Imposing prompt corrective action (PCA) on Allahabad Bank followed by Bank of India (BOI) underlines the formidable weaknesses of public sector banks (PSBs). With this move of Reserve Bank of India (RBI), 10 out of 21 PSBs are placed under PCA based on their weak performance fundamentals. In fact, besides prolonged weak governance structure, PSBs are also known to suffer from short-term leadership, truncated vision and business objectives unlike their private peers. Except BOI, other nine PSBs are mid-sized state-owned banks.
The basis for imposing PCA is steep rise in non-performing assets (NPAs) and negative return on assets (ROA) due to huge losses sustained by these banks in the last two years on account of additional provisions against increased NPAs. The move by RBI is an early alert for many other PSBs that are on the brink of incurring losses and deterioration in asset quality. Such banks should introspect and can avert PCA by proactively working towards improving their fundamentals. PCA is a globally-known regulatory tool to acknowledge weaknesses of banks and ramp up performance before it is too late. In the process, the job is well cut. They need to stay focused on improving critical parameters.
1. More Focused Monitoring
PCA is regulatory systemic control imposed on the banks showing signs of weaknesses in critical areas – capital, asset quality and profitability. It will impose closer tracking of – capital to risk-weighted assets, common equity tier (CET)-I, net NPA ratios and ROA by the regulator. In effect, RBI will be more focused on banks placed under PCA for closer scrutiny. More frequent exchange of information and tracking with a mind to guide these banks to overcome the weaknesses quickly.
Unless the performance of these banks are not checked at this stage, they may further slip to create systemic risk for the financial system. PCA would not in any way disrupt normal banking operations, but it will goad the banks to use more pointed strategies to quickly show improvements in the designated areas. Though it is just an early warning to the management of the banks and may not impact customer related perspectives, but it will call for internal reprioritisation in pursuing various lines of activities.
2. PCA – A Transparent Framework
RBI imposing PCA is no surprise to banks. The revised PCA framework effective from April 2017 brought full transparency about three levels of risk thresholds. It also explains the limitations, if any, that commensurate with the PCA applicable to each risk threshold. Banks can therefore review their own performance matrix and identify their own risk thresholds. They can even plan to avert PCA with a proactive approach.
These banks with a historical performance track record cannot be oblivious of the fact. The onset of asset quality review (AQR) of RBI meant to clean up the balance sheets brought to fore the asset quality woes of banks. Since then, every bank knows its NPA status and the incremental slippages. Moreover, the enactment of Insolvency and Bankruptcy Code 2016 – followed by its recent amendments was meant to speed up debt resolution. Banks should pursue the available tools more effectively to improve asset quality. The consequences and remedies of PCA are well in the knowledge of banks which could have been averted.
3. Impact Of Asset Quality
The whole framework of PCA spins around asset quality. Higher NPAs led to more provisions and allocation of more resources on NPA management that resulted in poor off take of fresh credit. It led to near stoppage of fresh lending by many of the PSBs resulting in shrinking of interest income and loss of customer base to competitors. It was compounded by reduction of interest income due to steep fresh slippage of assets debilitating profitability. It led to low ROA. Deterioration of asset quality with lack of plough back of profits led to shrinking of capital adequacy ratios. Therefore, deterioration of asset quality is the crux of weakness that permeated the whole internal ecosystem to invite PCA. Perhaps an effective systemic control on asset quality including quality of credit origination could have averted imposition of PCA.
4. Key Strategies
While the normal prudence in business operations is necessary, the initiatives like shutting down of ATMs, closing down of branches or reducing the organisational structure intended to reduce costs need to be viewed from their visibility angle. Other strategies could be:
- (i) Quick sale of NPAs to asset reconstruction companies (ARCs), preferably mass sale, if possible. It can reduce net NPAs, reduce risk weighted assets, trim future provisioning and can shore up capital adequacy.
- (ii) Launch massive schematic one-time settlement of mid/small size NPAs even with haircut to clean up balance sheet.
- (iii) Closer monitoring of NPAs of Rs 1 crore and above to speed up revival/restructuring/recovery.
- (iv) Continued thrust on fresh lending to various productive sectors carrying lower risk weights.
- (v) Using increased network of back offices, banks should quickly downsize branches in terms of people and also limit products that go well in the local geography.
- (vi) Fine tune turnaround time, simplify procedures and trim paperwork to be borrower friendly.
- (vii) Fix turnaround time for internal decision-making processes.
- (viii) Create team of turnaround leaders to execute strategies and monitor from a centralised single point.
- (ix) Closure and merger of chronic loss-making branches in a phased manner.
- (x) Improving fee-based services on a mission mode to supplement the income streams.
- (xi) The board and top management have to remain positive and handhold execution teams.
Banks under PCA need not therefore be diffident but have to be aggressive with clear strategies to reverse it. Hence PCA can be a bane or a boon depending on how it is interpreted. Bane because of its classification as a weak bank. It can be a boon because it can create an opportunity for quick turnaround and emerge again as a front runner.
K Srinivasa Rao is Adjunct Professor, Institute of Insurance and Risk Management – IIRM. The views expressed are his own.
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