QUESTION 5: Whether the dues of the State or its instrumentalities have priority over the

dues of secured creditors under SARFAESI 2002? Examine the position with the help of
decided case laws and relevant provisions under SARFAESI.

DUES of SECURED CREDITORS UNDER SARFAESI, 2002

[SARFAESI] Securitisation and Reconstruction of Financial Assets and Enforcement of Security

Interest 2002

Preamble, SARFAESI Act of 2002 is “an act to regulate securitization and reconstruction of
financial assets and enforcement of security interests, and to provide for a central database of
security interests created on property rights, and for matters associated with or incidental
thereto.”

The act can be utilized to tackle the problem of Non-Performing Assets (NPAs) through different
procedures. However, this is possible only for secured loans. For unsecured loans, banks should
move the court to file a civil case of defaulting. The first asset reconstruction company (ARC) of
India, ARCIL, was set up under this act.

• Doctrine of priority of crown debt

• Chapter- IVA Inserted by Enforcement of Security Interest and Recovery of Debts Laws
and Miscellaneous Provisions (Amendment) Act, 2016.
• Although, SARFAESI Act forms core of this answer, yet even in the DR&B Act, Section
31b is worded similarly to Sec 26E of SARFAESI, 2002.

26E. Priority to secured creditors.—Notwithstanding anything contained in any other law for the
time being in force, after the registration of security interest, the debts due to any secured creditor
shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable
to the Central Government or State Government or local authority.

Only exception is carved out in cases where proceedings have already been initiated under the
Insolvency and Bankruptcy Code 2016 against the borrower’s assets.

35. The provisions of this Act to override other laws.—The provisions of this Act shall have effect,
notwithstanding anything inconsistent therewith contained in any other law for the time being in
force or any instrument having effect by virtue of any such law.

37. Application of other laws not barred.—The provisions of this Act or the rules made thereunder
shall be in addition to, and not in derogation of, the Companies Act, 1956 (1 of 1956), the Securities
Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and Exchange Board of India Act,
1992 (15 of 1992), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51
of 1993) or any other law for the time being in force.

Section 31B of the DR&B Act:

31B. Priority to Secured Creditors- “Notwithstanding anything contained in any other law for
the time being in force, the rights of secured creditors to realize secured debts due and payable to
them by sale of assets over which security interest is created, shall have priority and shall be paid
in priority over all other debts and government dues including revenues, taxes, cesses and other
rates due to the Central Government, State Government or local authority.”
State Bank of India v. Jt. Director, Directorate of Enforcement, Kolkata.

On behalf of the Appellants it was contended that Secured Creditors have the priority over the
rights of the Central or State Government or any other local authority and that the amendment to
section 26E of SARFAESI and 31B of DR&B Act amendment had been introduced to facilitate
the rights of the Secured Creditors which were being hampered by way of provisional attachment
of the properties belonging to the Banks/Secured Creditors. Reliance is placed on the Judgment
dated 14.07.2017 passed by the Tribunal.

The Appellants had also referred to judgment of the Full Bench of the Madras High Court in the
case of The Assistant Commissioner (CT), Anna Salai-III Assessment Circle Vs. The
Indian Overseas Bank and Ors.,

“There is, thus, no doubt that the rights of a secured creditor to realise secured debts due and
payable by sale of assets over which security interest is created, would have priority over all debts
and Government dues including revenues, taxes, cesses and rates due to the Central Government,
State Government or Local Authority”. This section introduced in the Central Act is with
''notwithstanding'' clause and has come into force from 01.09.2016. Further it was also held that
the law having now come into force, naturally it would govern the rights of the parties in respect
of even a lis pending.

Additional/ancillary provisions –

Secured creditor, secured debt, security interest

Section 2 (zd) “secured creditor”

Section 2 (ze) “secured debt” means a debt which is secured by any security interest;

Section 2 (zf) “security interest” means right, title or interest of any kind, other than those specified
in section 31, upon property created in favour of any secured creditor and includes—

(i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind, on
tangible asset, retained by the secured creditor as an owner of the property, given on hire or
financial lease or conditional sale or under any other contract which secures the obligation to pay
any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided
to enable the borrower to acquire the tangible asset; or

(ii) such right, title or interest in any intangible asset or assignment or licence of such intangible
asset which secures the obligation to pay any unpaid portion of the purchase price of the intangible
asset or the obligation incurred or any credit provided to enable the borrower to acquire the
intangible asset or licence of intangible asset;

Cases—

Bombay Stock Exchange v. V. S. Kandalgaokar [(2015) 2 SCC 1](“BSE Case”)

State Bank of India v. State of Maharashtra [(2020) SCC online Bom 4190] (“SBI Case”)

EARC also relied upon the decision of the Hon’ble Supreme Court (“SC”) in the BSE case and
the decision of the BHC in the SBI case of It was submitted that in both the abovementioned

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judicial pronouncements, it was held that the Income Tax Act, 1961 (“IT Act”) does not provide
for paramountcy of income tax dues. It was further submitted that in the SBI Case (supra), it was
held that secured debt has priority over income tax dues and, therefore, EARC as secured creditor
has a prior superior charge over the income tax dues.

The BHC further observed that the SC while giving the decision in the BSE Case (supra) also
referred to its own decision in the case of Dena Bank v. Bhikhabhai Prabhudas Parekh & Co.
[(2000) 5 SCC 694],where it was held that Government dues have priority only over unsecured
debts.

The BHC further assessed that in the SBI Case, the BHC also considered the question of priority
between the charge of a secured creditor and tax/VAT dues under the Maharashtra Value Added
Tax Act, 2002 and, after considering the provisions of SARFAESI Act as well as RDDB Act, it
was observed that the mortgage of a secured creditor gets prior charge over the charge of the state
for tax/VAT dues.

The BHC, with reference to the CBI Case (supra) relied on by the ITD, observed that the said
decision was distinguished in the SBI Case (supra) wherein, the SC stated that, since Section 26E
of the SARFAESI Act and Section 31- B of the RDDB Act were not in the statue book at the
time of deciding the CBI Case (supra), the impact of the said sections did not come into
consideration. In light of the abovementioned case laws and provisions, the BHC was of the view
that EARC’s charge/mortgage over the Premises has priority over the dues of the ITD.

The section 31B of the Debts and Bankruptcy Act, 1993 came in force from 1st September 2016
and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 came in force from 24th January 2020.

Following this reasoning given in Kalupur, Bombay High Court in SBI judgment has recently
ordered that even if Section 26-E was effective only prospectively from 24-1-2020 and thus not
applicable to the facts at hand as they were prior in time, that would not make any difference; as
Section 31-B itself would be sufficient to give priority to a secured creditor over the statutory dues.

State of M.P. v. State Bank of Indore

M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, Income-Tax Department and
Others [2021]

Very Recently, the Bombay High Court (“BHC”) has in its judgement dated July 28, 2021, held
that, the secured debt shall take priority over the ‘Government’ dues/tax dues.

Hence, it is forthrightly clear the government dues do not take priority over dues of secured
creditors under the SARFASEI Act.

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QUESTION 4: Examine the different remedies available to a secured creditor under
SARFAESI? How does “securitization” work with respect to non-performing assets?

ALTERNATIVE REMEDIES VESTED WITH SECURED CREDITOR UNDER

SARFAESI ACT, 2002

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act
2002 [hereinafter SARFAESI Act]

was enacted with the intent to provide banks or financial institutions (FIs) to recover on NPAs
without intervention by the court. These financial institutions are those who have a presence in
India and are notified by the Government of India.

Its primary objective is to regulate securitization and reconstruction of financial assets and
enforcement of security interest created in favour of secured creditors. The Act provides for three
alternative methods for recovery of NPAs: (a) securitisation; (b) asset reconstruction; and (c)
enforcement of security without intervention of court. This includes either taking the possession
of the secured assets of the borrower (with the right to lease, assign or sell the secured assets)
or taking over the management or business of the borrowers until the NPA is recovered.
The SARFAESI Act also provides for the sale of financial assets by banks and financial institutions
to Asset Reconstruction Companies (ARCs). The financial assets can be sold to ARCs in
accordance with the guidelines and directions issued by the RBI.

Thus, asset can be acquired only:

a. for the purpose of realization of the financial assistance; and

b. when the borrower is in default; but not otherwise.

Section 11

Where any disputes relating to securitization or reconstruction or non-payment of any amount due
including interest arises amongst any or the parties, namely, the bank, or financial institution, or
securitization company or reconstruction company or qualified institutional buyer, such dispute
shall be settled by conciliation or arbitration as provided in the Arbitration and Conciliation Act,
1996, as if the parties to the dispute have consented in writing for determination of such dispute
by conciliation or arbitration and the provisions of that Act shall apply accordingly

Under the SARFAESI Act, 2002, an exhaustive procedure has been laid down under the
SARFAESI Act, 2002 along with rules defining the manner in which banks may exercise
against the delinquent borrower to enforce the security interest in the asset.

* Invocation of Act for enforcement of security is triggered by classification of the account as

“Non- performing Asset” by the Banks and Financial Institutions referred to as the secured
creditors. In terms of the present Reserve Bank of India guidelines, in case any amount, which is
due and payable by the borrower and has not, been paid for more than ninety days, the said account
can be classified as NPA.

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Section 13

Power to take possession

Upon classification of account of the secured creditor as non-performing asset, who defaults in
the payment of secured debt or any instalment thereof, the Bank or Financial Institution gives a
prior notice to the defaulting borrower including the mortgagors and guarantors under section
13(2) calling upon them to pay the entire due amount within a period of sixty days.

The notice referred under section 13(2) shall give details of the amount payable by the borrower
and the secured assets intended to be enforced by the secured creditor in the event of non-payment
of secured debts by the borrower.

The authorized officer of the bank/secured creditor shall consider such representation or
objections and if after considering such representation or objection secured creditor comes to the
conclusion that such representation or objection is not acceptable or tenable, he shall within fifteen
days from the date of its receipt of such representation or objection the reasons for non-acceptance
it, to the borrower. This enables the Bank to correct itself if it is wrong in the process of
adjudication. Before this exercise is done and the borrower has been suitably replied to, the secured
creditors cannot take possession of the secured asset and management of business of the borrower.

Section 13(4) makes provision for an alternate remedy in case the payment is not made by
the borrower in full within the stipulated 60 days time period mentioned in the notice under
section 13(2), the secured creditor may take one or more recourse mentioned in under section
13(4) namely—

a. To take possession of the secured assets of the borrower including the right to transfer by
way of lease, assignment or sale for releasing the secured asset. When it comes to taking
possession of the property, there are two concepts- taking symbolic possession & taking
actual possession.
b. To take over the management of the business of the borrower including the right to
transfer by way of lease, assignment or sale for releasing the secured asset.
c. Appoint the manager, to manage the secured asset whose possession has been taken.
d. Requiring money from any person who has acquired any of the secured assets from the
borrower and from whom any money is due to the borrower, to pay to the secured creditor,
by notice in writing.

Under Section 13(4), after the accounts are being declared as NPA and the representation of the
borrower/guarantor is rejected, the secured creditor (i.e. bank or FI) can take recourse to any of
the measures specified therein to recover its outstanding debt. This includes taking over “symbolic
possession” of the mortgaged property; or taking over the management of the business of the
borrower, as mentioned thereunder. In continuum, Sections 13(5-A), (5-B) and (5-C) encapsulate
the mechanism of auctioning of the mortgaged immovable property to 3rd parties for the recovery
of the outstanding dues. If the statutory scheme is being seen holistically, then it clearly implies
that taking over of symbolic possession followed by auction of the mortgaged property is all part
of the same proceedings as a series of steps towards the larger objective of recovery of outstanding
loan of the bank/FI. Section 13 is wide enough to allow the creditor to resort to any type of
measures of recovery, and this is the distinctive feature of the SARFAESI Act, that it has vested
the secured creditor with host of powers for arm-twisting the borrower or the guarantor for
expeditious realisation of the outstanding borrowings.

Section 14

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To apply under Section 14, a creditor has to establish that, on the date of making of such an
application, it is a secured creditor, in respect of a secured asset, and has a security interest, in
respect of such secured asset. After sale, the secured creditor can no longer claim a security interest
over such immovable property, as such security interest stands dissolved by the issuance of the
sale certificate. On the execution and registration of the deed of conveyance, the title to the
immovable property stands transferred to and vested with the purchaser and the secured creditor
does not retain any right, title or interest over and in respect of the immovable property sold.

In Apex Electricals Ltd. v ICICI Bank Ltd it has been held by the Gujarat High Court, that the
rights of the bank under sub section (1), (2), (3) and (4) of section 13 cannot be read as creating a
lawless situation, but should and must be preserved by maintaining rule of law and not allowing
the disturbances of law and order situation. And such rights of secured creditor cannot be read as
giving authority or power to the secured creditor to apply force of muscle power for taking
measure under section 13(4) of the Act, and for such situation where muscle power required
secured creditor resort of the provisions of section 14 of the present Act.

Right to Appeal and consequent Right to file a caveat

Any person aggrieved on account of any measure taken under section 13(4) by the secured creditor
may make an application, along with requisite fees, to the Debt Recovery Tribunal within forty
five days from the date on which such measures has been taken

And if the Debt Recovery Tribunal finds the measures taken by the secured creditor under section
13(4) in conformity with the provision of this Act, it may allow the secured creditor to proceed
with the measure taken by him. Aforesaid application must be disposed off as expeditiously as
possible within sixty days from the date of such application. However, it may extend such period
for reasons to be recorded in writing, for four months from the date of the making of the
application.

Section 17

Proceeding to Section 17, it employs the phrase “any person aggrieved by any of the measures
under Section 13(4)”, which implies any and every action resorted to by the bank, it is authorised
to take recourse to under and in pursuance of Sections 13(4), 14, 15, so on and so forth. The
section does not clearly stop at providing remedy for the decision under Section 13(4), but
transcends to include every such measure, which all are being undertaken by the bank towards
making its action under Section 13(4) fruitful and consequential.

Pertinently currently existing Section 17 had been amended recently by Act No. 44 of 2016,
wherein the previously available “right to appeal” or to “prefer an appeal” against the very same
set of measures by the creditor came to be substituted with the word “application”. The reasons
are not too far to seek for this intentful amendment to Section 17. Post amendment, the statutory
position is clear that the DRT is the first stop forum for redressal of any aggrieved borrower, and
widespread powers have been conferred on the DRT to undo the injustice or the wrong committed
to the borrowers by the financial institutions in a desperate bid to recover their outstanding
amount.

Section 13(4) and 17

The Supreme Court in Indian Overseas Bank v. Ashok Saw Mill interpreted the correlation
between Sections 13(4) and 17 holding that the plethora of remedies and powers conferred under
Section 17 acts as “checks and balances” on the creditors from misusing their powers. Section 17

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balances the stringent powers of recovery of their dues vested with the banks/FIs and DRT can
even restore possession after the same has been made over to the transferee by declaring any action
under Section 13 as void. This includes setting aside any concluded sale transaction, even when
the possession has been transferred to the auction purchaser. The Court referred to the judgment
of Mardia Chemicals Ltd. v. Union of India to hold that post the aforesaid judgment sweeping
amendments were effected to Section 17, whereafter the DRT has been conferred with ample
powers of restoring the position of the borrower back to its original place prior to Section 13(4)
initiation. Vide paras 36-39, the Court held that the DRT if it discovers after inquiry that resort to
Section 13(4) or any of its successive measures has been improper, then it can go to any extent
and pass any order for restituting the borrower to its pre-Section 13(4) situation. This includes
setting aside any transaction that might have happened including auction, sale, vesting of
ownership in the auction purchaser, so on and so forth. Thus Section 17 is a repository of remedies
and redressals available to any borrower against the bank and limited interpretation should not be
accorded to it.

Section 37

Unlike Section 35 that overrides other prevalent laws, the application of SARFAESI is in
addition to, and not in derogation of provisions under the Companies Act, 2013, RDDBFI
Act, 1993 among others. Hence, the intent of the drafters was clear to provide for parallel
remedies under the two legislations without one impeding/obstructing other’s
application.

The enactment of SARFAESI has been a major factor in improving the health of banks and
financial institution by enabling the them to reduce their NPAs to substantially lower levels. On
account of availability of dual remedy, i.e., remedy under the SARFAESI and DRT Act, the banks
and financial institutions have been able to substantially resolve the NPAs.

Further, now the Insolvency and Bankruptcy Code [IBC] 2016 also serves as a helping hand to
this object, yet the SARFAESI that dealt particularly with secured loans i.e. asset consists of lots
of complications under the Act for obtaining possession without the intervention of the court.
Taking peaceful and lawful possession the Banks and Financial Institutions is reliant on the
constraint to file an application for support before the Chief Metropolitan Magistrate or District
Magistrate, which is itself a time taking process.

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FUNCTIONALITY OF THE SECURITISATION IN CONTEXT OF NPAs

The concept of securitisation has been adopted more recently from the American financial
system and has been described as processing of acquiring financial asset and packaging
the same for investments by several investors. Securitisation as a technique gained
popularity in the US in the 1970. UK is the second largest market for securitisation after
the US.

Securitisation started in US in 1970 with the issue of residential mortgages by public

housing finance corporations. The institutions found that they had to pay higher interest
to attract short term deposits, while rates earned on long-term mortgage loans was less.
This created mismatch between assets and liabilities. The Solution was found in
securitisation.

Section 2(1)(z) “securitisation” means acquisition of financial assets by any [asset reconstruction
company]from any originator, whether by raising of funds by such [asset reconstruction
company]from [qualified buyers]by issue of security receipts representing undivided interest in
such financial assets or otherwise;

Thus, ARC makes money from money by taking up something of minimal value, enhance its
value, remodel it, and resells such refurnished assets.

The Basel Committee which in the year 2001, has released a document on Securitisation, covering
the banks in three context: (i) as originators of Securitised assets; (ii) as sponsors of assets based
securities; and (iii) as investors in assets based securities, the Article comprehends the international
practice of securitisation in the following words:

“As far as the international practice is concerned, the „Accounting for transfer and servicing of
financial assets and extinguishing of liabilities‟ governs the accounting and reporting standards. It
provides standards for distinguishing transfer of financial assets that are sales from transfers that
are actually nothing but secured borrowings. A transfer of financial assets, in which the transferor
surrenders control over those assets in accounted for as a sale to the extent that consideration
other than beneficial interests in the transferred assets, is received in exchange.

Process of Securitisation

The process of securitisation begins when the lender (originator) segregates

loans/lease/receivables into pools which are relatively homogeneous in regard to types of credit,
maturity and interest rate risk. The pools of assets are then transferred to a Special Purpose Vehicle
(SVP). The SVP issues assets backed securities in the form of debt, certificates of beneficial
ownership and other instruments.

These securities will be rated by Credit Rating Agencies. Presently, it is envisaged that such
securities will be offered to QIBs (Qualified Institutional Buyers) only. Public participation is not
envisaged. The SVP acts as intermediary. It buys financial assets from seller or transferor and issues
securities to the investors. Money received from investors is paid to the transferor. The investors
are serviced and repaid out of the assets realised over a period of time.

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ARCs collect loan files from different banks and sort them into different categories.

There are two preconditions for invoking the right of qualified buyers to regulate the conduct of
ARC.

1. There should be non-realization of financial assets.

2. The meeting should be called by holders of that class of security receipts who hold security
receipts of at least 75% of all security receipts.

Then whatever resolution is passed would be binding on the ARC. In this manner, the interest of
the investors is secured. The business model of ARC is subservient to any decision taken by the
qualified rights.

Benefits of Securitization

1. Quick access to liquidity – Encashing long term assets It will enable banks and financial
institutions to encash their long term assets and use the funds for further lending.
Securitisation will therefore result in further credit growth.

2. Availability of adequate funds with banks and FIs for financing infrastructure
projects – Gestation period and schedules for repayment in such projects are very long
and hence ability of banks and financial institutions to commit funds for such projects is
limited. With the creation of the legal framework for securitisation, the banks and financial
institutions will be encouraged to lend to such projects without having any concern for
locking up of their funds for number of years.

3. Enhanced quality of credit and improved assessment of credit – Any issue of

securitised debt instruments will in practice be credit rated by Credit Rating Institutions
and this practice will ensure that banks/financial institutions observe certain basic norms
of credit appraisal, documentation and standardize the terms and conditions. As a result,
the overall quality of credit will improve.

4. Security and convenience to new investors Power of enforcement given to

securitisation companies along with banks and financial institutions under the provisions
of the new law, will provide comfort to the investors that in the event of default, speedy
recovery is possible by enforcement of securities. This comfort will have a boost to
investment in such securitised debt instruments, and provide additional resource avenue
for banks and financial institutions.

Andhyrujina Committee Report – Identified the problematic link between Securitisation and
Taxation

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Analyzing the Keynesian perspective on the prevailing banking conditions in India in 1913,
highlight the background and necessity which led to the establishment of a Central Bank
in India. Also, discuss the debate between Dr. B.R. Ambedkar and J.M. Keynes on the
appropriateness of gold standard in India.

I have attempted to answer the question in two major head- the first head entails the first and
second part of the question; while the latter addressed the debate between Dr Ambedkar and JM
Keynes on appropriateness of gold-standard in India.

KEYNESIAN CONTENTIONS IN FAVOUR OF STATE BANK OF INDIA

Establishing the factual context prevalent then—

• Transition from trading entity to an administrative set-up [ruling entity]

What started as a merchant or trading activity in India, eventually became an empire. When trading
is started, maximization of wealth is the goal. However, if the territory is administered it has direct
impact on revenue and wealth generation. The administrative cost incurred by the British was to
maximise their return from zamindari system, ryotwari system, etc.

The British realised that extracting a lot of money from poor peasants was not as much
advantageous as it was a few years back, and thus a need was felt for a proper currency issue
system.

• Genesis of the idea of a Centralised Banking System

Colonial Rule to Imperial Rule – As per the political sciences the period prior to 1857 (First War
of Independence, Sepoy Mutiny) – India was subjected to colonisation by the British East India
Company. While the period post 1857, is when the British Crown directly ruled India, it then
transformed to an Imperialist rule. Although this constituted a mere technicality in the eyes of
many, yet once the crown rule was established many systemic changes were observed and one
among such was the idea of a Central Bank.

Arbitrary and baseless abuse of power at the hands of the government, lead to the idea of a Central
Bank which would further their profit motive. Idea of central bank gained traction.

• Commercial Banking v. Expansionist tendencies of Governments

Profiteering can happen only if assets are utilised in best possible way. This is not the case with
govts. It was an expansionist period involving many wars and thus, government had its hands full.
Ultimately, we have to have certain reserves of cash or assets. This is taken by bank to be useless
or idle money. It serves only the purpose of the govt.- no utility to the bank. Thus, the 2 world
wars changed perception towards commercial banking. Commercial banking requires a completely
different play field than central banking.

TRANSITION- Presidency Banks to an Imperial Bank (intended to function as a state

bank)

• Turning to efforts made in India to set up a banking institution with the elements
of a central bank, we find that up to as late as 1920, the functions envisaged for

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 the proposed bank were of a mixed type, reflecting the practices abroad. Also, it
was only towards the close of the nineteenth century and the beginning of the
twentieth that the term ‘central bank’ came to be used in India in the official
despatches.

• It was proposed at that time to amalgamate the three Presidency Banks into
one strong institution; the central banking functions envisaged for the new
institution were not only those of note issue and banker to Government, as in the
earlier proposals, but also maintenance of the gold standard, promoting gold
circulation as well as measuring and dealing with requirements of trade for foreign
remittances. The new bank was to perform commercial banking functions as well,
as the Presidency Banks had been doing till then. Even the ‘State Bank’ proposed
by John Maynard Keynes in 1913 was to engage in both central banking and
commercial banking functions.

• The amalgamation of the Presidency Banks took place in 1921, the new institution
being called the Imperial Bank of India, but it was not entrusted with all the
central banking functions; in particular, currency management remained with
Government.

• Another matter on which something should be said at the outset about the concept
of ‘State Bank’ is that the term was used in different senses from time to time. For
instance, Sir S. Montagu, in his evidence before the Fowler Committee in 1898,
stated that by ‘State Bank’ he did not mean a Government bank, but an Indian
national bank doing the local business of the country and having branches which
offered remittance facilities and which could also be entrusted with the function
of note issue.

KEYNES CONTENTION FOR SETTING UP A STATE BANK

He urged the creation of a central bank (or “State Bank”) for India, thus enabling centralization of
reserves, far greater monetary elasticity, and far more monetary expansion and inflation.

• In 1913, though Keynes did not define the term ‘State Bank’, he used that
expression for his proposed bank, presumably to convey the responsibility the
State was to have in respect of the functioning of that bank.

• According to Mr. Keynes, the ‘nucleus’ of the new bank was ‘to be obtained by the
amalgamation of the capital and reserves of the three Presidency Banks’. He named
the proposed bank ‘the Imperial Bank of India’. Government subscription to the
capital, he considered, was not necessary, as it would ‘complicate rather than
simplify the relations between the Government and the shareholders’.

• As regards control, the ‘supreme direction’ of the bank was to be vested in a

Central Board, consisting of the Governor of the bank (who was to be the
Chairman), the Deputy Governor, a representative of Government and three or
more assessors. The assessors were to be the Managers, or their deputies, of the
Presidency Head Offices or of other Head Offices. The assessors were to have no
vote. The Governor was to be appointed by the Monarch, on the Secretary of
State’s recommendation, while the Deputy Governor, the Government
representative and the Managers of the Presidency Head Offices were to be

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 appointed by the Viceroy; the appointment of the Managers of Presidency Head
Offices was to be subject to the approval of the Presidency Boards.

• The ‘State Bank’ proposed by Mr. Keynes was intended to put a little more
responsibility on Government, while at the same time providing them with a ‘
thoroughly satisfactory machinery ’ for the discharge of the responsibility.

Functions of the proposed State Bank --

The main functions of the proposed bank included:

(i) same functions as performed by the Presidency Banks, with relaxation of

some restrictions;

(ii) management of note issue;

(iii) management of public debt in India;

(iv) effecting remittance for the Secretary of State through the London Office;
and

(v) acceptance of payments and making of disbursements on behalf of

Government at all places where the bank had a branch.

Mr. Keynes also recommended in his scheme a proportional reserve system (though he
did not use this expression) of a flexible type, for regulation of the note issue. As regards
its relations with other banks, the bank was intended to do rediscount business ‘to the
greatest possible extent’. The ‘State Bank’ proposed by Mr. Keynes was thus to perform
central banking as well as commercial banking functions.

In August 1927, when the Reserve Bank Bill as amended by the Joint Committee came up before
the Legislative Assembly, the term ‘State Bank’ was used in ‘a very loose sense’ by Members
speaking on the Bill. It was used to convey two meanings, viz.,

(i) a bank wholly owned by the State and not by shareholders and

(ii) a bank to be managed under the complete control of the State.

The Finance Member expressed the view that the natural meaning of a ‘State Bank’, according to
him, was a bank under the control of the Government and the Legislature. In that sense, the
Reserve Bank, as proposed by the Joint Committee, was not a ‘State Bank’, because while it was
to be wholly owned by Government, it was to be completely independent of the Government and
the Legislature.

CONTROVERSY BETWEEN KEYNES AND DR. B.R. AMBEDKAR ON THE

APPROPRIATENESS OF A ‘GOLD-STANDARD’ VS ‘GOLD-EXCHANGE
STANDARD’ FOR INDIA

Dr Amedkar dealt with this debate, emerging from a silver standard (led by paper currency), gold
standard and then the gold exchange standard, in his book, “Problem of the Indian Ruppee”.

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He has attempted to explain this evolution and his contentions substantiated with the
circumstances that prevailed then, very lucidly to a common man, by the way of his book.

Keynes’s role in Indian finance was not only important but also ultimately pernicious, presaging
his later role in international finance. Upon converting India from a silver to a gold standard in
1892, the British government had stumbled into a gold-exchange standard, instead of the full gold-
coin standard that had marked Britain and the other major Western nations. Gold was not minted
as coin or otherwise available in India, and Indian gold reserves for rupees were kept as sterling
balances in London rather than in gold per se. To most government officials, this arrangement
was only a halfway measure toward an eventual full gold standard; but Keynes hailed the new gold-
exchange standard as progressive, scientific, and moving toward an ideal currency. The crucial
point, however, is that a phony gold standard, as a gold-exchange standard must be, allows far
more room for monetary management and inflation by central governments. It takes away the
public’s power over money and places that power in the hands of the government.

As per Dr Ambedkar though, most neglected period of Indian currency ranges from 1890-18993.

Other authors popularized the notion that exchange standard was the standard originally
contemplated by the Gov of India. (gross error) Indeed, the most interesting point about Indian
currency is the way in which the gold standard came to be transformed into a gold exchange
standard. Some old, but by now forgotten, facts had therefore, to be recounted to expose this
error.

On the theoretical side, there is no book but that of Professor Keynes which makes any attempt
to examine its scientific basis. But the conclusions he has arrived at are in sharp conflict with those
of Dr. Ambedkar. The differences extended to almost every proposition he has advanced in favour
of the exchange standard. This difference proceeds from the fundamental fact, which seems to be
quite overlooked by Professor Keynes, that nothing will stabilise the rupee unless we stabilise its
general purchasing power. That the exchange standard does not do. That standard concerns itself
only with symptoms and does not go to the disease: indeed, on Dr. Ambedkar’s showing, if
anything, it aggravates the disease.

When Dr. Ambedkar come to the remedy, Dr. Ambedkar again found himself in conflict with the
majority of those who like myself are opposed to the exchange standard. It is said that the best
way to stabilize the rupee is to provide for effective convertibility into gold. Dr. Ambedkar does
not deny that this is one way of doing it. But Dr. Ambedkar thought of a, a far better way would
be to have an inconvertible rupee with a fixed limit of issue. Dr. Ambedkar would have proposed
that the Government of India should melt the rupees, sell them as bullion and use the proceeds
for revenue purposes and fill the void by an inconvertible paper. But that may be too radical a
proposal, and Dr. Ambedkar do not therefore press for it, although he regards it as essentially
sound. in any case, the vita! point is to close the Mints, not merely to the public, as they have been,
but to the Government as well.

In his views the Indian currency, based on gold as legal tender with a rupee currency fixed in issue,
will conform to the principles embodied in the English currency system.

Fowler Committee and Dr. Ambedkar’s views contradicted

“It will be noticed that I do not propose to go back to the recommendations of the Fowler
Committee. All those, who have regretted the transformation of the Indian currency from a gold

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standard to a gold exchange standard, have held that everything would have been all right if the
Government had carried out in toto the recommendations of that Committee. I do not share that
view.”

On the other hand, Dr. Ambedkar found that the Indian currency underwent that transformation
because the Government carried out those recommendations. While some people regard that
Report as classical for its wisdom, Dr. Ambedkar regard it as classical for its nonsense. For Dr.
Ambedkar find that it was this Committee which, while recommending a gold standard, also
recommended and thereby perpetuated the folly of the Herschell Committee, that Government
should coin rupees on its own account according to that most naive of currency principles, the
requirements of the public, without realizing that the latter recommendation was destructive of
the former. Indeed, as Dr. Ambedkar argues, the principles of the Fowler Committee must be
given up, if we are to place the Indian currency on a stable basis.

Up to 1913, the Gold Exchange Standard was not the avowed goal of the Government of India
in the matter of Indian Currency, and although the Chamberlain Commission appointed in that
year had reported in favor of its continuance, the Government of India had promised not to carry
its recommendations into practice till the war was over and an opportunity had been given

to the public to criticize them. When, however, the Exchange Standard was shaken to its
foundations during the late war, the Government of India went back on its word and restricted,
notwithstanding repeated protests, the terms of reference to the Smith Committee to
recommending such measures as were calculated to ensure the stability of the Exchange Standard,
as though that standard had been accepted as the last word in the matter of Indian Currency. Now
that the measures of the Smith Committee have not ensured the stability of the Exchange Standard,
it is given to understand that the Government, as well as the public, desire to place the Indian
Currency System on a sounder footing.

There was a great deal of controversy on the reasons for this unprecedented export of the metal.
One view was that it reflected the economic distress following the depression; another view was
that the sales were commercial transactions intended to benefit from the rising trend of prices.
There was also a view that the rupee was under- valued in terms of gold on the basis of the
prevailing price of the metal abroad.

The official view was that, while it was probably true that a certain proportion represented distress
sales, the larger proportion was sold to realise profits from exports, it was not proper for
Government to interfere with this and that in any event, the exports had strengthened the country’s
foreign exchange reserves, exchange rate and credit abroad.

To sum up, it should be added that the exchange rate controversy not always ran in terms of pure economic issues;
politics and economics were mixed up a great deal.

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QUESTION 3: The government’s dual role in nationalized banks, as a majority
shareholder as well as a regulator, has exposed these banks to systemic risks and
functional inefficiencies. Analyse the recent initiatives of government and RBI that are
aimed at altering the existing governance structure to boost the efficiency and results of
such banks.

1. PJ NAYAK COMMITTEE REPORT

The core problem with PSBs, as the Nayak committee saw it, in chapter 1 para 7 and 8:
Governance difficulties in public sector banks arise from several externally imposed
constraints. These include dual regulation, by the Finance Ministry in addition to RBI;
board constitution; significant and widening compensation differences with private sector
banks; external vigilance enforcement though the CVC and CB.

The solution suggested by the committee was that:

• If the Government stake in these banks were to reduce to less than 50 per
cent, together with certain other executive measures taken, all these external
constraints would disappear. This would be a beneficial trade-off for the
Government because it would continue to be the dominant shareholder and,
without its control in banks diminishing, it would create the conditions for its
banks to compete more successfully.
• Repeal the Bank Nationalisation Act (1970, 1980), the SBI Act and the SBI
Subsidiaries Act as they require the government to have above 50% share in the
banks.
• After the above acts are repealed, the government should set up a Bank Investment
Company (BIC) as a holding company or a core investment company.
• The government to transfer its share in the banks to this BIC. Thus, the BIC would
become the parent holding company of all these national banks, which would
become subsidiaries. As a result of this, all the PSBs (public sector banks) would
become ‘limited’ banks. BIC will be autonomous and have the power to appoint
the Board of Directors and make other policy decisions.
• Nayak Committee noted the need to make the process for board appointments
more professional. Until the BIC is formed, a temporary body called the Bank
Boards Bureau (BBB) will be formed to do the functions of the BIC. Once BIC is
formed, the BBB will be dissolved which will advise on appointments to the board,
banks’ chairman and other executive directors.

2. PLOUGHING BACK OF CAPITAL [RECAPITALISATION]

Weak balance sheets of public sector banks warrant infusion of equity capital by the government.
Recapitalisation is liquidity neutral for the government when financed via an issue of government
securities that a recapitalised bank is mandated to purchase. Bank balance sheets at the time of
recognition of non-performing assets and the associated negative net worth is equivalent to that
when the bank receives equity through this liquidity neutral mode of financing. Correspondingly,
the fiscal deficit is higher than reported the moment a state-owned bank has negative net worth
and there are negative feedback loops between the fiscal and banking systems.

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Under recapitalisation, over the last three Financial Years, PSBs have been recapitalised to the
extent of Rs. 2.87 lakh crore, with infusion of Rs. 2.20 lakh crore by the Government and
mobilisation of over Rs. 0.66 lakh crore by PSBs themselves.

3. INDRADHAUNSH PLAN

Banks were in need of money and therefore Indradhanush plan was announced in order to address
issues such as Banks Board Bureau, Re-capitalisation of banking companies, etc. The plan
proposed to inject fresh capital in a phased manner. All in all, 75000 crore rupees would be injected
in public sector banks.

It was supposed to be the most comprehensive reform effort undertaken since banking
nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their
overall performance by the acronym of “ABCDEFG”.

• A-Appointments: Based upon global best practices and as per the guidelines in the
companies act, separate post of Chairman and Managing Director and the CEO will get
the designation of MD & CEO and there would be another person who would be
appointed as non- Executive Chairman of PSBs.
• B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials,
which will replace the Appointments Board for the appointment of Whole-time Directors
as well as non-Executive Chairman of PSBs.
• Capitalization: As per finance ministry, the capital requirement of extra capital for the
next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000
crores will be provided by the GOI and the rest PSBs will have to raise from the market.
• Destressing: PSBs and strengthening risk control measures and NPAs disclosure.
• E-Employment: GOI has said there will be no interference from Government and Banks
are encouraged to take independent decisions keeping in mind the commercial the
organizational interests.
• F-Framework of Accountability: New KPI (key performance indicators) which would
be linked with performance and also the consideration of ESOPs for top management
PSBs.
• G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial
institutions. Bank board Bureau for transparent and meritorious appointments in PSBs.

Mission Indradhanush did have strong points, but it did not go the distance when it came to PSB
reform. There is a need to recognize that incremental reforms do not cover the vital parts and will
not design the system for the results that the PSB and country needs.

4. PROPOSAL OF DISINVESTMENT SCHEME OF THE GOVERNMENT

STAKE IN THE PUBLIC SECTOR BANKS BY THE RBI

On 3rd August, 2020, the RBI has very rightly suggested the reduction of the stake of the
government in the six public sector banks to 51% over a period of the coming 12-18 months.
Various Public Sector banks like the State Bank of India, Punjab National Bank, Bank of Baroda,
Canara Bank, Union Bank of India and the Bank of India are shortlisted for this process.

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 5. BANK BOARD BUREAU

In light of the BASIL III requirements, the government was pushed the government to take
reforms w.r.t PSBs. The CG came out with gazette notification- it led to establishment of BBB [26
Feb, 2022]. It became autonomous recommending body of GOI.

This means that the top management of these banking companies should be selected on a
competitive basis. The idea was that one should not confine the idea of appoint of whole time
directors only through the route of lateral entering. Apart from this, the directions to be given by
BBB to PSBs and CG, the institution was not taken kindly by DFS. DFS has

reputation of its own function. It has appointed its own chairman, MDs, etc. they have absolute
control and so any dilution of their power was not taken well by the bureaucrats. However, the
range of operations is so wide and extensive, there is bound to be overlapping of work
between BBB and DFS and the same has led to a lot of conflict and thus BBB is not able
to perform well if it does not receive support from DFS. Due to lack of support, BBB has
been subject to a lot of criticism.

6. EASE 2.0 REFORMS FOR PUBLIC SECTOR BANKS

The EASE Reforms Agenda was launched in January 2018 jointly by the government and
PSBs. It was commissioned through Indian Banks’ Association and authored by Boston
Consulting Group. EASE Agenda is aimed at institutionalizing CLEAN and SMART banking.

The EASE Reforms Index: The Index measures performance of each PSB on 120+
objective,metrics.

(i) The Index follows a fully transparent scoring methodology, which enables banks to
identify their strengths as well as areas for improvement.

(ii) The goal is to continue driving change by encouraging healthy competition among
PSBs.

7. OTHER INITIATIVES TAKEN BY THE GOVERNMENT

• Change in credit culture with institution of Insolvency and Bankruptcy Code (IBC)
fundamentally changing the creditor-borrower relationship, taking away control of the
defaulting company from promoters/owners and debarring wilful defaulters from the
resolution process and debarring them from raising funds from the market.

• Fugitive Economic Offenders Act, 2018 has been enacted to enable confiscation of
fugitive economic offenders’ property.

• Heads of PSBs have been empowered to request for issuance of look-out circulars.

• National Financial Reporting Authority has been established as an independent

regulator for enforcing auditing standards and ensuring audit quality.

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 8. ALTERNATE SUGGESTIONS/RECOMMENDATIONS TO IMPROVE
EFFICIENCY IN THE PSB
- It is also a common knowledge that the number of banks did not have senior managers,
and that roles in key committees (such as audit committee) go unfilled. The sixty-eight
report of the Standing Committee on Finance (2017-18) also expressed concern over
the emerging gaps at senior levels. This is an area of significant risk as banking is
becoming increasingly complex and specialized function.
- There is a need to look at the Human Resources risk in an urgent manner, and mandate
HR committee with representation on the board. It is noteworthy that Khandelwal
Committee recommended Board’s committee on HR, but barring some banks, either
banks have not created such committees or they have become moribund. The
government should ensure that HR committee of the Boards are activated and an
annual Human Capital report is submitted as a part of annual report on the lines of
Governance report.
- There is also a need to look at the compensation in PSBs especially of whole-time
directors and senior management functionaries. The gap between the private and
public sector banks is already significant, and, as banking becomes more specialised
and domain expertise-based in the future, this gap could become even more. There is
a need to use Employee Stock Options strategically, as recommended in the Nayak
Committee report, which will also address to some extent the emerging gap between
PSBs and private banking pay levels.

ANALYSIS

I do believe any government machinery is recoverable if the government brings in the right,
thought out, planned economic reforms and the administration; this has to be smoothly executed
as well in due time for a fruitful and efficient outcome.

Nayak Committee on Governance and Khandelwal Committee on Human Resources

(HR) in PSB provided detailed description of the various problems, challenges and gaps
that need to be urgently addressed. In 2015, then Finance Minister, Late Mr. Arun Jaitley,
announced a seven-pronged Mission Indradhanush and “Gyan Sangam” (a Conclave of PSBs) to
bring about banking reforms. In spite of such works and initiatives, governance in PSB
remains complex and hardly conducive to good banking performance.

I disagree with the Indradhanush scheme which merely provides for recapitalization of the ailing
public sector banks as the core issue is not lack of capital but dual regulation and inefficient
appointment mechanism of the board.

I am in complete agreement with the PJ Nayak Committee reforms and the idea of
establishing BBB to resolve the core issue of structural reforms. Given their role and
complexity, PSBs are a significant player in the banking sector, and it is unrealistic to expect that
governance challenges in the banking sector can be addressed without working through the
governance issues that PSBs face. It is also unrealistic to expect that piecemeal and disjointed
efforts – as has been the case in the past - will yield governance reforms that PSBs urgent need.
The time is of essence and PSBs cannot be allowed to be a burden on exchequer to bear the burden
of recapitalisation from time to time.

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QUESTION 6.

Write short notes on:

SOCIAL AND ECONOMIC BENEFITS FROM THE PROHIBITION ON ‘RIBA’ IN

ISLAM

The economic system of Islam is the economic system is based on monotheism and superior
compared with conventional systems such as the capitalist economy. All transactions in the Islamic
economic system based on justice and reject all forms of oppression and exploitation like usury.

Those who indulge in these activities of usuary they have tendency to appropriate others’ wealth
w/o justification and this leads to more serious crimes which leads to disruption of all good values.

SOCIAL AND ECONOMIC BENEFITS FROM PROHIBITION OF RIBA

Following are the social and economic benefits from the prohibition on ‘Riba’ in Islam:

1. It will reduce concentration of wealth in the hands of a small minority - Because

interest is a low-risk way to increase wealth if you already have wealth, this function to
concentrate wealth into the hands of a minority, which has potential socially destructive
which can be reduced by prohibiting interest.
2. Reduces unemployment and inflation – Interest rates cause unemployment and
inflation in the conventional economic system as shown in a number of empirical studies
by economists. Even though, in the early 1970s, it was believed by most of the economists
that there is a trade-off between unemployment and inflation, subsequent findings have
shown that both high unemployment and inflation can co-exist which
gave rise to a new phenomenon known as stagflation. This phenomenon has caused many
economic problems in the industrialized countries.40 Hence, after many mechanism
attempted to solve the problem of stagflation have failed, the profit-sharing system has
been proposed as the best form to combat unemployment and inflation

3. It will reduce the wealth inequality between members of society: The rich (who are
most likely to be the lender) take advantage of the need of the poor (the borrower) for
money by charging interest, which adds to the burden on the borrower. As a result, the
rich becomes richer and the poor becomes poorer. Thus, interest increase wealth inequality
between the members of the society.

4. Leads to distribution of risk – The most important consequence of the prohibition of

interest in an interest-free Islamic economic system by replacing it with profit sharing is
the total elimination of risk-free assets and to spread the risk among the investors and
financiers.42 This is because PLS system has the characteristics of spreading risk on the
entire investment equitably than fixed (interest) return scheme. This may create for the
Islamic firm both incentive and feasibility for taking more risk compared to the
conventional system under the similar circumstances. In another words, in an Islamic
financial system, the availability of assets with a variety of risk characteristics is a distinct
possibility and there is no reason to assume that there is a limit to the diversity of assets in
such a system.

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 5. Interest can cause over-consumption that later can be life-destroying - If people are
given the option of borrowing against future earnings without knowing what those future
earnings are, people may over consume. A huge number of people's lives have been
destroyed by, for example, credit card debt. Many suicides, for example, have been related
to debt. As result percentage of homeless people are growing faster than ever. Therefore,
prohibition of interest could be one way to change this.

6. Riba leads to negative social and moral growth - Therefore, the moral level would be
low, society would be rigged with fear and corruption. They will have more money but
won’t know what to do with it due to which exploitative tendencies would prevail. These
can be curtailed by prohibiting interest. In contrast to Capitalist system, Islam believes in
striking at the roots of inequality rather than merely alleviating some of the symptoms.

7. Interest is a cause of injustice and exploitation- Interest is considered a form of

injustice and exploitation, which contradicts the core Islamic teachings of social justice.

It is unjust for lenders to guarantee return with no involvement in risk. Because riba entails
taking advantage of a man’s inferior economic position it breeds hatred, jealousy and ill-
will towards the rich. This behavior kills the spirit of cooperation in the society and
discourages people from doing good to each other. Interest also leads to the creation of a
materialistic society. Hence, prohibition of Riba would eliminate this and would provide
us a better society.

8. Interest introduces instability into the economic system - If people are lending money
to others, but it is untied to a physical resource and based on the expectation that not
everyone will try to get back their liquid assets at the same time (the so called liquidity ratio,
which allows banks to not have to hold all of the money they have lent in liquid form) this
can introduce financial instability into the system.

CONCLUSION

"With public sentiment, nothing can fail. Without it, nothing can succeed." -Abraham Lincoln

The concept of interest free banking is not obsolete/orthodoxical, it definitely has some socio-
cultural value in islam which is why it has the public sentiment, it continues to be relevant and
practical.

The reason why Islam prohibits Riba (interest) from all forms of transactions is Islam wishes to
establish an economic system where all forms of exploitation and injustice are eliminated. Islam
wishes to establish justice between the financier and the entrepreneur. It has been mentioned that
the prohibition of interest in economy and replacing it with profit-sharing system will increase the
level of savings and investment, able to combat the unemployment and inflation simultaneously
since interest rate will no more enter into the profit calculation in the investment. The Islamic
economic system is more profitable and productive than the conventional one.

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CHANGE IN MANAGEMENT OR TAKEOVER OF MANAGEMENT OF
DEFAULTING BORROWER UNDER SARFAESI

Section 9(a), Section 15 SARFAESI Act 2002;

RBI Notification 2010 – Notification on Change in or Take Over of the Management of the
Business of the Borrower by Securitisation Companies and Reconstruction Companies
(Reserve Bank) Guidelines, 2010.

The relevant portions of SARFAESI that encompass the provisions regarding change of
management aspect are Section 9 (applicable to Asset Reconstruction Companies for effecting
change of management for better reconstruction of financial assets), Section 13(4)(b) (which
provides for secured creditors including banks, financial institutions and ARCs, to implement
change of management aimed at recovery of debt) and also under Section15 (which provides for
manner to affect any such change of management u/s 9 or 13).

1. Under SARFAESI Act, one of the strategy to realize the debt is to change the management
or takeover the management of the business of borrower by the ARC. Reserve Bank of
India has issued guidelines to ensure fairness, transparency, non- discrimination, and non-
arbitrariness in the action of the ARC and to build in a system of check and balance while
effecting change in or takeover of the management of the business of the borrower by
ARC under Section 9(a) of SARFAESI Act, 2002.

2. The ARC shall utilize such method of realization after complying with the manner of
takeover of the management in accordance with the provisions of Section 15 of the
SARFAESI Act, 2002. On realization of dues in full, the ARC shall restore the
management of the business to the borrower as provided in Section 15(4) of the
SARFAESI Act.

3. Reserve Bank of India’s directions / guidelines issued to ARC in the matter of asset
reconstruction and matters related thereto, inter-alia stipulate that ARC shall formulate a
Board-approved policy regarding change in or takeover of the management of the business
of the borrower and borrower shall be made aware of such policy framed by the ARC.

GROUNDS FOR AFFECTING CHANGE IN OR TAKEOVER OF MANAGEMENT

Company can consider change in or takeover of management on happening of any of the following
event. However, before resorting to this method, company to weigh all available option for
resolution and the same be placed before competent authority with justification of going in for
this method.

1. the borrower makes a willful default in repayment of the amount due under the relevant
loan agreements;

2. the Company is satisfied that the management of the business of borrower is acting in a
manner adversely affecting the interest of the creditors (including the Company) or is
failing to take necessary action to avoid any event which would adverselyeffect the interest
of the creditors;

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 3. the Company is satisfied that the management of the business of the borrower is not
competent to run the business resulting in losses / non – repayment of dues to the
Company or there is lack of professional management of the business of the borrower or
the key managerial personnel of the business of the borrower have not been appointed for
more than one year from the date of such vacancy which would adversely affect the
financial health of the business of the borrower or the interest of the company as secured
creditor;

4. the borrower has without the prior approval of the secured creditors (including the
Company), sold, disposed of, charged, encumbered or alienated 10% or more (in
aggregate) of its assets secured to the Company;

5. there are reasonable grounds to believe that the borrower would be unable to pay its debts
as per terms of repayment accepted by the borrower;

6. the borrower has entered into any arrangement or compromise with creditors without the
consent of the Company which adversely affects the interest of the Company or the
borrower has committed any act of insolvency;

7. the borrower discontinues or threatens to discontinue any of its businesses constituting

10% or more of its turnover;

8. all or a significant part of the assets of the borrower required for or essential for its business
or operations are damaged due to the actions of the borrower,

9. the general nature or scope of the business, operations, management, control or ownership
of the business of the borrower are altered to an extent, which in the opinion of the SC /
RC, materially affects the ability of the borrower to repay the loan;

10. the Company is satisfied that serious dispute/s have arisen among the promoters or
directors or partners of the business of the borrower, which could materially affect the
ability of the borrower to repay the loan;

11. failure of the borrower to acquire the assets for which the loan has been availed and
utilization of the funds borrowed for other than stated purposes or disposal of the financed
assets and misuse or misappropriation of the proceeds;

12. fraudulent transactions by the borrower in respect of the assets secured to the creditor/s.

In all such cases where company decide to change in or takeover the management of the business
of borrower, the company shall appoint an Independent Advisory Committee (IAC) consisting of
professionals from technical / finance / legal background, not related to the Company in any
manner whether pecuniary or not except remuneration for acting as independent advisor, who
after assessment of financial possession, time frame etc. shall recommend to the ARC that it may
resort to change in or takeover of management and that such action would be necessary for
effective running of the business leading to recovery of its dues.

The Report of the IAC shall be considered by the Board of Directors including at least two
independent Directors alongwith various option available for recovery before deciding whether

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under the existing circumstances the change in or takeover is necessary and the decision shall be
specifically included in the minutes.

The company shall carry out the due diligence and record the details of the exercise including the
finding on the circumstances which led to default in repayment and why the decision to change in
or takeover of management of the business of the borrower has become necessary.

A suitable person shall be identified by the company who can take over the management of the
business of borrower by formulating a plan for operating and managing the business of the
borrower effectively. Such plan should include procedure to be adopted by the Company at the
time of restoration of management to borrower, borrower’s rights and liabilities at the time of
change and takeover by the Company and at the time of restoration and rights and liabilities of the
new management taking over the management at the behest of ARC. It should also be clarified by
the Company to the new management that their role is limited to recovery of dues of the Company
by managing the affairs of the business of the borrower in a prudent manner.

The Company shall report to the Reserve Bank of India all the cases where they have taken action
to cause change in or takeover of the management of the business of the borrower for realization
of its dues from the borrower.

Delegation of authority to consider cases of change in or takeover of management:

The Executive Committee for Resolution shall be empowered to appoint members of the
Independent Advisory Committee (IAC) on case to case basis and shall place the report /
recommendations of IAC to Board of Directors for their consideration alongwith its
recommendations. If the case is found suitable for change in or takeover of management by the
Board of Directors, the Executive Committee for Resolution will be the Competent Authority to
take all further actions required including appointment of agency for due-diligence and suitable
personnel / agency for managing the affairs of the business of borrower to effectively recover the
dues from the borrower under this measure.

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ANSWER 1: Analysing the Keynesian perspective on the prevailing banking conditions in
India in 1913, highlight the background and necessity which led to the establishment of a
Central Bank in India.

I. Introduction

The banking system in India in 1913 was facing multiple challenges. It comprised the following as
its four main constituents: (i) Presidency banks, (ii) European exchange banks, (iii) Indian
joint stock banks, and lastly the (iv) private bankers and moneylenders (Shroffs, Marwaris,
etc.). This means that if any person sought to raise a credit, the recourse would be to these
institutions in the market. They all functioned independently of each other and exploited the
market according to their own commercial objectives. In short, there was no cohesive force that
could produce the required synergy towards economic development. The absence of a central
banking authority led to a general lack of direction in the banking policy of India. This is
because no one was interested to look at the matter as a whole or to understand the position of
the market. Therefore, no matter how bad the banking system would be, there was no one to
enforce prudence in the system.

II. Background And Necessity Leading To The Establishment Of A Central Bank

A. NO RELATION BETWEEN BANK RATES, MARKET RATES, AND INTEREST

RATES

The banking enterprises, especially at that point of time, were totally dependent on the spread
between the rate of interest they charged on loans and the rate of interest they provided on
deposits. This system requires that almost all the banking companies keep their spread around a
fixed percentage so that all can benefit and grow together and at the same be competitive.
However, this was not done during that era as the banks had close to absolute autonomy in their
operations. Therefore, on one hand, while the exchange banks were greedy enough to receive fixed
deposits for short periods at 9, 10, and 11% of annual interest rates, on the other hand, the
presidency banks were straining to meet the demands for loans at 12 and 13% per annum.

B. LACK OF A STATE BANK IN INDIA

Keynes highlighted that the bad state of affairs in Indian banking is primarily owed to a lack of
state bank in India. The government did not know where to park its liquid funds for generating
the maximum returns out of it. There was no central bank governing all other banks and precisely
because of this, the government failed to understand the market functions. Therefore, Keynes
proposed the idea that regional presidency banks should be merged to create a new dual
bank (State Bank) which would perform both the functions, i.e. of a commercial bank and a
welfare bank.

C. MULTIPLE PROBLEMS PLAGUING THE PRESIDENCY BANKS

Keynes suggested that the Indian banks were established only during good times and therefore did
not feel the need to maintain any reserves. They just lent the money. Since the banking system in
India was unaware of the impact of depression, Keynes believed that Indian banks were playing
with fire by not maintaining reserves. This had the potential to lead up to significant financial
instability in the market.

D. PROBLEMS WITH THE EXCHANGE BANKS

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The exchange banks were able to rapidly increase the funds raised by them through deposits in
India itself. However, they were not mindful of the slow rate at which they had thought fit to
increase their Indian balances. The existing banking system did not anticipate for any crisis where
bank would have to provide its depositors funds. Yet again, there was a possibility of a heightened
financial instability brewing under such inefficient banking practices.

E. TRADES SPONSORED BY A LIMITED NUMBER OF BANKS

Only a handful of Indian banks had been able to extend the required financing for trading activities
in India. This reduced the availability of credit in the market. Consequently, the traders were forced
to limit their businesses and were at the mercy of such banks, who had their seat in London.

F. INCOMPETENT AND UNQUALIFIED PERSONNEL AT EXISTING BANKS

The lack of advice and expertise that the officers of a state bank should have clearly highlighted
the weakness of the government. There were no high ranking officials who took a keen interest in
the study of finance and wanted to specialise in it. As a result, the commercial banks were fraught
with incompetent personnel who did not possess the requisite skills to aid the market.

G. ISSUING BANKNOTES SUBSTANDARD TO MODERN BANKING PRACTICE

The responsibility to issue bank notes was sub-standard to the modern banking practise. It led to
the creation of two separate reserves, i.e. the government’s reserve and the banker’s reserve.
Specifically, in his book, Keynes noted that the “existing divorce between the responsibility for
note issuance and that for banking generally was contrary to the modern banking practice”. This
led to elasticity in the market and the reserves were not able to meet this elasticity.

H. SCARS LEFT BY THE INFREQUENT WARS

Wars require a lot of money and the banking institution were not able to command during such
times because sovereign takes over the functioning. The banks did not have the requisite resources
to fund such activities of the State. It had become a huge problem for the banks and prevented
their growth. Therefore, Keynes advocated for a state bank which would be free from
political, executive and industrial influences.

Iii. Conclusion: The Road To Establishing A Central Bank A. The Idea Of A State Bank

In light of the aforementioned problems, Keynes mooted the idea of a state bank, which would
perform primarily three functions: (i) note issuance, (ii) management of cash balance, and (iii)
regulation of foreign exchange. The idea of a central bank gained traction after the 1926 Hilton
Young Commission Report. It recommended setting up a reserve bank of India entrusted with
central banking. Even after it was decided that a central bank would be established, the problems
were not over. It was to be established in an independent manner to keep it free from political and
commercial influences.

B. PROBLEM OF CONTROL IN ESTABLISHING THE CENTRAL BANK

Since the person who controlled the bank will be in-charge of controlling its policies, if the
government itself would have been made the controller of the bank, the bank would not remain
independent from political, executive and industrial influence. Therefore, the voting rights of
investors (being the government) were sought to be curtailed. This took off the burden of

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managing the bank from the shoulders of government and ensured its independence. Similarly,
another curtailment was that not all directors were to be nominated by the government in the
central bank. This was done to ensure that the directors do not fall prey to the government. Despite
the Imperial Bank established could not be successful in its objectives. This led to the
establishment of the Reserve Bank of India in 1934.

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Question 2: The advent of Insolvency and Bankruptcy Code 2016 has been hailed as the
‘game changer’ in India’s fight against NPAs. However, the judicial setbacks received by
the RBI in this crusade may force it to re-strategies against erring corporate debtors.
Examine the above statement.

A. IBC: TIME-BOUND NATURE AND CREDITOR IN CONTROL MECHANISM

The IBC is a game changer in the resolution of NPAs because it provides a framework for time-
bound insolvency resolution (180 days extendable by another 90 days) with the objective of
promoting entrepreneurship and availability of credit while balancing the interests of all
stakeholders. The IBC represents a paradigm shift in which creditors take control of the assets of
the defaulting debtors, in contrast to the earlier system in which assets remained in possession of
debtors till resolution or liquidation.

B. GAME-CHANGING NATURE OF IBC: 4 TIMES MORE LIQUIDATION THAN

RESOLUTION

The experience so far has been encouraging with IBC providing resolutions to some large
corporate debtors. While data suggests that the number of cases ending with liquidation under
IBC is about four times higher than those ending with a resolution plan, I believe that liquidation
could be an efficient mode of resolution for debtors in default for long time wherein the scope for
revival of the enterprise is low and liquidation value exceeded resolution value. As such, the
number of liquidation orders should be seen as a natural step towards efficient reallocation of
resources rather than an adverse consequence of IBC itself. Therefore, it would not be an
exaggeration to call IBC the game-changer in India’s fight against NPAs. However, lately
the RBI has received multiple judicial setbacks in its crusade against NPAs. The same can be seen
in the next section.

II. JUDICIAL SETBACKS IN RBI’S CRUSADE AGAINST NPAS RELEVANT

PROVISIONS UNDER THE BANKING REGULATION ACT

S.35AA provides the RBI the power to issue directions to any banking company to initiate CIRP
against a defaulter under IBC. Further, 35AB provides that the RBI may issue directions to any
banking company for resolution of stressed assets and it may specify an authority/committee to
advise any banking company on resolution of stressed assets. Therefore, the RBI holds the power
to direct banks to initiate CIRP under IBC against any borrowing defaulter.

A. FATE OF THE 2017 RBI CIRCULAR

Under the aforementioned regulations, the RBI formed an Internal Advisory Committee [IAC] to
advise banking companies on resolution of stressed assets. Thereafter, the IAC identified the
NPAs against whom CIRP could be initiated on a priority basis depending on the amount of
NPAs. For NPAs that did not qualify under such criteria, the banks had to finalise a resolution
plan within six months, failing which CIRP could be initiated.

CHALLENGING THE VIRES OF THE CIRCULAR

In Essar Steel India Limited v. RBI, the constitutionality of RBI's power to direct banks to initiate
CIRP was challenged. It was contended that RBI had acted arbitrarily and in violation of Article
14 in directing the banks to initiate CIRP against the petitioner. The RBI contended that the
petitioner was a drain unto the financial performance of the banks and thereby such a move was

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necessary. Additionally, RBI had asserted in the circular that such CIRP applications should be
accorded priority by the NCLT.

Upholding the constitutional validity of the RBI Circular, while the refused to grant any relief to
the petitioner, it struck down the part of RBI circular which stated that the cases referred to the
NCLT under the scheme would be accorded priority the NCLT. It held that RBI cannot guide the
adjudicating authority under IBC and any attempt to do would be unconstitutional.

B. FATE OF THE 2018 CIRCULAR

The RBI in 2018 issued a circular to revitalise the extant framework for stressed assets in India.
The Circular provided that banks shall immediately refer NPA accounts with more than Rs. 2,000
crores to the IBC regime, if they are not resolved within 180 days of a default. Additionally, the
Circular laid down that banks shall disclose defaults if interest repayments were defaulted on by a
single day, and will have to ensure a resolution plan is in place within 180 days.

CHALLENGING THE VIRES OF THE CIRCULAR

In Dharani Sugars & Chemicals v. UOI, this Circular was challenged by firms on the ground that
it suffers from non-application of mind, the reason being that it does not distinguish between
various types of stressed assets from different industrial sectors. In checking the vires of this
Circular, the SC held that under Sections 35AA and AB, it was obvious that the RBI can issue
directions to banks but only after authorisation from the Central Government. Therefore, it was
held that the RBI can only direct banks to initiate CIRP on receiving authorisations from the
Central Government. Therefore, it invalidated the Circular. This meant that any CIRP initiated
under the said Circular became infructuous.

III. ANALYSIS AND THE WAY FORWARD

A. DILUTING THE SCOPE OF RBI’S MANDATE

I believe that the judgement dilutes the scope of RBI’s mandate. The ability to direct banks to refer
cases for CIRP will now be restricted to situations where Central Government authorisation is
received. This means that such general directions cannot be issued by the RBI. The invalidation of
the Circular would assist the lenders and borrowers entering into consensual restructuring
schemes, which can be achieved in lengthier timespans, allowing for complex restructuring
transactions with more pragmatic timelines.

B. ENSURING STRICT COMPLIANCE TO STATUTORY DIKTATS

The mandate of a court is to ensure strict compliance with the diktats of the statute. The reason
why the court had to strike down the 2018 Circular was that it did not adhere to the express
statutory requirement. As far as the 2017 Circular is concerned, the court struck down a small part
of it as it tried to bypass the IBC. Had the RBI adhered to its mandate, none of the Circulars would
have received that fate. For instance, in SEL Manufacturing Company Ltd. v. UOI, the petitioner
had entered into a Master Restructuring Agreement [“MRA”] against its debt with a banking
consortium. Violating the MRA and aforementioned RBI Circular, SBI filed for CIRP of the
petitioner under IBC. The HC held that through the circular, the RBI had imposed an implied
limitation on the exercise of right by the banks under IBC. However, since it was in the best
interest of the market and its mandate as a regulator under S.35AA, the HC ruled in favour of RBI
and quashed the insolvency proceedings.

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ANSWER 6:

A. SOCIAL AND ECONOMIC BENEFITS FROM PROHIBITION OF ‘RIBA’ IN

ISLAM

I. INTRODUCTION

Riba is considered to be an exploitative practice and therefore haram in Islam. It prohibits

charging any form of interest (usury) on the money lent to the borrower. Instead, the borrower
and lender into a sharing arrangement, wherein both would share the profits and losses arising
out of the capital lent. This ensures that nobody benefits out of misery. Having a share only in the
profits and not losses is also despised. This is because the borrower pays fixed amounts irrespective
of economic fluctuations. This resembles the equity sharing model in companies. Due to the
current banking framework in many jurisdictions, riba prohibits a major chunk of Muslims to join
mainstream banking. I believe that if it Islamic banking is channelled in a proper way, it can do
more good than harm.

II. SOCIAL AND ECONOMIC BENEFITS ASSOCIATED WITH PROHIBITING RIBA C.

PROPAGATES A MORE HUMANE AND ACCEPTABLE SOCIETY

Quran provides that riba should not be charged. It considers riba as tantamount to propagating a
corrupt society and a justification for negative social and moral growth of society. This is because
charging interest on borrowed money allows you to benefit from other person’s adversities in a
situation where there are unequal bargaining power between the borrower and lender. Resultantly,
the necessary offshoot of not charging interest is that it makes the society better off as a community
where people help each other financially without hidden interests.

D. GRANTS THE ECONOMICALLY DISADVANTAGED ACCESS TO BANKING

CHANNELS

The Muslim population in India suffer from the lack of banking channels because Islam prohibits
participation in current banking model in the country. Apart from their own social arrangements,
it gets difficult for them to arrange funds. Former RBI Governor, Mr. Raghuram Rajan mooted
the introduction of Islamic Banking in his Financial Sector Study, in which he proposed the
operation of interest-free banking techniques to provide access to people who cannot access
banking services, including those that form the economically deprived segment of society.

E. HELPS IN INCREASING EQUITY INVESTMENTS AT THE STOCK EXCHANGES

The introduction of an Islamic window in banks has many benefits. For instance, the majority of
Stock Exchange companies globally are shariat-based and attract large funds in the domestic
market alone. An Islamic banking window would inspire those in the Muslim community to invest
in ventures that mobilize enormous resources that they might not be prepared to put into banks.
This will also allow India to attract enormous investments in shariat-compliant projects from
Western Asia.

F. POTENTIAL TO ATTRACT FOREIGN CAPITAL FROM MIDDLE-EASTERN

COUNTRIES

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Since the population in middle-eastern countries is predominantly Islamic, they would prefer to
invest in anti-riba investment instruments. The extent of capital that can be invested by them is
clearly visible by the investment drive of UAE’s Sovereign Wealth Fund. Right from its
investments in Reliance Jio, the fund had invested heavily across the globe. This channel of funds
can be tremendously exploited by adopting an anti-riba banking system that coexists with the
current system.

G. REDUCES CONCENTRATION OF WEALTH

Interest is a low risk means of increasing wealth. If you already have wealth, charging interests on
provided capital concentrates wealth into a minority that has a socially disruptive capacity. This
can be minimized by banning interest.

H. REDUCES WEALTH INEQUALITY IN THE SOCIETY

The rich who are probably the lender benefit from the need for capital by charging interest for the
poor, i.e. the borrower, which increases the burden on the borrower. As a result, the wealthy get
wealthier and the poor get worse. Interest thus increases the inequality in income between the
members of society.

I. BRINGS MORE STABILITY IN THE BANKING SYSTEM

When people lend money to others, but the money so lent is not bound up with a physical resource,
the expectation is that not everyone will try to retrieve their liquid assets simultaneously. This
enables banks to keep considerably less amount of money in reserve. This has the potential to
bring financial uncertainty into the system.

III. CONCLUSION: TOWARDS A MORE INCLUSIVE BANKING SYSTEM

The above points illustrate that Islamic banking, centered on the concept of abolition of riba, can
help the banking channels tremendously. Therefore, it is necessary to have a banking framework
where the existing system can co-exist with Islamic banking.

A. CURRENT LEGAL FRAMEWORK INADEQUATE TO CAPITALISE ON RIBA

The Indian banking legislation would has to be changed to include provisions concerning Islamic
banking. The Banking Regulation Act, for example, allows payment of interest contrary to the
principles of Islamic Banking. It also stipulates that banking means accepting public money
deposits for lending or investment, thus excluding the instruments of Islamic banking which
promote profit and loss within its scope.

B. OPENING A SEPARATE WINDOW FOR ISLAMIC BANKING

The recent proposal from RBI to open a separate Islamic banking window is a positive step to
harmonise the current banking framework and include the latter within its ambit. However, in
India, such sound steps are marred by contentious religious debates and such steps take a political
rather than a financial angle. In contrast to personal rules, investing in shariat compliant projects
through Islamic banking windows would be an extra financial investment opportunity for all. Such
steps are necessary as the use of one type of banking service must not conflict with the use of
another.

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B. SHORT NOTE ON SUKUK BONDS I. INTRODUCTION

Sukuk bonds (Islamic bonds) refers to Sharia compliant bonds which are designed to not harm
any of the principles of Islamic banking. Conventional bond holders are paid interest on maturity
over the capital provided by them. It does not matter whether the issuer of such bonds has made
or not. The interest has to be paid. Under sukuk bonds, the holders do not charge interest rates,
but hold partial ownership of the assets purchased out of such bonds. The potential of such
investment instruments in driving growth in economy is often ignored by the States. In 2009,
Kerala became the first State in India to facilitate the sale of rupee-denominated sukuk bonds and
create investment funds that comply with Shariah law’s ban on interest.

II. FEATURES OF SUKUK BONDS

A. COMBINED OWNERSHIP OVER THE ASSETS

Whenever the bond holder needs the money back, the asset can be liquidated. This structure
suggests that the bond holders are exposed to the risks of the asset and share responsibility with
the issuer. When the asset matures, the issuer buys them back and returns the capital to the
bondholder.

B. SHARING OF PROFIT AND LOSS

The bondholder is paid from the profits arising out of the asset. Similarly, when there is loss, the
bondholder is not paid anything and is instead required to share the loss mutually. Therefore, this
system is again akin to a profit and loss sharing model.

C. OFFSHOOT OF THE PROHIBITION ON CHARGING INTEREST

In order to bypass the prohibition on riba, sukuk was established to connect debt funding returns
and cash flows to a particular asset and effectively distribute the advantages of that asset. This
enables borrowers to deal with the restriction outlined by Sharia law and continue to enjoy debt
financing benefits. However, since sukuk is organized, only recognizable properties can be
funded.

III. SIMILARITIES & DIFFERENCES BETWEEN SUKUKS & CONVENTIONAL

BONDS

A. SIMILARITIES BETWEEN THE INSTRUMENTS

i. Investors receive a stream of payments: Conventional bonds provide investors with

interest payments, while Sukuk allows investors to receive profit generated by the

underlying asset.

ii. Less risky investments than equity: Sukuk and bonds are considered less risky
investments relative to equities.

iii. Initially sold by the issuers: Both are initially sold by the issuers to the investors. Afterward,
both securities are traded over the counter.

B.DIFFERENCES BETWEEN THE INSTRUMENTS

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i. Receiving interest: Conventional bonds are such that the holder is liable to receive interest
payment on the date of maturity whether or not the issuer is making any profit (lucrative, attractive
– words used to describe the bonds since the lender is protected from risk).

ii. Maturity date: When Sukuk bonds are issued to investors, the money raised through them is
used in the purchase of an asset but the Sukuk allows the bond holder to have partial ownership
rights. The difference is that if you want you can liquidate your holdings and be repaid, unlike
conventional bonds which have a fixed maturity date.

iii. Time-period of interest payment: In conventional bond, monthly payment of interest. In

Sukuk, the bond holder is paid from profits that arise from the asset. At maturity period, the bonds
are required to be bought back by the investor.

IV. PROCESS OF ISSUING SUKUK BONDS

The unique nature of Sukuk requires a specific issuing process for the financial instrument. A series
of steps need to be followed in its issuance process. The same has been provided below.

1. A company that requires capital [“originator”] establishes an SPV.

2. SPV issues Sukuk certificates that are sold to the investors.
3. The originator purchases the required asset using the sale proceeds of Sukuks.
4. The SPV buys the asset from the originator.
5. The SPV pays the asset sale proceeds to the originator.
6. SPV sets up the lease of the asset to the Originator.
7. Originator makes lease payments to SPV [distributed among holders as income] On expiry
of lease, Originator repurchases the asset from SPV at nominal value.
8. The SPV distributes the proceeds to the certificate holders.

NOTE: Creating an SPV protects the underlying assets from creditors if the originator suffers
from financial problems.

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ANSWER 3: The government’s dual role in nationalised banks, as a majority shareholder
as well as regulator, has exposed these banks to systemic risks and functional ineffiencies.
Analyse the recent initiatives of the government and RBI that are aimed at altering the
existing structure to boost the efficiency and results of such banks.

I. INTRODUCTION

In the Indian banking system, public sector banks play an important role. It holds more than 65%
of the banking sector’s deposit and 60% of its distribution of loans. RBI is the banking regulatory
authority regulated by the government. In these PSBs, the government is the controlling
shareholder, which means it has the dual position of owner and regulator. Such a structure is
problematic for efficient function of the banks and leads to the following problems.

CONFLICT OF INTEREST AND LACK OF TRANSPARENCY

State ownership of banks is a concern for corporate governance because the state as owner and as
regulator generates a conflict of interest. State ownership may also mean that officials are given
the management of the bank instead of professionals. In addition, government ownership in these
banks allowed them to operate in an opaque way. On the transparency front, the central
investigative agencies have been under government control and even the RTI is not fully applicable
to these banks. Lack of transparency and the failure to maintain books of accounts is cited as the
main explanation for an exponential increase in PSBs.

INTERFERENCE IN DAY-TO-DAY DECISIONS AND LACK OF COMPETENT

PERSONNEL

The decision of PSPs is heavily affected by the government, as the government appoints the
Board of Directors. This tilts its working towards government initiatives and prevents private
investment opportunities from being capitalized. There is also a major disparity in the pay
awarded to the bank’s top brass. In addition, PSBs rotate the CEO and provide less versatility to
hire new talents. Thus, the PSBs are plagued by a lack of adequate personnel at the top level.

In light of these problems, the government and RBI have taken the following initiatives.

II. ANALYSING THE RECENT INITIATIVES OF THE GOVERNMENT AND RBI

Lately, both the government and the RBI have awoken to the need of revitalising the PSBs in
India. This shows that both the authorities do at least recognise the problems in the current
ownership structure of PSBs. Majorly, the initiatives taken by the government and RBI to alter the
extant ownership structure can be summarised in the following manner.

A. ESTABLISHMENT OF THE BANKS BOARD BUREAU

Appointment of directors in the Board of RBI has always been a bone of contention. An
independent Board would reduce government intervention the day-to-day affairs of banks.
Therefore, following the recommendation of the RBI, the Bank Board Bureau was established. It
is mandated to select and recommend appointments of Board members for various financial
institutions in public sector. It is also required to undertake activities in the sphere of governance
in these institutions. The Bank Boards Bureau would advise the Government on the selection and

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designation of members of the Board in PSBs. It is also entrusted with the task of formulating and
implementing a code of conduct and ethics for PSB managers. I think the bank boards must be
completely professional and empowered to take all bank decisions and be accountable for their
results.

B. MASSIVE DISINVESTMENT PROGRAMME BY THE GOVERNMENT

The central government is planning to reduce its shareholding in the banks and pushing for
privatisation of banks. The first part of the government’s plan is to sell majority stakes in five
PSBs, including Bank of India, Central Bank of India, Indian Overseas Bank, UCO Bank, Bank of
Maharashtra and Punjab & Sind Bank. This would lead to an effective privatisation of these state-
owned lenders. This step would not only reduce the conflict between the ownership and regulatory
functions of the bank but also provide the Government the required capital to channel into other
areas.

C. SPLITTING THE POSTS OF CHAIRMAN AND MANAGING DIRECTOR OF RBI

The RBI in 2014 proposed to segregate the post of Chairman and Managing Director [CMD] of
PSU banks. The proposal of RBI brought changes in the top management of the PSU banks.
Before 2014, the post of CMD in PSU banks was vested with one person only. As a result, CMDs
of PSU banks enjoy absolute power and often dominate the board during their tenure. To tackle
the same, the RBI recommended having separate posts for Chairman and MD. The Government
acted on it and the posts were split.

D. TIGHTENING CONTROL OVER FOREIGN BRANCHES

Previously, the RBI exerted almost no influence over overseas branches. This led to corporate
frauds and scams. Therefore, the Government allowed RBI to tightening its grip over those
branches. All transactions across the network of the bank that may use the modus operandi used
in a scam are assessed. All branches/regions that may be affected overseas are then be identified
and documentation and processes followed up in these transactions are reviewed. Thereafter, the
banks review their current internal controls to track trade transactions as well as to investigate the
position of banking workers and any collusion or negligence. Resultantly, this significantly boosted
the efficiency and results of various PSBs.

E. RBIPERFORMINGINTERNALAUDITOFPSBS

To check the growing menace of NPAs and the gross irregularities in maintaining the books of
accounts, the RBI has initiated an internal audit of the accounts of banks. This would assist in
fraud-risk assessment. It allows the RBI to internally scrutinize the accounts of PSBs and take prior
steps to initiate recovery if it finds an erring defaulter with huge downside potential. This has
significantly enhanced the accounting practices followed by PSBs, and as a result their efficiency
and results stand increased.

III. LACUNAE IN EXISTING FRAMEWORK AND THE WAY FORWARD

The aforementioned steps taken by the RBI and the Government have not been totally effective
in altering the ownership structure at PSBs.

NO PROPER PLAN OF ACTION ON THE DISINVESTMENT PROGRAMME

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While the disinvestment programme has been much touted, a proper timeframe for the same has
not been decided. Additionally, even if there is disinvestment, the actual stake held by the
Government would be an important factor. Media reports suggest that the Government is
mulling over keeping a 51% stake in PSBs even after the disinvestment. This greatly reduced the
positive impact set to flow from such steps. It appears that the only objective of the Government
in doing so is to generate capital for itself.

In light of the aforementioned problems, I have the following suggestions to make.

A. SETTING UP A BANKING INVESTMENT COMPANY

The Government should set up a Bank Investment Company [BIC] to hold the existing equity
stakes in banks which are presently held by the Government. BIC should be incorporated under
the Companies Act, and the transfer of powers from the Government to BIC through a suitable
shareholder agreement and relevant memorandum and articles of association.

B. ESTABLISHING CORPORATE GOVERNANCE BOARDS

The Government needs to move rapidly towards establishing fully empowered boards in public
sector banks, solely entrusted with the governance and oversight of the management of the banks.
It is a precondition to the survival of these banks, to their being able to compete in the
marketplace, and to their revival. It is also a precondition for the Government not having to
periodically recapitalise its banks with deeply negative returns, with recapitalisation amounts likely
to escalate and threaten fiscal consolidation.

C. CEASING ISSUANCE OF REGULATORY INSTRUCTIONS TO PSBS

The Government should cease to issue any regulatory instructions applicable only to public sector
banks, as dual regulation is discriminatory. RBI should be the sole regulator for banks, with
regulations continuing to be uniformly applicable to all commercial banks. The Government
should also cease to issue instructions to public sector banks in pursuit of development objectives.
Any such instructions should, after consultation with RBI, be issued by that regulator and be
applicable to all banks.

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