Any company in India that cannot pay its debts can be taken to the National Company Law Tribunal and put through insolvency. A bank cannot. The Insolvency and Bankruptcy Code leaves banks out on purpose, and India has never passed the law that was meant to replace it. What exists instead is a rescue power held by the Reserve Bank, and that single gap explains most of how Indian banking is regulated.
This is the fourth capsule in our series on the economy, explained in plain language for SSC, RRB NTPC, banking exams, State PSC and UPSC Prelims.
The Hinge: A Bank Is Not Allowed to Go Bankrupt
The Insolvency and Bankruptcy Code, 2016 covers companies, limited liability partnerships, partnership firms and individuals. It does not cover financial service providers, and banks are excluded outright.
Section 227 of the Code lets the Central Government notify certain financial service providers — not banks — for a special insolvency process run under rules made in 2019. In that process the regulator, not a creditor, files the application; the regulator proposes an Administrator in place of an insolvency professional; and the firm’s licence cannot be cancelled while the process runs. When those rules were notified, the Government described the framework in its own words as an interim mechanism, to be used until a full law on financial resolution is enacted.
That law has still not been enacted. A Financial Resolution and Deposit Insurance Bill was introduced in 2017 and withdrawn in 2018 after public alarm about a clause that would have allowed a failing bank’s deposits to be written down. So the question “what happens when an Indian bank fails?” has no answer in an insolvency law. It has an answer in a rescue power.
Section 45: How a Failing Bank Is Actually Dealt With
Section 45 of the Banking Regulation Act, 1949 is the provision that has handled every major Indian bank failure. Its steps are worth learning in order, because each one names a different authority.
| Sub-section | What happens | Who does it |
|---|---|---|
| 45(1) | An application is made for a moratorium — a freeze on the bank’s business | The Reserve Bank applies |
| 45(2) | The order of moratorium is made | The Central Government |
| 45(4) | A draft scheme of amalgamation or reconstruction is prepared | The Reserve Bank |
| 45(7) | The scheme is sanctioned and notified, and becomes binding | The Central Government |
Read the division of labour, because it is the examinable point. The Reserve Bank has the expertise and does the diagnosis and the design; the Central Government holds the pen that makes it law. Neither can rescue a bank alone — which is the same split of powers that runs through the Budget process, where the executive proposes and Parliament authorises.
One change is recent enough to be worth a line. The Banking Regulation (Amendment) Act, 2020 — the same amendment that brought cooperative banks properly under the Reserve Bank — allows a scheme of reconstruction or amalgamation to be made without first ordering a moratorium. The reason is practical: a moratorium freezes depositors’ money and announces the crisis to the world. Being able to rescue a bank without freezing it first is a better rescue.
Prompt Corrective Action: a Thermostat, Not a Punishment
Long before section 45 is needed, the Reserve Bank watches three numbers. If any of them crosses a line, restrictions switch on automatically. That is the Prompt Corrective Action framework, revised with effect from 1 January 2022, applying to scheduled commercial banks other than small finance banks, payments banks and regional rural banks.
| What is watched | The indicator | In plain words |
|---|---|---|
| Capital | CRAR and CET1 ratio | Does the bank have enough of its own money to absorb losses? |
| Asset quality | Net NPA ratio | How much of its lending has gone bad? |
| Leverage | Tier 1 leverage ratio | How large is the balance sheet compared with the capital holding it up? |
There are three risk thresholds, and the restrictions stack: whatever applies at Threshold 1 keeps applying at 2 and 3.
| Threshold | Net NPA ratio | Mandatory restriction added |
|---|---|---|
| 1 | 6 per cent to under 9 per cent | No dividend; promoters must bring in capital |
| 2 | 9 per cent to under 12 per cent | No branch expansion, in India or abroad |
| 3 | 12 per cent or more | No capital expenditure, except technology upgrades within Board-approved limits |
Alongside the mandatory list, the Reserve Bank may pick from a discretionary menu that runs from special audits and higher provisioning all the way to superseding the Board or replacing the management.
The design is the lesson. PCA is not a penalty imposed after an argument; it is a rule that fires on a measurement, like a thermostat. A regulator that must first decide to act will usually act late, because every delay is defensible one week at a time. Writing the trigger into the framework takes the decision away from the person who would be tempted to postpone it — the same idea as a statutory inflation target, where a number set in advance replaces a judgement made under pressure.
The Capital a Bank Must Hold
Capital here does not mean cash in the vault. It means the money the bank’s owners have put in and the profits it has kept — the cushion that absorbs losses before depositors are touched. The rules follow the international Basel III standards, as applied by the Reserve Bank.
| Requirement | Per cent of risk-weighted assets |
|---|---|
| Minimum Common Equity Tier 1 (CET1) | 5.5 |
| Additional Tier 1 | 1.5 |
| Minimum Tier 1 capital | 7.0 |
| Tier 2 capital | 2.0 |
| Minimum total capital, the CRAR | 9.0 |
| Capital Conservation Buffer, held in CET1 | 2.5 |
| Minimum total capital plus the buffer | 11.5 |
Risk-weighted assets is the phrase that does the work. A bank’s loans are not counted at face value; each is weighted by how risky it is, so a government bond and an unsecured personal loan do not demand the same capital. The requirement is not “hold 9 per cent of what you lent” but “hold 9 per cent of what you risked”.
The Capital Conservation Buffer is the clever part. It is not a hard minimum — a bank may dip into it. But while it is dipping, its freedom to pay dividends and bonuses is curtailed. It is a cushion the bank is allowed to use and discouraged from enjoying.
Deposit Insurance: Who Is Actually Being Protected
The Deposit Insurance and Credit Guarantee Corporation, a wholly owned subsidiary of the Reserve Bank set up under the DICGC Act, 1961, insures deposits up to ₹5 lakh per depositor per bank, counting principal and interest together.
- The bank pays the premium, not the depositor. It is charged on the bank’s total deposits and cannot be passed on as a visible fee.
- Cover is per depositor per bank, not per account. Three accounts in the same bank held the same way share one ₹5 lakh limit; accounts in two different banks are separately covered.
- Who is insured: commercial banks including branches of foreign banks in India, local area banks, regional rural banks, and cooperative banks. Primary cooperative societies are not.
- What is not insured: deposits of foreign governments and of the Central or State Governments, inter-bank deposits, and deposits received outside India.
- The 90-day rule. When a bank is placed under All Inclusive Directions, the whole sequence — the bank’s depositor list within 45 days, verification within 30, payment within 15 — must be completed in 90 days.
The 90-day limit is the part worth understanding rather than memorising. Before it existed, a depositor in a failed cooperative bank waited for liquidation, which could take years. Deposit insurance that arrives after a decade protects an accountant’s balance sheet, not a household. Putting a deadline on the payout is what turned the guarantee into something a depositor can rely on.
A higher limit has been under discussion for some time and has not been enacted. Until the law changes, the figure is ₹5 lakh — and the distinction between a proposal and a provision in force is one examiners use deliberately.
The Recovery Machinery
Before a bank is in trouble, it tries to get its money back. Three routes exist and each is asked about.
| Route | Law | What it allows |
|---|---|---|
| Debt Recovery Tribunal | Recovery of Debts and Bankruptcy Act, 1993 | A special tribunal for bank dues above a threshold, instead of a civil court |
| SARFAESI | Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 | The bank may seize and sell secured collateral without going to court first |
| Insolvency and Bankruptcy Code | IBC, 2016 | Insolvency of the borrower company, in a time-bound process before the National Company Law Tribunal |
Note the direction of each. DRT and SARFAESI are the bank acting against a defaulting borrower. The IBC is the borrower company itself being resolved. All three protect the bank; none of them resolves the bank. That asymmetry is the whole subject of this capsule.
Why a Reader Should Care
A bank is the only business whose customers are also its creditors. When you deposit money you are not storing it — you are lending it to the bank, which lends it on. The deposit is a claim, not a box of notes, which is also why inflation quietly reduces what it is worth while the number in the passbook stays the same. That is why a bank cannot simply be wound up like a failed factory: closing it does not just end a business, it destroys other people’s savings and the payments they were about to make.
So India chose rescue over bankruptcy, and the choice has a price. A rescue is faster and calmer than an insolvency, but it is discretionary, it is decided by two authorities rather than by a court, and there is no statute telling a shareholder or a large depositor in advance what will happen to them. The regulator and the rates are the part of banking that gets taught; the rescue power is the part that decides what your deposit is actually worth, and it is the part almost nobody reads.
Practice Questions
Q1. Which law gives the Reserve Bank the power to prepare a scheme of amalgamation for a failing bank?
(a) The Insolvency and Bankruptcy Code, 2016 (b) The Banking Regulation Act, 1949 (c) The SARFAESI Act, 2002 (d) The DICGC Act, 1961
Answer: (b) The Banking Regulation Act, 1949 Banks are outside the Code entirely. One wrong option is about seizing a borrower’s collateral and another is about insuring deposits, so neither can rescue a bank.
Q2. Under section 45, who sanctions the scheme once it is prepared?
(a) The Reserve Bank (b) The National Company Law Tribunal (c) The Central Government (d) The Supreme Court
Answer: (c) The Central Government The Reserve Bank applies for the moratorium and drafts the scheme; the authority that notifies it and makes it binding is the one that also issues the moratorium order.
Q3. The minimum total capital to risk-weighted assets ratio for banks in India, including the Capital Conservation Buffer, is
(a) 9 per cent (b) 11.5 per cent (c) 7 per cent (d) 5.5 per cent
Answer: (b) 11.5 per cent The first option is the requirement before the buffer is added, and the other two are the Tier 1 and Common Equity Tier 1 minimums.
Q4. Under the revised Prompt Corrective Action framework, which three parameters are monitored?
(a) Capital, asset quality and profitability (b) Capital, asset quality and leverage (c) Liquidity, profitability and leverage (d) Capital, liquidity and asset quality
Answer: (b) Capital, asset quality and leverage The revised framework dropped return on assets from the earlier version, so the option naming profitability describes the older design rather than the current one.
Q5. Deposit insurance in India covers
(a) ₹1 lakh per account (b) ₹5 lakh per account (c) ₹5 lakh per depositor per bank (d) ₹5 lakh per depositor across all banks
Answer: (c) ₹5 lakh per depositor per bank The cover is not counted per account, so several accounts in one bank share the limit, while accounts in two different banks are each protected.
