LLM Group 2 Business Law Banking Laws 2018 Question Paper with Solutions

For full marks, cover: organise the history round the four things a banking system has to be able to do, take deposits, remit value, issue a circulating medium and stand behind other banks in a crisis, and ask in each era who did each of them; that plan shows what the indigenous system had and what it lacked, and it makes the arrival of the Reserve Bank an answer to a specific gap rather than a date to be memorised; then the modern classification of banks tied to the statute that creates each; then the legal issues, argued.

(The same question is set on the 2015 paper in Q.P. Code 27229, where it is answered through the indigenous instruments and the crises that produced each statute. Here the plan is the four functions.)

Remittance was supplied by the hundi. The principal kinds were the darshani hundi payable at sight and the muddati or usance hundi payable after a stated period, with specialised forms such as the shah jog, payable only to a respectable person, and the jokhmi, payable only if the goods arrived, which combined a bill with marine insurance. Hundis circulated by indorsement and were discounted, and the networks of shroffs, chettiars, multanis and marwaris honoured them across the subcontinent.

The crucial legal point is that this law survives. Section 1 of the Negotiable Instruments Act, 1881, provides that nothing in the Act affects any local usage relating to any instrument in an oriental language, with a proviso that the usage may be excluded by words in the body of the instrument indicating an intention that the parties' legal relations shall be governed by the Act. A hundi is therefore governed by custom unless the parties contract into the statute, which reverses the ordinary relation between code and usage. The saving is not ornamental: disputes on hundis are still decided by proof of mercantile usage.

What the indigenous system did not supply was a note issue or a lender of last resort. There was no institution whose paper everyone would take, and no one to lend to a shroff whose debtors had failed. Both gaps were filled from outside, and both were filled late.

The colonial and modern layering in India

The circulating medium came first and it came in stages. The three presidency banks, the Bank of Calcutta of 1806 renamed the Bank of Bengal in 1809, the Bank of Bombay of 1840 and the Bank of Madras of 1843, were chartered with government capital and the right of note issue within their presidencies. That right was withdrawn by the Paper Currency Act of 1861, which transferred the issue to the Government, so India had a government note issue before it had a central bank. The presidency banks were amalgamated into the Imperial Bank of India by the Act of 1920, which performed some central banking functions as banker to the Government but was itself a commercial bank and could not be a lender of last resort to its own competitors.

Ownership and structure changed after independence. The Reserve Bank was nationalised with effect from 1 January 1949; the Imperial Bank became the State Bank of India in 1955; fourteen banks were nationalised in 1969 and six more in 1980; and the nationalisation of 1969 was struck down in Rustom Cavasjee Cooper v. Union of India, (1970) 1 SCC 248, for discriminating against the named banks and for illusory compensation, before being re-enacted in 1970 in a form that met those objections. The Narasimham Committee reports of 1991 and 1998 then reversed the direction, producing prudential norms on Basel lines, reduced statutory pre-emption and new private bank licences from 1993.

The kinds of banks, each with its statute

Commercial banks are banking companies licensed under section 22 of the Banking Regulation Act: public sector banks constituted under the State Bank of India Act, 1955, and the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980; private sector banks incorporated under the Companies Act and licensed by the Reserve Bank; and foreign banks operating through branches or wholly owned subsidiaries.

The legal issues

The definition is the first. Section 5(b) anchors banking on deposits withdrawable by cheque, and payment now happens overwhelmingly through the unified payments interface, cards and wallets. A prepaid payment instrument issuer authorised under the Payment and Settlement Systems Act, 2007, performs a bank's payment function without being a bank. The statutory boundary and the economic boundary have come apart.

Dual control of co-operative banks is the second, and it caused a failure. A co-operative bank answered to the Registrar of Co-operative Societies for its constitution and management and to the Reserve Bank for its banking business, so neither could act decisively. The collapse of the Punjab and Maharashtra Co-operative Bank in September 2019, where lending to a single connected group had been concealed behind thousands of fictitious accounts, produced the Banking Regulation (Amendment) Act, 2020, extending the Act to co-operative banks and allowing a scheme under section 45 without a prior moratorium. The bank was amalgamated into Unity Small Finance Bank in January 2022.

Two decisions that belong to this history

The regulatory stage of this history was tested in court almost as soon as it began, and Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, AIR 1962 SC 1371, decided on 7 March 1962, is the case. It arose from the failure of the Palai Central Bank Ltd., incorporated in 1927, which had grown into the largest bank in Kerala with twenty five branches and stood about fifteenth in India. Its collapse is itself an event in the history this question asks about.

The Reserve Bank formed the opinion that the bank could not pay its depositors in full and that its continuance was prejudicial to them, and applied for winding up. A director challenged sections 38 and 39 of the Banking Companies Act, 1949, under Article 14, saying that banking companies were denied the protections other companies enjoy and that the Bank had been given an unchecked power. The Supreme Court upheld the sections, holding banks to be a class apart because they trade on deposits taken from the public.

Conclusion. Judged by the four functions, the indigenous system was not primitive. It took deposits under a developed law and it remitted value across a subcontinent through the hundi, an instrument so well established that the Negotiable Instruments Act of 1881 saved its customary law in section 1 rather than replacing it. What it could not supply was a note that everyone would take and a lender who would stand behind a bank in a crisis, and neither of those is something a private network can create for itself.

Both were supplied from outside and both were supplied late: the note issue passed to the Government in 1861 and to the Reserve Bank in 1935, and the lender of last resort arrived only in 1935, nearly twenty years after the failures of 1913 to 1917 had shown what its absence cost. Every statute since has been an answer to a particular failure, down to the Amendment Act of 2020, which was the answer to a co-operative bank. The open legal issues are of exactly the same kind: a definition of banking anchored on the cheque, a boundary with non banking financial companies drawn by section 49A, and a resolution regime that still rests on Part III of an Act of 1949 because the Bill that would have replaced it was withdrawn.