RBI brings NBFCs under prompt corrective action framework

What is the News?

Reserve Bank of India(RBI) has introduced a Prompt Corrective Action(PCA) framework for large non-banking financial companies(NBFCs).

What is the need for this PCA Framework for NBFCs?

The PCA Framework for NBFCs has been brought after four big finance firms — IL&FS, DHFL, SREI and Reliance Capital — which collected public funds through fixed deposits and non-convertible debentures collapsed in the last three years despite the tight monitoring in the financial sector. They collectively owe over Rs 1 lakh crore to investors.

What is the PCA Framework for NBFCs?

The PCA framework for NBFCs will come into effect on October 1,2022 on the basis of their financial position on or after March 31. 

The objective of the framework is to enable supervisory intervention at the appropriate time and require the supervised entity to initiate and implement remedial measures in a timely manner, to restore its financial health

The framework will be applicable to all deposit-taking non-banking financial companies (NBFCs), all non-deposit taking NBFCs in the middle, upper and top layers including investment and credit companies, core investment companies, infrastructure debt funds, infrastructure finance companies and microfinance institutions.

However, it has excluded NBFCs not accepting/not intending to accept public funds, primary dealers and housing finance companies along with government-owned ones.

What are the indicators based on which PCA will be invoked for NBFC?

The central bank will track three indicators — capital to risk-weighted assets ratio (CRAR), Tier I ratio and net non-performing assets (NNPAs) including non-performing investments (NPIs).

In the case of core investment companies (CICs), the RBI will track adjusted net worth/aggregate risk-weighted assets, leverage ratio and NNPAs, including NPIs.

A breach in any of the three risk thresholds under the above-mentioned indicators could result in invocation of PCA.

What will happen once the PCA is invoked for an NBFC?

Based on the risk threshold, the RBI may prescribe mandatory corrective actions such as restriction on dividend distribution/remittance of profits, requiring promoters /shareholders to infuse equity and reducing leverage.

The RBI can also restrict the issuance of guarantees or take other contingent liabilities on behalf of group companies(only for CICs).

Further, the central bank may also restrict branch expansion, impose curbs on capital expenditure other than for technological up-gradation within board-approved limits and restrict/ directly reduce variable operating costs.

Source: This post is based on the following articles 

• “RBI brings NBFCs under prompt corrective action framework” published in Indian Express on 15th December 2021.
• “RBI will rein in fragile NBFCs to avert busts” published in Livemint on 14th December 2021.