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Recently, the Reserve Bank of India (RBI) came up with a Prompt Corrective Action (PCA) Framework for NBFCs with a view to introduce supervisory tools and provide remedial measures to protect the financial health of the NBFCs. This is not the first time when such a framework is introduced by the RBI. Earlier in 2002 a similar kind of protective framework was introduced by RBI to protect the financial health of Scheduled Commercial Banks. This programme was introduced with the objective of intervening in the functioning of the banks and forcing such banks to take corrective actions. Another motive was to inculcate discipline in the market and improve their financial health. As far as this PCA Framework for NBFCs, RBI has the mandate to take the below mentioned corrective decisions and any other action as it deems fit to intervene in the functioning of the NBFC and enforcing remedial measures.
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In order to protect the financial health of a lender or protect it from defaulting, the banking regulators of the country lay down certain financial metrics or parameters which must be followed by the lenders. If the lenders breach the risk thresholds listed out in the framework, then the banking regulator will impose restrictions on the operations conducted by the lenders.
Since these lenders are interconnected with other constituents of the market such restrictions are necessary for maintaining the balance and security of investments in the market.
The RBI came up with a PCA Framework and included the following entities within its purview:
However, following are the entities that are included within the scope of NBFCs-ND:
The NBFCs will be put under the PCA Framework on the basis of the audited Annual Financial Results along with the Supervisory Assessment done by the RBI[1]. However, RBI can impose this framework during the course of the accounting year itself if the existing circumstances so demand.
The market size and the share of the NBFCs have been growing. Given the fact that the NBFCs have been interconnected with the other parts of the market, the Reserve Bank being the banking regulatory authority of India wants to keep the health of these entities in check and introduce a supervisory framework over their activities so that the money invested in them is not squandered and the market as a whole has to bear the brunt of it.
The RBI has come up with a Prompt Corrective Action (PCA) Framework which will come into force from 1st October, 2022 onwards. This framework shall be based on the financial position of the NBFC on and after 31st March, 2022. Therefore, these NBFCs have been asked to adhere to the capital adequacy norms before 31st March 2022.
What is CRAR?
Capital to Risk (Weighted) Assets Ratio (CRAR) also called as Capital Adequacy Ratio which is a representation of the ratio of the bank’s capital to the associated risk weighted assets such as market risk, credit risks etc. A high CRAR represents the entity is highly capitalised. Higher the CRAR, higher the lender is capitalized.
What is Tier 1 Capital Ratio?
Tier 1 Capital Ratio represents the bank’s core Tier 1 capital i.e. the ratio of the bank’s equity reserves plus disclosed reserves to the total risk weighted assets.
What is NNPA ratio?
NNPA stands for Net Non-Performing Assets, which is the ratio of non-performing assets to the total loans given.
What is Adjusted Net Worth (ANW)?
Adjusted Net Worth refers to the estimated value of the business as per the company’s accounts books after adding unrealized capital gains, voluntary reserves and capital surplus.
What are Aggregate Risk Weighted Assets (RWA)?
It refers to the least amount of capital that is held by the banks in order to avoid the situation of insolvency.
According to the annexed framework:
Along with these the RBI can take discretionary corrective actions which are operations related, capital related, Human Resource related, supervisory actions etc. in order to protect the financial health of the above mentioned entities.
As the NBFCs are interconnected with various financial entities of the market, its decision making and functioning has the capacity to influence and affect the economy in a big way. Therefore, it is important the banking regulator of the country should have the ability and capacity to intervene in the operations of the NBFCs and at the same time enforce discipline so that market does not get adversely affected and sentiments remain positive. This PCA Framework for the NBFCs has given the RBI all powers to devise financial metrics, impose restrictions, intervene in operations and take any measure that is necessary to enforce discipline among the NBFCs. The framework introduced for NBFCs is not the final one and shall continue to evolve with the ever evolving market and modus operandi of the NBFCs.
Read our article:RBI announces Revised Regulatory Framework for NBFCs
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