Economic Survey suggests RBI to dig into its reserves to recapitalise banks

If the recommendation is accepted, it would release more than Rs 5 lakh crore from RBI reserves

The Survey suggested the Reserve Bank of India (RBI) could use its own equity to recapitalise public sector banks (PSBs), given the high share of capital the central bank holds and the tight fiscal condition of the government.

Even as the suggestion is highly thought provoking, the RBI is sure not to be amused, said economists.

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The Survey argued that while public sector banks can recapitalise themselves through their own balance sheet by letting the government sell off assets in nonfinancial companies, "what is less appreciated is that RBI could do the same. That is to say it could redeploy its capital as well," the Survey said.

 

Central banks hold capital to provide a buffer against the risks they take, that can arise through fluctuations in the value of the foreign exchange reserves due to exchange rate fluctuation and change in the value of government securities due to interest rate movement.

But the capital holdings vary widely across central banks.

The Reserve Bank of India's equity shareholding, which is capital plus reserves and revaluation of contingency accounts, is the second highest in the world. At 32 per cent of the balance sheet, the capital holding is second only to Norway. In comparison, the capital buffers of US Federal Reserve and Bank of England are less than two per cent. The conservative European Central Bank and some emerging markets central banks have much higher ratios, "but even they do not approach the level of the RBI," the survey said. The ratio of ECB, for example, is less than 20 per cent, while that of Sweden and Hong Kong are about 20 per cent.

"If the RBI were to move even to the median of the sample (16 per cent), this would free up a substantial amount of capital to be deployed for recapitalising the PSBs," the survey suggested.

Economists are not very clear if this mode of recapitalisation has been followed by other central banks, but the amount to be unlocked can be huge.

For example, as on 12 February, RBI's total balance sheet size was Rs 31,64,856 crore. Hence, the total equity of the RBI turns out to be more than Rs 10 lakh crore. If RBI moves into the median in terms of capital holding, that is, 16 per cent of the balance sheet, the capital released works out to be more than Rs 5 lakh crore, which is about the same amount of money that Indian banks need to meet Basel III norms by 2019.

"This is a feasible, and an interesting thought because even after the capital shedding, RBI is holding more than Rs 5 trillion as equity, but RBI will sure to have its own defences for not letting the money flow out from its reserves," said an economist who did not wish to be named.

In 2012, the then RBI governor D. Subbarao had said that banks would need about Rs.5 lakh crore of capital to meet the norms, of which equity capital would be Rs.1.75 lakh crore.

The economic survey's own estimate is that excluding internal generated profits, banks would need Rs 1.8 lakh crore of capital for the next four years up to fiscal 2018-19.Of this total requirement, government has already proposed to make Rs 70,000 crore available out of budgetary allocations during the current and succeeding years. So far, the government has released Rs 19,950 crore to 13 public sector banks.

Even as the recommendation seems theoretical in nature, if the government pesters RBI for it, it will further strain the relationship between the Centre and the RBI.

The language of the economic survey was cautious about it.

"Of course, there are wider considerations that need to be taken into account. Most important, any such move would need to be initiated jointly and cooperatively between the government and the RBI. It will also be critical to ensure that any redeployment of capital would preserve the RBI's independence, integrity, and financial soundness-and be seen to do so," the survey said, adding:

"At this stage, what is important is the broader point: that funds for recapitalization can be found, at least to a certain extent, by reallocating capital that already exists on the public sector's balance sheet."

The Survey said the economy is now suffering from 'twin balance sheet' problem - weakness in corporate and bank balance sheets. While corporate debt is high and profitability low, banking system is suffering from high stressed assets.

Thus banks have limited the flow of credit to the real economy to conserve capital and the corporate sector is not investing to preserve cashflow.

"This situation is not sustainable; a decisive solution is needed. But finding one is difficult."

Resolving the challenge comprehensively would require 4 Rs : Recognition, Recapitalization, Resolution and Reform. While banks are recognising their bad debts as much as possible, and as required by the RBI, recapitalisation would be done through government, banks' own balance sheet or even through ideas like using RBI reserves.

"Once the resources to back recognition are identified, the remaining 2 Rs (Resolution and Reform) can be pursued with vigour. There are many options here, including creating "bad banks" to implement the four Rs," the survey said.