Foundations and Framework of Banking Law in India: Complete Notes

This note brings together the foundations of banking law in India: how banking evolved from indigenous bankers to the present system, what the statute means by banking, banker and bank, the constitutional and legislative framework, the structure of the banking system, and the sources from which banking law is drawn. Read together, these five themes supply the method by which every later question in the subject is approached.

1. Evolution of Banking in India

Seven turning points in Indian banking

Figure 1: Seven turning points in Indian banking

Early period: indigenous bankers, shroffs and sahukars, financing trade through the hundi, whose usage the Negotiable Instruments Act, 1881 preserves.
First Western-style banks: Bank of Hindustan (1770) and the General Bank of India (1786), both of which failed.
Presidency banks: Bengal (1806), Bombay (1840) and Madras (1843), merged into the Imperial Bank (1921), which became the State Bank of India (1955).
Indian joint stock banks: Allahabad Bank (1865), Punjab National Bank (1894), Bank of India (1906), Bank of Baroda (1908) and Central Bank of India (1911).
Central bank: the Hilton Young Commission (1926) led to the RBI Act, 1934; the Reserve Bank began on 1 April 1935 and was nationalised on 1 January 1949.
Regulation: the Banking Companies Act, 1949 came into force on 16 March 1949 and was renamed the Banking Regulation Act from 1 March 1966.
Social control and nationalisation: social control in 1968, then 14 banks with deposits of ₹50 crore or more in 1969 and 6 banks with ₹200 crore or more in 1980, with R.C. Cooper (1970) striking down the first measure on compensation.
Liberalisation: the Narasimham Committees (1991, 1998), new private banks from 1993, the recovery statutes, differentiated banks from 2015, and consolidation to twelve public sector banks by 1 April 2020.

2. Meaning of Banking, Banker and Bank

Section 5(b), Banking Regulation Act, 1949

"banking" means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise.

The four elements of banking under Section 5(b)

Figure 2: The four elements of banking under Section 5(b)

A banking company is any company which transacts the business of banking in India (Section 5(c)), excluding a company which manufactures goods or carries on trade and accepts deposits only to finance its own business. All four elements must coexist: deposits, from the public, for lending or investment, and repayable and withdrawable. Banker and customer are undefined by the Act; the Negotiable Instruments Act defines banker in Section 3, and a customer is ordinarily a person for whom an account is opened.

Section 7: restricts use of the words bank, banker and banking, and requires a banking company to use one of them.
Section 6: lists the permitted forms of business, and sub-section (2) bars all other business.
Section 8: prohibits trading in goods, and Section 9 limits holding non-banking assets to seven years.

3. Constitutional and Legislative Framework

Union entries: Entry 45 (banking), Entry 38 (Reserve Bank), Entry 36 (currency and foreign exchange), Entry 43 (banking corporations) and Entry 46 (negotiable instruments) of List I.
State entries: Entry 32 (cooperative societies) and Entry 30 (money lending) of List II.
Fundamental rights: Article 19(1)(g) read with 19(6), Article 14, Article 300A and Article 301.
Statutes: the RBI Act, 1934 and the Banking Regulation Act, 1949 at the centre, with constituting, transactional, enforcement, compliance and payment statutes around them, and the general civil law governing banking contracts and securities.

📖 Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Ltd., (2020) 9 SCC 215

Facts: Cooperative banks proceeded against borrowers under the SARFAESI Act, 2002. The borrowers contended that cooperative banks are creatures of Entry 32 of List II and that Parliament could not bring them within a law made under Entry 45 of List I.

Held: A Constitution Bench held that the banking activity of cooperative banks falls within Entry 45 of List I, while their incorporation, regulation and winding up as societies remain under Entry 32 of List II. The SARFAESI Act therefore applies to cooperative banks, and the inclusion of multi-State and other cooperative banks within the definition of a bank is valid.

Ratio: Legislative heads are distinguished by activity, not by the form of the entity. The same institution may be governed by a State law in its corporate character and by a Union law in its banking character, which is the doctrinal basis of the dual control of cooperative banks.

4. Structure of the Banking System

Scheduled banks: listed in the Second Schedule to the RBI Act, requiring paid-up capital and reserves of at least ₹5 lakh and affairs not detrimental to depositors (Section 42(6)), and bound to maintain the cash reserve ratio under Section 42(1).
Public sector banks: the State Bank (Act of 1955) and nationalised banks (Acts of 1970 and 1980), now twelve after the mergers of 2017, 2019 and 1 April 2020.
Private and foreign banks: old private banks, banks licensed from 1993 and under on tap licensing, and foreign banks operating as branches or wholly owned subsidiaries. Section 12(2) caps voting rights at ten per cent, raisable by the Reserve Bank to twenty six per cent.
Cooperative banks: under dual control, with Section 56 and the Banking Regulation (Amendment) Act, 2020.
Regional rural banks: under the Act of 1976, owned by the Centre, the State and a sponsor bank, and reduced to twenty eight by the amalgamation effective 1 May 2025.
Differentiated banks: payments banks (deposits up to ₹2 lakh, no lending, capital ₹100 crore) and small finance banks (capital ₹200 crore, 75% priority sector, 50% of loans up to ₹25 lakh).
Not banks: NBFCs under Section 45-IA of the RBI Act, development finance institutions, and payment system operators.

5. Sources of Banking Law

Where the operative rule of banking law is found

Figure 3: Where the operative rule of banking law is found

Constitution, then statutes, then Reserve Bank directions under Section 35A and the RBI Act, consolidated as Master Directions and enforceable through Sections 46 and 47A.
Contract: the account terms and the security documents, controlled by the fair practices code and the charter of customer rights.
Custom: the origin of the banker's lien, now Section 171 of the Indian Contract Act, 1872, and of crossing; hundi usage is saved by the NI Act.
Case law: Tournier (1924) on secrecy with its four exceptions, Clayton's case (1816) on appropriation in a running account, R.C. Cooper (1970) and Pandurang Ganpati Chaugule (2020).
Soft law: Basel and FATF standards bind only when adopted by Reserve Bank instruments.

6. How the Foundations Fit Together

The history explains why the law exists, the definition decides whom it governs, the Constitution decides who may make it, the structure decides which statute constitutes a given bank, and the sources decide where the operative rule is found. A banking law problem is approached in that order: identify whether the entity carries on banking under Section 5(b), identify the statute that constitutes it, then look for the governing Reserve Bank direction, and read both against the contract and the case law.

The order also explains the shape of the subject. Because the definition is functional, regulation follows the activity rather than the label, which is why cooperative banks are regulated as banks and why a company that takes deposits only for its own trade is not. Because competence over banking is Union, the body of law is national and uniform, unlike money lending. Because the operative rule usually lies in a direction, the subject changes continuously beneath a stable statutory surface.

⚠ Key point

Indian banking moved from indigenous bankers and the hundi through the presidency banks to the Imperial Bank (1921) and State Bank (1955), with the Reserve Bank from 1935 and the Banking Regulation Act from 1949, nationalisation in 1969 and 1980, and liberalisation after 1991. Banking is defined by Section 5(b) as taking public deposits, repayable and withdrawable, for lending or investment. Power comes from Entry 45, List I, with cooperative banking settled by Pandurang Ganpati Chaugule (2020). The system comprises scheduled and non-scheduled banks, twelve public sector banks, private, foreign, cooperative, regional rural and differentiated banks. The law is found in the Constitution, statutes, Reserve Bank directions, contract, custom and case law, in that order of authority.

7. Quick Revision

✦ Points worth fixing

1770, 1806, 1921, 1935, 1949, 1969, 1991: the seven dates that carry the whole history.

Four elements in Section 5(b): deposits, from the public, for lending or investment, repayable and withdrawable.

Fourteen and fifty, six and two hundred: the banks nationalised and the deposit thresholds in 1969 and 1980.

Entry 45 for the activity, Entry 32 for the society. That one line is Pandurang Ganpati Chaugule.

Five lakh is the scheduling threshold under Section 42(6); twelve is the number of public sector banks.

Two lakh and no lending is a payments bank; two hundred crore and seventy five per cent is a small finance bank.

The hierarchy in five words: Constitution, statute, direction, contract, custom.

8. Frequently Asked Questions

What is the definition of banking in Indian law?

Section 5(b) of the Banking Regulation Act, 1949 defines banking as accepting, for the purpose of lending or investment, deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise. All four elements must be present together.

Which entry of the Seventh Schedule covers banking?

Entry 45 of List I, the Union List. Related entries are Entry 38 (Reserve Bank), Entry 36 (currency and foreign exchange), Entry 43 (trading corporations including banking corporations) and Entry 46 (negotiable instruments). Cooperative societies fall under Entry 32 of List II.

When was banking regulation first introduced in India?

The Banking Companies Act, 1949 came into force on 16 March 1949 and was renamed the Banking Regulation Act with effect from 1 March 1966. Earlier, banking companies were governed mainly by the general company law and by the limited provisions of the RBI Act, 1934.

Why is the Reserve Bank's power to issue directions so important?

Because most operative banking law is contained in directions rather than in the statute. Section 35A empowers the Reserve Bank to issue binding directions in the public interest, in the interest of banking policy, to prevent detriment to depositors or to secure proper management, and breach attracts penalty under Sections 46 and 47A.

What did R.C. Cooper decide about bank nationalisation?

In R.C. Cooper v. Union of India, (1970) 1 SCC 248 the Supreme Court struck down the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1969 on the grounds of inadequate and illusory compensation and hostile discrimination, not on the ground that Parliament lacked power to nationalise. A fresh Act was passed in 1970, and the measure survived.

How should a banking law problem be approached in an examination?

In five steps. First, ask whether the entity carries on banking within Section 5(b), since that decides whether the Banking Regulation Act applies at all. Second, identify the statute that constitutes the entity, because it decides how much of the Act applies and whether the entity is State under Article 12. Third, locate the Reserve Bank direction that supplies the operative rule. Fourth, read the contract between the parties. Fifth, apply the case law on the point.

Why is the definition of banking said to be functional?

Because it describes an activity rather than a form of organisation. Nothing in Section 5(b) turns on how the entity is incorporated, who owns it or what it calls itself. The consequence is that a cooperative society carrying on that activity is regulated as a bank, while a manufacturing company taking deposits only to finance its own trade is not, however large those deposits may be.

9. Related Topics and Provisions

The Reserve Bank of India: constitution and functions
Licensing of banking companies (Section 22)
Nature of the banker and customer relationship
Nationalisation and the Acquisition and Transfer Acts
Cooperative banks and the 2020 amendment
Inspection and the power to issue directions (Sections 35 and 35A)