The North Block of the Central Secretariat building, which houses the Ministries of Finance and Home Affairs. (Photographer: Prashanth Vishwanathan/Bloomberg)

RBI-Government Spat: Finance Ministry Seeks Review Of Central Bank Balance Sheet

Amid a stand-off between the government and the Reserve Bank of India, a senior government official has denied seeking capital from the central bank’s balancesheet. The official, however, confirmed that the government is looking for a review of the framework which governs the RBI’s balance sheet.

The comments may not signal an end to the very public battle between the government and the central bank over a host of issues, but could signal the Finance Ministry’s willingness to discuss a key point of dispute between the two sides.

In response to reports that the government is seeking Rs 3.6 lakh crore in capital from the RBI’s balance sheet, Subhash Chandra Garg, secretary in the Department of Economic Affairs, said that this is not the case. The government is only seeking a review of the Economic Capital Framework adopted by the RBI, Garg said in a series of tweets on his official account. The framework determines the amount of contingency and revaluation reserves held by the central bank.

Garg did not specify whether the process to “fix appropriate economic capital framework” includes a process of discussion on the same with the RBI or if the government has taken a view that it intends to ask the RBI to adhere to.

Ahead of its adoption, the RBI had explained the broad approach behind this framework in its annual report for 2015-16 by saying that the idea behind it is to build sufficient financial resilience.

The general approach towards financial risk management in central banks is that while they do not actively manage risks arising from policy actions, they seek to ensure that their balance sheets have sufficient financial resilience to absorb these risks. Thus, they maintain sufficient economic capital, supplemented by risk-transfer/dividend-smoothening mechanisms.
RBI’s 2015-16 Annual Report 

The formula used by the RBI to calculate capital needs under the economic capital framework is based on 'stressed value at risk' while most central banks use 'value at risk' valuation, BloombergQuint had reported on Nov. 6.

The concept of ‘stressed value at risk’ was popularised after the global financial crisis, and assesses capital needs based on the experience of a longer periods of time, which incorporates actual periods of stress. In contrast, a simple value at risk is assessed based on the experience of a pre-determined number of days.

Further the central bank uses a formula (stressed value at risk at 99.99 percent confidence level) which requires it to maintain an equity-to-assets ratio of 27 percent. Some other central banks calculate their capital needs based on a less stringent formula (value at risk at 99 percent confidence level),which requires the equity-to-assets ratio to be maintained at 14 percent, people aware of the development had told BloombergQuint earlier.

The RBI’s equity to asset ratio was 24 percent as on June 2018. If it were to bring it down 14 percent, it will free up capital around Rs 3.6 lakh crore, the people explained.

Fiscal Math ‘Completely On Track’

Garg also said that speculation that these funds are being sought to help the government meet its fiscal deficit target is unwarranted. The government is on track to meet its fiscal deficit target of 3.3 percent of GDP for the current fiscal, said Garg.