3. legal and regulatory aspects of banking iibf2nd edition

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3. legal and regulatory aspects of banking iibf2nd edition

  1. 1. LEGAL AND REGULATORY ASPECTS OF BANKING 2nd Edition INDIAN INSTITUTE OF BANKING & FINANCE MACMILLAN 'THE ARCADE', WORLD TRADE CENTRE, CUFFE PARADE MUMBAI400005 Established on 30th April 1928 MISSION • To develop professionally qualified and competent bankers and financial professionals primarily through a process of education, training, examination, consultancy/counselling and continuing professional development programs. VISION • To be the premier Institute for developing and nurturing competent professionals in banking and finance field. OBJECTIVES • To facilitate study of theory and practice of banking and finance. • To test and certify attainment of competence in the profession of banking and finance. • To collect, analyse and provide information needed by professionals in banking and finance. • To promote continuous professional development. • To promote and undertake research relating to Operations, Products, Instruments, Processes, etc., in banking and finance and to encourage innovation and creativity among finance professionals so that they could face competition and succeed. COMMITTED TO PROFESSIONAL EXCELLENCE Website: www.iibf.org.in LEGAL & REGULATORY ASPECTS OF BANKING (For JAIIB/Diploma in Banking & Finance Examination) 2nd Edition Indian Institute of Banking & Finance MACMILLAN © INDIAN INSTITUTE OF BANKING & FINANCE, MUMBAI, 2005, 2008 (This book has been published by Indian Institute of Banking & Finance. Permission of the Institute is essential for reproduction of any portion of this book. The views expressed herein are not necessarily the views of the Institute.) All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. J-'im t'tlitiim. 2005 Second edition, 2008 Reprinted, 2008 2009 (twice) MACMILLAN PUBLISHERS INDIA LIMITED Delhi Bangalore Chennai Kolkata Mumbai Ahmedabad Bhopal Chandigarh Coimbatore Cuttack Guwahati Hubli Hyderabad Jaipur Lucknow Madurai Nagpur Patna Pune Thiruvananthapuram Visakhapatnam Companies and representatives throughout the world ISBN 10:0230-63610-1 ISBN 13:978-0230-63610-1 Published by Rajiv Beri for Macmillan Publishers India Limited, 2/10 Ansari Road, Daryaganj, New Delhi 110 002 Printed by S.M. YOGAN at Macmillan India Press, Chennai 600 041. LEGAL & REGULATORY ASPECTS OF BANKING Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module B), P.R. Kulkarni (Module C), B. Gopalakrishnan (Module D) under the guidance of M.L. Chandak, Advocate, High Court, Mumbai. Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M. Ramamurthy, Legal Adviser, IDBI Ltd. (Modules B, C and D)
  2. 2. This book is meant for educational and learning purposes. The author(s) of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. Jn the event the author(s) has/have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. FOREWORD The world of banking and finance is changing very fast and banks are leveraging knowledge and technology in offering newer services to the customers. Banks and technology are evolving so rapidly that bank staff must continually seek new skills that enable them not only to respond to change, but also to build competence in handling various queries raised by customers. Therefore, there is a need for today's bank employees to keep themselves updated with a new set of skills and knowledge. The Institute, being the main provider of banking education, reviews the syllabus for its associate examinations viz. JAIIB/CAIIB and various other examinations with the help of Expert Groups from time to time to make the contents relevant and contemporary in nature. The latest revision has been done by an expert group under the Chairmanship of Prof. Y.K. Bhushan. This book and the other two books mentioned below are the courseware for JAIIB which aims to impart up-to-date knowledge in the field of banking and finance and equip the bankers to face the emerging challenges of today and tomorrow. As there is a growing demand for qualified manpower in the banking sector with accent on banking knowledge and skills, together with technology-familiarity, customer-orientation and hands-on application skills - which will substantially reduce the training intervention at the bank level before/immediately after they are employed - the institute has launched the Diploma in Banking & Finance in 2007 for graduation-plus level candidates. Candidates to the course will get extensive and detailed knowledge on banking & finance and details of banking operations. The Diploma is offered in the distance learning mode with a mix of educational support services like provision of study kits, contact classes, etc. The key features of the Diploma is that it aims at exposing students to real-life banking environment and that it is equivalent to JAIIB. The JAIIB and the Diploma in Banking & Finance has three papers viz. 1. Principles & Practices of Banking 2. Accounting & Finance for Bankers 3. Legal & Regulatory Aspects of Banking This book, the courseware for the third paper on Legal & Regulatory Aspects of Banking, deals with legal and regulatory aspects that have a bearing on banking operations, and are woven in to the units/chapters to make their relevance easily understandable. Banking and business laws insofar as they relate to day-to-day banking operations, have also been covered at appropriate places. Case laws are included, wherever appropriate. There are various newly enacted laws like Antimoney Laundering Act, Right to Information Act, Information Technology Act, etc., which have significantly changed the way banking operations are done, and these laws are explained in simple terms as needed to be understood by a practicing banker. The Institute had constituted teams consisting of eminent bankers and academicians to prepare the reading material for all the subjects as selfinstructional study kits obviating the need for the intervention of a teacher. This book represents the outcome of this endeavour to bring out self-contained comprehensive courseware/book on the subject. The Institute acknowledges with gratitude the valuable services rendered by the authors in preparing the
  3. 3. courseware in a short period of time. VI The team, who developed the book, has made all efforts to cover the entire syllabus prescribed for the subject. However, the candidates could still refer to a few standard textbooks to supplement this material which we are sure, will enhance the professional competence of the candidates to still a higher degree. We have no doubt that the study material will be found useful and will meet the needs of the candidates to prepare adequately for the examinations. In addition, we are sure that these books will also be useful to practitioners, academicians, and other interested readers. We welcome suggestions for improvement of the book. Mumbai 3-7-2008 R. Bhaskaran Chief Executive Officer RECOMMENDED READING The Institute has prepared comprehensive courseware in the form of study kits to facilitate preparation for the examination without intervention of the teacher. An attempt has been made to cover fully the syllabus prescribed for each module/subject and the presentation of topics may not always be in the same sequence as given in the syllabus. Candidates are also expected to take note of all the latest developments relating to the subject covered in the syllabus by referring to Financial Papers, Economic Journals, Latest Books and Publications in the subjects concerned. PAPER 3LEGAL&REGULATORY ASPECTS OF BANKING Objectives: The candidates would be able to acquire knowledge in: • The legal & regulatory framework of the banking system and • The various laws and enactments affecting day-to-day banking operations MODULE, A.-REGULATIONS &COMPLIANCE • The questions in this section will be with reference to legal issues and problems. A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking Companies [Acquisition and Transfer of Undertakings Act 1970 & 1980]. B. Government and RBIs Powers: Opening of New Banks and Branch Licensing Constitution of Board of Directors and their Rights Banks Shareholders and their Rights CRR/SLR Concepts Cash/Currency Management • Winding Up - Amalgamation and Mergers • Powers to Control Advances - Selective Credit Control - Monetary and Credit Policy • Audit and Inspection
  4. 4. • Supervision and Control-Board for Financial Supervision - Its Scope and Role • Disclosure of Accounts and Balance Sheets • Submission of Returns to RBI, etc. • Corporate Governance MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS • Case Laws on Responsibility of Paying/Collecting Banker • Indemnities/Guarantees - Scope and Application Obligations of a Banker Precautions and Rights • Laws Relating to Bill Finance, LC and Deferred Payments • Laws Relating to Securities • Valuation of Securities - Modes of Charging Securities - Lien, Pledge, Mortgage, Hypothecation, etc. • Registration of Firms/Companies • Creation of Charge and Satisfaction of Charge MODULE C - BANKING RELATED LAWS • Law of Limitation • Provisions of Bankers Book Evidence Act • Special Features of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 • TDS and Service Tax • Banking Cash Transaction Tax • Asset Reconstruction Companies • The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 • The Consumer Protection Act, 1986 • Banking Ombudsman 2006 • LokAdalats • Lender's Liability Act MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS • Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and Agency, etc.) • The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions, Conditions and Warranties, Express and Implied, Right of Unpaid Seller, etc.) • The Companies Act, 1956, Definition, Features of Company, Types of Companies, Memorandum, Articles of Association, Doctrines of Ultra Vires, Indoor Management and Constructive Notice, Membership of Company - Acquisition - Cessation, Rights and Duties of Members and Register of Members, Prospectus and Directors. • Indian Partnership Act, 1932, Definition and Types of Partnership, Relation of Partners to One Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of Partnership,
  5. 5. Dissolution of Firm, Effect of Non-Registration • The Transfer of Property Act • Foreign Exchange Management Act, 2000 • Prevention of Money Laundering Act, 2002 • Right to Information Act, 2005 • Information Technology Act, 2000 CONTENTS Foreword v MODULE A - REGULATIONS AND COMPLIANCE 1. Legal Framework of Regulation of Banks 3 2. Control Over Organisation of Banks 15 3. Regulation of Banking Business 31 4. Returns, Inspection, Winding Up 49 5. Public Sector Banks and Co-operative Banks 65 MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS 6. Case Laws on Responsibility of Paying Bank 83 7. Case Laws on Responsibility of Collecting Bank 93 8. Indemnities 101 9. Bank Guarantees 107 10. Letters of Credit 119 11. Deferred Payment Guarantee 131 12. Laws Relating to Bill Finance 135 13. Various Types of Securities 143 14. Law Relating to Securities and Modes of Charging -1 • 155 15. Law Relating to Securities and Modes of Charging - II 163 16. Different Types of Borrowers 173 17. Types of Credit Facilities 181 18. Secured and Unsecured Loans, Registration of Firms, Incorporation of Companies 187 19. Registration and Satisfaction of Charges 197 MODULE C - BANKING RELATED LAWS SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST, 2002 (SARFAESI ACT) 20. Introduction to SARFAESI Act, 2002 205 21. Definitions at SARFAESI Act, 2002 209 22. Regulation of Securitisation and Reconstruction of Financial Assets of Banks and Financial Institutions 219 xii 23. Enforcement of Security Interest 24. Central Registry 25. Offences and Penalties 26. Miscellaneous Provisions THE BANKING OMBUDSMAN SCHEME, 2006 27. Purpose, Extent, Definitions, Establishment and Powers 28. Procedure for Redressal of Grievances RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 (DRTACT) 29. Preliminary
  6. 6. 30. Establishment of Tribunal and Appellate Tribunal 31. Jurisdiction, Powers and Authority of Tribunals 32. Procedure of Tribunals 33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions THE BANKERS' BOOKS EVIDENCE ACT, 1891 34. The Bankers' Books Evidence Act, 1891 THE LEGAL SERVICES AUTHORITIES ACT, 1987 35. LokAdalats THE CONSUMER PROTECTION ACT, 1987 36. Preliminary, Extent and Definitions 37. Consumer Protection Councils 38. Consumer Disputes Redressal Agencies THE LAW OF LIMITATION 39. Limitations of Suits, Appeals and Applications TAX LAWS 40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service Tax 231 241 245 249 255 259 267 271 275 279 285 293 299 303 311 315 327 331 MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS 41. 42. 43. 44. 45. 46. 47. 48. Meaning and Essentials of a Contract Contracts of Indemnity Contracts of Guarantee Contract of Bailment Contract of Pledge Contract of Agency Meaning and Essentials of a Contract of Sale Conditions and Warranties 341 345 347 353 357 359 365 369 XIII 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. Unpaid Seller Definition, Meaning and Nature of Partnership Relations of Partners to One Another Relations of Partners to Third Parties Minor Admitted to the Benefits of Partnership Dissolution of a Firm Effect of Non-Registration Definition and Features of a Company Types of Companies Memorandum of Association and Articles of Association Doctrines of Ultra Vires/Constructive Notice/Indoor Management Membership
  7. 7. 61. Prospectus 62. Directors 63. Foreign Exchange Management Act, 1999 64. Transfer of Property Act, 1882 65. The Right to Information Act, 2005 66. Right to Information and Obligations of Public Authorities 67. The Prevention of Money Laundering Act, 2002 68. Information Technology Act, 2000 Bibliography 373 377 381 385 389 393 397 399 405 411 415 419 425 429 437 443 453 457 463 469 475 MODULE-A REGULATIONS AND COMPLIANCE Unit 1. Legal Framework of Regulation of Banks Unit 2. Control over Organisation of Banks Unit 3. Regulation of Banking Business Unit 4. Returns, Inspection, Winding Up Unit 5. Public Sector Banks and Co-operative Banks Unit 1 LEGAL FRAMEWORK OF REGULATION OF BANKS STRUCTURE 1.0 Objectives 1.1 Introduction 1.2 Business of Banking 1.3 Constitution of Banks 1.4 Reserve Bank of India Act, 1934 1.5 Banking Regulation Act, 1949 1.6 Reserve Bank as Central Bank and Regulator of Banks 1.7 Government as a Regulator of Banks 1.8 Control Over Co-operative Banks 1.9 Regulation by Other Authorities 1.10 Let Us Sum Up 1.11 Keywords 1.12 Check Your Progress 1.13 Answer to 'Check Your Progress' 1.14 Terminal Questions 1.0 OBJECTIVES The objectives of this Unit are to understand: • the definition and nature of the business of banking; • the constitution of different types of banks; • the regulatory scheme of the RBI Act and the BR Act; • the role of the Reserve Bank and the Central Government as regulators; and • the special position of public sector banks and co-operative banks. 1.1 INTRODUCTION Banking in India is mainly governed by the Banking Regulation Act, 1949 and
  8. 8. the Reserve Bank of India Act, 1934. The Reserve Bank of India and the Government of India exercise control over banks from the opening of banks to their winding up by virtue of the powers conferred under these statutes. All the regulatory provisions are not uniformly applicable to all banks. The applicability of the provisions of these Acts to a bank depends on its constitution; that is, whether it is a statutory corporation, a banking company or a co-operative society. In this unit, we look at the definition of banking, the constitution of different types of banks and applicability of regulatory laws, the general framework of the regulatory laws and the role of regulators namely, the Reserve Bank of India and the government. 1.2 BUSINESS OF BANKING i. Definition of Banking: Banking is defined in Section 5(b) of the Banking Regulation Act as the acceptance of deposits of money from the public for the purpose of lending or investment. Such deposits may be repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise. Thus, a bank must perform two essential functions: i) acceptance of public deposits, and ii) lending or investment of such deposits. The deposits may be repayable on demand or for a period of time as agreed by the banker and the customer. In terms of the definition, the banker can accept "deposits" of money and not anything else. Further, accepting deposits from the "public" implies that a banker accepts deposits from anyone who offers money for such purpose. However, a banker can refuse to open account for undesirable persons and further, the opening of accounts is subject to certain conditions like proper introduction and identification. The "Know Your Customer" guidelines issued by the Reserve Bank require banks to follow certain customer identification procedure for opening of accounts for protecting the banks from frauds, etc., and also for monitoring transactions of a suspicious nature for the purpose of reporting to appropriate authorities for taking anti-money laundering measurers and combating financing of terrorism. There is no exhaustive definition of "banking" in Common Law of England. However, the usual characteristics of banking as identified by Lord Denning MR in United Dominions Trust Ltd. vs Kirkwood ([1966] 1 All ER 968 at 975) are: (a) the conduct of current accounts; (b) the payment of cheques; and (c) the collection of cheques for customers. These characteristics are not equivalent to a definition, and these are also not the only characteristics. (See, Paget's Law of Banking, 12th Edn., pp. 107 to 109) ii. Deposits Withdrawable by Cheque: Under Section 49A of the Banking Regulation Act, no organisation other than a bank is authorised to accept deposits withdrawable by cheque. The Savings Bank Scheme run by the government, a Primary credit society and any other person or firm notified by the government are exempted from this prohibition. iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking companies, firms and other unincorporated associations of persons and individuals who accept deposits from the public. Acceptance of deposits by nonbanking financial companies is regulated by the Reserve Bank under the NonBanking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 and other directions issued by it under Chapter IIIB of the Reserve Bank of India Act. Other companies are regulated by the Central Government under the Companies (Acceptance of Deposit) Rules, 1975 issued
  9. 9. under Section 58A of the Companies Act, 1956. Individuals, firms and other unincorporated associations of persons whose business includes the business of a financial institution or whose principal business is acceptance of deposits, is prohibited under Section 45S of the RBI Act (as amended in 1997) from accepting deposits from the public, except relatives. This prohibition does not apply to acceptance of deposits by those who are mainly engaged in manufacturing or trading. iv. Licence for Banking: In India, it is necessary to have a licence from the Reserve Bank under Section 22 of the Banking Regulation Act for commencing or carrying on the business of banking. Every banking company has to use the word "bank" as part of its name (See, Section 7 of the Act) and no company other than a banking company can use the words "bank", "banker", "banking" as part of its name. Further, no firm, individual or group of individuals is permitted to use the words "bank", "banking" or "banking company" as a part of the name or for the purpose of business. Subsidiaries of banks and association of banks in certain cases as also Primary Credit Societies are exempted from this restriction. v. Permitted Business: Although, traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide into many allied and even unrelated activities. The forms of business permissible under Section 6(1) of the Banking Regulation Act, apart from banking business, are summarised below: (a) (i) Borrowing, raising or taking up of money; (ii) Lending or advancing of money either upon security or without security; (iii) Drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundis, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not; (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 of foreign exchange including foreign bank notes; (vii) Acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; (viii) Purchasing and selling of bonds, scrips and other forms of securities on behalf of constituents or others; (ix) Negotiating of loans and advances; (x) Receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; (xi) Providing of safe deposit vaults; and (xii) Collecting and transmitting of money and securities. (c) Contracting for public and private loans and negotiating and issuing the same. (d) Insure, guarantee, underwrite, participate in managing and carrying out any issue of state, municipal or other loans or of shares, stock, debentures or debenture stock of companies and lend money for the purpose of any such issue. (e) Carry on and transact every kind of guarantee and indemnity business. (f) Manage, sell and realise any property which may come into its possession in satisfaction of any of its claims. (g) Acquire, hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance. (h) Undertake and execute trusts. (i) Undertake the administration of estates as executor, trustee or otherwise.
  10. 10. (j) Establish, support and aid associations, institutions, funds, trusts, etc., for the benefit of its present or ex-employees; grant money for charitable purposes, (k) Acquire, construct and maintain any building for its own purpose. (L) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or turn into account or otherwise deal with all or any part of the business of any person or company, when such business is of a nature described in Section 6. (m) Acquire and undertake the whole or any part of the business of any person or company, when such business is of a nature described in Section 6. (n) Do all such things which are incidental or conducive to the promotion or advancement of the business of the company, (o) Do any other business specified by the Central Government as the lawful business of a banking company. The Central Government has accordingly specified leasing and factoring as permissible business for banks. vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a banking company from engaging directly or indirectly in trading activities and undertaking trading risks. Buying or selling or bartering of goods directly or indirectly is prohibited. However, this is without prejudice to the business permitted under Section 6(1) of the Act. Accordingly, a bank can realise the securities given to it or held by it for a loan, if need arises for the realisation of the amount lent. It can also buy or sell or barter for others in connection with: (i) bills of exchange received for collection or negotiation, and (ii) undertaking the administration of estates as executor, trustee, etc. Goods for the purpose of this Section means every kind of moveable property, other than actionable claims, stocks, shares, money, bullion and specie and all instruments referred to in Clause (a) of sub-Section (1) of Section 6. As regards immoveable properties, Section 9 prohibits a banking company from holding such property, howsoever acquired, except as is required for its own use, for a period exceeding seven years from the acquisition of the property. The Reserve Bank may extend this period by another five years, if it is satisfied that such extension would be in the interest of the depositors of the banking company. The banking company shall be required to dispose of such property within the permitted period. 1.3 CONSTITUTION OF BANKS i. Banks in India fall under one of the following categories: (a) Body corporate constituted under a special statute; (b) Company registered under the Companies Act, 1956 or a foreign company; (c) Co-operative society registered under a central or state enactment on cooperative societies. ii. Public Sector Banks: The public sector banks including nationalised banks, State Bank of India and its associates (subsidiaries) and the Regional Rural Banks fall in the first category. By the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 the Central Government nationalised (took over the business undertakings) of certain banking companies and vested them in newly created statutory bodies (corresponding new banks) constituted under Section 3 of the 1970/1980 Act. The State Bank of India was constituted under the State Bank of India Act, 1955 and the six associate/subsidiary banks were constituted under the State Bank (Subsidiary Banks) Act, 1959 or other statutes (See Para 5.2.6). The regional rural banks are constituted under the Regional Rural Banks Act, 1976. These banks are governed by the statutes
  11. 11. creating them as also some of the provisions of the Banking Regulation Act and the Reserve Bank of India Act. The details are discussed in Unit 5. iii. Banking Companies: A banking company, as defined in Section 5(c) of the Banking Regulation Act is a company which transacts the business of banking. Such company may be a company constituted under Section 3 of the Companies Act or a foreign company within the meaning of Section 591 of that Act. All the private sector banks are banking companies. These banks are governed by the Companies Act, 1956 in respect of their constitution and by the Banking Regulation Act and the RBI Act with regard to their business of banking. iv. Co-operative Banks: A co-operative bank is a co-operative society registered or deemed to have been registered under any Central Act for the time being in force relating to the multi-state co-operative societies, or any other central or state law relating to co-operative societies for the time being in force. If a cooperative bank is operating in more than one state, the Central Act applies. In other cases, the state laws apply. The Banking Laws (Application to Cooperative Societies) Act, 1965 extended certain provisions of the Banking Regulation Act and the Reserve Bank of India Act to the co-operative banking sector. After the Supreme Court held in Apex Co¬operative Bank's case (AI R 2004 SC 141) that multi-state co-operative societies cannot be licensed as cooperative banks, the Banking Regulation (Amendment) and Miscellaneous Provisions Act, 2004 was enacted to permit licensing of multi-state co-operative banks. A "multi-state co¬operative bank" under this Act means a multi-state cooperative society which is a primary co-operative bank. 1.4 RESERVE BANK OF INDIA ACT, 1934 i. The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve Bank of India: (i) to regulate the issue of bank notes, (ii) for keeping reserves for securing monetary stability in India, and (iii) to operate the currency and credit system of the country to its advantage. The Act came into force on 6th March 1934. The Act has been amended from time to time to meet the demands of changing times. The last amendment to the Act was effected by the RBI (Amendment) Act, 2006. ii. The Act deals with the constitution, powers and functions of the Reserve Bank. It does not directly deal with regulation of the banking system except for Section 42, which provides for cash reserves of scheduled banks to be kept with the Reserve Bank, with a view to regulating the credit system and ensuring monetary stability. Further, Section 18 of the Act provides for direct discount of bills of exchange and promissory notes when a special occasion arises, making it necessary or expedient for the purpose of regulating credit in the interests of trade, industry and agriculture. The Act, in short, deals with: (i) incorporation, capital, management and business of the bank: (ii) the central banking functions like issue of bank notes, monetary control, acting as banker to government and banks, lender of last resort; (iii) collection and furnishing of credit information; (iv) acceptance of deposits by non-banking financial institutions; (v) general provisions regarding reserve fund, credit funds, publication of bank rate, audit and accounts; and (vi) penalties for violation of the provisions of the Act or the directions issued thereunder. 1.5 BANKING REGULATION ACT, 1949 i. The Banking Regulation Act, 1949 was enacted to consolidate and amend the
  12. 12. law relating to banking and to provide for a suitable framework for regulating the banking companies. Initially, the Act provided for regulation of banking companies only, but in 1965 the Act was amended to cover co-operative banks as well with certain modifications (See, Section 56). However, the Act, as provided in Section 3, does not apply to primary agricultural credit societies and co-operative land mortgage banks. The provisions of the Act are applicable to banking companies in addition to other laws which are applicable to such companies, unless otherwise specifically provided in the Act. Thus, Companies Act, 1956 which deals with the incorporation and working of companies is applicable to banking companies except where special provisions are made in the Banking Regulation Act in that regard. ii. The Act regulates entry into banking business by licensing as provided in Section 22 thereof. The Act also puts restrictions on the shareholding, directorship, voting rights and other aspects of banking companies. There are several provisions in the Act regulating the business of banking such as restriction on loans and advances, rates of interest to be charged, requirement as to cash reserve and maintenance of percentage of assets, etc. There are provisions regarding audit and inspection and submission of balance sheets and accounts. The Act provides for control over the management of banking companies and also deals with the procedure for winding up of the business of the banks and penalties for violation of its provisions. In short, the Act deals with: (a) regulation business of banking companies; (b) control over the management of banking companies; (c) suspension and winding up of banking business; and (d) penalties for violation of the provisions of the Act. 1.6 RESERVE BANK AS CENTRAL BANK AND REGULATOR OF BANKS i. The Reserve Bank was constituted under Section 3 of the Reserve Bank of India Act, 1934 for taking over the management of currency from the Central Government and carrying on the business of banking in accordance with the provisions of the Act. Originally, under the RBI Act, the Bank had the responsibility of: (a) regulating the issue of bank notes; (b) keeping of reserves for ensuring monetary stability; and (c) generally to operate the currency and credit system of the country to its advantage. ii. The Reserve Bank is a body corporate having perpetual succession and common seal and shall sue and be sued in its name. The whole capital of the bank is held by the Central Government. The Bank has its central office in Mumbai and offices in Mumbai, Kolkata, Delhi and Chennai, and branches at most of the state capitals and some other cities. iii. The bank functions under the general superintendence and directions of the Central Board of Directors. The bank has to abide by the directions given by the Central Government in public interest after consultation with the Governor of the bank. The board shall consist of a Governor and not more than four Deputy Governors to be appointed by Central Government and other directors nominated by the Central Government. Apart from the Central Board, the bank has also local boards situated at Mumbai, Kolkata, Delhi and Chennai, which perform any duty delegated to them by the Central Board. The Governor has the power of general superintendence and direction of the affairs of the bank and exercise all powers of the bank unless otherwise provided in the regulations made by the Central
  13. 13. Board. The Deputy Governors, Executive Directors and other officers in different grades assist the Governor in the discharge of the Bank's functions. iv. The Reserve Bank is the sole authority for issue and management of currency in India under Section 22 of the RBI Act. The bank may issue notes of different denominations from Rs. 2 to Rs. 10,000 as the Central Government may decide on the recommendations of the Central Board of the bank. Such notes shall be legal tender at any place in India. v. The bank is the banker to the Central Government under Section 20 of the Act, and accordingly it is obligatory to undertake banking business for the Central Government. In the case of state governments, their banking business is undertaken by the bank based on agreements as provided in Section 21 A. Bank provides ways and means of advances to the Central and state governments. These are temporary advances to meet immediate needs when there is interval between expenditure and flow of revenue. vi. The role of the bank as regulator of banking sector is mainly by virtue of the provisions of the Banking Regulation Act, 1949. In exercise of the powers under that Act the bank regulates the entry into banking business by licensing, exercises control over shareholding and voting rights of shareholders, exercises controls over the managerial persons, and regulates the business of banks. The bank also inspects banks and exercises supervisory powers, and may issue directions from time to time in public interest and in the interest of the banking system with respect to interest rates, lending limits, investments and various other matters. vii. The major powers of the Reserve Bank in the different roles as regulator and supervisor can be summed up as under: (a) power to licence; (b) power of appointment and removal of banking boards/personnel; (c) power to regulate the business of banks; (d) power to give directions; (e) power to inspect and supervise banks; (f) power regarding audit of banks; (g) power to collect, collate and furnish credit information; (h) power relating to moratorium, amalgamation and winding up; and (i) power to impose penalties. 1.7 GOVERNMENT AS A REGULATOR OF BANKS i. The Reserve Bank is the primary regulator of banks. But the Central Government has also been conferred extensive powers under the RBI Act and BR Act either directly or indirectly over the banks. ii. The government holds the entire capital of the Reserve Bank and appoints the Governor and the mr.mhe.rs nf the Central Rmrd nnri Vns the power to remove them. The government has also the --•j i 10 necessary in public interest after consultation with the Governor. Thus, the government can exercise control over banks by influencing decision-making by the Reserve Bank and has also got appellate authority in respect of several matters in which the Reserve Bank has been conferred the power to decide at the first instance. Thus, under the Banking Regulation Act appeal lies with the Central Government on removal of managerial personnel under Sections 10B and 36AA of the BR Act. Similarly, there are also provisions for appeal in respect of cancellation of banking licence (under Section 22) and refusal of certificate regarding floating charge on assets (Section 14A).
  14. 14. iii. The government has the power to suspend the operations of the Banking Regulation Act or to give exemption from any of the provisions of the Act on the representation/recommendation of the Reserve Bank under Sections 4 and 53 of the Act, respectively. The government has also the power to notify other forms of business which a bank may undertake under Section 6(1 )(o) of the Act. Rulemaking powers under Sections 52 and 45Y are vested in the Central Government. There are also other provisions under which the Central Government exercises powers as under: (a) Approval for formation of subsidiary for certain business under Section 19; (b) Notification with reference to accounts and balance sheet under Section 29; (c) Issue of direction for inspection of banks under Section 35; (d) Power to acquire undertakings of banks (Section 36AE); (e) Appointment of court liquidator; (f) Suspension of business and amalgamation of banks under Section 45. The above provisions confer wide powers on the Central Government to regulate banks. These are in addition to the powers conferred on the government as majority shareholder or full owner of public sector banks under the statutes constituting them. 1.8 CONTROL OVER CO-OPERATIVE BANKS i. A co-operative bank is a co-operative society engaged in the business of banking and may be a primary Co-operative bank, a district central co-operative bank or a state co-operative bank. Co¬operative banks operating in one state only are registered under the State co-operative Societies Act concerned. The formation of such banks as well as their management and control over personnel is regulated by the co-operative law of the state. The Registrar of co-operative societies under the Co-operative Societies Act exercises a wide range of powers on co-operative societies from registration to winding up. ii. In the case of co-operative banks operating in more than one state, the MultiState Co-operative Societies Act, 2002 is applicable. In that case, the Registrar appointed by the Central Government takes the place of the Registrar appointed by the State Government in other cases. iii. With the introduction of Section 56 in the Banking Regulation Act, 1949 with effect from 1965, co¬operative banks have come under the regulatory purview of the Reserve Bank. While the formation and management of cooperative societies operating in one state only (including those conducting banking business) are under the control of the State Government, licensing and regulation of banking business rests with the Reserve Bank. Thus, there is dual control of State Governments and the Reserve Bank over these banks. IV. In the case of co-operative banks which are registered under the Deposit Insurance and Credit Guarantee Corporation Act, the Reserve Bank has the power to order their winding up. The circumstances in which Reserve Bank may require winding up are mentioned in Section 13D of the Act. 11 1.9 REGULATION BY OTHER AUTHORITIES i. Banks may be subject to the control of other regulatory agencies in the conduct of their business. For instance, a banking company will be subject to the control of the authorities under the Companies Act in respect of company matters. Similarly, a bank is answerable to labour authorities in respect of the terms and conditions of service of its workmen, opening and closing of its premises, engagement of contract labour, etc. Banks are also liable to pay income tax like cash transaction tax, service tax, etc., and other taxes and have to follow the
  15. 15. rules and regulations in that regard. ii. As provided in Section 6 of the Banking Regulation Act, banks may undertake certain non-banking business in addition to the business of banking. In that regard also, banks may be subject to the regulatory control of other agencies. For instance, in the case of dealings in securities like shares and debentures, banks are subject to regulation by the Securities Exchange Board of India under the Securities Contract (Regulation) Act, 1956 read with the Securities and Exchange Board of India Act, 1992. If the Bank desires to raise capital through public issue, it has to comply with SEBI guidelines. In case of Insurance Business - by IRDA and in case of Mutual Fund Business -RBI, SEBI. The study herein is, however, largely confined to the regulation of banks by the Reserve Bank and the Central Government under the Reserve Bank of India Act and the Banking Regulation Act. 1.10 LET US SUM UP 1. Banking means acceptance of deposits of money from the public for lending or investment. Such deposits may be repayable on demand or may be for a period of time as agreed to, by the banker and the customer, and may be repayable by cheque, draft or otherwise. Apart from banking, banks are authorised to carry on other business as specified in Section 6 of the Banking Regulation Act. Banks are, however, prohibited from undertaking any trading activities. 2. Banks are constituted as companies registered under the Companies Act, 1956, statutory corporations constituted under Special Statutes or Co-operative societies registered under the Central or State Co-operative Societies Acts. The extent of applicability of the regulatory provisions under the Banking Regulation Act and the Reserve Bank of India Act to a bank depends on the constitution of the bank. 3. Reserve Bank of India is the central bank of the country and the primary regulator for the banking sector. The government has direct and indirect control over banks. It can exercise indirect control through the Reserve Bank and also act directly in appeals arising from decisions of the Reserve Bank under the various provisions of the Banking Regulation Act. In public sector banks like the State Bank of India and its subsidiaries, nationalised banks and the regional rural banks, 50% or more of their shares are held by the Central Government. Central Government has substantial control over the management of these banks. Only certain provisions of the BR Act are applicable to these banks as indicated in that Act. Co-operative banks operating in one state only are registered under the State Co-operative Societies Act and are subject to the control of the State Government as also the Reserve Bank. In the case of non-banking business of the banks, they are subject to control by other regulatory agencies. 1.11 KEYWORDS
  16. 16. Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank; Regional Rural Bank; Public Sector Bank. 12 1.12 CHECK YOUR PROGRESS A. 1. State whether the following statements are True or False. (i) A public sector bank is a body corporate created under a special statute. (ii) A banking company is registered under the Banking Regulation Act. (iii) Co-operative banks are registered under the Multi-State Co-operative Societies Act or a State Co-operative Societies Act. (iv) Subsidiaries of the State Bank are companies registered under the Companies Act. (v) Accepting deposits for safe custody would fall within the definition of "banking". 2. Fill in the gaps choosing the answers from the brackets. (i) Reserve Bank was constituted under (BR Act, RBI Act, Companies Act) (ii) A Regional Rural Bank is (a body corporate created under a special statute, a co¬ operative society, a company) (Reserve Bank, Registrar of Companies, (iii) Banking companies are licensed by Company Law Board) (iv) Business which a banking company may undertake other than banking is as stipulated by (Reserve Bank, BR Act, RBI Act) (v) BR Act was enacted for (regulating banking companies, creating Reserve Bank, regulating acceptance of deposits from public) B. 1 State whether the following statements are True or False, (i) Central Government can give direction to the Reserve Bank, (ii) All kinds of business of banks is regulated only by the Reserve Bank, (iii) Central Government is the primary regulator of banks, (iv) State governments have no control over cooperative banks. (v) On cancellation of licence of any bank, an appeal lies with Central Government. Fill in the gaps choosing the answers from the brackets. (State Co¬ operative Societies Act, Multi-State Co-operative Societies Act, RBI Act) Government can exempt a bank from the provisions of BR Act (on the recommendation of RBI, whenever the government is satisfied, if requested by a bank) exercises the central banking function in India. (State Bank, Central Bank of (ii) (iii) (i) Co-operative banks operating in different states are registered under (Reserve Bank, India, Reserve Bank) (iv) Company matters of a banking company are regulated by (Controller Authorities under the Companies Act, SEBI) (v) Trading in shares and securities by banks is subject to regulation by . of Capital Issues, SEBI, Company Law Board) 1.13 ANSWERS TO 'CHECK YOUR PROGRESS'
  17. 17. A. 1. (i) True; (ii) False; (iii) True; (iv) False; (v) False. 2. (i) RBI Act (ii) a body corporate created under a special statute (iii) Reserve Bank (iv) BRAct (v) for regulating banking companies. B. 1. (i) True; (ii) False; (iii) False; (iv) False; (v) True. 2. (i) Multi-State Co-operative Societies Act (ii) On recommendation of RBI (iii) Reserve Bank 13 (iv) Authorities under the Companies Act (v) SEBI. 1.14 TERMINAL QUESTIONS Fill in the gaps choosing the answers from the brackets. 1. One of the essential characteristics of banking is _ (lending to traders; investment in _. (body corporate securities; acceptance of deposits from the public) 2. Banking companies operating in India are constituted in the form of. constituted under a special statute; company registered under the Companies Act, 1956 or a foreign company; society registered under the Societies Registration Act) 3. Companies Act applies to banking companies _. (notwithstanding the provisions of the Banking Regulation Act; insofar as its provisions are not inconsistent with the provisions of the Banking Regulation Act; only in relation to registration and winding up) 4. Under the Reserve Bank of India Act, Reserve Bank regulates acceptance of deposits by (all companies; non-banking financial companies; non-banking nonfinancial companies) _. (to the extent as provided in the state laws 5. BR Act is applicable to co-operative banks on co-operative societies; in a modified form as provided in Section 56 thereof; at par with commercial banks) 6. "Corresponding new banks" means (new banks [nationalised banks] constituted under the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970 and the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1980; new generation banking companies registered under the Companies Act; a new bank formed by amalgamation of two banking companies) 7. Central Government may give directions to the Reserve Bank when considered necessary in public interest only after consulting (the Governor of Reserve Bank; the Central Board of the Reserve Bank; the Finance Commission) 8. A co-operative society registered under the Multi-State Co-operative Societies Act (is prohibited from undertaking banking business; can be declared as a state cooperative bank; can undertake banking business as a primary co-operative bank) 9. A multi-state co-operative bank means a multi-state co-operative society which is a (primary co-operative bank; central co-operative bank; state co-operative bank) 10. For the purposes of the BR Act, a "co-operative society" means a society
  18. 18. registered or deemed to have been registered under (any Central Act for the time being in force relating to the multi-state co-operative societies only; any state law relating to co-operative societies for the time being in force only; any Central Act for the time being in force relating to the multi-state co¬operative societies or any other central or state law relating to co-operative societies for the time being in force) UNIT 2 CONTROL OVER ORGANISATION OF BANKS STRUCTURE 2.0 Objectives 2.1 Introduction 2.2 Licensing of Banking Companies 2.3 Branch Licensing 2.4 Paid-up Capital and Reserves 2.5 Shareholding in Banking Companies 2.6 Subsidiaries of Banking Companies 2.7 Board of Directors 2.8 Chairman of Banking Company 2.9 Appointment of Additional Directors 2.10 Restrictions on Employment 2.11 Control Over Management 2.12 Corporate Governance 2.13 Directors and Corporate Governance 2.14 Let Us Sum Up 2.15 Keywords 2.16 Check Your Progress 2.17 Answers to 'Check Your Progress' 2.18 Terminal Questions 16 2.0 OBJECTIVES The objectives of this unit are to understand the laws that govern banking companies, in respect of: • Licensing and branch licensing • Paid up capital and reserves • Shareholding and rights of shareholders • Formation of subsidiaries and holding of shares of other companies • Constitution and regulation of board of directors • Exercise of control by the Reserve Bank and the Government over the appointment and removal of chairmen, managerial and other personnel • Corporate governance 2.1 INTRODUCTION The Banking Regulation Act provides for regulation of the organisation of
  19. 19. banking companies. To start with, there are restrictions at the entry point, by way of licensing and then the requirement of permission for opening or shifting of branches. There are further regulations over the paid-up capital and reserves, shareholder's rights, constitution of the board of directors, appointment of chairman and formation of subsidiaries. Apart from the above, there are also controls over the managerial and other personnel, including the power to remove unsuitable persons and to appoint suitable persons. In this unit, we study various provisions of the Banking Regulation Act, providing for controls over the organisation and management of banking companies. 2.2 LICENSING OF BANKING COMPANIES i. License Requirement from RBI: To commence or carry on, the banking business in India, a company requires a licence from the Reserve Bank under Section 22 of the Banking Regulation Act, 1949. Commencing or carrying on a banking business without a licence is prohibited. When the Act came into force, the banking companies, which were then in existence were required to apply for licence within six months from the commencement of the Act. But, such banking companies were permitted to continue business, unless and until their applications for licence were rejected by the Reserve Bank. The requirement of licence was meant to ensure the continuance of only those banks, which were established and operating on sound lines and to prevent indiscriminate formation of banking companies. ii. Discretion of Reserve Bank: The granting of licence by the Reserve Bank may be subject to such conditions as the RBI may think fit in each case. As held by the Gujarat High Court in Shivabhai vs RBI, Ahmedabad (AIR 1986 Guj 19), Reserve Bank has the discretion to grant or refuse the licence and when such decision based on relevant, material and germane considerations, the decision cannot be assailed. Only if the decision is based on extraneous considerations or is perverse, the court will intervene. It is open to the RBI to consider the defects or improvements revealed in an inspection held under Section 35 of the BR Act while disposing of an application for licence. (See, Sajjan Bank Pvt. Ltd. vs RBI, AI R 1961 Mad 8). The refusal of licence to a company would make it ineligible to undertake banking business, but it would still be open to the company to carry on other business like money lending. iii. Conditions to be Satisfied: Before granting a licence under Section 22, Reserve Bank may have to be satisfied by an inspection of the books of the banking company or otherwise in respect of the fnllnwintr matters17 (a) Whether the company is or will be in a position to pay its present and future depositors in full as their claims accrue; (b) Whether the affairs of the company are being conducted or likely to be conducted in a manner detrimental to the interests of its present and future depositors; (c) Whether the general character of proposed management of the company will not be prejudicial to public interest or the interest of depositors; (d) Whether the company has an adequate capital structure and earning prospects; (e) Whether public interest will be served by grant of licence to the company;
  20. 20. (f) Whether considering the banking facilities available in the proposed area of operation, the potential scope for expansion of business by banks already in existence in that area and other relevant factors, the grant of licence would be prejudicial to the operation and consolidation of banking system, consistent with monetary stability and economic growth; (g) The fulfilment of any other condition which the Reserve Bank considers relevant in public interest or in the interest of depositors. Although Section 11 of BR Act specifies the minimum capital and reserves requirements of a banking company, the Reserve Bank can stipulate a higher requirement of capital for licensing a banking company as under Section 22 the Reserve Bank has to be satisfied that the company has an adequate capital structure and earning prospects. iv. Foreign Banks: In the case of companies incorporated outside India applying for a licence, apart from the conditions specified in the case of domestic companies, three additional conditions have been stipulated for consideration by the Reserve Bank. These are: (a) Whether carrying on of banking business by the company in India will be in public interest; (b) 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; (c) Whether the company complies with provisions of the BR Act, as applicable to foreign companies. v. Local Area Banks: The Reserve Bank has recognised the concept of local area banks and licensed a few(four) such banks. These are banking companies operating only in a limited geographical area. The licence issued to these banks would restrict their operations to the specified local area to ensure adequate banking services in that area. vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking Regulation Act authorises the Reserve Bank to cancel the licence granted to any banking company. The cancellation of licence may be on any one or more of the following grounds: (a) The company ceases to carry on banking business in India; (b) The company at any time fails to comply with any of the conditions imposed under the subSection (1) of Section 22 of Banking Regulation Act; (c) The company does not fulfil at any time, any of the conditions referred to in the sub-Section(3) or 3(A) of Section 22 of Banking Regulation Act. Before cancellation of a licence for non-compliance with any of the conditions as above, the company has to be given an opportunity for taking necessary steps for complying with or fulfilling the conditions. However, in cases where the Reserve Bank is of the opinion that delay will be prejudicial to the interests of depositors or the public, the requirement of opportunity can be dispensed with. As observed by the Madras High Court in Sajjan Bank Pyt. Ltd. vs RBI (AIR 1961 Mad. 8), the Reserve Bank has a wide range of administrative discretion under the Act, which it is competent to exercise, and it cannot be said that there is an excessive delegation of power. A banking company, whose licence is cancelled, can appeal to the Central Government within a ; i _r
  21. 21. t/ J r-. 18 2.3 BRANCH LICENSING i. Apart from the requirement of licence for commencing or carrying on banking business, banks have to obtain the prior permission of Reserve Bank for opening a new place of business or changing location of the existing place of business. Under Section 23 of the Banking Regulation Act, 'Place of business' for this purpose includes any sub-office, pay office, sub-pay office or any place at which deposits are received, cheques cashed or moneys lent. However, changing the location of an existing place of business within the same city, town or village would not need such permission. These restrictions also apply to foreign branches of banking companies incorporated in India. Opening of a temporary place of business up to one month for purpose of affording banking facilities for any exhibition, mela, conference or like occasion is exempt. However, the temporary branch has to be within the limits of the city; town or village where there is an existing branch or in the environs thereof. The present guidelines from RBI provide that Banks should submit their request for new branches, administrative offices, ATMs once in a year for consideration of RBI as against the earlier practice of making individual applications for each and every branch. When approved, the permission would be valid for a period of one year before which the branches/ offices should be operationalised. ii. For granting permission under Section 23, the Reserve Bank may require to be satisfied of the following: (a) Financial condition and history of the bank; (b) General character of its management; (c) Adequacy of capital structure and earning prospects; (d) Public interest. This may be done by an inspection of the bank under Section 35 or otherwise. While granting permission for opening or shifting a branch, the Reserve Bank may impose any conditions which it thinks fit necessary. If any bank fails to comply with such conditions, the permission may be revoked after giving an opportunity to the bank to show cause. iii. In the case of regional rural banks, the applications for permission have to be routed through the National Bank (NABARD), and the national bank has to offer its comments on merits to the Reserve Bank. 2.4 PAID-UP CAPITAL AND RESERVES Section 11 of the Banking Regulation Act provides for certain minimum requirements as to paid-up capital and reserves of banking companies. Any company wanting to commence banking business has to comply with these requirements. The amounts stipulated have reference to the places of business. 'Place of business' for this purpose means any office, sub-office, sub-pay office and any place at which deposits are received, cheques cashed or moneys lent. In the case of any dispute regarding computation of paid-up capital and reserves of any banking company, the decision of the Reserve Bank shall be final. i. Foreign Banks: Under the sub-Section (2) of Section 11 of the BR Act, a foreign bank (banking company incorporated outside India) operating in India, has to deposit and keep deposited with the Reserve Bank, an amount of Rs.15 lacs and if it has a place of business in Mumbai or Kolkata or both, Rs. 20 lacs. The amount has to be kept in cash, unencumbered approved securities or partly in both. Apart from this, an amount of twenty per cent of the profit for each year in respect of business transacted through the branches in India as disclosed in the profit and loss account has to be deposited with the Reserve Bank. The securities deposited can be replaced by other unencumbered
  22. 22. 19 approved securities or cash deposited can be similarly replaced by securities. The Central Government can exempt any foreign bank from this requirement on the recommendation of the Reserve Bank for a specified period if the amounts deposited already by it are considered adequate. On the cessation of business by any foreign bank for any reason, these deposits shall form the assets of the company on which the creditors in India shall have the first charge. ii. Indian Banks: In case of banking companies incorporated in India, the requirements of minimum paid-up capital and reserves under Section 11 (3) are as follows: (a) If it has a place of business in more than one state, Rs. 5 lac and if such places of business include Mumbai, Kolkata or both, Rs. 10 lac. (b) If the place of business is in only one state and does not include Mumbai or Kolkata, Rupees 1 lac for its principal place of business, plus Rs. 10,000 for other places of business, in the same district in which the principal place of business is situated, plus an additional Rs. 20,000, for each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank has only one place of business, the amount is limited to Rs. 50,000. For banking companies commencing business after the commencement of the Act, paid-up capital is stipulated as Rs 5 lac. (c) If places of business are in one state only, but one or more of them is in Mumbai or Kolkata, Rs. 5 lac, plus Rs. 25,000 for each place of business outside these cities and the aggregate not exceeding Rs. 10 lac. During 2005, RBI stipulated the minimum capital requirement for a new Private Bank at Rs 300 crore as a part of Corporate Governance guidelines and as a policy of Foreign Direct Investment. iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the above, Section 12(1) of the Banking Regulation Act stipulates that the subscribed capital of a banking company shall not be less than half of its authorised capital; and the paid-up capital shall not be less than half of its subscribed capital. If capital is increased, this requirement has to be complied within a period not exceeding two years as allowed by the Reserve Bank. Banking companies are permitted to have only ordinary or equity shares. However, preference shares issued before 1 July 1944 are exempt. Further, the provisions of Section 12(1) are not applicable to banks incorporated before 15 January 1937. Now preference shares and other capital instruments are also allowed. Since 2005, Banks have been permitted by RBI to raise capital even in the from of innovative debt instruments which are perpetual and perpetual noncumulative preference shares in addition to the equity capital. 2.5 SHAREHOLDING IN BANKING COMPANIES i. Voting rights of shareholders: There is no specified ceiling on a person's holding of shares in a banking company under the Banking Regulation Act or any other law. However, Section 12(2) of the Act puts certain restrictions on voting rights of shareholders. Accordingly, no shareholder can exercise voting rights in respect of the shares held by him/her in excess of ten per cent of the total voting rights of all the shareholders of the banking company. This provision does not in any way affect the transfer of shares or the registration of such
  23. 23. transfers. It only puts a limit on voting rights. However, Section 12(3) bars suits or other proceedings against registered shareholders by any other person claiming title except by a transferee of shares, in accordance with the law or on behalf of minors or lunatics for whom the registered shareholder holds the shares. The provisions of the Companies Act also govern transfer of shares of banking companies. ii. Acknowledgement by Reserve Bank: Reserve Bank has instructed banking companies that when 20 they receive more than the specified percentage of their shares for transfer to one party, the bank's board must refer the matter to the Reserve Bank. The banks shall not transfer the shares without receiving Reserve Bank's acknowledgement. This is with a view to ensure that the controlling interest in a banking company does not change hands without the knowledge and approval of the Reserve Bank. iii. Reports on shareholding: A report regarding the particulars of shareholding of the chairman, managing director or chief executive officer, by whatever name called, of every banking company, requires submission to the Reserve Bank. Such report should contain the full particulars and extent of value of shares held directly or indirectly and of any change in the extent of holding or of any variation in the rights attaching thereto. The Reserve Bank may also order for any other information relating to those shares. iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act imposes a ceiling on the commission, brokerage, discount or remuneration on the sale of shares of banking companies. Accordingly, the payments on this account in any form should not exceed two-and-a-half per cent of the paid-up value of the shares. v. Dividend: There are also certain restrictions on the payment of dividend to the shareholders of banking companies. Thus, under Section 15 of the Banking Regulation Act, no dividend is payable until all capitalised expenses are completely written off. Such expenses include preliminary expenses, organisation expenses, share-selling commission, brokerage, loss incurred and any other item, of expenditure not represented by tangible assets. However, dividends are payable without writing off depreciation, bad debt etc., as under: (a) Depreciation in value of approved securities, which is not capitalised or accounted for as a loss. (b) Depreciation in investment of shares, bonds or debentures, other than the approved securities for which adequate provision has been made. (c) Bad debts for which an adequate provision is provided. RBI has given detailed eligibility criteria for declaration of dividend by banks and also guidelines on the quantum of dividend that can be declared by banks. The eligibility criteria require a minimum 9 % of CAR and Net NPAs not exceeding 1%. The quantum of dividend that can be declared is based on the levels of net NPAs and in a graded level (Maximum 40% pay out ratio) and can be paid out of only current year's profits. 2.6 SUBSIDIARIES OF BANKING COMPANIES i. Formation of Subsidiaries: There are certain restrictions under Section 19 of the Banking Regulation Act on the formation of subsidiaries by banking companies. This is for purpose of preventing banks from carrying on trading activities by acquiring a controlling interest in non-banking companies. Accordingly, subsidiaries are permissible only for the following purposes:
  24. 24. (i) Undertaking any business which is permissible for banking companies under Section 6(1) clauses (a) to (o). (ii) Carrying on the business of banking exclusively outside India. Prior permission of the Reserve Bank is a must for this banking business. (iii) Undertaking any other business which Reserve Bank with prior approval of the Central Government permits. Reserve Bank may permit only such other business which it considers conducive to the spread of banking in India or otherwise useful or necessary in the public interest. The undertaking of any business by a subsidiary will not be deemed to amount to the bank itself taking up that business directly or indirectly for the purpose of Section 8. 21 ii. Shareholding in other companies: Apart from the restriction on subsidiaries, there is also a ceiling [Section 19(2)] on shareholding in companies other than subsidiaries. Thus, the holding of shares by a banking company in any company as pledgee, mortgagee or absolute owner shall not be exceeding thirty per cent of the paid-up share capital of that company or the paid-up share capital and reserves of the banking company. Further, holding of shares in any company in which the managing director or manager of a banking company is interested in or concerned with in any manner, is prohibited except in the case of subsidiaries. 2.7 BOARD OF DIRECTORS i. Qualifications: Section lOAofthe Banking RegulationAct stipulates certain qualifications fordirectors of banking companies. Accordingly at least fifty-one per cent of the total number of directors shall be persons, who have special knowledge or practical experience, with respect of accountancy, agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry or any other matter, the special knowledge or practical experience which is useful to the banking company, in the opinion of the Reserve Bank. Further, at least two of the directors should have special knowledge or practical experience in agriculture and rural economy or co-operation or small scale industry. ii. Substantial interest: The directors of a banking company shall not have a substantial interest in or be connected with as employee, manager or managing agent in a company or firm which carries on trade, commerce or industry as per Section 10A (2)(b) of the BR Act. However, companies registered under Section 25 of the Companies Act and small scale industrial concerns are not included for the purpose. The proprietors of trading, commercial or industrial concerns other than small scale industrial concerns are also disqualified for directorship. 'Substantial interest' for this purpose is defined in Section 2 of the Banking Regulation Act. Accordingly, holding of beneficial interest by any individual or his spouse or minor child, whether singly or taken together in the shares of a company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the company amounts to substantial interest. In the case of firms, such holding of beneficial interest exceeding ten per cent of the total capital of the firm amounts to substantial interest. iii. Period of office: The directors of a banking company shall not hold office for more than eight years continuously. However, this provision is not applicable to the chairman or a whole-time director. When the chairman or a whole-time director of a bank is removed from office, he/she ceases to be a director of the bank and shall not be eligible for further appointment as director of that banking company for a period of four years. iv. Reconstitution of Board: When the board of a banking company is not constituted in accordance with the requirements of Section 10A of the BR Act, the board has to be reconstituted, to comply with the provisions. If any director
  25. 25. has to be retired for such a reconstitution, this may be done by lots, in the prescribed manner and such decision shall be binding on every director of the board. If the Reserve Bank is of the opinion that the board of any banking company does not fulfil the requirements, it may order such a bank to reconstitute the board after giving reasonable opportunity of being heard. If, within two months' time, the bank does not fulfil the order of the Reserve Bank, the Bank may then remove any director (determined by lots drawn in the prescribed manner) and such a person shall cease to hold office. The Reserve Bank may also appoint a new director in the place of the person removed and he/she shall continue in office until the date up to which his predecessor would have held office. However, any proceedings of a banking company will not be invalid only because of any defect in the composition of the board. 22 2.8 CHAIRMAN OF BANKING COMPANY i. Whole-time Chairman/Managing Director: Section 1 OB of the Banking Regulation Act provides that every banking company should have a full-time or part-time chairman, appointed from among its directors. The chairman, if appointed on a whole-time basis is entrusted with the management of the entire affairs of the bank. The chairman on a part-time basis has to be appointed with the prior approval of the Reserve Bank and such an appointment shall be subject to any conditions that may be imposed by the Reserve Bank while granting approval. In the absence of a chairman, the management of the whole of the affairs of the banking company shall be entrusted to a managing director. The exercise of powers by the whole-time chairman or managing director is subject to the superintendence, control and directions of the board of directors. The whole-time chairman and a managing director shall hold office for a period not exceeding five years as the board may fix and is also eligible for reelection or reappointment. Although the chairman is in full-time employment of the bank, he may be a director of a subsidiary of the bank or of a company registered under Section 25 of the Companies Act. The Reserve Bank may also permit the whole-time chairman or the managing director to undertake part-time honorary work not likely to interfere with the duties of the chairman or the managing director. The whole-time chairman or the managing director of a banking company may continue in office at the end of the term of the office until his/her successor assumes office, subject to the approval of the Reserve Bank. ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time chairman or the managing director of a banking company should have special knowledge or practical experience of the working of a banking company or the State Bank or a subsidiary bank or a financial institution or financial, economic or business administration. The whole-time chairman or the managing director will be disqualified under the following circumstances: (a) if he/she is director of a company other than a subsidiary of the banking company or a charitable company (registered under Section 25 of the Companies Act); (b) if he/she is a partner of any firm which carries on trade, business or industry; (c) if he/she has substantial interest in any other company or firm or is director, manager, managing agent, partner or proprietor of any trading, commercial or industrial concern; or (d) if he/she is engaged in any other business or vocation. iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is of the opinion that the person elected to be the chairman of the board of directors
  26. 26. and appointed on a whole time basis or the managing director is not a fit and proper person to hold such office, the Reserve Bank may require the banking company to remove such a chairman or the managing director and appoint a suitable person. However, before taking such an action, the Reserve Bank has to give such a person, as also the banking company, a reasonable opportunity of being heard. If the banking company does not comply with the order within two months, the Reserve Bank may remove the person from the office and appoint a suitable person in his/her place. Such a chairman or managing director would continue in office, for the residual period of office of the person removed from office. The banking company or the person affected by the Reserve Bank's order may appeal to the Central Government within thirty days. The order of the Government where an appeal is filed and the order of the Reserve Bank, where no appeal is filed shall be final and not liable to be challenged before any civil court. vi. Temporary vacancies: In cases where the wholetime chairman or the managing director dies or 23 he/she resigns or is not capable of discharging his/her functions due to illness, temporary arrangements can be made to carry out the duties of the chairman or the managing director for a period not exceeding four months. However, this has to be done with the approval of the Reserve Bank. v. Power of Reserve Bank to appoint Chairman: In certain cases, the office of the whole-time chairman or the managing director of a banking company may fall vacant and may not be filled up by the bank immediately. This may adversely affect the interests of the banking company. If the Reserve Bank is of the opinion that continuation of such vacancy is likely to be against the interests of the banking company, it may appoint an eligible person to fill such vacancy under Section 10BB of the Banking Regulation Act. If the chairman or the managing director so appointed is not a director of the banking company, he/she shall be deemed to be a director of the banking company. Such appointment may be for a period not exceeding three years. There is also a provision for reappointment after the initial period. The chairman or the managing director so appointed may be removed from office only by the Reserve Bank and shall draw pay and allowances from the banking company, as determined by the Reserve Bank. vi. Qualification shares: The whole-time chairman or the managing director of a banking company is exempted under Section IOC of the Banking Regulation Act from the requirement of holding qualification shares. Similar exemption is also available to a director of a banking company appointed by Reserve Bank under Section 10A of the Act. vii. Overriding provisions: The provisions of Section 10A, Section 10B and Section 10BB of the Banking Regulation Act regarding the appointment and removal of a director, managing director or the chairman shall have overriding effect over all other laws, contracts, etc. Any person affected by any action taken under these provisions is not entitled to any compensation for any loss or for termination of office. 2.9 APPOINTMENT OF ADDITIONAL DIRECTORS i. The Reserve Bank has the power to appoint additional directors on the boards of banking companies under Section 36AB of the Banking Regulation Act. One
  27. 27. or more additional directors may be so appointed when the bank is of the opinion that it is necessary to do so in the interest of: (a) banking policy (b) public (c) banking company (d) depositors of the banking company. ii. The directors so appointed shall not require any qualification shares. They hold office during the pleasure of the Reserve Bank. Subject to this, appointment may be for a period not exceeding three years or further extended periods not exceeding three years at a time as specified by the Reserve Bank. The additional directors are protected from any liability or obligation for executing their functions in good faith. The provisions of Section 36AB have overriding effect over other laws. 2.10 RESTRICTIONS ON EMPLOYMENT i. The Banking Regulation Act (Section 10) prohibits employment of managing agents and imposes restrictions on employment of certain type of persons, namely — (a) a person who is or has been adjudicated insolvent or has suspended payment or has compounded with his/her creditors; a nprtnn r 9 r*riminQl rrmrt rf 'An invnivina mortal 24 (c) a person whose remuneration or part thereof is by way of commission or share in the profits of the company; (d) a person whose remuneration is excessive in the opinion of the Reserve Bank. Before forming an opinion regarding the remuneration, the Reserve Bank has to consider the financial condition and history of the banking company, its area of operation, resources, volume of business and the trend of its earning capacity, number of its branches, qualifications, age and experience of the person concerned, remuneration of other personnel in the bank or persons holding similar positions in other banks and the interest of depositors. The above restrictions are applicable to workmen as well as management personnel, as held by the Supreme Court in Central Bank of India vs Their Workmen (AIR 1960 SC 12). However, the restriction on remuneration does not affect payment of bonus according to a settlement or award or in accordance with a scheme framed by the bank or in accordance with the prevailing practice in banking business. Commission paid to brokers, auctioneers, forwarding agents, etc., who are not regular members of the bank's staff, is also not covered by these provisions. ii. Persons who are directors of any company other than a subsidiary of a banking company or company registered under Section 25 of the Companies Act are also prohibited from managing a banking company. However, this prohibition shall not apply to a director for a temporary period of three months, or a further period not exceeding nine months, if allowed by the Reserve Bank.
  28. 28. Apart from this, persons engaged in any other, business or vocation or whose term of office as a person managing the company is for a period exceeding five years also fall in the prohibited category. However, the period of office can be renewed or extended for further periods not exceeding five years at a time. 2.11 CONTROLS OVER MANAGEMENT i. Power to remove Management and other personnel: The Reserve Bank is empowered under Section 36AA of the Banking Regulation Act to remove any chairman, director, chief executive officer (by whatever name called), or other officer or employee of a banking company. For this purpose, the bank has to be satisfied that it is necessary to do so. The bank (RBI) has the discretionary power to remove management and other personnel in the following circumstances: (a) Public interest (b) Preventing the affairs of the banking company being conducted in a manner detrimental to the interest of depositors (c) Securing proper management of the banking company. The Reserve Bank has to pass such an order recording the reasons in writing. Before passing the order, the affected person has to be given a reasonable opportunity of making a representation against the proposed order. Where an urgent action is required and delay would be against the interests of the company or its depositors, the Reserve Bank is empowered to direct by order, at the time of giving opportunity of making a representation that the person concerned shall not act in his/her official capacity or directly or indirectly take part in the management of the bank from the date of such order, pending consideration of the representation. The person so removed shall not be entitled to any compensation for loss of office notwithstanding anything contained in any law, the memorandum, articles or any contract to the contrary as the provisions of Section 36AA have overriding effect. ii. Appeal: An appeal against the order of removal lies with the Central Government. Such an appeal has to be filed within thirty days from the date of communication of the order. The appellate decision of the Central Government, and subject thereto the order of the Reserve Bank, shall be final and not liable to challenge in any Civil Court. 25 iii. Effect of the order of removal: On the Reserve Bank passing a removal order, the person concerned ceases to hold office which he/she was holding till then. Further, he/she is prohibited, from directly or indirectly taking part in the management of any banking company for a period not exceeding five years as may be specified in the order. Contravention of the order is punishable with a fine of Rs. 250 for each day during which the contravention continues. iv. Appointment of a suitable person: When any chairman, director, chief executive officer, other officer or employee is removed by the Reserve Bank under Section 36AA as above, the Reserve Bank may appoint a suitable person in his place. Such person shall hold office at the pleasure of the Reserve Bank. Subject to this, the appointment may be for a period not exceeding three years and is extendable for further periods not exceeding three years at a time. Such appointee shall not incur any obligation or liability for action taken in good faith in the execution of the duties of his office. 2.12 CORPORATE GOVERNANCE i. The Concept: Corporate governance is a dynamic concept involving promotion of corporate fairness, transparency and accountability in the interest of shareholders, employees, customers and other stakeholders. It is a concept of recent origin. However, there is considerable divergence in the understanding
  29. 29. and practice of corporate governance across different jurisdictions. The concept has evolved since the first major study by the Cadbury Committee in 1992. The DECO principles of corporate governance published in 1999, the first international code of good corporate governance approved by governments, was revised in 2004. Corporate governance can be seen as 'the way in which boards oversee the running of a company by its managers, and how board members are in turn accountable to shareholders and the company' and it has implications for company behaviour towards employees, shareholders, customers, banks and other stakeholders. Further, good corporate governance plays a vital role in ensuring the integrity and efficiency of financial markets and the lack of it can pave the way for financial difficulties and sometimes even fraud. ii. OECD Principles of Corporate Governance, 2004: The OECD principles of corporate governance, 2004 stipulate what the corporate governance framework should ensure, which is briefly as under: (a) Ensuring the basis for an effective corporate governance framework: To promote transparent and efficient markets which are consistent with the rule of law. Also, to articulate clearly the division of responsibilities among the different supervisory, regulatory and enforcement authorities. (b) The rights of shareholders and key ownership functions: To protect and facilitate the exercise of shareholders' rights. (c) The equitable treatment of shareholders: In the equitable treatment of shareholders are included the minority and foreign shareholders. Further, all shareholders should have the opportunity to obtain an effective redress for violation of their rights. (d) The role of stakeholders in corporate governance: To recognise the rights of stakeholders, established by law or through mutual agreements and encourage active cooperation between the corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises. (e) Disclosure and transparency: Timely and accurate disclosures made on all material matters, regarding the corporation, including the financial situation, performance, ownership, and governance of the company. (f) The responsibilities of the board: Strategic guidance of the company, effective monitoring of management by the board and the board's accountability to the company and the shareholders are the important aspects. These principles are applicable to all types of companies including banks. 26 iii. Corporate Governance and Banks: Banks hold a special position in corporate governance as they accept and deploy large amounts of public funds in fiduciary capacity and also leverage such funds through credit creation. The position of banks is also important for the smooth functioning of the payment system.
  30. 30. Accordingly, legal prescriptions for ownership and governance of banks laid down in the statutes are supplemented by regulatory prescriptions. The Basel Committee on Banking Supervision has issued guidance (February 2006) for promoting the adoption of sound practices of corporate governance by banking institutions. This guidance, entitled Enhancing Corporate Governance for Banking Organisations, highlights the importance of: • the roles of boards of directors (with a focus on the role of independent directors) and senior management • effective management of conflicts of interest • the roles of internal and external auditors, as well as internal control functionaries • governing in a transparent manner, especially where a bank operates in jurisdictions, or through structures, that may impede transparency • the role of supervisors in promoting and assessing sound corporate governance practices.(See, http://www.bis.org/press/pO6O213.htni). Apart from the fiduciary role of banks, their cross-border operations add a special dimension. This provides an added impetus for convergence in standards internationally. In almost all countries, the policy framework with regard to corporate governance involves a multiplicity of agencies. In India, the Department of Company Affairs, Securities and Exchange Board of India (in respect of listed entities) are involved apart from the Reserve Bank in respect of banks. iv. Reserve Bank's approach: Following the formal policy announcement in regard to corporate governance, in the mid term Review of the Monetary and Credit Policy, in October, 2001, the Reserve bank constituted a Consultative Group in November, 2001 under the chairmanship of Dr. A.S. Ganguly with a view to strengthen the internal supervisory role of the boards of banks. The report of the group was transmitted to all the banks for their consideration in June, 2002 and simultaneously to the Government of India for consideration. Earlier, an advisory group on corporate governance under the chairmanship of Dr. R.H. Patil had submitted its report in March, 2001 which examined the issues relating to corporate governance in banks in India, including the public sector banks and made recommendations to bring the governance standards in India on par with the best international standards. There were also some relevant observations by the advisory group on banking supervision under the chairmanship of Shri M.S. Verma which submitted its report in January, 2003. Keeping all these recommendations in view and the cross-country experience, the Reserve Bank initiated several measures to strengthen the corporate governance in the Indian banking sector, including the concept of 'fit and proper' criteria for directors of banks which included the process of collecting information, exercising due diligence and constitution of a nomination committee of the board to scrutinise the declarations made by the bank directors. The RBI guidelines on ownership and governance in the private sector banks released on February 28, 2005 (Paras 5 and 6) provide as under: Shareholding (i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on 3 February, 2004 will be applicable for any acquisition of shares of five per cent and above of the paid-up capital of the private sector bank. (ii) In the interest of diversified ownership of banks, the objective will be to ensure that no single entity or group of related entities has shareholding or control, directly or indirectly, in any bank in excess of ten per cent of the paid-up
  31. 31. capital of the private sector bank. Any higher level of 27 acquisition will be with the prior approval of RBI and in accordance with the guidelines of 3 February, 2004 for grant of acknowledgement for acquisition of shares. (iii) Where ownership is that of a corporate entity, the objective will be to ensure that no single individual/entity has ownership and control in excess of ten per cent of that entity. Where the ownership is that of a financial entity the objective will be to ensure that it is a well-established regulated entity, widely held, publicly listed and enjoys good standing in the financial community. (iv) Banks (including foreign banks having a branch presence in India)/FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's/FI's holding exceeds five per cent of the investee bank's equity capital as indicated in RBI circular dated 6 July, 2004. (v) As per the existing policy, large industrial houses will be allowed to acquire, by way of strategic investment, shares not exceeding ten per cent of the paid-up capital of the bank, subject to RBI's prior approval. Furthermore, such a limitation will also be considered, if appropriate, in regard to important shareholders with other commercial affiliations. (vi) In case of a restructuring of the problem/weak banks or in the interest of consolidation in the banking sector, RBI may permit a higher level of shareholding, including by a bank. 2.13 DIRECTORS AND CORPORATE GOVERNANCE (i) The board of directors should ensure that the responsibilities of directors are well defined and the banks should arrange need based training for the directors in this regard. While the respective entities should perform the roles envisaged for them, private sector banks will be required to ensure that the directors on their boards representing specific sectors, as provided under the B.R. Act, are indeed representatives of those sectors in a demonstrable fashion, they fulfil the criteria under corporate governance norms provided by the Ganguly Committee and they also fulfil the criteria applicable for determining 'fit and proper' status of important shareholders (i.e., shareholding of five per cent and above) as laid down in RBI circular dated 25 June, 2004. (ii) As a matter of desirable practice, not more than one member of a family or a close relative (as defined under Section 6 of the Companies Act, 1956) or an associate (partner, employee, director, etc.) should be on the board of a bank. (iii) Guidelines have been provided in respect of 'fit and proper' criteria for directors of banks by the RBI circular dated 25 June, 2004 in accordance with the recommendations of the Ganguly Committee on corporate governance. For this purpose a declaration and undertaking is required from the proposed/existing directors. (iv) Being a director, the CEO should satisfy the requirements of the 'fit and proper' criteria applicable for directors. In addition, RBI may apply any additional requirements for the chairman and CEO. The banks will be required to provide all information that may be required while making an application to RBI for approval of appointment of chairman/CEO. With regard to public sector banks, the principles of corporate governance have been statutorily recognised as per Banking Companies (Acquisition and Transfer of Undertakings) Financial Institutions Laws (Amendment) Act, 2006. The Act as amended provides for shareholder directors to be a person having 'fit and proper' status and the Reserve Bank has to notify the 'Fit and Proper' criteria [Section 9(2)].
  32. 32. 28 2.14 LET US SUM UP A company wanting to commence banking business requires prior licence from the Reserve Bank. The Reserve Bank has the discretion to reject licence or approve the licence on such conditions as it thinks fit. Before granting licence, Reserve Bank has to be satisfied by inspection or otherwise of the suitability of the company for licence. A licence once given may also be cancelled after giving the bank an opportunity to be heard. Further, for opening new branches or shifting branches outside a city, town or village, permission of the Reserve Bank is required. Banking companies have to have minimum capital and reserves as specified in the Banking Regulation Act. The shareholders of a banking company are entitled to dividends only after all the capitalised expenses are written off. The commission or brokerage payable on selling shares is restricted to two and half per cent of the paid-up value of the shares. The board of directors of a bank has to be constituted with persons having special knowledge or experience in accountancy, banking, economics, law, etc., as stipulated. The directors should not have substantial interest in other companies or firms. The maximum period of office is limited to eight years continuously. The Reserve Bank is empowered to reconstitute the board, if the board is not properly constituted. Every banking company should have a full-time chairman (or a fulltime managing director, if there is no full-time chairman) with the specified qualifications. The Reserve Bank has powers to remove the chairman and appoint a suitable person in his place in certain cases. The Reserve Bank also has powers to remove the directors or managerial personnel or other employees of banking companies. The principles of corporate governance including the 'fit and proper' criteria for directors apply to banking companies as well as public sector banks. 2.15 KEYWORDS Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place of Business; Substantial Interest; Subscribed Capital; Subsidiary. 2.16 CHECK YOUR PROGRESS 1. Fill in the gaps choosing the answers from the brackets. (i) A company has to obtain a from the Reserve Bank to commence banking business in terms of Section 22 of the BR Act. (registration; licence; commencement certificate) (ii) Shifting of a bank's branch in the same does not require Reserve Bank's permission arising out under Section 23. (district; state, city, town or village) (iii) Foreign banks are required under Section 11 of the BR Act to deposit of their business in India with the Reserve Bank, (twenty per cent of profit for each year; thirty per cent of profit for each year; twenty per cent of the deposits collected each year) (iv) Banks may float subsidiaries for carrying on the business specified in . (their Memorandum of Association; Section 6(1 )(a) to (o) of the BR Act; their Articles of Association) (v) A shareholder of a banking company can exercise voting rights up to of the total voting rights of all shareholders, (one per cent; ten per cent; hundred per cent) (vi) Banking companies are not permitted to give dividend until all are
  33. 33. written off. (bad debts, expenses, capitalised expenses) 2. Say whether True or False, (i) A temporary branch for less than thirty days in a town where a bank has an existing branch does not require permission from Reserve Bank. (ii) A company whose banking licence is rejected can undertake business as a moneylender or undertake other business, (iii) The decision of Reserve Bank to revoke licence is final and no appeal lies from it. 29 (iv) Banking companies are permitted to give brokerage up to two-and-half per cent of the paid-up value of shares. (v) No person can hold the shares of banks beyond ceiling specified under the BR Act. (vi) A banking company cannot hold shares in any other company other than a subsidiary. 3. Fill in the gaps choosing the answer from the brackets. (i) A director of a banking company should not have in any other company, (beneficial interest, any interest, substantial interest) (ii) At least of the directors should have the qualifications prescribed under Section 10A(2) of the BR Act. (50 per cent, 75 per cent, 51 per cent) (iii) When the board of a banking company is ordered to be reconstituted under Section 10A of the BR Act, directors will be removed for the purpose of reconstitution. (by rotation, by lots, by majority decision) (iv) Before removing the chairman of a bank from office, Reserve Bank has to . (give compensation for loss of office, give opportunity of being heard, give an option to continue as director) (v) The provisions of Section 36AA of the BR Act regarding removal of managerial personnel have over other laws, (no effect, overriding effect, persuasive effect) (vi) Reserve Bank is authorised to appoint under Section 36AB of the BR Act. (directors, additional directors, managing director) (vii) The (Central Government; RBI; SEBI) has stipulated the 'fit and proper' criteria for directors of banking companies. 4. Say whether True or False. (i) The maximum period of office that may be held continuously by an ordinary director in a banking company is eight years, (ii) The decisions of the board of directors, during the period when the board's constitution is defective shall be void. (iii) The post of chairman of a banking company may be on part-time basis, (iv) The chairman of a banking company can hold office only for a maximum period of eight years, (v) From the order removing chairman of a banking company, appeal lies to the Central Government within thirty days of the order. (vi) Reserve Bank has the power to remove any

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