Professional Documents
Culture Documents
Legal Regulatory Aspects of Banking
Legal Regulatory Aspects of Banking
ASPECTS OF BANKING
MISSION
To develop professionally qualified and competent bankers and financial professionals primarily
through a process of education, training, examination, consultancy/counselling and continuing
professional development programs.
VISION
To he the premier Institute for developing and nurturing competent professionals in banking and
finance field.
OBJECTIVES
LEGAL REGULATORY
ASPECTS OF BANKING
(For JAIIB/Diploma in Banking &
Finance Examination)
2nd Edition
MACMILLAN
L E G A L & R E G U L A T O R Y A S P E C T S OF B A N K I N G
Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module B), P.R. Kulkarni
(Module C), B. Gopalakrishnan (Module D) under the guidance of M.L. Chandak, Advocate, High
Court, Mumbai.
Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M. Ramamurthy,
Legal Adviser. IDBI Ltd. (Modules B, C and D)
This book is meant for educational and learning purposes. The a u t h o r s ) of the book has/have taken all reasonable care to ensure that the contents of
the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the a u t h o r s )
has/have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective
action.
FOREWORD
The world of banking and finance is changing very fast and banks are leveraging knowledge and
technology in offering newer services to the customers. Banks and technology are evolving so rapidly
that bank staff must continually seek new skills that enable them not only to respond to change, but
also to build competence in handling various queries raised by customers. Therefore, there is a need for
today s bank employees to keep themselves updated with a new set of skills and knowledge.
The Institute, being the main provider of banking education, reviews the syllabus for its associate
examinations viz. JAIIB/CAIIB and various other examinations with the help of Expert Groups from
time to time to make the contents relevant and contemporary in nature. The latest revision has been
done by an expert group under the Chairmanship of Prof. Y.K. Bhushan. This book and the other two
books mentioned below are the courseware for JAIIB which aims to impart up-to-date knowledge in
the field of banking and finance and equip the bankers to face the emerging challenges of today and
tomorrow.
As there is a growing demand for qualified manpower in the banking sector with accent on banking
knowledge and skills, together with technology-familiarity, customer-orientation and hands-on application
skills - which will substantially reduce the training intervention at the bank level before/immediately
after they are employed - the institute has launched the Diploma in Banking & Finance in 2007 for
graduation-plus level candidates. Candidates to the course will get extensive and detailed knowledge on
banking & finance and details of banking operations. The Diploma is offered in the distance learning
mode with a mix of educational support services like provision of study kits, contact classes, etc. The
key features of the Diploma is that it aims at exposing students to real-life banking environment and that
it is equivalent to JAIIB.
The JAIIB and the Diploma in Banking & Finance has three papers viz.
1. Principles & Practices of Banking
2. Accounting & Finance for Bankers
3. Legal & Regulatory Aspects of Banking
This book, the courseware for the third paper on Legal & Regulatory Aspects of Banking, deals
with legal and regulatory aspects that have a bearing on banking operations, and are woven in to the
units/chapters to make their relevance easily understandable. Banking and business laws insofar as they
relate to day-to-day banking operations, have also been covered at appropriate places. Case laws are
included, wherever appropriate. There are various newly enacted laws like Anti-money Laundering
Act, Right to Information Act, Information Technology Act, etc., which have significantly changed the
way banking operations are done, and these laws are explained in simple terms as needed to be understood
by a practicing banker.
The Institute had constituted teams consisting of eminent bankers and academicians to prepare the
reading material for all the subjects as self-instructional study kits obviating the need for the intervention
of a teacher. This book represents the outcome of this endeavour to bring out self-contained
comprehensive courseware/book on the subject. The Institute acknowledges with gratitude the valuable
services rendered by the authors in preparing the courseware in a short period of time.
The team, who developed the book, has made all efforts to cover the entire syllabus prescribed for the
subject. However, the candidates could still refer to a few standard textbooks to supplement this
material which we are sure, will enhance the professional competence of the candidates to still a higher
degree. We have no doubt that the study material will be found useful and will meet the needs of the
candidates to prepare adequately for the examinations. In addition, we are sure that these books will
also be useful to practitioners, academicians, and other interested readers.
We welcome suggestions for improvement of the book.
Mumbai
3-7-2008
K. Bhaskaran
Chief Executive
Officer
RECOMMENDED
READING
The Institute has prepared comprehensive courseware in the form of study kits to facilitate
preparation for the examination without intervention of the teacher. An attempt has been made to
cover fully the syllabus prescribed for each module/subject and the presentation of topics may
not always be in the same sequence as given in the syllabus.
Candidates are also expected to take note of all the latest developments relating to the subject
covered in the syllabus by referring to Financial Papers, Economic Journals, Latest Books and
Publications in the subjects concerned.
MODULE A - R E G U L A T I O N S A N D C O M P L I A N C E
The questions in this section will be with reference to legal issues and problems.
A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking Companies [Acquisition
and Transfer of Undertakings Act 1970 & 1980].
B. Government and RBI's Powers:
-
Powers to Control Advances - Selective Credit Control - Monetary and Credit Policy
Supervision and Control-Board for Financial Supervision - Its Scope and Role
Corporate Governance
MODULE B - L E G A L A S P E C T S OF B A N K I N G O P E R A T I O N S
Indemnities/Guarantees
-
Registration of Firms/Companies
Law of Limitation
Lok Adalats
M O D U L E D - C O M M E R C I A L L A W S WITH R E F E R E N C E TO B A N K I N G O P E R A T I O N S
Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and Agency, etc.)
The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions, Conditions and Warranties,
Express and Implied, Right of Unpaid Seller, etc.)
The Companies Act, 1956, Definition, Features of Company, Types of Companies, Memorandum,
Articles of Association, Doctrines of Ultra Vires, Indoor Management and Constructive Notice,
Membership of Company - Acquisition - Cessation, Rights and Duties of Members and Register of
Members, Prospectus and Directors.
Indian Partnership Act, 1932, Definition and Types of Partnership, Relation of Partners to One
Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of Partnership,
Dissolution of Firm, Effect of Non-Registration
CONTENTS
Foreword
MODULE A - R E G U L A T I O N S A N D C O M P L I A N C E
1. Legal Framework of Regulation of Banks
15
31
49
65
MODULE B - L E G A L A S P E C T S OF B A N K I N G O P E R A T I O N S
6. Case Laws on Responsibility of Paying Bank
83
93
S. Indemnities
101
9. Bank Guarantees
107
119
131
135
143
155
163
173
181
187
197
MODULE C - B A N K I N G R E L A T E D L A W S
SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS
ANI) ENFORCEMENT OF SECURITY INTEREST, 2002
(SARFAESI ACT)
20. Introduction to SARFAESI Act, 2002
205
209
219
231
241
245
249
T H E BANKING O M B U D S M A N S C H E M E , 2006
27. Purpose, Extent, Definitions, Establishment and Powers
255
259
267
271
275
279
285
293
T i n LI ( l A L S I R V I C E S A U T H O R I T I E S ACT, 1987
35. Lok Adalats
299
T H E C O N S U M E R P R O T E C T I O N ACT, 1987
303
311
315
T H E LAW O F LIMITATION
39. Limitations of Suits, Appeals and Applications
327
TAX LAWS
40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service Tax
331
M O D U L E D - C O M M E R C I A L L A W S WITH R E F E R E N C E TO B A N K I N G O P E R A T I O N S
41. Meaning and Essentials of a Contract
341
345
347
353
357
359
365
369
XIII
49. Unpaid Seller
373
377
381
385
389
393
397
399
405
411
415
60. Membership
419
61. Prospectus
425
62. Directors
429
437
443
453
457
463
469
Bibliography
475
LEGAL FRAMEWORK OF
REGULATION OF BANKS
STRUCTURE
1.0
Objectives
1.1
Introduction
1.2
Business of Banking
1.3
Constitution of Banks
1.4
1.5
1.6
1.7
1.8
1.9
1.10
Let Us Sum Up
1.11
Kevwords
1.12
1.13
1.14
Terminal Questions
4
1.0 OBJECTIVES
The objectives of this Unit are to understand:
the
the
the
the
the
1.1 INTRODUCTION
Banking in India is mainly governed by the Banking Regulation Act, 1949 and the Reserve Bank of India
Act, 1934. The Reserve Bank of India and the Government of India exercise control over banks from
the opening of banks to their winding up by virtue of the powers conferred under these statutes.
All the regulatory provisions are not uniformly applicable to all banks. The applicability of the provisions
of these Acts to a bank depends on its constitution; that is, whether it is a statutory corporation, a
banking company or a co-operative society. In this unit, we look at the definition of banking, the
constitution of different types of banks and applicability of regulatory laws, the general framework of
the regulatory laws and the role of regulators namely, the Reserve Bank of India and the government.
5
Scheme run by the government, a Primary credit society and any other person or firm notified by
the government are exempted from this prohibition.
iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking companies, firms
and other unincorporated associations of persons and individuals who accept deposits from the
public. Acceptance of deposits by non-banking financial companies is regulated by the Reserve
Bank under the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank)
Directions, 1998 and other directions issued by it under Chapter IIIB of the Reserve Bank of India
Act. Other companies are regulated by the Central Government under the Companies (Acceptance
of Deposit) Rules, 1975 issued under Section 58A of the Companies Act. 1956. Individuals, firms
and other unincorporated associations of persons whose business includes the business of a financial
institution or whose principal business is acceptance of deposits, is prohibited under Section 45S
of the RBI Act (as amended in 1997) from accepting deposits from the public, except relatives.
This prohibition does not apply to acceptance of deposits by those who are mainly engaged in
manufacturing or trading.
iv. Licence for Banking: In India, it is necessary to have a licence from the Reserve Bank under
Section 22 of the Banking Regulation Act for commencing or carrying on the business of banking.
Every banking company has to use the word "bank" as part of its name (See, Section 7 of the Act)
and no company other than a banking company can use the words "bank", "banker", "banking" as
part of its name. Further, no firm, individual or group of individuals is permitted to use the words
"bank", "banking" or "banking company" as a part of the name or for the purpose of business.
Subsidiaries of banks and association of banks in certain cases as also Primary Credit Societies are
exempted from this restriction.
v. Permitted Business: Although, traditionally, the main business of banks is acceptance of deposits
and lending, the banks have now spread their wings far and wide into many allied and even unrelated
activities. The forms of business permissible under Section 6(1) of the Banking Regulation Act,
apart from banking business, are summarised below:
(a)
6
(c) Contracting for public and private loans and negotiating and issuing the same.
(d) Insure, guarantee, underwrite, participate in managing and carrying out any issue of state,
municipal or other loans or of shares, stock, debentures or debenture stock of companies
and lend money for the purpose of any such issue.
(e) Carry on and transact every kind of guarantee and indemnity business.
(f) Manage, sell and realise any property which may come into its possession in satisfaction of
any of its claims.
(g) Acquire, hold and deal with any property or any right, title or interest in any such property
which may form the security for any loan or advance.
(h) Undertake and execute trusts.
(i) Undertake the administration of estates as executor, trustee or otherwise.
(j) Establish, support and aid associations, institutions, funds, trusts, etc., for the benefit of its
present or ex-employees; grant money for charitable purposes.
(k) Acquire, construct and maintain any building for its own purpose.
(1) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or turn into account
or otherwise deal with all or any part of the business of any person or company, when such
business is of a nature described in Section 6.
(m) Acquire and undertake the whole or any part of the business of any person or company,
when such business is of a nature described in Section 6.
(n) Do all such things which are incidental or conducive to the promotion or advancement of the
business of the company.
(o) Do any other business specified by the Central Government as the lawful business of a
banking company. The Central Government has accordingly specified leasing and factoring
as permissible business for banks.
vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a banking company from
engaging directly or indirectly in trading activities and undertaking trading risks. Buying or selling
or bartering of goods directly or indirectly is prohibited. However, this is without prejudice to the
business permitted under Section 6(1) of the Act. Accordingly, a bank can realise the securities
given to it or held by it for a loan, if need arises for the realisation of the amount lent. It can also buy
or sell or barter for others in connection with: (i) bills of exchange received for collection or
negotiation, and (ii) undertaking the administration of estates as executor, trustee, etc. Goods for
the purpose of this Section means every kind of moveable property, other than actionable claims,
stocks, shares, money, bullion and specie and all instruments referred to in Clause (a) of subSection (1) of Section 6.
As regards immoveable properties, Section 9 prohibits a banking company from holding such
property, howsoever acquired, except as is required for its own use, for a period exceeding seven
years from the acquisition of the property. The Reserve Bank may extend this period by another
five years, if it is satisfied that such extension would be in the interest of the depositors of the
banking company. The banking company shall be required to dispose of such property within the
permitted period.
ii. Public Sector Banks: The public sector banks including nationalised banks, State Bank of India
and its associates (subsidiaries) and the Regional Rural Banks fall in the first category. By the
Banking Companies (Acquisition and Transfer of Undertakings) Act. 1970 and the Banking Companies
(Acquisition and Transfer of Undertakings) Act, 1980 the Central Government nationalised (took
over the business undertakings) of certain banking companies and vested them in newly created
statutory bodies (corresponding new banks) constituted under Section 3 of the 1970/1980 Act.
The State Bank of India was constituted under the State Bank of India Act, 1955 and the six
associate/subsidiary banks were constituted under the State Bank (Subsidiary Banks) Act, 1959 or
other statutes (See Para 5.2.6). The regional rural banks are constituted under the Regional Rural
Banks Act, 1976. These banks are governed by the statutes creating them as also some of the
provisions of the Banking Regulation Act and the Reserve Bank of India Act. The details are
discussed in Unit 5.
iii. Banking Companies: A banking company, as defined in Section 5(c) of the Banking Regulation Act
is a company which transacts the business of banking. Such company may be a company constituted
under Section 3 of the Companies Act or a foreign company within the meaning of Section 591 of
that Act. All the private sector banks are banking companies. These banks are governed by the
Companies Act, 1956 in respect of their constitution and by the Banking Regulation Act and the
RBI Act with regard to their business of banking.
iv. Co-operative Banks: A co-operative bank is a co-operative society registered or deemed to
have been registered under any Central Act for the time being in force relating to the multi-state
co-operative societies, or any other central or state law relating to co-operative societies for the
time being in force. If a co-operative bank is operating in more than one state, the Central Act
applies. In other cases, the state laws apply. The Banking Laws (Application to Co-operative
Societies) Act, 1965 extended certain provisions of the Banking Regulation Act and the Reserve
Bank of India Act to the co-operative banking sector. After the Supreme Court held in Apex Cooperative Bank s case (AI R 2004 SC 141) that multi-state co-operative societies cannot be
licensed as co-operative banks, the Banking Regulation (Amendment) and Miscellaneous Provisions
Act, 2004 was enacted to permit licensing of multi-state co-operative banks. A "multi-state cooperative bank" under this Act means a multi-state co-operative society which is a primary
co-operative bank.
2006.
ii. The Act deals with the constitution, powers and functions of the Reserve Bank. It does not directly
deal with regulation of the banking system except for Section 42, which provides for cash reserves
of scheduled banks to be kept with the Reserve Bank, with a view to regulating the credit system
and ensuring monetary stability. Further, Section 18 of the Act provides for direct discount of bills
of exchange and promissory notes when a special occasion arises, making it necessary or expedient
for the purpose of regulating credit in the interests of trade, industry and agriculture. The Act, in
short, deals with:
(i) incorporation, capital, management and business of the bank;
(ii) the central banking functions like issue of bank notes, monetary control, acting as banker to
government and banks, lender of last resort;
(iii) collection and furnishing of credit information;
(iv) acceptance of deposits by non-banking financial institutions;
(v) general provisions regarding reserve fund, credit funds, publication of bank rate, audit and
accounts; and
(vi) penalties for violation of the provisions of the Act or the directions issued thereunder.
9
Directors. The bank has to abide by the directions given by the Central Government in public
interest after consultation with the Governor of the bank. The board shall consist of a Governor
and not more than four Deputy Governors to be appointed by Central Government and other
directors nominated by the Central Government. Apart from the Central Board, the bank has also
local boards situated at Mumbai, Kolkata, Delhi and Chennai, which perform any duty delegated to
them by the Central Board. The Governor has the power of general superintendence and direction
of the affairs of the bank and exercise all powers of the bank unless otherwise provided in the
regulations made by the Central Board. The Deputy Governors, Executive Directors and other
officers in different grades assist the Governor in the discharge of the Bank s functions.
iv. The Reserve Bank is the sole authority for issue and management of currency in India under
Section 22 of the RBI Act. The bank may issue notes of different denominations from Rs. 2 to Rs.
10,000 as the Central Government may decide on the recommendations of the Central Board of the
bank. Such notes shall be legal tender at any place in India.
v. The bank is the banker to the Central Government under Section 20 of the Act, and accordingly it
is obligatory to undertake banking business for the Central Government. In the case of state
governments, their banking business is undertaken by the bank based on agreements as provided in
Section 21 A. Bank provides ways and means of advances to the Central and state governments.
These are temporary advances to meet immediate needs when there is interval between expenditure
and flow of revenue.
vi. The role of the bank as regulator of banking sector is mainly by virtue of the provisions of the
Banking Regulation Act, 1949. In exercise of the powers under that Act the bank regulates the
entry into banking business by licensing, exercises control over shareholding and voting rights of
shareholders, exercises controls over the managerial persons, and regulates the business of banks.
The bank also inspects banks and exercises supervisory powers, and may issue directions from
time to time in public interest and in the interest of the banking system with respect to interest
rates, lending limits, investments and various other matters.
vii. The major powers of the Reserve Bank in the different roles as regulator and supervisor can be
summed up as under:
(a) power to licence:
(b) power of appointment and removal of banking boards/personnel;
(c) power to regulate the business of banks;
(d) power to give directions;
(e) power to inspect and supervise banks;
(f) power regarding audit of banks;
(g) power to collect, collate and furnish credit information;
(h) power relating to moratorium, amalgamation and winding up; and
(i) power to impose penalties.
10
necessary in public interest after consultation with the Governor. Thus, the government can exercise
control over banks by influencing decision-making by the Reserve Bank and has also got appellate
authority in respect of several matters in which the Reserve Bank has been conferred the power to
decide at the first instance. Thus, under the Banking Regulation Act appeal lies with the Central
Government on removal of managerial personnel under Sections 10B and 36AA of the BR Act.
Similarly, there are also provisions for appeal in respect of cancellation of banking licence (under
Section 22) and refusal of certificate regarding floating charge on assets (Section 14A).
iii. The government has the power to suspend the operations of the Banking Regulation Act or to give
exemption from any of the provisions of the Act on the representation/recommendation of the
Reserve Bank under Sections 4 and 53 of the Act, respectively. The government has also the power
to notify other forms of business which a bank may undertake under Section 6(1 )(o) of the Act.
Rule-making powers under Sections 52 and 45Y are vested in the Central Government. There are
also other provisions under which the Central Government exercises powers as under:
(a)
(b)
(c)
(d)
(e)
(f)
Approval for formation of subsidiary for certain business under Section 19;
Notification with reference to accounts and balance sheet under Section 29;
Issue of direction for inspection of banks under Section 35;
Power to acquire undertakings of banks (Section 36AE);
Appointment of court liquidator;
Suspension of business and amalgamation of banks under Section 45.
The above provisions confer wide powers on the Central Government to regulate banks. These are
in addition to the powers conferred on the government as majority shareholder or full owner of
public sector banks under the statutes constituting them.
11
1.9 REGULATION BY OTHER AUTHORITIES
i. Banks may be subject to the control of other regulatory agencies in the conduct of their business.
For instance, a banking company will be subject to the control of the authorities under the Companies
Act in respect of company matters. Similarly, a bank is answerable to labour authorities in respect
of the terms and conditions of service of its workmen, opening and closing of its premises,
engagement of contract labour, etc. Banks are also liable to pay income tax like cash transaction
tax, service tax, etc., and other taxes and have to follow the rules and regulations in that regard.
ii. As provided in Section 6 of the Banking Regulation Act, banks may undertake certain non-banking
business in addition to the business of banking. In that regard also, banks may be subject to the
regulatory control of other agencies. For instance, in the case of dealings in securities like shares
and debentures, banks are subject to regulation by the Securities Exchange Board of India under
the Securities Contract (Regulation) Act, 1956 read with the Securities and Exchange Board of
India Act, 1992. If the Bank desires to raise capital through public issue, it has to comply with
SEBI guidelines. In case of Insurance Business - by IRDA and in case of Mutual Fund Business RBI, SEBI.
The study herein is, however, largely confined to the regulation of banks by the Reserve Bank and
the Central Government under the Reserve Bank of India Act and the Banking Regulation Act.
1.11 KEYWORDS
Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank; Regional Rural
Bank; Public Sector Bank.
12
1.12 CHECK YOUR PROGRESS
A . l . State
(i)
(ii)
(iii)
(i)
(i)
(iii)
(v)
B. I.
2.
(i)
(i)
(ii)
(iii)
13
(iv) Authorities under the Companies Act
(v) SEBI.
CONTROL OVER
ORGANISATION OF BANKS
STRUCTURE
2.0
Objectives
2.1
Introduction
2.2
2.3
Branch Licensing
2.4
2.5
2.6
2.7
Board of Directors
2.8
2.9
2.10
Restrictions on Employment
2.11
2.12
Corporate Governance
2.13
2.14
Let Us Sum Up
2.15
Keywords
2.16
2.17
2.18
Terminal Questions
Mi
16
2.0 OBJECTIVES
The objectives of this unit are to understand the laws that govern banking companies, in respect of:
2.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the organisation of banking companies. To start
with, there are restrictions at the entry point, by way of licensing and then the requirement of permission
for opening or shifting of branches. There are further regulations over the paid-up capital and reserves,
shareholder's rights, constitution of the board of directors, appointment of chairman and formation of
subsidiaries. Apart from the above, there arc also controls over the managerial and other personnel,
including the power to remove unsuitable persons and to appoint suitable persons. In this unit, we
study various provisions of the Banking Regulation Act, providing for controls over the organisation
and management of banking companies.
17
(a) Whether the company is or will be in a position to pay its present and future depositors in full
as their claims accrue;
(b) Whether the affairs of the company are being conducted or likely to be conducted in a manner
detrimental to the interests of its present and future depositors;
(c) Whether the general character of proposed management of the company will not be prejudicial
to public interest or the interest of depositors;
(d) Whether the company has an adequate capital structure and earning prospects;
(e) Whether public interest will be served by grant of licence to the company;
( f ) Whether considering the banking facilities available in the proposed area of operation, the
potential scope for expansion of business by banks already in existence in that area and
other relevant factors, the grant of licence would be prejudicial to the operation and consolidation
of banking system, consistent with monetary stability and economic growth;
(g) The fulfilment of any other condition which the Reserve Bank considers relevant in public
interest or in the interest of depositors.
Although Section 11 of BR Act specifies the minimum capital and reserves requirements of a
banking company, the Reserve Bank can stipulate a higher requirement of capital for licensing a
banking company as under Section 22 the Reserve Bank has to be satisfied that the company has
an adequate capital structure and earning prospects.
iv. Foreign Banks: In the case of companies incorporated outside India applying for a licence, apart
from the conditions specified in the case of domestic companies, three additional conditions have
been stipulated for consideration by the Reserve Bank. These are:
(a) Whether carrying on of banking business by the company in India will be in public interest;
(b) Whether the government or the law of the country, in which the company is incorporated
discriminates in any way against banking companies registered in India;
(c) Whether the company complies with provisions of the BR Act, as applicable to foreign
companies.
v. Local Area Banks: The Reserve Bank has recognised the concept of local area banks and licensed
a few(four) such banks. These arc banking companies operating only in a limited geographical
area. The licence issued to these banks would restrict their operations to the specified local area to
ensure adequate banking services in that area.
vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking Regulation Act authorises
the Reserve Bank to cancel the licence granted to any banking company. The cancellation of
licence may be on any one or more of the following grounds:
(a) The company ceases to carry on banking business in India;
(b) The company at any time fails to comply with any of the conditions imposed under the subSection ( l ) of Section 22 of Banking Regulation Act;
(c) The company does not fulfil at any time, any of the conditions referred to in the sub-Section(3)
or 3(A) of Section 22 of Banking Regulation Act.
Before cancellation of a licence for non-compliance with any of the conditions as above, the
company has to be given an opportunity for taking necessary steps for complying with or fulfilling
the conditions. However, in cases where the Reserve Bank is of the opinion that delay will be
prejudicial to the interests of depositors or the public, the requirement of opportunity can be
dispensed with. As observed by the Madras High Court in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961
Mad. 8), the Reserve Bank has a wide range of administrative discretion under the Act, which it is
competent to exercise, and it cannot be said that there is an excessive delegation of power. A
banking company, whose licence is cancelled, can appeal to the Central Government within a
period of 30 days from the date of the order rejecting licence.
18
2.3 BRANCH LICENSING
i. Apart from the requirement of licence for commencing or carrying on banking business, banks
have to obtain the prior permission of Reserve Bank for opening a new place of business or
changing location of the existing place of business. Under Section 23 of the Banking Regulation
Act, 'Place of business' for this purpose includes any sub-office, pay office, sub-pay office or any
place at which deposits are received, cheques cashed or moneys lent. However, changing the
location of an existing place of business within the same city, town or village would not need such
permission. These restrictions also apply to foreign branches of banking companies incorporated
in India. Opening of a temporary place of business up to one month for purpose of affording
banking facilities for any exhibition, mela, conference or like occasion is exempt. However, the
temporary branch has to be within the limits of the city, town or village where there is an existing
branch or in the environs thereof. The present guidelines from RBI provide that Banks should
submit their request for new branches, administrative offices, ATMs once in a year for consideration
of RBI as against the earlier practice of making individual applications for each and every branch.
When approved, the permission would be valid for a period of one year before which the branches/
offices should be operationalised.
ii. For granting permission under Section 23, the Reserve Bank may require to be satisfied of the
following:
(a)
(b)
(c)
(d)
19
approved securities or cash deposited can be similarly replaced by securities. The Central Government
can exempt any foreign bank from this requirement on the recommendation of the Reserve Bank
for a specified period if the amounts deposited already by it are considered adequate. On the
cessation of business by any foreign bank for any reason, these deposits shall form the assets of
the company on which the creditors in India shall have the first charge.
ii. Indian Banks: In case of banking companies incorporated in India, the requirements of minimum
paid-up capital and reserves under Section 11 (3) are as follows:
(a) If it has a place of business in more than one state, Rs. 5 lac and if such places of business
include Mumbai, Kolkata or both, Rs. 10 lac.
(b) If the place of business is in only one state and does not include Mumbai or Kolkata, Rupees l
lac for its principal place of business, plus Rs. 10,000 for other places of business, in the same
district in which the principal place of business is situated, plus an additional Rs. 20,000, for
each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank has only one
place of business, the amount is limited to Rs. 50,000.
For banking companies commencing business after the commencement of the Act, paid-up
capital is stipulated as Rs 5 lac.
(c) If places of business are in one state only, but one or more of them is in Mumbai or Kolkata,
Rs. 5 lac, plus Rs. 25,000 for each place of business outside these cities and the aggregate not
exceeding Rs. 10 lac.
During 2005, RBI stipulated the minimum capital requirement for a new Private Bank at Rs
300 crore as a part of Corporate Governance guidelines and as a policy of Foreign Direct
Investment.
iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the above. Section 12( 1) of
the Banking Regulation Act stipulates that the subscribed capital of a banking company shall not be
less than half of its authorised capital; and the paid-up capital shall not be less than half of its
subscribed capital. If capital is increased, this requirement has to be complied within a period not
exceeding two years as allowed by the Reserve Bank.
Banking companies are permitted to have only ordinary or equity shares. However, preference
shares issued before 1 July 1944 are exempt. Further, the provisions of Section 12(1) are not
applicable to banks incorporated before 15 January 1937. Now preference shares and other capital
instruments are also allowed. Since 2005, Banks have been permitted by RBI to raise capital even
in the from of innovative debt instruments which are perpetual and perpetual non-cumulative
preference shares in addition to the equity capital.
20
they receive more than the specified percentage of their shares for transfer to one party, the bank's
board must refer the matter to the Reserve Bank. The banks shall not transfer the shares without
receiving Reserve Bank's acknowledgement. This is with a view to ensure that the controlling
interest in a banking company does not change hands without the knowledge and approval of the
Reserve Bank.
iii. Reports on shareholding: A report regarding the particulars of shareholding of the chairman, managing
director or chief executive officer, by whatever name called, of every banking company, requires
submission to the Reserve Bank. Such report should contain the full particulars and extent of value
of shares held directly or indirectly and of any change in the extent of holding or of any variation
in the rights attaching thereto. The Reserve Bank may also order for any other information relating
to those shares.
iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act imposes a ceiling on
the commission, brokerage, discount or remuneration on the sale of shares of banking companies.
Accordingly, the payments on this account in any form should not exceed two-and-a-half per cent
of the paid-up value of the shares.
v. Dividend: There are also certain restrictions on the payment of dividend to the shareholders of
banking companies. Thus, under Section 15 of the Banking Regulation Act, no dividend is payable
until all capitalised expenses are completely written off. Such expenses include preliminary expenses,
organisation expenses, share-selling commission, brokerage, loss incurred and any other item, of
expenditure not represented by tangible assets. However, dividends are payable without writing off
depreciation, bad debt etc., as under:
. (a) Depreciation in value of approved securities, which is not capitalised or accounted for as a
loss.
(b) Depreciation in investment of shares, bonds or debentures, other than the approved securities
for which adequate provision has been made.
(c) Bad debts for which an adequate provision is provided.
RBI has given detailed eligibility criteria for declaration of dividend by banks and also guidelines on
the quantum of dividend that can be declared by banks. The eligibility criteria require a minimum 9
% of CAR and Net NPAs not exceeding 7%. The quantum of dividend that can be declared is based
on the levels of net NPAs and in a graded level (Maximum 40% pay out ratio) and can be paid out
of only current year's profits.
Undertaking any business which is permissible for banking companies under Section 6(1)
clauses (a) to (o).
(ii) Carrying on the business of banking exclusively outside India. Prior permission of the Reserve
Bank is a must for t h i s banking business.
(iii) Undertaking any other business which Reserve Bank with prior approval of the Central
Government permits. Reserve Bank may permit only such other business which it considers
conducive to the spread of banking in India or otherwise useful or necessary in the
public interest. The undertaking of any business by a subsidiary will not be deemed to
amount to the bank itself taking up that business directly or indirectly for the purpose
of Section 8.
21
ii. Shareholding in other companies: Apart from the restriction on subsidiaries, there is also a ceiling
[Section 19(2)] on shareholding in companies other than subsidiaries. Thus, the holding of shares
by a banking company in any company as pledgee, mortgagee or absolute owner shall not be
exceeding thirty per cent of the paid-up share capital of that company or the paid-up share capital
and reserves of the banking company. Further, holding of shares in any company in which the
managing director or manager of a banking company is interested in or concerned with in any
manner, is prohibited except in the case of subsidiaries.
agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry
or any other matter, the special knowledge or practical experience which is useful to the banking
company, in the opinion of the Reserve Bank. Further, at least two of the directors should have
special knowledge or practical experience in agriculture and rural economy or co-operation or
small scale industry.
ii. Substantial interest: The directors of a banking company shall not have a substantial interest in or
be connected with as employee, manager or managing agent in a company or firm which carries
on trade, commerce or industry as per Section I OA (2)(b) of the BR Act. However, companies
registered under Section 25 of the Companies Act and small scale industrial concerns are not
included for the purpose. The proprietors of trading, commercial or industrial concerns other than
small scale industrial concerns are also disqualified for directorship. 'Substantial interest' for this
purpose is defined in Section 2 of the Banking Regulation Act. Accordingly, holding of beneficial
interest by any individual or his spouse or minor child, whether singly or taken together in the
shares of a company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the company
amounts to substantial interest. In the case of firms, such holding of beneficial interest exceeding
ten per cent of the total capital of the firm amounts to substantial interest.
iii. Period of office: The directors of a banking company shall not hold office for more than eight
years continuously. However, this provision is not applicable to the chairman or a whole-time
director. When the chairman or a whole-time director of a bank is removed from office, he/she
ceases to be a director of the bank and shall not be eligible for further appointment as director of
that banking company for a period of four years.
iv. Reconstitution of Board: When the board of a banking company is not constituted in accordance
with the requirements of Section 10A of the BR Act, the board has to be reconstituted, to comply
with the provisions. If any director has to be retired for such a reconstitution, this may be done by
lots, in the prescribed manner and such decision shall be binding on every director of the board. If
the Reserve Bank is of the opinion that the board of any banking company does not fulfil the
requirements, it may order such a bank to reconstitute the board after giving reasonable opportunity
of being heard. If, within two months' time, the bank does not fulfil the order of the Reserve Bank,
the Bank may then remove any director (determined by lots drawn in the prescribed manner) and
such a person shall cease to hold office. The Reserve Bank may also appoint a new director in the
place of the person removed and he/she shall continue in office until the date up to which his
predecessor would have held office. However, any proceedings of a banking company will not be
invalid only because of any defect in the composition of the board.
22
2,8 CHAIRMAN OF BANKING COMPANY
i. Whole-time Chairman/Managing Director: Section I OB of the Banking Regulation Act provides that
every banking company should have a full-time or part-time chairman, appointed from among its
directors. The chairman, if appointed on a whole-time basis is entrusted with the management of
the entire affairs of the bank. The chairman on a part-time basis has to be appointed with the prior
approval of the Reserve Bank and such an appointment shall be subject to any conditions that may
be imposed by the Reserve Bank while granting approval. In the absence of a chairman, the
management of the whole of the affairs of the banking company shall be entrusted to a managing
director. The exercise of powers by the whole-time chairman or managing director is subject to the
superintendence, control and directions of the board of directors. The whole-time chairman and a
managing director shall hold office for a period not exceeding five years as the board may fix and
is also eligible for reelection or reappointment. Although the chairman is in full-time employment of
the bank, he may be a director of a subsidiary of the bank or of a company registered under Section
25 of the Companies Act. The Reserve Bank may also permit the whole-time chairman or the
managing director to undertake part-time honorary work not likely to interfere with the duties of
the chairman or the managing director.
The whole-time chairman or the managing director of a banking company may continue in office
at the end of the term of the office until his/her successor assumes office, subject to the approval
of the Reserve Bank.
ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time chairman or the managing
director of a banking company should have special knowledge or practical experience of the
working of a banking company or the State Bank or a subsidiary bank or a financial institution or
financial, economic or business administration. The whole-time chairman or the managing director
will be disqualified under the following circumstances:
(a) if he/she is director of a company other than a subsidiary of the banking company or a charitable
company (registered under Section 25 of the Companies Act);
(b) if he/she is a partner of any firm which carries on trade, business or industry;
(c) if he/she has substantial interest in any other company or firm or is director, manager, managing
agent, partner or proprietor of any trading, commercial or industrial concern; or
(d) if he/she is engaged in any other business or vocation.
iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is of the opinion that the
person elected to be the chairman of the board of directors and appointed on a whole time basis or
the managing director is not a fit and proper person to hold such office, the Reserve Bank may
require the banking company to remove such a chairman or the managing director and appoint a
suitable person. However, before taking such an action, the Reserve Bank has to give such a
person, as also the banking company, a reasonable opportunity of being heard. If the banking
company does not comply with the order within two months, the Reserve Bank may remove the
person from the office and appoint a suitable person in his/her place. Such a chairman or managing
director would continue in office, for the residual period of office of the person removed from
office.
The banking company or the person affected by the Reserve Bank s order may appeal to the
Central Government within thirty days. The order of the Government where an appeal is filed and
the order of the Reserve Bank, where no appeal is filed shall be final and not liable to be challenged
before any civil court.
vi. Temporary vacancies: In cases where the wholetime chairman or the managing director dies or
23
he/she resigns or is not capable of discharging his/her functions due to illness, temporary
arrangements can be made to carry out the duties of the chairman or the managing director for
a period not exceeding four months. However, this has to be done with the approval of the
Reserve Bank.
v. Power of Reserve Bank to appoint ('hairman: In certain cases, the office of the whole-time chairman
or the managing director of a banking company may fall vacant and may not be filled up by the
bank immediately. This may adversely affect the interests of the banking company. If the Reserve
Bank is of the opinion that continuation of such vacancy is likely to be against the interests of the
banking company, it may appoint an eligible person to fill such vacancy under Section 10BB of the
Banking Regulation Act. If the chairman or the managing director so appointed is not a director of
the banking company, he/she shall be deemed to be a director of the banking company. Such
appointment may be for a period not exceeding three years. There is also a provision for
reappointment after the initial period. The chairman or the managing director so appointed may be
removed from office only by the Reserve Bank and shall draw pay and allowances from the
banking company, as determined by the Reserve Bank.
vi. Qualification shares: The whole-time chairman or the managing director of a banking company is
exempted under Section IOC of the Banking Regulation Act from the requirement of holding
qualification shares. Similar exemption is also available to a director of a banking company appointed
by Reserve Bank under Section 10A of the Act.
vii. Overriding provisions: The provisions of Section 10A, Section 10B and Section 10BB of the
Banking Regulation Act regarding the appointment and removal of a director, managing director or
the chairman shall have overriding effect over all other laws, contracts, etc. Any person affected
by any action taken under these provisions is not entitled to any compensation for any loss or for
termination of office.
(b) public
(d) depositors of the banking company.
ii. The directors so appointed shall not require any qualification shares. They hold office during the
pleasure of the Reserve Bank. Subject to this, appointment may be for a period not exceeding three
years or further extended periods not exceeding three years at a time as specified by the Reserve
Bank. The additional directors are protected from any liability or obligation for executing their
functions in good faith. The provisions of Section 36AB have overriding effect over other laws.
24
(c) a person whose remuneration or part thereof is by way of commission or share in the profits
of the company;
(d) a person whose remuneration is excessive in the opinion of the Reserve Bank. Before forming
an opinion regarding the remuneration, the Reserve Bank has to consider the financial condition
and history of the banking company, its area of operation, resources, volume of business and
the trend of its earning capacity, number of its branches, qualifications, age and experience of
the person concerned, remuneration of other personnel in the bank or persons holding similar
positions in other banks and the interest of depositors.
The above restrictions are applicable to workmen as well as management personnel, as held by the
Supreme Court in Central Hank of India vs Their Workmen (AIR 1960 SC 12). However, the
restriction on remuneration does not affect payment of bonus according to a settlement or award
or in accordance with a scheme framed by the bank or in accordance with the prevailing practice
in banking business. Commission paid to brokers, auctioneers, forwarding agents, etc., who are
not regular members of the bank's staff, is also not covered by these provisions.
ii. Persons who are directors of any company other than a subsidiary of a banking company or company
registered under Section 25 of the Companies Act are also prohibited from managing a banking
company. However, this prohibition shall not apply to a director for a temporary period of three
months, or a further period not exceeding nine months, if allowed by the Reserve Bank. Apart from
this, persons engaged in any other, business or vocation or whose term of office as a person managing
the company is for a period exceeding five years also fall in the prohibited category. However, the
period of office can be renewed or extended for further periods not exceeding five years at a time.
iii. Effect of the order of removal: On the Reserve Bank passing a removal order, the person concerned
ceases to hold office which he/she was holding till then. Further, he/she is prohibited, from directly
or indirectly taking part in the management of any banking company for a period not exceeding five
years as may be specified in the order. Contravention of the order is punishable with a fine of Rs.
250 for each day during which the contravention continues.
iv. Appointment of a suitable person: When any chairman, director, chief executive officer, other
officer or employee is removed by the Reserve Bank under Section 36AA as above, the Reserve
Bank may appoint a suitable person in his place. Such person shall hold office at the pleasure of the
Reserve Bank. Subject to this, the appointment may be for a period not exceeding three years and
is extendable for further periods not exceeding three years at a time. Such appointee shall not incur
any obligation or liability for action taken in good faith in the execution of the duties of his office.
26
iii. Corporate Governance and Banks: Banks hold a special position in corporate governance as they
accept and deploy large amounts of public funds in fiduciary capacity and also leverage such funds
through credit creation. The position of banks is also important for the smooth functioning of the
payment system. Accordingly, legal prescriptions for ownership and governance of banks laid
down in the statutes are supplemented by regulatory prescriptions. The Basel Committee on Banking
Supervision has issued guidance (February 2006) for promoting the adoption of sound practices of
corporate governance by banking institutions. This guidance, entitled Enhancing Corporate
Governance for Banking Organisations, highlights the importance of:
the roles of boards of directors (with a focus on the role of independent directors) and senior
management
effective management of conflicts of interest
the roles of internal and external auditors, as well as internal control functionaries
governing in a transparent manner, especially where a bank operates in jurisdictions, or through
structures, that may impede transparency
the role of supervisors in promoting and assessing sound corporate governance practices.(See,
http://www.bis.org/press/p060213.htm).
Apart from the fiduciary role of banks, their cross-border operations add a special dimension. This
provides an added impetus for convergence in standards internationally. In almost all countries, the
policy framework with regard to corporate governance involves a multiplicity of agencies. In
India, the Department of Company Affairs, Securities and Exchange Board of India (in respect of
listed entities) are involved apart from the Reserve Bank in respect of banks.
iv. Reserve Bank's approach: Following the formal policy announcement in regard to corporate
governance, in the mid term Review of the Monetary and Credit Policy, in October, 2001, the
Reserve bank constituted a Consultative Group in November, 2001 under the chairmanship of Dr.
A.S. Ganguly with a view to strengthen the internal supervisory role of the boards of banks. The
report of the group was transmitted to all the banks for their consideration in June, 2002 and
simultaneously to the Government of India for consideration. Earlier, an advisory group on corporate
governance under the chairmanship of Dr. R.H. Patil had submitted its report in March, 2001
which examined the issues relating to corporate governance in banks in India, including the public
sector banks and made recommendations to bring the governance standards in India on par with
the best international standards. There were also some relevant observations by the advisory group
on banking supervision under the chairmanship of Shri M.S. Verma which submitted its report in
January, 2003. Keeping all these recommendations in view and the cross-country experience, the
Reserve Bank initiated several measures to strengthen the corporate governance in the Indian
banking sector, including the concept of 4 fit and proper* criteria for directors of banks which
included the process of collecting information, exercising due diligence and constitution of a
nomination committee of the board to scrutinise the declarations made by the bank directors. The
RBI guidelines on ownership and governance in the private sector banks released on February 28,
2005 (Paras 5 and 6) provide as under:
Shareholding
(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on 3 February,
2004 will be applicable for any acquisition of shares of five per ccnt and above of the paid-up
capital of the private sector bank.
(ii) In the interest of diversified ownership of banks, the objective will be to ensure that no single
entity or group of related entities has shareholding or control, directly or indirectly, in any bank
in excess of ten per ccnt of the paid-up capital of the private sector bank. Any higher level of
27
acquisition will be with the prior approval of RBI and in accordance with the guidelines of 3
February, 2004 for grant of acknowledgement for acquisition of shares.
(iii) Where ownership is that of a corporate entity, the objective will be to ensure that no single
individual/entity has ownership and control in excess of ten per cent of that entity. Where the
ownership is that of a financial entity the objective will be to ensure that it is a well-established
regulated entity, widely held, publicly listed and enjoys good standing in the financial community.
(iv) Banks (including foreign banks having a branch presence in India)/FIs should not acquire any
fresh stake in a bank's equity shares, if by such acquisition, the investing bank's/FYs holding
exceeds five per cent of the investee bank's equity capital as indicated in RBI circular dated 6
July, 2004.
(v) As per the existing policy, large industrial houses will be allowed to acquire, by way of strategic
investment, shares not exceeding ten per cent of the paid-up capital of the bank, subject to
RBI's prior approval. Furthermore, such a limitation will also be considered, if appropriate, in
regard to important shareholders with other commercial affiliations.
(vi) In case of a restructuring of the problem/weak banks or in the interest of consolidation in the
banking sector, RBI may permit a higher level of shareholding, including by a bank.
With regard to public sector banks, the principles of corporate governance have been statutorily
recognised as per Banking Companies (Acquisition and Transfer of Undertakings) Financial
Institutions Laws (Amendment) Act, 2006. The Act as amended provides for shareholder directors
to be a person having Tit and proper' status and the Reserve Bank has to notify the 'Fit and
Proper' criteria (Section 9(2)1.
28
2.14 LET US SUM UP
A company wanting to commence hanking 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 the Reserve Bank 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 hav ing 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.
Hvery banking company should have a full-time chairman (or a full-time managing director, if there is
no full-time 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 Tit and proper' criteria for directors apply to banking companies
as well as public sector banks.
2.15 KEYWORDS
Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place of Business:
Substantial Interest; Subscribed Capital; Subsidiary.
(iv) Banking companies are permitted to give brokerage up to two-and-half per cent of the paid-up
value of shares.
(v) No person can hold the shares of banks beyond ceiling specified under the BR Act.
(vi) A banking company cannot hold shares in any other company other than a subsidiary.
3,
4.
1. (i) licence; (ii) same city, town or village; (iii) 20 per cent of profit for each year; (iv) Section
6(1 )(a) to (o) of BR Act; (v) 10 per cent; (vi) capitalised expenses.
2. (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) False.
3. (i) substantial interest; (ii) 51 per cent; (iii) by lots; (iv) give opportunity of being heard; (v) overriding effect; (vi) additional directors; (vii) RBI
4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False
30
2.
3.
4.
5.
. (such conditions as the Central Government may specify; such conditions as the
Reserve Bank may think fit to impose; confirmation by the Central Government).
Reserve Bank is not empowered to cancel the licence granted to a banking company on the
ground that
. (the company ceases to carry on any of its business; the company
changes its registered office from one state to another state; the company is not in a position to
pay its depositors in full as their claims accrue).
A bank requires permission of the Reserve Bank for opening a new branch or shifting an existing
branch
. (to any new location from where it is situated; otherwise than within the
same city, town or village; otherwise than in the same building).
In addition to the requirements as to minimum capital and reserves under Section II of the BR
Act, Reserve Bank
. (cannot look into the capital structure of a banking company;
has to satisfy itself under Section 22(3) of the BR Act as to adequacy of capital structure and
earning prospects; has to consult the Central Government as to the adequacy of the capital
structure of a banking company before licensing).
In the case of a banking company, a shareholder cannot exercise voting rights on poll
.
(in excess of ten per cent of the total voting rights of all the shareholders of the company; in
excess of two per cent of the total voting rights of all the shareholders of the company; in excess
of ten per cent of the total voting rights of all the shareholders except with prior permission of the
Reserve Bank).
(i) There are no restrictions in the BR Act on payment of dividend by banking companies.
(ii) Before payment of dividend by a banking company, all its capitalised expenses, unless
specifically exempted under the BR Act, have to be completely written off.
(iii) Banking companies are not permitted to pay dividend above ten per cent of net profits.
7. (i) There are no specific qualifications required for the directors of a banking company.
(ii) At least fifty-one per cent of the directors of a banking company should consist of persons
with professional or other experience as provided in the BR Act.
(iii) At least fifty-one per cent of the directors of a banking company should be chartered accounts
or experts in finance.
8. (i) There is no provision for maintenance of reserves by a banking company under the BR Act.
(ii) Every banking company has to maintain a reserve fund and transfer before declaring dividend,
not less than twenty per cent of the profit to the reserve fund.
(iii) The maintenance of a reserve fund is optional for a bank.
(ii)
(iii)
10.
(i)
(ii)
(iii)
entrusted with the management of the whole of the affairs of the banking company.
The chairman of a banking company can be on part-time basis and a managing director can
be appointed on whole-time basis who shall be entrusted with the whole of the affairs of the
banking company.
The chairman of a banking company can be on part-time basis and the whole of the affairs
of the banking company shall be entrusted to a committee of the board of directors.
A banking company can form subsidiaries for undertaking any business approved by its
board of directors.
A banking company can form subsidiaries for undertaking any business mentioned in Section
6(1) (a) to (o) of the BR Act, which is permissible for a banking company to undertake.
A banking company does not require the permission of the Reserve Bank to form a subsidiary
for doing banking business exclusively outside India.
REGULATION OF BANKING
BUSINESS
STRUCTURE
3.0
Objectives
3.1
Introduction
3.2
3.3
Acceptance of Deposits
3.4
Nomination
3.5
3.6
3.7
3.8
3.9
3.10
Banking Ombudsman
3.11
Reserve Funds
3.12
3.13
3.14
Assets in India
3.15
Let Us Sum Up
3.16
Keywords
3.17
3.18
3.19
Terminal Questions
32
3.0 OBJECTIVES
The objectives of this unit are to understand the law, in particular the provisions of the Banking Regulation
Act. relating to:
3.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the business activities of banking companies.
Accordingly, the Act empowers the Reserve Bank to issue directions for regulating terms and conditions
of making of loans and advances and other matters including acceptance of deposits. The Banking
Regulation Act also imposes certain restrictions on loans and advances to the directors of banking
companies, and companies and firms in which they are interested. The Act contains provisions for
creation of a reserve fund and transfer of a percentage of profits to that fund. There are also provisions
for maintenance of cash reserve, liquid assets and assets in India. In this unit, we look at the relevant
provisions of law in this regard.
33
iii. Bonafides: The powers of the Reserve Bank to issue directions have to be exercised with bonafide
intentions, as held by the Gujarat High Court in RBI vs Harisidh Co-op. Bank Ltd. (AIR 1988 Guj
107). In that case the Court considered the power of the Reserve Bank to issue directions for
superseding the board of a co-operative bank for securing its proper management and upheld the
action taken by the Reserve Bank on the finding that it was without mala fide.
iv. Caution and Advice: Apart from giving directions, the Reserve Bank may also caution or give
advice to banking companies. Section 36 of the Banking Regulation Act provides that the Reserve
Bank may caution or prohibit banking companies generally or any banking company in particular
against any transaction or class of transactions. Further, the Reserve Bank may generally give
advice to any banking company.
34
3.4 NOMINATION
i. Repayment of Deposits: Section 45ZA of the Banking Regulation Act provides that a depositor or
depositors of a banking company (including co-operative banks) may nominate one person in the
prescribed manner as nominee to whom the deposit may be returned in the event of death of the
sole depositor or depositors. Unless the nomination is varied or cancelled, the nominee is entitled to
all the rights of the depositor/s in the event of death of the depositor/s. In the case of minor
nominees, there is also a provision to appoint a person to receive the deposit on behalf of the minor.
Payment by a bank in accordance with these provisions gives a valid discharge to the bank, but this
does not affect the right or claim a person may have against the nominee in respect of the amount
received by him. Rule 2 of the Banking Companies (Nomination) Rules, 1985 provides for the
procedure and forms for making nomination in respect of deposits with commercial banks. In the
case of Co-operative banks, similar provisions are incorporated in the Co-operative Banks
(Nomination) Rules, 1985.
ii. Articles in Safe Custody and Safety Lockers: There are also provisions in the Banking Regulation
Act for nomination in respect of articles kept in safe custody with banks and safety lockers.
Sections 45ZC and 45ZE provide that any person who leaves any article in safe custody and in
safety lockers respectively with a banking company, may nominate one person as nominee to
receive the article in the event of death of that person. The nomination has to be in the prescribed
manner and on return of articles kept in safe custody or removal of contents of locker by nominees
as provided, the bank gets a valid discharge. Rules 3 and 4 of the Banking Companies (Nomination)
Rules, 1985, and also the Rules 3 and 4 of the Co-operative Banks (Nomination) Rules, 1985 deal
with the form and procedure applicable to articles in safe custody and safety lockers respectively
in the case of banking companies and co-operative banks.
(b) The directions given by the Reserve Bank are binding on banking companies, and may be on
one or more of the following matters:
(i) Purpose for which advances may or may not be made.
(ii) Margins, to be maintained in respect of secured advances.
(iii) Maximum amount of advances or other financial accommodation which may be made to
any company, firm, association of persons or individual. The policy on these matters may
be specified having regard to the paid-up capital, reserves and deposits of the banking
company and other relevant considerations.
The Reserve Bank issues directions from time to time regulating the lending operations of
banking companies in exercise of these powers vested under Section 21. Apart from this,
the general powers to give directions under Section 35A are also available for regulation of
loans and advances.
8. Selective Credit Control
(a) Purpose: Banks have been traditionally financing trade and commerce and against items they
deal in even before the country started industrializing. To ensure that prices of essential
commodities like food grains, pulses, edible oils, sugar, jaggery and cotton and textiles are not
increased by certain sections of the business community with a motive of profit maximisation
by hoarding with the help of bank finance, these restrictions have been put in place. These
cover the quantum of credit that can be extended and also the rate at which it can be extended.
With self-sufficiency achieved by our country over the years in almost all of the above, RBI
had taken them out of the purview of selective credit control and currently restrictions are
there only in case of levy sugar.
(b) Methods and tools: Selective credit control seeks to influence the demand for credit by
(i) making borrowing more costly for certain purposes which are considered relatively inessential, or
(ii) by imposing stringent conditions on lending for such purposes, or
(iii) by giving concessions for certain desired types of activities.
The tools employed for exercising selective credit control are:
(i) minimum margins for lending against selected commodities;
(ii) ceilings on the levels of credit; and
(iii) charging of minimum rate of interest on advances against specified commodities.
The quantum and cost of credit are regulated by operating these tools of control.
Price control: In India, selective credit control has been generally used for preventing speculative
hoarding of essential commodities and basic raw materials using bank credit. This is with a view to
check the undue rise of prices of such sensitive commodities.
Restrictions on loans and advances: Section 20 of the Banking Regulation Act imposes certain
restrictions on loans and advances. Accordingly, no banking company shall grant loans or advances
on the security of its own shares. Further, a banking company, is prohibited from entering into any
commitment for granting any loans or advances to or on behalf of any of its directors. The
prohibition also applies to loans and advances to:
(a) firms in which any director is interested as a partner, manager, employee or guarantor, and
(b) any company (other than a company registered under Section 25 of the Companies Act) in
which a director of the banking company holds substantial interest as defined in Section 5(ne)
of the Act or of which he is director, manager, managing agent, employee or guarantor.
If the director of a banking company is a partner or guarantor of any individual, loans and advances
to such individual are also barred. 'Director' includes a member of any board for managing or
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advising the bank regarding management of all or any of its affairs. It is open to the Reserve Bank
to specify any transaction as not being a loan or advance for this purpose by a general or special
order. In so doing the bank has to consider the nature of the transaction, period, manner and
circumstances in which the amount is likely to be realised, the interest of depositors and other
relevant considerations. If there is any doubt or dispute as to whether a transaction is a loan or
advance, the decision of the Reserve Bank in the matter shall be final.
vi. Restrictions on power to remit debt: For remitting any debt to its directors, a banking company
requires prior permission of the Reserve Bank under Section 20A of the Banking Regulation Act.
Permission is also required for remission of loans to:
(a) any firm or company in which a director is interested as director, partner, managing agent, or
(b) any individual for whom a director is partner or guarantor. Any remission made in contravention
of Section 20 is void and will have no effect.
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iii. Usurious loans Act, 1918: The Usurious Loans Act, 1918 prohibits lending at exorbitant rates. The
law has been made to protect the weaker borrowers from the powerful moneylenders. Similarly,
debt relief legislation in different states attempts to protect the agriculturists and other weaker
sections from unscrupulous lenders, by remitting debts or giving other concessions. Although the
lending rates of banks are regulated by the Reserve Bank, borrowers often used to resort to these
laws for remitting loans or reducing rates of interest in respect of loans taken by them from banks.
This was coming in the way of the monetary policy decided by the central bank. Accordingly,
Section 21A was inserted in the Banking Regulation Act to make the rates of interest charged by
banking companies beyond the scrutiny of courts.
iv. Protection to interest rate: Section 21A of the Banking Regulation Act provides that a transaction
between a banking company and its debtor cannot be reopened by any court on the ground that the
rate of interest charged is excessive. This provision is given an overriding effect over the provisions
of the Usurious Loans Act, 1918 or any other law relating to indebtedness in force in any state.
Section 21A was held to be valid and not ultra vires the Constitution by the Supreme Court. In
Corporation Bank vs D. S. Gowda [(1994) 5 SCC 213], the Supreme Court held that banks can
compound interest on annual rates and not half yearly rates in view of the express directives of the
Reserve Bank. The court further held that where the Reserve Bank fixes both minimum and maximum
rates of interest, courts would not interfere in the matter of interest rate, if the rate charged by the
bank is not in violation of the Reserve Bank directive. However, the court did not express any
opinion on the question whether Section 21A would debar the courts from interfering if the circulars
or directives of the Reserve Bank do not fix the maximum and leave it to the discretion of the banks
to fix the rate above the minimum.