NOVEMBER 21, 2018

By TIOL Edit Team

ALL stakeholders of economy can heave a sigh of relief at the emerging common meeting ground for the Government and Reserve Bank of India (RBI).

The ground for defusing the unprecedented tension between the two is squeezed in a terse, one-paragraph release. RBI issued it on 19th November at the end of eagerly awaited meeting of RBI's Central Board. Reports indicate the meeting was stormy/tense and lasted nine hours.

One of the most crucial decisions is couched in jargon. It reads as: "The Board decided to constitute an expert committee to examine the ECF, the membership and terms of reference of which will be jointly determined by the Government of India and the RBI".

ECF refers to RBI's Economic Capital Framework (ECF), a term that masks Government reported move to transfer a pile of cash reserves of RBI to its own account.

The simmering tension between the two reached flashpoint when Indian Express reported that Finance Ministry was "seeking to transfer a surplus of Rs 3.6 lakh crore, more than a third of the total Rs 9.59 lakh crore reserves of the central bank, to the government".

The news story categorically mentioned that the reporter's queries to both Government and RBI remained unanswered.

On 8 th November, two days after the story was published, Economic Affairs Secretary denied expropriation move. Through a series of tweets, he explained that the Government only wanted a discussion to fix ECF.

Economic capital (EC) can be defined as the methods or practices that allow banks to consistently assess risk and attribute capital to cover the economic effects of risk-taking activities, according to Bank for International Settlements (BIS).

This definition has been culled from BIS' guide captioned 'Range of Practices and Issues in Economic Capital Frameworks' issued in March 2009. BIS' latest publications on ECF are hard to come as these apparently are not a priority area for it.

BIS says that EC was originally developed by banks as a tool for capital allocation and performance assessment.

EC is different from regulatory capital or capital adequacy specified by the relevant national banking law/regulations or as suggested by BIS.

As put by Fadi Zaher in Investopedia, "EC is the amount of risk capital that a bank estimates in order to remain solvent at a given confidence level and time horizon."

With this perspective in mind, we hope the Government and RBI would not lock horns over terms of reference and composition of agreed ECF committee.

The allocation of surpluses generated by RBI from its activities is governed by Reserve Bank of India Act. It says: "After making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and for all other matters for which provision is to be made by or under this Act or which are usually provided for by bankers, the balance of the profits shall be paid to the Central Government".

In 2017-18, RBI transferred the lion's share of Rs 50,000 crore from its net disposable income of Rs 50,040 crore to the Government. It has been transferring lion's share of its net disposal income to the Government for last several years.

The Government is apparently not satisfied with such levels of transfers and thus wants to dip into RBI reserves.

It is here pertinent to recall the fact that the subject of restructuring RBI's balance sheet and profit and loss account was last studied by a committee chaired by veteran chartered accountant Y. H. Malegam.

In its report submitted during April 2013, the committee observed "given the very small size of the Capital and Reserve Fund, it is necessary that the Contingency Reserves be built up".

It recalled different capital adequacy norms for RBI were earlier recommended by two internal working groups (WGs) in 1997 and 2004. The Central Board accepted first WG's recommendation for building reserves to 12% of total assets by 2005. The Board didn't accept 2nd WG's recommendation to enhance reserves to 18% of total assets. We don't know what is capital adequacy % at present.

All we can suggest is that the proposed committee should not only look into the work of past panels but also scan the global horizon on capital adequacy norms being followed by other central banks.

As put by European Central Bank's Occasional Paper (OP) released in April 2016, "The issue of central bank profit distribution is both complex and often politically controversial".

The OP titled 'Profit distribution and loss coverage rules for central banks' analyzed replies of 57 central banks worldwide to an ECB questionnaire.

It concluded: "profit distribution rules can affect the amounts distributed and the financial strength of central banks".

We hope the committee would visualize the worst-case financial turmoil/meltdown and project the level of reserves that would be needed to face such challenge.

All said and done, political regimes can come and go. Such changes do not make a great difference to the steel-framed governance system. It actually works with its own momentum. The country's economic security should, however, not go at any cost. And for this we need a robust RBI for all times.