Mumbai, April 13, 2017

New rules push mergers if capital levels fall below set ratios

The Reserve Bank of India's (RBI) new prompt corrective action (PCA) plan for banks, revised after 15 years, can potentially restrict normal business activities of at least 15 stressed banks, considering the early trigger points set by the by the central bank. And once a plan is put in place, the bank will have to do exactly what RBI wishes the lender to do, putting the central bank at the driver's seat in bad debt resolution.

Any bank that has a net non-performing assets (NPA) ratio of 6 per cent or more, as on March 2017, will fall under the direct scanner of the RBI, who can then direct the banks how to go about business in an environment where huge bad debt accretion is destabilising the banks by eating into precious capital. The system wide stressed assets (including gross bad debt plus restructured assets) is estimated to be at least Rs 9.5 lakh crore. Kotak Mahindra bank estimates the total stressed assets in the system to be at least Rs 14 lakh crore, parked in various resolution schemes.

Since all existing bad debt resolution plans have largely failed, the government is devising its own grand resolution plan, where the central bank is expected to be at the driver's seat. A strict PCA plan gives the RBI precisely that tool.

In the 2002 PCA plan, the threshold level was set at 10 per cent. Under the new norm, 17 banks get into RBI lens. As on December 2016, had net NPA ratio of more than 6 per cent. Out of these only three banks have net NPA ratio of more than 10 per cent, which means they are already under RBI lens. These three banks are Indian Overseas Bank (NNPA-14.3%), Bank of Maharashtra (10.7%) and United Bank of India (10.6%). Out of these, PCA has been triggered on IoB and United Bank of India already.

However, the new norm will be applicable based on results of March 31. Even as a couple of banks escape marginally RBI watch, sizeable chunk of these will surely get in the net.

Apart from the NPA, a PCA plan can be triggered if a bank slips up on any of the other three parameter - on capital, profitability, or even how much leverage it has taken on its books.

So for example, if a bank's capital adequacy falls below a critical level, or if a bank posts losses year after year RBI can impose a PCA plan on that bank.

When a PCA plan is activated, RBI imposes severe restrictions on many and any of the criterion the central bank deems fit. One particular harsh criterion is to limit the lending ability of the bank and in extreme cases, restrict compensation and fees of the management and directors.

Still, if a bank continues to bleed on its capital and the core capital ratio falls below a certain level, the bank can be liquidated or merged.

In 2002 plan, the threshold for winding up a bank was set at 3 per cent of capital adequacy ratio. In the revised plan, the threshold is 3.625 per cent of core capital, or tier1 ratio. Banks' capital has two layers - tier 1 and tier 2. So, a 3.625% tier 1 means that the total capital adequacy ratio would be higher, and definitely much higher than what was prescribed in the 2002 plan.

According to analysts, the main reason for the tightening the norms is definitely the current operating environment, where RBI is actively trying to stop banks bleeding capital through NPAs, but the country has also moved on to international Basel norms, which was not there in 2002. And these norms require that a bank is always healthy on capital adequacy and provisions. And therefore, whenever the situation looks shaky, RBI wants to take control of the situation, said analysts.

Like the previous plan, there will be three threshold levels. For breaching each level, certain level of restriction will fall upon the bank. For example, if the first threshold is beached, the central bank will impose restrictions on dividend distribution and ask the promoters or parent of a foreign bank to infuse capital. But if the third threshold is breached, the bank can be wound down or forcefully merged with others.

Unlike the last PCA, this time the revised PCA framework will be revised every three years.

As per the plan, when threshold two is breached, RBI can put restrictions of threshold one plus, such actions as restricting branch expansion, and direct higher provision as part of the coverage regime.

In threshold 3, RBI mandatorily will impose restriction on management compensation and directors' fees.

In fact, going by the rules, there is no restriction left that the RBI cannot impose. The central bank, can, at its discretion, impose restrictions and penalties such as special supervisory interactions, actions on strategy, governance, capital, credit risk, market risk, human resource, profitability and on operations.

RBI may review all business lines to identify scope for enhancement or contraction (restriction on lending and borrowing), restructuring of operations, devise plans for NPA reduction, many and any other restrictive steps that will halt the normal operation of the bank till such parameters are improved.

According to an analyst with a rating agency, this time the PCA regime is tighter, compared to the one RBI used in last decade. Now focus is much on early detection of stress signs and taking action in time to avoid further spread, the analyst said.


Banks will be monitored based on such measurable indicators as Capital Adequacy Ratio, Common Equity Tier 1 ratio (core capital), Net NPA ratio and Return on Assets.

For Threshold 1, the capital trigger will set when a bank's minimum total regulatory capital falls 250 basis points below indicator, or the minimum tier-1 capital adequacy ratio falls 162.50 basis points below indicator. Currently, RBI's minimum threshold for total capital is 10.25 per cent. So, as long as a bank has a total capital adequacy ratio between 10.25 per cent to 7.75 per cent, a bank escapes PCA. If the capital adequacy falls below 7.75 per cent, PCA is triggered.

Threshold 2 will be triggered when total CRAR fall more than 250 bps but less than 400 bps below indicator, or the tier-1 capital will fall more than 162.50 bps up to 312.50 bps. In excess of 312.50 bps fall in tier-1 capital below the regulatory minimum, a bank would be a candidate for amalgamation, reconstruction, or winding up.

In terms of asset quality, threshold 1 will trigger when the bet non-performing asset ratio is equal or greater than 6 per cent, but less than 9 per cent. For threshold 2, it would be 9 per cent to 12 percent and threshold 3 will be triggered when the Net NPA ratio is 12 per cent or more.

In terms of profitability, threshold levels will be negative ROA for two consecutive years, three years and four consecutive years.

Leverage of 25 times of the tier-1 capital will come under the threshold level.

The PCA framework would apply to all banks, including small banks and foreign banks.

"A bank will be placed under PCA framework based on the audited annual financial results and the supervisory assessment made by RBI. However, RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant," RBI said on its website.

[The Business Standard]