Competition issues in India's online economy

Smriti Parsheera, Ajay Shah and Avirup Bose.

The world of high technology companies is seen as a dynamic area with a rapid pace of creative destruction. There is, however, a class of industries where there are strong network effects, where the market tends to collapse into a narrow set of players. After one burst of innovation where a new online business is born, there is the possibility of entrenched market power with the extraction of consumer surplus.

Many firms, global and Indian, have resorted to the strategy of making large losses by subsidising users, as a way to obtain those network effects. This has created a new class of concerns about predatory pricing, with unprecedented negative profit margins on a sustained basis, being supported by equity capital infusions. In the short run, discounts are popular, but recoupment is inevitable and market power will adversely affect consumers in the future.

In a recent Paper, we argue that the existing competition law regime in India needs to be fine tuned, for technology-enabled markets with significant network effects, to address the possibility of new kinds of abusive conduct. We offer a series of tangible proposals through which the Competition Commission of India can better handle these emerging situations. We also look into the role and responsibilities of the investors who back these online businesses and the impact of their conduct on competition in the underlying markets.

Entry barriers in the new economy

Innovation is the foundation of economic progress. While we normally revere technology companies for their disruptive innovations and the efficiencies that they create, we must recognise that some technology-driven businesses are susceptible to the acquisition and abuse of market power. The Indian competition regime is an evolving one, and has only recently started facing some of these concerns. Our paper brings new evidence and arguments to the table, on these questions.

Internet-based businesses, along with several other high-technology sectors, form part of the 'new economy', characterised by high rates of innovation; low marginal cost; increasing returns of scale; and, in many cases, network effects. Direct `network effects' arise where a user's benefit from a product or service increases with the number of other users on that network. The benefit of being on Facebook or WhatsApp, for instance, corresponds with the number of friends and family who use that service. Contrast this with the benefit of having an email address, where the benefits are not limited to closed proprietary networks. This became possible due to the early adoption of interoperability standards in email protocols.

Network effects are particularly important in two-sided markets where users on each side of the market derive a positive effect from the expansion of users on the other side. Commuters who use taxi aggregation platforms like Ola and Uber will logically be attracted to a service that has a large number of drivers on its network, which yields a lower waiting time. The same is true for the drivers working with these platforms. Similarly, in case of payments wallets, in the absence of interoperability regulation, merchants and customers will both prefer a service that has the most addressable users.

With the use of modern technology, the cost of running the marketplace itself has dropped to near zero levels. As an example, the online classifieds site Craigslist reports that it has about 40 employees who manage a network that sees over 80 million classified ads per month. The marginal cost of a transaction has gone to near-zero levels. This gives a unique class of problems where technological innovation that yields cost reductions cannot be a mechanism to take on an incumbent.

Brain versus brawn

How can market power be established, in this new world? One mechanism through which one player can obtain a competitive advantage is to attract users through technological innovation, and thus get a network effect started. This is an attractive strategy for firms which have deep human capital. Another mechanism is by using financial capital to pay subsidies that entice users. This is an attractive strategy for firms which have superior access to financial capital. Many online businesses have resorted to practices like deep discounting, cash-back offers and other schemes designed to attract new users and establish the network effect. Sometimes, heavy losses have been sustained for years on end.

As an example, the global taxi company 'Uber' made worldwide losses in the first half of 2016 of US\$1.27 billion (approximately Rs.86.5 billion). Uber's behaviour impacts upon the Indian economy as it has applied the strategy of using financial capital as a competitive lever in India also. On a similar note, the Indian taxi company 'Ola' reported a net loss of Rs.7.96 billion in March, 2015. The company's financial records for the periods after that are not yet available although it is reasonable to expect that the losses will be significantly higher due to the higher driver incentives. In the last two years, it is estimated that the two taxi companies, Uber and Ola, burned cash adding up to about Rs. 130 billion in India.

Such behaviour is found in other industries also. In the field of payments, where regulations have blocked interoperability and thus created the opportunity to kick off a network effect, the firm One97 Communications, which owns 'PayTM', reported a loss of Rs.15.49 billion in March, 2016.

The scale of these discounting practices, and the sustained periods for which they are continued, has created new barriers to competition. It is difficult to rationalise these sustained losses as being an introductory offer by a new player. Rather, these practices appear to be a systematic competitive strategy. Capital has become a competitive weapon. This gives rise to concerns that the market may eventually tip in favour of the player that may not necessarily have the most innovative product or service, but one that succeeds in obtaining more capital and enticing more users in the early days, using subsidies. While seeming beneficial for consumers in the short run, such practices raise concerns about competition on account of the creation of market power, and elevated prices for consumers in the following years when losses are recouped.

The FDI guidelines issued by the government in March, 2016 turned the spotlight on pricing practices of e-commerce firms. It clarified that the automatic route of foreign investment would be available only to those e-commerce marketplaces that avoided such subsidies.

These issues have also come to the attention of the CCI in a few recent cases. In April 2015, the CCI passed a prima facie order recommending a detailed investigation into the allegation that, armed with substantial funding received from various investors, Ola had indulged in abusive market practices to garner greater market power in the city of Bengaluru. More recently, the COMPAT directed the Director General of the CCI to initiate a similar investigation to assess Uber's dominance in the market for radio taxi services in the National Capital Region (NCR) of Delhi after the CCI had refused such an investigation. Uber has now challenged this decision before the Supreme Court, citing a 'jurisdictional flaw' in the Tribunal's ability to order such an investigation. Alongside these developments, CCI is also reported to have set up an in-house panel to understand the cash-back incentives being offered by various online companies from the perspective of predatory pricing provisions under the Act.

Our paper explores the recent developments in India in this area, in the light of foundations of economics and competition law. It argues that there are grounds for concern about the harm to competitive dynamics from these new business strategies. At the same time, it is important to avoid intrusive interventions that bring the State into excessive involvement in the world of business.

New economy requires new thinking

There is a need to take into account the distinct economic features of certain high-technology businesses when looking into allegations of anti-competitive conduct by them. Practices like deep discounting and cash back offers may be aimed at building sufficient scale in today's market to ensure that the business is able to fully capture tomorrow's market, to the exclusion of other competitors. A robust economic analysis of the impact of increasing returns to scale, and network effects, is required for understanding the present and future impact of these practices on competition and consumer interests. A novel dimension, which is addressed in the paper, concerns collaboration between the investors in the multiple firms that they invest in.

Transient gains to consumers

We examine the question about gains to consumers from discounting. We suggest that the gains in the short term need to be seen in a larger context. The recoupment test examines the extent to which market power can be achieved in the future, after which prices can be raised. If the CCI were to adopt this test in investigations relating to predatory pricing by online firms it would see that in certain areas, there are network effects, and once a small cartel of firms has acquired market power, it would be difficult for entrants to compete with them in the future. In that future scenario, it would be possible for incumbents to raise prices, and recoup earlier losses.

Interoperability as a tool for competition policy

In some situations, the CCI could rely on the essential facilities doctrine to mandate interoperability between a dominant player that is found to be indulging in the abuse of its position and other operators in the market. For instance, imposing interoperability requirements on a dominant payments network can help extend the network effects of digital payments to the economy as a whole, rather than being limited
to a closed network. The imposition of any such requirements will, however, need to be balanced against factors such as the payment of fair and reasonable access fees, the complexity of institutional arrangements required to monitor such arrangements and assessment of the impact on future innovation. More generally, open standards are an important element of interoperability, and various arms of the regulatory State need to push in favour of competitive markets through interoperable open standards.

Acting within Internet time

Given the fast-changing nature of online businesses, there are concerns about the elapsed time between a full-fledged investigation and the determination of a violation. We suggest a two-pronged approach to address this issue. On one hand, the CCI needs to work towards adopting stricter time frames for the disposal of cases, particularly those relating to new economy firms. On the other, we propose a voluntary settlement process that will allow a business that is under investigation to voluntarily alter its market behaviour, with the concurrence of the authority but without the need for a conclusive finding of violation by the CCI.

Conclusion

In India, technology companies are generally revered as the source of technological progress. However, the problems of competition policy are universal and cut across all industries. The basic principles do not change. The purpose of competition policy is to stave off situations where a narrow set of firms have market power, and new players are not able to enter. Society gains when firms obtain profits and valuation through innovation, not through the crafty use of financial capital to kick off network effects.

These issues were not faced in thinking about Indian competition policy as recently as five years ago. They are, however, likely to become increasingly important in the future. We argue that this calls for fresh think about the legal framework also. There is a case for competition authorities to look into the unilateral abusive conduct of a firm, which, although not dominant at the given point of time, is engaging in anti-competitive practices that create a strong and imminent possibility of its dominance. We highlight some pros and cons of this approach and leave this question open for further research.

Smriti Parsheera and Ajay Shah are researchers at NIPFP, and Avirup Bose is a researcher at Jindal Global Law School.

Drafting hall of shame: A mistake in the Reserve Bank of India Act, 1934

Aditya Singh Rajput and Shubho Roy.

In the last two years, we have had a debate about monetary policy reform. On June 27, 2016, the Government, through the Finance Act, 2016, amended the Reserve Bank of India Act, 1934 and created a statutory Monetary Policy Committee (MPC). This is an 'executive MPC', which will control monetary policy. Section 222 of the Finance Act, 2016 introduced Chapter IIIF in the RBI Act titled Monetary Policy. In this Chapter, section 45ZL has a drafting error.

Section 45ZL requires RBI to publish the proceedings of meetings of the MPC. RBI is obliged to publish MPC meeting minutes, with three documents: The resolution of the meeting, The votes of individual members, and the statement of each member explaining their vote. Here is the text of S.45ZL:

The Bank shall publish, on the fourteenth day after every meeting of the Monetary Policy Committee, the minutes of the proceedings of the
meeting which shall include the following, namely:-

(a) the resolution adopted at the meeting of the Monetary Policy Committee;

(b) the vote of each member of the Monetary Policy Committee, ascribed to such member, on resolutions adopted in the said meeting; and 

(c) the statement of each member of the Monetary Policy Committee under sub-section (11) of section 45ZL on the resolutions adopted in the said meeting.

(Emphasis added)

This has an error. There is no subsection (11) in Section 45ZL. The correct cross-reference should have been to subsection (11) of Section 45ZI which reads:

Each Member of the Monetary Policy Committee shall write a statement specifying the reasons for voting in favour of, or against the proposed resolution.

In this case, this drafting error is minor and is unlikely to have substantial legal effects. However, it reveals weaknesses of the process through which laws are drafted, which could easily have major legal effects in other cases. This is not an isolated problem. As an example, the recent Insolvency and Bankruptcy Code has numerous cross-referencing mistakes.

Solution

Such errors can be minimised by the use of appropriate document processing software which automates cross-referencing. The files managed by human authors should have labels, cross-references should point to labels, and the software should map logical labels to physical section numbers.


The authors are researchers at the National Institute of Public Finance and policy, New Delhi. The authors thank Pratik Datta for valuable inputs.

Policy puzzles about UIDAI

A great debate is taking place about UIDAI. We have worked on many aspects of the policy puzzles about UIDAI.

-- Is UIDAI worth building, in the sense of comparing the financial costs and the financial benefits? In November 2012, we did a cost benefit analysis, and the answer seems to be Yes.

-- How should UIDAI think about the user charges for the infrastructure services that it provides? We were part of the UIDAI thought process on these questions in December 2013.

-- The public administration side: What were the ingredients that led up to the successful launch? A good paper is UIDAI's public policy innovations, by Ram Sewak Sharma, September 2016.  Building on this paper, Praveen Chakravarty has an article Building forts, not empires, 9 September 2016.

-- There are grave problems associated with privacy in India. How do we avoid the China model? An early paper on privacy in India is Towards a privacy framework for India in the age of the Internet, by Vrinda Bhandari and Renuka Sane, October 2016. This paper includes one section analysing the Aadhaar Act from the viewpoint of this proposed privacy framework.

-- Can the judiciary review the Speaker's decision on classifying the Aadhaar Bill as a money bill? Pratik Datta, Shefali Malhotra and Shivangi Tyagi have a paper from March 2017, in which they feel the answer is Yes.

-- If a country had to build an Aadhaar like system, what kind of law and regulations would be required?  Is the Aadhaar Act and the associated regulations (both of which were issued in 2016) an adequate legal foundation? Vrinda Bhandari and Renuka Sane feel this is not the case.

-- As Aadhaar becomes the core around which the citizen's relationship with the state revolves, we need to ask if citizens have access to an adequate grievance redressal mechanism? Vrinda Bhandari and Renuka Sane think the answer to this question is a resounding no.

-- Why do we need a fundamental right to privacy? Smriti Parsheera argues that the potential ramifications of not recognising this right run much deeper than the Aadhaar issues of today.

-- UIDAI is an important new organisation, and it should emerge as a high performance agency. Vrinda Bhandari, Renuka Sane and Bhargavi Zaveri argue that under the present law, UIDAI is neither performance oriented nor is there accountability for failure. They propose that the UIDAI should be held to appropriate accountability standards, so as to create an environment where it will perform well.

Is Aadhaar grounded in adequate law and regulations?

by Vrinda Bhandari and Renuka Sane.

The Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 ["the Aadhaar Act"], as the name suggests, aims at targeted delivery of subsidies, benefits and services by providing unique identity numbers based on an individual's demographic and biometric information. Enrollment into Aadhaar is, in principle, voluntary - both as per the Central Government's own stand and repeated orders of the Supreme Court since 2013. The Government has, however, slowly been linking government (and other services) to the Aadhaar card. Since January 2017, the Government has issued 22 notifications making Aadhaar mandatory for receipt of a range of services, ranging from the Mid-Day Meal scheme to maternity benefits. The Aadhaar number is likely to become a pre-requisite for filing income tax returns and applying for a PAN card.

As of March 2017, more than 1.1 billion individuals have been enrolled in the system and 4.9 billion authentication transactions have taken place. In the process, the Government has expanded the scope and coverage of Aadhaar while the Supreme Court has yet to decisively settle questions about constitutional challenge.

In this article, we ask if the legal foundations on which the Aadhaar operates match up to the requirements of a program that is likely to touch the lives of all citizens of India. Can we, as citizens of India, be satisfied that there are enough checks and balances in the functioning of Aadhaar?

This is important as we have already started seeing implementation problems in the form of failure of biometric authentication, server and connectivity problems, cryptic error messages, and the irrevocability of the biometric, all of which have left the Aadhaar number holder and intended recipient of a subsidy without any remedy. As well, in the absence of an over-arching privacy law, our regulatory surveillance architecture is heavily weighted in favour of the State leading to the very real possibility of strengthening mass surveillance with little regard for the effect on individuals' rights to privacy.

What should the legal framework provide?

A program such as Aadhaar, should be built on sound legal foundations. At the very least, the Aadhaar scheme should be able to guarantee first, good governance by the Unique Identification Authority of India ["UIDAI"], the statutory body responsible for the functioning of the Aadhaar system; second, privacy protection from the State and the private sector against the misuse of the Aadhaar number; third, security protection against data breaches; and fourth, an effective grievance redress mechanism against mistakes, deception, and abusive practices.

We evaluate the Aadhaar Act and the subsequent regulations on two issues namely their scope and ambit, and security standards. In a follow up article, we will focus on the privacy, accountability, and enforcement concerns that arise in the current legal framework.

Concerns about the Aadhaar Act

In a recent paper, Towards a privacy framework for India in the age of the internet, we proposed a privacy framework that incorporated universally accepted privacy principles and analysed the Aadhaar Act against these benchmarks. Our critique of the Aadhaar Act focused on the lack of clarity surrounding the scope and ambit of the Act; the absence of any meaningful provisions on consent; the omission of privacy considerations; the role of private companies; and inadequate redress mechanisms.

The Act leaves too much to be specified by the Regulations. For instance, the definition of biometric information [Section 2(g)], the procedure for sharing [Section 23(2)(k)], and publication [Section 29(4)] of an Aadhaar number holder's information are left to be specified by regulations. This causes uncertainty about the scope and ambit of the Aadhaar Act, apart from concerns about the lack of Parliamentary scrutiny over any subsequent Regulations. In fact, the constitutionality of the Act can be challenged on the ground that it delegates essential legislative functions, including important decisions on policy, to the Executive, and lacks sufficient control over its exercise (See Re Delhi Laws Act, AIR 1951 SC 332; Avinder Singh v State of Punjab, AIR 1979 SC 321; and Ajoy Kumar Banerjee v UOI on excessive delegated legislation).

Concerns with the Aadhaar Regulations

In an attempt to address some of these criticisms, the Government, through the UIDAI, released detailed Regulations on enrollment, authentication, data security, and sharing of information in September 2016. These Regulations are also incomplete for two reasons.

Lack of clarity on the scope and ambit of the Regulations

As with the Act, the UIDAI, which was expressly tasked with notifying the Regulations under the Aadhaar Act, has failed to exercise such power delegated to it, causing further uncertainty about the working of the Act and the Aadhaar Scheme. The UIDAI, while notifying various regulations in September 2016, left multiple aspects of the functioning of the Aadhaar Scheme to be ``specified by the Authority'', i.e. to be specified by itself at a future undetermined date.

For instance, the UIDAI was empowered under Section 23(2)(a) of the Act to "specify, by regulations, demographic information and biometric information required for enrollment and the processes for collection and verification thereof." However, Regulations 3(2) and 4(5) of the Enrollment Regulations leave the ``standards'' for collecting biometric and demographic information, required for enrollment, to be specified by the Authority for this purpose. Thus, despite being tasked with laying down the regulations to govern the enrollment and collection of demographic and biometric information, the UIDAI's own Enrollment Regulations leave the specification of such standards to be notified by itself at some point in the future.

Similarly, Regulation 13(2) of the Enrollment Regulations on the generation of Aadhaar numbers states The Authority shall process the enrollment data received from the Registrar, and after deduplication and other checks as specified by the Authority, generate the Aadhaar number. There is no guidance to the UIDAI on what kind of checks should be laid down, and principles that have to be followed in the interim, before further regulations are notified.

Through the four substantive regulations, the phrase specified by the Authority has been used 51 times (See Regulations 3(2), 4(5), 7(2), 8(2), 8(4), 11(2), 11(5), 13(2), 14(2), 17, 19(c), 20, 22(2), 23(5), 25(1), 29(2), 31(2), 32(1), 32(2), 32(3), 34 and Rules 17, 19, 22, 23, 24, 25, and 26 of the Code of Conduct in Aadhaar (Enrollment and Update) Regulations 2016; Regulations 6(2), 7(3), 12(1), 12(2), 12(4), 13(1), 14(1)(d), 16(8), 18(1)(c), 18(1)(d), 18(2), 19(1)(a), 19(1)(h), 22(2), 22(3), 23(2)(a), 28(3), and 28(4)(a) of the Aadhaar (Authentication Regulations); Regulations 4(2), 5(a), and 6(1) of the Aadhaar (Data Security) Regulations; and Regulations 4(1) and 4(2) of the Aadhaar (Sharing of Information) Regulations, 2016).

In some cases this may be justified because the standards relate to technical aspects such as the collection of information, the mode of updating residents' information, convenience fees, and certification processes; which may require a separate set of rules outside the regulations. However, important issues surrounding the enrollment, storing, and sharing of data -- issues that determine how our sensitive, personal information is collected, authenticated, stored, used, and shared with third parties -- have been left unspecified. This does not seem to have deterred the Government from pushing forward with the Aadhaar project.

The incompleteness of the various Regulations notified by the UIDAI underscores the lack of specificity in the working of the Act and the Regulations. The powers delegated to the UIDAI have in a sense been 'delegated' to its future self, to be notified when the UIDAI deems it appropriate. There is thus complete uncertainty about when, and whether, any future regulations will be notified by the UIDAI or whether the enrollment process will continue in this legal vacuum.

Lack of specification of security standards

The incompleteness of the Aadhaar Regulations is not limited to the Aadhaar (Enrollment and Update) Regulation. It extends to other Regulations as well, such as the Aadhaar (Data Security) Regulations. Notably, Section 23(2)(m) of the Aadhaar Act empowers the UIDAI to specify, by regulations, "various processes relating to data management, security protocols and other technology safeguards under this Act." Given the vast quantities of sensitive, personal data that is being stored in one centralised repository, one would imagine that the UIDAI would be quick in clarifying all the security protocols and technology safeguards. However, through Regulation 3(1) of the Data Security Regulation, the UIDAI does not lay out any specific measures for ensuring information security, instead only stating that: The Authority may specify an information security policy setting out inter alia the technical and organisational measures to be adopted by the Authority and its personnel, and also security measures to be adopted by agencies, advisors, consultants and other service providers engaged by the Authority, registrar, enrolling agency, requesting entities, and Authentication Service Agencies.

Regulation 5(a) then further requires service providers engaged by the UIDAI to ensure compliance with such information security policy ``specified by the Authority''. Such a policy, to the best of our knowledge, has not yet been notified.

Thus, despite the enactment of the Aadhaar Act and the notification of the Aadhaar (Data Security) Regulations 2016, the failure to notify/specify an information security policy has meant that the fear of identity theft remains. In fact, is only exacerbated in a country such as India, which does not have an adequate data protection regime, both in terms of the relevant legal provisions and effective enforcement mechanisms.

Conclusion

The Aadhaar regulations raise an important question on the consequences of a regulator's (UIDAI) failure to exercise the power that has been delegated to it, and to instead, postpone the specification of important standards/procedures to a future, undetermined time. In the meanwhile, the UIDAI is carrying on, and in fact, hastening, the process of enrollment, without any of these guidelines and processes having been notified. Thus, the various processes under the Act are happening in some sort of legal vacuum. This is a cause for worry.



Vrinda Bhandari is a practicing advocate in Delhi. Renuka Sane is a researcher at the Indian Statistical Institute, Delhi. We thank Anirudh Burman, Pratik Datta, Shubho Roy and Bhargavi Zaveri for useful discussions.

Interesting readings

Trump's benevolence by Ajay Shah in Business Standard, March 20, 2017.

Escape to another world by Ryan Avent in The Economist, April/May 2017.

Improving NCD outcomes: How to reduce the evidence-policy gap by Brian Oldenburg in NIPFP YouTube Channel, March 16, 2017.

'People are scared': Paranoia seizes Trump's White House by Alex Isenstadt and Kenneth P. Vogel in Politico, March 15, 2017.

Humans Made the Banana Perfect-But Soon, It'll Be Gone by Rob Dunn in Wired, March 14, 2017.

Media and the rise of the right wing by Vanita Kohli Khandekar in Business Standard, March 14, 2017.

Protest and persist: why giving up hope is not an option by Rebecca Solnit in The Guardian, March 13, 2017.

Big bang reforms are done; time to fix the nuts & bolts by Shrimi Choudhary in Business Standard, March 5, 2017.

What do Uber, Volkswagen and Zenefits have in common? They all used hidden code to break the law by Quincy Larson on FreeCodeCamp, March 3, 2017.

No End in Sight to India's Slow-Motion Bank Crisis by Mihir Sharma on Bloomberg, March 1, 2017.

The Enlightenment Project by David Brooks in The New York Times, February 28, 2017.

When Evidence Says No, but Doctors Say Yes by David Epstein and Propublica in The Atlantic, February 22, 2017.

Surveillance in India: Policy and Practice by Pranesh Prakash in NIPFP YouTube Channel, February 9, 2017.

IRDAI’s commission notification hikes total compensation for insurance intermediaries

by Monika Halan.

On 14 December 2016 the insurance regulator, the Insurance Regulatory and Development Authority of India (IRDAI), notified revised commission rules for both life and general insurance. Titled ‘IRDAI (Payment of Commission or Remuneration or Reward to Insurance Agents and Insurance Intermediaries) Regulations, 2016’, the new rules have raised overall payments in the insurance industry to agents and intermediaries. The notification has come 11 months after an exposure draft that proposed changes in existing rules. The draft was open to public comments. The author helped the team at NIPFP to draft a response to the insurance regulator that argued against raising upfront commissions and payments as it encourages mis-selling, churning and causes losses to investors. A blog on the draft can be read here. The final regulations have been notified after consultation with the Insurance Advisory Committee and will come into effect from 1 April 2017. IRDAI has not given a reason why it needed to rethink the payment structure in the insurance industry. Nor has it given a reason for the change in the manner of payment and the quantum of payment. It has mandated a board-approved written policy for payments of intermediary compensation.

I will examine the changes in payouts in the life insurance industry and not the general insurance industry in this blog. Examining high upfront costs in India’s life insurance industry is important because these have been identified in two government committee reports (Swarup Committee and Bose Committee) as one of the reasons for mis-selling of insurance products in India. Several papers (this, this and this) have documented mis-selling of such products in the Indian market and the money lost by investors. The IRDAI regulation is important to analyse because it has increased the total payouts in the first year of the product at a time when other regulators are reducing upfront costs. The capital market regulator had made the mutual fund product zero front commission in August 2009 and in 2015 had capped upfronting of trail commissions (that come out of the annual expense ratio) at 1% of the investment. The National Pension System (NPS) already has low front costs that are more in the nature of a transaction cost.

The Regulations

There are four changes in the new regulations.

1. Change in intermediary categories. Currently, there are five categories of intermediaries: agents, corporate agents, insurance brokers, web aggregators and insurance marketing firms. The notified regulations break up the market into three categories of distributors of life insurance products. Agents, intermediaries with more than half their income coming from insurance, and intermediaries with less than half their income coming from insurance. Agents represent one insurance company and are individuals. Intermediaries include corporate agents, insurance brokers, web aggregators and insurance marketing firms.
2. Change in nomenclature of intermediary payments. Currently, all intermediary payments are called ‘commissions’. The new rules mandate that agent payments will be called ‘commission’, while intermediaries’ sales commissions will be called ‘remuneration’.
3. Addition of a payment category. A new payment category has been introduced to compensate agents and intermediaries called ‘rewards’. A reward is an amount paid, directly or indirectly, as an incentive by the insurer to agents and intermediaries. Rewards seek to formalise informal (which were illegal thus far) payments made by insurance firms to agents and intermediaries. IRDAI believes that agents need to be rewarded to account for benefits such as gratuity, term insurance cover, various group insurance covers, telephone charges, office allowance, sales promotion, gift items, competition prizes and such other items. Intermediaries need rewards to compensate for services such a risk analysis, gap analysis, plan design, predictive modelling, data management, infrastructure, advertisement and such other items, including any additional incentives by whatever name called. All agents are eligible for rewards that are fixed at a maximum of 20% of the first year commission that the agent collects. Not all intermediaries are eligible for rewards. Only those who earn more than half their income from the insurance business are eligible for rewards, which are the same as that for agents. Others are not. In effect, IRDAI has legalised what were illegal payments in the industry.
4. Change in the compensation structure. The new rules have changed the existing commission structure in three ways.
1. Higher commissions for pure risk products. IRDAI has hiked commissions for pure risk policies as compared to policies that bundle investment and insurance across both single premium and regular premium products. Pure risk policies insure just the life of the policyholder. If the policyholder does not die, no money returns to him. Bundled policies combine life insurance cover with investment. These come in two variants. One, unit linked insurance plans (ULIPS) that are transparent, marked to market products that work like mutual funds with a crust of life cover. Two, traditional plans that are opaque products, do not disclose a net asset value but give either an assured investment return or an indicative payout number. These products invest largely in government securities of both the centre and the states. Further, there are two kinds of policies according to periodicity of premium payment. Single premium policies, which need funding once and stay alive for the duration of the policy tenure. And regular premium policies, which need to be funded each year till the premium paying term ends and can have tenures of between five and 100 years. The changes are in Table1 and Table 2.

Table 1: Pure risk gets more commission

Table 1a: 1st year commission on regular premium policies

	Existing 1st year commission for agents1	New 1st year commission for agents and intermediaries
	(%)	(%)
Pure risk	35/402	40
Bundled 3	35/402	35/40
1 For brokers the numbers are 30% in year one for all policies with premium paying term of 10 years or more
2 35% for firms more than 10 years old and 40% for firms less than 10 years old. Today, more than 90% of the market is made of firms that are over 10 years old, therefore the 35% commission number is effective
3 For a premium paying term of 12 years or more. Commissions range from 15% to 33% for premium tenures between 5 and 11 years

Table 1b: 1st year commission on single premium policies

	Existing commission for agents 1	New commission for agents and intermediaries
	(%)	(%)
Pure risk	2	7.5
Bundled	2	2
1 For brokers the numbers are 2% of the premium

2. Higher renewal commission on regular premium policies. On each renewal the intermediary gets a ‘renewal commission’. These rates are now higher than before for both pure risk and bundled plans, though pure risk gets more than bundled plans.

Table2: Renewal commission on regular premium policies rise

For agents and brokers	Existing commission	New commission
	(%)	(%)
Pure risk	51	10
Bundled	51	7.5
1 Currently, 3rd year and subsequent premiums get 7.5% commission. Year 4 onwards it is 5% commission on renewal.

3. Introduction of ‘rewards’. The impact of adding rewards to the commissions in the first year are captured in Table 3a, 3b, 3c and 3d.

Table 3: Total payouts on life insurance policies from 1 April 2017

Table 3a: Maximum first year payments on regular premium pure risk life insurance policies

For pure risk cover policies	Maximum commission on 1st year premium	Reward as % of first year commission	Total 1st year payment of Commissions + Reward
	(%)	(%)	(%)
Agent	40	20	481
Intermediary > half income from insurance	40	20	482
Intermediary < half income from insurance	40	0	402
1 Total first year commission currently is 35/40% depending on age of insurance firm
2 Total first year commission currently is 30% for a premium paying term of 10 years or more

Table3b: Maximum first year payments on regular premium bundled life insurance policies

For bundled policies (insurance + investment)	Maximum commission on 1st year premium	Reward as % of first year commission	Total 1st year payment of Commissions + Reward
	(%)	(%)	(%)
Agent	35	20	421
Intermediary > half income from insurance	35	20	422
Intermediary < half income from insurance	35	0	352
1 Total first year commission currently is 35/40% depending on age of insurance firm
2 Total first year commission currently is 30% for a premium paying term of 10 years or more

Table 3c: Maximum payments on single premium pure risk life insurance policies

For pure risk cover policies	Maximum commission on 1st year premium	Reward as % of first year commission	Total 1st year payment of Commissions + Reward
	(%)	(%)	(%)
Agent	7.5	20	91
Intermediary > half income from insurance	7.5	20	91
Intermediary < half income from insurance	7.5	0	7.51
1 Total commission currently is 2%

Table3d: Maximum payments on single premium bundled life insurance policies

For bundled policies (insurance + investment)	Maximum commission on 1st year premium	Reward as % of first year commission	Total 1st year payment of Commissions + Reward
	(%)	(%)	(%)
Agent	2	20	2.41
Intermediary > half income from insurance	2	20	2.41
Intermediary < half income from insurance	2	0	21
1 Total commission currently is 2%

What do these changes mean?

Post these changes, from 1 April 2017, the peak rates of payouts to agents and intermediaries will go up to as high as 48% in the first year, from the current levels of 35% or 40% depending on the age of the insurance firm. IRDAI has not given a reason for making changes to the compensation structure of the intermediation industry in insurance. Section 52(2) of the draft Indian Financial Code (Volume Two) of the Financial Sector Legislative Reforms Commission Report requires that all regulators should first publish a draft of the regulations to be made. This draft should be accompanied by a statement of objectives. The statement of objectives lists out the need for new regulation and the cost and benefit analysis of the proposed changes. The financial sector regulators, including IRDAI, have agreed to implement some of the recommendations that do not require legislative action. These actions can be read in the Handbook on Adoption of Governance Enhancing and non-legislative Elements of the Draft Indian Financial Code. Carrying out a cost benefit analysis for a new regulation and making it public is one of such actions. IRDAI did bring out a draft regulation on 13 January 2016 that was mentioned earlier, but there was no cost-benefit analysis or rationale for increasing commissions. Read the analysis of what IRDAI had proposed.

What’s good and what’s not

The new rules are good in parts, but IRDAI has let go of an opportunity to reduce mis-selling in the life insurance market in India. Some parts of the regulation are in the right direction but fail to address the larger malpractice issues; one rule is outright harmful.

1. Raising commissions for pure risk policies. Life insurance is a difficult concept to understand and the sales effort to sell life insurance needs a higher incentive than selling an investment product where a return is expected. India is a poorly insured country because life insurance is sold as an investment product with a thin covering of a life cover. Agents prefer to sell the bundled products because they generate a higher commission value than a pure risk plan. Therefore, giving a higher commission to a pure risk plan as compared to a bundled plan is a good step, but these remain still too high at 40% of the first year premium. To transition the market to pure risk plans, IRDAI could have reduced commissions on bundled products instead of keeping them at 35% of the first year premium. Two government committees have recommended that investment products go zero upfront commission and move to a full trail model (links to the reports are above in para two). The capital market regulator has already implemented these recommendations in mutual funds.
2. Raising renewal commissions. A long term financial product needs to be funded each year. When faced with very high first year commissions and significantly lower subsequent commissions, the incentive structure for agents gets skewed towards stopping old policies and selling new ones. Keeping policies alive is a big problem in the life insurance industry that sees very high rates of lapsation – or discontinuation of a long term plan in the first five years. The persistency (the number of policies that stay in business after the first year) rates in life insurance are very poor, with the industry average of 61st month (5-year) persistency of just 44% in FY15 for Life Insurance Corporation that accounts for over 70% of the industry. The private sector numbers are worse. Two largest private sector firms saw poor persistency levels, with ICICI Prudential Life’s 61st month persistency in FY2015 at just 16.7% and HDFC Standard Life’s at 31.78%. These numbers are from IRDAI’s Handbook of Statistics 2014-15 that can be seen here on page 211. One way to deal with this issue is to reduce front commissions and move to a trail heavy compensation model. The capital market regulator has successfully implanted this with no harm to the market. In 2009, the capital market regulator banned upfront commissions that go from investor’s money. In 2015, it banned even ‘upfronting’ of trail commissions beyond 1% of the investment. In fact, the move to a trail based model has raised investor confidence reading to a systematic investment pipeline of Rs 4,000 crore a month into mutual funds. IRDAI is right when it raised renewal commissions in the industry, but wrong because it has kept the upfronts high.
3. Introducing of ‘rewards’. Introducing a new head for payments in the first year that essentially formalises informal payments that breached the commission caps of IRDAI is a surprising regulatory action. It is common knowledge in the insurance industry that the exiting commission caps are regularly breached. A look at IRDAI orders corroborates this where the regulator finds many companies paying out commissions to agents and brokers under many heads, including skill building, promotions, office expenses. An 8 January 2017 Final Order from IRDAI fined HDFC Standard Life for hiding foreign junket costs as ‘skill building’. It does look like the regulator has attempted to formalise what were earlier informal (and therefore illegal) payouts by the industry to the intermediaries. Post the introduction of ‘rewards’ in the first year, the peak payout rate will hit 48%. IRDAI says that intermediaries must be paid these rewards for the benefits they need to be given, including sales promotion, gift items, office expenses, competitions, for data management, infrastructure, advertising and so on. But it is worth asking the question: aren’t the commissions paid meant to take care of such costs? Why does it need an extra head to reward agents and intermediaries for getting the first year business? It is very surprising that a regulator, instead of curbing illegal payments has actually gone ahead and legalised them.

What could IRDAI have done?

IRDAI could have implemented the recommendations of the two committees and reduced upfront commissions, moving to a full trail model. The problem with raising compensation in year one of a long term product has been flagged by multiple research papers and regulators. High front commissions and payouts are go against regulatory learning across the world where high front commissions are linked to investor churning, mis-selling and sharp sales practices. To raise intermediary payouts in the first year in an overall market that has seen reduction in costs is surprising. Had IRDAI hiked the upfront payouts with tighter rules on persistency and claw backs, there could have been an argument for raising compensation. Perversely, in a 2014 Guideline to all CEOs of inurance companies, IRDAI diluted its earlier guideline for stricter persistency targets. It said:

1. Renewal of Individual Agency License and Corporate Agency License will not be subject to meeting the Persistency Rates as stated in the above referred Guidelines/Circulars.

2. All Life Insurers are required to have their own company specific persistency criterion for renewal of Individual and Corporate Agency from 1st July 2014.

With no regulatory cost on poorer persistency, the economic signal of raising first year commissions and payouts is to continue with the hit-and-run sales process. Claw back of front commissions is another way that globally insurance companies ensure a minimum persistency rate, but IRDAI is silent on this. By pushing policy holder interest onto Boards of companies, while raising overall payout rates, the regulator has let the fox into the chicken coop and told the fox to be a good boy now.

 

The author works in the area of consumer protection in finance. She is Consulting Editor Mint, Consultant NIPFP, and on the Board of FPSB India.

Interesting readings

Strategy for dealing with the banking crisis by Ajay Shah in Business Standard, March 6, 2017.

Mahesh Vyas in the Business Standard about consumer sentiment after demonetisation, March 6, 2017.

Abhijit Banerjee in the Hindustan Times about GDP overestimation, March 6, 2017.

The Politics of Public Interest Litigation in Post-Emergency India by Anuj Bhuwania on NIPFP YouTube Channel, March 6, 2017.

U. K. Sinha speaks with Menaka Doshi, on BloombergQuint, March 5, 2017.

How Uber could end up as Silicon Valley's most spectacular crash, by Kevin Maney in Newsweek, March 4, 2017.

Making sense of algorithmic trading by Nidhi Aggarwal and Susan Thomas in Business Standard, March 3, 2017.

Closing of the University by Pratap Bhanu Mehta in The Indian Express, March 3, 2017.

Govt can do better with Sebi chairman's appointment process by Mobis Philipose in Mint, March 2, 2017.

Speaking Marathi not compulsory for auto permits: Bombay High Court by Ruhi Bhasin in The Indian Express, March 2, 2017.

Fixing the minimum premium price: The insurance cartel may just be back by Shyamal Majumdar in Business Standard, March 2, 2017.

RBI's monetary policy committee must improve its communication by Rajeev Malik in Mint, March 2, 2017.

Organisational hurdles in telecom sector by Shyam Ponappa in Business Standard, March 1, 2017.

India Post Payments Bank will keep operations simple: CEO Ashok Singh by Vivina Vishwanathan in Mint, March 1, 2017.

When debt funds malfunction by Monika Halan in Mint, March 1, 2017.

JPMorgan Software Does in Seconds What Took Lawyers 360,000 Hours by Hugh Son on Bloomberg, February 28, 2017.

Speedbreakers kill over nine a day, half of deaths in UP, TN & Karnataka by Anil Sasi in The Indian Express, February 28, 2017.

In court complex where Kanhaiya Kumar was attacked, police say they can now tackle any situation by Abhishek Dey in Scroll, February 27, 2017.

RBI deputy governor R Gandhi responds to the Watal panel report ; our take by Shashidhar KJ in Medianama, February 27, 2017.

Robert Mercer: the big data billionaire waging war on mainstream media by Carole Cadwalladr in The Guardian, February 26, 2017.

Revealed: how US billionaire helped to back Brexit by Carole Cadwalladr in The Guardian, February 26, 2017.

Who made my cheese? by Aditya Raghavan in The Hindu, February 24, 2017.

What The New SEBI Chairman Must And Must Not Do by Somasekhar Sundaresan on Bloomberg, February 24, 2017.

The Seemingly Immovable Object Standing in the Way of India's Satellite Internet Ambitions by Anuj Srivas in The Wire, February 23, 2017.

Governments must be held to account by Sachin Dhawan and John Sebastian in Business Line, February 23, 2017.

Animals know when they are being treated unfairly (and they don't like it) by Claudia Wascher in The Conversation , February 22, 2017.

Immediate challenges for new Sebi chairman by Somasekhar Sundaresan in Business Standard, February 22, 2017.

In pictures: Seven new species of night frogs discovered in the Western Ghats by Vinita Govindarajan in Scroll, February 21, 2017.

Who's To Blame For HDFC Bank Violating The Foreign Investment Limit? by Menaka Doshi in Bloomberg, February 20, 2017.

The Post-Human World by Derek Thompson in The Atlantic, February 20, 2017.

Why Cut Down Trees When They Can Be Translocated? Meet the Man Who Has Moved 5000 Trees This Way! by Aparna Menon in The Better India, February 20, 2017.

Burner phones are good for democracy. How to Run a Rogue Government Twitter Account With an Anonymous Email Address and a Burner Phone by Micah Lee in The intercept, February 20, 2017.

Why You'll Never Do Your Best Work Alone by Jeff Goins on fastcompany, February 18, 2017.

Public goods for health in India by Jeffrey S Hammer on NIPFP YouTube Channel, February 15, 2017.

4chan: The Skeleton Key to the Rise of Trump by Dale Beran on Medium, February 14, 2017.

Open access to expert reports? by A K Bhattacharya in Business Standard, February 14, 2017.

No Relief without Interim Relief by Somasekhar Sundaresan on Wordpress, February 9, 2017.

The size of personal bank credit in India

by Renuka Sane and Anjali Sharma.

In May, 2016, the Insolvency and Bankruptcy Code, 2016 (IBC) law was passed by Parliament and received Presidential assent. The law consists of provisions for both corporate and personal insolvency. However, only the corporate insolvency provisions of the law have been notified and are being implemented. The rapid implementation of the corporate insolvency provisions is largely a response to the policy discourse on the non-performing asset (NPA) problem of the banking sector.

In this article, we turn our attention to personal credit extended by banks, with a view to informing policy actions on the personal insolvency provisions of the IBC. While banks are just one source of personal credit amidst a variety of institutional and non-institutional sources, they are the largest "formal" source of credit, and therefore, the first likely users of the insolvency provisions. Understanding the nature and composition of personal credit extended by banks has implications for effectively designing the procedural aspects of of insolvency resolution under the Code, as well as the institutions that enable the resolution. The decisions surrounding personal insolvency can help lay the foundations for a healthy market for individual credit.

Bank credit to the HH sector

We use the data from the Quarterly BSR-1: Outstanding Credit of Scheduled Commercial Banks released by the RBI. This is a quarterly data series, from March, 2014 till September, 2016, which provides the composition of bank lending by organisation, occupation, loan size, interest rate bands and regions. RBI classifies household (HH) sector credit into three categories. These are credit to: (1) individual borrowers, (2) proprietary concerns, joint families and unregistered partnerships, and (3) joint liability groups (JLG), NGOs and trusts. The data gives us the following details on the size and composition of lending to this sector:

1. HH sector credit is large, both in terms of value and accounts.

   In September, 2016, credit to the HH sector was Rs. 32.2 trillion, 44.3% of the total credit given by banks. In terms of number of loan accounts, HH sector accounts were 98% of the total accounts of the banking system (Table 1). Within the HH sector, credit to single individual borrowers was the largest component, both in terms of value and in terms of accounts.

Table 1: Household sector credit in India

	Loan accounts	Loan value
Categories	(million)	(Rs. trillion)
Total bank credit	143.7	72.7
O/w credit to HH sector	140.2	32.2
- Individuals	134.3	25.2
- Proprietors/ partnerships	3.0	6.3
- JLGs, NGO, Trusts	2.9	0.7
Source: RBI, Quarterly BSR I, Table 1.6

2. Bank credit to HH sector is growing at a faster rate than credit to the corporate sector.

   In the last six quarters, from Q1 2015 to Q2 2016, bank credit to the HH sector has seen an average quarter-on-quarter (Q-o-Q) growth of 3%. By contrast, in the same period, bank credit to non-HH sectors has only seen an average Q-o-Q growth of 0.3%.

3. Bulk of HH sector credit is given as agri loans and personal loans.

   Personal loans (mostly in the form of secured housing and vehicle loans) and agri loans account for Rs. 22 trillion or 67% of the total bank credit to the HH sector. Average loan sizes are relatively small, Rs. 1.2 lakhs per loan for agriculture and Rs. 2.6 lakhs per loan for personal loans.

   The remaining 33% is spread mainly across three sectors: industries (12%), trade and transport (13%) and professional services (6%). These loans are in the nature of business loans. Within industries, most loans are given to proprietors and partnerships, and at an average of Rs. 9.3 lakhs loan size, are relatively large. In trade, transport and services, average loan size is between Rs. 3.5 to Rs. 5 lakhs per loan.

4. Southern and western regions account for more than 60% of agri and personal loans, by value and by accounts.

   38% of agri and personal loans by value, and 46% of the loan accounts, are in the southern region. 24% of loan value and 19% of loan accounts are in the western region. Two states: Tamil Nadu and Maharashtra account for 40% of the loan accounts and 30% of the loan value.

5. Agri loans are given mainly in rural and semi-urban centers while personal loans are given mainly in urban and metropolitan centers.

   Around 85% of agri loan accounts and 72% of the loans by value are given in rural and semi-urban centers. These are places with population less than 0.1 mn. In case of personal loans, 58% of loan accounts and 51% of loans by value are given in metropolitan areas. These are centers with population of 1 mn or more.

6. Agri credit is largely short tenure whereas personal loans are medium to long tenure.

   70% of agri credit is given in the form of cash credit or as demand loans. In contrast, more than 80% of personal loans are medium to long tenure loans.

7. The interest rate distribution of agri and personal loans suggests that, at an aggregate level, there is limited margin for NPAs

   Table 2 shows the distribution of agri and personal loans by interest rate ranges. A comparison of the lending rates with the marginal cost of lending rate (MCLR) for State Bank of India from September, 2016 shows that the margin available for NPAs is limited. The short term MCLR, relevant for agri loans, is 9.05%. Around 56% of agri loans, are in the 6 - 11% lending rate category, suggesting a less than 2% room for NPAs. Similarly, the MCLR relevant for personal loans is 9.25%. 67% of personal loans are in the 6 - 11% lending rate category, suggesting a less than 1.75% room for NPAs.




Table 2: Agri and personal loan lending rates

Lending rate	% agri-loans	% personal loans
Less than 9%	25%	5%
9% - less than 11%	31%	62%
11% - less than 13%	32%	16%
Above 13%	12%	17%
Source: RBI, Quarterly BSR I, Table 3.3

8. Banks have limited mechanisms for enforcement.

   Currently, banks can avail of SARFAESI for resolving secured loans. However, for individual debtors it is used more as a deterrent than an actual enforcement mechanism. DRTs, with their threshold of Rs. 10 lakhs, are available only to the 6-7% of personal credit loan accounts which meet the threshold. For the remaining segments of personal credit, the only mechanism available is the slow and costly Civil Court system. Some banks use the provisions of the Arbitration and Conciliation Act, 1996 for recovery. However, the enforcement of arbitration awards relies on the Civil Court system. There is no collective resolution process available to deal with an individual with a portfolio of loans. Each lender has to pursue its recovery action separately. This proves to be inefficient and costly.

In summary, the data tells us four important facts about personal credit given by banks. First that it is diverse, in terms of borrower profile, loan profile, and geographical spread. Second, it is growing at a faster rate than overall bank credit, given the slowdown in corporate credit and banks increased focus on extending personal credit. Third, the difference between lending rates and marginal cost of lending for this segment is narrow, leaving a limited margin for NPAs. Any deterioration in credit quality of these loans will spell trouble for the banks. Fourth, the mechanisms for recovery are inadequate.

Implications for IBC implementation

The size, and nature of personal credit extended by banks implications for:

The design of IBC resolution procedures:

Most personal loans are secured loans, and banks might continue to use SARFAESI for recovery action on them. IBC may be used mostly in cases where a debtor has multiple unsecured loans, or where the debtor wishes to file for protection under the Code.

A large proportion of agricultural loans are given to low income households. It is possible that many of them will qualify for the fresh start. As most of these loans are in rural and semi-urban areas, design of access will be important for these households to be able to apply for such a waiver.

For those loans that do come to the IBC, the IRP needs to be aligned with the borrowers' profile. A resolution procedure for an individual borrower with low value loans, needs to be simple, low cost and time effective. A simple form-based resolution mechanism, that requires little or no adjudication, may be desirable here. In contrast, resolution procedure for a large borrower or a proprietor may be closer in design to the process for a small company.

On reach, procedure, cost structure and role of the DRTs:

The size of the loans, their complexity, and their geographical spread will need to shape resourcing decisions of the DRTs. This will, in turn, decide their effectiveness as the adjudicating authority for personal insolvency cases. Today DRTs are designed to deal with bank loans above Rs. 10 lakhs. There are only 65 lakh loan accounts in this size threshold in the entire banking system. In contrast, there are 14 crore HH loan accounts, and their average size is Rs. 2.3 lakhs. To effectively deal with resolution of such loans, the DRT rules of procedure, reach, infrastructure, as well as their use of technology for case management, will require a comprehensive re-think.

On how the market for RPs may develop:

The role of RPs, as well as how the RP profession evolves for personal insolvency cases, will be critical. It is likely that, for high value loans, a market for private RPs, concentrated in urban and metropolitan centers, will develop organically. However, for small sized loans, which are geographically dispersed, the question of who will be the RPs and what role they will perform will require assessment, and perhaps even policy action. Further, even when RPs are identified, the process for their licensing, training and monitoring will need to be carefully formulated.

On design of IUs, their accessibility and cost
structures:

The institution of Information Utilities (IUs) is a core component of IBC design. The IUs are expected to facilitate the digitisation of credit transactions, and give such digital records sanctity as evidence in courts of law. Information in an IU can be used for establishing default, and initiating insolvency resolution processes. The structure of IUs, their mechanisms for accepting personal credit related information, and their standards of service will need to be aligned with the need to digitise a large number of small valued loan accounts given to individuals.

On the role of the Insolvency and Bankruptcy Board of India (IBBI):

For personal insolvency, one of the biggest challenges for the IBBI, will be dealing with consumer protection issues. Individual debtors will be vulnerable to biased advice on whether to file for insolvency, the process guiding the filing, and the process for resolution. The IBBI will have to step up to the challenge of protecting customer interests from misaligned incentives that stem from high powered sales practices that have plagued other sectors of the retail financial market.

Conclusion

The design of personal insolvency systems is a complex problem, with challenges that are completely different from those faced by corporate insolvency systems. This article has discussed only the market for bank credit. There will be a larger category of lenders, including money-lenders and friends and family, that may at some point wish to use the provisions under the IBC. Given the size and complexity of the personal credit market, and the paucity of effective recovery mechanisms, there is need for carefully planning and implementing the personal insolvency law sections of the IBC. This is unlike the approach followed for implementing corporate insolvency provisions where speed of implementation has been prioritised.

 

Renuka Sane is a researcher at the Indian Statistical Institute, Delhi and Anjali Sharma is a researcher at the Finance Research Group at IGIDR, Mumbai.

Announcements

Positions at IGIDR FRG

The Indira Gandhi Institute of Development Research is a PhD and Masters granting research institution set up in Bombay in 1989, and funded by the Reserve Bank of India. The Finance Research Group is a group of researchers working on financial markets, household finance and firm financing. At the Finance Research Group, we are recruiting in a few areas.

Policy research on data management in bankruptcy

The Insolvency and Bankruptcy Code, 2016, envisages a new industry of `information utilities' (IUs). We require a policy researcher who will develop expertise on the working of this industry, have thorough knowledge of the processes, critically evaluate regulations and  critique the developments in the policy space. This work will require mastery of information systems, finance and banking domain knowledge, knowledge of the Indian bankruptcy reforms, the Insolvency and Bankruptcy Code and the IU regulations issued by IBBI.

Policy research in payments

We require a policy researcher who will work on:

1. The legal framework of the payments and settlement systems, India and global.
   
2. Clearing in the area of payments.
   
3. Optimal competition policy in payments.
   
4. Policy issues and market barriers in payment systems, and how to design policy to ensure a vibrant fintech ecosystem.
   

The work profile will include studying contemporary policy developments, developing a point of view on the required reforms, writing policy papers and blog articles, running policy roundtables, etc.

Quantitative research on financial markets

Our research program on financial markets requires staffing in:

1. Measuring and monitoring market quality of exchange traded securities. The measures aim to capture changes in price efficiency, liquidity and volatility over time. This will involve using modern statistical techniques, doing parallel computation with high frequency data in R.
   
2. Impact of changes in regulations on market quality.
   
3. Evaluation of proposed regulations, and development of a cost-benefit analysis of the same.

Contact us

All these are full time positions. Please get in touch with Jyoti Manke at careersatFRG@gmail.com .

Judicial review of the Speaker's certificate on the Aadhar Bill

by Pratik Datta, Shefali Malhotra and Shivangi Tyagi.

Under the Indian Constitution, for a bill to be enacted into a law, it has to be approved by both Houses of the Parliament - the Lower House (Lok Sabha) and the Upper House (Rajya Sabha). There is one exception to this general rule. A bill certified as a 'money bill' by the speaker of the Lower House can be enacted into a law by the Lower House alone, without any approval from the Upper House. The Aadhar Act, 2016 was enacted using this route. After being passed by the Lok Sabha, the Lok Sabha speaker certified the Aadhar Bill as a 'money bill'. Accordingly, amendments suggested by Rajya Sabha were not considered and the bill was enacted into law. This led to a controversy, ultimately leading up to a constitutional challenge by Mr. Jairam Ramesh before the Supreme Court. Mr. Ramesh alleged that the speaker incorrectly certified Aadhar Bill as a 'money bill', allowing Lok Sabha to enact the law completely bypassing Rajya Sabha. This matter is going to come up for hearing before the Court on March 14.

Article 110(3) of the Indian Constitution states that the decision of the speaker, whether a bill is a money bill or not, "shall be final". In Mr. Ramesh's case, the Supreme Court has to first decide if it can question the speaker's "final" decision to certify Aadhar Bill as a 'money bill'. The Supreme Court has in three earlier decisions refrained from questioning the speaker's decision. These judgments are Mangalore Ganesh Beedi Works v. State of Mysore (1962), Mohd. Saeed Siddiqui v. State of UP (2014) and Yogendra Kumar Jaiswal v. State of Bihar (2015). As per these judgments, the speaker can certify each and every bill to be a `money bill' capable of being enacted by Lok Sabha alone, rendering the Rajya Sabha and the bicameral legislative system redundant. And the Supreme Court cannot question the speaker's decision since it is "final".

In a recent paper titled Judicial review and money bills, we argue that this position of law developed by the Supreme Court is incorrect. Many commentators have already argued that the enactment of the Aadhar Act through the money bill route was unconstitutional. For instance, Alok Prasanna Kumar, Amber Sinha and Suhrith Parthasarthy have pointed out that the Supreme Court's decisions denying judicial review are problematic. Vanya Rakesh and Sumandro Chattapadhyay have also made out a case favouring judicial review of the speaker's certificate. Our paper adds to this line of literature by substantiating these arguments in detail. In this post, we highlight five reasons why the Supreme Court could legitimately question the speaker's decision in spite of its "final" status under the Constitution.

Indian Constitution does not explicitly bar judicial review

The Indian Constitution adopted the concept of money bills from the British Parliament Act, 1911, with crucial modifications. The 1911 Act defines `money bill' and lays down a procedure for them. Section 1(2) defines a bill to be a money bill which 'in the opinion of the Speaker of the House of Commons' contains only specific provisions. Article 110(1) of the Indian Constitution defines a bill to be a money bill 'if it contains only' specific provisions. Effectively, in Britain the determination of whether a bill is a money bill is left to the subjective 'opinion' of the British speaker. In contrast, the definition of `money bill' under the Indian constitution is not left to the subjective opinion of the Indian speaker. The Indian speaker's decision has to be based on the definition provided in the Constitution.

The 1911 Act mandates the British speaker to endorse his
opinion on money bills, on a certificate. Section 3 gives absolute legal conclusivity to the certificate of the speaker. It reads:

Any certificate of the Speaker of the House of Commons given under this Act shall be conclusive for all purposes, and shall not be questioned in any court of law.

Article 110(3) of the Indian Constitution also grants 'finality' to the Indian speaker's decision. It reads:

If any question arises whether a bill is a Money Bill or not, the decision of the Speaker of the House of People thereon shall be final.

Unlike the 1911 Act, the Indian Constitution does not mention that the speaker's decision "shall be conclusive for all purposes" and "shall not be questioned in any court of law". Therefore, although the Indian Constitution grants conclusivity to the speaker's decision, it does not explicitly bar judicial review. We find that the Constituent Assembly intended for the "final" status given to the speaker's certificate, to be applicable only inside the Parliament - including the Rajya Sabha and the President. Our paper explains this argument in detail.

"Final" decisions have been questioned by Supreme Court

Decisions of various authorities have been given "final" status under the Indian Constitution. Yet the Supreme Court has on multiple occasions exercised judicial review over such decisions. For instance, in Kihoto Hollohan vs Zachillhu (AIR 1993 SC 412), the "final" decision of the speaker regarding disqualification of members of the House under Tenth Schedule of the Indian Constitution, has been held to be a judicial decision subject to judicial review. This suggests that the "final" status given by the Indian constitution does not automatically immune the Indian speaker's decision or certificate from judicial review. Our paper provides a detailed table where we show that there are 17 types of "final" decisions in the Constitution, out of which there are only 3 instances where the Constitution specifically mentions that the validity of such "final" decision cannot be questioned. The decision of the speaker, whether a bill is a money bill or not, is not one of them. Moreover, the Supreme Court has held 5 types of "final" decisions to be subject to judicial review.

British and Indian Parliamentary systems are different

Much of the differences between the 1911 Act and the Indian
Constitution originate from the inherent differences between the British and Indian parliamentary systems.

Britain follows a system of parliamentary sovereignty where the legislature is supreme. In their model it is possible to give absolute conclusivity to the speaker's certificate and immunise it from judicial review. We feel this was not possible under the Indian Constitution since it is not based on parliamentary sovereignty. Giving absolute conclusivity to the speaker's certificate or decision would have been incompatible with the overall scheme of the Indian Constitution, for two reasons.

First, India has a written constitution. All organs of the state (including the speaker) must abide by the Constitution. Any violation is liable to be struck down by the courts. This separation of powers is a basic feature of the Indian Constitution. Allowing the speaker to violate the constitution without any recourse to judicial review impinges upon this basic feature of the Indian Constitution.

Second, Britain does not have a written constitution. Therefore, it is impossible for the British speaker to violate the constitution. The British Speaker can only violate the rules made by either Houses of the British Parliament or procedural laws enacted by both of them. These being 'internal matters' of the Houses, such violations are immune from judicial review. In contrast, India has a written constitution. Certain law making procedures are prescribed by the Indian Constitution (like the money bill procedure), while some other procedures are prescribed through rules by both the Houses of the Indian Parliament (like voting on bills and resolutions). Similar to Britain, the rules made by the Indian Parliament are treated as 'internal matters' of the Houses, immune from judicial interference. We feel violation of constitutional procedures are not 'internal matters', and hence cannot be immune from judicial review. This explains why the Indian constitution framers did not explicitly bar judicial review of the speaker's decision as is the case in Britain.

Supreme Court's contradictory jurisprudence

Our research highlights the inherent contradiction within the Supreme Court's own jurisprudence on judicial review of legislative proceedings and the Indian speaker's certificate on money bills. Article 122 of the Indian Constitution prohibits the courts from questioning parliamentary proceedings on the ground of 'procedural irregularity'. We argue that 'procedural irregularity' refers to violation of procedures in rules made by each House under Article 118 or in any law made by the Houses under Article 119. Violation of a constitutional procedure is not mere 'procedural irregularity'. This distinction was highlighted by a seven judge bench of the Supreme Court in Special Reference No. 1 of 1964. It held that if the procedure followed by the legislature is illegal and unconstitutional, courts can exercise judicial review. This interpretation of Article 122 has been blatantly disregarded by lesser benches of the Supreme Court in the three decisions mentioned earlier. These three cases erroneously held that violation of the constitutional procedure for money bills is a mere 'procedural irregularity' and hence cannot be questioned by the courts.

Other common law jurisdictions allow judicial review

The position followed by the Indian Supreme Court is at odds with the position adopted across five common law countries with written constitutions and bicameral legislative systems. Our research shows that courts across these jurisdictions broadly support judicial review in this regard. In Australia, if a law imposing taxation deals with any extraneous matter, the Australian High Court can exercise judicial review under section 55 of the Commonwealth of Australia Constitution Act, 1900. The Canadian Supreme Court has observed that the procedural requirement must be complied with to create fiscal legislation. The Constitutional Court of South Africa has exercised judicial review to determine if a Bill was calculated to raise revenue or not. The US Supreme Court has categorically held that a law passed in violation of the Origination Clause (equivalent to money bills under the Indian Constitution) would not be immune from judicial review. Pakistan Supreme Court has in four cases struck down laws enacted as money bills since they did not fall within the definition of money bill under article 73 of their constitution.

Conclusion

Our research suggests that Indian legislative proceedings are immune from judicial review only on the ground of 'irregularity of procedure' and not for constitutional breaches. If a House commits breach of any procedure in any rule made by itself or in any legislation that the Houses themselves had passed, such breach is an internal matter for the House itself to act on. It is not open to judicial review. But if a House commits a breach of any constitutional procedure, such breach is open to judicial review. A contrary interpretation would mean that the Indian speaker can certify each and every bill to be a 'money bill', practically dispensing with the need for the Rajya Sabha. Such an interpretation would effectively render the constitutional design of a bicameral legislative system completely redundant. This is precisely what has been done by the three earlier judgements of the Supreme Court. Jairam Ramesh v. Union of India offers the Supreme Court an opportunity to revisit its interpretation of the Constitution on this issue.

References

Pratik Datta et al., The controversy about Aadhaar as a money bill, Ajay Shah's blog, March 20, 2016.

Vanya Rakesh and Sumandro Chattapadhyay, Aadhaar Act as Money Bill: Why the Lok Sabha isn't Immune from Judicial Review, The Wire, May 9, 2016.

Alok Prasanna Kumar, Why the Centre's dubious use of money bills must not go unchallenged, Scroll.in, May 11, 2016.

Amber Sinha, Can the Judiciary Upturn the Lok Sabha Speaker's Decision on Aadhaar?, The Wire, February 21, 2017.

Suhrith Parthasarthy, What exactly is a money bill?, The Hindu, February 27, 2017.

Pratik Datta et al., Judicial review and money bills, February 28, 2017.

 

The authors are researchers at the National Institute of Public Finance and Policy, New Delhi.