LEGAL FRAMEWORK OF REGULATION

OF BANKS
 Banking means acceptance of deposits of money from the public
for lending or investment. Such deposits may be repayable on
demand or may be for a period of time as agreed to, by the banker
and the customer, and may be repayable by cheque, draft or
otherwise. Apart from banking, banks are authorised to carry on
other business as specified in Section 6 of the Banking Regulation
Act. Banks are, however, prohibited from undertaking any trading
activities.
 Banks may be companies registered under the Companies Act,
1956/2013, statutory corporations constituted under Special
Statutes or Co-operative societies registered under the Central or
State Cooperative Societies Acts. The extent of applicability of the
regulatory provisions under the Banking Regulation Act and the
Reserve Bank of India Act to a bank depends on the constitution of
the bank.
 Reserve Bank of India is the central bank of the country and the
primary regulator for the banking sector. The government has direct
and indirect control over banks. It can exercise indirect control
through the Reserve Bank and also act directly in appeals arising
from decisions of the Reserve
 Bank under the various provisions of the Banking Regulation Act. In
public sector banks like the State Bank of India, nationalised
banks and the regional rural banks, 50% or more of their shares are
held by the Central Government. Central Government has
substantial control over the management of these banks. Only
certain provisions of the BR Act are applicable to these banks as
indicated in that Act.
 Co-operative banks operating in one state only are registered
under the State Co-operative Societies Act and are subject to the
control of the State Government as also the Reserve Bank. In the
case of non-banking business of the banks, they are subject to
control by other regulatory agencies.

CONTROL OVER ORGANISATION OF

BANKS
  A company wanting to commence banking business requires prior
licence from the Reserve Bank. The Reserve Bank has the discretion
to reject licence or approve the licence on such conditions as it
thinks fit.
 Before granting licence, Reserve Bank has to be satisfied by
inspection or otherwise of the suitability of the company for licence.
A licence once given may also be cancelled after giving the bank an
opportunity to be heard. Further, for opening new branches or
shifting branches outside a city, town or village, permission of RBI is
required. Banking Companies have to have minimum capital and
reserves as specified in the Banking Regulation Act.
 The shareholders of a banking company are entitled to dividends
only after all the capitalised expenses are written off. The
commission or brokerage payable on selling shares is restricted to
two and half per cent of the paid-up value of the shares.
 The board of directors of a bank has to be constituted with persons
having special knowledge or experience in accountancy, banking,
economics, law, etc., as stipulated. The directors should not have
substantial interest in other companies or firms. The maximum
period of office is limited to eight years continuously.
 The Reserve Bank is empowered to reconstitute the board, if the
board is not properly constituted. Every banking company should
have a full-time chairman (or a full-time managing director, if there
is no fulltime chairman) with the specified qualifications. The
Reserve Bank has powers to remove the chairman and appoint a
suitable person in his place in certain cases.
 The Reserve Bank also has powers to remove the directors or
managerial personnel or other employees of banking companies.
The principles of corporate governance including the ‘fit and
proper’ criteria for directors apply to banking companies as well as
public sector banks.

REGULATION OF BANKING BUSINESS

1. The Banking Regulation Act empowers the Reserve Bank to issue

directions to banking companies in public interest, in the interest
of banking policy and in the interest of depositors. Section 21
provides for the issue of directions to regulate loans and
advances by banking companies. This may be done by regulating
the purposes of lending, margins in respect of secured loans, rate
of interest and terms and conditions of lending. Section 35A
gives wide general powers to issue directions. The Reserve Bank
issues directions from time to time under Section 21 (read with
Section 35A) regulating acceptance of deposits and lending.
 Under Section 21A of the Act, the rate of interest on loans and
advances contracted between a bank and its customer is not
liable to be reopened by a court of law. Section 20 of the Act
imposes restrictions on loans and advances to directors, and
companies and firms in which directors are interested as director,
partner, etc.
2. With a view of ensuring financial stability a banking company
which is a scheduled bank has to maintain a certain percentage
of the time and demand liabilities as cash reserve with the
Reserve Bank under Section 42 of the Reserve Bank of India Act,
as notified by the Reserve Bank from time to time. Failure to do
so renders the banking company liable to penalty. For non-
scheduled banking companies, Section 18 of the BR Act
provides for cash reserve. Banking companies have also to
maintain a certain percentage of their demand and time liabilities
in liquid assets as stipulated under Section 24 of the BR Act.
3. These assets may be maintained to the extent and in the form
and manner as notified by the Reserve Bank. Apart from this,
banking companies are required to maintain such assets in India
at not less than seventy-five per cent of demand and time
liabilities as at the close of business of the last Friday of every
quarter. Banking companies also have to transfer to the reserve
fund twenty-five per cent of their annual profits as disclosed in
the profit and loss account.

RETURNS, INSPECTION, WINDING

UP, MERGERS

 Every Bank has to prepare its balance sheet and profit and
loss account annually as at the end of the calendar year or at
the end of twelve months as on a date notified by the Central
Government.
 The accounts have to be audited by auditors duly qualified to be
auditors of companies.
 Three copies of the balance sheet, profit and loss account and
the auditor’s report have to be submitted as returns to the
Reserve Bank and to the Registrar of Companies.

 Banking companies have also to furnish other returns like return

on maintenance of cash reserve, maintenance of liquid assets,
etc.
 The Reserve Bank is authorised to inspect or conduct, scrutiny of
banking companies, their books and accounts.
 The Board for Financial Supervision, which has been set up by the
Reserve Bank under the Reserve Bank of India Act, supervises
the affairs of banking companies.
 The Government may acquire the undertakings of banking
companies in certain circumstances based on a report from the
Reserve Bank.
 The Central Government may also order moratorium on banking
companies on the application of the Reserve Bank.
 During moratorium, the Reserve Bank may prepare a scheme
for amalgamation, which may be sanctioned by the Central
Government. Such an amalgamation scheme will have overriding
effect on any laws, agreements, etc.
 The Reserve Bank may also apply to the High Court for winding
up of a banking company when it is not able to pay its debts and
also in certain other circumstances.
 The Reserve Bank of India Act and the Banking Regulation Act
provide for certain penalties for contravention or default
committed by banking companies or other persons.
 Further, for some contraventions or defaults which tantamount to
offences as per provisions of the aforesaid Acts RBI can also file
complaint which may result in imprisonment of the persons who
are found guilty.

PUBLIC SECTOR BANKS, PRIVATE

SECTOR BANKS, REGIONAL RURAL
BANKS, DIFFERENTIATED BANKS,
CO-OPERATIVE BANKS AND LOCAL
AREA BANKS

 The public sector banks, namely, State Bank and the Nationalised
banks and the regional rural banks (as subsidiary of PSBs) are
statutory corporations (or body corporate) established under special
 statutes. State Bank, as also Nationalised banks, are commercial
banks engaged in the business of banking and other forms of
business permissible for banking companies.
 The regional rural banks are also commercial banks but
operating in limited local areas to cater to rural industries, trade,
farmers, artisans, etc. The State Bank and the Nationalised banks
also act as agents of the Reserve Bank to transact the banking
business of the Central Government.
 All public sector banks are governed by their respective, statutes
and the rules, regulations or schemes made under these statutes. In
addition to this, these banks are also governed by certain provisions
of the Banking Regulation Act as stipulated in Section 51 of that Act.
The provisions of the Reserve Bank of India Act are also applicable
to them.
 The co-operative banks, functioning in one state only are
registered under the state laws on cooperative societies. The co-
operative banks operating in more than one state are registered
under the multi-state Co-operative Societies Act. The Banking
Regulation Act is applicable to co- operative banks as provided in
Section 56 of that Act with certain modifications. For this purpose, a
co-operative bank means a state co-operative bank, Central co-
operative bank and a primary co-operative bank. While, the
constitution of the bank is governed by the co-operative laws, the
business of banking undertaken by them is regulated by the Reserve
Bank under the BR Act.
 Old and New Private Sector Banks mostly incorporated under the
Companies Act have started to play an increasingly important role in
intermediation of funds. Most of these 21 Banks have thrived
through use of advanced technology, error free, quick and efficient
customer service
 The RBI has since 2007 been encouraging setting up of
Differentiated Banks with the aim to introduce Banks functioning in
‘niche’ areas focusing on limited services or functioning under a
different regulatory dispensation. They may also be different on
account of capital requirement, scope of activities or area of
operations. There are many advantages in having such entities
functioning as financial institutions.
 There are 2 Local Area Banks operating in the country though
their importance has become limited due to the regulator granting
of licenses to certain differentiated banks such as small finance
banks etc. having decided advantages as compared to the Local
Area Banks.
 FINANCIAL SECTOR LEGISLATIVE
REFORMS & FINANCIAL STABILITY
AND DEVELOPMENT COUNCIL

 Since 1991, when India embarked on the path of liberalization and

globalization, attempts at structural reforms have been made, in
several sectors including the Financial Sector of which the Banking
Sector is an important constituent.
 The Narasimham Committee -1(committee chaired by Shri M
Narasimham, former Governor, Reserve Bank of India) was the first
such committee set up to examine all aspects relating to the
‘Structure, Organization, Functions and Procedures’ of the financial
system. It was also called the ‘Committee on Financial Systems’. It
gave a wide range of recommendations many of which were
implemented by the GOI/RBI and reviewed in the Narasimham
Committee-2 in 1998.
 This Narasimham Committee-2 also gave its own recommendations
for strengthening the banking system, improving the asset quality in
Banks, etc. after which the Financial Stability and Development
Council (FSDC) set up by the GOI in December 2010 was the next
major step towards reforming the sector.
 This step was taken because in view of the concerns mainly on
fragmentation of legislation, regulation enforcement, overlapping of
the regulatory jurisdiction, risk legal arbitrage among different
legislations, etc. a need was felt to rewrite and streamline the
financial sector laws, rules and regulations and to bring them in
harmony with the requirements of India’s fast growing financial
sector. The reforms introduced in various sectors including; (a)
Banking sector, (b) Monetary Policy, (c) Financial Markets;
and (d) Forex Market as explained in the relevant portion in the
unit.
 Financial sector regulation is a vital service for bringing healthy and
efficient financial system in the economy. There are different
regulators for various segments of financial sectors, like the RBI for
commercial banks and NBFCs, SEBI for capital market etc. In order
to ensure co-ordination among these financial sector regulators to
ensure better efficiency as well as for avoiding overlapping of
functions.
 The FSDC with the finance minister as the Chairman is an apex
level forum to strengthen and institutionalize the mechanism for
maintaining financial stability. It is for enhancing inter-regulatory
coordination and promoting financial sector development in the
country. There are different sections in FSDC as explained in the unit
with varied functions.