RBI introduces prompt corrective action framework for large NBFCs

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admin December 16, 2021
Updated 2021/12/16 at 2:11 PM

The Reserve Bank of India (RBI) introduced a prompt corrective action (PCA) framework for major non-banking financial institutions (NBFCs) on Tuesday, imposing limits on para-banks if key financial indicators fall below a certain level.

In terms of monitoring and regulatory reach, this puts them on the same level as banks. This follows the sector’s regulator’s introduction of scale-based restrictions and revisions to non-performing asset (NPA) criteria.

The PCA framework for NBFCs takes effect on October 1 next year, based on their financial situation as of March 31 or later. It will apply to all deposit-taking NBFCs and other major institutions that fall within the central bank’s scale-based regulation for the sector’s middle, upper, and top layers.

Primary dealers, government-owned NBFCs, and home finance businesses are free from this framework since they do not take deposits and have assets of less than Rs 1,000 crore.

As a result, just a few NBFCs will be affected, while the great bulk of the roughly 10,000 NBFCs will be exempt. Regardless of the size of an NBFC, the central bank has the authority to take action.

The PCA framework was created in response to the NBFC sector’s expanding size and “significant interconnectivity with other parts of the financial system,” according to the central bank. It says that the supervisory instruments for NBFCs will be strengthened further.

The RBI said in a statement that the PCA Framework’s goal is to allow supervisory involvement at the right time and force the monitored firm to undertake and execute corrective actions in a timely manner to restore its financial health.

Three risk thresholds and three yardsticks will be used to measure them. As an NBFC surpasses greater threshold levels, the limitations against it get tighter. A PCA action is triggered by a violation of any of the criteria, including the capital adequacy ratio, tier-1 capital ratio, and net NPA ratio.

When the NBFC’s capital adequacy ratio falls below the statutory minimum of 15%, the PCA’s first risk threshold will be activated. The second danger threshold is activated if the ratio goes below 12%, while the third is triggered if the ratio falls below 9%.

Trigger points for tier-1 capital and the net NPA ratio are also included. Leverage and asset quality will be the primary criterion for evaluating core investment businesses.

While an NBFC will be subject to the PCA based on its audited annual financial statements or the RBI’s supervisory assessment, the RBI may impose the PCA on an NBFC at any time throughout the year if circumstances require it.

“The industry organisation has submitted a plea to the RBI that it be granted some time since it is recovering from the pandemic,” said the chief executive officer of an NBFC.

The parameters surrounding overall capital adequacy and Tier-I capital for placing an entity in the PCA category are flexible, said A M Karthik, vice-president of ICRA. However, if asset quality does not improve, certain firms may violate the net NPA criteria by more than 6%. ICRA reports that roughly three big NBFCs (asset size of more than Rs 25,000 crore) are in violation of the NPA criteria. On the other hand, all of these entities have proven parentage.

According to industry experts, this might be a double whammy for NBFCs. The RBI issued recommendations for harmonising NPA recognition requirements for NBFCs last month, which is projected to increase NPAs in the industry.

“This is another effort by the RBI to harmonise the regulatory environment between banks and NBFCs,” said Krishnan Sitaraman, senior director and deputy chief rating at CRISIL. The RBI has provided businesses with a sufficient amount of time to take remedial steps. Most mid- and big CRISIL-rated NBFCs should not experience any challenges in terms of capital adequacy or asset quality, “says the report.

As a result of the PCA framework triggering the first threshold, an NBFC’s dividend payout will be restricted, and promoters will be requested to inject capital and decrease leverage. When the NBFC reaches risk threshold 2, it will be barred from building new branches, and when it reaches risk threshold 3, capital spending will be halted save for technology upgrades.

At a time when the economy is improving and the government is encouraging financial institutions to lend more, are RBI rules allowing NBFCs to expand their lending or constraining them?” According to Raman Agarwal, the Council for International Economic Understanding’s area chair (NBFCs),

 

Source: Business Standard

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