Why claims of RBI to regulate NBFC (MFIs) is > Federal state govt claims. An analysis of constitutional provisions.

This article was first posted on the "IFMR Blog". Am cross posting it here.

A verdict on the Malegam committee reports efficaciousness is still out. However there is a consensus arising about the benefits of a few suggestions. One of these being, if the recommendations of the Malegam report are accepted, the need for a separate Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act (henceforth the Act) will not survive.[1]

The AP state government has responded to the report in general and this recommendation in particular with dour criticism and expression of support for its legislation. Further the AP government is claiming the protection and empowering cloak of the Indian constitution for the continuance of its Act. Rural development principal secretary R Subrahmanyam was cited in a news report claiming:

“According to the List II of the Constitution, the regulation of money lending is the original jurisdiction of the state government. An Act is the will of the people. Accordingly, whether or not the need for AP MFI (Regulation of Money Lending) Act exists will be decided only by the AP Legislature and not by the RBI”.[2]

Other criticisms were levelled at the report which was submitted to the RBI in a 5 page report, excerpts of which can be found in the public domain[3]. However for the purpose of this article we will focus only on the above statement, whereby state government regulation is given primacy over central regulation.

The constitutional powers debate:

The primary issue in our context is one of jurisdiction. Is regulation by federal units of India valid if a class of institutions are already under the purview of ‘central watchdogs’.

The primary argument utilised by the AP govt deals with the concept of separation of powers which is enshrined by the Indian constitution via Article 246. This article combined with Schedule VII lists the areas which are the exclusive domains of the Centre, the State and common areas of interest.

Under List I which lists central government’s sphere of responsibility the following entries are relevant:

Entry 38: Reserve Bank of India.

Entry 43: Incorporation, regulation and winding up of trading corporations including banking, insurance and financial corporations but not including co-operative societies.

Entry 44: Incorporation, regulation and winding up of corporations, whether trading or not, with objects not confined to one State, but not including universities.

Under List II which lists state government’s sphere of responsibility the following entries are relevant:

Entry 30: Money-lending and money-lenders; relief of agricultural indebtedness.

Entry 32: Incorporation, regulation and winding up of corporations, other than those specified in List I, and universities; incorporated trading, literary, scientific, religious and other societies and associations; co-operative societies.

The Rural development principal secretary R Subrahmanyam is depending on entry 30 List II cited above to derive sustenance for the Act. A preliminary reading of the above entries leads us to see AP government’s Act as a case of constitutional over reach; especially when the act seeks to infringe onto RBI’s turf. The entries and hence the constitution is clear that the state government can only regulate those financial corporations which are not regulated by the central govt. Further the RBI is under the exclusive control of central regulation. Money lending under entry 30 list II cannot be given such a wide interpretation so as to encompass areas under exclusive central regulation and thus defeat the language and spirit of the constitution.

If we assume the above argument to be valid, RBI and its regulatory powers are derived from List I and will be equivalent to central government regulation. Thus in the present context we are dealing with over-regulation of NBFCs’ by state and central laws.

With the insertion of chapter IIIB in the RBI act, it has become compulsory for NBFCs to register with the RBI, which has specified various restrictions in the context of income recognition, asset classification, capital adequacy norm, provisioning requirements and disclosures in the balance sheet.

The objects and reasons for insertion of Chapter-IIIB would assume importance in order to better understand the controversy. The same reads as under:

……..For ensuring more effective supervision and management of the monetary and credit system by the Reserve Bank, it is desirable that the Reserve Bank should be enabled to regulate the conditions ……… The Reserve Bank should also be empowered to give any financial institution or institutions directions in respect of matters, in which the Reserve Bank, as the Central Banking institution of the country, may be interfered from the point of view of control over the credit policy. The Reserve Bank's powers in relation to commercial Banks should also be enhanced and extended in certain directions, so as to provide for stricter supervision of the operations and working……..[4] (emphasis added)

The aforesaid makes it clear that the intention of the Parliament to insert the provisions of Chapter-IIIB inter alia is to control and regulate the conditions for acceptance of deposit and to control the credit policy of Non-Banking Finance Companies and the financial institutions.[5] The overarching nature of RBI regulation can be seen through section 45Q:

“The provisions of this Chapter 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.]” 

This non-obstante clause overrides provision of any other law for the time being in force. Further, besides section 45Q, section 45JA is important as it allows the RBI to direct all or a class of financial institutions and to formulate policy for the same. This will put the burden on RBI to direct MFI NBFCs as it has the wherewithal and legislative competence for the same; not state governments who have experience of only regulating state corporations and money lenders. The Malegam report supports this notion when it forwards the idea that the State is often not the best agency to act as a regulator and this task is best left to an independent regulator[6].

The High Courts of Maharashtra and Gujarat have upheld the primacy of RBI over state regulation on these same grounds, in the cases of Vijay P vs. State of Maharashtra[7] and Sundaram Finance vs. State of Gujarat[8].

The Malegam report records that ideally there should not be any overlap of regulation and regulators for the smooth functioning of financial services. The above point’s buttress this argument and show that legally speaking there cannot be any overlap and the NBFCs must either be governed by List I or II.

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[1] Page 49; Para 25.7.

[2] http://www.business-standard.com/india/news/ap-govt-raps-malegam-says-mfi-act-to-stay/422621/; Last visited on 31^st January, 2011.

[3] http://www.dnaindia.com/money/report_andhra-pradesh-to-deep-six-malegam-panel-recos_1497525; Last visited on 31^st January, 2011.

[4] (2010)51GLR1529

[5] Ibid.

[6] Page no 48; Para no 25.6 (a).

[7] (2005) 128 Comp Cas 196 (Bom)

[8] (2010)51GLR1529

A foreign policy doctrine for India.

Hopes of emulating the success of an ‘Iraqi surge’ in Afghanistan may not have been fully realised. With the US stuck in a quagmire of economic crisis and a perception of loss of power, USA increasingly is looking for a way out. India should have been the traditional go to nation for sharing some of the burdens of the Afghan war, however with Pakistan objecting to even token Indian presence, this seems unlikely.

There is a fair amount of analysis on possible outcomes of USA withdrawal and role of India in such a post-USA Af-Pak world. One of the constants of such analysis has been the certainty of a de-facto Pakistan takeover of Afghanistan. With a return of Taliban and strengthened Pakistani elements, the 60 year old Indian endeavour of settling its western borders would be considerably weakened. A victorious Pakistan would be a recalcitrant negotiator.

Such a gloomy forecast is among others a case of simplification of an unclear narrative. We have frequently looked at the Pakistani and Afghani players as a monolith, with shared interests and common foes. The participants in this story are diverse and engaged in a fight with every other participant, including their supposed allies. Notably the Tehrik-i-Taliban and allies are opposed by the Punjabi governing elite, , national parties, the MQM and partly by the Balochs. Further the areas bordering Afghanistan wherein the Taliban and other extremist agencies are based have not been conclusively lost. Instead FATA, Quetta, Mohammed Agency are frontlines, with Pakistan being the prize.

Let us here for the moment assume Taliban’s victory over Afghanistan, with active Pakistani involvement. Is this really the nightmare situation for India, as has been painted in public discourse. In this author’s personal opinion, partition was the actual nightmare for Indian political and military strategists. All we are facing now are the after-shocks. It reflects negatively that we have yet to come up with a coherent public policy for dealing with results of said nightmare. Lack of communication of Indian foreign policy objectives to the public la the USA is a very significant lacuna on part of Indian administrators. This is so as it is the public which bears the cost for all policies.

In this article we will attempt to look at steps that India may take to turn around a Taliban takeover of af-pak region into a beneficial stand.

In our present context, it is interesting to note that the USA is looking at employing its time tested tactic of dividing a region it cannot hold. The Korean peninsula and Vietnam are prime examples of this approach. It is the US belief that short of an outright victory, a region clearly divided into blue and red is the most effective tactic in stopping a domino effect for the whole region. Vietnam being an example where after US withdrawal, the whole region became communist. A partition of Afghanistan will be of dubious benefit to USA and allies, as it will require continued expenditure of men and political will, to prop up and defend Northern Afghanistan. While this might be an easier task, with a friendlier population, the USA would be stuck in a semi-permanent deployment. From the Indian perspective this would be a very helpful development as;

1. The USA will continue to take an active interest in reducing Pakistani radical structures and manpower,
2. The focal point of Islamic extremism will continue to be divided between Kashmir and Afghanistan,
3. Northern Afghanistan will comprise of friendly elements of the Northern Alliance, which India shares a long standing relationship with.

Though this is a very brief summary of benefits, the logistics would allow India to establish a limited presence on the ground. The challenges for USA would be varied and would require renewed involvement with cold war era players, i.e. the CIS and Russia for setting up such a partition. The one nation which would be the clear beneficiary would be Iran, as it will gain prominence as a stabilising and influencing agent. The challenges for USA would however be gigantic and any partition may at best be a de-facto arrangement.

India needs to formulate a foreign policy doctrine for public consumption which takes into account the history of engagement with Pakistan and ways to deal with the threat of violence centred around the Af-Pak region. An attempt will be made to formulate an example of such a doctrine, later in this discussion.