prof. O.V. Nandimath

1. Indian banking sector – its evolution &
development
PART III

2. • 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

3. The beginning of Indian „modern banking‟
• Bank of Hindustan in 1770 [when
Alexander & Co., agency house started]
• The Bank of Calcutta [ established by East
India Company in 1806]
• The break-through in 1860 – introduction
of limited liability to banks

4. The interim period of 1906 to 1913
• The influence of „swadeshi movement‟ –
the following banks were started
–
–
–
–
–
Peoples Bank of India Ltd.,
The Bank of India Ltd.,
The Central Bank of India Ltd.,
Indian Bank Ltd.,
The Bank of Baroda Ltd.,
• The period ended with the crash of 191317 overtaking these initiatives

5. Establishment of Imperial Bank
• Three presidency banks of Calcutta,
Bombay and Madras were merged into
Imperial Bank
• Vide the Imperial Bank of India Act, 1920
• The same became State Bank of India
later

6. Establishment of Reserve Bank of India
• It was given the right of note issue
• Was also to act as „bankers bank‟ – the
function which it took-over from Imperial
Bank
• However, Imperial Bank was allowed to
operate as the agent of RBI, especially in
those places where RBI had no branches
• Initially RBI was a shareholder‟s bank – but
was nationalized in 1948

7. Establishment of State Bank of India
• Vide State Bank of India Act, 1955 [which
overtook Imperial Bank]
– The bank which commands approximately 25% of
total banking sector business
– With highest bank network in India

8. SBI Subsidiaries
• SBI (Subsidiary Banks) Act, 1959
–
–
–
–
–
–
–
The Bank of Bikaner
The Bank of Indore
The Bank of Jaipur
The Bank of Mysore
The Bank of Patiala
The Bank of Travancore
The Bank of Hyderabad

9. The banking scenario @ 60s
• Overall mismanagement of banks
• Major chunk of advances to
– Large;
– Medium; and
– Big industrial houses only
• Uncovered priority sectors like
– Small scale industries;
– Agriculture;
– Exports etc.,

10. The banking scenario @ 60s
• Composition of bank management
– Industrialist directors
– Conflicting interests with their ventures
– Indiscriminate lending to their „own‟ industrial
establishments

11. The immediate response
• Introduction of „social control‟
• Approach
– Establishment of National Credit Council (NCC)
– Legislative Control through amendment to the
Banking Regulation Act, 1949

12. Professional banking board
• Sec. 10A
• At least 51% of directors shall be possessing
„special knowledge, practical experience‟ in
–
–
–
–
–
–
–
–
–
Accountancy;
Agriculture & rural economy;
Banking;
Cooperation;
Economics;
Finance;
Law;
Small Scale Industry
Any other matter (in the opinion of RBI useful)

13. Further
“provided that, out of aforesaid number of
directors, not less than two shall be persons
having special knowledge or practical
experience in respect of agriculture and
rural economy, cooperation or small-scale
industry”

14. Other mandates
• Directors shall not have substantial interest
– In any other company, except S.25 company
– Any firm (carrying trade, commerce or industry, except
small scale industry)
• Restriction on tenure
– For continues period of eight years (not applicable to
Chairman)
– Not to be re-elected for four years – if he is removed
from his office as „chairman‟ or „whole-time director‟

15. Mandate of „whole time chairman‟
• S.10B – the objective was to curb
industrialist‟s encroachment over bank
management
• There shall be „whole-time‟ chairman or
„managing director‟ to manage the bank
• He shall have special knowledge & practical
experience in any of the following
–
–
–
–
Working of the bank
Finance
Economics
Business administration

16. Restriction on loans
• S.20 – no loans or advances on the security
of banks own shares
• No loan or advance, to
– Any of its directors;
– Any firm; or
– Any company (except its own subsidiary or S.25
company); or
– Any individual
– Provided the director is interested in such entity as
partner, manager, employee or guarantor etc.,

17. Miscellaneous
• Additional powers were conferred on RBI
– to supervise and enforce „social
control‟ initiative
• Punishment provided for
– Obstructing any person from entering or leaving a
bank;
– Holding demonstrations within the bank; and
– Acting to undermine the depositors‟ confidence in
a bank

18. Era of nationalization starts
• July 19, 1969 – 14 major banks
nationalized
• 1980 – 6 more banks were nationalized
• Nationalization was perceived as a major
step in achieving the socialistic pattern of
society

19. Modalities of nationalization
• The official point
– “public ownership of major banks will help most
effectively the mobilization and development of
national resources and its utilization for productive
purposes in accordance with the plans and priorities”
• The preamble [of the first ordinance, 1969]
– “in order to serve better the needs of development of
the economy in conformity with the national policy and
objectives”

20. Criticism levied against nationalization
• 168 days [from 1.2.69 to 19.7.69] are too
short period to declare „social control‟
did not work
– From June 1968 to March 1968 credit to
• Agriculture increased from Rs.30 crores to Rs.97 crores;
• Small scale industries from Rs.167 crores to Rs.222
crores
• The step was determined by political
tussles and was result of inter-party
struggle

21. Criticism levied against nationalization
• The banking industry is not nationalized in
some of socialistic countries (ex. Norway,
Sweden, Finland and Denmark etc.,)
• Public control would leave the door open
for corruption and favoritism
• Because of lack of competition the
„quality of banking‟ service will diminish
gradually

22. Legal mode
• Saturday, July 19, 1969 – Banking
Companies (Acquisition and Transfer of
Undertaking) Ordinance, 1969 was
passed
– 14 major banks (with deposit of Rs.50 crores or
more) were purported to be transferred to 14 new
body corporate viz. „corresponding new banks‟
– The machinery of management
– Compensation package for shareholders

23. Legal mode
• Monday, July 21, 1969 – Ordinance was
challenged before SC
• Before it was heard (on August 9, 1969) –
Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1969 was
passed (which repealed the ordinance)
• The act was also challenged in the SC –
interim injunction was granted against
the operation of the Act

24. Legal mode
• Decision on February 10, 1970
– 10:1 decision by majority
• The act is within the legislative competence;
but void due to the following reasons
– Only restricted 14 banks were selected – this a „hostile
discrimination‟;
– Although these 14 were allowed to do other business –
sans assets, staff, premises and even names that was
not possible hence – unreasonable restriction
– The principle of determination of compensation was
illusory and irrelevant

25. Post SC decision
• February 14, 1970 – Another Ordinance
promulgated
• This was followed by the Banking Companies
(Acquisition and Transfer of Undertakings)
Act, 1970
• March 31, 1970 – The Act receives President‟s
assent
• Most of provisions were deemed to have
come into force from July 19, 1969
• The enactment stood the test of
constitutionality

26. “the branch network which was 8262 in
June 1969 expanded to 60000 by 1992 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 30% and advances to 25% of
the GDP…”

27. “…deposits grew from a figure of Rs.4669
crores in June 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…”

28. Era of nationalization ends
• With the recommendations of
Narasimaham Committee being
accepted by the Government
• Which also started the entry of foreign
banks on Indian soil

29. What were the recommendations?
• 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
(not to be divided between RBI and
Department of Banking)
• SLR and CRR should be reduced to prudent
levels

30. What were the recommendations?
• Concessional lending to be phased out
• The capital base of banks should meet
international standards
• The appointment of the Chief Executive
of the banks to be de-politized

31. Bank regulation

32. Why regulate bank?
“the business of banking is fraught with
dangers, arising principally from the instability
in the world economy and from human error or
misjudgment. Like any other enterprise, a bank
may be overtaken by events or may be
governed unwisely. Bank failures are, therefore
no novelty. It is interesting that Bank of
England itself faced serious financial problems
within two years of its foundation in 1964”
- Sir John Clapham, The Bank of England – A
History, CUP, 1994

33. „standing‟ & „stability‟
“two matters have to be consistently watched in
order to avoid disruption to the system. The first
may be loosely described as the general standing
of institutions carrying on banking business. One
way of achieving this object is to enact laws that
regulate banking transactions. The other is to
impose restrictions on the free entry of firms into the
mail line of banking business. The second matter
that needs to be regulated is the stability of
individual banks. This involves the introduction of
measures to ensure that banks are able to meet
their liabilities” – Elinger‟s Modern Banking, 4th Edn.

34. Recent past
• Crash of world economy of 1929-33
(interim periods of world war)
• Banking crises of UK during 1973-76
– „life boat operation‟
– Similar crises in Germany
• Recent „melt-down‟

35. Few other points
•
•
•
•
•
Systemic risk
Prevention of fraud
Money laundering & terrorism
Consumer protection
Competitive (or antitrust) policy

36. Banking regulation in India

37. Banking
• „Banking‟ means the accepting, for the
purpose of lending or investment, of
deposits of money from the public,
repayable on demand or otherwise, and
withdrawal by cheque, draft, order or
otherwise – S. 2(b)

38. Essential functions
• Acceptance of public deposits
• Lending or investment or such deposits;
and
• Agency functions

39. Permissible banking business
• Sec. 6(1)
• About 15 elements
–
–
–
–
–
–
–
–
Borrowing, raising or taking up money;
Lending – with or without security;
Issuance of letters of credit, travelers cheques
Dealing in bullion and specie
Dealing in stocks and shares
Underwriting
Providing of safe deposit vaults
Collecting and transmitting of money and securities

40. – Acting as agents of the government
– Transact any kinds of guarantee and indemnity
business
– Undertake and execute trusts
– Acquire, construct and maintain any building for its
own purpose
– Do all such things which are incidental or conducive to
the promotion or advancement of the business of the
company
– Do any other business specified by the Central
Government as the lawful business of banking
company

41. • Further – Sec. 8 – prohibits specifically a
banking company from engaging
directly or indirectly in trading activities
and undertaking trading risks

42. Organization
• Dual control
– For entry
– For expansion

43. Entry license
• Sec. 22
• Criteria
– The capacity of the company to pay its present and
future depositors
– Whether there is anything to indicate – the permit
would affect the interests of the depositors
detrimentally
– Impact upon the public interest
– Company‟s capital structure and its adequacy
– Other „banking facilities‟ available in the proposed area
– Such other condition which RBI considers relevant

44. • Additional conditions for foreign banks
– Whether carrying of business by the company in
India will be in pubic interest
– 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; and
– Whether the company complies with the
provisions of the BR Act as applicable to foreign
companies

45. • The grant of license is a discretionary
administrative function – Shivabhai v RBI,
AIR 1986 Guj. 19
• Licence granted may be cancelled –
Sec. 22(4)

46. Expansion
• To open new branches – RBI sanction is
mandatory
• Sec. 23
• While grant of such licences RBI may
impose appropriate conditions
• There are exceptions

47. Capital & reserves
• Sec. 12(1)
– Subscribed capital of a banking company shall not
be less than half of its authorized capital;
– Paid up capital shall not be less than half of its
subscribed capital
– If the capital structure is changed then these
proportions shall also be changed, with in two
years

48. Capital composition
• Narasimham Committee has
recommended for public issue
• Hence, the Banking Companies
(Acquisition and Transfer of Undertakings)
Act, 1970/1980 were amended
– To enable public to subscribe to the capital of the
nationalized banks up to 49% of their total capital
• The State Bank of India Act, 1955 was also
suitably amended to raise public funds

49. Restriction on voting rights
• No shareholder (of the nationalized bank)
other than the Central Government shall
be entitled to exercise voting rights in
respect of any shares held by him in
excess of one percent of the total voting
rights of all the shareholders of the
corresponding new bank (s. 12(2))
• The limit was raised from 1% to 10% with
effect from 31.3.1994

50. • S. 13
• A banking co. shall not pay out directly or
indirectly by way of commission,
brokerage, discount or remuneration in
any form in respect of shares issued by it.
• It restricts the amount that may be paid
by a banking company as commission
etc. on the issue of shares.

51. • S. 15
• Prohibits payment of dividend by any
banking co. until all of its capitalized
expenses have been completely written
off.
• It is inappropriate when capitalized
expenses are outstanding

52. Exceptions
• The depreciation in the value of its
investments in approved securities, where
such depreciation has not been capitalized
• The depreciation in the value of its
investments in share etc., where adequate
provision for depreciation has been made to
the satisfaction of the auditor
• The bad debts, where adequate provision
has been made to the satisfaction of the
auditor

53. Reserve funds
• Sec. 17
• Creation of reserve fund (not applicable
to foreign banks)
– To be created out of profit
– Not less than 20% of the profits have to be
transferred to the reserve fund (before any
dividend to be declared)
– However, the Central Government (on the
recommendation of RBI) may exempt the bank for
certain period of time

54. • For foreign banks – there is no mandate
• But the foreign banks
– Shall deposit with RBI – 20% of their profits each
year
– The amount may be in cash or unencumbered
approved securities

55. Cash reserves
• Sec. 42 (RBI Act) – cash reserve to be
maintained by the Scheduled Bank (as to
be determined by RBI from time to time)
• Sec. 18 – (for non scheduled banks) at
least 3% of its demand and time deposits
in India
• Non scheduled banks are required to
submit a monthly statement to the RBI

56. Maintenance of liquid assets
• Sec. 24 – mandatory maintenance of
liquid assets not less than 25% of the net
demand and time liabilities.
• Not exceeding 40% of its total demand
and time liabilities in cash, gold or
unencumbered approved securities
• RBI will prescribe details (Statutory liquidity
ratio)

57. Annual accounts & audit
• Sec. 29
• Mandate to prepare final accounts (at
the end of each financial year)
• The Balance Sheet and Profit & Loss
Account have to be prepared in
accordance with the formats prescribed
in III Schedule

58. Audit & auditors
• Sec. 30
• The Balance Sheet and Profit & Loss
Accounts have to be audited
– Audit by a person duly qualified to audit
– The appointment, reappointment or removal of an
auditor – to be done with the prior approval of the
RBI

59. The audit report
• Sec. 227 of Companies Act – (regarding the
powers, functions and duties) are all
applicable to Banking Companies as well
• Some additional information to be provided
– Whether or not transactions of the company as noticed
by him were within the powers of the company
– Whether or not returns from branches were adequate
for the audit
– Any other matter which the auditor considers
necessary to bring to the notice of the shareholders of
the company

60. Publication of final accounts
• Sec. 31 r/w Rule 15 [of Banking Regulation
(Companies) Rules, 1949
• Final accounts are to be published in a
news paper, within a period of six months
• Three copies of final accounts are to be
submitted to RBI (within 3 months)
• Sec. 220 of Companies Act – Final
accounts and auditors report to the
Registrar of Companies

61. Special audit
• Sec. 30(1B)
• The RBI may order for special audit
– Such order may relate to any transaction or class of
transactions; or
– Such period or periods as RBI may specify in the order
– The RBI appoints such auditor (or can ask the regular
auditor)
– The directors are binding upon the auditor of the
banking company – and to make report directly to RBI
by furnishing the copy to the bank)

62. • S.35 RBI‟s Powers of Inspection
• S.35A RBI‟s Powers to issue directions
a. in the public interest / banking policy
b. to prevent the affairs conducted in a
manner detrimental to the interest of the
depositors / prejudicial to the interests of
the banking co.
c. to secure proper management

63. Amalgamation
• Voluntary amalgamation
– U/sec. 44A

64. • Procedure
– Scheme has to be prepared & the same to be placed
before the shareholders (notice to all shareholders is
must)
– Seeking sanction from the shareholders with 2/3rd
majority
– Dissenting share holders may take out their share
value
– Then the scheme has to be presented to RBI
– On sanction of RBI the amalgamation may happen

65. Compulsory amalgamation
• Induced or forced by RBI
– U/Sec. 45
• RBI recommends to the Central
Government

66. Merger of bank and NBFC
• Amalgamations are governed by Ss. 391
to 394 of the Companies Act, 1956
• The scheme of amalgamation has to be
approved by the High Court
• June 2004 – Banks were advised to obtain
the approval of RBI after the scheme of
amalgamation is approved by its board
before it is submitted to the HC for
approval

67. Amalgamation by government
• Central Government may order for
amalgamation of two banks – after due
consultation with the RBI
– u/sec. 396 of Companies Act, 1956

68. Winding up
• Suspension of business and winding up
– Sec. 37
• Winding up by the High Court
– Sec. 38
• Voluntary Winding up
– Sec. 44

69. Suspension of business
• When the bank is temporarily unable to
meet its obligations
• Procedure
–
–
–
–
The bank to apply to HC u/s 37
The report of the RBI be enclosed
If not the court can take action, by calling the report
If satisfied the court can (with conditions) for all
proceedings to stay for fixed term not exceeding six
months
– On passing of the moratorium order, the court may
appoint a special officer to take custody and control of
the assets, books etc., of the bank

70. Winding up by the HC
• To be initiated by RBI – by applying for
winding up
– Inability to pay debts
– If RBI is asked by the Central Government to make an
application
– Failure to comply with requirements of Sec. 11
– If the bank becomes incapable of carrying out the
banking business – by rejection or cancellation of
license
– Failure to comply with the requirements of the BR Act
other than Sec. 11 and continuance of such failure
beyond the period specified by RBI in this behalf

71. • Additional grounds for RBI
– A compromise or arrangement sanctioned – can‟t be
worked satisfactorily with or without modification; or
– The returns, statements and information given by the
bank under the Act show that it can‟t pay its debts; or
– The continuance of the banking company is prejudicial
to the interest of the depositors
• Once applied by RBI – the court is bound to
allow the application [Palai Central Bank
Case, AIR 1962 SC 1371]

72. Voluntary winding up
• Not possible unless RBI certifies
• The HC during this stage intervene (i) by
itself; or (ii) by the application of RBI
– And may order for continuation of the business for
some time
– It may even supervise the winding up proceedings