QUESTION 5: Whether the dues of the State or its instrumentalities have priority over

the dues of secured creditors under SARFAESI 2002? Examine the position with the
help of decided case laws and relevant provisions under SARFAESI.

DUES of SECURED CREDITORS UNDER SARFAESI, 2002

[SARFAESI] Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest 2002

Preamble, SARFAESI Act of 2002 is “an act to regulate securitization and reconstruction
of financial assets and enforcement of security interests, and to provide for a central
database of security interests created on property rights, and for matters associated with or
incidental thereto.”

The act can be utilized to tackle the problem of Non-Performing Assets (NPAs) through
different procedures. However, this is possible only for secured loans. For unsecured loans,
banks should move the court to file a civil case of defaulting. The first asset reconstruction
company (ARC) of India, ARCIL, was set up under this act.

 Doctrine of priority of crown debt

 Chapter- IVA Inserted by Enforcement of Security Interest and Recovery of Debts
Laws and Miscellaneous Provisions (Amendment) Act, 2016. 
 Although, SARFAESI Act forms core of this answer, yet even in the DR&B Act,
Section 31b is worded similarly to Sec 26E of SARFAESI, 2002.

26E. Priority to secured creditors.—Notwithstanding anything contained in any other law for
the time being in force, after the registration of security interest, the debts due to any secured
creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other
rates payable to the Central Government or State Government or local authority.

Only exception is carved out in cases where proceedings have already been initiated under
the Insolvency and Bankruptcy Code 2016 against the borrower’s assets.

35. The provisions of this Act to override other laws.—The provisions of this Act shall have
effect, notwithstanding anything inconsistent therewith contained in any other law for the
time being in force or any instrument having effect by virtue of any such law.

37. Application of other laws not barred.—The provisions of this Act or the rules made
thereunder shall be in addition to, and not in derogation of, the Companies Act, 1956 (1 of
1956), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and
Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks and
Financial Institutions Act, 1993 (51 of 1993) or any other law for the time being in force.

Section 31B of the DR&B Act:

31B. Priority to Secured Creditors- “Notwithstanding anything contained in any other law

for the time being in force, the rights of secured creditors to realize secured debts due and
payable to them by sale of assets over which security interest is created, shall have priority
and shall be paid in priority over all other debts and government dues including revenues,
taxes, cesses and other rates due to the Central Government, State Government or local
authority.”

State Bank of India v. Jt. Director, Directorate of Enforcement, Kolkata.

On behalf of the Appellants it was contended that Secured Creditors have the priority over
the rights of the Central or State Government or any other local authority and that the
amendment to section 26E of SARFAESI and 31B of DR&B Act amendment had been
introduced to facilitate the rights of the Secured Creditors which were being hampered by
way of provisional attachment of the properties belonging to the Banks/Secured Creditors.
Reliance is placed on the Judgment dated 14.07.2017 passed by the Tribunal.

The Appellants had also referred to judgment of the Full Bench of the Madras High Court in
the case of The Assistant Commissioner (CT), Anna Salai-III Assessment Circle Vs. The
Indian Overseas Bank and Ors.,

“There is, thus, no doubt that the rights of a secured creditor to realise secured debts due
and payable by sale of assets over which security interest is created, would have priority
over all debts and Government dues including revenues, taxes, cesses and rates due to the
Central Government, State Government or Local Authority”. This section introduced in the
Central Act is with ''notwithstanding'' clause and has come into force from 01.09.2016.
Further it was also held that the law having now come into force, naturally it would govern
the rights of the parties in respect of even a lis pending.

Additional/ancillary provisions –

Secured creditor, secured debt, security interest

Section 2 (zd) “secured creditor”

Section 2 (ze) “secured debt” means a debt which is secured by any security interest;

Section 2 (zf) “security interest” means right, title or interest of any kind, other than those
specified in section 31, upon property created in favour of any secured creditor and includes
—

(i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind,
on tangible asset, retained by the secured creditor as an owner of the property, given on hire
or financial lease or conditional sale or under any other contract which secures the obligation
to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit
provided to enable the borrower to acquire the tangible asset; or

(ii) such right, title or interest in any intangible asset or assignment or licence of such
intangible asset which secures the obligation to pay any unpaid portion of the purchase price
of the intangible asset or the obligation incurred or any credit provided to enable the borrower
to acquire the intangible asset or licence of intangible asset;

Cases—

Bombay Stock Exchange v. V. S. Kandalgaokar [(2015) 2 SCC 1](“BSE Case”)

2
State Bank of India v. State of Maharashtra [(2020) SCC online Bom 4190] (“SBI
Case”)

EARC also relied upon the decision of the Hon’ble Supreme Court (“SC”) in the BSE case
and the decision of the BHC in the SBI case of  It was submitted that in both the
abovementioned judicial pronouncements, it was held that the Income Tax Act, 1961 (“IT
Act”) does not provide for paramountcy of income tax dues. It was further submitted that in
the SBI Case (supra), it was held that secured debt has priority over income tax dues and,
therefore, EARC as secured creditor has a prior superior charge over the income tax dues.

The BHC further observed that the SC while giving the decision in the BSE Case (supra) also
referred to its own decision in the case of Dena Bank v. Bhikhabhai Prabhudas Parekh &
Co. [(2000) 5 SCC 694],where it was held that Government dues have priority only over
unsecured debts. 

The BHC further assessed that in the SBI Case, the BHC also considered the question of
priority between the charge of a secured creditor and tax/VAT dues under the Maharashtra
Value Added Tax Act, 2002 and, after considering the provisions of SARFAESI Act as well
as RDDB Act, it was observed that the mortgage of a secured creditor gets prior charge over
the charge of the state for tax/VAT dues.

The BHC, with reference to the CBI Case (supra) relied on by the ITD, observed that the said
decision was distinguished in the SBI Case (supra) wherein, the SC stated that, since Section
26E of the SARFAESI Act and Section 31- B of the RDDB Act were not in the statue book at
the time of deciding the CBI Case (supra), the impact of the said sections did not come into
consideration. In light of the abovementioned case laws and provisions, the BHC was of the
view that EARC’s charge/mortgage over the Premises has priority over the dues of the ITD.

The section 31B of the Debts and Bankruptcy Act, 1993 came in force from 1st September
2016 and Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 came in force from 24th January 2020.

Following this reasoning given in Kalupur, Bombay High Court in SBI judgment has recently
ordered that even if Section 26-E was effective only prospectively from 24-1-2020 and thus
not applicable to the facts at hand as they were prior in time, that would not make any
difference; as Section 31-B itself would be sufficient to give priority to a secured creditor
over the statutory dues.

State of M.P. v. State Bank of Indore

M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, Income-Tax Department
and Others [2021]

Very Recently, the Bombay High Court (“BHC”) has in its judgement dated July 28, 2021,
held that, the secured debt shall take priority over the ‘Government’ dues/tax dues.

Hence, it is forthrightly clear the government dues do not take priority over dues of secured
creditors under the SARFASEI Act.

3
4
QUESTION 4: Examine the different remedies available to a secured creditor under
SARFAESI? How does “securitization” work with respect to non-performing assets?

ALTERNATIVE REMEDIES VESTED WITH SECURED CREDITOR UNDER

SARFAESI ACT, 2002

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests

Act 2002 [hereinafter SARFAESI Act]

was enacted with the intent to provide banks or financial institutions (FIs) to recover on
NPAs without intervention by the court. These financial institutions are those who have a
presence in India and are notified by the Government of India.

Its primary objective is to regulate securitization and reconstruction of financial assets and
enforcement of security interest created in favour of secured creditors. The Act provides for
three alternative methods for recovery of NPAs: (a) securitisation; (b) asset reconstruction;
and (c) enforcement of security without intervention of court. This includes either taking the
possession of the secured assets of the borrower (with the right to lease, assign or sell the
secured assets) or taking over the management or business of the borrowers until the
NPA is recovered. The SARFAESI Act also provides for the sale of financial assets by
banks and financial institutions to Asset Reconstruction Companies (ARCs). The financial
assets can be sold to ARCs in accordance with the guidelines and directions issued by the
RBI.

Thus, asset can be acquired only:

a. for the purpose of realization of the financial assistance; and

b. when the borrower is in default; but not otherwise.

Section 11

Where any disputes relating to securitization or reconstruction or non-payment of any amount

due including interest arises amongst any or the parties, namely, the bank, or financial
institution, or securitization company or reconstruction company or qualified institutional
buyer, such dispute shall be settled by conciliation or arbitration as provided in the
Arbitration and Conciliation Act, 1996, as if the parties to the dispute have consented in
writing for determination of such dispute by conciliation or arbitration and the provisions of
that Act shall apply accordingly

Under the SARFAESI Act, 2002, an exhaustive procedure has been laid down under the
SARFAESI Act, 2002 along with rules defining the manner in which banks may
exercise against the delinquent borrower to enforce the security interest in the asset.

5
* Invocation of Act for enforcement of security is triggered by classification of the account as
“Non- performing Asset” by the Banks and Financial Institutions referred to as the secured
creditors. In terms of the present Reserve Bank of India guidelines, in case any amount,
which is due and payable by the borrower and has not, been paid for more than ninety days,
the said account can be classified as NPA.

Section 13

Power to take possession

Upon classification of account of the secured creditor as non-performing asset, who defaults
in the payment of secured debt or any instalment thereof, the Bank or Financial Institution
gives a prior notice to the defaulting borrower including the mortgagors and guarantors under
section 13(2) calling upon them to pay the entire due amount within a period of sixty days.

The notice referred under section 13(2) shall give details of the amount payable by the
borrower and the secured assets intended to be enforced by the secured creditor in the event
of non-payment of secured debts by the borrower.

The authorized officer of the bank/secured creditor shall consider such representation or
objections and if after considering such representation or objection secured creditor comes to
the conclusion that such representation or objection is not acceptable or tenable, he shall
within fifteen days from the date of its receipt of such representation or objection the reasons
for non-acceptance it, to the borrower. This enables the Bank to correct itself if it is wrong in
the process of adjudication. Before this exercise is done and the borrower has been suitably
replied to, the secured creditors cannot take possession of the secured asset and management
of business of the borrower.

Section 13(4) makes provision for an alternate remedy in case the payment is not made
by the borrower in full within the stipulated 60 days time period mentioned in the notice
under section 13(2), the secured creditor may take one or more recourse mentioned in under
section 13(4) namely—

a. To take possession of the secured assets of the borrower including the right to transfer
by way of lease, assignment or sale for releasing the secured asset. When it comes to
taking possession of the property, there are two concepts- taking symbolic possession
& taking actual possession.
b. To take over the management of the business of the borrower including the right to
transfer by way of lease, assignment or sale for releasing the secured asset.
c. Appoint the manager, to manage the secured asset whose possession has been taken.
d. Requiring money from any person who has acquired any of the secured assets from
the borrower and from whom any money is due to the borrower, to pay to the secured
creditor, by notice in writing.

Under Section 13(4), after the accounts are being declared as NPA and the representation of
the borrower/guarantor is rejected, the secured creditor (i.e. bank or FI) can take recourse to
any of the measures specified therein to recover its outstanding debt. This includes taking
over “symbolic possession” of the mortgaged property; or taking over the management of the
business of the borrower, as mentioned thereunder. In continuum, Sections 13(5-A), (5-B)
and (5-C) encapsulate the mechanism of auctioning of the mortgaged immovable property to
3rd parties for the recovery of the outstanding dues. If the statutory scheme is being seen
6
holistically, then it clearly implies that taking over of symbolic possession followed by
auction of the mortgaged property is all part of the same proceedings as a series of steps
towards the larger objective of recovery of outstanding loan of the bank/FI. Section 13 is
wide enough to allow the creditor to resort to any type of measures of recovery, and this is
the distinctive feature of the SARFAESI Act, that it has vested the secured creditor with host
of powers for arm-twisting the borrower or the guarantor for expeditious realisation of the
outstanding borrowings.

Section 14

To apply under Section 14, a creditor has to establish that, on the date of making of such an
application, it is a secured creditor, in respect of a secured asset, and has a security interest, in
respect of such secured asset. After sale, the secured creditor can no longer claim a security
interest over such immovable property, as such security interest stands dissolved by the
issuance of the sale certificate. On the execution and registration of the deed of conveyance,
the title to the immovable property stands transferred to and vested with the purchaser and the
secured creditor does not retain any right, title or interest over and in respect of the
immovable property sold.

In Apex Electricals Ltd. v ICICI Bank Ltd it has been held by the Gujarat High Court, that
the rights of the bank under sub section (1), (2), (3) and (4) of section 13 cannot be read as
creating a lawless situation, but should and must be preserved by maintaining rule of law and
not allowing the disturbances of law and order situation. And such rights of secured creditor
cannot be read as giving authority or power to the secured creditor to apply force of muscle
power for taking measure under section 13(4) of the Act, and for such situation where muscle
power required secured creditor resort of the provisions of section 14 of the present Act.

Right to Appeal and consequent Right to file a caveat

Any person aggrieved on account of any measure taken under section 13(4) by the secured
creditor may make an application, along with requisite fees, to the Debt Recovery Tribunal
within forty five days from the date on which such measures has been taken

And if the Debt Recovery Tribunal finds the measures taken by the secured creditor under
section 13(4) in conformity with the provision of this Act, it may allow the secured creditor
to proceed with the measure taken by him. Aforesaid application must be disposed off as
expeditiously as possible within sixty days from the date of such application. However, it
may extend such period for reasons to be recorded in writing, for four months from the date
of the making of the application.

Section 17

 Proceeding to Section 17, it employs the phrase “any person aggrieved by any of the
measures under Section 13(4)”, which implies any and every action resorted to by the bank, it
is authorised to take recourse to under and in pursuance of Sections 13(4), 14, 15, so on and
so forth. The section does not clearly stop at providing remedy for the decision under Section
13(4), but transcends to include every such measure, which all are being undertaken by the
bank towards making its action under Section 13(4) fruitful and consequential.

Pertinently currently existing Section 17 had been amended recently by Act No. 44 of 2016,
wherein the previously available “right to appeal” or to “prefer an appeal” against the very
7
same set of measures by the creditor came to be substituted with the word “application”. The
reasons are not too far to seek for this intentful amendment to Section 17. Post amendment,
the statutory position is clear that the DRT is the first stop forum for redressal of any
aggrieved borrower, and widespread powers have been conferred on the DRT to undo the
injustice or the wrong committed to the borrowers by the financial institutions in a desperate
bid to recover their outstanding amount.

Section 13(4) and 17

The Supreme Court in Indian Overseas Bank v.  Ashok Saw Mill interpreted the correlation
between Sections 13(4) and 17 holding that the plethora of remedies and powers conferred
under Section 17 acts as “checks and balances” on the creditors from misusing their powers.
Section 17 balances the stringent powers of recovery of their dues vested with the banks/FIs
and DRT can even restore possession after the same has been made over to the transferee by
declaring any action under Section 13 as void. This includes setting aside any concluded sale
transaction, even when the possession has been transferred to the auction purchaser. The
Court referred to the judgment of Mardia Chemicals Ltd. v. Union of India to hold that post
the aforesaid judgment sweeping amendments were effected to Section 17, whereafter the
DRT has been conferred with ample powers of restoring the position of the borrower back to
its original place prior to Section 13(4) initiation. Vide paras 36-39, the Court held that the
DRT if it discovers after inquiry that resort to Section 13(4) or any of its successive measures
has been improper, then it can go to any extent and pass any order for restituting the borrower
to its pre-Section 13(4) situation. This includes setting aside any transaction that might have
happened including auction, sale, vesting of ownership in the auction purchaser, so on and so
forth. Thus Section 17 is a repository of remedies and redressals available to any borrower
against the bank and limited interpretation should not be accorded to it.

Section 37

Unlike Section 35 that overrides other prevalent laws, the application of SARFAESI is
in addition to, and not in derogation of provisions under the Companies Act, 2013,
RDDBFI Act, 1993 among others. Hence, the intent of the drafters was clear to provide
for parallel remedies under the two legislations without one impeding/obstructing
other’s application.

The enactment of SARFAESI has been a major factor in improving the health of banks and
financial institution by enabling the them to reduce their NPAs to substantially lower levels.
On account of availability of dual remedy, i.e., remedy under the SARFAESI and DRT Act,
the banks and financial institutions have been able to substantially resolve the NPAs.

Further, now the Insolvency and Bankruptcy Code [IBC] 2016 also serves as a helping hand
to this object, yet the SARFAESI that dealt particularly with secured loans i.e. asset consists
of lots of complications under the Act for obtaining possession without the intervention of the
court. Taking peaceful and lawful possession the Banks and Financial Institutions is reliant
on the constraint to file an application for support before the Chief Metropolitan Magistrate
or District Magistrate, which is itself a time taking process.

8
FUNCTIONALITY OF THE SECURITISATION IN CONTEXT OF NPAs

The concept of securitisation has been adopted more recently from the American
financial system and has been described as processing of acquiring financial asset and
packaging the same for investments by several investors. Securitisation as a technique
gained popularity in the US in the 1970. UK is the second largest market for
securitisation after the US.

Securitisation started in US in 1970 with the issue of residential mortgages by public

housing finance corporations. The institutions found that they had to pay higher
interest to attract short term deposits, while rates earned on long-term mortgage loans
was less. This created mismatch between assets and liabilities. The Solution was found
in securitisation.

Section 2(1)(z) “securitisation” means acquisition of financial assets by any [asset

reconstruction company]from any originator, whether by raising of funds by such [asset
reconstruction company]from [qualified buyers]by issue of security receipts representing
undivided interest in such financial assets or otherwise;

Thus, ARC makes money from money by taking up something of minimal value, enhance
its value, remodel it, and resells such refurnished assets.

The Basel Committee which in the year 2001, has released a document on Securitisation,
covering the banks in three context: (i) as originators of Securitised assets; (ii) as sponsors of
assets based securities; and (iii) as investors in assets based securities, the Article
comprehends the international practice of securitisation in the following words:

“As far as the international practice is concerned, the „Accounting for transfer and servicing
of financial assets and extinguishing of liabilities‟ governs the accounting and reporting
standards. It provides standards for distinguishing transfer of financial assets that are sales
from transfers that are actually nothing but secured borrowings. A transfer of financial assets,
in which the transferor surrenders control over those assets in accounted for as a sale to the
extent that consideration other than beneficial interests in the transferred assets, is received in
exchange.

Process of Securitisation

The process of securitisation begins when the lender (originator) segregates

loans/lease/receivables into pools which are relatively homogeneous in regard to types of
credit, maturity and interest rate risk. The pools of assets are then transferred to a Special
Purpose Vehicle (SVP). The SVP issues assets backed securities in the form of debt,
certificates of beneficial ownership and other instruments.

These securities will be rated by Credit Rating Agencies. Presently, it is envisaged that such
securities will be offered to QIBs (Qualified Institutional Buyers) only. Public participation is
not envisaged. The SVP acts as intermediary. It buys financial assets from seller or transferor

9
and issues securities to the investors. Money received from investors is paid to the transferor.
The investors are serviced and repaid out of the assets realised over a period of time.

ARCs collect loan files from different banks and sort them into different categories.

There are two preconditions for invoking the right of qualified buyers to regulate the conduct
of ARC.

1. There should be non-realization of financial assets.

2. The meeting should be called by holders of that class of security receipts who hold
security receipts of at least 75% of all security receipts.

Then whatever resolution is passed would be binding on the ARC. In this manner, the interest
of the investors is secured. The business model of ARC is subservient to any decision taken
by the qualified rights.

Benefits of Securitization

1. Quick access to liquidity – Encashing long term assets It will enable banks and
financial institutions to encash their long term assets and use the funds for further
lending. Securitisation will therefore result in further credit growth.

2. Availability of adequate funds with banks and FIs for financing infrastructure
projects – Gestation period and schedules for repayment in such projects are very
long and hence ability of banks and financial institutions to commit funds for such
projects is limited. With the creation of the legal framework for securitisation, the
banks and financial institutions will be encouraged to lend to such projects without
having any concern for locking up of their funds for number of years.

3. Enhanced quality of credit and improved assessment of credit – Any issue of

securitised debt instruments will in practice be credit rated by Credit Rating
Institutions and this practice will ensure that banks/financial institutions observe
certain basic norms of credit appraisal, documentation and standardize the terms and
conditions. As a result, the overall quality of credit will improve.

4. Security and convenience to new investors Power of enforcement given to

securitisation companies along with banks and financial institutions under the
provisions of the new law, will provide comfort to the investors that in the event of
default, speedy recovery is possible by enforcement of securities. This comfort will
have a boost to investment in such securitised debt instruments, and provide
additional resource avenue for banks and financial institutions.

Andhyrujina Committee Report – Identified the problematic link between Securitisation

and Taxation

10
11
Analyzing the Keynesian perspective on the prevailing banking conditions in India in
1913, highlight the background and necessity which led to the establishment of a
Central Bank in India. Also, discuss the debate between Dr. B.R. Ambedkar and J.M.
Keynes on the appropriateness of gold standard in India.

I have attempted to answer the question in two major head- the first head entails the first and
second part of the question; while the latter addressed the debate between Dr Ambedkar and
JM Keynes on appropriateness of gold-standard in India.

KEYNESIAN CONTENTIONS IN FAVOUR OF STATE BANK OF INDIA

Establishing the factual context prevalent then—

 Transition from trading entity to an administrative set-up [ruling entity]

What started as a merchant or trading activity in India, eventually became an empire. When
trading is started, maximization of wealth is the goal. However, if the territory is
administered it has direct impact on revenue and wealth generation. The administrative cost
incurred by the British was to maximise their return from zamindari system, ryotwari system,
etc.

The British realised that extracting a lot of money from poor peasants was not as much
advantageous as it was a few years back, and thus a need was felt for a proper currency issue
system.

 Genesis of the idea of a Centralised Banking System

Colonial Rule to Imperial Rule – As per the political sciences the period prior to 1857 (First
War of Independence, Sepoy Mutiny) – India was subjected to colonisation by the British
East India Company. While the period post 1857, is when the British Crown directly ruled
India, it then transformed to an Imperialist rule. Although this constituted a mere technicality
in the eyes of many, yet once the crown rule was established many systemic changes were
observed and one among such was the idea of a Central Bank.

Arbitrary and baseless abuse of power at the hands of the government, lead to the idea of a
Central Bank which would further their profit motive. Idea of central bank gained traction.

 Commercial Banking v. Expansionist tendencies of Governments

Profiteering can happen only if assets are utilised in best possible way. This is not the case
with govts. It was an expansionist period involving many wars and thus, government had its
hands full. Ultimately, we have to have certain reserves of cash or assets. This is taken by
bank to be useless or idle money. It serves only the purpose of the govt.- no utility to the
bank. Thus, the 2 world wars changed perception towards commercial banking. Commercial
banking requires a completely different play field than central banking.

TRANSITION- Presidency Banks to an Imperial Bank (intended to function as a state

bank)

12
  Turning to efforts made in India to set up a banking institution with the
elements of a central bank, we find that up to as late as 1920, the functions
envisaged for the proposed bank were of a mixed type, reflecting the practices
abroad. Also, it was only towards the close of the nineteenth century and the
beginning of the twentieth that the term ‘central bank’ came to be used in
India in the official despatches.

 It was proposed at that time to amalgamate the three Presidency Banks into
one strong institution; the central banking functions envisaged for the new
institution were not only those of note issue and banker to Government, as in
the earlier proposals, but also maintenance of the gold standard, promoting
gold circulation as well as measuring and dealing with requirements of trade
for foreign remittances. The new bank was to perform commercial banking
functions as well, as the Presidency Banks had been doing till then. Even the
‘State Bank’ proposed by John Maynard Keynes in 1913 was to engage in
both central banking and commercial banking functions.

 The amalgamation of the Presidency Banks took place in 1921, the new
institution being called the Imperial Bank of India, but it was not entrusted
with all the central banking functions; in particular, currency management
remained with Government.

 Another matter on which something should be said at the outset about the
concept of ‘State Bank’ is that the term was used in different senses from time
to time. For instance, Sir S. Montagu, in his evidence before the Fowler
Committee in 1898, stated that by ‘State Bank’ he did not mean a Government
bank, but an Indian national bank doing the local business of the country and
having branches which offered remittance facilities and which could also be
entrusted with the function of note issue.

KEYNES CONTENTION FOR SETTING UP A STATE BANK

He urged the creation of a central bank (or “State Bank”) for India, thus enabling
centralization of reserves, far greater monetary elasticity, and far more monetary expansion
and inflation.

 In 1913, though Keynes did not define the term ‘State Bank’, he used that
expression for his proposed bank, presumably to convey the responsibility the
State was to have in respect of the functioning of that bank.

 According to Mr. Keynes, the ‘nucleus’ of the new bank was ‘to be obtained
by the amalgamation of the capital and reserves of the three Presidency
Banks’. He named the proposed bank ‘the Imperial Bank of India’.
Government subscription to the capital, he considered, was not necessary, as it
would ‘complicate rather than simplify the relations between the Government
and the shareholders’.

 As regards control, the ‘supreme direction’ of the bank was to be vested in a

Central Board, consisting of the Governor of the bank (who was to be the
Chairman), the Deputy Governor, a representative of Government and three or

13
 more assessors. The assessors were to be the Managers, or their deputies, of
the Presidency Head Offices or of other Head Offices. The assessors were to
have no vote. The Governor was to be appointed by the Monarch, on the
Secretary of State’s recommendation, while the Deputy Governor, the
Government representative and the Managers of the Presidency Head Offices
were to be appointed by the Viceroy; the appointment of the Managers of
Presidency Head Offices was to be subject to the approval of the Presidency
Boards.

 The ‘State Bank’ proposed by Mr. Keynes was intended to put a little more
responsibility on Government, while at the same time providing them with a ‘
thoroughly satisfactory machinery ’ for the discharge of the responsibility.

Functions of the proposed State Bank --

The main functions of the proposed bank included:

(i) same functions as performed by the Presidency Banks, with relaxation

of some restrictions;

(ii) management of note issue;

(iii) management of public debt in India;

(iv)effecting remittance for the Secretary of State through the London

Office; and

(v) acceptance of payments and making of disbursements on behalf of

Government at all places where the bank had a branch.

Mr. Keynes also recommended in his scheme a proportional reserve system (though he
did not use this expression) of a flexible type, for regulation of the note issue. As regards
its relations with other banks, the bank was intended to do rediscount business ‘to the
greatest possible extent’. The ‘State Bank’ proposed by Mr. Keynes was thus to perform
central banking as well as commercial banking functions.

In August 1927, when the Reserve Bank Bill as amended by the Joint Committee came up
before the Legislative Assembly, the term ‘State Bank’ was used in ‘a very loose sense’ by
Members speaking on the Bill. It was used to convey two meanings, viz.,

(i) a bank wholly owned by the State and not by shareholders and

(ii) a bank to be managed under the complete control of the State.

The Finance Member expressed the view that the natural meaning of a ‘State Bank’,
according to him, was a bank under the control of the Government and the Legislature. In that
sense, the Reserve Bank, as proposed by the Joint Committee, was not a ‘State Bank’,
because while it was to be wholly owned by Government, it was to be completely
independent of the Government and the Legislature.

14
CONTROVERSY BETWEEN KEYNES AND DR. B.R. AMBEDKAR ON THE
APPROPRIATENESS OF A ‘GOLD-STANDARD’ VS ‘GOLD-EXCHANGE
STANDARD’ FOR INDIA

Dr Amedkar dealt with this debate, emerging from a silver standard (led by paper currency),
gold standard and then the gold exchange standard, in his book, “Problem of the Indian
Ruppee”. He has attempted to explain this evolution and his contentions substantiated with
the circumstances that prevailed then, very lucidly to a common man, by the way of his book.

Keynes’s role in Indian finance was not only important but also ultimately pernicious,
presaging his later role in international finance. Upon converting India from a silver to a gold
standard in 1892, the British government had stumbled into a gold-exchange standard, instead
of the full gold-coin standard that had marked Britain and the other major Western nations.
Gold was not minted as coin or otherwise available in India, and Indian gold reserves for
rupees were kept as sterling balances in London rather than in gold per se. To most
government officials, this arrangement was only a halfway measure toward an eventual full
gold standard; but Keynes hailed the new gold-exchange standard as progressive, scientific,
and moving toward an ideal currency. The crucial point, however, is that a phony gold
standard, as a gold-exchange standard must be, allows far more room for monetary
management and inflation by central governments. It takes away the public’s power over
money and places that power in the hands of the government.

As per Dr Ambedkar though, most neglected period of Indian currency ranges from
1890-18993.

Other authors popularized the notion that exchange standard was the standard originally
contemplated by the Gov of India. (gross error) Indeed, the most interesting point about
Indian currency is the way in which the gold standard came to be transformed into a gold
exchange standard. Some old, but by now forgotten, facts had therefore, to be recounted to
expose this error.

On the theoretical side, there is no book but that of Professor Keynes which makes any
attempt to examine its scientific basis. But the conclusions he has arrived at are in sharp
conflict with those of Dr. Ambedkar. The differences extended to almost every proposition he
has advanced in favour of the exchange standard. This difference proceeds from the
fundamental fact, which seems to be quite overlooked by Professor Keynes, that nothing will
stabilise the rupee unless we stabilise its general purchasing power. That the exchange
standard does not do. That standard concerns itself only with symptoms and does not go to
the disease: indeed, on Dr. Ambedkar’s showing, if anything, it aggravates the disease.

When Dr. Ambedkar come to the remedy, Dr. Ambedkar again found himself in conflict with
the majority of those who like myself are opposed to the exchange standard. It is said that the
best way to stabilize the rupee is to provide for effective convertibility into gold. Dr.
Ambedkar does not deny that this is one way of doing it. But Dr. Ambedkar thought of a, a
far better way would be to have an inconvertible rupee with a fixed limit of issue. Dr.
Ambedkar would have proposed that the Government of India should melt the rupees, sell
them as bullion and use the proceeds for revenue purposes and fill the void by an
inconvertible paper. But that may be too radical a proposal, and Dr. Ambedkar do not

15
therefore press for it, although he regards it as essentially sound. in any case, the vita! point is
to close the Mints, not merely to the public, as they have been, but to the Government as well.

In his views the Indian currency, based on gold as legal tender with a rupee currency fixed in
issue, will conform to the principles embodied in the English currency system.

Fowler Committee and Dr. Ambedkar’s views contradicted

“It will be noticed that I do not propose to go back to the recommendations of the Fowler
Committee. All those, who have regretted the transformation of the Indian currency from a
gold standard to a gold exchange standard, have held that everything would have been all
right if the Government had carried out in toto the recommendations of that Committee. I
do not share that view.”

On the other hand, Dr. Ambedkar found that the Indian currency underwent that
transformation because the Government carried out those recommendations. While some
people regard that Report as classical for its wisdom, Dr. Ambedkar regard it as classical for
its nonsense. For Dr. Ambedkar find that it was this Committee which, while recommending
a gold standard, also recommended and thereby perpetuated the folly of the Herschell
Committee, that Government should coin rupees on its own account according to that most
naive of currency principles, the requirements of the public, without realizing that the latter
recommendation was destructive of the former. Indeed, as Dr. Ambedkar argues, the
principles of the Fowler Committee must be given up, if we are to place the Indian currency
on a stable basis.

Up to 1913, the Gold Exchange Standard was not the avowed goal of the Government of
India in the matter of Indian Currency, and although the Chamberlain Commission appointed
in that year had reported in favor of its continuance, the Government of India had promised
not to carry its recommendations into practice till the war was over and an opportunity had
been given

to the public to criticize them. When, however, the Exchange Standard was shaken to its
foundations during the late war, the Government of India went back on its word and
restricted, notwithstanding repeated protests, the terms of reference to the Smith Committee
to recommending such measures as were calculated to ensure the stability of the Exchange
Standard, as though that standard had been accepted as the last word in the matter of Indian
Currency. Now that the measures of the Smith Committee have not ensured the stability of
the Exchange Standard, it is given to understand that the Government, as well as the public,
desire to place the Indian Currency System on a sounder footing.

There was a great deal of controversy on the reasons for this unprecedented export of the
metal. One view was that it reflected the economic distress following the depression; another
view was that the sales were commercial transactions intended to benefit from the rising trend
of prices. There was also a view that the rupee was under- valued in terms of gold on the
basis of the prevailing price of the metal abroad.

The official view was that, while it was probably true that a certain proportion represented
distress sales, the larger proportion was sold to realise profits from exports, it was not proper

16
for Government to interfere with this and that in any event, the exports had strengthened the
country’s foreign exchange reserves, exchange rate and credit abroad.

To sum up, it should be added that the exchange rate controversy not always ran in terms of
pure economic issues; politics and economics were mixed up a great deal.

17
QUESTION 3: The government’s dual role in nationalized banks, as a majority
shareholder as well as a regulator, has exposed these banks to systemic risks and
functional inefficiencies. Analyse the recent initiatives of government and RBI that are
aimed at altering the existing governance structure to boost the efficiency and results of
such banks.

1. PJ NAYAK COMMITTEE REPORT

The core problem with PSBs, as the Nayak committee saw it, in chapter 1 para 7 and 8:
Governance difficulties in public sector banks arise from several externally imposed
constraints. These include dual regulation, by the Finance Ministry in addition to RBI;
board constitution; significant and widening compensation differences with private
sector banks; external vigilance enforcement though the CVC and CB.

The solution suggested by the committee was that:

 If the Government stake in these banks were to reduce to less than 50 per
cent, together with certain other executive measures taken, all these
external constraints would disappear. This would be a beneficial trade-off
for the Government because it would continue to be the dominant shareholder
and, without its control in banks diminishing, it would create the conditions
for its banks to compete more successfully.
 Repeal the Bank Nationalisation Act (1970, 1980), the SBI Act and the SBI
Subsidiaries Act as they require the government to have above 50% share in
the banks.
 After the above acts are repealed, the government should set up a Bank
Investment Company (BIC) as a holding company or a core investment
company.
 The government to transfer its share in the banks to this BIC. Thus, the BIC
would become the parent holding company of all these national banks, which
would become subsidiaries. As a result of this, all the PSBs (public sector
banks) would become ‘limited’ banks. BIC will be autonomous and have the
power to appoint the Board of Directors and make other policy decisions.
 Nayak Committee noted the need to make the process for board appointments
more professional. Until the BIC is formed, a temporary body called the Bank
Boards Bureau (BBB) will be formed to do the functions of the BIC. Once
BIC is formed, the BBB will be dissolved which will advise on appointments
to the board, banks’ chairman and other executive directors.

2. PLOUGHING BACK OF CAPITAL [RECAPITALISATION]

Weak balance sheets of public sector banks warrant infusion of equity capital by the
government. Recapitalisation is liquidity neutral for the government when financed via an
issue of government securities that a recapitalised bank is mandated to purchase. Bank
balance sheets at the time of recognition of non-performing assets and the associated
negative net worth is equivalent to that when the bank receives equity through this liquidity
neutral mode of financing. Correspondingly, the fiscal deficit is higher than reported the

18
moment a state-owned bank has negative net worth and there are negative feedback loops
between the fiscal and banking systems.

Under recapitalisation, over the last three Financial Years, PSBs have been recapitalised to
the extent of Rs. 2.87 lakh crore, with infusion of Rs. 2.20 lakh crore by the Government and
mobilisation of over Rs. 0.66 lakh crore by PSBs themselves.

3. INDRADHAUNSH PLAN

Banks were in need of money and therefore Indradhanush plan was announced in order to
address issues such as Banks Board Bureau, Re-capitalisation of banking companies, etc. The
plan proposed to inject fresh capital in a phased manner. All in all, 75000 crore rupees would
be injected in public sector banks.

It was supposed to be the most comprehensive reform effort undertaken since banking
nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their
overall performance by the acronym of “ABCDEFG”.

 A-Appointments: Based upon global best practices and as per the guidelines in the
companies act, separate post of Chairman and Managing Director and the CEO will
get the designation of MD & CEO and there would be another person who would be
appointed as non- Executive Chairman of PSBs.
 B-Bank Board Bureau: The BBB will be a body of eminent professionals and
officials, which will replace the Appointments Board for the appointment of Whole-
time Directors as well as non-Executive Chairman of PSBs.
 Capitalization: As per finance ministry, the capital requirement of extra capital for
the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which
70000 crores will be provided by the GOI and the rest PSBs will have to raise from
the market.
 Destressing: PSBs and strengthening risk control measures and NPAs disclosure.
 E-Employment: GOI has said there will be no interference from Government and
Banks are encouraged to take independent decisions keeping in mind the commercial
the organizational interests.
 F-Framework of Accountability: New KPI (key performance indicators) which
would be linked with performance and also the consideration of ESOPs for top
management PSBs.
 G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and
financial institutions. Bank board Bureau for transparent and meritorious
appointments in PSBs.

Mission Indradhanush did have strong points, but it did not go the distance when it came to
PSB reform. There is a need to recognize that incremental reforms do not cover the vital parts
and will not design the system for the results that the PSB and country needs.

19
 4. PROPOSAL OF DISINVESTMENT SCHEME OF THE GOVERNMENT
STAKE IN THE PUBLIC SECTOR BANKS BY THE RBI

On 3rd August, 2020, the RBI has very rightly suggested the reduction of the stake of the
government in the six public sector banks to 51% over a period of the coming 12-18 months.
Various Public Sector banks like the State Bank of India, Punjab National Bank, Bank of
Baroda, Canara Bank, Union Bank of India and the Bank of India are shortlisted for this
process.

5. BANK BOARD BUREAU

In light of the BASIL III requirements, the government was pushed the government to take
reforms w.r.t PSBs. The CG came out with gazette notification- it led to establishment of
BBB [26 Feb, 2022]. It became autonomous recommending body of GOI.

This means that the top management of these banking companies should be selected on a
competitive basis. The idea was that one should not confine the idea of appoint of whole time
directors only through the route of lateral entering. Apart from this, the directions to be given
by BBB to PSBs and CG, the institution was not taken kindly by DFS. DFS has

reputation of its own function. It has appointed its own chairman, MDs, etc. they have
absolute control and so any dilution of their power was not taken well by the bureaucrats.
However, the range of operations is so wide and extensive, there is bound to be
overlapping of work between BBB and DFS and the same has led to a lot of conflict and
thus BBB is not able to perform well if it does not receive support from DFS. Due to
lack of support, BBB has been subject to a lot of criticism.

6. EASE 2.0 REFORMS FOR PUBLIC SECTOR BANKS

The EASE Reforms Agenda was launched in January 2018 jointly by the government
and PSBs. It was commissioned through Indian Banks’ Association and authored by
Boston Consulting Group. EASE Agenda is aimed at institutionalizing CLEAN and
SMART banking.

The EASE Reforms Index: The Index measures performance of each PSB on 120+
objective,metrics.

(i) The Index follows a fully transparent scoring methodology, which enables banks
to identify their strengths as well as areas for improvement.

(ii) The goal is to continue driving change by encouraging healthy competition

among PSBs.

7. OTHER INITIATIVES TAKEN BY THE GOVERNMENT

 Change in credit culture with institution of Insolvency and Bankruptcy Code

(IBC) fundamentally changing the creditor-borrower relationship, taking away

20
 control of the defaulting company from promoters/owners and debarring wilful
defaulters from the resolution process and debarring them from raising funds from
the market.

 Fugitive Economic Offenders Act, 2018 has been enacted to enable confiscation
of fugitive economic offenders’ property.

 Heads of PSBs have been empowered to request for issuance of look-out circulars.

 National Financial Reporting Authority has been established as an independent

regulator for enforcing auditing standards and ensuring audit quality.

8. ALTERNATE SUGGESTIONS/RECOMMENDATIONS TO IMPROVE

EFFICIENCY IN THE PSB
- It is also a common knowledge that the number of banks did not have senior
managers, and that roles in key committees (such as audit committee) go unfilled.
The sixty-eight report of the Standing Committee on Finance (2017-18) also
expressed concern over the emerging gaps at senior levels. This is an area of
significant risk as banking is becoming increasingly complex and specialized
function.
- There is a need to look at the Human Resources risk in an urgent manner, and
mandate HR committee with representation on the board. It is noteworthy that
Khandelwal Committee recommended Board’s committee on HR, but barring
some banks, either banks have not created such committees or they have become
moribund. The government should ensure that HR committee of the Boards are
activated and an annual Human Capital report is submitted as a part of annual
report on the lines of Governance report.
- There is also a need to look at the compensation in PSBs especially of whole-time
directors and senior management functionaries. The gap between the private and
public sector banks is already significant, and, as banking becomes more
specialised and domain expertise-based in the future, this gap could become even
more. There is a need to use Employee Stock Options strategically, as
recommended in the Nayak Committee report, which will also address to some
extent the emerging gap between PSBs and private banking pay levels.

ANALYSIS

I do believe any government machinery is recoverable if the government brings in the right,
thought out, planned economic reforms and the administration; this has to be smoothly
executed as well in due time for a fruitful and efficient outcome.

Nayak Committee on Governance and Khandelwal Committee on Human Resources

(HR) in PSB provided detailed description of the various problems, challenges and gaps
that need to be urgently addressed. In 2015, then Finance Minister, Late Mr. Arun Jaitley,
announced a seven-pronged Mission Indradhanush and “Gyan Sangam” (a Conclave of
PSBs) to bring about banking reforms. In spite of such works and initiatives, governance
in PSB remains complex and hardly conducive to good banking performance.
21
I disagree with the Indradhanush scheme which merely provides for recapitalization of the
ailing public sector banks as the core issue is not lack of capital but dual regulation and
inefficient appointment mechanism of the board.

I am in complete agreement with the PJ Nayak Committee reforms and the idea of
establishing BBB to resolve the core issue of structural reforms. Given their role and
complexity, PSBs are a significant player in the banking sector, and it is unrealistic to expect
that governance challenges in the banking sector can be addressed without working through
the governance issues that PSBs face. It is also unrealistic to expect that piecemeal and
disjointed efforts – as has been the case in the past - will yield governance reforms that PSBs
urgent need. The time is of essence and PSBs cannot be allowed to be a burden on exchequer
to bear the burden of recapitalisation from time to time.

22
QUESTION 6.

Write short notes on:

SOCIAL AND ECONOMIC BENEFITS FROM THE PROHIBITION ON ‘RIBA’ IN

ISLAM

The economic system of Islam is the economic system is based on monotheism and superior
compared with conventional systems such as the capitalist economy. All transactions in the
Islamic economic system based on justice and reject all forms of oppression and exploitation
like usury.

Those who indulge in these activities of usuary they have tendency to appropriate others’
wealth w/o justification and this leads to more serious crimes which leads to disruption of all
good values.

SOCIAL AND ECONOMIC BENEFITS FROM PROHIBITION OF RIBA

Following are the social and economic benefits from the prohibition on ‘Riba’ in Islam:

1. It will reduce concentration of wealth in the hands of a small minority - Because

interest is a low-risk way to increase wealth if you already have wealth, this function
to concentrate wealth into the hands of a minority, which has potential socially
destructive which can be reduced by prohibiting interest.
2. Reduces unemployment and inflation – Interest rates cause unemployment and
inflation in the conventional economic system as shown in a number of empirical
studies by economists. Even though, in the early 1970s, it was believed by most of the
economists that there is a trade-off between unemployment and inflation, subsequent
findings have shown that both high unemployment and inflation can co-exist which
gave rise to a new phenomenon known as stagflation. This phenomenon has caused
many economic problems in the industrialized countries.40 Hence, after many
mechanism attempted to solve the problem of stagflation have failed, the profit-
sharing system has been proposed as the best form to combat unemployment and
inflation

3. It will reduce the wealth inequality between members of society: The rich (who
are most likely to be the lender) take advantage of the need of the poor (the borrower)
for money by charging interest, which adds to the burden on the borrower. As a result,
the rich becomes richer and the poor becomes poorer. Thus, interest increase wealth
inequality between the members of the society.

4. Leads to distribution of risk – The most important consequence of the prohibition of

interest in an interest-free Islamic economic system by replacing it with profit sharing
is the total elimination of risk-free assets and to spread the risk among the investors
and financiers.42 This is because PLS system has the characteristics of spreading risk
on the entire investment equitably than fixed (interest) return scheme. This may create
for the Islamic firm both incentive and feasibility for taking more risk compared to the
23
 conventional system under the similar circumstances. In another words, in an Islamic
financial system, the availability of assets with a variety of risk characteristics is a
distinct possibility and there is no reason to assume that there is a limit to the diversity
of assets in such a system.

5. Interest can cause over-consumption that later can be life-destroying - If people

are given the option of borrowing against future earnings without knowing what those
future earnings are, people may over consume. A huge number of people's lives have
been destroyed by, for example, credit card debt. Many suicides, for example, have
been related to debt. As result percentage of homeless people are growing faster than
ever. Therefore, prohibition of interest could be one way to change this.

6. Riba leads to negative social and moral growth - Therefore, the moral level would
be low, society would be rigged with fear and corruption. They will have more money
but won’t know what to do with it due to which exploitative tendencies would prevail.
These can be curtailed by prohibiting interest. In contrast to Capitalist system, Islam
believes in striking at the roots of inequality rather than merely alleviating some of the
symptoms.

7. Interest is a cause of injustice and exploitation- Interest is considered a form of

injustice and exploitation, which contradicts the core Islamic teachings of social
justice.

It is unjust for lenders to guarantee return with no involvement in risk. Because riba
entails taking advantage of a man’s inferior economic position it breeds hatred,
jealousy and ill-will towards the rich. This behavior kills the spirit of cooperation in
the society and discourages people from doing good to each other. Interest also leads
to the creation of a materialistic society. Hence, prohibition of Riba would eliminate
this and would provide us a better society.

8. Interest introduces instability into the economic system - If people are lending
money to others, but it is untied to a physical resource and based on the expectation
that not everyone will try to get back their liquid assets at the same time (the so called
liquidity ratio, which allows banks to not have to hold all of the money they have lent
in liquid form) this can introduce financial instability into the system.

CONCLUSION

"With public sentiment, nothing can fail. Without it, nothing can succeed." -Abraham
Lincoln

The concept of interest free banking is not obsolete/orthodoxical, it definitely has some socio-
cultural value in islam which is why it has the public sentiment, it continues to be relevant
and practical.

The reason why Islam prohibits Riba (interest) from all forms of transactions is Islam wishes
to establish an economic system where all forms of exploitation and injustice are eliminated.
Islam wishes to establish justice between the financier and the entrepreneur. It has been
mentioned that the prohibition of interest in economy and replacing it with profit-sharing
24
system will increase the level of savings and investment, able to combat the unemployment
and inflation simultaneously since interest rate will no more enter into the profit calculation
in the investment. The Islamic economic system is more profitable and productive than the
conventional one.

25
CHANGE IN MANAGEMENT OR TAKEOVER OF MANAGEMENT OF
DEFAULTING BORROWER UNDER SARFAESI

Section 9(a), Section 15 SARFAESI Act 2002;

RBI Notification 2010 – Notification on Change in or Take Over of the Management of

the Business of the Borrower by Securitisation Companies and Reconstruction
Companies (Reserve Bank) Guidelines, 2010.

The relevant portions of SARFAESI that encompass the provisions regarding change of
management aspect are Section 9 (applicable to Asset Reconstruction Companies for
effecting change of management for better reconstruction of financial assets), Section 13(4)
(b) (which provides for secured creditors including banks, financial institutions and ARCs, to
implement change of management aimed at recovery of debt) and also under Section15
(which provides for manner to affect any such change of management u/s 9 or 13).

1. Under SARFAESI Act, one of the strategy to realize the debt is to change the
management or takeover the management of the business of borrower by the ARC.
Reserve Bank of India has issued guidelines to ensure fairness, transparency, non-
discrimination, and non-arbitrariness in the action of the ARC and to build in a system
of check and balance while effecting change in or takeover of the management of the
business of the borrower by ARC under Section 9(a) of SARFAESI Act, 2002.

2. The ARC shall utilize such method of realization after complying with the manner of
takeover of the management in accordance with the provisions of Section 15 of the
SARFAESI Act, 2002. On realization of dues in full, the ARC shall restore the
management of the business to the borrower as provided in Section 15(4) of the
SARFAESI Act.

3. Reserve Bank of India’s directions / guidelines issued to ARC in the matter of asset
reconstruction and matters related thereto, inter-alia stipulate that ARC shall
formulate a Board-approved policy regarding change in or takeover of the
management of the business of the borrower and borrower shall be made aware of
such policy framed by the ARC.

GROUNDS FOR AFFECTING CHANGE IN OR TAKEOVER OF MANAGEMENT

Company can consider change in or takeover of management on happening of any of the

following event. However, before resorting to this method, company to weigh all available
option for resolution and the same be placed before competent authority with justification of
going in for this method.

1. the borrower makes a willful default in repayment of the amount due under the
relevant loan agreements;

2. the Company is satisfied that the management of the business of borrower is acting in
a manner adversely affecting the interest of the creditors (including the Company) or
is failing to take necessary action to avoid any event which would adverselyeffect the
interest of the creditors;
26
 3. the Company is satisfied that the management of the business of the borrower is not
competent to run the business resulting in losses / non – repayment of dues to the
Company or there is lack of professional management of the business of the borrower
or the key managerial personnel of the business of the borrower have not been
appointed for more than one year from the date of such vacancy which would
adversely affect the financial health of the business of the borrower or the interest of
the company as secured creditor;

4. the borrower has without the prior approval of the secured creditors (including the
Company), sold, disposed of, charged, encumbered or alienated 10% or more (in
aggregate) of its assets secured to the Company;

5. there are reasonable grounds to believe that the borrower would be unable to pay its
debts as per terms of repayment accepted by the borrower;

6. the borrower has entered into any arrangement or compromise with creditors without
the consent of the Company which adversely affects the interest of the Company or
the borrower has committed any act of insolvency;

7. the borrower discontinues or threatens to discontinue any of its businesses

constituting 10% or more of its turnover;

8. all or a significant part of the assets of the borrower required for or essential for its
business or operations are damaged due to the actions of the borrower,

9. the general nature or scope of the business, operations, management, control or

ownership of the business of the borrower are altered to an extent, which in the
opinion of the SC / RC, materially affects the ability of the borrower to repay the
loan;

10. the Company is satisfied that serious dispute/s have arisen among the promoters or
directors or partners of the business of the borrower, which could materially affect the
ability of the borrower to repay the loan;

11. failure of the borrower to acquire the assets for which the loan has been availed and
utilization of the funds borrowed for other than stated purposes or disposal of the
financed assets and misuse or misappropriation of the proceeds;

12. fraudulent transactions by the borrower in respect of the assets secured to the
creditor/s.

In all such cases where company decide to change in or takeover the management of the
business of borrower, the company shall appoint an Independent Advisory Committee (IAC)
consisting of professionals from technical / finance / legal background, not related to the
Company in any manner whether pecuniary or not except remuneration for acting as
independent advisor, who after assessment of financial possession, time frame etc. shall
recommend to the ARC that it may resort to change in or takeover of management and that
such action would be necessary for effective running of the business leading to recovery of its
dues.
27
The Report of the IAC shall be considered by the Board of Directors including at least two
independent Directors alongwith various option available for recovery before deciding
whether under the existing circumstances the change in or takeover is necessary and the
decision shall be specifically included in the minutes.

The company shall carry out the due diligence and record the details of the exercise including
the finding on the circumstances which led to default in repayment and why the decision to
change in or takeover of management of the business of the borrower has become necessary.

A suitable person shall be identified by the company who can take over the management of
the business of borrower by formulating a plan for operating and managing the business of
the borrower effectively. Such plan should include procedure to be adopted by the Company
at the time of restoration of management to borrower, borrower’s rights and liabilities at the
time of change and takeover by the Company and at the time of restoration and rights and
liabilities of the new management taking over the management at the behest of ARC. It
should also be clarified by the Company to the new management that their role is limited to
recovery of dues of the Company by managing the affairs of the business of the borrower in a
prudent manner.

The Company shall report to the Reserve Bank of India all the cases where they have taken
action to cause change in or takeover of the management of the business of the borrower for
realization of its dues from the borrower.

Delegation of authority to consider cases of change in or takeover of management:

The Executive Committee for Resolution shall be empowered to appoint members of the
Independent Advisory Committee (IAC) on case to case basis and shall place the report /
recommendations of IAC to Board of Directors for their consideration alongwith its
recommendations. If the case is found suitable for change in or takeover of management by
the Board of Directors, the Executive Committee for Resolution will be the Competent
Authority to take all further actions required including appointment of agency for due-
diligence and suitable personnel / agency for managing the affairs of the business of borrower
to effectively recover the dues from the borrower under this measure.

28
ANSWER 1: Analysing the Keynesian perspective on the prevailing banking conditions
in India in 1913, highlight the background and necessity which led to the establishment
of a Central Bank in India.

I. Introduction

The banking system in India in 1913 was facing multiple challenges. It comprised the
following as its four main constituents: (i) Presidency banks, (ii) European exchange
banks, (iii) Indian joint stock banks, and lastly the (iv) private bankers and
moneylenders (Shroffs, Marwaris, etc.). This means that if any person sought to raise a
credit, the recourse would be to these institutions in the market. They all functioned
independently of each other and exploited the market according to their own commercial
objectives. In short, there was no cohesive force that could produce the required synergy
towards economic development. The absence of a central banking authority led to a general
lack of direction in the banking policy of India. This is because no one was interested to
look at the matter as a whole or to understand the position of the market. Therefore, no matter
how bad the banking system would be, there was no one to enforce prudence in the system.

II. Background And Necessity Leading To The Establishment Of A Central Bank

A. NO RELATION BETWEEN BANK RATES, MARKET RATES, AND INTEREST

RATES

The banking enterprises, especially at that point of time, were totally dependent on the spread
between the rate of interest they charged on loans and the rate of interest they provided on
deposits. This system requires that almost all the banking companies keep their spread around
a fixed percentage so that all can benefit and grow together and at the same be competitive.
However, this was not done during that era as the banks had close to absolute autonomy in
their operations. Therefore, on one hand, while the exchange banks were greedy enough to
receive fixed deposits for short periods at 9, 10, and 11% of annual interest rates, on the other
hand, the presidency banks were straining to meet the demands for loans at 12 and 13% per
annum.

B. LACK OF A STATE BANK IN INDIA

Keynes highlighted that the bad state of affairs in Indian banking is primarily owed to a lack
of state bank in India. The government did not know where to park its liquid funds for
generating the maximum returns out of it. There was no central bank governing all other
banks and precisely because of this, the government failed to understand the market
functions. Therefore, Keynes proposed the idea that regional presidency banks should be
merged to create a new dual bank (State Bank) which would perform both the functions,
i.e. of a commercial bank and a welfare bank.

C. MULTIPLE PROBLEMS PLAGUING THE PRESIDENCY BANKS

Keynes suggested that the Indian banks were established only during good times and
therefore did not feel the need to maintain any reserves. They just lent the money. Since the
banking system in India was unaware of the impact of depression, Keynes believed that

29
Indian banks were playing with fire by not maintaining reserves. This had the potential to
lead up to significant financial instability in the market.

D. PROBLEMS WITH THE EXCHANGE BANKS

The exchange banks were able to rapidly increase the funds raised by them through deposits
in India itself. However, they were not mindful of the slow rate at which they had thought fit
to increase their Indian balances. The existing banking system did not anticipate for any crisis
where bank would have to provide its depositors funds. Yet again, there was a possibility of
a heightened financial instability brewing under such inefficient banking practices.

E. TRADES SPONSORED BY A LIMITED NUMBER OF BANKS

Only a handful of Indian banks had been able to extend the required financing for trading
activities in India. This reduced the availability of credit in the market. Consequently, the
traders were forced to limit their businesses and were at the mercy of such banks, who had
their seat in London.

F. INCOMPETENT AND UNQUALIFIED PERSONNEL AT EXISTING BANKS

The lack of advice and expertise that the officers of a state bank should have clearly
highlighted the weakness of the government. There were no high ranking officials who took a
keen interest in the study of finance and wanted to specialise in it. As a result, the commercial
banks were fraught with incompetent personnel who did not possess the requisite skills to aid
the market.

G. ISSUING BANKNOTES SUBSTANDARD TO MODERN BANKING PRACTICE

The responsibility to issue bank notes was sub-standard to the modern banking practise. It led
to the creation of two separate reserves, i.e. the government’s reserve and the banker’s
reserve. Specifically, in his book, Keynes noted that the “existing divorce between the
responsibility for note issuance and that for banking generally was contrary to the modern
banking practice”. This led to elasticity in the market and the reserves were not able to meet
this elasticity.

H. SCARS LEFT BY THE INFREQUENT WARS

Wars require a lot of money and the banking institution were not able to command during
such times because sovereign takes over the functioning. The banks did not have the requisite
resources to fund such activities of the State. It had become a huge problem for the banks and
prevented their growth. Therefore, Keynes advocated for a state bank which would be free
from political, executive and industrial influences.

Iii. Conclusion: The Road To Establishing A Central Bank A. The Idea Of A State Bank

In light of the aforementioned problems, Keynes mooted the idea of a state bank, which
would perform primarily three functions: (i) note issuance, (ii) management of cash balance,
and (iii) regulation of foreign exchange. The idea of a central bank gained traction after the
1926 Hilton Young Commission Report. It recommended setting up a reserve bank of India
entrusted with central banking. Even after it was decided that a central bank would be
30
established, the problems were not over. It was to be established in an independent manner to
keep it free from political and commercial influences.

B. PROBLEM OF CONTROL IN ESTABLISHING THE CENTRAL BANK

Since the person who controlled the bank will be in-charge of controlling its policies, if the
government itself would have been made the controller of the bank, the bank would not
remain independent from political, executive and industrial influence. Therefore, the voting
rights of investors (being the government) were sought to be curtailed. This took off the
burden of managing the bank from the shoulders of government and ensured its
independence. Similarly, another curtailment was that not all directors were to be nominated
by the government in the central bank. This was done to ensure that the directors do not fall
prey to the government. Despite the Imperial Bank established could not be successful in its
objectives. This led to the establishment of the Reserve Bank of India in 1934.

31
Question 2: The advent of Insolvency and Bankruptcy Code 2016 has been hailed as the
‘game changer’ in India’s fight against NPAs. However, the judicial setbacks received
by the RBI in this crusade may force it to re-strategies against erring corporate debtors.
Examine the above statement.

A. IBC: TIME-BOUND NATURE AND CREDITOR IN CONTROL MECHANISM

The IBC is a game changer in the resolution of NPAs because it provides a framework for
time- bound insolvency resolution (180 days extendable by another 90 days) with the
objective of promoting entrepreneurship and availability of credit while balancing the
interests of all stakeholders. The IBC represents a paradigm shift in which creditors take
control of the assets of the defaulting debtors, in contrast to the earlier system in which assets
remained in possession of debtors till resolution or liquidation.

B. GAME-CHANGING NATURE OF IBC: 4 TIMES MORE LIQUIDATION THAN

RESOLUTION

The experience so far has been encouraging with IBC providing resolutions to some large
corporate debtors. While data suggests that the number of cases ending with liquidation under
IBC is about four times higher than those ending with a resolution plan, I believe that
liquidation could be an efficient mode of resolution for debtors in default for long time
wherein the scope for revival of the enterprise is low and liquidation value exceeded
resolution value. As such, the number of liquidation orders should be seen as a natural step
towards efficient reallocation of resources rather than an adverse consequence of IBC itself.
Therefore, it would not be an exaggeration to call IBC the game-changer in India’s fight
against NPAs. However, lately the RBI has received multiple judicial setbacks in its crusade
against NPAs. The same can be seen in the next section.

II. JUDICIAL SETBACKS IN RBI’S CRUSADE AGAINST NPAS RELEVANT

PROVISIONS UNDER THE BANKING REGULATION ACT

S.35AA provides the RBI the power to issue directions to any banking company to initiate
CIRP against a defaulter under IBC. Further, 35AB provides that the RBI may issue
directions to any banking company for resolution of stressed assets and it may specify an
authority/committee to advise any banking company on resolution of stressed assets.
Therefore, the RBI holds the power to direct banks to initiate CIRP under IBC against any
borrowing defaulter.

A. FATE OF THE 2017 RBI CIRCULAR

Under the aforementioned regulations, the RBI formed an Internal Advisory Committee
[IAC] to advise banking companies on resolution of stressed assets. Thereafter, the IAC
identified the NPAs against whom CIRP could be initiated on a priority basis depending on
the amount of NPAs. For NPAs that did not qualify under such criteria, the banks had to
finalise a resolution plan within six months, failing which CIRP could be initiated.

CHALLENGING THE VIRES OF THE CIRCULAR

32
In Essar Steel India Limited v. RBI, the constitutionality of RBI's power to direct banks to
initiate CIRP was challenged. It was contended that RBI had acted arbitrarily and in violation
of Article 14 in directing the banks to initiate CIRP against the petitioner. The RBI contended
that the petitioner was a drain unto the financial performance of the banks and thereby such a
move was necessary. Additionally, RBI had asserted in the circular that such CIRP
applications should be accorded priority by the NCLT.

Upholding the constitutional validity of the RBI Circular, while the refused to grant any relief
to the petitioner, it struck down the part of RBI circular which stated that the cases referred to
the NCLT under the scheme would be accorded priority the NCLT. It held that RBI cannot
guide the adjudicating authority under IBC and any attempt to do would be unconstitutional.

B. FATE OF THE 2018 CIRCULAR

The RBI in 2018 issued a circular to revitalise the extant framework for stressed assets in
India. The Circular provided that banks shall immediately refer NPA accounts with more than
Rs. 2,000 crores to the IBC regime, if they are not resolved within 180 days of a default.
Additionally, the Circular laid down that banks shall disclose defaults if interest repayments
were defaulted on by a single day, and will have to ensure a resolution plan is in place within
180 days.

CHALLENGING THE VIRES OF THE CIRCULAR

In Dharani Sugars & Chemicals v. UOI, this Circular was challenged by firms on the
ground that it suffers from non-application of mind, the reason being that it does not
distinguish between various types of stressed assets from different industrial sectors. In
checking the vires of this Circular, the SC held that under Sections 35AA and AB, it was
obvious that the RBI can issue directions to banks but only after authorisation from the
Central Government. Therefore, it was held that the RBI can only direct banks to initiate
CIRP on receiving authorisations from the Central Government. Therefore, it invalidated the
Circular. This meant that any CIRP initiated under the said Circular became infructuous.

III. ANALYSIS AND THE WAY FORWARD

A. DILUTING THE SCOPE OF RBI’S MANDATE

I believe that the judgement dilutes the scope of RBI’s mandate. The ability to direct banks to
refer cases for CIRP will now be restricted to situations where Central Government
authorisation is received. This means that such general directions cannot be issued by the
RBI. The invalidation of the Circular would assist the lenders and borrowers entering into
consensual restructuring schemes, which can be achieved in lengthier timespans, allowing for
complex restructuring transactions with more pragmatic timelines.

B. ENSURING STRICT COMPLIANCE TO STATUTORY DIKTATS

The mandate of a court is to ensure strict compliance with the diktats of the statute. The
reason why the court had to strike down the 2018 Circular was that it did not adhere to the
express statutory requirement. As far as the 2017 Circular is concerned, the court struck down
a small part of it as it tried to bypass the IBC. Had the RBI adhered to its mandate, none of
the Circulars would have received that fate. For instance, in SEL Manufacturing Company
33
Ltd. v. UOI, the petitioner had entered into a Master Restructuring Agreement [“MRA”]
against its debt with a banking consortium. Violating the MRA and aforementioned RBI
Circular, SBI filed for CIRP of the petitioner under IBC. The HC held that through the
circular, the RBI had imposed an implied limitation on the exercise of right by the banks
under IBC. However, since it was in the best interest of the market and its mandate as a
regulator under S.35AA, the HC ruled in favour of RBI and quashed the insolvency
proceedings.

34
ANSWER 6:

A. SOCIAL AND ECONOMIC BENEFITS FROM PROHIBITION OF ‘RIBA’ IN

ISLAM

I. INTRODUCTION

Riba is considered to be an exploitative practice and therefore haram in Islam. It prohibits

charging any form of interest (usury) on the money lent to the borrower. Instead, the
borrower and lender into a sharing arrangement, wherein both would share the profits and
losses arising out of the capital lent. This ensures that nobody benefits out of misery. Having
a share only in the profits and not losses is also despised. This is because the borrower pays
fixed amounts irrespective of economic fluctuations. This resembles the equity sharing
model in companies. Due to the current banking framework in many jurisdictions, riba
prohibits a major chunk of Muslims to join mainstream banking. I believe that if it Islamic
banking is channelled in a proper way, it can do more good than harm.

II. SOCIAL AND ECONOMIC BENEFITS ASSOCIATED WITH PROHIBITING RIBA

C. PROPAGATES A MORE HUMANE AND ACCEPTABLE SOCIETY

Quran provides that riba should not be charged. It considers riba as tantamount to
propagating a corrupt society and a justification for negative social and moral growth of
society. This is because charging interest on borrowed money allows you to benefit from
other person’s adversities in a situation where there are unequal bargaining power between
the borrower and lender. Resultantly, the necessary offshoot of not charging interest is that it
makes the society better off as a community where people help each other financially without
hidden interests.

D. GRANTS THE ECONOMICALLY DISADVANTAGED ACCESS TO BANKING

CHANNELS

The Muslim population in India suffer from the lack of banking channels because Islam
prohibits participation in current banking model in the country. Apart from their own social
arrangements, it gets difficult for them to arrange funds. Former RBI Governor, Mr.
Raghuram Rajan mooted the introduction of Islamic Banking in his Financial Sector Study, in
which he proposed the operation of interest-free banking techniques to provide access to
people who cannot access banking services, including those that form the economically
deprived segment of society.

E. HELPS IN INCREASING EQUITY INVESTMENTS AT THE STOCK EXCHANGES

The introduction of an Islamic window in banks has many benefits. For instance, the majority
of Stock Exchange companies globally are shariat-based and attract large funds in the
domestic market alone. An Islamic banking window would inspire those in the Muslim
community to invest in ventures that mobilize enormous resources that they might not be
prepared to put into banks. This will also allow India to attract enormous investments in
shariat-compliant projects from Western Asia.

35
F. POTENTIAL TO ATTRACT FOREIGN CAPITAL FROM MIDDLE-EASTERN
COUNTRIES

Since the population in middle-eastern countries is predominantly Islamic, they would prefer
to invest in anti-riba investment instruments. The extent of capital that can be invested by
them is clearly visible by the investment drive of UAE’s Sovereign Wealth Fund. Right
from its investments in Reliance Jio, the fund had invested heavily across the globe. This
channel of funds can be tremendously exploited by adopting an anti-riba banking system that
coexists with the current system.

G. REDUCES CONCENTRATION OF WEALTH

Interest is a low risk means of increasing wealth. If you already have wealth, charging
interests on provided capital concentrates wealth into a minority that has a socially disruptive
capacity. This can be minimized by banning interest.

H. REDUCES WEALTH INEQUALITY IN THE SOCIETY

The rich who are probably the lender benefit from the need for capital by charging interest for
the poor, i.e. the borrower, which increases the burden on the borrower. As a result, the
wealthy get wealthier and the poor get worse. Interest thus increases the inequality in income
between the members of society.

I. BRINGS MORE STABILITY IN THE BANKING SYSTEM

When people lend money to others, but the money so lent is not bound up with a physical
resource, the expectation is that not everyone will try to retrieve their liquid assets
simultaneously. This enables banks to keep considerably less amount of money in reserve.
This has the potential to bring financial uncertainty into the system.

III. CONCLUSION: TOWARDS A MORE INCLUSIVE BANKING SYSTEM

The above points illustrate that Islamic banking, centered on the concept of abolition of riba,
can help the banking channels tremendously. Therefore, it is necessary to have a banking
framework where the existing system can co-exist with Islamic banking.

A. CURRENT LEGAL FRAMEWORK INADEQUATE TO CAPITALISE ON RIBA

The Indian banking legislation would has to be changed to include provisions concerning
Islamic banking. The Banking Regulation Act, for example, allows payment of interest
contrary to the principles of Islamic Banking. It also stipulates that banking means accepting
public money deposits for lending or investment, thus excluding the instruments of Islamic
banking which promote profit and loss within its scope.

B. OPENING A SEPARATE WINDOW FOR ISLAMIC BANKING

The recent proposal from RBI to open a separate Islamic banking window is a positive step to
harmonise the current banking framework and include the latter within its ambit. However, in
India, such sound steps are marred by contentious religious debates and such steps take a
political rather than a financial angle. In contrast to personal rules, investing in shariat
36
compliant projects through Islamic banking windows would be an extra financial investment
opportunity for all. Such steps are necessary as the use of one type of banking service must
not conflict with the use of another.

B. SHORT NOTE ON SUKUK BONDS I. INTRODUCTION

Sukuk bonds (Islamic bonds) refers to Sharia compliant bonds which are designed to not
harm any of the principles of Islamic banking. Conventional bond holders are paid interest on
maturity over the capital provided by them. It does not matter whether the issuer of such
bonds has made or not. The interest has to be paid. Under sukuk bonds, the holders do not
charge interest rates, but hold partial ownership of the assets purchased out of such bonds.
The potential of such investment instruments in driving growth in economy is often ignored
by the States. In 2009, Kerala became the first State in India to facilitate the sale of rupee-
denominated sukuk bonds and create investment funds that comply with Shariah law’s ban on
interest.

II. FEATURES OF SUKUK BONDS

A. COMBINED OWNERSHIP OVER THE ASSETS

Whenever the bond holder needs the money back, the asset can be liquidated. This structure
suggests that the bond holders are exposed to the risks of the asset and share responsibility
with the issuer. When the asset matures, the issuer buys them back and returns the capital to
the bondholder.

B. SHARING OF PROFIT AND LOSS

The bondholder is paid from the profits arising out of the asset. Similarly, when there is loss,
the bondholder is not paid anything and is instead required to share the loss mutually.
Therefore, this system is again akin to a profit and loss sharing model.

C. OFFSHOOT OF THE PROHIBITION ON CHARGING INTEREST

In order to bypass the prohibition on riba, sukuk was established to connect debt funding
returns and cash flows to a particular asset and effectively distribute the advantages of that
asset. This enables borrowers to deal with the restriction outlined by Sharia law and continue
to enjoy debt financing benefits. However, since sukuk is organized, only recognizable
properties can be funded.

III. SIMILARITIES & DIFFERENCES BETWEEN SUKUKS & CONVENTIONAL

BONDS

A. SIMILARITIES BETWEEN THE INSTRUMENTS

i. Investors receive a stream of payments: Conventional bonds provide investors

with interest payments, while Sukuk allows investors to receive profit generated
by the

underlying asset.

37
 ii. Less risky investments than equity: Sukuk and bonds are considered less risky
investments relative to equities.

iii. Initially sold by the issuers: Both are initially sold by the issuers to the investors.
Afterward, both securities are traded over the counter.

B.DIFFERENCES BETWEEN THE INSTRUMENTS

i. Receiving interest: Conventional bonds are such that the holder is liable to receive interest
payment on the date of maturity whether or not the issuer is making any profit (lucrative,
attractive – words used to describe the bonds since the lender is protected from risk).

ii. Maturity date: When Sukuk bonds are issued to investors, the money raised through them
is used in the purchase of an asset but the Sukuk allows the bond holder to have partial
ownership rights. The difference is that if you want you can liquidate your holdings and be
repaid, unlike conventional bonds which have a fixed maturity date.

iii. Time-period of interest payment: In conventional bond, monthly payment of interest. In

Sukuk, the bond holder is paid from profits that arise from the asset. At maturity period, the
bonds are required to be bought back by the investor.

IV. PROCESS OF ISSUING SUKUK BONDS

The unique nature of Sukuk requires a specific issuing process for the financial instrument. A
series of steps need to be followed in its issuance process. The same has been provided
below.

1. A company that requires capital [“originator”] establishes an SPV.

2. SPV issues Sukuk certificates that are sold to the investors.
3. The originator purchases the required asset using the sale proceeds of Sukuks.
4. The SPV buys the asset from the originator.
5. The SPV pays the asset sale proceeds to the originator.
6. SPV sets up the lease of the asset to the Originator.
7. Originator makes lease payments to SPV [distributed among holders as income] On
expiry of lease, Originator repurchases the asset from SPV at nominal value.
8. The SPV distributes the proceeds to the certificate holders.

NOTE: Creating an SPV protects the underlying assets from creditors if the originator suffers
from financial problems.

38
ANSWER 3: The government’s dual role in nationalised banks, as a majority
shareholder as well as regulator, has exposed these banks to systemic risks and
functional ineffiencies. Analyse the recent initiatives of the government and RBI that
are aimed at altering the existing structure to boost the efficiency and results of such
banks.

I. INTRODUCTION

In the Indian banking system, public sector banks play an important role. It holds more than
65% of the banking sector’s deposit and 60% of its distribution of loans. RBI is the banking
regulatory authority regulated by the government. In these PSBs, the government is the
controlling shareholder, which means it has the dual position of owner and regulator. Such a
structure is problematic for efficient function of the banks and leads to the following
problems.

CONFLICT OF INTEREST AND LACK OF TRANSPARENCY

State ownership of banks is a concern for corporate governance because the state as owner
and as regulator generates a conflict of interest. State ownership may also mean that officials
are given the management of the bank instead of professionals. In addition, government
ownership in these banks allowed them to operate in an opaque way. On the transparency
front, the central investigative agencies have been under government control and even the
RTI is not fully applicable to these banks. Lack of transparency and the failure to maintain
books of accounts is cited as the main explanation for an exponential increase in PSBs.

INTERFERENCE IN DAY-TO-DAY DECISIONS AND LACK OF COMPETENT

PERSONNEL

The decision of PSPs is heavily affected by the government, as the government appoints
the Board of Directors. This tilts its working towards government initiatives and prevents
private investment opportunities from being capitalized. There is also a major disparity in
the pay awarded to the bank’s top brass. In addition, PSBs rotate the CEO and provide less
versatility to hire new talents. Thus, the PSBs are plagued by a lack of adequate personnel at
the top level.

In light of these problems, the government and RBI have taken the following initiatives.

II. ANALYSING THE RECENT INITIATIVES OF THE GOVERNMENT AND RBI

Lately, both the government and the RBI have awoken to the need of revitalising the PSBs in
India. This shows that both the authorities do at least recognise the problems in the current
ownership structure of PSBs. Majorly, the initiatives taken by the government and RBI to
alter the extant ownership structure can be summarised in the following manner.

A. ESTABLISHMENT OF THE BANKS BOARD BUREAU

39
Appointment of directors in the Board of RBI has always been a bone of contention. An
independent Board would reduce government intervention the day-to-day affairs of banks.
Therefore, following the recommendation of the RBI, the Bank Board Bureau was
established. It is mandated to select and recommend appointments of Board members for
various financial institutions in public sector. It is also required to undertake activities in the
sphere of governance in these institutions. The Bank Boards Bureau would advise the
Government on the selection and designation of members of the Board in PSBs. It is also
entrusted with the task of formulating and implementing a code of conduct and ethics for
PSB managers. I think the bank boards must be completely professional and empowered to
take all bank decisions and be accountable for their results.

B. MASSIVE DISINVESTMENT PROGRAMME BY THE GOVERNMENT

The central government is planning to reduce its shareholding in the banks and pushing for
privatisation of banks. The first part of the government’s plan is to sell majority stakes in five
PSBs, including Bank of India, Central Bank of India, Indian Overseas Bank, UCO Bank,
Bank of Maharashtra and Punjab & Sind Bank. This would lead to an effective privatisation
of these state-owned lenders. This step would not only reduce the conflict between the
ownership and regulatory functions of the bank but also provide the Government the required
capital to channel into other areas.

C. SPLITTING THE POSTS OF CHAIRMAN AND MANAGING DIRECTOR OF

RBI

The RBI in 2014 proposed to segregate the post of Chairman and Managing Director [CMD]
of PSU banks. The proposal of RBI brought changes in the top management of the PSU
banks. Before 2014, the post of CMD in PSU banks was vested with one person only. As a
result, CMDs of PSU banks enjoy absolute power and often dominate the board during their
tenure. To tackle the same, the RBI recommended having separate posts for Chairman and
MD. The Government acted on it and the posts were split.

D. TIGHTENING CONTROL OVER FOREIGN BRANCHES

Previously, the RBI exerted almost no influence over overseas branches. This led to corporate
frauds and scams. Therefore, the Government allowed RBI to tightening its grip over those
branches. All transactions across the network of the bank that may use the modus operandi
used in a scam are assessed. All branches/regions that may be affected overseas are then be
identified and documentation and processes followed up in these transactions are reviewed.
Thereafter, the banks review their current internal controls to track trade transactions as well
as to investigate the position of banking workers and any collusion or negligence.
Resultantly, this significantly boosted the efficiency and results of various PSBs.

E. RBIPERFORMINGINTERNALAUDITOFPSBS

To check the growing menace of NPAs and the gross irregularities in maintaining the books
of accounts, the RBI has initiated an internal audit of the accounts of banks. This would assist
in fraud-risk assessment. It allows the RBI to internally scrutinize the accounts of PSBs and
take prior steps to initiate recovery if it finds an erring defaulter with huge downside
potential. This has significantly enhanced the accounting practices followed by PSBs, and as
a result their efficiency and results stand increased.
40
III. LACUNAE IN EXISTING FRAMEWORK AND THE WAY FORWARD

The aforementioned steps taken by the RBI and the Government have not been totally
effective in altering the ownership structure at PSBs.

NO PROPER PLAN OF ACTION ON THE DISINVESTMENT PROGRAMME

While the disinvestment programme has been much touted, a proper timeframe for the same
has not been decided. Additionally, even if there is disinvestment, the actual stake held by
the Government would be an important factor. Media reports suggest that the Government
is mulling over keeping a 51% stake in PSBs even after the disinvestment. This greatly
reduced the positive impact set to flow from such steps. It appears that the only objective of
the Government in doing so is to generate capital for itself.

In light of the aforementioned problems, I have the following suggestions to make.

A. SETTING UP A BANKING INVESTMENT COMPANY

The Government should set up a Bank Investment Company [BIC] to hold the existing equity
stakes in banks which are presently held by the Government. BIC should be incorporated
under the Companies Act, and the transfer of powers from the Government to BIC through a
suitable shareholder agreement and relevant memorandum and articles of association.

B. ESTABLISHING CORPORATE GOVERNANCE BOARDS

The Government needs to move rapidly towards establishing fully empowered boards in
public sector banks, solely entrusted with the governance and oversight of the management of
the banks. It is a precondition to the survival of these banks, to their being able to compete
in the marketplace, and to their revival. It is also a precondition for the Government not
having to periodically recapitalise its banks with deeply negative returns, with recapitalisation
amounts likely to escalate and threaten fiscal consolidation.

C. CEASING ISSUANCE OF REGULATORY INSTRUCTIONS TO PSBS

The Government should cease to issue any regulatory instructions applicable only to public
sector banks, as dual regulation is discriminatory. RBI should be the sole regulator for banks,
with regulations continuing to be uniformly applicable to all commercial banks. The
Government should also cease to issue instructions to public sector banks in pursuit of
development objectives. Any such instructions should, after consultation with RBI, be issued
by that regulator and be applicable to all banks.

41