[Editorial] PCA for NBFCs

What is the PCA for NBFCs?

  • The prompt corrective action or PCA framework was introduced by the RBI for the NBFCs (non-banking finance companies) recently. It is to be applicable to all deposit taking NBFCs in 3 layers: middle, upper and top layers.
  • The framework will trigger supervisory intervention by the RBI, at the appropriate time, to help nurse the NBFC back to health and to limit the impact on the overall financial system.
  • The framework will be triggered when certain parameters such as bad loans and capital adequacy ratio fall below pre-defined levels. When this happens, the RBI will impose certain restrictions on the NBFC’s activities.
  • This framework will be effective from October 2022 onwards.

What are the highlights?

  • The RBI is to use 3 indicators for deciding on the application of the framework to an NBFC:
    1. CRAR or capital to risk weighted assets ratio
    2. Tier I capital ratio
    3. NNPA or net NPA ratio
  • If an NBFC’s performance on these indicators worsen, it will move up the risk profile scale. The severity of the restrictions imposed on it will increase as its risk profile deteriorates.
  • At the initial levels, curbs will be imposed on:
    • Dividend distribution
    • Guarantees
    • Taking on contingent liabilities of group companies
  • At the higher risk levels, restrictions will also be imposed on:
    • Expansion of branches
    • Capital expenditure
    • Operating costs
  • The NBFC needs to keep within the risk thresholds for 4 continuous quarters to exit from the framework.

Most probable and repeated topics of upsc prelims

What is the way ahead?

  • The NBFC segment has been growing in size with its credit to GDP ratio standing at 11.6% in 2020. It has developed strong linkages with the rest of the financial system.
  • In this light, the NBFCs’ asset quality must be monitored- especially in case of the larger deposit taking entities.
  • Delayed action will complicate matters and increase uncertainty in the financial markets.
  • Recent incidents like the IL&FS (Infrastructure Leasing & Financial Services) collapse and the DHFL (Dewan Housing Finance Corporation Limited) case, along with their fallout in the larger financial system and economy underline the need for such a PCA framework.
  • The framework will be effective from October 2022 onwards. This gives sufficient time for the NBFCs to bolster their balance sheets (especially after the pandemic’s fallout on the economy).
  • This framework would bring some alignment in the supervision of NBFCs with that of banks. Note that the revised PCA framework for SCBs (Scheduled Commercial Banks) was issued in November this year.
  • The framework is to be reviewed after 3 years of operation. Notable, the RBI has been reviewing the PCA framework for SCBs since its introduction in 2002. This has helped in updating the framework depending on the lessons learnt and new developments in the banking system.

Conclusion:

The NBFC segment has grown over the years. However, it is also under scrutiny, world over, for possible excesses in credit. This is especially because of the leniency in NBFC regulation, compared to banks’ regulation. The segment has been facing many stresses in the recent past and addressing these earlier would reduce the associated costs.

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