Is the RBI really strict with banks under PCA?

It is for a good reason that RBI relied on industry experts to set the rules and turned to the board for general guidance. Photo: Mint

Mumbai: One of the recent criticisms of the Reserve Bank of India is its strict application of the Rapid Corrective Action Framework (PCA) for banks. This has hurt credit to the economy, critics say.

But one mint The analysis shows that far from being too strict, the central bank has shown tolerance vis-à-vis some of the banks that are not yet under PCA. At least four other banks must be censored for not meeting the risk thresholds specified by the central bank, if RBI takes a strict rule-based approach. These are Andhra Bank, Canara Bank, Punjab National Bank (PNB) and Union Bank of India, all of which have exceeded the maximum allowed level of 6% for net non-productive advances as a percentage of total advances. The NBI also exceeded the leverage ratio risk threshold, with exposure being multiplied by 25 times more than its Tier 1 capital. The RBI rules stipulate that the BCP may be taxed if any of the thresholds are met. risk of capital, asset quality, profitability or leverage is exceeded. Thanks to the government's recapitalization earlier this year, these banks have met the minimum capital requirements needed to avoid PCA. However, most government-owned banks that are not part of the BCP may soon be forced to ensure that the return on their assets is not negative for two consecutive years. Almost all of them recorded losses in FY18 and it seems that the situation will not be different this year, based on the results of the first half of FY19. Of course, this risk threshold is not not yet triggered, if at all.

But regarding the asset quality threshold, RBI is clearly patient. Net nonperforming asset (NPA) ratios were much worse a few quarters ago. In fact, using the measures taken in March 2018, another bank – Punjab and Sind Bank – had crossed the risk threshold prescribed by the central bank. Critics argue that the net NPA ratio should not be considered in isolation, especially if the banks have sufficient capital. But to the same extent, looking only at capital adequacy ratios is myopia. After all, while the recognition of NPAs has improved in the Indian banking system, provisioning standards remain conservative. As such, reported capital may be overstated because it does not take into account losses on certain accounts receivable. In countries where only capital ratios are taken into account under the PCA, the standards for supplying NPAs are stricter.

RBI's abstention may be linked to the hope that the government will recapitalize these banks, so that the provisioning of their NPAs does not result in alarming capital.

The PCA was imposed on 11 state-owned banks, which did not meet RBI's specified thresholds for capital adequacy, asset quality or profitability. The idea behind the restrictions on these banks is that they preserve capital and recover health, which means that credit takes a hit.

A related charge is that the RBI has not been open to logic about the need for greater liquidity, and calls are underway for the RBI board to have more say. Once again, this ignores the fact that several members of the RBI's board of directors have clear conflicts of interest. Clearly, professionals and business owners can not have a say in areas such as bank ownership. Similarly, government-appointed candidates may claim more leniency for CPA standards, but this would imply a conflict of interest since the government owns the majority of the country's banks.

It is for a good reason that RBI relied on industry experts to develop rules and turned to the board for guidance. If the government is not satisfied with the form of operation, it should perhaps review the accountability mechanisms that it has for the RBI.