The committee has recommended the adoption of expected shortfall (ES) methodology under stressed conditions to replace the extant stressed-value at risk for measuring the RBI’s market risk.
The Reserve Bank of India (RBI) on Monday decided to transfer Rs 1.76 lakh crore to the Centre in 2018-19 (July–June), the entire net disposable income of Rs 1.23 lakh crore and an additional Rs 52,637 crore of ‘excess provisions’ identified as per the Bimal Jalan committee, which reviewed the central bank’s economic capital framework (ECF). As this would mean the resource-hungry Centre would get Rs 1.48 lakh crore immediately for FY20 — the transfers approved by the central bank’s board includes Rs 28,000 crore paid in February — 64% higher than Rs 90,000 crore it had budgeted to receive from the RBI this fiscal.
Though this would indeed be a timely bonanza for the government, the ECF review has turned out to be potentially mush less rewarding for it than many analysts thought and some of the government managers clamoured for. This is because the panel stuck to the view that RBI’s gold and currency revaluation balances being notional and unrealised gains are not distributable. The panel said that RBI’s new surplus distribution policy would now target the level of realised equity to be maintained by it within the overall economic capital level, rather than just economic capital.
While the Jalan committee said 6.5% to 5.5% of the balance sheet as the realised equity to be kept, the RBI, which accepted all the recommendations of the committee, decided to maintain it at the lower end of 5.5% against available 6.8%, a move which enabled it to write back excess risk provisions of Rs 52,637 crore. If this is accepted as norm, the government could expect some amounts from this policy in many of the coming years as well; also, whenever realised equity exceeds the requirement level identified by the committee, the entire net income would get transferred to the government (as is the case for the current year).
Monday’s decisions showed that the RBI is sensitive to the government’s need for funds to pump-prime the slowing economy, But also proved that the huge expectations in some quarters from the ECF review were misplaced.
A recent report by Bank of America Merrill Lynch said the Jalan committee could identify an excess buffer of up to Rs 3 lakh crore (or roughly 1.5% of the GDP), including the excess capital in contingency reserves and revaluation reserves. Brokerage firm UBS recently said: “A staggered dividend of $10 billion a year, rather than a one-shot $30 billion, is our base case.”
Former finance secretary SC Garg had pitched for a substantial one-time transfer from the RBI’s reserves. It is not immediately clear whether the finance ministry insisted on a dissent note Garg had proposed; after Garg’s exit, department of economic affairs secretary Atanu Chakraborty represented the ministry in the panel.
What prompted many to pitch for a huge one-time transfer from the RBI to the government was the fact that including the revaluation accounts (unrealised gains) and realised equity, RBI’s reserves are over 25% of its total balance sheet assets, while the median level for major central banks is around 16%.
Many analysts, however, had disagreed with this and said the perception that the RBI capital was in excess of what generally other central banks had was because of the amounts held in its currency and gold revaluation account (CGRA). These analysts have pointed out that since foreign currency assets — which are being held for precautionary purposes and without a commercial intent — are periodically revalued at market rates, any gains from such exercises are unrealised and only notional and cannot be counted as profits generated by the RBI. The Jalan panel broadly agreed with this view.
The Economic Survey for 2015-16 (under then chief economic advisor Arvind Subramanian) had suggested that the RBI’s excess capital could be redeployed to infuse funds into state-owned banks and help them provide more for bad assets and step up lending.
As of June 30, 2018, the RBI’s contingency and asset development funds aggregated Rs 2,54,919 crore. These funds have been created by transfers from the central bank’s income account and are in the nature of provisions for contingencies. The amounts held in CGRA stood at Rs 6,91,641 crore at the end of June 2018.
Between 2014-2016, when Raghuram Rajan was at the helm, almost the entire net disposable income (sans any transfer to the contingency and asset development funds) went to the government’s kitty. Urjit Patel, as governor, was, however, less generous – before recognising the disposable amount (which is fully transferrable to the government), portions of what would have been surplus have got transferred to these funds on the expenditure side over 2017 and 2018.
Reviewing the status, need and justification of the various reserves, risk provisions and risk buffers maintained by the RBI, the Jalan panel recommended their continuance. A clearer distinction between the two components of economic capital – realised equity and revaluation balances – was also recommended by the committee. Realised equity could be used for meeting all risks and losses as they were primarily built up from retained earnings, while revaluation balances could be reckoned only as risk buffers against market risks as they represented unrealised valuation gains and hence were not distributable, the committee concluded.
The committee has recommended the adoption of expected shortfall (ES) methodology under stressed conditions to replace the extant stressed-value at risk for measuring the RBI’s market risk. It also pleaded for the development of methodologies to assess the concentration risk of the forex portfolio as well as jointly assessing the RBI’s market-credit risk.