LLM Group 2 Business Law Banking Laws 2016 Question Paper with Solutions

For full marks, cover: this version of the question adds two things the other papers in the folder do not ask, exchange control and the monopoly of currency notes, and an answer that does not deal with the Foreign Exchange Management Act, 1999, has missed a quarter of it; organise the answer around the idea that the Reserve Bank is a statutory monopolist in three markets, notes, foreign exchange and central bank money, and that each head of the question is one of those monopolies; give the sections throughout; and close on the change that the Finance Act, 2016, made to how the price of money is fixed.

(a) Regulation of currency

Section 22 confers the sole right to issue bank notes in India, and section 23 requires the issue to be conducted through a separate Issue Department whose assets are kept apart from those of the Banking Department, so that the note liability always has identifiable cover against it. Section 24 fixes the denominations and allows the Central Government to specify others up to a ceiling of ten thousand rupees, and section 25 requires the design, form and material to be approved by the Central Government on the recommendation of the Central Board.

One rupee notes and all coins fall outside the monopoly. They are issued by the Central Government under the Coinage Act, 2011, and section 38 provides that they are put into circulation only through the Bank. The monopoly in section 22 is therefore a monopoly of bank notes, not of legal tender.

That power was tested by the demonetisation of 8 November 2016 and upheld in Vivek Narayan Sharma v. Union of India, decided by a Constitution Bench on 2 January 2023. The majority held that "any series" is wide enough to include all series of a denomination, that the six month consultation between the Central Government and the Bank satisfied the requirement of a recommendation of the Central Board, and that hardship to some citizens does not invalidate a policy measure.

Nagarathna J. dissented, holding that "any series" cannot mean the entire denomination, that a proposal originating with the Government cannot be presented as a recommendation of the Board, and that the withdrawal of the greater part of the currency in circulation could be effected only by legislation. She granted no relief, the notes having long since been exchanged, so the dissent stands as a declaration of where the limit should lie.

The scheme of the Act of 1999 rests on a distinction between current and capital account transactions. Section 5 provides that any person may sell or draw foreign exchange for a current account transaction, subject only to reasonable restrictions imposed by the Central Government. Section 6 deals with capital account transactions, which are those that alter the assets or liabilities outside India of a person resident in India, or in India of a person resident outside India, and these may be undertaken only to the extent permitted. Section 6(3) formerly gave the Reserve Bank power to prohibit, restrict or regulate specified classes of capital account transactions; it was omitted by the Finance Act, 2015, which moved the power over non debt instruments to the Central Government, so the two authorities now share this field.

(b) Banker to the Government and bankers' bank

Section 20 imposes a duty and section 21 confers a right, and the pairing is deliberate. Section 20 obliges the Bank to accept money for the account of the Central Government, to make payments up to the credit balance, and to carry out its exchange, remittance and other banking operations, including the management of the public debt. Section 21 entitles the Bank to that business, requiring the Central Government to entrust it with all its money, remittance, exchange and banking transactions in India and to deposit free of interest all its cash balances with the Bank. Section 21A extends the arrangement to the States by agreement.

Three consequences follow. The Bank conducts the auctions of Government securities and treasury bills and maintains the ownership records, which makes it the manager of the public debt and not merely the Government's cashier. It provides Ways and Means Advances to bridge temporary mismatches between receipts and payments, repayable within three months. And since the Fiscal Responsibility and Budget Management Act, 2003, it may not subscribe to primary issues of Central Government securities, which ended automatic monetisation of the deficit and is the most important structural reform in this relationship.

(c) Bank rate policy and the monopoly of currency notes

Section 49 defines the bank rate as the standard rate at which the Bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the Act, and requires the rate to be made public. Historically it was the pivot: raising it made central bank refinance dearer, which fed through to lending rates and contracted credit.

It is no longer the operative rate and an answer that says otherwise is out of date. The working rate is the repo rate under the liquidity adjustment facility, and since the realignment of February 2012 the bank rate has been kept equal to the marginal standing facility rate, which is itself set at a margin above the repo rate. The bank rate therefore moves automatically and carries no independent signal.

Its survival is legal rather than economic, and this is the point that distinguishes a strong answer. Because a large number of statutes and contracts fix rates by reference to the bank rate, it continues to serve as a benchmark, including for the penalty on a shortfall in the cash reserve ratio. It has moved from being an instrument to being a reference.

How far these monopolies reach, and where the courts have stopped them

The width of the Bank's regulatory power was settled in Reserve Bank of India v. Peerless General Finance and Investment Co. Ltd., (1987) 1 SCC 424. Peerless, a residuary non banking company, ran a savings scheme under which a subscriber who stopped paying forfeited a large part of what he had already paid. The Reserve Bank issued directions under Chapter III B regulating such schemes, and the company said they were beyond power because it was not a bank.

The Supreme Court upheld the directions, holding that the power in Chapter III B is wide, is directed to the protection of depositors, and reaches institutions that are not banks at all. Chinnappa Reddy J. added the passage on interpretation for which the case is best known, that a statute must be read as a whole in its context and that its text is best understood when the reason for it is known. The monopoly of central bank money therefore carries with it a jurisdiction over anyone who takes money from the public.

Conclusion. The three heads of this question are three statutory monopolies and each has been reshaped in the last decade. The note monopoly under section 22 survived its severest test in the demonetisation case, where the majority upheld an executive withdrawal of eighty six per cent of the currency by value and Nagarathna J.'s dissent identified the constitutional limit that ought to apply, and it has since been extended to a digital bank note by an amendment to a definition. Exchange control was rebuilt in 1999 on the opposite premise from the Act it replaced, permitting what is not restricted rather than prohibiting what is not permitted, and it operates through banks as authorised persons under section 10.

The relationship with the Government under sections 20 and 21 was transformed by the prohibition on subscribing to primary issues under the Act of 2003, which ended the printing of money to fund the deficit. And the bank rate has been quietly demoted: section 49 still defines it, but the price of money is now set by a statutory committee against a statutory inflation target under Chapter III F, and the bank rate survives as a legal benchmark. What runs through all four changes is the same movement, from discretion vested in an institution to a rule laid down by statute, and it is the single most useful observation to make about the modern law of central banking in India.