What is More Desirable from a Central Bank – Surplus or Strength?

Last week, the Reserve Bank of India published its Annual Report for 2025-26. The RBI Annual Report is not just the annual accounts of the central bank of the country. It is a mirror for the state of the economy. Paradoxically, periods of economic stress can sometimes result in higher central bank surpluses, particularly when exchange-rate movements and interest-rate dynamics boost earnings.

As a precursor to the annual report, on May 22, 2026, the RBI Board passed the RBI’s annual accounts for 2025-26. The RBI, in its press release at the time, stated that its gross income increased by 26.42% over that of 2024-25. The net income, before risk provision and transfer to statutory funds, was ₹3.96 trillion in 2025-26 as against ₹3.13 trillion in 2024-25. It also said that the balance sheet of the RBI had expanded by 20.61%. And lastly, it said the RBI transferred a surplus of ₹2.87 trillion to the government after providing for Risk Buffer Capital of ₹1.09 trillion for 2025-26.

The government and the markets were jubilant on hearing this number. The larger question, however, is whether a central bank should focus on generating ever-higher surpluses or on strengthening its own balance sheet.

Conventional Wisdom
Transfer of surplus has been a bone of contention between the government and the RBI for some years now. As the owner of the central bank, the government is well-justified in asking for the surplus, since the central bank does not operate its policies for profit. So whatever it needs to spend to carry out its functions, the balance or the surplus should be returned to the government because it belongs to the government. However, to carry out its functions fearlessly and in the interest of the economy, the central bank needs a strong capital base.

While there is no consensus on how much capital a central bank should hold, a 2019 CAFRAL study found that “the RBI at 6.60% is 5% under-capitalised relative to the emerging economy average” and that “the RBI core capital should be above 16%”. The rationale is straightforward. Central banks can and do suffer operating losses. As the study notes, “over one in every seven central banks suffer operating losses in any given year, with the average loss amounting to 50% of core capital.”

The Economic Capital Framework, a transparent rule that was worked out by the Bimal Jalan Committee in 2018 so that the RBI could provide for a comfortable level of risk buffer before transferring the surplus to the government, provided flexibility to the RBI to provide economic capital for total non-valuation risks in the range of 5.5-6.5%. Subsequently, a more recent internal committee, while reviewing the framework as recommended by the Bimal Jalan Committee, widened the range to 4.5% and 7.5%.

The RBI provided for the risk buffer at the rate of 5.5% between 2018-19 and 2021-22 due to the COVID-19 pandemic. In 2023, it was 6.0%, and in 2024, 6.5%. It wisely raised the level to 7.5% in 2025. It was, however, again brought down to 6.5% in 2025-26. The RBI annual report does not explain the reason for the lower provisioning rate. The rupee depreciation was perhaps the culprit behind this drop. But instead of recapitalising the Contingent Risk Buffer and maintaining it at 7.5%, the central bank chose to reduce the buffer to 6.5% and transfer a larger surplus to the government.

The reason behind this is easy to guess. The government had budgeted for ₹3.16 trillion as dividends from the RBI, public sector banks and other financial institutions in its 2026-27 Budget. The surplus transferred to the government, in fact, has steadily increased year after year. From ₹303.07 billion in 2021-22 to ₹2.87 trillion in 2025-26. And given the state of our economy, the surplus will keep rising, at least in the near future.

But think of a year when the economy really does well, and the government, which is habituated to getting a hefty sum from the central bank every year, and even budgets for a large surplus, would suddenly be faced with a drastic fall on the receipts side of the budget. In other words, transferring a lower surplus will not only create bad blood between the government and the RBI but will also bring undue pressure on the central bank to transfer a larger sum to the government, even at the cost of lower or no transfers to the risk buffer fund.

Creating a Reserve Fund
To avoid such a situation, the RBI and the government can consider creating a Reserve Fund just for smoothening out the surplus transfer issue, and the government would get a steady amount of surplus from the RBI. The fund can be created from the same pool of surplus generated by the RBI.

To begin with, the government and the RBI can agree on a reasonable amount of surplus, with + or - 5%, to be transferred each year by the RBI. Any surplus over and above the agreed amount would be credited to the Reserve Fund. In the same vein, the central bank can draw from the Reserve Fund to give the agreed amount of surplus to the government in the year in which it does not generate enough surplus. Commercial banks are known to create similar funds to smooth out returns or dividends on customer investments.

In the context of the RBI, however, the RBI Act will need to be examined to see if such a fund can be created in addition to the existing funds.

It's good to strengthen the balance sheet of the central bank by building up reserves while the going is good. In bad times, one can fall back on it. It is wise for the economy to have a central bank that has a strong balance sheet, strong not in terms of earning higher profits, but intrinsically strong, having healthy reserves and high capital. Sadly, the euphoria of the market is too shrill when the RBI transfers higher surpluses, and such advice falls on deaf ears.