28-05-2025
New capital framework gives RBI more room to handle its finances
The
Reserve Bank of India
(RBI) has taken a step to strengthen its financial resilience by revising its
Economic Capital Framework
(ECF) and risk provisioning norms. Approved by the
RBI
's central board on May 15, 2025, these changes are designed to balance the central bank's need for robust financial buffers amid rising global uncertainties, while continuing to support the government's fiscal health through surplus transfers.
Rozebud Gonsalves
explains the ECF, why it is important, and its broader economic impact.
What is the ECF and why is it important?
The ECF is a structured mechanism implemented by the RBI to assess and determine the optimal level of risk provisions that the central bank needs to maintain. These provisions are made from the net revenue generated by the RBI through its daily operations. With this framework, the RBI arrives at its surplus earnings for the year that can be allocated as a dividend to the government of India.
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The ECF was recommended by the
Bimal Jalan Committee
, chaired by former Reserve Bank of India governor Bimal Jalan, and was formally adopted in 2019.
How does the RBI transfer its surplus income to the government?
The ECF balances the need to maintain adequate financial buffers to ensure monetary and financial stability amidst global and geopolitical uncertainties with the goal of prudent surplus distribution. After making necessary adjustments for various provisions, asset revaluations, and risk buffers, the RBI transfers the residual income as surplus to the central government.
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What are the major changes in the latest revision?
During its meeting held in mid-May 2025, the RBI's central board of directors reviewed and revised key components of the ECF.
Monetary and financial stability risk buffer: The buffer range was expanded from 4.5-5.5% to 3.5-6.5% of the RBI's balance sheet size. Contingency risk buffer: The fixed buffer of 6.5% was replaced with a flexible range of 6% ± 1.5% (4.5% to 7.5%) of balance sheet size.
What is the impact of the ECF on government finances?
The revision of the framework is important as it affects a key source of income for the central government. When the RBI declares a dividend, it transfers a portion of its surplus profits to the central government, thereby directly increasing the government's income. The government can use this additional income either for increased spending or to reduce its borrowings, which in turn helps lower the fiscal deficit. The changes in buffers, while giving flexibility to the RBI, also increase the chances of a higher dividend transfer to the government.
What does the new framework mean for the RBI?
The ECF helps the RBI to strike a balance between retaining sufficient capital for financial stability and meeting the government's expectations for surplus transfers. The higher risk buffers ensure that the RBI has sufficient capital to absorb financial and market risks, especially during economic or external shocks, and only the surplus beyond these buffers is eligible for transfer to the government. It bolsters the central bank's credibility, autonomy, and ability to support the economy in times of stress. The prudent capital management framework allows the central bank to respond effectively to global and domestic economic uncertainties.
How does the global economic environment impact a central bank's balance sheet?
The global macroeconomic environment affects a central bank's balance sheet through changes in interest rates, capital flows, exchange rate volatility, inflation trends, and financial market stability. In response, central banks adjust their asset holdings, reserve levels, and liquidity operations, leading to expansion or contraction of their balance sheets.
