Banking Regulation Act 1949

Introduction

Different types of banks, such as commercial banks, cooperative banks, rural banks, and private
sector banks exist in India. The Reserve Bank of India (RBI) is the governing body for regulating
and supervising the banks. Banking Regulation Act, 1949 is an Act that provides a framework for
regulating the banks of India. The Act came into force on 16th March 1949. This Act gives RBI
the power to control the behavior of banks. This Act was passed as the Banking Companies Act,
1949. It did not apply to Jammu and Kashmir until 1956. This Act monitors the day-to-day
operations of the bank. Under this Act, the RBI can license banks, put regulation over
shareholding and voting rights of shareholders, look over the appointment of the boards and
management, and lay down the instructions for audits. RBI also plays a role in mergers and
liquidation.

History of the Banking Regulation Act, 1949

The concept of banking started in India with the establishment of the Bank of Hindustan. Before
nationalisation took place in India, the banking system of India was more of a private nature.
Banks were struggling to keep their branches open. Low capital and reserves and greed for
obtaining high profits became a reason for the failure of the banking system. The banks were
supervised under the Companies Act, 1913, but this Act was not sufficient to regulate banks. The
economy was not performing well, and this started to damage the banks. Also, the concept of
banks was mostly used by the upper-class people. Fraud was also one of the reasons for the
decline in the usage of banks. This gave a need to regulate the banking system of India. As a
result, the Banking Regulation Act was introduced in 1949. It was initially applicable to banking
companies, but after the Amendment in 1965, the Act was also applicable to cooperative banks.

Objectives of the Banking Regulation Act, 1949

The objectives of the Banking Regulation Act are stated below:

1. To meet the demand of the depositors and provide them with security and guarantees.

2. To provide provisions that can regulate the business of banking.

3. To regulate the opening of branches and changing of locations of existing branches.

4. To prescribe minimum requirements for the capital of banks.

5. To balance the development of banking institutions.

The sections under this Act are to be interpreted along with the sections of the Companies Act,
1956, or any other laws prevalent in the banking system. This Act applies to banking companies
and cooperative banks. It will not apply to a primary agricultural credit society or a cooperative
land mortgage bank, or any other co-operative society, except mentioned in Part V of the Act.

Features of the Banking Regulation Act, 1949

The Act has been divided into five parts comprising 56 sections.

The main features of the Act are mentioned below:

1. Non-banking companies are forbidden to receive money deposits that are payable on
demand.

2. Non-banking risks are reduced by prohibiting trading by banking companies.

3. Maintaining minimum capital standards.

4. Regulation on the acquisition of shares of banking companies.

5. Power of the Central Government to make schemes for the banks.

6. Provisions regarding liquidation proceedings for banking companies.

Important provisions of the Banking Regulation Act, 1949

Some important provisions of the Act are stated below:

Definitions

The Act has defined some terms such as banking, banking company, branch office, etc. A
banking company means a company that conducts banking business in India. Banking means to
accept lending or investment deposits of money from the public which can be repaid on demand.
Subsidiary banks have the same meaning as given under the State Bank of India (Subsidiary
Banks) Act, 1959. A secured loan or advance means an advance, or a loan secured against the
security of assets.

Business which can be undertaken by the banking companies

Under Section 6(1), a banking company may be involved in the business of borrowing or lending
money; buying or selling bills of exchange, promissory notes, coupons, drafts, bills of lading,
railway receipts, warrants, debentures; buying or selling of foreign exchange; dealing stock,
funds, shares, debentures, bonds; carrying on agency business such as clearing and forwarding of
goods; conducting the business of guarantee and indemnity, etc.
Prohibition of trading

Trading is prohibited under Section 8 of this Act.

No banking company shall directly or indirectly deal in the buying or selling, or bartering of
goods except when it is selling the goods kept in its security. The bank should also not engage in
any trade or buy, sell, or barter goods except for bills of exchange received due to collection or
negotiation.

Management of bank

The bank should not employ or be employed by the managing partner as stated under Section 10
of the Act.

The bank should also not employ a person who has been adjudicated insolvent or whose
remunerations depend on the profits of the company. At least 51% of the total members of the
board must have professional experience in matters such as accountancy, agriculture, rural
economy, banking, cooperation, economics, finance, law, small-scale industry, etc. The term of
the office of the director should not be more than eight years.

Minimum paid-up capital and reserves

Section 11 states that if a banking company is incorporated outside India, then the total value of
its paid-up capital should be more than fifteen lakhs and if it has a place of business in Calcutta
or Bombay or both, then it should be more than twenty lakhs.

The banking company must deposit twenty percent of its profit for the year. If the company is
incorporated in India and if it has branches in different states, then the paid-up capital is five
lakhs of rupees, and if the place of business is situated in the city of Bombay or Calcutta or both,
then ten lakhs of rupees must be the minimum paid-up capital. If the company has all its
branches in the same state none of which is situated in the city of Bombay or Calcutta, then the
paid-up capital must be one lakh rupees concerning its principal place of business, plus ten
thousand rupees in respect of each of its other branches situated in the same district in which it
has its principal place of business, plus twenty-five thousand rupees in respect of each branch
situated elsewhere in the state otherwise than in the same district.

The subscribed capital of the company should not be less than one-half of the authorized capital,
and the paid-up capital should not be less than one-half of the subscribed capital. The banking
company cannot create any charge on unpaid capital. The company shall transfer every year at
least twenty percent of its profits to the Reserve Fund. The banking company must inform RBI
of the appropriation of the Reserve Fund within twenty-one days from the date of appropriation.
Limitations on nature of subsidiary companies

A banking company should not form a subsidiary company unless the formed company is for an
undertaking of a business or written permission was obtained from the Reserve Bank of India.
The banking company can hold shares of an amount of more than thirty percent of the paid-up
share capital of the company or its own paid-up capital.

Licensing of banking companies

No banking company can conduct business in India unless it has obtained a license from the
RBI. RBI can hold the inspection of books before granting the license. RBI can also cancel the
license if the company stops carrying on banking business in India.

Opening of new and transfer of existing branches

Every banking company must obtain the permission of RBI before opening a new branch or
transferring the existing branch to a different city, town, or state. No banking company
incorporated in India shall open a new branch outside India without the prior permission of RBI.
However, a new branch can be opened for a temporary period not exceeding one month.

Accounts and balance-sheet

The banking companies shall prepare a balance sheet and profit and loss account on the last
working day.

Inspection

RBI can cause the inspection of the banking company and must state its report to the company.
The directors of the banking company must submit all books, accounts, or documents for
inspection.

Power of RBI to issue directions

RBI may frequently issue directions to the banking company if it is satisfied that the directions
are in the interest of the public or to prevent the banking company from detrimentally conducting
business.

Restriction of certain activities by the banking company

The banking company cannot prevent any person from entering its place of business. It cannot
hold anything violent in the place of business. The banking is liable under Section 36AD for
violation of the above-mentioned activities.
Powers and functions of RBI

Section 36 mentions the powers of RBI. The Reserve Bank may prohibit banking companies
from entering into a particular transaction and can advise the banking company. It can also assist
the banking company by granting loans or advances under Section 18. It can direct the banking
company to call for a meeting of its directors to discuss the matters of the company. It can also
appoint officers to observe how the affairs of the banking company are conducted.

Suspension of business

If the banking company for a temporary period is unable to meet its obligation, it can apply for a
moratorium to the High court. The High court can grant the moratorium and stop the proceedings
for a temporary period as it deems proper. The period of the moratorium shall not exceed six
months. The banking company is only considered valid if it has attached the report of the RBI
stating that the banking company will be able to pay its debts if the application is granted.

Acquisition of the undertakings of banking companies

The undertaking of banking companies must be done by the Central Government after consulting
with the Reserve Bank of India. The undertaking must be done only after the banking companies
have been provided with an opportunity to show cause.

Payment of dividends

The banking companies should only pay dividends after all the capital expenses are paid up. It
shall not pay the dividends until the depreciation in the value of investments in approved
securities or investments in shares, debentures, or bonds are written off.

Reserve fund

Every banking company must form a reserve fund and must transfer at least twenty percent of its
profit to the reserve fund. Each banking company must report to the Reserve Bank if it has
appropriated any funds from the reserve fund.

Power of Central Government in respect of liquidation of companies

The Central Government may order the RBI to initiate insolvency proceedings if the banking
companies have committed a default under the Insolvency and Bankruptcy Code, 2016.

Offences and punishment under the Banking Regulation Act, 1949

Various provisions are mentioned in the Act which states that a person will be liable to
imprisonment and fine if he does any act which is in contravention with the Act. It is stated under
Section 46 as below:
  A person will be liable for imprisonment of up to three years and a fine which may
extend up to one crore rupees if he has misrepresented any facts or presented the wrong
acts intentionally.

 A person will be liable to a fine of up to twenty lakh rupees and up to fifty thousand
rupees in case of a continuing offence if he fails to produce the documents or books or
refuses to answer the questions asked by the inspection officer.

 All the directors of the banking company will be held liable and will be imposed a fine of
twice the amount of the deposits made with the banking company if the banking company
has illegally received any deposit.

 The directors or the secretary will be punished if the company has caused a default, or the
default occurred due to the negligence of the director.

Shortcomings of the Banking Regulation Act, 1949

The Banking Regulation Act has less scope on public sector banks. The amendments in the Act
are not enough to leverage the stressed assets in the financial system. There are no strict
provisions for non-performing assets (NPA), and this gives a chance to the defaulters to escape
from the situation. Some provisions of this act can hamper the working of the banks.

Amendments to the Banking Regulation Act, 1949

Banking Laws (Application to Co-operative Societies) Act, 1965

Initially, the Banking Regulation Act was passed as Banking Companies Act, 1949. But with the
introduction of the Banking Laws (Application to Co-operative Societies) Act, the word
Companies was omitted, and the word Regulation was added to the title of the Banking
Regulation Act, 1949. The Act also added a new Section called Section 56 as Part V after Part IV
in the Banking Regulation Act. This section will apply to co-operative societies subjected to
some modifications.

Banking Regulation (Amendment) Act, 2020 (Act 39 of 2020)

This Act came into force on September 29, 2020. The Banking Regulation Act will not be
applied to a cooperative society whose main business is providing long-term financial support
for agricultural development. The amendment also mentioned that societies should not use the
words ‘bank,’ ‘banker,’ or ‘banking’ in their name or connection with their business. A
cooperative bank may issue equity shares, preference shares, or special shares on face value or at
a premium to its members or to any other person residing within its area of operation after
obtaining prior approval from the Reserve Bank of India.

After the amendment, RBI may suspend the Board of Directors of a multi-cooperative bank for
five years to protect the depositors. This amendment omitted some provisions like granting of
unsecured loans or advances to its directors, and to private companies where the bank’s directors
or chairman is an interested party, opening a new place of business, or changing the location of
the cooperative bank outside of the city, town, or village in which it is currently located without
permission from RBI, etc.

Conclusion

All the banking companies will be controlled under the Banking Regulation Act, 1949. This Act
provides a proper structure to the banking system in India. The Act puts restrictions on the banks
to avoid fraud and protect the interests of the depositors. It also states the procedure for winding
up the banking company. The Act also states the acquisitions and mergers of the banking
companies. Thus, this Act led to the proper growth of the banking companies which were lacking
before 1949.

Frequently Asked Questions (FAQs)

What is the role of the RBI under the Banking Regulation Act of 1949?

RBI performs the roles of the supervisor, regulator, and controller. RBI issues licenses to banks,
conducts inspections of the banking companies, lays down instructions for audits, controls
mergers and liquidation, and regulates the operation of banks.

What is meant by approved securities under the Banking Regulation Act?

Approved securities mean securities in which a trustee may invest money. It also means
securities issued by the Central Government or any State Government or such other securities.

Who is entrusted with the power to lay down instructions to the banks in India for audits?

The Banking Regulation Act has given the Reserve Bank of India the power to lay down
instructions to the banks in India for audits. RBI, under Section 30 of the Act, can direct them to
perform a special audit of the company’s accounts if it is for the greater good of the public.

Can a foreign bank sanction loan or advance to firms and companies in India when one of
the directors, whether a foreign or an Indian national, on the foreign bank’s Board of
Directors abroad has an interest in said firms or companies in India or are on the Board of
such companies?

Foreign banks can grant loans or advances to companies in India under Section 20 of the
Banking Regulation Act. They can grant loans to companies if the director of the foreign bank
has some personal stake in the company if the company is a subsidiary of the company in which
the director is interested.