Banking Regulation Act, 1949

This article is written by Sanskriti Sharma of 2^nd Semester, University School of Law and Legal Studies, Intern under Legal Vidhiya

The Indian economy stands on a detailed framework, whose one of the essential components is the Banking sector. The banks in India are entrusted with the task of driving the economy in a way similar to that of a car engine. The banks, an institution equipped with financial management, carry out this function under their position as the credit supplier and by controlling money creation through lending. In turn, this credit finances the various needs and requirements of the citizens. Hence, one can draw inferences regarding the importance of banking in the Indian economy and the need for standardised and specified regulations governing their working. In India, this purpose is fulfilled by a set of legislations, including the Companies Act, the Reserve Bank of India Act, the Foreign Exchange Management Act, the Banking Regulation Act, and others.

Banks are also lucrative enterprises, evident with their share and contributions to a nation’s development. As a result, knowledge about the history of banking becomes crucial for a comprehensive understanding of the objectives of the legislation and for evaluating the extent to which these objectives are attained.

Banking in India

The first private bank in India dates back to the pre-independence era in the British-controlled city of Calcutta and was named Bank of Hindustan, established in 1770. The colonial powers were also essential players in the banking sector, considering the East India Company’s economic aspirations as a profit-seeking enterprise. The colonial powers established three presidential banks to facilitate economic trade with Britain – the Bank of Bengal, the Bank of Madras, and the Bank of Bengal. They were later merged into one bank named Imperial Bank of India in 1921.

After independence, the Imperial Bank of India was nationalised in 1955. It was renamed the State Bank of India, currently the most prominent public bank in the country.

During colonial rule, over 600 private banks had emerged with hopes of supporting the state’s economy. Still, only a few managed to sustain themselves. There are myriad reasons for the collapse of banks ranging from lack of machinery and technology to the account holders resorting to fraudulent practices. Apart from this, the lack of proper management skills and the insufficient facilities led to their demise.

The Colonial government, to regulate the functioning of the banks, enacted the Companies Act of 1913. However, the banks weren’t accessible to all classes of people back then. It was only the upper-class families that availed of the services of banks. To monitor and streamline the benefits of the banks and ensure optimum functioning, the Banking Companies Act was passed on March 16, 1949, in the post-independence era. It was reconfigured as the Banking Regulation Act, 1949 on March 1, 1966. It was made applicable to the entire nation in 1949, excluding the state of Jammu and Kashmir, where it was enforced in 1956.  

Scope and Objectives

The act was initially introduced to supplement the Companies Act of 1956, and the contents of the act would be applied along with and in harmony with other banking laws in force at the time.  

Primarily the provision only covered its ambit banking companies. With time and advancement in the economic sector, the legislature realised the importance of having dynamic laws to keep up and monitor changes. For this purpose, an amendment brought cooperative banks under the regulating sphere of the act in 1965. The only exceptions to this act are primary agricultural credit societies and cooperative land mortgage banks. The cooperatives were added through the introduction of section 56, which imparts power to the Reserve Bank of India to monitor their activities similar to that of banks in the nation. Cooperatives are small financial entities where the organization members participate in self-financing through the pooling of resources and are collective owners of the organisation. They are constituted under the State Cooperatives Societies Act.

Considering the inadequacies of the Indian Companies Act of 1913 in managing the various requirements of the banking sector, the prime objective of the BR Act was to cover the loopholes present in the former act and to provide comprehensive coverage of the banking enterprises.

Another prevalent issue faced by the banks was the need for more capital which often restricted the optimal functioning of the banks. To combat these issues and to further enhance the efficiency of the banking sector, the Banking Regulation Act was introduced for the following purpose –

Prescribing a minimum capital requirement which banks were obliged to maintain. This was done to prevent crashes that often occurred due to capital deficits. Hence through minimum capital requirements, the banks could control the capital levels.

• Maintaining competition levels among the banks and in the banking sector.

Although competition is a great driver and incentive for providing better customer services, excessive competition harms the banking sector’s health. Banks were lending abysmally low rates to attract more customers, which was not viable in the long run.

• Introduction of a system of licensing.

The system of licensing was introduced to prevent arbitrarily opening banks or the indiscriminate changing address of the present branches by the banking companies. Through licences, it was envisioned that uniformity could be restored and excessive competition curtailed.

• Protection of the interests of the depositors.

The interests of the depositors and public were given paramount attention to ensure that the welfare of citizens was not jeopardised. For this purpose, the act introduced specific provisions like cash reserve requirements and liquidity reserve ratio. Such conditions restrict the lending capacity of the banks to ensure that there is no capital shortage, and circumstances leading to inflation can be curtailed by adopting such measures.

• Increased supervision by the Reserve Bank of India.

The act also assigned increased powers to RBI for supervising the banks’ functioning and appointing chairmen, directors, and officers of the banks. It also can reappoint or remove any individual according to its discretion for the welfare of citizens.

• More straightforward liquidation and amalgamation of banks

This deals with the need for more accessible and more time-efficient procedures for liquidating banking companies in certain situations. Furthermore, amalgamating smaller banks with stronger banks to pool resources and enhance their performance would further strengthen the banking sector.

Features

The act is divided into parts and consists of 56 sections in total. Some of them are mentioned herein –

• Section 5 defines various terms, including banking, banking company, approved securities, branch, banking policy, etc.
• Banking has been defined under 5B as –
  • Accepting deposits of money from the public,
  • For lending or investments,
  • Repayable on demand or otherwise, 
  • Withdrawable by cheque, draft, order, or otherwise.
• Banking company, likewise under section 5C, has been as any company transacting in banking in India.

• Section 6 deals with businesses where companies, specifically banking companies, may engage. Some of them include the following –
  •  Managing and selling properties and estates under the control and possession of the bank, issuing letters of credit, traveler’s cheques, and circular notes;  
  • Contracting, negotiating, and issuing public and private loans;
  • Carrying on and transacting in any business related to indemnity and guarantee;
  • Managing or selling any property for satisfaction of its claims which may come into its possession;
  • Administrating estates as executor, trustee, or otherwise;
  • Undertaking any such tasks which are conducive to the advancement of the company’s business.

• Section 8 of the act restricts the areas where a banking company may trade. According to it, a banking company cannot take part directly or indirectly in the buying, selling, or bartering of goods unless they are for the realization of security attached to the banking company. The only exception concerning sale, barter, or buying bills of exchange is for collection or negotiation.

• Section 9 mentions nonbanking assets’ disposal by the banking companies. It directs no possession by a banking company of a property for more than seven years except those needed for its use. The period can be further extended by five years at the discretion of the RBI.

• Section 10 illustrates how the management of the company should be organised. It should have one of the directors as the chairman on board of directors and at least 51% of the total number of members on the board of directors should be experienced in the areas of accountancy, agriculture and rural economy, banking, finance, economics, law and other such places of importance.

Moreover, no insolvent person whose remuneration depends on the company’s profit should be employed. The director’s term should be at most eight years.

• Minimum paid-up capital and reserve requirements are detailed in section 11, wherein any company outside India must have a total of its paid-up capital of more than 15 lakhs. In the case of Bombay or Calcutta, the amount should be at least 20 lakhs. Also, no company in existence at the time of the commencement of the act may continue or carry on business after three years unless at the discretion of the RBI.

• The act limits commission, brokerage, discount, or any kind of remuneration on the sale or issuance of shares by the company directly or indirectly to an amount exceeding 2.5% of the price at which shares are issued under section 13.

• According to section 15 of the act, no banking company could pay dividends on its shares for any uncleared capitalised expenses.

• Section 17 of the act details the creation of a reserve fund by every banking company in India. It implies that the sum submitted to such reserve funds should be at least twenty percent of the profits attained before dividends are declared.

• The creation of cash reserves is also directed by section 18 of the act, which refers to the responsibility of every banking company in India. The cash reserve shall include the percentage of time and demand liabilities as detailed by the company. It shall be submitted before the 20th of every month.

• The legislation also imposes on the banking companies the responsibility to submit accounts and balance sheets at the end of every financial year under section 29. Such accounts and balance sheets should bear the sign of at least three directors in case of a company located in India and by a principal officer in case of outside India.

• Section 36 of the act elucidates the functions and powers of the RBI. It lists some of its functions being –
  • The RBI may restrict and prevent any banking company from indulging in any transaction.
  • It may call for any meeting of directors of the banking company relating to the affairs of the banking company.
  • It shall also remove any director, chief executive, or any other person holding office in a banking company depending upon the interest of the public at large.
  • It may also appoint additional company directors after observing the company’s functioning and believing in the need for such an individual to protect the interest of the banking company or its depositors.
  • It may also write a report to the central government, prompting it to acquire the undertaking of the companies in certain circumstances where it has failed to comply with the orders of the RBI.

• Section 46 details the penalties a banking company may accord following this legislation. The penalties as specified includes –
  • Case of a person deliberately misrepresenting the facts or omitting such facts material to the company shall be punished with imprisonment up to 3 years or a fine of up to 1 crore rupees or both.
  • In instances of a person failing to furnish any document under section 35, which he is liable to do in front of the officer, he will be charged with 2000 rupees as a fine for every offence and, after that, 100 rupees for every subsequent day.
  • Suppose the company fails to furnish or follow the orders directed. In that case, every member and employee shall be punished according to the law.
  • Any infringement committed by the company due to the consent or negligence of any director or officer shall be punished by a sum twice that of violation or a fine of 1 crore rupees.
  • Any infringement committed by the company shall be punished by taking action against individuals responsible for such violation or charged with the company’s conduct.
  • Any director, secretary, manager, or person holding an office would be punished and deemed liable for infringements due to such individual’s negligence, consent, or connivance.

Cases concerning Act

1. Rustom Cavasjee Cooper and Ors v. Union of India^[1]

This case dates back to the 1970s and consists of an appeal by the appellant to determine the constitutional validity of the Banking Companies (Acquisition and Transfer of Undertakings) Act which replaced an ordinance assented to by the vice president of the same name. The case involved Mr. Cooper, director of the Central Bank of India, who held shares in the Bank of Baroda, the Union Bank of India, and the Central Bank of India. The nationalisation of the banks was followed by a provision for an agreement between the parties for awarding compensation, underlined in Schedule II of the act. The decision of the court held the mentioned schedule to be unjustified.

2. Dharani Sugars and Chemicals Ltd. vs. Union of India^[2]

The case dating back to 2018 dealt with the validity of sections 35AA and 35AB of the Banking Regulation Act, 1979, which relates to the powers of RBI on authorization by the Central Government to issue and monitor directions to the Banking companies for insolvency and realisation of stressed assets. The court opined in this case that both the sections were constitutionally valid and held section 35AA to be more restrictive of the powers of RBI according to procedures to be observed. It, however, rejected the circular, which RBI passed.

3. Central Bureau of Investigation, Bank Securities and Fraud Cell, and Ors. vs. Ramesh Gelli and Ors.^[3]

This case dealt with the question of the position of the managers, directors, and chairmen of the banking company constituted under Banking Regulation Act. Herein a company’s employees took part in fraudulent activities and were charged under the Prevention of Corruption Act, despite being from a private company. The court ruled that the term public servant under section 2(c) of the Prevention of Corruption Act also included managing directors, executive directors, and other employees of the company.

Amendments

1956 – The first amendment to the act expanded the applicability of the act to include the state of Jammu and Kashmir.

1965 – This amendment included cooperative banks within the Banking Regulation Act 1979. It gave powers to the RBI to monitor and licence such banks which were earlier under the monitor of the state governments

1994 – It introduced a new position in a banking company by the title of chairman, who will preside over the board of directors’ meetings. He will be responsible for the management of the company.

2004 – It was passed as an ordinance. It enabled the RBI to supersede cooperative or multi-cooperative banks’ boards of directors.

2007 – It imposed the banks to maintain cash reserves with RBI mandatorily

2017 – This amendment dealt with the stressed assets of the company and introduced two new sub-sections in section 35 of the act.

2020 – Passed as an ordinance on September 29, 2020, the act places cooperative banks under the purview of RBI. RBI can initiate schemes for reconstruction or amalgamation without putting the bank under a moratorium.

Conclusion

The Banking Regulation Act of 199 is a statutory provision that controls all the banking companies in the countries. After an amendment, it now applies to cooperative banks. It awards the Reserve Bank of India controller, supervisor, and regulator positions. The statute aims to protect the interest of the depositors by increasing the banks’ liabilities. 

References

1. Ss.5, 6, 8, 9, 10, 11, 13, 15, 17, 18, 29, 36 & 46, Banking Regulation Act, 1979
2. The Banking Regulation (Amendment) Act, 2020 (passed, 29/9/2020)

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^[1] Rustom Cavasjee Cooper and Ors. vs. Union of India (1970) SC] AIR 564, SCR(3) 530

^[2] Dharani Sugars and Chemicals Ltd. vs. Union of India, (2019) SCC 460

^[3] Central Bureau of Investigation, Bank Securities and Fraud Cell, and Ors. vs. Ramesh Gelli and Ors. (2016), SC 0609