Hello Folks, here we come with our one more important article related to banking which can be flashing in news now a days. So lets have a look what it is.
What it is?
Imagine one fine day you wake and read in the newspaper that the bank where all your life time deposits are stored has been closed. Most people will have a heart attack. Well, you need not to worry because RBI has put in place some trigger points to assess, monitor, control and take corrective actions on banks which are weak and troubled. The process or mechanism under which such actions are taken is known as “Prompt Corrective Action or PCA”
History -- Why it came into action?
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 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.
Scheme of Prompt Corrective Action
RBI has set trigger points on the basis of CRAR, NPA and ROA. Based on each trigger point, the banks have to follow ‘structured action plan also called mandatory action plan’. Apart from this, the supervisor, i.e. RBI has discretionary action plans too. 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.
Before moving forward let us see what these abbreviations stand for.
CRAR is the acronym for Capital to Risk weighted Assets Ratio, a standard metric to measure balance sheet strength of banks. OR Capital to Risk (Weighted) Assets Ratio (aka Capital adequacy ratio), a ratio of a bank's capital to its risk.
NPA stands for non-performing assets. For example loan defaults and bad debts fall in this category.
ROA stands for return on assets. It is the percentage of net income generated with respect to average total assets.
• CRAR less than 9%, but equal or more than 6%
• CRAR less than 6%, but equal or more than 3%
• CRAR less than 3%
• Net NPAs over 10% but less than 15%
• Net NPAs 15% and above
ROA below 0.25%
Going into details of each and every action required for a trigger point will be quite lengthy. Just to have a feel of the actions required to be taken by the bank in case the ROA falls below 0.25% are
• Bank will not access / renew costly deposits and CDs
• Bank will take steps to Increase fee-based income
• Bank will take steps to contain administrative expenses
• Bank will launch special drive to reduce the stock of NPAs and contain generation of fresh NPAs
• Bank will not enter into new lines of business
• Bank will reduce / skip dividend payments
• RBI will impose restrictions on the bank on borrowings from interbank market
• Bank will not incur any capital expenditure other than for technological up gradation and for such emergent replacements within Board approved limits
• Bank will not expand its staff / fill up vacancies
May it be public sector bank or private sector bank, the RBI has stringent control mechanism for monitoring the health of the banks. In worst case scenario, RBI has the power to merge one bank with another. PCA mechanism ensures that your hard earned money remains in safe and sound.
In the past, RBI has placed restrictions on seven banks which include Oriental Bank of Commerce, Dena Bank, Central Bank of India, IDBI Bank, Indian Overseas Bank, Bank of Maharashtra and UCO Bank. The RBI has also clarified in the past that banks are placed under PCA to facilitate them to take corrective measures to restore their financial health.
Last week, RBI had placed similar restrictions on Corporation Bank. This makes Bank of India ninth bank to face restriction in a span of 10 months.