The need to update the economic capital framework. - Seeker's Thoughts

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Thursday, 27 December 2018

The need to update the economic capital framework.


The Money Matters

The Indian government has been insisting on the central bank (RBI) to hand over its surplus reserves to the government when revenue collection falls. The money will allow the government to meet the deficit targets, infuse capital into weak banks to boost lending, and fund welfare programmes. 


The government believes that RBI is sitting on much higher reserves than it actually needs to tide over financial emergencies that India may face. Some central banks around the world (like US and UK) keep 13% to 14% of their assets as a reserve compared to RBI’s 27% and some (like Russia) more than that.
Therefore, RBI and government needed to come to an agreement where the conflict does not rise. As a result, RBI has constituted a panel on economic capital framework. It will be headed by former-RBI governor Bimal Jalan. The expert panel on RBI’s economic capital framework has been formed to address the issue of RBI reserves.


What is economic capital framework?
Economic capital framework refers to the risn  k capital required by the central bank while taking into account different risks. That means, if there is a sudden condition of panic or any other risk arrives- there should be ‘money’ to face those risks.  The economic capital framework reflects the capital that an institution requires or needs to hold as a counter against unforeseen risks or events or losses in the future.
The expert panel has to come up with guidelines about holding provisions, reserves and surplus. It has to create a suitable distribution policy, and has to decide the minimum and maximum amount limit to be held by RBI. Clearly, the panel also has to decide about the surplus limit, and how much surplus can be used by the government in the time of need.
The Present
Existing economic capital framework which governs the RBI’s capital requirements and terms for the transfer of its surplus to the government is based on a conservative assessment of risk by the central bank. A review of the framework would result in excess capital being freed, which can be utilized by the government in the productive works.
Economists in the past have argued for RBI releasing ‘extra’ capital that can be put to productive use by the government. The Malegam Committee estimated the excess (in 2013) at Rs 1.49 lakh crore.

Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalized 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.