PROJECT ON BANKING LAW AND REGULATIONS

Preface
Banking law is not a discrete area of law like contract or torts. It conveniently describes, however, the collection of legal principles which impact on banking transactions and on the bankercustomer relationship. In that sense, the activity of banking is the location at which a diverse range of legal principles intersect which we call banking law. Those legal principles are drawn from a range of sources. In India, the nationalized banks are governed by the Banking Companies (Acquisition and Transfer of Undertaking) Acts of 1970 and 1980. State Bank of India and its subsidiaries are governed by their respective statutes. Private sector banks come under the purview of the Companies Act, 1956 and the Banking Regulation Act, 1949. Foreign banks which have registered their documents with the registrar under Section 592 of the Companies Act are also banking companies under the Banking Regulation Act. Certain provisions of the Banking Regulation Act have been made applicable to public sector banks. Similarly, some provisions of the RBI Act too are applicable to nationalized banks, SBI and its subsidiaries, private sector banks and foreign banks.

Acknowledgement
Inspiration and motivation have played a great role in the success of my project. It would be incomplete to submit this project without acknowledging the people behind this endeavour and without whose support I would not have been able to achieve this. I am extremely grateful to Mr. for giving me an opportunity to work on this project which helped me learn a lot about banking laws. I express my thanks for his direction and support . He has taken pain to go through the project and make necessary corrections as and when needed.

Table of Content
Preface.......................................................................................................... Acknowledgement.................................................................................... 1. History of Banking in India............................................................... 2. Evolution of banking regulations in India.................................... 2.1 Institutional evolution 2.2 Legislative evolution 2.3 Policy Framework and regulatory environment 2.3.1 Branch authorisation policy 2.3.2 Operations of foreign banks in India 2.3.3 Securitisation Guidelines of RBI 2.3.4 Migration to principle based regulation 3. Laws governing Indian Banks.......................................................... 3.1 Banking regulation act 3.2 Negotiable Instrument act 3.3 SARFAESI act 3.4 RBI act Appendices.................................................................................................. Bibliography...............................................................................................

HISTORY OF BANKING IN INDIA

Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money has become the order of the day. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below: Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991. To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III.

Phase I
The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda,

Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority. During those days public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.

Phase II
Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were nationalized. Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949 : Enactment of Banking Regulation Act. 1955 : Nationalization of State Bank of India. 1959 : Nationalization of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalization of 14 major banks. 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalization of seven banks with deposits over 200 crore.

After the nationalization of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.

Phase III
This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

The Evolution of Banking Regulation in India

Institutional Evolution of the Indian Banking
The roots of commercial banking in India can be traced back to the early eighteenth century when the Bank of Calcutta was established in June 1806 which was renamed as Bank of Bengal in January 1809 mainly to fund General Wellesleys wars. This was followed by the establishment of the Bank of Madras in July 1843, as a joint stock company, through the reorganisation and amalgamation of four banks viz., Madras Bank, Carnatic Bank, Bank of Madras and the Asiatic Bank. This bank brought about major innovations in banking such as use of joint stock system, conferring of limited liability on shareholders, acceptance of deposits from the general public, etc. The Bank of Bombay, the last bank to be set up under the British Raj pursuant to the Charter of the then British East India Company, was established in 1868, about a decade after the Indias first war of independence. The three Presidency Banks, as these were then known, were amalgamated in January 1921 to form the Imperial Bank of India, which acquired the three-fold role: of a commercial bank, of a bankers bank and of a banker to the government. It is interesting to note here that merger of banks and consolidation in the banking system in India, is not as recent a phenomenon as is often thought to be, and dates back to at least 1843 and the process, of course, still continues. With the formation of the Reserve Bank of India in 1935, some of the central banking functions of the Imperial Bank were taken over by the RBI and subsequently, the State Bank of India, set up in July 1955, assumed the other functions of the Imperial Bank and became the successor to the Imperial Bank of India.

Evolution of Legislative Regulation of Banking in India

In the very early phase of commercial banking in India, the regulatory framework was somewhat diffused and the Presidency Banks were regulated and governed by their Royal Charter, the East India Company and the Government of India of that time. Though the Company law was introduced in India way back in 1850, it did not apply to the banking companies. The banking crisis of 1913, however, had revealed several weaknesses in the Indian banking system, such as the low proportion of liquid assets of the banks and connected lending practices, resulting in large-scale bank failures. The recommendations of the Indian Central Banking Enquiry Committee (1929-31), which looked into the issue of bank failures, paved the way for a legislation for banking regulation in the country.

Though the RBI, as part of its monetary management mandate, had, from the very beginning, been vested with the powers, under the RBI Act, 1934, to regulate the volume and cost of bank credit in the economy through the instruments of general credit control, it was not until 1949 that a comprehensive enactment, applicable only to the banking sector, came into existence. Prior to 1949, the banking companies, in common with other companies, were governed by the Indian Companies Act, 1913, which itself was a comprehensive reenactment of the earlier company law of 1850. This Act, however, contained a few provisions specially applicable to banks. There were also a few ad hoc enactments, such as the Banking Companies (Inspection) Ordinance, 1946, and the Banking Companies (Restriction of Branches) Act, 1946, covering specific regulatory aspects. In this backdrop, in March 1949, a special legislation, called the Banking Companies Act, 1949, applicable exclusively to the banking companies, was passed; this Act was renamed as the Banking Regulation Act from March 1966. The Act vested in the Reserve Bank the responsibility relating to licensing of banks, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction and liquidation. Important changes in several provisions of the Act were made from time to time, designed to enlarge or amplify the responsibilities of the RBI or to impart flexibility to the relative provisions, commensurate with the imperatives of the banking sector developments. It is interesting to note that till March 1966, the Reserve Bank had practically no role in relation to the functioning of the urban co-operative banks. However, by the enactment of the Banking Laws (Application to Co-operative Societies) Act, 1965, certain provisions of the Banking Regulation Act, regarding the matters relating to banking business, were extended to the urban co-operative banks also. Thus, for the first time in 1966, the urban co-operative banks too came within the regulatory purview of the RBI.

Prudential Policy Framework for Banking Regulation and Supervision

The basic rationale for exercising fairly close regulation and supervision of banking institutions, all over the world, is premised on the fact that the banks are special for several reasons. The banks accept uncollateralised public deposits, are part of the payment and settlement system, enjoy the safety net of deposit insurance funded by the public money, and are an important channel for monetary policy transmission. Thus, the banks become a keystone in the edifice of financial stability of the system which is a public good that the public authorities are committed to provide. Preventing the spread of contagion

through the banking system, therefore, becomes an obvious corollary of regulating the banks to pre-empt any systemic crisis, which can entail enormous costs for the economy as a whole. This is particularly so on account of the inevitable linkages that the banks have by virtue of the nature of their role in the financial system. Ensuring safety and soundness of the banking system, therefore, becomes a predominant objective of the financial regulators. While the modalities of exercising regulation and supervision over banks have evolved over the decades, in tandem with the market and technological developments, the fundamental objective underlying the exercise has hardly changed. Of course, a well-regulated and efficient banking sector also enhances the allocative efficiency of the financial system, thereby facilitating economic growth. In this backdrop, as the functions of the RBI evolved over the years, the focus of its role as a regulator and supervisor of the banking system has shifted gradually from micro regulation to macro prudential supervision. A journey through the major landmarks in the evolution of the RBIs role vis--vis the commercial banks provide interesting insights. As regard the prudential regulatory framework for the banking system, we have come a long way from the administered interest rate regime to deregulated interest rates, from the system of Health Codes for an eight-fold judgmental loan classification to the prudential asset classification based on objective criteria, from the concept of simple statutory minimum capital and capitaldeposit ratio to the risk-sensitive capital adequacy norms initially under Basel I framework and now under the Basel II regime. There is much greater focus now on improving the corporate governance set up through fit and proper criteria, on encouraging integrated risk management systems in the banks and on promoting market discipline through more transparent disclosure standards. The policy endeavor has all along been to benchmark our regulatory norms with the international best practices, of course, keeping in view the domestic imperative and the country context. The consultative approach of the RBI in formulating the prudential regulations has been the hallmark of the current regulatory regime which enables taking account of a wide diversity of views on the issues at hand. On the supervisory side, we have traversed vast territory in progressively refining our supervisory focus to ensure a safe and sound banking system, comparable with the best in the world. Thus, we have continually graduated from the system of on-site Annual Appraisal of the banks by the RBI followed in the 1970s to the system of Annual Financial Review during the 1980s, then on to the Annual Financial Inspection of stand-alone banks during the 1990s and further on to the consolidated supervision of financial conglomerates so as to address the supervisory concerns on a group-wide basis. The off-site monitoring of the banking system was also introduced in 1995 as a part of the

supervisory strategy of ongoing supervision of the banks, so as to supplement the periodical full-scope on-site bank examinations. The supervisory ratings models (CAMELS and CACS), based on crucial prudential parameters, were also developed by the RBI to provide a summary view of the overall health of the banks. The Prompt Corrective Action (PCA) Framework was put in place to enable timely intervention in case of any incipient stress in a bank. The latest supervisory initiative has been the introduction of risk-based supervision of the banks so as to move away from transaction audit and to enable the modulation of the supervisory efforts in tune with the risk profile of the banks and to achieve optimal deployment of the scarce supervisory resources. Last but not the least, the Board for Financial Supervision, constituted in 1994 under the Chairmanship of the Governor, RBI has been the guiding force in securing the transformation in the regulatory and supervisory apparatus of the banking system. While the multi-dimensional regulatory and supervisory measures are justifiably reflected in the significantly improved prudential parameters of the Indian banking system, be it the level of NPAs or the capital adequacy ratios, there is hardly any room for complacence. In the era of ever-increasing financial globalisation and in the face of rapid financial innovations, all of us will continually need to remain on a steep learning curve and upgrade our skills and knowledge to be able to meet the emerging challenges in the financial world.

Some Elucidation Regarding the Regulatory Environment

Branch Authorisation Policy
The RBI announced a new Branch Authorisation Policy in September 2005 under which certain changes were brought about in the authorisation process adopted by the RBI for the bank branches in the country. As against the earlier system, where the banks approached the RBI, piece meal, through out the year for branch authorisation, the revised system provides for a holistic and streamlined approach for the purpose, by granting a bank-wise, annual aggregated authorisation, in consultation and interaction with each applicant bank. The objective is to ensure that the banks take an integrated view of their branch- network needs, including branch relocations, mergers, conversions and closures as well as setting up of the ATMs, over a one-year time horizon, in tune with their own business strategy, and then approach the RBI for consolidated annual authorisations accordingly. There seems to be some misunderstanding in some quarters that, under the new policy, the banks have to wait for the annual authorisation exercise and are constrained in approaching the RBI for any emergent authorisation in between. Since the branch expansion planning of the banks is expected to be a well thought out, Board-approved annual process, normally, there should be no need for any emergent or urgent authorisation being required by the banks, in the interim. However, I would like to emphasise that the new policy does not preclude the possibility of any urgent proposals for opening bank branches being considered by the RBI even outside the annual plan, specially in the rural / under-banked areas, anytime during the year. This flexibility has been clearly articulated in our policy guidelines as contained in the Master Circular of July 2007 but somehow, it seems to have got overlooked. There also seems to be a feeling among some banks that under the new authorisation policy, the process adopted is more cumbersome and, as a result, there have been delays in issuing authorisations. Since the banks are required to approach the RBI only after obtaining the approval of their respective Boards for their annual branch expansion plan, it is possible that the preparatory time required for filing their annual plan with the RBI might be a little longer. The processing time at the end of the RBI, however, has been generally in the range of one to two months which I consider to be reasonable, given the element of consultation with the banks built into the process. However, the actual number of authorisations issued by the RBI under the new policy has been much higher than before. For instance, as against the a total of 881, 1125 and 1259

authorisations given by the RBI under the old policy regime during 2003-04, 2004-05 and 2005-06, respectively, the number of authorisations issued under the new policy during 2006-07 was 2028. Thus, as against the general perception that the new policy has been more restrictive in granting authorisations, the fact is that there has been a sharp increase of about 61 per cent in the total number of authorisations granted last year.

Operations of Foreign Banks in India

At present, there are 29 foreign banks operating in India with a network of 273 branches and 871 offsite ATMs. Among some circles, a doubt is sometimes expressed as to whether the regulatory environment in India is liberal in regard to the functioning of the foreign banks and whether the regulatory approach towards foreign participation in the Indian banking system is consistent with liberalized environment. Undoubtedly, the facts indicate that regulatory regime followed by the Reserve Bank in respect of foreign banks is non-discriminatory, and is, in fact, very liberal by global standards. Here are a few facts which bear out the contention; y India issues a single class of banking licence to foreign banks and does not require them to graduate from a lower to a higher category of banking licence over a number of years, as is the practice followed in certain other jurisdictions. y This single class of licence places them virtually on the same footing as an Indian bank and does not place any restrictions on the scope of their operations. Thus, a foreign bank can undertake, from the very first day of its operations, any or all of the activities permitted to an Indian bank and all foreign banks can carry on both retail as well as wholesale banking business. This is in contrast with practices in many other countries. y No restrictions have been placed on establishment of non-banking financial subsidiaries in India by the foreign banks or of their group companies. y Deposit insurance cover is uniformly available to all foreign banks at a non-discriminatory rate of premium. In many other countries there is a discriminatory regime. y The prudential norms applicable to the foreign banks for capital adequacy, income recognition and asset classification, etc., are, by and large, the same as for the Indian banks. Other prudential norms such as those for the exposure limits, investment valuation, etc., are the same as those applicable to the Indian banks. y Unlike some of the countries where overall exposure limits have been placed on the foreign-country related business, India has not placed any restriction on the kind of business that can be routed through the branches

of foreign banks. This has been advantageous to the foreign bank branches as the entire home-country business is generally routed through these branches. Substantial FII business is also handled exclusively by the foreign banks. y In fact, some Indian banks contend that certain amount of positive discrimination exists in favour of foreign banks by way of lower Priority Sector lending requirement at 32 per cent of the adjusted net bank credit as against a level of 40 per cent required for the Indian banks. Unlike in the case of Indian banks, the sub-ceiling in respect of agricultural advances is also not applicable to foreign banks whereas export credit granted by the foreign banks can be reckoned towards priority sector lending obligation, which is not permitted for the Indian banks. y Notably, in terms of our WTO commitment, licences for new foreign banks may be denied when the share of foreign banks assets in India, including both on- as well as off-balance-sheet items, in the total assets (including both on- and off-balance-sheet items) of the banking system exceeds 15 per cent. However, we have autonomously not invoked this limitation so far to deny licences to the new foreign banks even though the actual share of foreign banks in the total assets of the banking system, including both on- and off-balance-sheet items (on Notional Principal basis), has been far above the limit. This share of foreign banks stood at 49 per cent, as at end-January 2007, as mentioned in the Indias Trade Policy Review, 2007. It is thus very obvious that the Indian regulatory regime is essentially non-discriminatory as between branches of foreign banks and domestic banks, in regard to their authorisation or the scope of their operations, though some hold that there is some positive discrimination in favour of the foreign banks. As explained, Indian regulatory regime is in fact much more equitable and provides a far more level playing field to the foreign banks, than in many other jurisdictions both developed and emerging economies

Securitisation Guidelines of the RBI

The RBI had first issued the draft guidelines for securitisation of standard assets in April 2005, for public comments and after an extensive consultative process, the final guidelines were issued in February 2006, in order to facilitate an orderly development of this market. In certain quarters, however, a view has been expressed that these guidelines, tend to negate the benefits envisaged in the very concept of securitisation, and thus, are hindering the growth of securitisation market in the country. Let me attempt to briefly present today the international perspective vis--vis RBI guidelines and the thinking and rationale underlying our formulation. RBIs guidelines are broadly in tune with the stipulations of several regulators in other jurisdictions. For instance, concept of true sale and the independence of the Special Purpose Vehicle (SPV) from the originator of the assets, prescribed in our guidelines is also embedded, in one form or the other, in the regulatory guidelines obtaining in Australia, Malaysia, Singapore, the UK and the USA. Similarly, the prudential treatment of the credit enhancement provided to the SPVs and the requirement of capital charge there against, as prescribed in our guidelines, is also echoed in the regulatory framework in Australia, the United Kingdom and Singapore. Likewise, the provisions relating to the Clean up Calls, or repurchase of the residual performing assets from the SPV by the originator, also figure in the regulations in Australia, the United Kingdom and Singapore. The restrictions placed by us on purchase of securities issued by the SPV by the originator are also found in other jurisdictions such as Australia, Singapore and the UK. Similarly, the restrictions in regard to the provision of liquidity facility to the SPV, underwriting of the securities issued by 10 the SPV and the servicing of the securitised assets are also found in several other jurisdictions, with variations in details and in the degree of stringency. I am citing all this at some length to point out that RBIs guidelines on securitisation are broadly in line with the practices obtaining in several other jurisdictions, though they have some unique features. The accounting treatment prescribed in our guidelines provides for upfront recognition of any loss incurred on sale of assets to the SPV but the profit arising from such sale is required to be amortised over the life of the securities issued / to be issued by the SPV. Thus, we have not permitted the banks to recognise the profit upfront, on sale of assets to the SPVs. As you are aware, the main considerations for the originator in undertaking a securitisation transaction are obtaining the regulatory-capital relief and generating liquidity from an otherwise illiquid loan book, and not the profit, per se. In this background,

RBIs guidelines have justifiably adopted such an approach in order to ensure that profit-booking does not become the primary motive for undertaking securitisation transactions which could perhaps lead to profit smoothening, possibly through inappropriate valuations, and the consequent window dressing of the financial statements none of which is prudentially desirable. In brief, the restrictions in our guidelines on upfront recognition of profit on sale of assets by the banks seek to create the right incentive framework for the banks so that the basic objective underlying the concept of securitisation does not get negated. In the aftermath of the recent sub-prime episode in some of the developed countries, caused also by wide dispersal of credit risk throughout the system through complex structured transactions, I am sure, you would appreciate the merit of adopting an appropriate incentive-compatible prudential approach towards securitisation. We need to squarely recognise that securitisation, after all, is also a credit-risktransfer instrument and has the potential of dispersing the risks from the originating banks to those parts of the system which might not necessarily be best equipped to manage that risk. Hence, RBIs stand in creating the right incentive framework through prudential restrictions would seem to be an approach which has much to commend itself.

Migration to Principles-Based Regulation (PBR)

A view has been expressed in certain quarters that the Indian regulatory framework should migrate to principles-based regulation from the current rulesbased approach. The merits of a principles-based approach are that in a dynamic market context, where the product innovation is the order of the day, the principles-based approach to regulation provides a more enduring regulatory option since the underlying principles would not need to change with every new product whereas the detailed rules may have to be constantly modified to address the unique features of market and product developments. However, despite the stated superiority of the principles-based approach, so far very few countries have adopted this model in a big-bang or comprehensive manner. The FSA of the UK which is one of the forerunners in adoption of principles-based regulation has a rule book which has over 8000 pages. So, the PBR is not as simple to operationalise as it is to advocate. Thus, in any regulatory regime, complete reliance on a principles-based approach would rarely be a feasible option since the high-level principles would need to be underpinned by the detailed rules at the operational level, to achieve the regulatory objectives. To illustrate, it might be easy to enunciate the principle that Treat your customer fairly but ensuring it at the ground level

would invariably require specific rules and prescriptions to achieve the objective underlying the principle. Besides, a PBR approach also pre-supposes greater reliance on the discretion and judgment of the supervisors and regulators in interpreting the broad principles an aspect with which the market players might not be very comfortable. On the other hand, the regulated entities too, in the absence of detailed regulatory prescriptions, would need to develop a certain level of maturity of outlook to correctly understand the spirit of the principles while implementing them at the operational level. This approach would, therefore, also require a good deal of skill up gradation on the part of the regulator as well as the regulated entities. Moreover, in any jurisdiction, there could be certain areas of regulation which would be more amenable to a PBR approach while certain other areas might inevitably require detailed prescriptive rules. Thus, the rules-based and principles-based approaches to regulation are not mutually exclusive options but could very well co-exist and complement each other. To illustrate, the Pillar 1 of the Basel II framework is essentially rule-based prescription while the Pillar 2 is more oriented towards principles-based regime. Within the RBI, we too are in the process of exploring the feasibility of adopting a principles-based approach to banking regulation but it may be quite some time before we could be ready for adoption of the PBR approach on a significant scale in the Indian context.

Laws Governing Indian Banks

Various laws have been made from time to time to govern the banking activities and to see the bank customer relationship as well. Some of these are as follows:  The Banking Regulation Act  The Reserve Bank Of India Act  The Negotiable Instrument Act  SARFAESI act  The State Bank Of India Act

BANKING REGULATION ACT, 1949

I. Introduction Financial sector reforms have been introduced in a calibrated and wellsequenced manner since the early 1990s and have resulted in a competitive, healthy and resilient financial system. There has been financial deepening: the deposits/ GDP ratio rose from 16.4 per cent in 1971-75 to 36.1 per cent in 198990 and further to 60 per cent in 2004-05. Bank credit to commercial sector increased from 15.6 per cent to 30.3 per cent of GDP in 1989-90 and 48 per cent in 2005-06. The Annual Policy Statement for the year 2007-08 by Governor, Reserve Bank of India at para 185 states that ' with a view to directing the resources of banks to their niche areas and to sustain efficiency in the banking system, a graded approach of licensing may be appropriate which can be equally applicable to both domestic and foreign banks. A technical paper on this subject will be placed on website inviting comments/suggestions from the public' Accordingly, an internal study in RBI covered the background on banking regulation, licensing of banks under Banking Regulation Act, 1949, extant policy relating to bank licensing, both Indian and foreign banks international experience and practice on limited bank licensing. II. Statutory background- Banking Regulation Act, 1949 2.1 Background Prior to the enactment of Banking Regulation Act, 1949 which aims to consolidate the law relating to banking and to provide for the nature of transactions which can be carried on by banks in India, the provisions of law relating to banking companies formed a part of the general law applicable to companies and were contained in Part XA of the Indian Companies Act, 1913. These provisions were first introduced in 1936, and underwent two subsequent modifications, which proved inadequate and difficult to administer. Moreover, it was recognised that while the primary objective of company law is to safeguard the interests of the share holder, that of banking legislation should be the protection of the interests of the depositor. It was therefore felt that a separate legislation was necessary for regulation of banking in India. With this objective in view, a Bill to amend the law relating to Banking Companies was introduced in the Legislative Assembly in November, 1944 and was passed on 10th March, 1949 as the Banking Companies Act, 1949. By Section 11 of the Banking Laws

(Application to Cooperative Societies) Act, 1965, the nomenclature was changed to the Banking Regulation Act, 1949. 2.2 Indian banking system The Indian financial system currently consists of commercial banks, cooperative banks, financial institutions and non-banking financial companies ( NBFCs). The commercial banks can be divided into categories depending on the ownership pattern, viz. public sector banks, private sector banks, foreign banks. While the State bank of India and its associates, nationalised banks and Regional Rural Banks are constituted under respective enactments of the Parliament, the private sector banks are banking companies as defined in the Banking Regulation Act. The cooperative credit institutions are broadly classified into urban credit cooperatives and rural credit cooperatives. 2.3 Powers and responsibilities of RBI in respect of regulation of

banks
The Reserve Bank of India has been entrusted with the responsibility under the Banking Regulation Act, 1949 to regulate and supervise banks' activities in India and their branches abroad. While the regulatory provisions of this Act prescribe the policy framework to be followed by banks, the supervisory framework provides the mechanism to ensure banks' compliance with the policy prescription. 2.4 General Framework of Regulation The existing regulatory framework under the Banking Regulations Act 1949 can be categorised as follows : a) Business of Banking Companies b) Licensing of banking companies c) Control over Management d) Acquisition of the Undertakings of banking companies in certain cases e) Restructuring and Resolution including winding up operation f) Penal Provisions 2.5 Licensing of banks In terms of Sec 22 of the B.R.Act, no company shall carry on banking business in India, unless it holds a licence issued in that behalf by Reserve Bank and any such licence may be issued subject to such conditions as the Reserve Bank may think fit to impose.

Before granting any licence, RBI may require to be satisfied that the following conditions are fulfilled: i) that the company is or will be in a position to pay its present or future depositors in full as their claims accrue; ii) 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; iii) that the general character of the proposed management of the proposed bank will not be prejudicial to the public interest or the interest of its depositors; iv) that the company has adequate capital structure and earning prospects; v) 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 already in existence in the area and other relevant factors the grant of the licence would not be prejudicial to the operation and consolidation of the banking system consistent with monetary stability and economic growth; 2.6 Business of banking As per Section 5 (b) of Banking Regulation Act, 1949 ' banking ' means the accepting , for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise. 2.7 Permissible Activities of a Banking Company Section 6 of B.R. Act, 1949 gives the details of forms of business in which a banking company may engage. However, it is a long list and banks may carry out one or more activities permitted in the section. III. Policy of issuing licence to banks in India The policy framework for issuing licences to private sector and foreign banks are discussed below: 3.1 Private sector banks
y

The guidelines for licensing of new banks in the private sector were issued by the Reserve Bank of India (RBI) on January 22, 1993. The revised guidelines for entry of new banks in private sector were issued on January 3, 2001. The foreign investment limit from all the sources in private banks was raised from a maximum of 49 per cent to 74 per cent in March 2004. In consultation with the Government of India, the Reserve Bank released a roadmap on February 28, 2005, detailing the norms for

the presence of foreign banks in India. The Reserve Bank also issued comprehensive guidelines on Ownership and Governance in private sector banks. The broad principles underlying the policy framework were to ensure that the ultimate ownership and control of private sector banks is well diversified. Further, the fit and proper criteria have to be the overriding consideration in the path of ensuring adequate investments, appropriate restructuring and consolidation in the banking sector. No single entity or group of related entities would have shareholding or control, directly or indirectly, in any bank in excess of 10 per cent of the paid up capital of the private sector bank. Any higher level of acquisition will be with the prior approval of RBI and in accordance with guidelines issued by RBI for grant of acknowledgement for acquisition of shares. These measures were intended to further enhance the efficiency of the banking system by increasing competition. The initial minimum paid-up capital for a new bank was kept at Rs. 200 crore. The initial capital was required to be to Rs.300 crore within three years of commencement of business. The aggregate foreign investment in private banks from all sources ( FDI, FII, NRI) cannot exceed 74 per cent. Mergers and amalgamations are a common strategy adopted for restructuring and strengthening banks internationally. Although the consolidation process through mergers and acquisitions of banks in India has been going for several years it gained momentum in late 1990s. With increased liberalisation, globalisation and technological advancement, the consolidation process of Indian banking sector is likely to intensify in the future, thereby imparting greater resilience to the financial system. The Reserve Bank ensures that mergers and amalgamation enhance the stability of the banking system. Thus, the guidelines issued by RBI on May 11, 2005 laid down the process of merger and determination of swap ratio.

3.2 Licensing of foreign banks India issues a single class of banking licence to banks and hence does not place any undue restrictions on their operations merely on the ground that in some countries there are requirements of multiple licences for dealing in local currency and foreign currencies with different categories of clientele. Banks in India, both Indian and foreign, enjoy full and equal access to the payments and settlement systems and are full members of the clearing houses and payments system. Procedurely, foreign banks are required to apply to RBI for opening their branches in India. Foreign banks application for opening their maiden branch is considered under the provisions of Sec 22 of the BR Act, 1949. Before granting

any licence under this section, RBI may require to be satisfied that the Government or the law of the country in which it is incorporated does not discriminate in any way against banks from India. Other conditions as enumerated in para 2.5 above are required to be fulfilled. Unlike the restrictive practices of certain foreign countries, India is liberal in respect of the licensing and operation of the foreign bank branches as illustrated by the following :
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India issues a single class of banking licence to foreign banks and does not place any limitations on their operations. All banks can carry on both retail and wholesale banking. Deposit insurance cover is uniformly available to all foreign banks at a non-discriminatory rate of premium. The norms for capital adequacy, income recognition and asset classification are by and large the same. Other prudential norms such as exposure limits are the same as those applicable to Indian banks.

3.3 Opening of branches in India by Foreign banks The policy for approving foreign banks applications to open maiden branch and further expand their branch presence has been incorporated in the Roadmap for presence of Foreign banks in India indicated in the Press Release dated February 28, 2005 as well as in the liberalized branch authorisation policy issued on September 8, 2005. The branch authorisation policy for Indian banks has been made applicable to foreign banks subject to the following:
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Foreign banks are required to bring an assigned capital of US $25 million up front at the time of opening the first branch in India. Existing foreign banks having only one branch would have to comply with the above requirement before their request for opening of second branch is considered. Foreign banks may submit their branch expansion plan on an annual basis. In addition to the parameters laid down for Indian banks, the following parameters would also be considered for foreign banks : o Foreign banks and its groups track record of compliance and functioning in the global markets would be considered. Reports from home country supervisors will be sought, wherever necessary. o Weightage would be given to even distribution of home countries of foreign banks having presence in India. o The treatment extended to Indian banks in the home country of the applicant foreign bank would be considered.

Due consideration would be given to the bilateral and diplomatic relations between India and the home country. The branch expansion of foreign banks would be considered keeping in view Indias commitments at World Trade Organisation (WTO). Licences issued for off-site ATMs installed by foreign banks are not included in the ceiling of 12.

In terms of Indias commitment to WTO, as a part of market access, India is committed to permit opening of 12 branches of foreign banks every year. As against these commitments, Reserve Bank of India has permitted upto 17- 18 branches in the past. The Bank follows a liberal policy where the branches are sought to be opened in unbanked/under-banked areas. Off-site ATMs are not counted in the above limit. Including off-site ATMs, foreign banks are having ( as on October 15, 2007) place of business at 933 locations ( 273 branches + 660 off site ATMs). The procedure regarding approval of proposals for opening branches of foreign banks in India has been simplified and streamlined for the sake of expeditious disposal. A licence under the provisions of B.R. Act, 1949 enables the foreign banks to carry out any activity which is permissible to a bank in India. This is in contrast with practices adopted in many countries, where foreign banks can carry out only a limited menu of activities. As against the requirements of achieving 40 per cent of net bank credit as target for lending to priority sector in case of domestic banks, it has been made mandatory for the foreign banks to achieve the minimum target of 32% of net bank credit for priority sector lending. Within the target of 32%, two subtargets in respect of advances (a) to small scale sector (minimum of 10%), and (b) exports (minimum of 12%) have been fixed. The foreign banks are not mandated for targeted credit in respect of agricultural advances. There is no regulatory prescription in respect of foreign banks to open branches in rural and semi-urban centres. IV. Differentiated Bank Licensing- Examining Pros and Cons A. Arguments in Favour of Adopting a Differentiated bank Licensing 4.1 With the broadening and deepening of financial sector, it is observed that banks are slowly migrating from a situation in the past where the number of banking services offered by the banks was limited and all banks provided all the services to a situation where banks are finding their niche areas and mainly providing services in their chosen areas. Many banks keep the plain vanilla

banking as a small necessary adjunct. It is widely recognized that banks providing services to retail customers have different skill sets and risk profiles as compared to banks which mainly deal with large corporate clients. The present situation where every bank can carry out every activity permissible under Section 6 of Banking Regulation Act, 1949 has the following implications, relevant to the subject under consideration :
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For a wholesale bank dealing with corporate clients only, it becomes a costly adjunct to maintain a skeleton retail banking presence. Moreover it becomes difficult for such a bank to meet priority sector obligations and obligations for doing inclusive banking. Retail banks may have to create risk management and regulatory compliance structures which are more appropriate to wholesale banks, thus resulting in non-optimal use of resources. Similar supervisory resources are devoted to banks with different business profiles. This may also result in non-optimal use of supervisory resources. The priority sector lending regime for foreign banks indicated in paragarph 3.3 has been causing some discomfort for some of the foreign banks. For example, some of the foreign banks find it difficult to fulfil even the less rigorous target of 32 per cent in respect of priority sector advances. Some banks find it difficult to provide ' no frills' facility to economically disadvantaged. For them the more liberal licensing regime causes a different set of problems.

It appears that given an opportunity, some of the banks may like to follow a niche strategy rather than competing as full service all purpose banks. 2. On the other hand, there are some factors which point towards desirability of continuing with the existing system of universal banking:
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In India, the penetration of banking services is very low. Less than 59 % of adult population has access to a bank account and less than 14 % of adult population has a loan account with a with a bank. Under such circumstances, it would be incorrect to create a regime where banks are allowed to choose a path away from carrying banking to masses. Priority sector lending is important for banks. The revised guidelines on priority sector lending have rationalized the components of priority sector. For the first time, investments by banks in securitised assets, representing loans to various categories of priority sector, shall be eligible for classification under respective categories of priority sector (direct or indirect) depending on the underlying assets, provided the securitised

assets are originated by banks and financial institutions and fulfil the Reserve Bank of India guidelines on securitisation. This would mean that the banks' investments in the above categories of securitised assets shall be eligible for classification under the respective categories of priority sector only if the securitised advances were eligible to be classified as priority sector advances before their securitisation. These measures would make it easier to comply with the priority sector lending requirements by those banks which had faced some difficulties in this regard. The business model adopted by such niche banks depends heavily on ample inter-bank liquidity. Any shock leading to liquidity crunch can translate into a run on the bank. This situation has been clearly illustrated recently in UK in the case of Northern Rock Bank.

V. International experience and practice International experience and practices of licensing procedure followed in major jurisdictions by the respective regulators have been studied and we have grouped them into two viz limited banking licence - equally applicable both for domestic and foreign banks and limited bank license-different for domestic and foreign banks. In addition, there are countries where different licences are issued for commercial banking, savings bank, rural banks or credit unions . In certain counties no distinction is made between domestic and foreign banks. Thus, there is no widely accepted recommended model available internationally. VI. Way forward It may be seen that one of the major objectives of banking sector reforms has been to enhance the efficiency and productivity of the banking system through competition. It is also aim of authorities to provide banking services to maximum number of people. To enable the banking system to operate at optimum efficiency, and in the interest of financial inclusion, it is necessary that all banks should offer certain minimum services to all customers, while they may be allowed sufficient freedom to function according to their own business models. Thus, it will be prudent to continue the existing system for the time being. The situation may be reviewed after a certain degree of success in financial inclusion is achieved and Reserve Bank is more satisfied with the quality and robustness of the risk management systems of the entire banking sector.

Negotiable Instruments ACT

There are certain documents which are freely used in commercial transactions. The word negotiable means transferable from one person to another in return for consideration. Instrument means a written document by which a right is created in favour of some person. A negotiable instrument is a document which entitles a person to a sum of money and which is transferable from one person to another by mere delivery or by endorsement and delivery. S.13says that a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer. Characteristics of a negotiable instrument 1. Freely transferable: The property in a negotiable instrument passes from one person to another by delivery, if the instrument is payable to bearer, and if is payable to order, it is done by endorsement. 2. Title of holder free from all defects: A person taking an instrument bona fide and for value, known as a holder in due course, gets the instrument free from all defects in the title of transferor. He is not in any way affected by any defect in the title of transferor or any prior party. 3. Recovery: The holder in due course can sue upon a negotiable instrument in his own name for the recovery of the amount. 4. Presumptions: Certain presumptions apply to all negotiable instruments, which are as follows: a. Consideration: Every negotiable instrument is presumed to have been made, drawn, accepted, endorsed, negotiated or transferred for consideration. This would help a holder to get a decree from a Court without any difficulty. b. Date: Every negotiable instrument bearing a date is presumed to have been made or drawn on such date. c. Time of acceptance: When a bill of exchange is accepted, it is presumed that it was accepted within a reasonable time of its date and before maturity. d. Time of transfer: every transfer of negotiable instrument is presumed to be made before its maturity. e. Order of endorsements: each endorsement is presumed to be in the order in which they appear thereon. f. Stamp: When an instrument has been lost, it is presumed that it was duly stamped. g. Holder presumed to be holder in due cours

Notes, Bills and cheques Promissory Note

A promissory note is an instrument in writing containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to or to order of a certain person or to the bearer of the instrument. The person who makes the promissory note and promises to pay is called the maker. The person to whom the payment is to be made is called the payee. Examples: I promise to pay to B or order Rs. 500. I acknowledge myself to be indebted to B in Rs. 1,000 to be paid on demand, for value received. Essential elements of a promissory note: 1. Writing: The instrument must be in writing. Mere verbal engagement to pay is not enough. 2. Promise to pay: The instrument must contain an express promise to pay. 3. Definite and unconditional: The following instruments signed by A are not promissory notes: I promise to pay B a sum of Rs. 500, when convenient or able. I promise to pay B Rs. 500 on Ds death, provided D leaves me enough to pay that sum. 4. Signed by the maker: The instrument must be signed by the maker otherwise it is incomplete and of no effect. 5. Certain sum of money: 6. Promise to pay money only: If the instrument contains a promise to pay something other than money or something in addition to money, it cannot be a promissory note. 7. It may be payable on demand or after a definite period of time. Lack of any requirements mentioned in s.4 will not make a document a promissory note.

BILL OF EXCHANGE

S. 5. A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a sum of money only to, or to the order of, a certain person or to the bearer of the instrument. Parties to a bill: There are three parties i.e. drawer, drawee and the payee. The person who gives the order to pay or who makes the bill is known as drawer. The person who is directed to pay is called the drawee. The person to whom the payment is to be made is called the payee. In some cases, the drawer and the payee may be one and the same person. The drawer or the payee who is in possession of the bill is called the holder. The holder must present the bill to the drawee for acceptance.

Essential Elements 1. 2. 3. 4. 5. 6. 7. 8. 9. It must be in writing. It must contain an order to pay. The order must be unconditional. It requires three parties i.e., drawer, drawee and payee. The parties must be certain. It must be signed by the drawer. The sum payable must be certain. It must contain an order to pay a certain sum of money. A bill must be affixed with the necessary stamp.

Distinction between a bill of exchange and a Promissory Note 1. Number of parties: In a note there are two parties, in a bill there are three parties. 2. Promise or order: A note contains an unconditional promise to pay; a bill contains an unconditional order to pay. 3. Debtor and the creditor: The maker of the note is a debtor and the drawer of a bill is the creditor.

4. Position of the maker: A note cannot be made payable to the maker himself, where as in case of bill, the drawer and the payee may be one and the same person. 5. Acceptance: A note requires no acceptance as it is signed by the person who is liable to pay. A bill after sight or after a certain period must be accepted by the drawee before it is presented for payment. 6. Payable to bearer: A note cannot be drawn payable to bearer. A bill can be so drawn. 7. Notice of dishonour: In case of dishonor of a bill either by non acceptance or by non payment, due notice of dishonour must be given to all the persons who are to be made liable to pay. This includes the drawer and the prior endorsers. But in case of dishonour of a note no such notice is required to be given to maker. CHEQUE A cheque is a bill of exchange drawn upon a specified banker and payable on demand and it includes the electronic image of a truncated cheque and a cheque in the electronic form. A cheque in the electronic form means cheque which contains the exact mirror image of a proper cheque, and is generated, written and signed in a secure system ensuring the minimum safety standards with the use of digital signature and asymmetric crypto system. A truncated cheque means a c heque which is truncated during the course of a clearing cycle, either by the clearing house or by the bank whether paying or receiving payment. A cheque is a species of a bill of exchange with two additional qualifications: 1. It is always drawn on a specified banker, and 2. It is always payable on demand. All cheques are bill of exchange, but all bills of exchange are not cheques. A cheque must have all the essential requisites of a bill of exchange. But it does not require acceptance as it is intended for immediate payment.

Crossing of cheques There are two types of cheque, open cheques and crossed cheques. Open cheque: A cheque which is payable in cash across the counter of a bank is called an open cheque. When such a cheque is in circulation, a great risk attends it. If its holder loses it, its finder may go to the bank and get the payment. A crossed cheque: A crossed cheque is one on which two parallel transverse lines with or without the words &co. are drawn. The payment of such a cheque can be obtained only through a banker. Thus crossing is a direction to the drawee banker to pay the amount of money on a crossed cheque generally to a banker so that the party who obtains the payment of the cheque can be easily traced. A crossed cheque affords security and protection to the owner of the cheque. Types of crossing: 1. General crossing, 2. Special crossing General crossing: A cheque is said to be crossed generally where it bears across its face an addition of a. The words and company between two parallel transverse lines, b. Two parallel transzverse lines simply. Special crossing: Where a cheque bears across its face an addition of the name of a banker, the cheque is deemed to be crossed specially. The payment of a specially crossed cheque can be obtained only through particular bank whose name appears across the face of the cheque, between the two transverse lines. Restrictive crossing: Another type of crossing known as restrictive crossing has developed out of business usage. In this type of crossing the words A/c Payee is added to the general or special crossing. The words A/c Payee on a cheque are a direction to the collecting banker that the amount collected on the cheque is to be credited to the account of the payee, Not negotiable crossing (S.130): the effect of the words not negotiable on a crossed cheque is that the title of the transferee of such a cheque cannot be better than that of the transferor. The addition of the words not negotiable does not restrict further transferability of the cheque. It takes away the main feature

of negotiability. Any one who takes a cheque marked not negotiable takes it at his own risk. Who may cross a cheque (S.126): 1. The drawer 2. The holder 3. The banker: where a cheque is crossed specially, the banker to whom it is crossed may again cross it especially to another banker for collection.

Parties to a Negotiable Instrument

Minors: As the minors agreement is void, he cannot bind himself by becoming a party to a negotiable instrument. But he may draw, endorse, deliver and negotiate a negotiable instrument so as to bind all parties except himself. Further, the instrument does not become void merely because a minor is a party to it. It remains binding on all the other parties to it. HOLDER AND HOLDER IN DUE COURSE Holder (s.8): The holder of a promissory note, bill of exchange or cheque means any person entitled in his own name: a. To the possession there of, and b. To receive or recover the amount due there to. Where a person obtains possession of an instrument by theft or under a forged endorsement, he is not a holder, as he cannot obtain or recover the payment 0f the instrument. Holder in due course (S. 9): Any person is a holder in due course if he fulfils the following conditions: 1. That, for consideration, he became the possessor of the negotiable instrument. 2. That he became the holder of the instrument before its maturity. 3. That he became the holder of the instrument in good faith i.e. without sufficient cause to believe that any defect existed in the title of the person from whom he derived the title.

Privileges of a holder in due course

1. Liability of prior parties: Every prior party to a negotiable instrument is liable to a holder in due course until the instrument is duly satisfied. 2. Negotiable instrument without consideration: If the negotiable instrument gets into the hands of a holder in due course, he can recover the amount on it from any of the prior parties thereto. 3. Conditional delivery: If a bill is negotiated to a holder in due course, the parties to the instrument cannot avoid liability on the ground that the delivery of the instrument was conditional. 4. Instrument cleansed of all defects: Once a negotiable instrument passes through the hands of a holder in due course, it cleansed of its defects, since, the holder himself was not a party to fraud. For example, a bill, originally obtained by fraud from the drawer, gets into the hands of A, a holder in due course. A endorses the bill to B by way of gift. B can sue the acceptor for he stands on As title. 5. Instrument obtained by unlawful means or unlawful consideration: As against holder in due course, the person liable to pay on a negotiable instrument cannot contend that he had lost it or that it was obtained from him by means of an offense or fraud or for an unlawful object. 6. Estoppel against denying original validity of instrument 7. Endorser not permitted to deny the capacity of prior parties: the endorser of a negotiable instrument cannot deny the signature or capacity to contract of any prior party to the instrument.

Negotiation
One of the essential characteristics of a negotiable instrument is that it is freely transferable from one person to another. This transfer may take place by negotiation. Methods of transfer by negotiation: 1. Negotiation by delivery: An instrument payable to bearer is negotiable by delivery there of. Example: A is the holder of a negotiable instrument payable to bearer. He delivers it to Bs agent to keep it for B. The instrument has been negotiated. 2. Negotiation by endorsement and delivery: An instrument payable to order is negotiable by the holder by endorsement and delivery thereon.

Endorsement
In the Negotiable Instrument Act endorsement means the writing of a persons name on the face or back of negotiable instrument or on a slip of paper annexed there to, for the purpose of negotiation. The person who so signs the instrument is called the endorser. The person to whom the instrument is endorsed is called the endorsee. Who may endorse: The first endorsement of an instrument can be made by the payee. Subsequent endorsements can be made by any person who becomes the holder of the instrument. Kinds of endorsement: 1. Blank or general endorsement: An endorsement is said to be blank or general if the endorser signs his name on the face or back of the instrument. In this case the bill may be passed merely by delivery. A blank endorsement does not specify any endorsee and the instrument becomes payable to bearer even though originally it was payable to order. 2. Full or special endorsement: If an endorser signs his name and adds a direction to pay the amount mentioned in the instrument to, or to the order of, a specified person , the endorsement is said to be a full endorsement 3. Restrictive endorsement: An endorsement is said to be restrictive when it prohibits or restricts the further negotiability of the instrument. 4. Partial endorsement: When an endorsement purports to transfer the endorsee a part of the amount only, the endorsement is said to be partial. It is not valid. For example, A is a holder of a bill for Rs. 10,000. He endorses it Pay B or orders.5, 000. This is a partial endorsement and is invalid for the purpose of negotiation. 5. Conditional endorsement: An endorsement is conditional or qualified, if it limits or negatives the liability of the endorser. It may be in the following ways: a. Sans recourse endorsement: The holder of a bill may endorse it in such a way that it does not incur the liability of the endorser. He can do so by adding the words Sans recourse. For example, Pay A or order without recourse to me or Pay A or order at his own risk. b. Liability dependent upon a contingency: For example, Pay A or order on his marriage with B.

SARFAESI act

Background
With an aim to provide a structured platform to the Banking sector for managing its mounting NPA stocks and keep pace with international financial institutions, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was put in place to allow banks and FIs to take possession of securities and sell them. As stated in the Act, it has enabled banks and FIs to realise long-term assets, manage problems of liquidity, asset-liability mismatches and improve recovery by taking possession of securities, sell them and reduce non performing assets (NPAs) by adopting measures for recovery or reconstruction. Prior to the Act, the legal framework relating to commercial transactions lagged behind the rapidly changing commercial practices and financial sector reforms, which led to slow recovery of defaulting loans and mounting levels of NPAs of banks and financial institutions. The SARFAESI Act has been largely perceived as facilitating asset recovery and reconstruction. Since Independence, the Government has adopted several ad-hoc measures to tackle sickness among financial institutions, foremost through nationalisation of banks and relief measures. Over the course of time, the Government has put in place various mechanisms for cleaning the banking system from the menace of NPAs and revival of a healthy financial and banking sector. Some of the notable measures in this regard include:
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Sick Industrial Companies (Special Provisions) Act, 1985 or SICA: To examine and recommend remedy for high industrial sickness in the eighties, the Tiwari committee was set up by the Government. It was to suggest a comprehensive legislation to deal with the problem of industrial sickness. The committee suggested the need for special legislation for speedy revival of sick units or winding up of unviable ones and setting up of quasi-judicial body namely; Board for Industrial and Financial Reconstruction (BIFR) and The Appellate Authority for Industrial and Financial Reconstruction (AAIRFR) and their benches. Thus in 1985, the SICA came into existence and BIFR started functioning from 1987. The objective of SICA was to proactively determine or identify the sick/potentially sick companies and enforcement of preventive, remedial or other measures with respect to these companies. Measures adopted

included legal, financial restructuring as well as management overhaul. However, the BIFR SARFAESI ACT 2002: An Assessment process was cumbersome and unmanageable to some extent. The system was not favourable for the banking sector as it provided a sort of shield to the defaulting companies.
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Recoveries of Debts due to Banks and Financial Institutions (RDDBFI) Act, 1993: The procedure for recovery of debts to the banks and financial institutions resulted in significant portions of funds getting locked. The need for a speedy recovery mechanism through which dues to the banks and financial institutions could be realised was felt. Different committees set up to look into this, suggested formation of Special Tribunals for recovery of overdue debts of the banks and financial institutions by following a summary procedure. For the effective and speedy recovery of bad loans, the RDDBFI Act was passed suggesting a special Debt Recovery Tribunal to be set up for the recovery of NPA. However, this act also could not speed up the recovery of bad loans, and the stringent requirements rendered the attachment and foreclosure of the assets given as security for the loan as ineffective. Corporate Debt Restructuring (CDR) System: Companies sometimes are found to be in financial troubles for factors beyond their control and also due to certain internal reasons. For the revival of such businesses, as well as, for the security of the funds lent by the banks and FIs, timely support through restructuring in genuine cases was required. With this view, a CDR system was established with the objective to ensure timely and transparent restructuring of corporate debts of viable entities facing problems, which are outside the purview of BIFR, DRT and other legal proceedings. In particular, the system aimed at preserving viable corporate/businesses that are impacted by certain internal and external factors, thus minimising the losses to the creditors and other stakeholders. The system has addressed the problems due to the rise of NPAs. Although CDR has been effective, it largely takes care of the interest of bankers and ignores (to some extent) the interests of borrowers stakeholders. The secured lenders like banks and FIs, through CDR merely, address the financial structure of the company by deferring the loan repayment and aligning interest rate payments to suit companys cash flows. The banks do not go for a one time large write-off of loans in initial stages.

SARFAESI ACT 2002: By the late 1990s, rising level of Bank NPAs raised concerns and Committees like the Narasimham Committee II and Andhyarujina Committee which were constituted for examining banking sector reforms considered the need for changes in the legal system to address the issue of NPAs. These committees suggested a new legislation for securitisation, and empowering banks and FIs to take possession of the securities and sell them without the intervention of the court and without allowing borrowers to take shelter under provisions of SICA/BIFR. Acting on these suggestions, the SARFAESI Act, was passed in 2002 to legalise securitisation and reconstruction of financial assets and enforcement of security interest. The act envisaged the formation of asset reconstruction companies (ARCs)/ Securitisation Companies (SCs).

Provisions of the SARFAESI Act

The Act has made provisions for registration and regulation of securitisation companies or reconstruction companies by the RBI, facilitate securitisation of financial assets of banks, empower SCs/ARCs to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default. The Act provides three alternative methods for recovery of NPAs, namely:
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Securitisation: It means issue of security by raising of receipts or funds by SCs/ARCs. A securitisation company or reconstruction company may raise funds from the QIBs by forming schemes for acquiring financial assets. The SC/ARC shall keep and maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired, out of investments made by a QIB and ensure that realisations of such financial asset is held and applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme. Asset Reconstruction: The SCs/ARCs for the purpose of asset reconstruction should provide for any one or more of the following measures: the proper management of the business of the borrower, by change in, or take over of, the management of the business of the borrower the sale or lease of a part or whole of the business of the borrower rescheduling of payment of debts payable by the borrower enforcement of security interest in accordance with the provisions of

this Act settlement of dues payable by the borrower taking possession of secured assets in accordance with the provisions of this Act.
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Exemption from registration of security receipt: The Act also provides, notwithstanding anything contained in the Registration Act, 1908, for enforcement of security without Court intervention: (a) any security receipt issued by the SC or ARC, as the case may be, under section 7 of the Act, and not creating, declaring, assigning, limiting or extinguishing any right, title or interest to or in immovable property except in so far as it entitles the holder of the security receipt to an undivided interest afforded by a registered instrument; or (b) any transfer of security receipts, shall not require compulsory registration.

The Guidelines for SCs/ARCs registered with the RBI are:

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act as an agent for any bank or FI for the purpose of recovering their dues from the borrower on payment of such fees or charges act as a manager between the parties, without raising a financial liability for itself; act as receiver if appointed by any court or tribunal.

Apart from above functions any SC/ARC cannot commence or carryout other business without the prior approval of RBI. The Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003 The Reserve Bank of India issued guidelines and directions relating to registration, measures of ARCs, functions of the company, prudential norms, acquisition of financial assets and related matters under the powers conferred by the SARFAESI Act, 2002. Defining NPAs: Non-performing Asset (NPA) means an asset for which:
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Interest or principal (or instalment) is overdue for a period of 180 days or more from the date of acquisition or the due date as per contract between the borrower and the originator, whichever is later; interest or principal (or instalment) is overdue for a period of 180 days or more from the date fixed for receipt thereof in the plan formulated for realisation of the assets interest or principal (or instalment) is overdue on expiry of the planning period, where no plan is formulated for realisation of the

any other receivable, if it is overdue for a period of 180 days or more in the books of the SC or ARC.

Provided that the Board of Directors of a SC or ARC may, on default by the borrower, classify an asset as a NPA even earlier than the period mentioned above. Registration:
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Every SC or ARC shall apply for registration and obtain a certificate of registration from the RBI as provided in SARFAESI Act; A Securitisation Company or Reconstruction Company, which has obtained a certificate of registration issued by RBI can undertake both securitisation and asset reconstruction activities; Any entity not registered with RBI under SARFAESI Act may conduct the business of securitisation or asset reconstruction outside the purview of the Act.

Net worth of Securitisation Company or Reconstruction Company: Net worth is aggregate of paid up equity capital, paid up preference capital, reserves and surplus excluding revaluation reserve, as reduced by debit balance on P&L account, miscellaneous expenditure (to the extent not written off ), intangible assets, diminution in value of investments/short provision against NPA and further reduced by shares acquired in SC/ARC and deductions due to auditor qualifications. This is also called Owned Fund. Every Securitisation Company or Reconstruction Company seeking the RBIs registration under SARFAESI Act, shall have a minimum Owned Fund of Rs 20 mn. Permissible Business: A Securitisation Company or Reconstruction Company shall commence/undertake only the securitisation and asset reconstruction activities and the functions provided for in Section 10 of the SARFAESI Act. It cannot raise deposits. Some broad guidelines pertaining to Asset Reconstruction are as follows:
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Acquisition of Financial Assets: With the approval of its Board of Directors, every SC/ARC is required to frame, a Financial Asset Acquisition Policy, within 90 days of grant of Certificate of Registration, clearly laying down policies and guidelines which define the; norms, type, profile and procedure for acquisition of assets, valuation procedure for assets having realisable value, which could be reasonably estimated and independently valued; plan for realisation of asset acquired for reconstruction

The Board has powers to approve policy changes and delegate powers to committee for taking decisions on policy/proposals on asset acquisition.
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Change or take over of Management/ Sale or Lease of Business of the Borrower: No SC/ARC can takeover/ change the management of business of the borrower or sale/lease part/whole of the borrowers business until the RBI issues necessary guidelines in this behalf. Rescheduling of Debt/ Settlement of dues payable by borrower: A policy for rescheduling the debt of borrowers should be framed laying the broad parameters and with the approval of the Board of Directors. The proposals should to be in line with the acceptable business plan, projected earnings/ cash flows of the borrower, but without affecting the asset liability management of the SC/ARC or commitments given to investors. Similarly, there should be a policy for settlement of dues with borrowers. Enforcement of Security Interest: For the sale of secured asset as specified under the SARFAESI Act, a SC/ARC may itself acquire the secured assets, either for its own use or for resale, only if the sale is conducted through a public auction. Realisation Plan: Within the planning period a realisation plan should be formulated providing for one or more of the measures including settlement/rescheduling of the debts payable by borrower, enforcement of security interest, or change/takeover of management or sale/lease of a part or entire business. The plan should clearly define the steps for reconstruction of asset within a specified time, which should not exceed five years from the date of acquisition.

Broad guidelines with regards to Securitisation are as follows:

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Issue of security receipts: A SC/ARC can set up trust(s), for issuing security receipts to QIBs, as specified under SARFAESI Act. The company shall transfer the assets to the trust at a price at which the assets were acquired from the originator. The trusteeship remains with the company and a policy is formulated for issue of security receipts. Deployment of funds: The company can sponsor or partner a JV for another SC/ARC through investment in equity capital. The surplus available can be deployed in G-Sec or deposits in SCBs. Asset Classification: The assets of SC/ARC should be classified as Standard or NPAs. The company shall also make provisions for NPAs.

Issues under the SARFAESI Right of Title A securitisation receipt (SR) gives its holder a right of title or interest in the financial assets included in securitisation. This definition holds good for securitisation structures where the securities issued are referred to as Pass through Securities. The same definition is not legally inadequate in case of Pay through Securities with different tranches. Thin Investor Base The SARFAESI Act has been structured to enable security receipts (SR) to be issued and held by Qualified Institutional Buyers (QIBs). It does not include NBFC or other bodies unless specified by the Central Government as a financial institution (FI). For expanding the market for SR, there is a need for increasing the investor base. In order to deepen the market for SR there is a need to include more buyer categories. Investor Appetite Demand for securities is restricted to short tenor papers and highest ratings. Also, it has remained restricted to senior tranches carrying highest ratings, while the junior tranches are retained by the originators as unrated pieces. This can be attributed to the underdeveloped nature of the Indian market and poor awareness as regards the process of securitisation. Risk Management in Securitisation The various risks involved in securitisation are given below: Credit Risk: The risk of non-payment of principal and/or interest to investors can be at two levels: SPV and the underlying assets. Since the SPV is normally structured to have no other activity apart from the asset pool sold by the originator, the credit risk principally lies with the underlying asset pool. A careful analysis of the underlying credit quality of the obligors and the correlation between the obligors needs to be carried out to ascertain the probability of default of the asset pool. A well diversified asset portfolio can significantly reduce the simultaneous occurrence of default. Sovereign Risk: In case of cross-border securitisation transactions where the assets and investors belong to different countries, there is a risk to the investor in the form of non-payment or imposition of additional taxes on the income repatriation. This risk can be mitigated by having a foreign guarantor or by

structuring the SPV in an offshore location or have an neutral country of jurisdiction Collateral deterioration Risk: Sometimes the collateral against which credit is sanctioned to the obligor may undergo a severe deterioration. When this coincides with a default by the obligor then there is a severe risk of nonpayment to the investors. A recent example of this is the sub-prime crisis in the US which is explained in detail in the following sections. Legal Risk: Securitisation transactions hinge on a very important principle of bankruptcy remoteness of the SPV from the sponsor. Structuring the asset transfer and the legal structure of the SPV are key points that determine if the SPV can uphold its right over the underlying assets, if the obligor declare bankruptcy or undergoes liquidation. Prepayment Risk: Payments made in excess of the scheduled principal payments are called prepayments. Prepayments occur due to a change in the macro-economic or competitive industry situation. For example in case of residential mortgages, when interest rates go down, individuals may prefer to refinance their fixed rate mortgage at lower interest rates. Competitors offering better terms could also be a reason for prepayment. In a declining interest rate regime prepayment poses an interest rate risk to the investors as they have to reinvest the proceedings at a lower interest rate. This problem is more severe in case of investors holding long term bonds. This can be mitigated by structuring the tranches such that prepayments are used to pay off the principal and interest of short-term bonds. Servicer Performance Risk: The servicer performs important tasks of collecting principal and interest, keeping a tab on delinquency, maintains statistics of payment, disseminating the same to investors and other administrative tasks. The failure of the servicer in carrying out its function can seriously affect payments to the investors. Swap Counterparty Risk: Some securitisation transactions are so structured wherein the floating rate payments of obligors are converted into fixed payments using swaps. Failure on the part of the swap counterparty can affect the stability of cash flows of the investors. Financial Guarantor Risk: Sometime external credit protection in the form of insurance or guarantee is provided by an external agency. Guarantor failure can adversely impact the stability of cash flows to the investors
.

RESERVE BANK OF INDIA ACT, 1934

To regulate the issue of Bank notes and for the keeping of reserves with a view to securing monetary stability in British India (now India) To operate the currency and credit system of the country to its advantage it was found expedient to constitute a Reserve Bank of India. RESERVE BANK OF INDIA ACT 1934.. Functions entrusted. Bank of issue (of currency) Banker to the government (including management of Banker to commercial banks (lender of last resort) Controller of volume of credit in India Organization of sound and healthy commercial banking system Concerned with the development of Rural banking; Promotion of financial institutions; and Development of money and capital markets Bankers bank Lender of last resort for Commercial banks Commercial co-operative banks Regional rural banks RBI offers refinancing facility to its scheduled banks public debt)

 The banking institutions which figure in the Second Schedule of the RBI Act Before admitting the banking company in to the schedule RBI satisfies itself that such banking company is worth it RBI also has the power to remove the banking company from the schedule RESERVE BANK OF INDIA ACT 1934 Chapter 1: Preliminary 1. Short title, extent, commencement This Act may be called the Reserve Bank of India Act, 1934. It extends to the whole of India. This section shall come into force at once, and the remaining provisions of this Act shall come into force on such date or dates as the Central Government may, by notification in the Gazette of India, appoint. Section 4 Capital of bank shall be five crores of rupees Section 8 Composition of the central board (1) The Central Board shall consist of the following Directors, namely: (a) a Governor and not more than four Deputy Governors to be appointed by the Central Government; (b) four Directors to be nominated by the Central Government, one from each of the four Local Boards as constituted by section 9; (c) ten Directors to be nominated by the Central Government; and (d) one Government official to be nominated by the Central Government

Chapter 2 Section 17

Business which bank may transact The Bank shall be authorized to carry on and transact the several kinds of business hereinafter specified, namely: the accepting of money on deposit without interest from, and the collection of money for, the Central Government, the State Government, local authorities, banks and any other persons: Section 19 Bank may not: Purchase the shares of any banking company or of any other company, or grant loans upon the security of any such shares Chapter 3 Section 20 Obligation of the Bank to transact Government business: The Bank shall undertake to accept monies for account of the Central Government and to make payments up to the amount standing to the credit of its account, and to carry out its exchange, remittance and other banking operations, including the management of the public debt of the Union.

Section 42.1(amended) The statutory minimum CRR requirement of 3 percent of total demand and time liabilities no longer exists. Reserve Bank having regard to the needs of securing monetary stability in the country, can prescribe the Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate

BANKERS BOOK EVIDENCE ACT, 1891 Section 3

Powers to extend provisions of Act The State Government may from time to time, by notification in the Official Gazette, extend the provisions of this Act to the books of any partnership or individual carrying on business of bankers within the territories under its administration, and keeping a set of not less than three ordinary account-books namely, a cash-book, a day-book or journal, an a ledger, and may in like manner rescind any such notification.

Section 5
Case in which officer of bank not comparable to produce booksNo officer of a bank shall in any legal proceeding to which the bank is not a party be comparable to produce any banker's book the contents of which can be proved under this Act, or to appear as a witness to prove the matters, transactions and accounts therein recorded, unless by order of the Court or a Judge made for special cause.

Section 6
Inspection of Books by order of Court or Judge On the application of any party to a legal proceeding the Court or a Judge may order that such party be at liberty to inspect and take copies of any entries in a Banker's Book for any of the purposes of such proceeding The Bank may at any time before the time limited for obedience to any such order as aforesaid either offer to produce their books at the trial or give notice of their intention to show cause against such Order, and thereupon the same shall not be enforced without further order.

STATE BANK OF INDIA ACT 1955

An Act to constitute a State Bank for India, to transfer to it the undertaking of the Imperial Bank of India and to provide for other matters, connected therewith or incidental thereto Its purpose is to extend the banking facilities on a large scale, more particularly in the rural and semi-urban areas, and for diverse other public purposes It has 8 Chapters ,53 sections

Section 5
Issued capital: The Central Board may from time to time increase the issued capital but no increase in the issued capital shall be made in such a manner that the Reserve Bank holds at any time less than fifty-five per cent. of the issued capital of the State Bank.

Section 6 and 7
Transfer of assets and liabilities of the Imperial Bank to the StateBank ( section 6) Transfer of service of existing officers and employees of the ImperialBank to the State Bank (section 7)

Section 11
Restrictions on voting rights.No shareholder, other than the Reserve Bank, shall be entitled to exercise voting rights in respect of any shares held by him in excess of ten per cent. of the issued capital

Section 17
Composition of the Central Board The Central Board shall consist of the following, namely:-(a) a chairman and a vice-chairman to be appointed by the Central Government in consultation with the RBI (b) not more than two managing directors, if any, appointed by the Central Government in consultation with the RBI

Section 32
The State Bank shall, if so required by the RBI, act as agent of the RBI at all places in India where it has a branch for (a) paying, receiving, collecting and remitting money, bullion and securities on behalf of any Government in India; and (b) undertaking and transacting any other business which the RBI may from time to time entrust to it. If a dispute arises between the State Bank and the Reserve Bank as to the interpretation of any agreement between them, the matter shall be referred to the Central Government and the decision of the Central Government thereon shall be final

Bibliography
Books Banking law and practices Legal aspects of banking Websites indiacode.nic.in rbi.org.in