Reserve Bank of India (RBI) has set four trigger points – CRAR, NPA (Non Performing Assets), ROA(Return on Assets), Leverage Ratio, on the basis of which it is decided whether bank need to put under the ambit of Prompt Corrective Action (PCA).
Prompt Corrective Action Framework Trigger Points
Three Risk Thresholds viz. Risk Threshold 1, Risk Threshold 2, Risk Threshold 3 on the basis of above trigger points. Further, These Risk Thresholds are linked with specific corrective actions need to be taken to secure bank’s financial health.
Corrective Action depends on the level of risk threshold. Higher the risk , more will be corrective actions imposed on the bank.
In our last article, we read about What is Prompt Corrective Action and about its features, objectives. Here in this article, we will discuss about trigger points on the basis of which bank’s financial health is evaluated for Prompt Corrective Action (PCA).
- Capital to Risk Weighted Ratio (CRAR) :
It is a first parameter under Prompt Corrective Action (PCA) used to measure financial health of a bank. This ratio is used to determine adequacy of bank capital in terms of risk assets.
If CRAR is above 9 percent then the bank is able to absorb reasonable amount of losses and considered to be financially sound. If it is below 9 percent then its financial health is weak and alarm is triggered for Prompt Corrective Action.
Common equity Tier 1 Capital Limit is also specified as below :
- Risk Threshold 1 : If 6.75%>Tier-1 Capital >= 5.125 %
- Risk Threshold 2 : If 5.125% > Tier-1 Capital >= 3.625%
- Risk Threshold 3 : If Tier-1 Capital <3.625%
- Asset Quality : It is defined as Net Non Performing Assets (NNPA).
Non Performing Assets is a classification of loan or advance on which the principal or interest payment has remained past due for a specified period of time. If NPA ratio breach following specified limit as below then the alarm is triggered for prompt corrective action.
- Risk Threshold 1 : If 9% >NPA Ratio >=6%
- Risk Threshold 2 : If 12% > NPA Ratio >=9%
- Risk Threshold 3 : NPA Ratio >=12%
- Profitability :
Third parameter evaluated for prompt corrective action is Profitability. Return on Assets is considered as indicator for evaluating profitability by RBI.
Return on Assets is calculated as :
ROA = (Net Income / Total Assets)
- Risk Threshold 1 : if ROA is negative for two consecutive years.
- Risk Threshold 2 : if ROA is negative for three consecutive years.
- Risk Threshold 3 : if ROA is negative for four consecutive years.
- Leverage Ratio :
Leverage ratio is fourth parameter which is used to measure a bank’s debt level. Leverage Ratio is proportion of debts that a bank has compared to its capital.
If Tier 1 leverage ratio is in between 3.5 and 4.0 percent then the bank is subject to PCA.
Prompt Corrective Action will be trigger on following Thresholds.
- Risk Threshold 1 : if its leverage is over 25 times its Tier-1 capital.
- Risk Threshold 2 : if its leverage is over 28.6 times its Tier-1 capital.
Once Prompt Corrective Action is triggered on a bank, certain restrictions are put on the activities of bank.
Bank is not allowed to renew or access costly deposit or take measure to increase their fee based income. Bank is restricted to carry out lending to companies that fall below investment grade. Bank is not allowed to open or expand its branch network. RBI imposes restriction on bank on borrowing from interbank market.
Banks are asked to launch special drive to reduce NPAs and contain generation of fresh NPAs.
However, these restrictions are categorised under Mandatory and Discretionary Actions depending on the level of RISK THRESHOLD.