Short Note on Nationalization of Bank and the RBI

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NATIONALIZATION OF BANKS

One of the most crucial evolutions which led to the foundation of current Banking system in India was the Nationalization of Banks in 1969. Subsequently, in 1980 six more private banks were nationalized. The Supreme Court in the case of All India Bank Officers’ Confederation v. Union of India[1]remarked that the object of Banking Companies (Acquisition and Transfer of Undertakings) Act was to nationalize the banks to render the largest good to the largest number of people. The object of Section 9 of the Act which is regarding Central Government’s power to make a scheme for constitution of Board of Directors, is to give the Board a truly representative character so as to reflect the genuine interests of the various persons manning or dealing with the bank as an industry and a commercial enterprise.

Some of the benefits of nationalization of banks were spreading of branch network of banks throughout the nation including the rural areas, wide deployment of credit across the country, increased mobilization of resources.

TYPES OF BANKS

Central Banking Services- The Central Bank issues currency and bank notes, discharges treasury functions of the Government and acts as the banker’s bank. Reserve Bank of India is the Central Banking Institution in India.

Commercial Banking Services- It includes services like receiving and giving of various types of loans and advances. It also performs some non-banking services like locker facilities, online payments of bills. Such banks also advise on investment and re-investment, transfer and allotment of funds.

Specialized Banking Services- Special Banking institutions are established with the objective to address any specific banking services like industrial banks to supply industrial long term credit and working capital, development banks to render financial support to any developmental activities. This also includes co-operative banks, established with the object to serve small industries and self-employed workers.

Non-Banking Financial Services- Many institutions in India have been establish which disburse non-banking financial services in the country. For instance, Mutual Funds which accept finances from members and investing money in both primary as well as capital market. Other Non-banking financial institutions include insurance companies like LIC, GIC Bank etc. This also includes Merchant Bankers who are governed by the Securities Exchange Board of India (Merchant Bankers) Rules 1992.

NARASIMHAM COMMITTEE REPORT

The Narasimham Committee was set up in the 1980’s to recommend changes in the financial system of the country. The Committee suggested some elementary changes in the system for de-regulation and liberalization of banks. Some of the recommendations included raising capital from the public, allowing entry of new private sector banks, allow foreign banks to open branches in India, centralized banking system, reducing SLR (statutory liquidity ratio) and CRR (cash reserve ratio) to prudent levels, making provision for bad debts and establishing Tribunals for recovery of bad debts. Several recommendations of the Narasimham Committee have been incorporated in the present financial and banking system of India.

RESERVE BANK OF INDIA

The Reserve Bank of India was established under the Reserve Bank of India Act, 1934. One of the essential functions of the RBI was currency issue, which was earlier performed by the Government of India. Other functions of the RBI include:

  1. Safeguarding financial and economic stability of the country
  2. Lender of last resort- RBI is the reservoir of credit and hence other banking institutions rely on it for aid in situations of crisis.
  • Acts as banker to the State and banker’s bank
  1. Ensures economic stability and promotes economic development
  2. Printing of currency notes and managing mints
  • Maintain internal as well as external value of currency
  • Monetary Policy- One of the primary functions of RBI includes use of monetary instruments by the RBI in a manner that it aids in achievement of the inflation target. To achieve this goal the Centre has constituted the Monetary Policy Committee (MPC) which determines the policy interest rates. The various instruments used by the RBI to regulate monetary policy includes:

Repo rate- It is the interest rate at which the RBI provides overnight liquidity to banks.

Reverse repo rate- The interest rate at which the RBI absorbs liquidity on an overnight basis from the banks.

Bank rate- This is the rate at which the RBI buys or rediscounts bills of exchange or other commercial papers.

Cash Reserve Ratio (CRR)- This is the average daily balance that a bank is required to maintain with the RBI as a share of such percent of its Net demand and time liabilities.

Statutory Liquidity Ratio- The share of Net Demand and Time Liabilities that a bank is required to maintain in safe and liquid assets.

Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.

  • Selective Credit Control– The RBI has been empowered under Section 21 of the Act to control advances given by the commercial banks. Under this selective credit control policy, the RBI can determine the norms relating to advances to be followed by commercial banks in India.
  1. Grant licenses to Banking companies subject to fulfillment of remove conditions by prospective bank as prescribed in the Act.
  2. Remove managerial and other persons from office– The RBI is also entrusted with the power the remove an office if it is satisfied that the said banking company is not acting in a desired manner or conducting activities detrimental to the interests of depositors. However, while taking such a step the RBI has to also give reasons for the same.
  • Foreign exchange management– The statutory power for exchange control has been provided in the Foreign Exchange Regulation Act, 1973. This Act empowers the RBI to control and regulate dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property in and outside India, among other transactions. It was observed by the Supreme Court in the case of Life Insurance Corporation v. Escorts Limited[2]that RBI is the ‘custodian general’ of foreign exchange.

Management of RBI:

The functions and operations of the RBI is managed by the Central Board of Directors. The Board comprises of:

  1. Governor and not more than four Deputy Governors
  2. Four Directors nominated by the Central Government
  3. One Government official nominated by the Central Government

The Bank has local boards in Mumbai, Madras, Kolkata and New Delhi.

BANKING REGULATION ACT

The Banking Companies Act, 1949 was changed the Banking Regulation Act. The Act was passed with the object to consolidate and amend the Law relating to Banking to provide for extension of social control over Banks. The Banking Regulation Act was substantially amended in 1968 for extension of social control of Banks and the steps taken in this direction were:

  • Setting up of National Credit Council (N.C.C.)
  • Introducing legislative control on the banks by suitable amendments to the Banking Regulation Act

Some of the amended provisions which led to extension of social control over Banks were:

Section 10A- This provision envisages that the Board of Directors shall include persons with professional and other experience. It provides that not less than 51% of total number of members of the Board of Directors of the Banking company shall comprise of persons having special knowledge or practical experience in respect of agriculture, banking, co-operation, economics etc.

Additionally section 10B of the Act provides for management of affairs of a banking company by a whole-time Chairman who has special knowledge and practical experience in the working of banking companies.

Licensing of Banking Companies- Section 22 of Banking Regulation Act

Section 22 of the Banking Regulation Act entails provisions relating to licensing of banking companies. It mandates possession of license for carrying on banking business in India. For grant of license, a banking company has to lodge a request for the same with the RBI in writing.

Prior to grant of license, the RBI under Section 22(3) of the Banking Regulation Act is required to be satisfied about the following conditions:

  1. The company is or will be in a position to pay its depositors in full as their claim accrue;
  2. The affairs of the company are not being or will not be conducted in a manner detrimental to its depositors;
  • The management of company will not be prejudicial to public interest of interest of depositors;
  1. The company has adequate capital structure and earning prospects;
  2. The grant of license would not be prejudicial to the operation and consolidation of banking system consistent with monetary stability and economic growth;
  • The carrying on of banking business would not be contrary to public interests.

License to banking company situated outside India (Section 22(3A))- In such cases, the RBI apart from the aforesaid requisites as enumerated under sub-section (3) is also required to determine that the laws of the country in which the Bank will be incorporated does not discriminate against Banking companies registered in India.

Cancellation of license- Under Section 22(4) of the Act, the RBI is also entrusted with the power to cancel the license of company under the following circumstances:

  1. Company ceases to carrying on banking business in India
  2. Company fails to adhere to any of the conditions of license

Prior to cancellation of license, the RBI is required to provide an opportunity to the banking company to fulfill the requisite conditions. Cancellation of license does not mean a stoppage also of other business than banking. The company may carry on money lending business[3].

Appeal against cancellation- The Act provides that a banking company whose license has been cancelled can appeal against the same with the Central Government within 30 days from the date on which cancellation has been ordered by RBI. In such cases, the order of Central Government is deemed to be final.

In the case of Sajjan Bank (P) Ltd. v. Reserve Bank[4]it has been held that the provisions of Section 22 of Banking Regulation Act, 1949 prescribes only a system of licensing, having for its object the regulation of business of banking and does not violate fundamental right of any person to carry on the business of banking.