The following is an overview of certain sector-specific Indian laws and regulations which are relevant to our Bank’s business. Taxation statutes such as the Income Tax Act, labour laws such as Contract Labour (Regulation and Abolition) Act, 1970 and other miscellaneous regulations and statutes such as the Trade Marks Act, 1999, apply to us as they do to any other Indian company.
The description of laws and regulations set out below is not exhaustive, and is only intended to provide general information to investors and is neither designed nor intended to be a substitute for professional legal advice. The statements below are based on the current provisions of Indian law, and the judicial and administrative interpretations thereof, which are subject to change or modification by subsequent legislative, regulatory, administrative or judicial decisions.
The main legislation governing commercial banks in India is the Banking Regulation Act. Other important laws include the Reserve Bank of India Act, the Negotiable Instruments Act, the SARFAESI Act and the Banker's Books Evidence Act. Additionally, the RBI, from time to time, issues guidelines to be followed by banks. Banking companies are also subject to the purview of the Companies Act, to the extent applicable, and if such companies are listed on a stock exchange in India then various regulations of the SEBI would additionally apply to such companies, including the Listing Agreements.
Reserve Bank of India Act, 1934
RBI may, subject to certain conditions, direct the inclusion or exclusion of any bank from the second schedule of the RBI Act. Scheduled banks are required to maintain cash reserves with the RBI. In this regard, RBI may stipulate an average daily balance requirement to be complied with by such banks and may direct that such banks regard a transaction or class of transactions as a liability. Further, RBI may direct any banking company to submit returns for the collection of credit information and may also furnish such information to a banking company upon an application by such company. RBI has the power to impose penalties against any person for inter-alia failure to produce any book, account or other document or furnish any statement, information or particulars which such person is duty-bound to produce or furnish under the RBI Act, or any order, regulation or direction thereunder.
Banking Regulation Act, 1949
Commercial banks in India are required to obtain a license from the RBI to carry on banking business in India. Such license is granted to the bank subject to compliance with certain conditions some of which include: (i) that the bank has the ability to pay its present and future depositors in full as their claims accrue; (ii) that the affairs of the bank will not be or are not likely to be conducted in a manner detrimental to the interests of present or future depositors;
(iii) that the bank has adequate capital structure and earnings prospects; and (iv) that public interest will be served if such license is granted to the bank. The RBI has the power to cancel the license if a bank fails to meet the conditions or if the bank ceases to carry on banking operations in India. Additionally, the RBI has issued various reporting and record-keeping requirements for such commercial banks. The appointment of the auditors of the banks is subject to the approval of the RBI. The RBI can direct a special audit in public interest, or in the interest of the banking company, or in the interest of its depositors. It also sets out the provisions in relation to the loan granting activities of a banking company. The Banking Regulation Act specifies the business activities in which a bank may engage.
Banks are prohibited from engaging in business activities other than the specified activities. No shareholder in a bank can exercise voting rights on poll in excess of 10% of total voting rights of all the shareholders of the bank.
However, the RBI may increase this ceiling to 26% in a phased manner. Pursuant to amendments to the Banking Regulation Act in January 2013, private sector banks are permitted, subject to the guidelines framed by the RBI, to issue perpetual, redeemable or ir-redeemable preference shares in addition to ordinary equity shares.
Further, the Banking Regulation Act, as amended, requires any person to seek prior approval of the RBI, to acquire or agree to acquire, directly or indirectly, shares or voting rights of a bank, by himself or with persons acting in concert, wherein such acquisition (taken together with shares or voting rights held by him or his relative or associate enterprise or persons acting in concert with him) results in aggregate shareholding of such person to be 5% or more of the paid up capital of a bank or entitles him to exercise 5% or more of the voting rights in a bank. Further, the RBI may, by passing an order, restrict any person holding more than 5% of the total voting rights of all the
shareholders of the banking company from exercising voting rights on poll in excess of the said 5%, if such person is deemed to be not fit and proper by the RBI.
Further, the RBI requires the banks to create a reserve fund to which it must transfer not less than 25% of the net profit before appropriations. If there is an appropriation from this account, the bank is required to report the same to the RBI within 21 days, explaining the circumstances leading to such appropriation.
Certain amendments also permit the RBI to establish a ‘Depositor Education and Awareness Fund’, which will take over the bank’s deposit accounts that have not been claimed or operated for a period of 10 years or more.
The amendments also confer power on the RBI (in consultation with the central government) to supersede the board of directors of a banking company for a period not exceeding a total period of 12 months, in public interest or for preventing the affairs of the bank from being conducted in a manner detrimental to the interest of the depositors or any banking company or for securing the proper management of any banking company.
The appointment, re-appointment, or termination of the appointment of a chairman, managing director or whole-time director, chief executive officer of a bank shall have effect only if it made with the previous approval of the RBI. Further, no amendment in relation to the remuneration of the chairman, managing director, whole-time director or any other director, chief executive officer shall have effect unless approved by the RBI. RBI is also empowered to remove a chairman, managing director and whole-time directors from office on the grounds of public interest, interest of depositors, securing the proper management. Moreover, RBI may order meetings of the board of directors to discuss any matter in relation to the bank, appoint observers to such meetings, make such changes to the management as it may deem necessary, and may also order the convening of a general meeting of the bank’s shareholders to elect new directors.
The RBI may impose penalties on banks, directors and its employees in case of infringement of regulations under the Banking Regulation Act. The penalty may be a fixed amount or may be related to the amount involved in the contravention. The penalty may also include imprisonment. Banks are also required to disclose the penalty in their annual report.
Regulatory reporting and examination procedures
The RBI is empowered under the Banking Regulation Act to inspect a bank. The RBI monitors prudential parameters at regular intervals. To this end and to enable off-site monitoring and surveillance by the RBI, banks are required to report to the RBI on various aspects. The RBI conducts periodical on-site inspections on matters relating to the bank's portfolio, risk management systems, internal controls, credit allocation and regulatory compliance, at regular intervals. Further, the RBI also conducts on-site supervision of selected branches with respect to their general operations and foreign exchange related transactions.
Maintenance of records
The Banking Regulation Act specifically requires banks to maintain books and records in a particular manner and file the same with the Registrar of Companies on a periodic basis. The provisions for production of documents and availability of records for inspection by shareholders as stipulated under the Companies Act and the rules thereunder would apply to our Bank as in the case of any company. The master circular on “Know Your Customer (KYC) norms/ Anti-Money Laundering (AML) Standards/ Combating of Financing of Terrorism (CFT)/ Obligation of banks under PMLA, 2002” issued by the RBI on July 1, 2014 also provides for transactional and identification records to be maintained for a minimum period of ten years from date of transaction and ten years from the cessation of relationship with the client respectively.
Regulations relating to the opening of branches
As per the “Master Circular on Branch Authorization” dated July 1, 2014 banks may open branches in Tier 1 to Tier 6 centres without permission from the RBI, subject to certain conditions. Prior approval from RBI is not required to shift a branch to any location within the city, town or village. Permission of the RBI is not required for installation of on-site ATMs. Since June 2009 the RBI has permitted installation of off-site ATMs at centres identified by
scheduled commercial banks, without the need for permission from the RBI in each case, provided certain stipulated conditions are met. This is also subject to any direction which the RBI may issue, including for closure/shifting of any such off-site/ mobile ATMs, wherever so considered necessary by it. Banks are required to report full details of the off-site ATMs so installed. Further, private sector banks are required to ensure that at least 25% of their total branches are in unbanked rural centres in Tier 5 and Tier 6 centres which do not have a brick and mortar structure of any scheduled commercial bank for customer based banking transactions. Furthermore, the total number of branches opened in Tier 1 centres during the financial year cannot exceed the total number of branches opened in Tier 2 to Tier 6 centres and all centres in the north eastern states and Sikkim.
Capital adequacy requirements
The RBI has set out the minimum capital adequacy standards for banks based on the guidelines of the Basel Committee on Banking Supervision. Under the “Master Circular on Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy Framework” dated July 1, 2014, a bank is required to maintain a minimum total Capital to Risk Asset Ratio (“CRAR”) of 9% and Tier 1 CRAR of 5.50%.
Further, under “Guidelines on Implementation of Basel III Capital Regulations in India”, RBI has permitted Banks to raise Additional Tier 1 (“AT1”) capital which may include inter-alia perpetual non-cumulative preference shares that comply with regulatory requirements, debt capital instruments eligible for inclusion in AT1 capital and that comply with regulatory requirements. One of the important criteria for AT1 instruments is that they should have principal loss absorption through either (i) conversion into common shares at an objective pre-specified trigger point or (ii) a write-down mechanism which allocates losses to the instrument at a pre-specified trigger point.
The RBI also permits banks to raise Basel III compliant Tier II capital in the form of (i) debt capital instruments; (ii) preference share capital instruments that could be perpetual cumulative preference shares, redeemable non-cumulative preference shares (RNCPS), redeemable non-cumulative preference shares. These instruments also need to have certain loss absorption features.
To further ensure compliance with the guidelines of Basel II, the RBI has set out compliance periods for banks to transition into the Internal Ratings Based and Advanced Measurement Approach methods of risk assessment. Under the RBI’s guidelines, banks were to submit their revised methodologies by April 1, 2012 and RBI was to submit their revised roadmap for transition to these methodologies.
The RBI Basel III guidelines were introduced in May 2012 and become effective from April 1, 2013 in a phased manner. In March 2013, the RBI deferred the implementation of credit valuation adjustment risk capital charges to January 1, 2014 due to certain issues related to introduction of mandatory forex forward guaranteed settlement through a central counterparty. On December 31, 2013, RBI further extended the abovementioned implementation timeline to April 1, 2014. Basel III capital regulations will be fully implemented by March 31, 2018.
Liquidity coverage ratio
The Basel III Framework on Liquidity Standards introduced two liquidity ratios i.e. Liquidity Coverage Ratio (“LCR”) and Net Stable Funding Ratio as well as liquidity risk monitoring tools. In this regard, the RBI issued draft guidelines in November 2012, which provided enhanced guidance on liquidity, risk governance, measurement, monitoring and reporting to the RBI on liquidity positions. The guidelines stipulate that banks are to ensure a LCR of 60% for the calendar year 2015 with effect from January 1, 2015 and will be expected to transition to a LCR of 100% in January 2019.
Prudential norms on income recognition, asset classification and provisioning pertaining to advances (“Prudential Norms”)
The RBI, pursuant to its “Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances” (“Prudential Norms”) issued on July 1, 2014, classifies NPAs into (i) sub-standard assets; (ii) doubtful assets; and (iii) loss assets. These guidelines specify provisioning requirements specific to the classification of the assets.
In July 2005, the RBI issued guidelines on sales and purchases of NPAs between banks, financial institutions and NBFCs. These guidelines require that the board of directors of a bank must establish a policy for purchases and sales of NPAs. An asset must have been classified as non-performing for at least two years by the seller bank to be eligible for sale. In October 2007, the RBI issued guidelines regarding valuation of NPAs being put up for sale.
The RBI revised the “Prudential Guidelines on Restructuring of Advances by Banks and Financial Institutions” on May 30, 2013. Pursuant to the revised guidelines the provisioning requirement has been increased to 5% in respect of new restructured standard accounts (flow) with effect from June 1, 2013 and in a phased manner for the stock of restructured standard accounts as of March 31, 2013 as follows:
(a) 3.50% with effect from March 31, 2014 (spread over the four quarters of 2013-2014);
(b) 4.25% with effect from March 31, 2015 (spread over the four quarters of 2014-2015); and (c) 5% with effect from March 31, 2016 (spread over the four quarters of 2015-2016).
Corporate debt restructuring mechanism (“CDR system”)
The institutional mechanism for restructuring has been set up through establishment of the CDR system in 2001. It is a joint forum of all banks and financial institutions and operates as a non-judicial body. The CDR system operates on the principle of super-majority amongst the participating banks and financial institutions for a particular advance.
The Prudential Norms as mentioned above equally apply to the accounts restructured under the CDR system.
The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“RDDBFI Act”)
The RDDBFI Act was enacted for adjudication of disputes pertaining to debts due to banks and financial institutions exceeding ` 10 million. The RDDBFI Act provides for the constitution of debt recovery tribunals, before which banks and financial institutions may file applications for recovery of debts. Further, no court or other authority, except the Supreme Court or a High Court exercising jurisdiction under Articles 226 and 227 of the Constitution of India, shall have, or is entitled to exercise, any jurisdiction, powers or authority in relation to the aforementioned matter. The tribunals may pass orders for directions including inter- alia recovery of such dues by the bank as may be deemed fit along with a recovery certificate to such effect from the presiding officer of the respective tribunal;
attachment of the secured properties towards the dues to the bank: injunctive orders restraining the debtors from alienating, transferring or disposing of such secured properties; appointment of receivers and/or local commissioners with respect to such secured properties and distribution of proceeds from sale of such secured properties towards dues. Pursuant to the recovery certificate being issued, the recovery officer of the respective debt recovery tribunal shall effectuate the final orders of the debt recovery tribunal in the application. Unless such final orders of the debt recovery tribunal have been passed with the consent of the parties to an application, an appeal may be filed against such final orders of the debt recovery tribunal before the debt recovery appellate tribunal, which is the appellate authority constituted under the RDDBFI Act.
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”)
The SARFAESI Act provides for sale of financial assets by banks and financial institutions to asset reconstruction companies. The Act enables the enforcement of security interest created in favour of a secured creditor, without the intervention of court or tribunal. Further, a secured creditor may, under certain conditions, also take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset. The Prudential Norms issued by the RBI describe the process to be followed for sale of financial assets to asset reconstruction companies. The banks may not sell financial assets at a contingent price with an agreement to bear a part of the shortfall on ultimate realisation. However, banks may sell specific financial assets with an agreement to share in any surplus realised by the asset reconstruction company in the future. Consideration for the sale may be in the form of cash, bonds or debentures or security receipts or pass-through-certificates issued by the asset reconstruction company or trusts set up by it to acquire the financial assets.
Pursuant to the amendment of the SARFAESI Act in January 2013, means for recovery of assets available to banks and financial institutions have been strengthened. Further, banks and financial institutions have been empowered to accept immovable property in full or partial satisfaction of the bank’s claim against the defaulting borrower at times
when they cannot find a buyer for the securities. The amendment also enables banks and financial institutions to enter into a settlement or compromise with the borrower and empowers DRTs to pass an order acknowledging any such settlement or compromise.
Priority sector lending
The RBI circular on “Priority Sector Lending- Targets and Classification” dated April 23, 2015 sets out the broad policy in relation to priority sector lending. In accordance with this circular, the priority sectors for all scheduled banks include (i) agriculture; (ii) MSE; (iii) education; (iv) housing, (v) social infrastructure; (vi) export credit; and (vii) renewable energy. Under the RBI guidelines, the priority sector lending targets are linked to Adjusted Net Bank Credit (“ANBC”) (outstanding bank credit minus bills rediscounted with RBI and other approved Financial Institutions plus permitted non SLR bonds/debentures under Held to Maturity category plus other investments eligible to be treated as part of priority sector lending (e.g. investments in securitised assets)) or credit equivalent amount of off-balance sheet exposure, whichever is higher, as on March 31 of the previous year. Currently, the total priority sector lending target for domestic banks is 40% of ANBC or credit equivalent amount of off-balance sheet exposure, whichever is higher.
Exposure norms
As a prudent measure aimed at better risk management and avoidance of concentration of credit risk, the RBI has prescribed credit exposure limits for banks and long-term lending institutions in respect of their lending to individual
As a prudent measure aimed at better risk management and avoidance of concentration of credit risk, the RBI has prescribed credit exposure limits for banks and long-term lending institutions in respect of their lending to individual