In this article, Varsha Jhavar, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on the legal framework regulating the banking sector in India

Introduction

Legal Framework

The Indian banking system is primarily governed by Banking Regulation Act, 1949.  The Reserve Bank of India Act, 1934 empowers the RBI (Reserve Bank of India) to act on a wide range of issues including rules, regulations, directions and guidelines with respect to banking and financial services. The RBI is the central bank of India.

Besides the above, the FEMA (Foreign Exchange Management Act, 1999) regulates with respect to cross-border transactions.

Reserve Bank of India (RBI)

The primary regulator for banks in India is RBI. The functions of RBI include:

• Making norms for opening up and licensing banks (including foreign bank branches in India)
• Corporate governance and organization
• Norms for various products and services
• Finalizing monetary policy
• Regulation of foreign exchange, government securities markets and financial derivatives
• Government debt and cash management
• Overseeing payment and settlement systems
• Currency Management
• To liaise with other financial sector regulators like SEBI, IRDAI etc. RBI needs to regulate banking activities which overlap or have an interaction with financial activities under the domain of other financial sector regulators.

Supervision and legislation on the functioning of banks and financial institutions is also done by the Ministry of Finance (under Central Government) through the Department of Financial Services. The Department of Financial Services does:

• Monitoring of banking operations
• Prescribes norms for the operation of public sector banks.
• Looks into the recovery of bank debts by way of examining legislative measures and establishing judicial mechanisms for the same.

Forms of Banks

There could be different form of banks as distinguished by the regulator:

• State-owned banks

State Bank of India (SBI) is the largest state-owned bank and has been established under a special statute, the State Bank of India Act, 1955. Additionally, between the years 1969 to 1980, the government nationalized several banks by a legislative mandate.

• Universal banks, commercial and retail banks

Universal banks are full-service banks and offer almost an entire range of financial products. They can be differentiated as private sector banks (non-state owned), public sector banks (state-owned) and foreign banks. As mentioned earlier licensing and operations of these banks fall under Banking Regulation Act.

• Investment Banks

These banks give investment advisory and related services. Investment banks are governed by the Securities Exchange Board of India (SEBI). The license is also issued by SEBI.

• Other Banks

For the purpose of providing banking services to underdeveloped and non-urban sectors, the banking sector has introduced special purpose banks – Cooperative Banks which cater to rural populace and small borrowers. They are formed on a co-operative basis and governed by cooperative laws formed by the state government and central banking laws. Additionally, regional rural banks were incorporated under the Regional Rural Banks Act, 1976 to develop the rural economy.

To promote financial inclusion, the Reserve Bank of India also introduced Payments Banks and Small Finance Banks. These offer basic and limited services like deposits, issuing payment instruments, savings vehicles and credit.

Banking License

Any entity that wants to do banking business has to obtain the license from the Reserve Bank of India (RBI). The license also entails the licensee to conduct ancillary business like guarantee and indemnity business, financial leasing, hire purchase business, securitization, trade finance besides borrowing and lending.

However, for dealing in foreign exchange, a separate license is required to be obtained under the Foreign Exchange Management Act.

Application Process for a banking license

• Form for application of banking license is as per the Banking Regulation Rules, 1949. Different forms are applicable based on nature of applicant or whether it is a domestic or foreign company.
• The application form for the license has to be submitted with the company’s constitutional documents and balance sheet & profit & loss statements for last 5 years (for an existing company).
• This is beside a host of information as mentioned in the form like information on ultimate individual promoters, information on various entities which are part of the promoter group, information on the persons/entities subscribing to or more than 5% of the paid-up equity capital, proposed management of the bank.
• Also, a project report has to be submitted showing business potential, financial services proposed, plan for various compliances, plan for financial inclusion.

Corporate Governance

The Companies Act 2013, prescribes the corporate governance rules for banks in the country. However, for listed banking companies SEBI Regulations, 2015 are also applicable. SEBI regulations are primarily listing obligations and disclosures.

Organizational & Supervisory Requirement

Under the Banking Regulation Act, banking business must be conducted by a company. Government-owned banks are normally incorporated under specific statutes. Private Banks need to be incorporated as companies and are governed by the Companies Act. Documents required for their constitution are – Memorandum of association, Articles of association, Certificate of incorporation & Certificate for the commencement of business.

Foreign banks can operate through a branch in India and are not required to form a separate company. In some situations, the Reserve Bank of India may prescribe the foreign bank to set up its banking business in India through a wholly owned subsidiary.

The Banking Regulation Act requires an audit of the balance sheet and profit and loss statements for all banks in India. The Reserve Bank of India has powers to order a special audit if it believes it is necessary in public interest.

Guidelines have also been prescribed for role and constitution of the board of directors. Key parameters for appointing directors include – The directors should have professional experience with 51% to have specific domain knowledge in prescribed fields. There are several other parameters prescribed by Reserve Bank of India, which need to be adhered to whilst appointing a director.

The Banking Regulation Act empowers RBI to remove the Chairman, Chief Executive Officer, Director or for that matter any other officer on grounds of public interest, improper management or if the banks functioning is being conducted in a manner which could be detrimental to the interests of the depositors.

Various risk management guidelines have also been prescribed by the Reserve Bank of India. The primary responsibility for understanding and managing risks is with the Board of Directors. The Board of Directors can appoint a risk management committee, which reports to the Board directly.

Liquidity and Capital Adequacy

Capital adequacy is having sufficient own funds to absorb losses for a limited amount of time during which it would be hoped the business can be returned to profit; liquidity is having sufficient cash to satisfy all current and expected demands by customers.

The Basel III capital regulations are being implemented in India (to be fully implemented by 31st March 2019). Banks are required to comply with the requirements as per Basel III norms. The Basel III frameworks main thrust has been enhancing the banking sector’s safety and stability emphasizes on the need to improve the quality and quantity of capital components, leverage ratio, liquidity standards, and enhance disclosures. 

Besides the above banks need to maintain – Cash reserve ratio (CRR), which is the average daily balance that a bank needs to maintain with the RBI. Currently, the CRR is 4% of NDTL. Besides CRR, banks are required to maintain statutory liquidity ratio (SLR ), which is currently 19.5% of NDTL.

Liquidation of Banks

The High Court is the authority for winding up or liquidation of the bank. The location of the registered office of the bank decides the jurisdiction of the respective High Court in case of liquidation matters. As per the Banking Regulation Act, as and when the order for winding up of a bank is passed by the High Court, a liquidator is appointed by the High Court to supervise the liquidation. RBI can also act as liquidator subject to Court approval.

Regulatory Development in recent times

To reinforce the ability of the lender to deal with distressed assets, the Reserve Bank of India has issued guidelines and norms on distressed asset resolution by lenders. The RBI has issued a notification on “Guidelines on Sale of Stressed Assets by Banks” as a part of the already existing “Framework for Revitalising Distressed Assets in the Economy”. The framework and guideline have been created as a part of the enforcement of and regulations under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The Insolvency and Bankruptcy Code, 2016 (IBC) seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. The bankruptcy code is a one-stop solution for resolving insolvencies which at present is a long drawn process and fails to offer an economically viable solution.

Conclusion

The Indian banking system is primarily governed by Banking Regulation Act, 1949.  The RBI is the central bank of India and also the primary regulator of banks. There are various types of banks, like state-owned, commercial, investment, co-operative banks. Any entity that wants to do banking business has to obtain a license from the Reserve Bank of India (RBI). The Insolvency and Bankruptcy Code, 2016 (IBC) seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. Regulation of a country’s banking sector is a reflection of its priorities and financial landscape. In India’s case, the Reserve Bank of India’s approach has been to prioritize stability and achieve financial inclusiveness.