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BANKING ON BAILOUTS

Why in news?

  • Just one day after it placed the financially troubled Yes Bank under a moratorium, the Reserve Bank of India announced a draft ‘Scheme of Reconstruction’ that entails the State Bank of India (SBI) investing capital to acquire a 49% stake in the restructured private lender.

Views on the Moratorium on Yes Bank and SBI Takeover

  • The alacrity with which the bailout has been proposed is commendable, however, the decision to suspend normal business operations raises several worrying questions, both about the health of the banking sector, and the adequacy of the oversight role that regulators essay.
  • The fact that the lender ended up at the resolution stage, without ever being placed under the central bank’s Prompt Corrective Action (PCA) framework, also raises a question mark over how and why Yes Bank eluded the specifically tailor-made solution to address weakness at banks.
  • India’s banking sector is still far from out of the woods and the RBI and Centre have their task cut out in ensuring that the need for such bailouts is obviated.

Prompt Corrective Action (PCA)

  • Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.
  • The PCA framework deems banks as risky if they slip below certain norms on three parameters — capital ratios, asset quality and profitability.
  • It has three risk threshold levels (1 being the lowest and 3 the highest) based on where a bank stands on these ratios.

Significance of PCA

  • As most bank activities are funded by deposits which need to be repaid, it is imperative that a bank carries a sufficient amount of capital to continue its activities.
  • PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble.
  • The idea is to head off problems before they attain crisis proportions.
  • Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.
  • On breach of any of the risk thresholds mentioned above, the RBI can invoke a corrective action plan.
  • Depending on the threshold levels, the RBI can place restrictions on dividend distribution, branch expansion, and management compensation.
  • Only in an extreme situation, breach of the third threshold, would identify a bank as a likely candidate for resolution through amalgamation, reconstruction or winding up.
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October 2022
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