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Supreme Court quashing 12 February circular a healthy wake-up call for RBI

RBI’s problem isn’t so much that it willingly breaks the law, but that it believes and acts as if it has the powers to issue broad regulations that lie outside its legal jurisdictions. (Reuters)Premium
RBI’s problem isn’t so much that it willingly breaks the law, but that it believes and acts as if it has the powers to issue broad regulations that lie outside its legal jurisdictions. (Reuters)

  • Supreme Court has held RBI's 12 February circular unconstitutional, simply because it went outside the remit of what the law allowed it to do
  • The good news, however, is that the quashing doesn’t mean the good work that has begun on bankruptcy resolution has been undone

"There is a very real danger that financial regulation will become a wolf in sheep’s clothing," former US treasury secretary Henry Paulson once said.

While the Supreme Court hasn’t exactly characterized the Reserve Bank of India (RBI) as a wolf in its latest ruling that went against the banking regulator, there are enough warning signs that should make the central bank welcome some reform.

First and foremost, the whole practice of regulating by issuing legally-questionable circulars should be called into question.

The infamous 12 February 2018 circular of RBI that laid down broad rules for banks to take back their dues from errant borrowers found no love from the judiciary.

The Supreme Court has said the circular is unconstitutional, simply because it went outside the remit of what the law allowed it to do.

RBI’s problem isn’t so much that it willingly breaks the law, but that it believes and acts as if it has the powers to issue broad regulations that lie outside its legal jurisdictions. The fact that it didn’t stand the courts’ scrutiny in this instance is a healthy wake-up call.

In recent years this belief is being increasingly questioned and the latest Supreme Court ruling should help in bringing change at RBI.

For perspective, while the law stated that the RBI can give instructions to banks to refer specific cases for bankruptcy proceedings, after consulting with the government, the 12 February circular had a broad remit and didn’t explicitly follow the consultation process to the court’s liking.

Bad loans and provisions surged for 39 listed banks as a sign of full recognition following RBI's 12 February circular that ended all forbearance schemes.
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Bad loans and provisions surged for 39 listed banks as a sign of full recognition following RBI's 12 February circular that ended all forbearance schemes. (Vipul Sharma/Mint)

Against this backdrop, the regulator needs an overhaul of some of its regulations, which are dated and loosely worded. Besides, the circulars it issues would need to be drafted carefully, with the help of good lawyers.

The good news is that the Supreme Court’s order quashing the RBI circular doesn’t mean the good work that has begun on bankruptcy resolution has been undone.

“RBI’s powers as a regulator is not challenged. What is challenged is RBI directing banks to take companies to NCLT. They can do it only in consultation with the govt," said Abizer Diwanji, partner and national leader (financial services) at EY India.

“As far as the existing cases referred to insolvency courts after the circular, the Supreme Court judgement is unlikely to affect them as these insolvency cases are not explicitly stating the circular as the reason," he added.

As such, there is enough room for RBI to continue issuing instructions to banks to refer defaulters for bankruptcy resolution. How this exactly plays out remains to be seen.

For now, if the court ruling nudges RBI to make changes in its policymaking process, it would be a good outcome. Regardless of the central bank’s response, there would be enough market participants who will be emboldened by the ruling and perhaps challenge some more regulations. Kotak Mahindra Bank Ltd’s decision to challenge regulations on bank shareholding may also well get an impetus, as it poses somewhat similar questions of law.

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