The Doctrine of Proportionality in Financial Regulations: Analyzing IAMAI v. RBI

Guna Sai Venkat Jagatha is a fourth-year B.A LL.B student at Guru Gobind Singh Indraprastha University, Delhi, Read More.

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Introduction

Internet and Mobile Association of India v. Reserve Bank of India 2020 forms a landmark judgment in the regulatory journey of India toward its cryptocurrency ecosystem. It was an important case related to the Reserve Bank of India’s controversial circular on April 6, 2018, wherein it virtually prohibited banks and other financial institutions from dealing in virtual currencies. This decision shook the foundations of India’s nascent cryptocurrency industry, driving several exchanges out of business and leaving investors in a lurch. At the heart of the case lay the debate over balancing innovation and regulation, as well as questions about the constitutional validity of the RBI’s actions.

The Internet and Mobile Association of India, an important industry association, had questioned the RBI circular by saying it violated the rights guaranteed under Article 19(1)(g) of the Constitution of India, which postulates that there is a freedom to practice any profession or trade or business. On March 4, 2020, the Supreme Court of India gave its verdict in which the RBI circular was declared quashed along with reaffirming the necessity of proportionality and legislative back up for regulation.

This case carries importance for multiple reasons. At a time when Indian cryptocurrency regulation may be defined, the judiciary has struck a fine balance between protection of innovation and preventing overreach of regulation in growth. Second, the judgment sets a precedent concerning the proportionality doctrine in relation to financial regulations. Striking down the circular, the Supreme Court has made it clear that policymaking in this rapidly evolving digital economy must be balanced.

With increasing popularity in cryptocurrencies, this case would act as a referential point for the future of digital financial systems in India by finding a balance between the imperatives of innovation, regulation, and consumer protection.

Background and Timeline

The rise of cryptocurrencies in India was a reflection of the global trend, particularly after the dramatic value appreciation of Bitcoin in 2017. As blockchain-based digital currencies started gaining relevance, cryptocurrency exchanges like ZebPay, CoinDCX, and WazirX offered venues for trade and investment. Since cryptocurrencies had several speculative aspects while concurrently offering avenues for malicious activities, such activities have led to increased scrutiny from regulators across the world, including in India.

On April 6, 2018, RBI issued a circular prohibiting all banks and regulated entities from providing services to individuals or businesses dealing in virtual currencies. This crippled the cryptocurrency ecosystem in India because it cut off exchanges from the formal banking system and made fiat transactions nearly impossible. The RBI defended its decision with money laundering, terror financing, consumer protection, and financial stability concerns. Although the circular did not outrightly ban cryptocurrencies, the effect of this move was no different than that of an outright ban.

The circular faced immediate backlash from the cryptocurrency industry and investors, who argued that the RBI’s action lacked legislative backing and was arbitrary. The Internet and Mobile Association of India (IAMAI), representing cryptocurrency exchanges, filed a writ petition in the Supreme Court challenging the circular. They contended that the ban violated Article 19(1)(g) of the Constitution, which guarantees the right to trade and profession, and lacked evidence of any tangible harm caused by cryptocurrencies.

It passed through multiple hearings over the course of two years. IAMAI and RBI continued to present their arguments before it. On 4 March 2020, the Supreme Court of India declared the RBI circular as ultra vires, held that the step taken by the RBI was disproportionate and lacked adequate evidence to provide for the order of prohibition. This revitalized the cryptocurrency market in India as it allowed the resumption of exchanges and marked a turning point in the approach towards digital currencies.

This judgment set the pace for India to discuss cryptocurrency regulations and the kind of challenges to be faced, in balancing financial oversight with innovation in technology at a fast-pace digital economy.

Arguments Presented by IAMAI

The Internet and Mobile Association of India (IAMAI), representing cryptocurrency exchanges and other stakeholders, challenged the RBI circular of April 6, 2018, on multiple legal and constitutional grounds. Their arguments were centered on the protection of fundamental rights, the absence of evidence to justify the circular, and the principles of proportionality. Below are the key contentions presented by IAMAI:

1. Violation of Fundamental Rights

• Article 19(1)(g): IAMAI contended that the RBI circular directly infringed on the fundamental right to practice any profession or carry out any trade or business. Cryptocurrency exchanges were legitimate businesses providing services to investors and traders, and the circular amounted to a complete shutdown of their operations.
• The association stressed that such a severe restriction could be imposed only in the presence of compelling public interest and legislative support, which were lacking.

2. No Evidence of Harm

• IAMAI highlighted that the RBI did not present any concrete evidence of harm caused by cryptocurrency trading to the Indian economy, financial institutions, or consumers.
• The petitioners pointed out that though speculative, cryptocurrency trading had not caused any significant disruption in India’s financial system.
• The petitioners further proposed that the ban was based on hypothetical risks and without any concrete data, making it arbitrary and excessive.

3. Proportionality of the Ban

• Applying the doctrine of proportionality, IAMAI averred that the RBI decision was disproportionate to the risks it intended to mitigate.
• The doctrine, as laid down in Modern Dental College and Research Centre v. State of Madhya Pradesh (2016) and K.S. Puttaswamy v. Union of India (2017), mandates that the regulatory measures must be:

1. Proportionate to the intended objective,
2. Necessary to achieve the objective, and
3. Proportionate to the harm caused by the restriction.

• IAMAI argued that less restrictive measures, such as regulatory oversight or targeted actions against misuse, could have addressed the RBI’s concerns without crippling the entire industry.

4. Lack of Legislative Backing

• The petitioners highlighted that cryptocurrencies were not declared illegal under any Indian law, such as the Payment and Settlement Systems Act, 2007, or the Banking Regulation Act, 1949.
• Thus, the act of RBI was an excess exercise of its power as it aimed to regulate something that lies beyond its domain as per statute and without the backing of legislative power.

5. Global Practices

• IAMAI quoted global practices whereby countries such as the US and Japan adopted regulations for cryptocurrency rather than outright prohibition. IAMAI argued that a similar policy of India should promote innovation along with risk minimization.

In a nutshell, the IAMAI argued that the circular issued by the RBI was unconstitutional, excessive, and not supported by any evidence or legislative authority. In conclusion, the case revolved around these contentions, which led to the favorable judgment from the Supreme Court of India.

RBI’s Defense and Counterarguments

The RBI defended its April 6, 2018, circular on multiple grounds, emphasizing its responsibility to safeguard the financial stability of the country. The RBI argued that its actions were both necessary and within its statutory powers to protect the financial ecosystem from the risks posed by cryptocurrencies. Below are the key counterarguments presented by the RBI:

1. Consumer Protection

• The RBI pointed out that cryptocurrencies are highly speculative and volatile in nature, thus risking the investments of individuals. With no intrinsic value and no government guarantee, cryptocurrencies are highly prone to price manipulation and market crashes.
• The central bank contended that it had an obligation to protect consumers from being duped by scams or losing money due to speculative trading in virtual currencies.

2. Prevention of Money Laundering and other Illicit Activities

• Anonymity and decentralization are some of the cited enabling features for criminal operations like money laundering, terror financing, and tax evasion.
• It claimed that there is a necessity for RBI-regulated entities to maintain financial integration through regulated channels within its jurisdictions that comprise banks and other financial institutions so as not to get into the mainstream system of money flow.

3. Financial Stability

• The RBI found the mushrooming use of cryptocurrencies threatening to the stability of India’s financial system. Cryptocurrencies, being decentralized and operating outside the framework of regulations, created risks for monetary policy control.
• RBI said that an uncontrolled cryptocurrency market poses risks to the banking sector and becomes systemically volatile should speculative investments lead to heavy losses by consumers and businesses.

4. Statutory Authority

The RBI justified its powers under:

• Section 35A of the Banking Regulation Act, 1949, empowering it to issue directions in the public interest, and
• Section 18 of the Payment and Settlement Systems Act, 2007, which empowers it to regulate payment systems.
• It contended that its circular was a preventive measure well within its mandate to ensure the sound functioning of the country’s financial institutions.

5. Global Concerns About Cryptocurrencies

• The RBI referred to the steps taken by other countries, such as China, which had strictly restricted the use of cryptocurrencies to safeguard their economies. The RBI argued that its step was not at variance with global best practices for dealing with the risks associated with virtual currencies.

6. Proportionality of the Measure

• The RBI argued that the circular was not disproportionate since it did not ban cryptocurrencies per se but restricted regulated entities from dealing with them. It argued that such restrictions were reasonable and necessary to protect the financial system.

In conclusion, the RBI defended the circular as a preventive measure to address the unknown and emerging risks of cryptocurrencies. It maintained that its actions were justified under its statutory mandate and were essential to protect India’s financial ecosystem. Despite these arguments, the Supreme Court found the RBI’s measures disproportionate, ultimately ruling in favor of the petitioners.

Supreme Court Judgment

On March 4, 2020, the Supreme Court of India, in its landmark judgment in Internet and Mobile Association of India v. Reserve Bank of India, struck down the RBI’s April 6, 2018, circular that prohibited regulated entities from providing services related to cryptocurrencies. A detailed judgement was pronounced by the three judge bench comprising Justices R.F. Nariman, Justice Aniruddha Bose, and Justice V. Ramasubramanian. Their judgment deals with the constitutional validity of the circular and its ramification in India’s cryptocurrency domain. Here is the essence of the judgment :

1. Applicability of Doctrine of Proportionality

• The Supreme Court heavily relied on the doctrine of proportionality, which is an evaluation to check whether a regulatory measure is appropriate, necessary, and proportionate to achieve its intended objective.
• Drawing from judgments like Modern Dental College and Research Centre v. State of Madhya Pradesh (2016) and K.S. Puttaswamy v. Union of India (2017), the Court made it clear that any restriction on fundamental rights must pass the proportionality test.
• The RBI was unable to show actual damage done to the financial system by cryptocurrencies. The Court observed that though risks such as money laundering and volatility were well-founded, no actual evidence was brought to achieve the ban on banks dealing with cryptocurrency exchanges.
• The Court viewed that there are less restrictive alternatives in which regulations or oversight could have solved the problem for the RBI without cutting off the cryptocurrency ecosystem.

2. Violation of Fundamental Rights

• The Court found that the RBI circular violated Article 19(1)(g) of the Constitution, which ensures the right to practice any profession or trade.
• The restriction imposed by the circular, in effect, prevented cryptocurrency exchanges and businesses from functioning, thus depriving them of their fundamental right to trade.
• The Court held that such a drastic restriction must be supported by clear legislative authority, which was absent here.

3. RBI’s Statutory Powers

• The Supreme Court acknowledged the RBI’s authority to regulate the banking sector under statutes such as the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007. However, it ruled that this power did not extend to imposing an outright prohibition on dealing with cryptocurrencies, particularly in the absence of any legislative framework declaring cryptocurrencies illegal.
• The Court clarified that regulatory measures must be reasonable, evidence-based, and aligned with the principles of natural justice.

4. Final Decision

• The Supreme Court quashed the RBI circular, declaring it unconstitutional. The ruling provided immediate relief to cryptocurrency exchanges and restored their access to banking services.
• Although the judgment did not declare cryptocurrencies legal or illegal, it established that regulatory action must be proportional and evidence-based.

Impact of the Judgment

• The verdict was widely seen as a victory for innovation and entrepreneurship that enabled the Indian crypto industry to begin operating again in India.
• It also sent an important signal by upholding the proportionality doctrine’s application in the regulation measure and safeguarding fundamental rights.

It showed a pragmatic approach towards the balance between financial regulation and technological innovation in the judgment of the Supreme Court. It sent a message to the regulatory authorities that they must operate within the confluence of the Constitution while resolving the emerging challenges of a digital economy.

The Supreme Court’s judgment in Internet and Mobile Association of India v. Reserve Bank of India (2020) was a landmark decision that had a profound and immediate impact on the Indian cryptocurrency landscape and significant implications for regulatory practices in the financial sector. The judgment not only revived the cryptocurrency ecosystem but also brought to the forefront the need to balance regulatory oversight with innovation and constitutional rights.

1. Revival of the Cryptocurrency Industry

• The judgment restored the access of cryptocurrency exchanges and businesses to banking services and enabled them to start trading activities. Major exchanges like WazirX, CoinDCX, and ZebPay restarted trading within a few days after the judgment.
• Investor confidence went up, thereby increasing participation in cryptocurrency trading. This also facilitated the entry of new players in the market.

2. Boost to Innovation and Startups

• The decision provided much-needed regulatory clarity, encouraging fintech startups and blockchain-based businesses to explore new opportunities. It signaled India’s willingness to embrace emerging technologies rather than stifling them through blanket restrictions.

3. Global Perception and Investments

• The ruling positioned India as a potential hub for cryptocurrency innovation. Global investors and companies viewed the judgment as a progressive step toward fostering a favorable environment for digital currencies and blockchain technology.

4. Precedent in Proportional Regulation

• The verdict held that the proportionality doctrine be applied more strictly where measures of regulation must prove to be based on evidence and justifiable. This may impact future cases where the fundamental rights are curtailed mainly in the fast-developing digital economy.

5. Future Challenges and Legislative Efforts

• The judgment did not declare the status of cryptocurrencies as legal or illegal, which left their legal status ambiguous. This left the onus on the government to develop a comprehensive regulatory framework. Subsequent efforts, such as the Cryptocurrency and Regulation of Official Digital Currency Bill, reflect ongoing attempts to address these gaps.

In short, such a judgment by the Supreme Court turned the table for the cryptocurrency sector in India. It underlined how the judiciary plays a crucial role in ensuring fair compliance with regulation that justifies and proportionate actions.

Comparative Perspective and Related Case Laws

This judgment, Internet and Mobile Association of India v. Reserve Bank of India (2020), finds significance not just in India but also in contrast with global approaches towards regulating cryptocurrencies. Different strategies are adopted worldwide regarding digital currencies: the opportunity it offers, and the risk involved, placing this case as an instance from the larger framework.

1. Global Regulatory Practices

• United States: The U.S. has adopted a regulatory approach that encourages innovation while ensuring consumer protection. Agencies like the SEC (Securities and Exchange Commission) and CFTC (Commodity Futures Trading Commission) regulate cryptocurrencies based on their classification as securities or commodities.
• Japan: Japan legalized cryptocurrencies as a mode of payment under its Payment Services Act (2017), ensuring oversight while promoting their use.
• China: On the other hand, China completely banned cryptocurrency trading and mining, calling it a threat to financial stability.
• Even the Supreme Court of India upheld the same law, closer to the progressive approaches seen in the U.S. and Japan, advocating regulation rather than prohibition.

2. Related Indian Case Laws

• Shreya Singhal v. Union of India (2015): Held Section 66A of the IT Act void, as nothing short of ‘proportionate regulation’ makes sense in an electronic medium of communication. Therefore, the ‘doctrine of proportionality’ took its birth into matters relating to fundamental rights and technology.
• K.S. Puttaswamy v. Union of India, 2017: Strengthened the understanding that any check on the availability of a Fundamental Right should qualify as reasonable; necessary and material.
• Modern Dental College v. State of Madhya Pradesh (2016): This set up the test of proportionality, which was a salient feature in the IAMAI judgment.

To sum it all, the IAMAI case has brought India onto the world scenario of proportionate and evidence-driven regulatory measures within the constitutional guardrails. As such, IAMAI is important for the cause of balancing innovative technology with appropriate governance and regulation.

Conclusion

The Internet and Mobile Association of India v. Reserve Bank of India judgment of 2020 was a landmark judgment that dictated India’s approach to the regulation of such emerging technologies as cryptocurrencies. Striking down the circular by RBI, the Supreme Court reaffirmed that regulatory objectives have to be balanced with constitutional principles, specifically protecting fundamental rights such as the right to trade enshrined under Article 19(1)(g).

This case highlighted that the judiciary indeed plays a great role in innovating while regulatory actions are also proportionate, evidence-based actions. The application of the Court’s reliance upon the doctrine of proportionality on the RBI emphasizes that regulatory agencies must provide objective evidence of why their measures might cause harm because such actions potentially disrupt an industry.

The judgment has also come out to the public that policymakers should hear: outright bans are neither sustainable nor effective in tackling the challenges that disruptive technologies pose; instead, the means for such an approach are appropriate legislation and regulation, taking the right balance between fostering innovation and ensuring consumer protection and financial stability.

This decision, although ruling in favor of reviving India’s cryptocurrency ecosystem, left many questions open about what the future of regulation would look like. Subsequent efforts, including the proposed Cryptocurrency and Regulation of Official Digital Currency Bill, reflect the challenge of navigating this complex and rapidly evolving space.

Ultimately, this case reminds the judiciary of its critical role in shaping the intersection of law, technology, and finance, ensuring that India remains open to innovation while adhering to its constitutional values.

References and Citations

Case Laws Cited

1. Internet and Mobile Association of India v. Reserve Bank of India (2020):
   • Supreme Court of India judgment quashing the RBI circular banning cryptocurrency dealings by regulated entities.
   • Citation: (2020) 10 SCC 274.
2. Shreya Singhal v. Union of India (2015):
   • Landmark case striking down Section 66A of the IT Act, emphasizing proportionality in digital regulation.
   • Citation: (2015) 5 SCC 1.
3. K.S. Puttaswamy v. Union of India (2017):
   • Right to privacy judgment; stressed proportionality and necessity in restricting fundamental rights.
   • Citation: (2017) 10 SCC 1.
4. Modern Dental College and Research Centre v. State of Madhya Pradesh (2016):
   • Established the doctrine of proportionality in regulatory measures.
   • Citation: (2016) 7 SCC 353.

Statutory Provisions

1. Article 19(1)(g), Constitution of India:
   • Guarantees the right to practice any profession, trade, or business.
   • Citation: Constitution of India.
2. Banking Regulation Act, 1949:
   • Section 35A: Powers of the RBI to issue directions in the public interest.
   • Citation: Act No. 10 of 1949.
3. Payment and Settlement Systems Act, 2007:
   • Section 18: Powers of the RBI to regulate payment systems.
   • Citation: Act No. 51 of 2007.

Reports and Publications

1. RBI Circular (April 6, 2018):
   • “Prohibition on dealing in Virtual Currencies (VCs)”.
   • RBI Notification No. RBI/2017-18/154.
2. IAMAI’s Writ Petition:
   • Filed under Article 32 of the Constitution challenging the RBI circular.
3. Supreme Court Judgment Analysis:
   • Detailed case law analysis on proportionality and its application in financial regulation.

International References

1. Japan’s Payment Services Act (2017):
   • Legalized cryptocurrencies as a payment method under a regulatory framework.
2. China’s Cryptocurrency Ban:
   • Policies restricting cryptocurrency trading and mining in mainland China.
3. U.S. Regulatory Framework:
   • Oversight by SEC and CFTC based on the classification of cryptocurrencies.

Additional References

1. Supreme Court of India website
2. Reserve Bank of India website
3. Reports on Cryptocurrency Regulation: Published analyses from legal and financial journals.