
The Reserve Bank introduced the PCA framework in the year 2002 as a structured initial-intervention mechanism for banks that were facing challenges due to poor asset quality or weakened due to loss of profitability…
This framework was revised in the year 2017 based on the recommendations of the Executive Group of the Council for Financial Stability and Development.
The objective of the PCA framework is to enable timely supervisory intervention and to make it mandatory for the supervised unit to implement remedial measures in a timely manner, in order to restore their financial health.
It aims to tackle the problem of non-performing assets (NPAs) in the Indian banking sector.
It aims to alert regulators as well as investors and depositors.
Its main goal is to combat it before the time takes a serious turn.
o Audited Annual Financial Results:
A bank will generally be placed under the PCA framework on the basis of audited annual financial results and supervisory assessment by the Reserve Bank of India.
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