The prompt corrective action framework (PCA) introduced by the Reserve Bank of India for non-banking finance companies will align their regulations with those of scheduled commercial banks. It will also make shadow lenders take steps to strengthen their balance sheets at a time their size and scale have grown and many also accept public deposits, say experts.
In the last few years, India’s financial services sector has been hit by several large non-banking finance companies such as IL&FS, SREI, Dewan Housing Finance (DHFL) and Reliance Capital going bankrupt. In this backdrop, the introduction of the PCA guidelines for the NBFCs is a big step.
The PCA norms will be applicable to all deposit taking NBFCs, excluding government companies, and also non-deposit taking NBFCs in middle, upper and top tiers. These will include investment and credit companies, infrastructure debt funds, infra finance companies and micro-finance institutions.
A PCA framework has already been in place for commercial banks since 2002. A revised PCA framework for banks was issued in November.
The objective of the PCA framework is to enable supervisory intervention at appropriate time and require the supervised entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health. The framework is also intended to act as a tool for effective market discipline, said the RBI.
It felt the need to introduce a PCA framework for NBFCs too given their growth in size and substantial interconnectedness with the other segments of the financial system, the central bank said.
The capital and asset quality will be the key areas for monitoring in the PCA framework in case of the deposit as well as non-deposit taking NBFCs. Capital to Risk Weighted Assets Ratio (CRAR), tier I capital ratio and net NPA ratio will be the key indicators to be tracked in case of NBFCs.
Breach of any risk threshold may result in invocation of PCA. “A NBFC will generally be placed under PCA Framework based on the audited annual financial results and/or the supervisory assessment made by the RBI. However, the RBI may impose PCA on any NBFC during the course of a year (including migration from one threshold to another) in case the circumstances so warrant,” RBI said.
Experts welcomed this move by the RBI to introduce the PCA framework for NBFCs.
“Lenders showing deterioration in performance metrics like capital, asset quality, and leverage have to be restricted on paying dividends, opening branches, and capex. Restrictions could be based on the severity of the situation while being subject to additional scrutiny till they come out of the bad phase. This is a welcome move, for it will stop bad lenders from going worse rather than brushing the issue aside. Ultimately, since NBFCs are now more closely integrated with the banking system than ever before, safer NBFCs also translate to a safer overall financial system,” said Jaya Vaidhyanathan, CEO of BCT Digital.
The RBI’s PCA framework for NBFCs will be effective from October 2022.
Krishnan Sitaraman, senior director at CRISIL Ratings said no major mid or large NBFCs are likely to face immediate challenges given their comfortable capitalisation levels. The RBI has also provided a reasonable transition time for NBFCs to strengthen their balance sheets, some of which have been impacted by asset quality challenges following the COVID-19 pandemic, he added.
“Capital adequacy and asset quality, the key factors influencing balance-sheet resilience, is what the RBI will assess when referring NBFCs to the PCA framework. The graded restrictions under the framework will enable NBFCs to take corrective action when they breach stipulated thresholds. That would reduce the chances of insolvency,” said Sitaraman further.
If a particular NBFC were to breach either of the three risk thresholds prescribed under the PCA framework, there will be certain mandatory actions that will be required including restriction of dividend distribution, reduction in leverage, promoters or shareholders infusing equity and restriction on branch expansion. There may be other discretionary actions that may be taken too.
According to analysts at broking firm Motilal Oswal Financial Services, currently only Mahindra and Mahindra Financial Services has a net stage 3 in excess of 6 per cent (net NPAs of 6.4 per cent as on September 30), which it can conveniently bring down to below 6 per cent by the end of the current financial year. The company has said it aims to maintain the net NPA below 4 per cent, by the year end.
Recently the RBI had also tightened NPA recognition norms for NBFCs.
On Wednesday, most NBFCs traded in the red. Poonawalla Fincorp was down 2.3 per cent, Bajaj Finserv fell 2.6 per cent, Mahindra Finance declined 3 per cent, and Muthoot Capital Services, Reliance Capital and Indostar Capital Finance closed over 4 per cent lower. The broader BSE Sensex ended down 329 points or 0.6 per cent at 57,788.03 points.
