Banks with weak balance sheets may be subject to, among other things, resolution processes such as amalgamation, reconstruction, winding up or mandatory actions such as restriction on management compensation and directors’ fees, the Reserve Bank of India said in its revised Prompt Corrective Action (PCA) framework.

Besides taking mandatory actions when they breach key risk thresholds within the indicators relating to areas such as capital, asset quality, profitability, and leverage, weak banks will also be subject to discretionary actions related, among others, to strategy, governance, capital, credit/ market risk, HR, profitability, operations and go through special supervisory interactions.

The RBI said breach of any of the three risk thresholds would result in invocation of the PCA. The provisions of the revised PCA framework will be effective from April 1, 2017, based on the financials of the banks for the year ended March 31, 2017. The framework would be reviewed after three years.

The RBI has come out with an elaborate PCA matrix encompassing areas, indicators and risk thresholds for guiding it on invoking the PCA.

The central bank will be closely monitoring banks’ capital-to-risk-weighted assets ratio/common equity tier-1 ratio when it comes to bank capital; net non-performing assets for asset quality; and return on assets indicator for tracking profitability.

For example, breach of ‘risk threshold 3’ of common equity tier 1 (if it is less than 3.625 per cent as against the current minimum prescription of 6.75 per cent) by a bank would identify it as a likely candidate for resolution through tools such as amalgamation, reconstruction, and winding up.

In the case of a default on the part of a bank in meeting the obligations to its depositors, possible resolution processes may be resorted to without reference to the PCA matrix. The mandatory actions that the RBI has prescribed for breaching ‘risk threshold 1’ include restriction on dividend distribution/remittance of profits, and promoters/owners/parent in the case of foreign banks to bring in capital.

If a bank breaches ‘risk threshold 2’, then in addition to actions under ‘threshold 1’, it will face restriction on branch expansion domestic and/or overseas, and higher provisions.

If a bank breaches ‘threshold 3’, then in addition to actions prescribed under ‘threshold 1’, it will face restriction on management compensation and directors fees, as applicable.

The PCA framework would apply without exception to all banks operating in India, including small banks and foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.

A bank will be placed under the PCA framework based on the audited annual financial results and the supervisory assessment made by the RBI. However, the RBI may impose the PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant.

RBI Governor Urjit Patel last week said orderly resolution of stressed assets will be undertaken concomitantly with resolution of the weakest bank balance sheets under a revised PCA, and the central bank’s new Enforcement Department.