Dual Regulation of Co-operative Banks- A Constitutional and Policy Analysis

Bharat Harne

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Analysing the judgement in Pandurang Ganpati Chaugule v Vishwasrao Patil Murgud Sahakari Bank Ltd

The Supreme Court (‘Court’) on 5th May in Pandurang Ganpati Chaugule v Vishwasrao Patil Murgud Sahakari Bank Ltd (‘Pandurang case’) held that the Co-operative banks  which are co-operative societies( ‘societies’) also are governed by the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act) and therefore the banks are competent to take recourse to the said Act rather than the recovery procedure prescribed in respective State Co-operative societies Act. Broadly the dispute was two-fold- firstly, the question was whether the recourse to SARFAESI by banks is Constitutionally valid and whether recourse to SARFAESI is statutorily valid, i.e. whether it is ultra vires SARFAESI Act itself. In this post I will focus on the Constitutional side of the dispute.

In order to appreciate the controversy at hand, it is important to understand the legal framework under which Co-operative Banks function in India. Co-operative Banks are governed by a ‘dual-regulatory’ structure wherein Reserve Bank of India by virtue of Banking Regulation Act (1949) and the respective State Co-operative Societies Act govern them. The roots of this structure lie in the Constitution of India (‘Constitution’)- more specifically Entry 43,44, 45 of Union List and Entry 32 of State list.

List I

Entry – 43- Incorporation, regulation and winding up of trading corporations,

including banking, ……. corporations but not including co-operative societies

Entry-44- Incorporation, regulation and winding up of corporations, whether

trading or not, with objects not confined to one State, but not including universities.

Entry 45- Banking

List II

Entry- 32- Incorporation, regulation and winding up of corporations, other than

those specified in List I, …….co-operative societies

Therefore incorporation, regulation and winding up of cooperative societies was an express domain of the State governments. Till 1966 co-operative societies of all kinds i.e. including the ones engaged in Banking were under State control. In 1966 the Union Government passed Banking Regulation (Application to Cooperative Societies) Act 1966 (1966 Act) and thus the dual structure was born. This extended some of the provisions of Banking Regulation Act to co-operative societies. Now the obvious question is – how could the Parliament do so in light of Entry 32? Parliament could do so because it made conscious effort to extend only those provisions which related to business of ‘Banking’ (these included et al. sections related to deposits, registration for branch, registration for carrying on the business etc) . Other provisions which were related to Incorporation, regulation and winding up of co-operative banks were left to State Governments. In Sant Sadhu Singh v State of Punjab the Punjab and Haryana High Court correctly identified this and reasoned (paragraph- 13) that-

“But in order to give a harmonious construction to both the entries, Nos. 43 and 45, it must be held that only business of banking as such falls within the ambit of entry No. 45; whereas the incorporation of the Corporations and other matter relating to them fall within the ambit of entry No. 43. Therefore, the constitution of the Societies and their working would have fallen within the ambit of entry No. 43; but for the fact that Co-operative Societies are excluded from its purview.”

Further the court reasoned that since ‘co-operative societies’ are excluded from Entry 43 and expressly included in Entry 32- the incorporation, regulation, and winding up of co-operative societies including the ones engaged in banking business are within the sole competence of the State Government whereas ‘Banking business’(including banking business of cooperative banks) as such is governed by Entry 45. This harmonious construction of Entries 43, 45 of List I and Entry 32 of List II is at the heart of the dual regulatory structure governing cooperative societies engaged in banking. This what the intention of lawmakers was when they enacted the 1966 Act and which the Court correctly identified.

Firstly, I argue that the failure to understand this dual regulatory structure (and the harmonious construction) was what had led to the controversy which has been correctly settled by the Supreme Court in the Pandurang case. Thereafter I will look into the policy aspects of the ‘dual-regulatory’ structure and argue that the government should re-think it.

The roots of the present controversy lie in the Court’s decision in Greater Bombay Coop Bank v United Yarn Tex Ltd. The moot question in this case was whether co-operative banks can take recourse to the Recovery of Debts Due to Banks and Financial Institutions Act 1993 (RDB Act) to recover their debts. Section 2(d) of RDB Act defined ‘bank’ as meaning et al a ‘banking company’ for this RDB Act borrowed definition of banking company from the BR Act. Given the harmonious construction explained above, ideally the court should have asked- from which Entry does the RDB Act flows? If a legislation flows from Entry 45 then as far as the entity is engaged in Banking activities the said legislation would be applicable. This is whole point of the dual structure- that Banking activities be governed by Entry 45. The RDB Act unquestionably relates to ‘banking’ because it facilitates recovery of loans given out in the course of banking. The court failed to appreciate the harmonious construction of entries and said that the state cooperative societies acts are in pith and substance relatable to Entry 32 and the encroachment on Entry 45 is incidental which is allowed as per doctrine of pith and substance. This approach itself is wrong because the court failed to understand that banking related function are under the purview of Entry 45 and management related under Entry 32 -these two areas are separate, there is no scope of encroachment. The court should instead have asked- in pith and substance which entry does RDB flows from? The answer to this is Entry 45[1] and since banking related functions are governed by Entry 45 the co-operative banks can take recourse to RDB Act. The court’s holding that state cooperative societies acts insofar as they provide for recovery only incidentally encroach on Entry 45 is incorrect because the fields are separate- there should be no question of encroachment either in law or in fact.

In Pandurang the moot question was whether the co-operative societies which are functioning as banks can take recourse to SARFAESI Act to recover their loans. Section 2(c) contains definition of ‘banks’, which includes a banking company defined in BR Act; SBI; subsidiary bank; and such of the other bank which they Government can specify.[2] In 2003 the government specified a ‘co-operative bank’ which can take recourse to SARFAESI. This notification was challenged. The prominent arguments in this case from the petitioners’ side were- firstly, they argued that there is a difference between an ‘entity’ and ‘activity’ and that ‘banking’ in Entry 45 is concerned with activity. Therefore, when the government is incompetent to notify ‘co-operative banks’ as banks which are capable of having recourse to SARFAESI Act would amount to regulating an ‘entity’ rather than an ‘activity’ and therefore it is not with respect to ‘Banking’. The assumption in this case being that SARFAESI is not in fact relatable to Entry 45 (with respect to ‘activity’) and is relatable to Entry 43 (with respect to ‘entity’) therefore the 2003 statute is ultra vires the Constitution. Secondly, they argued that the 2003 notification is ultra vires SARFAESI itself.

So far as Constitutional validity is concerned the court rightly pointed out that SARFAESI Act is relatable to Entry 45 because numerous judgments had made it clear.[3] The court reasoned that since ‘Banking’ is exclusive domain of the Central Government and it will not matter what the nature of ‘entity’ is and might as well be a co-operative bank because it amounts to regulation of ‘activity’ of that ‘entity’ and not the ‘entity’ itself, which is governed by Entry 32. This approach in my opinion is correct. The court’s reasoning on this point is summed up in paragraph 47-

“In view of the aforesaid discussion, we are of the opinion that recovery of dues would be an essential function of any banking institution and the Parliament can enact a law under Entry 45 of List I as the activity of banking done by co-operative banks within the purview of Entry 45 of List I. Obviously, it is open to the Parliament to provide the remedy for recovery Under Section 13 of the SARFAESI Act. Co-operative bank’s entire operation and activity of banking are governed by a law enacted under Entry 45 of List I, i.e., the BR Act, 1949, and the RBI Act under Entry 38 of List I.”

Although the court used the terminology of ‘aspects theory’ later on in the judgment, this is not the aspects theory[4]– this is harmonious construction as enunciated in the Sadhu Sant judgment(supra).

There is however a flaw in the judgment, when the court said that ‘it is open for the bank to adopt a procedure which it may choose’. This statement might unnecessarily obfuscate the law because the implication is that the co-operative banks can either take recourse to SARFAESI or the procedure in respective State Co-operative societies Act. This does not logically flow from the court’s reasoning because ‘Banking’ is exclusive domain for Central government and if ‘recovery of dues’ is an essential part of ‘Banking’ then the procedure too is exclusive domain for Central government and state governments cannot make any law with respect to it. This obviously means that every provision in any state co-operative societies acts across the country which provides for recovery of dues is unconstitutional because that area is reserved under ‘Banking’. This might seem stark in fact but in law, this, in my opinion, is the correct position.

Dual Regulation- Policy Considerations

At this point it is important to ask- how successful has dual-regulation policy been? This question is important because we have seen numerous instances where co-operative banks have come under stress due to high Non-Performing Assets (NPAs), leading commentators to question the whole governance structure. In 1999 itself, RBI submitted a report in which numerous stakeholders deposed that dual structure should end- in fact the report observed that ‘on no other issue was there such a unanimity of views.’ However, at the time committee felt otherwise. In 2019 in another report the committee set up by RBI admitted the problems with dual regulation.

In the backdrop of the Punjab and Maharashtra Bank crisis there is an overwhelming amount of commentary against dual regulation. From a policy perspective the judgment in Pandurang case will benefit depositors because it would allow speedy recovery of dues from defaulters which would make sure that the bank has enough liquid cash to meet daily cash withdrawals. The government recently promulgated an ordinance which gives relatively more power to RBI, for example- now the RBI can supersede co-operative bank boards after ‘consultation’ (which is not binding) but it can be argued that this is not within the competence Central government because it is not with respect to Entry 45 but Entry 32.  It remains to be seen whether this incremental increase in RBI’s power is enough to maintain effective regulation. At this point, the onus is on the government to pass a Constitutional amendment to do away with dual regulation so that a full- fledged control over co-operative banks is possible. This would go a long way to protect interests of depositors.


The dual-regulatory structure which is born out of the distribution of powers in the Seventh Schedule is at the heart of functioning of co-operative banks. In Greater Bombay the court failed to appreciate the harmonious construction Entries 43, 45 of List I and 32 and List II but in Pandurang case the court has laid down the law correctly with the exception of allowing recovery procedure to subsist in State Co-operative societies as well. The same should have been struck as unconstitutional. The judgment upholds the interest of depositors. Further, the government has made an effort to give RBI more power with respect to co-operative banks but its efficacy and constitutionality is questionable.

[1] Union of India v Delhi High Court Bar Association [2002] 4 SCC 275.

[2] s.2 (c)(v).

[3] SBI v Santosh Gupta [2017] 2 SCC 538.

[4] In fact, the so-called aspects theory does not even exist according to some commentators-see V. Niranjan in Oxford Handbook of Indian Constitution.

The Author is a student at NLSIU Bengaluru

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