Context: Reserve Bank of India (RBI) has approved the transfer of record Rs 1.76 lakh crore dividend and surplus reserves to the government.

• The excess reserve transfer is in line with the recommendation of former RBI governor Bimal Jalan-led panel constituted to decide size of capital reserves that the central bank should hold. 

• Background:

  RBI had constituted a panel on economic capital framework. It was headed by Ex-RBI governor Bimal Jalan.

  The expert panel on RBI’s economic capital framework was formed to address the issue of RBI reserves—one of the sticking points between the central bank and the government.

  What’s the isssue?

  The government has been insisting that the central bank hand over its surplus reserves amid a shortfall in revenue collections. Access to the funds will allow the government to meet deficit targets, infuse capital into weak banks to boost lending and fund welfare programmes.

  What is economic capital framework?

  Economic capital framework refers to the risk capital required by the central bank while taking into account different 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.

  Why it needs a fix?

• 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 and that a review of the framework would result in excess capital being freed, which the RBI can then share with the government.
• 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.
• 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.

• What is the nature of the arrangement between the government and RBI on the transfer of surplus or profits?

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

  Does the RBI pay tax on these earnings or profits?

  No. Its statute provides exemption from paying income-tax or any other tax, including wealth tax.

  Why RBI needs excess reserves?

• The RBI needs adequate capital reserves for monetary policy operations, currency fluctuations, possible fall in value of bonds, sterilisation costs related to open-market operations, credit risks arising from the lender of last resort function and other risks from unexpected increase in its expenditure.
• The RBI has maintained the view that it needs to have a stronger balance sheet to deal with a possible crisis and external shocks.