Principles and Practices of Banking

Principles and practices of
banking
Module 1
Role of RBI in regulating

Banking
One of the most important functions of RBI is to
work as regulator and supervisor of financial
system.
The financial system in India includes
Commercial Banks,
Regional Rural Banks,
Local Area Banks,
Cooperative Banks,
Financial Institutions including Development Financial
Institutions (DFIs) and Non-Banking Financial
Companies.
RBI derives its regulating powers for

Indian Banking System from the
provisions of the Banking Regulation Act
1949. For other entities, it derives power
from the RBI act 1934.
Licensing Requirements
To do a business of commercial banking in
India, whether it is India or Foreign, a license
from RBI is required.
At present, Indian banks no longer require a
license from the Reserve Bank for opening a
branch at a place with population of below
50,000.
Corporate Governance in Banks One

of the policy objectives of RBI is to
ensure high-quality corporate
governance in banks.
One of these guidelines is that the
directors of the banks should have
special knowledge / experience in the
various banking related areas.
Statutory Pre-emptions
Each commercial bank is required to
maintain certain portion of their Net
Demand and Time Liabilities (NDTL) in
the form of cash with the Reserve Bank,
called Cash Reserve Ratio (CRR)
in the form of investment in approved
securities, called Statutory Liquidity
Ratio (SLR). These are called statutory
Pre-emptions.
Interest Rates
The interest rates on most of the
categories of deposits and lending
transactions have been deregulated and
are largely determined by banks.
Reserve Bank regulates the interest
rates on savings bank accounts and
deposits of non-resident Indians (NRI),
small loans up to rupees two lakh,
export credits and a few other
categories of advances
Prudential Norms
Prudential Norms refers to ideal / responsible
norms maintained by the banks. RBI issues
Prudential Norms to be followed by the
commercial banks to strengthen the balance
sheets of banks.
Disclosure Norms
One of the important tools for marketing
discipline is to maintain public disclosure of
relevant information. As per RBIs directives, the
banks are required to make disclosures of their
annual reports and some other documents
Protection of Small Depositors

RBI has set up the Deposit Insurance and
Credit Guarantee Corporation (DICGC) to
protect the interest of small depositors, in
case of bank failure.
Para banking Activities
Parabanking activities are those activities which
dont come under the traditional banking activities.
Examples of such activities are asset management,
mutual funds business, insurance business,
merchant banking
The RBI has permitted banks to under take these
activities under the guidelines issued by it from
time to time
Annual Onsite Inspection

RBI undertakes annual on-site inspection of
banks to assess their financial health and
to evaluate their performance in terms of
quality of management, capital adequacy,
asset quality
OSMOS
OSMOS refers to Off Site Surveillance and
Monitoring System. The RBI requires banks to
submit detailed and structured information
periodically under OSMOS. On the basis of
OSMOS, RBI analyzes the health of the banks.
Government of India as a
regulator
Bankers work to supply loans,
accept deposits, and provide other
financial services to their customers,
they must do so within a climate of
extensive federal and state rules
designed primarily to protect the
public interest
No new bank can enter the industry without government

approval (in the form of a charter to operate).
The types of deposits and other financial instruments sold to the
public to raise funds must be sanctioned by each institutions
principal regulatory agency.
The quality of loans and investments and the adequacy of
capital are carefully reviewed by government examiners. For
example, when a bank seeks to expand by constructing a new
building, merging with another bank, setting up a branch office,
or acquiring or starting another business, regulatory approval
must first be obtained.
Finally, the institutions owners cannot even choose to close its
doors and leave the industry unless they obtain explicit approval
from the government agency that granted the original charter of
incorporation.
To encourage further thought concerning the process of
regulatory governance, we can use an analogy between the
regulation of financial firms and the experiences of youth.
Financial Regulatory Bodies in India

RBI
IRDA
SEBI
FMC
PFRDA
THE BANKING REGULATION ACT,1949
Introduction
The Banking companies act, presently known as banking
regulation act was enacted owing to safeguard the interest of
depositors, control abuse of power by some bank personnel
controlling the banks in particular and to the interest of
Indian economy in general.
The Banking Regulation Act was passed as the Banking
Companies Act 1949 and came into force w.e.f 16.3.49.
Subsequently it was changed to Banking Regulations Act
1949 wef 01.03.66.
However, it should be remembered that this act does not
supersede the provision of companies act or any other law for
the time being in force in respect of banking business.
Definition of banks
In India, the definition of the business of banking has been given
in the Banking Regulation Act, (BR Act), 1949. According to
Section 5(c) of the BR Act, 'a banking company is a company
which transacts the business of banking in India.' Further,
Section 5(b) of the BR Act defines banking as, 'accepting, for the
purpose of lending or investment, of deposits of money from the
public, repayable on demand or otherwise, and withdrawable, by
cheque, draft, order or otherwise.'
This definition points to the three primary activities of a
commercial bank which distinguish it from the other financial
institutions. These are: (i) maintaining deposit accounts
including current accounts, (ii) issue and pay cheques, and (iii)
collect cheques for the bank's customer
Applicability of the Banking

Regulation Act, 1949
This Act applies to following categories
of Banks:
1: Nationalized Banks
2: Non-Nationalized Banks
Cooperative Banks
Main provisions
Bigger banks have to be managed by whole time chairman possessing
special knowledge and practical experience of the working of a
banking company or of finance, economics or business administration.

The majority of the directors had to be persons with special
knowledge or practical experience in any of the areas such as
accountancy, agriculture, rural economy, banking, co-operative,
economics, finance, law, small scale industries.

At least two directors had to possess special knowledge and practical
experience in respect of agriculture, rural economy and co-operation.

The banks were also prohibited from making any loans or advances,
secured or unsecured to their directors or to any companies in which
they have substantial interest.
Prohibition of Trading (Sec. 8):

According to Sec. 8 of the Banking
Regulation Act, a banking company
cannot directly or indirectly deal in
buying or selling or bartering of goods.
But it may, however, buy, sell or barter
the transactions relating to bills of
exchange received for collection or
negotiation.
Non-Banking Assets (Sec. 9):

According to Sec. 9 A banking company
cannot hold any immovable property,
howsoever acquired, except for its own use,
for any period exceeding seven years from
the date of acquisition thereof. The
company is permitted, within the period of
seven years, to deal or trade in any such
property for facilitating its disposal. Of
course, the Reserve Bank of India may, in
the interest of depositors, extend the period
of seven years by any period not exceeding
five years.

Management (Sec. 10):
Sec. 10 (a) states that not less than 51% of the total number
of members of the Board of Directors of a banking company
shall consist of persons who have special knowledge or
practical experience in one or more of the following fields:
(a) Accountancy;
(b) Agriculture and Rural Economy;
(c) Banking;
(d) Cooperative;
(e) Economics;
(f) Finance;
(g) Law;
(h) Small Scale Industry.
The Section also states that at least not less than two directors
should have special knowledge or practical experience relating
to agriculture and rural economy and cooperative. Sec. 10(b)
(1) further states that every banking company shall have one
of its directors as Chairman of its Board of Directors.
Cash Reserve (CRR)

Section 18 r. w. 56 (j)
Every bank is required to keep cash reserve,
with itself or by way of balance in the current
account with RBI or Central / District Cooperative Bank or net balance in all such way, of
minimum prescribed % amount of its DTL as of
last Friday of fortnight
A return about this has to be submitted to RBI

before 15thof each month about alternate Friday
SLR
(Statutory Liquidity Ratio)
Bank shall maintain
unencumbered approved
securities, valued not
exceeding the current
market price, or an
amount which shall not be
less than 24% of the total
of its demand and time
liabilities (DTL)
Licensing of banking
companies
68[(1) Save as hereinafter
provided, no company shall
carry on banking business in
India unless it holds a licence
issued in that behalf by the
Reserve Bank and any such
licence may be issued subject
of such conditions as the
Reserve Bank may think fit to
impose.]
(2) Every banking company in
existence on the
commencement of this Act,
before the expiry of six
months from such
commencement, and every
other company before
commencing banking business
69[in India], shall apply in
writing to the Reserve Bank
for a licence under this
section.
Restrictions on loans and

advances
(1) Notwithstanding anything to the contrary contained in section 77 of
the Companies Act, 1956 (1 of 1956), no banking company shall,
(a) grant any loans or advances on the security of its own shares, or
(b) enter into any commitment for granting any loan or advance to or on
behalf of
(i) any of its directors,
(ii) any firm in which any of its directors is interested as partner,
manager, employee or guarantor, or
(iii) any company [not being a subsidiary of the banking company or a
company registered under section 25 of the Companies Act, 1956 (1 of
1956), or a Government company] of which 61[or the subsidiary or the
holding company of which] any of the directors of the banking company
is a director, managing agent, manager, employee or guarantor or in
which he holds substantial interest, or
(iv) any individual in respect of whom any of its directors is a partner or
guarantor.

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Principles and practices of

Role of RBI in regulating

RBI derives its regulating powers for

Corporate Governance in Banks One

Protection of Small Depositors

Annual Onsite Inspection

No new bank can enter the industry without government

Financial Regulatory Bodies in India

THE BANKING REGULATION ACT,1949

Applicability of the Banking

Prohibition of Trading (Sec. 8):

Non-Banking Assets (Sec. 9):

Cash Reserve (CRR)

A return about this has to be submitted to RBI

Restrictions on loans and

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