Banking Regulation Act 1949: Licensing, PCA, and Penalties

The Banking Regulation Act of 1949 is the central statute governing how banks operate in India. It requires every banking company to hold a license from the Reserve Bank of India, prescribes the capital, reserves, and liquid assets a bank must maintain, controls who can sit on a bank’s board or run it, and gives the RBI broad powers to inspect banks, issue binding directions, penalize violations, and reconstruct or wind up institutions that fail. Originally passed as the Banking Companies Act, it was renamed in 1966 and has been amended repeatedly, most significantly in 2020 to bring cooperative banks under the same regime as commercial banks.

Which Institutions the Act Covers

Section 5 defines “banking” as accepting deposits from the public for lending or investment, where those deposits are repayable on demand or otherwise and withdrawable by cheque, draft, or order.¹ Any company doing this business in India is a “banking company” and falls under the Act. Commercial banks, regional rural banks, and foreign banks operating branches in India are all covered.

Not every institution handling money is in. Section 3 carves out primary agricultural credit societies and cooperative land mortgage banks from the Act’s general provisions.² Other cooperative societies are governed by Part V, which applies a modified set of rules.

The Licensing Requirement

Section 22 makes licensing absolute. No company may carry on banking business in India without an RBI license, and operating without one is a violation of the Act.³ Before granting a license, the RBI assesses whether the applicant can pay its depositors in full, now and going forward. If the regulator concludes the proposed operations would harm the public interest, it can reject the application.

A license, once granted, can be revoked. The RBI can cancel it if the bank stops carrying on business in India, breaches the conditions attached to the license, or ceases to meet the original eligibility criteria.³

What Banks Can and Cannot Do

Section 6 enumerates the activities a banking company may undertake beyond taking deposits and making loans: dealing in bills of exchange and promissory notes, buying and selling foreign exchange and government securities, acting as agent for customers, managing trusts, underwriting share issues, and providing safe deposit vaults, among others.⁴ The list is also a limit. A banking company cannot engage in any business not listed in Section 6, so it cannot, for instance, run a manufacturing or retail trade operation on its own account.

Section 20 draws hard lines against self-dealing. A bank cannot lend against the security of its own shares. It cannot make loans or advances to its own directors, to firms where a director is a partner or guarantor, or to companies in which a director holds a substantial interest.⁵ If a dispute arises about whether a particular transaction counts as a loan for this purpose, the RBI decides and its decision is final. The RBI can also exempt specific transaction types if it determines, based on the nature of the deal and depositor safety, that the restriction is not warranted.

Capital, Reserves, and Liquidity

Section 11 requires a minimum level of paid-up capital and reserves, with the specific thresholds depending on whether the bank operates in a single state or across multiple states.² The point is that a bank must have enough of its own money at risk before it starts handling the public’s deposits.

Section 17 adds a reserve fund requirement. Every banking company incorporated in India must transfer at least 20 percent of its annual profits to a reserve fund before paying any dividends.² This is not optional, and the fund accumulates over time because profits must flow into it before shareholders see a rupee.

Section 24 sets the Statutory Liquidity Ratio, requiring banks to hold a specified percentage of their total demand and time liabilities in liquid assets such as cash, gold, or government securities.⁶ The RBI sets the exact percentage based on monetary policy needs; as of early 2026, it is 18 percent. Liquid assets at this scale let banks meet large or sudden withdrawal demands without having to sell illiquid loans at a loss.

Board Composition and Leadership Approval

Section 10A requires that at least 51 percent of a bank’s board members have specialized knowledge or practical experience in areas such as accountancy, banking, economics, finance, law, agriculture and rural economy, or small-scale industry.⁷ At least two of those qualified directors must have expertise specifically in agriculture, rural economy, cooperation, or small-scale industry.

Section 10 bars certain individuals from bank management outright. Anyone adjudicated insolvent or convicted of an offense involving moral turpitude cannot manage or direct a banking company.² A bank also cannot have a director who sits simultaneously on the board of another bank, unless the RBI itself made that appointment. Non-executive directors face a tenure cap of eight continuous years.

Section 35B puts the RBI directly in the loop on leadership changes. No appointment, reappointment, or removal of a chairman, managing director, or chief executive officer takes effect without the RBI’s prior approval. Amendments to a bank’s governing documents that relate to director numbers, appointments, or compensation also require RBI sign-off.

Inspection and Directions

Section 35 authorizes the RBI to inspect the books and accounts of any banking company at any time.⁸ Inspectors can demand documents, examine records, and require testimony from officers and employees. These inspections go beyond arithmetic and assess lending practices, risk management, and governance against regulatory standards.

When inspection surfaces problems, Section 35A lets the RBI issue binding directions to any banking company when it considers the directions necessary in the public interest, to prevent the bank’s affairs from being conducted in a way that harms depositors, or to secure proper management.⁸ These directions can cover almost anything, from halting risky lending to modifying investment policies or restricting specific transactions. Compliance is mandatory.

Section 36 lets the RBI require changes in a bank’s management if it considers them necessary and allows the regulator to appoint additional directors to a troubled bank’s board. Section 36ACA goes further, allowing the RBI to supersede an entire board of directors in certain cases and replace it with an administrator until the underlying problems are resolved.

How Distress Triggers Action: The PCA Framework

The RBI uses an early-warning system called the Prompt Corrective Action framework that imposes escalating restrictions when a bank’s financial health deteriorates. The framework tracks three indicators: capital adequacy, asset quality, and profitability.⁹

The capital thresholds work in tiers. A bank whose capital-to-risk-weighted-assets ratio drops below 10.25 percent enters the first risk threshold, facing restrictions on dividend payments and profit distribution. If the ratio falls below 7.75 percent, the bank hits the second threshold, which can trigger restrictions on branch expansion and management compensation. A bank breaching the third threshold, with a Common Equity Tier 1 ratio below 3.625 percent, becomes a candidate for resolution through amalgamation, reconstruction, or winding up.⁹

Asset quality works the same way. A net non-performing asset ratio between 6 and 9 percent puts a bank in the first tier; a ratio above 12 percent places it in the most severe category.⁹

Penalties for Non-Compliance

Section 46 sets criminal penalties. Anyone who knowingly makes a false statement in a return, balance sheet, or other document required under the Act faces up to three years of imprisonment, a fine of up to one crore rupees, or both.¹⁰ Deliberately omitting a material fact from a required disclosure carries the same penalties. These are pursued through the courts.

Section 47A gives the RBI a separate power to impose administrative penalties directly, without going to court.¹¹ For general regulatory violations, the penalty can reach twenty lakh rupees per offense, plus up to fifty thousand rupees for each day the violation continues. For unauthorized deposit-taking, the penalty can reach twice the amount of the deposits involved. For serious contraventions, the penalty can reach one crore rupees or twice the amount involved, whichever is higher, plus up to one lakh rupees per day for continuing violations.

Before imposing a penalty, the RBI must issue a show-cause notice and give the bank a reasonable opportunity to respond. Once levied, the penalty must be paid within 14 days; if it is not, the RBI can apply to the principal civil court in the jurisdiction of the bank’s registered office for enforcement.¹¹ The two enforcement tracks are mutually exclusive. Once the RBI has penalized a bank under Section 47A for a particular violation, no separate criminal complaint can be filed for the same conduct under Section 46.

Moratorium, Amalgamation, and Winding Up

When a bank is in serious distress, the Act offers a sequence of tools from temporary suspension to permanent closure. Section 45 lets the RBI impose a moratorium, temporarily freezing withdrawals and other obligations. A 2020 amendment to this section also lets the RBI prepare a scheme of reconstruction or amalgamation to rescue a struggling bank without first imposing a moratorium, so depositors are not left in limbo while restructuring is planned.¹²

Section 44A governs voluntary amalgamation, setting the procedure when two banking companies agree to merge. The scheme requires approval from the shareholders and the RBI before taking effect. On the involuntary side, the RBI can engineer a forced merger of a weak bank into a stronger one under the reconstruction provisions of Section 45.

If rescue is not viable, Part III of the Act (Sections 38 through 45) lays out the winding-up process.⁷ The High Court can order a bank wound up on an RBI application stating the bank cannot pay its debts. An Official Liquidator is appointed to manage the orderly distribution of the bank’s remaining assets, with depositors given priority. Once winding up is complete, the bank’s license is effectively cancelled and it ceases to exist.

The 2020 Amendments and Cooperative Banks

For decades, cooperative banks sat in a regulatory grey zone. State governments controlled their governance through registrars of cooperative societies, while the RBI had limited supervisory authority. The Banking Regulation (Amendment) Act of 2020 closed that gap by bringing cooperative banks under RBI regulation in the same manner as commercial banks. The amendments apply to primary cooperative banks (urban cooperative banks), state cooperative banks, and central cooperative banks. For urban cooperative banks, the enhanced provisions took effect on June 26, 2020.¹³ For state and central cooperative banks, the provisions take effect on dates to be notified by the central government.

The 2020 amendment also expanded the RBI’s power under Section 45 to prepare reconstruction or amalgamation schemes for cooperative banks without first imposing a moratorium.¹² The practical effect is that the RBI can now intervene in a failing cooperative bank on roughly the same terms, and at roughly the same speed, as it would in a commercial bank.

1
Indian Kanoon. Banking Regulation Act 1949
2
International Financial Services Centres Authority. The Banking Regulation Act, 1949
3
India Code. Banking Regulation Act 1949 – Section 22
4
Indian Kanoon. Section 6 in The Banking Regulation Act, 1949
5
Indian Kanoon. Section 20 in The Banking Regulation Act, 1949
6
Indian Kanoon. Section 24 in The Banking Regulation Act, 1949
7
Central Bank of India. Banking Regulation Act 1949
8
India Code. Banking Regulation Act 1949
9
Reserve Bank of India. Revised Prompt Corrective Action (PCA) Framework for Banks
10
Indian Kanoon. Banking Regulation Act, 1949
11
Indian Kanoon. Section 47A in The Banking Regulation Act, 1949
12
Press Information Bureau. President Promulgates Banking Regulation (Amendment) Ordinance, 2020
13
Press Information Bureau. Banking Regulation Amendment Act 2020