RBI's Prompt Corrective Action (PCA) Framework

Prompt Corrective Action (PCA) for Government NBFCs

Context (MINT I HBL): RBI has decided that the Prompt Corrective Action (PCA) framework will apply to Government NBFC except those in the base layer with effect from October 1, 2024.

NBFCs are classified into four categories based on their size, activity, and perceived riskiness:
1. Base Layer NBFCs
2. Middle Layer NBFCs
3. Upper Layer NBFCs
4. Top Layer NBFCs

The RBI PCA considers banks risky if they fall below certain thresholds on three parameters:
1. Asset Quality / Non-Performing Assets (NPAs)
2. Capital (BASEL Capital Adequacy Ratio (CRAR))
3. Leverage (BASEL Tier 1 Capital Ratio)

The RBI can invoke a corrective action plan in breach of the risk thresholds.

NPAs are loans that cease to generate income for lenders due to borrowers’ failure to repay principal and interest within 90 days.
There are different types of NPAs depending on how long they remain in the NPA category, including sub-standard assets, doubtful assets, and loss assets.
- Sub-standard Assets: Assets that have been classified as NPA for a period of 12 months or less.
- Doubtful Assets: Assets that have been NPA for more than 12 months.
- Loss Assets: These are loans where the bank or auditor has identified losses but the amount has not been written off wholly repaid.

Capital to Risk (Weighted) Assets Ratio (CRAR) indicates a bank’s ability to meet its obligations.
The minimum ratio of CRAR is 8% under Basel II and 10.5% under Basel III.
A high CAR indicates that a bank has a large enough financial cushion.

Tier 1 and tier 2 capital are two types of assets banks hold.
Tier 1 capital refers to a bank’s core capital, which includes equity capital and disclosed reserves.
It is used to measure a bank’s capital adequacy and is the primary funding source of the bank.
This capital can absorb losses immediately when they occur, allowing the bank to continue operating.
Under Basel III, a bank’s Tier 1 capital must be at least 6% of its risk-weighted assets.

The PCA Framework, established by the RBI in 2002, ensures the stability of banks and NBFCs.
In 2022, it was extended for most NBFCs, excluding government NBFCs.

Now, the PCA framework applies to:
- All Scheduled Commercial Banks except Regional Rural Banks, Payment Banks, and Small Finance Banks.
- Most NBFCs, including government NBFCs.

PCA allows timely supervisory intervention and requires entities to implement remedial measures to restore financial health.

2002: RBI Governor Bimal Jalan introduced PCA for Scheduled Commercial Banks, excluding Regional Rural Banks (RRBs).
2018: NABARD implemented a separate PCA framework for RRBs with its own set of regulations.

NBFCs are categorised into Risk Categories 1, 2, or 3 (The higher the number, the higher the risk), based on their capital, loan-asset quality, and other factors.

Banks in the PCA list can be removed from it by improving their Non-Performing Assets (NPAs), enhancing capital adequacy, and increasing profitability.

The RBI introduced the Supervisory Action Framework for Urban Co-operative Banks in 2012.
This framework is similar to the Prompt Corrective Action used for commercial banks.

The RBI established the Regulations Review Authority (RRA 2.0) in 2021 for banks and NBFCs.
The purpose of this authority is to streamline RBI rules and regulations.