1. THE EVOLUTION OF BANK ITS HISTORY IN INDIA iG SERVICES AND SUB-TOPICS 1. Introductory Note. 1.2, History of Banking in India 1.3. Bank Nationalisation 1.4. Various types of Banking Services 15. Social control measures on bank 1.6. Narasimham Committee Report 1,7. Concluding Remark 1.1. INTRODUCTORY NOTE In early societies functions of a Bank were done by the corresponding institutions dealing with loans and advances. The ‘modern banking and its networking are the products of modem. western civilization which rapidly developed with the advent of industrialization. Britishers brought with them this modern concept of banking in India, The Bank of England was started in 1694, when the Britishers were carrying on a long war with France. In 1708, the monopoly and the right to issue notes was given to Bank of England through an Act, Several joint stock banking companies started operating early in the nineteenth century. These banks primarily carried on funetions which are presently known as commercial functions like receiving money on deposits, lending money, transferring money from place to place and bill discounting. Banking has now presently become globally mobile service and it facilitates the capital movement from one part of the country to another, one part of the globe from another. Obviously it is now difficult to understand the banking system The present Indian banking system is requited to be studied, viewed and reviewed in the context of global banking trends. of a nation in isolation, 1.2. HISTORY OF BANKING IN INDIA Early History Banking in India has a very hoary origin. ‘The Vedic period has literature which records the giving of loans to others, Banking ‘was synonymous with money lending. The Manusmrithi speaks of deposits, pledges, loans and interest rate. Interest could be legally charged at between two and five per cent per month in order of class. The maximum amount of interest collectable on, the principal was laid down by the State. Usury was not allowed. ‘Payment of debt was made a pious obligation on the heir of dead person. With the growth of trade and commerce, the trading community soon evolved a system of money transfer throughout the country. ‘The main instrument through which banking and transfer of funds was carried out was through the inland bills of exchange or the Hundi. Indian bankers lent money, financed the rulers and trade, acted as treasurers of the State and also as insurers of goods. They also acted as money changers due to the differing coins circulating all over India. Business developed so well that certain castes or communities traditionally came to regard banking as their family business. The power and prestige of these banks rose and fell with the growth and decline of empires. “agirs’ were granted to select banks and some acted as revenue collectors for local rulers. However, tenets of modern banking. ‘were not practised as acceptance of deposits was not a regular part of the business. Modern History Modern banking in India began with the rise to power of the British. The British consolidated their power and became the ‘most powerful force in India after vanguishing Tipu Sultan in the battle of Srirangapattanam in 1799. The quest for power by Lord Mornington (Later Marquess of Wellesly). Governor General of Fort William in Bengal at that time led to a serious depletion of the resources of the Fast India Company. This led ‘© the Company promoting the Bank of Calcutta in 1806 (© The situation prevailing at that time could be known by the writing of some Britishers, C.N. Cooke, Deputy Secretary and Treasurer of the Bank of Bengal, writing in his book "Banking. in India’, has stated that usury prevailed in India more than in any other country inthe nineteenth century. The native money Tender lent to the farmers at 40, 50 and 60 per cent interest The European community was relatively better off. He attributed the very high rates to the riskiness of many of the endings and the difficulties in realising them. Indian businessmen very often acted as lender to the European businessmen with arate of interest lower than the market rate Till the advent of the three Presidency Banks, the European Agency Houses acted as bankers. They accepted deposits from British Officers serving in India and Europeans who had served in India and had returned to Europe, They financed trade with such funds and at certain times even helped the Government. There was a very effective credit network for flow of funds from one part of India to the other provided by the Indian banking firms. As the Agency Houses had prospered they also sought to operate Banks. Alexander & Company a leading Agency House started ‘managing the Bank of Hindustan from 1770's. The exact date of the founding of that bank is not known. ‘The Bengal Bank and the General Bank of India, to0, were started by the other Agency Houses in Bengal in the eighteenth century. In 1819 the Commercial Bank and in 1824 the Calcutta Bank were floated by the Agency Houses. None of these banks enjoyed limited liability nor were they proper joint stock banks. They ‘were partnership firms with unlimited liability ‘The concept of limited liability was not puton the statute books {ill the 1860 Companies Act. Till that date Banks had to either obtain a special Charter from the Crown to operate or had to ‘operate under unlimited liability (9/84) - DiehinulawechooboksimedThe Bank of Calcutta started in 1806 was the precursor of the Bank of Bengal, In 1862 the right of note issue was taken away from the Presidency Banks. The Government also withdrew their nominees as Directors on their Board. However, they were given the privilege of managing the Government ‘weasury at the Presidency Towns and at their branches. The Bank of Bombay collapsed in 1867 and was put into voluntary liquidation in early 1868. It was finally wound up in 1872, but the bank was able to meet its liability in full to the general public. Subsequently a new bank, aptly called the New Bank of Bombay, was started in 1867 to commence banking operations. “The Presidency Banks Act of 1876 was passed in order to have ‘a common law for all the three Banks in order to enable the government to regulate the working of these Banks. The Government had earlier withdrawn its shareholding from these three banks. “The Swadeshi Movement which prompted Indians to start many ‘new institutions also provided an impetus for starting new banks. The number of joint stock banks increased remarkably during the boom of 1906-13. The People’s Bank of India Ltd., The Bank of India, The Central Bank of India, Indian Bank Ltd and the Bank of Baroda were started during this period. This boom continued til it was overtaken by the erash of 1913-17, the first crisis that the Indian joint stock banks experienced. In 1921 the three Presidency Banks at Calcutta, Bombay and ‘Madras were merged into the Imperial Bank by the passing of the Imperial Bank of India Act 1920. ‘This bank did not have the power of issuing bank notes,but was permitted to manage the clearing house and hold government balances. With the passing of the Reserve Bank of India Act of 1934, the Reserve Bank of India came into being to act as the Central Bank. It acquired the right to issue notes and acted as the banker to the Government in place of the Imperial Bank. However, the Imperial Bank was given the right to act as the agent of the Reserve Bank of India in places where the Reserve Bank had ro branches. ‘By the passing of the State Bank of India Act 1955, the Imperial Bank was taken over and the assets vested in a new bank, the State Bank of India. The Reserve Bank was originally a shareholder's bank. It was nationalised by the Reserve Bank Amendment Act 1948, consequent to the nationalisation of the Bank of England in 1946, BANK NATIONALISATION The major historical event in the history of banking in India after independence is undoubtedly the nationalisation of 14 ‘major banks on 19th July 1969. ‘The imposition of social control ‘on the banks in early 1969 was deemed unsuccessful as the government felt that the Indian commercial banks did not inerease their lending to the priority sectors like agriculture, smal scale industry etc., Nationalisation was deemed as a major step in achieving the socialistic pattern of society 8 (Sys 4)- Dehindlawschostbooksimodulleortact aw ‘The nationalised banks were to increase lending to areas of importance to the government and to use their resources for subserving the common good. A detailed scheme of objectives, regulations, management, etc. was drawn up for these banks. In 1980 six more private sector banks were nationalised extending the public domain further over the banking sector. ‘Nationalisation was a recognition ofthe potential ofthe banking, system fo promote broader economic abjectives. The banks had to reach out and expand their network so that the concept of mass banking was given importance over class banking. Development of credit in the rural area was a prime objective. ‘The benefits of nationalisation has indeed been impressive, The branch network of these banks have spread practically all over the country especially in the rural and previously unbanked areas. ‘The branch network which was 8262 in June 1969 expanded to over 60000 by 1992 with a major expansion (80%) in ural areas. The average number of people served by a branch came down from over 60000 t0 11000, The deployment of credit is more widely spread all over the country as against only in the advanced states. In 1969 deposits amounted to 13% of G.DP and advances to 10%. By 1990 deposits grew to 30% and advances 25% of GDP. Rural deposits as a percentage of deposits grew from 3% to 15% making for increased mobilisation of resources from the rural areas. Deposits grew from a figure of Rs.4669 crores in July 1969 to Rs. 2,75,000 crores on 31.3.1993. 40% of the total credit was directed to the priority sector. More than 45% of the total deposits was used by the government to fund its five year plans However, this growth did not come without its costs, The banking system has grown too large and unmanageable. Customer service has suffered due to increasing costs and lower productivity. The directed credit program has led to large overdues affecting the very viability of the banking system. 1.4 VARIOUS TYPES OF BANKING SERVICES The flow chart given below shows the following types of banking services. 1, Central Banking Services 2, Commercial Banking Services 3 Specialized Banking Services 4, Non-banking financial services. 1, Central Banking Services : The Central Bank of any country (i) issues currency & bank notes; (i) discharges the treasury functions of the Government, (ii) manages the money affairs of the nation & regulates the internal and external value of money, (iv) acts as the bank of the Government and last bul rot the least, acts as the bankers” bank. 2. Commercial banking services: Commercial banking services include (i) receiving various types of deposits; (i) siving various types of loans, (ii) extending some non-banking customer services like facilities of locker, rendering services in paying directly house rent, electricity bill, share-calls, moneyor insurance premium and the like. Commercial bank also advises on investment re-investment, allotment or transfer of funds, 3. Specialized banking services : Special banking institutions are established for definite specialized banking services like industrial banks to supply industrial long term credit and working capital; land mortgage bank for granting loans on equitable mortgage; Rural Credit Banks for generating funds for extending rural credit; developmental banks to support any developmental activities. These types of banks accept all types of deposits but mobilises the amount in its specially focussed 4, Non-Banking Financial Services: Many institutions are established for carrying on non-banking financial services. Mutual funds are institutions accepting finances from its, _members and investing in long term capital of companies both, directly inthe primary market as well as indirectly inthe capital market. Financial institutions acting as portfolio managers receive funds from the public and manage the funds for or on bchalf of its depositors. This port-folio managers undertake the responsibility of managing the funds of the principal so as, (o generate maximum return, ‘Various Types of Banks and Banking Functions Central Bank Commercial Specialised Institutional Non-Banking Banks Banks Banks Financial Institutions Mutual Funds Nationalised State Bank [Hand Mortgage irc uml Banks (20) LIC Of India & © [ ~Rural Credit | sics Other MF Associate Industrial Development |_ jy) and LIC, Private Banks Co-operative [— Icict are ———— lousing Finance Bank Indi Fe ne mor c nk is Export Import | NABARD rive Secon Bank of India L upee vate Sector Non-Banking SOCIAL CONTROL MEASURES ON BANK The Indian economy in the 1960's passed though a stressful ‘phase due to drought and wars. Political uncertainty and popular discontent too caused concern. The Government veered around, towards ensuring a socialistic pattern of society. The Banking, Regulation Act was amended in 1968 to provide for social control over the banks. Under these measures the Board of Directors of the banks were reconstituted so that $1% of their number was made of persons having special knowledge or experience in accountancy, agriculture, rural economy, small scale industry, co-operation, banking, economic laws ete. A quota was specified for certain categories. The Reserve Bank of India (RBD) was given powers to reconstitute the Board. A fulltime Chairman was o be appointed who was a professional banker, with prior approval of the RBI. The Government also acquired power to acquire any bank in case it failed to comply with any direction issued (o it under the Banking Regulation Act, as regards banking policy. Financial Com, 1.6 THE NARASIMHAM COMMIT EE REPORT: ‘The 1980's were the decade of private enterprise all over the ‘world. The collapse of the USSR at the end of the 1980's is the end of one experiment of socialism. In India the country went through traumatic moments in 1990, after the heady economic ‘growth in the 1980's, due to a foreign exchange crisis on account of large scale external borrowings in the 1980's, that had ‘weakened the country's ability to service its debts. ‘The government felt that there was a need to initiate reform in the financial system and banks, as the system had developed ‘weaknesses. A great part of the savings of the community was pre-empted by the Government inthe form of the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio(SLR). Banks were burdened by a large percentage of non- performing loans. Customer service had suffered, and out-moded practices were in vogue. Internal weakness due to bad house-keeping practices hhad inereased. The Narasimham Committee was set up (© recommend changes in the financial system, The Narasimham Committee made revolutionary recommendation emphasising the need for de-regulation and (9/84) - Diehinulawechooboksimedliberalisation. Banks were to be allowed to raise capital from the public, Also no further nationalisation of banks were to be made. New private sector banks were to be allowed and no distinction was to be made between private and public sector banks. Forcign banks were to be allowed freedom to open branches. The pattern of banking structure should be broadened with 3-4 large banks on a international level 8-9 large banks on, ‘national level and the other as local banks. Control over the banking system should be centralised with the RBI and not split between the RBI and the department of banking of the government. A separate body, quasi autonomous, operating tunder the aegis of the RBI is to be formed to supervise the functioning of the banks. The SLR and the CRR should be reduced to prudent levels. Concessional lending should be phased out. Deposit interest rates should be raised along with the reduction of SLR. ‘The capital base of banks should meet with international norms of capital adequacy; provision was to be made for bad debts with special tribunals to be formed for realising bank debts. The appointment of Chief Executive of 10 (Sys 4)- Dehindlawschostbooksimodulleortact aw banks needs to be de-politicised and banks should be free (© make their own recruitment of employees and officers. ‘Some of the recommendations made have already been accepted and put into practice by the government while others are being considered, The wheel appears to have come full circle. While nationalisation has given immense benefits to the country, it has also exposed the defects in an excess of State control. At this present point, the future appears to be towards an open system based on increased private ownership. 1.7. CONCLUDING REMARKS ‘The banking system in India is likely to undergo a major change. Restrictions imposed upon foreign banks to establish Indian branches are going to be gradually withdrawn, The GATT multilateral treaty emphasised the role of free operations in the services sector like banking and insurance. As a result, itis expected that there shall be more openings inthe banking sector.8. CASE LAW Sajjan Bank Pyt, Ltd. v RBI (30 Comp. Cases, 146) The petitioner, a banking company which was in existence at the commencement of the Banking Companies Act, 1949, applied to Reserve Bank on Sept. 14, 1949, under section 22 of that Act for a licence to carry on banking business. Officers of the Reserve Bank inspected the banking company under section 22 ofthe Actin July, 1952, but as the inspection revealed defects in the method of keeping accounts and contravention of certain, provisions of the Act, the Reserve Bank kept in abeyance consideration of the question of issuing a licence. A fresh inspection carried out by the Reserve Bank under section 35 in September 1956, four years lateralso revealed certain defects. The Reserve bank not being satisfied that the affairs of the banking company were being conducted in the interests of the depositors, directed the banking company to show cause against the refusal of the licence and after considering the representations of the banking company,declined to grant the licence. Aggrieved by the refusal,the petitioner applied to the High Court for the issue of a writ of Certiorari quashing the order refusing the grant of the licence. ‘Three conditions were raised in the writ petition: (i) that Section 22 of the Banking Companies Act was unconstitutional in so far as it proceeded to restrict the fundamental right of the petitioner to carry on its business,namely the banking businesss(i) even if the provisions of the Sec 22 of the Act be held to be in accordance with the constitutionthe action of the respondent was arbitrary;and (iii) in any event the procedure adopted by the respondent was illegal and in that,afler an inspection under section 35,it could only proceed to act under Section 35(4) and not refuse the licence altogether. ‘The court held thatthe provisions of Section 22 of the Banking, Companies Act prescribed only a system of licensing with a view of regulating the banking business and was not repugnant to the provisions of Article 19(1)(g) of the Constitution. The provisions in Section 22 investing the Reserve Bank with the power to grant, refuse to grant or cancel, a licence did not, amount to an excessive delegation of legislative power. There was sufficient legislative guidance for the granting of licence embodied in the provisions of the Act, and of Section 22 in particular, and delegation of the power, having been made to ‘non-political body statutorily concerned with the credit structure of the country, the restriction imposed in the regulation of the banking business was nothing but reasonable. The power that was given to the Reserve Bank under the Act was a wide range of administrative discretion which it was peculiarly competent to undertake, and the determination whether the conditions which were required before the licence could be given or refused exist, was peculiarly within its competence as an expert statutory body. ‘The legislature having prescribed the nature of a real banking institution inthis country it could not be said that there was any excessive delegation of power. The provisions of Sec.35 (4) which empowered the Central Government to prohibit a banking company from continuing its business on the report of the Reserve Bank after inspection under Section 35, related to a banking company to which a licence has already been granted. It was open to the Reserve Bank to consider the defects revealed in an inspection under ‘8.35 for disposing of an application for the grant of a licence under See.22. Finally the court held that the jurisdiction of the Reserve Bank to refuse to grant a licence to the petitioner was properly exercised. ‘The powers vested in it under Section 22 of the Banking Companies Act are not ones invested with a mere officer of the bank. The standards forthe exercise of the power hhave been laid down in Section 22 itself. The Reserve Bank is ‘anon-political body concerned withthe finances of the country. ‘When a power is given to such a body under a statute which prescribes the regulations of a banking company, it ean be assumed that such power would be exercised so that geniune banking concerns could be allowed to function as a bank, while institutions masquerading as banks or those run on unsound lines or which would affect the interests of the public could be ‘weeded out. The nature of the power and its exercise after the investigation prescribed by the statute invested it with a quasi judicial character. Such a power cannot be said to be an arbitrary In re Supreme Court of India Ltd. v. Official Liquidator and Others (37, Comp. Cases. 392.) Five appeals arose out the order of the learned Company Judge in misfeasance proceedings against the Directors and Officers of a banking company by name The Supreme Bank of India LLtd., taken on an application of the official liquidator during the course of its winding up proceedings, (On appeal the High Court held that though both Section 196 of the Companies Act, 1913 & Section 45B of the Banking, Companies Act, 1949, provide for public examination of a Director or an officer of a company as to promotion, formation or the conduct of the business of the company or as to his conduct and dealings as Director or Manager or other officer, See. 196 of the Companies Act enables the liquidator to make such an application for public examination only when he is of opinion that fraud had been committed by a Director, while under Section 45G of the Banking Companies Act, all that is necessary for the liquidator to make such an application, is that, he should be of opinion that any loss had been caused to the banking company by any Act or omission of the Director, whether or not any fraud has been committed by such Act or Omission, The duties of the Directors were summarised by the court in the Following terms: 1, The Directors are not bound to give continuous attention to the affaits of the bank and their duty is of an intermittent nature to be performed at the periodical Board Mectings and the Meetings of Sub-committees of the Board, They are not bound to check the cash of the bank or the books of account to detect shortage of cash or manipulation of bank balances; 29 (9/84) - Diehinulawechooboksimed2. To begin with, the Directors are entitled to trust the Managing Director and other officers of the Bank to perform their duties honestly. They are entitled to continue to repose such trust until there are grounds for suspicion; 3. Once there was any ground for suspecting the honesty, competence or skill of the Managing Director or other officers of the bank, the Directors are bound to exercise such reasonable care as an ordinary prudent man would do in his own case, in order to avert losses fo the company. Even afer such ground for suspicion if they shut their eyes and do not take any effective steps to prevent losses resulting from their wilful neglect, they would make themselves liable for the resulting losses; 4, Until there is such ground for suspicion, the directors are not liable for losses due to the mistake, negligence or dishonesty of the managing director and other officers of the company, although such losses could have been averted if the directors had taken care; and 5. The crucial question in such cases is, therefore, whether there were any circumstances arousing the suspicion of the directors and, ifso, when should their suspicions have been aroused, Sardar Gulab Singh v. Punjab Zamindara Bank Ltd. (AIR 1942 Lah.47) ‘The plaintiff Managing Director of the company brought a suit against the company for a declaration that he was the managing director of the company and for injunction restraining the company from preventing him from discharging his duties. The ‘tial court decreed both the declaration and the injunction prayed for. On appeal the learned Senior Subordinate Judge dismissed the suit. On second appeal the High Court allowed the appeal as regards the declaration, but dismissed it with regard to the injunction. Both parties filed appeals. The plaintiff against the decision allowing him an injunction and the defendants against the decision granting the plaintiff declaration, The Court held that even if the memorandum and articles of association of a company are held not to constitute a contract, Jn themselves, an implied contract may be proved by the acts of the parties on the (erms set out in the articles of association of the company. Where in pursuance of certain articles acted upon by the company a shareholder was appointed Managing, Director and acted as Managing Director for 11 years and was remunerated in accordance with the terms set out inthe articles, the articles constituted an implied contract between the company and the share-holder so as to entitle him to the declaration that, he was the managing director of the company. With regard (o the second point, whether Sardar Gulab Singh js entitled to an injunction, the court held that it would not be proper to issue an injunction. In this connection the court observed that the position of the company and that of Sardar Gulab Singh as managing director was that of master and servant. With great respect we do not think that this is correct. A Director or Managing Director is in no way a servant of the company, he is the agent of the company for carrying on its 30 (Sys 4)- Dehindlawschostbooksimodulleortact aw business. But we agree that the same prineiples which have been held to apply to the issue of an injunction at the instance of a dismissed servant ought also to apply in the case of a dismissed agent. It would be contrary to public policy to impose upon an unwilling principal an agent whom he does not wish to employ, especially as there is nothing to prevent an agent whose contract of agency has been wrongfully broken from bringing an action for damages. Andhra Bank Ltd. v. Bonu Narasamma [(1988) 63 Com.Cas.p.328] In this case an appeal arose out of a suit filed for recovery of ‘Rs.2,87,681.85 with interest and in default of payment for the sale of the scheduled properties to realise the suit debt. The learned counsel for the appellant contended that the levy of interest by A.PBank is linked with and based upon the rate of ixed by the Reserve Bank and the question of charging penal or unconscionable interest does not arise and in any event such contention does not survive in view of S.21A of the Banking Regulation Act. On the other hand learned counsel, for the respondents secking to sustain the judgements of the courts contended that the levy of such exorbitant interest by a nationalised bank is unconstitutional as it is beyond the legislative competence of Parliament and isin breach of Art.14 of the constitution, ‘The High Court held that the provisions of See.21 A of the Banking Regulation Act, 1949, declaring that the rates of interest charged by banking companies shall not be subject to scrutiny by the courts from the point of view of excessiveness are within the legislative competence of parliament under entry 45 of list, I of Sch. VIL of the Constitution of India, which pertains to ‘banking’. The charging of interest is interwined with banking business and the element of interest is ingrained in the veins of all dealings in society. ‘The bank is a ‘dealer in credit’. Section 2IA strives to safeguard the levy of interst and quantum of interest charged and Section 21s essentially concerned with the banking operation and therefore, within the legislative competence of Parliament, ‘The Court further held that Sec. 21A does not violate the provisions of Art.14 of the Constitution, The modalities and the quantum of interest is uniform in all the banks as regulated by the Reserve Bank. ‘The charging of interest is tied up with the interest fixed by the Reserve Bank. The Reserve Bank is entrusted with diverse powers for regulating the banking business in the country and the Reserve Bank taking stock of the prevalent economic growth, cost of living, index, purchasing, and paying capacity and other factors fixes the rate of interest chargeable by the banks, Banking Companies are bound to adhere to the guidelines and directions given by the Reserve Bank. The rate of interest chargeable by the banks is rooted in the rate of interest fixed by the Reserve Bank and as a sequel of the decision of the experts, apparently with a view to having a uniform rate of interest in all banking companies throughout the country at all times and situations, The jurisdiction of Civil Courts is taken away.6. MONETARY CONTROL SUB-TOPICS 6.1 Introduction 6.22 Bank rate 6.3 Open market operations 64 Cash reserve 68 Statutory Liquidity Ratio 6.6 Interest rate 6.7 Selective Credit Control 6.8 Regulation of non-banking institution 6. Directions 6.10 Un-incorporated bodies. 6.1 INTRODUCTION Monetary Control is the main function of the Reserve Bank, as it is the Central Bank of the country. Formulating and administering monetary policy involves using of instruments within its control to influence the level of aggregate demand for goods and services by regulation of the total money supply and credit, The Reserve Bank exercises monetary regulation by influencing the availability and cost of credit by exercising different types of controls. General or quantitative controls are the instruments of Bank rate, reserve requirements and open ‘market operations. These methods affect the total money supply. The other types of controls called selective eredit control envisage the increase or decrease of margins upto which the commercial hanks can finance sensitive commodities like foodgrains, edible oils, cotton, pulses.ete. It exercises control over the direction of credit, namely the flow of credit to a particular commodity or sector of the economy. Control over interest rates on acceptance of deposits by non-banking, institution also forms a part of monetary control 62 BANK RATE Bank rate is defined in Section 49 ofthe RBI Actas the standard rate at which the Bank is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under the Act. In India Bank Rate has been changed frequently to effect change in the cost of funds available from Central Bank to banks and financial institutions. In actual practice, due to the absence of a genuine bill market, the rate on advance by Reserve Bank has become important and that rate has been commonly treated as the equivalent of Bank rate The effectiveness of bank rate as an instrument of monetary control depends on the extent of operation in the money market, and also on how far the commercial banks resort to borrowing, from Reserve Bank. Money market is the centre for dealings in monetary assets of short term nature. In Indian conditions, raising or lowering of the bank rate is of little operative significance as there is no well developed bill market. However, it is an important indicator of changes in the direction of the 50 (Sys 4)- Dehindlawschostbooksimodulleortact aw credit policy of the Reserve Bank as itis usually offered along ‘with the other control measures of the RBI as a package. 6.3 OPEN MARKET OPERATIONS. Section 17(8)of the Reserve Bank of India Act authorises the Reserve Bank to engage in the purchase and sale of securities of any maturity of the Central Government and the State Governments. Securities of local authorities like the State Electricity Boards, Water Supply and Sewerage Boards, Housing Boards, etc may also be purchased as specified by the Central Government on the recommendation of the Central Board of the Reserve Bank. A security whichis fully guaranteed by the Government or the authority concerned as tothe principal and interest is deemed to be a secutity of such Government or authority. Reserve Bank is also authorised to purchase and sell ‘commercial bills of short-term maturity under Section 17(2) of the Act ‘Open market operations are used by a Central Bank to alter the liquidity position of banks by dealing directly in the market instead of indirectly influencing it by variation of cost of credit. Reserve Bank can influence the resources or cash base of commercial banks by purchase and sale of Government securities in the open market, Open market operations can be carried out by purchase and sale of a variety of assets such as, Government securities, commercial bills of exchange, foreign exchange, gold and even company shares. In actual practice they are confined to the buying and selling of Government securities (RBI, 1983, p80). When securities are purchased from the open market, the reserves of the banks with the Reserve Bank increases and they can acordingly expand credit. Similarly selling of Government securities has the effect of contraction of eredit and reduction in supply of money. The market for Government securities being very narrow, namely public debt being held by a few institutions and their operations being limited, the potency of this instrument of monetary control is, reduced to that extent. Now these operations are used more t0 assist Government in its borrowing than as an instrument (0 influence the cost of credit. (Tannan, 1987 p 56). 64 CASH RESERVE Section 42 of the Reserve Bank of India Act and Section 18 of the Banking Regulation Act deal with cash reserves to be kept with the Reserve Bank by scheduled banks and non-scheduled banks respectively. “Scheduled bank’, as defined in Section 2(e) of the Reserve Bank of India Act means a bank included in the second schedule of the Act. Under Sub-section (6) of Section 42, a bank operating in India may be included in the Second Schedule by the Reserve Bank on the following conditions (The aggregate value of paid-up capital and reserves is not less than Rs. 5 lakhs;Gi) Satisfes the Reserve Bank that its affairs are not being ‘conducted in a manner detrimental to the interests of its depositors; and Is a State Co-operative Bank or a company of an institution notified by the Central Government in this behalf or a company, corporation incorporated under any law in force in any place outside India. Gi) The Bank is also empowered to direct exclusion of any scheduled bank from the Second Schedule if its paid up capital and reserve fall below the stipulated minimum, or its affairs are conducted in a manner detrimental to the interests of depositors (as found by the Bank after making an inspection of the Bank under Section 35 of the Banking Regulation Act) orit goes into liquidation or otherwise ceases to carry on banking, business. ‘The Bank may defer the making of such direction on an application from the scheduled bank concerned and give time, subject to suitable conditions, to increase capital and reserve or to remove the defects in the conduct of its affairs heduled banks have to maintain under sub-section (1) of Section 42, an average daily balance of not less than 3% of the total demand and time liabilities in India of such banks. Further, the Reserve Bank is empowered to increase the rate of cash reserve by notification in the official Gazette upto 20% of the total demand and time liabilities. ‘Liabilities’ for this purpose is defined in clause (¢) of the explanation to Section 42(1). The paid up capital, reserves and any credit balance inthe profit, and loss account of the bank as also any Toan from the RBI, the Industrial Development Bank of India, Exim Bank and certain other financial institutions is specially excluded from ‘Liability’ Similarly in the case of State Co-operative Banks certain liabilities like loans from State Government and in the ease of Regional Rural Banks, loans from Sponsor Banks are excluded. Further, under sub-section (IC), the Bank may speeify from time to time whether any transaction or transactions shall be regarded as liability of a scheduled bank for the purpose of cash reserve or not and in case of any doubt, the decision of the Bank shall be final. Sub-Section (1A) of Section 42 empowers the Bank to direct, scheduled banks to maintain a specified additional average daily balance from any specified date. Such additional balance is calculated with reference to the excess of the total of the demand, and time liabilities of a bank as shown in its return under sub- section (2) Section 42 over the total of the demand and time Tiabilities atthe close of business over the date specified in the notification. The additional balance should not be more than such excess and the total cash reserve should not in any case exceed twenty percent of the bank's total demand and time liabilities, Where any scheduled bank maintains additional balance as required under sub-section (1) or (IA), interest is payable at, the rates determined by the Bank. However, no interest is payable in respect of any balance in excess of the requirement, Every scheduled bank has to send to the Reserve Bank a return under Section 42(2) showing the amount of its demand and time liabilitcs and the amount of its borrowings from banks in India classifying them as demand and time liabilities and other details of its holdings, advances and investments, at the close ‘of business on each alternate Friday. Such returns have to be sent not Iater than seven days after the date to which it relates. ‘Scheduled banks have also to submit another return as at the close of business on the last Friday of every month (where itis not an alternate Friday) under sub-section (2) giving the details as required in fortnightly returns. However, in practice, itis ound that these returns are not properly compiled and submitted in time on account of the very large network of branches. In cases where the cash reserve falls short of the requirement under sub-section (1) and (1A), such scheduled banks are not entitled to interest on the reserve maintained and are also liable to pay panel interest on the short fall initially atthe rate of 3% above Bank rate and thereafter at the rate of 5% above Bank rate, Continued default will make every director, manager or secretary ofthe scheduled bank who is knowingly and willingly «party to the default punishable with fine. Further, the Bank is also empowered to prohibit the scheduled bank from receiving fresh deposits if the default persists. Default in complying with such probibition is also punishable with fine. Sub-section (4) provides for penalty for failure to comply with the provisions of sub-section (2) regarding returns. Sub-section (S) provides, for realisation of penalties imposed by issuing demand notice to the scheduled bank. If the amount is not paid within 14 days, Reserve Bank may apply to the principal Civil Court for a direction to levy the fine, ‘The Court making such direction shall issue a certificate specifying the sum payable which is enforceable like a decree in a suit. If the Bank is satisfied that the defaulting bank had sufficient cause for the default it may rot demand payment of penal interest or penalty. The requirement of cash reserve under Section 18 of Banking ‘Regulation Act for non-scheduled banks is also at least 3% of the total demand and time liabilities in India, Such cash reserve ‘may be maintained with the bank itself or by way of balance in f current account with the Reserve Bank or by way of net, balance in current accounts (with State Bank, its subsidiaries or nationalised banks) or in one or more of the aforesaid ways. TThe bank has to submit a return to the Reserve Bank before 20th of every month; a return showing the amount so held on alternate Fridays during a month with particulars of its demand, and time liabilities in India on such Fridays. 6.5 STATUTORY LIQUIDITY RATIO (SLR) Banks are required under Section 24(1) of the Banking Regulation Act, 1949 to maintain in India liquid assets in cash, gold or unencumbered approved securities amounting to 20% ofits total demand and time liabilities. “Approved security’, as, defined in Section S(a) of the Act means securities in which a trustee may invest money under Clauses (a), (b) (bb), (€) or (@) of Section 20 of the Indian Trusts Act, 1882 and certain other securities authorised by the Central Government. “Unencumbered approved securities” include approved securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against. SI (9/84) - DiehinulawechooboksimedThis provision enabled banks to liquidate their Government security holdings, to offset the impact of variable cash reserve requirements. Hence, sub-section (2A) to section 24 was {introduced in 1962 to require all banks to maintain a minimum amount of liquid assets of not less than 25% of their demand and time liabilities in India, excluding the cash balances to be ‘maintained under Section 42 of the Reserve Bank of India Act in the case of scheduled banks and that under Section 18 of the Banking Regulation Act in the ease of non-scheduled banks. The Reserve Bank is empowered to increase it up to 40 per cent. The balances maintained by scheduled banks on their ‘own in excess of the requirement of cash reserve ratio under Section 42 of the Reserve Bank of India Act or any balances in current account with State Bank or any notified bank are counted for the purpose of statutory liquidity ratio. Deposits of foreign banks with Reserve Bank under Section 11(2) of the Banking. ‘Regulation Act and any cash balances of non-scheduled banks with themselves or in current account with Reserve Bank, State Bank or any notified bank in excess of the requirements under Section 18 of the Banking Regulation Act and any balances ‘maintained by a Regional Rural Bank with its sponsor bank are also counted as liquid assets. The percentage of liquid assets maintainable by a Regional Rural Bank may be varied by the Reserve Bank by notification. ‘Banks have to submit a monthly return to the Reserve Bank tunder sub-section (3) of Section 24 for ensuring compliance with the requirements of liquidity ratio. Sub-section (4) provides for payment of panel interest by defaulting banks, which is 3 per cent above Bank rate initially and liable to be increased to 5% above Bank rate for continued default. When Reserve Bank is satisfied that the defaulting bank had sufficient cause for its default, penal interest may be waived. The penalty is payable within 14 days of demand by notice failing which the Reserve ‘Bank may obtain a direction and a certificate from the principal Civil Court which may be enforced in the manner of a decree from a civil court In case of default even afer increased penal interest becomes payable, Section 24(7) provides for punishment with fine. 6.6 INTEREST RATE, Reserve Bank exercises direct control over the lending rates of banks by influencing cost of bank credit by increase or decrease in the lending rates rather than the Bank rate. The relevant statutory provisions are sections 21 and 35A of the Banking, Regulation Act. Under Section 21, Reserve Bank is empowered to issue direction to banks in public interest or in the interests of depositors or banking policy. Such direction may, among, other things, stipulate the rate of interest and other terms and conditions on which advances may be made. Further, Section 35 authorises the Reserve Bank to issue directions to banks when itis satisfied that itis necessary to do so, in the public interest, in the interest of banking policy, to prevent the affairs of the banks being conducted in a manner detrimental to the Interest of the depositors and also to secure proper management of the banks. Under these provisions namely Section 21 and. 2 (Sys 4)- Dehindlawschostbooksimodulleortact aw 235A, Reserve Bank has issued direction regarding interest rates, fon both deposits and advances of banks. Section 21A of the Banking Regulation Act stipulates that notwithstanding the Usurious Loans Act, or any other law for the time being in force in any State relating to indebtedness the transaction between a bank and its debtor shall not be reopened by any court on the ground that the rate of interest charged by such bank is excessive, The Reserve Bank can accordingly fix the lending rate or the maximum or minimum lending rates, However, this has no bearing on the court’s jurisdiction to give rolief to an aggrioved party when itis established that a bank thas charged interest in excess of limit prescribed by the Reserve Bank. (H.P. Krishna Reddy v. Canara Bank, AIR 1985 Kant, 285; sce also Bank of India v. Karnam Renga Rao AIR 1986 Kant 246 regarding compounding of interest on agricultural loans and Jameela Beevi v. SBT, (1992) 74 Comp. Cas 736 rogarding Reserve Bank's power to regulate interest rate.) 6.7 SELECTIVE DIT CONTROL, "Selective Credit Control’ refers to regulation of distribution of direction of bank resources to certain sectors of the economy. This is done in terms of the broad national policies for achieving, developmental goals. Selective Credit Control is used by the Reserve Bank along with general eredit control. The provision of Sections 21 and 35A of the Banking Regulations Act empower the Reserve Bank here also. The wide powers conferred under these provisions enable the Reserve Bank to determine the policy in relation to advances to be followed by banks. ‘The directions may, apart from rate of interest, deal with the following aspects of advances: (‘The purpose of advances, for example, to prevent hoarding ‘of sensitive commodities like foodgrains, pulses, edible oils, ates, (Gi) Margins to be maintained in case of secured advances and (i) Maximum amount of advances or other financial accommodation to a single borrower. Such direction may be given to banks generally or to a specific bank. Selective credit control is exercised by Reserve Bank by stipulating (i) minimum margins for lending against selected commodities (ii) ceilings on the levels of credit and (fii) rates of interest on stipulated commodities. The first two control the ‘quantum of eredit and the last, the cost of eredit. By judietous use of these instruments, itis possible to regulate the availability of credit to different sectors of the economy. 6.8 REGULATION OF NON-BANKING INSTITUTIONS. 3 growth of non-banking institutions in the country and ppting deposits from the public at very high rates of, interest raised the question of regulating their activities. As credit from the banking sector was under the control of the Reserve Bank, the non-banking institutions had a ready market ‘and many unhealthy practices developed in course of time.Hence control over the acceptance of deposits by non-banking, institutions was conceived as an adjunct to monetary and credit, policy and also with a view to protecting the interests of depositors. Chapter IIE-B of the Reserve bank of India Act was introduced in 1964 by an amendment of the Act conferring powers on the Reserve Bank to regulate the acceptance of deposits by non-banking institutions. Chapter III of the Act which was introduced in 1984 secks to regulate the acceptance cf deposits by unincorporated bodies. The Prize Chits and Money Circulation Schemes (Banning) Act, 1978 and the Chit, Funds Act, 1982, were enacted pursuant to the recommendations of a study group appointed by the Reserve Bank in 1974 to examine the then existing statutory provisions and the directions, thereunder to suggest further regulatory measures. This statute ‘on prize chits and money citculation schemes is administered by the States and Union territories but the rules are required to be framed in consultation with the Reserve Bank, Further, the Bank has an advisory role for the winding up of the existing prize chits and money circulation schemes and generally on the implementation of the Act, The Chit Funds Act is also administered by the State Governments and the Reserve Bank has only advisory role in the framing of rules, giving exemption from the provisions of the Act and generally on question of policy. Sections 451, 45K and 45L of the Act empower the Reserve Bank to regulate acceptance of deposits by non-banking institutions. “Deposit” as defined in Section 451(bb) includes any receipt of money by way of deposit or loan or any other form except those specifically excluded. The excluded cealegories are = ) amounts raised by way of share capital fi) share capital brought in by partners. iii amounts received from banks and financial institutions. jv) amounts received in ordinary course of business by way of security deposit, dealership deposit,carnest money and advance for orders of goods and servicessand vy) subscriptions to chits Non-banking institution’ as defined in Section 451(c) means a company, corporation or co-operative society. ‘Financial institution’ as defined in Clause (¢) of Section 45-1 means any non-banking institution which carvies on the types of business specified therein. Section 451, provides for the Reserve Bank to regulate or prohibit in public interest issue of prospectus or advertisement soliciting deposits from the public, Section 45K provides for collection of information from non-banking institution regarding. deposits and also for issuing directions on matters relating to receipt of deposits including rates of interest and period of the deposit. On failure to comply with such directions, acceptance of deposits may be probibited, Under 45L, Reserve Bank may call for information from financial institutions and give direction relating to the conduct of the business of financial institutions, Non-banking institutions have a duty to furnish statements, information and particulars as called for by the Reserve Bank. ‘There is also provision under Section 45N for inspection of non-banking institutions by the Reserve Bank. Further soliciting of deposits, ‘on behalf of a non-banking institution by unauthorised persons is prohibited. According to Section 45Q, Chapter Il B shall over ride the provisions of other laws, With the amendment to Companies Act, 1956 introducing Section S8A (See also, Companies acceptance of Deposit Rules, 1975. For a detailed discussion, see, Ramaiya, (1988, pp 231-47), regarding prohibition of prize chits, See AIR 1981 SC S04) the Central Government is empowered to exercise control over acceptance cf deposits by non-banking non-financial companies and over advertisements for acceplance of deposits by all clauses of ‘companies. 6.9 DIRECTIONS, Under the authority of Section 45J, 45K and 45L, the Reserve Bank has issued the Non-Banking Financial Companies (Reserve Bank Directions 1977, the Miscellaneous Non- Banking Companies (Reserve Bank) Directions, 1977 and the Residuary Non-Banking Companies ( Reserve Bank) Directions, 1987. These directions are applicable to financial ‘companies or other non-banking companies as specified in the directions. These directions impose several restrictions on rate of interest, period of deposit, maintenance of assets ete. which, are modified from time to time. (See Peerless General Finance & Investment Company Ltd. v. RBI AIR 1992 SC 1033). 6.10 UNINCORPORATED BODIES Chapter III C of the Reserve Bank of India Act prohibits acceptance of deposits by individuals, firms or unincorporated bodies from more than the number of depositors specified therein. (See, (1993) 77 Comp. Cas (Part II) p.197). Accordingly an individual may not accept deposits from more than 25 persons excluding relatives of the individual. In the cease of firms the ceiling is twentyfive depositors per partner and two hundred and fifty depositors in all excluding relatives cf partners. In the case of unincorporated associations also the limit is twenty five depositors per individual and two hundred and fifty depositors in total excluding relatives of the individuals forming the association. “Relatives” for this purpose are detined in the Explanation to Section 45 $(2). However, any period not exceeding 6 months in any account relating to mutual dealings in the ordinary course of trade or business shall not be deemed to be a depositor on account of such balance. Under Section 45°T an authorised officer of the Bank or of the ‘State Government may obtain warrant from the court for search, of any place where documents regarding acceptance of deposits, in contravention of the provisions of Section 45 S are believed tobe kept. The Bank has no powers to regulate interest rate or impose other conditions regarding acceptance of deposits by unincorporated bodies. However, acceptance of deposits from more depositors than specified being in contravention of the provisions of the Act, the Bank can initiate prosecution under sion 58 B read with Section 58 E of the Act. 3 (9/84) - Diehinulawechooboksimed2. LICENSING OF BANKING ACTIVITIES SUB TOPICS 2.1. General provisions about Licensing 2.2 RBI Guidelines 2.1 GENERAL PROVISIONS ABOUT LICENSING Section 22 of the Banking Regulation Act deals with the Licensing provisions of Banking Companies 1) Save as hereinafter provided, no company shall carry on banking business in India unless it holds a licence issued in that behalf by the Reserve Bank, and any such licence may be issued subject to such conditions as the Reserve Bank may think fit to impose. 2) Every banking company in existnece on the commencement of this Act, before the expiry of six months from such commencement, and every other company before ‘commencing banking business in India, shall apply in ‘writing to the Reserve Bank for alicence under this section: Provided that in the case of a banking company inexistence ‘on the commencement of this Act, nothing in sub-section (1) shall be deemed to probibit the company from carrying ‘on banking business until itis granted a licence in pursuance of this section or is by notice in writing informed by the Reserve Bank that a licence eannot be granted to it Provided further that the Reserve Bank shall not give a notice as aforesaid to a banking company in existence at the commencement of this Act before the expiry of the three years referred to in sub-section (1) of section 11 or of such further period as the Reserve Bank may under that sub- section think fit to allow. 3) Before granting any license under this section, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the following. conditions are fulfilled, namely :- 8) thatthe company is or will be in a position to pay its present or future depositors in full as their claims ') that the affairs of the company are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors ; ©) that the general character of the proposed ‘management of the company will not be prejudicial to the public interest or the interest of its depositors 4) that the company has adequate capital structure and ‘earning prospects; ) that the public interest will be served by the grant of licence to the company to carry on banking business in India ; that having regard to the banking facilities available in the proposed principal area of operations of the ‘company, the potential scope for expansion of banks 8 (Sys 4)- Dehindlawschostbooksimodulleortact aw already in existence in the area and other relevant factors the grant of licence would not be prejudicial to the operational and consolidation of the banking system consistent with monetary stability and economic growth ; 2) any other condition, the fulfilment of which would, in the opinion of the Reserve Bank, be necessary t0 ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors. 3A) Before granting any licence under this section to a company incorporated outside India, the Reserve Bank may require to be satisfied by an inspection of the books of the company ‘or otherwise that the conditions specified in sub-section (Q) are fulfilled and that the carrying on of the banking business by such company in India will be in the public interest and that the Government or law of the country in which itis incorporated does not discriminate in any way against banking companies registered in India and that the ‘company complies with all the provisions of this Act applicable to banking companies incorporated outside India, 4). The Reserve Bank may cancel licence granted to a banking, ‘company under this section _ ) if the company ceases to carry on banking business in India ; of ii) ifthe company at any time fails to comply with any of the conditions imposed upon it under sub-section, (or iii) if at any time, any of the conditions referred to in sub-section (3) and sub-section (3-A) is not fulfilled: Provided that before cancelling a licence under clause (ii) for clause (ii) of this sub-section on the ground that the banking company has failed to comply with or has failed 1 fulfil any ofthe conditions referred to therein, the Reserve Bank, unless itis of opinion that the delay will be prejudicial to the interests of the company’s depositors or the public, shall grant to the company on such terms as it may specify, an opportunity of taking the necessary steps for complying with or fulfilling such condition, 5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a licence under this section may, within 30 days from the date on which such decision is ‘communicated to it, appeal to the Central Government, 6). The decision of the Central Government where an appeal has been preferred to it under Sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be final. This section originated with the demand for licensing of foreign banks doing business in India and was also recommended by the Indian Central Banking Enquiry Committee, mainly with the object of prohibiting the entry of banks started in countries‘which discriminated against banks started in India, The above section, however, introduces a comprehensive system of licensing of banks incorporated in India is dependent upon the ‘maintenance ofa satisfactory financial condition coupled with the additional qualification in case of forcign banks, vide sub- seotion (3A) which has been inserted by the Banking Laws (Amendment) Act, 1983 (1 of 1984) on the basis of existing clause (¢) of sub-section (3, thatthe countries of their origin do not discriminate in any Way against banks registered in India Ttalso provides for the issue of conditional licence. Laws of certain forcign countries such as Switzerland, U.S.A and Sweden have almost similar provisions. The requirements under this section may be classified under following three heads (a) necessity of licensing and mode of applying for it (©) conditions for granting of licences and compliance with further condition; (©) cancellation of licences and appeals from such orders No banking company ean commence or carry on banking business in India until it holds a licence granted to it by the Reserve Bank for the purpose. In the case of banking companies to be started, before granting a licence to them the Reserve Bank may require to be satisfied whether the conditions given in sub-section (3) of section 22 are fulfilled. By the Banking Laws (Amendment) Act, 1983 clauses (€) to (g) have been substituted for existing clause (c) wef. 15.2.1984, so as to widen the scope of the matters which the Reserve Bank may consider before granting licence. Itamy be added that while a banking company whose licence is cancelled by the Reserve Bank has the right to appeal to the Central Government whose decision is to be regarded as final, no such appeal can be preferred by & new banking company whose application for licence is turned down, In Sajjan Bank (P) Ltd, Vs. Reserve Bank (30 Comp.Cas. 146), thas been held that the provisions of Section 22 of the Banking, Regulation Act, 1949 prescribe only a system of licensing, having for its object the regulation of the business of banking and does not violate fundamental right of any person to carry ‘onthe business of banking, It was also laid down thatthe powers vested in the Reserve Bank of India under Section 22 of the Banking Companies Act, 1949 are not vested with a mere officer of the Reserve Bank. Restrictions on opening and transfer of Branches :- Under the provisions of Section 23, the Reserve Bank has been empowered to control the opening of new and transfer of existing places of business of banking companies as follows 1) without obtaining prior permission of the Reserve Bank _ a) no banking company shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business situated in India; and b) no banking company incorporated in India shall open ‘a new place of business outside India or change, ‘otherwise than within the same city, town or village in any country or area outside India, the location of an cxisting place of business situated in that country Provided that nothing in this sub-section shall apply to the ‘opening for a period not exceeding one month of a temporary place of business within a city, town or village or the environs, thereof within which the banking company already has a place of business, for the purpose of affording banking facilities to the public on the occasion of an exhibition, a conference or a mela or any other like occasion, 2) Before granting any permission under this section, the Reserve Bank may require to be satisfied by an inspection under section 35 as to the financial condition and history of the company, the general character of its management, the adequacy of its capital structure and earning prospects, and that publie interest will be served by the opening or, as the ease may be, change of location, ofthe place of business. 3). The Reserve Bank may grant permission under sub-section (1) subject to such conditions as it may think fit to impose either generally or with reference to any particular case. 4) Where, in the opinion of the Reserve Bank, a banking, ‘company has, at any time, failed to comply with any of the ‘conditions imposed on it under this section, the Reserve Bank may, by orderin writing and after affording reasonable ‘opportunity to the banking company for showing cause against the action proposed to be taken against it, evoke any permission granted under this section. 4A) Any regional rural bank requiring the permission of the Reserve Bank under this Section shall forward its application to the Reserve Bank through the National Bank which shall give its comments on the merits of the application and send it to the Reserve Bank ; Provided that the regional rural bank shall also send an advance ccopy of the application directly to the Reserve Bank. 5). Forthe purposes of this section ‘place of business’ includes any sub-office, pay-office, sub-pay ofice and any place of, business at which deposits are received, cheques cashed or moneys lent. The need for the permission for the opening of a new branch was first brought into operation by Banking Companies (Restriction of Branches) Act, 1946. Explanation to section does not serve to define the words “place of business”, unless he money aid was lent at that place. Similarly the words “cheques cashed” apply to cheques drawn on the bank at the place in question. The restrictions imposed by the section are not applicable to change of location of a place of business in the same city or village, in which a place of business is already existing, Itisalso provided that a banking company may without, the previous permission of the Reserve Bank open a new place cof business, for a period not exceeding a month for the purpose of affording exhibition, or a fair, if such temporary place of business is located with the environs of a city, town or village in which the banking company already has a place of business. 9 (9/84) - DiehinulawechooboksimedOriginally the section did not impose any restriction on the opening of branches of Indian banks outside India. It was, however, subsequently felt thatthe maintenance ofa satisfactory financial position, and the observance of sound banking, traditions by foreign branches of Indian banks were of vital importance not only to the banking prestige abroad but also in the larger interests of the country, $0 it is now necessary for Indian banks to obtain permission of the Reserve Bank before ‘opening branches in foreign countries. Besides, banks have to submit a monthly statement regarding the assets and liabilities of their branches in cach foreign country. After nationalisation the entry of new private Banks was externally prohibited, ‘However on the basis of the liberalisation of our economy the Reserve Bank of India have brought our guidelines on 22.1.1993 for floating new private sector banks. 2.2 RBI GUIDELINES ON ENTRY OF NEW PRIVATE BANKS For well over decades, after the nationalisation of 14 larger banks in 1969, no bank has been allowed to be set up in the private sector. Progressively, over this period, the publie sector banks have expanded their branch net work considerably and catered to the socio-economic needs of large masses of the population, especially the weaker section and those in the rural area, The public sector banks now have 91 per cent ofthe total bank branches and handle 86 per cent of the total banking business in the country. While recognising the importance and the role of public sector banks, there is increasing recognition of the need to introduce greater competititon which can lead to higher productivity and efficiency of the banking system. A stage has now been reached when new private sector banks may be allowed to be set up. It is necesary that while permitting the entry of new private sector banks the following considerations have to be kept in (a) they sub-serve the underlying goals of financial sector reforms which are to provide competitive, efficient and low ‘cost financial intermediation services for the society at large; (b) they are financially viable; (©) they should result in upgradation of technology in the banking sector; they should avoid the shortcomings such as unfair preemption and concentration of credit, monopolisation of ‘economic power, cross holdings with industrial groups et. Which beset the private sector banks prior to nationalisation; @ (©) freedom of entry in the banking sector may have to be ‘managed carefully and judiciously. Based on these consideration, the Reserve Bank has formulated the following guidelines for establishment of new banks in the private sector := a) Such a bank shall be registered as a public limited under the Companies Act, 1956 ; 80 company (Sys 4)- Dehindlawschostbooksimodulleortact aw » ° a 2 ) 2 by ‘The RBI may, on merits, grant licence under the Banking, Regulation act, 1949 for such a bank. The bank may also be included in the Second Schedule of the Reserve Bank ‘of India Act, 1934 at the appropriate time. The decision of the RBI in these matters shall be final ‘The bank will be governed by the provisions of the Banking Regulation Act, 1949 in regard to its authorised, subscribed and paid-up capital. The minimum paid-up capital for such a bank shall be determined by the RBI and will also be subject t0 other applicable regulations ; ‘The shares ofthe bank should be listed on stock exchanges: To avoid concentration of the headquarters of new banks in metropolitan cities and other overbanked areas, while granting a licence preference may be given to those the headquarters of which are proposed to be located in a centre which does not have the headquarters of any other bank ; ‘Voting rights ofan individual shareholder shall be governed by the ceiling of 1 per cent of the total voting rights as stipulated by Section 12(2) of the Banking Regulation Act. However, exemption from this ceiling may be granted under section $3 of the said Act, to public financial institutions; ‘The new bank shall not be allowed to have as a director any person who is director of any other banking company, ‘or of companies which among themselves are entitled (0 ‘exercise voting rights in excess of twenty per cent of the total voting rights of all the sharcholders of the banking ‘company, as laid down in the Banking Regulation Act, 1949; ‘The bank will be governed by the provisions of the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949 and other relevant statutes, in regard to its management set-up, liquidity requirements and the scope ofits activities, ‘The directives, instructions, guidelines and advices given by the RBI shall be applicable to such a bank as in the case ofother banks. It would be ensured that a new bank would ‘concentrate on core banking activities intially; Such a bank shall be subject to prudential norms in respect of banking operations, accounting policies and other policies as are laid down by RBI. The bank will have to achiove capital adequacy of 8 per cent of the risk weighted assets from the very beginning. Similarly, norms for income recognition, asset classification, and provisioning for bad and doubtful advances will also be applicable to it from the beginning. So will be the single borrower and group borrowers exposure limits that will be inforced from time totime ; ‘The bank shall have to observe priority sector lending targets applicable to other domestic banks. recognition ofthe fact that new entrants may require some time to lend to all categories of the priority sector, some modification in the composition of the priority sector lending may be considered by the RBI for an initial period of three years However, ink)_ Such a bank will also have to comply with such directions of the RBI as is applicable to existing banks in the matter ‘of export credit. As a facilitation of this it may be issued an authorised dealers licence to deal in foreign exchange, when applied for ; 1D) Arnow bank shall not be allowed to sct up a subsidiary or ‘mutual fund for at least three years after its establishment. ‘The holding of such a bank in the equity of other companies shall be governed by the existing provisions applicable to other banks viz .__ ) 30 percent of the bank’s or the investee company’s capital funds, whichever is less, as set up under the Banking Regulation Act, 1949, and ii) L.Spercentof the bank’s incremental deposits during ‘a year as per RBI guidelines, The aggregate of such investments in the subsidiaries and Mutual Fund (if and when set up) and portfolio investments in other companies shall not exceed 20 percent of the bank’s own, paid-up capital and reserves. m) In regard to branch opening, it shall be governed by the existing policy that banks are free to open branches at various centres including urban/metropolitan centres without the prior approval of the RBI once they satisfy the capital adequacy and prudential accounting norms. However, to avoid over concentration of their branches in metropolitan areas and cities, a new bank will be required to open rural and semi urban branches also, as may be laid down by RBI fn) Such a bank shall have to lay down its loan policy within the several policy guidelines of RBI. While doing so, it shall specifically provide prudential norms covering related party transactions, ©), Such a bank shall make full use of modern infrastructural facilities in office equipments, computer, telecommunications, ete in order to provide good customer The bank should have a high powered customer grievances cell to handle customer complains ; pp). Such other conditions as RBI may prescribe from time to time. In Terms of the Narasimham Committee Recommendations, the nationalised Banks, under the directions of the RBI and the government are now aiming atthe closure or merger of unviable branches. (9/84) - Diehinulawechooboksimed3 CAPITAL, RESERVE AND LIQUID ASSET REQUIREMENTS SUB TOPICS 3.1 Introduction 3.2 Capital Requirements 3.3 Reserves and Liquid Assets 3.4 Concluding Remarks 3.1 INTRODUCTION The Banking Regulation Act contains requirements as to minimum paid up capital (Sec.11), regulation of paid up capital, subscribed capital and authorised capital (Sec.12), and prohibition charge on unpaid capital (See.14). ‘The Act also contains prescriptions on reserve fund (Sec.17), Cash reserve (See.18), prohibition of floating charge on asset and assets to be kept in India (See.25), At the outset a few observations on the concept of capital are needed to make the terminological content ofthe word ‘Capital’ clear. ‘Until the acceptance of the Basle Accord, the term ‘Capital” referred to the owned funds of a bank comprising paid up capital and disclosed free reserves. It served mainly two purposes viz., (a) reflecting the owners’ stake in the enterprise and acting as a disincentive to them to take up higher risk-investments and (b) serving as a buffer to absorb adverse effects on a bank of various, risks. Till the Basle Accord, the capital requirements for a bank differed from one country to another. Virtually, every country had laid down a minimum capital requirement, but the size of the amount varied. In addition, certain countries had stipulated, that the banks should maintain an appropriate relationship between capital on the one hand and total assets risk asscts or liabilities on the other. Furthermore, some countries, such as Japan, did not formally prescribe capital adequacy. Others like the United States, had attempted at judgemental assessment. Developments in the early eighties had emphasised the need to strengthen the capital base of banks and to adopt a uniform standard to assess adequacy among countries, During that period, there was @ general deterioration in the asset portfolio of major international banks particularly to the debt problems of the developing countries. Notwithstanding the adverse rend, banks continued to acquire still high-risk assets to retain their market share. This tendency had further contaminated their asset portfolios because of the increased competition both among banks and between banks and pseudo-banking entities following world wide lineralisation of financial services sector. Consequently, the leverage ratios of banks had scaled unsustainable levels. Furthermore, the difference in capital requirements for different domestic markets had resulted in competitive inequalities. Such inequalities in the context of globalisation of the transactions following widespread application of new communication and computer technology and the trend towards liberalisation of international capital transactions had resulted in major banks attempting to take greater risks to protect their market shares, 2 (Sys 4)- Dehindlawschostbooksimodulleortact aw To counteract the trend and (0 restore health to the system, authorities in some counties had attempted to strengthen banks by prescribing simple leverage ratios and in some others, by laying down on balance sheet risk-asset ratios. These attempts hhad proved inadequate because the stipulation of simple leverage ratios had discouraged banks from holding low-risk assets while the prescription of on-balance sheet risk-asset ratios had encouraged them to substitute off-balance sheet exposure for conventional assets. A more sophisticated and realistic yardstick was required to measure the adequacy of capital. Also international co-ordination was considered necessary o prevent banks taking advantage of differences in national capital definitions and requirements thereby exposing themselves (0 greater risks. In this situation, supervisors in major industrial ‘countries were naturally prepared to sacrifice elements of their own capital adequacy requirements in the interest of reaching & ‘multilateral agreement. One of the notable developments in the banking regulatory framework inthe recent years relates to the stipulation of capital requirements. Banking supervisors world over have unanimously agreed on the method for assessing adequacy of capital as also on the need of harmonise such requirement at the international level, at least in respect of internationally active banks, The agreement is known technically a the “International Covergence of Capital, Measurement and Capital Standards’, and popularly as “The Basle Accord’. The Accord has become the reference point for policy action among nations. For example, the Solvency Ratio and Own Funds requirements of the European Community, which will become effective in 1993, are based on the norms contained in the Accord. In India, the Committee on the financial system under the Chairmanship of Shri, M. Narasimham has not only recommended the adoption of the Basle Accord but also laid down a time-frame for compliance. Against this backdrop, an attempt is made to briefly recapitulate the Basle Accord and its implications to Indian banks having overseas branches, The Basle Accord The new method of assessing adequacy of capital is based on a system of risk-weighted capital ratio for the banks. The Basle Banking Supervisory Committee had worked on this since 1987, and had recommended it for the banks in G-10 countries. The authorities ofthese countries had endorsed the recommendations in July 1989, The new ratio has the following advantages i) providing a fairer basis for international comparision between banking systems with structural differences ; ii) allowing off-balance sheet exposures to be incorporated more easily into the measure ; and iii) non-detering banks from holding liquid or other assets with low risk Capital : New Definition For supervisory purposes, the Basle Accord has defined capital in two tiers. The Core Tier 1, Capital comprises fully paid-upcapital and disclosed reserves and corresponds to the traditional measure of capital. ‘The Accord has also recognised the supplementary or Tier II Capital consisting of undisclosed reserves, revaluation reserves, general provisions, hybrid debt, capital instruments and subordinated term debt. Besides, the national authorities are left with the discretion to ineludevexclude any items, in the light of their national accounting and supervisory regulations. This is an improvement over the conventional definition of capital. However, Tier 1 Capital is granted greater importance due to certain well recognised facts. This is the only element common to the banking system the world over; it is wholly visible in the published account; and it has a crucial bearing on the profit margins and the banks ability to compete. Aslo, the strengthening of the Core Capial would, facilitate a progressive enhancement in the quality as well as the level ofthe total capital resources maintained by the banks. ‘Thus, the maximum permissible size of Tier Il Capital i limited to the actual size of Tier I Capital. Assets and Risk Weighting For risk-weighting, assets are classified into five broad classes, cach class carrying different weights ranging from 0 percent to 100 percent, ‘The risk-weights attached to a specific assets is based mainly on the perceived riskiness of the assets. Obviously, this method has certain caveats, The weighting is nota substitute for commercial judgement. Further, the risk-weights capture only credit-isk and hence exclude other risks such as investment risk, interest rate risk, exchange risk and concentration risk. Weighting also differs in respect of county exposure, Industrialised debtor countries, for instance, carry a lower weight implying thereby that such exposure is safer than that in respect of LDCs. As for the bank’s claim on public sector enterprises, the Accord has allowed discretion to each national supervisory authority to determine the appropriate weights in factors. On other assets (both on-and-off balance sheet assets), the Accord has enumerated each item and has prescribed different ratios ranging from 20 per cent to 100 per cent The Targets ‘The Accord has provided for a minimum risk-weighted capital! asset ratio of 8 per cent to be achieved by G-10 countries by the end of 1992, A transitional minimum ratio of 7.25 per cent was also stipulated for the end of 1990. Capital adequacy Prevailing capital requirements for banks in India are rather complex. ‘The State Bank of India Act, 1955 prescribes the capital structure forthe State Bank of India (SBD). According to the provisions inthis Act, the authorised capital of SBI is Rs. 1,000 Crores; the actual paid-up captial is Rs.200 Crores. The sued capital of each of the seven Associate Banks of SBI was fixed by SBI with the approval of the Reserve Bank of India (RBD. The capital structure of the nationalised banks is laid down by the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1979/80. According to these Acts, the paid- up capital of these banks are equal to their respective paid-up capital atthe time of their nationalisation, Inthe case of a foreign bank, the aggregate value of its paid-up capital and reserves should not be less than Rs. 15 lakhs and this level is raised to 8.20 lakhs if it has a place or places of business in Bombay. and/or Calcutta. ‘The absolute minimum requirement for an Indian private sector bank, as Jaid down in the Banking Regulation Act, 1949, is Rs. 5 lakhs. (Rs. 10 lakhs if it has offices in more than one State and/or has office(s) in Bombay and/or Calcutta). ‘The Committee on the financial system under the Chairmanship of Shri.M. Narasimham has recognised that the Indian banking system has inadequately capitalised and the situation is a cause of concern. It has, therefore, suggested that the banks should achieve a minimum of 4 per cent capital adequacy ratio in relation to risk-weighted assets by March 1993. The standards by the Basle Accord should be achieved by March 1996. For these banks with an international presence, it would be necessary to reach these figures even earlier’ 32 CAPITAL REQUIREMENTS Section 11 of the Banking Regulation Act, lays down the requirements regarding the minimum standard of paid-up capital and reserves as a condition for the commencement of business. ‘These conditions apply to the banking companies wherever incorporated, but companies in existence at the time of the commencement of the Act were given a period of three years or such further period not exceeding one year as the Reserve Bank of India extended to comply with the provisions contained in Section 11, which are shown for easy reference in a tabular form, Under the provisions of sub-sections (i) and (i) of Section 12 it has been Isid down that no banking company shall carry on, business in any State of India, unless (a) the subscribed capital of the company is not less than half of its authorised capital, and the paid-up capital is not less than half of its subscribed. capital, provided that when capital is increased this proportion ‘may be permitted to be secured within a period to be determined, by the Reserve Bank not exceeding two years from the date of increase; and (b its share capital docs not comprise shares other than ordinary shares, provided that preference shares, if any, issued before Ist uly 1944 will not operate asa disqualification. These provisions deal with the minimum ratios betwe authorised, subscribed and paid-up capital of a banking company. The need for these provisions arose from the fact, that the management of some banks used to mislead members, of the public by displaying large figures of authorised capital, while only a small portion of their capital might have been subscribed, a still smaller portion might have been ealled-up. By calling only a small amount of the subscribed capital the promoters of banking companies were able to persuade persons, with small means to go in for much larger number of shares, than they could afford to purchase (9/84) - DiehinulawechooboksimedRequirements of Aggregate Value of Paik Reserve ‘up Capital and Aggregate Value of Paid-up Capital and Reserve I. Incorporated in India Rupees A.) Por banking company incorporated in India having places of business more than one stale. 5,00,000 i) Many such place or places of business is o are ‘or Calcutta or both. 10,00,000 B. fall places of business in one State but none of which in Bombay eity or Caleata situated in the city of Bombay )_Forprincipal place of business in one state 1,00,000 (except in City of Bombay and Caleuta) plus (i) Foreach other place of business in the same 10,000 sdstct ii) For each place of business situated outside that dstct 25,000 Subject oa total of 500,000 iv) For having only one place of business 50,000 . IFall places of busines in one State (One or more of which isfare inthe ety of Bombay or Calcutta 5,00,000 plus (ii) Inrespeet of each place of business situated ‘outside the city of Bombay or Caleuta 25,000 Subject toa total of 10,00,000 T. Incorporated outside India @)_Aithas no place of business in Bombay city or .. 15,00,000 Caleutta i). AFithasa place of business in Bombay city or Caleutta or both 20,00,000 Note :- Banking companies incorporated outside India have to deposit the amount required as above either in cash or in unencumbered approved securities or partly in cash and partly in such securities with the Reserve Bank. Ifaplace of business situated in a State other than that in which the prineipal place of business of a banking company is situated and the distance is less than twenty-five miles between these ‘two places, they will be considered as places of business in one State, “Place of Business” means any office, sub-office, sub-pay office and any place of business at which deposits are received, cheques cashed and moneys lent. ‘Commission on the sale of shares Section 13 prohibits a banking company from paying out directly or indirectly by way of commission, brokerage, disocunt or remuneration in any form in respect of shares issued by it, any amount exceeding in the aggregate two and half per cent of 84 (Sys 4)- Dehindlawschostbooksimodulleortact aw the paid-up value of the said shares. Section 76 and 79 of the Companies Act, 1956 provide for higher percentage of Commission. The present provisions of the Banking Regulation Actalter the effect of the provisions of the Companies Act 1956, so far as banking companics are concerned and to the extent of commission that can be paid. Prol jon of charge on Unpaid Capital No banking company shall ereate any charge upon its unpaid capital, and any such charge, ifereated, shall be invalid (Section 14). It is unusual for banks in India to ereate any charge on their future assets, Unpaid capital of a company constitutes its future asset. However, the provision of this section is based ‘upon the salutary principle that all the creditors of a banking company should participate in the future assets which should not be realised for the benefit of one or more preferred creditors ‘The Companies Act, 1956 permits the creation of a charge by a ‘company on its uncalled capital provided the instrument creating the said charge is registered with the Registrar of Companies within 30 days from the date ofits creation (Seetion 125 of the Companies Act, 1956) Section 14A prohibits every banking company from creating a floating charge on its undertaking or any property or any part thereof unless the creation of such a floating charge is certified in writing by the Reserve Bank as not being detrimental to the interests of the depositors of such company. The floating charge if created without obtaining the Reserve Bank's certificate is invalid. Restrictions on holding of shares in other Companies Section 19 lays down that “Restriction on nature of subsidiary companies - (2) A banking company shall not form any subsidiary company ‘except a subsidiary company formed for one or more of the following purposes, namely: (a) the undertaking of any business which, under clauses (4) ( (0) of sub-section (1) of Section 6, is permissible for a banking company to undertake; (b) with the previous permission in writing of the Reserve Bank, the carrying on of the business of banking exclusively outside India ; (©) the undertaking of such other business, which the Reserve Bank may, with the prior approval of the Central Government, consider to be conducive to the spread of banking in India or to be otherwise useful or necessary in the public interest; ‘planation > For the purposes of Section 8, a banking company shall not be deemed, by reason of its forming or having a subsidiary company, to be engaged indirectly, in the business carried on by such subsidiary company. (2) Save as provided in sub-section (1), no banking company shall hold shares in any company, whether as pledgec, ‘mortgagee or absolute owner, of an amount exceeding thirty pet cent of the paid-up share capital of that company orthirty per cent ofits own paid-up share capital and reserves, whichever is less Provided that any banking company which ison the date of commencement ofthis Act holding any shares in contravention of the provisions of this sub-section shall not be liable to any penalty therefor if it reports the matter without delay to the Reserve Bank and if it brings its holding of shares into conformity with the said provisions within such period, not exceeding (wo years, as the Reserve Bank may think ft to allow. (3) Save as provided in sub-section (1) and notwithstanding, anything contained in sub-section (2), a banking company shall not, after the expiry of one year from the date of the ‘commencement ofthis Act, hold shares, whether as pledgee, mortgagee or absolute owner, in any company in the management of which any managing director or manager of the banking company is in any manner concerned or interested, This section restricts the scope of formation of subsidiary companies by a banking company, as well as the holding of shates in other companies. A banking company may form a subsidiary company for the purposes referred to in this section, as well as for other purposes subject tothe previous permission in writing of the Reserve Bank. Sub section (1) has been substituted by the Banking Laws (Amendment) Act, 1983, w.e., 15,2.1984 so as to amplify, in pursuance of the recommendation of the Banking Commission, the scope of the said section with a view to enlarging the purposes for which a banking company can form subsidiaries. A banking company would now be permitted to form subsidiaries for carrying on one or more kinds ‘of business which it s permitted to engage in under clauses (a) to (0) of Section 6(1) of the Banking Regulation Act, 1949. Prior to the amendment a banking company was not permitted to form subsidiaries except for undertaking and executing trusts, administration of estates as executors and for doing banking business outside India Itappears, however, that the definition ofa subsidiary company as given in the Companies Act, 1956 excludes the case of a company holding shares as security, when the ordinary business of the company so holding shares includes the lending of money. It may be noted that a company, even though it is not incorporated under the Companies Act, will be regarded as subsidiary company within the meaning of that Act, if the holding banking company incorporated under the Banking, Regulation Act and/or the Companies Act, is interested in it in such a way that it controls the composition of the Board of Directors of such a Company. Under Section 4 of the Companies Act, 1956, a company is deemed to be a subsidiary of another, if and only if _ (a) that other controls the composition of its Board of Directors ; or (b) that other holds more than half in nominal value of its equity share capital; or (©) the first mentioned company is subsidiary of any ‘company which is that other’s subsidiary. As regards the second restriction mentioned in Section 19 of the Banking Regulation Act, its clear that a banking company can hold shares in any company (ie., a company liable to be ‘wound up under the Companies Act) to the extent of thirty per cent of the paid-up share capital of the latter, but this should not exceed thirty per cent of the paid-up share capital and reserve of the former. ‘Thus, it would appear that a banking company may hold shares of a forcign company, exceeding thirty per cent if that company does not operate in India, but such holding must not exceed fifty per cent as to the close of an accounting, period. The main object of the provision as laid down under this section is, thata banking company may not enter into non- banking business by means of a subsidiary company or any other company in which it is to be largely interested. The restriction regarding the holding of shares seems to apply only when the shares are held as pledgee, mortgagee or owner, and rot when they arc held as trustee, custodian or agent, or otherwise than a pledgee, mortgagee or owner. Ifon the date of commencement ofthis Act, a banking company hholds shares beyond the limit stated inthe sub-section, provided it forthwith reports the matter to the Reserve Bank of India, it ccan dispose off the excess holding within such period (not exceeding two years as the Reserve Bank may permit) to comply with the provisions of Section 19(1). Sub section (3) of the same section absolutely prohibits the holding after the expiry of one year from the date of the commencement of the Act of shares as pledgee, mortgagee or owner, in any company in the ‘management of which a managing director or manager of the banking company in question is concerned or interested. This prohibition, however, does not apply’to the shares in a subsidiary ‘company permitted under sub-section (1) of Section 19. Itdoes rot appear to be quite clear whether the period of one year referred to above, is automatically allowed to every banking, ‘company or is the maximum period of concession that can be allowed by the Reserve Bank. It may be observed that the word “concerned” or “interested” appears to have rather wide meaning. Probably it will be interpreted with reference to Section 295 and other provisions contained in Sections 297, 299, 300, 301 and 302 of the Companies Act, 1956. A critique on capital adequacy position of some Nationalised Banks: In this context an academic exercise is attempted to assess the prevailing position of capital in nine Indian banks having overseas branches vis-a-vis the requirements of the Basle Accord as also of the Narasimham Committee for 1993. The nine banks are Bank of India, Bank of Baroda, Bharat Overseas Bank, Canara Bank, Indian Bank, Indian Overseas Bank, SBI, Syndicate Bank and UCO Bank. This exercise presents the position at end-March 1991, Since the published balance sheets ff these banks do not conform to the details of assets as enumerated in the Basle Accord, available data are treated to conform broadly to the classification of the Accord. Thus, cash ‘on hand, balances with other banks and money at call and short- notice are taken as cash and equivalent having no risk, Total investments, contra-items and contingent liabilities were allotted 85 (9/84) - Diehinulawechooboksimed50 per cent risk-weight (each). All other assets are given 100 per cont risk-weight, Aggregate Picture AAs on March 31, 1991, the combined owned funds, ie., paid- ‘up capital and disclosed reserves of these nine banks ageregated toRs, 3,859 crores, Their total assets amounted to Rs, 1,63,994 crores. The risk unadjusted capital asset ratio, therefore, worked. out to Rs, 2.35 percent. On the other hand the risk weighted assets (including contra-items and contingency liabilities) totalled Rs. 1,53,172 crores. The capitalrisk-weighted alset ratio stood higher at 2.52 per cent because of the complete exclusion of cash and equivalent, and one half of investments, contra-items, and contingent liabilities from the denominator. While considering Tier I norm of the Basle Accord, therefore, there was adeficit of 1.48 per cent of Rs. 2,267 crores in respect, of the required capital of these Banks. According to the prescription of Narasimham Committee, however, the banks have fulfilled their Tier I needs (2.0 per cent) but fell short of total capital adequacy by 1.48 percentage points (Rs. 2,267 crores), Disaggregated position Bank-wise, the position varied widely. Only three banks, viz., Canara Bank, Indian Overseas Bank, and UCO Bank, have fulfilled the Tier I Capital requirement of the Basle Accord. ‘The shortfall in respect of other banks ranged from RS. 5 crores (Bharat Overseas Bank) toRs. 1,507 crores (SBI); in percentage terms, the shortfall ranged from 1.46 per cent (Bank of India) to 2.41 per cent (Syndicate Bank). The norms of the Narasimham Committee (2.0 per cent Tier I Capital) was met by six banks. Only three banks, viz., SBI, ‘Bank of Baroda, and Syndicate Bank, have fallen short of the target Caveats It should be reiterated that these computations are illustrative and at best are indicative ofthe direction and possible dimension, the precise amount could be different. ‘The position by end March 1994 will also depend upon other factors such as the growth in the balance sheets, contingent liabilities, extent of asset contamination, ete. of these banks. Again, the role of the injection of substantial funds by the Government to augment the capital of weak banks needs to be remembered. Av ble options : 1 T capital Available options to cover the shortfall are rather limited. Tier capital refers to purely owned funds consisting paid-up capital and disclosed reserves, The scope for additional allocation of operating surplus to reserves is limited because of the diminishing profitability of the banks. There could also be a greater need to make larger provision for loan losses from the available meagre surplus. The scope of augmenting paid-up capital by the government is also limited since the present emphasis is on curtailing expenditure as much as possible. ‘Notional augmentation through issue of special securities, as 86 (Sys 4)- Dehindlawschostbooksimodulleortact aw hhad been done hitherto in this context, would hardly serve any useful purpose. Perhaps, fresh capital could be issued to the public. Response will, however, depend naturally upon the track record of the issuer. Recognising this, the Narasimham Committee has recommended that in respect of banks which have had a consistent record of profitability and enjoy a good reputation in the market, it should be possible to tap the capital market by issuing fresh capital to the public. Mutual funds, insurance companies and profitable public sector companies could subscribe to such equity, besides employees of the banks and the general public. In respect of other banks, it may be necessary for the government to supplement the capital by direct subscription. In this context, it should be remembered that the paid-up capital ofall the nationalised banks have almost reached their respective authorised levels. hence, legislative measures may have to be taken to increase the capital structure of these banks if additional capital funds are to be injected. Holding company We could also conceive the establishment of a new holding company with adequate capital to take care of these banks. According to the stipulations of the Basle Accord, the Tier I capital needs ofthe proposed holding company, as at end-March 1991 would be around Rs. 6,130 crores, as per our estimates. In the present context of economy measures, perhaps, RBI alone may be in a position to contribute this amount. In due course, however, these could be professionally managed. Similarly, officials for posting to the foreign branches should undergo a stringent process of sclection procedure establishing their efficiency. Necessary safeguards ought to be built in the procedure fo provide representation to all the participant banks as also to discourage any possible brain-drain ‘Tier II Capital ‘The components of supplementary capital of Ticr Il capital are undisclosed reserves, revaluation reserves, general provisions.hybrid debt instruments,and subordinate term debt Hitherto, the actual financial position of the banks is not fully clearly reported. With the implementation of new accounting policies and procedures as well as the adoption of new formats for the final accounts, it should be possible to effect greater transparency tothe financial status of the reporting banks. Once these changes ae effected, perhaps, the banks could fully satisfy the needs of Tier I Capital, In cases where shortfalls are noticed, ‘one could think of issuing subordinate term debs. CONCLUSION Indian banks operating abroad need to subject themselves t0 the capital regulatory requirements as laid down in the Basle Accord. It is true that the requirements of the Accord are stiff for Indian situation, Recommendations made by the Narasimham Committee in this context are very reasonable, practicable and achievable. This could be considered as the transitory provisions and intensive attempts should be made t0 attain the BIS standards at the earliest. A precondition in this,regard, as noted by the Narasimham Committee, is that the Indian banks should have their assets revalued on a more realistic basis and on the basis of their realisable value, Then alone a clearer picture would emerge facilitating appropriate action. 33. RESERVES AND LIQUID ASSETS Provisions relating to the building up of reserves are relatively simple, Indian banks are statutorily required to build up reserves by transferring sums equivalent to not less than 20 per cent (25 per cent since 1974as per RBI's advice) oftheir annual disclosed profit, Foreign banks need to maintain 20 per cent of their annual profits in respect of their Indian operations with RBI either in cash or in unencumbered approved securities. Since some of these banks have often complied with provision by transferring securities in their investment portfolio (which enabled them to remit the entire profit), they are required, since 1989, to retain in a separate account, 20 per cent of the profits of their Indian operations as disclosed in their annual accounts every year. This reserve is permanent in nature and forms part of owned funds of these banks [ See See.17] Every Banking Company shall maintain a cash reserve with itselfor by way of balance in a current account with the Reserve Bank or by way of net balance partly with itself and partly with Reserve Bank, a sum equivalent to atleast three percent of the total ofits demand and time liabilitics in India as on the last Friday of the second preceding fortnight and shall submit to the Reserve Bank before the 20th day of every month a return to that effect. This is known as CRR or Cash Reserve Ratio. As has already been stated the RBI instructs the banking ‘companies to keep a certain CR. This type of manipulation of RR js done for regulating the money market, 34 CONCLUDING REMARKS ‘Adequate capital and sufficient liquidity are the two hall marks of success of commercial banks. If the liquidity goes higher capital remains under-utilised, In fact one of the strongest criticism of commercial banking in India is that loans and advances are costlier because of high rate of interest. The interest rate is high because a big part of the capital is required to be locked up on account of CRR and SLR. It means that a part of the capital has to work for the total capital. Liquidity is required for having confidence on the monetary system and banking institution. Certain percentage of cash keeps up the thickness ‘of monetary flow. But keeping reserve higher than that is ccounter- productive. Generally speaking this step is used also for checking the inflation, But theoretically checking flow of money may lead to stagflation instead of controlling inflation. (9/84) - Diehinulawechooboksimed7. ACCOUNTS AND AUDIT SUB TOPIC 7.1 General Control over Accounts and Audit 7.1 GENERAL CONTROL OVER ACCOUNTS AND AUDIT Section 29 of the Banking Regulation Act deals with Accounts and Balance Sheet of a Banking company. The Section reads ~ (1) Atthe expiration of each calendar year or atthe expiration ‘ofa period of twelve months ending with such date as the Central Government may, by notification in the Official Gazette, specify in this behalf, every banking company incorporated in India, in respect of all business transacted by it, and every banking company incorporated outside India, in respect of all business transacted through its branches in India, shall prepare with reference to that year or period, as the case may be, @ balance sheet and profit, and loss account as on the last working day of the year or the period, as the case may be, in the Forms set out in the ‘Third Schedule or as near thereto as circumstances admit. Provided that with a view to facilitating the transition from one period of accounting to another period of accounting under this sub-section, the Central Government may, by order published in the Official Gazette, make such provisions as it considers necessary or expedient forthe preparation of, or for other matters relating to, the balance sheet or profit and loss account in respect of the concerned year or period, as the ease may be. Note:- Consequent to the amendment made in the Income-Tax Act, 1961, every assessee shall follow the uniform Accounting year beginning as on the Ist of April every year. Accordingly, Banking companies are required to prepare their balance shect and the corrected Financial statements beginning April 1 of every year. Hence the section has to be read in lieu of what is stated above in this note, (2) The balance sheet and profit and loss account shall be signed- (@) in the case of a banking company incorporated in India, by the manager or the principal officer of the company and where there are more than three directors of the company, by at least three of those directors, or where there are not more than three directors, by all directors, and (b) _inthecase ofa banking company incorporated outside India by the manager or agent of the principal office of the company in India (3) Notwithstanding that the balance sheet of a banking ‘company is under sub-section (1) required to be prepared in a form other than the form set out in Part I of Schedule VI to the Companies Act, 1956, the requirements of that Act relating tothe balance sheet and profit and loss account ‘of a company shall, in so far as they are not inconsistent with this Act, apply to the balance sheet or profit and loss account, as the ease may be, of @ banking company. (3-A) Notwithstanding anything to the contrary contained in sub-section (3) of section 210 of the Companies Act, 1956 (1 of 1956), the period to which the profit and loss account relates shall, in the ease of a banking company, be the period. ending with the last working day of the year immediately preceding the year in which the annual general meeting is held. Explanation - In Sub-seetion (3-A), “Year” means the year or, as the case may be, the period referred to in sub-section (I). ‘The third schedule prescribed in the section has undergone a great change from the Accounting year ending March 1993, particularly those relating to the classification of assets, Section 30 of the Banking Regulation Act deals with ‘Audit’, and Sections 31, 32, 33, 34 and 34A deal with the related provisions ~ ‘The sections read - Section 30 Audit- The balance sheet and profit and loss account prepared in accordance with section 29 shall be audited by a person duly {qualified under any law for the time being in force to be an auditor of companies. (IA) Notwithstanding anything contained in any law for the time being in force or in any contract tothe contrary, every banking company shall, before appointing, reappointing or removing any auditor, or auditors obtain the previous approval of the Reserve Bank. (1B) Without prejudice to anything contained in the Companies ‘Act, 1956, or any other law for the time being in force, ‘where the Reserve Bank is of opinion that it is necessary in the public interest or in the interests ofthe banking company orits depositors to doso, it may at any time, by order direct, that a special audit ofthe banking company’s accounts, for any such transaction or class of transactions or for such period or periods as may be specified in the order, shall be conducted and may by the same or a different order either appoint a person duly qualified under any law for the time being in force to be an auditor of companies or direct the auditor of the banking company himself to conduct such special audit, and the auditor shall comply with such directions and make a report of such audit to the Reserve Bank and forward a copy thereof to the company. (IC) The autor shall have the powers of, exercise the functions vested in, and discharge the duties and be subject to the liabilities and penalties imposed on, auditors of companies by Section 227 of the Companies Act, 1956 and auditors, if any, appointed by the law establishing, constituting or forming the banking company concerned. (3) In addition to the matters which under the aforesaid Act, the auditor is required to state in his report, he shall, in the cease of a banking company incorporated in India, state in his report - 101 (9/84) - Diehinulawechooboksimed(a) whether or not the information and explanations required by him have been found to be satisfactory ; (b) whether or not the transactions of the company which have ‘come to his notice have been within the powers of the Company; (©) whether or not the returns received from branch offices of the company have been found adequate for the purposes of his audit ; (@) whether the profit and loss account shows a true balance of profit and loss for the period covered by such account ; (@) any other matter which he considers should be brought 10 the notice of the shareholders of the company. Section 31: Submission of returns ‘The accounts and balance sheet referred to in Section 29 together with the auditor's report shall be published in the prescribed ‘manner and three copies thereof shall be furnished as returns to the Reserve Bank within three months from the end of the period. to which they refer Provided that the Reserve Bank may in any case extend the said period of three months for the furnishing of such returns by a further period not exceeding three months: Provided further that a regional rural bank shall furnish returns also to the National Bank. Section 32: (1) copies of balance sheets and accounts to be sent to Registrar Where a banking company in any year furnished its accounts and balance sheet in accordance with the provisions of Section 31, it shall atthe same time send to the registrar three copies of such accounts and balance sheet and of the auditor's report, and where such copies are so sent, it shall not be necessary to file with the registrar, inthe case of public company, copies of accounts and balance-sheet and of the auditor’s report, and, in the case of a private company, copies of the balance sheet and of the auditor’s report as required by sub-section (1) of Section 220 with the same fee and shall be dealt within all respects as if they were filed in accordance with that section. (2) When in pursuance of sub-section (2) of Section 27 the Reserve Bank requires any additional statement or information jn connection with the balance sheet and accounts furnished under Section 31, the banking company shall, when supplying each statement or information, send a copy thereof to the registrar Section 33 : Display of audited balance sheets by companies \corporated outside India Every banking company incorporated [outside India] shall, not later than the first Monday in August of any year in which it carries on business, display in a conspicuous place in its principal office and in every branch office [in India] a copy of its last audited balance sheet and profit and loss account prepared under Section 29, shall keep the copy so displayed until replaced by a copy of the subsequent balance sheet and profit and loss account so prepared, and every such banking company shall 102 (Sys 4)- Dehindlawschostbooksimodulleortact aw display in like manner copies of its complete audited balance shect and profit and loss account rclating to its banking business as soon as they are available, and shall keep the copies so displayed until copies of such subsequent accounts are available. Section 34 : Accounting provisions of the Act not retrospective Nothing in this Act shall apply to the preparation of accounts by a banking company and the audit and submission thereof in respect of any accounting year which has expired prior to the commencement of this Act, and notwithstanding the other provisions of this Act, such accounts shall be prepared, audited and submitted in accordance with the law in force immediately before the commencement of this Act Section 34-A : Production of documents of confidential nature (2) Notwithstanding anything contained in Section 11 of the Industral Disputes Act. 1947, or other law forthe time being in force, no banking company shall, in any proceeding under the said Act or in any appeal or other proceeding arising therefrom or connected therewith, be compelled by any authority before which such proceeding is pending to produce, or give inspection of, any of its books of account fr other document or furnish or disclose any statement or information, when the banking company claims that such document, statement or inspection of such document or the furnishing of disclosure of such statement or information would involve disclosure of information relating o - (@) any reserves not shown inits published balance-sheet, () any particulars not shown therein in respect of provisions made for bad and doubtful debts and other usual or necessary provisions (2) Hany such proceeding in relation to any banking company other than the Reserve Bank of India, any question arises as to whether any amount out ofthe reserves or provisions referred to in sub-section 1) should be taken into account by the authority before which such proceeding is pending the authority, may, if it so thinks fit, refer the question the Reserve Bank and the Reserve Bank shall after taking into account principles of sound banking and all relevant circumstances coneerning the banking company, furnish to the authority & certificate stating thatthe authority shall rot take into account any amount as such Reserves and provisions ofthe banking company oF may take them into account only to the extent ofthe amount specified by it in the certificate, andthe certificate of the Reserve Bank on such question shall be final and shall not be called in ‘question in any such proceeding. @) For the purposes of this section “banking company” includes the Reserve Bank, the Development Bank, the :xim Bank, the Reconstruction Bank, the National Housing Bank, the national Bank, the Small Industries Bank, the State Bank of India, a corresponding new bank a regional rural bank and a subsidiary bank.Section 35: Inspection (1) Notwithstanding anything to the contrary contained in Section 235 of the Companies Act, 1956, the Reserve Bank at any time may, and on being directed so to do by the ‘Central Government shall, cause an inspection to be made by one or more of its officers of any banking company and its books and accounts; and the Reserve Bank shall supply to the banking company a copy of its report on such inspection. 1-A.: (a) Notwithstanding to the contrary contained in any law for the time being in force and without prejudice to the provisions of sub-section (1), the Reserve Bank, at any time, may also cause a scrutiny to be made by any one or more of is officers, of the affairs of any banking company and its books and accounts; and (b) copy of the report of the scrutiny shall be furnished to the banking company if the banking company ‘makes a request for the same or if any adverse action is contemplated against the banking company on the basis of the serutiny. It shall be the duty of every director or other officer or ‘employee of the banking company to produce to any officer making an inspection under sub-section (1) or a scrutiny under sub-section (LA) all such books, accounts and other documents in his custody or power to furnish him with any statements and information relating to the affairs of the banking company as the said officer may require of him within such time as the said officer may specity. (3) any person making an inspection under sub-section (1) of a scrutiny under sub-section (LA) may examine on oath any director ot other officer or employee of the banking ‘company in relation to its business, and may administer an ‘oath accordingly. (4) The Reserve Bank shall, if it has been directed by the Central Government to cause an inspection to be made, and may, in any other ease, report to the Central Government ‘on any inspection or scrutiny made under this section, and the Central Government, if tis of opinion after considering the report thatthe affairs of the banking company are being ‘conducted tothe detriment of the interest of the depositors, ‘may, after giving such opportunity to the banking company to make a representation in connection with the report as, Q inthe opinion of the Central government, seems reasonable, by order in writing - (a) prohibit the banking company from receiving fresh deposits; (b) direct the Reserve Bank to apply under Section 38 for the winding up of the banking company; Provided that the Central Government may defer, for such, period as it may think ft, the passing of an order under this sub-section, or cancel or modify any such order upon such terms and conditions as it may think fit to impose. (5) The Central Government may, after giving reasonable notice to the banking company, publish the report submitted by the Reserve Bank or such portion thereof as may appear necessary, Explanation: For the purposes of this section, the expression “banking company” shall include - j)_inthecase ofa banking company incorporated outside India, all its branches in India; and ii) in the case of a banking company incorporated in India - 1) all its subsidiaries formed for the purpose of carrying on the business of banking exclusively outside India; and b) all its branches whether situated in India or outside India, (6) the powers exercisable by the Reserve Bank under this section in relation to regional rural banks may without prejudice to the exercise of such powers by the Reserve Bank in relation to any regional rural bank whenever it ‘considers necessary so to do to be exercised by the national Bank in relation to the regional rural banks as if every reference therein to the Reserve Bank included also a reference to the National Bank. Sub-section (4) of section 35 relates to Bank for which licence has already been given. [Sajjan Bank (P) Ltd. Vs. Reserve Bank of India, AIR 1961 Mad 8.] It is open to the Reserve Bank to consider the defects or improvements revealed in an application under Section 35 for disposing of the application for licence as there is nothing in the Act to prohibit it from taking into consideration all relevant, facts. [Sajjan Bank (P) Ltd Vs. Reserve Bank of India, AIR 1961 Mad 8} 103 (9/84) - Diehinulawechooboksimed