Analysis: Banking Regulation Act

Reading time: 8-10 minutes.

The Banking Regulation Act, 1949 is Central legislation that regulates all banking firms based in India. Passed as the Banking Companies Act, it is one of the most important legislation for banks. It was first enforced from 16 March 1949 only to be later changed to the Banking Regulation Act in 1966. It is applicable in Jammu and Kashmir since 1956. Initially, the provisions of this legislation applied only to banking companies. But, after the 1965 amendment, it applied to cooperative banks as well.

It must be noted that the provisions of the Banking Regulation Act, 1949 (previously known as the Banking Companies Act, 1949) are in addition to, and not in the derogation of the Companies Act, 1956 unless expressly provided.

The banking business may be carried on by a sole trader, a partnership, or by a company. The Companies Act, however, provides that if an association, company, or partnership of more than ten persons is to carry on the banking business, it has to be registered as a company under the Act.

The Banking Regulation Act empowers the Reserve Bank of India (RBI) to license banks and regulate their shareholding. It also empowers the RBI regarding the appointments and management of the boards. RBI can also lay down instructions for audits, control mergers and liquidation as well as issue directives on banking policy.

The salient features of this Act are as follows:

  • Definitions – The Banking Regulation Act defines the term banking and banking company under section 5 among other definitions.
  • Trading prohibition – According to section 8 of the Banking Prohibition Act, a banking company cannot buy, sell, or barter goods, either directly or indirectly. However, it may do so when the transactions relating to bills of exchange received for collection or negotiation.
  • Non-banking asset – According to section 9, a banking company cannot hold any immovable property, howsoever acquired, beyond seven years from the date of its acquisition. Though, such an immovable property can be held by the banking company if it is for its own use. Further, it has to deal, trade, or facilitate the immovable property’s .disposal.
  • Management – Section 10 of the Banking Regulation Act, prohibits the banking company from employing a Managing agent, Director of any other company or any other person as specified in the section. Section 10A provides that at least 51 percent of the Board of Directors of a banking company must comprise of people who have special knowledge or practical experience in matters as specified in this section. Section 10B states that the banking company must be managed by a whole-time Chairman.
  • Minimum Capital – Section 11 provides that a banking company can commence or carry out business in India only when it has a minimum paid-up capital and reserve according to the provisions of this section.
  • Commission Payment – According to section 13, a banking company cannot pay more than 2.5% of the price of shares in the form of commission, discount, remuneration, or brokerage, either directly or indirectly, or such shares.
  • Dividend Payment Section 15 lays down restrictions on a banking company regarding the payment of dividends. It states that a banking company must not pay any dividend on its shares unless all its expenses have been completely written off.
  • Reserve Funds – Section 17 states that every banking company must create a reserve fund. This reserve fund can be created through the year-end profits and must equal at least 20 percent of such profits.
  • Cash Reserve –According to section 18, every banking company except a scheduled bank must maintain a cash reserve daily in India. This amount must be equal to such percent of the banking company’s demand and time liabilities as specified by the RBI and must be submitted before the 20th of every month.
  • Accounts and Balance Sheets – Section 29 provides that every banking company incorporated in India must prepare and submit a balance sheet and a profit loss account on the last working day of a financial year.

Its objectives and purposes

The Act, as amended up-to-date, is a comprehensive piece of legislation aimed at the development of the banking business in the country. From the definition of the term banking to their licensing and functioning along with the provisions of their taking-over, amalgamation, and their liquidation — it has been an attempt by the legislators to extensively cover it all under the Act. It does not apply to primary agriculture credit societies, cooperative land mortgage banks, and any other cooperative society.

Purpose: The provisions of the Indian Companies Act, 1913 were proving to be inadequate to regulate the banking business in India. It was highly unorganized and in poor health. A majority of the banks were private. Only a few people received benefits from the monopolies created by these banks. Moreover, there was an inadequacy of capital that led to the failure of many banks. Thus, a need for specific legislation was felt by the government for the proper functioning of the banking sector. It led to the enactment of the Banking Regulation Act, 1949 (initially the Banking Companies Act) to exhibit some sort of control over the nation’s banking sector.

The Banking Regulation Act enacted in February 1949 has the following objectives:

  • To introduce specific legislation for the banking business in India
  • To ensure a sound and balanced growth of the banking business
  • To cut competition among banks
  • To prevent the random opening of new branches of banks or a random shift in their location
  • To establish minimum capital requirements for banks
  • To empower RBI to regulate, license, and manage the banking companies and ensure their smooth and efficient functioning
  • To protect the interest of depositors and the public at large

Critical analysis

There are many advantages and disadvantages of regulating the banking sector. These advantages and limitations depend upon the financial conditions, economic policies, and existing legal framework of the country on the subject.

Regulating the banking business can bring fairness through government control. It can go a long way in safeguarding the interests of the depositors. But, most importantly, it can help build the confidence and trust of the public in banks. However, on the other hand, unnecessary control and heavy regulation can also restrict the banks. It can prevent them from performing their tasks freely and ultimately stop them from earning adequate profits.

Now, if we look at the Banking Regulation Act, 1949, it was enacted to organize the banking business in India to better serve the interests of the public.  It gave several powers to the RBI including the power to license banks, regulate the shareholding and other operations, and control mergers among others.

This Act has seen multiple amendments over the years.  The 1965 Amendment Act brought cooperative banks under the purview of the Banking Regulation Act. The 1994 Amendment Act introduced the post of Chairman. An amendment in 2004 empowered RBI to supersede the board of directors of cooperative banks. The amendment in 2007 made it mandatory for scheduled banks to maintain cash reserve while the one in 2017 focused on stressed assets.

Many blank spaces were filled by these amendments. The primary objective was to free the banking system from its lacunas and promote its growth and development. The recent amendment of 2017 came as a result of the sufferings faced by the banking system of the country due to stressed assets.

The banks were comfortable in lending to customers without a thorough background check and this led to serious credibility issues. Estimates tell that a humongous amount of Rs 9.64 trillion was stuck under stressed assets. The 50 major defaulters included some well-known companies as well as some banks. The 2017 amendment allowed RBI to deal with the situation. It empowered RBI to initiate insolvency proceedings on certain stressed assets and issue directives for the same.

However, the ground reality is different. The newly introduced provisions fail to solve the underlying issues. As per an RBI official, the Banking Regulation Act does not wholly apply to state-owned banks as much as it does on private banks. It lacks the essential powers that render it helpless when it comes to dealing with certain errant banks and bankers.      

Scope for reform

The Banking Regulation Act dates back to the year 1949 and contains certain rules and regulations that do not fit well with the current banking system. There have been many amendments to ensure the same but certain lacunas still exist. The issue of NPAs and other stressed assets has haunted the banking sector of India for years now. And with the major cases of defaulters coming out in the open over the last few years, it brings forth the question—Is the 2017 Amendment enough?

RBI has many powers including supervisory ones. Though, it has to consult the government before taking any action against the public sector banks. The Finance Ministry maintains that the RBI has adequate powers to resolve the issues. It has even identified 13 sections of the Banking Regulation Act in this regard.

The newly introduced amendment has tried to leverage the stressed assets burden from the financial system. But it doesn’t seem enough. The stressed assets and NPAs are allowed to linger on for years to the extent it is too late and the defaulters make a run out of the country. It not only hampers the banks but also puts a dent in the public’s confidence and trust. The need of the hour is not just strong provisions but also a more vigilant attitude from the RBI. The present laws are not sufficient to deal with the NPA crisis and they have not been sufficient for years. The Indian banking sector needs reform not just on paper but also in reality.

Conclusion

Before the passing of the Banking Regulation Act, 1949 there were many discrepancies prevalent in the banking sector. It was highly unorganized and a failure. With the introduction of this Act, the functioning of the banking firms has been regulated. This Act has ensured developed and balanced growth in the banking sector. The breakthrough was the conferring of powers on RBI to regulate banks and their functioning. In a nutshell, this Act has brought all the banking firms under one umbrella with the RBI being the governing body.

However, we are still witnessing the poor status of the banking sector. The burden of NPAs and stressed assets has choked the system. In recent years, we have witnessed cases such as the case of Rs. 13,000 crore fraud with PNB. We have also witnessed bank mergers on a large scale. This must be seen as a cry for help. The Banking Regulation Act was introduced to help strengthen the root level of the banking structure within India. If the Act is not equipped well, it will not be able to serve its objectives.

Author: Devansh Garg from Vivekananda Institute of Professional Studies (VIPS).

Editor: Shalu Bhati  from Campus Law Centre, Faculty of Law, University of Delhi.

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