Authors:
The Prompt Corrective Action Framework
On December 14, 2021, citing their growing size and interconnectedness, the Reserve Bank of India (RBI) issued the Prompt Corrective Action (PCA) framework for Non-Banking Financial Companies (NBFCs), proposed to come into effect from October 1, 2022[1]. The PCA framework applies to all deposit-taking NBFCs (NBFCs-D) and all non-deposit taking NBFCs (NBFCs-ND) in the Middle, Upper, and Top Layers, identified under RBI’s new Scale Based Regulations[2]. It excludes NBFCs not accepting/not intending to accept public funds, Government Companies, Primary Dealers, and Housing Finance Companies (HFCs).
The PCA framework is intended to act both as a supervisory tool and a tool for effective market discipline to restore the financial health of the supervised entity in question. It proposes to track the following indicators across three key areas – capital, asset quality, and leverage (only for Core Investment Companies (CICs)).
There are three graded risk thresholds for each of the above indicators, and breach of any of these thresholds will result in invocation of corrective actions under the PCA framework. These corrective actions include both mandatory and discretionary actions that the RBI may prescribe and range from remedial measures intended to target improvement in specific financial health indicators to special supervisory actions that allow RBI to recommend NBFCs for resolution.
In this note , we discuss how the current approach of the PCA framework is inconsistent with the objectives it seeks to achieve. We argue that this approach has led to two errors – the inclusion error and the exclusion error. Further, we also argue that the PCA framework is an incomplete remedy.
Inclusion and Exclusion Errors
The inclusion error arises due to RBI’s decision to supervise smaller NBFCs under the PCA framework, i.e., Middle Layer NBFCs, which do not pose any threat to the stability of the financial system. This represents a misutilisation of the RBI’s supervisory capacity. On the other hand, the exclusion error arises as the RBI has left large and interconnected HFCs and those (HFCs) with permission to accept retail deposits outside the scope of the PCA framework.
An Incomplete Remedy to Address Risks
We also argue in the note that the PCA framework is an inadequate remedy to address the risks originating from the NBFC sector. To truly protect retail and unsophisticated term depositors of NBFCs and ensure the least impact on systemic stability, in addition to the PCA framework, the RBI should also – a) remove the regulatory arbitrage that NBFCs-D continue to have compared to NBFCs-ND and non-financial corporates, i.e., permission to access retail customer’s money with a less stringent public disclosure regime as compared that applicable for issuance of listed debt, and b) put in place a robust resolution framework along the lines of a Resolution Corporation (RC) as recommended by the Financial Sector Legislative Reforms Commission (FSLRC) for resolving NBFCs-D and NBFCs in the Upper and Top Layer.
The full note is available here .
[1] See ‘Prompt Corrective Action (PCA) Framework for Non-Banking Financial Companies (NBFCs)’, December 14, 2021, Reserve Bank of India, https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12208&Mode=0
[2] See ‘Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs’, October 22, 2021, Reserve Bank of India, https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12179&Mode=0
Cite this Item:
APA
Sowmini Prasad, D. B. (2022). Note on RBI’s Prompt Corrective Action Framework for Non-Banking Financial Companies. Retrieved from Dvara Research.
MLA
Sowmini Prasad, Dwijaraj Bhattacharya. “Note on RBI’s Prompt Corrective Action Framework for Non-Banking Financial Companies.” 2022. Dvara Research.
Chicago
Sowmini Prasad, Dwijaraj Bhattacharya. 2022. “Note on RBI’s Prompt Corrective Action Framework for Non-Banking Financial Companies.” Dvara Research.
