RBI's tightening of prompt corrective action framework positive for banking sector

According to credit rating agency ICRA, the Reserve Bank of India's (RBI)'s revision in the prompt corrective action (PCA) framework for the banks is a positive and a welcome step, given the operating and financial profile of some of the banks.

The rating agency believes that the increasing levels of gross non-performing assets in Indian Banks is a matter of great concern as it has adversely impacted the profitability, capitalization and solvency levels of Indian banks, especially during the last two years, i.e. FY2016 and FY2017.

The revision in PCA has also increased the required overall capital levels and has also introduced the minimum core equity (CET) capital levels required to be maintained by the bank so as to avoid its inclusion under the PCA framework.

In a recent update note titled, 'Indian Banking Sector: Tightening of Prompt corrective action framework is positive for the banking sector', ICRA expects a further weakening in asset quality during FY2018 and consequently pressure on internal capital generation and increasing capital requirements under the Basel III capital adequacy framework.

The capital requirement, especially for public sector banks (PSBs) is enormous. The same during FY 2018 and FY 2019 is estimated at Rs. 1.25-1.35 trillion of which Rs. 800-850 billion has to be by way of core equity capital.

"Based on the revised PCA framework, a total of 16 PSBs out of 21 (excluding SBI associates) and two out of 16 private banks will require taking mandatory corrective actions such as raising capital levels, restricting the dividend payments, branch expansions or face restrictions on management compensation to come out of the PCA framework," said Group Head Financial Sector Ratings, Karthik Srinivasan.

Additionally, the RBI has brought down the net NPA levels required to include the bank under PCA framework to a level of six percent now as against 10 percent earlier; thereby mandating the banks to increase the provision coverage on the NPAs for remaining outside the PCA framework.

ICRA expects overall these steps will strengthen the banking system over the medium term. While it will allow the stronger and well managed banks to grow; the onus of improving the systems and procedures will be more on the weaker banks and their promoters/management.