Sajjan Bank (Private) Ltd. v. Reserve Bank of India (1961)

This is the licensing case. It answers three questions at once, and each is examinable on its own.

First, is a licensing requirement for banking constitutional? The argument that it restrains trade is obvious and was pressed hard, and the judgment's answer — the licence and permit distinction — is a portable piece of constitutional technique that applies far beyond banking.

Second, what is banking? The judgment contains the clearest short statement of the essence of the s. 5(b) definition, and draws from it the practical consequence that an ordinary moneylender is not a bank.

Third, how far will a court review the Reserve Bank's refusal of a licence? The answer is a sustained study of what makes an administrative decision non-arbitrary, and it is worth reproducing as a checklist.

The judgment also carries a compressed account of the Reserve Bank's constitution and functions, and a section-by-section survey of the scheme of the Banking Regulation Act, which makes it a useful single source for a question on either.

The petitioner originated from Sajjan and Co. Ltd., incorporated in November 1944 with the main object of carrying on money-lending business. In May 1946 the company was converted into a banking company, and in November of that year its name was changed to Sajjan Bank (Private) Ltd. All its shares were held by its three directors, who were closely related. It carried on business at Alandur.

The Banking Companies Act 1949 came into force on 16 March 1949. Section 22 required every banking company in existence at the commencement to apply in writing to the Reserve Bank for a licence within six months, and every other company to apply before commencing banking business; a company in existence at the commencement could continue to carry on banking business until final orders were passed on its application.

On 14 September 1949 the petitioner applied for a licence.

In July 1952 the Reserve Bank's officers inspected the bank under s. 22; a report of 11 October 1952 revealed defects. The Reserve Bank kept the question of the licence in abeyance, to watch the bank's progress in eradicating them. Correspondence followed; it was not until 1955 that the defects were sought to be explained away or remedied.

In September 1956 a fresh inspection was carried out under s. 35, and it too revealed defects. The Reserve Bank was not satisfied that the affairs of the bank were being conducted in the interests of the depositors. The petitioner was directed to show cause against refusal and was furnished a copy of the inspection report.

By letter dated 18 March 1957 the Reserve Bank declined to grant the licence. The bank moved the High Court under Art. 226 for certiorari to quash that order.

1. That s. 22 was unconstitutional so far as it restricted the fundamental right to carry on banking business.
2. That even if s. 22 were valid, the Reserve Bank's action was arbitrary.
3. That after an inspection under s. 35 the Reserve Bank could only proceed under s. 35(4) and could not refuse the licence altogether.

The petition was dismissed with costs. The refusal was within jurisdiction and the jurisdiction had been properly exercised.

The essence of banking, and who falls outside it

The Court set out the definition in s. 5(b): banking means accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise. That definition, the Court said, follows the accepted legal concept of the word.

From it the Court drew the operative consequence: the essence of a banking business is receiving money on current account for deposit from the public, repayable on demand and withdrawable by cheque, draft or otherwise. An ordinary moneylender who does not accept moneys on terms enabling a depositor to draw cheques upon him is therefore not a bank or banker properly so called, and the provisions of the Act apply only to the limited class of cases where the banker allows withdrawal of money by the issue of cheques.

That proposition does the work later in the judgment, on the question of hardship.

The Reserve Bank, and why the power was given to it

The Court's account of the Reserve Bank is compact and quotable. It came into existence on 1 April 1935. It is a central bank combining in its functions the regulation of both the credit and the currency of the country. Before its formation, responsibility for currency lay with the Central Government while the Imperial Bank of India performed the banking functions; the Royal Commission on Indian Currency and Finance in 1926 found that dichotomy between currency and credit a weakness in the Indian monetary system and recommended a central bank, whose structure was modelled very largely on the Bank of England.

It is a non-political statutory body. The general superintendence and management of its affairs is vested in the Central Board of Directors, and for each of the four regional areas — Bombay, Calcutta, Madras and New Delhi — there is a Local Board, whose function is to advise the Central Board on matters referred to it and to perform such duties as the Central Board may validly delegate.

The main function of the Reserve Bank is to regulate the monetary system of the country so as to ensure the maintenance of economic stability and assist in its growth. It has the sole right to issue currency notes; it acts as banker to the Government; it acts as banker to commercial banks and other financial institutions; and for the regulation of credit it has powers of control of the bank rate and of open market transactions. Its responsibilities include the development of an adequate and sound banking system, not only for trade and commerce but also for the agricultural industry.

The scheme of the Act

The Court then surveyed the Act, and the survey is a ready-made answer to a question on the powers of the Reserve Bank under the Banking Regulation Act:

| Section | What it does | |---|---| | 5(b), 5(c) | Define banking and banking company | | 6 | Allied businesses a banking company may engage in | | 12, 12A | Prevent control of companies by a few persons to the detriment of the majority of shareholders | | 14 | Prohibits creation of charges on unpaid capital | | 17, 18 | Minimum reserve fund and cash reserve | | 20 | Prohibits loans on the security of the company's own shares and unsecured loans to directors and their firms | | 21 | Power of the Reserve Bank to control advances | | 22 | The system of licensing, the power being vested in the Reserve Bank | | 23 | Restrictions on opening new places of business or changing existing ones | | 24, 25 | Maintenance of sufficient liquid assets | | 26 | Annual report of unclaimed deposits | | 27, 28 | Power to call for information | | 35, 36 | Periodical returns and inspection of books; action against banks conducting business detrimentally to depositors | | 35A | Power to give directions, generally or to a particular bank |

The Court's conclusion on the survey: the legislation is a comprehensive measure covering the establishment, the working and the liquidation of banks, and the Reserve Bank is substantially invested with the power of regulation of banking companies. In a country with banks ranging from the village moneylender to a big commercial bank, it was found necessary in the interests of the public that there should be a regulation of the banking system.

Licence or permit: the constitutional point

The petitioner relied on Namazi v. Deputy Custodian of Evacuee Property, Madras (AIR 1951 Mad 930), where a disposition by an intending evacuee was made subject to the Custodian's permission, no rules were framed for his guidance, and the Chief Justice observed that to assume the Custodian would not ordinarily refuse approval except on proper grounds would be gambling on the reasonableness of the Custodian, since as the section stood nothing prevented him from most unreasonably refusing.

Namazi is therefore the petitioner's best case and also the answer to it. It held that a permit system would be unconstitutional so far as it relates to the exercise of fundamental rights, but a system of licensing which has for its object the regulation of trades is not repugnant to Art. 19(1)(g). And it identified the marks which show that what a statute prescribes is regulation by licence and not the insistence of a permit:

1. the existence of rules for the guidance of the authority;
2. the insistence on reasons for the refusal of a licence;
3. provision for a right of appeal; and
4. the judicial nature of the enquiry before refusal.

Applying those marks, s. 22 is a licensing provision. The Act was passed in the interests of the public after detailed enquiry by a Committee which itself recommended a system of licensing of all banking companies; even foreign banking experts were not averse to it. The licensing power is vested not in a mere officer but in a statutory authority which is itself a central banking institution concerned with the currency and credit operations of the country. The Reserve Bank was established with a view to fostering the banking business and not to impeding its growth. The standards for the exercise of the power are laid down in s. 22 itself.

The Court's conclusion: the power, being regulated by the statute, entrusted to a statutory body which is itself regulating the credit of the country, and exercised after the investigation the statute prescribes, is invested with a quasi-judicial character; it cannot be said to be arbitrary. It is a mere licence granted as a matter of course to all genuine banking institutions run on sound lines, so that institutions masquerading as banks, or run on unsound lines, or affecting the interests of the public, can be weeded out. It is not a permit.

The hardship point

There is a further answer, and it depends on the definition of banking with which the Court began. Refusal of a licence under s. 22 does not mean a stoppage of business. Since the essence of banking is the opening of current accounts and the enabling of the constituent to draw by cheques, refusal entails only the loss of that type of business; it remains perfectly open to the petitioner to carry on business as a moneylender, the only restriction being that it cannot have transactions under which the constituents draw cheques on it.

Was the refusal arbitrary?

No. The Court's reasons, which make a usable checklist:

• Sufficient opportunity was given; there was no complaint to the contrary.
• The first inspection in 1952 showed the bank was not conducted on sound banking lines, with fundamental errors in the accounts and non-compliance with the Act.
• The Reserve Bank very properly kept the licence question in abeyance and gave periodical instructions, since the bank, having existed before the Act, could continue business until the licence was granted or refused.
• The defects were not sought to be remedied until 1955, which entailed the further inspection of 1956.
• The report went to the local board, which was satisfied that refusal was proper.
• The bank had not been able to effectuate any material improvement in the pattern of its working and could not attract sufficient deposits from the public.
• It had been converted from a private limited company into a banking company evidently to circumvent the Madras Pawn Brokers Act 1943.
• Its paid-up capital was only Rs. 50,000; its reserves were poor; establishment charges absorbed more than fifty per cent of the gross income.
• More than one opportunity to show cause was given, and a comparative statement of the undesirable features with the bank's representations and comments went before the Central Committee.
• The progress and working of the bank were watched for more than four years. The delay in disposal was explained as anxiety not to precipitate a crisis which a quick refusal might occasion.

Far from being arbitrary, the Reserve Bank had given the utmost consideration to the petitioner's case.

Section 22 of the banking legislation prescribes a system of licensing for the regulation of banking, not a permit system, and is therefore not repugnant to Art. 19(1)(g): the power is conferred on a statutory central banking authority, is guided by standards stated in the section itself, is exercised after a statutory investigation and on a show-cause opportunity, and is subject to appeal — which invests it with a quasi-judicial character. A refusal reached after repeated inspections, prolonged opportunity to remedy defects and consideration of the bank's representations is not arbitrary and will not be quashed under Art. 226.