INDIAN ACADEMY OF LAW

AND MANAGEMENT

Legal Framework Governing Banks

MODULE-2

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 Module 2

Legal Framework Governing Banks

Banks play a vital role in the economic development of the country. They are distinct from other
business units. It is said that a banker is a businessman who deals with other people’s money. Banks
form an integral part of the financial system. An efficient financial system requires a regulatory
framework with well defined objectives, adequate and clear legal framework and transparent
supervisory procedure. A comprehensive legislation is also a pre – requisite for the regulatory authority
to discharge its responsibilities effectively. Notable progress has been made in India in the field of
banking legislation. A number of acts containing provisions affecting banking business have been passed.

This unit explores the various laws that underpin the concept of Banking. The various laws regulating the
Banking System are as follows:

a. Banking Regulation Act, 1949:

The Banking Regulation Act was passed in the year 1949. It is a legislation that regulates all banking
firms in India. Initially the law was applicable only to Banking Companies but after the amendment made
in the year 1965 it became applicable to Co – Operative Banks also. This Act provides a framework using
which Commercial Banking in India is supervised and regulated. Primary Agricultural Credit Society and
Co – Operative Land Mortgage Banks are excluded from the purview of the Banking Regulation Act,
1949.

This Act confers the Reserve Bank Of India with the authority and power to issue licenses to banks to
commence their banking operations, power to appoint Chairman for various banks, lay down regulations
pertaining to the regulation of capital, power to give directions, to remove managerial and other
persons, to appoint additional directors, power to acquire undertakings of the Banking Companies, to
order suspension of business and winding up of the Banking Company.

Section 10BB of the Banking Regulation Act, 1949 confers RBI with the power to appoint Chairman of a
Banking Company. Section 11 of the Act prescribes certain requirement pertaining to minimum paid up
capital and reserves and Section 12 of the Act contains provisions relating to regulation of Paid Up,
Subscribed and Authorized Capital and voting rights of shareholders. Section 12 A deals with the
election of new Directors. Section 22 of the Act grants the Reserve Bank of India the power to issue
licenses to banking companies in order to function as a bank. Section 35 of the Act confers the power of
inspection on RBI.

b. Reserve Bank Of India Act, 1934:

The Reserve Bank Of India Act was passed in the year 1934 and it is the second important legislation
governing the Indian Banking System. This Act confers RBI the powers to act as Note Issue Authority,
Banker’s Bank, and Banker to the Government. The RBI was established under this Act. It was mainly
enacted to provide a framework for the supervision of the banking firms in India. This Act extends to the
whole of India. The Act is divided into five Chapters, 61 Sections and five Schedules.

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c. Negotiable Instruments Act,1881:
The Negotiable Instruments Act was passed in the year 1881. It deals with various kinds of Negotiable
Instruments. Some of the Negotiable Instruments are Cheque, Promissory Note, Hundi, Bill of Exchange
etc. The Negotiable Instruments Act has a chequered history. It was originally drafted in 1866 by the
Third India Law Commission and was introduced in the year 1867.

The Negotiable Instruments Act defines the term Cheque, Promissory Note, Bills of Exchange,
Endorsement. This Act describes the characteristic features of a Cheque, Promissory Note and Bill of
Exchange. It further talks about the concept of Crossing of Cheques and its types, and types of
endorsement.

d. Indian Contracts Act, 1872:

The Indian Contracts Act popularly known as the Law of Contracts was enacted during the British Period
in the year 1872. Banks enter into various contracts with customers, banks, and financial institutions.
This is the place where the Law of Contracts comes into play. The Law of Contracts defines what a
contract is and what are the essential ingredients that are required to constitute a valid contract. These
principles are applicable to Banks when they enter into Contracts.

e. SARFAESI Act, 2002:

The SARFAESI Act was enacted in the year 2002. SARFAESI stands for Securitization And Reconstruction
of Financial Assests and Enforcement of Security Interests Act. The main objective behind enacting this
Act is to enable the banks to reduce the mounting Non – Performing Assests (NPA’s). It is applicable to
whole of India. This Act deals with three different concepts namely Securitization, Assest Reconstruction
and Enforcement of Security Interest. This Act is divided into Five Chapters and 42 Sections. The term
Securitization refers to the process implying transformation of financial assests into securities. In simple
words it refers to a process which converts a financial relation into a transaction. Assest Reconstruction
refers to the process of acquiring the Non – Performing Loan Accounts by Assest Reconstruction or
Assest Management Companies from banks and financial institutions. Enforcement of Security Interest
refers to the measures available under the Act to enforce the security by selling it and realizing the
money and reducing the amount of bad debts.

Chapter II of the SARFAESI Act deals with the Regulation of Securitization and reconstruction of financial
assests of banks and financial institutions. Section 3 deals with the aspect of registration of
securitization and assest reconstruction companies. Section 4 deals with cancellation of certificate of
registration. Chapter III talks about the Enforcement of Security Interest and Sections 13 – 19 deal with
this aspect. Chapter V deals with the offences and penalties. Section 27 of the Act, talks about penalties.
The Reserve Bank of India contains guidelines relating to Securitization of Assests.

f. Recovery of Debts Due to Banks and Financial Institutions Act, 1993:

The Recovery of Debts Due to Banks and Financial Institutions Act was passed in the year 1993. This Act
extends to whole of India except Jammu and Kashmir. The main objective behind enacting this Act was
to provide an alternative process of law for recovery of bank dues. The Act is divided into six chapters,
37 sections and four rules. The Four Rules enacted under this Act are Debts Recovery Tribunal
(Procedure) Rules, 1993, Debts Recovery Appellate Tribunal (Procedure) Rules, 1994, Debts Recovery
Tribunal (Financial and Administrative Power) Rules, 1997, Debts Recovery Appellate Tribunal (Financial
and Administrative Power) Rules, 1997.

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The Debt Recovery Tribunal and Debt Recovery Appellate Tribunal are constituted under this Act. It
gives power to the establishment of these two tribunals. Chapter II of the said Act deals with the
Establishment of the Debt Recovery and Appellate Tribunals. Section 3 talks about the establishment of
the tribunal and Section 4 talks about the composition of the tribunal. Section 5 deals with the
Qualification for appointment as Presiding Officer. Section 8 deals with the establishment of the
Appellate Tribunal and Section 9 with the Composition of Appellate Tribunal.
Chapter III deals with the Jurisdiction, Powers and Authority of the Tribunals. Chapter IV deals with the
Procedure of Tribunals. Chapter V deals with Recovery of Debt determined by Tribunal.

g. Consumer Protection Act, 1986:

The Consumer Protection Act was enacted in the year 1986. This Act becomes applicable to banks as
banks perform various services to its customers and any dispute with regard to such services would form
part of the Consumer Protection Act and the same would be filed as a suit in the respective Consumer
Court.

h. Security Laws
Security Laws otherwise known as Capital Market Laws are applicable to banks when banks enter the
stock exchange and are desirous of listing its securities.

i. Payment And Settlement Systems Act, 2007:

The Payment And Settlement Systems Act was enacted in the year 2007. It extends to whole of India.
This Act was enacted to regulate and supervise the payment systems in India. The Act provides the legal
basis for netting and settlement finality. The Act has given powers to the Reserve Bank of India to act as
the Authority for the purposes of this Act. The Reserve Bank is authorized under the Act to constitute a
Committee of its Central Board known as the Board for Regulation and Supervision of Payment and
Settlement Systems (BPSS), to exercise its powers and perform its functions and discharge its duties
under this statute. Under this Act two regulations are made by the Reserve Bank of India, namely, the
Board for Regulation and Supervision of Payment and Settlement Systems Regulations, 2008 and the
Payment and Settlement Systems Regulations, 2008.

The Board for Regulation and Supervision of Payment and Settlement Systems Regulation, 2008 deals
with the constitution of the Board for Regulation and Supervision of Payment and Settlement Systems
(BPSS), a Committee of the Central Board of Directors of the Reserve Bank of India. It also deals with the
composition of the BPSS, its powers and functions, exercising of powers on behalf of BPSS, meetings of
the BPSS and quorum, the constitution of Sub-Committees/Advisory Committees by BPSS, etc. The BPSS
exercises the powers on behalf of the Reserve Bank, for regulation and supervision of the payment and
settlement systems under the PSS Act, 2007.The Payment and Settlement Systems Regulations, 2008
covers matters like form of application for authorization for commencing/ carrying on a payment system
and grant of authorization, payment instructions and determination of standards of payment systems,
furnishing of returns/documents/other information, furnishing of accounts and balance sheets by
system provider etc.

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