15-Nov-2019: Rules notified to bring financial firms under IBC

The Centre issued rules that provide a framework for bringing ‘systemically important financial service providers’ under the purview of the Insolvency and Bankruptcy Code (IBC).

Section 227 of the [Insolvency and Bankruptcy] Code enables the Central government to notify, in consultation with the financial sector regulators, financial service providers (FSPs) or categories of FSPs for the purpose of insolvency and liquidation proceedings, in such manner as may be prescribed.

Accordingly, the Ministry of Corporate Affairs has notified the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 to provide a generic framework for insolvency and liquidation proceedings of systemically important FSPs other than banks.

Finance Minister Nirmala Sitharaman said the notification was necessitated because there was no system like the IBC that was designed exclusively for financial institutions. This notification was brought out in an environment where it might be necessary to invoke an IBC-like proceeding on a financial institution, but where there is no exclusive arrangement for financial institutions.

The introduction of an interim framework for resolution of financial service providers under the IBC is a timely and important step for resolution of financial service providers permitting an interplay between regulators, creditors and the NCLT (National Company Law Tribunal) for appropriate actions.

27-Aug-2019: Report of the Expert Committee to Review the Extant Economic Capital Framework of the Reserve Bank of India

The Expert committee to review the extant Economic Capital Framework of the RBI was constituted in accordance with the decision of the Central Board, taken in its meeting held on November 19, 2018.

The committee reviewed the extant framework and surplus distribution policy of RBI in light of the cross-country practices, statutory mandate under section 47 of the RBI Act and impact of RBI's public policy mandate, including financial stability considerations on its balance sheet and risks.

The Reserve Bank of India (RBI) has developed an Economic Capital Framework (ECF) to provide an objective, rule-based, transparent methodology for determining the appropriate level of risk provisions to be made under Section 47 of the Reserve Bank of India Act, 1934. The framework was developed in 2014–15, and while it was used to inform the risk provisioning and surplus distribution decisions for that year, it was formally operationalized in 2015–16. The ECF was supplemented by a Staggered Surplus Distribution Policy (SSDP) in 2016-17 to smoothen the cyclicality in RBI’s economic capital and incorporate a certain degree of flexibility in surplus distribution.

As decided by the Central Board of the RBI in its meeting held on November 19, 2018, the RBI, in consultation with the Government of India (Government), constituted an Expert Committee to review the extant ECF of the RBI. Shri Subhash Chandra Garg, the then Secretary, Department of Economic Affairs, was initially a member of the Committee. Subsequently, with the appointment of Shri Rajiv Kumar, Finance Secretary, the composition of the Committee is as under:

The terms of reference (ToR) of the Committee are given below:

1. Keeping in consideration (i) statutory mandate under Section 47 of the RBI Act that the profits of the RBI shall be transferred to the Government, after making provisions ‘which are usually provided by the bankers’, and (ii) public policy mandate of the RBI, including financial stability considerations, the Expert Committee would:
   1. review status, need and justification of various provisions, reserves and buffers presently provided for by the RBI; and
   2. review global best practices followed by the central banks in making assessment and provisions for risks which central bank balance sheets are subject to;
2. To suggest an adequate level of risk provisioning that the RBI needs to maintain;
3. To determine whether the RBI is holding provisions, reserves and buffers in surplus / deficit of the required level of such provisions, reserves and buffers;
4. To propose a suitable profits distribution policy taking into account all the likely situations of the RBI, including the situations of holding more provisions than required and the RBI holding less provisions than required;
5. Any other related matter including treatment of surplus reserves, created out of realized gains, if determined to be held.

The Committee held eleven meetings during the course of its deliberations. The first meeting was held on January 8, 2019. As the Committee was required to submit its report within a period of 90 days from the date of its first meeting, an extension was granted by the RBI.

The Committee finalized its recommendations after, inter alia, taking an overview of the role of the central bank’s financial resilience, reviewing cross-country practices, and assessing the impact of RBI’s public policy mandate and operating environment on its balance sheet and risks.

Executive summary

The Expert Committee constituted to review the RBI’s extant ECF, was guided by the principle that the alignment of the objectives of the Government and the RBI is important. As a central bank is a part of the Sovereign, ensuring the credibility of the RBI is as important, if not more, to the Government as it is to the RBI itself. The Committee also noted that while there may occasionally arise a difference of views in the conduct of the central bank’s operations, there always needs to be harmony in the objectives of the Government and the RBI.

In recognition of the fact that the RBI forms the primary bulwark for monetary, financial and external stability, the Committee was of the view that the financial resilience of the RBI needs to be maintained above the level of peer central banks, as would be expected of the central bank of one of the fastest growing economies of the world.

Towards this end, the Committee recommended adopting the Expected Shortfall (ES) methodology (in place of the extant Stressed-Value at Risk) for measuring market risk on which there was growing consensus among central banks as well as commercial banks over the recent years. While central banks are seen to be adopting ES at 99 per cent confidence level (CL), the Committee recommended adoption of a target of ES 99.5 per cent CL and a range defined between the target and downward risk tolerance of 97.5 per cent (both under stress conditions). The range is considered appropriate to address the cyclical volatility of RBI’s valuation balances based on historical analysis.

The Committee recognized that the RBI’s Contingency Risk Buffer (CRB) is, inter alia, the country’s savings for a ‘rainy day’ (a financial stability crisis) which has been consciously maintained with RBI in view of its role as Lender of Last Resort (LoLR). Financial stability risks are those rarest of the rare, fat tail risks whose likelihood can never be ruled out, especially in light of the Global Financial Crisis (GFC) and whose impact can be potentially devastating. Public policy prudence and extant statutory provisions require the RBI to maintain appropriate level of risk buffers for this purpose. The Committee recommended that the same be maintained at a range of 5.5 per cent to 6.5 per cent of the RBI’s balance sheet which is above the available level of 2.4 per cent of balance sheet as on June 30, 2018 (vis-à-vis a target of 3.7 per cent of balance sheet).

Application of these recommendations to RBI’s 2017-18 balance sheet is seen to result in RBI’s risk equity levels in a range of 25.4 per cent to 20.8 per cent of balance sheet which will enable the RBI to retain one of the highest levels of financial resilience among central banks globally.

The Committee recognized that the opportunity cost of RBI’s capital is minimal as the RBI returns a major part of the coupon interest on the Government of India Securities (G-Sec) held against its capital, reserves and risk provisions as surplus transferable to Government. Further, the composition and size of RBI’s balance sheet is determined by public policy considerations and generates positive externalities of fostering monetary and financial stability.

The Committee has recommended a surplus distribution policy which targets not only the total economic capital (as per the extant framework) but also the realized equity level of the RBI’s capital. This will help bring about greater stability of surplus transfer to the Government, with the quantum of the latter depending on balance sheet dynamics as well as the risk equity positioning by the Central Board. There will be no transfer of unrealized valuation buffers and these will be used as risk buffers against market risks.

In view of the above recommendation, the excess realized equity as on June 30, 2018 ranges from ₹ 26,280 crores (at upper bound of CRB) to ₹ 62,456 crores (at lower bound of CRB). The excess realized equity as on June 30, 2019 will need to be determined on the basis of RBI’s finalized annual accounts for the financial year 2018-19 as well as the realized equity level decided upon by the RBI’s Central Board.

The Committee recommends the alignment of the financial year of RBI with the fiscal year of the Government for greater cohesiveness in various projections and publications brought out by RBI. Further, in the following years, interim dividend to the Government may be paid only under exceptional circumstances.

The Committee recommends that the framework may be periodically reviewed every five years. Nevertheless, if there is a significant change in the RBI’s risks and operating environment, an intermediate review may be considered.

The Reserve Bank of India (RBI) is one of the pioneers in the area of central bank capital, starting with the Subrahmanyam Group which submitted its report in early 1997. This was followed by the Thorat Committee in 2004 (recommendations of which were not accepted), the Malegam Committee in 2014 (recommendations of which were accepted) and the Economic Capital Framework (ECF) which was developed between 2014 - 2015 and operationalized by the RBI in 2015-16, so as to operate concurrently with the Malegam Committee’s recommendations which were valid for a three-year period, i.e. 2013-14 to 2015-16.

This periodic assessment indicates the importance that the Government of India (Government) and the RBI have placed on finding the right balance between the opportunity cost of central bank capital vis-à-vis the socio-economic cost and the negative externalities of having an undercapitalized central bank, making it imperative that a holistic and comprehensive perspective be taken based on what is in the best interest of the country as a whole.

Central bank capital and its role in monetary and financial stability: Central banks do not require capital to carry on operations, as being the managers of domestic liquidity, they can do so simply by printing currency/ creating liquidity. The Committee recognised that central banks require financial resilience to absorb the risks that arise from their operations and the delivery of their public policy mandate of buffering the economy from monetary shocks and financial stability headwinds (by virtue of them being the monetary authority as well as LoLR). Emerging Market and Developing Economy (EMDE) central banks have an additional role of managing external stability in the face of volatile capital flows, and the spillover effect of monetary policy changes by Advanced Economies (AE) central banks. The Committee is of the view that there is an important link between central banks’ financial resilience and its policy efficacy. A survey of international literature also reveals that this is the predominant view in the academia and the central banking community.

Existing economic capital framework which governs the RBI’s capital requirements and terms for the transfer of its surplus to the government is based on a conservative assessment of risk by the central bank and that a review of the

framework would result in excess capital being freed, which the RBI can then share with the government. The government believes that RBI is sitting on much higher reserves than it actually needs to tide over financial

emergencies that India may face. Some central banks around the world (like US and UK) keep 13% to 14% of their assets as a reserve compared to RBI’s 27% and some (like Russia) more than that. Economists in the past have argued for RBI releasing ‘extra’ capital that can be put to productive use by the government. The Malegam Committee estimated the excess (in 2013) at Rs 1.49 lakh crore.

Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalised RBI in January 1949, making the sovereign its “owner”. What the central bank does, therefore, is transfer the “surplus” — that is, the excess of income over expenditure — to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934.

RBI does not pay tax on its earnings or profits, as its statute provides exemption from paying income-tax or any other tax, including wealth tax.