Prompt Corrective Action: An Essential Element of Financial Stability Framework
- Viral V Acharya, Deputy Governor, Reserve Bank of India1
Remarks delivered at the Indian Institute of Technology, Bombay - 12th October 2018
Abstract
This talk explains why the Prompt Corrective Action (PCA) framework of the
Reserve Bank of India (RBI) is an essential element of its financial stability
framework. It lays out the case for structured early intervention and resolution by
regulators for banks that become under-capitalised due to poor asset quality or
vulnerable due to loss of profitability. Detailing the mandatory and discretionary
actions under the RBI's Revised PCA framework, it compares and contrasts these
with the PCA framework operating in the United States. Finally, it documents
empirically how Indian banks under the PCA framework are being restored back to
health through better capitalisation, preservation of capital, and provisioning for
losses.
I would like to thank the Indian Institute of Technology (IIT), Bombay, and in particular,
Professor Pushpa Trivedi, who inspired me to pursue Economics and Finance, for inviting me
back to IIT, my undergraduate alma mater. It is always an occasion of great pride and immense
satisfaction for me to return to the Powai campus and be reminded of what I learnt here - the
importance of identifying big problems to solve, approaching them with an analytical mindset,
scything through seemingly attractive but incomplete fixes, and in the process, discovering
durable solutions that address the root causes underlying the problems.
About thirteen months back on the 7th of September, 2017, I spoke at the 8th R K Talwar
Memorial Lecture about "The Unfinished Agenda: Restoring Public Sector Bank Health in
India," wherein, I touched upon three themes:
(i) How under-capitalised banking systems engage in ever-greening of the distressed
borrowers ("zombie lending"), as witnessed in the United States during the Savings
and Loan (S&L) crisis of 1980's, Japan in the 1990's, and the Eurozone following the
global financial crisis;
(ii) What steps the Reserve Bank of India had undertaken to address the stressed assets
problem of Indian banks, viz., the creation of Central Repository of Information on
Large Credits (CRILC) in early 2014; the Asset Quality Review in 2015; and
reference of the largest, aged non-performing assets (NPAs) to the Insolvency and
Bankruptcy Code (IBC) under the powers bestowed upon the Bank by promulgation
of the Banking Regulation (Amendment) Ordinance 2017 (since notified as an Act);
and, finally,
(iii) The need for the Government of India (GoI) to meet the recapitalisation needs of
public sector banks (PSBs), in their current ownership structure or otherwise.
Since then, the GoI has announced a recapitalisation package for PSBs in October 2017 of INR
2.11 trillion, comprising INR 1.53 trillion of government capital infusion and balance to be
raised from market funding, by March 2019. Equally importantly, the Reserve Bank of India
issued a circular on the 12th of February, 2018 for the resolution of stressed assets, which
employs the IBC reference as its lynchpin for resolution and is aimed at improving the credit
culture in both borrowers and lenders.
Another significant step has been taken by the Reserve Bank of India in parallel which has been
somewhat under-appreciated, viz., the imposition of Prompt Corrective Action (PCA) on a
number of banks whose capital, asset quality and/or profitability do not meet pre-specified
thresholds. Today, I wish to explain why PCA is an essential element of the Reserve Bank's (and
more generally, of a banking supervisor's) financial stability framework.
Loss-absorption Role of Bank Capital
Before I discuss the Prompt Corrective Action approach, it would be useful to briefly talk about
the critical role of bank capital in relation to the process of resolution of stressed banks.
In its simplest form, a bank balance-sheet has assets on the left hand side of the balance-sheet,
and liabilities on the right hand side in the form of equity capital and deposits (and other forms of
debt liabilities such as unsecured bonds, and wholesale finance such as inter-bank liabilities or
short-term commercial paper).
Equity capital is the primary loss-absorption buffer - means of protection - against the asset
losses of a bank. It is meant to be at levels high enough to absorb unanticipated losses with
enough margin so as to inspire confidence and enable the bank to continue as a going concern, in
particular, without passing on losses to bank creditors. Once the capital level is fully consumed
by the deteriorating financials, it exposes the unsecured creditors, including depositors, to bear
the losses. While the deposits typically are insured up to a certain level, economic history shows
that more often than not the ultimate costs of paying off all deposits fall on the sovereign,
especially in the case of large, complex and inter-connected banks.
Capital constraints at a wider, systemic level also impact the resolution of weak banks. The
United States experience, empirically documented by Granja, Matvos and Seru (2017), shows
that an optimal bidding strategy of a healthier bank - a potential acquirer, which may value the
weaker bank for its franchise value from deposits, gets adversely impacted if it is itself poorly
capitalized. In such a scenario, the overall value realization for the weak bank goes down. The
poor capitalization of potential acquirers can also drive a wedge between their willingness and
ability to pay for a failed bank. In this manner, bank capital being at healthy levels also has a
system-wide loss-absorption role by helping sell weak banks to healthy ones in an efficient
manner.
Given this criticality of bank capital in absorbing losses, it is natural why minimum bank capital
requirements are in place globally and why capital becomes one of the most important factors for
supervisors to monitor. In the aftermath of the global financial crisis, there has been a complete
overhaul of the international regime for minimum regulatory capital requirements of banks, as
enshrined in the revised Basel norms, viz., Basel-III.
The goal of Basel III is to raise the quality, consistency and transparency of the capital base of
banks to withstand unanticipated losses and to strengthen the overall risk coverage of the capital
framework. In addition to revising the minimum capital ratio requirements for credit risk, Basel
III also introduced a capital conservation buffer (CCB) and a countercyclical capital buffer.
CCB is designed to ensure that banks build up a capital buffer outside periods of financial stress
that can be drawn down when banks face financial (systemic or idiosyncratic) stress. Banks
which draw down their capital conservation buffer during a stressed period are required to have a
definite plan to replenish the buffer and face capital distribution constraints. The objective of the
countercyclical capital buffer is to use capital as a macro-prudential instrument aimed at
protecting the banking sector from periods of excess aggregate credit growth, that have often
been associated with the build-up of system-wide risk.
In this regard, it is instructive to note that the minimum bank capital ratio (to suitably
riskweighted assets) required to be held under the Basel norms is only a floor. Since the global
financial crisis, many countries require their banks to hold capital at higher levels, as shown
below. Further, in other major jurisdictions like the US and the UK, effective capital
requirements tend to be even higher on account of several add-ons; for instance, in the US,
higher leverage ratio (put simply, bank capital to unweighted assets ratio) and the stress tests -
annual Comprehensive Capital Analysis & Review (CCAR) - also push up the effective capital
requirements beyond Basel requirements for systemically important and/or large banks.
While this view of bank capital focuses on its benefits in the form of loss-absorption adequacy at
individual bank and systemic level, there is an equally important incentive role played by bank
capital that is worthy of discussion.
Minimum
Minimum Tier 1 Minimum Total Capital
Jurisdictions Common Equity
Capital Ratio Ratio
Ratio
Basel III Prescriptions 4.5 6.0 8.0
11 from 2013, gradually
Brazil aligning to Basel III by 2019 -
subsequently as per Basel
China 5.0 6.0 8.0
India 5.5 7.0 9.0
Mexico (CCB is integrated
7.0 8.5 10.5
into minimum requirements)
Singapore 6.5 8.0 10.0
South Africa 5.0 6.75 9.0
Switzerland 4.5 to 10.0 6.0 to 13.0 8.0 to 19.0
Turkey 4.5 6.0 12.0
Source: Regulatory Consistency Assessment Programme (RCAP) reports of the Bank for International
Settlements (BIS)
Incentive Role of Bank Capital
Let me now explain why it becomes imperative for bank supervisors to intervene in a weak bank
much before the capital is completely eroded. Conceptually, there are at least two reasons why
the world over banks that make losses to the point of being under-capitalised do not recapitalise,
or are not recapitalised, promptly.
First, while private banks typically hold greater capital than required by regulatory requirements,
shareholders are reluctant to inject capital once the capital is eroded by losses as it gets primarily
deployed in stabilising bank liabilities. To compensate for this wealth transfer for injecting
capital, shareholders require a much higher rate of return than when banks are better capitalised,
but such high required returns may render banking activity unprofitable to pursue. This is the
well-known "debt overhang" problem, studied extensively in financial economics (Myers, 1977).
Secondly, when banks become under-capitalised en masse or are government-owned to start
with, it is often thought that recapitalisation should occur swiftly given the attendant real and
systemic risk costs of not recapitalising banks - costs that a government should internalise. In
practice, however, banking sectors are sometimes "too big to save" relative to the size of
government balance-sheets. Even when that is not so, governments may themselves be
financially constrained: bank recapitalisations must earn effective returns that exceed the costs of
raising additional finance (usually additional borrowings) or from cutting back on other fiscal
expenditures. Hence, it is quite common, even for government-owned under-capitalised banks to
take a while to get adequately recapitalised, if at all.
Regardless of the reason for the under-capitalisation of banks to persist, what is observed is that
creditors of under-capitalised banks are not only offered off-balance sheet government
guarantees, notably deposit insurance, but also implicit guarantees to uninsured creditors. This is
done in the interest of financial stability and safeguarding of payment and settlement systems,
but carries the downside that under-capitalised banks often continue to access credit markets at
artificially low costs of borrowing. Consequently, without appropriate supervisory constraints in
place, such banks are in a position to delay the recognition of losses and engage in ever-greening
or zombie lending, which is essentially the rolling over of debts of unviable borrowers that
would have otherwise defaulted.
In fact, this was precisely what happened in Japan at the turn of the last century when the
problem of non-performing loans and bank capital shortage persisted for over a decade. Hoshi
and Kashyap (2010) attribute this to two factors: first, banks not recognising the true losses on
NPAs, thereby overstating the quality of their loans; and, second, prevalence of zombie lending
by under-capitalised banks. It was only after the implementation of the of Financial Revival
Program (Takenaka Plan) starting in 2003, involving more rigorous evaluation of bank assets,
increasing of bank capital, and strengthening of governance for recapitalised banks, that the
Japanese banks finally stopped the process of ever-greening non-performing loans and started to
accumulate capital through retained earnings over the next five years.
In addition to the above evidence on Japan which I covered in some detail in the 8th R K Talwar
Memorial Lecture, my recent joint work with Sascha Steffen and Lea Steinruecke, titled
"Kicking the Can Down the Road: Government Interventions in the European Banking Sector,"
examined all government interventions in the Eurozone banking sector during the 2007 to 2009
financial crisis. In particular, we analysed the implications of these interventions in the European
banking sector for the subsequent sovereign debt crisis and found that:
(i) Governments with weaker public finances were more reluctant to recapitalise
distressed banks during the financial crisis; and,
(ii) The resulting insufficient recapitalisation of distressed banks had significant negative
consequences for the efficiency of real sector lending. In particular, weak banks
remained vulnerable to future shocks and increased their risk-taking. Furthermore,
these banks did not write down defaulted loans but instead ever-greened loans to
zombie borrowers, crowding out in the process credit extension to healthier
borrowers.
The Case for Regulatory Prompt Corrective Action
How should under-capitalised banks, and more generally, banks whose asset quality and
profitability make them vulnerable to further stress, be dealt with, taking cognizance of the
reality that the strength of market discipline by bank creditors is blunted by the presence of
explicit and implicit government guarantees?
This question received significant academic and policy-maker attention in the United States
following the Savings & Loans (S&L) crisis, in which by mid-1980's, so many thrifts had to be
resolved at such low levels of capitalisation that in the end a significant government bailout in
the form of blanket deposit insurance had to be engineered. Effectively, it had been left until too
late to exercise regulatory discipline that could have substituted for the lack of adequate market
discipline; as a result, the authorities had to engage in excessive forbearance and full-scale
bailout.
Key insight that emerged from the debate around the S&L crisis was that the banking regulator
needed to adopt a "structured early intervention and resolution" (SEIR) approach (see, for
instance, Benston and Kaufman, 1990, and White, 1991). This insight, in turn, led to the passage
of Federal Deposit Insurance Corporation (FDIC) Improvement Act (FDICIA), 1991, and thus
was born the Prompt Corrective Action (PCA) framework of the FDIC as modern banking has
witnessed. [Another twin born then was risk-based deposit insurance premium!]
Prompt Corrective Action frameworks adopt the core principles of structured early intervention
and resolution in the following manner:
(i) Thresholds of performance (in case of FDIC, bank capitalisation) are identified to
classify banks that breach the thresholds into categories, for instance, in the case of
FDIC into "under-capitalised", "significantly under-capitalised" and "critically
undercapitalised". The first thresholds are set at levels that are well above what would
allow for an effective resolution or revival of banks.
(ii) Banks that do not meet the thresholds are subjected to a layered, progressively
stringent "program", consisting of mandatory and discretionary regulatory actions,
which aim to prevent further hemorrhaging, effectively quarantining the banks in
breach until they are resolved. Another important rationale is to help supervisors
enforce corrective measures in a rule-based manner and this way reduce the risk of
forbearance.
Put simply, this is what Prompt Corrective Action (or PCA) is intended to achieve - to intervene
early and take corrective measures in a timely manner, so as to restore the financial health of
banks that are at risk by limiting deterioration in their health and preserving their capital levels.
By construction then, PCA involves some restrictions on bank scope and expansion as not doing
so would lead to excessive risks on the balance-sheets of these banks. Similarly, putting up PCA
banks for sale in the market and / or replacing bank management become potential mechanisms
for prompt resolution. It follows as a corollary that the strength of the PCA framework depends
crucially on the extent of regulatory powers that can be exercised by the banking regulator.
While the intent of PCA is primarily remedial, it can also act as a deterrence and incentivise bank
management and shareholders to contain risks so they do not end up in PCA in the first place.
And, by the virtue of being reasonably rule-based, PCA reduces the scope for discretion; like
Odysseus, bank regulators tie themselves to the mast to evade the voices of the forbearance
sirens.
Reserve Bank's Prompt Corrective Action (PCA) Framework
The Reserve Bank's PCA framework was introduced in December 2002 as a structured early
intervention mechanism along the lines of the FDIC's PCA framework. Subsequently, the
framework was reviewed by the Reserve Bank keeping in view the international best practices
and recommendations of the Working Group of the Financial Stability and Development Council
(FSDC) on Resolution Regimes for Financial Institutions in India (January 2014) and the
Financial Sector Legislative Reforms Commission (FSLRC, March 2013). The Revised PCA
Framework was issued by the Reserve Bank on April 13, 2017 and implemented with respect to
the bank financials as on March 31, 2017.
Annex Ia provides the thresholds deployed under the revised framework, publicly available at
https://www.rbi.org.in, linked to capital (CRAR - regulatory capital to risk-weighted assets ratio
- and Leverage ratio), asset quality (NNPA - net non-performing assets to advances ratio), and
profitability (ROA - return on assets). Under each measure, once the initial threshold is crossed,
successive thresholds are employed to categorise banks into those violating Threshold 1 only,
Threshold 1 and Threshold 2 only, or even Threshold 3.
The revised PCA framework strengthened the earlier one along several dimensions, the salient
changes being as follows:
(i) While capital, asset quality and profitability continue to be the key areas for
monitoring under the revised framework, common equity Tier-1 (Common equity
Tier 1 capital to risk-weighted Assets) ratio has also been included to constitute an
additional trigger along with monitoring of leverage. This change acknowledges that
it is common equity capital of a bank that has the highest loss-absorption capacity and
is the least like debt. Overall, risk thresholds under the revised framework have been
made more granular.
(ii) Some of the corrective actions which were earlier a part of 'structured (mandatory)
actions' to be taken by the supervisor have been moved to a more comprehensive
menu of 'discretionary actions' under the revised framework (detailed comparison is
in Annex Ib). Thus, the scope of mandatory actions across all risk thresholds has
been restricted essentially to:
a. Restriction on dividend distribution/remittance of profits;
b. Requirement on promoters/owners/parents to bring in more capital;
c. Restrictions on branch expansion;
d. Higher provisioning requirement; and,
e. Restrictions on management compensation.
(iii) While no restriction has been imposed on the retail deposit-taking activity of any
bank till date, banks can be advised under the revised framework as a cost reduction
measure to reduce or avoid altogether the high-cost bulk deposits and instead improve
their Current Account and Saving Account (CASA) deposit levels.
It is useful to compare this Revised PCA Framework of the Reserve Bank to the PCA
Framework of the FDIC as an international benchmark.
Comparison with the FDIC's PCA Framework
Details of various thresholds as well as the mandatory and discretionary actions under the PCA
Framework of the FDIC are given in Annex II. In terms of the conceptual design, both
frameworks mirror the core principles of structured early intervention and resolution. However,
there are at least three significant differences:
(i) While FDIC triggers the PCA based only on bank capital thresholds, the Reserve Bank's
PCA thresholds also include asset quality and profitability. The rationale for this
difference is as follows. When provision coverage ratio (provisions to gross
nonperforming assets ratio) of banks is at international standards as in the US, most
anticipated losses are already built into bank capital. In other words, non-performing
assets net of provisions (NNPA ratio) is low. However, the provision coverage ratio of
Indian banks has historically been much lower as we will see below (Chart 8), in part due
to their maintaining only the minimum required provisions. As a result, the present level
of bank capital masks the expected capital write-offs that will occur in future; this risk of
future under-capitalisation is captured by looking for below-threshold asset quality (if
NNPA ratio is high) and profitability (if return on assets or ROA is low so that capital
accretion in future will be weak).
(ii) The mandatory actions are much stricter and triggered earlier in terms of capitalisation
levels in case of the FDIC. For instance, restrictions on asset growth and prior approval
of certain expansion proposals kick in right at the breach of Threshold-1
("undercapitalised" category of FDIC's PCA bank classification).
(iii) Beyond Threshold 2 ("significantly under-capitalised"), the mandatory actions by FDIC
may include recapitalisation, change in management or even divestiture. Indeed, most
banks under FDIC's PCA are resolved through auctions where typical outcome is a
purchase by another bank with an assumption of the PCA bank's liabilities. Powers to
undertake such actions in case of India's public sector banks (PSBs) lie with the
Government of India. As enunciated in Governor Patel's speech in March 2018,
"Banking Regulatory Powers Should Be Ownership Neutral," the Reserve Bank lacks
legislative powers to enforce divestiture or change in management at PSBs.
On balance, therefore, it can be concluded that the RBI's PCA Framework is less onerous as
compared to the FDIC's PCA Framework.
Let me elaborate on the point (iii) above. Purchase and Assumption (P&A) is the most
commonly used resolution method by the FDIC, as part of which a healthy institution purchases
some or all of the assets of a failed bank and assumes some or all of the liabilities. When
deciding which of these techniques to employ, the FDIC is guided legislatively by the "least cost
to the taxpayers" requirement. The FDIC seeks bids from qualified bidders for the failed bank's
assets and the assumption of certain liabilities, including deposits, and accepts the bid that is
judged least costly.
If no viable P&A buyer can be found, then the FDIC typically deploys a deposit payoff. A
deposit payoff involves repaying insured depositors, liquidating assets of the bank, and, dividing
the proceeds from asset liquidation between itself and uninsured bank creditors. The FDIC might
also use a Deposit Insurance National Bank (DINB) or bridge banks to resolve a failed bank,
which entail establishing a new national bank with a short-period charter from the Office of the
Comptroller of the Currency (OCC). The FDIC retains the majority of the assets in its corporate
capacity as the receiver and eventually sells them.
In India, merger of weak banks with stronger ones has been the primary mode of resolution of
weak banks in the past. Section 45 of Banking Regulation Act 1949 empowers the Reserve Bank
to make a scheme of amalgamation of a bank with another bank if it is in the depositors' interest
or in the interest of overall banking system. The operation of the weak bank may be kept under
moratorium for a certain period of time to ensure smooth implementation of the scheme. Many
private sector banks have been merged with other private sector banks or the PSBs under this
mechanism. Since the onset of reforms in 1991, there were 22 mergers in the India banking space
till 2010, 11 of which were compulsory mergers under Section 45 of the BR Act, 1949 (Bishnoi
and Devi, 2015). However, one of the critical preconditions for this approach to succeed is that a
substantial part of the banking sector be well-capitalised. If the potential acquirers are poorly
capitalised, it may result in inefficiencies in prices as well as timing in resolution of weak banks,
besides increasing the risk of weakening the acquirers themselves through such acquisitions.
Performance of the PCA banks in India
Let me now turn to some data. The goal of the exercise will be to help understand the ten-year
performance (wherever data is available) of banks on which the Reserve Bank has imposed the
PCA. The reason for examining the performance of these banks over a long time period is to
appreciate the fact that the progress of banks under PCA cannot be judged over a relatively short
time scale. The longer the under-capitalisation and asset quality problems have festered, the
more patient one has to be during the rehabilitation process. There is no quick fix or overnight
silver bullet here; the reforms have to be implemented and allowed to run their course; they can't
be chopped or diluted mid-stream; the focus has to be on stability that is durable.
As I explain below, there are emerging signs that the performance of banks under PCA is slowly
but steadily being restored.
Presently, there are twelve banks, eleven in the public sector and one in the private sector, under
the Reserve Bank's Revised PCA Framework, with PCA having been imposed on them between
February 2014 and January 2018. I will focus below only on the eleven PSBs under the PCA.
The share of these PCA banks in advances and deposits as on March 31, 2018 was 18.5% and
20.8%, respectively.
The following trends emerge as one tracks the performance of these banks in terms of
capitalisation and asset quality:
(i) Capitalisation (Chart 1, 2): The declining trend of CRAR and Tier-1 capital ratio for
PCA banks that started in 2011 has been arrested and the ratio has been maintained
steady since 2014 at or above internationally prescribed levels. It may, however, be
noted that the PCA banks have had lower CRAR and Tier-1 capital ratios compared
to non-PCA banks (barring 2011), and especially private banks (right since 2009).
Chart 1: Capital to Risk-weighted Assets Ratio (CRAR)*
PSBs - PCA PSBs - Non-PCA Pvt Banks
18%
17%
16.43%
16%
15%
14%
13%
12% 12.04%
11%
10.58%
10%
9%
8%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
* Total Capital / Risk-weighted Assets
Source: Reserve Bank of India
Chart 2: Tier 1 Capital Ratio*
PSBs - PCA PSBs - Non-PCA Pvt Banks
16%
14.24%
14%
12%
10%
9.77%
8% 8.05%
6%
4%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
* Tier 1 Capital /Risk Weighted Assets
Source: Reserve Bank of India
(ii) Asset quality (Charts 3, 4, 5): Both the gross and net NPA ratios of PCA banks
mirrored those of non-PCA banks up until about 2014. However, post the Asset
Quality Review (AQR) exercise, the NPA recognition at PCA banks has led to a
sharper rise in both gross and net NPAs, relative to non-PCA banks, and especially
relative to private banks. This does not mean that AQR caused the NPAs; it simply
induced the long-overdue recognition of NPAs. Notably, the stressed assets ratio,
which besides NPAs includes the Restructured Standard assets (that enjoyed the
regulatory forbearance under the earlier guidelines), reveals that the underlying asset
quality at PCA banks was deteriorating at a sharper pace compared to non-PCA banks
right since 2011, which is now accepted as the time by which the lending boom of
2009-10 began to unravel.
Chart 3: Gross Non-performing Assets Ratio (GNPA) (%)*
25
PSBs - PCA PSBs - Non-PCA Pvt Banks
20.56
20
15
12.28
10
5
4.62
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
* Gross NPAs / Gross
Advances
Source: Reserve Bank of India
Chart 4: Net Non-performing Assets Ratio (NNPA) (%)*
14%
PSBs - PCA PSBs - Non-PCA Pvt Banks
12%
11.53%
10%
8%
6.66%
6%
4%
2.39%
2%
0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
*(Gross NPAs - NPA Provisions) /
(Gross Advances - NPA Provisions)
Source: Reserve Bank of India
Chart 5: Stressed Assets Ratio*
25.00%
PSBs - PCA PSBs - Non-PCA Pvt Banks
21.69%
20.00%
15.00%
12.92%
10.00%
5.00% 5.07%
0.00%
March March March March March March March March March March March
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
* (Gross NPAs + Restructured
Source: Reserve Bank of India Standard Advances) / Gross Advances
The Tide is Turning for the PCA Banks...
As I have tried to explain, an important objective of the PCA is to first and foremost limit further
losses and prevent erosion of bank capital, creating a platform of stability for the bank, and in
turn, setting the stage for structural interventions to be implemented and pushed through.
In assessing whether this objective is being attained, three observations are in order:
(i) Recapitalisation (Chart 6): The Government of India has infused more than Rs.
2,300 billion in public sector banks since 2005, more than half of which has gone into
banks currently under PCA. Within PCA banks, almost half of the total infusion (i.e.,
Rs. 635 billion) has occurred during FY2018 and FY2019, after the banks were
classified under PCA. This recapitalisation has been an important contributor to
financial stability of these banks and of the rest of the banking system they deal with.
Chart 6: Capital Infusion by Government of India in PSBs
600
542
500
400
358
300
billion
Rs.
200
100
-
2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-172017-18
PSBs - PCA PSBs - Non-PCA
Source: Reserve Bank of India
(ii) Preventing further deterioration (Chart 7): In spite of their worse capitalisation
and stressed assets ratio compared to other banks, PCA banks had credit growth that
was as strong as that of other banks up until 2014. However, since the AQR exercise
and the imposition of PCA, the year on year growth in advances for PCA banks has
declined from over 10% in 2014 to below zero (contraction) by 2016 and remained in
the contraction zone since. Given the evidence presented above on PCA bank's
sustained problem of asset quality (Charts 3, 4 and 5), this is indeed the required
medicine to prevent further hemorrhaging of their balance-sheets.
Chart 7: Yearly Growth in Advances (%)
PSBs - PCA PSBs - Non-PCA Pvt Banks
35
30
25
20.26
20
15
10
8.13
5
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
-3.29
-5
Source: Reserve Bank of India
(iii) Improvement in provision coverage ratio (Chart 8): Given the recapitalisation and
prevention of further hemorrhaging, the provision coverage ratio (PCR) of PCA
banks which had fallen off relative to that of other banks starting 2011 and reached
below 40% during 2012-2016, has now recovered to that of non-PCA PSBs. The
recovered level of PCR remains at present at around 50%, which is more 10% below
that of private banks, and away from the desirable 70%. These numbers suggest that
the loss-absorption capacity of PCA banks is on the mend, but that there is some
distance to go in their catch-up to healthy levels.
Chart 8: Provision Coverage Ratio (%)*
PSB Banks - PCA PSB Banks - Non-PCA Pvt Banks
80%
70%
62.23%
60%
50%
49.06%
40%
30%
20%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
* Total NPA Provisions /
Gross NPAs
Source: Reserve Bank of India
There is an assertion being made in some circles that imposition of the PCA has starved the
Indian economy of credit. There is little factual basis for this assertion, either for the overall
economy or at sectoral level. While it is true as shown above that PCA banks are experiencing
lending contraction on average (in terms of their year on year growth in overall advances), the
nominal non-food credit growth of scheduled commercial banks has been close to or above
double-digit levels, for past several quarters, and with a robust distribution across the sectors of
the real economy (Chart 9). This is because the reduction in lending at PCA banks is being more
than offset by credit growth at healthier banks. This is indeed what one wants - efficient
reallocation of credit for the real economy with a financially stable distribution of risks across
bank balance-sheets. Indeed, the funding for the economy as a whole has become diversified
over this period, also due to the growth of capital markets.
Chart 9: Credit Growth in Scheduled Commercial Banks (year on
year %)
30.0
Total Non-food credit Services Large Industries MSME
26.7
25.0
20.0
15.0
12.4
12.4
10.0
5.0
1.6