• HDFC securities
• 28 Jun 2018
• Knowledge Centre,Life Insurance

With many PSU banks witnessing disappointing Q4 numbers, the chances of the central bank adopting more stringent measures, in addition to bringing more banks under the Prompt Corrective Action (PCA) framework, are high.

 

Steps involved

 

Banks under PCA would be scrutinized on the basis of asset quality, capital, and profitability. The three main triggers on which immediate action will be taken are:

 

• The bank’s CRAR or capital-to-risk-weighted assets ratio (measures the strength of the bank’s balance sheet),
• NPA or non-performing assets (refers to loans that are in jeopardy of default), and
• ROA (percentage of profit a company earns as a measure of its total resources or assets).

Banks have to follow a mandatory pre-determined action plan if any of these triggers are visible. Apart from this, the central bank also has discretionary action plans. This includes stipulations such as:

 

• Giving banks access to costly deposits and CDs,
• Steps to increase fee-based income,
• Restrictions on administrative expenses, 
• Reduction in banks’ NPAs, 
• Caution to avoid the generation of fresh ones. 
• Banks will be disallowed to foray into any new business.
• Banks will reduce or avoid dividend payment, and
• Restrict bank borrowings from the interbank market.

 

Looking at the advantages

 

However stringent the rules, PCA brings with it a number of positives. For one, it authorizes the regulators to close undercapitalized banks (having insufficient capital for efficient operations) and provides the necessary guidelines for doing so. There is a provision of a 90-day closure that allows for an unhurried process.

 

Though it is believed that the PCA label does not affect banks’performance, this feature is viewed with anxiety by the banking sector. This is largely owing to the belief that banks under RBI’s PCA structure will be adversely impacted because of the imposition of curbs on lending. Currently, 11 public sector banks are under the PCA framework. These include:

 

• Central Bank of India,
• IDBI Bank,
• Indian Overseas Bank,
• Corporation Bank, 
• Bank of India, 
• United Bank of India, 
• Dena Bank, 
• Bank of Maharashtra, 
• UCO Bank, 
• Oriental Bank of Commerce and 
• Allahabad Bank.

 

Grim picture

 

Public sector banks with a strong possibility of coming under the PCA umbrella have appealed to the RBI to postpone the imposition of restrictions on their lending. In order to strengthen their case, a number of PSU banks – nine as of now – have submitted a two-year recovery plan to the Government. In another move to cut costs, banks have been pulling down the shutters of a number of their ATMs. RBI data reveals that banks shut down 2000 ATMs across the country between May 2017 and February 2018.

 

Summarizing the situation, Deepak Jasani, Head of Retail Research, HDFC securities Ltd says, “Banks under PCA account for 20% of advances in the system. Fresh lending restrictions on these banks mean that they could lose their existing prime customers, and be left with the not-so-good ones. This will make their turnaround more difficult. However, the RBI is in an unenviable position as it has tried various measures in the past which have had little impact.”

 

“Talks on the street suggest the possibility of an additional four to five banks being added to the PCA list. Global experience suggests that a large portion of these banks (more than 40%) are closed, while others take more than three years to get back on track. In a country like India, the closure of banks is unheard of, especially in the PSU space. In the meanwhile, private banks and small finance banks could benefit from this predicament faced by these banks and gain market share,” he adds.

However severe, PCA promises to works as a positive measure, as it brings about an improvement in PSU banks’ internal functioning and control. It is viewed as a move to maintain the financial health of these banks in an otherwise bleak scenario.