Banking laws and regulatory shake-ups

Regulatory action against Paytm's payments bank points to the need for reform of banking regulation

A press release issued by the Reserve Bank of India (RBI) two weeks ago directed the Paytm Payments Bank Ltd (PPBL) to stop onboarding customers with immediate effect. Existing customers were allowed to withdraw or utilise the balance in all their accounts but were not permitted to make additional deposit or credit transactions. No other banking services can be carried out by PPBL after February 29. Essentially, the RBI has stopped the operations of the PPBL. Why was this done?

An established and respected regulator like the RBI does not act without reason and justification. We presume that PPBL has engaged in egregious violations that necessitated a drastic response. It is likely that many smaller violations have occurred in the past. We would also presume that the top-management of PPBL was informed about the violations and given a chance to correct past behaviour. But these are presumptions; the truth is we do not know.

We do not have a formal legal order from the RBI setting out the failures and the justification for the action. All we have is a press release that specifies punishments, without offering evidence or rationale. The press release simply says that “the Comprehensive System Audit report and subsequent Compliance Validation report of the external auditors revealed persistent non-compliances and continued material supervisory concerns in the bank, warranting further supervisory action”.

This statement leaves many questions unanswered. We do not know whether a hearing took place, we have not heard PPBL’s side of the story, and we do not know the RBI’s rebuttal of PPBL’s defence. It is thus unclear whether due process and rule of law principles were followed by public authorities before imposing punitive actions.

This is an issue of some relevance because as Lord Hewart, the Lord Chief Justice of England, famously remarked in a 1924 case: “It is not merely of some importance but is of fundamental importance that justice should not only be done, but should manifestly and undoubtedly be seen to be done”.

At heart, this requires adherence to principles of rule of law and natural justice:

1. The term “rule of law” is about equal treatment of everyone, with the same set of laws and fair procedures in the legal process. Encyclopaedia Britannica defines it as “the mechanism, process, institution, practice, or norm that supports the equality of all citizens before the law, secures a non-arbitrary form of government, and more generally prevents the arbitrary use of power”.

2. Closely related to this notion is the notion of natural justice, which has two basic elements. The first principle is that no person should be judged without a fair hearing, providing the person the opportunity to respond to the evidence against her. Second is the principle that no one should be a judge in her own cause.

All of us in India will readily agree that a modern market economy requires these concepts to be fully in play, for arbitrary exercise of state power is unfair and deters private investment.

Is it possible that banking is special, and hence the foundations of constitutional law need to be suspended in this field? A look at contemporary examples of regulatory orders in the domain from the US and the UK (t.ly/Lyz8J and t.ly/9lqk9) shows that this is not the case. It is possible to reconcile the rule of law and constitutionalism with the field of banking.

Another possibility is that if the RBI is more transparent in such matters it could cause a run on a bank. Hence, it is argued that rule of law procedures are inappropriate for regulation and supervision of banks. But that argument cannot be made here. Prior to the action, PPBL had 30 million accounts and over 700,000 point-of-sale terminals. There are more than 35 million UPI QR codes associated with PPBL and 300 million wallets. On the Indian roads there are nearly 10 million FASTags of PPBL. All of them are impacted by the RBI action. Each of these users does not know what went wrong at PPBL, and only sees strong RBI action. This could lead to panic; if anything, it is the RBI action that potentially might set off a bank run. Indeed, there are market rumours that this entity is not alone; as a result, many other new-age financial firms are also facing considerable stress.

On the second principle of natural justice, it is relevant to ask if the RBI supervisors who inspected PPBL and found violations are distinct and separate from those who weighed the evidence and concluded that drastic actions were called for. In all likelihood they are. But we don’t know.

Prima facie, the evidence of the application of the two elements of natural justice in the case is thin. We are not able to say that justice has been manifestly and undoubtedly seen to be done.

Finally, is the RBI to blame for these observed difficulties? Not really. Section 35A of the Banking Regulation Act effectively instructs the RBI to do all the things that they have done. RBI employees are faithfully implementing the old laws with which they are obliged to work.

Consequently, it is time to revisit these old laws. This is part of India’s journey in building the institutions of a modern economy. In the case of Securities and Exchange Board of India (Sebi) the concept of a “speaking order” (with a rationale) came about as a result of two developments. A modern legislation, namely the Securities and Exchange Board of India Act, 1992 and the creation of relevant jurisprudence by the Securities Appellate Tribunal, which performs judicial oversight functions over Sebi.

Likewise, India needs a modern Banking Regulation Act, one that would ensure that the rule of law and natural justice apply fully in regulatory enforcement matters, whenever authorities engage with financial firms. After all, in a democracy, financial firms need reassurance that justice will not be arbitrary. And all of us as citizens, depositors, and users of wallets and QR codes have the right to know more about what went wrong at PPBL.

The writer is an honorary professor at CPR, member of a few for-profit and not-for-profit boards, and a former civil servant