Banking Regulation Act, 1949

The Banking Regulation Act, 1949 (BR Act) is the main law governing banking companies in India. Originally enacted as the Banking Companies Act, 1949 and renamed in 1966, it supplements the RBI Act by laying down detailed rules for bank supervision, management, licensing, permitted activities, and operations.

Introduced after bank failures in the 1940s to ensure stability and soundness of the banking system, the Act has been amended over time to address issues such as cooperative banks and bad loans. Simply put, it defines what banks can and cannot do, how they are licensed, and how they are regulated in India.

Scope and Applicability

Initially, the Act applied only to banking companies (commercial banks) in British India. In 1965, it was extended, with modifications, to cooperative banks, bringing urban cooperative banks under RBI regulation.

Today, it covers:

• commercial banks (public sector, private sector, and foreign banks in India)
• regional rural banks, and
• cooperative banks (excluding primary agricultural credit societies).

The Act does not apply to non-banking financial companies (NBFCs) or development banks, as it is limited to institutions engaged in the business of “banking” as defined under the Act.

Definition of Banking  – Section 5(b) and 5(c)

Section 5(b) defines “banking” as accepting deposits from the public for lending or investment, repayable on demand or otherwise, and withdrawable by cheque, draft, order, or similar means, thereby clearly distinguishing banks from other financial entities.

Only entities licensed under the Act can call themselves banks and accept such withdrawable public deposits.

Section 5(c) defines a “banking company” as any company carrying on the business of banking in India, and the Act also defines key terms such as approved securities, loans, advances, and demand liabilities, which are essential for regulatory purposes.

Licensing of Banks – Section 22, 23

Under Section 22, a banking company can be established in India only with an RBI license. RBI grants a license after assessing factors such as capital structure, management competence, business plans, and public interest, ensuring that only fit and proper entities enter banking.

RBI may cancel a license for non-compliance with the Act, insolvency, or cessation of banking business. We note that bank mergers and branch expansion are also linked to licensing approvals, with Section 23 requiring RBI permission to open, shift, or close bank branches.

Capital Requirements and Reserves – Section 11, 17 etc.

The Act mandates minimum paid-up capital and reserve requirements for banks under Section 11 to ensure depositor protection, with amounts varying by bank type and updated over time. Section 17 further requires banks to create a Reserve Fund and transfer at least 20% of annual net profits to it until the fund equals paid-up capital, thereby building a financial buffer. The Act also restricts the use of capital and reserves to prevent their depletion through excessive payouts.

Permissible Business and Restrictions

Section 6 lists the forms of business banks may undertake in addition to core banking, such as borrowing and lending, providing credit facilities, dealing in securities, foreign exchange business, and locker services.

To ensure safety and focus on banking, the Act imposes key restrictions:

• Section 8 prohibits banks from trading in goods, except for selling pledged goods from defaulted loans;
• Section 9 limits the holding period of immovable property or non-banking assets acquired (generally to seven years, extendable), requiring their disposal thereafter.
• The Act also empowers RBI to cap banks’ exposure to single and group borrowers and, under Section 20, restricts lending to directors or related entities to prevent conflicts of interest.
• Further, Section 21 historically empowered RBI to regulate interest rates on advances (now largely liberalized), while Section 24 mandates maintenance of liquid assets through the Statutory Liquidity Ratio, with RBI determining the requirement; the Cash Reserve Ratio is now governed by the RBI Act.
• Section 6 of the Act enumerates forms of business a bank may engage in (besides the core business of banking). These include borrowing money, lending/advancing, credit facilities, dealing in securities, foreign exchange business, locker facilities, etc.

Prohibitions upon Banks

Alongside permissible business, the Act imposes certain prohibitions to ensure safety:

• No Trading: Section 8 prohibits banks from trading in goods (i.e., buying or selling goods directly), as commodity speculation could endanger depositors’ money. Banks can of course sell pledges they hold from defaulted loans, but they cannot run commercial businesses.
• Disposal of Non-Banking Assets: Section 9 stipulates if a bank acquires any immovable property or non-banking asset (e.g., by foreclosure of a loan), it cannot hold it beyond a period (usually 7 years, with an extension possible) – they must dispose of such assets. This keeps banks focused on banking, not hoarding real estate or similar assets.
• Limits on Exposures: The Act empowers RBI to set limits on banks’ exposures to single borrowers and group borrowers (to prevent over-concentration of credit). It also restricts loans to bank’s own directors or companies associated with them (Section 20) to avoid conflicts of interest.
• Interest Rates and CRR/SLR: Historically, Section 21 gave RBI power to control interest rates on advances (though interest rate controls have since been liberalized). The Act also mandates maintenance of liquid assets – originally, Section 24 required banks to maintain a Statutory Liquidity Ratio (SLR), a percentage of their net demand and time liabilities to be held in cash, gold, or approved securities. (Currently, SLR requirement is still there and decided by RBI, but note that CRR moved to the RBI Act’s purview). These tools are used by RBI to manage liquidity and credit in the economy.

Management and Governance

The Act places checks on bank management to foster good governance:

• Fit and Proper Directors: It sets criteria for who can be a bank director (for example, MPs/MLAs or convicted persons cannot be on boards). At least 51% of a bank’s directors must have special knowledge or experience in areas like finance, economics, banking, etc. Also, the CEO’s appointment (Managing Director or Wholetime Director) requires prior approval of RBI (Section 35B) to ensure competent leadership.
• RBI’s Power to Remove Management: Under Section 36AA, RBI can remove any chairman, director, or CEO of a bank (except SBI and some select institutions) if found unfit or acting detrimentally to the bank’s interest. Similarly, RBI can supersede the board of directors of a bank (for a temporary period) under certain conditions and appoint an administrator.
• Accounts and Audit: Banks are required to maintain their books as per uniform accounting year (which was made April–March) and have them audited. Section 30 gives RBI the power to direct special audits of a bank in public interest or in the bank’s interest. Banks must submit their financial statements to RBI and publish them for shareholders annually (Section 31). This ensures transparency of bank finances.

Supervisory Powers of RBI

The Banking Regulation Act significantly empowers RBI to supervise banks:

Inspection (Section 35)

RBI can inspect the books and accounts of any bank at any time. It regularly conducts annual financial inspections of banks (AFI) to monitor their health, asset quality, compliance, etc. RBI can also ask for any information from banks relating to their business.

Regulatory Directions

Section 35A is a broad provision which allows RBI to issue binding directions to banks in the public interest, or in the interest of banking policy or depositor interests. This has been a potent tool – RBI has issued thousands of circulars over time under this section to guide banks on various aspects (from asset classification norms to customer service). If a bank is found weak, RBI can impose restrictions (like limiting fresh loans or deposits) using these powers (this concept later evolved into the Prompt Corrective Action framework).

Moratorium and Reconstructing Banks

In cases where a bank’s finances deteriorate badly, Section 45 gives the central government (acting on RBI’s application) the power to impose a moratorium on a bank – essentially halting its operations temporarily. During a moratorium, RBI can prepare a scheme of reconstruction or amalgamation for the bank to protect depositors. This was used notably in cases like Yes Bank (2020), where RBI swiftly arranged for a rescue plan and new capital infusion. It’s a critical tool to handle failing banks without resorting immediately to liquidation.

Winding Up

If a bank must be closed, only RBI (or the central government) can trigger its winding up (liquidation) by applying to a High Court (Section 38). Grounds for winding up include inability to pay debts, or if continuance of the bank is prejudicial to depositors. When a bank is liquidated, depositors have preferential claim on assets (after secured creditors) as per the Act.

Key Recent Amendments

The BR Act has been amended many times. A few notable changes:

• 1965: Brought cooperative banks under its ambit (certain sections applied with modifications).
• 1985: Introduction of sections empowering RBI to remove managerial and other persons from control of banks.
• 1993: Strengthened transparency – introduced new norms for income recognition, asset classification, provisioning (Narasimham Committee reforms reflected in law).
• 2004: Gave RBI more say in mergers and allowed consolidation in the sector (making voluntary amalgamations of banks easier with RBI approval).
• 2017: Enabled RBI to push banks to resolve bad loans under the Insolvency and Bankruptcy Code (this amendment inserted Section 35AA allowing RBI to direct banks to initiate insolvency proceedings against defaulters, and Section 35AB to issue directions for stressed asset resolution).
• 2020: Brought sweeping changes in response to certain bank failures – giving RBI greater oversight over cooperative banks (including powers to supersede their boards, like commercial banks). It also allowed scheme of reconstruction or amalgamation to be undertaken for a bank without placing it under complete moratorium (ensuring quicker resolution and depositor access to funds). This change was prompted by the Punjab & Maharashtra Co-op Bank crisis and aimed to strengthen depositor protection.

Banking Laws (Amendment) Act, 2025 — Major New Changes

The Banking Laws (Amendment) Act, 2025 is a wide-ranging statutory reform affecting multiple banking statutes — including the Banking Regulation Act, 1949 — that came into force in phased notifications in 2025.  The 2025 Act was enacted to modernize the banking legal framework by:

• Enhancing bank governance standards
• Improving audit transparency and quality
• Strengthening depositor rights and protections
• Updating statutory thresholds after decades
• Aligning the law with evolving economic and digital banking realities
  These reforms aim to make the regulatory system more depositor-centric and forward-looking.

The key features & provisions affecting the Banking Regulation Act in Banking Laws Amendment Act 2025 are as follows:

• Revised “Substantial Interest” Threshold:  The threshold for what constitutes a ‘substantial interest’ under banking law was revised from ₹5 lakh to ₹2 crore to reflect modern economic conditions. This threshold is relevant for directors/officers and their financial interests, reducing risk of conflicts.
• Cooperative Bank Governance Reform:  Tenure of directors (other than Chairperson and Whole-Time Directors) in co-operative banks has been extended from 8 years to 10 years (excluding the exempt directors), harmonising with cooperative principles and constitutional norms.

• Enhanced Nomination Rights for Depositors:  Under the amended law, bank customers can now nominate up to four individuals for Deposit accounts; Items held in safe custody and Contents of safety lockers. These nominations can be made either simultaneously or successively (with share allocation possible for simultaneous nominees). This change took effect from 1 November 2025 for nomination-related provisions.
• Public Sector Bank Audit & Investor Protection Improvements: Public Sector Banks (PSBs) may now remit unclaimed shares, interest, and redemption amounts to the Investor Education and Protection Fund (IEPF), bringing banking law in line with company law standards for unclaimed financial assets. PSBs are also permitted to compensate statutory auditors, which helps attract more qualified audit professionals and enhance audit quality.
• Computation & Compliance Modernization: Some technical amendments (notified later in December 2025) replaced outdated references such as “alternate Fridays” with modern calendar benchmarks like “last day of the month/quarter” for reserve/return calculations — simplifying compliance timelines.

The 2025 Act did not come into force all at once. Instead, different sections were notified at different times:

• 1 August 2025: Core provisions regarding governance, thresholds, and audit/PSB reforms came into force.
• 1 November 2025: Nomination-related provisions relating to deposit accounts, lockers, and safe custody items were notified.
• 15 December 2025: Some compliance and statutory timeline reforms were brought into effect.

Significance

The Banking Regulation Act, 1949 is vital for maintaining trust in the banking system. It ensures that banks operate prudently – with adequate capital, good governance, and under vigilant supervision – so that depositors’ money is safe. The Act balances freedom for banks to conduct business (loan, invest, etc.) with safeguards to prevent excessive risk-taking.