RBI’s Prompt Corrective Action doesn’t address the real problems. Outcomes, not processes, are the hallmark of a good regulator.
RBI’s new framework for Prompt Corrective Action (PCA), replacing its 14-year-old PCA, is a classic example of the triumph of hope over experience; of RBI’s faith in theoretical constructs and inability to come to terms with what is really the crux of the problem on the ground: ownership, and flowing from that, the inability of public sector banks (PSBs) to match their private sector counterparts in a host of areas, ranging from recruitment to business agility.
Today, PSBs, with their bureaucratic procedures (devised to obviate questions by the CBI, CVC, ED et al) often find themselves with a large portfolio of non-performing assets (NPAs), while their more nimble-footed private sector counterparts pare their exposures, often at the expense of the former. The dilemma in designing a solution is that harsh action against PSBs only ends up hurting the economy, read taxpayers, even more. Witness the abrupt and drastic drying up credit following the crackdown on non-performing assets. Given the dominance of PSBs in the banking sector, this impacted growth far more.
In such a scenario, it is doubtful whether merely substituting the earlier Framework with a far more complicated one will improve matters. The success of any regulator must be measured by outcomes, not by its ability to design complicated processes—much like the Basel guidelines that have become so incredibly complicated that banks now have two new (and huge!) departments, one to ensure compliance on paper and the other to find new ways of gaming the system. RBI’s PCA Mark 2 is unlikely to change much on the ground, other than increase compliance costs for banks.
Breach of any of the indicators listed in a complicated matrix of indicators would result in ‘invocation of PCA’, says RBI. It then goes on to list three Risk Threshold levels, with the severest action reserved for threshold three. In the case of ‘capital’ for instance, Risk Threshold three would be crossed if the CRAR (Capital-to-Risk Weighted Assets) or CET (Common Equity Tier 1 Ratio) falls by more than 312.5 basis points (3.125%) below the current minimum RBI prescription of 10.25%. Risk Threshold 2 would be crossed if the shortfall is more than 162.5 (1.625%) but less than 312.5 basis points. Trigger points have, likewise, been specified for asset quality, profitability and leverage.
All this sounds very scientific and precise—until one examines the outcome of the Bank’s earlier PCA regime, in operation since December 2002, cast on broadly similar lines. It clearly failed to stem the rot, as the steady decline in the financial position of banks, particularly PSBs, shows.
Unfortunately, there is little reason to expect the new framework will fare any better. Never mind the far more elaborate matrix! For instance, breach of ‘Risk Threshold 3’ in respect of the Common Equity Tier 1, defined as a CET1 of less than 3.625%, would mark the bank out as a ‘likely candidate for resolution through tools like amalgamation, reconstruction, winding up, etc.’ A dire threat. Or so it would seem. Except, amalgamating a bank in poor health with a good bank is no solution and winding-up a PSB is next-to-impossible, given political realities.
The of idea that a sub-set of PSBs can be penalised, whether by restricting operations/withholding capital and/or restricting dividend payout is naïve. To the extent that government is the majority share-holder in PSBs, anything that hurts PSBs’ profitability or dividend distribution only ends up hurting taxpayers. In case of the listed PSBs, shareholders might also be hurt but they will simply exit, and the bank will find it next to impossible to raise fresh funds, scuppering any chance of a turnaround.
The fact is that despite having a Framework for prompt, corrective action in place since December 2002, RBI’s actions in the intervening period from 2002 to 2017 have been neither prompt nor corrective, as evident from the state of the banking industry today. There could be some extenuating factors, such as government’s insistence , in the aftermath of the global financial crisis, that RBI keep monetary policy looser-than-warranted and for much longer-than warranted, contributing to the frenzy of lending.
RBI is not blameless. Some of its actions, possibly, contributed to the present stress. Consider the relaxing of exposure limits for lending to infrastructure in the aftermath of the global financial crisis. Or the Bank’s willingness to look the other way even as formal consortia arrangements for loans above a certain threshold gave way to multiple banking, allowing borrowers to play one bank against the other. RBI is now cautioning banks against exposure to the telecom sector. But it is not very long ago that it had signalled banks could lend against the security of spectrum allocation letters.
Fortunately, for RBI, few questions have been raised about its own culpability. Instead, the onus has been put squarely on the banks. The reality, however, is that RBI has much to answer for the state of the banking industry, particularly of PSBs. Not only does RBI have a director on the Board of every PSB, as the banking supervisor, it conducts a detailed inspection of banks. Consequently, it should have been entirely au fait with the build-up of NPAs much before. But for reasons best known to the Bank, it did not do very much; or if it did, its actions proved singularly ineffective.
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Global rating agency, Fitch, points out PCA Mark 2 could potentially affect more than 50% of PSBs. According to RBI data, at the end of March 2016, Central Bank of India, Dena Bank and IDBI Bank had net NPA ratios of more than 6% (Risk Threshold 1) and Indian Overseas Bank, Punjab National Bank and UCO Bank had ratios of more than 9%. Since then, the position has only worsened. Will or can RBI do anything to rectify the situation? And without embarking on remedial action that is, in many ways, worse than the disease?
Empty threats of ‘mandatory’ and ‘discretionary actions’ are likely to be far less effective than the fear of being hauled up by a sharp and informed regulator in case of errors of commission in lending and ‘criminal intent’. PCA Mark 2 showcases RBI’s naivety and its reluctance to see the reality that theoretical constructs don’t work. The triumph of hope over experience.
Author is Professor and Dean, Management Development Institute, Gurgaon.