Prompt Corrective Action: RBI’s dilemma and government’s helplessness

The finance ministry is continually making a case for relaxing PCA norms, insisting that public sector banks will then have the freedom and money to infuse liquidity in a cash-strapped banking system. The RBI, meanwhile, insists that these PCA norms are needed to keep banks in check, especially in the current jittery scenario.

Dec 14, 2018 11:12 IST India Infoline News Service

Like a deer registering danger with perked up ears, the RBI tightened the prompt corrective action (PCA) framework, placing a lending freeze on several banks reeling under stressed balance sheets. However, these measures have come to the head, adding to the existing liquidity crunch in the market. 

The finance ministry is continually making a case for relaxing PCA norms, insisting that public sector banks will then have the freedom and money to infuse liquidity in a cash-strapped banking system. Moreover, they are also hoping that this will allow these beleaguered banks to buy off the debt of NBFCs. The RBI, meanwhile, insists that these PCA norms are needed to keep banks in check, especially in the current jittery scenario.

Hold on. Before we jump the gun, why had the RBI pulled the strings on PCA norms in the first place? How does it affect banks? And, how compelling is FM’s argument asking RBI to loosen the rules?

First off, what is PCA?

To see to it that banks do not go bust, RBI has put in some triggers. This barometer monitors, measures, and controls banks suffering financial weakness, initiating corrective action against them. This action is termed Prompt Corrective Action, or PCA.
How though are the restrictions decided upon? The bank’s health is assessed based on its capital adequacy ratio, asset quality, and profitability.

So, why did the RBI tighten these PCA rules?

Public sector banks have been under pressure in the last few years, mainly on the back of debilitating asset quality, careless credit off-take, and believing in debt-ridden companies. These banks have also been the worst hit, mainly because of heavy corporate lending and exposure to distressed sectors such as infra, power, steel, and textiles. Further, scams like the 11,500cr Nirav Modi scam and Rs9,000cr Vijay Mallya loan default case has exacerbated the situation of some banks.

As the phenomenon of bad loans (together accounting to about Rs3lakh cr), weak capital levels, and low return on assets continued to balloon, the RBI decided “enough is enough.” It placed 11 of its 21-owned banks under the PCA framework. This included Bank of India, Central Bank of India, IDBI Bank, UCO Bank, Dena Bank, Oriental Bank of Commerce, Indian Overseas Bank, Bank of Maharashtra, Corporation Bank, United Bank of India, and Allahabad Bank.

In April 2017, RBI tightened its noose around these banks. As per its discretion, it placed restrictions on banks’ dividends, branch expansion, and lending. It also directed banks to take up special drives that reduces the stock of NPAs and limits the generation of fresh NPAs. Besides, if warranted, it also insists on audits and restructuring.

Despite these curbs, RBI claimed that toughening these PCA norms was no cause to panic. It insisted that this shouldn’t be considered as a punishment. Instead, it was intended to facilitate the banks to take corrective action for restoring their financial health.

But, can RBI dissolving PCA norms be considered a pragmatic move?

A vicious circle? Past experience suggests that in India and other countries, if such constraints are not put in place, banks overlook bad loans, extending the debt of borrowers who may have otherwise defaulted. Thus, pretence becomes the norm. However, on the other hand, banks argue that PCA leads to banks suffering and being in bed without medication. They lose creditworthy customers because they can’t lend to them, affects resource mobilization, that is, their growth and in turn, their income.

Under PCA, creditworthy borrowers are the king! Incidentally, in a speech at IIT Bombay, Deputy Governor Viral Acharya stated that credit growth in banks under PCA from 2008-2014 was as strong as that of other PSU banks. These banks generally lend to high-risk borrowers to augment their credit. But, due to this, they tend to ignore healthier borrower, which affects their asset quality. Hence, PCA restrictions keeps these banks in check, forcing them to cut back on lending and mainly deal in government securities and with creditworthy borrowers.

Can NPA-laden banks bail out NBFCs? Banks are reportedly already reeling under the pressure of bad loans worth Rs10lakh cr. In this scenario, the government’s expectation that banks will pull out the NBFC sector from this precarious situation seems far-fetched. Moreover, bank credit to NBFCs is already high and banks taking on more risk would be ill-advised. Besides, the government is already finding it difficult to pump in capital in its troubled banks. The latest updates on the issue, however, indicate that the government is only looking at making changes to align PCA with international standards and not exactly relaxing the norms.

Long story short...yes, it’s true that the NBFC issue could further spiral out of control, spelling doom for the economy. However, this would require the government to come up with some other solutions.

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