Central Idea

The RBI has announced the extension of the Prompt Corrective Action (PCA) framework to Government Non-Banking Financial Companies (NBFCs), excluding those in the Base Layer, starting from October 1, 2024.

PCA Framework Expansion

Scope: Government-owned NBFCs, such as PFC, REC, IRFC, and IFCI, will now fall under the PCA framework.
Impact: These NBFCs will face restrictions on dividend distribution and profit remittances. Promoters and shareholders will have limitations on equity infusion, and leverage reduction will be required. Issuing guarantees or taking contingent liabilities on behalf of group companies will also be restricted.

Definition: The PCA Framework is a watchlist of banks identified as financially weak by the central bank.
Regulatory Measures: When a bank falls under PCA, the regulator imposes restrictions on its operations, such as curbs on lending activities.
Coverage: The PCA Framework applies exclusively to commercial banks and does not extend to cooperative banks or non-banking financial companies (NBFCs).
History: The RBI introduced the PCA Framework in December 2002 as an early intervention mechanism, inspired by the US Federal Deposit Insurance Corporation’s PCA framework.
Last Update: The revised PCA framework came into effect on January 1, 2022.
Monitoring Areas: The revised framework places a heightened focus on capital adequacy, asset quality, and leverage.
Risk Threshold: The RBI has updated the level of capital adequacy ratio shortfall that triggers classification into the “risk threshold three” category.

Capital-to-Risk Weighted Assets Ratio (CRAR): CRAR measures a bank’s capital in relation to risk-weighted assets. If CRAR falls below 9 percent, the RBI takes action, including the submission of a capital restoration plan, restrictions on business activities, and dividend payments. Additional steps may follow if CRAR is below 6 percent but equal to or above 3 percent.
Net Non-Performing Assets (NPA): If net NPAs exceed 10 percent but remain below 15 percent, the RBI initiates measures to reduce bad loans and strengthen credit appraisal skills.
Return on Assets (RoA): If RoA drops below 0.25 percent, restrictions are imposed on deposit renewal, access to costly deposits and CDs, and the bank’s entry into new lines of business.

Growing Significance: NBFCs have witnessed substantial growth and have strong linkages with various financial segments.
Supervisory Enhancement: In 2022, the RBI introduced the PCA framework for NBFCs to strengthen supervisory tools. The objective is to facilitate timely supervisory intervention and mandate corrective actions to restore financial health.
Market Discipline: The framework serves as a mechanism for effective market discipline, ensuring that NBFCs adhere to financial prudence.