Prompt Corrective Action (PCA) is a tool used by the Reserve Bank of India (RBI), to take action against banks which indicate poor and weak financial health. The PCA is based on primarily 4 parameters which the RBI evaluates to assess and monitor the financial health of a bank. If any of the parameters benchmark is breached indicating growing level of financial stress, the RBI jumps into action putting restrictions on certain operations of the bank. PSU Banks have increasingly come under the RBI’s PCA in the last couple of years after reporting high NPAs and corresponding provisions eroding their bottomline.
The Four Performance Parameters:
1. Capital Adequacy Ratio (CAR) - It is the amount of capital that a bank has to hold as required by its financial regulator to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. It is the measure of a bank’s capital cushion in relation to its risk weighted assets (CRAR). As per Basel-III regulations, RBI has directed Indian scheduled commercial banks to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12%.
2. Asset Quality - It is defined as the net Non Performing Assets of the bank, net of provisions. If the net NPA of the bank crosses 6%, RBI will trigger the first level of PCA.
3. Profitability - RBI evaluates the profitability of a bank based on its Return on Asset (RoA). If a bank reports a negative RoA for two consecutive years, the RBI will initiate the first level of PCA. In case of 3 consecutive years of negative ROA, the second level of PCA is triggered.
4. Total Debt level (Leverage) – It is used to measure the financial risk of the bank. The RBI will initiate first level PCA if the total leverage crosses 25 times the Tier-I capital. (Tier 1 capital consists of shareholders' equity and retained earnings)
Levels of Prompt Corrective Action
1. First Level- The RBI will impose restriction on the quantum of dividend that a bank can declare as well as repatriation of profits by foreign banks. Promoters can be called upon to infuse fresh capital.
2. Second Level- This includes measures in addition to those under the first level. Additional measures include restriction on domestic and overseas expansion of bank branches and higher provisions for asset impairment.
3. Third Level- This is triggered when the situation becomes very grave. RBI will impose restrictions on pay hikes, directors’ fees, annual increments and new recruitments. Senior management remuneration and compensations will come under intense constraint. Extreme measures may include mergers and acquisition and sale of bank’s strategic assets.