Viral Acharya, previously a professor of finance at New York University and now the deputy governor at the Reserve Bank of India, speaks during an event at the New York Stock Exchange. (Photographer: Jin Lee/Bloomberg)

RBI’s Acharya Bats For Persisting With Prompt Corrective Action Framework

Reserve Bank of India Deputy Governor Viral Acharya on Friday made a strong argument in favour of the regulator’s prompt corrective action framework, which has drawn flack from many quarters including the government.

“It’s important that the PCA framework to deal with financially weak banks is persisted with. Any slackening of the approach in the midst of required course of action is an all-too-familiar and ultimately harmful habit that we must eschew,” Acharya said in a speech at IIT Bombay.

Eleven government-owned banks are currently under the framework, which imposes restrictions on banks with a high level of bad loans and low return on assets.

Through his comments today, Acharya made a case that without PCA some banks would’ve been even worse off than where they are right now. He said the objective of PCA is to limit further losses, prevent erosion of capital, create a stable platform for the bank while “setting the stage for structural interventions to be implemented and pushed through”.

Acharya made three observations to assess how these objectives are being attained.

Recapitalisation

Acharya noted that since 2005 the government has infused over Rs 2.3 lakh crore in public sector banks. Of this, more than half has gone towards PCA. And half of the total infusion within PCA banks has happened just in the last two fiscals.

This recapitalisation has been an important contributor to financial stability of these banks and of the rest of the banking system they deal with.
Viral Acharya, Deputy Governor, RBI
RBI’s Acharya Bats For Persisting With Prompt Corrective Action Framework

Curbing The Slide

The credit growth of banks under PCA was strong as that of other banks till 2014, despite their worse capitalsation and stressed asset ratio, Acharya said. However, since the asset quality review was put in place by former Governor Raghuram Rajan, and the PCA was imposed, their year-on-year growth in loan advances turned negative by 2016 compared with more than 10 percent in 2014, preventing further deterioration, he said.

Given the evidence presented above on PCA bank’s sustained problem of asset quality, this is indeed the required medicine to prevent further hemorrhaging of their balance sheets.
Viral Acharya, Deputy Governor, RBI
RBI’s Acharya Bats For Persisting With Prompt Corrective Action Framework

Improving Provision Cover

The deputy governor explained that the provision coverage ratio of banks under PCA has now recovered to the level of non-PCA public sector banks after having fallen relatively between 2012 and 2016. “The recovered level of PCR remains at present at around 50 percent, which is more 10 percent below that of private banks, and away from the desirable 70 percent,” he said.

These numbers suggest that the loss-absorption capacity of PCA banks is on the mend, but that there is some distance to go in their catch-up to healthy levels.
Viral Acharya, Deputy Governor, RBI
RBI’s Acharya Bats For Persisting With Prompt Corrective Action Framework

Acharya said there is “little factual basis” for the assertion that the imposition of PCA has starved the Indian economy of credit. While it is true banks under PCA have seen lending go down on average, he said, they have seen double-digit growth in nominal non-food loans with a robust distribution across sectors. “This is because the reduction in lending at PCA banks is being more than offset by credit growth at healthier banks.”

The key point is that PCA banks are de-risking the asset side of their balance sheets by moving away from riskier sector loans to less riskier ones and government securities; the first and foremost priority is to limit (effectively, taxpayer) losses at PCA banks and prevent further erosion of their capital.
Viral Acharya, Deputy Governor, RBI

Without PCA, Acharya added, some banks would’ve incurred even higher losses and hence required more money of the taxpayer’s money for recapitalisation. “Imposition of PCA can thus be seen as first, stabilising the banks at risk, and then, undertaking the deeper bank reforms needed for long-term viability of the business model of these banks.”