Legal & Regulatory Aspects of Banking

LEGAL REGUIATORY ASPECTS OF BANKING

INDIAN INSTITUTE OF BANKING & FINANCE

MAC MIL LAN

LEGAL & REGULATORY ASPECTS OF BANKING

INDIAN INSTITUTE OF BANKING & FINANCE T H E ARCADE', WORLD TRADE CENTRE, CUFFE PARADE MUMBAI400005

Established on 30th April 1928

MISSION •

To develop professionally qualified and competent bankers and financial professionals primarily through a process of education, training, examination, consultancy/counselling and continuing professional development programs.

VISION To he the premier Institute for developing and nurturing competent professionals in banking and finance field.

OBJECTIVES • • • • •

To facilitate study of theory and practice of banking and finance. To test and certify attainment of competence in the profession of banking and finance. To collect, analyse and provide information needed by professionals in banking and finance. To promote continuous professional development. To promote and undertake research relating to Operations, Products, Instruments, Processes, etc., in banking and finance and to encourage innovation and creativity among finance professionals so that they could face competition and succeed.

COMMITTED TO PROFESSIONAL EXCELLENCE Website: www.iibf.org.in

LEGAL REGULATORY ASPECTS OF BANKING (For JAIIB/Diploma in Banking & Finance Examination) 2nd Edition

Indian Institute of Banking & Finance

MACMILLAN

© INDIAN I N S T I T U T E OF B A N K I N G & F I N A N C E , M U M B A I , 2005, 2008 (This book has been published by Indian Institute of Banking & Finance. Permission of the Institute is essential for reproduction of any portion of this book. The views expressed herein are not necessarily the views of the Institute.) All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

First edition, 2(X)5 Second edition, 2008 Reprinted. 200S 2009 (twice) 2010

MACMILLAN PUBLISHERS INDIA LIMITED Delhi Bangalore Chennai Kolkata Mumbai Ahmedabad Bhopal Chandigarh Coimbatore Cuttack Guwahati Hubli Hyderabad Jaipur Lucknow Madurai Nagpur Patna Pune Thiruvananthapuram Visakhapatnam C o m p a n i e s and representatives throughout the world ISBN 10: 0230-63610-1 ISBN 13:978-0230-63610-1 Published by Rajiv Beri for Macmillan Publishers India Limited, 2/10 Ansari Road, Daryaganj, New Delhi 110 0 0 2 Printed by S.M. YOG AN at Macmillan India Press, Chennai 600 041.

L E G A L & R E G U L A T O R Y A S P E C T S OF B A N K I N G Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module B), P.R. Kulkarni (Module C), B. Gopalakrishnan (Module D) under the guidance of M.L. Chandak, Advocate, High Court, Mumbai. Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M. Ramamurthy, Legal Adviser. IDBI Ltd. (Modules B, C and D)

This book is meant for educational and learning purposes. The a u t h o r s ) of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the a u t h o r s ) has/have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action.

FOREWORD

The world of banking and finance is changing very fast and banks are leveraging knowledge and technology in offering newer services to the customers. Banks and technology are evolving so rapidly that bank staff must continually seek new skills that enable them not only to respond to change, but also to build competence in handling various queries raised by customers. Therefore, there is a need for today s bank employees to keep themselves updated with a new set of skills and knowledge. The Institute, being the main provider of banking education, reviews the syllabus for its associate examinations viz. JAIIB/CAIIB and various other examinations with the help of Expert Groups from time to time to make the contents relevant and contemporary in nature. The latest revision has been done by an expert group under the Chairmanship of Prof. Y.K. Bhushan. This book and the other two books mentioned below are the courseware for JAIIB which aims to impart up-to-date knowledge in the field of banking and finance and equip the bankers to face the emerging challenges of today and tomorrow. As there is a growing demand for qualified manpower in the banking sector with accent on banking knowledge and skills, together with technology-familiarity, customer-orientation and hands-on application skills - which will substantially reduce the training intervention at the bank level before/immediately after they are employed - the institute has launched the Diploma in Banking & Finance in 2007 for graduation-plus level candidates. Candidates to the course will get extensive and detailed knowledge on banking & finance and details of banking operations. The Diploma is offered in the distance learning mode with a mix of educational support services like provision of study kits, contact classes, etc. The key features of the Diploma is that it aims at exposing students to real-life banking environment and that it is equivalent to JAIIB. The JAIIB and the Diploma in Banking & Finance has three papers viz. 1. Principles & Practices of Banking 2. Accounting & Finance for Bankers 3. Legal & Regulatory Aspects of Banking This book, the courseware for the third paper on Legal & Regulatory Aspects of Banking, deals with legal and regulatory aspects that have a bearing on banking operations, and are woven in to the units/chapters to make their relevance easily understandable. Banking and business laws insofar as they relate to day-to-day banking operations, have also been covered at appropriate places. Case laws are included, wherever appropriate. There are various newly enacted laws like Anti-money Laundering Act, Right to Information Act, Information Technology Act, etc., which have significantly changed the way banking operations are done, and these laws are explained in simple terms as needed to be understood by a practicing banker. The Institute had constituted teams consisting of eminent bankers and academicians to prepare the reading material for all the subjects as self-instructional study kits obviating the need for the intervention of a teacher. This book represents the outcome of this endeavour to bring out self-contained comprehensive courseware/book on the subject. The Institute acknowledges with gratitude the valuable services rendered by the authors in preparing the courseware in a short period of time.

The team, who developed the book, has made all efforts to cover the entire syllabus prescribed for the subject. However, the candidates could still refer to a few standard textbooks to supplement this material which we are sure, will enhance the professional competence of the candidates to still a higher degree. We have no doubt that the study material will be found useful and will meet the needs of the candidates to prepare adequately for the examinations. In addition, we are sure that these books will also be useful to practitioners, academicians, and other interested readers. We welcome suggestions for improvement of the book. Mumbai

3-7-2008

K. Bhaskaran Chief Executive

Officer

RECOMMENDED

READING

The Institute has prepared comprehensive courseware in the form of study kits to facilitate preparation for the examination without intervention of the teacher. An attempt has been made to cover fully the syllabus prescribed for each module/subject and the presentation of topics may not always be in the same sequence as given in the syllabus. Candidates are also expected to take note of all the latest developments relating to the subject covered in the syllabus by referring to Financial Papers, Economic Journals, Latest Books and Publications in the subjects concerned.

PAPER 3 - LEGAL & REGULATORY ASPECTS OF BANKING

Objectives: The candidates would be able to acquire knowledge in: •

The legal & regulatory framework of the banking system and

•

The various laws and enactments affecting day-to-day banking operations

MODULE A - R E G U L A T I O N S A N D C O M P L I A N C E •

The questions in this section will be with reference to legal issues and problems. A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking Companies [Acquisition and Transfer of Undertakings Act 1970 & 1980]. B. Government and RBI's Powers: -

Opening of New Banks and Branch Licensing Constitution of Board of Directors and their Rights Banks Shareholders and their Rights CRR/SLR Concepts Cash/Currency Management

•

Winding Up - Amalgamation and Mergers

•

Powers to Control Advances - Selective Credit Control - Monetary and Credit Policy

•

Audit and Inspection

•

Supervision and Control-Board for Financial Supervision - Its Scope and Role

•

Disclosure of Accounts and Balance Sheets

•

Submission of Returns to RBI, etc.

•

Corporate Governance

MODULE B - L E G A L A S P E C T S OF B A N K I N G O P E R A T I O N S •

Case Laws on Responsibility of Paying/Collecting Banker

•

Indemnities/Guarantees -

Scope and Application Obligations of a Banker Precautions and Rights

•

Laws Relating to Bill Finance, LC and Deferred Payments

• •

Laws Relating to Securities Valuation of Securities - Modes of Charging Securities - Lien, Pledge, Mortgage, Hypothecation, etc.

•

Registration of Firms/Companies

•

Creation of Charge and Satisfaction of Charge

MODULE C - BANKING RELATED LAWS •

Law of Limitation

•

Provisions of Bankers Book Evidence Act Special Features of Recovery of Debts Due to Banks and Financial Institutions Act, 1993

•

TDS and Service Tax

•

Banking Cash Transaction Tax

•

Asset Reconstruction Companies The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

•

The Consumer Protection Act, 1986

•

Banking Ombudsman 2006

•

Lok Adalats

•

Lender's Liability Act

M O D U L E D - C O M M E R C I A L L A W S WITH R E F E R E N C E TO B A N K I N G O P E R A T I O N S Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and Agency, etc.) The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions, Conditions and Warranties, Express and Implied, Right of Unpaid Seller, etc.) The Companies Act, 1956, Definition, Features of Company, Types of Companies, Memorandum, Articles of Association, Doctrines of Ultra Vires, Indoor Management and Constructive Notice, Membership of Company - Acquisition - Cessation, Rights and Duties of Members and Register of Members, Prospectus and Directors. •

Indian Partnership Act, 1932, Definition and Types of Partnership, Relation of Partners to One Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of Partnership, Dissolution of Firm, Effect of Non-Registration

•

The Transfer of Property Act

•

Foreign Exchange Management Act, 2000

•

Prevention of Money Laundering Act, 2002

•

Right to Information Act, 2005

•

Information Technology Act, 2000

CONTENTS Foreword

MODULE A - R E G U L A T I O N S A N D C O M P L I A N C E 1. Legal Framework of Regulation of Banks

3

2. Control Over Organisation of Banks

15

3. Regulation of Banking Business

31

4. Returns, Inspection, Winding Up

49

5. Public Sector Banks and Co-operative Banks

65

MODULE B - L E G A L A S P E C T S OF B A N K I N G O P E R A T I O N S 6. Case Laws on Responsibility of Paying Bank

83

7. Case Laws on Responsibility of Collecting Bank

93

S. Indemnities

101

9. Bank Guarantees

107

10. Letters of Credit

119

11. Deferred Payment Guarantee

131

12. Laws Relating to Bill Finance

135

13. Various Types of Securities

143

14. Law Relating to Securities and Modes of Charging - I

155

15. Law Relating to Securities and Modes of Charging - II

163

16. Different T^pes of Borrowers

173

17. Types of Credit Facilities

181

18. Secured and Unsecured Loans, Registration of Firms, Incorporation of Companies

187

19. Registration and Satisfaction of Charges

197

MODULE C - B A N K I N G R E L A T E D L A W S SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS ANI) ENFORCEMENT OF SECURITY INTEREST, 2002 (SARFAESI ACT) 20. Introduction to SARFAESI Act, 2002

205

21. Definitions at SARFAESI Act, 2002

209

22. Regulation of Securitisation and Reconstruction of Financial Assets of Banks and Financial Institutions

219

23. Enforcement of Security Interest

231

24. Central Registry

241

25. Offences and Penalties

245

26. Miscellaneous Provisions

249

T H E BANKING O M B U D S M A N S C H E M E , 2006 27. Purpose, Extent, Definitions, Establishment and Powers

255

28. Procedure for Redressal of Grievances

259

REC1 D E B T S D U E TO B A N K S AND

FINANCIAL INSTITUTIONS ACT. 1993(DRTACT) 29. Preliminary

267

30. Establishment of Tribunal and Appellate Tribunal

271

31. Jurisdiction, Powers and Authority of Tribunals

275

32. Procedure of Tribunals

279

33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions

285

T H E B A N K E R S ' B O O K S E V I D E N C E ACT, 1891 34. The Bankers' Books Evidence Act, 1891

293

T i n LI ( l A L S I R V I C E S A U T H O R I T I E S ACT, 1987 35. Lok Adalats

299 T H E C O N S U M E R P R O T E C T I O N ACT, 1987

36. Preliminary, Extent and Definitions

303

37. Consumer Protection Councils

311

38. Consumer Disputes Redressal Agencies

315

T H E LAW O F LIMITATION 39. Limitations of Suits, Appeals and Applications

327

TAX LAWS 40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service Tax

331

M O D U L E D - C O M M E R C I A L L A W S WITH R E F E R E N C E TO B A N K I N G O P E R A T I O N S 41. Meaning and Essentials of a Contract

341

42. Contracts of Indemnity

345

43. Contracts of Guarantee

347

44. Contract of Bailment

353

45. Contract of Pledge

357

46. Contract of Agency

359

47. Meaning and Essentials of a Contract of Sale

365

48. Conditions and Warranties

369

XIII 49. Unpaid Seller

373

50. Definition, Meaning and Nature of Partnership

377

51. Relations of Partners to One Another

381

52. Relations of Partners to Third Parties

385

53. Minor Admitted to the Benefits of Partnership

389

54. Dissolution of a Firm

393

55. Effect of Non-Registration

397

56. Definition and Features of a Company

399

57. Types of Companies

405

58. Memorandum of Association and Articles of Association

411

59. Doctrines of Ultra Vires/Constructive Notice/Indoor Management

415

60. Membership

419

61. Prospectus

425

62. Directors

429

63. Foreign Exchange Management Act, 1999

437

64. Transfer of Property Act, 1882

443

65. The Right to Information Act, 2005

453

66. Right to Information and Obligations of Public Authorities

457

67. The Prevention of Money Laundering Act, 2002

463

68. Information Technology Act, 2000

469

Bibliography

475

REGULATIONS AND COMPLIANCE Unit 1. Legal Framework of Regulation of Banks Unit 2. Control over Organisation of Banks Unit 3. Regulation of Banking Business Unit 4. Returns, Inspection. Winding Up Unit 5. Public Sector Banks and Co-operative Banks

REGULATIONS AND COMPLIANCE Unit 1. Legal Framework of Regulation of Banks Unit 2. Control over Organisation of Banks Unit 3. Regulation of Banking Business Unit 4. Returns, Inspection. Winding Up Unit 5. Public Sector Banks and Co-operative Banks

LEGAL FRAMEWORK OF REGULATION OF BANKS STRUCTURE 1.0

Objectives

1.1

Introduction

1.2

Business of Banking

1.3

Constitution of Banks

1.4

Reserve Bank of India Act, 1934

1.5

Banking Regulation A c t 1949

1.6

Reserve Bank as Central Bank and Regulator of Banks

1.7

Government as a Regulator of Banks

1.8

Control Over Co-operative Banks

1.9

Regulation by Other Authorities

1.10

Let Us Sum Up

1.11

Kevwords

1.12

Check Your Progress

1.13

Answer to 'Check Your Progress'

1.14

Terminal Questions

w

4 1.0 OBJECTIVES The objectives of this Unit are to understand: • • • • •

the the the the the

definition and nature of the business of banking; constitution of different types of banks; regulatory scheme of the RBI Act and the BR Act; role of the Reserve Bank and the Central Government as regulators; and special position of public sector banks and co-operative banks.

1.1 INTRODUCTION Banking in India is mainly governed by the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934. The Reserve Bank of India and the Government of India exercise control over banks from the opening of banks to their winding up by virtue of the powers conferred under these statutes. All the regulatory provisions are not uniformly applicable to all banks. The applicability of the provisions of these Acts to a bank depends on its constitution; that is, whether it is a statutory corporation, a banking company or a co-operative society. In this unit, we look at the definition of banking, the constitution of different types of banks and applicability of regulatory laws, the general framework of the regulatory laws and the role of regulators namely, the Reserve Bank of India and the government.

1.2 BUSINESS OF BANKING i. Definition of Banking: Banking is defined in Section 5(b) of the Banking Regulation Act as the acceptance of deposits of money from the public for the purpose of lending or investment. Such deposits may be repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise. Thus, a bank must perform two essential functions: (i) acceptance of public deposits, and (ii) lending or investment of such deposits. The deposits may be repayable on demand or for a period of time as agreed by the banker and the customer. In terms of the definition, the banker can accept "deposits" of money and not anything else. Further, accepting deposits from the "public" implies that a banker accepts deposits from anyone who offers money for such purpose. However, a banker can refuse to open account for undesirable persons and further, the opening of accounts is subject to certain conditions like proper introduction and identification. The "Know Your Customer" guidelines issued by the Reserve Bank require banks to follow certain customer identification procedure for opening of accounts for protecting the banks from frauds, etc., and also for monitoring transactions of a suspicious nature for the purpose of reporting to appropriate authorities for taking anti-money laundering measurers and combating financing of terrorism. There is.no exhaustive definition of "banking" in Common Law of England. However, the usual characteristics of banking as identified by Lord Denning MR in United Dominions Trust Ltd. vs Kirk wood ([I966| I All ER 968 at 975) are: (a) the conduct of current accounts; (b) the payment of cheques; and (c) the collection of cheques for customers. These characteristics are not equivalent to a definition, and these are also not the only characteristics. (See, Paget's Law of Banking, 12th Edn., pp. 107 to 109) ii. Deposits Withdrawable by Cheque: Under Section 49 A of the Banking Regulation Act, no organisation other than a bank is authorised to accept deposits withdrawable by cheque. The Savings Bank

5 Scheme run by the government, a Primary credit society and any other person or firm notified by the government are exempted from this prohibition. iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking companies, firms and other unincorporated associations of persons and individuals who accept deposits from the public. Acceptance of deposits by non-banking financial companies is regulated by the Reserve Bank under the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 and other directions issued by it under Chapter IIIB of the Reserve Bank of India Act. Other companies are regulated by the Central Government under the Companies (Acceptance of Deposit) Rules, 1975 issued under Section 58A of the Companies Act. 1956. Individuals, firms and other unincorporated associations of persons whose business includes the business of a financial institution or whose principal business is acceptance of deposits, is prohibited under Section 45S of the RBI Act (as amended in 1997) from accepting deposits from the public, except relatives. This prohibition does not apply to acceptance of deposits by those who are mainly engaged in manufacturing or trading. iv. Licence for Banking: In India, it is necessary to have a licence from the Reserve Bank under Section 22 of the Banking Regulation Act for commencing or carrying on the business of banking. Every banking company has to use the word "bank" as part of its name (See, Section 7 of the Act) and no company other than a banking company can use the words "bank", "banker", "banking" as part of its name. Further, no firm, individual or group of individuals is permitted to use the words "bank", "banking" or "banking company" as a part of the name or for the purpose of business. Subsidiaries of banks and association of banks in certain cases as also Primary Credit Societies are exempted from this restriction. v. Permitted Business: Although, traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide into many allied and even unrelated activities. The forms of business permissible under Section 6(1) of the Banking Regulation Act, apart from banking business, are summarised below: (a)

(i) Borrowing, raising or taking up of money; (ii) Lending or advancing of money either upon security or without security; (iii) Drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundis, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not; (iv) Granting and issuing of letters of credit, travellers* cheques and circular notes; (v) Buying, selling and dealing in bullion and specie; (vi) Buying and selling of foreign exchange including foreign bank notes; (vii) Acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; (viii) Purchasing and selling of bonds, scrips and other forms of securities on behalf of constituents or others; (ix) Negotiating of loans and advances; (x) Receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; (xi) Providing of safe deposit vaults; and (xii) Collecting and transmitting of money and securities. (b) Acting as an agent of the government, local authority or any other person and carrying on agency business.

6 (c) Contracting for public and private loans and negotiating and issuing the same. (d) Insure, guarantee, underwrite, participate in managing and carrying out any issue of state, municipal or other loans or of shares, stock, debentures or debenture stock of companies and lend money for the purpose of any such issue. (e) Carry on and transact every kind of guarantee and indemnity business. (f) Manage, sell and realise any property which may come into its possession in satisfaction of any of its claims. (g) Acquire, hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance. (h) Undertake and execute trusts. (i) Undertake the administration of estates as executor, trustee or otherwise. (j) Establish, support and aid associations, institutions, funds, trusts, etc., for the benefit of its present or ex-employees; grant money for charitable purposes. (k) Acquire, construct and maintain any building for its own purpose. (1) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or turn into account or otherwise deal with all or any part of the business of any person or company, when such business is of a nature described in Section 6. (m) Acquire and undertake the whole or any part of the business of any person or company, when such business is of a nature described in Section 6. (n) Do all such things which are incidental or conducive to the promotion or advancement of the business of the company. (o) Do any other business specified by the Central Government as the lawful business of a banking company. The Central Government has accordingly specified leasing and factoring as permissible business for banks. vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a banking company from engaging directly or indirectly in trading activities and undertaking trading risks. Buying or selling or bartering of goods directly or indirectly is prohibited. However, this is without prejudice to the business permitted under Section 6(1) of the Act. Accordingly, a bank can realise the securities given to it or held by it for a loan, if need arises for the realisation of the amount lent. It can also buy or sell or barter for others in connection with: (i) bills of exchange received for collection or negotiation, and (ii) undertaking the administration of estates as executor, trustee, etc. Goods for the purpose of this Section means every kind of moveable property, other than actionable claims, stocks, shares, money, bullion and specie and all instruments referred to in Clause (a) of subSection (1) of Section 6. As regards immoveable properties, Section 9 prohibits a banking company from holding such property, howsoever acquired, except as is required for its own use, for a period exceeding seven years from the acquisition of the property. The Reserve Bank may extend this period by another five years, if it is satisfied that such extension would be in the interest of the depositors of the banking company. The banking company shall be required to dispose of such property within the permitted period.

1.3 CONSTITUTION OF BANKS i. Banks in India fall under one of the following categories: (a) Body corporate constituted under a special statute; (b) Company registered under the Companies Act, 1956 or a foreign company; (c) Co-operative society registered under a central or state enactment on co-operative societies.

ii. Public Sector Banks: The public sector banks including nationalised banks, State Bank of India and its associates (subsidiaries) and the Regional Rural Banks fall in the first category. By the Banking Companies (Acquisition and Transfer of Undertakings) Act. 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 the Central Government nationalised (took over the business undertakings) of certain banking companies and vested them in newly created statutory bodies (corresponding new banks) constituted under Section 3 of the 1970/1980 Act. The State Bank of India was constituted under the State Bank of India Act, 1955 and the six associate/subsidiary banks were constituted under the State Bank (Subsidiary Banks) Act, 1959 or other statutes (See Para 5.2.6). The regional rural banks are constituted under the Regional Rural Banks Act, 1976. These banks are governed by the statutes creating them as also some of the provisions of the Banking Regulation Act and the Reserve Bank of India Act. The details are discussed in Unit 5. iii. Banking Companies: A banking company, as defined in Section 5(c) of the Banking Regulation Act is a company which transacts the business of banking. Such company may be a company constituted under Section 3 of the Companies Act or a foreign company within the meaning of Section 591 of that Act. All the private sector banks are banking companies. These banks are governed by the Companies Act, 1956 in respect of their constitution and by the Banking Regulation Act and the RBI Act with regard to their business of banking. iv. Co-operative Banks: A co-operative bank is a co-operative society registered or deemed to have been registered under any Central Act for the time being in force relating to the multi-state co-operative societies, or any other central or state law relating to co-operative societies for the time being in force. If a co-operative bank is operating in more than one state, the Central Act applies. In other cases, the state laws apply. The Banking Laws (Application to Co-operative Societies) Act, 1965 extended certain provisions of the Banking Regulation Act and the Reserve Bank of India Act to the co-operative banking sector. After the Supreme Court held in Apex Cooperative Bank s case (AI R 2004 SC 141) that multi-state co-operative societies cannot be licensed as co-operative banks, the Banking Regulation (Amendment) and Miscellaneous Provisions Act, 2004 was enacted to permit licensing of multi-state co-operative banks. A "multi-state cooperative bank" under this Act means a multi-state co-operative society which is a primary co-operative bank.

1,4 RESERVE BANK OF INDIA ACT, 1934 i. The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve Bank of India: (i) to regulate the issue of bank notes, (ii) for keeping reserves for securing monetary stability in India, and (iii) to operate the currency and credit system of the country to its advantage. The Act came into force on 6th March 1934. The Act has been amended from time to time to meet the demands of changing times. The last amendment to the Act was effected by the RBI (Amendment) Act,

2006. ii. The Act deals with the constitution, powers and functions of the Reserve Bank. It does not directly deal with regulation of the banking system except for Section 42, which provides for cash reserves of scheduled banks to be kept with the Reserve Bank, with a view to regulating the credit system and ensuring monetary stability. Further, Section 18 of the Act provides for direct discount of bills of exchange and promissory notes when a special occasion arises, making it necessary or expedient for the purpose of regulating credit in the interests of trade, industry and agriculture. The Act, in short, deals with: (i) incorporation, capital, management and business of the bank;

(ii) the central banking functions like issue of bank notes, monetary control, acting as banker to government and banks, lender of last resort; (iii) collection and furnishing of credit information; (iv) acceptance of deposits by non-banking financial institutions; (v) general provisions regarding reserve fund, credit funds, publication of bank rate, audit and accounts; and (vi) penalties for violation of the provisions of the Act or the directions issued thereunder.

1.5 BANKING REGULATION ACT, 1949 i. The Banking Regulation Act, 1949 was enacted to consolidate and amend the law relating to banking and to provide for a suitable framework for regulating the banking companies. Initially, the Act provided for regulation of banking companies only, but in 1965 the Act was amended to cover co-operative banks as well with certain modifications (See, Section 56). However, the Act, as provided in Section 3, does not apply to primary agricultural credit societies and co-operative land mortgage banks. The provisions of the Act are applicable to banking companies in addition to other laws which are applicable to such companies, unless otherwise specifically provided in the Act. Thus, Companies Act, 1956 which deals with the incorporation and working of companies is applicable to banking companies except where special provisions are made in the Banking Regulation Act in that regard. ii. The Act regulates entry into banking business by licensing as provided in Section 22 thereof. The Act also puts restrictions on the shareholding, directorship, voting rights and other aspects of banking companies. There are several provisions in the Act regulating the business of banking such as restriction on loans and advances, rates of interest to be charged, requirement as to cash reserve and maintenance of percentage of assets, etc. There are provisions regarding audit and inspection and submission of balance sheets and accounts. The Act provides for control over the management of banking companies and also deals with the procedure for winding up of the business of the banks and penalties for violation of its provisions. In short, the Act deals with: (a) (b) (c) (d)

regulation business of banking companies; control over the management of banking companies; suspension and winding up of banking business; and penalties for violation of the provisions of the Act.

1.6 RESERVE BANK AS CENTRAL BANK AND REGULATOR OF BANKS i. The Reserve Bank was constituted under Section 3 of the Reserve Bank of India Act, 1934 for taking over the management of currency from the Central Government and carrying on the business of banking in accordance with the provisions of the Act. Originally, under the RBI Act, the Bank had the responsibility of: (a) regulating the issue of bank notes; (b) keeping of reserves for ensuring monetary stability; and (c) generally to operate the currency and credit system of the country to its advantage. ii. The Reserve Bank is a body corporate having perpetual succession and common seal and shall sue and be sued in its name. The whole capital of the bank is held by the Central Government. The Bank has its central office in Mumbai and offices in Mumbai, Kolkata, Delhi and Chennai, and branches at most of the state capitals and some other cities. iii. The bank functions under the general superintendence and directions of the Central Board of

9 Directors. The bank has to abide by the directions given by the Central Government in public interest after consultation with the Governor of the bank. The board shall consist of a Governor and not more than four Deputy Governors to be appointed by Central Government and other directors nominated by the Central Government. Apart from the Central Board, the bank has also local boards situated at Mumbai, Kolkata, Delhi and Chennai, which perform any duty delegated to them by the Central Board. The Governor has the power of general superintendence and direction of the affairs of the bank and exercise all powers of the bank unless otherwise provided in the regulations made by the Central Board. The Deputy Governors, Executive Directors and other officers in different grades assist the Governor in the discharge of the Bank s functions. iv. The Reserve Bank is the sole authority for issue and management of currency in India under Section 22 of the RBI Act. The bank may issue notes of different denominations from Rs. 2 to Rs. 10,000 as the Central Government may decide on the recommendations of the Central Board of the bank. Such notes shall be legal tender at any place in India. v. The bank is the banker to the Central Government under Section 20 of the Act, and accordingly it is obligatory to undertake banking business for the Central Government. In the case of state governments, their banking business is undertaken by the bank based on agreements as provided in Section 21 A. Bank provides ways and means of advances to the Central and state governments. These are temporary advances to meet immediate needs when there is interval between expenditure and flow of revenue. vi. The role of the bank as regulator of banking sector is mainly by virtue of the provisions of the Banking Regulation Act, 1949. In exercise of the powers under that Act the bank regulates the entry into banking business by licensing, exercises control over shareholding and voting rights of shareholders, exercises controls over the managerial persons, and regulates the business of banks. The bank also inspects banks and exercises supervisory powers, and may issue directions from time to time in public interest and in the interest of the banking system with respect to interest rates, lending limits, investments and various other matters. vii. The major powers of the Reserve Bank in the different roles as regulator and supervisor can be summed up as under: (a) power to licence: (b) power of appointment and removal of banking boards/personnel; (c) power to regulate the business of banks; (d) power to give directions; (e) power to inspect and supervise banks; (f) power regarding audit of banks; (g) power to collect, collate and furnish credit information; (h) power relating to moratorium, amalgamation and winding up; and (i) power to impose penalties.

1.7 GOVERNMENT AS A REGULATOR OF BANKS i. The Reserve Bank is the primary regulator of banks. But the Central Government has also been conferred extensive powers under the RBI Act and BR Act either directly or indirectly over the banks. ii. The government holds the entire capital of the Reserve Bank and appoints the Governor and the members of the Central Board and has the power to remove them. The government has also the power to issue directions to the Reserve Bank under Section 7( I) of the RBI Act whenever considered

10 necessary in public interest after consultation with the Governor. Thus, the government can exercise control over banks by influencing decision-making by the Reserve Bank and has also got appellate authority in respect of several matters in which the Reserve Bank has been conferred the power to decide at the first instance. Thus, under the Banking Regulation Act appeal lies with the Central Government on removal of managerial personnel under Sections 10B and 36AA of the BR Act. Similarly, there are also provisions for appeal in respect of cancellation of banking licence (under Section 22) and refusal of certificate regarding floating charge on assets (Section 14A). iii. The government has the power to suspend the operations of the Banking Regulation Act or to give exemption from any of the provisions of the Act on the representation/recommendation of the Reserve Bank under Sections 4 and 53 of the Act, respectively. The government has also the power to notify other forms of business which a bank may undertake under Section 6(1 )(o) of the Act. Rule-making powers under Sections 52 and 45Y are vested in the Central Government. There are also other provisions under which the Central Government exercises powers as under: (a) (b) (c) (d) (e) (f)

Approval for formation of subsidiary for certain business under Section 19; Notification with reference to accounts and balance sheet under Section 29; Issue of direction for inspection of banks under Section 35; Power to acquire undertakings of banks (Section 36AE); Appointment of court liquidator; Suspension of business and amalgamation of banks under Section 45.

The above provisions confer wide powers on the Central Government to regulate banks. These are in addition to the powers conferred on the government as majority shareholder or full owner of public sector banks under the statutes constituting them.

1.8 CONTROL OVER CO-OPERATIVE BANKS i. A co-operative bank is a co-operative society engaged in the business of banking and may be a primary Co-operative bank, a district central co-operative bank or a state co-operative bank. Cooperative banks operating in one state only are registered under the State co-operative Societies Act concerned. The formation of such banks as well as their management and control over personnel is regulated by the co-operative law of the state. The Registrar of co-operative societies under the Co-operative Societies Act exercises a wide range of powers on co-operative societies from registration to winding up. ii. In the case of co-operative banks operating in more than one state, the Multi-State Co-operative Societies Act, 2002 is applicable. In that case, the Registrar appointed by the Central Government takes the place of the Registrar appointed by the State Government in other cases. iii. With the introduction of Section 56 in the Banking Regulation Act, 1949 with effect from 1965, cooperative banks have come under the regulatory purview of the Reserve Bank. While the formation and management of co-operative societies operating in one state only (including those conducting banking business) are under the control of the State Government, licensing and regulation of banking business rests with the Reserve Bank. Thus, there is dual control of State Governments and the Reserve Bank over these banks. i v. In the case of co-operative banks which are registered under the Deposit Insurance and Credit Guarantee Corporation Act, the Reserve Bank has the power to order their winding up. The circumstances in which Reserve Bank may require winding up are mentioned in Section 13D of the Act.

11 1.9 REGULATION BY OTHER AUTHORITIES i. Banks may be subject to the control of other regulatory agencies in the conduct of their business. For instance, a banking company will be subject to the control of the authorities under the Companies Act in respect of company matters. Similarly, a bank is answerable to labour authorities in respect of the terms and conditions of service of its workmen, opening and closing of its premises, engagement of contract labour, etc. Banks are also liable to pay income tax like cash transaction tax, service tax, etc., and other taxes and have to follow the rules and regulations in that regard. ii. As provided in Section 6 of the Banking Regulation Act, banks may undertake certain non-banking business in addition to the business of banking. In that regard also, banks may be subject to the regulatory control of other agencies. For instance, in the case of dealings in securities like shares and debentures, banks are subject to regulation by the Securities Exchange Board of India under the Securities Contract (Regulation) Act, 1956 read with the Securities and Exchange Board of India Act, 1992. If the Bank desires to raise capital through public issue, it has to comply with SEBI guidelines. In case of Insurance Business - by IRDA and in case of Mutual Fund Business RBI, SEBI. The study herein is, however, largely confined to the regulation of banks by the Reserve Bank and the Central Government under the Reserve Bank of India Act and the Banking Regulation Act.

1.10 LET US SUM UP 1. Banking means acceptance of deposits of money from the public for lending or investment. Such deposits may be repayable on demand or may be for a period of time as agreed to, by the banker and the customer, and may be repayable by cheque, draft or otherwise. Apart from banking, banks are authorised to carry on other business as specified in Section 6 of the Banking Regulation Act. Banks are, however, prohibited from undertaking any trading activities. 2. Banks are constituted as companies registered under the Companies Act, 1956, statutory corporations constituted under Special Statutes or Co-operative societies registered under the Central or State Co-operative Societies Acts. The extent of applicability of the regulatory provisions under the Banking Regulation Act and the Reserve Bank of India Act to a bank depends on the constitution of the bank. 3. Reserve Bank of India is the central bank of the country and the primary regulator for the banking sector. The government has direct and indirect control over banks. It can exercise indirect control through thx: Reserve Bank and also act directly in appeals arising from decisions of the Reserve Bank under the various provisions of the Banking Regulation Act. In public sector banks like the State Bank of India and its subsidiaries, nationalised banks and the regional rural banks, 50% or more of their shares are held by the Central Government. Central Government has substantial control over the management of these banks. Only certain provisions of the BR Act are applicable to these banks as indicated in that Act. Co-operative banks operating in one state only are registered under the State Co-operative Societies Act and are subject to the control of the State Government as also the Reserve Bank. In the case of non-banking business of the banks, they are subject to control by other regulatory agencies.

1.11 KEYWORDS Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank; Regional Rural Bank; Public Sector Bank.

12 1.12 CHECK YOUR PROGRESS A . l . State (i) (ii) (iii)

whether the following statements are True or False. A public sector bank is a body corporate created under a special statute. A banking company is registered under the Banking Regulation Act. Co-operative banks are registered under the Multi-State Co-operative Societies Act or a State Co-operative Societies Act. (iv) Subsidiaries of the State Bank are companies registered under the Companies Act. (v) Accepting deposits for safe custody would fall within the definition of "banking".

2. Fill in the gaps choosing the answers from the brackets. (i) Reserve Bank was constituted under (BR Act, RBI Act, Companies Act) (ii) A Regional Rural Bank is (a body corporate created under a special statute, a cooperative society, a company) (iii) Banking companies are licensed by (Reserve Bank, Registrar of Companies, Company Law Board) (iv) Business which a banking company may undertake other than banking is as stipulated by (Reserve Bank, BR Act, RBI Act) (v) BR Act was enacted for (regulating banking companies, creating Reserve Bank, regulating acceptance of deposits from public) B. I. State (i) (ii) (iii) (iv) (v)

whether the following statements are True or False. Central Government can give direction to the Reserve Bank. All kinds of business of banks is regulated only by the Reserve Bank. Central Government is the primary regulator of banks. State governments have no control over co-operative banks. On cancellation of licence of any bank, an appeal lies with Central Government.

2. Fill in the gaps choosing the answers from the brackets. (i) Co-operative banks operating in different states are registered under (State Cooperative Societies Act, Multi-State Co-operative Societies Act, RBI Act) (ii) Government can exempt a bank from the provisions of BR Act (on the recommendation of RBI, whenever the government is satisfied, if requested by a bank) (iii) exercises the central banking function in India. (State Bank, Central Bank of India, Reserve Bank) (iv) Company matters of a banking company are regulated by (Reserve Bank, Authorities under the Companies Act, SEBI) (v) Trading in shares and securities by banks is subject to regulation by (Controller of Capital Issues, SEBI, Company Law Board)

1.13 ANSWERS TO 'CHECK YOUR PROGRESS' A. 1. 2.

(i) (i) (iii) (v)

True; (ii) False; (iii) True; (iv) False; (v) False. RBI Act (ii) a body corporate created under a special statute Reserve Bank (iv) BR Act for regulating banking companies.

B. I. 2.

(i) (i) (ii) (iii)

True; (ii) False; (iii) False; (iv) False; (v) True. Multi-State Co-operative Societies Act On recommendation of RBI Reserve Bank

13 (iv) Authorities under the Companies Act (v) SEBI.

1.14 TERMINAL QUESTIONS Fill in the gaps choosing the answers from the brackets. 1. One of the essential characteristics of banking is (lending to traders; investment in securities; acceptance of deposits from the public) 2. Banking companies operating in India are constituted in the form of (body corporate constituted under a special statute; company registered under the Companies Act, 1956 or a foreign company; society registered under the Societies Registration Act) 3. Companies Act applies to banking companies (notwithstanding the provisions of the Banking Regulation Act; insofar as its provisions are not inconsistent with the provisions of the Banking Regulation Act; only in relation to registration and winding up) 4. Under the Reserve Bank of India Act, Reserve Bank regulates acceptance of deposits by (all companies; non-banking financial companies; non-banking non-financial companies) 5. BR Act is applicable to co-operative banks (to the extent as provided in the state laws on co-operative societies; in a modified form as provided in Section 56 thereof; at par with commercial banks) 6. "Corresponding new banks" means (new banks [nationalised banks] constituted under the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970 and the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1980; new generation banking companies registered under the Companies Act; a new bank formed by amalgamation of two banking companies) 7. Central Government may give directions to the Reserve Bank when considered necessary in public interest only after consulting (the Governor of Reserve Bank; the Central Board of the Reserve Bank; the Finance Commission) 8. A co-operative society registered under the Multi-State Co-operative Societies Act (is prohibited from undertaking banking business; can be declared as a state co-operative bank; can undertake banking business as a primary co-operative bank) 9. A multi-state co-operative bank means a multi-state co-operative society which is a (primary co-operative bank; central co-operative bank; state co-operative bank) 10. For the purposes of the BR Act, a "co-operative society" means a society registered or deemed to have been registered under (any Central Act for the time being in force relating to the multi-state co-operative societies only; any state law relating to co-operative societies for the time being in force only; any Central Act for the time being in force relating to the multi-state cooperative societies or any other central or state law relating to co-operative societies for the time being in force)

CONTROL OVER ORGANISATION OF BANKS STRUCTURE 2.0

Objectives

2.1

Introduction

2.2

Licensing of Hanking Companies

2.3

Branch Licensing

2.4

Paid-up Capital and Reserves

2.5

Shareholding in Banking Companies

2.6

Subsidiaries of Banking Companies

2.7

Board of Directors

2.8

Chairman of Banking Company

2.9

Appointment of Additional Directors

2.10

Restrictions on Employment

2.11

Control Over Management

2.12

Corporate Governance

2.13

Directors and Corporate Governance

2.14

Let Us Sum Up

2.15

Keywords

2.16

Check Your Progress

2.17

Answers to 'Check Your Progress'

2.18

Terminal Questions

Mi

16 2.0 OBJECTIVES The objectives of this unit are to understand the laws that govern banking companies, in respect of: • • • • • • •

Licensing and branch licensing Paid up capital and reserves Shareholding and rights of shareholders Formation of subsidiaries and holding of shares of other companies Constitution and regulation of board of directors Exercise of control by the Reserve Bank and the Government over the appointment and removal of chairmen, managerial and other personnel Corporate governance

2.1 INTRODUCTION The Banking Regulation Act provides for regulation of the organisation of banking companies. To start with, there are restrictions at the entry point, by way of licensing and then the requirement of permission for opening or shifting of branches. There are further regulations over the paid-up capital and reserves, shareholder's rights, constitution of the board of directors, appointment of chairman and formation of subsidiaries. Apart from the above, there arc also controls over the managerial and other personnel, including the power to remove unsuitable persons and to appoint suitable persons. In this unit, we study various provisions of the Banking Regulation Act, providing for controls over the organisation and management of banking companies.

2.2 LICENSING OF BANKING COMPANIES i. License Requirement from RBI: To commence or carry on, the banking business in India, a company requires a licence from the Reserve Bank under Section 22 of the Banking Regulation Act. 1949. Commencing or carrying on a banking business without a licence is prohibited. When the Act came into force, the banking companies, which were then in existence were required to apply for licence within six months from the commencement of the Act. But, such banking companies were permitted to continue business, unless and until their applications for licence were rejected by the Reserve Bank. The requirement of licence was meant to ensure the continuance of only those banks, which were established and operating on sound lines and to prevent indiscriminate formation of banking companies. ii. Discretion of Reserve Bank: The granting of licence by the Reserve Bank may be subject to such conditions as the RBI may think fit in each case. As held by the Gujarat High Court in Shivabhai vs RBI, Ahmedabad (AIR 1986 Guj 19), Reserve Bank has the discretion to grant or refuse the licence and when such decision based on relevant, material and germane considerations, the decision cannot be assailed. Only if the decision is based on extraneous considerations or is perverse, the court will intervene. It is open to the RBI to consider the defects or improvements revealed in an inspection held under Section 35 of the BR Act while disposing of an application for licence. (See, Sajjan Bank Pvt. Ltd. vs RBI, AI R 1961 Mad 8). The refusal of licence to a company would make it ineligible to undertake banking business, but it would still be open to the company to carry on other business like money lending. iii. Conditions to be Satisfied: Before granting a licence under Section 22, Reserve Bank may have to be satisfied by an inspection of the books of the banking company or otherwise in respect of the following matters:

17 (a) Whether the company is or will be in a position to pay its present and future depositors in full as their claims accrue; (b) Whether the affairs of the company are being conducted or likely to be conducted in a manner detrimental to the interests of its present and future depositors; (c) Whether the general character of proposed management of the company will not be prejudicial to public interest or the interest of depositors; (d) Whether the company has an adequate capital structure and earning prospects; (e) Whether public interest will be served by grant of licence to the company; ( f ) Whether considering the banking facilities available in the proposed area of operation, the potential scope for expansion of business by banks already in existence in that area and other relevant factors, the grant of licence would be prejudicial to the operation and consolidation of banking system, consistent with monetary stability and economic growth; (g) The fulfilment of any other condition which the Reserve Bank considers relevant in public interest or in the interest of depositors. Although Section 11 of BR Act specifies the minimum capital and reserves requirements of a banking company, the Reserve Bank can stipulate a higher requirement of capital for licensing a banking company as under Section 22 the Reserve Bank has to be satisfied that the company has an adequate capital structure and earning prospects. iv. Foreign Banks: In the case of companies incorporated outside India applying for a licence, apart from the conditions specified in the case of domestic companies, three additional conditions have been stipulated for consideration by the Reserve Bank. These are: (a) Whether carrying on of banking business by the company in India will be in public interest; (b) Whether the government or the law of the country, in which the company is incorporated discriminates in any way against banking companies registered in India; (c) Whether the company complies with provisions of the BR Act, as applicable to foreign companies. v. Local Area Banks: The Reserve Bank has recognised the concept of local area banks and licensed a few(four) such banks. These arc banking companies operating only in a limited geographical area. The licence issued to these banks would restrict their operations to the specified local area to ensure adequate banking services in that area. vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking Regulation Act authorises the Reserve Bank to cancel the licence granted to any banking company. The cancellation of licence may be on any one or more of the following grounds: (a) The company ceases to carry on banking business in India; (b) The company at any time fails to comply with any of the conditions imposed under the subSection ( l ) of Section 22 of Banking Regulation Act; (c) The company does not fulfil at any time, any of the conditions referred to in the sub-Section(3) or 3(A) of Section 22 of Banking Regulation Act. Before cancellation of a licence for non-compliance with any of the conditions as above, the company has to be given an opportunity for taking necessary steps for complying with or fulfilling the conditions. However, in cases where the Reserve Bank is of the opinion that delay will be prejudicial to the interests of depositors or the public, the requirement of opportunity can be dispensed with. As observed by the Madras High Court in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961 Mad. 8), the Reserve Bank has a wide range of administrative discretion under the Act, which it is competent to exercise, and it cannot be said that there is an excessive delegation of power. A banking company, whose licence is cancelled, can appeal to the Central Government within a period of 30 days from the date of the order rejecting licence.

18 2.3 BRANCH LICENSING i. Apart from the requirement of licence for commencing or carrying on banking business, banks have to obtain the prior permission of Reserve Bank for opening a new place of business or changing location of the existing place of business. Under Section 23 of the Banking Regulation Act, 'Place of business' for this purpose includes any sub-office, pay office, sub-pay office or any place at which deposits are received, cheques cashed or moneys lent. However, changing the location of an existing place of business within the same city, town or village would not need such permission. These restrictions also apply to foreign branches of banking companies incorporated in India. Opening of a temporary place of business up to one month for purpose of affording banking facilities for any exhibition, mela, conference or like occasion is exempt. However, the temporary branch has to be within the limits of the city, town or village where there is an existing branch or in the environs thereof. The present guidelines from RBI provide that Banks should submit their request for new branches, administrative offices, ATMs once in a year for consideration of RBI as against the earlier practice of making individual applications for each and every branch. When approved, the permission would be valid for a period of one year before which the branches/ offices should be operationalised. ii. For granting permission under Section 23, the Reserve Bank may require to be satisfied of the following: (a) (b) (c) (d)

Financial condition and history of the bank; General character of its management; Adequacy of capital structure and earning prospects; Public interest.

This may be done by an inspection of the bank under Section 35 or otherwise. While granting permission for opening or shifting a branch, the Reserve Bank may impose any conditions which it thinks fit necessary. If any bank fails to comply with such conditions, the permission may be revoked after giving an opportunity to the bank to show cause. iii. In the case of regional rural banks, the applications for permission have to be routed through the National Bank (NABARD), and the national bank has to offer its comments on merits to the Reserve Bank.

2.4 PAID-UP CAPITAL AND RESERVES Section 11 of the Banking Regulation Act provides for certain minimum requirements as to paid-up capital and reserves of banking companies. Any company wanting to commence banking business has to comply with these requirements. The amounts stipulated have reference to the places of business. 'Place of business' for this purpose means any office, sub-office, sub-pay office and any place at which deposits are received, cheques cashed or moneys lent. In the case of any dispute regarding computation of paid-up capital and reserves of any banking company, the decision of the Reserve Bank shall be final. i. Foreign Banks: Under the sub-Section (2) of Section 11 of the BR Act, a foreign bank (banking company incorporated outside India) operating in India, has to deposit and keep deposited with the Reserve Bank, an amount of Rs.l5 lacs and if it has a place of business in Mumbai or Kolkata or both, Rs. 20 lacs. The amount has to be kept in cash, unencumbered approved securities or partly in both. Apart from this, an amount of twenty per cent of the profit for each year in respect of business transacted through the branches in India as disclosed in the profit and loss account has to be deposited with the Reserve Bank. The securities deposited can be replaced by other unencumbered

19 approved securities or cash deposited can be similarly replaced by securities. The Central Government can exempt any foreign bank from this requirement on the recommendation of the Reserve Bank for a specified period if the amounts deposited already by it are considered adequate. On the cessation of business by any foreign bank for any reason, these deposits shall form the assets of the company on which the creditors in India shall have the first charge. ii. Indian Banks: In case of banking companies incorporated in India, the requirements of minimum paid-up capital and reserves under Section 11 (3) are as follows: (a) If it has a place of business in more than one state, Rs. 5 lac and if such places of business include Mumbai, Kolkata or both, Rs. 10 lac. (b) If the place of business is in only one state and does not include Mumbai or Kolkata, Rupees l lac for its principal place of business, plus Rs. 10,000 for other places of business, in the same district in which the principal place of business is situated, plus an additional Rs. 20,000, for each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank has only one place of business, the amount is limited to Rs. 50,000. For banking companies commencing business after the commencement of the Act, paid-up capital is stipulated as Rs 5 lac. (c) If places of business are in one state only, but one or more of them is in Mumbai or Kolkata, Rs. 5 lac, plus Rs. 25,000 for each place of business outside these cities and the aggregate not exceeding Rs. 10 lac. During 2005, RBI stipulated the minimum capital requirement for a new Private Bank at Rs 300 crore as a part of Corporate Governance guidelines and as a policy of Foreign Direct Investment. iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the above. Section 12( 1) of the Banking Regulation Act stipulates that the subscribed capital of a banking company shall not be less than half of its authorised capital; and the paid-up capital shall not be less than half of its subscribed capital. If capital is increased, this requirement has to be complied within a period not exceeding two years as allowed by the Reserve Bank. Banking companies are permitted to have only ordinary or equity shares. However, preference shares issued before 1 July 1944 are exempt. Further, the provisions of Section 12(1) are not applicable to banks incorporated before 15 January 1937. Now preference shares and other capital instruments are also allowed. Since 2005, Banks have been permitted by RBI to raise capital even in the from of innovative debt instruments which are perpetual and perpetual non-cumulative preference shares in addition to the equity capital.

2.5 SHAREHOLDING IN BANKING COMPANIES i. Voting rights of shareholders: There is no specified ceiling on a person's holding of shares in a banking company under the Banking Regulation Act or any other law. However, Section 12(2) of the Act puts certain restrictions on voting rights of shareholders. Accordingly, no shareholder can exercise voting rights in respect of the shares held by him/her in excess of ten per cent of the total voting rights of all the shareholders of the banking company. This provision does not in any way affect the transfer of shares or the registration of such transfers. It only puts a limit on voting rights. However, Section 12(3) bars suits or other proceedings against registered shareholders by any other person claiming title except by a transferee of shares, in accordance with the law or on behalf of minors or lunatics for whom the registered shareholder holds the shares. The provisions of the Companies Act also govern transfer of shares of banking companies. ii. Acknowledgement by Resarvc Bank: Reserve Bank has instructed banking companies that when

20 they receive more than the specified percentage of their shares for transfer to one party, the bank's board must refer the matter to the Reserve Bank. The banks shall not transfer the shares without receiving Reserve Bank's acknowledgement. This is with a view to ensure that the controlling interest in a banking company does not change hands without the knowledge and approval of the Reserve Bank. iii. Reports on shareholding: A report regarding the particulars of shareholding of the chairman, managing director or chief executive officer, by whatever name called, of every banking company, requires submission to the Reserve Bank. Such report should contain the full particulars and extent of value of shares held directly or indirectly and of any change in the extent of holding or of any variation in the rights attaching thereto. The Reserve Bank may also order for any other information relating to those shares. iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act imposes a ceiling on the commission, brokerage, discount or remuneration on the sale of shares of banking companies. Accordingly, the payments on this account in any form should not exceed two-and-a-half per cent of the paid-up value of the shares. v. Dividend: There are also certain restrictions on the payment of dividend to the shareholders of banking companies. Thus, under Section 15 of the Banking Regulation Act, no dividend is payable until all capitalised expenses are completely written off. Such expenses include preliminary expenses, organisation expenses, share-selling commission, brokerage, loss incurred and any other item, of expenditure not represented by tangible assets. However, dividends are payable without writing off depreciation, bad debt etc., as under: . (a) Depreciation in value of approved securities, which is not capitalised or accounted for as a loss. (b) Depreciation in investment of shares, bonds or debentures, other than the approved securities for which adequate provision has been made. (c) Bad debts for which an adequate provision is provided. RBI has given detailed eligibility criteria for declaration of dividend by banks and also guidelines on the quantum of dividend that can be declared by banks. The eligibility criteria require a minimum 9 % of CAR and Net NPAs not exceeding 7%. The quantum of dividend that can be declared is based on the levels of net NPAs and in a graded level (Maximum 40% pay out ratio) and can be paid out of only current year's profits.

2.6 SUBSIDIARIES OF BANKING COMPANIES i. Formation of Subsidiaries: There are certain restrictions under Section 19 of the Banking Regulation Act on the formation of subsidiaries by banking companies. This is for purpose of preventing banks from carrying on trading activities by acquiring a controlling interest in non-banking companies. Accordingly, subsidiaries are permissible only for the following purposes: (i)

Undertaking any business which is permissible for banking companies under Section 6(1) clauses (a) to (o). (ii) Carrying on the business of banking exclusively outside India. Prior permission of the Reserve Bank is a must for t h i s banking business. (iii) Undertaking any other business which Reserve Bank with prior approval of the Central Government permits. Reserve Bank may permit only such other business which it considers conducive to the spread of banking in India or otherwise useful or necessary in the public interest. The undertaking of any business by a subsidiary will not be deemed to amount to the bank itself taking up that business directly or indirectly for the purpose of Section 8.

21 ii. Shareholding in other companies: Apart from the restriction on subsidiaries, there is also a ceiling [Section 19(2)] on shareholding in companies other than subsidiaries. Thus, the holding of shares by a banking company in any company as pledgee, mortgagee or absolute owner shall not be exceeding thirty per cent of the paid-up share capital of that company or the paid-up share capital and reserves of the banking company. Further, holding of shares in any company in which the managing director or manager of a banking company is interested in or concerned with in any manner, is prohibited except in the case of subsidiaries.

2.7 BOARD OF DIRECTORS i. Qualifications: Section 1 OA of the Banking Regulation Act stipulates certain qualifications for directors of banking companies. Accordingly at least fifty-one per cent of the total number of directors shall be persons, who have special knowledge or practical experience, with respect of accountancy, %

agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry or any other matter, the special knowledge or practical experience which is useful to the banking company, in the opinion of the Reserve Bank. Further, at least two of the directors should have special knowledge or practical experience in agriculture and rural economy or co-operation or small scale industry. ii. Substantial interest: The directors of a banking company shall not have a substantial interest in or be connected with as employee, manager or managing agent in a company or firm which carries on trade, commerce or industry as per Section I OA (2)(b) of the BR Act. However, companies registered under Section 25 of the Companies Act and small scale industrial concerns are not included for the purpose. The proprietors of trading, commercial or industrial concerns other than small scale industrial concerns are also disqualified for directorship. 'Substantial interest' for this purpose is defined in Section 2 of the Banking Regulation Act. Accordingly, holding of beneficial interest by any individual or his spouse or minor child, whether singly or taken together in the shares of a company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the company amounts to substantial interest. In the case of firms, such holding of beneficial interest exceeding ten per cent of the total capital of the firm amounts to substantial interest. iii. Period of office: The directors of a banking company shall not hold office for more than eight years continuously. However, this provision is not applicable to the chairman or a whole-time director. When the chairman or a whole-time director of a bank is removed from office, he/she ceases to be a director of the bank and shall not be eligible for further appointment as director of that banking company for a period of four years. iv. Reconstitution of Board: When the board of a banking company is not constituted in accordance with the requirements of Section 10A of the BR Act, the board has to be reconstituted, to comply with the provisions. If any director has to be retired for such a reconstitution, this may be done by lots, in the prescribed manner and such decision shall be binding on every director of the board. If the Reserve Bank is of the opinion that the board of any banking company does not fulfil the requirements, it may order such a bank to reconstitute the board after giving reasonable opportunity of being heard. If, within two months' time, the bank does not fulfil the order of the Reserve Bank, the Bank may then remove any director (determined by lots drawn in the prescribed manner) and such a person shall cease to hold office. The Reserve Bank may also appoint a new director in the place of the person removed and he/she shall continue in office until the date up to which his predecessor would have held office. However, any proceedings of a banking company will not be invalid only because of any defect in the composition of the board.

22 2,8 CHAIRMAN OF BANKING COMPANY i. Whole-time Chairman/Managing Director: Section I OB of the Banking Regulation Act provides that every banking company should have a full-time or part-time chairman, appointed from among its directors. The chairman, if appointed on a whole-time basis is entrusted with the management of the entire affairs of the bank. The chairman on a part-time basis has to be appointed with the prior approval of the Reserve Bank and such an appointment shall be subject to any conditions that may be imposed by the Reserve Bank while granting approval. In the absence of a chairman, the management of the whole of the affairs of the banking company shall be entrusted to a managing director. The exercise of powers by the whole-time chairman or managing director is subject to the superintendence, control and directions of the board of directors. The whole-time chairman and a managing director shall hold office for a period not exceeding five years as the board may fix and is also eligible for reelection or reappointment. Although the chairman is in full-time employment of the bank, he may be a director of a subsidiary of the bank or of a company registered under Section 25 of the Companies Act. The Reserve Bank may also permit the whole-time chairman or the managing director to undertake part-time honorary work not likely to interfere with the duties of the chairman or the managing director. The whole-time chairman or the managing director of a banking company may continue in office at the end of the term of the office until his/her successor assumes office, subject to the approval of the Reserve Bank. ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time chairman or the managing director of a banking company should have special knowledge or practical experience of the working of a banking company or the State Bank or a subsidiary bank or a financial institution or financial, economic or business administration. The whole-time chairman or the managing director will be disqualified under the following circumstances: (a) if he/she is director of a company other than a subsidiary of the banking company or a charitable company (registered under Section 25 of the Companies Act); (b) if he/she is a partner of any firm which carries on trade, business or industry; (c) if he/she has substantial interest in any other company or firm or is director, manager, managing agent, partner or proprietor of any trading, commercial or industrial concern; or (d) if he/she is engaged in any other business or vocation. iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is of the opinion that the person elected to be the chairman of the board of directors and appointed on a whole time basis or the managing director is not a fit and proper person to hold such office, the Reserve Bank may require the banking company to remove such a chairman or the managing director and appoint a suitable person. However, before taking such an action, the Reserve Bank has to give such a person, as also the banking company, a reasonable opportunity of being heard. If the banking company does not comply with the order within two months, the Reserve Bank may remove the person from the office and appoint a suitable person in his/her place. Such a chairman or managing director would continue in office, for the residual period of office of the person removed from office. The banking company or the person affected by the Reserve Bank s order may appeal to the Central Government within thirty days. The order of the Government where an appeal is filed and the order of the Reserve Bank, where no appeal is filed shall be final and not liable to be challenged before any civil court. vi. Temporary vacancies: In cases where the wholetime chairman or the managing director dies or

23 he/she resigns or is not capable of discharging his/her functions due to illness, temporary arrangements can be made to carry out the duties of the chairman or the managing director for a period not exceeding four months. However, this has to be done with the approval of the Reserve Bank. v. Power of Reserve Bank to appoint ('hairman: In certain cases, the office of the whole-time chairman or the managing director of a banking company may fall vacant and may not be filled up by the bank immediately. This may adversely affect the interests of the banking company. If the Reserve Bank is of the opinion that continuation of such vacancy is likely to be against the interests of the banking company, it may appoint an eligible person to fill such vacancy under Section 10BB of the Banking Regulation Act. If the chairman or the managing director so appointed is not a director of the banking company, he/she shall be deemed to be a director of the banking company. Such appointment may be for a period not exceeding three years. There is also a provision for reappointment after the initial period. The chairman or the managing director so appointed may be removed from office only by the Reserve Bank and shall draw pay and allowances from the banking company, as determined by the Reserve Bank. vi. Qualification shares: The whole-time chairman or the managing director of a banking company is exempted under Section IOC of the Banking Regulation Act from the requirement of holding qualification shares. Similar exemption is also available to a director of a banking company appointed by Reserve Bank under Section 10A of the Act. vii. Overriding provisions: The provisions of Section 10A, Section 10B and Section 10BB of the Banking Regulation Act regarding the appointment and removal of a director, managing director or the chairman shall have overriding effect over all other laws, contracts, etc. Any person affected by any action taken under these provisions is not entitled to any compensation for any loss or for termination of office.

2.9 APPOINTMENT OF ADDITIONAL DIRECTORS i. The Reserve Bank has the power to appoint additional directors on the boards of banking companies under Section 36AB of the Banking Regulation Act. One or more additional directors may be so appointed when the bank is of the opinion that it is necessary to do so in the interest of: (a) banking policy (c) banking company

(b) public (d) depositors of the banking company.

ii. The directors so appointed shall not require any qualification shares. They hold office during the pleasure of the Reserve Bank. Subject to this, appointment may be for a period not exceeding three years or further extended periods not exceeding three years at a time as specified by the Reserve Bank. The additional directors are protected from any liability or obligation for executing their functions in good faith. The provisions of Section 36AB have overriding effect over other laws.

2.10 RESTRICTIONS ON EMPLOYMENT i. The Banking Regulation Act (Section 10) prohibits employment of managing agents and imposes restrictions on employment of certain type of persons, namely — (a) a person who is or has been adjudicated insolvent or has suspended payment or has compounded with his/her creditors; (b) a person who is or has been convicted by a criminal court of an offence involving moral turpitude;

24 (c) a person whose remuneration or part thereof is by way of commission or share in the profits of the company; (d) a person whose remuneration is excessive in the opinion of the Reserve Bank. Before forming an opinion regarding the remuneration, the Reserve Bank has to consider the financial condition and history of the banking company, its area of operation, resources, volume of business and the trend of its earning capacity, number of its branches, qualifications, age and experience of the person concerned, remuneration of other personnel in the bank or persons holding similar positions in other banks and the interest of depositors. The above restrictions are applicable to workmen as well as management personnel, as held by the Supreme Court in Central Hank of India vs Their Workmen (AIR 1960 SC 12). However, the restriction on remuneration does not affect payment of bonus according to a settlement or award or in accordance with a scheme framed by the bank or in accordance with the prevailing practice in banking business. Commission paid to brokers, auctioneers, forwarding agents, etc., who are not regular members of the bank's staff, is also not covered by these provisions. ii. Persons who are directors of any company other than a subsidiary of a banking company or company registered under Section 25 of the Companies Act are also prohibited from managing a banking company. However, this prohibition shall not apply to a director for a temporary period of three months, or a further period not exceeding nine months, if allowed by the Reserve Bank. Apart from this, persons engaged in any other, business or vocation or whose term of office as a person managing the company is for a period exceeding five years also fall in the prohibited category. However, the period of office can be renewed or extended for further periods not exceeding five years at a time.

2.11 CONTROLS OVER MANAGEMENT i. Power to remove Management and other personnel: The Reserve Bank is empowered under Section 36AA of the Banking Regulation Act to remove any chairman, director, chief executive officer (by whatever name called), or other officer or employee of a banking company. For this purpose, the bank has to be satisfied that it is necessary to do so. The bank (RBI) has the discretionary power to remove management and other personnel in the following circumstances: (a) Public interest (b) Preventing the affairs of the banking company being conducted in a manner detrimental to the interest of depositors (c) Securing proper management of the banking company. The Reserve Bank has to pass such an order recording the reasons in writing. Before passing the order, the affected person has to be given a reasonable opportunity of making a representation against the proposed order. Where an urgent action is required and delay would be against the interests of the company or its depositors, the Reserve Bank is empowered to direct by order, at the time of giving opportunity of making a representation that the person concerned shall not act in his/her official capacity or directly or indirectly take part in the management of the bank from the date of such order, pending consideration of the representation. The person so removed shall not be entitled to any compensation for loss of office notwithstanding anything contained in any law, the memorandum, articles or any contract to the contrary as the provisions of Section 36AA have overriding effect. ii. Appeal: An appeal against the order of removal lies with the Central Government. Such an appeal has to be filed within thirty days from the date of communication of the order. The appellate decision of the Central Government, and subject thereto the order of the Reserve Bank, shall be final and not liable to challenge in any Civil Court.

iii. Effect of the order of removal: On the Reserve Bank passing a removal order, the person concerned ceases to hold office which he/she was holding till then. Further, he/she is prohibited, from directly or indirectly taking part in the management of any banking company for a period not exceeding five years as may be specified in the order. Contravention of the order is punishable with a fine of Rs. 250 for each day during which the contravention continues. iv. Appointment of a suitable person: When any chairman, director, chief executive officer, other officer or employee is removed by the Reserve Bank under Section 36AA as above, the Reserve Bank may appoint a suitable person in his place. Such person shall hold office at the pleasure of the Reserve Bank. Subject to this, the appointment may be for a period not exceeding three years and is extendable for further periods not exceeding three years at a time. Such appointee shall not incur any obligation or liability for action taken in good faith in the execution of the duties of his office.

2,12 CORPORATE GOVERNANCE i. The Concept: Corporate governance is a dynamic concept involving promotion of corporate fairness, transparency and accountability in the interest of shareholders, employees, customers and other stakeholders. It is a concept of recent origin. However, there is considerable divergence in the understanding and practice of corporate governance across different jurisdictions. The concept has evolved since the first major study by the Cadbury Committee in 1992. The DECO principles of corporate governance published in 1999, the first international code of good corporate governance approved by governments, was revised in 2004. Corporate governance can be seen as kthe way in which boards oversee the running of a company by its managers, and how board members are in turn accountable to shareholders and the company* and it has implications for company behaviour towards employees, shareholders, customers, banks and other stakeholders. Further, good corporate governance plays a vital role in ensuring the integrity and efficiency of financial markets and the lack of it can pave the way for financial difficulties and sometimes even fraud. ii. OECD Principles of Corporate Governance, 2004: The OECD principles of corporate governance, 2(X)4 stipulate what the corporate governance framework should ensure, which is briefly as under: (a) Ensuring the basis for an effective corporate governance framework: To promote transparent and efficient markets which are consistent with the rule of law. Also, to articulate clearly the division of responsibilities among the different supervisory, regulatory and enforcement authorities. (b) The rights of shareholders and key ownership functions: To protect and facilitate the exercise of shareholders' rights. (c) The equitable treatment of shareholders: In the equitable treatment of shareholders are included the minority and foreign shareholders. Further, all shareholders should have the opportunity to obtain an effective redress for violation of their rights. (d) The role of stakeholders in corporate governance: To recognise the rights of stakeholders, established by law or through mutual agreements and encourage active cooperation between the corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises. (e) Disclosure and transparency: Timely and accurate disclosures made on all material matters, regarding the corporation, including the financial situation, performance, ownership, and governance of the company. (f) The responsibilities of the board: Strategic guidance of the company, effective monitoring of management by the board and the board's accountability to the company and the shareholders are the important aspects. These principles are applicable to all types of companies including banks.

26 iii. Corporate Governance and Banks: Banks hold a special position in corporate governance as they accept and deploy large amounts of public funds in fiduciary capacity and also leverage such funds through credit creation. The position of banks is also important for the smooth functioning of the payment system. Accordingly, legal prescriptions for ownership and governance of banks laid down in the statutes are supplemented by regulatory prescriptions. The Basel Committee on Banking Supervision has issued guidance (February 2006) for promoting the adoption of sound practices of corporate governance by banking institutions. This guidance, entitled Enhancing Corporate Governance for Banking Organisations, highlights the importance of: • • • • •

the roles of boards of directors (with a focus on the role of independent directors) and senior management effective management of conflicts of interest the roles of internal and external auditors, as well as internal control functionaries governing in a transparent manner, especially where a bank operates in jurisdictions, or through structures, that may impede transparency the role of supervisors in promoting and assessing sound corporate governance practices.(See, http://www.bis.org/press/p060213.htm).

Apart from the fiduciary role of banks, their cross-border operations add a special dimension. This provides an added impetus for convergence in standards internationally. In almost all countries, the policy framework with regard to corporate governance involves a multiplicity of agencies. In India, the Department of Company Affairs, Securities and Exchange Board of India (in respect of listed entities) are involved apart from the Reserve Bank in respect of banks. iv. Reserve Bank's approach: Following the formal policy announcement in regard to corporate governance, in the mid term Review of the Monetary and Credit Policy, in October, 2001, the Reserve bank constituted a Consultative Group in November, 2001 under the chairmanship of Dr. A.S. Ganguly with a view to strengthen the internal supervisory role of the boards of banks. The report of the group was transmitted to all the banks for their consideration in June, 2002 and simultaneously to the Government of India for consideration. Earlier, an advisory group on corporate governance under the chairmanship of Dr. R.H. Patil had submitted its report in March, 2001 which examined the issues relating to corporate governance in banks in India, including the public sector banks and made recommendations to bring the governance standards in India on par with the best international standards. There were also some relevant observations by the advisory group on banking supervision under the chairmanship of Shri M.S. Verma which submitted its report in January, 2003. Keeping all these recommendations in view and the cross-country experience, the Reserve Bank initiated several measures to strengthen the corporate governance in the Indian banking sector, including the concept of 4 fit and proper* criteria for directors of banks which included the process of collecting information, exercising due diligence and constitution of a nomination committee of the board to scrutinise the declarations made by the bank directors. The RBI guidelines on ownership and governance in the private sector banks released on February 28, 2005 (Paras 5 and 6) provide as under:

Shareholding (i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on 3 February, 2004 will be applicable for any acquisition of shares of five per ccnt and above of the paid-up capital of the private sector bank. (ii) In the interest of diversified ownership of banks, the objective will be to ensure that no single entity or group of related entities has shareholding or control, directly or indirectly, in any bank in excess of ten per ccnt of the paid-up capital of the private sector bank. Any higher level of

27 acquisition will be with the prior approval of RBI and in accordance with the guidelines of 3 February, 2004 for grant of acknowledgement for acquisition of shares. (iii) Where ownership is that of a corporate entity, the objective will be to ensure that no single individual/entity has ownership and control in excess of ten per cent of that entity. Where the ownership is that of a financial entity the objective will be to ensure that it is a well-established regulated entity, widely held, publicly listed and enjoys good standing in the financial community. (iv) Banks (including foreign banks having a branch presence in India)/FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's/FYs holding exceeds five per cent of the investee bank's equity capital as indicated in RBI circular dated 6 July, 2004. (v) As per the existing policy, large industrial houses will be allowed to acquire, by way of strategic investment, shares not exceeding ten per cent of the paid-up capital of the bank, subject to RBI's prior approval. Furthermore, such a limitation will also be considered, if appropriate, in regard to important shareholders with other commercial affiliations. (vi) In case of a restructuring of the problem/weak banks or in the interest of consolidation in the banking sector, RBI may permit a higher level of shareholding, including by a bank.

2.13 DIRECTORS AND CORPORATE GOVERNANCE (i) The board of directors should ensure that the responsibilities of directors are well defined and the banks should arrange need based training for the directors in this regard. While the respective entities should perform the roles envisaged for them, private sector banks will be required to ensure that the directors on their boards representing specific sectors, as provided under the B.R. Act, are indeed representatives of those sectors in a demonstrable fashion, they fulfil the criteria under corporate governance norms provided by the Ganguly Committee and they also fulfil the criteria applicable for determining 'fit and proper' status of important shareholders (i.e., shareholding of five per cent and above) as laid down in RBI circular dated 25 June, 2004. (ii) As a matter of desirable practice, not more than one member of a family or a close relative (as defined under Section 6 of the Companies Act, 1956) or an associate (partner, employee, director, etc.) should be on the board of a bank. (iii) Guidelines have been provided in respect of 'fit and proper' criteria for directors of banks by the RBI circular dated 25 June, 2004 in accordance with the recommendations of the Ganguly Committee on corporate governance. For this purpose a declaration and undertaking is required from the proposed/existing directors. (iv) Being a director, the CEO should for directors. In addition, RBI CEO. The banks will be required application to RBI for approval

satisfy the requirements of the Tit and proper' criteria applicable may apply any additional requirements for the chairman and to provide all information that may be required while making an of appointment of chairman/CEO.

With regard to public sector banks, the principles of corporate governance have been statutorily recognised as per Banking Companies (Acquisition and Transfer of Undertakings) Financial Institutions Laws (Amendment) Act, 2006. The Act as amended provides for shareholder directors to be a person having Tit and proper' status and the Reserve Bank has to notify the 'Fit and Proper' criteria (Section 9(2)1.

28 2.14 LET US SUM UP A company wanting to commence hanking business requires prior licence from the Reserve Bank. The Reserve Bank has the discretion to reject licence or approve the licence on such conditions as it thinks fit. Before granting licence. Reserve Bank has to be satisfied by inspection or otherwise of the suitability of the company for licence. A licence once given may also be cancelled after giving the bank an opportunity to be heard. Further, for opening new branches or shifting branches outside a city, town or village, permission of the Reserve Bank is required. Banking companies have to have minimum capital and reserves as specified in the Banking Regulation Act. The shareholders of a banking company are entitled to dividends only after all the capitalised expenses are written off. The commission or brokerage payable on selling shares is restricted to two and half per cent of the paid-up value of the shares. The board of directors of a bank has to be constituted with persons hav ing special knowledge or experience in accountancy, banking, economics, law, etc., as stipulated. The directors should not have substantial interest in other companies or firms. The maximum period of office is limited to eight years continuously. The Reserve Bank is empowered to reconstitute the board, if the board is not properly constituted. Hvery banking company should have a full-time chairman (or a full-time managing director, if there is no full-time chairman) with the specified qualifications. The Reserve Bank has powers to remove the chairman and appoint a suitable person in his place in certain cases. The Reserve Bank also has powers to remove the directors or managerial personnel or other employees of banking companies. The principles of corporate governance including the Tit and proper' criteria for directors apply to banking companies as well as public sector banks.

2.15 KEYWORDS Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place of Business: Substantial Interest; Subscribed Capital; Subsidiary.

2.16 CHECK YOUR PROGRESS 1. Fill in the gaps choosing the answers from the brackets. (i) A company has to obtain a from the Reserve Bank to commence banking business in terms of Section 22 of the BR Act. (registration; licence; commencement certificate) (ii) Shifting of a bank's branch in the same does not require Reserve Bank's permission under Section 23. (district; state, city, town or village) (iii) Foreign banks are required under Section 11 of the BR Act to deposit arising out of their business in India with the Reserve Bank, (twenty per cent of profit for each year; thirty per cent of profit for each year; twenty per cent of the deposits collected .each year) (iv) Banks may float subsidiaries for carrying on the business specified in . (their Memorandum of Association; Section 6( I )(a) to (o) of the BR Act; their Articles of Association) (v) A shareholder of a banking company can exercise voting rights up to of the total voting rights of all shareholders, (one per cent; ten per cent; hundred per cent) (vi) Banking companies are not permitted to give dividend until all are written off. (bad debts, expenses, capitalised expenses) 2.

Say whether True or False. (i) A temporary branch for less than thirty days in a town where a bank has an existing branch does not require permission from Reserve Bank. (ii) A company whose banking licence is rejected can undertake business as a moneylender or undertake other business. (iii) The decision of Reserve Bank to revoke licence is final and no appeal lies from it.

(iv) Banking companies are permitted to give brokerage up to two-and-half per cent of the paid-up value of shares. (v) No person can hold the shares of banks beyond ceiling specified under the BR Act. (vi) A banking company cannot hold shares in any other company other than a subsidiary. 3,

Fill in the gaps choosing the answer from the brackets. (i) A director of a banking company should not have in any other company, (beneficial interest, any interest, substantial interest) (ii) At least of the directors should have the qualifications prescribed under Section 10A(2) of the BR Act. (50 per cent, 75 per cent, 51 per cent) (iii) When the board of a banking company is ordered to be reconstituted under Section 10A of the BR Act, directors will be removed for the purpose of reconstitution. (by rotation, by lots, by majority decision) (iv) Before removing the chairman of a bank from office, Reserve Bank has to . (give compensation for loss of office, give opportunity of being heard, give an option to continue as director) (v) The provisions of Section 36AA of the BR Act regarding removal of managerial personnel have over other laws, (no effect, overriding effect, persuasive effect) (vi) Reserve Bank is authorised to appoint under Section 36AB of the BR Act. (directors, additional directors, managing director) (vii) The (Central Government; RBI; SEBI) has stipulated the Tit and proper' criteria for directors of banking companies.

4.

Say whether True or False. (i) The maximum period of office that may be held continuously by an ordinary director in a banking company is eight years. (ii) The decisions of the board of directors, during the period when the board's constitution is defective shall be void. (iii) The post of chairman of a banking company may be on part-time basis. (iv) The chairman of a banking company can hold office only for a maximum period of eight years. (v) From the order removing chairman of a banking company, appeal lies to the Central Government within thirty days of the order. (vi) Reserve Bank has the power to remove any officer or other staff of a banking company under Section 36M of the BR Act. (vii) The concept of Tit and proper' criteria for directors is not applicable to public sector banks.

2.17 ANSWERS TO 'CHECK YOUR PROGRESS

1

1. (i) licence; (ii) same city, town or village; (iii) 20 per cent of profit for each year; (iv) Section 6(1 )(a) to (o) of BR Act; (v) 10 per cent; (vi) capitalised expenses. 2. (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) False. 3. (i) substantial interest; (ii) 51 per cent; (iii) by lots; (iv) give opportunity of being heard; (v) overriding effect; (vi) additional directors; (vii) RBI 4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False

2.18 TERMINAL QUESTIONS Fill in the gaps choosing answers from the brackets. 1. Reserve Bank may issue licence to a banking company under Section 22 of the BR Act subject to

30

2.

3.

4.

5.

. (such conditions as the Central Government may specify; such conditions as the Reserve Bank may think fit to impose; confirmation by the Central Government). Reserve Bank is not empowered to cancel the licence granted to a banking company on the ground that . (the company ceases to carry on any of its business; the company changes its registered office from one state to another state; the company is not in a position to pay its depositors in full as their claims accrue). A bank requires permission of the Reserve Bank for opening a new branch or shifting an existing branch . (to any new location from where it is situated; otherwise than within the same city, town or village; otherwise than in the same building). In addition to the requirements as to minimum capital and reserves under Section II of the BR Act, Reserve Bank . (cannot look into the capital structure of a banking company; has to satisfy itself under Section 22(3) of the BR Act as to adequacy of capital structure and earning prospects; has to consult the Central Government as to the adequacy of the capital structure of a banking company before licensing). In the case of a banking company, a shareholder cannot exercise voting rights on poll . (in excess of ten per cent of the total voting rights of all the shareholders of the company; in excess of two per cent of the total voting rights of all the shareholders of the company; in excess of ten per cent of the total voting rights of all the shareholders except with prior permission of the Reserve Bank).

Choose the correct statements from the following. 6.

(i) There are no restrictions in the BR Act on payment of dividend by banking companies. (ii) Before payment of dividend by a banking company, all its capitalised expenses, unless specifically exempted under the BR Act, have to be completely written off. (iii) Banking companies are not permitted to pay dividend above ten per cent of net profits. 7. (i) There are no specific qualifications required for the directors of a banking company. (ii) At least fifty-one per cent of the directors of a banking company should consist of persons with professional or other experience as provided in the BR Act. (iii) At least fifty-one per cent of the directors of a banking company should be chartered accounts or experts in finance. 8. (i) There is no provision for maintenance of reserves by a banking company under the BR Act. (ii) Every banking company has to maintain a reserve fund and transfer before declaring dividend, not less than twenty per cent of the profit to the reserve fund. (iii) The maintenance of a reserve fund is optional for a bank.

(ii)

(iii) 10.

(i) (ii) (iii)

entrusted with the management of the whole of the affairs of the banking company. The chairman of a banking company can be on part-time basis and a managing director can be appointed on whole-time basis who shall be entrusted with the whole of the affairs of the banking company. The chairman of a banking company can be on part-time basis and the whole of the affairs of the banking company shall be entrusted to a committee of the board of directors. A banking company can form subsidiaries for undertaking any business approved by its board of directors. A banking company can form subsidiaries for undertaking any business mentioned in Section 6(1) (a) to (o) of the BR Act, which is permissible for a banking company to undertake. A banking company does not require the permission of the Reserve Bank to form a subsidiary for doing banking business exclusively outside India.

REGULATION OF BANKING BUSINESS STRUCTURE 3.0

Objectives

3.1

Introduction

3.2

Power to Issue Directions

3.3

Acceptance of Deposits

3.4

Nomination

3.5

Loans and Advances

3.6

Regulation of Interest Kate

3.7

Regulation of Payment Systems

3.8

Internet Banking Guidelines

3.9

Regulation of Money Market Instruments

3.10

Banking Ombudsman

3.11

Reserve Funds

3.12

Maintenance of Cash Reserve

3.13

Maintenance of Liquid Assets

3.14

Assets in India

3.15

Let Us Sum Up

3.16

Keywords

3.17

Check Your Progress

3.18

A n t w e n to 'Check Your Progress'

3.19

Terminal Questions

32 3.0 OBJECTIVES The objectives of this unit are to understand the law, in particular the provisions of the Banking Regulation Act. relating to: • • • • • • • •

issue of directions by Reserve Bank to banks regulation of acceptance of deposits by banks regulation of loans and advances regulation of interest rates of banks on deposits and borrowing maintenance of reserve fund maintenance of cash reserve by scheduled banks and other banks maintenance of liquid assets maintenance of assets in India

3.1 INTRODUCTION The Banking Regulation Act provides for regulation of the business activities of banking companies. Accordingly, the Act empowers the Reserve Bank to issue directions for regulating terms and conditions of making of loans and advances and other matters including acceptance of deposits. The Banking Regulation Act also imposes certain restrictions on loans and advances to the directors of banking companies, and companies and firms in which they are interested. The Act contains provisions for creation of a reserve fund and transfer of a percentage of profits to that fund. There are also provisions for maintenance of cash reserve, liquid assets and assets in India. In this unit, we look at the relevant provisions of law in this regard.

3.2 POWER TO ISSUE DIRECTIONS i. The Banking Regulation: Act authorises the Reserve Bank to issue directions to banks under Sections 21 and 35A of the Act. While Section 21 gives the power to regulate advances by banking companies, Section 35A gives wide powers generally to regulate banking companies. The Reserve Bank has been issuing directions from time to time under Section 21 (read with Section 35A) regulating rates of interest and other terms and conditions of acceptance of deposits and making of loans and advances. Regulation of deposits and loans and advances are discussed below (See, Paras 3.4 and 3.5, respectively). ii. Nature of Directions: The directions issued by the Reserve Bank in exercise of powers under Sections 21 and 35A of the BR Act, being statutory directions, are binding on the banks. The circulars of the Reserve Bank giving instructions to banks where it has statutory powers to give such instructions are also binding on the banks, even if they do not specifically refer to any statutory provisions. However, as held by the Supreme Court in State Bank of India vs. CIT (AIR 1986 SC 757), non-statutory circulars of the Reserve Bank cannot affect legal rights. The Reserve Bank's powers to issue directions are over the banks. Hence, the directions are addressed to banks only and not to customers or the public. The effect of violation of Reserve Bank s directions/ instructions which are binding on banks, has been considered by the Supreme Court in BOI Finance Ltd. vs. The Custodian (AIR 1997 SC 1952) in the context of some banks entering into certain repo transactions against the circulars of the Reserve Bank prohibiting such transactions. The court found that the action of the banks violated the Reserve Bank's instructions and held that the violations would not invalidate the contracts with third parties but would render the banks liable to prosecution. The effect of directions will be prospective and not retrospective in the absence of any statutory provisions providing for retrospective operation of directions.

33 iii. Bonafides: The powers of the Reserve Bank to issue directions have to be exercised with bonafide intentions, as held by the Gujarat High Court in RBI vs Harisidh Co-op. Bank Ltd. (AIR 1988 Guj 107). In that case the Court considered the power of the Reserve Bank to issue directions for superseding the board of a co-operative bank for securing its proper management and upheld the action taken by the Reserve Bank on the finding that it was without mala fide. iv. Caution and Advice: Apart from giving directions, the Reserve Bank may also caution or give advice to banking companies. Section 36 of the Banking Regulation Act provides that the Reserve Bank may caution or prohibit banking companies generally or any banking company in particular against any transaction or class of transactions. Further, the Reserve Bank may generally give advice to any banking company.

3.3 ACCEPTANCE OF DEPOSITS i. As discussed in unit I, the essence of banking business is the acceptance of deposits from the public withdrawable by cheque. [See also the judgement of Madras High Court in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961 Mad 8)1. The definition of "banking" in Section 5(b) of the Banking Regulation Act acknowledges this position. ii. Types of Deposits: Banks accept different types of deposits, both time and demand deposits, from the public. While time deposits, like fixed deposits or recurring deposits are repayable after an agreed period, demand deposits, like deposits in currcnt account and savings bank accounts, are repayable on demand, subject to the terms and conditions of the deposits. The period of the deposit and rate of interest applicable to the deposit are matters to be agreed between the depositor and the bank under the terms of the deposit, subject to any directions given by the Reserve Bank in this regard. iii. Regulation of acceptance of deposits: The Banking Regulation Act does not contain any specific provisions for regulation of acceptance of deposits of banks. However, Section 35A which authorises the Reserve Bank to give directions is wide enough to cover acceptance of deposits. Accordingly, acceptance of deposits may be regulated in the public interest or in the interest of banking policy or in the interests of depositors by issuing directions. The Reserve Bank issues directions from time to time regulating the rates of interest applicable to deposits. The directions may either fix the rates or specify the minimum and/or maximum rate of interest on savings deposits and time deposits for various periods as also for special categories of deposits like senior citizen, NRI deposits. If only minimum and/or maximum rates are specified or no rates are specified, the banks are free to decide their rates accordingly. The directions issued by the Reserve Bank may also stipulate conditions regarding minimum or maximum periods for which deposits may be accepted, reduction of interest payable on premature withdrawal and payment of interest on renewal of overdue deposits. However, currently RBI prescribes the minimum and maximum period for which deposits can be accepted and prescribes interest rates only in respect of Savings Deposits and NRI deposits leaving others for the individual banks. iv. Returns on unclaimed deposits: Banks have to file a return every year on their unclaimed deposits under Section 26 of the Banking Regulation Act. The return has to be filed within thirty days of the end of each calendar year in the form and manner prescribed and should cover all deposits not operated for ten years. In the case of fixed deposits the period of ten years starts from the expiry of the period of the deposit.

34 3.4 NOMINATION i. Repayment of Deposits: Section 45ZA of the Banking Regulation Act provides that a depositor or depositors of a banking company (including co-operative banks) may nominate one person in the prescribed manner as nominee to whom the deposit may be returned in the event of death of the sole depositor or depositors. Unless the nomination is varied or cancelled, the nominee is entitled to all the rights of the depositor/s in the event of death of the depositor/s. In the case of minor nominees, there is also a provision to appoint a person to receive the deposit on behalf of the minor. Payment by a bank in accordance with these provisions gives a valid discharge to the bank, but this does not affect the right or claim a person may have against the nominee in respect of the amount received by him. Rule 2 of the Banking Companies (Nomination) Rules, 1985 provides for the procedure and forms for making nomination in respect of deposits with commercial banks. In the case of Co-operative banks, similar provisions are incorporated in the Co-operative Banks (Nomination) Rules, 1985. ii. Articles in Safe Custody and Safety Lockers: There are also provisions in the Banking Regulation Act for nomination in respect of articles kept in safe custody with banks and safety lockers. Sections 45ZC and 45ZE provide that any person who leaves any article in safe custody and in safety lockers respectively with a banking company, may nominate one person as nominee to receive the article in the event of death of that person. The nomination has to be in the prescribed manner and on return of articles kept in safe custody or removal of contents of locker by nominees as provided, the bank gets a valid discharge. Rules 3 and 4 of the Banking Companies (Nomination) Rules, 1985, and also the Rules 3 and 4 of the Co-operative Banks (Nomination) Rules, 1985 deal with the form and procedure applicable to articles in safe custody and safety lockers respectively in the case of banking companies and co-operative banks.

3.5 LOANS AND ADVANCES i. The definition of "banking' in Section 5(b) of the Banking Regulation Act indicates that acceptance of deposits may be for lending or investment. Thus, lending or making of loans and advances is a core business of a banking company. Lending may be for short term or long term, on secured or unsecured basis and for different purposes. ii. Regulation of Loans and Advances (a) The Reserve Bank is empowered under Section 21 of the Banking Regulation Act to issue directions to control advances by banking companies. Such directions may be issued to banking companies generally or to any particular banking company. The Reserve Bank may determine the policy in relation to advances and issue directions when it is satisfied that it is necessary to give directions: (i) In public interest (iii) In the interests of banking policy.

(ii) In the interests of depositors

(b) The directions given by the Reserve Bank are binding on banking companies, and may be on one or more of the following matters: (i) Purpose for which advances may or may not be made. (ii) Margins, to be maintained in respect of secured advances. (iii) Maximum amount of advances or other financial accommodation which may be made to any company, firm, association of persons or individual. The policy on these matters may be specified having regard to the paid-up capital, reserves and deposits of the banking company and other relevant considerations.

REGULATION OF BANKING BUSINESS I 35 (iv) M a x i m u m amount up to which guarantees may be given by of any company, firm, association of persons or individual. capital, reserves, deposits and other relevant considerations for determining the maximum amount. (v) Rate of interest and other terms and conditions on which accommodation may be made or guarantees may be given.

a banking company on behalf In this case, also the paid-up have to be taken into account advances and other financial

The Reserve Bank issues directions from time to time regulating the lending operations of banking companies in exercise of these powers vested under Section 21. Apart from this, the general powers to give directions under Section 35A are also available for regulation of loans and advances. 8. Selective Credit Control (a) Purpose: Banks have been traditionally financing trade and commerce and against items they deal in even before the country started industrializing. To ensure that prices of essential commodities like food grains, pulses, edible oils, sugar, jaggery and cotton and textiles are not increased by certain sections of the business community with a motive of profit maximisation by hoarding with the help of bank finance, these restrictions have been put in place. These cover the quantum of credit that can be extended and also the rate at which it can be extended. With self-sufficiency achieved by our country over the years in almost all of the above, RBI had taken them out of the purview of selective credit control and currently restrictions are there only in case of levy sugar. (b) Methods and tools: Selective credit control seeks to influence the demand for credit by (i) making borrowing more costly for certain purposes which are considered relatively inessential, or (ii) by imposing stringent conditions on lending for such purposes, or (iii) by giving concessions for certain desired types of activities. The tools employed for exercising selective credit control are: (i) minimum margins for lending against selected commodities; (ii) ceilings on the levels of credit; and (iii) charging of minimum rate of interest on advances against specified commodities. The quantum and cost of credit are regulated by operating these tools of control. Price control: In India, selective credit control has been generally used for preventing speculative hoarding of essential commodities and basic raw materials using bank credit. This is with a view to check the undue rise of prices of such sensitive commodities. Restrictions on loans and advances: Section 20 of the Banking Regulation Act imposes certain restrictions on loans and advances. Accordingly, no banking company shall grant loans or advances on the security of its own shares. Further, a banking company, is prohibited from entering into any commitment for granting any loans or advances to or on behalf of any of its directors. The prohibition also applies to loans and advances to: (a) firms in which any director is interested as a partner, manager, employee or guarantor, and (b) any company (other than a company registered under Section 25 of the Companies Act) in which a director of the banking company holds substantial interest as defined in Section 5(ne) of the Act or of which he is director, manager, managing agent, employee or guarantor. If the director of a banking company is a partner or guarantor of any individual, loans and advances to such individual are also barred. 'Director' includes a member of any board for managing or

36 advising the bank regarding management of all or any of its affairs. It is open to the Reserve Bank to specify any transaction as not being a loan or advance for this purpose by a general or special order. In so doing the bank has to consider the nature of the transaction, period, manner and circumstances in which the amount is likely to be realised, the interest of depositors and other relevant considerations. If there is any doubt or dispute as to whether a transaction is a loan or advance, the decision of the Reserve Bank in the matter shall be final. vi. Restrictions on power to remit debt: For remitting any debt to its directors, a banking company requires prior permission of the Reserve Bank under Section 20A of the Banking Regulation Act. Permission is also required for remission of loans to: (a) any firm or company in which a director is interested as director, partner, managing agent, or (b) any individual for whom a director is partner or guarantor. Any remission made in contravention of Section 20 is void and will have no effect.

3,6 REGULATION OF INTEREST RATE The Reserve Bank is authorised to regulate interest rates under Section 21 (read with Section 35A) of the Banking Regulation Act. This includes rates of interest for loans and advances as well as deposits. While giving directions on interest rates, there should not be any discrimination against any class of depositors or loanees or banks. Any differential treatment should be justifiable in law as not being against the principles of equality. In Harjit Singh vs Union of India (AIR 1994 SC 1433), the Supreme Court held in the context of reduction of rate of interest on bank loans to riot victims that the concession should be extended to loanees from financial institutions also, as there was no basis for discrimination between loanees from banks and loanees from financial institutions. i. Interest on deposits: The rates of interest on deposits were not regulated by the Reserve Bank until 1964. Hence, it was open to the banks to decide their deposit rates freely. Thereafter the Reserve Bank has been issuing directions from time to time regulating rates of interest applicable to different types of deposits. Accordingly, payment of interest on current account was prohibited. As the directions are issued by virtue of the powers vested in the Reserve Bank under Section 35A of the Banking Regulation Act, before issuing the directions the Bank has to be satisfied that the directions are necessary in public interest or in the interest of depositors or of banking policy. Reserve Bank may permit higher rate of interest in favour of certain categories of depositors like former/existing employees or depositors of certain classes of banks like co-operative banks. Of late, the movement has been in the direction of liberalisation of interest rates, thereby giving increased freedom to banks to decide the rates themselves. ii. Interest rate on loans and advances: Interest rate on loans and advances is subject to regulation specifically under Section 21 (2)(e) of the Banking Regulation Act apart from the general provisions of Section 35 A. The Reserve Bank has been issuing directions from time to time under Section 21 (read with Section 35A) of the Act regulating different aspects of lending including lending rates. Accordingly, different rates are permissible for different sectors like small-scale industries, agriculture, large-scale industries, etc., and of late, much freedom has been given to banks to decide the rates themselves. Further, the rate of interest may vary on the basis of the period of the loan. The Reserve Bank tightens the regulations or gives relaxations thereby permitting banks to decide the rates on their own, depending on the position of money supply in the public interest or in the interest of depositors or of banking policy. Currently the directions of RBI regarding interest rates of advances cover only finance to exporters and small loans with limits up to Rs 2 lac and DRI loans.

37 iii. Usurious loans Act, 1918: The Usurious Loans Act, 1918 prohibits lending at exorbitant rates. The law has been made to protect the weaker borrowers from the powerful moneylenders. Similarly, debt relief legislation in different states attempts to protect the agriculturists and other weaker sections from unscrupulous lenders, by remitting debts or giving other concessions. Although the lending rates of banks are regulated by the Reserve Bank, borrowers often used to resort to these laws for remitting loans or reducing rates of interest in respect of loans taken by them from banks. This was coming in the way of the monetary policy decided by the central bank. Accordingly, Section 21A was inserted in the Banking Regulation Act to make the rates of interest charged by banking companies beyond the scrutiny of courts. iv. Protection to interest rate: Section 21A of the Banking Regulation Act provides that a transaction between a banking company and its debtor cannot be reopened by any court on the ground that the rate of interest charged is excessive. This provision is given an overriding effect over the provisions of the Usurious Loans Act, 1918 or any other law relating to indebtedness in force in any state. Section 21A was held to be valid and not ultra vires the Constitution by the Supreme Court. In Corporation Bank vs D. S. Gowda [(1994) 5 SCC 213], the Supreme Court held that banks can compound interest on annual rates and not half yearly rates in view of the express directives of the Reserve Bank. The court further held that where the Reserve Bank fixes both minimum and maximum rates of interest, courts would not interfere in the matter of interest rate, if the rate charged by the bank is not in violation of the Reserve Bank directive. However, the court did not express any opinion on the question whether Section 21A would debar the courts from interfering if the circulars or directives of the Reserve Bank do not fix the maximum and leave it to the discretion of the banks to fix the rate above the minimum.

3.7 REGULATION OF PAYMENT SYSTEMS The Reserve Bank of India Act, until recently, did not contain any provision for regulation of payment systems. Section 58 empowers the Bank to make regulations for giving effect to the provisions of the Act and Clause (g) of the sub-Section (2) thereof, provides for making provisions for regulation of clearing houses for the banks including post office saving banks. (The clearing houses are now functioning under the uniform clearing house rules and regulations framed by the mutual consent of members and no statutory rules or regulations have been framed.) However, the regulation of payment systems has become important in the context of electronic payment systems becoming popular and the probability of complications in the absence of a suitable regulatory framework with statutory backing. In the absence of specific powers under the Act, the Bank has not been able to frame any regulations relating to payment systems. Hence, the Information Technology Act, 2000 has amended the Reserve Bank of India Act, inserting the Clause (pp) in Section 58 (2) empowering the Reserve Bank to frame regulations for payment systems of banks and financial institutions. Financial institution for this purpose will have the same meaning as provided in the Clause (c) of Section 45 of the Reserve Bank of India Act. Accordingly, the Central Board of the Reserve Bank has framed the Reserve Bank of India (Board for Regulation and Supervision of Payment and Settlement Systems) Regulations, 2005. Further, RBI is in the process of finalising the guidelines under the Payment and Settlement Systems Act, 2007. i. Board for regulation and supervision of Payment and Settlement Systems: The Reserve Bank, in terms of the RBI (Board for Regulation and Supervision of Payment and Settlement Systems) Regulations, 2005, has constituted a Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) as a committee of its Central board. The Board has the Governor of the Bank as its chairman and its functions include prescribing policies relating to the regulation and supervision of all types of payment and settlement systems, setting standards for existing and future systems,