A major contentious issue amidst stand-off between the Reserve Bank of India [RBI] and the union government [this had reached a brink prior to the meeting of RBI board on November 19, 2018 but a showdown was averted due to some flexibility shown by both the sides at the last minute] was in regard to the Prompt Corrective Action [PCA] framework for the weak public sector banks [PSBs].
In the wake of the steep increase in the NPAs [non-performing assets] of the PSBs resulting in their capital erosion, the apex bank has brought 11 PSBs – out of a total of 21 – under the PCA framework which it made stiffer than even the global standards. Thus, it uses three parameters viz. capital to risk (weighted) asset ratio [CRAR], net-NPAs and return on assets [RoA] as against an international practice of using one one of these parameters.
Furthermore, the RBI fixes the threshold [a bank exceeding this bar/number gets inducted under PCA which entails restriction on lending especially to risky ventures, branch expansion, staff recruitment etc] at a much higher level than the norm adopted by central banks globally. For instance, CRAR adopted for banks in India at 9% is one percentage point higher than Basel-III norm.
The reason d’atre of bringing a weak bank under PCA is to nurse it back to health besides preventing further NPAs. The objective is laudable as only thereafter, it would be in a position to effectively perform the assigned role viz. increase in lending to meet the growing requirement of industries and businesses and in turn, support overall GDP [gross domestic product] growth.
The preferred course should be to allow the banks continue lending even while injecting necessary capital to bring it up to the level of prudential norms. Yet, acting in a contrarian mode, the apex bank has put restrictions on their lending, acceptance of deposits, branch expansion etc. Far from nursing them back to health, such a course is pregnant with the possibility of aggravating their woes.
True, a person suffering from prolonged sickness needs to be hospitalized and given treatment/medication for a reasonable period. But, the essential body functions don’t stop. The same logic applies to an institution [in this case, bank] which must not be pushed to a point whereby its basic functions are drastically curtailed. The regulator seems to be driving weak banks precisely towards that.
The stubbornness of the RBI may also be seen from the fact that despite some banks under PCA already reporting profits, it is in no mood to take them out as they don’t meet the RoA criterion. If, an entity has started reporting profit, that is a good sign. This should be leveraged to remove restrictions so that the bank can proactively engage in lending leading to acceleration in recovery. Instead, by not loosening the string, the regulator may only be impeding the process.
There was a time [especially during 2008-2014 under then UPA dispensation] when these banks took recourse to indiscriminate lending; in many cases, they sanctioned loans without conducting due diligence and assessing the viability of projects for which loans were taken. They showed least concern even when these were not paid back/serviced; instead, more loans were given to enable the borrowers pay back previous loans [or ever-greening, as is commonly known].
During that phase, even the RBI abdicated its responsibility by not exercising necessary supervision which could have detected the irregularities/wrongdoings in time and forced implementation of corrective steps thereby preventing build-up to the present unsustainable/high NPAs.
That was one extreme. Now, when the entire banking system has been put into a correction mode and the NPAs afflicted banks are undergoing major governance reforms – along with requisite capital infusion by the union government, it is swinging to the other extreme by insisting on their adherence to pretty tough norms.
In the meeting of RBI board [November 19, 2018], with a view to increase liquidity, it was decided to defer the mandated 0.625% fourth tranche hike in the capital conservation buffer [CCB] by one year to March 31, 2020. This has the effect of augmenting their capital base by Rs 35,000 crore in turn, increasing the lending capacity of banks by Rs 350,000 crore. However, its benefit won’t be available to weak banks as long as the PCA tag continues.
The banks play a crucial role in ensuring high growth. The RBI intervention/actions should not do anything which compromises on this fundamental objective. This is all the more so at the current juncture when, the economy is coming out of sudden disruption caused by demonetization and GST – both necessary for cleansing the system and put it on sustainable growth trajectory.
The banks need to ensure adequate availability of credit particularly to small and micro enterprise [SMEs] which were affected the most by the above-mentioned twin reform measures. This overarching objective cannot be served if nearly half of the PSBs remain incapacitated; courtesy their being parked on PCA platform and resultant severe restrictions on their activities.
An argument that the other banks [those outside the PCA] will increase their lending to compensate for the shortfall is self-defeating. The banks under PCAs cater to particular geographies/regions and sectors; so substitution can’t be as smooth and simple as is thought to be. Besides, it can’t be any body’s case that the weak banks should not be given a fair opportunity to come out of the mess.
The banking regulator does not want the weak banks to get into the funding of SMEs citing these as ‘risky ventures’. Nothing could be farther from the truth. The SMEs track record of servicing the loan is much better than those of big enterprises. For instance, under MUDRA [Micro Units Development Refinance Agency] scheme, the NPAs is just about 3.4% much lower than the 10% norm.
To sum up, the RBI should shed its present utterly conservative approach, remove all restrictions by taking them out of PCA framework and let the banks proactively engage in lending subject to exercising due diligence.