The RBI board has transferred Rs 1,760bn, including Rs 526bn of excess capital, to the fisc, up from 2018’s Rs 500bn. We expect Delhi to apportion RBI’s transfer between recapitalising PSU banks and fiscal support as budgeted in July
By Indranil Sen Gupta & Aastha Gudwani
We see the just-released Jalan report as a game changer if it is partly used to recapitalise PSU banks to lower lending rates. It will be recalled that RBI had appointed a committee, under its distinguished ex-governor Bimal Jalan, to identify its excess economic capital. The RBI board has decided to transfer a surplus of Rs 1,760.5bn, including Rs 526.4bn of excess capital, to the fisc, up from Rs 500bn last year. This is at the lower end of our Rs 1-3bn expectation, with Rs 500bn as profit transfer. This begs the question, what will be the new methodology to decide RBI’s surplus? It will be set by limits on a contingent risk buffer (5.5-6.5% of balance sheet) and economic capital (of 20-24.5% of balance sheet) and expected shortfall (ES) estimation at 97.5-99.5% confidence intervals.
The Jalan committee has recommended a three-pronged definition of RBI’s excess capital. 5.5-6.5% CRB: It has proposed a contingent risk buffer (CRB) of 5.5-6.5% (including 1% for credit and operational risks) far higher than the 2% average for BRICS central banks (see graphic). The RBI board considered 5.5% sufficient
ES at 97.5-99.5% CF: It will introduce an ES estimation at 97.5-99.5%, replacing VaR to determine risk provisioning for market risk. Informal economic capital band of 20-24.5% of RBI balance sheet: As RBI’s economic capital, at 23.3%, is in this range, the RBI board has released the entire net income of Rs 1,234bn to the fisc. The Jalan committee has eschewed defining excess RBI capital in terms of revaluation reserves. At 71 rupees to the dollar, the RBI balance sheet would have an appreciation cover of 25% even after releasing Rs 2,000+bn (see graphic).
How will RBI’s transfer be utilised? We think it will likely be used to recapitalise PSU banks by Rs 700bn, as announced by finance minister Nirmala Sitharaman on Friday, with the balance transferred to the fisc as already budgeted. This, in turn, should help reduce lending rates. Excessive fiscalisation would cut down RBI OMO.
PSU bank recap liquidity-neutral, fiscal deficit-neutral: We highlight that using excess RBI capital to recapitalise PSU banks should be liquidity- and fiscal deficit- neutral . The MoF will infuse capital into PSU banks with excess RBI capital. PSU banks, in turn, will park it in a government account with RBI. Rs 1,000bn of excess RBI capital will allow 12% PSU bank (except SBI) loan growth till 2024.Our banking analysts assume that, 1. Rs 200bn is used to write off NPLs; 2. RoE of 8% with a 20% pay out (see graphic). We take minimum sustainable CET ratio at 8%.
Edited excerpts from BofAML’s Jalan Report: What Next? (August 27, 2019)
Sen Gupta is Chief India economist, and Gudwani is India economist, BofA Merrill Lynch. Views are personal