What Banking Is

Broken down: the five ingredients of banking

A company is doing banking only if all five are present. Take one away and the definition is not satisfied.

One: accepting deposits. The money must come in as a deposit, meaning a sum received on terms that it will be returned. Money received as the price of goods, as a subscription for shares, or as a loan raised on debentures is not a deposit of this kind.

Two: of money. Deposits of ornaments in a locker, or of documents for safe custody, are not deposits of money. That business is bailment, and a bank does it, but doing only that is not banking.

Three: from the public. This is the clause that separates a bank from a family finance company. Money taken from a small, closed and identified group, from members of one family, or from the company's own directors, is not taken from the public.

Four: for the purpose of lending or investment. The deposits must be taken in order to be lent out or invested. A trader who takes advances from customers in order to buy stock is not banking, and the Explanation to section 5(c) says so expressly.

Five: repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise. The depositor must be able to get the money back, and the words "or otherwise" are wide enough to include a term deposit repayable at the end of a fixed period.

A worked example

Ramesh Kulkarni runs a chain of three hardware shops in Nashik. Customers who order in bulk pay him fifty per cent in advance, and he uses that money to buy stock from his suppliers. He holds several lakhs of customers' money at any time.

Is Ramesh doing banking? He is accepting money, from the public, and using it in his business. But the money is not accepted for the purpose of lending or investment: it is accepted to finance his own trade. The fourth ingredient fails, and the Explanation to section 5(c) puts it beyond argument, because he is a person carrying on a trade who accepts money merely to finance that trade. He needs no licence under section 22.

Now change one fact. Ramesh stops selling hardware, advertises in the local paper for deposits at nine per cent, and lends the money he collects to small builders at fifteen per cent. He is now accepting deposits of money from the public for the purpose of lending. All five ingredients are present, and he is transacting the business of banking without a licence, which is an offence.

Change one more fact. Ramesh incorporates Kulkarni Finance Private Limited, takes deposits only from eleven named relatives, and lends to builders. The money is not from the public, so this is not banking under section 5(b). He has, however, walked into a different regime: he is now very likely a non-banking financial company, regulated by the Reserve Bank under Chapter IIIB of the Reserve Bank of India Act, 1934, which chapter 280 works out.

Where the boundary actually runs

The middle column is the one that moves. The Reserve Bank's reach over deposit-taking institutions that are not banks was upheld in Reserve Bank of India v. Peerless General Finance and Investment Co. Ltd., (1987) 1 SCC 424, worked in chapter 280. The lesson for this chapter is only that falling outside section 5(b) is not the same as falling outside regulation.

What it does NOT mean

It does not mean that anyone holding your money is a bank. A chit fund, a co-operative credit society lending only to its members, an insurance company and a mutual fund all hold public money, and none of them is doing banking, because none takes deposits withdrawable by cheque for the purpose of lending.

It does not mean that a bank must do only banking. Section 6 lists a long catalogue of other businesses a banking company may engage in, from issuing letters of credit to acting as an executor, and chapter 60 works through it. Banking is the business that defines the licence; it is not the only business the licensee may do.

It does not mean the deposit is held for you. This is the largest misconception in the whole subject, and the next chapters return to it: money paid into a bank becomes the bank's own money, and the depositor is an unsecured creditor. The bank does not hold your notes in a box with your name on it.

And it does not mean "bank" is a word anyone may use. Section 7 reserves the words bank, banker and banking to licensed banking companies, which is why a lender calling itself a "bank" in its trading name is committing an offence, not merely misdescribing itself.

Limits and criticism

The definition has not been amended since 1949, and it shows. It is built around a deposit withdrawable by cheque, at a time when the cheque was the only instrument of transfer. Withdrawal today happens overwhelmingly by card, by electronic transfer and by mobile application. The phrase "or otherwise" has carried that entire change without a word being altered, which is either good drafting or an accident, depending on who is arguing.

"From the public" is left undefined, and its content has been supplied case by case and by the Reserve Bank's directions rather than by Parliament. That is workable but it means the outer edge of the licensing requirement is not on the face of the Act.

The rise of institutions that do part of banking has strained the definition further. A payments bank takes deposits and offers withdrawal by cheque but is forbidden to lend, so it satisfies the definition only awkwardly, and it exists by the Reserve Bank's licensing conditions rather than by any distinction Parliament drew. Chapter 630 takes that up.

Quick revision

Section 5(b). Banking is 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.

Section 5(c). A banking company is any company which transacts the business of banking in India.

The Explanation to 5(c). A manufacturer or trader who takes public deposits merely to finance his own business is not banking.

Five ingredients: deposits; of money; from the public; for lending or investment; repayable and withdrawable.

The consequence of falling inside: licence under section 22, and the whole Act. The consequence of falling outside: possibly the non-banking financial company regime instead, not freedom.

Why any of it exists: a bank promises on demand what it has already lent out, so it is regulated before it fails.

Test yourself

1. Give the statutory definition of banking, with its section. Section 5(b) of the Banking Regulation Act, 1949: the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.

2. A steel manufacturer accepts fixed deposits from the public at ten per cent and uses the money to build a new furnace. Is it a banking company? No. It accepts deposits from the public, but to finance its own manufacture and not for lending or investment. The Explanation to section 5(c) excludes it expressly.

3. Which single ingredient separates a bank from a company that takes deposits only from its own directors? "From the public". Money from a closed and identified group is not taken from the public, so section 5(b) is not satisfied.

4. Why does the law regulate banks more heavily than other companies? Because a bank trades on money that belongs to its depositors and is repayable on demand, while that money has already been lent out. It cannot meet all its depositors at once, so the law intervenes before failure rather than after it.

5. Does falling outside section 5(b) mean falling outside regulation? No. A deposit-taking institution that is not a bank is very likely a non-banking financial company under Chapter IIIB of the Reserve Bank of India Act, 1934, and needs registration under section 45IA of that Act.