This article is written by Sarabjit Singh, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here he discusses “Rules and Regulations Governing Financial Institutions in India”.

Introduction

Reserve Bank of India (RBI) is the biggest financial institution in India.  All others dwarf in size, power and capability. It steers the economy of India, holding the destiny of 140 crores inhabitants at its command.  The ‘Godfather’ to all other financial institutions that exist or those that shall come into existence in the future.  A nation may have the most lethally equipped and determined armed force in the world, but if it does not have an equally strong economic power to sustain this force; it is but a deceptive illusion. 

Thomas Jefferson president of USA is quoted to have said in 1800’s, “I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”  Implying both to its might and the importance of regulating the economic wellbeing of a country.  Consequently, it is paramount to maintain a healthy balance between regulation and economy.  

Every human being who has lived on this earth has at one-time or the other desperately needed financial assistance either to fight off a crisis beyond his control or to enrich himself further.  For both purposes, financial assistance is required. Without any doubt, it will be ideal to seek financial assistance from a legally established financial institution than to be left at the mercy of ubiquitous money lenders locally called mahajan, sahukar etc. The latter provide succor, but after gaining their pound of flesh. 

For a welfare state like India, it is the Government’s solemn duty to provide financial assistance easily, at affordable prices and within walking distance of where the most impoverished population resides.  “Out of the total population living in the rural parts of 35 states and UTs of India, 25.7 per cent of them is living below the poverty line, according to Reserve Bank of India (Sharma, 2019).”  It will be a mammoth task for the government alone or its welfare schemes to uplift all below the poverty line.  So, it is the financial institutions that will provide an opportunity to escape poverty, for those willing to help themselves.  Noble prize winner, Muhammad Yunus, Bangladeshi social entrepreneur, banker, economist and civil society leader has summed it aptly, “People.. were poor not because they were stupid or lazy. They worked all day long, doing complex physical tasks. They were poor because the financial institution in the country did not help them widen their economic base.”

Reserve Bank of India (RBI)

The premier financial institution of India RBI was formed under the Reserve Bank of India Act, 1934, and nationalized in the year 1949.  The preamble of RBI reads as follows:

“to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth.”

Breaking into simple terms it envisages:

• Issues Notes.
• Maintaining reserves, to ensure stability. Ref. to Exchange management.
• Operation of currency and credit system. Ref. to Controller of Credit.
• Practice modern monetary policy.
• Maintaining price stability to aid growth

Therefore, after setting such high standards for itself it is even more incumbent upon RBI that all financial institutions sanctioned by it perform equally well.  And in order to regulate them it conceptualizes and recommends to the legislature for all kinds of statutory norms, regulations, rules, and issues from time-to-time directions / guidelines it deems necessary so that the highest standards of Corporate Governance are maintained.  

RBI is the administering authority to enforce the following acts: –

• Reserve Bank of India Act, 1934.
• Government Securities Act, 2006.
• Government Securities Regulations, 2007.
• Banking Regulation Act, 1949.
• Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
• Credit Information Companies (Regulations) Act, 2005.
• Payment and Settlement Systems Act, 2007. 
  • Payment and Settlement Systems Regulations, 2008 and amended up to 2011and BPSS Regulations, 2008.
  • The Payment and Settlement Systems (Amendment) Act, 2015.

• Factoring Regulations Act, 2011.
• The Insolvency and Bankruptcy Code, 2016. 

Other relevant Acts administered by RBI: – 

• Negotiable Instruments Act, 1881
• Bankers’ Books Evidence Act, 1891
• State Bank of India Act, 1955
• Companies Act, 1956/ Companies Act, 2013
• Securities Contract (Regulation) Act, 1956
• State Bank of India Subsidiary Banks) Act, 1959
• Deposit Insurance and Credit Guarantee Corporation Act, 1961
• Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970
• Regional Rural Banks Act, 1976
• Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980
• National Bank for Agriculture and Rural Development Act, 1981
• National Housing Bank Act, 1987
• Recovery of Debts Due to Banks and Financial Institutions Act, 1993
• Competition Act, 2002
• Indian Coinage Act, 2011 : Governs currency and coins
• Banking Secrecy Act
• The Industrial Development Bank (Transfer of Undertaking and Repeal) Act, 2003
• The Industrial Finance Corporation (Transfer of Undertaking and Repeal) Act, 1993
• Banking Laws Act, 1956 & 1963

RBI has the dual responsibility to regulate and supervise the financial system in the country.  Empowered with the various acts and regulations at its disposal it sanctions the establishment of new financial institutions and controls their functioning.  They are categorized as follows:

1. Scheduled Banks
   1. State Co-operative Banks
   2. Commercial Banks
      • Public Sector Banks
      • Private Sector Banks
2. Non-Scheduled Banks
   1. Commercial Banks
   2. Central Co-operative Banks & Primary Credit Societies

Some of the important financial institutions are:

• National Bank for Agriculture and Rural Development (“NABARD”)
• Small Industries Development Bank of India (“SIDBI”)
• EXIM Bank
• National Housing Bank
• Life Insurance Corporation
• Unit Trust of India

Major functions of RBI

Issues Notes

Issues the legal tender rupee of India in every denomination except for one-rupee note and coins.  Thus, preserving the faith of the public in the paper currency. At all times it holds a minimum reserve of Rs.200 Crores i.e. Rs. 115 crores are backed by gold, and 85 crores in the form of foreign securities against the currency issued.

Banker’s Bank   

It holds a part of cash reserves of commercial banks and lends funds for short periods. By fixing the cash reserve ratio reserve bank controls credit and inflation.  Empowered vide numerous regulations mentioned above reserve bank controls the activities of all financial institutions. 

Banker to the government

It handles all banking facilities for the Central Government and the State Governments. Accepts and pays money, carries out exchange remittances.  Lender to the Government of India. Short term credit needs of the government are met by issuing treasury bills and long term by bonds. Deals with the IMF and World Bank on behalf of the government.  Advisor to the government on all matters relating to banking, financial, mobilization of resources, credit, economic issues and international finance. 

Exchange management

At all costs external value of rupee is to be maintained.  It is directly related to internal stability, economy and monetary affairs.  RBI is vested with the power of managing the investment and utilization of the reserves mostly held in the form of monetary gold, foreign assets etc, in the most advantageous manner. 

Lender of Last Resort

It comes to the rescue of commercial banks to tide over financial difficulties. 

Controller of Credit

Has the all-important control oversupply of money and bank credit.  Thus, supervising price and exchange rate stability. To achieve its end bank rate is adjusted accordingly. 

Since the availability of credit at desirable rates is hugely important to sustain growth, and equally important to protect the creditor.  Credit is controlled in accordance with the economic priorities of the government. Therefore, to keep pace with the modern world and restore the faith of the international community pertaining to ease of business parameters and investments, insolvency bankruptcy code was enacted.  Though RBI has a plethora of regulations at its disposal, we shall peep into IBC only.   

Insolvency and Bankruptcy Code, 2016 (IBC)

Insolvency is the inability of an individual or entity to pay its debts when they fall due.  Or simply put when liabilities exceed assets. Even after selling or mortgaging of the assets, debt still cannot be resolved.   While bankruptcy is the legal procedure that comes into operation if insolvency is not resolved. This can happen at the asking of either the creditor or debtor.  Once all assets of the debtor have been liquidated and proceeds paid to creditors. The adjudicating authority may debar creditors from pursuing recovery proceedings thereafter. 

Why IBC?

Earlier insolvency was dealt under Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920.  It was applicable only to individuals and partnerships; corporations were excluded. This was followed by Companies Act, 1956, Sick Industrial Companies (Special Provision) Act, 1985 (SICA),   Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI), Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFESI), and Companies Act, 2013.  However, non-performing assets of banks and non-banking financial institutions kept mounting.  Perhaps due to multiplicity of laws and judicial forums; recovery proceedings kept on lingering endlessly.  Recovery of legitimate debts remained complex and time-consuming process. To give an example in Jeevan Diesels vs. Hongkong Shanghai Banking Corporation decided by Calcutta High Court, 02.12.2014.  High court had to decide on the question that could one creditor move a winding-up petition, while the other initiated enforcement action before the DRT under RDDBFI Act.  Meaning thereby that the same matter was agitated before the High Court and DRT at the same time but by different creditors. Many more such incidents led to the enactment of IBC. 

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Brief insight into IBC 

The Insolvency and Bankruptcy Board of India is the implementation authority of IBC, and National Company Law Tribunal (NCLT) and Debt Recovery Tribunal (DRT) are the adjudicating authorities.  NCLT hears cases involving incorporated Public and Private companies and Limited Liability Partnership firms while DRT is tasked with individuals and partnership firms.  Decisions of NCLT can be challenged before the National Company Law Appellate Tribunal (NCLAT), and the last appeal lies before the Apex Court of India.   Under this code matters pertain to insolvency, liquidation, voluntary liquidation or bankruptcy.  Creditor as defined under this code means, “any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree holder.”

Salient features of IBC

Briefly: 

• To resolve matters in a time bound manner.
• Maximize value of assets.
• Balance the interests of all the stake holders. 
• Ensure availability of Credit. 

Sections 6 – 32 under Chapter II of IBC deal with ‘Corporate Insolvency Resolution Process’.  On corporate debtor’s default in paying due debt anyone i.e. financial creditor, operational creditor or the debtor himself may apply to resolve the insolvency before NCLT.  Within 14 days of receiving the application, the adjudicating authority shall pass orders whether to accept or reject the application. In case of any deficiency on the part of the applicant additional 7 days can be afforded to rectify the defect. 

From the date of admission of the application the insolvency resolution process is mandated to be completed within 180 days.  However, if the circumstances so demand the resolution professional could request more time, and if the adjudication authority deems fit time can be extended, maximum 90 days. 

On admission of the application a moratorium is declared, which prohibits the following acts:

• Pending legal proceedings before any court of law, tribunal, arbitration panel or other authority ceases nor can any new proceedings begin against the corporate debtor. 
• Corporate debtor is barred from transferring, encumbering, alienating, disposing, or creating any legal right or beneficial interest w.r.t. his assets. 
• SARFESI Act, cannot be enforced, nor can any owner or lessor recover his property which is in the possession of corporate debtor. 

Moratorium shall continue until completion of resolution process.  Besides order of moratorium public announcement is made inviting claims from creditors.  An interim resolution professional is appointed, and he shall manage the affairs of the corporate debtor to the exclusion of all others.  Relevant information is collated from the authorities concerned and claimants. Details of assets in any form and manner are tabulated, and where necessary control and custody is exerted.  All concerned personal are statutorily required to cooperate. After gathering all the information, a committee of creditors is formed, and meeting called within 7 days. Committee of creditors may decide to continue with the interim resolution professional as resolution professional or appoint a new one by a majority vote of 75%.  Even the newly appointed resolution professional can be replaced later at the discretion of the committee of creditors. 

Resolution professional shall be singularly responsible to conduct the smooth functioning of the entire process in a time bound manner and monitor the operations of the corporate debtor’s business.   He shall invite offers from prospective lenders, investors, and any other persons with his resolution plans.   

Once an information memorandum is prepared, a copy of it shall be supplied to the resolution applicant with all other relevant information that he shall desire.  The resolution plan is then submitted to the committee of creditors for approval. It requires approval by no less than 75% vote. On approved resolution plan shall be submitted to the adjudicating authority.  If it meets all the legal requirements the adjudicating authority shall pass orders binding all the parties for its execution. Any person aggrieved by the order has the remedy to appeal before the National company law Appellate tribunal.  The procedure explained above with slight variations is also applicable to LLPs, partnership firms and Individuals. 

liquidation 

 It is covered by Chapter III of IBC sections 33 – 54.  If for any reason insolvency resolution process fails; the adjudicating authority shall order liquidation of the corporate debtor.  The insolvency resolution professional already appointed shall function as liquidator. He shall sell the immovable and movable property vide public auction or private contract.  He possesses the power to transfer the auctioned assets to any person or body corporate to realize the debt. Similarly, he shall have the power to draw, accept, make and endorse any negotiable instruments including bill of exchange, hundi or promissory note in the name and on behalf of corporate debtor.  Proceeds from liquidation shall be distributed in the following order of priority. 

1. Expenses of insolvency resolution process and liquidation.
2. Payments of workmen; secured creditors who relinquish security interest. 
3. Financial debts owed to unsecured creditors.
4. Central and state government dues.
5. Secured creditors for any amount unpaid following the enforcement of security interest.
6. Remaining debts and dues.
7. Preference shareholders or partners.
8. Equity shareholders or partners. 

If after liquidation nothing remains the corporate debtor shall be dissolved on the orders of the adjudicating authority.

Chapter VII of IBC enlists offences and penalties that shall apply to corporate debtor when he does any act prior to commencement of resolution process or during to conceal, defraud, destroy, gift, mutilates or falsifies accounts, alienates, alters, pawns, pledges, encumbers any of his assets to deprive the creditors of their legitimate dues.  

As per Business Standard dated 03.12.2019: “As many as 10,860 cases under the Insolvency and Bankruptcy Code were pending before the National Company Law Tribunal (NCLT) at the end of September 2019, Parliament was informed on Tuesday (India, 2019).”

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