Primer | A deep dive into the RBI’s balance sheet

Gaurav Kapur

The debate around the level that the Reserve Bank of India should hold has become very active in recent months.  An expert committee headed by former RBI governor Bimal Jalan is looking into whether the central bank is holding provisions, reserves and buffers in excess of the required level and to propose a suitable profit distribution policy. Its report is due soon.

But the debate is not an entirely new either. The Economic Survey of 2015-16 had pointed out that RBI’s capital and reserves, in relation to its assets and to cover various risks, appear high in comparison to other central banks around the world. A recent study by research institute, CAFRAL however, concludes the RBI is under-capitalized relative to emerging economy average.

To understand the issues involved in this debate, we first need to understand the balance sheet structure and income statement of the central bank, especially in the context of its unique role. The RBI’s key functions include issuing bank notes, managing the monetary system (through the repo rate and liquidity operations), acting as the lender of last resort for banks, maintaining and managing foreign exchange reserves through exchange rate operations and managing the debt of the government.

The structure of the RBI balance sheet

The liabilities side of the RBI’s balance sheet mainly consists of Notes in circulation, deposits held by the central and state governments, banks and other financial institutions and other liabilities and provisions. These provisions mainly consist of

1) Contingency fund (CF): a reserve kept to manage any risks arising out of the RBI’s functions of monetary policy management which involves liquidity operations, exchange rate operations and other systemic risks like emergency liquidity assistance. This fund is to maintained from the net income of the RBI.

2) Currency and gold revaluation account (CGRA): to record the unrealised gains or losses on the foreign currency assets and gold reserves on account of rupee appreciation / depreciation and gold price movements. For instance, rupee depreciation leads to an increase in the local currency value of foreign assets and vice versa.

The assets side of the balance sheet, consists of foreign currency assets, gold reserves and domestic assets which mainly are central government securities. As per the latest balance sheet, as of 30 June 2018, the RBI had total assets worth Rs. 36.18 lakh crore. Foreign currency assets accounted for 73 percent of total assets, rupee securities 17 percent, and gold 4 percent.

On the liability side, notes in circulation amounted to 53 percent of the total, deposits were 13 percent, CF was 6.4 percent and CGRA was 19.1 percent. The CGRA is the largest reserve and since 2013-14, the average of CGRA as a percentage of assets has been around 20 percent.

The core capital is about 8.2 percent of its total assets and includes the CF and asset development fund (ADF). If ADF is excluded, then the core capital is 6.6 percent. Total capital and provisions were 27.7 percent of assets.

RBI’s income statement

In the RBI’s income statement, the main component of earnings is interest receipts from its foreign currency and domestic securities holding. During the year end 30th June 2018, earnings from foreign currency assets stood at Rs 27,400 crore and from domestic securities at Rs. 47,970 crore, with a total income of Rs. 78,281 crore. Being a central bank, the RBI earns interest on its assets, while its liabilities are largely interest free. Most of this income is transferred to the central government as dividend. Since 2013-14, the RBI has been transferring all its surplus income to the government as dividend, without adding to the contingency fund.

RBI reserves: surplus or deficit? 

An essential part of the debate around the level of RBI’s capital holding is whether it is sufficient in comparison to international standards and to withstand various market related risks, especially in case its income turns negative.

On one side of this debate is the former chief economic advisor, Arvind Subramanian, who in a recent paper in the Economic and Political Weekly, estimated that the RBI may be holding excess capital at least to the tune of Rs 4.5 lakh crore. The paper points out that the RBI has neither made a loss in the last 20 years nor has its core capital level declined in any year. It further points out that the RBI’s balance sheet hasn’t experienced any stress during this period despite several instance of intense economic stress. Subramanian and his co-authors employ both a portfolio risk management approach using Value-at-Risk analysis and a cross-country econometric analysis to arrive at excess levels of capital in the range of 13 – 22 percent of assets compared to 27.7 percent held in capital and reserves. They also suggest ways in which the RBI can transfer a part of the revaluation reserves to the government without impacting reserve money stock, which in turn can use the same to capitalize public sector banks or reduce the size of its outstanding debt by buying it back from the RBI and reduce its interest outgo.

An alternative view  

Presenting a more conservative alternative view, another paper from authors at CAFRAL and University of British Columbia, basing their analysis on the balance sheets of 45 central banks, point out that the RBI’s core capital at 6.6 percent is lower than the emerging market average of about 7 percent. The authors focus only on core capital and do not include revaluation reserves (CGRA) in their analysis. They consider those reserves as largely an accounting entry and including them may over-estimate the capital position, especially during periods of sharp Rupee depreciation.

They estimate (using VAR methodology over 2013-2018) that the desirable core-capital level of the RBI should be above 16 percent. This study also points out that one in seven central banks suffer an operating loss in any given year with the average loss being 50 percent of core capital. Operational losses can in turn necessitate capital infusion by the central government, which in case of India would be difficult given the higher level of prevailing fiscal deficit.

The choices for the Jalan panel

The RBI committee will weigh in all these aspects and propose an optimal capital structure for the central bank, which allows it to manage various risks including market and systemic risks. The crucial parts of the recommendations will be on the appropriate level of capital, treatment of revaluation gains while estimating capital position and the transfer modalities in case the committee determines that there are excess reserves. The last committee to deliberate on this issue in 2013 under Y H Malegam observed that contingency and asset development reserves were at adequate level and the RBI should transfer its entire surplus to the government over three years. The RBI has followed that advice for 5 years now, by transferring all its surplus to the government as dividend, including the special dividend of Rs. 28,000 crore announced recently.

If the Jalan committee indeed arrives at the conclusion that the RBI is holding excess reserves, the proposed mode of transfer to the government will be crucial. Any one-time transfer of accumulated reserves will have the impact of shrinking the RBI balance sheet, except in a case where the RBI transfers a part of that excess reserves to the deposits of the central government held with it. In the latter case, the transfer will only change the composition of liabilities side. And, depending on their use, the government can reduce its outstanding debt and/ or recapitalize public sector banks or fund infrastructure development. While there may be other ways to effectively use these reserves, the government should certainly avoid using them for its fiscal needs.

(The author is the chief economist of IndusInd Bank. Views are personal.)