The banking regulation law in India was more focused on commercial banks and co-operate banks lacked oversight and proper regulation. The Banking Regulation (Amendment) Bill, 2020 aims at correcting this bottleneck of the Indian Banking system and brings co-operative banks within the ambit of the Central Bank. This article aims at analysing the backdrop and constructive changes brought about by this particular amendment.
The Rajya Sabha recently adopted the Banking Regulation (Amendment) Bill 2020 during its session on 22 September 2020. Several provisions in the Bill will significantly impact the banking industry in the country. It aims to amend the Banking Regulations Act and to strengthen its scope on the operation of co-operative banks. In introducing the Bill in Parliament, Finance Minister Nirmala Sitharaman claimed that after the recent failure of well-known Punjab and Maharashtra Co-operative Bank and other co-operate banks, it was required to regulate the actions of such co-operative banks, whose failure had seriously affected the financial market and disrupted the depositors’ trust in the banks.
A Disorderly Framework for Co-operate Banks
Co-operative banks provide citizens with small-scale banking services. However, the lack of RBI regulatory supervision at the same level as that of commercial banks has led to the weak performance of co-operative banks. In terms of management, money, audit and liquidation, the Bill seeks to expand the RBI regulation over co-operative banks.
Banking is an element of the Union List in the Constitution and the ‘incorporation, control and liquidation’ of cooperating banks is included in Entry 32 of the State List under Schedule VII. The question is whether the management, audit, capital and liquidation of cooperative banks must be regulated in order to regulate banking activities and, thus, whether the Bill falls within the Parliament’s legislative power.
In India, scheduled commercial banks, regional rural banks, small finance banks and cooperative banks make up the banking sector. Co-operative banks empower small-scale individuals with banking services, thus achieving the goal of financial inclusion. As of 2015, approximately 90% of the loans provided by co-operate banks were less than five lakh rupees each, representing 33% of the banks’ overall lending. Co-operative banks are such co-operate societies whose main operation is banking. These societies are owned, facilitated, operated and regulated by their members to provide financial assistance.
The ambiguous and uncertain distribution of regulatory powers over co-operate banks between the Registrar of Co-operative Societies (ROCS) and the Reserve Bank of India (RBI) is a major reason for the ineffective regulation of co-operative banks in India. While the Registrar of Co-operate Societies regulates the administrative aspects of these banks, including management election control and audit-related issues, the RBI is empowered to regulate liquidity-related aspects such as licencing, cash reserve maintenance, statutory liquidity and capital adequacy ratios, and inspection. The issue in the dual regulatory system for the regulation of the conduct of co-operate banks is due to the bifurcation of powers between two regulatory bodies.
The backdrop of Dual Regulatory Framework
The issue began with the amendment to the Banking Regulation Act in 1966, which introduced Part V, explicitly addressing provisions relating to the applicability of the Act to certain categories of co-operate banks given under the Second Schedule of the Reserve Bank of India Act. The following activities of the Scheduled Co-operate Banks are brought under the oversight of the RBI under this amendment:
Section 11 of the Act was amended to include not less than a lakh of rupees in the amount of its paid-up capital and reserves.
Section 18 of the Act was amended to provide a provision for co-operate banks to establish a cash reserve ratio on their own or through a current account with the RBI or the State Co-operative bank of the State concerned and, in case of primary co-operate banks, with the central co-operate bank of the district concerned. The CRR rate, as provided for in the statute, must be determined by the Reserve Bank of India via an official gazette.
Section 19 of the Act has been revised to prohibit co-operates from owning securities among other co-operate societies.
Section 20 of the Act was altered to prohibit co-operate banks from making such loans and advances in respect of the protection of their shares. Furthermore, it prohibits co-operate banks from offering unsecured loans to any of its directors, firms or private companies. The directors are involved as a partner of the managing agent or guarantor or any other undertaking in which the chairman of the board of directors of the co-operate bank is involved as its managing agent (where the appointment of the Chairman is for a fixed term) or where the Chairman of the Board of Directors of the co-operate bank is concerned as its Managing Agent.
Section 22 of the Act was amended to require primary co-operate banks to obtain a licence from the Reserve Bank of India to carry out the banking transactions specified by the Act.
Section 23 of the Act was amended to prevent co-operate banks from establishing, without the prior approval of the Reserve Bank, a new place of business or modifying their current place of business. Each co-operate bank is required by the amendment to file a balance sheet and profit and loss on 30 June each year. Format of the forms is specified in the Schedule to the Act by the Central Government.
Section 30 of the Act was modified to allow the RBI to carry out an additional audit of the Co-operate Bank in the interest of the public, the Co-operate Bank or its depositors if it considers it necessary.
The RBI can suppress the Board of Directors of the ‘Primary Co-operate’ Banks in the public interest, in the interest of depositors, or preserve the business of the co-operate bank. To inculcate this power, section 36AAA was amended. In this section, other co-operate banks were excluded from its scope. It was amended to limit the authority to supersede the Board for a term of up to five years.
These points demonstrate the current powers of the RBI to control the conduct of co-operate banks under the Banking Regulation Act. Along with other state legislation, the amended provisions of the Banking Regulation Act constitute a dual regulatory structure for co-operate banks in India. This bifurcation of powers between the states’ RBI and ROCS limited the powers of the RBI to effectively control and revive troubled co-operate banks without disturbing the financial market and the interests of depositors.
Need for an Overhaul
In the recent past, failure of many co-operate banks shows the lacunae in the current regulatory structure and necessity to take adequate steps to resolve financial stress among co-operate banks that have reached a point of financial distress, rendering them unable to perform their daily functions. The list of failed financially troubled co-operate banks, to name a few, includes the Madhavpur Co-operative Bank, for which the government had to introduce a 10-year turnaround scheme that was still unable to boost the bank’s financial position and its growing NPAs.
A committee was set up by the RBI under the chairmanship of K Madhav Rao, following the failure of Madhavpur Co-operative Bank. In its report submitted in 1999, the Committee mainly raised its concerns about the size of the operations of urban commercial banks and about the need for RBI to interfere in their activities. The committee observed that as the bank increases its area of operation, it tends to lose its co-operate character and gradually chooses to believe that it is a commercial bank. Such an extension must also be followed by a prescription of the conditions under which commercial banks may operate. For these purposes, the Committee recommended that guidelines be enacted to govern the management and banking activities of co-operate urban banks. It further suggested taking corrective steps to ensure that any financially poor bank would not become a sick bank.
This was compounded by the collapse of the Punjab and Maharashtra Co-operate Bank (PMC) in 2019, which forced the RBI to issue directions under Section 35A (1) since the RBI had to restrict the regular withdrawals made by depositors while seizing the bank’s operations. The RBI recently cancelled the licence of the CKP Co-operative bank, following the failure of a 10-year revival plan.
Key Changes brought by the Amendment Act
- Supersession of Board of Directors: Under the BR Act, RBI is allowed to issue an order to supersede, for a maximum period of five years, the Board of Directors of multi-state co-operate banks and to appoint an Administrator. Multi-state co-operate banks are co-operate banks operating in two or more states and are registered under the 2002 Act on Multi-state Co-operate Societies. For other co-operate banks, the RBI can contact the RCS to replace the Board. The Bill expands RBI’s authority to replace all co-operate banks with the Board of Directors. If the bank is registered with the state RCS, RBI can, in consultation with the state government concerned, issue an order seeking its comments within the time prescribed by RBI.
- Instruction of qualifications for management: Co-operative banks are exempt from the provisions of the BR Act concerning the terms and conditions of employment and the qualifications of the Chairman and the Board of Directors. The Bill provides that, among other limits, co-operate banks should not appoint someone who is insolvent or has been convicted of a felony involving moral turpitude as chairman. If he is not fit and proper, it empowers RBI to remove the Chairman and nominate a suitable individual if the bank does not see to it.
- The Bill stipulates that no less than 51% of the members of the Board of Directors must have special expertise or practical experience in fields such as accounting, banking, economics or law, among others. If it does not comply with the criteria, it enables RBI to guide a bank to reconstitute the Board. If the bank fails to comply, the RBI may dismiss individual directors and appoint appropriate persons.
- Provision for Audit and winding up:The audit of co-operate banks will be carried out on par with scheduled commercial banks under the Bill. Accounts must be audited by a competent person and before appointing, re-appointing or dismissing an auditor, RBI approval would be required. For those transactions and such periods as stated in the order, RBI may order a special audit. In addition to the audit required under the Co-operative Societies Acts, RBI was previously able to issue an order for an additional audit for co-operate banks.
- The Bill makes some laws relating to winding up, and special provisions for the swift disposal of bank winding-up procedures will now extend to co-operate banks.
- Issue of shares and securities: Co-operative banks are exempted under the BR Act from the provision relating to the issue of shares and securities. Other banks are permitted to issue equity or preference shares and RBI is permitted to impose conditions on the issuance of preference shares. Usually, voting rights are allocated based on one share and one vote. An upper limit of 15% on voting rights exercised by an equity shareholder is imposed by the Act (read with RBI Directions).
- The Bill modifies the relevant provisions of the BR Act to provide that co-operate banks can issue equity, preference or special shares at face value or a premium to members or other persons residing in the area of operation of the banks, with the prior approval of the RBI. Banks can also issue unsecured debentures or bonds of not less than 10 years’ maturity. Without permission from the RBI, banks can not withdraw money. Besides, the members are not entitled to the bank’s payment against the surrender of shares.
- The bill enables the Reserve Bank to initiate a scheme to reconstruct or amalgamate a bank without subjecting it to a moratorium.According to the Bill, if the central bank imposes a moratorium on a bank, the lender is unable to issue any loans or make investments in any credit instrument during the moratorium period.
- Under the BR Act, RBI was previously able to prepare a scheme for the reconstruction or amalgamation of the bank after putting the bank under a moratorium. This may be done to ensure that the bank is efficiently run, or in the interests of depositors, the general public or the banking system. Banks put under a moratorium face no legal action for a span of up to six months. Also, during the moratorium, banks cannot make any payments or discharge any liabilities.
- These clauses are also subject to exclusion. The Banking Regulation Amendment Bill, 2020 will not apply to Primary Agricultural Credit Societies as well as Co-operate Societies with long-term funding for agricultural production as their main business. These two entities must not: a) use in their name or relation with their company the words ‘bank’,’ banker’ or ‘banking’; b) Function as an institution clearing the cheque.
Government’s Legislative Competence
Through the Bill, Parliament expands the RBI-Co-operate Bank Regulation to include matters relating to the management, resources, auditing and winding – up of such banks. The issue seems to be whether Parliament has the authority for co-operate banks to legislate on these matters. These entities are registered under various state Co-operative Societies Acts as co-operative societies and carry out banking activities.
In the Seventh Schedule to the Constitution, Parliament has the authority to legislate on ‘banking’ by entry 45 of the Union List. Under entry 32 of the State List, matters relating to the ‘incorporation, control and winding up’ of co-operate societies are covered. Furthermore, Entry 43 of the Union List excludes matters relating to the incorporation, regulation and winding – up of co-operate societies from the competence of Parliament.
A question might be posed as to whether the regulation of management, capital, audit and winding up is necessary for the regulation of ‘banking’ and thus falls within the scope of entry 45 of the Union List, or whether it relates primarily to the ‘incorporation, regulation and liquidation’ of a co-operate company within the context of entry 32 of the State List. The Statement of Object and Reasons of that Bill noted that such clauses are not included in the Union or Concurrent List in terms of substance within the scope of any entry (including ‘banking’).
A judgement of the Supreme Court in the matter of Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Ltd., via a Constitution Bench may be relevant. It takes into consideration whether or not Parliament has the jurisdiction to permit co-operative banks to recover debt under SARFAESI Act, 2002. It held that recovery of debt was a vital aspect of ‘banking’ and consequently it is withinside the scope of Parliament to permit co-operative banks to recover debt under the SARFAESI Act. It was observed in the judgment that the entire operation of a co-operate bank and banking activity is administered by the BR Act. As banking is essentially covered under Entry 45, touching upon a related subject reserved for states [under Entry 32] is admissible. It supplemented that in matters regarding ‘incorporation, regulation and winding up’, that are unconnected to Entry 45 of the Union List, co-operative banks would be administered by the State legislation. Hence, the issue that persists is whether regulation of management, audit, capital and winding up is fundamental to the activity of banking and the functioning of a co-operative bank, and thus, whether the Parliament is competent to pass such legislation.
The introduced bill puts into practise many provisions that are well suggested and well-debated. These enactments also empower the regulator with adequate power to address the co-operate banks that are financially troubled effectively. Even if the FSLRC ‘s recommendations are not taken into account, the new enactment is a measure taken by the legislature in the right direction towards successful regulation of the actions of co-operate banks.
Frequently Asked Questions
- What is the main aim of the Banking Regulation Act, 1949?
Ans: The main aim of the BR Act is to provide a regulatory framework and supervision of activities of commercial banks. Through the Amendment of 2020, co-operate banks shall also fall under the ambit of Banking Regulation Act.
- What are co-operate banks?
Ans: Co-operative banks are financial entities established on a co-operative basis and belonging to their members. This means that the customers of a co-operative bank are also its owners. These banks provide a wide range of regular banking and financial services. Broadly, co-operative banks in India are divided into two categories – urban and rural.
- What are the main sections amended by the Banking Regulation (Amendment) Bill, 2020?
Ans: The main sections that are amended by the Amendment Bill are Sections 3, 45 and 56 of the Banking Regulation Act, 1949 majorly concerning the application of the parent Act and reconstruction and amalgamation without moratorium in co-operate banks.
- When was the Banking Regulation (Amendment) Bill passed?
- Under which entry of the State List is incorporation, regulation and winding up of co-operative societies covered?
- What is the minimum maturity period granted for unsecured debentures and bonds?
- Who can issue an order for re-audit in co-operate banks?
- Which committee raised concerns regarding the operation of Urban Commercial banks?
 Indian Const. schedule VII, List I Entry 45.
 Indian Const. schedule VII, List II Entry 32.
 supra note 3.
 Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Ltd. 2015 SCC OnLine SC 1873.