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Explained: Why and how does the RBI transfer ‘surplus’ to government?

The central bank, on its part, has traditionally preferred to be more cautious and build its reserves - keeping in mind potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets.

, Edited by Explained Desk | New Delhi |
Updated: August 27, 2019 10:04:57 pm
Explained: Why and how does the RBI transfer 'surplus' to government? The Central Board of the Reserve Bank of India (RBI) Monday decided to transfer a surplus of Rs 1.76 lakh crore to the exchequer, nearly double the estimated Rs 90,000 crore in the Budget for 2019-20.

On Monday, the Reserve Bank of India (RBI) Board approved a transfer of Rs 1,76,051 crore to the government, including a surplus or dividend of Rs 1,23,414 crore, and a one-time transfer of excess provisions amounting to Rs 52,637 crore. Unlike the banks it regulates, RBI isn’t a company or an organisation that announces a dividend. So how does the transfer of its surplus work out?

How does a central bank like the RBI make profits?

The RBI is a “full service” central bank— not only is it mandated to keep inflation or prices in check, it is also supposed to manage the borrowings of the Government of India and of state governments; supervise or regulate banks and non-banking finance companies; and manage the currency and payment systems.

While carrying out these functions or operations, it makes profits. Typically, the central bank’s income comes from the returns it earns on its foreign currency assets, which could be in the form of bonds and treasury bills of other central banks or top-rated securities, and deposits with other central banks.

It also earns interest on its holdings of local rupee-denominated government bonds or securities, and while lending to banks for very short tenures, such as overnight. It claims a management commission on handling the borrowings of state governments and the central government.

READ | Bimal Jalan Committee report: ‘Surplus transfer only from realised gains over RBI need’

Its expenditure is mainly on the printing of currency notes and on staff, besides the commission it gives to banks for undertaking transactions on behalf of the government across the country, and to primary dealers, including banks, for underwriting some of these borrowings.

What is the nature of the arrangement between the government and RBI on the transfer of surplus or profits?

The RBI isn’t a commercial organisation like the banks or other companies that are owned or controlled by the government – it does not, as such, pay a “dividend” to the owner out of the profits it generates.

Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalised it in January 1949, making the sovereign its “owner”.

What the central bank does, therefore, is transfer the “surplus” – that is, the excess of income over expenditure – to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934: “After making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation fund [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.”

The Central Board of the RBI does this in early August, after the July-June accounting year is over.

Does the RBI pay tax on these earnings or profits?

No. Its statute provides exemption from paying income-tax or any other tax, including wealth tax. Section 48 (Exemption of Bank from income-tax and super-tax) of the RBI Act, 1934, says: “Notwithstanding anything contained in [the Income-Tax Act, 1961], or any other enactment for the time being in force relating to income-tax or super-tax, the Bank shall not be liable to pay income-tax or super-tax on any of its income, profits or gains.”

Is there an explicit policy on the distribution of surplus?

No. But a Technical Committee of the RBI Board headed by Y H Malegam, which reviewed the adequacy of reserves and a surplus distribution policy, recommended, in 2013, a higher transfer to the government.

Earlier, the RBI transferred part of the surplus to the Contingency Fund, to meet unexpected and unforeseen contingencies, and to the Asset Development Fund, to meet internal capital expenditure and investments in its subsidiaries in keeping with the recommendation of a committee to build contingency reserves of 12% of its balance sheet.

But after the Malegam committee made its recommendation, in 2013-14, the RBI’s transfer of surplus to the government as a percentage of gross income (less expenditure) shot up to 99.99% from 53.40% in 2012-13.

Have the RBI and the government differed on this issue?

The government has long held the view that going by global benchmarks, the RBI’s reserves are far in excess of prudential requirements. Former Chief Economic Advisor Arvind Subramanian had suggested that these funds be utilised to provide capital to government-owned banks.

The central bank, on its part, has traditionally preferred to be more cautious and build its reserves – keeping in mind potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets.

From the central bank’s perspective, bigger reserves on its balance sheet is crucial to maintaining its autonomy.

The quantum of surplus transfer has, however, not been a major factor in defining the central bank’s relationship with the government — “a settlement is reached with both sides showing some flexibility”, former RBI Governor Duvvuri Subbarao has written.

How do other central banks manage the transfer of surplus?

Like in India, central banks in both the UK and US decide after consultations with the government. But in Japan, it is the government that decides.

By and large, with a few exceptions, the quantum of surplus transfer averages around 0.5% of the GDP.

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