FinMin seeks review of RBI’s capital framework
Anjana Das

Ahead of the RBI board meeting on November 19, the government on Friday categorically stated that there was no move to draw capital from the central bank’s balance sheet.

FinMin seeks review of RBI’s capital framework
FinMin seeks review of RBI’s capital framework

Ahead of the RBI board meeting on November 19, the government on Friday categorically stated that there was no move to draw capital from the central bank’s balance sheet. There would be, however, a review of its capital framework, which decides such reserves accumulation.

As the stand-off between the government and the Reserve Bank of India (RBI) continues, secretary in the Department of Economic Affairs (DEA) Subhas Chandra Garg tweeted it is not that the government was seeking Rs 3.6 lakh crore from RBI reserves. The government is only seeking a review of the economic capital framework adopted by the RBI. The framework determines the amount of contingency and revaluation reserves held by the central bank.

The comments may not signal an end to the public spat between the government and the central bank over a host of issues. It, however, signals the finance ministry’s willingness to discuss a key point of dispute between the two sides.

As the issue of who actually owns these reserves heats up, a senior finance ministry official said this issue has not been discussed between the RBI and government for many years. The money belongs to the people of India and it should be chanellised towards welfare schemes to be undertaken by the government instead of keeping it idle.

The official further added globally there is a reserves cap limit of 14 per cent but government is even ready to accept 20 per cent threshold limit keeping in mind Indian economic and banks’ conditions but RBI is keeping a high level of 27 per cent, which should be discussed among members if such high reserves are warranted or not.

It is this limit that would now be discussed at the November 19 board meeting of RBI. The government is seeking a dialogue on this issue, a volcano that may just be waiting to erupt as RBI deputy governors turn by turn have said the central bank needs to be well capitalised to act as a buffer in case of meltdowns and sudden risks.

Anticipating that this would be a friction point anytime, the RBI explained the broad approach behind this framework in its annual report for 2015-16 by saying that the idea behind it is to build sufficient financial resilience.

The general approach towards financial risk management in central banks is that while they do not actively manage risks arising from policy actions, they seek to ensure that their balance sheets have sufficient financial resilience to absorb these risks. Thus, they maintain sufficient economic capital, supplemented by risk-transfer/dividend-smoothening mechanisms.

The formula used by the RBI to calculate capital needs under the economic capital framework is based on ‘stressed value at risk’, while most central banks use ‘value at risk’ and the government is all set to press upon the RBI to change this formula.

The concept of ‘stressed value at risk’ was popularised after the global financial crisis, and assesses capital needs based on the experience of a longer periods of time, which incorporates actual periods of stress. In contrast, a simple value at risk is assessed based on the experience of a pre-determined number of days.

Further the central bank uses a formula (stressed value at risk at 99.99 per cent confidence level), which requires it to maintain an equity-to-assets ratio of 27 per cent. Some other central banks calculate their capital needs based on a less stringent formula (value at risk at 99 per cent confidence level), which requires the equity-to-assets ratio to be maintained at 14 per cent.

The RBI’s equity to asset ratio was 24 per cent as on June 2018. If it were to bring it down 14 per cent, it will free up capital around Rs 3.6 lakh crore, the people explained.

Asserting that economy does not need any assistance from the RBI reserves to meet the fiscal deficit, Garg said there is no danger to the fiscal position.

“Government’s FD (fiscal deficit) in FY 2013-14 was 5.1 per cent. From 2014-15 onwards, the government has succeeded in bringing it down substantially. We will end the FY 2018-19 with FD of 3.3 per cent. Government has actually foregone Rs 70,000 crore of budgeted market borrowing this year,” he twitted.

The Reserve Bank, which follows July-June financial year, has paid about 63 per cent higher dividend than the previous year (2016-17). The RBI made a dividend payout of Rs 30,659 crore for the fiscal ended June 2017.

As per the budget estimate, the government projected to collect Rs 54,817.25 crore as dividend or surplus from the Reserve Bank, nationalised banks and financial institutions. The government realised Rs 51,623.24 crore under this head in the previous fiscal.

It is to be noted that the RBI transferred a surplus of Rs 30,659 crore as dividend to the government for the year ended June 30, 2017, which was less than half of what it paid in the previous year (Rs 65,876 crore).