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Careful with RBI's equity PDF Print E-mail
Wednesday, 22 June 2016 04:20
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Make Malegam report public, evaluate RBI needs

 

Given how central banks such as in the UK have bailed out banks before, given how desperately Indian PSU banks need capital and how short the government is of cash to recapitalise them, it is only natural it should look at the RBI’s equity capital of close to Rs 9 lakh crore – this includes retained earnings and contingencies – to help fund this. As the Economic Survey pointed out in February, after a survey of major central banks, RBI’s equity capital is around a third of its balance sheet, making it a clear outlier, save for Norway’s central bank whose equity levels are at 40%; the ECB is around 20% and central banks in the US and the UK are under 2%. If Rs 2 lakh crore of this money is used for either recapitalising banks or for setting up a bad bank which can buy the bad debts of PSU banks – that’s one of the numbers doing the rounds among government circles – RBI will still have an equity-to-asset ratio of around 25%; if Rs 4 lakh crore is taken out, the equity will still be at 19% or around the same as that for the ECB. With Raghuram Rajan, who opposed this as RBI Governor, now on his way out, the task of sequestering the funds should be a lot easier.

 

In reality, it may not. To understand this, it is important to understand that most of this isn’t really money in the bank, as it were. Of the Rs 9 lakh crore as on June 30, 2015, nearly two thirds was in the form of what is called Currency and Gold Revaluation Account (CGRA) – a tenth is in the Contingency and Asset Development funds. The CGRA, however, isn’t real money, it is the unrealised gain/loss in the value of gold and foreign exchange RBI holds based on movements in their value – this is not taken to the income account but instead recorded as a balance sheet item. So, if RBI has a certain amount of gold worth $10 billion and the price of gold rises 30%, $3 billion will be credited to this account; when the reverse happens, $3 billion will be debited. In case there is, post-Brexit, a great volatility in exchange rates, it is likely the CGRA will reduce as the rupee value of RBI’s forex holdings fall. So if money has to be given from the Rs 9 lakh crore equity base, effectively it means the central bank will have to create fresh money – or finance the government deficit, a practice ended a long time ago – which is inflationary; that is why many former RBI officials are also opposed to the idea. Also, to the extent RBI makes losses in currency and bond markets, having a big cushion helps. Keep in mind, many of the countries the Survey compares have convertible currencies, so don’t need such large intervention in markets – the fact that their numbers range from 2% for the US and UK to around 19% for ECB also makes it clear a simple average is not the way to approach the issue.

 

Even so, it can be argued, as the Survey has, that RBI doesn’t need such large balances, and there is a technical way to figure out what the optimum balances should be by looking at various risk scenarios. That, in fact, is what RBI has been doing, and the current policy of such high equity levels emerges from the exercise done by the last committee, headed by YH Malegam. While a new committee can be set up to relook the numbers, as a start, it would be a good idea to release the Malegam committee report so that the reasons behind the seemingly large equity can be made public. 

 

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