Professional Documents
Culture Documents
Legal Regulatory Aspects of Banking PDF
Legal Regulatory Aspects of Banking PDF
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
• To facilitate study of theory and practice of banking and finance.
• To test and certify attainment of competence in the profession of banking and finance.
• To collect, analyse and provide information needed by professionals in banking and finance.
• To promote continuous professional development.
• To promote and undertake research relating to Operations, Products, Instruments, Processes,
etc., in banking and finance and to encourage innovation and creativity among finance professionals
so that they could face competition and succeed.
2nd Edition
MACMILLAN
© INDIAN I N S T I T U T E OF B A N K I N G & F I N A N C E , M U M B A I , 2005, 2008
(This book has been published by Indian Institute of Banking & Finance. Permission
of the Institute is essential for reproduction of any portion of this book. The views
expressed herein are not necessarily the views of the Institute.)
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 K. Bhaskaran
3-7-2008 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.
PAPER 3 - LEGAL & REGULATORY
ASPECTS OF BANKING
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:
- Opening of New Banks and Branch Licensing
- Constitution of Board of Directors and their Rights
- Banks Shareholders and their Rights
- CRR/SLR Concepts
- Cash/Currency Management
• Winding Up - Amalgamation and Mergers
• Powers to Control Advances - Selective Credit Control - Monetary and Credit Policy
• Audit and Inspection
• Supervision and Control-Board for Financial Supervision - Its Scope and Role
• Disclosure of Accounts and Balance Sheets
• Submission of Returns to RBI, etc.
• 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
• Case Laws on Responsibility of Paying/Collecting Banker
• Indemnities/Guarantees
- Scope and Application
- Obligations of a Banker
- Precautions and Rights
• Laws Relating to Bill Finance, LC and Deferred Payments
• Laws Relating to Securities
• Valuation of Securities - Modes of Charging Securities - Lien, Pledge, Mortgage, Hypothecation,
etc.
• Registration of Firms/Companies
• Creation of Charge and Satisfaction of Charge
MODULE C - BANKING RELATED LAWS
• Law of Limitation
• Provisions of Bankers Book Evidence Act
Special Features of Recovery of Debts Due to Banks and Financial Institutions Act, 1993
• TDS and Service Tax
• Banking Cash Transaction Tax
• Asset Reconstruction Companies
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002
• The Consumer Protection Act, 1986
• Banking Ombudsman 2006
• Lok Adalats
• Lender's Liability Act
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
• The Transfer of Property Act
• Foreign Exchange Management Act, 2000
• Prevention of Money Laundering Act, 2002
• Right to Information Act, 2005
• Information Technology Act, 2000
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
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
7. Case Laws on Responsibility of Collecting Bank 93
S. Indemnities 101
9. Bank Guarantees 107
10. Letters of Credit 119
11. Deferred Payment Guarantee 131
12. Laws Relating to Bill Finance 135
13. Various Types of Securities 143
14. Law Relating to Securities and Modes of Charging - I 155
15. Law Relating to Securities and Modes of Charging - II 163
16. Different T^pes of Borrowers 173
17. Types of Credit Facilities 181
18. Secured and Unsecured Loans, Registration of Firms, Incorporation of Companies 187
19. Registration and Satisfaction of Charges 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
21. Definitions at SARFAESI Act, 2002 209
22. Regulation of Securitisation and Reconstruction of Financial Assets of
Banks and Financial Institutions 219
23. Enforcement of Security Interest 231
24. Central Registry 241
25. Offences and Penalties 245
26. Miscellaneous Provisions 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
28. Procedure for Redressal of Grievances 259
REC<)VERV (>1 D E B T S D U E TO B A N K S AND
FINANCIAL INSTITUTIONS ACT. 1993(DRTACT)
29. Preliminary 267
30. Establishment of Tribunal and Appellate Tribunal 271
31. Jurisdiction, Powers and Authority of Tribunals 275
32. Procedure of Tribunals 279
33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions 285
T H E B A N K E R S ' B O O K S E V I D E N C E ACT, 1891
34. The Bankers' Books Evidence Act, 1891 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
36. Preliminary, Extent and Definitions 303
37. Consumer Protection Councils 311
38. Consumer Disputes Redressal Agencies 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
42. Contracts of Indemnity 345
43. Contracts of Guarantee 347
44. Contract of Bailment 353
45. Contract of Pledge 357
46. Contract of Agency 359
47. Meaning and Essentials of a Contract of Sale 365
48. Conditions and Warranties 369
XIII
STRUCTURE
1.0 Objectives
1.1 Introduction
1.2 Business of Banking
1.3 Constitution of Banks
1.4 Reserve Bank of India Act, 1934
1.5 Banking Regulation A c t 1949
1.6 Reserve Bank as Central Bank and Regulator of Banks
1.7 Government as a Regulator of Banks
1.8 Control Over Co-operative Banks
1.9 Regulation by Other Authorities
1.10 Let Us Sum Up
1.11 Kevwords
w
1.0 OBJECTIVES
The objectives of this Unit are to understand:
• the definition and nature of the business of banking;
• the constitution of different types of banks;
• the regulatory scheme of the RBI Act and the BR Act;
• the role of the Reserve Bank and the Central Government as regulators; and
• the special position of public sector banks and co-operative banks.
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.
(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 sub-
Section (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.
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.
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.
1.11 KEYWORDS
Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank; Regional Rural
Bank; Public Sector Bank.
12
A. 1. (i) True; (ii) False; (iii) True; (iv) False; (v) False.
2. (i) RBI Act (ii) a body corporate created under a special statute
(iii) Reserve Bank (iv) BR Act
(v) for regulating banking companies.
B. I. (i) True; (ii) False; (iii) False; (iv) False; (v) True.
2. (i) Multi-State Co-operative Societies Act
(ii) On recommendation of RBI
(iii) Reserve Bank
13
(iv) Authorities under the Companies Act
(v) SEBI.
STRUCTURE
2.0 Objectives
2.1 Introduction
2.2 Licensing of Hanking Companies
2.3 Branch Licensing
2.4 Paid-up Capital and Reserves
2.5 Shareholding in Banking Companies
2.6 Subsidiaries of Banking Companies
2.7 Board of Directors
2.8 Chairman of Banking Company
2.9 Appointment of Additional Directors
2.10 Restrictions on Employment
2.11 Control Over Management
2.12 Corporate Governance
2.13 Directors and Corporate Governance
2.14 Let Us Sum Up
2.15 Keywords
Mi
2.0 OBJECTIVES
The objectives of this unit are to understand the laws that govern banking companies, in respect of:
• Licensing and branch licensing
• Paid up capital and reserves
• Shareholding and rights of shareholders
• Formation of subsidiaries and holding of shares of other companies
• Constitution and regulation of board of directors
• Exercise of control by the Reserve Bank and the Government over the appointment and removal of
chairmen, managerial and other personnel
• Corporate governance
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.
(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 sub-
Section ( 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
ii. For granting permission under Section 23, the Reserve Bank may require to be satisfied of the
following:
(a) Financial condition and history of the bank;
(b) General character of its management;
(c) Adequacy of capital structure and earning prospects;
(d) Public interest.
This may be done by an inspection of the bank under Section 35 or otherwise.
While granting permission for opening or shifting a branch, the Reserve Bank may impose any
conditions which it thinks fit necessary. If any bank fails to comply with such conditions, the
permission may be revoked after giving an opportunity to the bank to show cause.
iii. In the case of regional rural banks, the applications for permission have to be routed through the
National Bank (NABARD), and the national bank has to offer its comments on merits to the
Reserve Bank.
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
(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.
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.
2.15 KEYWORDS
Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place of Business:
Substantial Interest; Subscribed Capital; Subsidiary.
1
2.17 ANSWERS TO 'CHECK YOUR PROGRESS
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) over-
riding effect; (vi) additional directors; (vii) RBI
4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False
. (such conditions as the Central Government may specify; such conditions as the
Reserve Bank may think fit to impose; confirmation by the Central Government).
2. 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).
3. 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).
4. 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).
5. 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).
Choose the correct statements from the following.
6. (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.
entrusted with the management of the whole of the affairs of the banking company.
(ii) 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.
(iii) 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.
10. (i) A banking company can form subsidiaries for undertaking any business approved by its
board of directors.
(ii) 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.
(iii) 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 Power to Issue Directions
3.3 Acceptance of Deposits
3.4 Nomination
3.5 Loans and Advances
3.6 Regulation of Interest Kate
3.7 Regulation of Payment Systems
3.8 Internet Banking Guidelines
3.9 Regulation of Money Market Instruments
3.10 Banking Ombudsman
3.11 Reserve Funds
3.12 Maintenance of Cash Reserve
3.13 Maintenance of Liquid Assets
3.14 Assets in India
3.15 Let Us Sum Up
3.16 Keywords
3.17 Check Your Progress
3.18 A n t w e n to 'Check Your Progress'
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:
• issue of directions by Reserve Bank to banks
• regulation of acceptance of deposits by banks
• regulation of loans and advances
• regulation of interest rates of banks on deposits and borrowing
• maintenance of reserve fund
• maintenance of cash reserve by scheduled banks and other banks
• maintenance of liquid assets
• maintenance of assets in India
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.
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.
i. Board for regulation and supervision of Payment and Settlement Systems: The Reserve Bank, in
terms of the RBI (Board for Regulation and Supervision of Payment and Settlement Systems)
Regulations, 2005, has constituted a Board for Regulation and Supervision of Payment and Settlement
Systems (BPSS) as a committee of its Central board. The Board has the Governor of the Bank as
its chairman and its functions include prescribing policies relating to the regulation and supervision
of all types of payment and settlement systems, setting standards for existing and future systems,