The distribution of Reserve Bank of India profits

The Reserve Bank of India committed an unprecedented level of profits to the government of India in late May 2024, but the people of India would have been better off if the Central bank of the country had redirected its capital and reserves to the banking system, writes Romar Correa.

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THE record disbursal of Reserve Bank of India (RBI) profits to the government of India in May 2024 has been in the news. The magnitude of the disbursal caught everyone by surprise. There is a fair bit of confusion as well since many in the mainstream media are trying to paint this move by the RBI in a positive light. In fact, the move raises a host of matters of principle.

Distribute or hold

Will the Indian government use the windfall to reduce the country's fiscal deficit or increase its expenditure? Students of economics will be bewildered— the item not figuring in government budget constraints in the books.

Also, the government of India, like others, swears by Central bank autonomy. Accordingly, money financing of fiscal deficit is anathema. It is not clear how profit financing of the deficit does not violate this tenet.

The autonomy is for the Central bank to use the 'dual' of the money supply— the short-term interest rate— to target inflation. The action of the RBI board of governors has led, naturally, to a softening of interest rates.

How does this outcome square with the resoluteness of the Monetary Policy Committee with regard to not softening interest rates for the purpose of targeting inflation at its last meeting?

In addition, the profits are nominal returns on foreign exchange assets. Countries with managed exchange rates hold large open positions in foreign country reserves. If unhedged, profits are at the mercy of exchange rate swings. Historically, the policy use of foreign exchange reserves has been the main route through which Central banks have incurred losses.

Also read: Economic Impact of RBI's record dividend to government

India has one of the surveyed 70 Central banks that does not have a reciprocal arrangement in place for government transfer of capital to the Central bank in the event of losses. In a tabular annexure to the paper, India draws a blank under the headings:

1. Arrangements in response to a Central bank financial loss
2. Arrangements for losses arising from revaluations 
3. Arrangements in response to low capital 

With regard to 2, Central banks record unrealised profits and losses in the forex and securities markets due to price movements. Such fluctuations are short-lived, and when unrealised losses are not offset symmetrically, an irreversible channel to erosion of Central bank equity is opened. 

When assets are marked to the market, it is critical that the prevention of unrealised profits being recorded as distributable profits be incorporated into the rule books. Another practice is the establishment of a revaluation account to retain profits and losses on the balance sheet rather than have them flow through to the income account. Belize and Guyana are two countries whose Central banks have both features in place. 

With regard to 3, in a situation of recapitalisation, the current scenario goes into reverse. A fiscally-constrained government is unlikely to be well disposed to recapitalise a Central bank.

The word 'dividends' is often used to describe the distribution of profits to shareholders. How is the government of India a shareholder in RBI profits? It represents the people of India, will be the answer. Are there other stakeholders?

It is worth clarifying here that the 'expenditure' on the RBI balance sheet which allegedly has fallen should not be taken literally. The term includes transfer to the 'contingency fund' and 'asset reconstruction fund' which has dropped markedly in comparison with last year. The fund is earmarked for subsidiaries to meet internal capital expenditure.

Commercial banks are an appendage of Central banks in history and logic. Central banks were once commercial banks. The RBI is at least consistent in its obeisance to the government in undermining the banking system in India. Deposits are falling as more attractive avenues to savers present themselves. Lending is lacklustre as the private accumulation of capital is depressed.

Also read: Union Budget 2024-2025: Of the, for the and by the organised sector

The newspapers report bank profits this year as a shot in the arm of the RBI for its gesture. This blimp on the radar of commercial bank profitability does not reflect the continuing downward trail of bank metrics. Profits are flows. The stock of non-performing assets (NPAs) continues to fester under the regulatory radar.

Attempts to clean up via a bad bank and an asset-reconstruction fund and so on have come a cropper due to lethargy and incompetence. Recently, warning bells have been rung concerning the buildup of debt in retail lending. Hapless citizens are forced to borrow in the absence of adequate income and hapless banks are forced to lend in the absence of credit-worthy borrowers.

In sum, the RBI should have earmarked its profits to resurrect banks, following forensic audits and assessing profit possibilities. As 'leader of the club of banks' it can dust off its power of 'moral suasion' and direct credit to employment-generating and environmentally-friendly projects.

The risks are gargantuan but only the RBI would be able to suffer many big misses for a few mighty hits. Besides, the mind cannot wrap itself around 'wilful defaulters' being treated with kid gloves by the government.

By definition, they are criminals with visible wealth in excess of payback of principal and interest, cocking a snook at the government. Why should their assets not be confiscated and they be thrown into jail? Irreparable banks should be clinically and swiftly excised from the banking system. The concept of 'debt forgiveness', of wiping the slate clean and beginning anew should be examined afresh.

Conclusion

Negative real shocks such as wars and the spinoffs of climate change are not rare events. The cosy appraisal of the Indian economy and the world by the RBI authorities is unlikely to be shared. A Central bank must have adequate capital and reserves to meet its lender-of-last-resort obligation. Banks are vulnerable to liquidity shocks and in the absence of Central bank intervention, financial stability might be jeopardised.