Q and A

1. (A) WHAT WAS THE POLICY OBJECTIVE BEHIND INTRODUCING NON-BANKING

FINANCIAL COMPANIES (NBFCS) INTO THE INDIAN CREDIT AND FINANCE SYSTEM?
(B) WHAT ROLE DO NBFCS PLAY IN THE CREDIT AND FINANCIAL SYSTEM?
(C) WHAT IS THE LEGAL AND STATUTORY BASIS FOR ESTABLISHMENT OF NBFCS?
(D) A NUMBER OF NOTEWORTHY FAILURES OF WELL-KNOWN NBFCS HAVE BEEN

REPORTED IN THE NEWS MEDIA RECENTLY – IN YOUR VIEW, IS THERE ANY ASPECT(S) OF

THE LEGAL & REGULATORY FRAMEWORK FOR NBFCS THAT IS CONTRIBUTING TO THIS?
EXPLAIN BRIEFLY

A) NBFC’s were initially started in the 1960s an alternative for individuals whose
financial needs were not sufficiently met by the existing banking system. They have
been in use in several jurisdictions for decades and their benefits were undeniable, and
complimentary to the existing banking system. Since these intermediaries have lower
transaction costs and are relatively free from regulatory encumbrances, they would be
an attractive option for a developing economy like ours1. Not only would they provide
financial services to inaccessible areas, they would also complement and substitute
banks in situations where regulatory constraints prevented them from rendering
certain services2. Thus, apart from acting as backup institutions, they were also seen
to have the potential to widen the scope of provision of financial services.

B) NBFCs provide financial services to the Micro, Small, and Medium Enterprises
(MSMEs), as well as act as a stimulus for transportation, employment generation,
wealth creation, bank credit in rural segments and to support financially weaker
sections of the society. They transcend the scope of meeting the needs of the
corporate sector, by extending credit to the unorganized sector and to small local
borrowers (which would generally not be eligible for bank loans), whilst remaining
within the bounds of Indian Banking regulations. NBFC services are not extended to
agricultural or industrial activity, or for transactions of immovable property.
However, they do provide business related loans, as well as advances for acquisition
of stock and securities.
1
RBI Docs, Non-Banking Finance Companies in India’s Financial Landscape, available at:
https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/01AR101017F2969F6115EB4B5992BD73976F9A905D.PDF
2
Id.
 C) NBFCs are governed by Chapter III-B of the Indian Finance Act, 1934 3. All NBFCs
(with the exception of Housing Finance Companies) fall under the ambit of the
Reserve Bank of India (RBI). Registration of an NBFC with the RBI has been made
mandatory by the RBI (Amendment) act 1997, which also provide for an entry point
norm of INR 2,00,00,000 (Indian rupee two crores) as the minimum net owned fund
(NOF).4 NBFCs are mandated to maintain an investment between 5-25% in
unencumbered approved securities5, 15% of their deposit in liquid assets, and even a
reserve fund comprising of 20% of net profits, annually6. NBFCs are prohibited from
accepting deposits payable on demand, and cannot exceed the government enforced
ceiling for the quantum of public funds as well as the rate of interest. Moreover, all
NBFCs holding or accepting public deposits have to adhere to the prudential norms
(such as capital adequacy of 8%), and also have to submit periodical returns to RBI at
quarterly, half yearly and annual intervals. The RBI is the governing institution and
has the authority to create policies, inspect and even penalize NBFCs for non-
compliance.

D) The decline of NBFCs in India can be attributed to a single starting point- The IL&FS
scandal of 2018. Major mutual funds in India were financing IL&FC and once the
scam was exposed all the money had to be repaid. As a result a slow rate of growth
was seen towards the end of 2018. The liquidity crisis that followed ended up being
prolonged due to lack of inaction by the government. In 2019 the election happened,
followed by the Kashmir issue. All that was done by the RBI was to reduce the rates
of interest7. This was followed by the RBI’s second edition of targeted long-term repo
operation, which was also an insufficient measure, considering the lack of fiscal
stimulus8.

3
Indian Finance Act, 1934 https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIA1934170510.PDF
4
RBI (Amendment) Act 1997, https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=9481; section 45-IA (1),
Indian Finance Act, 1934 https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIA1934170510.PDF.
5
section 45-IB (1), Indian Finance Act, 1934
https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIA1934170510.PD
6
Box 6.2, RBI (Amendment) Act 1997, https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=9481
7
https://www.businesstoday.in/opinion/columns/nbfc-crisis-domino-effect-on-indian-economy-ilfs-scam-gdp-
growth/story/378109.html
8
https://www.livemint.com/market/stock-market-news/nbfc-stocks-fall-after-tepid-response-to-tltro-2-0-
11587701773183.html
2. WHAT DOES THE TERM “NEGOTIABLE” MEAN IN THE CONTEXT OF THE NEGOTIABLE
INSTRUMENTS ACT, 1881 AND WHAT ARE THE KEY FEATURES OF A NEGOTIABLE
INSTRUMENT?

Negotiable Instruments in India are governed by the Negotiable Instruments Act, 1881.
According to section 13 of Negotiable Instruments Act, 1881- A 'negotiable instrument'
means a promissory note, bill of exchange or cheque payable either to order or to bearer. The
term “negotiable” refers to the fact that the note in question can be transferred or assigned to
another party9, i.e. transfer of title and not mere possession. It thus creates the pre-condition
for negotiability, that the instrument has to be freely transferable and obtained without any
defects in title (i.e. entirely in one’s own name) 10. And despite the three instruments
predefined in the Act (Cheque, Bill of Exchange and Promissory Note), the ambit of a
negotiable instrument isn’t restricted and can be extended to other instruments, subject to the
aforementioned condition. Share warrants payable to bearer are a negotiable instrument,
despite not being included in the definition clause 11. Similarly, debentures payable to bearer
have been held to be a negotiable instrument 12. Moreover, dividend warrant is also stated to
be a negotiable instrument.

Key features of a negotiable instrument:

a) Full title to transferee: The transferee (known as holder in due course) has a title
which is free from defects, as long as it was a bonafide transfer. The holder of a
bonafide transfer will acquire good title, even if the previous holder had a defect in
title.
b) Property: The negotiable instrument, when transferred, doesn’t merely give
possession of the instrument but also of the property contained within. The holder of
the instrument is presumed to have title to the property as well. Since it’s a negotiable
instrument, property is transferred without any formality. In bearer instrument,
property is transferred by mere delivery. In the case of an order instrument,
endorsement and delivery are required for the transfer of property.

9
https://www.investopedia.com/terms/n/negotiable-instrument.asp
10
Dr. SS Kundu, Principles of Insurance and Banking http://www.ddegjust.ac.in/studymaterial/mcom/mc-207-
f.pdf
11
Section 114, Indian Companies Act, 2013.
12
The Mercantile Bank Of India vs A.J. Mascarenhas on 26 March, 1928
 c) Transfer: A negotiable instrument can be transferred endlessly. There is no limit as to
the number of times it can be transferred. However, it can only be transferred until its
maturity.
d) Right to sue: In the event of a dishonour, the transferee can sue in his own name.
Since the transferee receives it free from encumbrances, he can exert his title. There is
also no requirement of a notice of transfer to the debtor.

3. BRIEFLY DISCUSS THE EVOLUTION OF THE LEGAL AND STATUTORY FRAMEWORK FOR

DEBT RECOVERY AND DEBT ENFORCEMENT (INCLUDING INSOLVENCY) FROM THE

SCENARIO PRE-1993 TO THE CURRENT DAY – INCLUDE IN YOUR ANSWER (AT LEAST) ONE

DISTINGUISHING FEATURE OF EACH OF THE STATUTES PASSED FROM 1993 ONWARDS.

The relevant legislations in relation to debt recovery and debt instruments are: the
‘Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 (SARFAESI)’, ‘Recovery of Debt Due to Banks and Financial Institutions Act,
1993 (DRT Act)’, ‘Sick Industrial Companies Act, 1985’, and ‘Insolvency and Bankruptcy
Code, 2016’.
Prior to 1985, Companies Act 1956 was the only legislation governing matters of corporate
insolvency. Largely unchecked, and that too in an emerging economy, the problem low
investment and high financial distress was evident. Against the problem of widespread
sickness in companies, the Tiwari Committee was constituted in 1980, and as an outcome of
this, the Sick Industrial Companies Act (SICA) was passed in 1985 with the objective of
identifying “sickness” in industrial companies and reviving them. A single bench of Board of
Industrial and Financial Reconstruction (BIFR) and the Appellate Authority for Industrial and
Financial Reconstruction (AAIFR) were set up. As industry grew, it was realized that this
mechanism is insufficient to deal with the matters. More often than not, many of their orders
of winding up were reopened by High Courts, creating an excessive amount of delay.
After that, the Narsimham Committee in 1991 recommended setting up special tribunals for
speedy recoveries. This led to the enactment of Recovery of Debt due to Banks and Financial
Institutions Act, 1993 (RDDBFI, 1993). Under this legislation, Debt Recovery Tribunal
(DRT) and Debt Recovery Appellate Tribunal (DRAT) were set up. Prior to the enactment of
the RDDBFI Act, the normal remedy for recovery of debts was either to pursue a civil suit (as
per Civil Procedure Code under Order XXXVII) or to file a suit for foreclosure (as per
Transfer of Property Act). However, DRTs and DRATs were set up with the main purpose to
ensure expeditious recovery of debt from the defaulters and were empowered to order
recovery through sale or even imprisonment of the defaulter. However, due to inefficiencies
in procedure and resources, it was found that there wasn’t much progress that had been made.

In 1998, the Narsimham Committee - II was made along with the Adhyarujana Committee to
examine the necessary reforms in the banking sector. It was suggested to enact a legislation
that allowed for securitization and allowing banks to posess and sell securities, without
involving the court at all. Based on these, The Securitization & Reconstruction of Financial
Assets & Enforcement of Security Interest Act, 2002 (SARFAESI) was passed. The Act
empowered banks and financial institutions to recover against secured debtors, this was an
alternate route of recovery, one which allowed banks to possess the security without
intervention of the court. Subsequently, a downward trend in number of new cases was seen.
However, the benefits did not last long, and even worsened over time. SARFAESI only
empowered a limited set of creditors, i.e banks. Moreover, actions under SARFAESI took
precedence over the BIFR High Court proceedings, which led to misuse of SARFAESI to
delay in rehabilitation under SICA and winding up under Companies Act.
Following this, the Insolvency and Bankruptcy Code was passed in 2016 to include
insolvency resolution of entities other thank banks, like corporate persons, partnership firms
and individuals. IBC created a new mechanism for the recovery and liquidation process, one
which was clearly defined and more organized. The resolution process (CIRP) involves filing
an application before the NCLT, formulating a committee of creditors, appointing resolution
professional and finally formulating a resolution plan or liquidating.

SECTION 2

1. WHAT ARE THE KEY PRINCIPLES OF THE BASEL NORMS, WHICH WERE FIRST

INTRODUCED VIDE BASEL II, AND THEN ENHANCED AND EXPANDED UNDER BASEL III?
PROVIDE A BRIEF OVERVIEW.

Basel II were a refined version of the initial Basel norms, which only focused on credit risk.
This was partial in nature, as it ignored market and operational risks. Basel II, was more
comprehensive since it was centered around 3 parameters – minimum capital requirements,
supervisory mechanisms and transparency, and market discipline. Banks were mandated to
maintain a minimum capital adequacy of 8%, to develop better mechanisms to measure
credit, operational, and market risk, and to adhere to disclosure requirements, CAR, risk
exposure, etc. to the central bank.
Basel III norms were introduced in 201013. They aimed to prevent ‘2008’ by rectifying the
root causes, such as poor corporate governance and liquidity management, over-levered
capital structures due to lack of regulatory restrictions, and misaligned incentives in Basel I
and II. They focused on four vital banking parameters viz. capital, leverage, funding and
liquidity and laid down mandatory ratio requirements.

2. WHAT WAS THE REASON FOR THE LEGISLATURE TO AMEND THE NEGOTIABLE
INSTRUMENTS ACT, 1881, IN 1988 WITH THE INSERTION OF CHAPTER XVII (WHICH
INCLUDES SECTION 138)? WHAT IS THE DIFFERENCE BETWEEN SECTION 138 AND OTHER
CRIMINAL LAW PROVISIONS UNDER THE INDIAN LEGAL FRAMEWORK?

Section 138 is the principal section dealing with punishment for dishonor of cheques. It is a
non-cognizable offence and allows for punishment of defaulter, imprisonment up to 2 years
or fine twice the amount of the cheque. It was recognized as a special provision which
imposed strict liability14.
The main difference between section 138 and other criminal law provisions is that the offence
of dishonor is not a natural crime (ex. Murder), it is an offence based on legal fiction where
civil liability was transformed into criminal liability. It’s a petty offense which is civil in
nature since it is a wrong against another individual. It does not fit the basic definition of a
crime, which is wrongs against society at large. The legislature wanted to criminalize such
dishonor to ensure that the drawer honors his cheques out of fear of criminal prosecution. The
sole objective of criminalizing it was boost credibility and thereby, usage of cheques

3. CONSIDER THE MASTER DIRECTION - EXTERNAL COMMERCIAL BORROWINGS, TRADE

CREDITS AND STRUCTURED OBLIGATIONS ISSUED BY THE RESERVE BANK OF INDIA (I.E.,
THE ‘ECB POLICY’), WHICH IS REQUIRED TO BE COMPLIED WITH FOR ANY LENDING BY

NON-RESIDENT LENDERS TO RESIDENT INDIAN CORPORATE BORROWERS – NOTE THAT

THIS IS A SET OF REGULATIONS ISSUED BY THE RBI AND NOT A LAW PASSED BY THE

INDIAN PARLIAMENT. WHAT GIVES THESE REGULATIONS (I.E., THE ECB POLICY) THE

13
They were to be implemented in India in March 2020, However in light of the coronavirus pandemic, the RBI
decided to defer the implementation of Basel norms by further 6 months.
14
Dalmia Cement (Bharat) Ltd. V Galaxy Traders and Agencies Ltd (2001) 6 SCC 463
FORCE OF LAW, DESPITE IT BEING THE RBI (AND NOT THE LEGISLATURE) THAT ISSUES

SUCH POLICY?

RBI regulations are given the force of law because they are delegated legislations. While
there is no explicit provision for it, Article 312 of the Constitution has been interpreted to
include it. Our legislature is empowered to delegate its legislative powers in favor of another
authority by way of a primary legislation, which enables the authority to make laws in order
to implement and administer the requirements of that primary legislation. The laws thus
made, are made a by a person or entity other than the legislature, but have the same treatment
as any other law passed by the legislature. In the present case, the parent regulation is the RBI
Act, 1934 passed by the legislature. Section 58 of the Act empowers the RBI to make to
make regulations, and the regulations thus made are a part of our body of laws.

4. WHAT WERE THE KEY REASONS FOR THE INDIAN LEGISLATURE TO PROMULGATE THE

BANKING REGULATION ACT, 1949?

The Banking Regulation Act, 1949 was introduced to cover up the drawbacks of the Indian
Companies Act, 1913. The colonial legislation was exceptionally disorganized and led to
very poor level of development in the banking sector. Monopolization of capital was
prevalent, and it was due to the inadequacies of capital that caused many banks to collapse.
As a result, the government resolved to create legislation for proper governance of the
banking sector and the result was the enactment of the Banking Regulation Act, 1949
(initially the Banking Companies Act). It was enacted with the objectives to ensure balanced
growth and reduce competition among banks, by mandating minimum level of requirements.
The aim was to bring banks under RBI for regulation and management of banks for smooth
functioning. It was ultimately aimed at creating a specific legislation for banks and ensuring
proper safeguards for depositors.

5. BRIEFLY EXPLAIN THE ROLE AND FUNCTION OF THE RBI AS THE ‘LENDER OF LAST

RESORT’ WITH REFERENCE TO THE RELEVANT STATUTORY PROVISION FOR THE SAME.

RBI a banker to the banks, aside from being the regulatory authority, all banks maintain a
deposit ratio with the RBI and thereby need to maintain accounts. In the event of a liquidity
crisis, the RBI plays a vital role by extending credit to that bank when no other is willing to
do so. The bank (which is solvent) but has a temporary liquidity problem, is rescued by RBI
which supplies it with the requisite liquidity. The RBI undertakes this role to ensure the bank
survives and to also protect interests of depositors (i.e. public at large). Hence, by acting as a
guarantor for commercial banks, the RBI ensures stability in the banking sector, and thereby
in the economy. It therefore ensures stability in the market and that the banking system
doesn’t suffer.