RBI tightens norms on bank performance

• The Reserve Bank of India (RBI) has tightened the rules that trigger regulatory action on lenders when they fall short of capital or exceed bad loan limits.
• Under the revised rules, as many as 16 banks could face RBI intervention if their December quarter numbers are considered.

About prompt corrective action (PCA) framework:

• Under this framework banks are assessed on three parameters: capital ratios, asset quality and profitability. Failure to meet any of these norms could invite RBI action on these lenders, which could include strictures on lending and branch expansion, change in management and reduction in assets.
• First risk threshold under PCA would be triggered if the capital-to-risk assets ratio falls below the minimum mandated 10.25%. The original rules introduced in 2002 had set this limit at 9%. Breaching this threshold would mean restrictions on dividend distribution or remittance or profits; promoters would also be asked for capital infusion, said RBI.
• RBI has also defined two more risk thresholds—when the capital adequacy ratio falls below 7.75% and below 6.25%. Each higher threshold brings more strictures such as stopping branch expansion, higher provisions and even restrictions on management compensation and directors’ fees.
• Apart from these mandatory actions, RBI has armed itself with discretionary powers such as winding up the bank or merging it, which it would use when the highest risk threshold is breached.
• As of December, Dhanlaxmi Bank and Central Bank of India were the only ones to have a capital adequacy ratio of less than 10%. These rules are applicable based on 31 March 2017 numbers.
• On asset quality, RBI has mandated a maximum net NPA ratio of 6%. A net bad loan ratio of more than 12% is the highest limit and breaching it could result in RBI asking lenders to sell assets, cut unsecured exposures and so on. Under the old rules, net NPA had to breach 10% for RBI action to kick in.
• There were 16 commercial banks which had a net NPA ratio of more than 6% at the end of December. Indian Overseas Bank—where RBI had previously initiated action under PCA in October 2015—had the maximum net NPA ratio of 14.32%. For Bank of Maharashtra and United Bank of India, it is in excess of 10%.
• The provisions of the revised PCA framework will be effective from April 1, 2017 based on the financials of the banks for the year ended March 31, 2017. The framework would be reviewed after three years.

By: Vishal