PCA FRAMEWORK REVISED

PCA FRAMEWORK REVISED

CONTEXT

Capital Adequacy Ratio (CAR)

The CAR is a measure of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures.
The Capital Adequacy Ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to protect depositors and promote the stability and efficiency of financial systems around the world.

Tier 1 Leverage Ratio:

It is the relationship between a banking organization’s core capital and its total assets.
The tier 1 leverage ratio is calculated by dividing tier 1 capital by a bank’s average total consolidated assets and certain off-balance sheet exposures.
- A leverage ratio is any one of several financial measurements that assesses the ability of a company to meet its financial obligations.Some of the examples are :
  - Equity Ratio : This ratio indicates total owner contribution in the company.
  - Debt Ratio : This ratio indicates total leverage used in the company.
  - Debt To Equity Ratio : This ratio indicates total debt used in the business in comparison to equity.

Recently, the Reserve Bank of India (RBI) has announced a revised Prompt Corrective Action (PCA) framework. The PCA framework enables supervisory intervention of RBI over Banks at an appropriate time and ensures effective market discipline.

PROMPT CORRECTIVE ACTION

Prompt Corrective Action Plan are the RBI suggested measures that should be a taken by banks when certain financial indicators like capital adequacy ratio and NPAs goes worsen beyond a level.
RBI has issued a policy action guideline in the form of Prompt Corrective Action (PCA) Framework if a commercial bank’s financial condition worsens below a mark. The PCA framework specifies the trigger points or the level in which the RBI will intervene with corrective action. This trigger points are expressed in terms of parameters for the banks.
The parameters that invite corrective action from the central bank are
- Capital to Risk Weighted Asset Ratio (CRAR)
- Net Non-Performing Assets (NPA) and
- Return on Assets (RoA)
- Leverage ratio
When these parameters reach the set trigger points for a bank (like CRAR of 9%, 6%, 3%), the RBI will initiate certain structured and discretionary actions for the bank. As per the revised framework by the RBI, in April 2017, capital, asset quality and profitability continue to be the key areas for monitoring. Along with this, leverage of banks also will be monitored.

REVISED FRAMEWORK

Revised Framework scheduled commercial banks, which will be applicable from January 1, 2022.
New PCA framework would apply to all banks operating in India including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
Monitored Areas
- Capital, Asset Quality and Capital-To-Risk Weighted Assets Ratio (CRAR), NPA ratio, Tier I Leverage Ratio, will be the key areas for monitoring in the revised framework.
- However, the revised framework excludes return on assets as a parameter that may trigger action under the framework.
Invocation of PCA
- The breach of any risk threshold may result in the invocation of the PCA. Stressed banks may not be allowed to expand credit/investment portfolios.
- However, they are allowed to invest in government securities/other high-quality liquid investments.
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.
Withdrawal of PCA Restrictions
- 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.