Banking Law

[By Kapil Devnani]  The author is a student at the Hidayatullah National Law University, Raipur.  Section 138 of the Negotiable Instrument Act, 1881 (hereinafter “NI Act”) is a penal provision that allows the payee to institute a suit against the payer in case the cheque drawn by him got dishonoured. Recently, in the month of January 2022, three important judgements of different High Courts regarding this provision came. The first one is Parvaiz Ahmad Bhat & Anr. v. Fida Mohamamd Ayoub, given by the Jammu and Kashmir and Ladakh High Court; the second one is Rajeswary v. State of Kerala, given by the Kerala High Court; and the last one if Kodam Danalakshmi v. State of Kerala, given by the Telangana High Court. This blog is an attempt to comprehend the scope of Section 138 through these decisions. Parvaiz Ahmad Bhat & Anr. V. Fida Mohamamd Ayoub (Dishonour of cheque due to incomplete signature will be considered as an offence under Section 138) Facts of the Case In this case, the Petitioners challenged the complaint that was filed by the Respondent against them under Section 138 of the NI Act read with Section 420 of the IPC. The complaint was still pending before the CJM, however, by an order dated August 27th, 2020 the learned Magistrate issued the process against the Petitioners, to which the Petitioners responded and filed the petition before the Jammu and Kashmir and Ladakh High Court. The issue in this case was that the Petitioner’s cheque was dishonoured due to an incomplete signature on the cheque, and the High Court needed to decide whether or not this constituted an offence under Section 138 of the NI Act. The Petitioner argued that the Respondent’s complaint is not maintainable because the cheque got dishonoured due to incomplete signature and not because of insufficient funds. They relied on the case of Vinod Tanna v. Zaheer Siddqui,  (hereinafter “Vinod Tanna’s case”) in which it was held that the dishonour of cheque just because of incomplete signature will not attract Section 138 of the NI Act. Analysing the Judgement A mere reading of Section 138 is sufficient to conclude that this provision is attracted in two situations. First, when the individual drawing the check has insufficient funds in his or her bank account and second, if the amount to be paid is greater than the amount arranged to be paid from that account. However, there have been instances where the dishonour of the cheque was the result of some other reasons, but the judiciary allowed the application of Section 138. The Supreme Court in NEPC Micon Limited v. Magma Leasing Limited, held that Section 138 should not be interpreted strictly and for giving this verdict it relied on the cases of Kanwar Singh v. Delhi Administration and Swantraj and Others v. State of Maharashtra, in which it was held that the narrow interpretation of this provision will defeat the legislative purpose for which it was enacted. Walking on the lines of these judgments, the Supreme Court in M.M.T.C. Ltd. v. M/S Medchl Chemicals held that in case a cheque is dishonoured because of the instruction to stop payment, then Section 138 would be attracted. The only protection available with the petitioner in this case was the verdict of Vinod Tanna’s case, however, this verdict of the Supreme Court came up for consideration in Laxmi Dyechem v. State of Gujarat. In this case, the SC did not follow the ratio laid down in the case of Vinod Tanna and the reason was that the case of Vinod Tanna was based on the verdict of Electronics Trade & Technology Development Corpn. Ltd. v. Indian Technologists and Engineers Ltd, however, the same was overruled by the case of Modi Cements Ltd v. Kuchil Kumar Nandi. In Laxmi Dyechem, the Supreme Court held that in case the cheque is dishonoured due to incomplete signature or wrong signature, Section 138 will be attracted. Both the judgments of Vinod Tanna and Laxmi Dyechem were given by the bench of equal strength. However, Laxmi Dyechem’s case is the latest one and based on that the SC in the present case gave the decision in the favour of the Respondent and held that in case a cheque has been dishonoured just because of incomplete signature, then in that scenario Section 138 would be attracted.  Rajeswary v. State of Kerala (The Case of Cheque Bounce under Section 138 could be closed in case the fine is paid directly to the Complainant) Facts of the Case In this case, the accused was convicted by the trial Court under Section 138 of the NI Act for simple imprisonment for a period of 1 year and further to pay a fine of Rs.7,17,000/- and in case of default, additional imprisonment for further 3 months. Later on, the Kerala High Court modified the imprisonment of 1 year awarded by the Trial Court as a sentence to pay a fine of Rs.7,17,000/-. Following that, the convict paid the plaintiff the fine of Rs.7,17,000/-, which was acknowledged by the plaintiff himself when he issued a receipt of the transaction. Thereafter, the convict presented that receipt before the Trial Court and requested to close the case. However, the Court rejected this petition, stating that the convict was required by the Court’s Order to deposit the amount of fine in the Court, but he instead paid the fine directly to the plaintiff, so the Court could not accept the receipt of the payment and the case would continue. Aggrieved by this, the convict preferred an appeal before the Kerala HC. Analysing the Judgement The question before the HC was to determine whether the case of cheque bounce be closed in case the convict pays the fine directly to the plaintiff. To determine this, the Court relied on the judgment of Beena v. Balakrishnan, (hereinafter“Beena’s case”) in which it was held that if the person receiving the fine directly from the convict (in this case, the petitioner) files

[By Karma Shah and Diya Vaya] The authors are third year students at the Gujarat National Law University. Introduction Our nation is facing a massive issue of Non-Performing Assets (hereinafter “NPAs”). Put simply, an NPA is any bank asset or receivable that has stopped making payments to the bank and has remained unpaid for a specified amount of time. The Reserve Bank of India (hereinafter “RBI”), in its Master Circular, dated 30th August, 2001, has given an extensive definition of NPAs, which aids Indian banks in identifying and treating NPAs. In this definition, the RBI has specified the period after which assets stop giving returns as a meagre 90 days. NPAs are a threat to the Indian economy, as due to the strict prudential norms set by the RBI with respect to NPAs, banks have virtually stopped lending. This has led to the downfall of economic growth. An increase in NPAs leads to several unfavourable outcomes for the economy as a whole. These include, but are not limited to first, lower profit margins for banks and an increase in rates by banks for achieving a higher profit margin, second, reduction of liquidity in the organised financial sector, third, increased work-load on the judiciary, leading to an increased social cost to the society and lastly, stressed balance sheets of banks, less return to investors, and other such tangential issues. To combat this threat to the nation’s economy, Ms. Nirmala Sitharaman (hereinafter “the finance minister”) proposed the introduction and setting up of ‘bad banks’ in the 2020-2021 Union Budget. Moreover, most recently, i.e., on 16th September 2021, the finance minister laid down the framework for the National Asset Reconstruction Company Ltd. (hereinafter “NARC”), India’s first ‘bad bank’. This blog aims to, first, explain the meaning of bad banks and their crucial need in the contemporary Indian economy. Second, examine the recent framework establishing bad banks laid down by the finance minister, and third, analyze the impact on the banks and the national economy. Bad Banks – Meaning and Function Bad banks are those institutions that, simply put, buy the NPAs and bad loans of banks and other financial institutions in exchange for cash and/or securities. The first-ever bad bank set up in the world was by Mellon Bank in the USA. In practice, a bad bank plays the role of asset reconstruction. It buys the NPAs, bad loans, and other risky assets from various financial institutions, specifically banks. The bad bank then manages and recovers these over time. Hence, contrary to a conventional bank, their core and primary function is the recovery of NPAs and bad loans. Banks essentially isolate and divide their assets into two separate categories. One category contains the illiquid assets, including the NPAs, risky securities, non-strategic assets from businesses that are no longer beneficial to the bank, non-performing loans, and other high-risk or troubled assets. The second category contains the good and beneficial assets that perform well and represent the bank’s core business. A bad bank, a corporate structure, takes the NPAs and bad loans of such banks and provides cash and/or government securities in return. This allows the bank to clear their balance sheets, infuse themselves with liquidity, and helps them focus on their core business instead of trying and recovering the NPAs. The Critical Need for Bad Banks in the Indian Economy  The Covid-19 pandemic has led to an unprecedented negative impact on our economy. Cash flow has reduced, leading to issues of loan repayments, tax payments, and interest payments. Furthermore, NPAs have been blocking the progress of our economy since the last decade. In such a desperate financial scenario, the need of introducing bad banks in the Indian Economy was critically felt due to the following reasons: First, primarily to resolve the NPA crisis. NPAs have been a constant obstacle preventing the Indian economy from unleashing its true potential. NPAs have started to drastically increase in Indian Banks since 2013, forming almost 10% of the loans provided by the banks. As per RBI, NPAs of all the scheduled commercial banks have increased from 2.35% in 2011 to 8.21% in 2021, amounting to an increase of almost 250% in a decade. Moreover, due to the onset of Covid-19, RBI has presented a warning in its July 2021 Financial Stability Report that the gross NPA ratio may increase to 9.80 percent by March 2022 under the baseline scenario; and to 11.22 percent under a severe stress scenario. India has the third-highest gross NPA ratio. When a bank has a high NPA ratio, it spends a high percentage of its profits covering consequential losses incurred due to the high NPAs. This creates a situation of decelerating the cash flow in the economy, reducing the lending frequency of the banks and ultimately affecting the economy as a whole. . In this scenario, NARC is a much-needed expert entity required to fuel the economy’s growth, provide capital to banks and resolve the financial crisis. Second, to provide support to the Insolvency and Bankruptcy regime (hereinafter “IBC”). The IBC was enacted with the objective of debt recovery and reducing the NPAs in the economy, among others. However, it did not perform as per expectations. Furthermore, it is argued that the IBC and associated debt recovery mechanisms are still at a nascent stage in India. For IBC to resolve all issues of NPAs plaguing our economy it requires greater judicial capacity, manpower and time. This can be provided by the bad bank, which creates a separate entity for quicker and more efficient one-time resolution and debt recovery. Now, banks need not worry about debts and can focus on strengthening the economy. Furthermore, the appreciable role played by bad-banks in other countries is the greatest testimony of its potential to resolve the issue of NPA’s in India and accelerate economic growth. Hence, a bad bank is necessary to tackle the issue of the large stock of NPAs in the economy as a one-time solution. Impact of the recent framework on Banks and Indian Economy On September 16, 2021, the finance minister set

[By Tushar Chitlangia & Vipasha Verma]  The authors are students at the National Law University Odisha.  Introduction The Reserve Bank of India (RBI) released a Consultative Document on Regulation of Microfinance on June 14, 2021 (Document). Microfinance is a type of banking service which provides loan to small borrowers at favourable terms. Prima facie, the major policy changes the Document aims is abolishing the inconsistency of a regulatory framework and dealing with the issue of over-indebtedness of the borrowers. However, the Consultative Document presents some challenges that need to be detailed out. RBI has recommended assessment of household income, while also capping outstanding loans at 50%of household income. Additionally, the Document suggests that requirement that 50% of the loan portfolio of the Non-Banking Financial Company-Micro Finance Institutions (NBFC-MFIs) is to be advanced for income generation activities, should be abolished. Further, it increases the limit of minimum of Net Owned Fund (NOF)requirement, which raises certain issues for NBFC-MFIs in an economy ravaged by the pandemic. Conversely, the Consultative Document also recommends sagacious policies such as abolition of external benchmarking for NBFC-MFIs, and of the interest rate ceilings. In this post, the authors present a critical review of the key policy changes introduced by the Document and provide suggestions at the institutional level to smoothen the implementation of these policies over the years. Assessment of Household Income In the past five years, the pool of borrowers in the microfinance sector of India has doubled, to around 5.8 crore. However, roughly 1 in every 20 Indian is indebted to a lender. Default risks are substantially high due to the lenders inability to predict borrower cash-flows during and after each cycle. Take for instance, the case of Assam, where micro-lenders classified borrowers with more than five loans as eligible for another. This is typically due to dependence of lenders primarily on information furnished by the borrowers on assets, income, and expenditure. These declarations are mostly of poor quality and not necessarily the best indicators of eligibility as the target demography are low-income households, wherein income varies with seasons and in most cases, assets do not generate cash. It is therefore, essential, to institute a robust cash-flow assessment mechanism. Micro-lenders adopt the practice of “lending to the limit”, which implies that outstanding loan (including interest) will be till 50% of that household’s income. The Document further underlines a few “criterion of income assessment”, but ultimately relies on Board policies of the micro-lenders. Due to the prescriptive nature of limits and the open-endedness of the criterion, micro-lenders have no real incentive or assume liability beyond adhering to them on surface level. Therefore, RBI must consider establishing a uniform policy to mandate all micro-lenders to carry out income assessments under a legal obligation. Instead of dependence on unverifiable declarations, this policy must include adding cross-checks of primary and secondary sources of income, a consumption roster with questions broken down into relevant purchase periods, and data check points (based on cross-checks) to capture informal loans. Further, micro-lenders must adopt cash-flow based underwriting, such a process would require lenders to capture details of occupational profiles, income flows, expense flows, and debt flows of the entire household, either directly or through the use of proxies and questions and combining these with information from credit bureau records. This would allow lenders to assess sustainability of the income under adverse conditions. RBI, by enumerating assessment processes in detail will increase adherence and limit a risky customer base going into the future. Consumption Loans Microfinance is an innovation that fosters entrepreneurship. It allows recipients to develop a wide range of productive activities that generate revenues. However, in the recent years, it has been observed that customers have had little success. There are increasing levels of indebtedness owing to repayment inability. The major reasons for which have been: first, using credit loans for consumption purposes, and second, borrowing from multiple sources (mostly informal) to service debt, and the deteriorating effect of cumulative debt is worse since they earn no profit. The document has abolished the limit of minimum percentage of loans to be lent for income-generation activities, citing that most borrowers depend on micro-lenders for consumption needs. However, the Malegam Committee, in its report, had observed that the main objective of micro-credit is to move its customer base out of poverty by using the loan for income-generating activities and developing a stable income. Further, it had argued that credit used for consumption purposes might increase the financial burden on the poor due to over indebtedness. Unless customers are able to progress from lower to higher incomes, they may become permanently dependent on the bank. Therefore, there is significance in income-generation activities. The RBI, by abolishing this limitation, allows micro-lenders to forego assessments that were an essential element of providing microcredit, such as evaluation of the clients’ business model for profit-generation, and providing workshops for entrepreneurship expertise. This is because any incentive to uphold the purpose of microcredit is lost. The RBI has mentioned that microcredit as consumption loans is essential in the Indian context. But without income generation there will be minimal income sustainability. It is imperative that RBI enforces the creation of different loan products for unplanned/consumption expenses, through an appropriate mix of savings and micro-insurance products through policy and guidelines. RBI, by reinstating a limit, will ensure that the micro-lending sector does not dilute to a basic personal loans bank. NOF Requirement The document leaves the doors open to consider whether the extant minimum NOF requirement for NBFC-MFIs should be increased or not. The current minimum NOF requirement for NBFC-MFIs is Rs. 5 crores (and Rs. 2 crores for the NBFC-MFIs located in the North-East region). A Discussion Paper released by RBI on January 22, 2021,suggested that the minimum NOF requirement for all NBFCs, including NBFC-MFIs, should be increased to Rs. 20 crores. The reasons given were that there are high costs to be incurred to maintain the necessary IT infrastructure, and there is a need for the NBFCs to be