Revoking of bank licence should be considered only in the rarest of rare cases

It is well settled that banks must honour their commitment on bank guarantees and only in exceptional cases, where there is an element of fraud, the payment can be declined. The legal aspects of this as well as direction from the Reserve Bank of India have been discussed in these columns ( ‘Sanctity of bank guarantees is sacrosanct’, BusinessLine March 2, 2020).

Recently, the Special Leave Petition filed by Bank of Baroda with the Supreme Court was dismissed and the apex court upheld the Calcutta High Court's February order that asked the RBI to consider revoking the bank's licence for failing to honour Simplex Projects' unconditional bank guarantee given to Indian Oil Corporation.

The Calcutta High Court had earlier asked the RBI to consider “appropriate steps” against Bank of Baroda, including cancelling its banking licence, for delaying to honour a bank guarantee. The High Court order said: “Considering the conduct of the appellants, the Reserve Bank of India should consider what appropriate steps may be taken against the Bank of Baroda, including revoking its licence or the authority to carry on banking business, if necessary.”

This is a setback for the public sector bank. While everyone will agree that a bank cannot refuse to honour its commitment on guarantees issued, is not revocation of licence for such a lapse too harsh a demand?

Appropriate punishment

It is all right to fix responsibility on the functionaries of the bank for the lapses and initiate necessary disciplinary action. Whenever banks do not comply with the RBI’s instructions on Income Recognition and Asset Classification norms or Know Your Guidelines, the RBI imposes the erring banks with monetary penalty.

Never in the history of Indian banking has the regulator ever considered cancellation of licence for such lapses. It is a different matter that the penalty is levied on the banks and not on the individuals who have committed the lapse.

Licence cancellation

Section 22(4) of the Banking Regulation Act discusses cancellation of banking licence. As per this section, the RBI may cancel a licence granted to a banking company: if the company ceases to carry on banking business in India; if the company at any time fails to comply with any of the conditions imposed upon it under sub-section (1); or if at any time, any of the conditions referred to in sub-section (3) [and sub-section (3A)] is not fulfilled.

It is doubtful whether a banking licence can be cancelled for failure to honour a bank guarantee as per this section. Section 38 of the Banking Regulation Act discusses winding up of banks. Winding up of a bank must arise only when the bank is unable to pay its debts.

Is cancellation of licence justified?

The bank has got a deposit of more than ₹8 lakh crore and advance of ₹5 lakh crore. Government of India’s shareholding is 71.60 per cent in the bank. If the banking licence is cancelled the repercussion will be enormous.

There are any number of corporate accounts that execute Demand Promissory Note to pay back bank dues but fail to honour their commitment and there have been no moves seeking closure of the companies for the defaults.

Though the bank has not paid on this particular guarantee, the bank must be paying for thousands of invoked guarantees on a regular basis. Hence this should be seen as an exception and not as a regular feature of failure of the bank.

In the past, on failure of any bank, such bank was merged with other banks and there was no attempt to cancel the licence and close down the bank. Even in the case of YES Bank, where there were serious lapses, the regulator has put in place a revival plan without cancelling the licence.

Hence, if Bank of Baroda’s licence is cancelled, it can be compared to capital punishment under criminal law, which should be given only for rarest of the rare cases.

The writer is a retired banker