Opinion Lesson from demonetisation verdict: There is now greater judicial scrutiny of RBI decisions

Pratik Datta writes: Policymakers need to be careful while extending the role of an independent central bank beyond its traditional and uncontested activities

Pratik Datta writes: This shifting trend in judicial deference should nudge policymakers to consider the appropriate role of an independent central bank (File)

Pratik Datta

New DelhiJanuary 11, 2023 08:14 PM IST First published on: Jan 11, 2023 at 08:14 PM IST

In a widely reported judgment, Vivek Narayan Sharma v. Union of India, the Supreme Court has upheld the constitutionality of the 2016 demonetisation by a 4-1 majority. The court did not grant any relief to the writ petitioners. Consequently, the decision may not be of any immediate utility to the parties involved. However, if one is to step back and contextualise this judgment against the broader trend of Supreme Court decisions involving the RBI, judicial deference towards the central bank appears to be waning.

In a recent article published in the Indian Law Review, we argue that traditional RBI functions involving balance-sheet operations as well as regulatory actions against regulated entities have usually been uncontested. Consequently, the Supreme Court got relatively fewer opportunities to review the RBI’s actions. On the rare occasion when the RBI’s regulatory actions were challenged before the Court, judges were extremely deferential towards the central bank till the late 1990s.

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Starting with the 1962 decision in Joseph Kuruvilla Vellukunnel v RBI upholding the RBI’s extraordinary powers to wind up a banking company, to several decisions from 1963 to 2000 consistently upholding the RBI’s increasing regulation of deposit-taking activities by NBFCs, and finally, the 1996 decision upholding the constitutionality of the High Denominations Bank Notes (Demonetisation) Act, 1978 — the Supreme Court had always shown extreme deference towards the RBI during this period, both in words as well as in action.

With the turn of the century, this traditional judicial deference towards the RBI started changing due to various exogenous factors. The first such factor was the enactment of the Right to Information Act, 2005. It empowered citizens to demand myriad information from public authorities including the central bank. The RBI refused to release information obtained from its regulated banks. Such refusal went beyond its traditional uncontested central banking functions, exposing the RBI to multiple judicial review challenges. The Supreme Court finally decided against the central bank in RBI v. Jayantilal N Mistry (2015). Although this decision is now likely to be reviewed by a higher judge bench, it marks a prominent turning point in the traditional judicial deference shown by the Court towards the central bank.

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Various subsequent exogenous events such as demonetisation, the enactment of the Insolvency and Bankruptcy Code, 2016, the emergence of virtual currencies and the Covid-19 pandemic, saw the RBI issuing legal instruments that directly impacted various stakeholders beyond its immediate jurisdiction. These aggrieved stakeholders increasingly challenged those legal instruments. As a result of some prominent instances of successful challenges against the RBI, there appears to be a corresponding increase in the overall judicial review challenges against the RBI since 2015.

This increase appears to have eroded the traditional judicial deference towards the RBI. In many of the prominent decisions since 2015, the Supreme Court has actively used its judicial review powers against the RBI, while (at times) simultaneously acknowledging the central bank’s expertise and cautioning against judicial review of economic and fiscal policy measures.

In Dharani Sugars and Chemicals Ltd. v. Union of India (April 2019), the Court struck down an RBI circular that required banks to compulsorily trigger the IBC against corporate debtors with aggregate debt exposure of Rs 2,000 crores or more. The Court found the circular ultra vires section 35AA of the Banking Regulation Act 1949. In State Bank of India v. M/s. Jah Developers Pvt. Ltd. (May 2019), the Court effectively rewrote the impugned RBI Master Circular on Wilful Defaulters to effectively insert natural justice principles within the regulated banks’ internal procedures. In Internet and Mobile Association of India v. RBI (2020), the Court struck down another RBI circular that had prohibited its regulated entities from dealing or settling in virtual currencies. The Court found the prohibition to be disproportionate. In Small Scale Industrial Manufacturers’ Association v. Union of India (2021), the Court effectively quashed an RBI notification that had allowed lenders to charge interest on interest during the Covid-19-induced moratorium period. Overall, the Court continues to show utmost deference towards the RBI in its words, although its actions post-2015 reveal a relatively less deferential approach towards the central bank at least on regulatory process aspects.

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The Supreme Court’s demonetisation judgment has kept with this trend. The Court directed the RBI to produce relevant internal records to determine if it had taken into consideration the relevant factors and eschewed the irrelevant ones. Upon detailed scrutiny of those records, the majority was satisfied that the central board of the RBI had considered the relevant factors while recommending withdrawal of the legal tender status. This precedent thus firmly establishes the remit of judicial review powers over the RBI’s internal decision-making processes. In the future, this precedent may well be used to hold the RBI to higher standards of regulatory governance in its regulation-making as well as quasi-judicial activities.

This shifting trend in judicial deference should nudge policymakers to consider the appropriate role of an independent central bank. Paul Tucker, a former deputy governor of the Bank of England, argued in his book, Unelected Powers, that the constitutional argument for central bank independence applies only to monetary policy, with its latent power of taxation. It does not apply to other responsibilities that a central bank may have, notably regulatory policy and prudential supervision. Policymakers, therefore, need to be judicious while extending the role of an independent central bank beyond its traditional uncontested activities. By imposing additional responsibilities, they may inadvertently expose the central bank to greater risks of frequent judicial review. That may, in turn, have implications for its operational independence.

Datta is a Senior Research Fellow at Shardul Amarchand Mangaldas & Co., New Delhi. Views are personal