B.A. LL.B. (Five Years) Sem 8 Banking Law 2018 Dec Question Paper with Solutions

For full marks, cover: the Reserve Bank as India's central bank (Reserve Bank of India Act, 1934); its functions grouped as (A) traditional central banking: currency authority (sections 22, 24, 26, 38; the e-rupee; demonetisation and Vivek Narayan Sharma v. Union of India), banker to Governments and debt manager (sections 20, 21, 21A), banker's bank and lender of last resort (sections 17, 42), monetary authority (sections 45ZA, 45ZB), custodian of foreign exchange (FEMA); (B) regulatory and supervisory: banks, NBFCs, payment systems (Internet and Mobile Association of India v. Reserve Bank of India), rescue of weak banks (Ganesh Bank of Kurundwad); (C) developmental and promotional; (D) consumer protection; (E) research, statistics and financial stability; a table.

The central bank

The Reserve Bank of India was established under the Reserve Bank of India Act, 1934 and began functioning on 1 April 1935. It has been wholly owned by the Central Government since 1 January 1949. Unlike a commercial bank, it does not deal with the public for profit. Its business is the currency, the Government's money, the banks' money and the stability of the system. Its functions fall into five groups.

Withdrawing legal tender. On the Central Board's recommendation, the Central Government may declare a series of notes no longer legal tender (section 26(2)). In Vivek Narayan Sharma v. Union of India, 2023 SCC OnLine SC 1, the notification of 8 November 2016 had withdrawn all Rs 500 and Rs 1,000 notes. A Constitution Bench upheld it by four to one. The power reaches "all series", and the Board's recommendation is the safeguard. Nagarathna J. dissented.

2. Banker to Governments and manager of public debt. The Reserve Bank must transact the Central Government's banking business (section 20), and may act for States by agreement (section 21A). It receives and pays money for them, keeps their accounts, and gives short-term ways and means advances. It also manages the public debt, auctioning Government securities and treasury bills to fund the Government's borrowing.

3. Banker's bank and lender of last resort. Banks keep accounts with the Reserve Bank, and scheduled banks keep their cash reserve there (section 42, now 3 per cent). Interbank payments settle across these accounts. The Reserve Bank lends to banks against eligible securities (section 17). Through its liquidity facilities it supplies funds overnight. In a crisis it can act as lender of last resort to a solvent bank facing a run.

Rescue in practice. In Ganesh Bank of Kurundwad Ltd. v. Union of India, (2006) 10 SCC 645, a weak bank with 32 branches and a negative net worth was placed under a moratorium on 7 January 2006. It was merged into the Federal Bank by 24 January, and every depositor was protected. The Supreme Court upheld the speed of the scheme. The Reserve Bank's first duty under section 45 is to depositors' confidence.

2. NBFCs. Under Chapter IIIB of its Act, it registers non-banking financial companies (section 45-IA) and issues directions to them (sections 45JA and 45L).

3. Payment systems. Under the Payment and Settlement Systems Act, 2007, it authorises and regulates every payment system (sections 3 and 4). It also runs RTGS and NEFT.

The reach and the limit. In Internet and Mobile Association of India v. Reserve Bank of India, AIR 2021 SC 2720, a circular of 6 April 2018 had barred regulated entities from serving virtual currency businesses. The Supreme Court accepted that the Reserve Bank's powers over banking and payments are wide and can be used to prevent harm. It set the circular aside as disproportionate, since no actual harm had been shown.

C. Developmental and promotional functions

How the functions fit together

The functions support each other. Because the Reserve Bank is the banks' bank, it can move interest rates through the money it lends them. Because it supervises them, it knows which bank is merely short of cash and which is unsound. So it knows whom to support as lender of last resort. Because it manages the Government's debt, it watches how borrowing affects interest rates and prices. A single institution doing all this can act quickly in a crisis, without waiting for several agencies to agree.

Limits and criticisms

Combining so many roles in one body also creates tensions. Managing the Government's borrowing cheaply may conflict with fighting inflation. Being both regulator and rescuer may tempt delay in recognising a bank's failure. The 2016 inflation target, the Monetary Policy Committee and risk-based supervision were designed partly to manage these tensions. The courts add a check by insisting that its directions be proportionate and within statute.

The functions at a glance

Conclusion. The Reserve Bank's functions start with the classic central banking roles. It is the sole issuer of currency (Vivek Narayan Sharma) and banker to the Governments. It manages their debt and is the banks' bank and lender of last resort. It is also the monetary authority working to an inflation target, and custodian of foreign exchange. It regulates and supervises banks, NBFCs and payment systems. Its reach is wide but bound by proportionality (Internet and Mobile Association), and it rescues weak banks (Ganesh Bank). It also promotes development, protects consumers and watches over financial stability.