New Economic Capital Framework Of The RBI

• There was a debate about how much surplus of the Reserve Bank of India (RBI) is to be transferred to the government of India. Current ECF is based on a conservative assessment of risk by the RBI which leads to unnecessary lock up of funds by the RBI.
• As per the government, reserves with RBI are in excess of its contingency needs. Some central banks around the world (like US and UK) keep 13% to 14% of their assets as a reserve compared to RBI’s 27%.
• The Malegam Committee also favoured pruning of RBI’s coffers and estimated RBI’s surplus amounts at around Rs 1.49 lakh crore in 2013.
• In this light, the RBI on 26 December 2018 set up an expert committee, headed by its former governor Bimal Jalan to review the existing economic capital framework and recommend the appropriate size of reserves the central bank should maintain and the dividend it should give to the government.

• The RBI should maintain a Contingent Risk Buffer, which mostly comes from the CF, of between 5.5-6.5% of the central bank’s balance sheet. Since the latest CF amount was about 6.8% of the RBI’s balance sheet, the excess amount (beyond 5.5%) was to be transferred to the government (around Rs 52000 crore).
• Keep the CGRA fund reserve in the range of 20-24.5% of the RBI’s balance sheet. Since it stood at 23.3% as of June 2019, the committee felt that there was no need to add more to it, and so the full net income of the RBI this year, a whopping Rs 1,23,414 crore, should be transferred to the Centre making the total transferable amount to be around Rs 1.76 lakh crore.
• Align the central bank’s accounting year with the financial year to reduce the need for paying interim dividend to the government. This would also help in providing better estimates of the projected surplus transfers by the RBI to the government for the financial year for budgeting purposes.
• RBI should put in place a framework for assessing the market risk of its off-balance sheet exposures in view of their increasing significance.
• A clearer distinction between the two components of economic capital i.e. realised equity and revaluation balances, mainly because of the volatile nature of the revaluation balances.
• The surplus distribution policy should move away from targeting total economic capital alone. It should have dual set of targets, that is, the total economic capital of the RBI and the level at which realised equity is to be maintained. The minimum level of realised equity to be maintained should be the sum of the monetary and financial stability risks, credit risk and operational risk.
• A review of RBI’s economic capital framework should be conducted every five years.

• Review of the framework would result in excess capital being freed, which the RBI can then share with the government at a time when the economy is slowing and funds are urgently needed by the government.
• It will have domino effect on the Indian economy as it will pump in liquidity in the market thereby creating demand in the economy.
• While it does not immediately do the RBI any harm, the fact remains that the central bank now has far less wiggle room in the event of a financial catastrophe, since its reserves have been emptied to their minimum levels or thereabouts. That is, it has the minimum amount to deal with a crisis, but extra cash always comes in handy.
• The RBI’s transfers had emptied it’s coffin and now there is no scope for the government to rely on this source of funding in the near future.

The government in its Budget already accounted for a transfer of 90,000 crore from the RBI, and so the unexpected amount is 86,000 crore. This is a one-time bonanza and does not fix the fact that tax revenues — both direct and indirect tax — are coming in much lower than they need to. So the need of hour is to reform conventional sources of funding such as increasing Tax Base, DTC reform and Tax to GDP ratio.