RBI comes out with PCA framework for NBFCs

The Reserve Bank of India (RBI) on Tuesday released a prompt corrective action (PCA) framework for non banking finance companies (NBFCs) detailing punitive action against shadow lenders in case their capital adequacy ratio falls or non performing assets (NPAs) rise above a certain threshold. In a notification on its website the RBI said the new framework, the first of its kind for NBFCs will come into effect from October 1 next year.
The central bank's action comes after multiple jolts to the financial system in the last three years starting with the collapse of IL&FS in September 2018. The collapse of IL&FS has been followed by the bankruptcy of Dewan Housing Finance Ltd (DHFL) in 2019 and the Kolkata based Srei Group and Anil Ambani controlled Reliance Capital this year.

In a notification on its website the RBI said the PCA framework for NBFCs has been put in place "to further strengthen the supervisory tools" applicable to the sector as NBFCs have substantial interconnectedness with other segments of the financial system.

Capital adequacy ratio and asset quality will be the key moniterables for deposit and non deposit taking NBFCs while the central bank will also look at leverage along with capital and asset quality for core investment companies (CICs), RBI said.



A NBFC will be placed under PCA based on the audited annual financial results and/or supervisory assessment made by RBI, however the central bank also clarified that it may impose restrictions on NBFCs even during the course of the year in case the circumstances so warrant.

NBFCs will be judged according to three risk threshold parameters. For example if the capital adequacy for deposit or non deposit taking NBFCs fall more than 300 basis points below the minimum required 15% or Tier 1 capital ratio drops 200 basis points below the minimum required 8% or net NPA ratio increases above 6%, the RBI may restrict dividend distribution or remittance of profits. Promoters and shareholders will also be called to infuse equity and reduce leverage.

If capital adequacy falls a further 300 basis points, Tier 1 capital ratio another 200 basis points below the minimum required and net NPA rises above 9% the central bank will restrict branch expansion in addition to the above actions. A further deterioration and fall in capital adequacy to less than 9% and
Tier 1 capital to less than 6% with net NPA rising to more than 12% will lead to restrictions on capital expenditure, other than for technological upgradation and a reduction in variable operating costs, RBI said.

The RBI can also take discretionary action like calling for special monitoring meetings or inspections, special audits through external auditors or even file a insolvency application against an NBFC or issue a show cause notice for winding up of the NBFC.

RBI may also recommend a change in management, remove directors or supersede the board of the NBFC under the PCA framework. It can also restrict borrowings from the debt market, ban accepting new deposits or prevent the NBFC from making new investments.

For core investment companies the central bank will also look at leverage ratios besides the capital adequacy and net NPAs. If the leverage ratio for such companies increased above 2.5 times the central bank will restrict such companies from issuing guarantees or taking on other contingent liabilities on behalf of group companies. CICs hold shares or debentures in other group companies. These companies mostly control the subsidiaries through holding majority shareholding.

PCA restrictions will be withdrawn from an NBFC if no breaches in risk thresholds in any of the parameters are observed as per four continuous quarterly financial statements, one of which should be annual audited financial statement (subject to assessment by RBI) after a RBI led supervision.