The Reserve Bank of India’s (RBI’s) prompt corrective action (PCA) rules state that banks which breach the third threshold for any parameter are ripe candidates for a merger with another bank. Analysts at brokerage firm Jefferies India Pvt. Ltd have identified four banks that breach the third threshold under various parameters based on data from latest September quarter results.

IDBI Bank Ltd, the weakest lender, has breached the third threshold for net bad loans, capital adequacy ratio and common equity Tier-1 ratio. Indian Overseas Bank has breached the third threshold on three parameters as well, while Bank of India and United Bank of India have fallen foul on one count.

The September quarter results also revealed that six banks which are currently not under PCA should be, because of the extensive erosion in their capital notwithstanding government infusion. To be sure, RBI considers annual performance in determining the need for a bank to be put under PCA and therefore the performance for the first half of a fiscal year is not a real indicator.

As an earlier Mint report stated, based on the annual March 2018 results, four banks that were not already under PCA had crossed the threshold on asset quality. Latest results show the list has expanded to six banks. Clearly, unless RBI PCA norms are relaxed, more state-run banks are expected to be put under corrective action, rather than the government’s expectation that restrictions are lifted on some.

It becomes clear why the government has been insisting that RBI should revisit its PCA framework. At the last board meeting of the central bank, it was decided that a committee would look into these norms and give recommendation to the board.

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Whatever the decision, the outlook on profitability of these banks is far from being sanguine. Analysts expect slippages to rise in the coming two quarters because of the stress from Infrastructure Leasing and Financial Services Ltd. Since most banks are at the bare minimum regulatory requirement in capital, even a mild erosion of capital may send them into PCA.

The impact of 17 banks out of 21 public sector lenders being in PCA would be disastrous for lending. Public sector banks are crucial for giving loans to small businesses and their share is large. For instance, the half- yearly report on the government’s Mudra scheme shows that they contribute to more than half of the lending to small and micro businesses. Mudra is a scheme that offers refinance for loans up to 10 lakh given out by lenders.

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The lenders are also an important platform through which the government can push its flagship social schemes. Non-banking financial companies that have become an important source of funding for small borrowers are not in a position to meet the demands any more due to the liquidity crunch.

But given the precarious state of some of these banks, the solution clearly is to adequately capitalize them, so that depositors’ funds are shielded.

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