Friday, April 21, 2017

Liquidity and its Management by RBI

With Rs 4.8 trillion of excess funds flooding the system, the RBI  shifted its policy focus to liquidity management by raising reverse repo rate by 25 bps and slashing MSF by an equal measure. In its First Bi-Monthly Monetary Policy on 6th April 2017 RBI stressed upon the "Liquidity Management". 

                 The central bank also promised to have a more effective liquidity management tool in a new instrument called a Standing deposit facility (SDF) at the earliest. 

                  It is therefore essential for a common man to know what is meant by Liquidity Management. It is our endeavour to make common man understand about Liquidity and Liquidity Management.

             Liquidity: Liquidity Means available cash in the economic system, be it neutral, deficient or surplus. Availability of the higher amount of cash in the system leads to lowering/softening of the interest rates, whereas deficiency of cash may lead to higher interest rates even without the RBI intervention.  Similarly availability of the liquidity in the system influences RBI policy action either through increase or reduction in the policy rates.
           RBI's Apprehensions : The banking system had excess cash. In March, the average liquidity was about Rs 4.81 lakh crore, which was conducive to lower overnight rates. In fact, inter-bank call money rate dipped about 65 bps lower than the policy or repo rate at 6.25%. This was clearly not in RBI's comfort zone and could well upset its policy stance. RBI likes to have overnight rates within 15-25 bps range over the policy rate. The central bank changed its policy stance to `'neutral'' from “accommodative“. A neutral stance is contrary to surging liquidity in the system.

                 Reasons for Excessive Liquidity: The Government's move of demonitisation by banning Rs 500 and Rs 1000 SBN's wef 8th Nov 2016 has flooded the economic system with cash and high Bank deposits. Now with the remonitisation the situation has started coming to normalcy.

         RBI's Tools for Sucking Excess Liquidity from the system:  With the remonitisation drive of the Government after 31st December 2016 and RBI to print new Currencies and the removal of cash withdrawal limits the excess cash from the system is being withdrawn. This is yielding positive results in addition to the traditional tools such as Open market operations, Cash Management Bills (CMB) and reverse repo auctions.

          Impact of Narrowing of LAF Corridor by increasing Reverse Repo rate: By increasing the reverse repo rate the RBI has curbed volatility. This will help short term rates to increase thereby bringing them in line with the policy rates. We expect the short term bonds to outperform long term bonds. Short term bonds are less sensitive to the policy outlook as well as to global risks. In the past few days the policy move has yielded positive results in raising overnight rates.

              Liquidity vs Inflation: Since the Economic System which is having excess liquidity is prone to Inflationary tendency. Since RBI's prime objective is to control Inflation RBI focuses on the Management of Liquidity in the system. RBI Governor Mr. Urjit Patel said liquidity management has become important now to contain inflation 

Source: Economic Times, Business Line

Thursday, April 13, 2017

Revised Prompt Corrective Action (PCA) framework for banks

Reserve Bank of India vide its notification no.RBI/2016-17/276 / DBS.CO.PPD. BC.No.8/11.01.005/2016-17 dated 1th April 2017 has revised existing Prompt Corrective Action (PCA) framework for banks which will come into effect from April 1, 2017 based on the Financials of the Bank for March 31st 2017.
The PCA framework does not preclude the Reserve Bank of India from taking any other action as it deems fit in addition to the corrective actions prescribed in the framework.
RBI Clarification on Banks under Prompt Corrective Action

The Reserve Bank has emphasized that the PCA framework has been in operation since December 2002 and the guidelines issued on April 13, 2017 is only a revised version of the earlier framework.

The salient features of revised PCA framework for banks
A. Capital, asset quality and profitability continue to be the key areas for monitoring in the revised framework.
B. Indicators to be tracked for Capital, asset quality and profitability would be CRAR/ Common Equity Tier I ratio1, Net NPA ratio2 and Return on Assets3respectively.
C. Leverage would be monitored additionally as part of the PCA framework.
D. Breach of any risk threshold (as detailed under) would result in invocation of PCA.
PCA matrix - Areas, indicators and risk thresholds
IndicatorRisk Threshold 1Risk Threshold 2Risk Threshold 3
(Breach of either CRAR or CET 1 ratio to trigger PCA)
CRAR- Minimum regulatory prescription for capital to risk assets ratio + applicable capital conservation buffer(CCB)
current minimum RBI prescription of 10.25% (9% minimum total capital plus 1.25%* of CCB as on March 31, 2017)
And/ Or
Regulatory pre-specified trigger of Common Equity Tier 1 (CET 1min) + applicable capital conservation buffer(CCB)
current minimum RBI prescription of 6.75% (5.5% plus 1.25%* of CCB as on March 31, 2017)
Breach of either CRAR or CET 1 ratio to trigger PCA
upto 250 bps below Indicator

<10.25% but >=7.75%

upto 162.50 bps below Indicator

<6.75% but >= 5.125%
more than 250 bps but not exceeding 400 bps below Indicator
<7.75% but >=6.25%

more than 162.50 bps below but not exceeding 312.50 bps below Indicator

<5.125% but >=3.625%


In excess of 312.50 bps below Indicator

Asset QualityNet Non-performing advances (NNPA) ratio>=6.0% but <9.0%>=9.0% but < 12.0%>=12.0%
ProfitabilityReturn on assets (ROA)Negative ROA for two consecutive yearsNegative ROA for three consecutive yearsNegative ROA for four consecutive years
LeverageTier 1 Leverage ratio4<=4.0% but > = 3.5%
(leverage is over 25 times the Tier 1 capital)
< 3.5% (leverage is over 28.6 times the Tier 1 capital)
*CCB would be 1.875% and 2.5% as on March 31, 2018 and March 31, 2019 respectively.
  1. Breach of ‘Risk Threshold 3’ of CET1 by a bank would identify a bank as a likely candidate for resolution through tools like amalgamation, reconstruction, winding up, etc.
  2. 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.
E. 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.
F. A bank will be placed under PCA framework based on the audited Annual Financial Results and the Supervisory Assessment made by RBI. However, RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant.
Mandatory and discretionary actions
SpecificationsMandatory actionsDiscretionary actions
Risk Threshold 1
Restriction on dividend distribution/remittance of profits.
Promoters/owners/parent in the case of foreign banks to bring in capital
Common menu
Special Supervisory Interactions
Strategy related
Governance related
Capital related
Credit risk related
Market risk related
HR related
Profitability related
Operations related
Any other
Risk Threshold 2
In addition to mandatory actions of Threshold 1,
Restriction on branch expansion; domestic and/or overseas
Higher provisions as part of the coverage regime
Risk Threshold 3
In addition to mandatory actions of Threshold 1,
Restriction on branch expansion; domestic and/or overseas
Restriction on management compensation and directors’ fees, as applicable
Common menu for selection of discretionary corrective actions
1. Special Supervisory interactions
  • Special Supervisory Monitoring Meetings (SSMMs) at quarterly or other identified frequency
  • Special inspections/targeted scrutiny of the bank
  • Special audit of the bank
2. Strategy related actions
RBI to advise the bank’s Board to:
  • Activate the Recovery Plan that has been duly approved by the supervisor
  • Undertake a detailed review of business model in terms of sustainability of the business model, profitability of business lines and activities, medium and long term viability, balance sheet projections, etc.
  • Review short term strategy focusing on addressing immediate concerns
  • Review medium term business plans, identify achievable targets and set concrete milestones for progress and achievement
  • Review all business lines to identify scope for enhancement/ contraction
  • Undertake business process reengineering as appropriate
  • Undertake restructuring of operations as appropriate
3. Governance related actions
  • RBI to actively engage with the bank’s Board on various aspects as considered appropriate
  • RBI to recommend to owners (Government/ promoters/ parent of foreign bank branch) to bring in new management/ Board
  • RBI to remove managerial persons under Section 36AA of the BR Act 1949 as applicable
  • RBI to supersede the Board under Section 36ACA of the BR Act 1949/ recommend supersession of the Board as applicable
  • RBI to require bank to invoke claw back and malus clauses and other actions as available in regulatory guidelines, and impose other restrictions or conditions permissible under the BR Act, 1949
  • Impose restrictions on directors’ or management compensation, as applicable.
4. Capital related actions
  • Detailed Board level review of capital planning
  • Submission of plans and proposals for raising additional capital
  • Requiring the bank to bolster reserves through retained profits
  • Restriction on investment in subsidiaries/associates
  • Restriction in expansion of high risk-weighted assets to conserve capital
  • Reduction in exposure to high risk sectors to conserve capital
  • Restrictions on increasing stake in subsidiaries and other group companies
5. Credit risk related actions
  • Preparation of time bound plan and commitment for reduction of stock of NPAs
  • Preparation of and commitment to plan for containing generation of fresh NPAs
  • Strengthening of loan review mechanism
  • Restrictions on/ reduction in credit expansion for borrowers below certain rating grades
  • Reduction in risk assets
  • Restrictions on/ reduction in credit expansion to unrated borrowers
  • Reduction in unsecured exposures
  • Reduction in loan concentrations; in identified sectors, industries or borrowers
  • Sale of assets
  • Action plan for recovery of assets through identification of areas (geography wise, industry segment wise, borrower wise, etc.) and setting up of dedicated Recovery Task Forces, Adalats, etc.
6. Market risk related actions
  • Restrictions on/reduction in borrowings from the inter-bank market
  • Restrictions on accessing/ renewing wholesale deposits/ costly deposits/ certificates of deposits
  • Restrictions on derivative activities, derivatives that permit collateral substitution
  • Restriction on excess maintenance of collateral held that could contractually be called any time by the counterparty
7. HR related actions
  • Restriction on staff expansion
  • Review of specialized training needs of existing staff
8. Profitability related actions
  • Restrictions on capital expenditure, other than for technological upgradation within Board approved limits
9. Operations related actions
  • Restrictions on branch expansion plans; domestic or overseas
  • Reduction in business at overseas branches/ subsidiaries/ in other entities
  • Restrictions on entering into new lines of business
  • Reduction in leverage through reduction in non-fund based business
  • Reduction in risky assets
  • Restrictions on non-credit asset creation
  • Restrictions in undertaking businesses as specified.
Any other specific action that RBI may deem fit considering specific circumstances of a bank.
RBI Clarification on Banks under Prompt Corrective Action 
Date : Jun 05, 2017
The Reserve Bank of India has come across some misinformed communication circulating in some section of media including social media, about the Prompt Corrective Action (PCA) framework.
The Reserve Bank has clarified that the PCA framework is not intended to constrain normal operations of the banks for the general public.
It is further clarified that the Reserve Bank, under its supervisory framework, uses various measures/tools to maintain sound financial health of banks. PCA framework is one of such supervisory tools, which involves monitoring of certain performance indicators of the banks as an early warning exercise and is initiated once such thresholds as relating to capital, asset quality etc. are breached. Its objective is to facilitate the banks to take corrective measures including those prescribed by the Reserve Bank, in a timely manner, in order to restore their financial health. The framework also provides an opportunity to the Reserve Bank to pay focussed attention on such banks by engaging with the management more closely in those areas. The PCA framework is, thus, intended to encourage banks to eschew certain riskier activities and focus on conserving capital so that their balance sheets can become stronger.
The Reserve Bank has emphasized that the PCA framework has been in operation since December 2002 and the guidelines issued on April 13, 2017 is only a revised version of the earlier framework.

1 CET 1 ratio – the percentage of core equity capital, net of regulatory adjustments, to total risk weighted assets as defined in RBI Basel III guidelines
2 NNPA ratio – the percentage of net NPAs to net advances
3 ROA – the percentage of profit after tax to average total assets
4 Tier 1 Leverage ratio – the percentage of the capital measure to the exposure measure as defined in RBI guidelines on leverage ratio.