Bimal Jalan Committee Report on Economic Capital Framework
The Reserve Bank of India (RBI) had constituted an Expert Committee to Review the Extant Economic Capital Framework of the Reserve Bank of India. The committee was chaired by Dr Bimal Jalan. The committee has submitted its report.
Recommendations of the Committee
RBI’s economic capital
- The Committee called for a clearer distinction between the two components of economic capital (realized equity and revaluation balances).
- The committee recommended that realised equity could be used for meeting all risks/ losses as they were primarily built up from retained earnings.
- Revaluation balances could be reckoned only as risk buffers against market risks as they represented unrealised valuation gains and hence were not distributable.
- The entire net income can be transferable to the government only if realised equity is above its requirement. If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government.
- The committee reviewed the status, need and justification of the various reserves, risk provisions and risk buffers maintained by the RBI and recommended their continuance.
- The committee notes that there was only one-way fungibility between them realised equity and revaluation balances. This implies that while a shortfall, if any, in revaluation balances vis-a-vis market risk provisioning requirements could be met through increased risk provisioning from net income, the reverse vis-a-vis the use of surplus in revaluation balances over market risk provisioning requirements for covering the shortfall in provisions for other risks is not permitted. The committee has recommended revising the presentation of the liabilities side of the RBI balance sheet to reflect this distinction.
Risk provisioning for market risk
- The committee has recommended the adoption of Expected Shortfall (ES) methodology under stressed conditions (in place of the extant Stressed-Value at Risk) for measuring the RBI’s market risk.
- The committee has recommended the adoption of a target of ES 99.5 per cent CL keeping in view the macroeconomic stability requirements.
Size of Realized Equity
- Realised equity is required to cover credit risk and operational risk. The Contingent Risk Buffer (CRB) to be maintained within a range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet, comprising 5.5 to 4.5 per cent for monetary and financial stability risks and 1.0 per cent for credit and operational risks.
- Development of methodologies for assessing the concentration risk of the forex portfolio as well as jointly assessing the RBI’s market-credit risk
Surplus Distribution Policy
- The Committee has recommended a surplus distribution policy which targets the level of realized equity to be maintained by the RBI, within the overall level of its economic capital vis-à-vis the earlier policy which targeted total economic capital level alone.
- Only if realized equity is above its requirement, the entire net income is transferable to the Government. If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government.
- Within the range of CRB, i.e., 6.5 to 5.5 per cent of the balance sheet, the Central Board will decide on the level of risk provisioning.
Action Taken by the RBI
Accepting the recommendations of the committee the RBI approved a surplus transfer of Rs 1.76 lakh crore to the government. The surplus comprises Rs 1,23,414 crore for 2018-19 and Rs 52,637 crore of excess provisions identified as per the revised Economic Capital Framework (ECF) adopted at the board.
Topics: Balance Sheet • Equity • Finance • Financial markets • Financial risk • Money • RBI’s economic capital • Realized Equity • Reserve Bank of India • Risk provisioning for market risk • Surplus Distribution Policy • TARGET2