RBI’s Capital Reserve –Components and Controversies

RBI’s Capital Reserve –Components and Controversies

Capital reserve of the central bank is the fund available with it to face any financial contingency. Liquidity emergencies like the Global Financial Crisis, IL&FS liquidity situation etc. points towards the strengthening of such a reserve to manage contingencies.

RBI’s capital reserve is estimated to be about 9.5 lakh crores or 26.25% of the total assets as on end June 2018. It is a buffer for the RBI to meet financial contingencies while facing the any potential financial crisis situation in the economy.

In recent months, there occurred a controversy that the RBI has excess capital reserves and it has to be used for specific purposes. Later, on 19th of November, the RBI Central Board decided to create a Committee to decide on an Economic Capital Framework. Such a Framework is expected to determine the right volume of capital reserve for the RBI.

What is the purpose of the Capital Reserve?

The main purpose of the capital reserve is to enable the RBI to meet any financial emergency situation out of liquidity crisis etc., – on its own. Capital actually indicate the ready funds available with the RBI to manage own business.

For example, the most important component of the Capital Reserve – the Contingency Fund is expected to help the central bank to meet risks from sudden liquidity shortages in the market, steep exchange rate movements, fall in the value of government securities held by the RBI etc.

Similarly, the Asset Development Fund is expected to give support to the associates of the RBI (like the NHB) when the latter is facing crisis.

What are the components of the capital reserve?

There are five components in the RBI’s capital reserve. The first two (CF and ADF) are Funds created to meet specific purposes and provisions are made yearly to add money to these funds.

The other three (CGRA, IRA and FCVA) are valuation accounts just shows the gain or losses in foreign exchange, government securities or foreign currency contracts handled by the RBI.

Following are the five components of the RBI’s capital reserve.

  1. Contingency Fund (CF)
  2. Asset Development Fund (ADF)
  3. Currency and Gold Revaluation Account (CGRA)
  4. Investment Revaluation Account (IRA) and
  5. Foreign Exchange Forward Contracts Valuation Account (FCVA).

All these five components are recorded in the liability side of the RBI’s balance sheet.

  1. What is Contingency Fund (CF)?

The CF is a fund set apart for meeting the unforeseen contingencies, including depreciation in the value of securities, risks arising out of monetary/exchange rate policy operations, systemic risks and any risk arising on account of the special responsibilities enjoined upon the Bank.

  1. What is Asset Development Fund?

The Asset Development Fund (ADF) has been set aside for investment in subsidiaries and associates and internal capital expenditure.

How DF and ADF are financed?

From 2014 onwards, both CF and ADF are financed through provisioning. Meaning of the word provisioning is that an estimated amount is allocated from a given source.

Hence, the allocation to the CF and ADF may is not shown in the final income statement of the RBI. Income is estimated after making the provisioning to the DF and ADF.

On the other hand, before 2014, deductions to DF and ADF were made after estimating the income. After making allocations to DF and ADF from Income, transfer to the government was made.

Table: RBI’s CF and ADF and the transfer of income to the government – the two phases (amount is in Rs billion).

Item 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18
Income of the RBI 531 743 646 792 808 618 782
Transfer/Provisioning to CF and ADF Transfer Provisioning
270 287 0 9 -4 81 39
Transfer to the Govt. 160 330 526 659 658 306 500

Source: Compiled from different Annual Reports of the RBI.

The practice of provisioning instead of allocating from income seems to be made after the recommendations of the Y H Malegam Committee recommendations (2013). Report of the Committee is not available in the public domain.

Table: Components of Capital Reserves of the RBI

Component Amount in Rs crores
Contingency Fund (CF) 232108
Asset Development Fund (ADF) 22811
Currency and Gold Revaluation Account (CGRA) 691641
Investment Revaluation Account (IRA) and 13285
Foreign Exchange Forward Contracts Valuation Account (FCVA). 3262
Total 949822

Provisioning was quite weak in 2017-18 according to the data of the RBI AR (2017-18). An amount of Rs 3901 crores were added to CF but nothing was added to ADF. During the previous years also, the provisioning was weak and hence the CF plus ADF came down significantly from 9.2% of the RBI’s capital assets in 2014 to 7.05% in 2018.  The table below shows the weak addition to CF and nil addition to ADF in 2017-18.

Table: CF and the ADF Outstanding during 2017-18 and 2016-17

Item 2017-18 Outstanding (Rs bn crores) 2016-17 Outstanding (Rs bn crores Change (Rs bn crores)
CF 2321 2282 39
ADF 22811 22811 0

Source: RBI Annual Report 2018

What is happening to the DF and the DF over the last few years?

At the same time, the proportion of the DF and the ADF are declining since the last few years. Especially, they have shown a rapid decline since the launch of provisioning instead of allocation from declared income. The table below shows that the combined value of the DF and the ADF are showing a decline since 2014.

Year (as on June 30) Balance Amount in CF and ADF together (Rs crores) CF+ADF as a % of total assets of the RBI.
2014 242413 9.2
2015 243375 8.4
2016 242944 7.5
2017 251018 7.6
2018 254919 7.05

Source: RBI Annual Report 2018

Understandably, the RBI’s CF and ADF – the two critical funds have registered decline due to high transfer to the government in the background of provisioning adoption

What are Revaluation Accounts?

The RBI holds several accounts for its holding and handling of the foreign currencies and foreign currency assets (for example US Securities), government securities (Central government), Gold, Forward Contracts etc. Simply, these assets (foreign currencies, gold, foreign currencies, government securities etc.,) may change values with market changes. Hence, the values of these assets with the RBI also may change. A revaluation is to be made with respect to their values. Such changes are accommodated in the three respective revaluation/valuation accounts. Following are the revaluation/valuation accounts of the RBI. Remembers since they are part of the Capital Reserves (after CF and ADF), continuous numbering after CF and ADF is given.

  1. Currency and Gold Revaluation Account (CGRA)

The CGRA shows fund that is available to compensate RBI’s loss in the value of gold and foreign exchange reserve holdings. Gains and losses of the values of Gold and Foreign Currency Assets decreases or increases the CGRA money.

Thus, changes in the market value of gold and forex assets (like the US Government securities where the RBI invested its foreign exchange reserves) is reflected in the CGRA.

CGRA provides a buffer against exchange rate/gold price fluctuations. When CGRA is not enough to fully meet exchange losses, it is replenished from the contingency fund.

Increase in gold price and depreciation of the rupee increases the CGRA fund.

As on end June 2018, the CGRA has an amount of Rs 6,91600 crores billion. It registered an increase in 2018 mainly due to depreciation of rupee against US dollar and rise in the international price of Gold.

  1. Investment Revaluation Account (IRA)

The investment Revaluation Account shows the buffer amount available with the RBI to compensate losses and to accommodate gains in (i) foreign securities and (ii) domestic securities. RBI holds significant portion of foreign securities and domestic securities (government of India). Under IRA, the marked to market gains and losses are measured.

  1. Foreign Exchange Forward Contracts Valuation Account (FCVA)

The FCVA measures marked to market (periodic) gains and losses for the RBI from foreign exchange forward contracts.

Central bank balance sheet purpose

The purpose of central bank balance sheet is not to yield profit; though central banks can earn profit. Now, the main fact is that it has to maintain enough funds to manage emergencies. Dr SS Tarapore (late) in his September 3, 2015 (the Hindu Business Line) article pointed out that central banks should maintain its balance sheet by focusing on wider interest of the economy.

Accretion to Contingency Fund and Asset Development Fund as on end June between 2011 and 2018 (Rs Billion)

2011 2012 2013 2014 2015 2016 2017 2018
Transfer to CF & ADF Provisioning to CF and ADF
CF Outstanding 1707 1954 2216 2216 2216 2201 2282 2321
Addition 122 247 262 0 0 -15 81 39
ADF Outstanding 158 182 207 207 217 227 228 228
Addition 12 24 25 0 9 10 1 0
Total (CF+ADF) Outstanding 1865 2136 2424 2424 2433 2429 2510 2549
  Addition 134 271 287 0 9 -4 81 39

Source: Estimated (by indianeconomy.net) from different Annual Reports of the RBI (2013 to 2018). CF is Contingency Fund and ADF is Asset Development Fund. Exclusion of fractions caused difference of 1 for few entries (eg 2017 total is 81 instead of 82).