RBI introduces tough PCA framework for large NBFCs, effective October 2022

An NBFC under the framework, caused by triggering the first threshold, will face restrictions on dividend distribution and promoters will be asked to infuse capital and reduce leverage

The Reserve Bank of India (RBI) on Tuesday introduced a prompt corrective action (PCA) framework for large non-banking financial companies (NBFCs), putting restrictions on para-banks whenever vital financial metrics dip below the prescribed threshold.

This brings them almost on a par with banks in terms of supervision and regulatory reach. This follows the scale-based regulations and revision in non-performing asset (NPA) norms brought in by the regulator for the sector.

The PCA framework for NBFCs comes into effect on October 1 next year on the basis of their financial position on or after March 31. It will be applicable for all deposit-taking NBFCs and other large ones that sit in the middle, upper, and top layers of the central bank’s scale-based regulation for the sector.

However, those not taking deposits and with an asset size of less than Rs 1,000 crore, primary dealers, government-owned NBFCs, and housing finance companies are exempt from this framework.

This will, therefore, be applicable for only a few NBFCs while the vast majority of the nearly 10,000 such entities will be excluded. However, the central bank can take any action irrespective of the size of an NBFC.

The central bank cited the growing size of the NBFC sector and “substantial interconnectedness with other segments of the financial system” as the reason for the PCA framework. It said it would further strengthen the supervisory tools for 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.

PCA thresholds

There will be three risk thresholds and three yardsticks to measure them. The restrictions against an NBFC get progressively tightened as it breaches higher threshold levels. A breach of any criterion – the capital adequacy ratio, tier-1 capital ratio, and net NPA ratio -- triggers PCA action.   

The first risk threshold of the PCA will be triggered when the capital adequacy ratio of the NBFC falls below the regulatory minimum of 15 per cent. If the ratio falls below 12 per cent, the second risk threshold will be triggered, while the ratio falling below 9 per cent triggers the third.  

Similarly, there are trigger points for tier-1 capital and the net NPA ratio as well. For core investment companies, leverage and asset quality will be the core criteria for evaluation.

While an NBFC will be placed under the PCA on the basis of its audited annual financial results or the RBI’s supervisory assessment, the PCA may also be imposed on an NBFC during the course of a year in case the circumstances compel the RBI to do so.

“The industry body has made a request to the RBI that since it is recovering from the pandemic, it wishes to be given some time,” said the chief executive officer of an NBFC.

A M Karthik, vice-president, ICRA, said: “The thresholds around total capital adequacy and Tier-I capital for classifying an entity in the PCA category are liberal. However, some entities could breach the net NPA criterion of more than 6 per cent if the asset quality does not improve. Among the large NBFCs (asset size more than Rs 25,000 crore), ICRA notes that about three entities are in breach of the NPA criterion. However, all these entities have an established parentage.”

An industry expert said this might be a double whammy for NBFCs. Last month the RBI had brought in guidelines for harmonising NPA recognition norms for NBFCs, and this is expected to push up NPAs in the sector.

Krishnan Sitaraman, senior director and deputy chief ratings, CRISIL, said: “This is another step by the RBI to harmonise the regulatory framework between banks and NBFCs. The RBI has given reasonable time to the entities to take corrective action. As far as CRISIL-rated NBFCs are concerned, most of the mid and large entities should not face any challenge either on capital adequacy or asset quality.”

What happens if PCA framework is imposed?

An NBFC under the PCA framework, caused by triggering the first threshold, will face restrictions on dividend distribution and promoters will be asked to infuse capital and reduce leverage. 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 a technological upgrade.

“At a time when the economy is recovering and the government is urging financial institutions to lend more, are RBI norms liberating lending or restricting the NBFCs?” said Raman Agarwal, area chair (NBFCs) at the Council for International Economic Understanding.