Prompt Corrective Action

Prompt corrective action and the framework based on it is like a police baton in India that is used by RBI to control the financial institution in India. In this article, you will learn about prompt corrective action definition, norms, parameters and its significance, etc.

This article will provide key insights for GS Paper-3 Environment & Ecology of UPSC IAS Exam.

Table of Content

• What is Prompt corrective action?
• Prompt corrective action framework by RBI
• Parameters of Prompt corrective action framework for Banks
• Capital Adequacy Ratio according to the framework for Banks
• Asset Quality according to the framework for Banks
• Profitability according to the framework for Banks
• Debt Level according to the framework for Banks
• Actions taken when Banks are placed under it
• Significance of the framework
• Prompt corrective action banks list as of 2022
• Conclusion
• Frequently Asked Questions

What is prompt corrective action?

• Definition: The Prompt corrective action is a framework introduced by the Reserve Bank of India (RBI) in 2002 to ensure sound financial health of Indian financial institution.

Prompt corrective action framework by RBI:

• Prompt corrective action frameworkis a set of guideline that enables supervisory intervention of the Reserve Bank of India (RBI) as and when required to initiate and implement remedial measures for the Scheduled Commercial Banks (SCBs) or non-banking financial companies (NBFCs) in order to restore its financial health.
• Prompt corrective action frameworkwas introduced in 2002 by the RBI.
• Prompt corrective action frameworkis reviewed after three years of being in operation.

Parameters of Prompt corrective action framework for Banks:

• 4 factors on the basis of which SCBs are evaluated– profitability, asset quality, Capital Adequacy Ratio (CAR) and debt level. 
• These factors determine whether SCBs should be placed under the framework.
• The SCBs are categorised on the basis of these factors from one to three, where 1 is the lowest and 3 is the highest.

Capital Adequacy Ratio according to the framework for Banks:

• It is the capital required by a bank to be maintained in terms of assets (majorly loans) disbursed by it.
• If the assets are higher, the capital retained by the bank should also be higher.
• It measures how much debt and equity capital banks possess to cover any associated risk.
• Grade 1: When banks have a CRAR between 7.75%- 10.25%.
• Grade 2: When banks have a CRAR between 6.25%- 7.75%.
• Grade 3:  When banks have a CRAR less than 3.625%.

Asset Quality according to the framework for Banks:

• It refers to the non-performing assets (NPA) of a bank.
• Grade 1: When banks have net NPA between 6%- 9%.
• Grade 2: When banks have net NPA between 9%- 12%.
• Grade 3: When banks have net NPA more than 12%.

Profitability according to the framework for Banks:

• The RBI takes into account the return on assets (ROA) of a bank to measure the profitability.
• Grade 1: When banks have negative ROA for 2 years in a row.
• Grade 2: When banks have negative ROA for 3 years in a row.
• Grade 3: When banks have negative ROA for 4 years in a row.

Debt Level according to the framework for Banks:

• It measures the financial risk of any bank due to its overall debt level or leverage.
• Grade 1: When the overall leverage of a bank is more than 25 times its Tier 1 capital.
• Grade 2: When the overall leverage of a bank is more than 28.5 times its core capital (including disclosed reserves).

Actions taken when Banks are placed under prompt corrective action:

• The RBI imposes 2 types of limitations on it – mandatory and discretionary.
• Mandatory restrictions on SCB: expansion of a branch, dividend of shareholders and director’s remuneration among other restrictions.
• RBI under this framework has authority to:
  • Ask Bank’s board can reassess its business model and evaluate the profitability of the operations.
  • Advise Banks to reassess its business strategy to take remedial measures.
  • Advise Banks to gauge its viability from the medium to long term basis along with evaluating balance sheet estimates.

Significance of the framework:

• It helps to reduce the volatility in Indian market by taking appropriate action whenever there is a chance that a bank may go bankrupt.
• As RBI controls the loan disbursal of banks placed under this framework, it helps bank to recover its potential losses.
• In rare cases, RBI can close down non-compliant banks or merge them with better running banks or recapitalise it with appropriate financial instruments such as issuing bank bonds.
• It alerts the regulator, investors and depositors when a bank is heading for trouble.
• It helps in ease of doing business in banking sector due to its stable and clearly defined policy.
• It boosts depositor’s confidence who will then feel more encouraged to institutionalise their savings.

Prompt corrective action banks list as of 2022:

• Allahabad Bank, United Bank, Corporation Bank, IDBI Bank, Uco Bank, Bank of India, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce, Dena Bank and Bank of Maharashtra.

Conclusion

Scheduled Commercial Banks and NBFCs plays an important role in helping shaping India’s economy. Failure of these 2 financial institutions might lead to financial crises in the country. Thus, Prompt corrective action framework in India is a positive step towards their regulation. However, the regulations under this framework should be made flexible on case-to-case basis.

Ref: Source-1

FAQs (Frequently Asked Questions)