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All you need to know the Banking Laws in India

7 min read

By Shaurya Raj

Published on: May 8, 2022 at 09:30 IST


During the Budget 2021-22, Finance Minister Nirmala Sitharaman announced the privatization of public sector banks (PSBs), which will be part of a disinvestment campaign to raise Rs. 1.75 lakh crore for the government.

The union government introduce the Banking Laws (Amendment) Bill, 2021, during the winter session of Parliament in December 2021 as a way forward.

The ‘Banking Laws (Amendment) Bill, 2021‘ failed to see light. In the context of the Union Budget statement 2021 proposing the privatization of two public sector banks, the bill proposes to change the Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970 and 1980, as well as incidental amendments to the Banking Regulation Act, 1949.

The minimum government ownership in PSBs will be reduced from 51 percent to 26 percent as a result of this action this was also suggested.

The government has said repeatedly that the Cabinet committee designated for disinvestment is in charge of considering different topics linked to disinvestment, including the nomination of the bank(s).

The concerned Cabinet committee has not yet made a decision on the privatization of PSBs. Any decision in this regard appears to be more political than economic, and the bill was put on hold for the time being because states like Uttar Pradesh and Punjab had elections.

Before dwelling into this bill, lets understand the evolution of banking sector and bank privatization.

Evolution of Banking Law in India.

India’s banking system has evolved from cocoon to butterfly over the last two centuries. In ancient times, banking was primarily carried out by businessmen such as Sharoffs, Mahajans, Seths, and Sahukars. They performed the normal function of lending money to merchants and craftsmen and sometimes funded the king’s battlefield.

Modern-day banking began across the fag end of the 18th century, with the General Bank of India and Hindustan Bank entering existence. Then the 3 presidency banks had been made which had been – the Bank of Madras, Bombay, and Calcutta.

The presidency banks acted as quasi-relevant banks for pretty a while. They merged into what become known as the Imperial Bank of India in 1925. The swadeshi motion stimulated the Indian commercial enterprise network to shape banks on their very own from 1906 to 1911.

A wide variety of banks hooked up then have nevertheless controlled to continue to exist until date, which incorporates Canara Bank, Indian Bank, Bank of Baroda and the Central Bank of India, etc.

In 1934, when the Reserve Bank of India was decided to be established, it was a milestone moment in the Indian Banking history that marked the development of the banking industry. RBI started functioning in 1935. Since then, RBI has been the country’s central bank and regulator of the banking sector. It draws its power from the 1934 RBI Act.

The two other major events in the modern banking era are the nationalization of the 14 largest commercial banks in 1969, through the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969.

Later another set of 4 banks was merged, taking this count to 20. At this point, more than 90% of all banking business in India was controlled by the Government of India.

Post the government’s liberalization policies, a host of private players entered the Indian banking market where RBI made sure that they were being closely watched and strictly regulated.

Further, there were regular checks on the compliance with various guidelines and any irregularities would have led to the disqualification of their licenses.

Laws Concerning the Banking Sector.

Reserve Bank of India Act, 1934

It was enacted to establish the RBI with the aim of regulating the issuance of banknotes, holding reserves to ensure the stability of the monetary system, and effectively operating the national currency and credit system.

The law primarily deals with the RBI’s constitution, powers, and obligations. The law does not deal with the regulation of the banking system, except for Section 42, which deals with the regulation of the reserve requirement ratio, and Section 18, which deals mainly with direct discounts on bills of exchange and promissory notes.

Therefore, the RBI method deals with: Establishment, capital, management, and operation of RBI. Various features of the RBI include banknote issuance, cash management, central and state bank, and lender of last resort.

Provisions for reserves, credit funds, audits, and accounting. Issue orders and impose penalties for violations of laws and regulations.

Banking Regulation Act, 1949

It is considered one of the most important legal frameworks for banks. Originally passed as the Banking Companies Act of 1949, it was finally amended to the Banking Regulations Act of 1949 (“BR Act”). In addition to the RBI law, the BR law provides banks with many guidelines.

They cover a wide range of areas and some of the most important provisions are:

  • Banking is defined in Section 5 (i)(b), as acceptance of deposits of money from the public for the purpose of lending and/or investment. Such deposits can be repayable on demand or otherwise withdraw able by means of cheque, drafts, order or otherwise;
  • Section 5 (i)(c) defines a banking company as any company which handles the business of banking;
  • Section 5(i)(f) distinguishes between the demand and time liabilities, as the liabilities which are repayable on demand and time liabilities means which are not demand liabilities;
  • Section 5(i)(h) deals with the meaning of secured loans or advances. Secured loan or advance granted on the security of an asset, the market value of such an asset in not at any time less than the amount of such loan or advances. Whereas unsecured loans are recognized as a loan or advance which is not secured;
  • Section 6(1) deals with the definition of banking business; and
  • Section 7 specifies banking companies doing banking business in India should use at least on work bank, banking, banking company in its name.

The BR Act also restricts certain activities:

  • Trading activities of goods are restricted as per Section 8.
  • Prohibitions: Banks are prohibited to hold any immovable property subject to certain terms and conditions as per Section 9. Furthermore, a banking company cannot create any kind of charge upon any unpaid capital of the company as per Sec 14. Section 14(A) further says that a banking company additionally cannot create a floating charge on the undertaking or any property of the company without prior permission of the RBI.
  • A bank cannot declare dividend unless all its capitalized expenses are fully written off as per Section 15.

Bank Privatisation.

The purpose of macroeconomic policy is to prioritize the steady growth of the economy. The government has introduced various mechanisms and plans with a targeted approach to improving fiscal policy in order to promote the steady growth of the economy.

The Indian banking sector has played a major role in economic development, and the business activities of this sector have consistently supported economic growth.

In the banking sector, public sector banks (PSBs) are the leaders in providing banking services in the most remote areas of the country, providing many welfare schemes and benefits to their clients.

PSB conducts various banking operations nationwide, centering on lending to priority sectors and support by welfare systems for sectors that have reached their limits.

For these reasons, the increase in stress assets and the issuance of bad assets, the government will increase the capital of banks and implement better plans to maintain the trust and trust of public institutions. I have the right.

A program to maintain the efficiency of public banks without obstructing the flow of credit to the production sector. The country’s current and pre-pandemic economic poverty has prompted the government to take major steps to change the structure of the banking sector through its sales plans.

Reason behind Privatization.

There are many reasons for privatization, and economic decline is the main and most important reason. The Indian economy has been hit hard by the pandemic that has prompted the government to take such a bold divestment move.

The growing NPA problem is also a driving force for privatization courses. The biggest contributor to NPA is the PSB through the welfare state system and credit waiver. The government is trying to minimize the NPA problem and reduce the burden on the PSB by privatizing the PSB.

There’s also the problem of dual control, which refers to the Ministry of Finance’s dual control over PSBs under the Banking Regulation Act of 1949 and the RBI Act of 1934.

Unlike commercial banks, the RBI does not have autonomy in the governance of PSBs since the government is always intervening, which tends to politicize the normal operation of PSBs. The decision to privatize PSBs has sparked a national debate, including an economic and political analysis of the move.


Indian banks are already grappling with Non-Performing Assets (NPAs), which have recently begun to recover. Some citizens are concerned that initiatives like bank privatization will put the banks in jeopardy.

Money held by ordinary people may be at risk at that time. A bank’s money withdrawal policy can also be quite severe or limited.

In India, the banking sector is one of the most important contributors to economic growth and is evolving at a steady rate. However, the banking industry, particularly PSBs, has had a significant impact on the economy’s collapse as a result of the ongoing pandemic.

To boost the economy and the sector, the government’s decision to privatize the PSBs will be a structural change in the banking sector, opening it up to private players, increasing capital inflow and foreign investment, and potentially ushering in a new era for the banking sector, resulting in the country’s economic resilience.

Edited by: Tanvee Jain, Publisher, Law Insider