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Understanding Indian Banking Sector
& Banking Institution’s Regulation

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Dr. Nandimath Omprakash V.,
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Professor in Law,
National Law School of India University,
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Bangalore-560 072
Email – ovnandimath@nls.ac.in
The immediate response

• Introduction of ‘social control’

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• Approach
– Establishment of National Credit Council (NCC)
– Legislative Control through amendment to the

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Banking Regulation Act, 1949
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Professional banking board
• Sec. 10A
• At least 51% of directors shall be possessing

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‘special knowledge, practical experience’ in
– Accountancy;
– Agriculture & rural economy;

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– Banking;
– Cooperation;
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– Economics;
– Finance;
– Law;
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– Small Scale Industry
– Any other matter (in the opinion of RBI useful)
Further

“provided that, out of aforesaid number of

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directors, not less than two shall be persons
having special knowledge or practical
experience in respect of agriculture and

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rural economy, cooperation or small-scale
industry”
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Other mandates
• Directors shall not have substantial interest

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– In any other company, except S.25 company
– Any firm (carrying trade, commerce or industry, except
small scale industry)

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• Restriction on tenure
– For continues period of eight years (not applicable to
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Chairman)
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– Not to be re-elected for four years – if he is removed
from his office as ‘chairman’ or ‘whole-time director’
Mandate of ‘whole time chairman’
• S.10B – the objective was to curb
industrialist’s encroachment over bank

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management
• There shall be ‘whole-time’ chairman or
‘managing director’ to manage the bank

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• He shall have special knowledge & practical
experience in any of the following
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– Working of the bank
– Finance
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– Economics
– Business administration
Restriction on loans
• S.20 – no loans or advances on the security
of banks own shares

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• No loan or advance, to
– Any of its directors;

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– Any firm; or
– Any company (except its own subsidiary or S.25
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company); or
– Any individual
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– Provided the director is interested in such entity as
partner, manager, employee or guarantor etc.,
Miscellaneous

• Additional powers were conferred on RBI

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– to supervise and enforce ‘social
control’ initiative
• Punishment provided for

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– Obstructing any person from entering or leaving a
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bank;
– Holding demonstrations within the bank; and
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– Acting to undermine the depositors’ confidence in
a bank
Era of nationalization starts

• July 19, 1969 – 14 major banks

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nationalized
• 1980 – 6 more banks were nationalized
• Nationalization was perceived as a major

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step in achieving the socialistic pattern of
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society
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Modalities of nationalization
• The official point

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– “public ownership of major banks will help most
effectively the mobilization and development of
national resources and its utilization for productive
purposes in accordance with the plans and priorities”

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• The preamble [of the first ordinance, 1969]
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– “in order to serve better the needs of development of
the economy in conformity with the national policy and
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objectives”
Criticism levied against nationalization
• 168 days [from 1.2.69 to 19.7.69] are too
short period to declare ‘social control’

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did not work
– From June 1968 to March 1968 credit to

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• Agriculture increased from Rs.30 crores to Rs.97 crores;
• Small scale industries from Rs.167 crores to Rs.222
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crores
• The step was determined by political
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tussles and was result of inter-party
struggle
Criticism levied against nationalization

• The banking industry is not nationalized in

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some of socialistic countries (ex. Norway,
Sweden, Finland and Denmark etc.,)
• Public control would leave the door open

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for corruption and favoritism
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• Because of lack of competition the
‘quality of banking’ service will diminish
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gradually
Legal mode

• Saturday, July 19, 1969 – Banking

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Companies (Acquisition and Transfer of
Undertaking) Ordinance, 1969 was
passed

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– 14 major banks (with deposit of Rs.50 crores or
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more) were purported to be transferred to 14 new
body corporate viz. ‘corresponding new banks’
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– The machinery of management
– Compensation package for shareholders
Legal mode
• Monday, July 21, 1969 – Ordinance was
challenged before SC

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• Before it was heard (on August 9, 1969) –
Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1969 was

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passed (which repealed the ordinance)
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• The act was also challenged in the SC –
interim injunction was granted against
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the operation of the Act

Legal mode
• Decision on February 10, 1970

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– 10:1 decision by majority
• The act is within the legislative competence;
but void due to the following reasons

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– Only restricted 14 banks were selected – this a ‘hostile
discrimination’;
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– Although these 14 were allowed to do other business –
sans assets, staff, premises and even names that was
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not possible hence – unreasonable restriction
– The principle of determination of compensation was
illusory and irrelevant
Post SC decision
• February 14, 1970 – Another Ordinance
promulgated

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• This was followed by the Banking Companies
(Acquisition and Transfer of Undertakings)
Act, 1970

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• March 31, 1970 – The Act receives President’s
assent
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• Most of provisions were deemed to have
come into force from July 19, 1969
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• The enactment stood the test of
constitutionality
“the branch network which was 8262 in
June 1969 expanded to 60000 by 1992 wit

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major expansion (80%) in rural areas. The
average number of people served by a
branch came down from 60000 to 11000.

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the development of credit is more widely
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spread all over the country as against only
in advanced states. In 1969 deposits
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amounted to 30% and advances to 25% of
the GDP…”
“…deposits grew from a figure of Rs.4669

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crores in June 1969 to Rs.2,75,000 crores on
31.3.1993. More than 45% of the total credit
was directed to the priority sector. More

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than 45% of the total deposits were used by
the government to fund its five year
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plans…”
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Era of nationalization ends

• With the recommendations of

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Narasimaham Committee being
accepted by the Government
• Which also started the entry of foreign

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banks on Indian soil
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What were the recommendations?
• Overall emphasis upon ‘de-regulation’

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• No further nationalization to be adhered to
• No distinction between ‘public’ and
‘private’ sector banks

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• Control of banking sector to be centralized
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(not to be divided between RBI and
Department of Banking)
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• SLR and CRR should be reduced to prudent
levels
What were the recommendations?

• Concessional lending to be phased out

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• The capital base of banks should meet
international standards
• The appointment of the Chief Executive

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of the banks to be de-politized
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Bank regulation

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Why regulate bank?
“the business of banking is fraught with
dangers, arising principally from the instability

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in the world economy and from human error or
misjudgment. Like any other enterprise, a bank
may be overtaken by events or may be
governed unwisely. Bank failures are, therefore

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no novelty. It is interesting that Bank of
England itself faced serious financial problems
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within two years of its foundation in 1964”
- Sir John Clapham, The Bank of England – A
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History, CUP, 1994
‘standing’ & ‘stability’
“two matters have to be consistently watched in
order to avoid disruption to the system. The first

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may be loosely described as the general standing
of institutions carrying on banking business. One
way of achieving this object is to enact laws that
regulate banking transactions. The other is to

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impose restrictions on the free entry of firms into the
mail line of banking business. The second matter
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that needs to be regulated is the stability of
individual banks. This involves the introduction of
measures to ensure that banks are able to meet
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their liabilities” – Elinger’s Modern Banking, 4th Edn.
Recent past

• Crash of world economy of 1929-33

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(interim periods of world war)
• Banking crises of UK during 1973-76
– ‘life boat operation’

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– Similar crises in Germany
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• Recent ‘melt-down’
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Few other points

• Systemic risk

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• Prevention of fraud
• Money laundering & terrorism
Consumer protection

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•
• Competitive (or antitrust) policy
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Banking regulation in India

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Banking

• ‘Banking’ means the accepting, for the

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purpose of lending or investment, of
deposits of money from the public,
repayable on demand or otherwise, and

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withdrawal by cheque, draft, order or
otherwise – S. 2(b)
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Essential functions

• Acceptance of public deposits

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• Lending or investment or such deposits;
and
• Agency functions

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Permissible banking business
• Sec. 6(1)

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• About 15 elements
– Borrowing, raising or taking up money;
– Lending – with or without security;

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– Issuance of letters of credit, travelers cheques
– Dealing in bullion and specie
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– Dealing in stocks and shares
– Underwriting
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– Providing of safe deposit vaults
– Collecting and transmitting of money and securities
– Acting as agents of the government
– Transact any kinds of guarantee and indemnity

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business
– Undertake and execute trusts
– Acquire, construct and maintain any building for its
own purpose

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– Do all such things which are incidental or conducive to
the promotion or advancement of the business of the
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company
– Do any other business specified by the Central
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Government as the lawful business of banking
company
• Further – Sec. 8 – prohibits specifically a

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banking company from engaging
directly or indirectly in trading activities
and undertaking trading risks

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Organization

• Dual control

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– For entry
– For expansion

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Entry license
• Sec. 22
• Criteria

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– The capacity of the company to pay its present and
future depositors
– Whether there is anything to indicate – the permit

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would affect the interests of the depositors
detrimentally
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– Impact upon the public interest
– Company’s capital structure and its adequacy
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– Other ‘banking facilities’ available in the proposed area
– Such other condition which RBI considers relevant
• Additional conditions for foreign banks

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– Whether carrying of business by the company in
India will be in pubic interest
– Whether the government or the law of the country
in which the company is incorporated

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discriminates in any way against banking
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companies registered in India; and
– Whether the company complies with the
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provisions of the BR Act as applicable to foreign
companies
• The grant of license is a discretionary

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administrative function – Shivabhai v RBI,
AIR 1986 Guj. 19
• Licence granted may be cancelled –

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Sec. 22(4)
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Expansion

• To open new branches – RBI sanction is

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mandatory
• Sec. 23
• While grant of such licences RBI may

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impose appropriate conditions
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• There are exceptions
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Capital & reserves

• Sec. 12(1)

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– Subscribed capital of a banking company shall not
be less than half of its authorized capital;
– Paid up capital shall not be less than half of its

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subscribed capital
– It the capital structure is changed then these
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proportions shall also be changed, with in two
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years
Capital composition
• Narasimham Committee has
recommended for public issue

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• Hence, the Banking Companies
(Acquisition and Transfer of Undertakings)
Act, 1970/1980 were amended

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– To enable public to subscribe to the capital of the
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nationalized banks up to 49% of their total capital
• The State Bank of India Act, 1955 was also
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suitably amended to raise public funds
Restriction on voting rights

• No shareholder (of the nationalized bank)

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other than the Central Government shall
be entitled to exercise voting rights in
respect of any shares held by him in

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excess of one percent of the total voting
rights of all the shareholders of the
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corresponding new bank
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Reserve funds
• Sec. 17

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• Creation of reserve fund (not applicable
to foreign banks)
– To be created out of profit

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– Not less than 20% of the profits have to be
transferred to the reserve fund (before any
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dividend to be declared)
– However, the Central Government (on the
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recommendation of RBI) may exempt the bank for
certain period of time
• For foreign banks – there is no mandate

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• But the foreign banks
– Shall deposit with RBI – 20% of their profits each
year

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– The amount may be in cash or unencumbered
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approved securities
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Cash reserves

• Sec. 42 (RBI Act) – cash reserve to be

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maintained by the Scheduled Bank (as to
be determined by RBI from time to time)
• Sec. 18 – (for non scheduled banks) at

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least 3% of its demand and time deposits
in India
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Maintenance of liquid assets

• Sec. 24 – mandatory maintenance of

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liquid assets
• Not exceeding 40% of its total demand
and time liabilities in cash, gold or

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unencumbered approved securities
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• RBI will prescribe details
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Annual accounts & audit

• Sec. 29

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• Mandate to prepare final accounts (at
the end of each financial year)
• The Balance Sheet and Profit & Loss

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Account have to be prepared in
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accordance with the formats prescribed
in III Schedule
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Audit & auditors

• Sec. 30

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• The Balance Sheet and Profit & Loss
Accounts have to be audited
– Audit by a person duly qualified to audit

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– The appointment, reappointment or removal of an
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auditor – to be done with the prior approval of the
RBI
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The audit report
• Sec. 227 of Companies Act – (regarding the
powers, functions and duties) are all

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applicable to Banking Companies as well
• Some additional information to be provided
– Whether or not transactions of the company as noticed

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by him were within the powers of the company
– Whether or not returns from branches were adequate
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for the audit
– Any other matter which the auditor considers
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necessary to bring to the notice of the shareholders of
the company
Publication of final accounts
• Sec. 31 r/w Rule 15 [of Banking Regulation
(Companies) Rules, 1949

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• Final accounts are to be published in a
news paper, within a period of six months

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• Three copies of final accounts are to be
submitted to RBI (within 3 months)
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• Sec. 220 of Companies Act – Final
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accounts and auditors report to the
Registrar of Companies
Special audit
• Sec. 30(1B)

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• The RBI may order for special audit
– Such order may relate to any transaction or class of
transactions; or
– Such period or periods as RBI may specify in the order

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– The RBI appoints such auditor (or can ask the regular
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auditor)
– The directors are binding upon the auditor of the
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banking company – and to make report directly to RBI
by furnishing the copy to the bank)
Amalgamation

• Voluntary amalgamation

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– U/sec. 44A

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• Procedure

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– Scheme has to be prepared & the same to be placed
before the shareholders (notice to all shareholders is
must)
– Seeking sanction from the shareholders with 2/3rd

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majority
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– Dissenting share holders may take out their share
value
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– Then the scheme has to be presented to RBI
– On sanction of RBI the amalgamation may happen
Compulsory amalgamation

• Induced or forced by RBI

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– U/Sec. 45
• RBI recommends to the Central
Government

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Merger of bank and NBFC
• Amalgamations are governed by Ss. 391
to 394 of the Companies Act, 1956

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• The scheme of amalgamation has to be
approved by the High Court

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• June 2004 – Banks were advised to obtain
the approval of RBI after the scheme of
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amalgamation is approved by its board
before it is submitted to the HC for
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approval
Amalgamation by government

• Central Government may order for

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amalgamation of two banks – after due
consultation with the RBI
– u/sec. 396 of Companies Act, 1956

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Winding up

• Suspension of business and winding up

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– Sec. 37
• Winding up by the High Court
– Sec. 38

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• Voluntary Winding up
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– Sec. 44
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Suspension of business
• When the bank is temporarily unable to meet its
obligations

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• Procedure
– The bank to apply to HC u/s 37
– The report of the RBI be enclosed

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– If not the court can take action, by calling the report
– If satisfied the court can (with conditions) for all proceedings
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to stay for fixed term not exceeding six months
– On passing of the moratorium order, the court may appoint a
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special officer to take custody and control of the assets,
books etc., of the bank
Winding up by the HC
• To be initiated by RBI – by applying for winding
up

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– Inability to pay debts
– If RBI is asked by the Central Government to make an
application

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– Failure to comply with requirements of Sec. 11
– If the bank becomes incapable of carrying out the banking
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business – by rejection or cancellation of license
– Failure to comply with the requirements of the BR Act other
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than Sec. 11 and continuance of such failure beyond the
period specified by RBI in this behalf
• Additional grounds for RBI

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– A compromise or arrangement sanctioned – can’t be
worked satisfactorily with or without modification; or
– The returns, statements and information given by the
bank under the Act show that it can’t pay its debts; or
– The continuance of the banking company is prejudicial

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to the interest of the depositors
• Once applied by RBI – the court is bound to
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allow the application [Palai Central Bank
Case, AIR 1962 SC 1371]
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Voluntary winding up

• Not possible unless RBI certifies

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• The HC during this stage intervene (i) by
itself; or (ii) by the application of RBI
– And may order for continuation of the business for

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some time
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– It may even supervise the winding up proceedings
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