One of the contentious issues in the conflict between the government and the RBI was the size of the central bank’s reserves which at Rs 9.6 lakh crore was reckoned as excessive by the government. A debate on whether a large chunk of that hoard in the form of the revaluation reserves may well be closed for now with the RBI central board making it clear that these reserves cannot be paid out, according to sources.
Of the RBI’s total reserves of Rs 9.6 lakh crore, the currency and gold revaluation reserves alone account for Rs 6.9 lakh crore. The other components of the reserves include the contingency fund — Rs 2.31 lakh crore, the asset development fund of Rs 22,811 crore, the investment revaluation account of Rs 13,285 crore and foreign exchange forward contracts valuation account at Rs 3,282 crore. The considered view is that the gains recorded because of revaluation or owing to changes in the price of securities are notional and it would be prudent not to transfer funds from this reserve.
What this could spell is that the potential surplus which the government — the sole shareholder of the RBI can expect the central bank to transfer to it in the future would be far more modest.
The RBI board on Monday decided to set up an expert committee to examine the central bank’s Economic Capital Framework (ECF) — or the capital which is needed to protect RBI against future losses — which was adopted last year. The view of some of the directors was that the RBI is holding excess reserves and that the government should receive a larger share of the surplus or dividend. The counter view, according to sources, was that a distinction has to be made between stock and flows in the bank’s balance sheet. That’s because the RBI holds a large stock of foreign securities against its forex reserves and taking into gains which are notional or not accounting for its role as a lender of last resort or in its role in ensuring financial stability is not fully factored in these, the sources said.
They said that the economic capital framework and the issue of transferring a surplus to the government may take time to be addressed and the board may prefer to have a committee to provide direction on these two issues and also on governance. While the government had earlier indicated that the RBI has Rs 3.6 lakh crore as “excess capital” in its reserves and wanted the RBI to transfer more money to it as part of the surplus, this claim would have to be drastically reduced in the wake of the decision not to consider the revaluation gain.
According to analysts, the committee will have to address the question of excess ‘reserves’ which is subjective with varying opinions on optimal levels of ‘reserves’, and the degree of conservatism of the central bank. While the RBI necessarily needs to be conservative, another argument is that a central bank can always print money to provide support in an adverse situation and hence does not require excess ‘reserves’.
Meanwhile, the RBI Board’s decision to extend the timeline for implementation of the last tranche of capital conservation buffer (CCB) under Basel capital regulations is likely to reduce the burden of public sector banks this fiscal by Rs 35,000 crore.
Government nominees and an independent director were arguing for 8 per cent capital for banks in line with the Basel recommendations. The RBI Board, while deciding to retain the capital adequacy requirement at 9 per cent, on Monday agreed to extend the transition period for implementing the last tranche of 0.625 per cent under the Capital Conservation Buffer (CCB) by one year — up to March 31, 2020.
“This will provide some breathing space to capital-starved PSBs,” said Krishnan Sitaraman, Senior Director, CRISIL Ratings. “As per our earlier estimates, they needed Rs 1.2 lakh crore over the next five months up to March 2019 to meet Tier 1 capital stipulated under Basel III norms. Now they would need only Rs 85,000 crore on implementation of deferral of the last tranche of CCB.”
CCB is the capital buffer that banks have to accumulate in normal times to be used for offsetting losses during periods of stress. It was introduced after the 2008 global financial crisis to improve the ability of banks to withstand adverse economic conditions.
“The impact of the measures announced is likely to be some temporary relief, at best, for public sector banks. There are six public banks that are currently under and three public banks that are outside the PCA (prompt recovery action) framework which are below the minimum threshold requirements (post the relaxation),” said an analyst.
“We have been assuming that any capital shortfall would be funded by the government in the past and hence, this move would have a positive impact for minority shareholders as the book value/ share erosion would now be pushed forward by a year to FY2020,” Kotak Securities said in a report. PCA framework appears to be achieving its key objectives of rehabilitating banks that are under severe stress. “SME lending has been an area of risk, especially for public banks and we are still unsure of the risk-reward framework even if temporary relief is provided,” Kotak said.
“After considerable discussion and debate on these issues by the government and other experts, the RBI Board has addressed some of the critical issues. While the two committees will have to come out with workable solutions, the other two measures relating to MSMEs and capital adequacy will be helpful for the SME sector as well as the banking system. The weaker banks will gain from the capital adequacy relaxation for sure. In a way these two measures will also help the liquidity situation as banks will be able to lend more while restructuring stressed loans of SMEs. They would however have to have their due diligence processes in place when conducting this restructuring exercise to ensure that it is done in a prudential manner,” Care Ratings said.