Banking regulation in India: overview
Legislation and regulatory authorities
1. What is the legal framework for banking regulation?
Banking business and related financial services are governed primarily by the Banking Regulation Act, 1949 (“Banking Regulation Act”).
The Reserve Bank of India Act, 1934 (“RBI Act”) empowers the Reserve Bank of India (RBI) to issue rules, regulations, directions and guidelines on a wide range of issues relating to banking and the financial sector. The RBI is the central bank of India, and the primary regulatory authority for banking.
Cross-border transactions and related activities are governed by the Foreign Exchange Management Act, 1999. This provides for, among other things, certain banking and other institutions to be licensed as authorized dealers in foreign exchange.
2. What are the regulatory authorities for banking regulation in your jurisdiction? What is the role of the central bank in banking regulation?
Lead bank regulators
The primary banking regulator in India is the Reserve Bank of India (RBI). The RBI has wide-ranging powers to regulate the financial sector. These include prescribing norms for setting up and licensing banks (including branches of foreign banks in India), corporate governance, prudential norms and conditions for structuring products and services.
Its other functions include, among other things:
· Setting monetary policy.
· Regulation of money, foreign exchange, government securities markets and financial derivatives.
· Debt and cash management for the government.
· Oversight of payment and settlement systems.
· Currency management.
India has several other financial sector regulators, including the:
· Securities Exchange Board of India (“SEBI”), which is the regulatory authority for the securities market in India.
· Insurance Regulatory and Development Authority of India (“IRDAI”), which regulates the insurance sector.
· Insolvency and Bankruptcy Board of India (“IBBI”), which regulates the process relating to conducting insolvency proceedings under the Insolvency and Bankruptcy Code (“IBC”).
The RBI often liaises closely with the SEBI, IRDAI and, where required, other financial sector regulators, to regulate banking activities which interact with other financial activities.
See above, Lead bank regulators.
The central government, in particular the Ministry of Finance, also supervises and legislates on the functioning of banks and financial institutions. Acting through its Department of Financial Services, it:
· Monitors banking operations.
· Prescribes norms for the operation and functioning of public sector banks.
· Examines legislative measures for recovery of bank debts, and establishes judicial mechanisms for this purpose.
3. What licence(s) are required to conduct banking services and what activities do they cover?
An entity intending to carry out banking business in India must obtain a license from the RBI.
A licensed banking company can also conduct certain ancillary business such as borrowing and lending, trade finance, guarantee and indemnity business, financial leasing and hire purchase and securitization.
An entity proposing to deal in foreign exchange is also required to obtain a separate license as an authorized dealer from the RBI. This license is issued under the Foreign Exchange Management Act. Authorised dealers are granted wide-ranging powers to monitor and facilitate foreign exchange and cross-border transactions. All remittances of foreign currency from or into India are routed through such authorized dealers.
4. What is the application process for bank licences?
An application for a bank licence must be made to the RBI. The RBI on August 1, 2016, introduced Guidelines for “on-tap” Licensing of Universal Banks in the Private Sector (“On-Tap Guidelines”). This replaces the previous approach which involved a ‘Stop and Go’ licensing policy by providing a window for applicants to approach the RBI for a licence.
The application is usually prepared by the company seeking to obtain the licence. The On-Tap Guidelines prescribe requirements such as ‘fit and proper’ criteria for the promoters of the applicants, eligibility conditions such as the bank being controlled by residents and shareholding requirements including minimum capitalisation requirements etc. For Indian incorporated entities seeking a bank licence, the initial minimum paid-up voting equity capital must be at least INR 5 billion. Thereafter, the bank must have a minimum net worth of INR 5 billion at all times.
The form of application is set out in the Banking Regulation (Companies) Rules, 1949. This prescribes different forms, depending on the nature of the applicant and whether it is a domestic or foreign company.
The application must be submitted with:
· A copy of the company’s constitutional documents.
· Copies of a prospectus (for a new company) and the balance sheet and profit and loss account statements for the previous 5 years (for an existing company).
The application must also include information as below in relation to the promoters or the promoter group:
· Information on the ultimate individual promoters, including:
- a self-declaration by the individual promoters in a prescribed form; and
- detailed profiles on their individual background and experience, expertise, and business track record.
· Information on entities in the promoter group, including:
- names and details of the promoter group entities;
- shareholding structure of the entities;
- a pictorial diagram indicating the corporate structure of the entities and the shareholdings and total assets; and
- annual reports of the past 5 years of all the group entities.
· Information on the promoting/converting entity, including:
- a declaration by the promoting/converting entity in a prescribed form;
- its shareholding pattern;
- constitutional documents and financial statements for the previous 5 years (including important financial indicators);
- board composition and representation of the directors over a period of 10 years;
- income tax returns for last 3 years; and
- Chartered accountant’s certificate indicating the source of funds for the promoting/converting entity.
· Information about the persons/entities who will subscribe to 5% or more of the paid-up equity capital of the proposed bank, including foreign equity participation and the sources of capital of the proposed investors.
· The proposed promoter shareholding, and plan for dilution of the shareholding.
· Proposed management of the bank.
In addition, the applicant must provide a project report covering:
· Business potential and viability of the proposed bank.
· Any other financial services proposed to be offered.
· Plan for compliance with prudential norms.
· How the bank proposes to achieve financial inclusion.
· In the case of a non-banking financial company as the applicant, how the existing lending business will fold into the bank or be disposed of.
The RBI can call for other additional information, if required.
The RBI’s decision to grant a licence is based on several factors, including whether:
· The company is or will be able to pay its present or future depositors in full as their claims accrue.
· The promoters / promoter groups are ‘`fit and proper’ in order to be eligible to promote banks.
· The company complies with the conditions specified in the On-Tap Guidelines.
· The company’s affairs are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors.
· The general character of the proposed management will not be prejudicial to the public interest or its depositors.
· The company has adequate capital structure and earning prospects.
· The public interest will be served by granting the licence.
· In relation to banking facilities in the company’s proposed main area of operations, the potential expansion of banks already in the area and other relevant factors, granting the licence is not prejudicial to the operation and consolidation of the banking system, and is consistent with monetary stability and economic growth.
The RBI can also consider any other condition which, in the RBI’s opinion, is necessary to ensure that the company carrying on banking business will not prejudice the public interest or the interests of the depositors. The RBI’s decision to grant a licence is discretionary and based on its assessment of the above conditions.
At the first stage, the applications are screened by the RBI to assess the eligibility of the applicants vis-à-vis the criteria laid down in the On-Tap Guidelines. RBI may apply additional criteria to determine the suitability of applications and thereafter, the applications will be referred to a Standing External Advisory Committee (SEAC) to be set up by RBI.
The SEAC will meet periodically, as and when required. SEAC has the right to call for more information as well as to have discussions with any applicant/s and seek clarification on any issue as may be required by it and subsequently, submit its recommendations to RBI for consideration.
The Internal Screening Committee (ISC), consisting of the Governor and the Deputy Governors of RBI examine all the applications. The ISC also deliberates on the rationale of the recommendations made by SEAC and then submits its recommendations to the Committee of the Central Board (CCB) of RBI for the final decision to issue in-principle approval.
In addition to the general conditions, in case of foreign entities the RBI must be satisfied that both:
· The government or law of the country in which the foreign bank is incorporated does not discriminate against banking companies registered in India.
· The banking company complies with the provisions of the Banking Regulation Act that apply to banking companies incorporated outside India.
Timing and basis of decision
While there is no specific time-line prescribed for the RBI to issue a decision, typically the process can take about 18 months or longer. This also depends on discussions with the RBI, clarifications and information sought by the RBI, and how quickly these issues are resolved.
The validity of the in-principle approval issued by RBI will be 18 months from the date of granting in-principle approval and would thereafter lapse automatically. Therefore, the applicant bank will have to obtain the banking licence within a period of 18 months of granting of the in-principle approval.
An applicant who has not been found suitable for issue of licence will be advised of RBI’s decision. Such applicants will not be eligible to make an application for a banking licence for a period of 3 years from the date of that decision
Cost and duration
Apart from the prudential norms of maintaining capital and liquidity reserves there are no specific ongoing costs associated with a bank licence. In the authors’ experience, bank licences issued by the RBI are not usually subject to an expiry date. There is no licence fee while submitting the form to apply for a banking licence.
5. Can banks headquartered in other jurisdictions operate in your jurisdiction on the basis of their home state banking licence?
Foreign banks must obtain a banking licence in India before carrying on banking business in India, regardless of whether they are licensed to carry on such activities in their home state.
Forms of banks
6. What forms of bank operate in your jurisdiction, and how are they generally regulated? Does the regulatory regime distinguish between different forms of banks?
The largest state-owned bank in India is the State Bank of India (SBI), which is established under and governed by a special statute, the State Bank of India Act, 1955. Over the years, SBI has acquired several other state owned banks, which are governed by the State Bank of India (Subsidiary Banks) Act, 1959. Additionally, between 1969 and 1980, the government nationalised several banks by legislative mandate.
Universal banks, commercial and retail banks
Universal banks are full service banks offering a wide range of financial products. These can be categorised into domestic private sector banks (not state-owned), public sector banks (state-owned) and foreign banks. The licensing and operation of these banks is governed by the Banking Regulation Act and the guidelines issued under it.
Investment advisory services and related services are governed by the Securities Exchange Board of India (SEBI). Such activities are undertaken by entities which are licensed by and registered with the SEBI. The licensing and regulatory regime for such entities depends largely on the activities they undertake.
Private banks can be domestic entities or foreign banks operating through a branch in India. The licensing and operation of these banks is governed by the Banking Regulation Act and the guidelines issued under it.
The Indian banking sector has introduced certain special types of banks to support banking activities in underdeveloped and non-urban sectors. For instance, co-operative banks cater for the rural sector and small borrowers. They are organised on a co-operative basis, and governed by co-operative laws introduced by the state governments of India and the central banking laws. Similarly, regional rural banks are incorporated under the Regional Rural Banks Act, 1976 to develop the rural economy.
The RBI has also introduced the following categories of banks to promote financial inclusion and support small businesses, the unorganised sector, low income households, farmers and migrant workers:
· Payment banks vide the issue of guidelines for licensing of payment banks in 2014. Payments banks are governed by the Banking Regulation Act, Payments and Settlement Systems Act, 2007 and other applicable laws. Payment banks offer basic banking services such as accepting demand deposits, issuing payment instruments other than credit cards, payment and remittance services, and distribution of financial products.
· Small finance banks offer limited services such as savings vehicles and credit. They are subject to special operational guidelines and licensing conditions prescribed by the RBI.
Regulation of systemically important financial institutions (SIFIs)
The RBI Act also recognises non-banking financial companies (NBFCs), which are registered with the RBI. NBFCs are companies undertaking financial activities but not regulated as banks. NBFCs undertake a range of activities such as investment, hire-purchase, leasing, factoring and lending, subject to the RBI Act and RBI regulations specifically for NBFCs. Under the powers provided under the RBI Act, RBI also issues directions, guidelines, and circulars in relation to activities, operations, prudential norms and other related aspects of NBFC operations.
Organisation of banks
7. What legal entities can operate as banks? What legal forms are generally used to operate as banks?
Under the Banking Regulation Act, banking business must be conducted by a company.
8. What are the legislative and non-legislative corporate governance rules for banks?
Corporate Governance for Banks
Corporate governance rules for banks in India are governed by the Companies Act 2013. If a banking company is listed, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 also apply.
The Companies Act does not differentiate between financial and non-financial companies. SEBI Guidelines are generally from the perspective of investor protection, with an emphasis on disclosure and transparency. The RBI, as the prudential regulator of non-banking financial companies, additionally emphasises risk management and business practices, and its framework is mainly from the angle of depositor and customer protection.
Various guidelines have been issued to strengthen corporate governance, for instance relating to the fit and proper criteria for the directors of banks, separation of the post of chairman and managing director, and remuneration.
To ensure that ownership and control of banks are well diversified, guidelines on ownership and governance in private sector banks were issued by RBI in February 2005.
The importance of diversified ownership is also underlined in recent guidelines on new bank licences. These stipulate that non-operative financial holding companies (NOFHC) which set up new banks should, after an initial lock in period of 5 years, reduce their equity capital in the bank from the minimum requirement of 40% down to 15% within 12 years.
To ensure the fit and proper status of groups that set up new banks, entities/groups must have a past record of sound credentials and integrity, and be financially sound with a successful track record of 10 years.
The RBI has also issued minimum guidelines in relation to a bank’s compliance function. A bank must comply with:
· Various statutes such as the Banking Regulation Act, RBI Act, Foreign Exchange Management Act and Prevention of Money Laundering Act.
· Regulatory guidelines issued from time to time.
· Standards and codes prescribed by bodies such as the Basel Committee and the Indian Banks Association.
· Its internal policies and fair practices code.
Compliance laws, rules and standards generally cover matters such as observing proper standards of market conduct, managing conflicts of interest, treating customers fairly, and ensuring the suitability of customer advice. Each bank must formulate a list of compliance functions. The bank’s compliance officer must assist the senior management in managing compliance risks.
Corporate Governance for NBFC(s)
Due to the significance of NBFCs in the financial system, the regulatory framework on corporate governance for NBFCs was revamped in 2014 and strengthened in terms of capital adequacy and exposure norms. In 2015, the RBI issued revised guidelines/directions on corporate governance for NBFCs with a certain deposit base or asset size. Listed NBFCs must also comply with the Listing Agreement of the Securities and Exchange Board of India (SEBI). Other NBFCs are governed by the Companies Act, 1956.
Certain NBFCs with having assets of at least INR 5 billion have been notified by the Ministry of Finance as a ‘financial institution’ under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI). Such NBFCs have been granted enforcement powers under the provisions of the SARFAESI, which include rights to enforce security interests outside of court process.
9. What are the organisational requirements for banks?
Under the Banking Regulation Act, banking business can only be conducted by a company. State-owned banks are typically incorporated under specific statutes. Private Banks are incorporated as companies and governed by the Companies Act. Their constitutional documents include the following:
· Memorandum of association.
· Articles of association.
· Certificate of incorporation.
· Certificate of commencement of business.
Foreign banks are not required to incorporate a separate company in India and can operate through a branch in India. In certain cases, RBI can require the foreign entity to set up its banking presence in India through a wholly owned subsidiary. This is usually due to the RBI’s assessment of the laws of the applicant’s home country, and a general preference for systemically important banks to have a wholly-owned-subsidiary in India and not a branch. Foreign banks will be permitted to either have branches or subsidiaries but not both. A foreign bank may operate in India through only 1 of the 3 channels viz., (i) branches (ii) a wholly-owned subsidiary (iii) a subsidiary with aggregate foreign investment up to a maximum of 74 % in a private bank.
10. What are the rules concerning appointment of auditors and other experts?
The Banking Regulation Act requires all banks to have their balance sheet and profit and loss statements audited. The appointment/re-appointment and removal of auditors is permissible only with prior approval of RBI. Persons qualified to be auditors by law are also eligible to audit banks. Along with compliance with the Companies Act, auditors must provide additional information. For banks incorporated in India, auditors must provide the following information:
· Whether information supplied to the auditor was satisfactory.
· Whether transactions noticed by the auditor were within the powers of the bank.
· Whether returns from branches were adequate for the purposes of the audit.
· Whether the profit and loss account shows a true account of the status of the bank.
· Any other matter the auditor considers necessary to bring to the notice of the shareholders.
Case law suggests that the auditor will be liable if, after signing the auditors’ report for an apparently sound balance sheet, it is found that the banking company is insolvent.
The RBI can, under the Banking Regulation Act, order a special audit of a banking company, if it believes that the audit is necessary in the interests of the public, the depositors, or the banking company. A special audit can relate to any class of transactions or period as specified by the RBI. The RBI can appoint an auditor, or require the bank’s auditor to produce the special audit report.
Further, as per a recent notification of the RBI an audit firm, after completing its 4 year tenure as the auditor in a particular private/ foreign bank, will not be eligible for appointment as the auditor of the same bank for a period of 6 years.
11. What is the supervisory regime for management of banks?
In accordance with the provisions of the Banking Regulation Act, the appointment, re-appointment or termination or remuneration of a chairman, a managing or whole-time director, manager or chief executive officer and any amendment thereto requires prior approval of the RBI. Further, various guidelines have been issued on the role of the board of directors of banks and the fit and proper criteria for appointing directors of banks. Some key requirements regarding bank boards under the Banking Regulation Act are set out below:
· Directors must have professional or other experience, and at least 51% of the board must have special knowledge or practical experience in any of the following fields: accountancy, agriculture and rural economy, banking, co-operation, economics, finance, law, small-scale industry, or any other matter which in the RBI’s opinion would be useful to the bank. Of these directors, at least 2 must have special knowledge in agriculture and rural economy, co-operation or small-scale industry.
· A bank director must not have a substantial interest in, or be connected with (as an employee, manager or managing agent) any company or firm carrying on trade, commerce or industry which is not a small-scale industrial concern.
· Directors of banks are not allowed to own a trading, commercial or industrial concern.
· A director cannot hold office continuously for a period exceeding 8 years, except for the chairman or a full-time director.
· A bank cannot have a director that is a director of another bank, unless the director is appointed by the RBI. A bank cannot have more than 3 directors who are directors of companies which are together entitled to exercise voting rights exceeding 20% of the total voting rights of the bank’s shareholders.
· Each bank must appoint 1 director as chairman of the board. A full-time chairman is manages the bank’s affairs, subject to the superintendence, control and direction of the board.
Under the Banking Regulation Act, the RBI can remove from office any chairman, director, chief executive officer or other officer or employee of a bank, on the following grounds:
· Public interest.
· To prevent the bank’s affairs being conducted in a manner detrimental to the interests of the depositors.
· To ensure proper management of the bank.
In all instances, the individual must be provided a reasonable opportunity to be heard.
If the delay caused in removing any chairman, director, chief executive officer or other officer or employee of a bank is detrimental to the bank or its depositors, the RBI can immediately remove an individual from office and provide an opportunity to make a representation. Such an order can be appealed to the central government and its decision is final. An individual removed from office cannot be involved in the affairs of another bank for a period of 5 years. The RBI also has power to appoint another individual to replace a removed individual who will hold office at the pleasure of the RBI for a period not exceeding 3 years or such further periods not exceeding 3 years as may be prescribed by RBI.
12. Do any remuneration policies apply?
The Banking Regulation Act states that no banking company shall employ or continue the employment of any person whose remuneration or part of whose remuneration takes the form of commission or of a share in the profits of the company, or whose remuneration is, in the opinion of the RBI, excessive. Under the Banking Regulation Act, the remuneration of a chairman, a managing or whole-time director, manager or chief executive officer and any amendment thereto requires prior approval of the RBI
The RBI also published the Guidelines on Compensation of Whole Time Directors/Chief Executive Officers/Risk takers and Control function staff (Guidelines) on January 13, 2012. These apply to private and foreign banks. Compensation packages in state-owned banks are determined by the central government.
The Guidelines have adopted the Financial Stability Board Principles for Sound Compensation. These intend to reduce incentives for excessive risk taking that may arise from compensation schemes. The principles call for effective governance of compensation, alignment of compensation with prudent risk taking, effective supervisory oversight and stakeholder engagement. They have been endorsed by the G-20 countries and the Basel Committee on Banking Supervision.
The Guidelines provide that banks should formulate and adopt a comprehensive compensation policy covering all their employees. This policy must cover aspects such as fixed pay, benefits, bonuses, guaranteed pay, severance packages, stocks, pension plans and gratuities. The Guidelines call for the board to set up a remuneration committee, to oversee the framing, review and implementation of the bank’s compensation policy.
The Guidelines also provide that the board of directors of banks should constitute a ‘Remuneration Committee’ of the board of directors to oversee the framing, review and implementation of compensation policy of the bank on behalf of the board.
For full time directors and chief executive officers (CEO), the Guidelines state that banks should ensure compensation is adjusted for all types of risk. The Guidelines set out the compensation structure for full time directors/CEOs with the following components:
· Fixed pay: reasonable fixed pay, based on factors such as industry practice.
· Variable pay: proper balance of variable and fixed pay. Variable pay should not exceed 70% of the fixed pay in a year. Variable pay can be in cash, stock linked instruments, or both.
· Clawback: in the event of negative contributions of the bank and/or a relevant business line in any year, deferred compensation should be subject to malus/clawback arrangements.
· Guaranteed bonus: these are not consistent with sound risk management or pay-for-performance principles, and should not be part of a compensation plan.
The Guidelines also provide that members of staff engaged in financial and risk control should be compensated independently of the business areas they oversee, and in proportion to their key role in the bank. Additionally, the Guidelines provide that foreign banks operating in India must submit a declaration to RBI annually from their head office that their compensation structure in India complies with Financial Stability Board principles and standards.
To ensure regulatory and supervisory oversight, banks’ compensation policies are subject to review. Deficiencies in the policy have the effect of increasing the risk profile of banks, including requiring additional capital if they are very significant.
Further, the RBI also released ‘Guidelines on Compensation of Non-executive Directors of Private Sector Banks’ to address the need to bring professionalism to the boards of banks. As per the said guidelines, the board of directors of a bank, in consultation with the Remuneration Committee, are required to formulate and adopt a comprehensive compensation policy for the non-executive directors (other than part-time non-executive chairman), in accordance with the provisions of Companies Act, 2013. The board may, at its discretion, provide for payment of compensation in the form of profit related commission to the non-executive directors, subject to the bank making profits and such compensation not exceeding INR 1 million per annum for each director. In addition to the compensation, the non-executive directors will also be entitled to sitting fees and reimbursement of expenses. The banks are required to obtain approval of the RBI for remuneration of part-time non-executive chairman.
The RBI has further specified that for the purposes of the Banking Regulation Act, the following loans/advances granted to the chief executive officer / whole time directors will not be considered as ‘loans and advances’:
· Loan for purchasing of car
· Loan for purchasing of personal computer
· Loan for purchasing of furniture
· Loan for constructing/acquiring a house for personal use
· Festival advance
· Credit limit under credit card facility
The RBI has in relation to the above categories of loan, permitted commercial banks to grant loans and advances to the chief executive officer/ whole time directors as part of the compensation and remuneration policy of the bank, without seeking prior approval of RBI, subject to certain conditions. The guidelines on base rate will not be applicable on the interest charged on such loans. However, the interest rate charged on such loans cannot be lower than the rate charged on loans to the bank’s own employees.
13. What are the risk management rules for banks?
The RBI has issued various guidelines on risk management policies to be adopted by banks. Risk management should include:
· The organisational structure of the bank.
· A comprehensive risk measurement approach.
· Risk management policies approved by the board, consistent with broader business strategies, capital strength, management expertise and overall willingness to assume risk.
· Guidelines and other parameters used to govern risk taking, including detailed structure of prudential limits.
· A strong management information system for reporting, monitoring and controlling risks.
· Well laid out procedures, effective control and a comprehensive risk reporting framework.
· A separate risk management framework independent of operational departments, with clear delineation of responsibility for risk management.
· Periodical review and evaluation of the risk management function.
The primary responsibility of understanding risks and ensuring that risks are appropriately managed is vested with the board. The board should set risk limits by assessing the risk-bearing capacity of the bank. At an organisational level, overall risk management should be assigned to an independent risk management committee or executive committee of senior executives reporting directly to the board.
The functions of the risk management committee are to identify, monitor and measure the risk profile of the bank. The committee should also:
· Develop policies and procedures.
· Verify the models used for pricing complex products.
· Review the risk models as development takes place in the markets.
· Identify new risks.
The RBI has also issued guidance notes on the management of credit risk and market risk. As part of effective risk management, banks are required, inter-alia, to have a system of separation of credit risk management function from the credit sanction process. As a step to bring uniformity in risk management across banks, the RBI has in 2017, advised banks to appoint a chief risk officer (CRO) and has prescribed certain role and responsibilities of such CRO, such as:
· Banks should have a board approved policy clearly defining the role and responsibilities of the CRO.
· The CRO shall be a senior official in the banks’ hierarchy and shall have the necessary and adequate professional qualification/experience in the areas of risk management.
· The CRO shall have direct reporting lines to the MD & CEO / Risk Management Committee of the Board.
· The CRO shall not have any reporting relationship with the business verticals of the bank and shall not be given any business targets.
· In case the CRO is associated with the credit sanction process, it shall be clearly enunciated whether the CRO’s role would be that of an adviser or a decision maker. The policy shall include the necessary safeguards to ensure the independence of the CRO.
· There shall not be any ‘dual hatting’ i.e. the CRO shall not be given the responsibility of chief executive officer, chief operating officer, chief financial officer, chief of the internal audit function or any other function.
Liquidity and capital adequacy
Role of international standards
14. What international standards apply? How have they been incorporated into domestic law/regulation?
The Basel III capital regulations are being implemented in India with effect from 1 April 2013. Banks must comply with the regulatory limits and minima prescribed under Basel III capital regulations.
To ensure a smooth transition to Basel III, appropriate transitional arrangements have been provided for meeting the minimum Basel III capital ratios and adjustments to the capital components. Basel III capital regulations will be fully implemented by 31 March 2019. The phasing out of non-Basel III compliant regulatory capital instruments began from 1 January 2013.
The RBI also continues to monitor and review the Indian framework of Basel III capital regulations and releases periodical circulars/notifications aligning the Indian framework with Basel committee rules and reports wherever there are discrepancies. As an example, the RBI has issued notifications modifying the treatment of certain balance sheet items under the Indian regulations on Basel III to align the same with what has been prescribed by the Basel Committee on Banking Supervision.
Further, while the RBI has previously released guidelines on maintenance and computation of liquidity ratio, the RBI has recently issued guidelines on Net Stable Funding Ratio (NSFR) which are based on final rules on NSFR published by the Basel Committee. The NSFR should be equal to at least 100% on an ongoing basis. However, the NSFR would be supplemented by supervisory assessment of the stable funding and liquidity risk profile of a bank. On the basis of such assessment, RBI may require an individual bank to adopt more stringent standards. The requirement to maintain 100% NSFR would be binding on banks with effect from a date which will be communicated by the RBI in due course.
Main liquidity/capital adequacy requirements
15. What liquidity requirements apply?
The cash reserve ratio (CRR) is the average daily balance that a bank must maintain with RBI, as a share of its net demand and time liabilities deposits (NDTL). The RBI has issued guidelines to determine the calculation of NDTL. Currently, banks must maintain a CRR of 4%.
The statutory liquidity ratio (SLR) is the share of NDTL that banks must maintain in safe and liquid assets, such as unencumbered government securities, cash and gold. Currently, banks must maintain an SLR of 19.5%. As mentioned in the response to Question 15, from a date to be notified by the RBI, the banks must maintain NSFR (i.e. ratio of available stable funding to required stable funding) of 100%.
16. Is a leverage ratio applicable?
Yes. Currently, the Indian banking system is operating at a leverage ratio of more than 4.5%. However, under the Basel III framework, the minimum leverage ratio is 3% and will be set in line with the final rules prescribed by the Basel Committee. The Basel committee intends to migrate to a pillar 1 (minimum capital requirements) approach in 2018. In the meantime, the RBI will monitor individual banks against an indicative leverage ratio of more than 4.5%.
Banks in India have been required to disclose the leverage ratio and its components from 1 April 2015 on a quarterly basis, according to prescribed disclosure templates, along with detailed calculations of capital and exposure measures.
As the leverage ratio is an important supplementary measure to the risk-based capital requirements, the same disclosure requirement also applies to the leverage ratio. Therefore banks, at minimum, must disclose Tier 1 capital, exposure measure and leverage ratio on a quarterly basis, irrespective of whether their financial statements are audited.
17. What is the capital adequacy framework that applies for banks?
The capital adequacy ratio is the ratio of capital funds (including tier I capital and tier II capital) to risk weighted assets.
The RBI prescribes the:
· Risk weights for balance sheet assets, non-funded items and other off-balance sheet exposures.
· Minimum capital funds to be maintained as a ratio to total risk weighted assets and other exposures.
· Capital requirements in the trading book.
Banks must maintain a minimum capital adequacy ratio of 9%. Wholly owned subsidiaries of foreign banks must maintain a minimum capital adequacy ratio of 10%, continuously for an initial period of 3 years from the start of its operations (that is, 1% higher than that required under the phased implementation of Basel III).
Role and requirements
18. What is the role of consolidated supervision of a bank in your jurisdiction and what are the requirements?
Consolidated supervision consists of an overall evaluation of the strength of a group with a large bank. The objective is to assess the potential impact of other group companies on the bank. All risks run by the banking group are taken into account, independent of where they are booked.
A major element is financial statements prepared on a consolidated basis, combining the assets and liabilities and off-balance sheet items of banks and their related entities, as if they were a single entity. Supervisors can then measure the financial risks faced by bank groups and apply supervisory standards on a group basis, such as large exposure and connected exposure limits and minimum capital adequacy ratios.
The RBI has issued guidelines for consolidated supervision. The supervisory framework consists of:
· Consolidated financial statements.
· Consolidated prudential returns.
· Consolidated supervision by application of prudential regulations like capital adequacy, large exposures and liquidity gaps on a group basis.
Consolidated financial statements are public documents prepared and published annually, in addition to solo annual reports of financial institutions and their subsidiaries, and submitted to RBI.
The objective of a consolidated prudential return is to collect consolidated prudential information at group level. It aims to capture data, in the prescribed format, mainly on the:
· Consolidated balance sheet.
· Consolidated profit and loss account.
· Financial/risk profile of the group.
· Operations of subsidiaries and related entities.
The RBI has prescribed group prudential norms for capital adequacy and large exposures for financial institutions, taking into account the assets and liabilities of their subsidiaries and associates, in addition to prudential norms that may apply on a solo basis. For group prudential norms, a group is defined as a group of entities (which can include a bank) engaged in financial activities, with a financial institution as the parent. Areas have been prescribed for compliance on a group basis for capital adequacy, large exposures and liquidity mismatches.
International co-ordination and co-operation
19. To what extent is there co-operation with other jurisdictions?
The RBI regularly enters into memoranda of understanding and agreements for co-operation with the central banks of other jurisdictions. For instance, the RBI has entered into a memorandum of understanding:
· On Supervisory Cooperation and Exchange of Supervisory Information with the Bank of Israel.
· With the European Central Bank for co-operation in the area of central banking.
· On co-operation on currency swap agreements with the Central Bank of the United Arab Emirates (UAE).
· With Bangladesh Bank for exchange of supervisory information.
· On Supervisory Cooperation and Exchange of Supervisory Information with the National Bank of Cambodia Bank of Guyana, Bank of Thailand, the Royal Monetary Authority of Bhutan, Central Bank of Nigeria, Bank of Zambia, Nepal Rastra Bank etc.
Shareholdings/acquisition of control
20. What reporting requirements apply to the acquisition of shareholdings in banks?
The requirements on shareholdings and change of control in banks in India depend on the nature of the entity.
In a private Indian bank, the Banking Regulation Act and RBI impose shareholding limits on certain types of shareholders as follows (not applicable to urban co-operative banks, foreign banks and banks established under specific statutes).
Further, a bank cannot acquire equity shares in another bank if the acquisition leads to the acquiring bank holding 10% or more in the other bank’s equity capital. The RBI can in certain circumstances allow an entity to acquire shares in a domestic private bank in excess of the above limits. In some cases, such as new banks set up under a holding company, promoters have been provided a time limit in which they must dilute or divest their shareholding to meet the above limits.
Despite the shareholding limits, voting rights are limited to the ceiling notified by RBI under the Banking Regulation Act, which is currently 10%.
Further, an acquisition of shareholding voting rights of 5% or more of the paid-up capital of a bank or total voting rights of a bank is subject to prior approval from the RBI.
For a foreign banking company operating through a branch in India, there are no specific regulations on a change in its shareholding or acquisition, but this may be subject to a condition in its banking licence. In addition it is advisable to notify the RBI of the acquisition, particularly if it results in a change in control of the entity (when issuing the licence to the foreign entity, the RBI would have considered its promoters and major shareholders).
21. What approval requirements apply to the acquisition of shareholdings and of control of banks?
See Question 20.
22. Are there specific restrictions on foreign shareholdings in banks?
Acquisition of shareholdings by foreign entities in an Indian bank is subject to the limits and conditions in the Foreign Direct Investment (FDI) policy issued by the government, and to any specific requirements in the relevant bank’s licence.
Under the latest FDI Policy (August 2017):
(i) foreign investment in domestic private banks from all sources is permitted up to 49% without approval, and up to 74% with government approval. At all times, at least 26% of the paid-up capital must be held by residents, except in case of a wholly owned subsidiary of a foreign bank. In case of Non-Resident Indians (NRIs), individual holdings is restricted to 5% of the total paid up capital both on repatriation and non-repatriation basis and aggregate limit cannot exceed 10% of the total paid up capital both on repatriation and non-repatriation basis. However, NRI holdings can be allowed up to 24% of the total paid up capital both on repatriation and non-repatriation basis subject to a special resolution to this effect passed by the banking company’s general body.
(ii) foreign investment in public sector banks, including the State Bank of India (subject to Banking Companies (Acquisition & Transfer of Undertakings) Acts, 1970/ 80) is 20% with government approval.
100% foreign investment is also permitted in NBFC’s under the automatic route.
23. What is the legal framework for liquidation of banks?
The High Court has authority to order the winding up or liquidation of a bank. Its jurisdiction is based on where the registered office of the bank is located (for a bank incorporated in India) and where the principal place of business is located (for a bank incorporated outside India).
Under the Banking Regulation Act, the following can apply to wind up a banking company:
· The central government can direct the RBI to inspect or report on a bank. After examining the report and giving the bank an opportunity to respond, if the central government believes that the bank’s affairs are detrimental to the interests of its depositors, it will direct the RBI to apply to wind up the bank.
· The RBI can initiate the winding up of a bank if the:
- bank fails to comply with its minimum capital and reserve requirements or other provisions of the Banking Regulation Act;
- banks’ licence is cancelled;
- bank is prohibited from accepting fresh deposits, under certain provisions of the Banking Regulation Act or RBI Act; or
- RBI believes that the bank is unable to pay its debts, or is continuing to the detriment of its depositors; or
- In the opinion of RBI, a compromise or arrangement sanctioned by a Court in respect of the banking company cannot be worked satisfactorily with or without modifications; or
- The bank itself can apply for voluntary winding up (solvent) if the RBI certifies that it is able to pay its debts in full.
Under the Banking Regulation Act, once an order for winding up a bank is passed by the High Court, a liquidator attached to the High Court is appointed to conduct the liquidation. The RBI can also apply to the High Court to be appointed as the liquidator.
The Insolvency and Bankruptcy Code (‘IBC’) was passed by the Indian parliament in 2016 to deal with cases of corporate entities (other than financial service providers). The government is in the process of drafting and introducing a separate bankruptcy law to deal with insolvency in financial sector companies which includes banks and NBFCs.
24. What is the resolution regime for banks?
Currently there are no statutory provisions for bank resolution. However under the Banking Regulation Act, a bank that is unable to temporarily pay its debts can apply to the High Court for a moratorium to stay continuance or commencement of proceedings against it. The High Court can grant this moratorium for up to 6 months.
The application must be supported by a report from the RBI indicating that if the moratorium is granted, the bank will be able to pay its debts. The High Court can grant such relief even without a report from the RBI, but the report will be called for and the order for relief may be modified. The High Court can also appoint a special officer to take control of the bank’s assets and books in the interest of its depositors. If the RBI applies to the High Court to wind up the bank, the High Court will not extend the moratorium period.
The Financial Resolution and Deposit Insurance Bill, 2017 has been introduced in the Lok Sabha and provides for the resolution of financial firms, including banks. It proposes to, among others:
· Provide speedy and efficient resolution of financial firms in distress.
· Establish a resolution corporation.
· Provide deposit insurance for consumers of certain categories of financial services.
· Provide for the liquidation and winding up of financial firms as per the provisions of the IBC.
Regulatory developments and recent trends
25. What are the regulatory developments and recent trends in bank regulation?
As mentioned in our response to Question 23, the IBC was notified in 2016, replacing the entire gamut of corporate insolvency laws in India by introducing a single comprehensive law that empowers all creditors (whether secured, unsecured, domestic, international, financial or operational) to trigger resolution processes. The IBC distinguishes between two main categories of creditors; financial creditors and operational creditors. A financial creditor is a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred. An operational creditor is any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.
Prior to the introduction of IBC, RBI had issued various instructions/ schemes (such as Framework for Revitalizing Distressed Assets, Corporate Debt Restructuring Scheme, Strategic Debt Restructuring Scheme, Formation of Joint Lenders Forum and Scheme for Sustainable Structuring of Stressed Assets (S4A)) aimed at resolution of stressed assets in the Indian economy. However, in view of the enactment of IBC, RBI has withdrawn the said schemes and substituted the existing guidelines with a harmonized and simplified framework for resolution of stressed assets. Key features of the said framework are as set out below:
· Early identification and reporting of stress: Lenders are required to identify incipient stress in loan accounts, immediately on default, by classifying stressed assets as ‘special mention accounts’ in the categories specified by RBI.
· Implementation of Resolution Plan: All lenders are required to have board approved policies for resolution of stressed assets including the timelines for resolution and upon default in the borrower entity’s account with any lender all lenders should initiate steps to cure the default. The resolution plan (RP) may involve actions including sale of the exposures to other entities, change in ownership, or restructuring.
· ‘Large Accounts’ under IBC: For accounts with aggregate exposure of lenders at INR 20 billion and above, on or after March 1, 2018, the RP shall be implemented in accordance with the timelines specified by RBI and if a RP in respect of large accounts is not implemented as per such timelines, lenders are required to initiate insolvency under IBC.
Separately, recently, the Union Cabinet has approved the proposal for establishment of National Financial Reporting Authority (NFRA), which is an independent regulator for the auditors (aimed to be established under the Companies Act, 2013). This will help strengthen the auditing process of banks and financial institutions as well.
Recently, the Union Cabinet has also approved the proposal of the Ministry of Finance to introduce the Fugitive Economic Offenders Bill, 2018 in Parliament. The said bill lays down measures to deter economic offenders from evading the process of Indian law by remaining outside the jurisdiction of Indian courts. The bill deals with cases where the total value involved in such offences is INR 1 billon or more and is aimed at curbing the instances of economic offenders fleeing the jurisdiction of Indian courts, anticipating the commencement, or during the pendency of proceedings.
1. Bahram N Vakil, Partner
2. Suharsh Sinha, Partner