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Journalism of Courage
The Bimal Jalan Committee report on Economic Capital Framework (ECF) which looked into the manner in which the central bank’s surplus can be shared with the government, has said revaluation balance of the central bank should not be distributed.
While giving a clearer distinction between the two components of economic capital — realized equity and revaluation balances — the committee recommended that realised equity could be used for meeting all risks/ 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.
As proposed by the panel and approved by the RBI, the entire net income can be transferable to the government only if realised equity is above its requirement. If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government, the RBI said.
The RBI Board, which met here decided to accept the Jalan Committee report and decided to transfer Rs 1.76 lakh crore to the government.
On the issue of the RBI’s economic capital, the committee reviewed the status, need and justification of the various reserves, risk provisions and risk buffers maintained by the RBI and recommended their continuance.
The committee’s recommendations were based on the consideration of the role of central banks’ financial resilience, cross-country practices, statutory provisions and the impact of the RBI’s public policy mandate and operating environment on its balance sheet and the risks involved. According the report, there was only a one-way fungibility between them (realised equity and revaluation balances) which implies that while a shortfall, if any, in revaluation balances vis-a-vis market risk provisioning requirements could be met through increased risk provisioning from net income, the reverse vis-a-vis the use of surplus in revaluation balances over market risk provisioning requirements for covering shortfall in provisions for other risks is not permitted.
It has recommended revising the presentation of the liabilities side of the RBI balance sheet to reflect this distinction.
On the risk provisioning for market risk, the committee has recommended the adoption of Expected Shortfall (ES) methodology under stressed conditions (in place of the extant Stressed-Value at Risk) for measuring the RBI’s market risk on which there was growing consensus among central banks as well as commercial banks over the recent years.
While central banks are seen to be adopting ES at 99 per cent confidence level (CL), the committee has recommended the adoption of a target of ES 99.5 per cent CL keeping in view the macroeconomic stability requirements.
In view of the cyclical volatility of the RBI’s revaluation balances, a downward risk tolerance limit (RTL) of 97.5 per cent CL has also been articulated. “Both levels were stress-tested for their adequacy by the committee,” the RBI said. Regarding the size of realized equity, the committee said the RBI’s provisioning for monetary, financial and external stability risks is the country’s savings for a ‘rainy day’ (a monetary/ financial stability crisis) which has been consciously maintained with the RBI in view of its role as the Monetary Authority and the Lender of Last Resort, it said.
The reprot says realised equity is also required to cover credit risk and operational risk. This risk provisioning made primarily from retained earnings is cumulatively referred to as the Contingent Risk Buffer (CRB) and has been recommended to be maintained within a range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet, comprising 5.5 to 4.5 per cent for monetary and financial stability risks and 1.0 per cent for credit and operational risks, the RBI said.
“Further, any shortfall in revaluation balances vis-à-vis the market risk RTL would add to the requirement for realized equity,” it said. The committee also recommended the development of methodologies for assessing the concentration risk of the forex portfolio as well as jointly assessing the RBI’s market-credit risk. The Jalan committee has recommended a “surplus distribution policy which targets the level of realised equity to be maintained by the RBI, within the overall level of its economic capital vis-a-vis the earlier policy which targeted total economic capital level alone”.
