The RBI’s ‘prompt corrective action’ (PCA) framework suggests a greater willingness to regulatory action to address problems of struggling banks, Fitch Ratings said today. However, its implementation is only likely to be effective if it is matched by credible plans to address banks’ significant asset quality issues and capital shortages, it said.
The RBI has tightened the thresholds — for capital ratios, NPLs, profitability and leverage – at which banks enter the PCA framework. “This appears to be an acknowledgement of the significant asset quality stress in the system and that more banks are in need of regulatory intervention,” the US-based agency said. It said PCA was previously viewed as an extraordinary step, which the RBI urged banks to make great efforts to avoid. That now looks likely to change.
“More than half of state-owned banks would breach at least one of the new thresholds, mainly owing to high NPLs, based on their latest financial reports,” it said. The gross NPAs of public sector banks have risen from Rs 5.02 lakh crore at the end of March 2016 to Rs 6.06 lakh crore in December 2016. The new PCA framework will be invoked on the basis of the banks’ 2016-17 financials.
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The RBI has also given itself greater discretion in terms of the measures it can use to intervene in banks once they fall under the PCA framework, which suggests it has recognised a need to take corrective action at an earlier stage when banks run into difficulties. Fitch said the previous PCA, in contrast, explicitly reserved the most interventionist actions for banks that had breached more extreme thresholds.
“It is possible that intervention could involve forcing banks to conserve capital, if other actions do not address problems. The risk of non-performance on bank capital instruments may therefore have risen,” it said, adding the actual impact of the new rules will depend on how the RBI uses them. The RBI has recently tightened the PCA rules requiring regulatory action on lenders if they fall short of capital or exceed bad loan limits.
According to PCA framework, banks are assessed on three grounds– asset quality, profitability and capital ratios. Not meeting the requirements in any of these parameters could lead to RBI action on banks. The actions could include stricter norms for lending, branch expansion, management change and asset reduction.
“These circulars might weigh on bank earnings in the next round of reports. Should the additional disclosures reveal weaknesses that are greater than expected, there could be further pressure on the banks’ Viability Ratings,” the agency said.
Under the amended PCA norms the scope for possible regulatory actions has been broadened, but it remains uncertain to what extent the RBI will use the tools it has just made available, it added
“The RBI may use the PCA framework to identify weak banks as candidates for mergers. State Bank of India took over five smaller lenders earlier this month, and further consolidation could be part of the overall strategy to clean up the banking system. However, mergers would also require the support of the government,” Fitch said.