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This article is written by Rohit Jain, a student of Bharati Vidyapeeth University’s New Law College, Pune.

Introduction

Ever since the independence, banking had been the backbone of the Indian Economy. The growth prospective of our nation is based on its well-built banking system. And in recent times, the Indian Banking Industry has witnessed continued growth in demand and this substantially increasing market size of the Banking Industry clearly indicates its growth potential, and thus forming a Banking Company can be absolutely lucrative. But unlike the unregulated markets, the formation of a Banking Company entails the awareness of a variety of legal issues. And thus, accordingly, the present article discusses and explains the various matters relating to the formation of a Banking Company in India.

The Banking Industry as it stands today is just limited to just 34 Banking Companies, out of which 12 are public sector banks and the remaining 22 are private sector banks. Statistically, the banking industry in India yields 7.7% of the nation’s GDP and has a market size of around 105 Trillion Rupees. Despite all these facts, 20% of the Indian population doesn’t have a bank account, and this fact clearly indicates the growth potential of the banking industry in India.

In India, we have a Federal form of government and thus we have a division of power between centre and the states. Banking is included in the Union List (Entry 45) so it is under the exclusive control of the Central Government, which is empowered to control the banking business in India. And hence the law governing the banking industry in India is uniform throughout the country.

Meaning of the word bank and banking company

The definition of the words Banking and Banking Company is been provided under Section 5(b) and Section 5(c) of the Banking Regulation Act, 1949 (herein referred to as the Act) respectively. 

Section 5(b) of the Act provides for the feature of Banking. These features are:

  1. Accepting deposits from the general public, 
  2. Lending or further investing the money received from such deposits, 
  3. The money is repayable on demand, and
  4. The money deposited can be withdrawn by cheque, draft, order or otherwise. 

Section 5(c) of the Act defines banking company as a company which transacts the business of banking. The explanation to the section makes it clear that any company which accepts deposits merely for the purpose of financing its business will not be treated as a banking company. This explanation had been added because Section 58-A of the Companies Act also empowers the company to accept deposits from public. 

Business of banking

As discussed above, a banking company is one which transacts into the business of banking, and so it becomes important for us to discern as to what constitutes the business of banking in India. So, section 6 of the Act provides for the activities that constitutes the business of banking. 

  1. Borrowing, raising or taking up of money;
  2. Advancing of money;
  3. Making, accepting, discounting of bill of exchange, pro notes, bill of lading, railway receipts, etc;
  4. Acting as an agent of the government to carry the work of clearing and forwarding of goods;
  5. Contracting, negotiation, and issuing public and private loans;
  6. Insuring, guaranteeing, underwriting, participating of shares, stocks, debentures, of any company;
  7. Managing, selling, realizing any property which comes into possession of company;
  8. Undertaking and executing trusts;
  9. Administration of estates;
  10. Selling, managing, exchanging, leasing, mortgaging or dealing of any part of company’s property, etc;
  11. Other tasks incidental to the above-mentioned functions;
  12. Any other function as notified by the central government. 

Registration of a company under the provisions of the Companies Act

The first and the foremost requirement for the formation of a banking company in India is that the applicant needs to be a ‘Company’ formed under the provisions of The Companies Act, 1956. Any person who wishes to start a banking business in India needs to set up a separate legal entity distinct from is owner. The procedure for the formation of a company is given under Section 7 of the Act. Every company needs to register itself with the registrar of the company, by filing an application and submitting the relevant documents like MoA and AoA. If the registrar is satisfied with all documents, then he will issue a certificate of registration under Section 7(1)

Major documents required for the formation of a company are:

  1. Memorandum of Association (MoA): Framing of the MoA is the first step towards the formation of a company. It is the most important document of a company often known as the Constitution of the Company. As per Section 4 of the MoA is five parts in a MoA which can be found in Table A to Table E in Schedule 1 of the Act. It contains various clauses like the name clause, capital clause, liability clause, object clause etc. This document mainly deals with the external matters of a company. It must be noted that the MoA of every company is available as a public document on the portal of the Ministry of Corporate Affairs
  2. Article of Association (AoA): The next most important document in addition to MoA is the AoA. This document deals with the internal matters of a company and is commonly known as the by-laws of a company. Section 5 of the act deals with the provisions relating to AoA, it states that the AoA of a company shall consist of details relating to the Regulation and management of a company and all the other matters which are considered necessary for its functioning. The AoA of a company, as similar to MoA contains five parts which can be found in Table F to Table J in Schedule 1.

Capital requirements

Statutory requirements

Section 11 of The Banking Regulation Act prescribes the minimum capital requirement for every banking company and no banking company is allowed to carry on its banking business unless the statutory requirements as discussed below are maintained. The act has classified the capital requirements on the basis of the place where the company is incorporated. 

Section

Place of Incorporation

Capital Required

11(2)

Banking Company Incorporated Outside India (Foreign Banking Company)

  • If business is in the city of Bombay or Calcutta: amount of its paid up capital shall not be below twenty lakhs rupees.

  • If no business in the city of Bombay or Calcutta: amount of its paid up capital shall not be below fifteen lakhs rupees.

11(3)

Banking Company is Incorporated in India

  1. If it has place of business in more than one state: five lakhs rupee and if such a place is Bombay or Calcutta then ten lakh rupees.
  2. If it has place of business in more than one state none of which is situated in Bombay or Calcutta: One Lakh rupees in respect of the principal place of business + Ten Thousand rupees for each place where its business is situated in same district, + Twenty five thousand rupees of each place of business situated elsewhere in the state other than in the district. 
  3. If it has a place of business in one state, one or more of which is situated in Bombay or Calcutta: Five lakh rupees + twenty five thousand rupees for each place outside Bombay and Calcutta. 

Points to be noted:

  1. Provided further that no banking company incorporated in India shall be required to have a paid-up capital requirement exceeding ten lakh rupees. 
  2. The amount stated above needs to be deposited and keep deposited with the Reserve Bank of India, either in cash or in any form is unencumbered approved security.
  3. These are just the statutory requirements of capital and reserves. But in actuality, the Reserve Bank of India prescribes the guidelines for licensing of a new banking business in India. The capital requirements for the formation of a new banking company is required to be maintained according to the guidelines of the RBI.

Capital requirements according to the guidelines issued by the Reserve Bank of India

The minimum paid-up voting equity capital for a bank shall be 500 Crore Rupees for universal banks and 200 Crore Rupees for small finance banks. And any addition to this capital will be based upon the plan presented by the promoters of the bank to the RBI.

However recently, in November 2020, a panel led by P.K. Mohanty has recommended RBI to increase the minimum initial capital requirements for licensing of a new banking firm to 1000 Crore Rupees for universal bank and 300 Crore Rupees for Small finance banks.

Regulations of paid-up capital, subscribed capital and authorized capital and voting rights of shareholders

Statutory requirements

According to Section 12 of the Banking Regulation Act, 1949, no banking company is allowed to carry on its business unless it satisfies the following conditions:

  1. Its subscribed capital is not less than one-half of its authorized capital;
  2. Its paid-up capital is not less than one-half of the subscribed capital;
  3. The capital of the company consists of ordinary shares only or of ordinary shares or equity shares;
  4. No person holding shares in a banking company shall have voting rights of above 10% of total voting rights of all the shareholders;
  5. Every managing executive of the bank needs to disclose, to the RBI, the extent and the amount of his shareholding in the firm.

RBI’s Guidelines

As per the guidelines issued by the RBI the promoters of a banking company operating its business for over 15 years can raise their share cap to 15%. And according to a recent recommendation of The PK Mohanty Committee the RBI may increase this limit of 15% to 26%.

Management of the banking companies

As per the provisions of the Companies Act, 1956 the management of a company is done through the scheme of Board of Directors, on a parallel line the Banking Regulation Act, 1949 u/s 10-A has also provided for similar model of management for a Banking Company. So according to Section 10-A of the Act the constitution of the Board of Directors and prescribes the eligibility of the people who can be appointed as the Directors.

So according to Section 10-A every company is required to constitute a Board of Directors, and while constituting the BOD the following points need to be considered:

  1. 51% of the members of the BOD should have special knowledge or practical experience in the field of accounts, banking, finance, law, agriculture and rural development, Co-operation, small scale industry or any other field as prescribed by the Reserve Bank of India. 
  2. None of the members of the BOD shall have a substantial interest in the company and must not be connected to the company as a manager, agent, employee, etc (this provision does not applies to a company registered under Section 25 of the Companies Act).
  3. The members should not be a member of any trading, commercial or industrial concerns. 
  4. No director shall hold the office (except chairman or whole-time director) shall hold the office for a period exceeding 8 years.
  5. On failure of compliance with the above provisions the Reserve Bank of India is empowered to appointment any suitable person for such a job. 

Further Section 10 of the Act prohibits for employment of certain person which includes:

  1. Person adjudicated as insolvent;
  2. Who have compounded with his creditors;
  3. Convicted for some criminal act involving moral turpitude;
  4. Person whose remuneration is taken in form of commission or profit on shares;
  5. Person who is a director of its subsidiary company;
  6. Person who is the director of a company registered u/s 25 of the Companies Act.

Licensing of banking companies

Section 22 of the Act provides that no banking company is permitted to carry on the banking business in India unless it holds a license issued on behalf of the Reserve Bank. Such a license is issued only when the RBI is satisfied that all the conditions are satisfied. Since the banking is the backbone of the Indian Economy, so for the smooth conduct of the banking business in India is it important that no unscrupulous element is added to this banking industry. So the licensing system makes sure that no undesirable element is taking part in the Indian banking system.

Procedure: Every company desiring to start a banking company shall before commencing the banking business in India, shall apply in writing to the Reserve Bank of India.

Condition: Section 22(3) states that the Reserve Bank is required to be satisfied with the following conditions before granting license:

  1. That the company will be in a stance to pay its present and future depositors;
  2. That the affairs of the company are not conducted in a manner which is detrimental to the banking business;
  3. That the management structure of the company is not prejudice to public interest;
  4. That the company has adequate capital as prescribed under the statute and prescribed by RBI;
  5. That the public interest will be served if the license is granted;
  6. That adequate facilities are available in the proposed business area of the firm.

Cancellation of License: Section 22(4) states the situations where the RBI is entitled to cancel a banking business:

  1. If the company ceases to carry on the business of banking;
  2. If the company fails to comply with the conditions mentioned under the Act.

Opening of new branches or transfer of existing place of business

As per the provisions of Section 23 of the Act, no banking company is allowed to open a new place of business without obtaining prior permission of the RBI, and neither the banks can transfer their existing place of business without prior permission of the RBI

Reserve funds

As per the provisions of Section 17 of the Act, every bank is required to transfer, each year, an amount equivalent to 20% of its profit for that year to the Reserve Funds

Cash reserve

As per the provisions of Section 18 of the Act, every banking company needs to maintain, at all time, an amount in cast with the RBI which is equivalent to 3% of its demand and time liabilities. Any decision taken by the reserve bank in this regards shall be final and cannot be appealed. 

Maintainance of assets in India

As per the provisions of Section 24 of the Act, every banking company is required to maintain assets in India which are equivalent to 20% of its demand and time liabilities. The act also prescribes the asset in which such an amount is to be maintained, those assets are: gold, unencumbered securities, or approved securities.

Conclusion

On denouement, it can be stated that the procedure for the formation of a banking company in India is provided under the Banking Regulation Act, 1949 and as per the guidelines issued by the employees. The procedure for the formation of a banking company in India is rigid and complex. While forming a banking company the provisions of both the Companies Act, 1956 and The Banking Regulation Act, 1949 has to be kept in mind, in addition to these two legislations the Guidelines issued by the RBI has also to be considered. 

References

  1. R.N. Choudhary, Banking Laws, Central Law Publications, Third Edition, 2014
  2. Rohit Jain, Legal Framework of Internet Banking in India, International Journal of Law Management and Humanities, Volume 4, Issue 1, Pg. 699, see here
  3. rbidocs.rbi.org.in/
  4. Banking Regulation Act, 1949
  5. m.businesstoday.in 

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