Regulatory framework

Key policies

What are the principal governmental and regulatory policies that govern the banking sector?

  • The Reserve Bank of India Act 1934 (RBI Act) and the Banking Regulation Act 1949 (BR Act) are the primary legislation governing the Indian banking sector;
  • the RBI Act constitutes the Reserve Bank of India (RBI), which is the central bank of India and the primary regulating authority for the banking sector. To implement regulatory policies in India, the RBI Act and the BR Act empower the RBI to issue rules, regulations, directions and guidelines on a wide range of issues relating to the banking and the financial sector; and
  • transactions related to foreign exchange, current and capital account transactions are also regulated by the RBI by virtue of the powers granted to it under the Foreign Exchange Management Act 1999 (FEMA).
Regulated institutions

What are the defining characteristics of a bank to be caught by the banking laws and regulations? Is non-bank fintech regulated differently?

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Do the rules vary depending on the size or complexity of the banking institution?

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Primary and secondary legislation

Summarise the primary statutes and regulations that govern the banking industry.

Banks in India can be broadly categorised in two categories: commercial banks and cooperative banks.

Commercial banks include:

  • government-owned banks or public-sector banks (PSBs), private banks, branches or subsidiaries of foreign banks and small finance banks (scheduled commercial banks). They are authorised by the RBI to perform all banking functions; and
  • commercial banks also include regional rural banks, which provide credit facilities for agricultural purposes to rural areas.

 

Cooperative banks are divided into two categories:

  • urban cooperative banks; and
  • state cooperative banks that provide financing services to small borrowers.

 

The RBI has recently introduced payments banks to provide basic banking and remittance related facilities and accept small deposits.

Since there are different categories of banks set up for different purposes, there are various statutes and regulations made under these statutes that govern and regulate banks set up for specific purposes, as set out below.

 The RBI Act
  • The RBI Act was enacted to constitute the RBI. The RBI’s primary objectives are to regulate the issue of bank notes, keep reserves to ensure stability in the monetary system and operate the nation’s currency and credit system effectively. The main provisions of the RBI Act are:
    • the granting of powers to the Central Board of the RBI for superintendence and directions of the affairs and business of the RBI;
    • the functioning of the RBI, which includes accepting deposits from Indian central and state governments, providing advances to Indian central and state governments, issuing currency, the purchase and sale of foreign exchange and banker to other banks, etc;
    • developing policies for the credit control function; and
    • supervisory functions such as issuing directions and imposing penalties for violation of provisions of the RBI Act.
 The BR Act

The BR Act was enacted to consolidate and amend the laws relating to banking in India. This Act lays down how the banks in India should conduct their business (eg, the type of business they can engage in, the eligibility requirements for a person to be appointed on the board of a bank, the amount of minimum and paid-up capital and reserves a bank should have, the type of subsidiary companies they can incorporate, etc).

The Act also empowers the RBI to have control over the management of a bank.

The BR Act also deals with suspending the business of a bank, winding up and speedy disposal of winding-up proceedings of banks.

 FEMA

FEMA was enacted to consolidate and amend the laws relating to foreign exchange. The main objective of FEMA is to facilitate external trade and payments and promote development of foreign exchange market in India.

FEMA also deals with regulation and management of foreign exchange by regulating which entities can deal, hold and transact in foreign exchange. For this purpose, the Act designates the RBI to authorise any person to act an authorised dealer, money changer or an offshore banking unit.

Further, FEMA lays down contraventions and the penalties that can be imposed for violating its provisions.

 Other

The other key statutes and schemes include:

  • the Negotiable Instruments Act 1881 (NIA Act) relates to promissory notes, bills of exchange and cheques, etc;
  • the Recovery of Debts and Bankruptcy, Insolvency Resolution and Bankruptcy of Individuals and Partnership Firms Act 1993 (RDBB Act) provides for the recovery of debts that are due to banks and other financial institutions and the establishment of tribunals and an appellate tribunal for efficient adjudication of disputes;
  • the Bankers Books Evidence Act 1891 (BBE Act) defines banker’s book to include ledgers, day-books, cash-books, account-books and all other records used in the ordinary business of a bank, and lays down the conditions required to be fulfilled when banker’s books are to be admitted as material evidence before any adjudicating authority;
  • the Payment and Settlement Systems Act 2007 (PSS Act) provides for the supervision and regulation of payment systems in India and the RBI is authorised under this Act to constitute the Board for Regulation and Supervision of Payment and Settlement Systems;
  • the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFESI) expedites the recovery of non-performing assets by banks and financial institutions. Under SARFAESI, attached assets can be managed by the bank or put up for sale or auction without the intervention of a court; and
  • the Banking Ombudsman Scheme 2006.

 

Besides the aforementioned statutory laws, the RBI issues directions, prudential regulations, master circulars, master directions and other guidelines and instructions from time to time for effective regulation in the banking sector.

Regulatory authorities

Which regulatory authorities are primarily responsible for overseeing banks?

The RBI is the supervising authority responsible for overseeing the operations and management of the Indian banking sector.

Government deposit insurance

Describe the extent to which deposits are insured by the government. Describe the extent to which the government has taken an ownership interest in the banking sector and intends to maintain, increase or decrease that interest.

Deposit Insurance and Credit Guarantee Corporation Act 1961 (Corporation Act) was enacted to establish the Deposit Insurance and Credit Guarantee Corporation (DICGC). The DICGC insures all deposits of commercial banks, including branches of foreign banks functioning in India, local area banks and regional rural banks.

Specifically, the DICGC insures all deposits such as savings, fixed, current, recurring, etc, but does not insures deposits of foreign governments, deposits of central or state governments, inter-bank deposits, deposits of the state land development banks with the state cooperative banks, any amount due on account of and deposit received outside India and any amount that has been specifically exempted by the DICGC with the previous approval of the RBI.

The liability of DICGC in respect of the deposits insured is to the extent of 100,000 rupees. This insured amount is for both, the principal and the interest amount held by the depositor.

Regarding the role of government ownership in the banking sector, PSB’s are banks in India where the majority stake (more than 50 per cent) is held by Indian government. There were 14 private banks that were commercialised in 1969, while another six were nationalised in 1980. The Indian government has been working towards consolidation of PSBs for the past couple of years, and those efforts continue.

Transactions between affiliates

Which legal and regulatory limitations apply to transactions between a bank and its affiliates? What constitutes an ‘affiliate’ for this purpose? Briefly describe the range of permissible and prohibited activities for financial institutions and whether there have been any changes to how those activities are classified.

The term ‘affiliate’ has not been defined under any banking statutes. However, the Master Circular on Para-Banking Activities of 1 July 2015 (Para-banking Circular) defines ‘subsidiary’ as an enterprise controlled by another enterprise known as the ‘parent’. Provisions of the BR Act and Para-banking Circular in relation to subsidiaries of banks are discussed below.

As per the BR Act, banks can form subsidiaries after prior approval of the RBI. The banks may form the subsidiaries to undertake certain business activities which a bank is allowed to undertake as per the provisions of the BR Act. These subsidiaries are also permitted to carry on the business of banking exclusively outside India. Among other things, activities which subsidiaries of banks can undertake include acting as agents of the government, contracting for public and private loans, carrying on and transacting every kind of guarantee and indemnity, undertaking and executing trusts.

The Para-banking Circular also puts investment ceilings on the banks when investing in subsidiaries and other companies. Under the provisions of the BR Act, a banking company cannot hold shares in any company whether as pledgee, mortgagee or absolute owner of an amount exceeding 30 per cent of the paid-up share capital of that company or 30 per cent of its own paid-up share capital and reserves, whichever is lesser. There are various other prudential regulations for banks’ investments in subsidiaries and financial services companies such as the ceiling on equity investment in a subsidiary.

In relation to financial activities that are prohibited under the BR Act, section 8 of the BR Act prohibits any banking company from directly or indirectly dealing in the buying and selling, or bartering of goods, except when it is in connection with the realisation of security given to the bank, or being held by it. The banking companies cannot engage in any trade, or buy, sell or barter any goods for any transaction otherwise than in connection with bills of exchange received for collection or negotiation.

Regulatory challenges

What are the principal regulatory challenges facing the banking industry?

The principal regulatory challenges facing the banking industry in recent times are as follows:

  • slow resolution of stressed assets: With the introduction of the Insolvency and Bankruptcy Code 2016 (Code) it was expected that nonperforming accounts of banks would undergo speedier resolution. This remains work in progress with significant work underway;
  • fraud and lack of corporate governance standards: There have been a couple of large frauds that have taken place in the past financial year in the Indian financial sector. This remains a case for concern; and
  • cybersecurity and cyber resilience: Since a large part of banking financial business is now, and will continue to be, technology driven, cybersecurity remains a challenge for banks.
Consumer protection

Are banks subject to consumer protection rules?

The main remedy available to customers of banks is the Banking Ombudsman Scheme (Ombudsman Scheme) launched by the RBI in 1995 to bring under its ambit the growing number of grievances of customers availing services of banks.

Further, the RBI in its Master Circular on Customer Service in Banks of 1 July 2015 (Customer Service Master Circular) has issued instructions to the banks in the matter of customer service. It lays down that banks must have a well-documented customer compensation policy that should be approved by the bank’s board, and should include aspects such as erroneous debits arising on fraudulent or other transactions, payment of interest for delays in collection, payment of interest for delay in issue of duplicate draft and other unauthorised actions of the bank leading to a financial loss to customer.

Banks must also have a well-documented customer grievance redressal policy for resolving complaints fairly and expeditiously regardless of the source of the complaints wherein a time frame is fixed for resolving the complaints received.

The Banking Codes and Standards Board of India (BCSBI) in collaboration with the Indian Banks’ Association has also evolved its Bank’s Commitment to Customers Code (BCSBI Code), wherein the members of BCSBI have to comply with minimum standards of banking practices. The BCSBI Code lays down the right to a grievance redressal mechanism and compensation and states the obligations of the bank while dealing with problems of the customers.

The above measures have been put in place because of increasing numbers of grievances relating to banking practices followed by banks.

Future changes

In what ways do you anticipate the legal and regulatory policy changing over the next few years?

Merger of public-sector banks

To improve corporate governance within banks, and to have banks that will have the ability to take on more risk and an increased ability to give credit, the Indian government is in the process of merging 10 public-sector banks to form four separate entities.

 Increased regulation of Non-Banking Financial Companies and Housing Finance Companies by the RBI

Owing to a large number of defaults by Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs), the RBI has now been given increased regulatory and supervisory powers over NBFCs, and the regulatory body of HFCs has changed from the National Housing Board to the RBI. This is to allow for stronger RBI powers over NBFCs and HFCs to prevent any further defaults.

 Regulatory sandbox

Fintech is emerging as one of the major sources of providing services in the financial sector. However, it possesses no specific regulations to deal with innovations and the risks these innovations may pose to the financial system and its customers. In order to address these issues, in 2019, the RBI introduced a framework for the creation of a regulatory sandbox. The introduction of the regulatory sandbox is expected to allow the RBI to understand first-hand the risks and benefits of new fintech in India, and also allow areas such as microfinance, innovative small savings and micro-insurance products, remittances, mobile banking and other digital payments to expand and grow.

 Resolution of stressed assets

The Indian government, with the help of the RBI and the Insolvency and Bankruptcy Board of India, has been proactive in the amendment of the Code to address the issue of stressed assets plaguing banks in India.

Law stated date

Correct on

Give the date on which the information above is accurate.

February 2020.