Amendment to Banking Regulation Act is just a political signal: Some insights from history..

Under the Ordinance, the Central Government .. empowered, at any time, to direct the Reserve Bank to undertake an inspection of the books and accounts of any banking company incorporated under the Indian Companies Act and to make a report to the Central Government. If, after considering the Bank’s report of inspection, the Central Government were of the opinion that the concerned bank’s affairs were being conducted to the detriment of the interests of its depositors, the Government could prohibit the bank from receiving fresh deposits or refuse its inclusion in the Second Schedule or, if it had been so included, direct its exclusion from the Schedule. The Ordinance further prescribed penalties for contravention of its provisions and empowered the Central Government to publish the whole or any part of the inspection report after giving reasonable notice to the concerned bank.

One might be thinking that this Ordinance is the recent amendment to Banking Regulation Act 2017, which has been much in news. But this Ordinance was passed 70 years ago in 1946! Though, the ordinance was defective as it only gave RBI powers to regulate banks in British India and not Princely States. But still it is not as if RBI did not have powers over banking.

Further the Ordinance gave sweeping powers to RBI:

Prior to the promulgation of this Ordinance, the inspections carried out by the Bank to determine the eligibility of banks for inclusion or retention in the Second Schedule were confined to ascertaining the real value of the paid-up capital and reserves of banks. The scope of inspection under the Ordinance was much wider as it involved a qualitative assessment of a bank’s management, policy and methods of business from the point of view of the depositors’ interests. Soon after the promulgation of the Inspection Ordinance, the Central Government issued instructions, on the suggestion of the Bank, that all inspections of banks incorporated in British India should thenceforth be carried out under the provisions of the Ordinance, including those .for the purpose of determining the eligibility of banks for inclusion or retention in the Second Schedule.

This was followed by Banking Companies Bill (1946) which added more powers like prescribing capital ratios, dividend rules, maintenance of liquid assets and so on. The Bill got delayed due to Partition, differences between members over some issues etc. Finally it took shape of Banking Regulation Act (1949) which happens to be the mainstay of Indian banking ever since…

I had blogged about these RBI inspection powers over banking earlier as well:

RBI is perhaps one of those few central banks which has extensive powers to regulate and monitor our banks. The central bank got these powers under Banking Regulation Act (1949). Section 35 of the Act gives wide inspection powers to the central bank. RBI in its first history volume celebrates passage of this Act which gave central bank powers to put our banks in order. Apart from capital and reserves requirements, the History notes:

The clause was redrafted somewhat on the lines of the Banking Companies (Inspection) Ordinance, 1946. The Reserve Bank was given full discretion to inspect a bank at any time so that the public might have no ground for drawing any unfavourable inference from the fact that a bank was inspected. Other important features of the new clause were that the Reserve Bank should employ only its own officers to conduct the inspections and that a copy of the Bank’s report on the inspection should in all cases be sent to the inspected bank.

In view of the much publicised criticism regarding the aloofness of the Bank, a new clause was added enlarging the Bank’s powers and functions in relation to banks. The clause empowered the Bank to caution and advise banks, to assist them as intermediary or otherwise in proposals for amalgamation and to grant loans to them [under amendment proposed by the Select Committee to Section 18(3) of the Reserve Bank Act referred to later] against any security the Bank might consider sufficient. The Bank could also call upon an inspected bank to hold a meeting for considering matters relating to the inspection and to make such changes in its management as might be necessary thereupon. The Bank was also placed under a statutory obligation to submit an annual report to the ‘Central Government on the trend and progress of banking in the country.

The act gave RBI a responsibility to issue a statutory report on banking which became Report on Trend and Progress of Banking in India. Read the BR Act (1949) for more details. One would imagine there is enough ammunition in the act to act on basic banking principles. We have thought and worked on the source of banking problems nearly 60 years ago. One wonders which other central bank has such powers over its banking system.

The RBI Inspection team should be able to pretty much see and caution against  the source of the prblem. That is their job.

Compare these powers to the new Ordinance which says:

In exercise of the powers conferred by Section 35AA of the Banking Regulation Act, 1949 (10 of 1949), the Central Government hereby authorises the Reserve Bank of India to issue such directions to any banking company or banking companies which may be considered necessary to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.

I mean this is much later. Why is there a need to come to resolution having such wide inspection powers? It is not very often that you see government having a horse before the cart. Usually it is a case of cart before the horse.

But then thanks to our experts and media who seem to have no other job other than sing praises and call everything game changer.

Anantha Nageshwaran who is usually the lone dissenter sums it up nicely:

(10) As a layman (not a lawyer, that is), I find Section 35 A of the Banking Regulation Act 1949 sweeping enough:

35A. Power of the Reserve Bank to give directions

(1) Where the Reserve Bank is satisfied that-

(a) in the [public interest]; or
[(aa) in the interest of banking policy; or]

(b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or

(c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions.

 (2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect. [Link]

The Section 35A and some provisions in it have been inserted in 1956, 1960 and 1968 respectively.  They seem broad enough for RBI to act. IF it has not acted on these, I doubt if it was lack of legal empowerment. May be, it was waiting for the political signal.

In other words, the utility of the Ordinance lies in the political signalling rather than incremental empowerment of RBI, the Banking Regulator.

Indeed. That is pretty much it. You do not even need to know all this history. Just see current Banking Regulation Act (1949) and decide for yourself.

Given the mess around banking, RBI inspection reports should be made public. We should know whether and when did RBI inspection start warning banks about their NPAs? Did the warnings escalate overtime? How frequently were these inspections done?

With so much powers already and not knowing what went wrong, we are just looking at the wrong source of problems. The blame game has been between banks and the government but clearly there is much more than meets the eye..


2 Responses to “Amendment to Banking Regulation Act is just a political signal: Some insights from history..”

  1. The RBI’s new (potentially compromising) powers | | Qell the Free UK Business Directory Says:

    […] problem. For example, there are those who argue the RBI already had broad powers that allowed it to inspect, caution and advise banks. But the answer to that seems to be… yes, but they were indeed broad and now have been […]

  2. The Banking Regulation ordinance- an imperfect solution to a perfect problem? Says:

    […] Legally speaking, Section 35A of the BRA included within itself wide enough powers to act on matters of the nature envisaged in the Ordinance. One can only speculate that this is more of a political green signal to the RBI to act rather than a legislative one. (Read: reluctance on part of bankers to initiate insolvency resolution against politically connected corporate borrowers). […]

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