Research Paper

IMPACT OF PROMPT
CORRECTIVE ACTION
(PCA) FRAMEWORK

Subject-Managerial Economics
Submitted To- Ms. Sushmita

Parangat Kapur,
Roll No. - 18100,
BMS 1-A,
SSCBS
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 ACKNOWLEDGEMENT

It gives me immense pleasure to present the research paper on

the topic ‘Impact of Prompt Corrective Action (PCA)
Framework’. It would not have been possible without the kind
support of my teacher in charge, Ms. Sushmita under whose
guidance and constant supervision the project was brought to
the present state.

Parangat Kapur

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 IMPACT OF PROMPT CORRECTIVE ACTION (PCA)
FRAMEWORK

Parangat Kapur, Roll No. 18100, BMS 1-A

Abstract
Prompt Corrective Action is a framework issued by the Reserve Bank of India (RBI) to ensure good
financial health of the banks. This framework comes into force when a bank breaches risk thresholds
for areas of monitoring set up by the RBI, viz., capital adequacy, asset quality and profitability, in
order to take corrective action to maintain sound financial health in a timely manner. This paper
attempts to talk about and compare financial situation of the banks before and after they were placed
under the PCA Framework. This paper also mentions about the various methods which are used to
place a bank under the PCA framework. The mandatory and discretionary actions being taken up by
the RBI for the banks which were placed under this framework which hit the trigger points to
improve the situation are also mentioned in this research paper.

Keywords: financial health, risk thresholds, capital adequacy, asset quality, mandatory and discretionary
actions

Paper Submission Date: March 24, 2019

1. INTRODUCTION

T he Prompt Corrective Action (PCA) framework is set up by RBI for the banks which
are weak in terms of certain parameters which are asset quality, capital adequacy and
profitability. It is a framework which was started by the RBI to ensure the stable
performance of the banks and to ensure they don’t report poor and risky results and
performance so as to maintain financial discipline in the banking sector. In 2014, United
Bank of India was place under the watch of RBI. In 2017 RBI revised the PCA
framework to tackle the rising NPA situation and deteriorating asset quality. It came up
with the objective of tightening the functioning of the underperforming banks, which
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seemed to be necessary as the NPA (non performing assets) of the state run banks rose
from 5.5 lakh crore at the end of June 2016 to 6.3 lakh crore in September
2016.Moreover bad loans summed up to about 80 billion US Dollars that was about 15%
of the loans given at that time. As on September 2018, 11 of the public sector banks
(PSB’s) and 1 private sector bank were placed under the ambit of this framework. The
banks are placed under this framework on the basis of the supervisory assessment report
by the RBI and the annual audited financial statements. The trigger points are set on the
basis of asset quality (net NPA), capital adequacy (capital to risk weighted asset ratio
CRAR), profitability (return on assets ROA) and Tier 1 Leverage ratio. If the trigger
points are hit by the banks they are considered risky under the PCA framework and
require immediate action.
RBI can put restrictions on the compensation of the management, expansion of branches
and also on the distribution of dividends to ensure that the money is used in improving
the condition of the banks rather than distributing it among the owners and managers. It
may also put restriction on the borrowing from the interbank market and may restrict
entry of the banks into new lines of business. Restrictions may also be placed on the
credit given by the banks under the PCA to borrowers with low credit rating, but it
doesn’t imply complete ban on the lending activity of the PCA banks .In some rare cases
RBI may take an action to merge or shut down the banks if it is found suitable to improve
the financial situation of the banks.
The challenges and issues regarding the PCA Framework is that, it is such a serious
action that hits the reputation of the banks very hard. It results in reduction in consumer
confidence as well as in ratings of the bank. It raises questions on the management of the
bank and can lead to irrecoverable loss of market share. Central government is asking for
easing the lending norms while RBI is saying it is necessary to improve the situation. In
January 2019, three banks after improving their results were able to come out of the PCA
by showing positive results which are as follows: Bank of Maharashtra (BOM), Oriental
Bank of Commerce (OBOC) and Bank of India (BOI) and many stands in queue to come
out of this framework. RBI said that the Bank of India and the Bank of Maharashtra have
managed to maintain the capital adequacy and also was able to maintain recquired net
non performing asset ratio. But in case of Oriental Bank of Commerce the net bad loan
ratio was above the risk threshold set by the RBI, but government helped in bringing
down the ratio by infusing necessary capital. In December 2018, capital infusion of Rs
10,000 crore for Bank of India, Rs 5,500 crore for Oriental Bank of Commerce and Rs
4500 crore for Bank of Maharashtra helped the banks in exiting the PCA framework. But
the RBI didn’t considered return on assets as the banks would have to report losses for
2019 as well, thus, violating threshold of no losses for straight two years but RBI may
have felt that losses would reduce or the profits will be earned.

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2. Literature Review

Shinde and Kaveri V.S. (1992), performed analysis on the non-performing assets and
explained all the related programmes conducted on “Management of Non-Performing
Advances”. They also talked about the importance of early detection of warning signals
and timely follow up recquired to prevent an advance becoming a non performing
advance.
Debanth (1994), he analyzed how commercial bank manages non-performing assets. He
observed that the banks are ineffective in management of credit and suggested new
approach of management to tackle the problem.
Urjit Patel (2000), it highlighted the problem of growth of NPA’s in banks and bad loans.
He talked about adopting effective lending practices by banks with high NPA’s and
mentioned about adopting transparent guidelines and practices and following stringent
methods of disclosure.
Roopak Kumara Gupta and Ekta Sikarwar (2010), they mentioned about the competition
the public sector banks are facing from the private sector banks. They also mentioned that
the asset quality is also an important factor which can be ascertained by calculating
NNPA (net Non performing Assets) ratio. Lower the ratio, higher the asset quality of the
bank. Asset quality tells about the credit risk associated with the loan and investments
and off balance sheet transactions.
Viral V Acharya (2012), outlines about how important is the PCA framework for the RBI
to maintain financial stability network and also gives details about the mandatory and
discretionary actions. It also gives details about the performance of PCA banks in India
by comparing various ratios across different years. It also mentions growth in advances in
the banking sector to check the capital adequacy as well as asset quality of the PCA
banks.

3. Objectives of the Study

 To know the before and after financial position of the banks which were placed under
the PCA framework.
 To know what are the parameters within which the RBI can take actions to improve
the weak financial position of the banks.
 To analyse and learn about the performance of PCA banks in India.
 To gain thorough knowledge about the Prompt Corrective Action Framework

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4. Research Methodology

The information available at the official website of the RBI is the major source with the
help of which analysis and the information is presented. Secondary data available at
various news websites and articles published are studied to write this research paper.
Since major decisions regarding the PCA took place recently, majority of the paper is
related to the projections and the information made available by the RBI and other trusted
sources. Majority of the information which is available over the internet is presented. The
12 banks available under the framework will be analyzed and will be divided in two
groups i.e. performers and underperformers to check the effectiveness of this Framework.

5. Features of Revised PCA and Risk Thresholds Set Up By RBI

Features-Capital adequacy, asset quality and profitability are the parameters of

monitoring the banks. Capital adequacy would be tracked by CRAR (capital to risk
weighted asset) or Common Equity tier ratio 1. Asset quality would be tracked by Net
NPA ratio and profitability by calculating by Return on Assets. Leverage ratio would also
be monitored under the PCA Framework. Invocation of PCA would occur if any of the
risk thresholds are breached. Small banks as well as foreign banks will be placed under
the PCA Framework and the regulation depending upon the level of breach of
parameters. A bank is placed after considering the audited statements of performance and
RBI’s supervisory assessment. However, RBI may impose PCA on any bank during the
course of a year (including shifting from one threshold to another) according to the
circumstances.
How to calculate the ratios:

1. NNPA ratio- Net NPA’s divided by net advances.

2. CRAR- Banks Tier 1 capital + Banks tier 2 capital divided by risk weighted assets
ratio.

3. RoA - profit after tax divided by total average ratio.

4. CET 1 ratio- Core equity capital and net adjustments (regulatory) divided by total risk
weighted assets ratio.

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5. NNPA ratio- Net NPA’s (In %) divided by net advances.

Risk Thresholds set up by RBI-

Area Level 1 Level 2 Level 3

CRAR/CET1 CRAR>=7.75% CRAR>=6.25% -

but but
(CAPITAL) CRAR<10.25% CRAR<7.75% -
CET1>=5.125% CET1>=3.625% CET1<3.625%
but CET1<6.75% but
CET1<5.125%

ASSET NNPA>=6% but NNPA>9=%

NNPA<9% but NNPA>=12%
QUALITY
NNPA<12%

Continuously, Continuously,
RETURN ON Continuously,
Return for 3 years Return for 4 years in
ASSETS(ROA) Return for 2 years in negative. negative
in negative

Leverage ratio is Leverage ratio is

LEVERAGE
greater than equal less than 3.5%
RATIO -
to 3.5 % and less
than equal to 4%

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 Breach or level 3 thresholds leads to merger or winding up of the banks (CET 1).

6. Mandatory and Discretionary Actions

Mandatory Actions
If risk threshold 1 is breached, it invites action under PCA Framework which is
restriction on the distribution of dividends and in case of foreign banks the
owners/parent/promoters are told to bring in decent amount of capital to take corrective
action to manage the situation.
If risk threshold 2 is breached, in addition to the mandatory actions taken by the RBI
under risk threshold 1, RBI can restrict the branch expansion in domestic areas as well as
overseas places too. They are also supposed to maintain large amount of provision as part
of the coverage regime.
If risk threshold 3 is breached, addition to the mandatory actions taken by the RBI under
risk threshold 1 and 2, RBI can put considerable amount of restriction on the distribution
of management compensation and/or director’s fees applicable.
Bank of India reported a provision coverage ratio of 76% in December 2018 which is the
highest among the banks and Bank of Maharashtra announced provision of Rs 4,538
crore and also accelerated provision against doubtful and substandard and almost
complete provision against accounts which are facing l proceedings for solvency at
National Company Law Tribunal. These two are the two banks out of the many which
were placed under the PCA framework in calendar year 2017-18.

Discretionary Actions

1. Supervisory related

 Regular supervisory meetings of the banks.

 Audit of the banks

2. Strategy related

3. Governance related

 RBI should take part in activities which are considered important with the board of the
bank
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 RBI should recommend the owners to bring in new board or management for the bank.

4. Capital related

 Review of board level planning should be done in detail.

 Plans and proposals should be submitted for raising the extra recquired capital.
 Banks should be told to maintain huge amount of reserve.

5. Credit risk related

 For the reduction of stock of NPA’s, time bound plan and commitment should be
prepared.
 Plan should be made for restricting the generation of NPA’s
 Strengthening the mechanism for loan revision.

6. Market risk related

 Restriction on accessing and renewing costly deposits and the certificate of deposits.
 Borrowings from the inter-bank should be reduced or restricted.

7. HR related

 Restriction on the expansion of staff

 Review of specialized training recquired for the staff.

8. Profitability related

 Restrictions on capital expenditure, other than the upgradation of technology within

Board approved limits.
 Restrictions on payment of dividends

9. Operations related

 Restrictions on branch expansion plans overseas as well as domestic.

 Restriction should be placed in entering the new lines of business

RBI reserves the right to take any action other than the actions mentioned which it may
find necessary.

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7. Analysis-Financial Situation of the Banks Before/After PCA
Framework

The financial situation is tested in terms of the parameters which are CRAR as per
BASEL III norms (capital adequacy ratio), Net NPA’s, Return on Assets and profit after
tax (profitability).It is tested after analysis of the parameters over different time periods.
According to the analysis of the 12 banks placed under the PCA Framework, the list of
the 12 banks is divided into performers and underperformers.

PERFORMERS:
These include the banks that after being placed under the framework have been able to
improve their results on the basis of above mentioned parameters. It was able to happen
because of the extra restrictions placed by the RBI and the safe play or the cautiousness
of the banks.

1. Allahabad Bank

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2. Bank of India

Since the introduction of PCA framework Bank of India started showing better results
and was one of the three banks which exited the PCA Framework. Profit after tax
improved in June quarter 2018 to Rs 95.11 crores from the loss of Rs. 3969.27 crore in
March quarter 2018. Return on Assets stood at 0.06% after two quarters of negative
returns. CAR = 11.4 per cent. Net NPA’s also reduced since the implementation of PCA
Framework.

3. Bank of Maharashtra

Since the introduction of PCA framework in June 2017, Bank of Maharashtra started
showing better results and was one of the three banks which exited the PCA Framework.
Return of Assets stood at 0.07% in September quarter 2018 after straight 10 quarters of
negative returns. CAR as per Basel III norms stood at 9.87% which reduced by 1.21%
percent from last quarter. It showed profit of Rs 27 crore in September quarter 2018. Net
NPA’s witnessed a fall of about 1.59% in last quarter.

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4. Oriental Bank of Commerce

Since the introduction of PCA framework in June 2017, Oriental Bank of Commerce
started showing better results and was one of the three banks which exited the PCA
Framework. Profit after tax increased by about 125% from (-) Rs393.21 crores to Rs
101.74 crores. Return on Assets stood at 0.16% after being negative for about 7 quarters
straight. Capital Adequacy Ratio stood at 10.35%. NPA stood at just over 10% at
10.35%.
5. Dhanalaxmi Bank

It is the only private sector bank which was placed under the PCA Framework in
November 2015. Since then its losses has reduced considerably. It posted a loss of about
24.87 crores in March quarter 2018. Return on Assets worsened and stood at (-) 0.2%.
The only positive point about Dhanalaxmi Bank is that it has fewer NPA’s compared to
other PCA banks. In September 2018 NPA/s stood at only 2.92% (which is not
mentioned in the schedule).

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6. UCO Bank

Its profit after tax stood at (-) RS 633.88 crore. Return on Assets stood weak at about
(-) 1.1 %. CAR as per Basel III norms stood at 9.18%. Net NPA’s was about 12.74% in
June quarter 2018. It’s situation before and after the PCA framework has been more or
less same.
7. Corporation Bank

Corporation Bank has improved its performance since being placed under the purview of
PCA Framework. It showed a profit of about Rs 84.96 crore in Q1 of the financial year
2019.Capital Adequacy Ratio (CAR) = 8.46 per cent. NPA’s stood at 11.46% showing
rise of 0.73% (this information is not mentioned in the schedule given above). Net NPA’s
stood at 7.32% as of June 2018.
UNDERPERFORMERS:
These include the banks that after being placed under the framework have not been able
to improve their results on the basis of above mentioned parameters. Considerable
amount of restrictions were placed. Some of the banks are improving but that is not
enough despite of the capital infusion done by the government from time to time.

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1. Central Bank of India

2. Dena Bank

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3. IDBI Bank

4. United Bank of India

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5. Indian Overseas Bank

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8. Analysis- Performance of the PCA banks in India
There are majorly two factors to be considered capitalisation and the asset quality.
1. Capitalisation-

CRAR and Tier-1 capital ratio has been declining for PCA banks (from 2011) and is
restricted from and is better than internationally approved parameters. It is also important
to mention that the PCA banks had lower CRAR and Tier 1 Capital Ratio in relation to
the other banks i.e. private as well as Non PCA banks.

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2. Asset Quality-

Up until 2014, both the GNPA and NNPA ratios for both the Non PCA and PCA banks
had same results. NNPA AND GNPA increased after the AQR for PCA banks compared
to Non PCA banks. Stressed assets also suggested that the NPA’s are increasing at PCA
banks compare to non- PCA banks.

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Observations are presented to know about the effectiveness of the framework
1. Recapitalisation-

Since 2005 government has helped PSB’s with Rs 2301 (billion) and more than 50 %
(Rs635 billion) has been infused in PCA banks. So the recapitalisations have been the
major contributor in the financial stability of the PCA banks and the financial sector.
2. Preventing further Deterioration-

PCA banks have continuously shown a rise in advances despite the worse capital
situation and stressed asset ratio until 2014. However, since the asset quality review was

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conducted the growths in advances have declined by over 10% in year 2014 and have
reached the contraction zone in year 2016 and remained there since then. Given the
problem of asset quality and capital adequacy it is the recquired action to improve the
situation of the banking sector.
3. Improvement in provision coverage ratio-

Provision coverage ratio has fallen below 40% in the year 2012-2016 but since it has
recovered and has reached near about the provision coverage ratio of the Non PSU’s in
2018. PCA banks have continuously shown a rise in advances despite the worse capital
situation and stressed asset ratio until 2014. However, since the asset quality review was
conducted the growths in advances have declined by over 10% in year 2014 and have
reached the contraction zone in year 2016 and remained there since then. Given the
problem of asset quality and capital adequacy it is the recquired action to improve the
situation of the banking sector.

9. Conclusion
PCA as a Framework helped the banks under the PCA to repair their balance sheet to
some extent but that was possible only due to the capital infusion done by the banks. The
graphs as well as schedules given above along with the analysis of the data shows that
without the introduction of the PCA Framework, the banks would have shown
comparatively higher losses and a worse financial position. It is a process which would
yield better results in long term and will help in controlling the NPA situation. The key
point is that the PCA is playing a vital role in derisking the asset side of the balance sheet

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by opting for less risky sector loans. Credit growth is decreasing in the PCA banks and is
offsetting the credit growth in healthier banks, but it is required to ensure efficient
reallocation of the credit in the economy across balance sheets which are financially
stable.

10. Limitations of the Study and Scope for Further Research

Since most of the developments regarding the PCA Framework and steps to improve the
financial situation of the banks took place in last two years (4th quarter2017- 1st quarter
2019) there is not sufficient information available to analyse the situation of the banks.
Extensive Mathematical and Statistical analysis is not possible because of the limited data
available. This topic can only be studied and conclusion can be drawn only to the extent
of short term results and the limited information available. There is not sufficient research
material done by the research scholars available. There is enough scope for further
research as a lot of analysis would be possible only after years of financial performance
of the PCA banks will be available. As more and more information will be available, the
situation could be studied from various angles and more meaningful conclusions could be
drawn and the effectiveness of the framework would be known and tested.

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11. References
1. Debanth and Kalyan (1994) “Managing Non-Performing Assets: A Professional
Approach for Better Asset Management”, IBA Bulletin, Vol.XVI, No.5.
2. Patel and Urjit R., (2000) “Outlook of the Indian Financial Sector”, Economic and
Political Weekly, Vol.XXXV, No.45, Nov 4, pp.29-38.
3. Gupta Roopak Kumara and Ekta Sikarwar (2010), “Financial Performance of Indian
New Private Sector and Public Sector Banks: Comparison”, BVIMSR’s Journal of
Management Research, Vol.2, No.1, April, 2010, pp.101-111
4. Viral V Acharya (2018),
https://secure.urkund.com/view/externalSource/redirect/aHR0cHM6Ly93d3cucmJpLm9y
Zy5pbi9TY3JpcHRzL0JTX1NwZWVjaGVzVmlldy5hc3B4P0lkPTEwNjU1
5. Article- RBI puts Bank of India under Prompt Corrective Action
https://www.thehindubusinessline.com/money-and-banking/rbi-puts-bank-of-india-
under-prompt-corrective-action/article9997650.ece
6. Article- RBI releases Three More Banks from Prompt Corrective Action Framework
https://www.bloombergquint.com/business/rbi-releases-three-more-banks-from-pca-
framework#gs.2ai1b6
7. Article- Banks shows good results under PCA’s watch.
https://secure.urkund.com/view/externalSource/redirect/aHR0cHM6Ly93d3cuYnVzaW5l
c3N0b2RheS5pbi90b3Atc3RvcnkvY29ycC1iYW5rLWJvaS1vcmllbnRhbC1iYW5rLXN
ob3ctc2lnbnMtb2YtcmV2aXZhbC11bmRlci1yYmktcGNhLXdhdGNoL3N0b3J5LzI4Nz
gwMi5odG1s0

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