RBI brings NBFCs under PCA Framework

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    In News

    • The Reserve Bank of India (RBI) has decided to bring non-banking finance companies (NBFCs) under the ambit of the prompt corrective action (PCA) framework.

    About

    • RBI had introduced a PCA framework for scheduled commercial banks in 2002 and the same has been reviewed from time to time.

    Changes made in NBFC sector

    • Time frame: The PCA framework for NBFCs will come into effect from October 1, 2022, based on the financial position of NBFCs on or after March 31, 2022.
    • Restrictions: NBFCs will face restrictions when certain parameters like non-performing assets, capital adequacy ratio and Tier 1 capital fall below the stipulated levels.
    • Application: The revised PCA framework is applicable to all deposit-taking non-banking financial companies (NBFCs), all non-deposit taking NBFCs in the middle, upper and top layers, including investment and credit companies, core investment companies, infrastructure debt funds, infrastructure finance companies and microfinance institutions.
    • Exclusion: It has excluded NBFCs not accepting/not intending to accept public funds, primary dealers and housing finance companies along with government-owned ones.
    • Supersede the board: The central bank can even supersede the board under the RBI Act, appoint an administrator and send the NBFC to NCLT for insolvency resolution.
    • Review: The PCA framework will be reviewed after three years of being in operation.

    There are three risk thresholds in the PCA framework for NBFCs

    • First threshold: will be restricted on dividend distribution, promoters will be asked to infuse capital and reduce leverage. The RBI will also restrict issuance of guarantees or taking other contingent liabilities on behalf of group companies, in case of core investment companies.
      • PCA will be imposed if the net non-performing asset is between 6-9 per cent.
      • If the capital adequacy ratio falls 300 basis points from the current level of 15-12 per cent.
    • Threshold 2: the NBFC will be prohibited from opening branches.
      • A net non-performing asset is between 9-12 per cent.
      • If the capital adequacy ratio falls 300-600 bps from 12-9 per cent
    • Threshold 3: capital expenditure will be stopped, other than for technological upgradation.
      • A net non-performing asset is greater than 12 per cent.
      • If the capital adequacy ratio falls by 600 bps from 9 per cent.

    Issues/ Challenges

    • Collapse of big firms: The RBI decision has come after four big finance firms IL&FS, DHFL, SREI and Reliance Capital which collected public funds through fixed deposits and non-convertible debentures collapsed in the last three years despite the tight monitoring in the financial sector.
    • Intervention: The RBI will also actively engage with the board of the NBFCs on various aspects as deemed appropriate by the central bank.
    • Supervision and inspections: There will be other issues such as heightened regulatory supervision and inspections.
    • Hinders the sectoral growth: In view of the above regulatory changes, ICRA expects the sectoral growth to be impacted in the near term, as entities tighten their credit norms and operational focus shifts towards collections.

    Significance

    • Growth: According to the RBI, NBFCs have been growing in size and have substantial inter-connectedness with other segments of the financial system.
    • Strengthen the supervisory tools: A PCA framework for NBFCs has also been put in place to further strengthen the supervisory tools applicable to NBFCs.
    • Restoring the financial health: The RBI said the objective of the framework is to initiate and implement remedial measures in a timely manner, so as to restore its financial health.
    • Effective market discipline: The PCA framework is also intended to act as a tool for effective market discipline.
    • On par with banks: This brings them almost on a par with banks in terms of supervision and regulatory reach.

    Way forward

    • Tight NPA recognition norms for NBFCs: Recently, the RBI has made NPA recognition norms for NBFCs tighter bringing them at par with banks.
    • Stop bad lenders: This is a welcome move, for it will stop bad lenders from going worse rather than brushing the issue aside.
    • Safer overall financial system: Ultimately, since NBFCs are now more closely integrated with the banking system than ever before, safer NBFCs also translate to a safer overall financial system.

    Prompt Corrective Action (PCA) framework

    • Introduction: The RBI’s PCA Framework was introduced in December 2002 as a structured early intervention mechanism along the lines of the US Federal Deposit Insurance Corporation’s PCA framework.
    • Banks under this framework: In the past, IDBI Bank, Indian Overseas Bank and Central Bank of India were put under the PCA framework. The first two banks are out of PCA, while the Central Bank of India is still under the watch of the RBI.  
    • Objectives: The objective of the PCA Framework is to enable Supervisory intervention at appropriate time and require the Supervised Entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.
      • The PCA Framework is also intended to act as a tool for effective market discipline.
      • It refers to the central bank’s watch list of weak banks.
      • PCA entails curbs on high-risk lending, setting aside more money on provisions and restrictions on management salary.
    • Does not preclude the Reserve Bank of India: The PCA Framework does not preclude the Reserve Bank of India from taking any other action as it deems fit at any time, in addition to the corrective actions prescribed in the Framework.
    • Application: The PCA Framework would apply to all banks operating in India including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
    • Assessment: A bank will generally be placed under PCA Framework based on the Audited Annual Financial Results and the ongoing Supervisory Assessment made by RBI.
    • Time period: RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances warrant.

    Source: IE