AUTONOMY & INDEPENDENCE OF RBI

12th Feb 2018 Circular- On stressed assets

The loan is taken by the company on its assets from the bank. When the
asset is not performing because they become doubtful and NPAs (Non
performing Assets) from doubtful become bad loans.

Before the period of 90 days, they are called Stressed Assets. Stressed
assets= NPAs + restructured loans + Written off Assets.

Types:-

Sub-standard Assets-If borrower fails to repay the instalment, interest on

principal or principal for 90 days the loan becomes NPA and it is termed
as Special Mention Account (SMA). If it remains SMA for a period less
than or equal to 12 months it is termed as Substandard Assets.

Loss Assets-If the loan is not repaid even after it remains substandard for
more than three years it would be called as loss Asset.

Written Off Assets-Written off assets are those on which the bank or
lender doesn’t count the money borrower owes to it.

Case: Independent Power Producers Association of India v. UOI

- Government invoked Section 7 of the RBI Act.

- Government’s Argument- RBI has no authority to ensure a circular

where there is a public interest matter, without consulting the
government.
On 2nd April 2019 justice Nariman and Justice Saran delivered a
landmark judgement in the case of Darani Sugars and Chemical ltd vs
UOI which dealt with the pertinent issue of the controversial circular
issued by RBI on 12th February 2018 titled resolution of stressed assets
which instructed the lenders to take defaulting companies into
proceedings immediately after 180 days of default.

The RBI declared that banks shall not waste any time when it comes to
referring to accounts with more than 2000 crores to the IBC regime, if
they are not resolved within 180 days. The circular also laid down that
the bank would have to disclose defaults if the interest repayment was
defaulted even by a single day and immediately plan a resolution.
Additionally all previous schemes laid down by RBI were abolished by
the circular.

The circular led to panic and confusion by various power and energy
firms who immediately sought for some relaxation from RBI. The circular
was challenged by the Association of Power Producers and Independent
Power Producers Association of India who argued that the circular clearly
suffers from non-application of mind and thus not draw crucial
distinctions between various types of trust assets from different industrial
sectors. It was also contended that the circular fails to distinguish between
genuine and wilful defaulters.

In August 2018 the Allahabad HC refused to grant interim relief in the

case of Independent Power Producers Association v. Union of India and
the court went ahead to direct the central government to consider the
initiation of a consultative process envisaged under s.7 of the RBI act
1934.
When the matter went up to the Supreme Court it observed that the
banking regulation amendment 2017 which introduced section 35AA
and 35AB is constitutional in nature but the RBI while issuing
directions to banks can act only within the tenets laid down by central
government. This means that RBIs power can only be exercised after
specific authorisation by the central government. The SC invalidated
the entire circular and essentially stated that the circular will have no
effect in law. It is believed by the experts that from a regulatory point
of view the judgement certainly dilutes the power of India’s banking
regulators as it is restricted to the authorisation received by the Central
government.

The battle between the government and the RBI has raised important
legal and policy issues with respect to the scope of Section 7 of RBI Act
and the impact of issuing such unprecedented directions on the
autonomy of the RBI.

The various issues for discussion can be as follows-

1. Why is there a need for a Central Bank?

2. Is the Central Bank Independent?
3. What do we understand by independence of regulators?
4. What is the difference between consultation and expression of
views?
5. What is a democratice system? Who is ultimately responsible? (In a
democratic system who is ultimately responsible?)
Answer to Issue 1 and 2-

 The proposal for establishment of the central bank of India was first
made by the Royal Commission on Indian Currency and Hilton
Young commission in 1926. Prior to this
 The Imperial Bank of India, (the predecessor of State Bank of India)
functioned as the quasi central bank. The need for a central bank
was reemphasised by Indian Central Banking Enquiry committee in
1931. The RBI was established under the RBI act 1934 similar to the
Federal Reserve Bank of USA. The RBI was initially a privately
owned bank with its share capital owned by Private Shareholders.
The justification for such establishment of RBI was explained by
George Susher the finance member of the legislative committee that
the experience of all the other countries shows that when the
direction of public finance is in the hands of ministry responsible to
a popularly elected legislature it will be liable to frequent change
with changing political situations.
 Therefore, it is desirable that the control of currency and the credit
in the country should be in the hands of independent authority
which can act with continuity. It is therefore practical to set up a
central bank independent of political influence. The RBI acts as
originally enacted did not contain a provision permitting the
government to issue directions to RBI. After independence the
 government passed the transfer of Public Ownership Act 1948 and
took over RBI from private shareholders.
 The proposal for nationalisation of RBI was based on the belief that
monetary organization of the country should be a national concern
and cannot be left in private hands. Government introduced Section
7 of the RBI act empowering the central government to issue
directions to RBI influenced by Section 4 of Bank of England Act,
1946 and Section 9 of Commonwealth Bank of Australia Act, 1945
but both the Acts curtails the government's powers to issue
direction to central bank in relation to monetary policies and crucial
banking functions while our act allows for the same.

Issues-

3. What do we understand by independence of regulators?

4. What is the difference between consultation and expression of views?

Answer to Issue 3&4-

 The principle rationale for making the central bank independent

was to enhance the credibility of monetary policy. The main
argument being that in restoring economic stability and growth, the
government usually takes a backseat due to political pressure and
power.
 Therefore, a distinction has to be made between independence and
accountability. Independence does not mean that monetary policy
actions should be free from public discussions and criticism.
 An independent Central bank cannot remain completely divorced
from government policies and objectives nor can it be unanswerable
to any authority. The independence of Central Bank would only
imply insulation from political interest i.e., independence within the
government rather than independence from the government.
 The manifest legislative intent of Section 7 of the RBI Act states that
once a direction is issued by the government the directions must be
complied by the RBI. Perhaps taking into account the importance of
ensuring independence of RBI, Section 7 also prescribes multiple
levels of checks and balances to prevent any misuse of this
provision.
 Section 7 mandates that the direction can be only issued in public
interest and after consultation with the governor of RBI. It is seen
that in almost all cases, the government has reserved itself an
overriding authority to issue directions to regulators.
 Example- Section 16 of the SEBI Act, Section 15(5) of the
Competition Act, Section 83 of the RERA Act, Section 18 of IRDA,
etc.
 However, a significant distinction between RBI and other regulators
is that the RBI Act mandates consultation whereas the other
legislations only provide the regulators to express their views
before the issuance of any direction. The language used in the RBI
Act appears to give a stronger protection to RBI against any
overriding direction.
  The word ‘consultation’ has come up for judicial interpretation on
number of occasions with vastly differing views being expressed.

Cases-

1. Union of India v Sakalchand Seth

- SC understood consultation to be in nature of an informed

deliberation.

2. State of J&K vs AK Zakki

- It was recognised that consultation does not mean concurrence, but it

cannot be said to be complete till both sides make their points known
to each other.

3. SC Advocates on Record Association vs Union of India

- Consultation was understood as seeking opinion, advice, aid,

information and instruction.

Issue 5- What is a democratice system? Who is ultimately responsible? (In

a democratic system who is ultimately responsible?)

Answer to Issue 5-

 Article 325 and 326 of the Constitution of India recognises the right
of every citizen to vote and therefore, be duly represented in the
governance of the nation. In terms of Article 74 of the Constitution,
 the executive functions are also placed in the hands of the elected
government.
 Though a part of sovereignty delegated by the people to the elected
government relating to the monetary policy of a country has been
assigned to the RBI, the power to direct the monetary affairs of the
country ultimately vests with the elective representative of the
people and it is for this reason that Section 7 of the RBI Act was
introduced to permit the elected government to issue directions to
RBI where it feels necessary.
 However, as observed by the Court, the power under Section 7 is
not an unfettered power and cannot be exercised unreasonably or
arbitrarily. The Court can take action as a check against government
excess directions if any condition under Section 7 is violated.