Banking Regulations CBCFB5T09B

Syllabus topics (RTMNU)

• Evolution of Banking Regulation in India
• Structure of the Indian Banking System: Commercial Banks, Cooperative Banks, Regional Rural Banks, Small Finance Banks and Payment Banks
• Role and Functions of Reserve Bank of India
• Overview of Banking Regulation Act, 1949
• Reserve Bank of India Act, 1934

Evolution of Banking Regulation in India

Banking regulation means the laws, rules and supervision by which the government and the central bank control banks, so that depositors' money is safe and the banking system stays stable.

1. Before Independence: Banks were set up under the Companies Act. Many banks failed (e.g. in the 1913–17 and 1938–39 crises). The Reserve Bank of India Act, 1934 created the RBI (started 1 April 1935).
2. 1949: RBI was nationalised (1 January 1949) and the Banking Companies Act, 1949 was passed – renamed the Banking Regulation Act in 1966, when it was also applied to cooperative banks.
3. Social control and nationalisation: SBI was formed in 1955; 14 major banks were nationalised in 1969 and 6 more in 1980 to take banking to villages and priority sectors.
4. 1975–76: Regional Rural Banks set up (RRB Act, 1976). NABARD formed in 1982.
5. Reforms after 1991: Narasimham Committee (1991 and 1998) – prudential norms, capital adequacy, lower CRR/SLR, new private banks, DRTs (1993).
6. 2000s onwards: SARFAESI Act 2002, Basel II and III, Insolvency and Bankruptcy Code 2016, small finance and payments banks (licences 2015), mergers of public sector banks (2019–20), Banking Regulation (Amendment) Act 2020 giving RBI more control over cooperative banks, digital banking rules.

Structure of the Indian Banking System

RBI is at the top as the central bank and regulator. Below it are:

Role and Functions of Reserve Bank of India

RBI is India's central bank, set up on 1 April 1935 under the RBI Act, 1934, with headquarters in Mumbai.

1. Issue of currency notes (except ₹1 notes and coins, issued by the Government) – Section 22 of the RBI Act.
2. Banker to the Government: Keeps government accounts, manages public debt, gives ways and means advances.
3. Banker's bank: Banks keep CRR with RBI; RBI acts as lender of last resort.
4. Monetary policy: The Monetary Policy Committee fixes the repo rate to keep inflation within the target (4% ± 2%) – check the latest repo rate.
5. Regulator and supervisor of banks, NBFCs, payment systems.
6. Manager of foreign exchange under FEMA 1999 and custodian of forex reserves.
7. Controller of credit: Through CRR, SLR, open market operations, repo, selective credit control.
8. Developmental role: Financial inclusion, priority sector lending, digital payments (UPI with NPCI), financial literacy.
9. Consumer protection through the Ombudsman scheme.

Overview of Banking Regulation Act, 1949

The BR Act is the main law regulating banks. Important provisions:

1. Section 5(b): Defines banking – accepting deposits of money from the public for lending or investment, repayable on demand or otherwise, and withdrawable by cheque, draft or order.
2. Section 6: Lists the business a bank may do; Section 8 bars trading in goods.
3. Section 22: Licence from RBI needed to start banking.
4. Section 23: RBI permission for opening branches.
5. Section 24: Statutory Liquidity Ratio (SLR).
6. Minimum capital, restrictions on loans to directors, management and board rules.
7. Section 35: RBI inspection; Section 35A: RBI can give directions.
8. Power to remove directors/managers, to supersede boards, to impose penalties.
9. Section 45: Moratorium and reconstruction/amalgamation of weak banks (e.g. Yes Bank 2020).
10. Returns, accounts and audit (Section 29, 30).

Overview of Reserve Bank of India Act, 1934

1. Establishment, capital and management of RBI (Central Board of Directors).
2. Section 17: Business RBI can do.
3. Section 22: Sole right to issue bank notes.
4. Section 42: Scheduled banks to keep Cash Reserve Ratio with RBI.
5. Chapter III-B (Section 45-IA etc.): Registration and regulation of NBFCs.
6. Section 45ZB: Monetary Policy Committee (added 2016).
7. Second Schedule – list of scheduled banks; RBI's power to collect credit information.

Likely exam questions

1. (Long, 8/16 marks) Trace the evolution of banking regulation in India and explain the structure of the Indian banking system.
2. (Long, 8/16 marks) Explain the role and functions of the Reserve Bank of India. Give an overview of the Banking Regulation Act, 1949.
3. (Short, 4 marks) Distinguish between Small Finance Banks and Payments Banks.
4. (Short, 4 marks) Write a note on Regional Rural Banks.
5. (Short, 4 marks) State the main provisions of the RBI Act, 1934.

Syllabus topics (RTMNU)

• Licensing of Banks: Conditions and Procedure
• Branch Authorisation Policy
• Capital Structure of Banks
• Capital Adequacy Norms (Basel Framework – Basic Overview)
• CRR and SLR
• Income Recognition and Asset Classification (IRAC Norms)
• Non-Performing Assets (NPA): Classification and Provisioning Norms
• Risk Management in Banks (Credit, Market, Operational Risk)

Licensing of Banks: Conditions and Procedure

Under Section 22 of the BR Act, 1949, no company can carry on banking in India without a licence from RBI.

Conditions RBI checks (Section 22(3)):

1. The company can pay its present and future depositors in full.
2. Its affairs are not conducted against the interest of depositors.
3. It has adequate capital structure and earning prospects.
4. The general character of management is sound ("fit and proper" promoters).
5. Public interest will be served by the licence.
6. Banking needs of the area and competition are considered.

Procedure (as per RBI's "on-tap" licensing guidelines for universal banks, 2016, and for SFBs, 2019 – check latest):

1. Promoters (individuals with 10 years' banking/finance experience, or eligible entities) apply to RBI in the prescribed form.
2. Minimum paid-up capital: ₹500 crore for a universal bank; ₹200 crore for a small finance bank; ₹100 crore for a payments bank – check latest.
3. RBI and a Standing External Advisory Committee scrutinise the application.
4. RBI gives an "in-principle" approval, valid for 18 months, within which the bank must be set up.
5. After compliance, RBI issues the final licence; the bank starts business and is included in the Second Schedule.

Branch Authorisation Policy

Under Section 23 of the BR Act, banks need RBI permission to open branches. RBI has liberalised this:

1. Domestic scheduled commercial banks have general permission to open banking outlets anywhere, without asking RBI each time (rationalised policy of 2017).
2. At least 25% of new banking outlets opened in a year must be in unbanked rural centres.
3. A "banking outlet" includes a fixed-point Business Correspondent (BC) outlet open at least 4 hours a day, 5 days a week.
4. Foreign banks, RRBs, cooperative banks, SFBs and payments banks follow separate rules.

Capital Structure of Banks

Bank capital is divided into:

1. Tier I (core) capital: Common Equity Tier 1 (CET1) – paid-up equity, share premium, statutory and free reserves; and Additional Tier 1 – perpetual bonds (AT1).
2. Tier II (supplementary) capital: Revaluation reserves (at a discount), general provisions, subordinated debt.

Banks are highly leveraged – most funds are deposits – so capital is the cushion that absorbs losses.

Capital Adequacy Norms (Basel Framework – Basic Overview)

Capital adequacy ratio (CRAR/CAR) = (Tier I + Tier II capital) ÷ Risk-Weighted Assets × 100.

1. Basel I (1988): Minimum 8% capital against credit risk. India adopted it in 1992.
2. Basel II (2004): Three pillars – (1) minimum capital for credit, market and operational risk, (2) supervisory review, (3) market discipline (disclosure).
3. Basel III (2010): Better quality capital, capital conservation buffer, leverage ratio, liquidity ratios (LCR and NSFR), counter-cyclical buffer.

In India RBI requires a minimum CRAR of 9% (stricter than Basel's 8%) plus a Capital Conservation Buffer of 2.5%, i.e. 11.5% in all; minimum CET1 is 5.5% (8% with the buffer) – check latest.

Illustration: Tier I ₹900 crore, Tier II ₹300 crore, risk-weighted assets ₹10,000 crore. CRAR = 1,200 ÷ 10,000 × 100 = 12%, which is above 11.5%, so the bank meets the norm.

CRR and SLR

Current rates change with RBI policy – check the latest RBI figures.

Income Recognition and Asset Classification (IRAC Norms)

1. Income recognition: Interest is recognised on accrual basis only for performing assets. On an NPA, interest is booked only when actually received; unpaid interest already booked is reversed.
2. Asset classification: Loans are classified by how long they have been overdue (below).
3. Provisioning: A set % of each class is kept aside as provision.

Non-Performing Assets (NPA): Classification and Provisioning Norms

NPA: A loan or advance where interest or instalment of principal remains overdue for more than 90 days (for agricultural loans: two crop seasons for short-duration crops, one crop season for long-duration crops). Before NPA, banks flag stress as SMA-0 (1–30 days), SMA-1 (31–60) and SMA-2 (61–90).

Illustration: Standard ₹500 cr × 0.40% = ₹2 cr; Sub-standard ₹40 cr × 15% = ₹6 cr; Doubtful D1 secured ₹20 cr × 25% = ₹5 cr and unsecured ₹5 cr × 100% = ₹5 cr; Loss ₹10 cr × 100% = ₹10 cr. Total provision = ₹28 crore.

Risk Management in Banks (Credit, Market, Operational Risk)

1. Credit risk: Borrower fails to repay. Managed by credit appraisal, credit rating, collateral, exposure limits, diversification, CIBIL checks.
2. Market risk: Loss from changes in interest rates, exchange rates, share prices. Managed by ALM (asset-liability management), gap analysis, Value at Risk, hedging.
3. Operational risk: Loss from failed processes, people, systems or outside events – frauds, cyber attacks, errors. Managed by internal controls, audit, IT security, insurance, business continuity plans.
4. Others: liquidity risk (LCR), reputational risk. Banks have a Risk Management Committee of the Board and a Chief Risk Officer.

Likely exam questions

1. (Long, 8/16 marks) Explain the conditions and procedure for licensing of banks in India. State the branch authorisation policy.
2. (Long, 8/16 marks) What is an NPA? Explain the IRAC norms with classification of assets and provisioning requirements.
3. (Short, 4 marks) Write a short note on the Basel framework.
4. (Short, 4 marks) Distinguish between CRR and SLR.
5. (Short, 4 marks) Explain credit, market and operational risk in banks.

Syllabus topics (RTMNU)

• Supervisory Role of RBI
• On-site and Off-site Supervision
• Inspection and Audit of Banks
• KYC (Know Your Customer) and AML (Anti-Money Laundering) Norms
• Role of Financial Intelligence Unit
• Banking Ombudsman Scheme

Supervisory Role of RBI

Supervision means continuous watching of banks to check that they are safe, follow the law and protect depositors. In India, RBI supervises banks under the BR Act and RBI Act.

1. Board for Financial Supervision (BFS), set up in 1994 under RBI, guides supervision of banks, financial institutions and NBFCs.
2. Department of Supervision of RBI carries out on-site and off-site supervision.
3. Risk-Based Supervision (RBS): More attention to riskier banks. RBI uses a framework called SPARC (Supervisory Programme for Assessment of Risk and Capital).
4. Prompt Corrective Action (PCA): When a bank's capital, asset quality (NPA) or leverage crosses risk thresholds, RBI restricts its dividends, branch expansion and lending until it improves.
5. Powers: Inspection (Section 35), directions (Section 35A), removal of directors, supersession of board, penalties, moratorium and amalgamation (Section 45).
6. Early warning: Stress tests, Financial Stability Report, monitoring of large exposures (CRILC database).

On-site and Off-site Supervision

CAMELS stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems/Sensitivity – the factors on which banks were rated.

Inspection and Audit of Banks

1. RBI inspection (Section 35, BR Act): RBI may inspect any bank's books and accounts at any time. The report goes to the bank for corrective action.
2. Statutory audit (Section 30): Annual audit of accounts by qualified auditors (approved by RBI). Large banks have branch audits too.
3. Concurrent audit: Audit at the same time as transactions take place, in large branches and treasury.
4. Internal audit / inspection: By the bank's own inspection department – checks compliance and fraud.
5. Information systems (IS) audit: Checks computer and cyber security systems.
6. Audit Committee of the Board reviews audit findings.

KYC (Know Your Customer) and AML (Anti-Money Laundering) Norms

KYC is the process by which a bank verifies the identity and address of its customer before opening an account or doing business. Money laundering means making illegally earned ("black") money look legal by passing it through banks. AML norms are rules to stop this. The law is the Prevention of Money Laundering Act (PMLA), 2002; RBI issues the KYC Master Direction (2016, amended from time to time).

Elements of KYC policy:

1. Customer Acceptance Policy: No anonymous or fictitious (benami) accounts.
2. Customer Identification Procedure: Verification by Officially Valid Documents (OVDs) – Aadhaar, passport, driving licence, voter ID etc. – and PAN. Video-based KYC and e-KYC are allowed.
3. Monitoring of transactions: Watching for unusual or large cash transactions.
4. Risk management: Customers graded low, medium or high risk; periodic re-KYC (more often for high-risk).

Central KYC Records Registry (CKYCR) keeps KYC records so a customer need not submit documents again to every institution.

Role of Financial Intelligence Unit

Financial Intelligence Unit – India (FIU-IND) was set up in 2004 under the Ministry of Finance. It is the national agency for receiving, analysing and sharing information about suspicious financial transactions.

1. Receives reports from banks and other reporting entities: Cash Transaction Reports (CTR) for cash above ₹10 lakh, Suspicious Transaction Reports (STR), Counterfeit Currency Reports, cross-border wire transfer reports, etc.
2. Analyses the data and passes intelligence to enforcement agencies – Enforcement Directorate, Income Tax, CBI, police.
3. Coordinates with foreign FIUs (member of the Egmont Group).
4. Can impose penalties on reporting entities that fail to report.

Banking Ombudsman Scheme

The Banking Ombudsman Scheme started in 1995 to give bank customers a quick, free, out-of-court way to resolve complaints. It has been merged into the Reserve Bank – Integrated Ombudsman Scheme, 2021 (RB-IOS) – "One Nation One Ombudsman" – covering banks, NBFCs and payment system participants (check latest version).

1. Who can complain: Any customer with a complaint of "deficiency in service".
2. When: First complain to the bank; if no reply in 30 days or the reply is unsatisfactory, approach the Ombudsman within one year.
3. How: Online on RBI's Complaint Management System (cms.rbi.org.in), by e-mail or post to the centralised receipt centre. No fee.
4. Process: Conciliation/mediation first; if not settled, an Award is passed.
5. Compensation: Up to ₹20 lakh for loss, plus up to ₹1 lakh for harassment and loss of time (check latest).
6. Appeal: To the Appellate Authority (an Executive Director of RBI).
7. Examples: ATM debit without cash, delay in cheque collection, unauthorised charges, mis-selling.

Likely exam questions

1. (Long, 8/16 marks) Explain the supervisory role of RBI. Distinguish between on-site and off-site supervision.
2. (Long, 8/16 marks) What are KYC and AML norms? Explain the role of the Financial Intelligence Unit in preventing money laundering.
3. (Short, 4 marks) Write a note on inspection and audit of banks.
4. (Short, 4 marks) Explain the Banking (Integrated) Ombudsman Scheme.
5. (Short, 4 marks) What is Prompt Corrective Action?

Syllabus topics (RTMNU)

• Insolvency and Bankruptcy Framework (Overview of Insolvency and Bankruptcy Code, 2016)
• SARFAESI Act – Basic Provisions
• Banking Sector Reforms in India
• Digital Banking Regulations
• Regulation of NBFCs
• Financial Inclusion and Priority Sector Lending

Insolvency and Bankruptcy Framework (Overview of IBC, 2016)

Insolvency is a situation where a person or company cannot pay its debts. Bankruptcy is the legal declaration of an individual as insolvent. The Insolvency and Bankruptcy Code, 2016 (IBC) gives one time-bound law to resolve insolvency of companies, LLPs, partnership firms and individuals.

Institutions under IBC:

1. IBBI (Insolvency and Bankruptcy Board of India) – the regulator.
2. Adjudicating Authority: NCLT for companies and LLPs; DRT for individuals and firms.
3. Insolvency Professionals (IPs) who run the process.
4. Information Utilities that store debt and default records.

Corporate Insolvency Resolution Process (CIRP) – steps:

1. On a default (minimum ₹1 crore – check latest), a financial creditor (e.g. bank), operational creditor or the company itself applies to NCLT.
2. NCLT admits the case; a moratorium starts – no suits or recovery against the company.
3. An Interim Resolution Professional takes over the management from the board.
4. A Committee of Creditors (CoC) of financial creditors is formed.
5. Resolution plans are invited; the CoC approves a plan with 66% voting share.
6. NCLT approves the plan. The process should finish in 180 days (extendable by 90), with an outer limit of 330 days including litigation.
7. If no plan is approved, the company goes into liquidation and assets are distributed in the order of priority ("waterfall").

Benefit to banks: faster recovery, change of control from defaulting promoters, better credit discipline. A pre-packaged process exists for MSMEs.

SARFAESI Act – Basic Provisions

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 lets banks recover secured loans without going to court.

1. Applicability: Banks and notified financial institutions (and larger NBFCs) for secured debts of ₹1 lakh and more, where the account is an NPA. Not for agricultural land, or where the amount due is less than 20% of principal and interest.
2. Notice – Section 13(2): The lender gives the borrower a 60-day notice to repay.
3. Action – Section 13(4): If not paid, the lender can take possession of the secured asset, take over management, appoint a manager, or ask debtors of the borrower to pay the lender.
4. Sale: The asset is sold by public auction/tender to recover the dues.
5. Help of authorities – Section 14: The District Magistrate/Chief Metropolitan Magistrate helps take physical possession.
6. Appeal – Section 17: The borrower can appeal to the DRT within 45 days, and then to the DRAT.
7. Asset Reconstruction Companies (ARCs): Banks can sell NPAs to ARCs registered with RBI; securitisation of assets.
8. CERSAI: Central registry of security interests, to prevent the same asset being mortgaged to many lenders.

Banking Sector Reforms in India

1. Narasimham Committee I (1991): Lower CRR and SLR, deregulation of interest rates, prudential norms (IRAC, capital adequacy), entry of new private banks (e.g. HDFC Bank, ICICI Bank, Axis Bank in 1994), Debt Recovery Tribunals.
2. Narasimham Committee II (1998): Stronger capital, lower NPAs, mergers of strong banks, better technology and governance.
3. Legal reforms: SARFAESI 2002, IBC 2016, BR (Amendment) Act 2020.
4. Basel II and III implementation.
5. Indradhanush plan (2015) and the "4R" approach (Recognition, Resolution, Recapitalisation, Reforms); Asset Quality Review (2015).
6. Mergers of public sector banks (2017–2020): e.g. Bank of Baroda with Dena and Vijaya; reduced the number of PSBs to 12.
7. National Asset Reconstruction Company (NARCL) – a "bad bank" for large stressed loans (2021).
8. New types of banks: Small finance and payments banks; on-tap licensing.
9. Digital reforms: CBS, RTGS/NEFT 24×7, UPI.

Digital Banking Regulations

1. Payment and Settlement Systems Act, 2007: RBI regulates payment systems (UPI, cards, wallets) run by NPCI and others.
2. Information Technology Act, 2000 (amended 2008) gives legal validity to e-records and punishes cyber crime; Digital Personal Data Protection Act, 2023 protects customers' personal data – check latest rules.
3. RBI Digital Payment Security Controls (2021): Strong security for internet and mobile banking.
4. Additional factor of authentication (OTP etc.) for digital payments; card tokenisation – merchants cannot store card details.
5. Limited liability of customers: If a fraud is due to a third-party breach and the customer reports quickly (within 3 working days), customer liability is zero.
6. Digital Lending Guidelines (2022): Loans disbursed directly into the borrower's bank account, Key Fact Statement with all-in cost (APR), cooling-off period, grievance officer – check latest.
7. Digital Banking Units and the RBI's digital rupee (e₹) pilot.

Regulation of NBFCs

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act whose main business is lending, investment, leasing, hire purchase etc., but which is not a bank. Examples: Bajaj Finance, Muthoot Finance, Shriram Finance.

1. Registration with RBI under Section 45-IA of the RBI Act; minimum Net Owned Fund prescribed (being raised in phases – check latest).
2. Scale-Based Regulation (from 2022): NBFCs placed in Base, Middle, Upper and Top layers; bigger NBFCs face stricter, bank-like rules.
3. Prudential norms – capital adequacy, NPA classification, provisioning, concentration limits.
4. NBFCs cannot accept demand deposits, issue cheques, or be part of the payment system like banks; their deposits are not insured by DICGC.
5. Fair Practices Code, KYC rules, Ombudsman coverage.

Financial Inclusion and Priority Sector Lending

Financial inclusion means giving affordable banking services – accounts, credit, insurance, pension, payments – to all, especially poor and rural people. Measures: PM Jan Dhan Yojana (2014), Business Correspondents, RuPay cards, Aadhaar-based payments, PMJJBY/PMSBY/APY, Mudra loans, UPI, RBI's Financial Inclusion Index.

Priority Sector Lending (PSL): RBI requires banks to give a fixed share of their loans to sectors that may not get enough credit. Categories: agriculture, MSMEs, export credit, education, housing, social infrastructure, renewable energy, others.

(ANBC = Adjusted Net Bank Credit. Sub-targets are revised from time to time – check latest RBI Master Direction.) Banks that fall short deposit the shortfall in funds like RIDF with NABARD, or buy Priority Sector Lending Certificates (PSLCs).

Likely exam questions

1. (Long, 8/16 marks) Give an overview of the Insolvency and Bankruptcy Code, 2016. Explain the corporate insolvency resolution process.
2. (Long, 8/16 marks) Explain the basic provisions of the SARFAESI Act, 2002 and describe the major banking sector reforms in India.
3. (Short, 4 marks) Write a note on digital banking regulations.
4. (Short, 4 marks) How does RBI regulate NBFCs?
5. (Short, 4 marks) What is priority sector lending? State its targets.