NBFCs To Get Equally Treated As Banks Under Prompt Corrective Action By RBI

The Reserve Bank of India (RBI) has introduced Prompt Corrective Action for NBFC’s as a punitive action against the lenders in case their capital adequacy ratio falls or Non Performing Assets (NPA’s) rise above certain threshold limits.

But Before We Begin Concepts To Know

Prompt Corrective Action

Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. The PCA framework deems banks as risky if they slip below certain norms on three parameters — capital ratios, asset quality and profitability.

What Is Non Performing Assets(Npas)

NPA expands to Non- Performing Assets (NPA). Reserve Bank of India defines NPA as any advance or loan that is overdue for more than 90 days. “An asset becomes non-performing when it ceases to generate income for the bank,”

Why This Step By RBI ?

• RBI has said in its notification that this framework is first in its kind for NBFCs and will come in to effect from next year October.

• PCA seeks to put a bank, whose financial parameters are out of kilter, back on the rails. The framework is intended to encourage banks to eschew certain riskier activities and focus on conserving capital so that their balance sheets can become stronger.

• RBI puts a Bank under PCA if they breach any one of the three risk thresholds under the three indicators that it tracks – capital, asset quality and leverage.

• Under PCA, RBI asks a lender to take corrective actions, including preparing a time bound plan for reduction of bad loans; make higher provisions for bad loans/ investments; restrict/ reduce credit for borrowers below certain rating grades and restrict/reduce unsecured exposures, among others.

• Additionally, the central bank can also ask a bank to submit plans for raising additional capital; restrict investment in subsidiaries/ associates; restrict expansion of high risk-weighted assets to conserve capital. RBI can also seek resolution of the bank by amalgamation or reconstruction.

• Then there are mandatory actions prescribed by RBI such as restriction on dividend distribution/ remittance of profits; requiring promoters to bring in capital; and restriction on branch expansion; and restriction on directors’ or management compensation, as applicable.

• The central bank’s action comes after multiple jolts to the financial system in the last three years starting with the collapse of IL&FS in September 2018. The collapse of IL&FS has been followed by the bankruptcy of Dewan Housing Finance Ltd (DHFL) in 2019 and the Kolkata based Srei Group and Anil Ambani controlled Reliance Capital this year.

• In a notification on its website the RBI said the PCA framework for NBFCs has been put in place “to further strengthen the supervisory to 

How Successful It Has Been?

Between February 2014 and September 2019, 13 banks, 11 in the public sector and two in the private sector were under the PCA Framework.

 Now, barring one bank, all others have been taken out of PCA by RBI’s Board For Financial Supervision (BFS) as their promoters infused capital and the banks upped loan loss provisions. They also focussed on recovery of bad loans and re-oriented their portfolio towards less capital consuming segments such as retail.

Central bank of India, currently the only Bank under PCA, has written to RBI requesting that it be taken out of PCA as it is no longer in breach of the four parameters (capital, asset quality, profitability and leverage) under the 2017 PCA framework.

Its Impact on NBFCs

• The RBI is gradually harmonising the regulations of NBFCs with those of banks. It has decided to put in place a scale-based regulatory framework with effect from October 01, 2022.

• Further, it has prescribed a phased introduction of a liquidity risk management framework for NBFCs, including a liquidity coverage ratio (LCR). Capital adequacy and asset quality, the key factors influencing balance-sheet resilience, is what the RBI will assess when referring NBFCs to the PCA framework.

• The graded restrictions under the framework will enable NBFCs to take corrective action when they breach stipulated thresholds. That would reduce the chances of insolvency. Experts do not expect any mid or large NBFCs to face immediate challenges given their comfortable capitalisation levels.

• They also opine that the regulator has provided reasonable transition time for the NBFCs to strengthen their balance sheet and reduce the net NPA levels.

The PCA Framework

There are three risk thresholds in the PCA framework for NBFCs. An NBFC under PCA framework, caused by triggering the first threshold, will be restricted on dividend distribution, promoters will be asked to infuse capital and reduce leverage.

The RBI will also restrict issuance of guarantees or taking other contingent liabilities on behalf of group companies, in case of core investment companies. After hitting risk threshold , the NBFC will be prohibited from opening branches, while on risk threshold capital expenditure will be stopped, other than for technological up gradation.

PCA will be imposed if the net non-performing assets is between

• 6-9 per cent (risk threshold1),

• 9-12 per cent (risk threshold 2)

• Greater than 12 per cent (risk threshold 3).

If the capital adequacy ratio falls 300 basis points from the current level of

• 15-12 per cent (risk threshold 1),

• 300-600 bps from 12-9 per cent (risk threshold 2) and

• by 600 bps from 9 per cent (risk threshold 3), then PCA will be imposed.

There will be other issues such as heightened regulatory supervision and inspections. The RBI will also actively engage with the board of the NBFCs on various aspects as deemed appropriate by the central bank.

RBI’s View

According to the RBI, NBFCs have been growing in size and have substantial inter-connectedness with other segments of the financial system. “Accordingly, a PCA framework for NBFCs has also been put in place to further strengthen the supervisory tools applicable to NBFCs,” it said. The RBI said the objective of the framework is to enable supervisory intervention at appropriate time and require the supervised entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.