Banking Regulation Act @75: A blueprint for modernizing India’s banking laws

By Amol Agrawal,

The finance minister recently proposed amendments in the Banking Regulation (BR) Act, 1949. Interestingly, 2024 also marks 75 years of the BR Act, which is one of the first few laws passed after India’s independence.

Banking has existed in India for ages but there was no single legislation to regulate and govern the sector. After the arrival of British, the three Presidency Banks of Bengal, Bombay, and Madras were incorporated under a special government charter. The Indian Companies Act, enacted in 1850, did not include banks. The amended Act in 1913 included banks but its scope was limited. In 1930, the Central Banking Enquiry Committee recommended enacting a separate law to govern banks.

The Reserve Bank of India was established in 1935 via the RBI Act, 1934. The RBI Act, modelled on the lines of Bank of England, specified the core function of the RBI to unify currency and credit but had limited scope for bank regulation. Under the RBI Act, the central bank could inspect banks to include them in the Second Schedule of the Act. The Act also specified that banks should publish weekly returns for watching maintenance of the cash reserve ratio.

In 1937, the Indian Companies Act was amended to incorporate recommendations from the Central Banking Enquiry Committee and suggestions from the RBI. For the first time, the banking company was defined and only those businesses which did banking according to the definition were allowed to function as banks. The amendments also specified minimum capital for banks (`50,000 and above) and granted moratorium to them in difficult times. The Act also barred managing agencies from banking. This lack of comprehensive legislation and regulation was exposed by the failure of the Travancore National and Quilon Bank in 1938. Then RBI Governor James Taylor decided to establish a comprehensive banking regulation but it had to wait due to the Second World War and Independence. However, there were interim legislation in 1946-49 to manage the banking system.

In 1949, the government of independent India legislated the BR Act. The RBI was also a banking regulator, apart from being a central bank. The Act modified the definition of banking to include time deposits and specify that banks also lend and invest. All banks, new and existing ones, could function as one only after getting a licence from the RBI. The Act also gave the RBI full powers to inspect banks. The new Act also defined minimum capital standards, implemented cash reserve for both scheduled and non-scheduled banks, maintaining liquid assets and so on.

The BR Act became a potent tool in the RBI’s arsenal. It used the Act to clean up India’s fragile and fragmented banking system. Banks had no choice but to open themselves to the RBI’s supervisory inspections. They had to improve their prudential and governance requirements in order to be eligible for banking licence. Having said that, the RBI got a wake-up call due to the failure of the Palai Central Bank in 1960. Palai was a south-based bank and southern India was home to many small banks. There were concerns threat that there would be a run on small banks. The government ushered in deposit insurance in 1962 to prevent bank runs. In 1966, the Act was also extended partly to cooperative banks. The regulation of non-banking finance companies was included in the RBI Act (1934).

The next challenge for the BR Act came from bank nationalisation in 1969. It shifted the regulation of nationalised banks to the ministry of finance. As nationalised banks went on to form nearly 90% of the banking system, the scale and scope of the BR Act became highly limited. The 1991 reforms led to the licensing of new private banks, which gradually contributed 30% of the banking system. The rise of new private banks brought the BR Act back to the fore as, unlike nationalised banks, the Act applied completely to private banks.

In 2007 and 2008, two committees — on Mumbai as an international financial centre, and Committee on Financial Sector Reforms — suggested rewriting financial regulations. In 2013, the Financial Sector Legislative Reforms Commission, acting on these two committees, proposed a unified India Financial Code (IFC) repealing 15 financial Acts including the BR Act. The IFC was not implemented due to controversies.

How can the Act continue to play an instrumental role in its next 25 years?

First, the conflict over the dual regulation of public sector banks governed by the Bank Nationalisation Act and private banks governed by the BR Act has to end. The 1991 Narasimham Committee had mentioned this duality which has been reiterated by several RBI officials. The regulation and supervision of all types of commercial banks should be shifted to the RBI.

Second, with the advent of digital banking and the rise of non-bank and private credit, the definition of banking and its scope has changed significantly. The BR Act needs to be rethought and reframed to include these realities.

In the recent Budget, the finance minister announced releasing a financial sector vision and strategy document to set the agenda for the next 5 years. It could start with a comprehensive review of all the regulations that govern the Indian banking sector.

The author teaches at Ahmedabad University.

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