Govt seeks dilution of PCA framework, shift to Basel III standards

The government has filed a request with the Reserve Bank of India (RBI) to weaken the Prompt Corrective Action (PCA) framework that imposes stringent rules on public sector banks to ensure their financial health. Banking banks were struggling to expand their lending because of the central bank's directive, aimed at keeping their stressed assets in check.

Last year, the RBI tightened the PCA standards, which increased the stress in the sector. The provision for bad loans from banks increased after reviewing the asset quality of the regulator in 2015-16. In February, the central bank published a circular with the aim of tightening up the standards that must be followed when identifying and highlighting assets.

The government wants the RBI to revise 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 complying with one of these three clauses in the PSO.

Under the regulatory framework, banks with a net NPA level of more than 6 percent, two consecutive years of negative return on assets, or those with a capital adequacy ratio (CAR) below the minimum requirement, they may be faced with penalties that affect their ability to provide new loans.

The government wants banks that show profitability in one year to be taken out of the PCA, in contrast to the requirement of two consecutive years. It also wants banks that have already made full provisions for bad assets to be removed from the PCA sphere. Banks have already taken the February February issue of the RBI, with more bad loans as NPAs.

The funding ratio (PCR) for banks for Q1 FY19 was 63.8 percent, more than 6 percentage points higher than FY15 PCR of 57.5 percent. Banks were forced to report and offer more bad loans in the aftermath of the RBI's asset quality review in 2015. The PCR is defined as the percentage of stressed assets provided by banks.

Business Standard reports that the government had sought to relax the minimum capital standards for banks. The RBI requires banks to hold a minimum capital, which is measured in terms of capital / risky assets ratio (CRAR) and the common equity tier (CET) 1. This ensures that banks do not borrow all the money they receive from savers and acts as a buffer in the case of a run on the bank.

The government is of the opinion that banks should hold CET-1 at 4.5 percent of the total risk-weighted assets (RWA), in contrast to the applicable minimum requirement of 5.5 percent. According to Basel III standards, the minimum CET-1 requirement is 4.5 percent of the RWA.

The Basel Committee on Banking Supervision published a report in 2010 specifying measures to improve the health of banks and to reduce the possibility of bank failure through random lending. It was formulated after the financial crisis of 2008, where many banks in the US went under. By switching to Basel III, banks will have more leeway in lending and capital formation.

The RBI has gradually implemented the Basel III standards in stages, with the first tranche of reforms coming into effect in April. It is expected that all Indian banks next year next March will be Basel-III compliant. The government remains challenging that the worst is over for banks in the public sector. Banks recovered Rs 36,500 crore in Q1 FY19. By getting state banks out of the PCA framework, they will be able to achieve modest growth in the coming fiscal year.

The PCA framework was first approved in 2002, but was later updated in 2017. Under the old regime the net NPA ratio had to be more than 10 percent to activate the PCA. PCA standards are currently enforced, even if the ratio of net non-performing assets (NPA) exceeds the limit of six percent. The next review of the PCA framework will take place in 2020.

State banks have fallen against the PCA standards. 11 of the 21 public banks are covered by the PSO. These include Bank of India, Indian Overseas Bank, IDBI Bank, UCO Bank and Bank of Maharashtra. The RBI has imposed new credit restrictions on Dena Bank.

By falling under the PCA, banks are burdened with the addition of new offices, dividend payments and management compensation. If the situation deteriorates further, the RBI may ask weak banks to merge with others.

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