The latest annual report of the Reserve Bank of India released August-end shows the profit (surplus) generated by the central bank in 2015-16 at ₹658.76 billion, almost matching the number for 2014-15, which stood at ₹658.96 billion.
As in the previous two years, the entire profit has been paid to the Union Government without any retention towards augmenting the internal reserves of the RBI. This unprecedented dividend policy of the RBI is ostensibly justified on the basis of an assessment made by its board each year that the RBI’s capital position remains robust and adequate vis-a-vis risks that the central bank faces.
Hence the RBI has seen no need for ploughing back any portion of its profits. It has claimed that its internal framework checks its capital adequacy each year before any decision on how much it pays as dividend, reducing the scope for differences with the Government in this regard.
This is all very well, provided the RBI’s risk management/stress-testing methodology and technology compare well with the best used elsewhere. But since the methodology is not revealed to the public, one has to rely on the RBI’s annual reports and other publications.
Touch of complacency
The fact is that the RBI’s risk calculations have thrown up numbers that have enabled the bank to say it will retain no share of its surplus during the last three years; this is also the period in which the RBI has seen a little over 35 per cent increase in its risk assets (domestic plus foreign assets, including gold). This in itself is certain to raise a few questions about the prudence of the current dividend policy.
The approach also needs to be understood against the backdrop of a somewhat bland analysis in the last Economic Survey, which concluded that the RBI was capitalised much more than its needs, and hence a good portion of its profit could be utilised for infusing fresh equity in PSU banks. The RBI governor Raghuram Rajan was quick to dismiss this as less-than-professional work, but he recognised later the importance of providing adequate resources to the Government by way of dividends to recapitalise public sector banks.
In view of all this, there is a need to examine whether the balance between the Government’s claim on the RBI’s profit and the RBI’s own need for capital might have undergone a shift in recent years.
Reliance on RBI transfers
Historically, the RBI’s dividend payouts constituted a very small proportion of the aggregate revenue receipts of the Centre. However, for the last ten years or so, this ratio has been on the rise. From a low of 0.93 per cent in 2005-06, it rose to 3.62 per cent, on average, during the last three years. It is noteworthy that in 2014-15, the ratio jumped to 3.65 per cent from 2.44 per cent in 2013-14. Clearly, reliance on the RBI’s dividend payout for the revenue receipts of the Government is higher now by several orders of magnitude, both in absolute and relative terms.
What are the implications of this trend for the RBI’s own capital needs? For a variety of reasons, chief being providing exchange rate guarantee for free on FCNR deposits, the RBI’s capital stood significantly depleted in the early 1990s. In response, a policy decision was taken in 1997 to retain a good portion of the RBI’s profit each year till the ratio of its internal reserves (Contingency Fund and Asset Development Fund) reached 12 per cent of its assets. In the case of the RBI, its internal reserves are almost identical with its usable equity (equity that can be freely used to meet any kind of financial loss), since the other components, like paid-in capital, are insignificantly small.
Pursuance of this approach yielded good results. The ratio of internal reserves to total assets rose steadily, exceeding 12 per cent in 2009-10 and remaining close to 12 per cent in the following year. It fell in the subsequent years and currently it is at 7.5 per cent. The last three years have witnessed a sharp reversal of the strength of the usable equity of the RBI.
International comparison
Rajan in his last public speech as RBI governor explained the central bank’s risk management and dividend policy in some detail, claiming that it is intended to establish and retain the RBI’s creditworthiness at the highest, that is, ‘AAA’ level. Central banks are not rated by credit rating agencies. Hence, it will be informative to look at the financials of the World Bank group (IBRD) which has long been a triple A-rated financial institution, for a comparison. During the last three years, the ratio of its usable equity to total assets has been, on average, 11.2 per cent, while for the RBI it was much lower at 8.9 per cent.
Compared to the situation prevailing in 1997, there has been a structural rise in the RBI’s risk exposure over the last 10-15 years. As against a predominance of domestic assets on its book then, foreign assets now comprise a little over 76 per cent of aggregate risk assets. Foreign assets carry more risk but yield less compared to domestic assets. Hence, based on this shift in asset composition alone, it can be surmised that the RBI’s target ratio of internal reserves to total assets should now be even higher than 12 per cent. It would thus be reasonable to argue that, in all likelihood, the RBI is under-capitalised right now.
Ironically, this understanding has emerged as a result of the RBI bringing about significant changes in its accounting policies over the last few years to align them with global standards — such as periodic marking-to-market its securities portfolios as well as its off-balance sheet foreign currency exposures.
Formats for the preparation of its financial statements have also been modernised. It is now possible to obtain a better assessment of the RBI’s financial risks from its published accounts. However, a notable departure from this improved accounting policy was made in respect of the forex amount of $26 billion mobilised under the special three-year off-market swap arrangement with banks in the wake of market turmoil in September 2013. Both the dollar amount thus added to the forex reserves as well as the off-balance sheet commitment to sell dollars to banks on maturity of the swap have not been revalued/marked to market.
This was presumably to avoid significant losses that might have been caused on doing so. The effect of the scheme was to give an exchange rate guarantee at a subsidised price, making this a quasi-fiscal activity. The published accounts of RBI have not captured the financial risks of the special swap. However, one hopes that the RBI has noticed the incompatibility between providing subvention through a quasi-fiscal scheme such as the special swap and following good standards of accounting.
(The writer is a former central banker and consultant to the IMF. Syndicated by The Billion Press.)