What is Prompt Corrective Action (PCA) Framework for Banks?

Last updated on September 21st, 2023 at 04:45 pm

Prompt Corrective Action (PCA) is a defense mechanism created by RBI for monitoring and safeguarding the banks from financial collapse.

Thus the PCA is a process or mechanism under which RBI can initiate a corrective action on banks. Which involves monitoring of certain performance indicators of the banks as an early warning exercise for financial instability.

The Objective of PCA is to facilitate banks to take corrective action to restore their financial health.

When PCA is imposed on banks?

As said earlier the PCA is imposed when the performance of the bank in certain areas is not satisfactory.

Thus the Prompt Corrective Actions is imposed on banks when there is a decline in the following factors.

1. Capital
2. Asset Quality
3. Profitablity

Moreover, RBI ascertains these factors by tracking CRAR/ Common Equity Tier I ratio, Net NPA ratio and Return on Assets and Leverage.

RBI will invoke the Prompt Corrective Action on any bank even any one of the thresholds is breached by the bank.

A bank will be placed under PCA framework, based on the audited Annual Financial Results and the Supervisory Assessment made by RBI.

But RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant.

What is PCA Framework?

The Prompt Corrective Action (PCA) has three thresholds under which the banks are categorized based on the level of Downfall. They are.

1. Risk Threshold 1
2. Risk Threshold 2
3. Risk Threshold 3

Threshold 1 is the lowest level and Thereshold 3 is the highest level.

Risk Threshold 1

The Banks are placed in Threshould 1 if the bank breaches the following factors.

• Banks with a capital to risk-weighted assets ratio (CRAR) of less than 10.25 per cent but more than 7.75 per cent fall under threshold 1.
• Banks that have a Net NPA of 6 per cent or more but less than 9 per cent fall under threshold 1.
• On Profitablity Banks with negative return on assets for two consecutive years fall under threshold 1.

Risk Threshold 2

The Banks in Threshold 1 will be moved to Threshold 2 when the bank breaches the following margins.

• Banks with CRAR of more than 6.25 per cent but less than 7.75 per cent fall in the second threshold.
• If the Net NPA of the bank is more than 9% and Less than 12%, the bank is placed under threshold two.
• The bank that made negative return for consecutive three years is places in the second threshould.

Risk Threshold 3

Risk threshold is the lowest grade of the PCA and is imposed on banks on following conditions.

• In case a bank’s common equity Tier 1 (the bare minimum capital under CRAR) falls below 3.625 per cent, it gets categorised under the third threshold level.
• The Net Non Performing Asset is more than 12%.
• If the bank posted a Negative Return for more than Four Years it is placed in Threshold 3.

Restriction on Banks under PCA

Banks are to undertake certain Mandatory actions as per Risk Threshold level they breached and have to face discretionary actions from RBI, which is as under:

Risk Threshold 1

The Banks under Risk Threshold 1 are having Restriction on

• dividend distribution/remittance of profits
• Promoters/owners/parent in the case of foreign banks to bring in capital.

Risk Threshold 2

Apart from the Restriction of Threshold 1 it has following restriction.

• Restriction on branch expansion
• Domestic and/or overseas Higher provisions as part of the coverage regime

Risk Threshold 3

Along with the restrictions provided on Threshold 1 and 2 the following restrictions are imposed.

• Restriction on branch expansion
• Domestic and/or overseas Restriction on management compensation and directors’ fees, as applicable.

How Banks Come out of PCA?

Thus RBI will withdraw the PCA on bank once the bank becomes financially secured and has a stable performance.

But the bank has to perform in all the parameters namely Capital, Asset Quality and Profitability for Four consecutive quarters to come out of PCA.

The restriction implied by RBI on the Banks are to make sure the banks does not dissipate its capital into the supplementary areas.

Conclusion

Prompt Corrective Action is implied on the banks that are weak in the balance sheet. Thus it does not mean the bank is going to crumble.

All the actions are RBI is to prevent such Exstream scenarios. Hence you don’t need to worry when the bank is put on PCA.

In contrary it is actually better for banks to be on PCA. Though there are many restrictions, this will help the banks to generate capital for functioning.