What is PCA?

It is a regulatory and remedial mechanism and correctional strategy designed by RBI, intended for implementation towards resurrecting a commercial bank that exhibits symptons of a progressive downward trend in its operational parameters and quality of assets. It diagnoises and identifies the symptoms of an impending crisis developing in the banking institution and responds towards arresting and preventing further decadence on the one hand and promoting quick resurgence through timely restorative measures.

The study Report of RBI analyses the issue as under:

"The 1980s and early 1990s were a period of great stress and turmoil for banks and financial institutions all over the globe, viz. Brazil, Chile, Indonesia, Mexico, several Nordic countries, Venezuela and USA, etc. In USA, more than 1600 commercial and savings banks insured by the Federal Deposit Insurance Corporation (FDIC) were either closed or given FDIC financial assistance during this period. More than 900 Savings and Loan Associations were closed or merged with assistance from Federal Savings and Loan Insurance Corporation (FSLIC) during 1983 to 1990. The cumulative losses incurred by the failed institutions exceeded US $ 100 billion. These losses resulted in the insolvency and closure of FSLIC and its replacement by the Resolution Trust Corporation (RTC) and the Savings Association Insurance Fund (SAIF).

"These events led to the search for appropriate supervisory strategies to avoid bank failures as they can have a destabilising effect on the economy. For this reason, medium sized or large banks are rarely closed and the governments try to keep them afloat. In both industrial and emerging market economies, bank rescues and mergers are far more common than outright closure of the banks. If banks are not to be allowed to fail, it is essential that corrective action is taken well in time when the bank still has adequate cushion of capital so as to minimise the cost to the insurance fund / public exchequer in the event of a forced liquidation of the bank. In this context, supervisory action can be at two levels:

1. "early stage recognition of problems and corrective actions

2. "supervision and monitoring of troubled banks

"Identifying problem banks early is one of the responsibilities of bank supervisors. The other responsibility is to monitor the behaviour of troubled banks in an attempt either to prevent failure or to limit losses.

"These objectives are sought to be achieved by establishing various trigger points and graded mandatory responses by the supervisors. This represents partial replacement of regulatory discretion by rules, as the prescribed actions are generally likely to be a mix of mandatory and discretionary actions. The case for automatic rules is that it will contain regulatory forbearance (i.e. hoping that problems will solve themselves) - which has been a very common complaint against the supervisors - and will lead to prompter action. Prompt actions are important as the cost of restructuring / liquidation of a bank is likely to rise, the longer that action is delayed."

Under the powers conferred under RBI Act, 1934 and Banking Regulation Act, 1949, Reserve Bank has been taking bank-specific supervisory corrective actions where the financial position warrants such measures. These included directing banks to submit quarterly Monitorable Action Plans and progress reports on various targets set by the Reserve Bank, such as augmentation of capital, improvement in profitability, reduction of NPAs, reconciliation of entries in inter-branch, inter-bank and nostro accounts, review / renewal of borrowal accounts, etc. In extreme cases, Reserve Bank had also put caps on credit-deposit ratio, restrictions on payment of dividend, call money borrowings and refinancing with high cost deposits including Certificate of Deposit, ban on recruitment and opening of branches, etc. Where the financial position so warrants, Reserve Bank effects changes in the management of banks by removal of the Chief Executive Officer or Directors of the Board. In addition, RBI appoints additional Directors / Observers to oversee the functioning of the bank so as to prevent the affairs of the bank being conducted in a manner detrimental to the interest of present or future depositors. RBI also exercises powers in extreme cases to place banks under moratorium or initiate winding up proceedings.

Though there are explicit provisions (Sections 35A, 36AA, 36AB, 37, 46 to 48 of Banking Regulations Act, 1949) empowering Reserve Bank to initiate appropriate corrective actions against banks which are showing signs of distress, these are not properly structured and no time limit is set for response to such actions in the case of definite weaknesses in banks. It is, therefore, necessary that clearly-defined and rule-based corrective actions consisting both mandatory and discretionary directives/guidelines should be formulated, which are transparent for addressing early warning signals.

In the light of analysis of the ground situation prevailing in our country, RBI has felt the need to put in place a rule-based PCA regime, as a part of its commitment to adopt the international best practices and comply fully with the Core Principles.

The PCA or the rule-based framework prevalent in USA and other countries focuses on the need to prevent insolvency of banks by taking corrective actions well in time. It is, however, considered desirable to build a broader PCA regime in India so as to delineate rule-based actions not only for shortfall in capital but also for other indicators of deficiency so that a seamless paradigm for corrective actions can be put in place for major deficiencies in banks' functioning.

Accordingly, a schedule of corrective actions has been worked out based on three parameters i.e. CRAR, Net NPAs and Return on Assets (RoA) which represent the three important parameters, viz. capital adequacy, asset quality and profitability. Certain trigger points have been determined for the PCA framework under the three parameters taking into the practicability of implementation of certain measures in the Indian context.

Trigger points have been set up under all the three parameters, i.e. CRAR, Net NPAs and Return on Assets (RoA). Composite Rating, being the supervisor's assessment of the overall condition of a bank, has not been taken as a trigger point. Composite Rating is a combined assessment based on the rating given on each component of CAMELS, viz. capital adequacy, asset quality, management, earnings, liquidity and systems and controls. Presently, supervisory ratings and actions taken based on such ratings are not made public. The triggers based on CRAR, Net NPAs and ROA take care of a bank's performance in three critical areas which are quantifiable and forming integral part of the rating framework.

For every trigger point a set of mandatory and discretionary PCAs have been laid down. The PCAs are designed to pre-empt any deterioration in the soundness of banks. Any actions, without duly recognising the diverse profile and factors contributing to the problems in banks, however, may not achieve the desired effect. The PCA should, therefore, encompass certain actions, which should bring immediate improvements, while some action points would be initiated in alignment with the severity of the problem. Thus, a set of Mandatory and Discretionary action points, in conformity with the magnitude of problems should be in place to bring about improvement in the functioning of banks. The rationale for classifying the rule based action points into Mandatory and Discretionary is that some of the actions are essential to restore the financial health of banks while other actions will be taken at the discretion of RBI depending upon the profile of each bank. In cases where banks do not show improvement, despite taking mandatory actions, some of the discretionary actions will get converted into mandatory actions. However, in exceptional cases, RBI will have the right to waive mandatory provisions.

The published balance sheets, off-site returns and on-site inspection reports may be the primary sources for identifying the banks which could be placed under the PCA framework. If a bank's performance under any of the four broad parameters has crossed the trigger point, permission of the Board for Financial Supervision (BFS) will be taken for placing any bank under corrective action programme. Such permission will also include specific mandatory action and those of discretionary actions, which in the opinion of BFS, may be applied to the bank.

The total PCA framework for a bank has been determined by aggregating the PCAs under the various parameters. Full details are furnished in the next webpage. It applies to all commercial banks, excluding RRBs and has been advised by RBI to all the Commercial banks vide their communication No.DBS.CO.PP.BC.9/11.01.005 / 2002-03 dated December 21, 2002. The schme is to be implemented initially for a period of one year and will be reviewed at the end of the year 2003.