The RBI’s Central Board of Directors (CBD) which is the administrative body of the RBI, in a meeting on August 26, decided to transfer Rs 1.76 lakh crore to the government. The transfer amount is comprised of two components; first transfer of net income of the RBI and second, transfer of surplus reserves.
Here is the division:
(1) the entire net income of Rs 1,23,414 crore for the year 2018-19,
(2) there is an excess (surplus) reserve of Rs 52,637 crore that has been written back and consequently will be transferred to the Government.
The first one is the transfer of RBI’s income (read profit) to the government as the government is the single shared holder of the RBI. Over the last five years, the government is withdrawing nearly 100% of the RBI’s net income.
But the second component ie., the surplus capital is the interesting one. This is not the one that the government gets from the RBI usually. Rather this is the first time that the government is getting surplus capital from the RBI.
It indicates that the RBI has surplus capital over the risk situation requires and hence it should be transferred to the government. According to the CBD, the Committee on Economic Capital Framework of the RBI (Chairman Bimal Jalan) has discovered this surplus capital (of Rs 52,637 crore) and hence the RBI is transferring it to the government. The Commitee report was published on August 28, 2019.
Out of this Rs 1.76 lakh crores, Rs 28000 crore has been already transferred to the government.
Now, to understand the significance of the RBI decision espeically that related to the identificaiton of excess reserves (52,637 crore), we have to go through the basic concepts related to capital reserves from a central bank angle.
1. What is the capital reserves of the RBI?
Capital reserve of the RBI is the fund available with it to face any financial contingency in the economy. It is considered as own money of the RBI to manage the central bank operations. Capital in a literary sense implies the money put by the owner to run the business.
2. Why a central bank like the RBI need capital reserves?
During emergency financial situation like a liquidity crisis, the RBI can support with the supply of money only if it has some credible assets. Capital reserves simply indicate the financial capacity of the central bank.
It is a buffer for the RBI to meet financial contingencies while facing the any potential financial crisis situation in the economy.
Usually, it is the commercial banks habit to keep own money or capital to meet financial contingencies. You may be heard about Capital Adequacy Ratio (Proportion of capital as a percentage of the loans given by the bank). But central banks also behave like commercial banks and the central bank faces lot of risk related to the management of the economy.
3. How the capital reserves are acquired by the RBI?
The RBI accumulates reserves out of its own income. Several of the RBI functions like giving loans to commercial banks (repo) gives interest income to the RBI. As per the statute, this income has to be transferred to the government as the government is the single owner of the RBI. At the same time, a certain proportion of the income is kept apart as Contingency Fund, Asset Development Fund etc. to strengthen the RBI operations. These funds and the valuation gains of the RBI in the form of gold, foreign currencies etc are indicated as Capital Reserve.
4. What is the amount of capital reserves with the RBI?
In the last few years, people in the government were pointing out that the RBI has higher capital compared to its assets.
As per the August 26th, 2019 intimation of the RBI Central Board, as on June 30, 2019 the RBI’s capital reserve lies within the range of 24.5 per cent to 20.0 per cent of balance sheet. The central board concluded that with this level of capital reserve, the RBI is supposed to be one of the highest capitalised central banks in the world. Or in other words, its capital reserves is more than enough.
Earlier data for June 2018 indicates RBI capital reserve at around Rs 9.5 lakh crores or 26.25% of the total assets.
5. What is the meaning of surplus capital reserve or excess provisions?
Surplus capital reserve or excess capital reserve or excess provisions means the RBI is stocking excess own funds over what actually requires to face contingency situations. The reserve addition is called provisions as these funds are made through provisioning (fund transfer from RBI’s income) by the RBI to its capital reserves.
6. Whether there is a surplus reserve for the RBI?
Several analysts especially from the government side view that the RBI is one of the highly capitalized central banks in the world. Its’ capital reserves are nearly 29 % of its assets. Hence, they argued that a part of this reserves has to be transferred to the government.
7. What the government has done to examine whether the RBI is keeping excess (surplus) reserves?
The RBI in November 2018 appointed a Committee called Committee on Economic Capital Framework under former RBI Governor Bimal Jalan to examine whether the RBI is holding excess capital reserves.
8. What is the meaning and significance of the Economic Capital level?
Economic Capital simply indicate the amount of capital to be kept by an institution (here RBI) to manage its risk. The economic capital goes up with the risk incidence. From the RBI angle, the significance of Economic Capital is that the RBI has to limit its capital reserve only around the Economic Capital level. (More than that amount can be called as excess reserve and it has to be transferred by the RBI to the government).
9. What was the responsibility of the Committee on Economic Capital Framework?
Though there were several responsibilities to the Bimal Jalan led committee, two of them were more important. First, the Committee has to examine whether the reserves and buffers (capital) of the RBI are in surplus or deficit compared to the required level.
Secondly, the Committee has to propose a suitable profit distribution policy for the RBI. This means the amount of profit to be transferred by the RBI to the government.
By considering all situations of the RBI, the Committee has to find whether the RBI is holding more provisions (capital) than required or whether the RBI holding less provisions (capital) than required.
10. What is the level of Economic capital suggested by the Committee?
The detailed report of the Committee is yet to be published. At the same time, important views of the committee were mentioned in the RBI Director Board report.
Here, the Director Board news brief says that “ While the revised framework technically would allow the RBI’s economic capital levels as on June 30, 2019 to lie within the range of 24.5 per cent to 20.0 per cent of balance sheet, the economic capital as on June 30, 2019 stood at 23.3 per cent of balance sheet.”
This means that based on the current situation, the Committee advocated a minimum reserve of 20 % (maximum 24%). But as on June 2019, the RBI has an economic capital of 23.3%. So, the Committee identified Rs 52,637 crore excess reserves and recommended its transfer to the government.
11. What is the logic behind the transfer of Recommendations of the committee based on?
According to the RBI’s Director Board meeting, the Committee’s recommendations were guided by monetary policy, financial and external stability considerations. “The Committee’s recommendations were based on the consideration of the role of central banks’ financial resilience, cross-country practices, statutory provisions and the impact of the RBI’s public policy mandate and operating environment on its balance sheet and the risks involved.”
12. What is the justification for the discovery of capital surplus and its transfer to the government?
This is an important question. Ultimately what is the justification for the transfer of excess reserves to the government than keeping it with the RBI?
The Committee here highlighted that any shortfall in reserves when market risk goes up, could be met through increased allocation from net income to capital reserves. Or in other words, whenever the market risk increases, the RBI adds money from its income to capital reserves.
In the same way, whenever the capital reserves are excess, it has to be returned back as income and thus has to be transferred to the government (implication).
13. How important is this transfer of Rs 1.76 lakh crore to the government?
The transfer is like an energy drink for a starving government that need tremendous money to overcome the current slowdown. Remember, the size of the transfer is huge. Government anticipated nearly Rs 90000 crores but is getting Rs 1.76 lakh crore.
In the current year, tax revenues are expected to be lower than the estimate because of the slowdown in the economy. Whenever there is slowdown, tax revenue will be hit. Here, the government will be in trouble with low revenues.
On the other side, the government has the responsibility to spend more to stimulate the economy. In this context, the high transfer from the RBI to the government is a blessing in disguise for the government.