On 5 May 2020, a five-judge constitutional bench of the Supreme Court in Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Limited ruled that co-operative banks could resort to the mechanism under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) for debt recovery.
Essentially, the Court clarified the relationship between two entries in the seventh schedule to the Constitution that divides legislative domains between the Union and the States: entry 45, list I (the Union entry), i.e. ‘banking’, and its interaction with entry 32, list II (the State entry”), viz., ‘… incorporation, regulation, and winding-up…of…co-operative societies’. The judgment held that the SARFAESI Act was related to the banking business of co-operative banks, and since it did not regulate incorporation, regulation, and winding up of co-operative banks, there was no encroachment upon the State entry. The Court pronounced that with respect to their ‘banking’ business, co-operative banks registered under state legislation are governed by the Union entry, but with respect to ‘incorporation, regulation and winding up’ of co-operative banks registered under state legislation, the competency to legislate rested with the states under the State entry. The pronouncement in Chaugule is bound to impact future Union legislation related to co-operative banking, beginning with the Banking Regulation (Amendment) Bill, 2020 pending before the Lok Sabha.
The Banking Regulation (Amendment) Bill, 2020
Co-operative banks already have their banking business partially governed by section 56 of the Banking Regulation Act, 1949 (the “BR Act”), which introduces bare minimum banking regulation for co-operative societies, enabling them to conduct banking activities. However, the BR Act’s provisions under parts IIA (control over management), IIB (supersession of board), and III and IIIA (winding-up affairs) are not extended to co-operative banks, as these subjects are deemed covered by the State entry.
Introduced in the Lok Sabha on 3 May 2020, perhaps compelled by the recent co-operative bank scandals and failures, the Bill seeks to extend the application of professional management and governance standards and requirements to co-operative banks, and bring their regulation on par with ordinary banking corporations. To summarise, it achieves these ends inter alia by:
- enabling issue of equity capital and long-term unsecured debentures by co-operative banks via private placement or public issue;
- empowering the Reserve Bank of India (“RBI”) to supersede boards of co-operative banks registered with State registrars, after ‘consultation’ with the State government concerned;
- removing restrictions on co-operative banks with regards to loans to directors or related entities, and loans and advances with the co-operative banks’ shares as security;
- enabling co-operative banks to open business activities at new locations without RBI permission; and
- removing certain credit adequacy restrictions.
The meaning of ‘banking’
As stated above, the view in Chaugule furthers the regulation of ‘banking’ activity of co-operative banks by the Union, while the regulation of remaining aspects of co-operative banks continues to remain with the States. Case law referred to in the judgment reaffirms the view that the term ‘banking’ cannot be straightjacketed, and that the courts recognise the fluidity of banking business and its temporally changing nature.
Reference may be made to the bank nationalisation case, i.e., Rustom Cavasjee Cooper v. Union of India, wherein it was held that the term ‘banking’ in the Union entry is to be read widely. The term encapsulates within its fold ‘banking’ and ‘banking business’ as defined under the BR Act, as well as any other activity permitted to be carried out by banks under that statute. Further, the Court observed:
“The word “banking” has never had any static meaning and the only meaning will be the common understanding of men and the established practice in relation to banking. That is why all these disputed forms of business come within the legitimate business of a bank.”
Being a commercial activity, the meaning of ‘banking’ changes contemporarily, and the law must refrain from solidifying its meaning to permit conformity with the practicalities of commerce à la mode. This understanding was further developed in ICICI Bank Ltd. v. Official Liquidator, wherein the Supreme Court laid down that banks could undertake novel activities with RBI permission, and the central bank was free to grant permission as long as the activity was not restricted by sections 8 and 9 of the BR Act.
It can be argued that, even otherwise, such extension and modification of banking business with time would not be held to surpass the term ‘banking’ in the Union entry, principally for two reasons. First, as a principle of interpretation, the Supreme Court has consistently held that entries in the seventh schedule must be given the most liberal meaning permissible. In Elel Hotels and Investment Limited v. Union of India, for example, the Court held:
“In construing the words in a constitutional document conferring legislative power the most liberal construction should be put upon the words so that the same may have effect in their widest amplitude.”
Second, as the Court mentioned in State of Madras v. Gannon Dunkerley & Co., in the context of the seventh schedule, that if new facts surface with time, which were not contemplated at the time of enactment of a legislation, it can still be applied to the new facts, provided that the language of the statute is wide enough to incorporate the new circumstance. If drafters use terms that can be interpreted broadly, then it can be assumed that they anticipated the changing nature of such terms and their understanding with time. In the view of the author, the term ‘banking’ meets this test in Gannon Dunkerly, especially considering that the federal power of regulating “[b]anking, that is to say, the conduct of banking business by corporations other than corporations owned or controlled by a Federated State and carrying on business only within that State.” under legislative lists of the Government of India Act, 1935, was converted to mere “banking” by the Constitution.
Thus, a conjoint reading of Chaugule and the aforesaid decisions enables future regulation of co-operative banks by the Union Parliament and, resultantly, brings expansive banking activity under the regulatory powers of the RBI.
How much can the Union Parliament do?
Co-operative banks are subject to a hybrid regulatory structure under Indian law, wherein both the State and the Central governments maintain oversight. This hybrid system, referred to as ‘dual control’ or ‘dual regulation’ arose out of disagreements between the RBI and State governments. The Constitution of India accorded ‘banking’ as a subject to the Central Government, and gave regulation of co-operative societies to the States. However, soon after independence, the need to extend the RBI’s deposit insurance to co-operative banks arose. The RBI was unwilling to agree to broaden deposit insurance cover without correlated expansion of its regulatory oversight over co-operative banks. The States initially deemed this to be an unfair bargain for losing regulatory powers. However, co-operative banks were growing and so was their impact on the country’s monetary condition. After lengthy discussions, the current hybrid regime was agreed to and established by RBI and State governments, especially byextending the application of the BR Act to co-operative banks.
Since then, the importance of co-operative banks in the economy has increased substantially. Nonetheless, parallel modifications in its regulatory scheme have not caught up with that increasing importance. In 2016, then RBI Governor Raghuram Rajan reasserted the importance of co-operative banks while noting:
“There are some very successful co-operative banks, on par with any universal bank, but far too many suffer from governance problems. The RBI has been engaged in bringing stronger governance to urban co-operative banks, but split supervision with state authorities limits how much it can do.”
The Bill seeks to enlarge the regulatory powers of RBI, as Rajan would have sought, and extends its regulatory arm to ensure better administration of co-operative banks.
However, any such increment in powers surely would raise questions about legislative competency vis-à-vis the two entries. On one hand, the test to examine permissibility of any such regulation, including the Bill, would be whether it concerns ‘banking’ as it is understood at the time of such assessment. The Chaugule decision substantially reaffirms the law and paves the way for answering such a question. Moreover, while the State entry does read ‘… regulation … of … co-operative societies’, any regulation deemed to be covered under the Union entry would prevail following the general rule that in case of overlaps with no possibility of harmonious construction, an entry in the Union List prevails over an entry in the State List. As far as the pith and substance of a legislation is within the competence of the legislature with reference to the seventh schedule, it will not be ultra vires merely because it also ventures into the other list. Such an expansive interpretation given to the Union List surely benefits Parliamentary competency in enacting the Bill and such legislations in the future.
On the other hand, what remains to be decided, and where the Court did not have the opportunity in Chaugule to answer, is how to reconcile interests when the Union’s power to regulate ‘banking’ necessarily requires it to regulate matters falling in their entirety within the State entry. For example, the Bill allows the RBI to supersede co-operative bank boards, after ‘consultation’ with the State Government concerned. It could be argued that such supersession powers are governance measures necessary to ensure adherence to sound banking practices. To the contrary, regulation of co-operative bank management has been repeatedly held within the State’s powers, and the term used in the Bill is merely ‘consultation’ and not ‘concurrence’. The former is a process by which a party’s views are communicated to assist the other party in making a decision, while the latter means “approval”. The RBI would not be under any obligation to follow the States’ advice, effectively shifting that power to the Union. The issue of equity capital and unsecured debentures by co-operative banks, and their regulation by the RBI also appears to be prima facie beyond the Union Parliament’s powers, as it would fundamentally change a cooperative society’s incorporated structure.
It is therefore likely that these questions touching upon legislative competence, and whether the regulatory measures sought to be implemented through the Bill to regulate ‘banking’ affairs of co-operative banks and possess requisite nexus with the Union entry or venture into the States’ domain, would fall for determination by the courts.
– Karan Kamath