On August 26, 2019, the RBI's Central Board decided to transfer Rs 52,637 crore as excess reseerves to the government along with the RBI’s net income of Rs 1,23,414 crore for the year 2018-19. The Central Board of Directors (CBD) is the administrative body of the RBI. Total transfer comprising of this excess reserve and the net income share is around Rs 1.76 lakh crores. Regarding the net income transfer (Rs 123414 crore), it is the share of the government in the RBI’s net income. Since government is the sole shareholder of the RBI, it is customary to transfer the amount to the government. Net income is effectively the profit of the RBI that has been occurred after meeting all expenses. But the interesting fact is that nearly 99% of the RBI’s profit is transferred to the government. This is the practice over the last five years. READ: RBI's capital transfer to the government -basics The surplus capital reserves Now, the second amount that is the Rs 52637 crore is the curious one. Here, the RBI is transferring this amount as it has been found excess or surplus in its capital reserve. The capital reserve in simple terms is the money procured by the RBI out of its income and kept with itself to meet emergency situations. Though the capital reserves are not directly deployed to fight any emergency situation, it can be considered as a sound base for the RBI to make its actions. Over the last few years, there is a debate that whether the RBI has surplus capital reserves or not. Those who are in the government were suggesting that the RBI is one of the highest capitalised central banks in the world. The Bimal Jalan Committee and the discovery of surplus capital reseve People in the government argue that the surplus reserve must be identified and should be transferred to the government. As per this idea, a Committee on Economic Capital Framework under the Chairmanship of former RBI Governor Dr Bimal Jalan was constituted. The Committee’s final report has been published on August 29, 2019 and the Central Board of Directors (CBD) decided to transfer Rs 52637 crores to the government as the surplus capital reserve. This means that the Bimal Jalan Committee has identified this amount as excess reserve with the RBI. Read: Major Recommendations of the Committee on Economic Capital Framework of the RBI The RBI has around Rs 9.5 lakh crore as capital with it. Total assets of the RBI are around Rs 36 lakh crores as per the 2018 Annual Report of the RBI. Remember, the 2019 Annual Report that gives an updated details of the RBI’s balance sheet including the capital reserves is ratified by the August 26 CBD, but that is not published. Practically, the surplus capital reserve of Rs 52,637 crore should be taken out of the Contingency Fund of the RBI. This is because the other components of the capital are just revaluation that occurred in stocks of foreign currency, gold and government securities that are kept with the RBI. The Contingency Fund is the more of a cash form of capital reserve. Capital reserve of the central bank is the fund available with it to face any financial contingency. Liquidity emergencies like the Global Financial Crisis, IL&FS liquidity situation etc. points towards the strengthening of such a reserve to manage contingencies. RBI's Assets and Liabilities (PDF) What is the purpose of the Capital Reserve? The main purpose of the capital reserve is to enable the RBI to meet any financial emergency situation out of liquidity crisis etc., - on its own. Capital actually indicate the ready funds available with the RBI to manage own business. The RBI can consider this as a financial capacity while delivering some action like liquidity injection. When your purse is big or assets are strong, your readiness to provide funds during a crisis also will be big. Liquidity emergencies like the Global Financial Crisis, IL&FS liquidity situation etc. points towards the strengthening of such a reserve to manage contingencies. For example, the most important component of the Capital Reserve – the Contingency Fund is expected to help the central bank to meet risks from sudden liquidity shortages in the market, steep exchange rate movements, fall in the value of government securities held by the RBI etc. Similarly, the Asset Development Fund is expected to give support to the associates of the RBI (like the NHB) when the latter is facing crisis. How capital reserves are obtained? Funds to the capital reserves are added out of the net income or profit of the RBI. Every year, such allocation from the net income is made to the capital reserve. This addition is made mostly to the Contingency Fund of the RBI. But over the last five years, no major fund injection is made out of the net income to the capital reserves. Rather, the entire net income is transferred to the government as profit share (during 2018-19, profit share is Rs 1,23,414 crore). What are the components of the capital reserve? There are five components in the RBI’s capital reserve. The first two (CF and ADF) are Funds created to meet specific purposes and provisions are made yearly to add money to these funds. The other three (CGRA, IRA and FCVA) are valuation accounts just shows the gain or losses in foreign exchange, government securities or foreign currency contracts handled by the RBI. Following are the five components of the RBI’s capital reserve. Contingency Fund (CF) Asset Development Fund (ADF) Currency and Gold Revaluation Account (CGRA) Investment Revaluation Account (IRA) and Foreign Exchange Forward Contracts Valuation Account (FCVA). All these five components are recorded in the liability side of the RBI’s balance sheet. What is Contingency Fund (CF)? The CF is a fund set apart for meeting the unforeseen contingencies, including depreciation in the value of securities, risks arising out of monetary/exchange rate policy operations, systemic risks and any risk arising on account of the special responsibilities enjoined upon the Bank. What is Asset Development Fund? The Asset Development Fund (ADF) has been set aside for investment in subsidiaries and associates and internal capital expenditure. How DF and ADF are financed? From 2014 onwards, both CF and ADF are financed through provisioning. Meaning of the word provisioning is that an estimated amount is allocated from a given source. Hence, the allocation to the CF and ADF may is not shown in the final income statement of the RBI. Income is estimated after making the provisioning to the DF and ADF. On the other hand, before 2014, deductions to DF and ADF were made after estimating the income. After making allocations to DF and ADF from Income, transfer to the government was made. The practice of provisioning instead of allocating from income seems to be made after the recommendations of the Y H Malegam Committee recommendations (2013). Report of the Committee is not available in the public domain. Later, in November 18, 2018 the RBI appointed Committee on Economic Capital Framework (Bimal Jalan Commitee to assess the capital reseves of the RBI. “As financial resilience was within the desired range, the entire net income of ₹1,234.14 billion for the year 2018-19, of which an amount of ₹280 billion has already been paid as interim dividend, will be transferred to the Government of India. This is in addition to the ₹526.37 billion of excess risk provisions which has been written back and consequently will be transferred to the Government.” – RBI Annual Report 2019. Provisioning was quite weak in 2017-18 according to the data of the RBI AR (2017-18). An amount of Rs 3901 crores were added to CF but nothing was added to ADF. During the previous years also, the provisioning was weak and hence the CF plus ADF came down significantly from 9.2% of the RBI’s capital assets in 2014 to 5.34% in 2019. The table below shows that providioning to CF and ADF together was negative (-35800) in 2018-19. Table: RBI’s CF and ADF and the transfer of income to the government – the two phases (amount is in Rs billion except for 2018-19). Item 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 (figures are in Rs crores Amount in Rs billion Rs crores Income of the RBI 531 743 646 792 808 618 782 193000 Transfer/ Provisioning to CF and ADF Transfer Provisioning 271 287 0 9 -4 81 39 -35800 Transfer to the Govt. 160 330 526 659 658 306 500 175987 Source: Compiled from different Annual Reports of the RBI. Provisioning was almost nil for 2018-19 after the recommendations of the Committee on Economic Capital Framework (Bimal Jalan Committee). The Committee observed that RBI is well capitalized. It has also found excess capital with the RBI. Hence the RBI Board decided to transfer all net income to the RBI besides transferring the newly discovered excess capital (Rs 175987 as shown in the table). Table: Components of Capital Reserves of the RBI: 2019 and 2018. Component 2019 (Amount in Rs crores) 2018 (Amount in Rs crores) Contingency Fund (CF) 1,96344 232108 Asset Development Fund (ADF) 22875 22811 Currency and Gold Revaluation Account (CGRA) 6,64480 691641 Investment Revaluation Account (IRA) and 65285 13285 Foreign Exchange Forward Contracts Valuation Account (FCVA). 1304 3262 Total 11,62451 949822 Source: RBI Annual Report 2019. Table: CF and the ADF Outstanding during 2017-18 and 2016-17 Item 2018-19 Outstanding (Rs bn crores) 2017-18 Outstanding (Rs bn crores Change (Rs bn crores) CF 1,96344 232108 39 22875 22811 0 Source: RBI Annual Report 2019 and previous Annual Reports What is happening to the DF and the DF over the last few years? At the same time, the proportion of the DF and the ADF are declining since the last few years. Especially, they have shown a rapid decline since the launch of provisioning instead of allocation from declared income. The table below shows that the combined value of the DF and the ADF are showing a decline since 2014. Year (as on June 30) Balance Amount in CF and ADF together (Rs crores) CF+ADF as a % of total assets of the RBI. 2014 242413 9.2 2015 243375 8.4 2016 242944 7.5 2017 251018 7.6 2018 254919 7.05 2019 219219 5.34 Source: RBI Annual Report 2019 Understandably, the RBI’s CF and ADF – the two critical funds have registered decline due to high transfer to the government in the background of provisioning adoption. CF+ADF amount came down to 5.34% of the RBI's asset in 2019 as a result of the surplus transfer. What are Revaluation Accounts? The RBI holds several accounts for its holding and handling of the foreign currencies and foreign currency assets (for example US Securities), government securities (Central government), Gold, Forward Contracts etc. Simply, these assets (foreign currencies, gold, foreign currencies, government securities etc.,) may change values with market changes. Hence, the values of these assets with the RBI also may change. A revaluation is to be made with respect to their values. Such changes are accommodated in the three respective revaluation/valuation accounts. Following are the revaluation/valuation accounts of the RBI. Remembers since they are part of the Capital Reserves (after CF and ADF), continuous numbering after CF and ADF is given. Currency and Gold Revaluation Account (CGRA) The CGRA shows fund that is available to compensate RBI’s loss in the value of gold and foreign exchange reserve holdings. Gains and losses of the values of Gold and Foreign Currency Assets decreases or increases the CGRA money. Thus, changes in the market value of gold and forex assets (like the US Government securities where the RBI invested its foreign exchange reserves) is reflected in the CGRA. CGRA provides a buffer against exchange rate/gold price fluctuations. When CGRA is not enough to fully meet exchange losses, it is replenished from the contingency fund. Increase in gold price and depreciation of the rupee increases the CGRA fund. As on end June 2018, the CGRA has an amount of Rs 6,91600 crores billion. It registered an increase in 2018 mainly due to depreciation of rupee against US dollar and rise in the international price of Gold. Investment Revaluation Account (IRA) The investment Revaluation Account shows the buffer amount available with the RBI to compensate losses and to accommodate gains in (i) foreign securities and (ii) domestic securities. RBI holds significant portion of foreign securities and domestic securities (government of India). Under IRA, the marked to market gains and losses are measured. Foreign Exchange Forward Contracts Valuation Account (FCVA) The FCVA measures marked to market (periodic) gains and losses for the RBI from foreign exchange forward contracts. Central bank balance sheet purpose The purpose of central bank balance sheet is not to yield profit; though central banks can earn profit. Now, the main fact is that it has to maintain enough funds to manage emergencies. Dr SS Tarapore (late) in his September 3, 2015 (the Hindu Business Line) article pointed out that central banks should maintain its balance sheet by focusing on wider interest of the economy. Table: Accretion to Contingency Fund and Asset Development Fund as on end June between 2011 and 2019 (Rs Billion) 2011 2012 2013 2014 2015 2016 2017 2018 2019 Transfer to CF & ADF Provisioning to CF and ADF CF Total 1707 1954 2216 2216 2216 2201 2282 2321 1,963 Add ition 122 247 262 0 0 -15 81 39 -358 ADF Total 158 182 207 207 217 227 228 228 228 Add ition 12 24 25 0 9 10 1 0 0.1 Total (CF+ ADF) Total 1865 2136 2424 2424 2433 2429 2510 2549 2191 Add ition 134 271 287 0 09 -4 81 39 -358 Estimated from different Annual Reports of the RBI (2013 to 2019). CF is Contingency Fund and ADF is Asset Development Fund. Deviation by 1 occurred for few years due to fraction adjustments (e.g., 2017 total is recorded as 81 instead of 82). *********