Central banks and other financial regulatory authorities are responsible for influencing major investment decisions and resource allocation through their policies. In India, the Reserve Bank of India (RBI) has joined a growing number central banks and financial regulators, who have incorporated climate change into their financial stability mandate seeking to frame prudential regulations and/or direct credit towards sustainable projects. We have analysed the recent developments in our previous posts available here and here.
However, in exercise of their powers, central banks and financial regulators are bound by their constituent statutes and the powers conferred upon them therein. Sometimes these may be narrow and limited and may not include sustainability. It is, therefore, critical to examine the legal mandate of central banks, including RBI (more so given recent challenges to its powers and its regulations being struck down by the judiciary) and where necessary, to expand them.
International context
Climate risks can affect the core responsibilities of central banks, and framing policies to address them will safeguard macro-financial stability, even if their mandates make no explicit reference to sustainability. A research study shows that out of 135 central banks across the world, only 12% have explicit sustainability mandates, while 40% are mandated to support the government’s policy priorities, which may include sustainability goals. Jurisdictions like Russia, Malaysia, Singapore, Nepal, Philippines, South Africa etc. specifically recognise sustainable economic growth in the mandates of their respective central banks[1].
The Bank of England is an example of a central bank that was accused of over-stepping its mandate for addressing challenges posed by climate change[2] as it did not specifically include sustainability. However, in the aftermath of Brexit, the UK government has announced the Edinburgh reforms[3] to repeal, and replace EU retained laws and establish a smarter regulatory framework that is agile, less costly and more responsive to emerging trends, including sustainable finance.
Recent challenges to RBI actions
Recently, there have been at least two instances where the judiciary has questioned or struck down the vires of circulars issued by the RBI. One was the RBI’s February 12 circular for resolution of stressed assets. Although issued under Section 35AA of the Banking Regulation Act, 1949 (BR Act), the Supreme Court[4] struck down this circular on the basis that it did not follow the procedure in the provision, by referring cases to insolvency without : (i) considering specific defaults[5]; and (ii) without the prior authorisation of the Central Government.
The Supreme Court also struck down an RBI circular aimed at ring-fencing the banking sector from the risks of crypto assets in the IAMAI case[6]. The Supreme Court found that the circular, while within the RBI’s power, had disproportionate impact that outweighed the issue it sought to address. However, the court also acknowledged the wide preventive and curative powers bestowed on the RBI in view of the statutory scheme, as also in view of the special role it has in the economy.
This raises the issue of whether the RBI’s recent actions in relation to climate finance are adequately covered in its legal mandate and whether it will stand the test of judicial scrutiny should they be challenged in a court of law.
Statutory power
The RBI has wide-ranging powers in respect of the entities regulated by it. The preamble of the Reserve Bank of India Act, 1934 (RBI Act), provides for the RBI to inter alia “…generally to operate the currency and credit system of the country to its advantage, AND WHEREAS the primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth (..)”.
Under Section 45JA of the RBI Act, which is applicable to NBFCs, the RBI has wide powers to determine policy and issue directions in public interest or to regulate the financial system of the country to its advantage[7]. Similarly, Section 21 and Section 35A of the BR Act provides ample power to the RBI to issue directions to banking companies ‘in the public interest’[8] or ‘in the interest of banking policy’[9]. Additionally, the RBI also has limited powers to give directions to ‘financial institutions’ in relation to the conduct of business by them[10].
A close reading of the BR Act and RBI Act does not enumerate ‘sustainability’ as a factor for RBI to consider in policy making. However, these legislations are decades old and were written before climate change became a major economic issue. Unsurprisingly, legal mandates of other Indian regulators like SEBI, IRDAI, etc., do not remotely mention ‘sustainability’. Even recent legislation like IFSCA Act 2019, has not taken sustainability considerations into account.
However, with the evolving international legal and regulatory environment, it is imperative for the government and regulators as watchdogs of financial and securities market to take pre-emptive measures to safeguard against climate risks. SEBI had taken cognisance of this aspect and issued the BRSR[11], by deriving power from its overarching duty to “protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit”[12].
Jurisprudence
Sustainability, environment conservation and the right to clean, healthy environment have been repeatedly and constitutionally recognised by the courts in India. The courts have also acknowledged the corporate responsibility towards the environment and the balance required between development and environment degradation in a slew of public interest litigations. The Supreme Court recently recognised the RBI’s powers to determine and frame economic measures in the public interest to ensure proper management of banking companies as long as the same comports with the due process of law[13]. It is well settled that the RBI is a regulator backed by statutory force, equipped with expertise to advise on and to formulate economic policies which are binding on the banking system [14]. While leaving policy decisions to the government and regulators, courts do have a duty to ensure that regulatory decisions do not violate, any law and that people’s fundamental rights are not transgressed, except to the extent permissible under the Constitution[15].
Possible challenges
RBI is also tasked with facilitating circulation of credit in the relevant sectors, of the economy[16]. Incentivising lending by banks/NBFCs to green projects might garner resistance from such individuals, industries and businesses that are involved or invested in so-called ‘brown’ projects like fossil fuels, plastics, thermal/nuclear power, etc. This is because availing financing for such sectors will become expensive, as well as limited in scope.
Such ‘green-only lending’ might even be challenged as violation of the fundamental right to practice any trade or profession guaranteed. However, merely because some class/sector may be individually impacted with such framework, the courts, in exercise of the power of judicial review, will not ordinarily interfere with the policy decisions, unless such policy could be faulted on the ground of unreasonableness, mala fides, arbitrariness, unfairness or violative of any provisions of the Constitution or any statute[17].
Way forward
India has committed to various international net-zero goals that mandate collaborative action by all stakeholders, including regulators, to act in a time-bound manner. Additionally, the central bank is engaged in many international fora that prioritise climate change[18]. It is noteworthy that India is also the highest ranked G20 country according to the Climate Change Performance Index 2023 and is also the fifth-best performing country globally[19]. Given that India is vulnerable to climate change, and is widely expected to remain one of the fastest-growing economies in the world, it is imperative for the RBI to prioritise climate finance and risk and have the rightful mandate to do so.
Moreover, the RBI will only be guiding regulated entities to frame policies with the approval of their boards. Each entity’s board of directors may frame policies incorporating principles of commercial prudence and the RBI’s directions, as it is also their duty under the Companies Act, 2013[20] and the apex court’s ruling in the case of the Great Indian Bustard[21].
Central banks’ actions and inactions impact and shape financial markets, in turn affecting capital formation and the carbon trajectory of an economy. Pending stricter environmental, social and governance laws and green taxonomy, sustainable finance measures can be a crucial intermediate way to urgently nudge the economy towards green transition. While the term ‘public interest’ is wide enough to include sustainability in its ambit and jurisprudence appears to support actions the RBI may take in this regard, if they have followed due process, in the event of specific challenges, it will be critical to see if courts concur with this view.
Given the enormous powers of central bank, it is critical for them to have the autonomy to take policy decisions in specialised fields while honouring the need for accountability to the public[22]. As long as the RBI directions proposed to be issued in relation to climate finance, carefully consider the interests of all stakeholders and have a nexus with the object sought to be achieved, it is likely to stand judiciary scrutiny better. Irrespective, specific inclusion of ‘sustainability’ in the legislation, post stakeholder consultation is likely the best way forward to enable the ‘greening’ the financial system within legal bounds.
[1] Central bank mandates, sustainability objectives and the promotion of green finance, Simon Dikau, Ulrich Volz, available at: Central bank mandates, sustainability objectives and the promotion of green finance – ScienceDirect
[2] ibid
[3]Financial Services: The Edinburgh Reforms, HM treasury, December 9, 2022, available at: https://www.gov.uk/government/collections/financial-services-the-edinburgh-reforms
[4] Dharani Sugars and Chemicals Limited vs. Union of India & Others, (2019) 5 Supreme Court Cases 480
[5]Dharani Sugars v. Union of India: RBI’s Regulatory Powers Re-affirmed by the Supreme Court, India Corporate Law, L. Viswanathan, Amey Pathak & Madhav Kanoria, available at: https://corporate.cyrilamarchandblogs.com/2019/04/rbis-regulatory-powers-indian-supreme-court/
[6] The Internet and Mobile Association of India v. The Reserve Bank of India, AIR 2021 SC 2720
[7] Section 45JA(1), RBI Act, 1934
[8] Section 35A(1)(a), BR Act, 1949
[9] Section 35A(1)(aa), BR Act, 1949
[10] Section 45L of RBI Act, 1934
[11] Business responsibility and sustainability reporting by listed entities, SEBI Circular, May 2021, available at: https://www.sebi.gov.in/legal/circulars/may-2021/business-responsibility-and-sustainability-reporting-by-listed-entities_50096.html
[12] Section 11(1) of SEBI Act, 1992
[13] State Bank of India and Ors. vs. Rajesh Agarwal and Ors., 2023 SCC OnLine SC 342
[14] Peerless General Finance & Investment Co. Ltd. v. RBI, (1992) 2 SCC 343
[15] Narmada Bachao Andolan v. Union of India, (2000) 10 SCC 664
[16] Court on its own motion vs. Govt. of NCT of Delhi and Ors., 2023/DHC /001827
[17]Small Scale Industrial Manufacturers Association (Registered) v. Union of India, (2021) 8 SCC 511
[18] Heed to Heal – Climate Change is the Emerging Financial Risk – M. Rajeshwar Rao, October 18, 2021, available at: https://rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=20563
[19] G20 for a Better Global Economic Order during India’s Presidency – Shaktikanta Das, March 21, 2023, available at: https://rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=21661
[20] S. 166(2) of Companies Act, 2013: “A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment”
[21] “Section 166(2) of the Companies Act, 2013 ordains the Director of a Company to act in good faith, not only in the best interest of the Company, its employees, the shareholders and the community, but also for the protection of environment”- M.K. Ranjitsinh & Ors. v. Union of India & Ors., 2021 SCC OnLine SC 326
[22] Central bank mandates, sustainability objectives and the promotion of green finance, Simon Dikau, Ulrich Volz, available at: Central bank mandates, sustainability objectives and the promotion of green finance – ScienceDirect
