RBI reserves to recap banks amid economic slowdown? Experts divided

“Meeting the minimum capital requirement is necessary, but not a sufficient condition for financial stability,” Das said at the SBI Economics and Banking Conclave
With economic stress leading to a pile-up of bad debts, banks need to raise capital fast to nurse back to health, say economists.

In fact, Reserve Bank of India (RBI) Governor Shaktikanta Das last week said banks should not wait for any event to happen, but actively raise capital to ensure financial resilience.   

“Meeting the minimum capital requirement is necessary, but not a sufficient condition for financial stability,” Das said at the SBI Economics and Banking Conclave, adding, “building buffers and raising capital will be crucial for credit flow and resilience of the financial system”. Therefore, he said banks must identify their vulnerabilities “and raise capital on time”. 

But economists argue that with government coffers running dry, who will provide capital to the public sector banks that run 70 per cent of the country’s banking needs? They argue that unless the banks get capital, they cannot lend more and the economy cannot grow. At the same time, when bad debts exist, banks use the capital to make provisions against such loans. So, capital is needed both for making provisions against bad loans as well as to grow the credit book, according to them.  

The International Monetary Fund (IMF) in mid-April expected the general government debt of India (Centre and states combined) to rise to 74.3 per cent of gross domestic product (GDP) in calendar year 2020, from 71.9 per cent in 2019. 

The debt can increase even further as both the government and the states announced more borrowings and a Rs 20 trillion stimulus measures later. With such high debt, it is difficult for any government to provide capital to banks, they say.  

Some of them are suggesting that the RBI should chip in, particularly by transferring a portion of its large revaluation reserves to the government. This can be used to recapitalise public sector banks. This is not a new thought and even former chief economic advisor Arvind Subramaniayan had proposed a similar measure. But that was vehemently criticised by the then RBI governor Raghuram Rajan. However, such proposals now hold a special meaning, considering the economic mess the country is in, the experts feel.  

One such proponent of reserve transfer is Bank of America’s Chief Economist Indranil Sengupta. He estimates that the banks would require $7-15 billion as recapitalisation money. The government can use recapitalisation bonds, but importantly, “RBI today has $130 billion of revaluation reserves and therefore, those can be utilised to recapitalise banks,” Sengupta said. 

The transaction can be liquidity and fiscal neutral in nature, and can be done in the same manner as recapitalisation bonds. According to Sengupta, the banks do not need resources, they have ample liquidity, but that’s not the same as having capital.  “Banks need capital but not resources. The capital is needed only to satisfy Basel norms,” he says. 

Economists say while the government asking more money from the RBI, in whatever form, is always a possibility that cannot be ruled out, doing so will be detrimental to the country’s overall health. Besides, such transfer was categorically rejected by the Jalan Committee report on the RBI’s economic capital framework. However, the report had also given a leeway to the RBI to change its calculation. The revaluation reserve was allowed to drop to 20 per cent, from 23.3 per cent of the balance sheet. And that enabled higher transfer of Rs 1.76 trillion in total in fiscal 2018-19.   

If the government has to touch the reserves further on any pretext, that can actually be quite detsabilising, economists say.   The economic capital framework takes cognizance of the fact that emergency liquidity assistance operations would be riskier in the banking sector with high non-performing asset (NPA) levels. 

“The NPA crisis has thrown light on the challenges that arise if a sizeable majority of the banking sector needs to be recapitalised during a financial stability crisis. This necessitates the need for RBI’s balance sheet to be demonstrably credible to discharge the lender of the last resort function,” said Group Chief Economic Advisor of State Bank of India Group Soumya Kanti Ghosh.

“India’s rating is ‘BBB-’ with a negative outlook. A country with such international rating should ideally have a strong central bank, otherwise the credibility in international arena sinks and swap functions difficult to come by,” said another senior economist. “The revaluation reserves is a nominal reserve and not realised. Tomorrow, for whatever reason, if the rupee sharply depreciates, most of the reserves would deplete and the central bank will be left weak," said the economist. 

“The most significant impact of public policy considerations on the RBI’s balance sheet is the size of the forex reserves maintained to manage the volatility in the exchange rate. While these reserves provide the economy with a buffer against external stress, they give rise to significant risks for the RBI, as they have to be maintained as open, unhedged positions thereby exposing the RBI to currency risk on more than three-fourths of its balance sheet,” Ghosh of SBI said.


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