Why in the News?

• Reserve Bank of India’s (RBI) Governor said the central bank is currently reviewing the Economic Capital Framework (ECF).

What’s in Today’s Article?

• About ECF (Meaning, Utility, etc.)
• RBI’s Review of ECF (Key Observations, Impact of Review, Significance, etc.)

Understanding the Economic Capital Framework (ECF):

• The Economic Capital Framework (ECF) is a policy that determines how the Reserve Bank of India (RBI) manages its financial reserves, risk provisioning, and surplus transfers to the central government.
• It sets guidelines for the contingency risk buffer (CRB)—a financial reserve maintained by the RBI to address unforeseen economic crises.
• The Bimal Jalan Committee, formed in 2018, recommended that the CRB should be maintained between 5.5% to 6.5% of the RBI’s balance sheet.
• This buffer acts as a safeguard for economic stability, ensuring that the RBI can function effectively as the Lender of Last Resort (LoLR) during financial crises.
• Since 2019, the RBI has followed these recommendations, and any revisions to the framework could influence how much surplus the RBI transfers to the government in future years.

RBI’s Current Review of the ECF:

• RBI Governor’s Statement on ECF Review
  • Recently, RBI Governor confirmed that the central bank is reviewing the Economic Capital Framework.
  • This periodic review, recommended by the Bimal Jalan Committee, is meant to assess whether any adjustments are needed in the CRB range.
  • Malhotra clarified that while the current CRB stands at 6.5% (as of March 31, 2024), the review could lead to an increase or decrease in the required buffer, though no immediate changes have been confirmed.
• Background on the Bimal Jalan Committee Recommendations
  • The Bimal Jalan-led panel had suggested a five-year review cycle for the ECF, with its recommendations valid from June 2019 to June 2024.
  • Given this timeline, the RBI has now begun an internal assessment to evaluate whether changes are necessary.
  • According to RBI Deputy Governor, the review will help determine if the current framework remains effective or if modifications are required to address evolving financial conditions.

Impact of the ECF Review on RBI’s Surplus Transfers:

• Record Surplus Transfer to the Government in 2023-24
  • For the financial year 2023-24, the RBI approved a record surplus transfer of ₹2.11 lakh crore to the central government.
  • This amount significantly boosts government revenue and helps finance fiscal policies, including infrastructure projects and social welfare programs.
• How CRB Adjustments Could Affect Future Dividends
  • Economists believe that any revision in the CRB threshold could directly impact future surplus transfers.
  • If the CRB requirement is increased, the RBI may need to set aside more reserves, reducing the amount of surplus available for government transfers.
  • Conversely, if the CRB is lowered, it could free up more funds for dividend payments.
• However, as per the officials, the decision to revise the CRB is not linked to current global uncertainties, and any change will be based purely on economic factors rather than short-term concerns.

Importance of ECF Review:

• Ensuring Economic Stability
  • The contingency risk buffer serves as an essential financial safeguard against global financial instability, banking crises, and currency fluctuations.
  • Maintaining an adequate buffer ensures that the RBI can respond effectively to any economic downturn.
• Impact on Government Budget Planning
  • The RBI’s surplus transfers play a crucial role in supporting government spending and fiscal deficit management.
  • Any change in the ECF could influence the government’s budgetary planning for the upcoming fiscal years.
• Balancing Risk and Development Needs
  • The RBI must strike a balance between maintaining financial stability and providing surplus funds to the government.
  • If the CRB is increased, it could strengthen the financial resilience of the central bank but may reduce funds available for government initiatives.

Conclusion:

• The RBI’s review of the Economic Capital Framework is a crucial exercise that could determine the future allocation of financial reserves and surplus distribution.
• While the current contingency risk buffer (CRB) stands at 6.5%, the review will assess whether adjustments are needed to maintain economic resilience.
• A higher CRB could enhance financial security but reduce the RBI’s surplus transfers to the government, while a lower CRB could provide the government with more fiscal resources but may increase financial risks.
• As the five-year review process unfolds, all eyes will be on the RBI’s decision, which will have long-term implications for India’s economic and fiscal stability.