Does the RBI’s claim to regulate NBFC (MFIs) have more merit than Federal state governments’ claims? An analysis of constitutional provisions by Vishnu Peri, IFMR Mezzanine Finance.
A verdict on the Malegam committee report’s 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.
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”.
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. 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*…….. (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**.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.
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*** and Sundaram Finance vs. State of Gujarat****.
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 points 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. __________________________________________________________________________________________
***(2005) 128 Comp Cas 196 (Bom)