RBI, Government Step Back From the Edge After 9-Hour Meet 

The 175-word statement saw both the RBI and the government make an attempt to step back from the edge.

5 min read
RBI, Government Step Back From the Edge After 9-Hour Meet 

Nearly a month worth of barbs exchanged through speeches and comments. A nine-hour meeting at the Mumbai headquarters of the Reserve Bank of India. Followed by a 175-word statement, which saw both the RBI and the government make an attempt to step back from the edge.

The carefully worded statement, which came late in the evening, helped put to rest the worst fears of a government raid on the central bank’s balance sheet and an exit from the top ranks of the RBI. Yet, it resolved none of the underlying issues, choosing to leave those for another day.

For now, the RBI board has pushed the regulator into making a few small concessions, decided to set up a few committees and examine some demands.


The decisions announced by the central board on Monday include:

  • A committee to examine the central bank’s Economic Capital Framework. The members and terms of reference of the committee will be decided jointly by the RBI and the government.
  • “Advising” the RBI to consider a scheme for the restructuring of small accounts of upto Rs 25 crore.
  • Extending the full implementation of the Capital Conservation Buffer (CCB) under the Basel rules by one year, while maintaining the minimum capital requirement at 9 percent.
  • Referring a review of the RBI’s prompt corrective action to the Board for Financial Supervision (BFS) of RBI.

The board meet took place amidst intense scrutiny given the very public spat that had broken out between the RBI and the government after a speech by deputy governor Viral Acharya. In his speech, Acharya had cautioned against the implications of impinging on central bank independence. It later emerged that the speech had been prompted by the government’s threat to use a rare provision of the RBI Act to direct it to take actions in public interest. It is not clear whether that provision (Section 7 of the RBI Act) came up for discussion at Monday’s board meet.

All in all it is a very welcome move. The issues which had escalated so much are probably getting resolved in a professional way.
CM Vasudev, Former Economic Affairs Secretary

Economic Capital Framework

The most contentious of issues was that of the RBI’s balance sheet. On this, the two sides have decided to set up a committee to review the economic capital framework which governs the amount of capital that the central bank holds.

While no timeline has been announced the RBI board has agreed to constitute an expert committee to examine the ECF. The membership and terms of reference of the committee will be jointly determined by the Government of India and the RBI.

Some sections in the government have argued that the RBI is holding excess reserves, which should be transferred to the government. There are two material components to RBI’s reserves:

  • A Contingency Fund of Rs 2.5 lakh crore
  • A Currency and Gold Revaluation Reserve of Rs 6.91 lakh crore

Most economists agree that a transfer from the unrealised gains in the currency and gold revaluation reserve is not possible without a sale of gold or foreign currency assets. Hence, the debate is centered around whether the central bank is holding excess contingency reserves and whether it should transfer any more funds to it in the future.

The economic capital framework is likely to review these aspects.

The current economic capital framework followed by the RBI is not in public domain. A committee in 1997 had recommended that contingency reserves be maintained at about 12 percent of total assets. At present, these reserves are at about 7 percent.

The government has argued it differently and is looking at the total capital on the RBI’s balance sheet, which it believes is excessive. According to one government calculation, the RBI may be sitting on Rs 3.6 lakh crore in excess capital.


India’s Version Of Basel Rules

In what amounts to a marginal change to the capital norms applicable to banks, the RBI board, while deciding to retain the Risk-weighted Assets Ratio (CRAR) at 9 percent, agreed to extend the transition period for implementing the last tranche of 0.625 percent under the Capital Conservation Buffer (CCB), by one year, i.e., up to March 31, 2020.

Government representatives had argued that India has prescribed capital norms that are tougher than many other countries. The government had asked the RBI to bring down capital to risk (weighted) assets ratio to 8 percent, in line with Basel III norms, from 9 percent currently. This would have helped banks save Rs 55,000 crore in capital.

However, the RBI has not given in on this.

Clearly, the government does not have the capital, because of the budget deficit issues, and clearly, the banks need the capital. On extension of the timeline for the capital conservation buffer, I think it is better to defer it because that gives a lot more capital to the bank since we were anyway compliant with Basel.

As per the Basel implementation plan put out by RBI in 2013, banks were asked to maintain a total minimum capital of 9 percent, with a core equity tier-1 (CET-1) capital of 5.5 percent. In addition, banks were asked to build a capital conversation buffer in stages, reaching 2.5 percent by March 2019. This process will now be completed by 2020.


Prompt Corrective Action Norms

No immediate change has been made regarding banks under PCA but the RBI board said in its statement on Monday that the matter will be examined by its Board for Financial Supervision (BFS).

Prompt corrective action as a tool to prevent weak banks from getting weaker has existed for some time now. Its implementation, though, was whimsical. So, in April 2017, the Reserve Bank of India issued a revised set of benchmarks, with an attempt to move towards a more rule-based framework.

At the time the framework was implemented, the government didn’t raise objections. However, it now feels that it’s hurting the flow of credit in the economy. The health of these banks remains weak, supporting the need for continuing with the corrective action, showed a recent BloombergQuint analysis.

Restructuring For Stressed MSMEs

In the face of government and industry demands that RBI enhance credit facilities to medium and small enterprises, the central bank’s board advised the RBI to “consider a scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities of up to Rs 25 crore, subject to such conditions as are necessary for ensuring financial stability”.

The decision validates the stress that has been building up in the SME segment, said Saswata Guha of Fitch Ratings. “Restructuring as a tool is not unique to India. But in the past, Indian banks have used restructuring in a rather less prudent way, which forced RBI to eventually do away with (any forbearance for) restructuring,” he said.

(This article was first published on BloombergQuint)

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