Specialised and Public Sector Banking Institutions: Complete Notes

Most of what is written about Indian banking describes a company with a licence. Yet the majority of Indian banking institutions are not that. A cooperative bank is a society, a regional rural bank is a statutory corporation created by notification, a public sector bank is a creature of a special Act, and a development finance institution is not a bank at all. Each of these forms exists because a gap was found in what a licensed company would do on its own, and each carries legal consequences that an ordinary bank does not. These notes cover all four, and the two differentiated licences that sit between them.

Figure 1: The institutional pyramid of Indian banking

1. Cooperative banks and dual control

A cooperative bank is a cooperative society that carries on banking. Section 56(c) of the Banking Regulation Act, 1949 defines it as a state cooperative bank, a central cooperative bank or a primary cooperative bank, the last being the urban cooperative bank of ordinary usage. The Act reaches such societies only through Section 56, which applies it with a long list of modifications, and the cooperative law continues to govern the society as a society. That is dual control.

Section 3, as substituted in 2020, provides that, notwithstanding the National Bank for Agriculture and Rural Development Act, 1981, the Banking Regulation Act does not apply to (a) a primary agricultural credit society, or (b) a cooperative society whose primary object and principal business is providing long term finance for agricultural development, provided that it does not use the words bank, banker or banking in its name or in connection with its business and does not act as drawee of cheques.

Why dual control failed

1. The Reserve Bank could find a management unfit but could not remove it, because appointment and removal lay under the cooperative law.
2. Cooperative share capital was withdrawable by a departing member, so it was not permanent capital and could shrink when it was most needed.
3. Section 45, which saves a failing commercial bank by reconstruction or amalgamation, did not work for a cooperative bank, so the only exit was liquidation and a deposit insurance payout.

The Banking Regulation (Amendment) Act, 2020

• An Ordinance of 26 June 2020, and Act 39 of 2020 with assent on 29 September 2020. The Act is deemed in force from 26 June 2020 except Section 4; Section 4 is deemed effective from 29 June 2020 for primary cooperative banks and took effect for state and central cooperative banks from 1 April 2021, the date notified by the Central Government.
• Section 3 was substituted, excluding primary agricultural credit societies and long term agricultural finance societies, conditionally on their using no banking name and not acting as drawee of cheques.
• Section 45 was amended to permit reconstruction as well as amalgamation, to allow loans, advances and investments in the reconstructed entity, and to allow the Reserve Bank to act at any other time and not only during a moratorium.
• Section 12 as applied now permits the issue of equity, preference and special shares and certain bonds with the prior approval of the Reserve Bank, forbids reduction of share capital except as the Reserve Bank permits, and gives a shareholder no right to demand payment for shares he surrenders.
• Section 36AAA as applied requires the Reserve Bank to consult the State Government before superseding the board of a State registered cooperative bank, and a new Section 53A lets the Reserve Bank exempt a bank or a class from specified provisions.
• The Banking Laws (Amendment) Act, 2025 later raised the maximum tenure of a cooperative bank director, other than the chairperson and a whole time director, from eight to ten years, with effect from 1 August 2025.

The four tier framework for urban cooperative banks

Announced on 19 July 2022 and given effect by the categorisation circular that followed, it scales regulation by deposits: Tier 1 for unit and salary earners' banks and others up to one hundred crore rupees, Tier 2 above that to one thousand crore, Tier 3 above that to ten thousand crore, and Tier 4 beyond. Minimum net worth is two crore rupees for a single district Tier 1 bank and five crore rupees for the rest. The capital to risk weighted assets ratio stays at nine per cent for Tier 1 and rises to twelve per cent for the others.

2. Regional Rural Banks

Five banks were set up under an ordinance on 2 October 1975 on the recommendation of the Narasimham Working Group, and the Regional Rural Banks Act, 1976 put them on a permanent footing. A regional rural bank is established by a notification of the Central Government, which names it, fixes the districts within which it may operate and names its sponsor bank. It is a body corporate, not a company and not a society.

• It is a scheduled bank, but it is inspected, supervised and refinanced by NABARD rather than by the Reserve Bank.
• Its priority sector target is seventy five per cent of adjusted net bank credit, with a fifteen per cent weaker sections sub-target.
• Section 23A permits the Central Government to amalgamate two or more such banks by notification, in the public interest, in the interest of the area served or in the interest of the banks, after consulting NABARD, the State Governments and the sponsor banks.
• Consolidation has gone 196 to 82 in the first phase, 82 to 56 in the second, 56 to 43 in the third, and 43 to 28 in the fourth, notified in April 2025 on the principle of one State one regional rural bank, covering twenty six banks across ten States and one Union territory.
• It is an authority under Article 12, so a writ lies against it, and specified provisions of the Banking Regulation Act, 1949 apply to it through Section 51.

3. Small finance banks and payments banks

Both categories were created by guidelines of 27 November 2014, and both are licensed under Section 22 of the Banking Regulation Act, 1949. On tap licensing of small finance banks followed on 5 December 2019. The two licences divide the banking function rather than diluting it.

The reasoning behind the division is that the two things a bank does carry very different risks. An institution that only holds money and moves it takes almost no credit risk, and can therefore operate on a thinner capital base. An institution that lends only small sums within a defined segment can build the appraisal skills for that segment without maintaining a corporate credit department. The local area bank, permitted from 1996 across three contiguous districts, was the first experiment along these lines; it is a closed category that the small finance bank superseded with a far more serious capital requirement.

Figure 2: The priority sector target by class of institution

• The promoter's minimum initial contribution is forty per cent of the paid up voting equity capital for both licences, locked in for five years, and a holding above forty per cent must be brought down to forty per cent within five years and in stages thereafter.
• Listing is mandatory for a small finance bank within three years of its net worth reaching five hundred crore rupees, and a bank below that threshold may list voluntarily.
• Eligible promoters of a small finance bank include residents with ten years in banking and finance, resident owned and controlled companies and societies, and existing non-banking financial companies, microfinance institutions, local area banks and payments banks.
• A payments bank may act as a business correspondent of another bank, which is how its customers reach credit, and may distribute simple non-risk sharing products and handle personal cross border remittances on the current account.
• Neither is exempt from the cash reserve ratio or the statutory liquidity ratio.

4. Public sector banks

A public sector bank is constituted by a special statute. There are three: the State Bank of India Act, 1955, in force from 1 July 1955, which transferred to the new bank the undertaking of the Imperial Bank of India; and the two Banking Companies (Acquisition and Transfer of Undertakings) Acts, of 1970 and 1980.

Parliament re-enacted the acquisition as the Act of 1970, with revised compensation provisions and retrospective effect from 19 July 1969. The Twenty fifth Amendment of 1971 substituted amount for compensation in Article 31(2) and made its adequacy non-justiciable. The Act of 1980, in force from 15 April 1980, acquired six more banks whose demand and time liabilities were not less than two hundred crore rupees as shown by the return for 14 March 1980: Andhra Bank, Corporation Bank, New Bank of India, Oriental Bank of Commerce, Punjab and Sind Bank and Vijaya Bank.

• The undertaking of each named bank vests in a corresponding new bank, which is a body corporate; the old company survives only to receive compensation.
• Section 3(2B)(c) requires the Central Government to hold at all times not less than fifty one per cent of the paid up equity capital. The corresponding floor in the State Bank of India Act was reduced from fifty five to fifty one per cent by the Amendment Act of 2010.
• Consolidation: New Bank of India into Punjab National Bank in 1993; the five associate banks and the Bharatiya Mahila Bank into the State Bank of India on 1 April 2017; Vijaya Bank and Dena Bank into Bank of Baroda on 1 April 2019; and ten banks into four on 1 April 2020, leaving twelve public sector banks where there were twenty seven in 2017.
• Mergers are effected by a scheme framed by the Central Government under the relevant Act, not under Section 44A of the Banking Regulation Act, 1949, because these banks are not banking companies.

Figure 3: Statute or licence, and what follows from the answer

5. Development finance institutions

A development finance institution supplies medium and long term finance to a sector the ordinary credit market does not serve. It is not a bank, because it does not take deposits from the public, and the Reserve Bank supervises the principal ones as All India Financial Institutions under Section 45L of the Reserve Bank of India Act, 1934.

• National Bank for Agriculture and Rural Development: Act of 1981, operational 12 July 1982. It refinances rural credit, inspects and supervises state and central cooperative banks and regional rural banks, and administers the Rural Infrastructure Development Fund.
• Small Industries Development Bank of India: Act of 1989, operational 2 April 1990. The principal institution for the promotion, financing and development of micro, small and medium enterprises.
• Export-Import Bank of India: Act of 1981, operational 1 January 1982. Lines of credit to overseas buyers, and buyer's credit under the national export insurance account.
• National Housing Bank: Act of 1987, operational 9 July 1988. Its ownership moved from the Reserve Bank to the Central Government in 2019, and the regulation of housing finance companies moved to the Reserve Bank, the National Housing Bank retaining supervision and refinance.

The older generation of industrial development banks depended on concessional funding. When that was withdrawn the model failed, and the answer adopted was conversion: ICICI reverse merged into ICICI Bank in 2002 and IDBI became a banking company in 2004. The consequence was that for seventeen years India had no development bank of the old kind for infrastructure; specialised lenders such as India Infrastructure Finance Company Limited filled only part of the gap, and commercial banks funded long projects with short deposits.

The National Bank for Financing Infrastructure and Development Act, 2021 answers that gap. Authorised share capital of one lakh crore rupees, with the Central Government initially holding the whole of it and never below twenty six per cent; a grant of five thousand crore rupees by the end of the first financial year; power for the Central Government to guarantee its borrowings at a concessional rate and to reimburse the cost of hedging foreign exchange; and a requirement of prior sanction before any investigation into an offence alleged against an employee, from the Central Government for the Chairperson and directors and from the Managing Director for others.

6. Quick Revision

1. Dual control divides the society from the banking, and the Amendment Act of 2020 moved the line rather than erasing it.
2. Section 45 is why the amendment was made, because a cooperative bank could previously only be liquidated.
3. Cooperative share capital is now locked in by the Reserve Bank's permission requirement.
4. A regional rural bank is created by notification and inspected by NABARD, not by the Reserve Bank.
5. A payments bank never lends; a small finance bank lends but must keep the loans small in composition.
6. A public sector bank is a statutory corporation whose undertaking vested from an acquired company.
7. R. C. Cooper struck down the Act of 1969; the Act of 1970 re-enacted it from the original date.
8. A development finance institution is not a bank because it takes no deposits from the public.
9. Statutory institutions are authorities under Article 12; licensed companies ordinarily are not.

7. Frequently Asked Questions

Why is a cooperative bank regulated by two authorities at all?

Because the Constitution divides the subject. Cooperative societies are Entry 32 of the State List, so their registration, bye-laws, elections, members' rights and winding up as societies belong to the States and are administered by the Registrar. Banking is Entry 45 of the Union List, so licensing, prudential norms, management fitness, capital and resolution belong to Parliament and are administered by the Reserve Bank. A single institution that is both a society and a bank therefore cannot be placed under one authority without a constitutional amendment, which is precisely the attempt that failed in Union of India v. Rajendra N. Shah.

What is the difference between a regional rural bank and a small finance bank?

Almost everything except the priority sector target. A regional rural bank is created by the Government through a notification under the Act of 1976, is owned by the Centre, a State and a sponsor bank in fixed proportions, is confined to the districts notified for it, and is inspected by NABARD. A small finance bank is a private company that applied for a licence under Section 22, is owned by its promoters and public shareholders, may operate anywhere in the country, and is inspected by the Reserve Bank. Both carry a seventy five per cent priority sector target, because both exist to serve small borrowers, but one is an instrument of policy and the other is a business model.

Can the Government reduce its holding in a public sector bank below fifty one per cent?

Not without amending the relevant statute. Section 3(2B)(c) of each Acquisition and Transfer Act, and the corresponding provision of the State Bank of India Act, 1955, require the Central Government to hold at all times not less than fifty one per cent of the paid up equity capital. This is the legal obstacle between a policy decision to privatise and its execution, and it is why proposals in that direction take the form of amending legislation rather than a sale of shares. The contrasting case is IDBI Bank, which could change hands because it had already been converted into a banking company under the Companies Act in 2004 and was no longer governed by a constituting statute of its own.

Is a development finance institution subject to the Banking Regulation Act?

No, because it is not a bank. It does not accept deposits of money from the public repayable on demand or otherwise and withdrawable by cheque, draft or order, which is the definition in Section 5(b), and it needs no licence under Section 22. It is a financial institution under Chapter IIIB of the Reserve Bank of India Act, 1934, and the Reserve Bank regulates and supervises the principal ones as All India Financial Institutions under Section 45L, with power to call for information and issue directions. Prudential norms on capital, exposure and asset classification are applied to them by direction rather than by statute.

Which institution supervises which, in one answer?

The Reserve Bank regulates every institution in these notes, in the sense of licensing, prudential norms and directions. Supervision and inspection are divided. The Reserve Bank inspects commercial banks, including small finance banks and payments banks, and urban cooperative banks. NABARD inspects state cooperative banks, district central cooperative banks and regional rural banks, and refinances them. The National Housing Bank supervises and refinances housing finance companies, although their regulation moved to the Reserve Bank in 2019. Public sector banks are constituted by their own Acts and are brought under the Banking Regulation Act, 1949 through Section 51 of that Act.

What single question separates all of these institutions?

Ask what brought the institution into existence, because every other consequence follows from the answer. A statute or a notification under one produced the State Bank of India, the nationalised banks, the regional rural banks and the development institutions, and with it came status as an authority under Article 12, service regulations with the force of law, officers who are public servants without any deeming provision, and amalgamation by a scheme of the Central Government. A certificate of incorporation and a licence under Section 22 produced the private banks, the small finance banks and the payments banks, and with it came contractual service conditions, amalgamation under Section 44A or Section 45, and public servant status only through Section 46A. A registration under a cooperative law produced the cooperative banks, and with it came the dual control that the Amendment Act of 2020 redrew but did not abolish.

8. Related Topics and Provisions

• Structure of the Indian banking system
• Licensing of banking companies under Section 22
• Moratorium, reconstruction and amalgamation under Section 45
• Priority sector lending and the targets for different classes of bank
• Reserve Bank regulation of non-banking financial companies and payment systems
• Criminal liability in banking and the Prevention of Corruption Act, 1988
• Deposit insurance and the Deposit Insurance and Credit Guarantee Corporation