Why was SEBI appealing SAT order? Answer can give clue to fix India’s govt litigation crisis

Understanding the incentives of the bureaucracy to litigate to the highest court will help us determine how to undo those incentives.

29 March, 2023
The Print

In a recent order, the Supreme Court directed the Securities and Exchange Board of India to return Rs 300 crore to the National Stock Exchange. The SEBI had collected Rs 625 crore under a disgorgement order against the NSE in 2019, which the Securities Appellate Tribunal had set aside. The SEBI was appealing this SAT judgment at the Supreme Court. The pertinent question to ask is, was the SEBI appealing the SAT order because that is what any government department in India does — appeal every order against it regardless of its chances? Or did the SEBI think that it actually had a strong case, after its loss at SAT? This question goes to the heart of the “government litigation crisis” that we see in India.

In August 2022, in an appeal filed by Reliance Industries Limited, the Supreme Court said: “Criminal action in commercial transactions, should take place with a lot of circumspection.” These are important words for a country where litigation by the government is a contributor to judicial pendency.

Government as a litigant

One of our laments about the Indian judiciary is that it is overburdened. About half the cases in the courts involve the government. There are two ways in which the government finds itself in the court. Either it is a respondent to a case filed by a private party for not fulfilling its contract, or it is a petitioner appealing to a higher court having lost in a lower court or in arbitration. A large number of writ petitions in the Delhi High Court are linked to the enforcement of public contracts. One way to reduce government litigation is to improve how the government writes and lives up to its contracts. Another way is for the government to weigh its decision to pursue cases with a more careful cost-benefit analysis.

According to the Legal Information Management & Briefing System (LIMBS) database, there are more than 6 lakh pending court cases involving the government. If government litigation can be brought down even marginally, the burden on courts would be reduced enormously and save public money spent on pursuing cases. This would also reduce the time, resources, and cognitive burden on defendants who may, sometimes, have a stronger case.

An update to the National Litigation Policy of the government is in the works. As per the 2010 policy, the Central Board of Direct Taxes (CBDT) and the Central Board of Indirect Taxes and Customs (CBIC) have issued directions that cases below certain thresholds should not be pressed further and focus should be placed on high-demand litigations. The policy also suggests that the filing of an appeal should be decided strictly on the merits of the case, and if the issue has been lost in two stages of appeal, it should not be contested further. There seems to be some effort to reduce the number of the 80,000 cases pending before the Customs Excise and Service Tax Appellate Tribunal (CESTAT). It would be interesting to study the policies put in place by the departments to reduce litigation. But policies are not useful unless they shape the incentives of the players.

Reducing the need to appeal

It’s not very obvious why the bureaucracy appeals cases. Anecdotes suggest that the reasons range from fear of allegations of corruption to the low costs of losing a case. For a bureaucrat, losing an appeal in court may have no consequences. This is especially so because the State doesn’t run out of money trying to hire lawyers, the interest rates awarded by the courts are low, and costs are rarely awarded. But not appealing may elicit allegations of corruption or incompetence. It is then, not surprising, that the default action is to appeal a loss. Understanding the incentives of the bureaucracy to litigate all the way to the highest court will help us determine how to undo those incentives. What we need is a system wherein each case is evaluated on the probability of a win and the size of the case.

In the meantime, a possibility that can be considered is to set up an external committee in the form of an ‘appeals approval committee’ that decides whether a government department or a regulatory body should appeal a case further. The committee could consist of members external to the government such as former judges of a court or subject matter experts. The sitting fee of the members should be equal to a post-retirement arbitration fee and the decision of the committee binding. This will force departments, and especially the regulators, to demonstrate why they have a good chance of winning a case on appeal. It will also put additional pressure on the regulator to write carefully reasoned orders that stand the scrutiny of the Appellate Tribunal.

SVB fall shows it’s not just about credit risk. It’s also about the silent role of interest rate

The SVB case has once again raised questions on the role of banking regulation and deposit insurance.

15 March, 2023
The Print

California’s Silicon Valley Bank was shut down by regulators in the United States last Friday, followed by New York-based Signature Bank on Sunday. Several Indian startups with accounts at SVB may also be impacted by this sudden closure. Bank runs or panic withdrawals and the resulting contagion effects have once again raised questions about banking regulation around the world.

The SVB impact

When SVB announced last Wednesday that it needed $2.25 billion to shore up its balance sheet, most of its depositors were caught by surprise. Panic ensued, and depositors withdrew funds worth $42 billion in a day, making a bad situation worse and leading to its shutdown. The Federal Deposit Insurance Corporation (FDIC) said depositors would have access to only the insured deposits (up to $250,000) by Monday morning.

Many startups in India with deposits in SVB had difficulties accessing funds, especially those with deposits that are more than the insured amount. Losing access to their deposits would damage the ability of these firms to make downstream payments. Rajeev Chandrasekhar, the Minister of State for Skill Development and Entrepreneurship in India, is meeting with startups to assess the impact. Late Sunday evening, the Federal Reserve System (also known as the Fed) announced it would help banks meet the needs of their depositors. The UK arm of SVB has already been sold to HSBC. What seemed like the bank failure of a relatively small institution has turned into an event with global ramifications.

An unusual bank run

The SVB bank run is unusual for three reasons. First, it did not get into trouble because of a deteriorating loan portfolio. SVB clients were largely venture-capitalists who made deposits but did not need loans. SVB, therefore, invested these funds in US government bonds. When the Fed increased interest rates, the price of bonds fell, causing a liquidity crisis. The bank’s financial position was thus a result of poor management of its interest-rate risk and not its credit risk.

Second, since the client base consisted mostly of venture-capitalists, their demand for funds to SVB, for instance, to pay salaries to their employees, would be made at the same time. The homogeneity of the client base meant that the bank itself was not diversified.

Third is the response of the government. Bank failures are not new to the US. There is a well-understood process of resolution wherein the bank assets get sold over a period of time, and ownership changes hands. Initially, the response of the FDIC was as expected — it would only provide access to insured deposits and proceed with the sale of the bank. This was because SVB was not considered systemically important given its size (16th largest in the US in terms of deposits before its downfall). However, the Fed got into action with a Bank Term Funding Program (BTFP). With this program, the government will make available up to $25 billion, thus guaranteeing all depositors access to their funds. This funding comes from the insurance fund and not tax-payer money.

The need for financial regulation

Banks are risky institutions. They take money from depositors and lend the same money to businesses. Repayment by creditors takes place over a long period of time, whereas depositors can withdraw their balances at any point. Instead of lending to customers, the banks sometimes invest in government bonds, whose prices fluctuate depending on the interest rate environment. The bank, thus, always faces a mismatch in the tenure of its funds. It keeps a buffer capital for such events, but this buffer can also fall short.

If all depositors were to withdraw their money at the same time, then the bank would not be able to meet these demands, causing a “bank run”. Countries around the world have constituted “deposit insurance” programmes. If a bank fails, part of the deposits that are insured is paid back to depositors. The insurance is financed through a premium charged to banks. In the US, FDIC, the country’s deposit insurance institution, not only insures bank deposits but also acts as a receiver of the bank — selling or collecting the failed bank’s assets and settling its debts.

The SVB case has once again raised questions on the role of banking regulation and deposit insurance. We have generally considered bank runs as emanating from credit risk and paid less attention to interest-rate risk. There are standard processes to deal with interest-rate risk in banks’ books. The question that regulators will need to examine is if the exposure of SVB to interest rate risk raised alarm bells earlier. Should SVB also have been subjected to more regular stress tests? Should banks be asked to keep a larger buffer of shareholder funds to absorb losses? Does this buffer fund change for banks that service only a community and are, therefore, not diversified themselves? Banking regulation will have to evolve to grapple with problems related to interest rate risk.

India must detach from Russia. Exports, IT, or education, its interests lie with the West

Young Indians' aspirations are tied to work and education in the West, not the China-Russia axis. Govt must weigh that in while considering its stance on the Ukraine war.

01 March, 2023
The Print

On 23 February, India once again abstained from voting on a United Nations resolution related to the Russia-Ukraine conflict. New Delhi has greatly expanded oil purchases from Russia, and, in effect, has helped Moscow finance its invasion at a time when Europe has sharply cut back on purchases. Foreign policy experts suggest that the Indian support for Russia is on account of two reasons — our long-term strategic relationship with Russia and the aim to reduce the extent to which Russia becomes bound to China. But by supporting Moscow, New Delhi is running the risk of being alienated by the West. What is the economic perspective that should be brought into this story?

Economics and foreign policy

State coercion limits engagement between individuals in two countries. Governments make such decisions based on a balance of economic interests and foreign policy. One arena where this plays out is visa diplomacy. Denial of visas is a lever of international relations and often used as a tool to influence actions by another State. Europe has often used relaxed travel conditions as a tool for readmission to the European Commission. The United Kingdom granted 3,000 visas for Indians in November 2022 after Prime Minister Narendra Modi met UK PM Rishi Sunak. Another important tool is trade agreements. Such deals have big consequences for developing countries because they can impact a nation’s economic growth. Trade agreements may sometimes be driven primarily by geopolitical and strategic reasons. An example is the 2015 Australia–Japan free trade agreement.

In a globalised world, cooperation between countries extends to multiple arenas. An example is the recognition of central counterparties (CCPs) in financial markets that allow investors to invest and trade in financial assets. If these fail, then a country runs the risk of becoming less competitive for foreign investors. Another example of cooperation is the United States-India initiative on Critical and Emerging Technologies (iCET), which will form the basis for the framework for collaboration between the two countries in many respects. The energy, support, and prioritisation for all these initiatives on the part of the two governments are shaped by their security environment. This has major implications for people living in both countries.

India’s interest lies with the West

In FY22, India’s total exports amounted to $422 billion. Of these, 24 per cent were to the Americas, while 21 per cent were to Europe — almost half of India’s total exports, therefore, were tied to the West. In the same year, the share of Russia was 0.7 per cent while that of China was 5 per cent. Services exports is where India shines — they are now bigger than goods exports. Indian services exports go almost entirely to the West; with Russia and China, they are negligible. Information Technology is now India’s biggest industry, and the future of the Indian economy is tied to success in this sector. For further doubling of services exports, support and cooperation from Western governments is important.

Western universities are key destinations for Indian students. According to the Ministry of External Affairs, a total of 11,33,749 students went overseas in 2021. Of these, 51 per cent went to Australia, Canada, the UK and US; 2 per cent went to China and 1.4 per cent to Russia. In 2022, Indian students received more US visas than students in any other country. The aspirations of young Indians are tied with the West and not the Russia-China axis.

Work visas are important for Indian IT giants such as Wipro, TCS, and Infosys to be able to service Western markets. The decision of the Donald Trump administration to temporarily suspend the issuance of H-1B visas in 2020 had caused much anxiety for the Indian IT sector. The current lay-offs in the tech sector in the US have brought together technology professionals associations to influence policymakers and decision-makers at US Citizenship and Immigration Services (USCIS). India’s approach to the Ukraine war will shape the extent to which Western governments choose to support India’s services exports growth targets.

Firms are as important as governments in making material decisions — they run the global production system. The decisions of the board of directors of the top 1,000 global companies impact India’s future in a major way. If global firms want to exit China on the grounds that it is an authoritarian country hostile to the West, then it is in India’s interest to look ‘un-China’ in the eyes of the world. Our equation and policies vis-a-vis Russia may shape the attitude of these global corporate players.

Foreign policy is a balancing act. Multiple considerations go into arriving at a country’s position — India must do the same with regard to the Ukraine-Russia conflict. Most of us in India think that this is not our fight or that our current stance will not cost us. But India’s economic interests lie with the West, and the latter is extremely worried about Russia’s invasion of Ukraine.