Source: The Hindu
The Reserve Bank of India’s review of its capital buffer regulations, which have an impact on the amount of dividends it may pay to the government, is of direct importance to the Ministry of Finance.
RBI officials have been examining the central bank’s Economic Capital Framework (ECF) since January of this year. A committee led by former RBI Governor Bimal Jalan last examined the ECF in 2018. The committee’s recommendation was that the bank’s contingency risk buffer should account for 5.5–6.5% of the RBI’s balance sheet. The remainder is to be given to the government as a dividend or surplus after certain thresholds are reached. The CRB serves as a safety net against potential crises that could jeopardize financial stability. In 2019, the Jalan Committee’s recommendations were accepted.
Higher transfers to the government, which is apparently looking to increase its defense spending this year owing to continued tensions with Pakistan, would result from a lower CRB. In order to reach its own conclusions regarding the buffers, the Ministry of Finance is carrying out a parallel review procedure.
We would undoubtedly have more fiscal flexibility if the RBI could transmit a larger surplus while still keeping sufficient safety buffers, according to its own judgment.
Model Question:
“What is the Economic Capital Framework (ECF) of the Reserve Bank of India (RBI)? Discuss its significance in ensuring financial stability and balancing fiscal needs of the government.”
Model Answer:
The Economic Capital Framework (ECF) refers to the methodology used by the Reserve Bank of India (RBI) to determine the appropriate level of risk provisioning and surplus transfer to the Central Government, while maintaining financial stability and central bank autonomy.
It was formalized in 2019 following the Bimal Jalan Committee Report, which was constituted to review the RBI’s capital structure and surplus distribution practices.
Components of ECF:
- Contingent Risk Buffer (CRB): Created from retained earnings. Meant to cover monetary, financial, and credit risks. Jalan Committee recommended 5.5%–6.5% of RBI’s balance sheet
- Revaluation Reserves: Reflect unrealized gains/losses on foreign currency assets, gold, etc. These are non-distributable
- Realized Equity: Buffer used for meeting financial contingencies. Determines surplus transfer capacity
Significance of ECF:
- Maintains RBI’s Financial Resilience: Ensures adequate capital to deal with global or domestic financial shocks.
- Ensures Predictable Surplus Transfers: Balances the government’s fiscal needs and the RBI’s financial autonomy.
- Strengthens Central Bank Credibility: Discourages arbitrary transfers that could undermine confidence.
- Enables Fiscal Prudence: Surplus from RBI provides non-tax revenue to the government, easing fiscal pressure.
Recent Developments:
In May 2024, RBI approved a record surplus transfer of ₹2.11 lakh crore to the government, citing strong balance sheet and lower provisioning needs under the ECF.
The ECF is a crucial institutional mechanism to balance RBI’s risk management responsibilities with the government’s resource requirements. A prudent and transparent ECF ensures macro-financial stability, while upholding the independence and credibility of the RBI.
