In this article we will discuss about the Legal Provisions of Banking in India:- 1. Definition of Banking 2. Forms of Banking Business 3. Non-banking Assets 4. Management 5. Minimum Capital and Reserves 6. Floating Charge 7. Restrictions of Dividends 8. Statutory Reserve 9. Cash Reserves and Statutory Liquidity Reserve 10. Restrictions on Loans and Advances 11. Subsidiary Companies 12. Control.
- Definition of Banking
- Forms of Banking Business
- Non-banking Assets
- Minimum Capital and Reserves
- Floating Charge
- Restrictions of Dividends
- Statutory Reserve
- Cash Reserves and Statutory Liquidity Reserve
- Restrictions on Loans and Advances
- Subsidiary Companies
1. Definition of Banking:
The Banking Regulation Act, 1949 defines banking as “the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise.”
Till 1949, there was no special legislation to regulate banking companies but since that year the Banking Regulation Act applies to corporate entities carrying on the business of banking in India.
Such companies are also subject to the Companies Act, 1956. The nationalized banks are also subject to the Banking Regulation Act except in regard to appointment of directors and disposal of profit etc. But the Act is not applicable to a primary agricultural society, a cooperative land mortgage bank and any other cooperative society, except in the manner and to the extent specified in Part V of the Act.
2. Forms of Banking Business:
Section 6(1) of the Act lays down that in addition to the usual banking business, the following business may also be carried on by a banking company:—
(i) borrowing, raising or taking up of money;
(ii) lending or advancing of money;
(iii) drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundis, promissory notes and other instruments;
(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 on commission, underwriting and dealing in stock, shares, debentures, bonds etc.;
(vii) receiving of all kinds of scripts or valuables on deposit or for safe custody;
(viii) providing of safe deposit vaults;
(ix) collecting and transmitting of money and securities;
(x) acting as agents for any Government or local authority or any other person or persons; the carrying on of agency business of any description including the clearing and forwarding of goods, giving of receipts and discharges and otherwise acting as an attorney on behalf of customers, but excluding the business of a managing agent or secretary and treasures of a company;
(xi) contracting for public and private loans and negotiating and issuing the same;
(xii) effecting, insuring, guaranteeing, underwriting, participating in managing and carrying out of any issue, public or private, of State, municipal or other loans or of shares, stock, debentures, or debenture stock of any company, corporation or association and of lending of money for the purpose of any such issue;
(xiii) carrying on and transacting every kind of guarantee and indemnity business;
(xiv) managing, selling and realising any property which may come into the possession of the company in satisfaction or part satisfaction of any of its claims;
(xv) acquiring and holding and generally dealing with any property or any right title or interest in any such property which may form the security or part of the security for any loans or advances or which may be connected with any such security;
(xvi) undertaking and executing trusts;
(xvii) undertaking and administration of estates as executor, trustee or otherwise;
(xviii) establishing and supporting associations, funds, trusts, and conveniences for the benefit of employees, their dependents and the general public;
(xix) acquiring, constructing, maintaining and altering any building or works necessary for the purposes of the banking company;
(xx) selling, improving, managing, developing, exchanging, leasing, mortgaging, disposing of or turning into account or otherwise dealing with all or any part of the property and rights of the company;
(xxi) acquiring and undertaking the whole or any part of the business of any person or company when such business is of a nature enumerated or described in this sub-section;
(xxii) doing all such things as are incidental or conducive to the promotion or advancement of the business of the company;
(xxiii) any other form of business which the Central Government may notify in the Official Gazette.
Other types of business are prohibited for a banking company. No banking company can directly or indirectly deal in the buying or selling or bartering of goods, except in connection with the realisation of security given to or held by it, or engage in any trade or buy or sell or barter goods for others otherwise than in connection with bills of exchange.
Immovable property, except that required for its own use, however acquired, must be disposed of within seven years from the date of acquisition. However, the Reserve Bank may in any particular case extend the aforesaid period of seven years by such period not exceeding five years.
3. Non-banking Assets:
A bank cannot acquire certain assets but it can always lend against the security of such assets. This means that sometimes, in case of failure on the part of the loanee to repay the loans, the bank may have to take possession of such assets. In that case, the assets are shown as “non-banking assets”. These must be disposed of within seven years.
It may be noted that should the bank lend against such assets as are allowed to be held by a bank, say, government securities, it can continue to hold them if the loanee fails to meet his obligations. Such assets cannot be treated as non-banking assets.
A banking company must have a whole-time chairman appointed for five years at a time. He may become a director of a subsidiary of the banking company or of a guarantee company registered under section, 25 of the Companies Act but cannot take up any other appointment. The chairman is appointed by the Board of Directors but, in the case of nationalised banks, he is appointed by the Central Government.
At least 51% of the directors of a banking company must be such persons as have specialised knowledge, or practical experience, in respect of accountancy, agriculture, rural economy, banking, cooperation, economics, finance, law or any other matter which is approved by the Reserve Bank as useful to the banking company.
Directors must not be proprietors of any trading, commercial or industrial concerns (other than small industrial concerns) and also must not have substantial interest in, or be connected with (as employee or manager, etc.), any commercial company except a guarantee company incorporated under section 25 of the Companies Act and except a small-scale industrial concern.
The Reserve Bank of India has the power to order the removal of a director or the chairman.
5. Minimum Capital and Reserves:
Sections 11 lays down the following minimum limit of paid up capital and reserves:—
Banking companies carrying on business in India must see to it that—
(a) The subscribed capital is not less than half the authorised capital;
(b) The paid up capital is not less than half the subscribed capital; and
(c) The capital of the company consists only of ordinary or equity shares and such preference shares as may have been issued before July, 1,1944.
A shareholder cannot exercise more than one per cent of the total voting rights of the company. A chairman, managing director or chief executive of a banking company must declare his full holdings in the capital of the company.
Underwriting commission or brokerage or discount on shares issued by a banking company cannot exceed 2V°/o of the paid up value of the shares. A charge on unpaid capital cannot be created. No dividend can be declared unless expenses not represented by tangible assets have been completely written off.
6. Floating Charge:
Section 14A lays down that a banking company shall not create a floating charge on the undertaking or any property of the company or any part thereof except upon a certificate from the Reserve Bank that such a charge is not detrimental to the interests of the depositors of the company. A floating charge created without such a certificate is invalid. A charge on un-called capital is invalid.
7. Restrictions of Dividends:
Under section 15, a banking company cannot pay dividends unless all of its capitalised expenses (including preliminary expenses, organisation expenses, share selling commission, brokerage, amounts of losses incurred and any other item of expenditure not represented by tangible assets) have been completely written off.
But a banking company need not:
(a) Write off depreciation in the value of its investments in approved securities (except in ‘current’ investments) in any case where such depreciation has not actually been capitalised or otherwise accounted for as a loss ;
(b) Write off depreciation in the value of its investments in shares, debentures or bonds (other than approved securities) in any case where adequate provision for such depreciation has been made to the satisfaction of the auditor;
(c) Write off bad debts in any case where adequate provision for such debts has been made to the satisfaction of the auditors of the banking company.
8. Statutory Reserve:
Section 17 of the Act lays down that at least 20 per cent of the profits prior to declaration of dividend must be transferred to the Reserve Fund. The Reserve Fund thus built up has to be shown separately from other reserves.
The Central Government may, on the recommendation of the Reserve Bank and having regard to the adequacy of the paid up capital and reserves of the bank in relation to its deposit liabilities, exempt the bank for a period of time from the obligation of transfer of profits to the Reserve Fund.
But the Central Government shall not pass such an order unless the amount in the statutory reserve fund together with the amount in the securities premium account is at least equal to the paid-up capital of the bank.
9. Cash Reserves and Statutory Liquidity Reserve:
Section 18 of the Banking Regulation Act requires that every banking company, not being a scheduled bank, shall maintain in India by way of cash reserve with itself, or by way of balance in a current account with the Reserve Bank, or by way of net balance in current accounts, or in one or more of the aforesaid ways, a sum equivalent to at least three per cent of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight.
Every scheduled Bank is required, by virtue of the provisions of section 42(1) of the Reserve Bank of India Act, to maintain with the Reserve Bank an average daily balance the amount of which shall not be less than three per cent of the total of its demand and time liabilities in India.
The said rate may, however, be increased by the Reserve Bank of India by notification up to 15% of the total of demand and time liabilities in India.
Section 24 of the Banking Regulation Act requires that every banking company shall maintain in India in cash, gold or unencumbered approved securities an amount which shall not, at the close of business on any day, be less than thirty five per cent, or such other percentage not exceeding forty, as the Reserve Bank of India may from time to time specify, of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight. This is known as Statutorily Liquidity Ratio (SLR).
The Term ‘demand liabilities’ means liabilities which must be met on demand. The term ‘liabilities’ means liabilities which are not demand liabilities.
10. Restrictions on Loans and Advances:
After the amendment of the law in 1968, a bank cannot:
(i) Grant loans or advances on the security of its own shares; and
(ii) Grant or agree to grant loan or advance to or on behalf of: (a) any of its directors; (b) any firm in which any of its directors is interested as partner, manager or guarantor; (c) any company of which any of its directors is a director, manager, employee guarantor or in which he holds substantial interest; or (d) any individual in respect of whom any of its directors is a partner or guarantor.
(ii) (c) does not apply to subsidiaries of the banking company, registered under section 25 of the Companies Act or a government company.
11. Subsidiary Companies:
A banking company is allowed to form a subsidiary company (a) only for the purpose of undertaking of any business laid down in section 6 (1) of the Banking Regulation Act, 1949; or (b) with the written permission of the Reserve Bank to carry on the banking business exclusively outside India, or (c) to undertake such other business which the Reserve Bank may, with the prior approval of the Central Government, consider conducive to the spread of banking in India or useful or necessary in the public interest.
The Reserve Bank of India has the authority to exercise general supervision of banks. A bank has to obtain the prior permission of the Reserve Bank for opening a new place of business or for transfer of an existing place of business either in India or abroad. The Reserve Bank is authorised to determine the policy in relation to advances to be followed by banks.
For example, it may give direction to banks regarding the purposes for which advances may or may not be made. It may lay down the margins to be maintained in respect of secured advances. It may prescribe the maximum amount of advances that may be made to any one company, firm or an individual.
It may determine the rate of interest and other conditions on which advances or other financial accommodation may be made or guarantees may be given.