About

What is the war chest and how does it get created?

War chest is unofficial moniker for the RBI capital reserves that are accumulated over time from various income sources of RBI.

Income accrues to the RBI from interest on its holdings of government securities, its overnight lending to commercial banks and the returns on its foreign currency assets. Under the expenditures head, its main outgo tends to be towards the cost of printing currency, agency commission paid to commercial banks to act on its behalf for government transactions, and the cost of employing over 17,000 staff.

Why does the RBI require it?

Out of the surplus, the RBI makes allocations to various statutory reserve funds. The controversy pertains to the policy for determining how much the RBI must maintain as statutory reserves.

The first reserve fund is meant mainly to absorb losses from its operations in money, securities and forex markets, and to absorb shocks arising out of variations in exchange rates and gold prices.

The second reserve fund is for meeting the RBI’s internal capital expenditure and investments in its subsidiaries and associated institutions.

The surplus after allocations to the reserves as per predefined formulae is transferred every year to the government.

As on June 30, 2018, the RBI had accumulated ?6.91 lakh crore in its currency and gold revaluation reserve, and ?2.32 lakh crore in its contingency reserve.

How much reserves are required by RBI?

The debate over the appropriate level of capital on the central bank’s balance sheet is an old one. The issue was raised up by former Chief Economic Adviser Arvind Subramanian, who argued the Indian central bank is overcapitalised.

Over time, many technical committees have examined the question of how much reserves the RBI ideally needs. Central banks can almost always discharge their financial obligations by simply creating new money if necessary, but large exposures and sustained losses can weaken their ability to conduct policy effectively.

The norms in place currently for maintaining reserves were evolved over a period of time, through deliberations between successive governments and the RBI, and were guided by the recommendations from various committees. The RBI’s contingency fund, for instance, has been reduced from 12 per cent of RBI’s assets to 6 per cent over the past 10 years. The RBI is working on a framework that will systematically assess its risk-buffer requirements to determine the transferable surpluses every year.

Learning Aid

Practise question:

Central bank’s reserves are a contingency reserve meant for urgent situation. Has NPA situation and Basel-III implementation targets created situation so contingent to use them. Examine.