PCA framework helped reduce contagion losses: RBI report

The lending and other restrictions imposed on 11 banks under the prompt corrective action (PCA) framework has helped in reducing contagion losses on the banking system in case these lenders fail, according to a Reserve Bank of India (RBI) report.

The RBI has placed 11 state-run banks, including Bank of India, Allahabad Bank, United Bank of India, Corporation Bank, IDBI Bank and UCO Bank, under the PCA framework.

"Lending and other restrictions imposed on PCA banks under the PCA framework have led to a reduced impact on the system through connectivity. This has reduced the contagion losses incurred by the banking system in case of PCA banks failure," RBI said in its Financial Stability Report released Monday.

The findings were based on a contagion analysis to assess whether the PCA framework has helped in reducing the systemic footprint of PCA banks.

The report said the true or the underlying systemic footprint can only be estimated if the implicit sovereign guarantees enjoyed by the PCA banks is done away with.

Systemic impact, then, can be estimated by considering the total solvency losses that will be incurred by the banking system if PCA banks fail simultaneously, it said.

"Solvency losses due to a simultaneous failure of 11 PCA banks have declined from Rs 73,500 crore (6.8 per cent of total tier-1 capital) to Rs 34,200 crore (3.1 per cent of total tier-1 capital) in the last four quarters and to this extent the PCA framework has been successful in reducing the systemic footprint of the PCA banks," the report said.

The PCA framework was revised by the RBI with effect from April 1, 2017.

Under the framework, the RBI monitors key performance indicators of the banks as an early warning exercise and PCA is initiated once the thresholds relating to capital, asset quality and profitability are breached.

These parameters are tracked through the CRAR/CET 1 ratio, the net NPA ratio and RoA.

Additionally, leverage is monitored through the tier 1 leverage ratio.