Regulation of Banks

The architecture of banking regulation in India is anchored primarily upon two legislative pillars alongside supplementary enactments that vest administrative, supervisory, and corrective powers in the Reserve Bank of India (RBI).

Reserve Bank of India Act, 1934

• Defines the statutory basis for the constitution and governance structure of the central bank.
• Section 42: Empowers the RBI to maintain and alter the Cash Reserve Ratio (CRR) for scheduled banks.
• Second Schedule: Banks fulfilling requirements under Section 42(6)(a) (minimum paid-up capital and reserves threshold, along with non-detrimental operations to depositors) are listed here, granting them lender-of-last-resort and clearinghouse privileges.

Banking Regulation Act, 1949

• Extends comprehensive operational, structural, and management control to the RBI over commercial, regional rural, and cooperative banking entities.
• Section 22: Mandates compulsory licensing for commencing or carrying out banking businesses in India.
• Section 24: Dictates the maintenance of the Statutory Liquidity Ratio (SLR) up to a statutory ceiling of 40% of Net Demand and Time Liabilities (NDTL).
• Section 35: Confers sweeping powers for the inspection, scrutiny, and physical audit of banking books.

Banking Laws (Amendment) Act, 2025

• Nomination Framework Updates: Multi-nomination facility introduced, allowing depositors to nominate up to four individuals simultaneously (via percentage allocation) or successively for bank accounts and safe lockers.
• Governance Alignments: Extends the maximum tenure of directors (excluding chairpersons and whole-time directors) from 8 years to 10 years for cooperative institutions, aligning them structurally with the 97th Constitutional Amendment.
• Audit Uniformity: Tightens accounting standards and uniformity in data reporting obligations directly to the RBI to strengthen early-stress detection.

Structural Classification of Regulated Banking Entities

The domestic banking grid is systematically segregated into distinct categories based on operational scope, target consumer base, and equity ownership models.

Scheduled Commercial Banks (SCBs)

• Public Sector Banks (PSBs): Majority equity (51% or higher) is held by the Central Government (e.g., State Bank of India, Punjab National Bank).
• Private Sector Banks: Private shareholding predominates; subject to stringent voting right ceilings and promoter lock-in periods mandated by the RBI.
• Foreign Banks: Operate via branch networks or Wholly Owned Subsidiaries (WOS) under reciprocal obligations and capital adequacy rules consistent with international protocols.

Regional Rural Banks (RRBs)

• Established via the RRB Act, 1976, to bridge credit gaps in rural ecosystems.
• Equity Structure: Split systematically among the Central Government (50%), Sponsor Commercial Bank (35%), and the concerned State Government (15%).

Differentiated Banks

• Small Finance Banks (SFBs): Tailored for financial inclusion targeting small businesses, marginal farmers, and micro-enterprises. At least 75% of their Adjusted Net Bank Credit (ANBC) must be directed toward Priority Sector Lending (PSL), with a minimum capital requirement of ₹200 crore.
• Payments Banks: Restricted to accepting demand deposits (savings and current accounts) up to a threshold of ₹2 lakh per individual customer. They cannot issue loans or credit cards and must invest their deposits in government securities or short-term bank deposits.

Cooperative Banks

• Urban Cooperative Banks (UCBs): Supervised under a dual arrangement involving State Registrars of Cooperative Societies (RCS)/Central Registrar (CRCS) for administrative functions and the RBI for core banking operations.
• Structure Alignment: The Banking Regulation (Amendment) Act, 2020 brought UCBs fully under the RBI’s regulatory ambit regarding management, capital issuance, and resolution strategies.

Core Instruments of Regulation and Credit Control

The RBI deploys quantitative and qualitative toolkits to anchor macroeconomic indicators, handle system liquidity, and curb unbridled asset expansion.

Institutional Machinery for Supervision

The execution of oversight relies on a specialized institutional architecture within the RBI designed to isolate systemic risks.

Board for Financial Supervision (BFS)

• Constituted in November 1994 as a specialized committee of the RBI’s Central Board of Directors.
• Composition: Chaired by the Governor of the RBI, featuring Deputy Governors (with the Deputy Governor in charge of banking regulation functioning as the Vice-Chairman) and four co-opted directors from the Central Board.
• Jurisdiction: Exercises integrated oversight over commercial banks, non-banking financial companies (NBFCs), and All India Financial Institutions (AIFIs).

Supervisory Approaches

• CAMELS Framework: On-site inspection framework evaluating Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Systems & Control.
• Off-Site Surveillance and Monitoring System (OSMOS): A data-driven electronic return platform enabling real-time micro and macroprudential evaluation without physical presence.

Risk Management, Capital Standards, and Stressed Assets

The RBI mandates global benchmark standards alongside domestic early-intervention mechanisms to maintain structural solvency.

Basel III Accords Implementation

• Capital to Risk-Weighted Assets Ratio (CRAR): Domestic scheduled commercial banks are mandated to maintain a minimum CRAR of 9% (higher than the Basel III minimum of 8%).
• Capital Conservation Buffer (CCB): An additional counter-cyclical capital buffer of 2.5% composed of Common Equity Tier-1 capital.
• Liquidity Coverage Ratio (LCR) & Net Stable Funding Ratio (NSFR): Mandated to guarantee that high-quality liquid assets are sufficient to withstand severe short-term economic stress scenarios.

Classification of Non-Performing Assets (NPAs)

• Sub-Standard Assets: Assets which have remained an NPA for a period less than or equal to 12 months.
• Doubtful Assets: An asset that has remained in the sub-standard category for a period exceeding 12 months.
• Loss Assets: Identified by the bank, internal/external auditors, or the RBI inspection team as entirely uncollectible, though not entirely written off.

Prompt Corrective Action (PCA) Framework

• A supervisory watch-list triggered when a bank breaches predefined thresholds across specific risk parameters.
• Core Indicators Monitored: Capital Adequacy (CRAR), Asset Quality (Net NPA ratio), and Leverage (Tier-1 Leverage Ratio).
• Corrective Actions: Restricting dividend distribution, freezing branch expansions, placing ceilings on director compensation, or forcing mergers and structural restructuring.

Depositor Protection and Grievance Redressal Mechanisms

To prevent run-on-the-bank scenarios and uphold financial integrity, the regulatory framework integrates specialized protection subsidiaries and grievance resolution portals.

Deposit Insurance and Credit Guarantee Corporation (DICGC)

• A specialized, wholly owned subsidiary of the RBI operating under the DICGC Act, 1961.
• Coverage Limit: Insures cumulative bank deposits (including cumulative savings, fixed, current, and recurring balances) up to a ceiling of ₹5 lakh per depositor per bank (inclusive of both principal and accrued interest).
• Statutory Payout Timeline: Amending provisions mandate the disbursement of insured amounts to eligible depositors within a strict window of 90 days from the imposition of a banking moratorium.

Reserve Bank – Integrated Ombudsman Scheme (RB-IOS)

• Merged the pre-existing standalone ombudsman architectures (Banking, NBFC, and Digital Transactions) into a centralized, single-window system.
• Operates on the foundational principle of ‘One Nation One Ombudsman’, addressing deficiencies in customer service across all regulated entities via a single point of digital contact.

Depositor Education and Awareness (DEA) Fund

• Established via Section 26A of the Banking Regulation Act, 1949.
• Any deposit account or financial instrument operating within India that remains inactive or unclaimed for a consecutive duration of 10 years must be transferred to this fund within three months of the expiry of the 10-year period. Funds are subsequently utilized for institutional programs targeting financial literacy and consumer awareness.