The government has petitioned the Reserve Bank of India (RBI) to water down the Prompt Corrective Action (PCA) framework which imposes strict regulatory curbs on public sector banks to ensure their financial health. Cash-strapped banks have been struggling to expand their lending base on account of the central bank’s directive aimed at keeping their stressed assets in check.
The RBI had tightened PCA norms last year, adding to stress in the sector. Banks’ bad loan provisioning rose after the regulator’s asset quality review in 2015-16. In February, the central bank issued a circular to the effect that it was tightening norms to be followed in identifying and stressed assets.
The government wants the RBI to review all three aspects of the PCA framework, namely net non-performing assets, minimum capital requirement and profitability criteria. At present, it can impose sanctions on banks for not meeting either of these three clauses in the PCA.
Under the regulatory framework, banks with a net NPA level exceeding 6 percent, two consecutive years of negative returns on assets, or those with a capital adequacy ratio (CAR) below the minimum requirement, are liable to face sanctions curtailing their ability to issue fresh loans.
The government wants banks showing profitability in a single year to be taken out of the PCA as opposed to the requirement of two consecutive years. It also wants banks that have already made full provisioning for bad assets to be removed from the ambit of PCA. Banks have already adhered to the RBI’s February diktat, listing more bad loans as NPAs.
Banks’ provision coverage ratio (PCR) for Q1 FY19 was 63.8 percent, over 6 percentage points higher than FY15 PCR of 57.5 percent. Banks were forced to report and provision more bad loans in the aftermath of the RBI’s asset quality review in 2015. The PCR is defined as the proportion of stressed assets that have been provided for by banks.
The Business Standard reports the government had sought relaxation of minimum capital norms for banks. The RBI requires banks to maintain a minimum level of capital with it, which is measured in terms of capital to risky assets ratio (CRAR) and the common equity tier (CET) 1. This ensures that banks do not lend all money they receive from depositors and acts as a buffer in the event of a run on the bank.
The government is of the opinion that banks should be allowed to keep CET-1 at 4.5 percent of total risk-weighted assets (RWA), as opposed to the prevailing minimum requirement of 5.5 percent. According to Basel-III norms, the minimum CET-1 requirement is 4.5 percent of RWA.
The Basel Committee on Banking Supervision released a report in 2010, prescribing measures to bolster the health of banks and diminish the possibility of bank failure induced by indiscriminate lending. It was formulated after the financial crisis of 2008, where many banks in the US went under. By moving to Basel-III, banks will have more leeway in lending and asset formation.
The RBI has been gradually implementing Basel-III norms in phases, with the first tranche of reforms coming into effect on April. All Indian banks are expected to be Basel-III compliant by March next year. The government remains defiant that the worst is over for public sector banks. Banks recovered Rs 36,500 crore in Q1 FY19. By bringing state-run banks out of the PCA framework, they will be able to deliver modest growth in the coming fiscal.
The PCA framework was first adopted in 2002, but was later updated in 2017. Under the old regime, the net NPA ratio had to be in excess of 10 percent to trigger the PCA. At present, even if the net non-performing asset (NPA) ratio breaches the six percent mark, PCA norms will be enforced. The next revision to the PCA framework is set to happen in 2020.
State-run banks have fallen afoul of the PCA norms. Of the 21 public banks, 11 are under the PCA. These include Bank of India, Indian Overseas Bank, IDBI Bank, UCO Bank and Bank of Maharashtra. The RBI has put fresh lending restrictions on Dena Bank.
By coming under the PCA, banks will be encumbered in adding new branches, dividend distribution and management compensation. If the situation deteriorates further, the RBI can ask weak banks to merge with others.