By Vignesh Ganesh, G.J. Advani Law College, Mumbai.

India has been under the grip of a banking crisis since a while now. With State-controlled institutions dotting the financial landscape, a large number of these institutions have a bad loan ratio that is almost twice as bad as their private counterparts. Non-performing assets (NPAs) continue to rise faster, with some banks having NPAs making up for more than ten percent of their advances. Credit growth continues to hit new lows and banks faced with these burdensome assets aren’t very eager to lend.

To combat this crisis and to ensure that banks do not go bust, the Reserve Bank of India (RBI) has set out to take some corrective actions on banks that are facing troublesome conditions. The RBI has put in place certain trigger points and parameters to assess and monitor the health of banks and in response to the results, corrective actions will be taken. This process is known as Prompt Corrective Action (PCA).

With some banks believed to be too large to fail, the Government of India believes in keeping financially burdened behemoths afloat rather than closing them down. Thus, bank mergers and bailouts are far more common than outright closures. It would be in the best interests of the economy if preventive measures are taken to provide banks with essential and adequate cushion to minimize their losses. This is where Prompt Corrective Action comes in.

What is Prompt Corrective Action based on?

The RBI has structured certain trigger points on the basis of some parameters like Capital to Risk (Weighted) Asset Ratio (CRAR) (a measure to test the balance sheet’s strength), Net Non Performing Assets (NPA) and Return on Assets (ROA). If a bank sets off a trigger point, it has to follow the respective action plan to deal with the problem. PCA sanctions are categorized as “mandatory” and “discretionary” as some actions are mandatory for improving the financial health of banks, while other actions are implemented on the basis of the RBI’s discretion upon the profile of each bank.

Under PCA’s norms, if a bank triggers a point, it is not allowed to renew or access costly deposits or take steps to increase its fee-based income. Also, a special drive has to be launched by the Bank to reduce the accumulation of NPAs and limit the generation of new NPAs. RBI has prevented such banks from entering new lines of businesses and restrictions have been imposed on these banks from borrowing from other banks.

With the norms of Prompt Corrective Action being imposed on a few public sector banks like IDBI Bank, Indian Overseas Bank, Central Bank of India, Bank of Maharashtra, etc., restrictions like the halting of branch expansion, limitation of the bank’s lending limit to a particular entity or sector, stopping dividend payments, restructuring operations, superseding a bank’s board , etc. are some measures among others, wielded by the RBI, to prevent the further fracturing of these banks. But these measures have definitely raised eyebrows.

The All India Bank Officers Confederation (AIBOC) has questioned the implementation of these measures to regulate the working of banks. The organization states that most of the loans have become NPAs because of the sanctions of board-level executives consisting of RBI representatives and members nominated by the Central Government. It also states that instead of looking at the miserable plight of the NPA position of these banks, the Government would do better by bringing in a specific and stringent law that empowers banks to initiate legal action against wilful defaulters. Over and above that, with the Government torn between its commitment to see that PSU banks are never cash starved and its commitment to maintain fiscal discipline, friction arises between the Government and the RBI, when the Government meddles in the functioning of the RBI through the Ministry of Finance.

In the month of January, 2018, the RBI initiated prompt corrective action against the Allahabad Bank over the vast amount of bad loans the bank had accumulated. With high net NPA and a negative ROA for two years in a row, the Allahabad Bank joined a growing line of institutes, along with the Bank of India, which was placed under the PCA framework the previous month itself, following an on-site inspection under the Risk Based Supervision Model, carried out for year ended March, 2017, and the report issued thereof.

Taking the Bank of India as an example, the RBI placed the Bank of India under its PCA framework in the month of December, 2017. The reason for this can be owed to the fact that the bank had high NPAs, insufficient common equity tier 1 capital (CET 1) and negative ROA.

The PCA framework placed restrictions on dividend distribution and remittance of profits, branch expansion and management compensation and these restrictions depended on the bank’s risk threshold. The framework also called for higher provisioning coverage and made it mandatory for the promoters to infuse capital into the bank.

With the implementation of varying degrees of PCA on a number of banks under the authority of the RBI in full swing, a number of banks have improved the strength of their balance sheets in the quarters following the crisis period. Over and above that, the Government has taken steps to initiate financial reforms to bring the banking industry and credit growth back on track.

Conclusion

The PCA mechanism gives the RBI the required powers to clean up the mess the banking system is in. With financial experts and economists analyzing and interpreting the legal and financial ramifications of the Government’s measures, there is no doubt that Prompt Corrective Action is the best possible method we have, to resolve the NPA crisis of banks. With the first step having been taken, a lot depends on how swiftly the RBI and Government can act to implement fresh measures of PCA.