“Regulation of Banking in India : An Analysis”

Project Submitted to:

Dr. Kiran Kori

(Faculty of Banking Law)

Project Submitted by:

Diksha Oraon

Semester IX, Section B

Roll No.46

Submitted on:

25.10.2018

Hidayatullah National Law University, Atal Nagar Raipur, Chhattisgarh.

 DECLARATION

I hereby declare that the project work entitled “The concept of execution of a decree”
submitted to Hidayatullah National Law University, Raipur, is record of an original work
done by me under the able guidance of Dr. Mohd. Aamir Khan ,Faculty of Civil Procedure
Code, HNLU, Raipur.

Diksha Oraon

Semester- IX

Section B

Roll no-46
ACKNOWLEDGEMENT

I feel highly elated to work on the topic “Regulation of Banking in India : an analysis” . The
practical realization of this project has obligated the assistance of many persons. I express my
deepest regard and gratitude for Mrs. Kiran Kori Mam, Faculty of Banking law. Her consistent
supervision, constant inspiration and invaluable guidance has been of immense help in
understanding and carrying out the nuances of the project report. I would like to thank my family
and friends without whose support and encouragement, this project would not have been a
reality. I take this opportunity to also thank the University and the Vice Chancellor for providing
extensive database resources in the Library and through Internet. Some printing errors might
have crept in, which are deeply regretted. I would be grateful to receive comments and
suggestions to further improve this project report.

Diksha Oraon

Semester- IX

Section B

Roll no-46
 TABLE OF CONTENT

Acknowledgements...........................................................................................................03
Chapter-I
Introduction.........................................................................................................................05
Objectives……………………………………………………………………………….….06
Research methodology…………………………………………………………………..…06
Chapter-II
Banking aspect in india……………………………………………………………………..07-09
Chapter-III
Regulations governing the banking in india…………………………………………….10-13
Conclusion…………………………………………………………………………………..14
Reference……………………………………………………………………………………..15
 CHAPTER-I

INTRODUCTION

In India, banking has developed from the primitive stage to the modern system of banking in a
fashion that has no parallel in the world history. With the dawn of independence, changes of vast
magnitude have taken place in India. After independence India launched a process of planned
economic activity in order to overcome the multitude of problems it faced as an underdeveloped
nation. The increasing tempo of economic activity leads to tremendous increase in the volume
and complexity of banking activity. Therefore, the role of banks has had to expand at a fast pace.
As engines of development and vehicle of silent Socio -economic revolution in the country,
Indian banks have assumed new responsibilities in the fields of geographical expansion,
functional diversification and personal portfolio. Indian banking transformed itself from Class
banking to Mass banking.
 OBJECTIVES

1. To study the concept of Banking regulations in India.

2. To study the regulatory policies of banking and its impact in Indian economy.

RESEARCH METHODOLOGY

The study is primarily doctrinal. Analytical, comparative, critical, historical and statistical
methods are also employed. An empirical study was conducted by the researcher to find out the
real problems faced by the displaced/interested persons in connection with the application of the
provisions of the Land Acquisition Act at the time of acquisition of land. The primary and
secondary sources include the Constitutions of various States, statutes, case law, international
instruments, authoritative treatises on jurisprudence, articles published in national and
international journals and web sites.

0
CHAPTER II

Banks are among the most regulated businesses. Ever since the inception of banking as a
business in the medieval period, the state has exercised some form of control. By the 19th
century, banks had become more numerous, larger, and a significant part of the economy in the
Western world. With that, the extent of control over them increased. By the end of the 20th
century, banks were subject not only to national but also international regulations, such as those
under the Basel regime.

While banks have been regulated since their inception, the approach to regulation has followed
an evolutionary path where we can discern different paradigms. In this article, I shall describe
two paradigms that were prevalent over the last two centuries and a third emergent one that may
become more relevant in the future. I will call these three paradigms the Money paradigm, the
Intermediation paradigm, and the emerging Marketplace paradigm.

The Money paradigm views banks essentially as monetary institutions whose primary role is to
“create” money. Until the end of 19th century, the main function of banks was to issue bank
notes that were then used as a means of exchange. Banks would issue notes against stocks of
gold (the earliest depositors were goldsmiths) that could be used as money. This practice set the
foundation of the gold standard which dominated until the mid-20th century.

When banks are seen primarily as issuers of money, issuing loans is incidental. The approach to
bank regulation focuses on the role they play in the creation and use of money, and on
controlling the price of money i.e interest rates. In most economies, there was some form of
interest rate regulation on liabilities up until the 1980s. Controlling the quantity of money issued
also resulted in adherence to the gold standard.

Central banks became more powerful in the 20th century, with a monopoly in issuance of money
which transformed note issuance of banks into deposits. Post World War II, under the Bretton
Woods system, the gold standard was abandoned and central banks started issuing “fiat” money,
making the money role much less important. The intermediation role became more prominent
and progressively became the focus of regulation. This led to the Intermediation paradigm of
regulation.

In the Intermediation paradigm, the role of banks is to use loans with deposits as “raw material”.
The Banking Regulation Act of 1949, which is the principal law for banking regulation in India,
defines banking as an activity of “accepting for the purpose of lending or investing, deposit of
money from public”, thus indicating the primacy of the Intermediation paradigm.

Regulating banks as financial intermediaries anchors regulations on the asset side. The most
prominent example of the Intermediation paradigm is the Basel regime that has at its core capital
regulation based on risk-weighted assets.

These two traditional paradigms of bank regulation sit somewhat uncomfortably with each other.
The Money paradigm results in some form of administered interest rates, which will invariably
result in mispricing of risk and, hence, misallocation of capital by banks due to artificially and
somewhat arbitrarily determined cost of funds. The Intermediation paradigm, on the other hand,
will mostly result in capital regulation with unregulated deposit pricing, which will invariably
dampen monetary transmission. Policy conversations on monetary policy transmission focus on
lending rates of banks, with very little, if any, attention paid to deposit pricing. As a result, the
banking channel is quite poor in transmitting monetary policy, as we witness in India.

With the development of financial markets, the role of banks has evolved. Banks have more
tradable assets and liabilities on their balance sheets. With this, a third paradigm has emerged,
which we could call the Marketplace.

The banking system can be viewed as a marketplace for funds where banks act as market
makers. We could view the two sides of the balance sheets of banks as autonomous businesses
that operate under independent competitive dynamics. Banks, as market makers, are constantly
giving two-way quotes (the bid-ask quotes) through deposit and loan pricing. Regulating market
making is primarily about regulating the liquidity provided by the market maker. It means that
the primary approach to banking regulation should be to act on both sides of the balance sheet so
that the system stays liquid.

In the more developed financial systems, there is a clear evolution of the regulatory approach
from the Money to the Marketplace paradigm, reflecting the underlying evolution in the role and
functioning of banks. As the financial markets develop in India and bank balance sheets have
more tradable securities and loans, this paradigm will become more relevant. But we are not
there yet. A comprehensive approach should carefully balance these three paradigms. Banks are
a collection of several businesses and activities. For specific businesses or activities, one of the
three paradigms may be more relevant.

Banks are complex and regulating them is always challenging. Their central role in the economy,
especially for a developing country like India, means that regulating banks is an important
component of the management of the overall economy. Effective regulation must recognize the
complexity of banks. Striking a balance between the three paradigms outlined above can help in
more effective regulation.

Legal Framework

The Indian banking system is primarily governed by Banking Regulation Act, 1949. The
Reserve Bank of India Act, 1934 empowers the RBI (Reserve Bank of India) to act on a wide
range of issues including rules, regulations, directions and guidelines with respect to banking and
financial services. The RBI is the central bank of India. Besides the above, the FEMA (Foreign
Exchange Management Act, 1999) regulates with respect to cross-border transactions.
Reserve Bank of India (RBI) - The primary regulator for banks in India is RBI. The functions of
RBI include:

 Making norms for opening up and licensing banks (including foreign bank branches

in India)

 Corporate governance and organization

 Norms for various products and services

 Finalizing monetary policy

 Regulation of foreign exchange, government securities markets and financial

derivatives

 Government debt and cash management

 Overseeing payment and settlement systems

 Currency Management

 To liaise with other financial sector regulators like SEBI, IRDAI etc. RBI needs to

regulate banking activities which overlap or have an interaction with financial

activities under the domain of other financial sector regulators.

Supervision and legislation on the functioning of banks and financial institutions is also done by

the Ministry of Finance (under Central Government) through the Department of Financial

Services. The Department of Financial Services does:

 Monitoring of banking operations

 Prescribes norms for the operation of public sector banks.

 Looks into the recovery of bank debts by way of examining legislative measures and

establishing judicial mechanisms for the same.

CHAPTER-III

The Regulations That Govern Banking in India

The banking system in India is regulated by the Reserve bank of India ( RBI), through the
provisions of the Banking Regulation Act, 1949. Some important aspects of the regulations that
govern banking in this country, as well as RBI circulars that relate to banking in India, will be
explored below.

 Exposure limits - Lending to a single borrower is limited to 15% of the bank’s capital
funds (tier 1 and tier 2 capital), which may be extended to 20% in the case of
infrastructure projects. For group borrowers, lending is limited to 30% of the bank’s
capital funds, with an option to extend it to 40% for infrastructure projects. The lending
limits can be extended by a further 5% with the approval of the bank's board of directors.
Lending includes both fund-based and non-fund-based exposure.

 Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)- Banks in India are
required to keep a minimum of 4% of their net demand and time liabilities (NDTL) in the
form of cash with the RBI. These currently earn no interest. The CRR needs to be
maintained on a fortnightly basis, while the daily maintenance needs to be at least 95% of
the required reserves. In case of default on daily maintenance, the penalty is 3% above
the bank rate applied on the number of days of default multiplied by the amount by which
the amount falls short of the prescribed level. Over and above the CRR, a minimum of
22% and a maximum of 40% of NDTL, which is known as the SLR, needs to be
maintained in the form of gold, cash or certain approved securities. The excess
SLR holdings can be used to borrow under the Marginal Standing Facility (MSF) on an
overnight basis from the RBI. The interest charged under MSF is higher than
the repo rate by 100 bps, and the amount that can be borrowed is limited to 2% of NDTL.
(To learn more about how interest rates are determined, particularly in the U.S., consider
reading more about who determines interest rates.)

 Provisioning- Non-performing assets (NPA) are classified under 3 categories:

substandard, doubtful and loss. An asset becomes non-performing if there have been no
interest or principal payments for more than 90 days in the case of a term loan.
Substandard assets are those assets with NPA status for less than 12 months, at the end of
which they are categorized as doubtful assets. A loss asset is one for which the bank
or auditor expects no repayment or recovery and is generally written off the books. For
substandard assets, it is required that a provision of 15% of the outstanding loan amount
for secured loans and 25% of the outstanding loan amount for unsecured loans be made.
For doubtful assets, provisioning for the secured part of the loan varies from 25% of the
outstanding loan for NPAs that have been in existence for less than one year, to 40% for
NPAs in existence between one and three years, to 100% for NPA’s with a duration of
more than three years, while for the unsecured part it is 100%. Provisioning is also
required on standard assets. Provisioning for agriculture and small and medium
enterprises is 0.25% and for commercial real estate it is 1% (0.75% for housing), while it
is 0.4% for the remaining sectors. Provisioning for standard assets cannot be deducted
 from gross NPA’s to arrive at net NPA’s. Additional provisioning over and above the
standard provisioning is required for loans given to companies that have
unhedged foreign exchange exposure.

 Priority sector lending - The priority sector broadly consists of micro and small
enterprises, and initiatives related to agriculture, education, housing and lending to low-
earning or less privileged groups (classified as "weaker sections"). The lending target of
40% of adjusted net bank credit (ANBC) (outstanding bank credit minus certain bills and
non-SLR bonds) – or the credit equivalent amount of off-balance-sheet exposure (sum of
current credit exposure + potential future credit exposure that is calculated using a credit
conversion factor), whichever is higher – has been set for domestic commercial
banks and foreign banks with greater than 20 branches, while a target of 32% exists for
foreign banks with less than 20 branches. The amount that is disbursed as loans to the
agriculture sector should either be the credit equivalent of off-balance-sheet exposure, or
18% of ANBC – whichever of the two figures is higher. Of the amount that is loaned to
micro-enterprises and small businesses, 40% should be advanced to those
enterprises with equipment that has a maximum value of 200,000 rupees, and plant and
machinery valued at a maximum of half a million rupees, while 20% of the total amount
lent is to be advanced to micro-enterprises with plant and machinery ranging in value
from just above 500,000 rupees to a maximum of a million rupees and equipment with a
value above 200,000 rupees but not more than 250,000 rupees. The total value of loans
given to weaker sections should either be 10% of ANBC or the credit equivalent amount
of off-balance sheet exposure, whichever is higher. Weaker sections include specific
castes and tribes that have been assigned that categorization, including small farmers.
There are no specific targets for foreign banks with less than 20 branches. The private
banks in India until now have been reluctant to directly lend to farmers and other weaker
sections. One of the main reasons is the disproportionately higher amount of NPA’s from
priority sector loans, with some estimates indicating it to be 60% of the total NPAs. They
achieve their targets by buying out loans and securitized portfolios from other non-
banking finance corporations (NBFC) and investing in the Rural Infrastructure
Development Fund (RIDF) to meet their quota.

 New bank license norms- The new guidelines state that the groups applying for a license
should have a successful track record of at least 10 years and the bank should be operated
through a non-operative financial holding company (NOFHC) wholly owned by the
promoters. The minimum paid-up voting equity capital has to be five billion rupees, with
the NOFHC holding at least 40% of it and gradually bringing it down to 15% over 12
years. The shares have to be listed within three years of the start of the bank’s operations.
The foreign shareholding is limited to 49% for the first five years of its operation, after
which RBI approval would be needed to increase the stake to a maximum of 74%. The
board of the bank should have a majority of independent directors and it would have to
comply with the priority sector lending targets discussed earlier. The NOFHC and the
bank are prohibited from holding any securities issued by the promoter group and the
bank is prohibited from holding any financial securities held by the NOFHC. The new
regulations also stipulate that 25% of the branches should be opened in
previously unbanked rural areas.
  Willful defaulters- A willful default takes place when a loan isn’t repaid even though
resources are available, or if the money lent is used for purposes other than the designated
purpose, or if a property secured for a loan is sold off without the bank's knowledge or
approval. In case a company within a group defaults and the other group companies that
have given guarantees fail to honor their guarantees, the entire group can be termed as a
willful defaulter. Willful defaulters (including the directors) have no access to funding,
and criminal proceedings may be initiated against them. The RBI recently changed the
regulations to include non-group companies under the willful defaulter tag as well if they
fail to honor a guarantee given to another company outside the group.

 The Bottom Line- The way a country regulates its financial and banking sectors is in
some senses a snapshot of its priorities, its goals, and the type of financial landscape and
society it would like to engineer. In the case of India, the regulations passed by its reserve
bank give us a glimpse into its approaches to financial governance and shows the degree
to which it prioritizes stability within its banking sector, as well as economic
inclusiveness.

Though the regulatory structure of India's banking system seems a bit conservative, this has to be
seen in the context of the relatively under-banked nature of the country. The excessive capital
requirements that have been set are required to build up trust in the banking sector while the
priority lending targets are needed to provide financial inclusion to those to whom the banking
sector would not generally lend given the high level of NPA’s and small transaction sizes.

Since the private banks, in reality, do not directly lend to the priority sectors, the public banks
have been left with that burden. A case could also be made for adjusting how the priority sector
is defined, in light of the high priority given to agriculture, even though its share of GDP has
been going down.
Regulatory Development in recent times

To reinforce the ability of the lender to deal with distressed assets, the Reserve Bank of India has

issued guidelines and norms on distressed asset resolution by lenders. The RBI has issued a

notification on “Guidelines on Sale of Stressed Assets by Banks” as a part of the already existing

“Framework for Revitalising Distressed Assets in the Economy”. The framework and guideline

have been created as a part of the enforcement of and regulations under the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI

Act). The Insolvency and Bankruptcy Code, 2016 (IBC) seeks to consolidate the existing

framework by creating a single law for insolvency and bankruptcy. The bankruptcy code is a

one-stop solution for resolving insolvencies which at present is a long drawn process and fails to

offer an economically viable solution.

Conclusion

The Indian banking system is primarily governed by Banking Regulation Act, 1949. The RBI is

the central bank of India and also the primary regulator of banks. There are various types of

banks, like state-owned, commercial, investment, co-operative banks. Any entity that wants to do

banking business has to obtain a license from the Reserve Bank of India (RBI). The Insolvency

and Bankruptcy Code, 2016 (IBC) seeks to consolidate the existing framework by creating a

single law for insolvency and bankruptcy. Regulation of a country’s banking sector is a

reflection of its priorities and financial landscape. In India’s case, the Reserve Bank of India’s

approach has been to prioritize stability and achieve financial inclusiveness.

REFERENCES

BOOKS:

 C.P CHANDRASHEKHAR AND JAYATI GHOSH;2004,”ASPECTS OF INDIAN

ECONOMY”.

WEBSOURCES

 www.rbi.org.in

 www.yourarticlelibrary.com

 www.morning star.com

 www.erewise.com