Supreme Court Sets Aside RBI’s 2018 Circular Restricting Banking Services to Virtual Currency Entities, Citing Disproportionality

SC Recognizes Virtual Currencies as Digital Representations of Value Capable of Performing Currency Functions; Upholds RBI’s Regulatory Powers but Strikes Down Circular for Violating Fundamental Rights

In a landmark judgment delivered on March 4, 2020, the Supreme Court of India in the case of Internet And Mobile Association of India v. Reserve Bank of India has set aside the Reserve Bank of India’s (RBI) circular dated April 6, 2018, which directed entities regulated by the RBI not to provide banking services to individuals or businesses dealing with virtual currencies (VCs), including cryptocurrencies such as Bitcoin.

The Court recognized the complex nature of virtual currencies, which are known by various names including crypto assets, digital currency, and electronic currency. The Court acknowledged that while virtual currencies are not recognized as legal tender in India, they are digital representations of value capable of functioning as a medium of exchange, unit of account, and store of value. Citing international definitions and judicial decisions from multiple jurisdictions, the Court concluded that virtual currencies are neither purely commodities nor currencies in the traditional legal sense but can perform many functions of real money.

The judgment examined the statutory powers of RBI under the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007. It held that RBI’s mandate to operate and regulate the currency and credit system of the country includes the power to regulate or prohibit activities that potentially threaten monetary stability and financial systems, including those involving virtual currencies.

While affirming RBI’s authority to regulate virtual currencies and associated entities, the Supreme Court found that the 2018 circular imposing a blanket restriction on banking services to virtual currency exchanges was disproportionate and violated Article 19(1)(g) of the Constitution, which guarantees the right to practice any profession or carry on any occupation, trade or business. The Court observed that the circular effectively severed the lifeline of the virtual currency exchanges by denying banking access, thereby crippling their operations without establishing any actual adverse impact on RBI-regulated entities.

The Court also noted that the circular did not prohibit the use or trading of virtual currencies per se, but only restricted the regulated entities from providing services to those dealing with VCs. It further held that RBI had not shown any empirical evidence of harm or loss to the banking system caused by virtual currency exchanges. The Court directed RBI to defreeze funds held by one of the petitioners and allowed the writ petitions, thereby setting aside the circular on grounds of proportionality and violation of fundamental rights.

This judgment is significant as it clarifies the legal status of virtual currencies in India, affirms the regulatory powers of the RBI over the financial system, and underscores the need for proportionate regulatory measures that do not unduly stifle emerging digital economies.

Statutory provisions

Reserve Bank of India Act, 1934 Sections 3(1), 17, 20, 21, 22, 26, 38, 45JA, 45L, 45W;

Banking Regulation Act, 1949 Sections 5(ca), 8, 21, 22, 27, 29A, 30, 35A, 36;

Payment and Settlement Systems Act, 2007 Sections 2(1)(i), 3, 4, 10, 11, 17, 18;

Foreign Exchange Management Act, 1999 Section 2(h), 2(i), 2(q);

Constitution of India Article 19(1)(g).

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Detailed Analysis and Step-by-Step Guide to the Judgment:

1. Background and Impugned Circular:

 The RBI issued a statement on April 5, 2018, followed by a circular on April 6, 2018, directing all entities regulated by it (including banks and financial institutions) not to deal with or provide services to any individual or business engaged in virtual currencies (VCs). The circular mandated regulated entities to exit existing relationships with such individuals or entities within three months.

2. Petitioners’ Challenge:

 The Internet and Mobile Association of India and various virtual currency exchanges and traders challenged the circular, contending that RBI lacks the power to impose such a ban, that VCs are not legal tender but commodities/digital goods, and that the circular violates their fundamental right to carry on trade/business under Article 19(1)(g).

3. RBI’s Defense:

 RBI defended the circular as a necessary regulatory measure taken under its powers to protect the financial system and consumers from risks associated with VCs, including volatility, anonymity facilitating money laundering and terrorist financing, and lack of consumer protection mechanisms.

4. Legal Issues Addressed:

 - Whether RBI has the statutory power to regulate or prohibit dealings in virtual currencies.

 - The legal status of virtual currencies in India.

 - Whether the impugned circular amounts to a total ban or a regulation.

 - Whether RBI applied its mind properly and the exercise of power was bona fide.

 - The constitutional validity of the circular under Article 19(1)(g) and the test of proportionality.

5. RBI’s Powers and Role:

 The Court traced RBI’s historical and statutory role as the central bank with exclusive rights over currency issuance and monetary policy. It emphasized RBI’s broad mandate to regulate the financial and credit system of the country to its advantage and its powers under various statutes to issue directions to banking companies and regulate payment systems.

6. Nature and Identity of Virtual Currencies:

 The Court surveyed international regulatory definitions and judicial decisions, noting that virtual currencies are digital representations of value, not legal tender but capable of functioning as medium of exchange, unit of account, and store of value. It rejected the petitioners’ argument that VCs are merely commodities and outside RBI’s regulatory reach.

7. Whether Circular Imposed a Ban:

 The Court clarified that the circular did not ban the use or trading of virtual currencies but prohibited regulated entities from providing banking services to those dealing with VCs. Although this effectively crippled virtual currency exchanges that depend on banking channels, peer-to-peer transactions remained unaffected.

8. Satisfaction and Application of Mind by RBI:

 The Court held that RBI applied its mind over a period of five years, issuing multiple press releases and reports warning of risks. RBI’s detailed point-wise replies to petitioners’ representations further demonstrated bona fide exercise of its power.

9. Malice and Colorable Exercise of Power:

 The Court rejected allegations of malice or colorable exercise, holding that RBI acted in public interest and banking policy interest, not to target petitioners unfairly.

10. Judicial Deference to RBI’s Decision:

 Given RBI’s special status as central bank with constitutional and statutory independence, the Court accorded due deference to RBI’s policy decisions in regulating the financial system.

11. Article 19(1)(g) Challenge and Proportionality:

 The Court found that the circular severely restricted the right to carry on trade/business of virtual currency exchanges by cutting off banking access. The restriction was disproportionate as RBI did not demonstrate actual harm to regulated entities or the financial system, nor consider less restrictive alternatives.

12. Outcome:

 The Supreme Court set aside the RBI’s circular dated April 6, 2018, on grounds of disproportionality and violation of fundamental rights, while affirming RBI’s authority to regulate virtual currencies. The Court directed RBI to defreeze funds of one petitioner’s bank account that had been frozen, despite RBI denying giving such directions.

13. Significance:

 This judgment balances the need for regulatory oversight with protection of fundamental rights and emerging digital enterprises. It recognizes the evolving nature of virtual currencies and the necessity for proportionate regulatory measures rather than blanket restrictions.

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This comprehensive report covers the essence of the Supreme Court’s judgment, its statutory and constitutional analysis, and its implications for virtual currency regulation in India.

Internet And Mobile Association of India v. Reserve Bank of India (SC) : Law Finder Doc Id # 1699197