Page 46 - Banking Finance April 2019

ARTICLE

under the powers bestowed upon the Bank by capital buffer. CCB is designed to ensure that banks build up
promulgation of the Banking Regulation (Amendment) a capital buffer outside periods of financial stress that can
Ordinance 2017 (since notified as an Act); be drawn down when banks face financial (systemic or

Y Reserve Bank of India issued a circular on the 12th of idiosyncratic) stress.
February, 2018 for the resolution of stressed assets,
which employs the IBC reference as its lynchpin for Intent behind PCA:
resolution and is aimed at improving the credit culture The intent behind Prompt Corrective Action (or PCA) is to
in both borrowers and lenders; achieve - to intervene early and take corrective measures
in a timely manner, to restore the financial health of banks
Thus, raising the bar step by step, Reserve Bank of India that are at risk by limiting deterioration in their health and
imposed Prompt Corrective Action (PCA) on a number of preserving their capital levels. By construction then, PCA
banks whose capital, asset quality and/or profitability do not involves some restrictions on bank scope and expansion as
meet pre-specified thresholds. not doing so would lead to excessive risks on the balance-
sheets of these banks. Similarly, putting up PCA banks for
Importance of Bank Capital and Basel III: sale in the market and / or replacing bank management
Equity capital is the primary loss-absorption buffer - means become potential mechanisms for prompt resolution.
of protection - against the asset losses of a bank. It is meant
While the intent of PCA is primarily remedial, it can also act
to be at levels high enough to absorb unanticipated losses
as a deterrence and motivate management of other banks
with enough margins to inspire confidence and enable the
(not falling under PCA) to contain risks so that they do not
bank to continue as a going concern, in particular, without
passing on losses to bank creditors. Once the capital level is end up in PCA in the first place.
fully consumed by the deteriorating financials, it exposes the Performance of the PCA banks in India:
unsecured creditors, including depositors, to bear the losses.
While the deposits typically are insured up to a certain level, There are emerging signs that the performance of banks
economic history shows that often the ultimate costs of under PCA is slowly but steadily being restored. Following
paying off all deposits fall on the sovereign, especially in the are a few charts which show the performance of 11 public
case of large, complex and inter-connected banks. sector PCA banks for the last 10 years.

Capitalization (Chart 1, 2):
Given this criticality of bank capital in absorbing losses, it is
natural why minimum bank capital requirements are in place The declining trend of CRAR and Tier-1 capital ratio for PCA
globally and why capital becomes one of the most important banks that started in 2011 has been arrested and the ratio
factors for supervisors to monitor. In the aftermath of the has been maintained steady since 2014 at or above
global financial crisis, there has been a complete overhaul internationally prescribed levels.
of the international regime for
minimum regulatory capital
requirements of banks, as enshrined in
the revised Basel norms, viz., Basel-III.

The goal of Basel III is to raise the
quality, consistency and transparency
of the capital base of banks to
withstand unanticipated losses and to
strengthen the overall risk coverage of
the capital framework. In addition to
revising the minimum capital ratio
requirements for credit risk, Basel III
also introduced a capital conservation
buffer (CCB) and a countercyclical

46 | 2019 | APRIL | BANKING FINANCE