Banking law

Dr. Nandimath Omprakash V,

Associate Professor in Law & Coordinator,
Distance Education Department,
National Law School of India University,
Bangalore-560 072
Email: ovnandimath@nls.ac.in
Course No. II (MBL)

1. Structure and Functions of Commercial Bankers &

Financial Institutions (Module I)
2. Reserve Bank of India – Structure and Functions
(Module II)
3. Law of Banking Regulations (Module III)
4. Negotiable Instruments – Law and Procedure
(Module IV & V)
5. Banker and Customer relation (Module VI)
6. Advances, Loans and Securities (Module VII & VIII)
7. Procedural Aspects of Banking Law (Module IX)
Evolution of banking services in India

• British brought the modern concept of banking

to India
• But the concept of ‘banking’– was known to us
– Banking was used in synonymous with money
lending
– Vedic literature records the details of banking
transactions
– Manusmrithi speaks about – deposits, pledge, loans
and interest rates etc.,
– Sons ‘pious obligation’ – to discharge the loan of
the father
Indian ‘modern banking’

• Alexander & Company a leading agency house

started managing the Bank of Hindustan in
1770’s
• The Bank of Calcutta was established by the
East India Company in 1806
• Commercial Bank – in 1819
• The concept of limited liability was not known
– hence, till 1860 banks had to either obtain a
special charter from the crown or had to
operate under ‘unlimited liability’
• 1921 – three Presidency Banks at Calcutta,
Bombay and Madras were merged into the
Imperial Bank (vide Imperial Bank of India
Act, 1920)
• Reserve Bank of India was established in 1934
– It was given the right of note issue;
– Was also to act as ‘bankers bank’;
– However, Imperial Bank was allowed to operate as
the agent of RBI, especially in those places where
RBI had no branches.
• The RBI was initially a shareholder’s bank –
but was nationalized in 1948 [vide Reserve
Bank (Amendment) Act, 1948]
• State Bank of India Act, 1955
– Imperial Bank was taken over by SBI
Bank Nationalization – an important milestone

• Nationalization was perceived as a major step

in achieving the socialistic pattern of society
• July 19, 1969 – 14 major banks were
nationalized
• 1980 – 6 more banks were nationalized
• A detailed scheme of objectives, regulations,
management etc., was drawn-up for these
banks
“the branch network which was 8262 in June 1969
expanded to 60000 by1992 with major expansion
(80%) in rural areas. The average number of people
served by a branch came down from 60000 to 11000.
the development of credit is more widely spread all
over the country as against only in advanced states. In
1969 deposits amounted to 13% of GDP and advances
to 10%. By 1990 deposits grew to 30% and advances
to 25% of the GDP…Deposits grew from a figure of
Rs.4669 crores in July 1969 to Rs.2,75,000 crores on
31.3.1993. More than 45% of the total credit was
directed to the priority sector. More than 45% of the
total deposits were used by the government to fund its
five year plans…”
Types of banking services in India
CENTRAL BANK

COMMERCIAL BANK

INSTITUTIONAL BANKS

Commercial banking service include –

(i) Receiving
SPECIALIZED variousBANKStypes of deposits;
(ii) Giving various types of loans
(iii) Extending some non-baking facilities
(i)
NON Locker;
-BANKING FI’S
(ii) Electricity bill;
(iii) Payment of insurance premium etc.,
Types of banking services in India
CENTRAL BANK

COMMERCIAL BANK

INSTITUTIONAL BANKS

SPECIALIZED BANKS

Special banking institutions are established for definite

NON-BANKING
specialized banking FIservices
’S
The types of banks accept all types of deposits but mobilize
the amount in its specially focused area
Types of banking services in India
CENTRAL BANK

COMMERCIAL BANK

INSTITUTIONAL BANKS

SPECIALIZED BANKS

NON-BANKING FI’S

Many institutions are established for carrying on non-banking

financial services – but to a great extent resemble the
banking activity Ex: Mutual funds, financial institutions
acting as portfolio managers
Types of banking services in India
CENTRAL BANK

COMMERCIAL BANK

NATIONALIZED BANKS (20) PRIVATE BANKS

SBI AND ASSOCIATE BANKS

NATIONALIZED BANKS (20) NATIONALIZED BANKS (20)

Types of banking services in India
CENTRAL BANK

SPECIALIZED BANKS

LAND MORTGAGE

RURAL CREDIT

IND. DEVELOPMENT

CO-OPERATIVE

HOUSING FINANCE

EXPORT IMPORT
Types of banking services in India
CENTRAL BANK

INSTITUTIONAL BANKS

IFCI

SFC’S

IDBI

ICICI

NABARD

HDFC
The Narasimham Committee

• 1990s India had traumatic moments

• Banks were burdened with large percentage of
non-performing loans
• Customer service had suffered and out-moded
practices were in vogue
• Overall re-hauling was needed for entire
financial systems in general and banking sector
in particular
• The Narasimham Committee was set up to
recommend changes in financial system
Committee recommends
– Overall emphasis upon ‘de-regulation’
– No further nationalization to be adhered to
– No distinction between ‘public’ and ‘private’ sector
banks
– Control of banking sector to be centralized (and
not to be divided between RBI and Dept. of
Banking)
– SLR and CRR should be reduced to prudent levels
– Concessional lending to be phased out
– The capital base of banks should meet
international standards
– the appointment of Chief Executive of the banks
to be de-politicized
Role of a ‘commercial’ and ‘central
bank’
Commercial bank

• There is no specific definition (although

Banking Regulation Act – defines banking)
• The ‘banker’ is one who deals in ‘money’
• Two essential functions of banking
1. Borrowing (accepting of deposits) of money; and
2. Lending of money for needy purposes
– Besides these essential function a banking
company also performs
– Other agency and
– General utility functions
“a commercial bank mobilizes the savings of the society.
This money is then provided to those who are in need
of it by granting overdrafts or fixed loans or by
discounting bills of exchange or promissory notes. In
short, the primary function of a commercial bank is
that of a broker and a dealer in money. By discharging
this function efficiently and effectively, a commercial
bank renders a very valuable service to the community
by increasing the productive capacity of the country
and thereby accelerating the pace of economic
development. It gathers the small savings of the
people, thus reducing to the lowest limits the quantity
of idle money…”
“…the banker should always bear in mind that it
is the guardian of a very delicate mechanism
which paves the way for failure of economic
development and which, if disturbed, will
create monetary disequilibrium with all the evil
effects incidental thereto…”
Banking – liquidity & profitability

LIQUIDITY
• cash in hand
• money at call & short
notice
• bills discounted
• investments

PROFITABILITY
• loans & Advances
Commercial banks & credit creation

• ‘Every loan creates a deposit’ – Hartly Withers

• The commercial banks as a system can and do
increase the total amount of money in
circulation by increasing the purchasing power
of the people through the deposit money
created by them
Model

LIABILITIES ASSETS
Deposits 10,000 Cash in hand 10,000
Total 10,000 Total 10,000

LIABILITIES ASSETS
Deposits 10,000 Cash in hand 10,000

Deposits 9,000 Loans to clients 9,000

(credit
balance)
Total 19,000 Total 19,000
Investment & mixed banking

• Investment banks are organizations, which

assist business corporations and governmental
bodies to raise funds for long term capital
requirements through the sale of shares, stocks,
bonds etc.,
• Mixed banking lies in extension of operations
of investment banker to commercial banking
filed
Universal banking

• Often referred to as ‘financial service

supermarket’
• An universal bank offers entire (or often most
of) financial services within the bank or
through its subsidiaries, like
– Commercial banking solutions
– Investment banking
– Other related financial services including
insurance
Merchant banking

• No specific universally accepted definition

• But the financial institution which centers its
operations on all or most of the following
– Corporate financial advice (on matter as new
shares and bond issues, capital reconstructions,
mergers and acquisitions)
– Taking deposits and money market operations
– Foreign exchange dealings
– Medium term lending
– Export finance
– Fund management on behalf of clients (pension
funds, unit trusts, investment trusts etc.,)
Virtual banking

• ‘relationship banking’ to ‘electronic banking’

• Extensive use of IT based solutions
– Automated Teller Machines (ATMs)
– Shared ATM networks
– Electronic Fund Transfer @ Point of Sale (EFTPoS)
– Smart cards
– Stored – value cards
– Phone Banking
– Internet Banking
Central banking
“The Central Bank is an institution charged with
the responsibility of managing the expansion
and contraction of the volume of money in the
interest of the general public welfare…”
-- R. P. Kent, Money and Banking, p. 351
Central banks – world view

• Today almost all nations in the globe have their

‘Central Banks’
• The idea of having central bank attained
popularity during 20th century (although some
central banks in existence earlier as well)
• International Monetary Conference held in
Brussels (1929) – strongly emphasized the need
of central banking unit
Necessity of central bank

Control of credit in any nation

monopoly power of currency issue

Friend, philosopher & guide to commercial banks

Implementation of government’s monetary policies

Principles of central banking

Autonomy
Monetary stability No competition

National welfare
Functions of central bank

• Monopoly of note issue

• Lender of last resort
• Central clearance & settlement
– Banker’s bank
• Controller of credit
• Banker to the government
• Publishes economic statistics and other useful
information
• Research & development
RBI Act, 1934 – preamble

“Whereas it is expedient to constitute a RBI to regulate the issue of Bank

notes and the keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit
system of the country to its advantage;
And whereas in the present disorganization of the monetary systems of the
world it is not possible to determine what will be suitable as permanent
basis for the Indian monetary system;
But whereas it is expedient to make temporary provision on the basis of the
existing monetary system, and to leave the question of the monetary
standard best suited to India to be considered when the international
monetary position has become sufficiently clear and stable to make it
possible to frame permanent measures”
RBI – an introduction

• Established in 1935
• Overtook
– Currency issue from central government of India;
and
– Credit control from the then Imperial Bank of India
• Nationalized in 1948
Functions entrusted

• Bank of issue (of currency)

• Banker to the government (including management of
public debt)
• Banker to commercial banks (lender of last resort)
• Controller of volume of credit in India
• Organization of ‘sound and healthy commercial
banking system’
• Concerned with the development of
– Rural banking;
– Promotion of financial institutions; and
– Development of money and capital markets
RBI – in its promotional role

• The establishment of BILL MARKET scheme

(1952)
• Establishments of financial corporations
– For agricultural sector; and
– Industrial sector
• Promotion of Regional Rural Banks (with the
able assistance of commercial banks)
• Assistance (to commercial banks) to open
foreign branches
• Establishment of Export-Import bank
Organization of the RBI

• Ss. 8 & 9 of the Act

– Governor
– Central Board
• 4 Deputy Governors
• 10 Directors (nominated by the Central Government)
• 4 Directors from Local Boards
• 1 Government Representative (nominated by the
Central Government)
– Local Boards
• Delhi
• Mumbai
• Calcutta
• Madras
• Department in the Central Office
– Secretariat
– Banking operations & development
– Industrial credit
– Agricultural credit
– Rural planning & credit
– Exchange control
– Currency management
– Expenditure & budgetary control
– Government accounts
– Economic analysis & Policy
– Credit planning cell
– Statistical analysis and computer
– Management service
– Administration & personnel
– Legal services
– Inspection
– Premises
– Banking training colleges
• Mumbai
• Pune; and
• Madras
RBI & Commercial Banks

• Controller to commercial banks

– By virtue of Banking Regulation Act, 1949; and
– Reserve Bank of India Act, 1934
General control over commercial banks

• License to commence banking business

• Licensing the commercial banks – to open
branches
• Revoke the license – if the banking company is
operating improperly
• Power to inspect (sec. 35)
• Power to appoint additional directors on the
Board of Directors
• Approval of RBI is necessary – for
appointment, re-appointment or termination of
an appointment of a Chairman
• Power to prevent a commercial bank from
undertaking certain type of activities
Licensing the banking company

• The RBI will satisfy itself about

– The capital structure and earning prospectus of the
company
– The general character of the proposed
management (that it is of high order and not
detrimental to the interests of the depositors
– That granting of license will be in the public
interest
– That the proposed bank’s working will be in
consistent with the monetary stability of the
economy
• RBI has sufficient power to
– Remove any managerial personnel from the office
– Appoint another alternative suitable person in the
vacancy so caused
• Power to Audit
– Prior approval – before appointing, re-appointing
or removing any auditor or auditors
– Order for ‘special audit’
• Of such transactions; or
• Class of transactions; or
• Transactions for particular period
– RBI can direct the auditor to conduct special audit
and submit his report independently
Quantative control of credit

• Uses globally accepted tools

– The bank rate
– Open market operations
– Variable cash reserve requirements
• Formulation of credit policies (by way of an
order)
Selective credit control

• Sec. 21
– Fixation of margin requirements of secured loans
– ‘credit rationing’
– Selective credit controls
– Direct action
– Moral suasion
Banker’s bank

• Lender of last resort for

– Commercial banks
– Commercial co-operative banks
– Regional rural banks
• RBI offers – refinancing facility to its
‘scheduled banks’
– The banking institutions which figure in the
Second Schedule of the RBI Act
– Before admitting the banking company in to the
schedule – RBI satisfies itself that such banking
company is worth it
– RBI also has the power to remove the banking
company from the schedule
Miscellaneous powers

• Prohibit certain transactions of any banking

company
• Advise to any banking company to tie-up loose
ends in its operation
• Act as an intermediary to the amalgamating
banks (but only upon the request)
• In the ‘public interest’ – to prevent matters
detrimental to the depositors etc.,
– Order the banking company to call a meeting of its
directors to discuss any matters of relevance
– Depute one or more of its officers to watch the
proceedings at any meeting of the board
– Appoint one or more of its officers to observe the
manner in which the affairs of the banking
company or of its offices or branches are being
conducted and make a report thereon
– Compel the bank to change its management
approach with regard to certain matter
• Make an annual report to the Central
Government – regarding the trend and progress
of banking in the country
• Power to apply to HC for winding up of a
banking company
Thanks very much…