RBI Board Decides to Set Up Panel to Review Amount in Reserve, Handing Over Balance to Govt
The board of Reserve Bank of India (RBI) has decided to form an expert committee to examine the economic capital framework (ECF) of the central bank, which will decide the amount of reserves it can maintain, handing over the balance to the government.
"The Board decided to constitute an expert committee to examine the ECF, the membership and terms of reference of which will be jointly determined by the Government of India and the RBI," the central bank said in a release.
The board also considered other issues related to the liquidity crunch in the economy and relaxation, prompt corrective action (PCA) norms to clean up balance sheet of banks burdened with bad loans will be looked into by RBI's Board for Financial Supervision (BFS).
Eleven of the 21 state-run banks are under the PCA framework. The non-performing assets (NPAs), or bad loans, accumulated in the Indian banking system have touched a staggering Rs10 lakh crore.
The RBI had been at loggerheads with the government over three demands: transfer a higher portion of its reserves to the Centre to keep the fiscal deficit in control; inject more liquidity into the system to stave off a possible blowout among housing and finance companies; and relax the norms for PCA and income recognition of banks.
The differences between the government and the central bank came out in the open after RBI deputy governor Viral Acharya spoke about the consequences of messing around with the central bank's independence while delivering the AD Shroff Memorial lecture in Mumbai on 26th October.
Dr Acharya had said, “Governments that do not respect central bank independence will sooner or later incur the wrath of the financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.”
Since then, the government has been openly critical about the RBI and was apparently prepared to use its powers under Section 7 of the RBI Act to issue directives to the central bank. However, during the board meeting, members have decided to refer this to the expert committee.
According to CARE Ratings, the issue is important, as there has been a strong case made to transfer the surplus reserves of the RBI to the government as the present level is higher than global standards. "These reserves would presumably be used by the government for the welfare of the people. The argument on the other side is that these reserves are notional and required for contingencies. The committee will have to decide on how much of such reserves would have to be maintained and the purposes for which they should be used. Also the effect on forex reserves and money in circulation will have to be worked out when such a decision is taken," it says.
These decisions were taken following a crucial board meeting in Mumbai that lasted over nine hours to discuss the liquidity crisis that initially triggered a tiff between the government and the central bank last month.
"The Reserve Bank of India's Central Board met today in Mumbai and discussed the Basel regulatory capital framework, a restructuring scheme for stressed MSMEs (micro small and medium enterprises), bank health under the PCA framework and the Economic Capital Framework (ECF) of RBI," a central bank statement said.
The government has been wanting the RBI to transfer more money to it from its reserves. However, the RBI feels it needs to have a stronger balance sheet to deal with any potential crisis and external shocks.
The meeting had been called amid growing tensions between the Centre and the RBI after the Finance Ministry recently sought discussions under the never-used-before Section 7 of the RBI Act, which empowers the government to issue directions to the RBI Governor.
"The Board also advised that the RBI should consider a scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities of up to Rs250 million (Rs25 crore), subject to such conditions as are necessary for ensuring financial stability," it added.
This, CARE Ratings feel will be a positive for the SME sector which is facing various challenges. It says, "The RBI will have to work out the guidelines and ensure that banks go about this process in a prudent manner. The restructuring exercise for large loans in the past had led to the creation of the NPA pile which is still to be resolved. Therefore this exercise should be undertaken with the necessary safeguards."
Though, the board decided to retain commercial banks' capital adequacy ratio at 9%, it agreed to extend the period for implementing the last tranche by one year.
"The Board, while deciding to retain the capital to risk weighted assets ratio (CRAR) at 9%, agreed to extend the transition period for implementing the last tranche of 0.625% under the Capital Conservation Buffer (CCB), by one year, that is, up to 31 March 2020," RBI said.
On the CRAR issue, the government maintains that the capital norm for Indian banks at 9% are much higher than that prevailing for banks overseas.
"The approach taken to these banks will be interesting as presently the framework does put restraints on the operations of these banks. It can be conjectured that any relaxation will be linked to performance so that the banks are able to come out of this framework in a seamless manner. It would also be necessary for the government to follow up and provide capital to these banks as their net worth is low and under pressure from higher provisioning for NPAs," the ratings agency says.
The RBI's central board currently has 18 members, including Governor Urjit Patel and his four deputies as full-time official directors, while the rest have been nominated by the government, including the secretaries from the economic affairs and financial services department.