Here’s all you need to know about RBI’s PCA framework for NBFCs

Come October 2022 and all non-banking finance companies (NBFCs) in India will be subject to a prompt corrective action (PCA) framework. The new PCA framework was unveiled by the Reserve Bank of India (RBI) on Tuesday. 

The central bank-mandated framework introduces three risk-threshold categories that NBFCs will have to abide by. 

But what exactly is a PCA framework?

PCA refers to restrictions imposed by the central bank on a lender’s operations if the key financial parameters of these entities fall below certain limits. 

So, which entities were under the PCA framework until now?

Up until now, only banks were required to adhere to PCA norms. Last month, the central bank had issued a revised set of PCA guidelines for scheduled commercial banks. 

Why has the RBI brought NBFCs under the PCA framework now?

The RBI has done so as NBFCs have grown in size significantly and their operations have also become complex. 

“NBFCs have been growing in size and have substantial inter-connectedness with other segments of the financial system. Accordingly, a PCA framework for NBFCs has also been put in place to further strengthen the supervisory tools applicable to NBFCs,” the RBI said. 

Which NBFCs will be brought under the PCA framework?

The new framework will apply to all deposit-taking NBFCs, excluding government companies, and all non-deposit taking NBFCs in middle, upper and top layers. 

From when will the new framework be enforced?

The PCA framework for NBFCs will come into effect from October 1, 2022, based on the financial position of NBFCs on or after March 31, 2022, the RBI said.

What are the three risk threshold categories that the RBI has specified?

An NBFC will fall under risk threshold-1 if its Capital to Risk (Weighted) Assets Ratio (CRAR) falls up to 300 basis points below the regulatory minimum CRAR, Tier-1 capital ratio falls up to 200 bps below the regulatory minimum and net non-performing assets (NPA) ratio goes beyond 6%.

The RBI will then impose restrictions on various business operations and will conduct special inspections and targeted scrutiny of the company. For an NBFC under threshold-1, the RBI can impose restriction on dividend distribution or remittance of profits. There also will be restriction on issue of guarantees or taking on other contingent liabilities on behalf of group companies.

An NBFC will fall into risk threshold-2 if the CRAR falls more than 300 bps but up to 600 bps below the regulatory minimum, Tier-1 capital ratio falls more than 200 bps but up to 400 bps below the regulatory minimum and net NPA shoots up beyond 9%.

If the CRAR falls 600 bps below the regulatory minimum, Tier-1 capital ratio falls more than 400 bps below the regulatory minimum and net NPA is greater than 12%, the NBFC will fall in the risk threshold-3 category.

In such cases, in addition to the mandatory actions of threshold 1 and 2, the RBI will take appropriate restrictions on capital expenditure and will impose restrictions on variable operating costs, the central bank said.

How can an NBFC come out of the PCA framework?

The RBI will consider withdrawal of restrictions imposed under the PCA framework if no breaches in risk thresholds in any of the parameters are observed for four continuous quarterly financial statements, one of which should be the annual audited financial statement.