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The Reserve Bank of India (RBI) on Tuesday introduced prompt corrective action (PCA) framework for large non-banking financial companies (NBFC). This will place severe restrictions on the para-banks whenever critical financial metrics dip below the prescribed threshold, thereby bringing them almost at a par with commercial banks in terms of supervision and regulatory reach.
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. It will be applicable for all deposit taking NBFCs, and other large NBFCs that sit in the middle, upper, and top layers of the central bank’s scale-based regulation for NBFCs.
This would, therefore, be applicable for only a few NBFCs while the vast majority of the nearly 10,000 NBFCs would be excluded from such tight regulatory purview, till they grow up in size. However, the central bank can take any action it deems appropriate, irrespective of the size of an NBFC, on a case-by-case basis.
The central bank cited the growing size of NBFC sector and “substantial interconnectedness with other segments of the financial system” as the reason for the PCA framework on NBFCs. The central bank said it will further strengthen the supervisory tools applicable to NBFCs.
“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 RBI said in its statement. The framework is also intended to act as a tool for effective market discipline.
PCA thresholds
There will be three risk thresholds, inviting different actions under the framework.
The first trigger of the PCA will be triggered when the capital adequacy ratio of the NBFC falls below 300 basis points of the regulatory minimum of 15 per cent. Therefore, NBFCs having capital adequacy ratio over 12 and below 15 per cent would not trigger an immediate PCA, provided they don’t trigger other criteria.
If the Tier-1 capital, or core capital, falls 200 basis points below the regulatory minimum (currently 10 per cent) then also the PCA will be triggered.
Importantly, if the net non-performing assets (NNPA) ratio is greater than 6 per cent, but less than or equal to 9 per cent, then the first risk threshold will be triggered.
There are three risk thresholds in this framework. Threshold 3 will be triggered if capital adequacy falls more than 600 basis points from the regulatory minimum, or tier-1 capital falls more than 400 basis points below the minimum, or if the NNPA ratio rises above 12 per cent.
The NBFC will face varying degree of PCA framework restrictions based on the threshold triggered.
For core investment companies, the thresholds are measured differently.
What happens if PCA framework is imposed
An NBFC under PCA framework, caused by triggering the first threshold, will be restricted on dividend distribution, promoters will be asked to infuse capital and reduce leverage. The central bank will also restrict issuance of guarantees or taking other contingent liabilities on behalf of group companies, in case of core investment companies.
Upon hitting risk threshold 2, the NBFC will be prohibited from opening branches, while on risk threshold 3, capital expenditure will be stopped, other than for technological upgradation. There would be restrictions in variable operating cost as well on such an NBFC, the RBI said.
There will be other issues that the NBFCs will face, such as heightened regulatory supervision and inspections. The RBI will also actively engage with the board of the NBFCs on various aspects as deemed appropriate by the central bank.
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