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Photo: Reuters
Photo: Reuters

Opinion | A judgement that balances power and proportionality

The apex court’s order on virtual currencies reinforces RBI’s authority but calls for care in its exercise

In a judgement on Wednesday spanning elements as diverse as Vedic philosophy and cypherpunks, Jain parables and the history of central banking, the Supreme Court set aside a circular issued by the Reserve Bank of India (RBI) banning entities regulated by it from dealing in virtual currencies. Rich with details on the character of virtual currencies and their manner of regulation, as also the power and role of RBI, the judgement provides learnings on proportionality in regulatory response and governance. The top court acknowledged RBI’s pre-emptive as well as reactive powers to regulate virtual currencies, but held that such powers should be exercised by demonstrating the harm sought to be addressed or mitigated through its action.

The judgement has set the stage for RBI to recalibrate its policy response towards the regulation of virtual currencies in a way so as to address potential consumer protection issues and systemic financial stability issues, as well as cybersecurity issues. Regulating rather than banning virtual currencies presents an opportunity for RBI to explore their potential in the present environment, more so at a time when the International Monetary Fund has advocated that central banks issue digital currency themselves. Most of all, one hopes that the judgement will foster the evolution of better regulatory governance on the part of RBI, such that any regulatory action on its part is backed by empirical data and a cost-benefit analysis of why the regulation is required and how it is likely to mitigate the stated risk.

The circular in question through which it banned entities regulated by it—banks, non-banking finance companies and payment and settlement systems—from providing any service with respect to the purchase and sale of virtual currencies was issued by RBI on 5 April 2018. It is, however, useful to remember RBI’s earlier foresight on the regulation of financial technology. RBI issued guidelines on internet banking way back in 2001, with several prescient features, such as two-factor authentication. A more recent example is that of the regulatory sandbox, where it inducted the very first cohort. RBI has often been ahead of the curve in encouraging the use of digital and other technologies in finance, and their regulation.

Indeed, the top court in its judgement also acknowledged that RBI could not have been accused of non-application of mind. RBI had taken cognisance of virtual currencies and the technology that underlies them as early as June 2013, and had factored in multiple considerations on the risks and attendant regulation, including those raised by the Financial Action Task Force and the Bank of international Settlements. The Institute for Development and Research in Banking Technology, which was established by RBI, has, in fact, put out a white paper on the potential of the use of blockchain technology, on which virtual currencies are predicated.

The Supreme Court examined international precedents to determine the character of virtual currencies—scanning the definition and usage of the term in the statutes of 18 different countries and nine US states—and arrived at the conclusion that governments and regulators realize that virtual currencies are capable of being traded as real money and perform the role of legal tender, but they are in “denial mode".

The apex court relied on an analysis of the nature and role of virtual currencies, but also acknowledged that RBI was the sole repository of the power to regulate them, even if they did not have all the features of money (medium of exchange; unit of exchange, store of value, and final discharge of debt). The top court had no doubt or ambiguity on the power of RBI to regulate virtual currencies, given its overall power to operate India’s currency, credit and payment systems. It even reinforced RBI’s special role in the economy. It is with respect to the manner in which RBI’s powers are exercised that the top court made an argument about proportionality. It held that RBI did not demonstrate how banks, other financial firms and payment systems suffered any adverse impact to justify the ban.

In several developed jurisdictions, it is considered a good practice to conduct a cost-benefit analysis and place this in the public domain before any regulation is framed. Similarly, an impact analysis is regularly carried out following the issuance of a rule to ascertain whether it is having the intended effect and whether it has had any unintended consequences. The top court’s judgement could perhaps nudge RBI to adopt similar practices, which could serve to demonstrate the mode, manner and basis of the exercise of its regulatory powers. It would also serve as a defence if and when its regulatory actions are challenged.

Former US Supreme Court Justice Louis Brandeis famously said that sunlight is the best disinfectant. Moving virtual currencies from the darkness of the ban towards the light of regulation is perhaps the appropriate action to mitigate the risks of volatility, anonymity, money laundering and financing of crime.

The Supreme Court’s Wednesday judgement is an example of the country’s top court respecting RBI’s autonomy while fostering responsive regulation. This should not be mistaken as judicial activism, as it has reinforced the powers of the central bank and its unique role in the economy, while also encouraging it to exercise its powers with proportionality and responsibility, backed with adequate empirical evidence.

L. Viswanathan & Richa Roy are, respectively, a partner focused on infrastructure projects and financing, and a partner in the insolvency, restructuring and policy practice at Cyril Amarchand Mangaldas

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