Bimal Jalan Committee report: Economic Capital Framework

BIMAL JALAN COMMITTEE REPORT: ECONOMIC CAPITAL FRAMEWORK

A high-level advisory committee was set up by the Reserve bank of India (RBI) in consultation with the central government to review the economic capital framework of the Reserve bank of India which is a six-member committee headed by the former RBI governor Bimal Jalan. The decision will be done by the panel on the appropriate size of the reserve that should maintain by RBI and the amount of dividend it should give to the government.

The composition of the committee

• Bimal Jalan (Chairman), Former RBI governor
• Rakesh Mohan (Deputy Chairman), Former deputy governor of RBI
• Subhash Chandra Garg (member), Economic affairs secretary
• RBI deputy governor N.S. Vishwanathan (member)
• RBI board member Bharat Doshi (member)
• RBI board member Sudhir Mankad (member)

What is Economic Capital Framework (ECF)?

• Economic capital framework refers to the capital requirement by the central bank while taking into account different risks.
• 27 per cent of ECF reserves holding by RBI.
• At the time of economic depression in the country, this ECF amount can be used which can increase more liquidity in the market to tackle capital requirement issues.

What is the process of arrangements between the government and RBI on the transfer of surplus and profits?

In 1935 RBI got promotion as a private shareholders’ bank with a paid capital of Rs 5 crore. And then the government nationalised it in January 1949.

So, the central bank (RBI) transfer the “surplus” that is, excess of income over expenditure to the government as mention in section 47 (allocation of surplus profits) of the Reserve Bank of India Act, 1934.

• RBI does not pay taxes on these earnings or profits. Its statute provides an exemption from paying income tax or any other taxes, including wealth tax.

RBI Reserve:

RBI contingency fund core reserve is only around 7% of total assets and the rest of it is largely in the revaluation process. Revaluation reserves fluctuate with changes in currency and gold revaluation.

Contingency funds and revaluation reserves of central bank’s stood at Rs 2.32 trillion and Rs 6.92 trillion respectively in 2017-18.

According to the data growth in revaluation reserve has far exceeded the growth in the contingency fund. The revaluation reserves have more than tripled from Rs 1.99 trillion in 2008-09 to Rs 6.92 trillion in 20017-18. 50% increase in contingency fund during the same period from 1.53 trillion to Rs 2.32 trillion.

Note:

Core reserve– It is considered to be of the highest quality and consists mainly of share capital and disclosed reserve. They are fully available to cover losses.

Revaluation reserve– from the revaluation of assets that are undervalued in the bank’s books. It can be used at the time of unexpected losses. It mainly depends upon the level of certainty which can be placed on estimates.

Background:

• The tussle between the government and the central bank over the issues including of prompt corrective action norms relaxation on weak banks, special liquidity window for non-banking financial companies (NBFC), and the transfer of surplus reserve of RBI to the government.
• The central government has been insisting that the central bank hand over its surplus reserves amid a shortfall in revenue collections.
• This will allow the government to meet deficit targets, infuse capital into weak banks to boost lending and fund welfare programmes.
• The transfer of surplus reserves in the currency and gold revaluation reserves is not possible without selling gold or foreign currency assets.
• Hence the debate is about whether the RBI is holding excessive contingency reserves or more funds should be transferred to it in the future.
• It is clear that all the profits of the Reserve Bank must be transferred to the government according to the RBI act. So, the issue is what are the profits based on the accounting method.
• Earlier the same issue has been referred by RBI (to review the level and adequacy of internal reserve and surplus distribution policy of the RBI) to a committee headed by Mr. Y H Malegam in 2013-14.
• A draft Economic Capital Framework was formulated which highlighted the reasons why the RBI needs resources.
• Reasons are-
• Market intervention operations
• Functions as a lender during a crisis or as a last option.
• To decrease risk in the financial system

It also focuses on the issue that if losses occur to the central bank accounts and do not have adequate buffers, they would have to depend on the government for recapitalisation.

Result of that had a bad implication on the central bank autonomy as well as the concern that in a crisis situation government might not have any reserves.

Why fixing of this issue is needed?

Existing Economic capital framework which works for the RBI’s capital requirement and the surplus transfer to the government is based on a conservative risk assesment by the central bank and result of that review framework in extra capital being freed, which the RBI can then share with the government.

It is believed by the government that RBI is having much higher reserves than it actually needs to cover financial emergencies that India may face.

Central bank around the world like US and UK keep 13% to 14% of their assets as a reserve compared to RBI’s 27%.

The mandate of the committee:

• To review all the best practices used by the central banks from different countries in making assessment and provisions for risks, for central bank balance sheets.
• Review the status, whether RBI is holding provisions, reserves and buffers in surplus of the required levels.
• Propose a suitable profit distribution policy taking including all the situation of RBI, including extra provisions by RBI and fewer provisions by RBI than required.
• Suggestion on an adequate level of risk provisioning that the RBI needs to maintain.
• Any other related matter including usage of surplus reserves created out of realised gains.

So, basically, the committee is expected to provide for an objective criterion to address the friction between the government and the RBI.

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