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Regulatory framework
What are the principal governmental and regulatory policies that govern the banking sector?
The Reserve Bank of India Act, 1934 (the RBI Act) and the Banking Regulation Act, 1949 (the BR Act) are the primary pieces of legislation governing the banking sector in India.
The RBI Act constituted the Reserve Bank of India (RBI), which is the central bank of India and the primary regulatory authority for the banking sector. To implement regulatory policies in India, the RBI Act and the BR Act empower the RBI to issue rules, regulations, directions and guidelines on a wide range of issues relating to the banking and financial sector.
Transactions related to foreign exchange, current and capital account transactions are also regulated by the RBI by virtue of the powers granted to it under the Foreign Exchange Management Act, 1999 (FEMA).
There are also other supplementary pieces of legislation regulating the banking sector, such as:
What are the defining characteristics of a bank to be caught by the banking laws and regulations? Is non-bank fintech regulated differently?
The defining characteristics of a bank are generally understood to be fundamental banking services, such as acceptance of deposits and providing loans. The BR Act defines 'banking' to include acceptance of deposits of money from the public for the purpose of lending or investment, which are repayable on demand or otherwise and withdrawable by cheques, draft, order or otherwise.
As a general rule, any banking services or activities conducted in India must be licensed by the RBI. In this regard, the definition of banking activities and services is very broad, and may be extended to different scopes of activities. There is always a risk, even if remote, that such activities may be interpreted as being banking activities. Therefore, any entity that provides such services may trigger licensing requirements depending on the nature of banking activity, product and market.
Further, in terms of section 22 of the BR Act, no company can carry on banking business in India unless it holds a licence issued by the RBI to do so.
Non-bank fintech entities are regulated differently by the RBI and this would depend upon the nature of the activities of the fintech entity. Non-bank fintech entities typically engage in the business of digital lending or digital payments. Some of these entities include the following.
There is no umbrella legislation for regulating non-bank fintech activities. Such activities are typically regulated under the relevant guidelines or directions applicable to their business. Some of the key regulations that govern fintech products in India include the PSS Act, the Master Direction on Prepaid Payment Instruments (dated 27 August 2021), the NBFC-P2P Directions and the Guidelines on Regulation of Payment Aggregators and Payment Gateways (dated 17 March 2020).
The various regulations prescribe different requirements for such non-bank fintech entities in terms of, among others:
Do the rules vary depending on the size or complexity of the banking institution?
Rules vary depending on the size and complexity of the activities as well as the structure, etc, of the banking institution. Banks in India can be broadly categorised under one of two categories: commercial banks and cooperative banks.
Commercial banks include:
Scheduled commercial banks are authorised by the RBI to perform all banking functions, whereas RRBs provide credit facilities for agricultural purposes to rural areas.
Cooperative banks are divided into two categories:
In 2015, the RBI introduced payments banks to provide basic banking and remittance-related facilities, and to accept small deposits.
Primary and secondary legislation
Summarise the primary statutes and regulations that govern the banking industry.
There are different categories of banks set up for different purposes. Therefore, there are various statutes and regulations made under the following statutes, which govern and regulate banks set up for specific purposes.
The RBI Act was enacted to constitute the RBI. The RBI’s primary objectives are to regulate the issue of bank notes, keep reserves to ensure stability in the monetary system, and operate the nation’s currency and credit system effectively.
The main provisions of the RBI Act are:
The BR Act was enacted to consolidate and amend the laws relating to banking in India. This act lays down how the banks in India should conduct their business. For example, the type of business they can engage in, the eligibility requirements for a person to be appointed on the board of a bank, the amount of minimum and paid-up capital and reserves a bank should have, and the type of subsidiary companies they can incorporate are contained in the BR Act.
The BR Act also empowers the RBI to have control over the management of a bank, and deals with suspending the business of a bank and speedy disposal of winding-up proceedings of banks.
FEMA was enacted to consolidate and amend the laws relating to foreign exchange. The main objective of FEMA is to facilitate external trade and payments, and promote the development of the foreign exchange market in India.
FEMA also deals with regulation and management of foreign exchange by regulating which entities can deal, hold and transact in foreign exchange. For this purpose, FEMA designates the RBI to authorise any person to act as an authorised dealer, a money changer or an offshore banking unit.
Further, FEMA lays down contraventions and the penalties that can be imposed for violating its provisions.
The Negotiable Instruments Act, 1881
The Negotiable Instruments Act, 1881 relates to promissory notes, bills of exchange and cheques, etc.
The RDDB Act provides for the recovery of debts that are due to banks and other financial institutions. The RDDB Act also governs the establishment of tribunals and an appellate tribunal for the efficient adjudication of disputes.
The Bankers Books Evidence Act, 1891
The Bankers Books Evidence Act, 1891 (the BBE Act) defines a banker’s book to include ledgers, day books, cash books, account books and all other records used in the ordinary business of a bank. The BBE Act also lays down the conditions that must be fulfilled when banker’s books are to be admitted as material evidence before an adjudicating authority.
The PSS Act provides for the supervision and regulation of payment systems in India. The RBI is authorised under the PSS Act to constitute the Board for Regulation and Supervision of Payment and Settlement Systems.
The SARFAESI Act
The SARFAESI Act was enacted to expedite the recovery of non-performing assets by banks and financial institutions. Under the SARFAESI Act, attached assets can be managed by the bank, or put up for sale or auction without the intervention of a court.
The Integrated Ombudsman Scheme, 2021
The RBI issued the Integrated Ombudsman Scheme, 2021 (the 2021 Scheme) to provide cost-free redress of customer complaints that involve a deficiency in services rendered by entities regulated by the RBI. The 2021 Scheme integrates the three existing ombudsman schemes pertaining to banking (introduced in 2006), NBFCs (introduced in 2018) and system participants (introduced in 2019). The 2021 Scheme adopts a 'one nation, one ombudsman' approach by making the redress mechanism jurisdiction neutral.
Besides the aforementioned statutory laws, the RBI issues directions, prudential regulations, master circulars, master directions, and other guidelines and instructions from time to time for effective regulation in the banking sector.
Which regulatory authorities are primarily responsible for overseeing banks?
The RBI is the supervisory authority responsible for overseeing the operations and management of the Indian banking sector.
Government deposit insurance
Describe the extent to which deposits are insured by the government. Describe the extent to which the government has taken an ownership interest in the banking sector and intends to maintain, increase or decrease that interest.
The Deposit Insurance and Credit Guarantee Corporation Act, 1961 was enacted to establish the Deposit Insurance and Credit Guarantee Corporation (DICGC). The DICGC insures all deposits of commercial banks, including branches of foreign banks functioning in India, local area banks and RRBs.
Specifically, the DICGC insures all deposits – such as savings, fixed, current, recurring, etc – but does not insure:
The liability of the DICGC in respect of the deposits insured is to the extent of 500,000 rupees. This insured amount is for both the principal and the interest amount held by the depositor.
Regarding the role of government ownership in the banking sector, PSBs are banks in India where the majority stake (more than 50 per cent) is held by the Indian government. There were 14 private banks commercialised in 1969, while another six were nationalised in 1980. The central government has worked towards the consolidation of PSBs over the past couple of years, as a result of which there are only 12 PSBs that function as at January 2022.
Transactions between affiliates
Which legal and regulatory limitations apply to transactions between a bank and its affiliates? What constitutes an ‘affiliate’ for this purpose? Briefly describe the range of permissible and prohibited activities for financial institutions and whether there have been any changes to how those activities are classified.
The term 'affiliate' has not been defined under any banking statutes. However, the Master Circular on Para-banking Activities (dated 1 July 2015) (the Para-banking Circular) defines 'subsidiary' as an enterprise controlled by another enterprise, known as the 'parent'.
Under the BR Act, banks can form subsidiaries after obtaining the prior approval of the RBI. Banks may form subsidiaries to undertake certain business activities that a bank is allowed to undertake under the provisions of the BR Act. These subsidiaries are also permitted to carry on the business of banking exclusively outside India. Among other things, activities that subsidiaries of banks can undertake include:
The Para-banking Circular also puts investment ceilings on the banks when investing in subsidiaries and other companies. Under the provisions of the BR Act, a banking company cannot hold shares in any company whether as pledgee, mortgagee or absolute owner of an amount exceeding 30 per cent of the paid-up share capital of that company, or 30 per cent of its own paid-up share capital and reserves, whichever is the lesser. There are various other prudential regulations for banks’ investments in subsidiaries and financial services companies, such as the ceiling on equity investment in a subsidiary.
In relation to financial activities that are prohibited under the BR Act, section 8 of the BR Act prohibits any banking company from directly or indirectly dealing in the buying and selling or bartering of goods, except when it is in connection with the realisation of security given to the bank or being held by it. Banking companies cannot engage in any trade, or buy, sell or barter any goods for any transaction otherwise than in connection with bills of exchange received for collection or negotiation.
What are the principal regulatory challenges facing the banking industry?
The principal regulatory challenges facing the banking industry in recent times are as follows:
Are banks subject to consumer protection rules?
Banking is a service industry that deals with a variety of customers who need to be protected against deficiencies in the services extended to them. Bank customers are covered under the definition of 'consumer' and can take recourse through the Consumer Protection Act, 2019. In addition to this, the 2021 Scheme provides a cost-free redress mechanism for resolving customer complaints that involve deficiency in services rendered by banks.
Further, in its Master Circular on Customer Service in Banks (dated 1 July 2015), the RBI issued instructions to the banks regarding the matter of customer service. It lays down that banks must have a well-documented customer compensation policy that should be approved by the bank’s board. The policy should include aspects such as erroneous debits arising on fraudulent or other transactions, payment of interest for delays in collection, payment of interest for delay in issue of duplicate draft and other unauthorised actions of the bank leading to a financial loss to the customer.
Banks must also have a well-documented customer grievance redressal policy for resolving complaints fairly and expeditiously, regardless of the source of the complaints, wherein a time frame is fixed for resolving the received complaints.
The Banking Codes and Standards Board of India (BCSBI), in collaboration with the Indian Banks’ Association, has also set forth its Bank’s Commitment to Customers Code (the BCSBI Code), wherein the members of the BCSBI have to comply with minimum standards of banking practices. The BCSBI Code lays down the right to a grievance redress mechanism and compensation, and states the obligations of the bank when dealing with the problems of the customers.
In addition to the above, in 2021, the RBI also introduced a comprehensive framework for dealing with customer grievances in its Strengthening of Grievance Redress Mechanism in Banks Circular, which details:
The above measures have been put in place because of increasing numbers of grievances relating to the banking practices followed by banks.
In what ways do you anticipate the legal and regulatory policy changing over the next few years?
Dedicated fintech department
Acknowledging the dynamic and growing financial landscape, and with a focus on facilitating innovation in the fintech sector, the RBI has set up a fintech department. This department will be responsible for promoting innovation in this sector as well as identifying challenges and opportunities associated with it to address them in a timely manner. This department is also expected to be responsible for taking up some of the pressing issues in the fintech industry, including the launch of India’s first central bank digital currency (CBDC).
India’s first bad bank
As at March 2021, the total non-performing assets (NPAs) in the banking system amounted to approximately 8.35 trillion rupees. To resolve the rise in NPAs, the central government set up the National Asset Reconstruction Company Limited, popularly referred to as a 'bad bank', to consolidate and take over stressed debt from banks based on decided characteristics. The aggregation of assets is expected to assist in turning around such assets and eventually offloading them to other potential investors for further value unlocking.
Regulation of cryptocurrencies
The debate on banning versus regulating cryptocurrency in India has been gaining momentum over the past few years. From a blanket ban imposed by the RBI on dealing with cryptocurrencies in 2016, the government’s stance on cryptocurrency and digital assets has changed considerably. Currently, there is neither any regulation nor any ban on the use of cryptocurrencies in India. However, the fate of cryptocurrencies is currently pending with the upcoming Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which is yet to be passed by the central government. While the draft of the bill has not been made public, it seeks to prohibit all private cryptocurrencies in India and instead seeks to introduce India’s first CBDC.
Introduction of pre-packaged insolvency
The Insolvency and Bankruptcy Board of India, realising the financial stress caused by the covid-19 pandemic on the MSME sector, introduced a pre-packaged insolvency resolution process (the PPIR Process). The PPIR Process contemplates the resolution of debt of MSMEs through a direct agreement between secured creditors and the existing owners or outside investors, instead of a public bidding process. The PPIR Process will give a boost to the MSME sector with an opportunity to restructure their liabilities and start with a clean slate.
Resolution of stressed assets
The Indian government, with the help of the RBI and the Insolvency and Bankruptcy Board of India, has been proactive in the amendment of the 2016 Code to address the issue of stressed assets plaguing banks in India.
Law stated date
Give the date on which the information above is accurate.
