In News:

• The Reserve Bank of India (RBI) recently placed Thrissur (Kerala)-based private bank Dhanlaxmi under close scrutiny.
• The RBI's decision to increase its oversight of Dhanlaxmi Bank's financial position is seen as a reaction to the bank's capital adequacy deterioration.
• Dhanlaxmi Bank's capital adequacy has previously fallen below required levels and it has even been placed under the RBI's prompt corrective action framework (PCA) to deal with serious deteriorations in its financial position.

 What’s in today’s article:

• Prompt Corrective Action (PCA) Framework for Banks
• News Summary 

Prompt Corrective Action (PCA) Framework for Banks:

• The PCA framework was introduced by the Reserve Bank of India (RBI) in 2002 as a structured early intervention mechanism.
• The PCA framework, which applies only to commercial banks (does not cover cooperative banks and NBFCs), refers to the central bank’s watchlist of troubled banks and the regulator (RBI) imposes restrictions (like curbs on lending) on such banks.

The process followed under the PCA framework:

• Initiation of the process: The RBI has specified certain regulatory trigger points with respect to three parameters - capital-to-risk weighted assets/capital adequacy ratio (CRAR), net non-performing assets (NPA) and return on assets (RoA).
  • CRAR is a ratio that gauges a bank's financial stability by measuring its available capital as a percentage of its risk-weighted credit exposure, to assist banks in protecting their depositors and promoting financial health.
    • Banks are required to keep their CRAR at 9% or higher under Basel-III
  • A NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
  • RoA is a type of profitability ratio that measures the returns generated by a company or financial institution on its assets.
• CRAR, and how does a violation result in action?
  • If CRAR falls to less than 9%: The RBI asks banks to submit a capital restoration plan, restricts new businesses and dividend payments.
  • If CRAR is less than 6% but equal to or more than 3%: The RBI could take additional steps (bringing a new management or board, initiating the process for merger of the bank, etc) if the bank fails to submit a recapitalization plan.
    • Under the Banking Regulation Act (1949), in governance related actions, the RBI can supersede the bank’s board.
  • If CRAR falls below 3%: If a bank’s CRAR does not improve beyond 3%, closer monitoring and steps to merge or amalgamate or liquidate the bank or impose a moratorium on the bank, will follow.
• The second part of the trigger:
  • If net NPAs rise beyond 10% but are less than 15%, a special drive to reduce bad loans and contain the generation of fresh NPAs begins.
  • If net NPAs shoot up above 15%, the bank’s board is called for discussion on the PCA.
• The third parameter:
  • If RoA is less than 0.25%, the RBI bars the bank from entering new lines of business.
  • The bank’s borrowings from the inter-bank market, making dividend payments and increasing staff will be restricted. 

News Summary:

How did the bank get to this point?

• Dhanlaxmi Bank's CRAR fell to around 13% at the end of March this year, down from 14.5% a year earlier, prompting the RBI to assess the bank's financial health.
• Dhanlaxmi Bank has been accused of mismanagement by its minority shareholders following the management's decision to expand the bank into new geographies despite an unexpected increase in expenses.
• The management has also been accused of not disclosing enough information to explain the cost increase.

Way ahead:

• The RBI is likely to keep a close eye on Dhanlaxmi Bank in the coming months as the bank's ability to meet capital adequacy norms is strained.
• To address its capital adequacy issues, Dhanlaxmi Bank has attempted to issue additional shares in the open market via a rights issue.
  • The bank will be able to raise additional equity capital from existing shareholders through a rights issue.
  • In contrast, during an initial public offering (IPO), shares are issued to new shareholders.
• The RBI may even decide to intervene if the bank's ability to comfortably meet the capital adequacy norms recommended by Basel-III regulations is jeopardized by the delay of the rights issue.
• In fact, if Dhanlaxmi Bank's management is unable to raise the necessary capital, the bank could become an acquisition