In today’s Finshots, we tell you about a new tussle brewing between the RBI and the government.

But before we begin, if you’re someone who loves to keep tabs on what’s happening in the world of business and finance, then hit subscribe if you haven’t already. If you’re already a subscriber or you’re reading this on the app, you can just go ahead and read the story.

The Story

Exactly a year ago, we wrote about the Reserve Bank of India (RBI) transferring a record ₹2.1 lakh crores to the government. We told you where the money came from and why the RBI was even handing over such a chunky cheque to the government.

But in case you missed it, here’s a quick recap.

The RBI earns profits from its regular operations — things like lending to banks, trading government bonds and a little something called seigniorage. That’s just a fancy word for the difference between the face value of money (like ₹100) and what it costs to actually print it. So if it costs ₹3 to print a ₹100 note, the RBI technically pockets ₹97 as profit.

Now, before it hands over any money to the government, the RBI keeps a portion of these profits aside. This is called the Contingency Risk Buffer (CRB). It’s like a rainy day fund for the RBI. This buffer helps cover potential hits like bad loans, falling asset values, staff costs or surprise economic shocks. Only what’s left over or the surplus, gets transferred to the government as a dividend. And the government, in turn, uses that money on improving infrastructure, health, education, etc. … just like it uses our tax money.

But there’s a bit of a tug of war going on again between the RBI and the government.

The RBI has been reviewing something called the Economic Capital Framework (ECF). It’s the formula it uses to decide how much money to keep and how much to give the government. And while doing that, it’s seeking approval to expand the CRB’s range.

Right now, it sits between 5.5–6.5% of the RBI’s balance sheet. This range was recommended by the Bimal Jalan committee back in 2019. But the RBI is proposing to stretch that to 5.5–7.5%.

Now, that matters because a bigger buffer means a smaller dividend. So the more the RBI keeps for itself, the less the government gets. And that’s not something the government’s Finance Ministry is thrilled about. It’s conducting its own review of the ECF, probably with an eye on squeezing out a higher dividend from the RBI.

So yeah, both sides seem to be pulling in different directions. The RBI wants to keep more. The government wants more handed over.

So how do we solve this problem, you ask?

Well, let’s be honest. It’s not for us to solve. That decision lies with the RBI, which will sit down with the government and take a call when its board meets on Friday (May 23rd). But we can certainly try to understand whether the RBI needs to maintain a higher CRB or not.

Let’s start by looking at it from the RBI’s point of view and talking about liquidity or the amount of money floating around in the banking system. When banks have more liquidity, they can lend, invest or meet payment obligations easily.

If the RBI raises the CRB, it keeps more of its profits and gives less to the government. That means the government has less cash in hand and may need to borrow more to fund its spending. When the government borrows, it may issue bonds for example. And that pulls money out of the system. In short, liquidity tightens.

But if the RBI lowers the CRB, it transfers more to the government. More money in government hands means more spending and more liquidity in the economy.

Now if you look at what’s happening today, you’ll notice that bond yields, or the interest rates the government pays on the bonds it issues, have been falling. That’s partly because people expect the RBI to hand over a hefty dividend again. If the government receives more money, it won’t need to borrow or issue bonds as much. And fewer bonds in the market means higher demand for the ones that do exist, which pushes bond prices up and yields down. And if you’ve read Finshots enough, you know by now that bond prices and yields move in opposite directions.

And there’s something else. Consumer price inflation is easing. That tells markets that the RBI is less likely to hike interest rates, and might even cut them later. So investors are rushing to lock in the current bond yields before they fall further. Again, more demand, higher prices, lower yields.

Put both together, and you have bond yields drifting downwards.

Now here’s the catch. If the RBI really does transfer a large dividend by keeping the CRB low, it could flood the system with even more liquidity — possibly over ₹6 lakh crores. That kind of excess cash could overheat the economy and even stoke inflation.

So the RBI may want to tweak its liquidity management tools. Maybe mop up some of that surplus money. Or simply keep the dividend in check by sticking with a higher CRB.

There’s also another angle — internal risk assessments. The RBI’s push to expand the CRB range likely reflects a cautious outlook. Maybe it’s spotting vulnerabilities and wants to bulk up its rainy day fund. And sometimes, central banks don’t speak. They signal. If the RBI boosts its CRB, it’s like saying, “We think things might get risky out there. We’re preparing for trouble.” Banks hear this and may respond by behaving more cautiously themselves, such as lending more carefully or keeping extra capital aside. It’s the classic signalling effect.

We saw something similar earlier this year with the IndusInd Bank fiasco. The bank had to take a ₹1,300 crore hit after the RBI flagged some wrongly classified derivatives. If other banks have similar risk exposures, the RBI might just be bracing for more shoes to drop.

And here’s the thing. Even with a higher CRB, the government might still get a sizeable payout. Last year, despite the RBI raising the CRB range to 5.5–6.5%, it still paid a record dividend. And this year, even if the CRB is pushed up to 7.5%, the government could receive around ₹2.5 lakh crores. If the CRB remains unchanged, that could go up to ₹3.5 lakh crores.

Which brings us to the government’s side of the story.

From its lens, that extra ₹1 lakh crore could be a big deal. And it’s not hard to guess why. The geopolitical situation isn’t exactly calm and quiet. With rising tensions with Pakistan, it may feel the need to ramp up spending on defence. That could mean more allocation for research, development, procurement of weapons, ammunition and other critical military infrastructure. And that’s on top of the already massive ₹7 lakh crore defence budget, which, by the way, is 13% of the entire Union Budget and the highest among all ministries.

So from the government’s perspective, every extra rupee from the RBI helps.

It could also argue that the RBI doesn’t need to be that cautious. If the actual risks the central bank is guarding against fall closer to the lower end of the recommended buffer range, then keeping provisions at the upper end might just be a bit too much. After all, isn’t holding on to more than necessary just locking away useful funds that could be put to better use?

And maybe it has a point.

Raising the CRB could backfire too. If the RBI transfers less money, the government may need to borrow more to meet its spending plans. And when liquidity tightens, banks start feeling the pressure to meet growth targets. That’s when they might begin lending more aggressively, even to riskier borrowers, just to keep things moving.

And that’s not great news for banks or the economy. It could lead to more bad loans and bloated balance sheets — something no one wants to see again.

So yeah, there’s a lot to think through. What happens on Friday will tell us which way the scale tips.

Until then...

Don’t forget to share this story on WhatsApp, LinkedIn and X.

75% of Indians are NOT covered by Life Insurance!

Don’t be a part of the herd — take the first step and lead the way.

A term life insurance plan offers a crucial safety net for your loved ones, ensuring they’ll be financially supported even in your absence.

Book a FREE call with Ditto to learn more about term life insurance and find the best plan for you and your family.