Should Urjit Patel as new guv use RBI surplus capital to bolster PSBs?

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New Delhi | Published: August 21, 2016 6:14:16 AM

The Economic Survey 2015-16 authored by chief economic adviser Arvind Subramanian suggested that the RBI’s capital (‘excess capital’, some would say) could be redeployed to infuse funds into state-owned banks and help them recognise losses on bad assets and step up lending.

 Outgoing RBI governor Raghuram Rajan said the proposal seemed a non-transparent way of proceeding and warned that if implemented, it could get the banking regulator once again into the business of owning banks, with attendant “conflicts of interest”. (Reuters)Outgoing RBI governor Raghuram Rajan said the proposal seemed a non-transparent way of proceeding and warned that if implemented, it could get the banking regulator once again into the business of owning banks, with attendant “conflicts of interest”. (Reuters)

The Economic Survey 2015-16 authored by chief economic adviser Arvind Subramanian suggested that the RBI’s capital (‘excess capital’, some would say) could be redeployed to infuse funds into state-owned banks and help them recognise losses on bad assets and step up lending. Outgoing RBI governor Raghuram Rajan said the proposal seemed a non-transparent way of proceeding and warned that if implemented, it could get the banking regulator once again into the business of owning banks, with attendant “conflicts of interest”. Governor-designate Urjit Patel has not articulated his view on this. FE asked former RBI deputy governor Shyamala Gopinath and former chief economic adviser Arvind Virmani what they thought of Subramanian’s proposal.

‘Gains from foreign currency assets notional’

Shyamala Gopinath, Former deputy governor, RBI

As per the annual accounts of RBI as on June 30, 2015, contingency and asset development fund aggregated R2433.75 billion. These funds have been created by transfer from the income account and are in the nature of provisions for contingencies. As percentage to total assets it amounts to 8.4%. It appears that the perception that the RBI capital is in excess of what generally other central banks have is because of the amounts held in CGRA. This amounts to R5591.93 billion.

India holds foreign currency assets for precautionary purposes and, therefore, needs to hold structurally long positions in foreign currency for policy purposes. This is not with a commercial intent. Foreign currency assets also form a high proportion of the total balance sheet assets. For the purpose of financial reporting and transparency, such assets are revalued at market rates and gains and losses are transferred to a revaluation account. The gains arising from such revaluation are unrealised and notional and have not come out of profits generated by RBI. It cannot, therefore, be treated as free reserves eligible for distribution. Any utilisation of these funds also has consequences for inflation and money supply.

‘Unless risks are gauged, it’s unclear what excess means’

Arvind Virmani, Former chief economic adviser

The required capital depends on the risks, which RBI is faced with, and the risks it is expected to handle in its mandated operations. Without accounting for these risks, it’s unclear what ‘excess’ capital means. If there is accurately defined ‘excess’, it could in principle be returned to the government as dividend. Whether this dividend should be allocated as equity in a bad bank is as much an issue of financial engineering as anything else.

Whether RBI’s equity-asset level should be high or closer to median, depends on whether its risk level is high or close to the median. I am not aware of any study that measure the relative risk level of RBI relative to that of other banks. The optimal amount of foreign reserves depends on many factors.

In the 1990s, I wrote a note in the ministry of finance, arguing that RBI shouldn’t sit on bank boards, as this was a clear conflict of interest with its regulatory role. I also argued that it was potentially also in conflict with its monetary policy role. I am, therefore, opposed to RBI owning any shares in banks or being represented on bank boards.

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