Banking Regulation Amendment Act, 2020: A Flog on the Co-operative Bank and Powers of the State

[By Eilin Maria Baiju and Hemang Arrora]

The authors are students of Gujrat National Law University.

Introduction

Post the Punjab and Maharashtra Cooperative Scam, the Banking sector of the country faced quite a setback affecting the financial market as well as disrupting the trust of innocent depositors. As eye-opening as it was for the banking sector, it also showed the Indian economy the need for regulating the conduct of the corporative bank sector. The cooperative banking of India had major age-old lacunas owing to the dual regulatory framework under the Reserve Bank of India and the Registrar of Cooperative Societies. That is the Urban Cooperatives Bank is supervised by the Registrar of Cooperative Societies whereas the licensing, regulation, and supervision are vested with the RBI. Under Schedule VII of the Indian Constitution, the regulation of corporate banks is a subject of both the State and the Centre. The problem originated from the 1966 rule[i] that extended the applicability of the provisions over certain categories of cooperative banks provided under the Reserve Bank of India. By the virtue of the 2020 amendment, these lacunas were attempted to be cemented and certain new progressive measures were implemented. These include changes pertaining to the cash reserve ratio, restrictions on holding shares and lending loans and advances, regulation of the board of directors, etc. Towards the end of this paper, the authors have also made a humble attempt to discuss how the amendment act possibly took away the Legislative powers of the State under Item 32 List II in Schedule 7 and discusses the constitutionality of the amendment act.

Significance and Scope of Study

The Banking Regulation Co-operative Societies Rules[ii] along with the amendment created Part V and extended the applicability of provisions to certain sectors of cooperative banking societies under the Second Schedule of the Reserve Bank of India Act.[iii] This not only constituted the conflict of interest between the Centre and the State but also helped in the budding of future scams in the banking sector. The scope of this study is to analyse the developments revolving around the 2020 amendment act[iv] and the recent measures of the Reserve Bank of India through various precedents and analyse the rationale behind the respective cases, by following a doctrinal type of interest.

The Banking Ordinance: Formulation, Implementation, and Implications

India’s banking system has often been criticized for its dual framework for regulating cooperative banks. There has always been a tussle between the Registrar of Cooperative Societies (‘ROCS’) and the Central Bank of India, i.e., the Reserve Bank of India (‘RBI’).[v] Although, at a broad level, the ROCS primarily deals with the administrative aspects of such banks like auditing and managing elections, on the other hand, the RBI deals with finance-related factors like the minimum liquidity ratio, maintenance of cash reserves, inspection, etc. The past indicates several flaws in the framework, which has led to inadequate measures in resolving those banks’ financial distress, which is finding it difficult to perform their everyday functions.[vi]

A few of such failures include the government’s lack of success in reviving the cooperative bank of Madhavpura, wherein a ten-year plan scheme was implemented, but the same could not restore the bank.[vii] Similarly, in 2019, seeing Punjab and Maharashtra Cooperative Bank’s condition, the Reserve Bank of India was forced to issue directions under S.35A(1)[viii] to limit depositors’ daily withdrawals and take hold of the bank’s operations.[ix]

The Rajya Sabha had recently passed the Banking Regulation (Amendment) Bill 2020 (Bill) in its session on September 22, 2020. Several aspects of the Bill will impact the banking industry long-term. It aims to alter the Banking Regulations Act (Act) and broaden its scope to include cooperative banks’ operations. While introducing the Bill in parliament, Finance Minister Nirmala Sitharaman stated that, in light of the recent failures of the Punjab and Maharashtra Cooperative Bank and other cooperative banks, it was imperative to regulate the conduct of such cooperative banks whose failures had severely impacted the financial market and disrupted depositor’s trust in the banking industry.

Without a moratorium, devise a plan for reconstruction or merging

Post the task of placing a bank under a moratorium, the Reserve Bank of India may propose a strategy for its amalgamation or reconstruction under the Banking Regulation Act. This could be done to ensure good bank administration or protect depositors, the banking system, or the wider public. For up to six months, banks that have been put under a moratorium are immune from legal action. Furthermore, banks will be unable to make any payments or discharge any liabilities during the moratorium. The Bill empowers the Reserve Bank to launch a bank restructuring or consolidation scheme without imposing a moratorium on a stressed lender.[x]

Issuance of shares by the corporate banks

Under the new BR Amendment Bill 2020, cooperative banks are exempt from the provision on the issuance of securities and shares. Other banks are permitted to issue equity or preference shares, and the RBI has the authority to impose preference share issue restrictions. In most cases, voting rights are distributed on a one-to-one basis. An equity shareholder’s voting rights are limited to 15 per cent under the Act (read with the directions of the Reserve Bank of India). Hence, no person would be entitled to demand towards surrender of shares issued by a co-operative bank in future. The bill changes the Banking Regulation Act to allow cooperative banks to offer equity, preference, or special shares to members or other persons who live in the banks’ operational zone at face value or at a premium, subject to the Reserve Bank’s approval. Unsecured debentures or bonds with a 10-year maturity period may also be issued by banks.[xi] Without clearance from the Reserve Bank, banks are unable to withdraw capital. Members are also not eligible for reimbursement from the bank if they relinquish their shares.

Provisions related to the appointment of chairman, qualification of Board, etc.

  • Prescription of management qualifications: Cooperative banks are exempt from the Banking Regulation Act’s restrictions on qualifications and employment conditions for the Chairman and Board of Directors. It further states that cooperative banks cannot appoint as Chairman anybody who has been found guilty of a crime involving moral turpitude or is insolvent, among other criteria.                                                                                                                        The Bill mandates that at least fifty-one percent of the members of the Board of Directors have particular expertise or actual experience in fields such as economics, accounting, banking or law, among others. It enables the Reserve Bank to order a bank to reconstitute its Board if it fails to meet the conditions. If the bank fails to comply, the Reserve Bank has the authority to remove individual directors and select acceptable replacements.
  • Board of Directors Supersession: Under the Banking Regulation Act, the Reserve Bank of India can issue an order superseding the Board of Directors of multi-state cooperative banks for 5 years and appoint an Administrator.[xii] Multistate cooperative banks operate in two or more states and are governed by the Multi-State Co-operative Societies Act of 2002. The Reserve Bank may seek the Registrar of Cooperative Societies to have the Board superseded in the case of other cooperative banks. The Reserve Bank’s ability to supersede the Board of Directors is extended to all cooperative banks under the Bill. Suppose the bank is registered with a state Registrar. In that case, the Reserve Bank may issue the order after consulting with the state government and soliciting opinions within the time frame set by it.                                                                                                                          Another long-term implication of the bill is that it eliminates the option of cooperative banks opening a new place of business or change their location as provided for in the Banking Regulation Act of 1949 without the prior permission of RBI.

Regulation of Banking at Crossroad: Tussle Between the Centre and The State

The new amendment as previously discussed has forced urban cooperative banks to constitute their own board of management. In addition, a managing director has to be also appointed who will work in tandem with the Board of Directors, which will be elected by the General Body of the Co-operative Societies. Co-operative societies are left as a matter that is left for the State to entirely legislate upon under Entry 32 List II. At the same time, Entry 43 of List 1 of the Seventh Schedule, that is the Union List deals with incorporation, regulation and winding up of trading corporations. The court in the case of Union of India v. Rajendra Shah[xiii] has struck down the 97th constitutional amendment[xiv] to be unconstitutional. Part IX B was inserted by the said amendment and the 2nd proviso to Article 243ZL (1)[xv] was extended and applied to all co-operative banks. The case also held that the union will have the power to legislate on Multi-State Co-operative Societies with objects not confined to one State,[xvi] relying on the doctrine of federal supremacy. The amendment was held to be unconstitutional as it encroaches the right of State under Entry 32.

The new amendment and the RBI notification[xvii] mandate the whole of the country to appoint CEOs of these banks as per the criteria set by the RBI. The impugned notification is in violation of Section 4 of the Banking Regulation Amendment Act and hence lacks authority.

Recently, a petition was filed before the Kerala High Court challenging that the 2021 amendment and the notification affect the legislative powers of the state and hence should be declared unconstitutional.[xviii] The petitioner, in this case, contended that the amendment annihilates the provision and power ensured under the Kerala Co-operative Societies. The powers including amendment of the by-laws of these banks are also regulated and require the sanction of the RBI. The single-judge bench felt that the amendment is cutting a direct road into the State list and issued a notice to the Centre and Reserve Bank of India in the matter. A two judges bench of the Madhya Pradesh High Court also recently stayed the notification from RBI on similar grounds. From this, it is very evident that the banking laws of the country are in juxtaposition at present and the honourable judiciary should lead a way out and help the PCBs which play a pivotal role in strengthening the urban banking structure of the country.

The Division Bench of the Supreme Court on 14 October 2022 transferred all the writ petitions filed before various High Courts challenging the validity of the Banking Regulation (Amendment) Act 2020 and/or the Circular dated 25 June 2021 to the Madras High Court as per Transfer Petition (Civil Nos. 659), filed by the Reserve Bank of India.  Justices D.Y. Chandrachud and Hima Kohli observed that such a transfer would be suitable in the interests of justice so that all common questions raised before different High Courts could be considered at once. It further stipulated that any future petitions contesting the legality of the Amending Act and/or the circular shall be immediately transferred from the relevant High Court to the High Court of Madras.[xix]

Analysis and Conclusion

The conflict that is brought in by the new amendment is a conflict of the Lists, it is a tussle on the power to legislate in the field of Co-operative Societies when it falls exclusively with State and does not specifically lie within the domain of the Union, much less the Reserve Bank of India. It was in view of this possible conflict that Sections 10, 10 A, 10B, 10BB, 10C and 35B were purposely omitted through the 1965 amendment. Though the Finance Minister, Smt. Nirmala Sitaraman,  in her speech in Lok Sabha, mentioned that the Bill under question is in no way affecting or modifying the existing powers of the State. But the provisions of the bill have been knitted to let the roots of the central government directly regulate the co-operative societies. Though the new amendment has not directly taken over the co-operative banks from the State; the power to regulate has been significantly diluted. The Amendment Act has only excluded Primary Agricultural Credit Societies and Co-operative Societies with the principal business of financing agricultural development from the purview of the centre. The new notification dated 25.06.2021along with the amendment prima facie looks like a colourable legislation to allow the Union to purposefully meddle with the powers of the State and completely nullify its authority over the PCBs. The bill also states that the Central Government can from now on supersede the lender’s board, provided the Co-operative Bank is registered with the Registrar of Co-opertaive Societies of the State for a period of 5 years.  But the authors agree to the narrative that the economic situation of the co-opertaive banks has significantly changed during the covid-19 pandemic and the amendment might directly help in strengthening the sector.  Numerous Co-operative Societies have approached various courts of the country to decide on the validity of the amendment, especially the constitutionality of Section 4 of the Banking Regulation Amendment Act alleging it to be ultra-vires of the constitution. The RBI order is also challenged and is under stay before the Madhya Pradesh High Court as well as the Kerala High Court on the ground that RBI lacks authority to legislate on the matter.

 

[i] The Banking Regulation Co-operative Societies Rules, (1966), Available at: https://thc.nic.in/Central%20Governmental%20Rules/Banking%20Regulations%20(Co-Operative%20Societies)%20Rules,%201966.pdf.

[ii] Ibid.

[iii] Reserve Bank of India Act, 1934, No. 2 Acts of Parliament, 1934 (India).

[iv]  Banking Regulation (Amendment) Act, 2020,  No. 30, Acts of Parliament, 2020 (India).

[v] Reserve Bank of India, Reserve Bank of India – Reports Available at: <https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1185#Box_2>  ( Mar. 19, 2022).

[vi] Reserve Bank of India, Developments in Co-operative Banking, (2020), <https://rbi.org.in/scripts/PublicationsView.aspx?id=20271 > (Mar. 15, 2022).

[vii] Akshat Singh, RBI scraps licence of ailing Madhavpura co-operative bank, The Indian Express (Feb. 19, 2022, 8.30 pm) https://indianexpress.com/article/cities/ahmedabad/rbi-scraps-licence-of-ailing-madhavpura-cooperative-bank/.

[viii] Banking Regulation Act, 1949, § 35 A(1), No. 10, Acts of Parliament, 1949 (India).

[ix] Reserve Bank of India, Press Releases, Directions under Section 35-A of the Banking Regulations Act, 1949, (2021), https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=52959 (Mar. 15, 2022).

[x] Anulekha Ray, Banking Regulation Amendment Act: What it means for the customers and banks, Live Mint, (Feb. 22, 2022, 4.32 pm) https://www.livemint.com/industry/banking/banking-regulation-amendment-bill-2020-passed-what-it-means-for-banks-customers-11600337144895.html.

[xi] Nikuj Mehta, Implications of the Banking Regulation Amendment Bill, IPleaders (Mar. 01, 2022, 6.30 am) https://blog.ipleaders.in/implications-banking-regulation-amendment-bill-2020/.

[xii] The Ministry of Finance Industry and Labour, The Banking Regulation Amendment Bill, 2020 https://prsindia.org/billtrack/the-banking-regulation-amendment-bill-2020 (last visited  Mar.12, 2022).

[xiii] Union of India v. Rajendra Shah, LL 2021 SC 312.

[xiv] India Const. (Ninety-Sixth Amendment) Act 2011.

[xv] India Const. art. 243ZL cl.1.

[xvi] Supra Note 4 at ¶ 23.

[xvii] Reserve bank of India, Notification No. RBI/2021-22/60

https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MDWTD207E35D0F9F749B69C27F7AD9330D1DE.PDF, dated June 25, 2021.

[xviii] Tiruvalla East Co-operative Bank & Anr. v. Union of India and Others., WP(C) No.15295/21.

[xix]  Mohammad Imranullah S., Madras HC to hear cases filed across the country challenging validity of Banking Regulation Act of 2020, The Hindu, (Jan. 20, 2022 6.34 pm) https://www.thehindu.com/news/national/tamil-nadu/madras-hc-to-hear-cases-filed-across-the-country-challenging-validity-of-banking-regulation-act-of-2020/article66025418.ece.

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