Recently the Reserve Bank of India decided to put in place a Prompt Corrective Action (PCA) Framework for non-banking financial companies (NBFCs) to further strengthen the supervisory tools applicable to them.

The RBI had introduced a PCA framework for Scheduled Commercial Banks in 2002 with periodic reviews thereafter. The objective of the PCA Framework is to enable supervisory intervention at appropriate time and require the supervised entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.

The PCA Framework is also intended to act as a tool for effective market discipline. The PCA Framework does not preclude the RBI from taking any other action as it deems fit at any time in addition to the corrective actions prescribed in the Framework.

Now the PCA framework has been extended to NBFCs as they have been growing in size and have substantial interconnectedness with other segments of the financial system. The PCA Framework for NBFCs comes into effect from October 1, 2022, based on the financial position of NBFCs on or after March 31, 2022.

All these objectives are laudable, that too when there are concerns about functioning of some of the NBFCs and their failure recently. But the outcome of the PCA framework that was put in place for commercial banks needs to be studied before extending it to NBFCs. There is also a distinction between banks and NBFCs. As NBFCs do not take demand deposits, there cannot be any pressure on their asset-liability mismatch due to sudden withdrawals of deposits. Though their assets may deteriorate suddenly, their payment of liabilities can be calculated as repayment under different buckets can be anticipated.

Under the present guidelines, government-owned NBFCs are exempted from this framework for reasons best known to the RBI. When the government banks are subjected to this, why not government controlled NBFCs?

A closer look at the PCA enforced on banks reveal that public sector banks have responded far better than their private sector counterparts. This may be due to the financial support and recapitalisation of the government and not due to the PCA formula.

PCA’s performance

Let us see how the PCA has worked for banks.

Lakshmi Vilas Bank: The bank was placed under the PCA framework in September 2019 considering the breach of PCA thresholds as on March 31, 2019. But there was no improvement in their functioning. After considering the RBI’s request, the Centre imposed moratorium for 30 days on November 17, 2020 and was sold to another entity.

YES Bank: In spite of reports of the bank’s problems appearing in the public domain, it was never put under the PCA framework. Either the trigger points envisaged for the onset of PCA are defective or there should have been failure to place the bank under PCA in spite of triggers. It is not known why no action was initiated by the RBI on the failure.

PMC Bank: The RBI imposed restrictions on urban cooperative banks for deterioration of financial position, in line with the PCA framework. But this has not saved the bank and the stakeholders are facing a tough time and the RBI is in the process of arranging a takeover of this bank by another entity.

IOB, IDBI Bank and UCO Bank: These banks are out of PCA now. All these are public sector banks and the support by the government may be the main reason for their coming out of PCA frame work. The Centre’s decision to privatise two PSU banks may also be another factor. The Central Bank of India, which is another public sector bank is still under PCA stipulation.

Hence before subjecting NBFCs under PCA, it is better to make an empirical study of the effectiveness of PCA framework.

The writer is a retired banker