Banking Law: Notes On

NOTES ON
BANKING LAW
For
10th Semester BBA LLB(Hons.)
Collaborated By on 07/11/2018
EBIN EMERSON, ASHWIN MENON V., ANSU SARA MATHEW, ANUSREE S.V.,
SRUTHI DAS, VIGNESH R., NAVANEETH P., SRUTHI A. & AJAY RATNAN
10/5 BBA LLB(Hons.)
GOVERNMENT LAW COLLEGE, KOZHIKODE
CONTENTS
Title Page No.
MODULE 1 2-17
MODULE 2 18-48
MODULE 3 49-60
MODULE 4 61- 114
MODULE 5 115-134
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NOTES ON BANKING LAW
MODULE 1
Definition of Banking – Common Law & Statutory Law – Functions of Banks- Multifunctional
Banks – Core Banking, Merchant Banking – Investment Banking – Clearing Houses –
International Banking Control over banks – Purpose & Functions.
DEFINITION OF BANKING
The word bank is derived from the Italian word ‘banco’ which means a bench. A bench was
used in the market place to transact business.
According to section 5 of the Banking Regulation Act 1949, Banking means “accepting for
the purpose of lending or investment of deposits of money from public, repayable on demand
or otherwise and withdrawals by cheque, draft, order or otherwise”.
According to section 3 of the interpretation clause ‘banker’ means any person acting as a
banker and includes a post office savings bank.
According to English author, H.L.A. Hart defined a banker or bank as “A person or company
carrying on the business of receiving moneys, and collecting drafts, for customers subject to
obligation of honouring cheques drawn upon them from time to time by the customers to the
extent of the amounts available on their current accounts”
NATIONALIZATION OF BANKS FOR IMPLEMENTING GOVT. POLICIES
Indian Banking System witnessed a major revolution in the year 1969 when 14 major
commercial banks in the private sector were nationalized on 19th July,1969. Most of these
banks having deposits of above ` 50 crores were promoted in the past by the industrialists.
The purpose of nationalization was:
(a) to increase the presence of banks across the nation.
(b) to provide banking services to different segments of the Society.
(c) to change the concept of class banking into mass banking, and
(d) to support priority sector lending and growth.
In 1980, another six more commercial banks with deposits of above` 200 crores were
nationalized. The nationalization of banks resulted in rapid branch expansion and the number
of commercial bank branches have increased many folds in Metro, Urban, Semi – Urban and
Rural Areas. The branch network assisted banks to mobilize deposits and lot of economic
activities have been started on account of priority sector lending.
Regional Rural Banks: In 1975, a new set of banks called the Regional Rural Banks, were
setup based on the recommendations of a working group headed by Shri Narasimham, to serve
the rural population in addition to the banking services offered by the co-operative banks and
commercial banks in rural areas. Inception of regional rural banks (RRBs) can be seen as a
unique experiment as well as experience in improving the efficacy of rural credit delivery
mechanism in India. With joint shareholding by Central Government, the concerned State
Government and the sponsoring bank, an effort was made to integrate commercial banking
Collaborated By: Ebin Emerson, Ashwin Menon V., Ansu Sara Mathew, Anusree S.V., Sruthi Das, Vignesh R.,
Navaneeth P., Sruthi A. & Ajay Ratnan Page | 2
within the broad policy thrust towards social banking keeping in view the local peculiarities.
RRBs were expected to play a vital role in mobilizing the savings of the small and marginal
farmers, artisans, agricultural labourers and small entrepreneurs and inculcate banking habit
among the rural people. These institutions were also expected to plug the gap created in
extending the credit to rural areas by largely urban-oriented commercial banks and the rural
cooperatives, which have close contact with rural areas but fall short in terms of funds.
Local area banks Local Area Banks with operations in two or three contiguous districts were
conceived in the 1996 Union budget to mobilise rural savings and make them available for
investments in local areas. They are expected to bridge the gaps in credit availability and
enhance the institutional credit framework in rural and semi-urban areas. Although the
geographical area of operation of such banks is limited, they are allowed to perform all
functions of a scheduled commercial bank. The Raghuram Rajan Committee had envisaged
these local area banks as private, well governed, deposit-taking small-finance banks. They were
to have higher capital adequacy norms, a strict prohibition on related party transactions, and
lower concentration norms to offset chances of higher risk from being geographically
constrained.
New Private Sector Banks In 1991, the Narasimham committee recommended that banks
should increase operational efficiency, strengthen the supervisory control over banks and the
new players should be allowed to create a competitive environment. Based on the
recommendations, new private banks were allowed to start functioning.
STRUCTURE OF BANKS IN INDIA
Banks can be classified into scheduled and non- scheduled banks based on certain factors
(a) Scheduled Banks: Scheduled Banks in India are the banks which are listed in the Second
Schedule of the Reserve Bank of India Act, 1934. The scheduled banks enjoy several
privileges as compared to non- scheduled banks. Scheduled banks are entitled to receive
refinance facilities from the Reserve Bank of India. They are also entitled for currency chest
facilities. They are entitled to become members of the Clearing House. Besides commercial
banks, cooperative banks may also become scheduled banks if they fulfil the criteria stipulated
by RBI.
(b) Non-scheduled banks: These are those banks which are not included in the Second
Schedule of the Reserve Bank of India. Usually those banks which do not conform to the norms
of the Reserve Bank of India within the meaning of the RBI Act or according to specific
functions etc. or according to the judgement of the Reserve Bank, are not capable of serving
and protecting the interest of depositors are classified as non-scheduled banks.
DIFFERENT TYPES OF BANKS IN INDIA
I.) COMMERCIAL BANKS:

1. Public Sector Banks: The term ‘public sector banks’ by itself connotes a situation where
the major/full stake in the banks are held by the Government. By default, the minimum 51%
shares would be kept by the Government of India, and the management control of these
nationalized banks is only with Central Government. Since all these banks have ownership of
Central Government, they can be classified as public sector banks. Apart from the nationalized
banks, State Bank of India, and its associate banks, IDBI Bank and Regional Rural Banks are
also included in the category of Public Sector banks.
2. Private Sector Banks The major stakeholders in the private sector banks are individuals
and corporate. When banks were nationalized under two tranches (in 1969 and in 1980), all
banks were not included. Those non-nationalized banks which continue operations even today
are classified as Old Generation Private Sector Banks. like The Jammu & Kashmir Bank Ltd,
The Federal Bank, The Laxmi Vilas Bank etc. In July 1993 on account of banking sector
reforms the Reserve Bank of India allowed many new banks to start banking operations. Some
of the leading banks which were given licenses are: UTI bank (presently called Axis Bank)
ICICI Bank, HDFC Bank, Kotak Mahindra Bank, Yes Bank etc., These banks are recognized
as New Generation Private Sector Banks.
3. Foreign Banks The other important segment of the commercial banking is that of foreign
banks. Foreign banks have their registered offices outside India, and through their branches
they operate in India. Foreign banks are allowed on reciprocal basis. They are allowed to
operate through branches or wholly owned subsidiaries. These foreign banks are very active in
Treasury (forex) and Trade Finance and Corporate Banking activities. These banks assist their
clients in raising External Commercial Borrowings through their branches outside India or
foreign correspondents. They are active in loan syndication as well. Foreign banks have to
adhere to all local laws as well as guidelines and directives of Indian Regulators such as
Reserve Bank of India, Insurance and Regulatory Development Authority, Securities Exchange
Board of India.
II. CO-OPERATIVE BANKING SYSTEM
Cooperative banks play an important role in the Indian Financial System, especially at the
village level. The growth of Cooperative Movement commenced with the passing of the Act
of 1904. A cooperative bank is a cooperative society registered or deemed to have been
registered under any State or Central Act. If a cooperative bank is operating in more than one
State, the Central Cooperative Societies Act is applicable. In other cases, the State laws are
applicable.
These cooperative banks cater to the needs of agriculture, retail trade, small and medium
industry and self-employed businessmen usually in urban, semi urban and rural areas. In case
of co-operative banks, the shareholders should be members of the co-operative banks. The
share linkage to borrowing is a distinctive feature of a co-operative bank.
1. Short Term Agricultural Credit Institutions The short-term credit structure consists of
the Primary Agricultural Credit Societies at the base level, which are affiliated at the district
level into the District Central Cooperative bank and further into the State Cooperative Bank at
the State level.
2. Long Term Agricultural Credit Institutions The long-term cooperative credit structure
consists of the State Cooperative Agriculture & Rural Development Banks (SCARDBs) and
Primary Cooperative Agriculture & Rural Development Banks (PCARDBs) which are
affiliated to the SCARDBs.
3. Urban Cooperative Banks The term Urban Cooperative Banks (UCBs), although not
formally defined, refers to the primary cooperative banks located in urban and semi-urban
areas. These banks, until 1996, were allowed to lend money only to non-agricultural purposes.
This distinction remains today. These banks have traditionally been around communities,
localities working out in essence, loans to small borrowers and businesses. Today their scope
of operation has expanded considerably. The urban co-operative banks can spread operations
to other States and such banks are called as multi state cooperative banks. They are governed
by the Banking Regulations Act 1949 and Banking Laws (Cooperative Societies) Act, 1965.
III.DEVELOPMENT BANKS
History of development Banking in India can be traced to the establishment of the Industrial
Finance Corporation of India in 1948. Subsequently, with the passing of State Financial
Corporation Act,1951, several SFCs came into being. With the introduction of financial sector
reforms, many changes have been witnessed in the domain of development banking. There are
more than 60 Development Banking Institutions at both Central and State level.
1.) National Bank for Agriculture and Rural Development (NABARD)
National Bank for Agriculture and Rural Development (NABARD) was established in July
1982 by an Act of Parliament based on the recommendations of CRAFICARD. It is the apex
institution concerned with the policy, planning and operations in the field of agriculture and
other rural economic activities. NABARD has evolved several refinance and promotional
schemes over the years and has been making constant efforts to liberalize, broad base and
refine/ rationalize the schemes in response to the field level needs. The refinance provided by
NABARD has two basic objectives:
(i) Supplementing the resources of the cooperatives banks and RRBs for meeting the credit
needs of its clientele, and
(ii) Ensuring simultaneously the build-up of a sound, efficient, effective and viable cooperative
credit structure and RRBs for purveying credit. NABARD undertakes a number of inter-related
activities/services which fall under three broad categories
(a) Credit Dispensation: NABARD prepares for each district annually a potential linked credit
plan which forms the basis for district credit plans. It participates in finalization of Annual
Action Plan at block, district and state levels and monitors implementation of credit plans at
above levels. It also provides guidance in evolving the credit discipline to be followed by the
credit institutions in financing production, marketing and investment activities of rural farm
and non- farm sectors.
(b) Developmental & Promotional The developmental role of NABARD can be broadly
classified as:– Nurturing and strengthening of - the Rural Financial Institutions (RFIs) like
SCBs/SCARDBs, CCBs, RRBs etc. by various institutional strengthening initiatives. –
Fostering the growth of the SHG Bank linkage programme and extending essential support to
SHPIs NGOs/VAs/ Development Agencies and client banks. – Development and promotional
initiatives in farm and non-farm sector. – Extending assistance for Research and Development.
– Acting as a catalyst for Agriculture and rural development in rural areas.
(c) A Supervisory Activities as the Apex Development Bank, NABARD shares with the
Central Bank of the country (Reserve Bank of India) some of the supervisory functions in
respect of Cooperative Banks and RRBs.
2.) Small Industries Development Bank of India (SIDBI) Small Industries Development
Bank of India (SIDBI) was established in October 1989 and commenced its operation from
April 1990 with its Head Office at Lucknow as a development bank. It is the principal and
exclusive financial institution for the promotion, financing and development of the Micro,
Small and Medium Enterprise (MSME) sector and for co-ordination of the functions of the
institutions engaged in similar activities. It is a central government undertaking. The prime aim
of SIDBI is to support MSMEs by providing them the valuable factor of production finance.
Many institutions and commercial banks supply finance, both long-term and short-term, to
small entrepreneurs. SIDBI coordinates the work of all of them.
Functions of Small Industries Development Bank of India (SIDBI): Over the years, the
scope of promotional and developmental activities of SIDBI has been enlarged to encompass
several new activities. It performs a series of functions in collaboration with voluntary
organisations, nongovernmental organisations, consultancy firms and multinational agencies
to enhance the overall performance of the small-scale sector. The important functions of SIDBI
are discussed as follows:
(i) Initiates steps for technology adoption, technology exchange, transfer and up
gradation and modernisation of existing units.
(ii) SIDBI participates in the equity type of loans on soft terms, term loan, working
capital both in rupee and foreign currencies, venture capital support, and different forms
of resource support to banks and other institutions.
(iii) SIDBI facilitates timely flow of credit for both term loans and working capital to
MSMEs in collaboration with commercial banks.
(iv) SIDBI enlarges marketing capabilities of the products of MSMEs in both domestic
and international markets.
(v) SIDB1 directly discounts and rediscounts bills with a view to encourage bills culture
and helping the SSI units to realise their sale proceeds of capital goods / equipments
and components etc.
(vi) SIDBI promotes employment-oriented industries especially in semi-urban areas to
create more employment opportunities so that rural-urban migration of people can be
checked.
3.) National Housing Bank (NHB) National Housing Bank was set up in July, 1988 as the
apex financing institution for the housing sector with the mandate to promote efficient, viable
and sound Housing Finance Companies (HFCs). Its functions aim at to augment the flow of
institutional credit for the housing sector and regulate HFCs. NHB mobilizes resources and
channelizes them to various schemes of housing infrastructure development. It provides
refinance for direct housing loans given by commercial banks and non-banking financial
institutions. The NHB also provides refinance to Housing Finance Institutions for direct
lending for construction/purchase of new housing/dwelling units, public agencies for land
development and shelter projects, primary cooperative housing societies, property developers.
At present, it is a wholly owned subsidiary of Reserve Bank of India which contributed the
entire paid-up capital. RBI has proposed to transfer its entire shareholding to Government of
India to avoid conflict of ownership and regulatory role. For this transfer, the central bank will
pay RBI, in cash, an amount equal to the face value of the subscribed capital issued by the RBI.
The outstanding portfolio of NHB at ` 33,083 crores as on 31st December 2012 is almost
equally divided between the commercial banks and the HFCs.
4.) Export Import Bank of India (EXIM Bank) Export-Import Bank of India was set up in
1982 by an Act of Parliament for the purpose of financing, facilitating and promoting India’s
foreign trade. It is the principal financial institution in the country for coordinating the working
of institutions engaged in financing exports and imports. Exim Bank is fully owned by the
Government of India and the Bank’s authorized and paid up capital are Rs.10,000 crore and
Rs. 2,300 crores respectively. Exim Bank lays special emphasis on extension of Lines of Credit
(LOCs) to overseas entities, national governments, regional financial institutions and
commercial banks. Exim Bank also extends Buyer’s credit and Supplier’s credit to finance and
promote country’s exports. The Bank also provides financial assistance to export-oriented
Indian companies by way of term loans in Indian rupees or foreign currencies for setting up
new production facility, expansion/modernization or up gradation of existing facilities and for
acquisition of production equipment or technology. Exim Bank helps Indian companies in their
globalization efforts through a wide range of products and services offered at all stages of the
business cycle, starting from import of technology and export product development to export
production, export marketing, pre-shipment and post-shipment and overseas investment.
The Bank has introduced a new lending programme to finance research and development
activities of export-oriented companies. R&D finance by Exim Bank is in the form of term loan
to the extent of 80 per cent of the R&D cost. In order to assist in the creation and enhancement
of export capabilities and international competitiveness of Indian companies, the Bank has put
in place an Export Marketing Services (EMS) Programme. Through EMS, the Bank proactively
assists companies in identification of prospective business partners to facilitating placement of
final orders. Under EMS, the Bank also assists in identification of opportunities for setting up
plants or projects or for acquisition of companies overseas. The service is provided on a success
fee basis.
Exim Bank supplements its financing programmes with a wide range of value-added
information, advisory and support services, which enable exporters to evaluate international
risks, exploit export opportunities and improve competitiveness, thereby helping them in their
globalisation efforts.
FUNCTIONS OF BANKS
The functions of banks are mainly divided into two:

• Primary functions
• Secondary functions
I. Primary functions: Primary functions of banks are also known as banking functions. They
are the main functions of a bank. These primary functions of banks are explained below:
1.) Accepting deposits
The bank collects deposits from the public. These deposits can be of different types, such as
a) Savings Deposits: This type of deposit encourages savings habit among the public. The
rate of interest is low. Withdrawals of deposits are allowed subject to certain restrictions.
This account can be opened in single name or in joint names.
b) Fixed Deposits: Lump sum amount is deposited at one time for a specific period. Higher
rate of interest is paid, which varies with the period of deposits. Withdrawals are not
allowed before the expiry of the period.
c) Current Deposit: This kind of account is operated by businessmen. Withdrawals are
freely allowed. No interest is paid. Account holders can get the benefit of overdraft
facility.
d) Recurring Deposits: A certain sum of money is periodically deposited into the bank.
Withdrawals are permitted only after the expiry of a certain period.
2.) Granting of loans and advances
The bank advances loan to the business community and other members of the public. The rate
charged is higher than what it pays on deposits. The difference in the interest rates is their
profit. The types of bank loans and advances are:
a) Overdraft: The type advance given to current account holders. No separate account is
maintained. All entries are made in the current account. A certain amount is sanctioned
as overdraft which can be withdrawn within a certain period of time. Interest is charged
on actual amount withdrawn. An overdraft facility is granted against a collateral
security.
b) Cash Credits: The client is allowed cash credit upto a specific limit fixed in advance.
It can be given to current account holders as well as to others who do not have an
account with bank. Separate cash credit account is maintained. Interest is charged on
the amount withdrawn in excess limit.
c) Loans: It is normally for a short period of one year or medium period of five years.
Nowadays banks do lend money for long term. Repayment of money can be in the form
of installments spread over a period of time or in lumpsum amount. Interest is charged
on the amount sanctioned, whether withdrawn or not.
d) Discounting of Bill of Exchange: The bank can advance money by discounting or by
purchasing bills of exchange both domestic and foreign bills. The bank pays the bill
amount to the drawer or the beneficiary of the bill by deducting usual discount charges.
On maturity, the bill is presented to the drawee or acceptor of the bill and the amount
is collected.
II. Secondary Functions
The bank performs a number of secondary functions, also called as non-banking functions. The
important secondary functions of banks are:
1.) Agency functions
The bank acts as an agent of its customers. The bank performs a number of agency functions
which includes: -
a) Transfer of funds: The bank transfer funds from one branch to another or from one
place to another.
b) Collection of cheques: The bank collects the money of the cheques through clearing
section of its customers. The bank also collects money of the bills of exchange.
c) Periodic payments: On standing instructions of the client, the bank makes periodic
payments in respect of electricity bills, rent, etc.
d) Portfolio management: The bank also undertakes to purchase and sell the shares and
debentures on behalf of the clients and accordingly debits or credits the account. This
facility is called portfolio management.
e) Periodic collections: The bank collects salary, pension, divided, and such other
periodic collections on behalf of the client.
f) Other Agency functions: They act as trustees, executors, advisers and administrators
on behalf of its clients. They act as representatives of the clients to deal with other banks
and institutions.
2.) General Utility functions: The bank performs general utility functions such as
a) Issue of Drafts, Letter of Credit: Bank issue drafts for transferring money from one
place to another. It also issues letters of credit, especially in case of import trade. It also
issues travellers cheques.
b) Locker Facility: The bank provides a locker facility for the safe custody of valuable
documents, gold ornaments and other valuables.
c) Underwriting of shares: The bank underwrites shares and debentures through its
merchant banking division.
d) Dealing in foreign exchange: The commercial banks are allowed by RBI to deal in
foreign exchange.
e) Project Reports: The bank may also undertake to prepare project reports on behalf of
its clients.
f) Social welfare programmes: It takes social welfare programmes, such as adult literacy
programmes, public welfare campaigns, etc.
g) Other utility functions: It acts as a referee to financial standing of customers. It
collects creditworthiness information about clients of its customers. It provides market
information to its customers.
CORE BANKING
Core (Centralized Online Real-time Exchange) banking is a banking service provided by a

group of networked bank branches where customers may access their bank account and
perform basic transactions from any of the member branch offices.
Core banking is often associated with retail banking and many banks treat the retail customers
as their core banking customers. Businesses are usually managed via the corporate
banking division of the institution. Core banking covers basic depositing and lending of money.
Core banking functions will include transaction accounts, loans, mortgages and payments.
Banks make these services available across multiple channels like automated teller
machines, Internet banking, mobile banking and branches.[1]
Banking software and network technology allow a bank to centralise its record keeping and
allow access from any location.
History: Core banking became possible with the advent of computer and telecommunication
technology that allowed information to be shared between bank branches quickly and
efficiently.
Before the 1970s it used to take at least a day for a transaction to reflect in the real account
because each branch had their local servers, and the data from the server in each branch was
sent in a batch to the servers in the data center only at the end of the day (EOD).
Over the following 30 years most banks moved to core banking applications to support their
operations creating a Centralized Online Real-time Exchange (or Environment) (CORE). This
meant that all the bank's branches could access applications from centralized data centers.
Deposits made were reflected immediately on the bank's servers, and the customer could
withdraw the deposited money from any of the bank's branches.
It offers invariably all information that a bank's customer would need if he/she visits a bank
branch in person.
These are as herein follows:-

o To make enquiries about the balance or debit or credit entries in the account.
o To obtain cash payment out of his account by tendering a cheque.
o To deposit a cheque for credit into his account.

o To deposit cash into the account.
o To deposit cheques/cash into account of some other person who has account in a CBS
branch.
o To get the statement of account.
o To transfer funds from his account to some other account – his own or of third party,
provided both accounts are in CBS branches.
o To obtain Demand Drafts or Banker’s Cheques from any branch on CBS – amount
shall be online debited to his account.
Customers can continue to use ATMs and other Delivery Channels, which are also interfaced
with CBS platform.
Advantages of Core Banking

Nowadays most of the banks in India have CBS, CORE stands for ‘Centralized Online Real-
time Exchange’. Deposits made are reflected immediately on the banks servers and the
customer can withdraw the deposited money from any of the bank’s branches throughout the
world. The benefits are:
• improves operational efficiency, reduces cost, and is a base for growth
• Reduce the risk arising from manual data entry
• Increases management information and review
• Easier introduction of new products and faster customer service as there is real-time
transaction processing
• Integration of all products and services, leading to improved risk management
• Increased speed in working, resulting in more business opportunities and reduction in
penalties and legal expenses
• Availability of efficient and easy e-transactions which can be conducted 24×7
Challenges to Core Banking
• Excessive reliance on technology
• Any failure in computer systems can cause entire network to go down
• If the data is not protected properly and if proper care is not taken, hackers can gain
access to the sensitive data.
CORE BANKING SOLUTIONS (CBS)
Core Banking Solutions has helped banks to offer better customer service. It has also reduced
the time and increased the efficiency. The Core Banking Solutions mainly work on the support
of effective communication and good information technology. It is on account of merger of
communication technology and information technology which enables the banks to offer core
banking needs of the clients. Core Banking Solutions are computer-based banking applications
(software) which works on a platform. The computer software handles the different functions
of the bank like, recording of transactions, updating the balances in the accounts based on the
type of transactions, calculate interests and application of interest, charges etc., The software
is installed in the branches and the computer systems are interconnected with a main computer
server though communication lines (telephones, satellite, internet, fibre optical)
CBS is a back-end system, and it processes daily banking transactions and updates the records
accordingly. CBS helps the clients to operate their accounts from any CBS branch. CBS branch
assist customers to handle their funds transfers in a quick turnaround time. It also assists the
client to withdraw and deposit funds in other branches apart from the parent branch, where he
maintains his account.
Data Warehousing- A Data Warehouse or Enterprise Data Warehouse (DWH/EDW) is a
database used for reporting and data analysis. It is a central repository of data which is created
by integrating data from one or more separate sources. DWH store current as well as historical
data and are used for creating trending reports for use by senior management. The data stored
in the warehouse are uploaded from the operation systems. The main source of data is cleaned,
transformed, catalogued and made available for use by the managers for data mining, online
analytical processing and decision support.
INVESTMENT BANKING
An investment bank is a financial institution that assists individuals, corporations, and

governments in raising finance by underwriting or acting as the client’s agent in the issuance
of securities. Investment banks specialize in large and complex financial transactions such as
underwriting, acting as intermediary between a securities issuer and the investing public,
facilitating and other corporate reorganizations, acting as a broker for financial clients. They
work both as financiers and underwriters. As financiers, they themselves provide long term
fund to business and industries. As underwriters, they work as middlemen between business
corporations and investors.
Major investment banks in India include Bajaj capital, Barclays India, Cholamandalam
Investment and Financing Company, ICICI securities ltd, Industrial Development Bank of
India (IDBI), and SBI capital markets.
Investment banking is a specific division of banking related to the creation of capital for other
companies, governments and other entities. Investment banks underwrite new debt and equity
securities for all types of corporations, aid in the sale of securities, and help to
facilitate mergers and acquisitions, reorganizations and broker trades for both institutions and
private investors. Investment banks also provide guidance to issuers regarding the issue and
placement of stock.
The Role of Investment Bankers
Investment banks employ investment bankers who help corporations, governments and other
groups plan and manage large projects, saving their client time and money by identifying risks
associated with the project before the client moves forward. Investment banks serve as
middlemen between a company and investors when the company wants to issue stock or bonds.
The investment bank assists with pricing financial instruments to maximize revenue and with
navigating regulatory requirements. Investment bank stands to make a profit, as it will
generally price its shares at a mark-up from the price initially paid.
MERCHANT BANKING
Merchant Banking is a combination of Banking and consultancy services. It provides

consultancy to its clients for financial, marketing, managerial and legal matters. Consultancy
means to provide advice, guidance and service for a fee. It helps a businessman to start
a business. It helps to raise (collect) finance. It helps to expand and modernize the business. It
helps in restructuring of a business. It helps to revive sick business units. It also helps
companies to register, buy and sell shares at the stock exchange.
In short, merchant banking provides a wide range of services for starting until running a
business. It acts as Financial Engineer for a business.
Functions of Merchant Banking
The functions of merchant banking are listed as follows:
1) Raising Finance for Clients: Merchant Banking helps its clients to raise finance
through issue of shares, debentures, bank loans, etc. It helps its clients to raise finance
from the domestic and international market. This finance is used for starting a new
business or project or for modernization or expansion of the business.
2) Broker in Stock Exchange: Merchant bankers act as brokers in the stock exchange.
They buy and sell shares on behalf of their clients. They conduct research on equity
shares. They also advise their clients about which shares to buy, when to buy, how
much to buy and when to sell. Large brokers, Mutual Funds, Venture capital companies
and Investment Banks offer merchant banking services.
3) Project Management: Merchant bankers help their clients in the many ways. For e.g.
Advising about location of a project, preparing a project report, conducting feasibility
studies, making a plan for financing the project, finding out sources of finance, advising
about concessions and incentives from the government.
4) Advice on Expansion and Modernization: Merchant bankers give advice for
expansion and modernization of the business units. They give expert advice on mergers
and amalgamations, acquisition and takeovers, diversification of business, foreign
collaborations and joint-ventures, technology up-gradation, etc.
5) Managing Public Issue of Companies: Merchant bank advice and manage the public
issue of companies. They provide following services:
i) Advise on the timing of the public issue.
ii) Advise on the size and price of the issue.
iii) Acting as manager to the issue, and helping in accepting applications and allotment
of securities.
iv) Help in appointing underwriters and brokers to the issue.
v) Listing of shares on the stock exchange, etc.
6) Handling Government Consent for Industrial Projects: A businessman has to get
government permission for starting of the project. Similarly, a company requires
permission for expansion or modernization activities. For this, many formalities have
to be completed. Merchant banks do all this work for their clients.
7) Special Assistance to Small Companies and Entrepreneurs: Merchant banks advise
small companies about business opportunities, government policies, incentives and
concessions available. It also helps them to take advantage of these opportunities,
concessions, etc.
8) Services to Public Sector Units: Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of securities,
foreign collaborations and arranging long-term finance from term lending institutions.
9) Revival of Sick Industrial Units: Merchant banks help to revive (cure) sick industrial
units. It negotiates with different agencies like banks, term lending institutions, and
BIFR (Board for Industrial and Financial Reconstruction). It also plans and executes
the full revival package.
10) Portfolio Management: A merchant bank manages the portfolios (investments) of its
clients. This makes investments safe, liquid and profitable for the client. It offers expert
guidance to its clients for taking investment decisions
11) Corporate Restructuring: It includes mergers or acquisitions of existing business
units, sale of existing unit or disinvestment. This requires proper negotiations,
preparation of documents and completion of legal formalities. Merchant bankers offer
all these services to their clients.
12) Money Market Operation: Merchant bankers deal with and underwrite short-
term money market instruments, such as:
i) Government Bonds.
ii) Certificate of deposit issued by banks and financial institutions.
iii) Commercial paper issued by large corporate firms.
iv) Treasury bills issued by the Government (Here in India by RBI).
13) Leasing Services: Merchant bankers also help in leasing services. Lease is a contract
between the lessor and lessee, whereby the lessor allows the use of his specific asset
such as equipment by the lessee for a certain period. The lessor charges a fee called
rentals.
14) Management of Interest and Dividend: Merchant bankers help their clients in the
management of interest on debentures / loans, and dividend on shares. They also advise
their client about the timing (interim / yearly) and rate of dividend.
CLEARING HOUSE
Clearing house is a third-party agency or separate entity that acts as a go-between for buyers
and sellers in financial markets. The term is most often associated with commodity and futures
markets. The clearing house is responsible for settling the exchange member’s trade accounts,
maintaining margin accounts and collecting money. The clearing house also oversees delivery
and reports trading data. In India the Reserve Bank of India acts as the clearinghouse for
scheduled banks, which have statutory accounts with it. Through this function the Reserve
Bank of India enables the banks to settle their transactions among various banks easily and
economically.
The Reserve Bank of India has its clearinghouse offices in 14 places in India. Some of the cities
where it has its own clearinghouses are Mumbai, Bangalore, Kolkata, Chennai, Nagpur,
Hyderabad, New Delhi, Patna and Kanpur. In other places, the clearinghouse function is carried
out in the premises of SBI and its Associate Banks. At present 578 centers are run by SBI and
its associate bankers.
In Banking, it is a bank-operated affiliated agency or facility within a geographical area. It acts
as a central site for collecting, exchanging, and settling of checks drawn on each other.
Electronic funds transactions are also cleared by modern clearance houses. In Futures, this is
a governing exchange’s agency or affiliate, such as a stock exchange. It acts as a counter-party
to every transaction on that exchange. Its accountability includes guaranteeing, reconciling,
settling, collecting, and clearing, on all trades.
MULTI- FUNCTIONAL BANKS (For Details Refer Module 2)
Multi-functional means having or fulfilling different functions. Banks are the institutions which
perform the deposit and lending functions. When a bank performs different functions then such
banks are termed as multifunctional banks.
RBI the central bank of India performs multiple functions and thus it can be seen as a good
example of multi-functional bank. The various functions performed by RBI are as follows:
1) Issue Bank notes
2) Banker to government
3) Custodian of cash reserves of commercial banks
4) Custodian of County’s Foreign Currency Reserves
5) Lender of last resort
6) Central clearance and Accounts settlement
7) Controller of credit.
INTERNATIONAL BANKING
“International Banking” can be defined as a sub-set of commercial banking transactions and

activity having a cross-border and/or cross currency element. Multinational banking refers to
the location and ownership of banking facilities in a large number of countries and geographic
regions. International banking comprises a range of transactions that can be distinguished from
purely domestic operations by (a) the currency of denomination of the transaction, (b) the
residence of the bank customer and (c) the location of the booking office.
International Banking – features: –
1) Expansion: International Banking assists traders to expand their business and trade
activities beyond the boundaries of a nation. Economic growth and conducive climate for
carrying out the business activities in new nations are the factors because of which many
enterprises are looking beyond the borders of their own nations for their business growth.
2) Legal and Regulatory framework: Flexible legal and regulatory framework encourages
traders and investors to enter into the international markets. Quick approval to set up
business, less complicated compliance requirements and stable political situations help
many new players to enter into a number of nations to expand their activities.
3) Cost of Capital: The operating efficiency of an enterprise depends upon the average cost
of capital. Many companies enter into new emerging markets to take advantages of the
lower cost of capital in such markets. Banks as a financial intermediary play an important
role as source of funds.
4) Current account and Capital account transactions: Banks play crucial role in export
and import trade. By providing different types of financial and non-financial support, banks
help enterprises, corporate customers and individuals doing business in different countries,
by extending trade finance and investment opportunities.
5) Risks: Different risks paved ways for diversification, thereby global investors look for
alternative destinations to invest their savings with twin objectives of safety of funds and
better returns. In view of their presence in different time zones, international banks also
face various risks.
LEGAL ISSUES IN INTERNATIONAL BANKING TRANSACTIONS
Legal issues associated with international banking transactions arise due to involvement of
more than one law/ s of different countries. Due to various reasons, even in a simple two-party
loan agreement a number of different legal systems may be involved, for example an
independent currency may be used for the transaction, but the loan is guaranteed by a third
party based in another country. Under such circumstances, more than one law would be used.
In such a situation, the court would consider such cases, which contains a foreign element,
principles of private international law, or conflict of laws, come into operation.
The objects of private international law are:
1. to ascertain whether a court has jurisdiction to determine the case
2. to identify which system of law the court will apply to the determine fact of the case
3. to determine whether the court will recognize or enforce a judgment obtained in a
foreign court
It is of the utmost importance that the legal aspects of any international banking transactions
are made as predictable as possible. This question of predictability does not normally pose a
significant problem in purely domestic banking transactions, since the rights and obligations
of the various parties will normally be determined by the local systems of law under which
they contract. However, this will not necessarily be the case in international banking and it will
therefore be crucial to structure the transaction documentation within a competent legal
framework.
The most effective way in which this can be achieved is by selecting both (i) the system of law
which governs the substantive aspects of the transaction, and (ii) the court which will have
jurisdiction to resolve any dispute that may arise.
In view of the above, the international banks sometimes, face difficulties while handling the
syndicated loans, depending upon the number of banks and countries involved.
FEATURES AND BENEFITS OF INTERNATIONAL BANKING
1) Flexibility: International banking facility provides flexibility to the multinational
companies to deal in multiple currencies. The major currencies that multinational
companies or individuals can deal with include euro, dollar, pounds, sterling, and rupee.
The companies having headquarters in other countries can manage their bank accounts and
avail financial services in other countries through international banking without any hassle.
2) Accessibility: International banking provides accessibility and ease of doing business to
the companies from different countries. An individual or MNC can use their money
anywhere around the world. This gives them a freedom to transact and use their money to
meet any requirement of funds in any part of the world.
3) International Transactions: International banking allows the business to make
international bill payments. The currency conversion facility allows the companies to pay
and receive money easily. Also, the benefits like overdraft facility, loans, deposits, etc. are
available every time for overseas transactions.
4) Accounts Maintenance: A multinational company can maintain the records of global
accounts in a fair manner with the help of international banking. All the transactions of the
company are recorded in the books of the banks across the globe. By compiling the data
and figures, the accounts of the company can be maintained.
TYPES OF SERVICES OFFERED
1) To arrange trade finance: An international bank arranges the finance for the traders who
want to deal with the foreign country.
2) To arrange foreign exchange: The core services provided by the international bank are to
arrange a foreign exchange for the import-export purpose.
3) To hedge the funds: The international bank hedges the funds by buying the securities at
the lower price level and sell it when the price level rising.
4) Offer investment banking services: It also offers an investment banking services by
signing underwriting of shares, financial decisions for investment.
TYPES OF BANKS
1) Correspondent banks: Correspondent banks involve the relationship between different
banks which are in different countries. This type of bank is generally used by the
multinational companies for their international banking. This type of banks is in small size
and provides service to those clients who are out of their country.
2) Edge act bank: Edge act banks are based on the constitutional amendment of 1919. They
will operate business internationally under the amendment.
3) Offshore banking centre: It is a type of banking sector which allows foreign accounts.
Offshore banking is free from the banking regulation of that particular country. It provides
all types of products and services.
4) Subsidiaries: Subsidiaries are the banks which incorporate in one country which is either
partially or completely owned by a parent bank in another country. The affiliates are
somewhat different from the subsidiaries like it is not owned by a parent bank and it works
independently.
5) Foreign branch bank: Foreign banks are the banks which are legally tied up with the
parent bank but operate in a foreign nation. A foreign bank follows the rules and regulations
of both the countries i.e. home country and a host country.
TYPES OF RISKS
1) Currency risk: An international bank has to be familiar with the currency exchange rate
while doing business internationally. The companies which choose to operate in a foreign
country and at that time it has to deal with currency risk.
2) Political risk: Political risk also affects the business because business has to follow the
rules and regulation of host country and each country has their political effect on the
business. If the political decisions are unfavourable it affects the business.
3) Reputation risk: A reputation risk means the potential loss in reputational capital based
on either real or observed loss in reputational capital. A bank faces reputation risks like
rumours about the bank, data manipulation, bad customer service, and experience. A bank's
reputation is judged by the clients, investors, leaders, and critics.
4) Systematic risk: The systematic risk is not related to particular one bank but it affects the
whole economy. A systematic risk is associated with failures of the big entity and it affects
the whole economy.
Examples of international banking

• City group
• HSBC Holdings
• Bank of America
MODULE 2
Central Banking - Functions of Central Banks - Bankers to Government Credit Card Monetary
Policy - Banker Bank – Preventing Systemic Risks - Reserve Bank as Central Bank. RBI –
Supervision Over Commercial Banks - Bank Licensing - Renewal of License - Branch
Licensing - Permitted Functions - Control Over Management- Account and Audit of Banks -
Amalgamation, Reconstruction and Liquidation of Banks.
CENTRAL BANKING - FUNCTIONS OF CENTRAL BANKS
There is only one Central Bank in a country whose main function is to control the operations
of the rest of the banking system. It supervises controls and regulates the activities of
commercial banks and acts as a banker to them. It also acts as a banker, agent and adviser to
the government in all financial and monetary matter.
Reserve Bank of India Act, 1934 The Reserve Bank of India as the Central Bank of our
country was established on 1st April, 1935 under the Reserve Bank of India Act, 1934. The
Bank was started originally as a shareholder’s bank and its paid-up capital was Rs. 5 crores.
The Bank took over the function of currency issue from the Government of India and the power
of credit control from the then Imperial Bank of India. The Bank was nationalised in the year
1948, soon after Independence, following a post-war trend towards nationalisation of central
banks all over the world. The Bank of England was nationalised in 1946. Secondly, a centrally
administered system had then become necessary to control a runaway inflation raging in India
since 1939, control inflation in the country effectively. Thirdly, as India had to embark upon a
programme of economic development and growth, it was necessary to have a complete control
over the activities of banking so that a Central Bank could be used effectively as an instrument
of economic change in the country.
Constitutional Validity: The Reserve Bank was established under the Reserve Bank of India
Act, 1934 on April 1. 1935 as a private shareholders' bank, but since its nationalization in 1949,
is fully owned by the Government of India. The Reserve Bank; is placed under the Entry 38 of
List I of Schedule VII of the Constitution of India, which is the Union List.
Principles of Central Banking Following are the three main principles of Central Banking:
(i) National Welfare: The Central Bank is always inspired by the Spirit of National Welfare.
The Commercial Banks are generally guided almost exclusively by the profit-motive.
According to De-Kock the directive principles of Central Bank is that it should work
exclusively in the interest of public Welfare. It should not consider profit as the primary motive.
This however, does not mean that the Central bank should suffer losses while working in
national interest. What it implies is that the profit motive for the Central Bank should only be
a secondary consideration.
(ii) Monetary and Financial Stability: Another important principle of Central Banking is that
the Central Bank should help in the maintenance of monetary and financial stability in the
country. There are several weapons in the armoury of the Central Bank which it can utilise for
the achievement of this objective.
(iii) Freedom from Political influence: The Central Bank should remain free from all political
influences. In other words, it should not allow itself to be dominated by the ideology of a
particular political party. On the contrary, it should work strictly in accordance with the well-
known principles of Central Banking. At the same time, it is also necessary that there should
be perfect cooperation between the Central Bank and the Government of the country, the reason
is that the economic problems of the country cannot be satisfactorily solved without the fullest
co-operation between the Government and the Central Bank
FUNCTIONS OF RBI
Functions of RBI can be classified into following categories:

I. Traditional functions
II. Development functions
III. Supervisory functions
I. Traditional Functions of RBI
Traditional functions are those functions which every central bank of each nation performs all
over the world. Basically, these functions are in line with the objectives with which the bank
is set up. It includes fundamental functions of the Central Bank. They comprise the following
tasks.
1) Issue of Currency Notes: The RBI has the sole right or authority or monopoly of
issuing currency notes except one rupee note and coins of smaller denomination. These
currency notes are legal tender issued by the RBI. Currently it is in denominations of
Rs. 2, 5, 10, 20, 50, 100, 500, and 1,000. The RBI has powers not only to issue and
withdraw but even to exchange these currency notes for other denominations. It issues
these notes against the security of gold bullion, foreign securities, rupee coins, exchange
bills and promissory notes and government of India bonds.
2) Banker to other Banks: The RBI being an apex monitory institution has obligatory
powers to guide, help and direct other commercial banks in the country. The RBI can
control the volumes of banks reserves and allow other banks to create credit in that
proportion. Every commercial bank has to maintain a part of their reserves with its
parent's viz. the RBI. Similarly, in need or in urgency these banks approach the RBI for
fund. Thus, it is called as the lender of the last resort.
3) Banker to the Government: The RBI being the apex monitory body has to work as an
agent of the central and state governments. It performs various banking function such
as to accept deposits, taxes and make payments on behalf of the government. It works
as a representative of the government even at the international level. It maintains
government accounts, provides financial advice to the government. It manages
government public debts and maintains foreign exchange reserves on behalf of the
government. It provides overdraft facility to the government when it faces financial
crunch.
4) Exchange Rate Management: It is an essential function of the RBI. In order to

maintain stability in the external value of rupee, it has to prepare domestic policies in
that direction. Also, it needs to prepare and implement the foreign exchange rate policy
which will help in attaining the exchange rate stability. In order to maintain the
exchange rate stability, it has to bring demand and supply of the foreign currency (U.S
Dollar) close to each other.
5) Credit Control Function: Commercial bank in the country creates credit according to
the demand in the economy. But if this credit creation is unchecked or unregulated then
it leads the economy into inflationary cycles. On the other credit creation is below the
required limit then it harms the growth of the economy. As a central bank of the nation
the RBI has to look for growth with price stability. Thus, it regulates the credit creation
capacity of commercial banks by using various credit control tools.
6) Supervisory Function: The RBI has been endowed with vast powers for supervising
the banking system in the country. It has powers to issue license for setting up new
banks, to open new branches, to decide minimum reserves, to inspect functioning of
commercial banks in India and abroad, and to guide and direct the commercial banks
in India. It can have periodical inspections an audit of the commercial banks in India.
II. Developmental / Promotional Functions of RBI
Along with the routine traditional functions, central banks especially in the developing country
like India have to perform numerous functions. These functions are country specific functions
and can change according to the requirements of that country. The RBI has been performing
as a promoter of the financial system since its inception. Some of the major development
functions of the RBI are maintained below.
1) Development of the Financial System: The financial system comprises the financial
institutions, financial markets and financial instruments. The sound and efficient
financial system is a precondition of the rapid economic development of the nation. The
RBI has encouraged establishment of main banking and non-banking institutions to
cater to the credit requirements of diverse sectors of the economy.
2) Development of Agriculture: In an agrarian economy like ours, the RBI has to provide
special attention for the credit need of agriculture and allied activities. It has
successfully rendered service in this direction by increasing the flow of credit to this
sector. It has earlier the Agriculture Refinance and Development Corporation (ARDC)
to look after the credit, National Bank for Agriculture and Rural Development
(NABARD) and Regional Rural Banks (RRBs).
3) Provision of Industrial Finance: Rapid industrial growth is the key to faster economic
development. In this regard, the adequate and timely availability of credit to small,
medium and large industry is very significant. In this regard the RBI has always been
instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI
and EXIM BANK etc.
4) Provisions of Training: The RBI has always tried to provide essential training to the
staff of the banking industry. The RBI has set up the bankers' training colleges at several
places. National Institute of Bank Management i.e NIBM, Bankers Staff College i.e
BSC and College of Agriculture Banking i.e CAB are few to mention.
5) Collection of Data: Being the apex monetary authority of the country, the RBI collects
process and disseminates statistical data on several topics. It includes interest rate,
inflation, savings and investments etc. This data proves to be quite useful for
researchers and policy makers.
6) Publication of the Reports: The Reserve Bank has its separate publication division.
This division collects and publishes data on several sectors of the economy. The reports
and bulletins are regularly published by the RBI. It includes RBI weekly reports, RBI
Annual Report, Report on Trend and Progress of Commercial Banks India., etc. This
information is made available to the public also at cheaper rates.
7) Promotion of Banking Habits: As an apex organization, the RBI always tries to
promote the banking habits in the country. It institutionalizes savings and takes
measures for an expansion of the banking network. It has set up many institutions such
as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-1982,
NHB-1988, etc. These organizations develop and promote banking habits among the
people. During economic reforms it has taken many initiatives for encouraging and
promoting banking in India.
8) Promotion of Export through Refinance: The RBI always tries to encourage the
facilities for providing finance for foreign trade especially exports from India. The
Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee
Corporation of India (ECGC) are supported by refinancing their lending for export
purpose.
III. Supervisory Functions of RBI
The reserve bank also performs many supervisory functions. It has authority to regulate and
administer the entire banking and financial system. Some of its supervisory functions are given
below.
1) Granting license to banks: The RBI grants license to banks for carrying its business.
License is also given for opening extension counters, new branches, even to close down
existing branches.
2) Bank Inspection: The RBI grants license to banks working as per the directives and in
a prudent manner without undue risk. In addition to this it can ask for periodical
information from banks on various components of assets and liabilities.
3) Control over NBFIs: The Non-Bank Financial Institutions are not influenced by the
working of a monitory policy. However, RBI has a right to issue directives to the NBFIs
from time to time regarding their functioning. Through periodic inspection, it can
control the NBFIs.
4) Implementation of the Deposit Insurance Scheme: The RBI has set up the Deposit
Insurance Guarantee Corporation in order to protect the deposits of small depositors.
All bank deposits below Rs. One lakh are insured with this corporation. The RBI work
to implement the Deposit Insurance Scheme in case of a bank failure.
Reserve Bank of India's Credit Policy
The Reserve Bank of India has a credit policy which aims at pursuing higher growth with price
stability. Higher economic growth means to produce more quantity of goods and services in
different sectors of an economy; Price stability however does not mean no change in the general
price level but to control the inflation. The credit policy aims at increasing finance for the
agriculture and industrial activities. When credit policy is implemented, the role of other
commercial banks is very important. Commercial banks flow of credit to different sectors of
the economy depends on the actual cost of credit and arability of funds in the economy
MONETARY POLICIES OF RBI
Monetary policy is a policy formulated by the central bank, i.e., RBI (Reserve Bank of India)
and relates to the monetary matters of the country. The policy involves measures taken for
regulating the money supply, availability and cost of credit in the economy. The policy also
oversees distribution of credit among users as well as borrowing and lending rates of interest.
In a developing country like India, it is significant in the promotion of economic growth.
The various instruments of monetary policy include variations in bank rates, other interest rates,
selective credit controls, supply of currency, variations in reserve requirements and open
market operations.
Objectives of Monetary Policy
While the main objective of monetary policy is economic growth as well as price and exchange
rate stability, there are other aspects that it can help with as well.
a) Promotion of saving and investment: Since the monetary policy controls the rate of interest
and inflation within the country, it can impact the savings and investment of the people. A
higher rate of interest translates to a greater chance of investment and savings, thereby,
maintaining a healthy cash flow within the economy.
b) Controlling the imports and exports: By helping industries secure a loan at a reduced rate of
interest, monetary policy helps export-oriented units to substitute imports and increase
exports. This, in turn, helps improve the condition of the balance of payments.
c) Managing business cycles: The two main stages of a business cycle are boom and
depression. Monetary policy is the greatest tool using which boom and depression of
business cycles can be controlled by managing the credit to control the supply of money.
The inflation in the market can be controlled by reducing the supply of money. On the other
hand, when the money supply increases, the demand in the economy will also witness a rise.
d) Regulation of aggregate demand: Since monetary policy can control the demand in an
economy, it can be used by monetary authorities to maintain a balance between demand and
supply of goods and services. When credit is expanded and the rate of interest is reduced, it
allows more people to secure loans for the purchase of goods and services. This leads to the
rise in demand. On the other hand, when the authorities wish to reduce demand, they can
reduce credit and raise the interest rates.
e) Generation of employment: As monetary policy can reduce the interest rate, small and
medium enterprises (SMEs) can easily secure a loan for business expansion. This can lead
to greater employment opportunities.
f) Helping with the development of infrastructure: The monetary policy allows concessional
funding for the development of infrastructure within the country.
g) Allocating more credit for the priority segments: Under the monetary policy, additional
funds are allocated at lower rates of interest for the development of the priority sectors such
as small-scale industries, agriculture, underdeveloped sections of the society, etc.
h) Managing and developing the banking sector: The entire banking industry is managed by
the Reserve Bank of India (RBI). While RBI aims to make banking facilities available far
and wide across the nation, it also instructs other banks using the monetary policy to
establish rural branches wherever necessary for agricultural development. Additionally, the
government has also set up regional rural banks and cooperative banks to help farmers
receive the financial aid they require in no time.
Monetary Policy Tools
To control inflation, the Reserve Bank of India needs to decrease the supply of money or
increase cost of fund in order to keep the demand of goods and services in control.
Quantitative tools –
The tools applied by the policy that impact money supply in the entire economy, including
sectors such as manufacturing, agriculture, automobile, housing, etc.
Reserve Ratio:
Banks are required to keep aside a set percentage of cash reserves or RBI approved assets.
Reserve ratio is of two types:
• Cash Reserve Ratio (CRR) – Banks are required to set aside this portion in cash with
the RBI. The bank can neither lend it to anyone nor can it earn any interest rate or profit
on CRR.
• Statutory Liquidity Ratio (SLR) – Banks are required to set aside this portion in liquid
assets such as gold or RBI approved securities such as government securities. Banks
are allowed to earn interest on these securities, however it is very low.
Open Market Operations (OMO):
In order to control money supply, RBI buys and sells government securities in the open market.
These operations conducted by the Central Bank in the open market are referred to as Open
Market Operations.
When RBI sells government securities, the liquidity is sucked from the market, and the exact
opposite happens when RBI buys securities. The latter is done to control inflation. The
objective of OMOs are to keep a check on temporary liquidity mismatches in the market, owing
to foreign capital flow.
Qualitative tools: Unlike quantitative tools which have a direct effect on the entire economy’s
money supply, qualitative tools are selective tools that have an effect in the money supply of a
specific sector of the economy.
• Margin requirements – RBI prescribes a certain margin against collateral, which in

turn impacts the borrowing habit of customers. When the margin requirements are
raised by the RBI, customers will be able to borrow less.
• Moral suasion – By way of persuasion, RBI convinces banks to keep money in

government securities, rather than certain sectors.
• Selective credit control – Controlling credit by not lending to selective industries or
speculative businesses.
There are various direct and indirect instruments used for implementing monetary policy
including Repo Rate, Reverse Repo Rate, Liquidity Adjustment Facility (LAF), Marginal
Standing Facility (MSF), Corridor, Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity
Ratio (SLR), Open Market Operations 2 (OMOs) and Market Stabilization Scheme (MSS).
They are briefly explained below:
Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to
banks against the collateral of government and other approved securities under the Liquidity
Adjustment Facility (LAF).
Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on
an overnight basis, from banks against the collateral of eligible government securities under
the LAF.
Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo
auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected
under variable rate repo auctions across the range of tenors. The aim of term-repo is to help
develop the inter-bank term-money market, which in turn can set market-based benchmarks
for pricing of loans and deposits, and hence improve transmission of monetary policy. The RBI
also conducts variable interest-rate reverse-repo auctions, as necessitated under market
conditions.
Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can
borrow additional amount of overnight money from the Reserve Bank by dipping into their
Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides
a safety valve against unanticipated liquidity shocks to the banking system.
Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement
in the weighted average call money rate.
Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers. The Bank Rate is published under Section 49 of the
Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore,
changes automatically as and when the MSF rate changes alongside policy repo rate changes.
Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain
with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL)
that the Reserve Bank may notify from time to time in the Gazette of India.
Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in
safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes
in SLR often influence the availability of resources in the banking system for lending to the
private sector.
Open Market Operations (OMOs): These include both, outright purchase and sale of
government securities, for injection and absorption of durable liquidity, respectively.
Market Stabilisation Scheme (MSS): This instrument for monetary management was
introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital
inflows is absorbed through sale of short-dated government securities and treasury bills. The
cash so mobilised is held in a separate government account with the Reserve Bank.
Policy Rates:
Bank rate – The interest rate at which RBI lends long term funds to banks is referred to as the
bank rate. However, presently RBI does not entirely control money supply via the bank rate. It
uses Liquidity Adjustment Facility (LAF) – repo rate as one of the significant tools to establish
control over money supply.
Bank rate is used to prescribe penalty to the bank if it does not maintain the prescribed SLR or
CRR.
Liquidity Adjustment Facility (LAF) – RBI uses LAF as an instrument to adjust liquidity
and money supply. The following types of LAF are:
a) Repo rate: Repo rate is the rate at which banks borrow from RBI on a short-term basis
against a repurchase agreement. Under this policy, banks are required to provide
government securities as collateral and later buy them back after a pre-defined time.
b) Reverse Repo rate: It is the reverse of repo rate, i.e., this is the rate RBI pays to banks
in order to keep additional funds in RBI. It is linked to repo rate in the following way:
Reverse Repo Rate = Repo Rate – 1
Marginal Standing Facility (MSF) Rate: MSF Rate is the penal rate at which the Central
Bank lends money to banks, over the rate available under the rep policy. Banks availing MSF
Rate can use a maximum of 1% of SLR securities.
MSF Rate = Repo Rate + 1
Conclusion: RBI has been following a neutral policy stance for some time now. This means
that with inflation being at an all-time low of 4.0%, and the growth projections of the Indian
economy being at a constant 7.30%, the RBI will try not to destabilize the delicate balance, by
either infusing or removing too much funds from the markets.
To this end, the Central Bank has increased the repo rate and reverse repo rate on 1 August
2018 by 25 basis points taking them to 6.50% and 6.25%, respectively. It has also increased
the Bank Rate and MSF Rate to 6.75% each. This ensures that the government’s requirement
for more liquidity for industry growth is fulfilled, without the risk of increase in inflation being
too high.
RBI AS BANKER’S BANK
The RBI serves as a banker to the Scheduled Commercial Banks in India. All the Scheduled
Commercial Banks keep their accounts with the RBI for the purpose of maintaining cash
reserves as also for settlement of clearing transactions.
In terms of section 17 of the RBI Act,1934, Scheduled Banks may have recourse to RBI for
financial assistance in the form of rediscount of eligible bills of exchange and promissory notes.
The Act also empowers Reserve Bank to make loans and advances to Scheduled Banks against
the security of stocks, funds and other eligible trustee securities etc. repayable on demand or
on the expiry of fixed periods not exceeding 180 days. In case a commercial bank is not in a
position to raise finances from other sources, then as a last resort, it may approach RBI for
necessary financial accommodation. In its capacity of the lender of the last resort, the RBI
assumes the responsibility of meeting directly or indirectly all reasonable demands for credit
facilities from commercial banks and other credit institutions in terms and conditions as may
be specified under Section 42 of the RBI Act,1934. The RBI holds the cash reserves of
commercial and other banks and thus act as a custodian of the ultimate reserves of the country
which support its credit and banking system. The RBI acts as a clearing house for member
banks for settling their mutual transactions by book entries.
According to Section 18 of the RBI Act,1934 when in the opinion of the RBI a special occasion
has arisen making it necessary or expedient that action should be taken for regulating credit in
the interests of Indian trade, commerce, industry and agricultural the bank may,
notwithstanding any limitation contained in section 17 of the Act,-
(1) purchase, sell or discount any bill of exchange or promissory note, through the same may
not be eligible for purchase or discount under Section 17 ;
(2) make loans or advances to-
(a) a state cooperative bank, or
(b) on the recommendation of a state cooperative bank, to a co-operative society registered
within the area in which the state co-operative bank operates, or
(c) any other person such loans or advances should be repayable on demand or on the expiry
of fixed periods, not exceeding 90 days, on such terms and conditions as the RBI may consider
to be sufficient.
As bankers’ bank, the RBI holds a part of the cash reserves of banks, lends them funds for short
periods, and provides them with centralized clearing and cheap and quick remittance facilities.
In the early stages of the development of central banking, banks used to keep some of their
cash reserves voluntarily with a leading bank which gradually took over the role of a central
bank. The obvious advantage to individual banks was that of the facility of centralized inter-
bank clearing it automatically provided.
Reserve-holding banks could settle their daily mutual clearings by drawing upon or crediting
to their individual accounts with one bank, the central hank. Thus, the mere entries in the books
of the central bank can settle claims against each other among banks without the actual transfer
of cash.
The pooling of cash reserves of banks with one bank as the central bank also led to a great
economy of cash reserves for the banking system as whole, because individual banks could
borrow from the central pool of reserves with the central bank whenever they fell short of cash.
The conditions are substantially different in India. The RBI as the country’s central bank is
authorized statutorily to require scheduled commercial bank to deposit with it a stipulated ratio
(lying between 3 per cent and 15 per cent) of their net total liabilities. This ratio is called Cash
Reserve Ratio (CRR). These reserves of banks with the RBI are held neither voluntarily nor
are available to them for meeting interbank clearing drains except temporarily over the reserve
period, that is, the period over which the daily average of the required cash reserves is
calculated. Till March 29, 1985, this reserve period used to be a week. From that date the length
of this period has been doubled to a fortnight.
The true rationale of the statutory reserve requirement now is that by varying it within limits
the RBI can use it as a tool of monetary and credit control. To meet any clearing drains, banks
must hold extra reserves over and above their statutory reserves or raise cash in other ways.
The pool of bank reserves with the RBI, however, does serve as the common fund out of which
the RBI can and does make advances to banks in temporary need of funds. Normally, banks
are supposed to meet their shortfalls of cash from sources other than the RBI and go to it only
as a matter of last resort, because the RBI as the central bank is supposed to function as only
‘the lender of last resort’.
Under the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 (as amended
from time to time), the RBI enjoys extensive powers of supervision, regulation, and control
over commercial and co-operative banks.
The Bank’s regulatory functions relating to banks cover their establishment (i.e. licensing),
branch expansion, liquidity of their assets, management and methods of working,
amalgamation, reconstruction and liquidation. The control by the Bank is exercised through
periodic inspection of banks and follow-up action and by calling for returns and other
information from them. The objective of such supervision and control is to ensure the
development of a sound banking system in the country.
ROLE OF RESERVE BANK OF INDIA (RBI)/ SUPERVISION OVER

COMMERCIAL BANKS
The Banking Regulation Act, 1949 empowers the Reserve Bank of India to control the banking
institutions of India. Some of them are as under.
(i) Power of Reserve Bank of India to appoint Chairman of a Banking Company:- Section
10-BB of the Act empowers the RBI to appoint Chairman of a Banking Company where the
office of the Chairman of the Board of Directors appointed on a whole-time basis or a
Managing Director of a banking company is vacant, the RBI may, if it is of opinion that the
continuation of such vacancy is likely to adversely affect the interests of the banking company,
appoint a person who has special knowledge and practical experience of the working of a
banking company or the State Bank of India or any subsidiary bank or a financial institution,
or financial, economic or business administration to be so appointed, to be the Chairman of the
Board of Directors who is appointed on a whole-time basis or a Managing Director of the
banking company and where the person so appointed is not a director of such banking company,
he shall, so long as he holds the office of the Chairman of the Board of Directors who is
appointed on a whole-time basis or a Managing Director, be deemed to be a Director of the

banking company.
(ii) Minimum paid-up capital and reserves: - Section 11 of the Act imposes that every
banking company should deposit the prescribed minimum paid-up capital and reserves with
the RBI either in cash or in the form of unencumbered approved securities, or partly in cash
and partly in the form of such securities within prescribed time prescribed in this section.
(iii) Cash Reserve: - According to Section 18 of the Act,

Every banking company, not being a scheduled bank, shall maintain in India on a daily basis
by way of cash reserve with itself or by way of balance in a current account with the Reserve
Bank, or by way of net balance in current accounts or in one or more of the aforesaid ways, a
sum equivalent to such per cent of the total of its demand and time liabilities in India as on the
last Friday of the second preceding fortnight as the Reserve Bank may specify, by notification
in the Official Gazette, from time to time, having regard t6 the needs of securing the monetary
stability in the country and shall submit to the Reserve Bank before the twentieth day of every
month a return showing the amount so held on alternate Fridays during a month with particulars
of its demand and time liabilities in India on such Fridays or if any such Friday as a public
holiday under the Negotiable Instruments Act, 1881 (26 of 1881), at the close of business on
the preceding working day.
(1-A) If the balance held by such banking company at the close of business on any days is
below the minimum specified under sub-section (1), such banking company shall, without
prejudice to the provisions of any other law for the time being in force, be liable to pay to the
Reserve Bank, in respect of that day, penal interest at a rate of three per cent above the bank
rue on the amount by which such balance falls short of the specified minimum, and if the
shortfall continues farther, the penal interest so charged shall he increased to a rate of five per
cent above the bank rate in respect of each subsequent day during which the default continues.
(1-B) Notwithstanding anything contained in this section, if the Reserve Bank is satisfied, on
an application in writing by the defaulting banking company, that such defaulting banking
company had sufficient cause for its failure to comply with the provisions of sub-section (1), it
may not demand the payment of the penal interest.
(1-C) The Reserve Bank may, for such period and subject to such conditions as may be
specified, grant to any banking company such exemptions from the provisions of this section
as it thinks fit with reference to all or any of its offices or with reference to the whole or any
part of its assets and liabilities.
(2) The Reserve Bank may, for the purposes of this section and section 24, specify from time
to time, with reference to any transaction or class of transactions, that such transaction or
transactions shall be regarded as liability in India of a banking company and, if any question
arises as to whether any transaction or class of transactions shall be regarded for the purposes
of this section and section 24 as liability in India of a banking company, the decision of the
Reserve Bank thereon shall be final.
(iv) Reserve Bank control over Banking Companies:— Under Section 12-A of the Act, the
RBI may, by order, require any banking company to call a general meeting of the shareholders
of the company within such time, not less than two months from the date of the order, as may
be specified in the order or within such further time as RBI may allow in this behalf, to elect
in accordance with the voting rights permissible under this Act fresh Directors, and the banking
company shall be bound to comply with the order.
(iva) Regulation of acquisition of Shares or voting rights:- (1) No person (hereinafter

referred to as “the applicant”) shall, except with the previous approval of the Reserve Bank, on
an application being made, acquire or agree to acquire, directly or indirectly, by himself or
acting in concert with any other person, shares of a banking company or voting rights therein,
which acquisition, taken together with shares and voting rights, if any, held by him or his
relative or associate enterprise or person acting in concert with him, makes the applicant to
hold five per cent or more of the paid-up share capital of such banking company or entitles him
to exercise five per cent or more of the voting rights in such banking company.
(2) An approval under sub-section (1) may be granted by the Reserve Bank if it is satisfied
that—
a) in the public interest; or
b) in the interest of banking policy; or
c) to prevent the affairs of any banking company being conducted in a manner detrimental
or. prejudicial to the interests of the banking company; or
d) in view of the emerging trends in banking and international best practices; or
e) in the interest of the banking and financial system in India, the applicant is a fit and
proper person to acquire shares or voting rights:
Provided that the Reserve Bank may call for such information from the applicant as it may
deem necessary for considering the application referred to in sub-section (1):
Provided further that the Reserve Bank may specify different criteria for acquisition of shares
or voting rights in different percentages.
(v) Power of the Reserve Bank of India to control advances by banking companies: -
According to Section 21 of the Act the RBI may determine the policy in relation to advances
to be followed by banking companies generally or by any banking company in particular, and
when the policy has been so determined, all banking companies or the banking company as the
case may be, shall be bound to follow the policy as so determined.
(vi) Licensing of banking companies: - As per Section 22 of the Act, no company shall carry
on banking business in India unless it holds a licence issued in that behalf by die RBI and any
such licence may be issued subject to such conditions as the RBI may think fit to impose.
According to Section 23 of the Act, no banking company shall open a new place of business in
India or change otherwise than within the same city, town or village, the location of an existing
place of business situated in India without obtaining the prior permission of the RBI.
Establishment of Depositor Education and Awareness Fund:

According to Section 26-A of the Act: The Reserve Bank shall establish a Fund to be called
the “Depositor Education and “Awareness Fund” (hereafter in this section referred to as the
“Fund”). There shall be credited to the Fund the amount to the credit of any account in India
with a banking company which has not been operated upon for a period of ten years or any
deposit or any amount remaining unclaimed for more than ten years, within a period of three
months from the expiry of the said period of ten years: Provided that nothing, contained in this
sub-section shall prevent a depositor or any other claimant to claim his deposit or unclaimed
amount or operate his account or deposit account from or with the banking company after the
expiry of said period of ten years and such banking company shall be fable to repay such
deposit or amount at such rate of interest as may be specified by the Reserve Bank in this
behalf.
The fund shall be utilized for promotion of depositors’ interests & for such other purposes
which may be necessary for the promotion of depositors' interests as may be specified by the
Reserve Bank from time to time.
(vii) Monthly returns: - Section 27 of the Act imposes that every bank should submit monthly
returns to the RBI in the prescribed form and manner showing its assets and liabilities in India
as at the close of business on the last Friday of every month or if that Friday is a public holiday
on the preceding working day. The RBI has the power to call for other returns and information
if required. The banking companies are bound to submit every return and information, which
are required by the RBI. Section 28 of the Act gives the power to RBI to publish such
information in the public interest
(viii) Accounts and balance-sheet: - Under Section 29 of the Act, at the expiration of each
calendar year, every banking company incorporated in India shall prepare with reference to
that year, a balance-sheet and profit and loss account as on the last working day of the year in
the Forms set out in the Third Schedule and shall submit them to the RBI.
(lx) Audit: - According to Section 30 of the Act, every Bank should get audited its accounts
periodically, and shall submit the reports to the BRBI. Every banking company shall, before
appointing, reappointing or removing any auditor or auditors, obtain the previous approval of
the RBI.
(x) Submission of returns: - Under Section 31 of the Act, the accounts and balance-sheet
together with the Auditor's report shall be published in the prescribed manner and three copies
thereof shall be furnished as returns to the RBI within three months from the end of the period
to which they refer.
(xi) Inspection: - As per Section 35 of the Act, the RBI had got the power to inspect the books
and accounts of a banking company. After the inspection it sends a copy of it to the concerned
Bank.
When the RBI is inspecting a particular Bank, every Director or Officer or Employee of the
bank is under an obligation to produce all the books, accounts and documents in his custody
and furnish the information required.
Any Officer of the RBI, who is inspecting the bank 9 has a right to examine any Director,
Officer or Employer of the banking company under oath in relation to its business.
The inspection by the RBI may be on its own or under the direction of the Central Government.
In any case it reports to the Government on the inspection made under this section. If the
Central Government opines that the affairs on the bank are conducted in a manner detriment to
the interests of the depositors, it may give an opportunity to the bank to make a representation
in connection with the inspection. If after such representation in connection with the inspection,
If after such representation the Central Government opines that it is reasonable, it may
a) prohibit the bank from receiving fresh deposits.
b) direct the RBI to apply Section 38 for winding up of the banks.
The Central Government may publish the report of the inspection if it thinks necessary after
giving a reasonable notice to the bank.
(xii) Directions: - According to Section 35-A of the Act, the RBI may, from time to time, issue
directions as it deems fit, to a banking company in particular or to the banking companies in
general and the banking company or companies shall be bound to comply with such direction.
The RBI, may, of its own or on representation made to it, modify or cancel any of its directions.
But in so cancelling or modifying, it may impose some other conditions subject to which the
cancellation or modification shall have effect
(xiii) Power to remove managerial and other persons from office: - To control over
management, Section 36-AA of the Act empowers the RBI to remove managerial and other
persons from office of the banking companies, whose conduct is detrimental to the interests of
the deposits and to secure proper management. Section 36-AB of the Act empowers the RBI
to appoint additional directors.
(xiv) Power of Reserve Bank to Impose penalty: — Under Section 47A of the Act the
Reserve Bank of India may impose on such banking company-
(a) where the contravention is of the nature referred to in sub-section (3) of Section 46, a penalty
not exceeding twice the amount of the deposits in respect of which such contravention was
made;
(b) where the contravention or default is of the nature referred to in sub-section (4) of Section
46, a penalty not exceeding five lakh rupees or twice the amount involved in such contravention
or default where such amount is qualifiable, whichever is more, and where such contravention
or default is a continuing one, a further penalty which may extend to twenty five thousand
rupees for every day, after the first, during which the contravention or default continues.
The Banking Regulation Act, 1949 vested the RBI with a wide range of powers of supervision
and control over commercial and cooperative banks. Having the enormous powers, the RBI
control frauds and embezzlements in entire banking industry in India.
(xv) Amalgamation: - Section 36(l)(b) provides that the RBI may Bequest or assist in proposal
of amalgamation and Section 44-A of the Act provides the procedure for amalgamation of
banking companies. The RBI may prepare a scheme for the reconstruction of the banking
company or {for amalgamation of the banking company with any other banking institution.
The scheme can be prepared only when the RBI thinks that it is in public interest or in the
interest of the depositors or in order to secure the proper management of the Banking Company
or in the interest of the banking system of the country as whole.
(xvi) Suspension of business and winding up of banking companies: - Sections 38 to 45 of
the Act deal with the procedure of winding up of a banking company. The winding up of a
Banking Company is governed by the Banking Regulation Act, 1949 and not by the Companies
Act, 1956. Further no proceedings under Section 397 of the Companies Act can be taken
against the Banking Company and as the RBI factually control the Bank.
LICENSING OF BANKING COMPANIES
Section 22 of the Banking Regulation Act 1949 provides licensing of Banking companies. No
company shall carry on banking business in India unless it holds a licence issued on behalf by
the Reserve Bank.
Such license may be issued subject to such conditions as the reserve bank may think fit to
impose. No company shall commence banking business without the license. This aspect may
be discussed in the following heads.
1. Necessity of license
2. Procedure of obtaining license
3. Conditions for issue of license
4. Cancellation of license
5. Appeal and remedy against cancellation
Banking system is the backbone of the economy condition of the country does very
development of the country depends upon the smooth and healthy functioning of the banking
system in the country. So, by licensing system, it is insured that no undesirable persons or
elements Should come in and should be prevented from taking part in banking business. Central
Indian Banking Enquiry Committee was formed for introducing a licensing system for the
Foreign Banks operating India
At the commencement of the Act.
Every banking company in existence before the commencement of this act, shall apply before
the expiry of six months from such commencement and every other company before
commencing banking business in India shall apply in writing to the Reserve Bank for license
under this section.
Provided that in the case of banking company in existence on commencement of this act,
nothing in sub section (1) shall be deemed to prohibit the company from carrying on banking
business:
(i)Until it is granted license in pursuance of this section, or
(ii) is by notice in writing informed by the Reserve Bank that a license cannot be granted to it.
Provided further that the reserve bank shall not give a notice as aforesaid to a banking company
in existence on the commence of this Act before the expiry of three years referred to in sub
section (1) of section 11 or of such further period as the Reserve Bank may under such sub
section may think fit to allow.
(2) Procedure of license (sec 22(2))
(i)Every banking company in existence on the commencement of this Act, before the expiry of
six months from such commencement
And
(ii) Every other company before commencing banking business in India,
Shall apply in writing to the Reserve Bank for license.
(3) Condition for license: Section 22(3)
A. COMPANY INCORPORATED IN INDIA- before granting any license under this
section, the Reserve Bank may require to be satisfied by an inspection of the books of the
company or otherwise than the following conditions are fulfilled: -
a) that the company is or will be in a position to pay its present or future depositors in full
as their claims accrue;
b) that the affairs of the company are not being, or are not likely to be, conducted in a
manner detrimental to the interests of its present or future depositors;
c) that the general character of the proposed management of the company will not be
prejudicial to the public interest of its present or future depositors;
d) that the company has adequate capital structure and earning prospects;
e) that the public interest will be served by the grant of a license to the company to carry
on banking business in India;
f) that having regard to the banking facilities available in the proposed principal area of
operations of the company, the potential scope for expansion of banks already in
existence in the area and other relevant factors the grant of the license would not be
prejudicial to the operation and consolidation of the banking system consistent with
monetary stability and economic growth;
g) any other condition, the fulfilment of which would, in the opinion of the Reserve Bank,
be necessary to ensure that the carrying on of banking business in India by the company
will not be prejudicial to the public interest or the interests of the depositors.
B) COMPANY INCORPORATED OUTSIDE INDIA- Before granting any license, under

this section to a company incorporated outside INDIA, the Reserve Bank may require to be
satisfied by an inspection of the books of the company or otherwise that the conditions specified
in sub section 3 are fulfilled and that the carrying on of banking business by such company in
INDIA will be in the public interest and that the government or law of the country in which it
is incorporated does not discriminate in any way against banking companies registered in India
and that the company complies with all the provisions of this act applicable to banking
companies incorporated in India.
Thus, Reserve Bank may enquire as to:
a) Such companies fulfil conditions of subsection (3);
b) To carryon banking business by it will be in public interest;
c) Government or law of the country in which it is incorporated does not discriminate in
any way against banking companies registered in India, and
d) Company complies with all the provisions of this Act applicable to banking companies
incorporated outside India [section 22(3-A)].
(4) Cancellation of License: Section 22(4)
The Reserve Bank may cancel a license granted to a banking company under this section:
(i) If the company ceases to carry on banking business in India; or
(ii) If the company at any time fails to comply with any of the conditions imposed upon
it under sub-section (1); or
(iii) If at any time, any of the conditions referred to in sub-section (3) and sub-section
(3A) is not fulfilled:
PROVIDED that before cancelling a license under clause (ii) or clause (iii) of this sub-section
on the ground that the banking company has failed to comply with or has failed to fulfil any of
the conditions referred to therein, the Reserve Bank, unless it is of opinion that the delay will
be prejudicial to the interests of the company’s depositors or the public, shall grant to the
company on such terms as it may specify, and opportunity of taking the necessary steps for
complying with or fulfilling such condition.
In Reserve Bank of India v. Pattern Surya Prakash Rai, where the affairs of the co-operative
Bank were conducted in a manner detrimental to the interest of the depositors and gross
mismanagement were found by the RBI in successive inspections, the order of cancelling the
license of the bank on not satisfying the requirements of Sections 22 (3) and (3-A) of the 1949
act was held to be proper.
(5) Appeal and remedy against cancellation (Section 22(5))

Any banking company aggrieved by the decision of the Reserve Bank cancelling a license
under this section may, within thirty days from the date on which such decision is
communicated to it, appeal to the Central Government.
(6) The decision of the Central Government where an appeal has been preferred to it under sub-
section (5) or of the Reserve Bank where no such appeal has been preferred shall be final.
In Sajjan Bank (P) Ltd vs RBI, it has been held that refusal of license does not mean a stoppage
of business. The company can carry on as money lender.
In Urban development co-operative bank vs. Industrial Tribunal, it was held that court cannot
interfere over policy decision of RBI.
BRANCH LICENSING
Apart from the requirement of licence for commencing or carrying on banking business, banks
have to obtain the prior permission of Reserve Bank for opening a new place of business or
changing location of the existing place of business. Under Section 23 of Banking Regulation
Act,1949, ‘Place of business’ for this purpose includes any sub-office, pay office, sub-pay
office or any place at which deposits are received, cheques cashed or money lent. However,
changing the location of an existing place of business within the same city, town or village
would not need such permission. These restrictions also apply to foreign branches of banking
companies incorporated in India. Opening of a temporary place of business up to one month
for purpose of affording banking facilities for any exhibition, mela, conference or like occasion
is exempt. However, the temporary branch has to be within the limits of the city, town or village
where there is an existing branch or in the environs thereof. The present guidelines from RBI
provide that Banks should submit their request for new branches, administrative offices, ATMs
once in a year for consideration of RBI as against the earlier practice of making individual
applications for each and every branch. When approved, the permission would be valid for a
period of one year before which the branches/ offices should be operational.
For granting permission under Section 23, the Reserve Bank may require to be satisfied of the
following:
(i) Financial condition and history of the bank ;
(ii) General character of its management;
(iii) Adequacy of capital structure and earning prospects;
(iv) Public interest.
This may be done by an inspection of the bank under section 35 or otherwise.
While granting permission for opening or shifting a branch, the reserve bank may impose any
conditions which it thinks fit necessary. If any bank fails to comply with such conditions, the
permission may be revoked after giving an opportunity to the bank to show cause.
In the case of regional rural banks, the applications for permission have to be routed through
the National Bank (NABARD), and the national bank has to offer its comments on merits to
the Reserve Bank.
PERMITTED FUNCTIONS
Section 6 of Banking Regulation Act, 1949 deals with 'Forms of business in which banking
Companies may engage.
The primary functions of a bank are also known as banking functions. They are the main
functions of a bank. These primary functions of banks are explained below.
1. Accepting Deposits: The bank collects deposits from the public. These deposits can be of
different types, such as:- Saving Deposits, Fixed Deposits, Current Deposits, Recurring
Deposits
a. Saving Deposits: This type of deposits encourages saving habit among the public. The rate
of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed subject to
certain restrictions. This account is suitable to salary and wage earners. This account can be
opened in single name or in joint names.
b. Fixed Deposits: Lump sum amount is deposited at one time for a specific period. Higher
rate of interest is paid, which varies with the period of deposit. Withdrawals are not allowed
before the expiry of the period. Those who have surplus funds go for fixed deposit.
c. Current Deposits: This type of account is operated by businessmen. Withdrawals are freely
allowed. No interest is paid. In fact, there are service charges. The account holders can get the
benefit of overdraft facility.
d. Recurring Deposits: This type of account is operated by salaried persons and petty traders.
A certain sum of money is periodically deposited into the bank. Withdrawals are permitted
only after the expiry of certain period. A higher rate of interest is paid.
2. Granting of Loans and Advances: The bank advances loans to the business community
and other members of the public. The rate charged is higher than what it pays on deposits. The
difference in the interest rates (lending rate and the deposit rate) is its profit.
The types of bank loans and advances are: - Overdraft, Cash Credits, Loans, Discounting of
bill of exchange
a. Overdraft: These types of advances are given to current account holders. No separate
account is maintained. All entries are made in the current account. A certain amount is
sanctioned as overdrafts which can be withdrawn within a certain period of time say three
months or so. Interest is charged on actual amount withdrawn. An overdraft facility is granted
against a collateral security. It is sanctioned to businessman and firms.
b. Cash Credits: The client is allowed cash credit upto a specific limit fixed in advance. It can
be given to current account holders as well as to others who do not have an account with bank.
Separate cash credit account is maintained. Interest is charged on the amount withdrawn in
excess of limit. The cash credit is given against the security of tangible assets and / or
guarantees. The advance is given for a longer period and a larger amount of loan is sanctioned
than that of overdraft.
c. Loans: It is normally for short term say a period of one year or medium term say a period of
five years. Now-a-days, banks do lend money for long term. Repayment of money can be in
the form of installments spread over a period of time or in a lump sum amount. Interest is
charged on the actual amount sanctioned, whether withdrawn or not. The rate of interest may
be slightly lower than what is charged on overdrafts and cash credits. Loans are normally
secured against tangible assets of the company.
d. Discounting of Bill of Exchange: The bank can advance money by discounting or by

purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount to
the drawer or the beneficiary of the bill by deducting usual discount charges. On maturity, the
bill is presented to the drawee or acceptor of the bill and the amount is collected.
In addition to the business of banking, a banking company may engage in any one or more of
the following forms of business, namely: --
(a) the borrowing, raising, or taking up of money; the lending or advancing of money either
upon or without security; the drawing, making, accepting, discounting, buying, selling,
collecting and dealing in bills of exchange, hoondees, promissory notes, coupons, drafts, bills.
of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments, and
securities whether transferable or negotiable or not; the granting and issuing of letters of credit,
traveller's cheques and circular notes; the buying, selling and dealing in bullion and specie; the
buying and selling of foreign exchange including foreign bank notes; the acquiring. holding,
issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture
stock, bonds, obligations, securities and investments of all kinds; the purchasing and selling of
bonds, scrips or other forms of securities on behalf of constituents or others, the negotiating of
loans and advances; the receiving of all kinds of bonds, scrips or valuables on deposit or for
safe custody or otherwise; the providing of safe deposit vaults; the collecting and transmitting
of money and securities;
(b) acting as agents for any Government or local authority or any other person or persons; the
carrying on of agency business of any description including the clearing and forwarding of
goods, giving of receipts and discharges and otherwise acting as an attorney on behalf of
customers, but excluding the business of a managing agent or secretary and treasurer of a
company;
(c) Contracting for public and private loans and negotiating and issuing the same;
(d) the effecting, insuring, guaranteeing, underwriting, participating in managing and carrying
out of any issue, public or private, of State, municipal or other loans or of shares, stock,
debentures, or debenture stock of any company, corporation or association and the lending of
money for the purpose of any such issue;
(e) Carrying on and transacting every kind of guarantee and indemnity business;
(g) acquiring and holding and generally dealing with any property or any right, title or interest
in any such property which may form the security or part of the security for any loans or
advances or which may be connected with any such security;
(h) Undertaking and executing trusts;
(i) Undertaking the administration of estates as executor-trustee or otherwise;
(j) establishing and supporting or aiding in the establishment and support of associations,
institutions, funds, trusts and conveniences calculated to benefit employees or ex-employees
of the company or the dependents or connections of such persons; granting pensions and
allowances and making payments towards insurance; subscribing to or guaranteeing moneys
for charitable or benevolent objects or for any exhibition or for any public, general or useful
object;
(k) The acquisition, construction, maintenance and alteration of any building or works
necessary or convenient for the purposes of the company;
(l) selling, improving, managing, developing, exchanging, leasing, mortgaging, disposing of or
turning into account or otherwise dealing with all or any part of the property and rights of the
company;
(m) Acquiring and undertaking the whole or any part of the business of any person or company,
when such business is of a nature enumerated or described in this sub-section;
(n) Doing all such other things as are incidental or conducive to the promotion or advancement
of the business of the company;
(o) any other form of business which the Central Government may, by notification in the
Official Gazette, specify as a form of business in which it is lawful for a banking company to
engage.
No banking company shall engage in any form of business other than those referred above.
CONTROL OVER MANAGEMENT
To ensure effective control over the management, some provisions have been added in the Act.
They are:
Election of new Directors (Section 12A, added by Act 95 of 1956)
(1) The Reserve Bank may, by order, require any banking company to call a general meeting
of the shareholders of the company within such time, not less than two months from the date
of the order, as may be specified in the order or within such further time as the Reserve Bank
may allow in this behalf, to elect in accordance with the voting rights permissible under this
Act fresh Directors, and the banking company shall be bound to comply with the order.
(2) Every Director elected under sub-section (1) shall hold office until the date up to which his
predecessor would have held office, if the election had not been held.
(3) Any election duly held under this section shall not be called in question in any court.
Power of Reserve Bank to remove managerial and other persons from office [Section
36AA]
(1) Where the Reserve Bank is satisfied that in the public interest or for preventing the affairs
of a banking company being conducted in a manner detrimental to the interests of the depositors
or for securing the proper management of any banking company it is necessary so to do, the
Reserve Bank may, for reasons to be recorded in writing, by order, remove from office, with
effect from such date as may be specified in the order, any Chairman, Director, chief executive
officer(by whatever name called) or other officer or employee of the banking company.
(2)No order under sub-section (1) shall be made unless the Chairman, Director or chief
executive officer or other officer or employee concerned has been given a reasonable
opportunity of making a representation to the Reserve Bank against the proposed order:
PROVIDED that if, in the opinion of the Reserve Bank, any delay would be detrimental to the
interests of the banking company or its depositors, the Reserve Bank may, at the time of giving
the opportunity aforesaid or at any time thereafter, by order direct that, pending the
consideration of the representation aforesaid, if any, the Chairman or, as the case may be,
Director or chief executive officer or other officer or employee, shall not, with effect from the
date of such order—
(a) act as such Chairman or Director or chief executive officer or other officer or employee of
the banking company;
(b) in any way, whether directly or indirectly, be concerned with, or take part in the
management of, the banking company.
(3)(a) Any person against whom an order of removal has been made under subsection (1) may,
within thirty days from the date of communication to him of the order, prefer an appeal to the
Central Government. (b) The decision of the Central Government on such appeal, and subject
thereto, the order made by the Reserve Bank under sub-section (I), shall be final and shall not
be called into question in any court.
(4) Where any order is made in respect of a Chairman, Director or chief executive officer or
other officer or employee of a banking company under subsection (1), he shall cease to be a
Chairman or, as the case may be, a Director, chief executive officer or other officer or employee
of the banking company and shall not, in any way, whether directly or indirectly, be concerned
with, or take part in the management of, any banking company for such period not exceeding
five years as may be specified in the order.
(5) If any person in respect of whom an order is made by the Reserve Bank under sub-section
(1) or under the proviso to sub-section (2) contravenes the provisions of this section, he shall
be punishable with fine which may extend to two hundred and fifty rupees for each day during
which such contravention continues.
(6) Where an order under sub-section (1) has been made, the Reserve Bank may, by order in
writing, appoint a suitable person in place of the Chairman or Director, or chief executive
officer or other officer or employee who has been removed from his office under that sub-
section, with effect from such date as may be specified in the order.
(7) Any person appointed as Chairman, Director or chief executive officer or other officer or
employee under this section shall, -
(a) hold office during the pleasure of the Reserve Bank and subject thereto for a period not
exceeding three years or such further periods not exceeding three years at a time as the Reserve
Bank may specify;
(b) not incur any obligation or liability by reason only of his being a Chairman, Director or
chief executive officer or other officer or employee or for anything done or omitted to be done
in good faith in the execution of the duties of his office or in relation thereto.
(8) Notwithstanding anything contained in any law or in any contract, memorandum or articles
of association, on the removal of a person from office under this section, that person shall not
be entitled to claim any compensation for the loss or termination of office.
Amendments of provisions relating to appointments of Managing Directors, etc., to be
subject to previous approval of the Reserve Bank. [Section 35 B]
(1) In the case of a banking company- (a) no amendment of any provision relating to the
maximum permissible number of Directors or the appointment or re-appointment or
termination of appointment or remuneration of a Chairman, a Managing Director or any other
Director, whole-time or otherwise or of a manager or a chief executive officer by whatever
name called, whether that provision be contained in the company's memorandum or articles of
association, or in an agreement entered into by it, or in any resolution passed by the company
in general meeting or by its Board of Directors shall have effect unless approved by the Reserve
Bank; (b) no appointment or re-appointment or termination of appointment of a Chairman, a
Managing or whole-time Director, manager or chief executive officer by whatever name called,
shall have effect unless such appointment, re-appointment or termination of appointment is
made with the previous approval of the Reserve Bank. Explanation. --For the purpose of this
sub-section, any provision conferring any benefit or providing any amenity or perquisite, in
whatever form, whether during or after the termination of the term of office of the Chairman
or the manager or the chief executive officer by whatever name called or the Managing
Director, or any other Director, whole-time or otherwise, shall be deemed to be a provision
relating to his remuneration.
(2) Nothing contained in sections 268 and 269, the proviso to sub-section (3) of section 309,
sections 310 and 311,the proviso to section 387, and section 388(in so far as section 388 makes
the 2 provisions of sections 269, 310 and 311 apply in relation to the manager of a company)
of the Companies Act, 1956 (1 of 1956), shall apply to any matter in respect of which the
approval of the Reserve Bank has to be obtained under sub-section (1).
(2A) Nothing contained in section 198 of the Companies Act, 1956 (1 of 1956) shall apply to
a banking company and the provisions of sub-section (1) of section 309 and of section 387 of
that Act shall, in so far as they are applicable to a banking company, have effect as if no
reference had been made in the said provisions to section 198 of that Act.
(3) No act done by a person as Chairman or a Managing or whole-time Director or a Director
not liable to retire by rotation or a manager or a chief executive officer by whatever name
called, shall be deemed to be invalid on the ground that it is subsequently discovered that his
appointment or reappointment had not taken effect by reason of any of the provisions of this
Act; but nothing in this sub-section shall be construed as rendering valid any act done by such
person after his appointment or reappointment] has been shown to the banking company not to
have had effect.
Further powers and functions of Reserve Banks [Section 36]
(1) The Reserve Bank may-
(a) caution or prohibit banking companies or any banking company in particular against
entering into any particular transaction or class of transactions, and generally give
advice to any banking company;
(b) on a request by the companies concerned and subject to the provision of section 44A,
assist, as intermediary or otherwise, in proposals for the amalgamation of such banking
companies;
(c) give assistance to any banking company by means of the grant of a loan or advance to
it under clause (3) of sub-section (1) of section 18 of the Reserve Bank of India Act,
1934 (2of 1934);
(d) at any time, if it is satisfied that in the public interest or in me interest of banking policy
or for preventing the affairs of the banking company being conducted in a manner
detrimental to the interests of the banking company or its depositors it is necessary so
to do, by order in writing and on such terms and conditions as may be specified therein-
(i) require the banking company to call a meeting of its Directors for the purpose of
considering any matter relating to or arising out of the affairs of the banking company;
or require an officer of the banking company to discuss any such matter with an officer
of the Reserve Bank;
(ii) depute one or more of its officers to which the proceedings at any meeting of the
Board of Directors of the banking company or of any committee or of any other body
constituted by it; require the banking company to give an opportunity to the officers so
deputed to be heard at such meetings and also require such officers to send a report of
such proceedings to the Reserve Bank; (iii) require the Board of Directors of the
banking company or any committee or any other body constituted by it to give in
writing to any officer specified by the Reserve Bank in this behalf at his usual address
all notices of, and other communications relating to, any meeting of the Board,
committee or other body constituted by it;
(iv) appoint one or more of its officers to observe the manner in which the affairs of the
banking company or of its offices or branches are being conducted and make a report
thereon;
(v) require the banking company to make, within such time as may be specified in the
order, such changes in the management as the Reserve Bank may consider necessary;
(2) The Reserve Bank shall make an annual report to the Central Government on the trend and
progress of banking in the country, with particular reference to its activities under clause(2) of
section 17 of the Reserve Bank of India Act, 1934 (2 of 1934), including in such report its
suggestions, if any, for the strengthening of banking business throughout the country.
(3) The Reserve Bank may appoint such staff at such places as it considers necessary for the
scrutiny of the returns, statements and information furnished by banking companies under this
Act, and generally to ensure the efficient performance of its functions under this Act.
Power of Reserve Bank to appoint additional Directors [Section 36AB]: (1) If the Reserve
Bank is of [opinion that in the interest of banking policy or in the public interest or] in the
interests of the banking company or its depositors it is necessary so to do, it may, from time to
time by order in writing, appoint, with effect from such date as may be specified in the order,
one or more persons to hold office as additional Directors of the banking company:
(2) Any person appointed as additional Director in pursuance of this section-
(a) shall hold office during the pleasure of the Reserve Bank and subject thereto for a
period not exceeding three years or such further periods not exceeding three years at a
time as the Reserve Bank may specify;
(b) shall not incur any obligation or liability by reason only of his being a Director or
for anything done or omitted to be done in good faith in the execution of the duties of
his office or in relation thereto; and
(c) shall not be required to hold qualification-shares in the banking company.
(3) For the purpose of reckoning any proportion of the total number of Directors of the banking
company, any additional Director appointed under this section shall not be considered.
Part IIA to override other laws [Section 36 AC]: Any appointment or removal of a Director,
Chief Executive Officer or other officer or employee in pursuance of section 36AA or section
36AB shall have effect notwithstanding anything to the contrary contained in the Companies
Act, 1956 (1 of 1956), or any other law for the time being in force or in any contract or any
other instrument.
ACCOUNTS AND BALANCE SHEET [Section 29]
(1) At the expiration of each calendar years or at the expiration of a period of twelve months
ending with such date as the Central Government may, by notification in the Official Gazette,
specify in this behalf, every banking company incorporated in India, in respect of all business
transacted by it, and every banking company incorporated outside India, in respect of all
business transacted through its branches in India, shall prepare with reference to that year or
period, as the case may be, a balance-sheet and profit and loss account as on the last working
day of the year or the period, as the case may be, in the Forms set out in the Third Schedule or
as near thereto as circumstances admit:
PROVIDED that with a view to facilitating the transition from one period of accounting to
another period of accounting under this sub-section, the Central Government may by order
published in the Official Gazette, make such provisions as it considers necessary or expedient
for the preparation of, or for other matters relating to, the balance-sheet or profit and loss
account in respect of the concerned year or period, as the case may be.
(2) The balance-sheet and profit and loss account shall be signed-
(a) in the case of a banking company incorporated in India, by the manager or the
principal officer of the company and where there are more than three Directors of the
company, by at least three of those Directors, or where there are not more than three
Directors, by all the Directors, and
(b) in the case of a banking company incorporated outside India by the Manager or
Agent of the principal office of the company in India.
(3) Notwithstanding that the balance-sheet of a banking company is under subsection (1)
required to be prepared in a form other than the form set out in Part I of Schedule VI to the
Companies Act, 1956 (1 of 1956), the requirements of that Act relating to the balance-sheet
and profit and loss account of a company shall, in so far as they are not inconsistent with this
Act, apply to the balance-sheet or profit and loss account, as the case may be, of a banking
company.
(3A) Notwithstanding anything to the contrary contained in sub-section (3) of section 210 of
the Companies Act, 1956 (1 of 1956), the period to which the profit and loss account relates
shall, in the case of a banking company, be the period ending with the last working day of the
year immediately preceding the year in which the annual general meeting is held.
Explanation: In sub-section (3A), "year" means the year or, as the case may be, the period
referred to in sub-section (1).
(4) The Central Government after giving not less than three months' notice of its intention so
to do by a notification in the Official Gazette, may from time to time by a like notification
amend the Forms set out in the Third Schedule.
AUDIT [Section 30]

(1) The balance-sheet and profit and loss account prepared in accordance with section 29 shall
be audited by a person duly qualified under any law for the time being in force to be an auditor
of companies.
(1A) Notwithstanding anything contained in any law for the time being in force or in any
contract to the contrary, every banking company shall, before appointing, re-appointing or
removing any auditor or auditors, obtain the previous approval of the Reserve Bank.
(1B) Without prejudice to anything contained in the Companies Act, 1956 (1 of 1956), or any
other law for the time being in force, where the Reserve Bank is of opinion that it is necessary
in the public interest or in the interest of the banking company or its depositors so to do, it may
at any time by order direct that a special audit of the banking company’s accounts, for any such
transaction or class of transactions or for such period or periods as may be specified in the
order, shall be conducted and may by the same or a different order either appoint a person duly
qualified under any law for the time being in force to be an auditor of companies or direct the
auditor of the banking company himself to conduct such special audit] and the auditor shall
comply with such directions and make a report of such audit to the Reserve Bank and forward
a copy thereof to the company.
(1C) the expenses of, or incidental to the special audit specified in the order made by the
Reserve Bank shall be borne by the banking company.
(2) The auditor shall have the powers of, exercise the functions vested in, and discharge the
duties and be subject to the liabilities and penalties imposed on, auditors of companies by sec-
tion 227 of the Companies Act, 1956 (1 of 1956), and auditors, if any, appointed by the law
establishing, constituting or forming the banking company concerned.
(3) In addition to the matters which under the aforesaid Act the auditor is required to state in
his report, he shall, in the case of a banking company incorporated in India, state in his report,—
(a) Whether or not the information and explanation required by him have been found
to be satisfactory;
(b) Whether or not the transactions of the company which have come to his notice have
been within the powers of the company;
(c) Whether or not the returns received from branch offices of the company have been
found adequate for the purposes of his audit;
(d) Whether the profit and loss account shows a true balance of profit or loss for the
period covered by such account;
(e) Any other matter which he considers should be brought to the notice of the
shareholders of the company.
WINDING UP OF BANKING COMPANIES
Banking company is playing major role in the society for their day to day work.
Nowadays people has are so much depended on the banking sector and most of the time they
requiretheir help in the business or other thing. Many people keep their money in the bank for
the purpose of saving also. So their money is kept safely. But sometime it happens that some
of the bank closes down due to non recovery of loan or such other issues. In such condition
many people have to suffer as their money are with that bank then.For these reasons there are
provision for winding up of the banking company under The Banking (Regulation) Act, 1949.
The provision from sec. 38 to 44 deals with the winding up procedure for banking company.
The types of winding up are
(A). Winding up by High Court (S 38)

Notwithstanding anything contained in section 391, section 392, section 433 and section 583
of the Companies Act, 1956 (1 of 1956), but without prejudice to its powers under sub-section
(1) of section 37 of this Act, the High Court shall order the winding up of a banking company-
if the banking company is unable to pay its debts; or
(b) if an application for its winding up has been made by the Reserve Bank under section 37 or
this section.
(2) The Reserve Bank shall make an application under this section for the winding up of a
banking company if it is directed so to do by an order under clause (b) of sub-section (4) of
section 35.
(3) The Reserve Bank may make an application under this section for the winding up of a
banking company-
(a) if the banking company-
(i) has failed to comply with the requirements specified in section 11; or
(ii) has by reason of the provisions of section 22 become disentitled to carry on banking
business in India; or
(iii) has been prohibited from receiving fresh deposits by an order under clause (a) of sub-
section (4) of section 35 or under clause (b) of subsection (3A) of section 42 of the Reserve
Bank of India Act, 1934 (2 of 1934); or
(iv) having failed to comply with any requirement of this Act other than the requirements laid
in section 11, has continued such failure, or, having contravened any provision of this Act
continued such contravention beyond such period or periods as may be specified in that behalf
by the Reserve Bank from time to time, after notice in writing of such failure or contravention
has been conveyed to the banking company; or (b) if in the opinion of the Reserve Bank- a
compromise or arrangement sanctioned by a court in respect of the banking company cannot
be worked satisfactorily with or without modifications; or the returns, statements or
information furnished to it under or in pursuance of the provisions of this Act disclose that the
banking company is unable to pay its debts; or the continuance of the banking company is
prejudicial to the interests of its depositors.
(4) Without prejudice to the provisions contained in section 434 of the Companies Act, 1956
(I of 1956) a banking company shall be deemed to be unable to pay its debts if it has refused
to meet any lawful demand made at any of its offices or branches within two working days, if
such demand is made at a 83 place where there is an office, branch or agency of the Reserve
Bank, or within five working days, if such demand is made elsewhere, and if the Reserve Bank
certifies in writing that the banking company is unable to pay its debts.
(5) A copy of every application made by the Reserve Bank under sub-section (1) shall be sent
by the Reserve Bank to the registrar.
B.) Voluntary winding up (S.44)

(1) Notwithstanding anything to the contrary contained in section 484 of the Companies Act,
1956 (1 of 1956), no banking company may be voluntarily wound up unless the Reserve Bank
certifies in writing that the company is able to pay in full all its debts to its creditors as they
accrue.
(2) The High Court may, in any case where a banking company is being wound up voluntarily,
make an order that the voluntary winding up shall continue, but subject to the supervision of
the court.
(3) Without prejudice to the provisions contained in sections 441 and 521 of the Companies
Act, 1956 (1 of 1956), the High Court may of its own motion and shall on the application of
the Reserve Bank, order the winding up of a banking company by the High Court in any of the
following cases, namely: —
a) where the banking company is being wound up voluntarily and at any stage during the
voluntary winding up proceedings the company is not able to meet its debts as they
accrue; or
b) where the banking company is being wound up voluntarily or is being wound up subject
to the supervision of the court and the High Court is satisfied that the voluntary winding
up or winding up subject to the supervision of the court cannot be continued without
detriment to the interests of the depositors.
RECONSTRUCTION AND AMALGAMATION
Power of Reserve Bank to apply to Central Government for suspension of business by a

banking company and to prepare scheme of reconstitution of amalgamation has been provided
under section 45 of the banking regulations act 1949.
During the period of moratorium (suspended period), if the Reserve Bank is satisfied that-
(a) in the public interest; or
(b) in the interests of the depositors; or
(c) in order to secure the proper management of the banking company; or
(d) in the interests of the banking system of the country as a whole, it is necessary so
to do, the Reserve Bank may prepare a scheme-
(i) for the reconstruction of the banking company, or
(ii) for the amalgamation of the banking company with any other banking
institution.
Procedure for amalgamation of banking companies (Section 44A). -

(1) Notwithstanding anything contained in any law for the time being in force, no banking
company shall be amalgamated with another banking company, unless a scheme containing the
terms of such amalgamation has been placed in draft before the shareholders of each of the
banking companies concerned separately, and approved by a resolution passed by a majority
in number representing two-thirds in value of the shareholders of each of the said companies,
present either in person or by proxy at a meeting called for the purpose.
(2) Notice of every such meeting as is referred to in sub-section (1) shall be given to every
shareholder of each of the banking companies concerned in accordance with the relevant
articles of association indicating the time, place and object of the meeting, and shall also be
published atleast once a week for three consecutive weeks in not less than two newspapers
which circulate in the locality or localities where the registered offices of the banking
companies concerned are situated, one of such newspapers being in a language commonly
understood in the locality or localities.
(3) Any shareholder, who has voted against the scheme of amalgamation at the meeting or has
given notice in writing at or prior to the meeting of the company concerned or to the presiding
officer of the meeting that he dissents from the scheme of amalgamation, shall be entitled, in
the event of the scheme being sanctioned by the Reserve Bank, to claim from the banking
company concerned, in respect of the shares held by him in that company, their value as
determined by the Reserve Bank when sanctioning the scheme and such determination by the
Reserve Bank as to the value of the shares to be paid to the dissenting shareholder shall be final
for all purposes.
(4) If the scheme of amalgamation is approved by the requisite majority of shareholders in
accordance with the provisions of this section, it shall be submitted to the Reserve Bank for
sanction and shall, if sanctioned by the Reserve Bank by an order in writing passed in this
behalf, be binding on the banking companies concerned and also on all the shareholders
thereof.
(6) On the sanctioning of a scheme of amalgamation by the Reserve Bank, the properly of the
amalgamated banking company shall, by virtue of the order of sanction, be transferred to and
vest in, and the liabilities of the said company shall, by virtue of the said order be transferred
to, and become the liabilities of, the banking company which under the scheme of
amalgamation is to acquire the business of the amalgamated banking company, subject in all
cases to the provisions of the scheme as sanctioned.
(6A) Where a scheme of amalgamation is sanctioned by the Reserve Bank under the provisions
of this section, the Reserve Bank may, by a further order in writing, direct that on such date as
may be specified therein the banking company (hereinafter in this section referred to as the
amalgamated banking company) which by reason of the amalgamation will cease to function,
shall stand dissolved and any such direction shall take effect notwithstanding anything to the
contrary contained in any other law.
(6B) Where the Reserve Bank directs dissolution of the amalgamated banking company, it shall
transmit a copy of the order directing such dissolution to the Registrar before whom the banking
company has been registered and on receipt of such order the Registrar shall strike off the name
of the company.
(6C) An order under sub-section (4) whether made before or after the commencement of
section 19 of the Banking Laws (Miscellaneous Provisions) Act, 1963 (55 of 1963) shall be
conclusive evidence that all the requirements of this section relating to amalgamation have
been complied with, and a copy of the said order certified in writing by an officer of the Reserve
Bank to be a true copy of such order and a copy of the scheme certified in the tike manner to
be a true copy thereof shall, in all legal proceedings (whether in appeal or otherwise and
whether instituted before or after the commencement of the said section 19), be admitted as
evidence to the same extent as the original order and the original scheme.
(7) Nothing in the foregoing provisions of this section shall affect the power of the Central
Government to provide for the amalgamation of two or more banking companies under section
396 of the Companies Act, 1956 (1 of 1956): PROVIDED that no such power shall be
exercised by the Central Government except after consultation with the Reserve Bank.
MODULE 3
Control Over Banking Operations - Capital - SLR And CRR – Foreign Exchange Dealings
Merchant Banking
CONTROL OVER BANKING OPERATIONS
Regulatory regime over Banking Companies: Regulatory regime over banking companies
means the regulation of control over banking companies. In India, banking companies are
regulated by Banking Regulation Act, 1949 and Reserve Bank of India Act, 1934.
Reserve Bank of India holds the status of apex bank of India it is empowered to supervise the
functioning of all the banks in India. Only Reserve Bank of India has the power of printing of
currency notes.
Why is there a need of regulatory regime over banking companies? Since India has very
large geographical area and population, it also has huge no. of banks which are needed to be
regulated to keep the economy stable. If the banks are not regulated it would create imbalance
in the economy.
How are banking companies regulated in India?
Regulatory Regime Exercises Its Control on Banks in Followings Ways:
• RBI (Reserve Bank of India) decides the rate of interest charged on loans.
• RBI (Reserve Bank of India) decides the rate of interest given on FDRs which usually
is higher for senior citizens.
• RBI (Reserve Bank of India) decides the Statutory Liquidity Ratio (SLR) which a
commercial bank has to maintain in order to control the expansion of credit.
• RBI (Reserve Bank of India) decides the Cash Reserve Ratio (CRR) it is the ratio of
cash which the bank has to deposit to RBI without and interest.
• RBI (Reserve Bank of India) decides the withdrawal limit from ATM.
All the above-mentioned points are needed to be checked to ensure smooth running of the
economy.
Central Government implements its financial policy through the regulatory regime
Recently our Central Government has undergone the policy of DEMONETISATION of Rs.
500 and Rs.1000 notes which mean that the currency notes ceases to have the legal tender.
Demonetisation was a step against black money government has carried its policy through RBI.
RBI had restricted the withdrawal limit of cash from banks and had also converted the old
currency notes.
Demonetisation process was carried out in a very effective manner by banks throughout the
India which could not have been possible without the regulatory regime over banking
companies.
Regulatory regime prohibits the banking company to indulge in trading: U/S 8 of BR Act,
1949 banks are not allowed to indulge in the practices of trading of goods. Bank Regulation
Act, 1949 permits a bank to do trade of securities, bills of exchange and other negotiable
instruments but not of any goods directly or indirectly through barter system.
Reserve Bank of India controls inflation and deflation in the economy: Inflation is a
situation in an economy where the demand increases and supply decreases, this leads to rise in
value of goods which reduces the purchasing power of the people. To control such situation
the RBI sells the securities held with it by the commercial banks. This step by RBI reduces the
cash lending power of banks which leads to increase in rate of interest on lending money by
bank. This causes the decrease in demand as the people will opt to savings. In this way inflation
is controlled by the RBI.
On the other hand, in situation of deflation, demand decreases which increases the supply. This
reduces the value of goods causing an increase in purchasing power of people. To control the
situation the RBI buys the securities from commercial banks which increases their cash lending
capacity which further results in fall in interest rate on lending money by bank. This causes
people to spend money rather than saving it, which helps to increase the demand and making
the market stable. Controlling of Inflation and Deflation is one of the most important regulatory
measure performed by RBI.
Supervision and Control: Reserve Bank of India for better supervision and control over
banking companies has constituted a separate board viz. “The Board for Financial
Supervision”. This board meets on monthly basis it has power to constitute sub-committees.
1. RBI regulates the licensing of banking companies: U/S 22 of BR Act, 1949 a company to
function as a banking company must hold a license of banking issued by Reserve Bank of
India.
2. Board of Directors and Chairman: Section 10A of BR Act, 1949 says that every banking
company shall have the board of directors who shall have special knowledge and practice
experience in banking field and a Chairman. If RBI is of opinion that composition of the
board of directors of any banking company does not fulfil the requirement of the provisions
of BR Act, 1949 it can after giving such banking company an opportunity of being heard,
directs the banking company to re-constitute the board of directors.
3. RBI as lender of last resort: Usually, banks perform the function of lending money to
people, but in a situation where bank runs out of cash and does not have left cash for its
operation, then RBI comes to rescue the bank from such crisis. RBI lends loans to the bank
so that bank could operate.
4. Amalgamation of Banks: BR Act, 1949 regulates the process of amalgamation of banking
companies. The banking companies planning to amalgamate shall have to create a draft copy
of scheme of amalgamation covering terms and conditions, such draft should be approved by
the resolution passed by members of banking companies. RBI holds the power of sanctioning
the draft, once the draft is sanctioned by RBI then the assets and liabilities of banking
companies are amalgamated.
5. Submission of returns by banks: Every bank in India as a measure of regulation has to
prepare and submit returns of liquid assets, unclaimed deposits, balance sheets, liabilities,
etc. to the Reserve Bank of India under provisions of BR Act, 1949 and RBI Act, 1934. The
returns sent by the banks are analyzed by Reserve Bank of India this is kind of a measure
through which RBI gets to know about the performance of the bank in the economy.
(For More Refer Module 2: Role of Reserve Bank of India (RBI)/ Supervision Over Commercial Banks)
CASH RESERVE RATIO (CRR)
Banks in India are required to hold a certain proportion of their deposits in the form of cash.
However, Banks don't hold these as cash with themselves, they deposit such cash (aka currency
chests) with Reserve Bank of India, which is considered as equivalent to holding cash with
themselves. This minimum ratio (that is the part of the total deposits to be held as cash) is
stipulated by the RBI and is known as the CRR or Cash Reserve Ratio.
When a bank's deposits increase by Rs100, and if the cash reserve ratio is 9%, the banks will
have to hold Rs. 9 with RBI and the bank will be able to use only Rs 91 for investments and
lending, credit purpose. Therefore, higher the ratio, the lower is the amount that banks will be
able to use for lending and investment. This power of Reserve bank of India to reduce the
lendable amount by increasing the CRR, makes it an instrument in the hands of a central bank
through which it can control the amount that banks lend. Thus, it is a tool used by RBI to
control liquidity in the banking system.
The objective of maintaining the cash reserve is to prevent the shortage of funds in meeting the
demand by the depositor. The amount of reserve to be maintained depends on the bank’s
experience regarding the cash demand by the depositors. If there had been no government rules,
the commercial banks would keep a very low percentage of their deposits in the form of
reserves.
Since cash reserve is non-interest bearing, i.e. no interest is paid on the deposits, therefore, the
commercial banks often keep the reserve below the safe limits. This might lead to a financial
crisis in the banking sector. Thus, in order to avoid such uncertainty, the central bank imposes
a cash reserve ratio or CRR on commercial banks. The central bank has the legal power to
change the CRR any time at its discretion. The cash reserve ratio is a legal requirement and
therefore it is also called as a Statutory Reserve Ratio (SRR).
Cash Reserve Ratio Cash Reserve Ratio (CRR) is the mandatory reserves to be maintained
with Reserve Bank of India. Every scheduled Bank is required to keep certain percentage of
their demand and time liabilities, as cash balances with the Reserve Bank of India from time
to time as per Section 42 of the Reserve Bank of India Act. There is no maximum ceiling or
floor rate in respect of CRR. The non-scheduled banks are required to maintain the cash reserve
as per Section 18 of the Banking Regulation Act.
Objectives of Cash Reserve Ratio

In order to determine the base rate, the Cash Reserve Ratio acts as one of the reference rates.
Base rate means the minimum lending rate which is determined by the Reserve Bank of India
(RBI) and no bank is allowed to lend funds below this rate. This rate is fixed to ensure
transparency with respect to borrowing and lending in the credit market. The Base Rate also
helps the banks to cut down on their cost of lending so as to be able to extend affordable loans.
Apart from this, there is two main objective existence of cash reserve ratio:
1. Cash reserve ratio ensures that a part of the bank’s deposit is with the Central Bank and
is hence, safe
2. The second and a very important reason is for the purpose of combating inflation. To
keep the liquidity in check, the RBI resorts to increasing and decreasing the Cash
Reserve Ratio
How does Cash Reserve Ratio work?
When the RBI decides to increase the Cash Reserve Ratio, the amount of money that is
available with the banks reduces. This is the RBI’s way of controlling the excess supply of
money. The cash balance that is to be maintained by scheduled banks with the RBI should not
be less than 4% of the total NDTL, which is the Net Demand and Time Liabilities. This is
done on a fortnightly basis.
NDTL refers to the total demand and time liabilities (deposits) that is held by the banks of
public and with other banks. Demand deposits consist of all liabilities which the bank needs to
pay on demand like current deposits, demand drafts, balances in overdue fixed deposits and
demand liabilities portion of savings bank deposits.
Time deposits consist of deposits that need to repay on maturity and where the depositor can’t
withdraw money immediately; instead, he is required to wait a certain time period to access the
funds. It includes fixed deposits, time liabilities portion of savings bank deposits and staff
security deposits. The liabilities of a bank include call money market borrowings, certificate of
deposits and investment in deposits other banks.
In short, higher the Cash Reserve Ratio, lesser is the amount of money available to banks for
lending and investing.
How does CRR affect the economy?
Cash Reserve Ratio (CRR) is one of the components of the monetary policy of the RBI which
is used to regulate the money supply, level of inflation and liquidity in the country. The higher
the CRR, the lower is the liquidity with the banks and vice-versa.
During high levels of inflation, attempts are made to reduce the money supply in the economy.
For this, RBI increases the CRR, sucking the loanable funds available with the banks. This, in
turn, slows down investment and reduces the supply of money in the economy. As a result, the
growth of the economy is negatively impacted. However, this also helps bring down inflation.
On the other hand, when the RBI needs to pump funds into the system, it lowers CRR which
increases the loanable funds with the banks. The banks thus extend a large number of loans to
the businesses and industry for different investment purposes. It also increases the overall
supply of money in the economy. This ultimately boosts the growth rate of the economy.
Why is Cash Reserve Ratio changed regularly?
In accordance with the RBI guidelines, every bank is decreed to maintain a ratio of their total
deposits that can also be held with currency chests. This is considered to be the same as it is
kept with the RBI. This ratio can be changed by the RBI from time to time in regular intervals.
When this ratio is changed, it impacts the economy.
For banks, profits are made by lending. In pursuit of this goal, banks may lend out to the max
to make higher profits and have very less cash with them. In such a scenario, if there is an
unexpected rush by the customers to withdraw their deposits, the banks will not be in a position
to meet all the repayment needs. Therefore, CRR is vital to ensure that there is always a certain
fraction of all the deposits in every bank, kept safe with them. RBI curbs these issues with the
help of the CRR.
While ensuring liquidity against deposits is the prime function of the CRR, it has an equally
important role in the control of the rates in the economy. The RBI controls the short-term
volatility in the interest rates by the amount of liquidity allowed in the system. Too much
availability of cash leads to the fall in rates while the scarcity of it leads to a sudden rise in
rates, both of which are unhealthy for the economy.
Thus, as a depositor, it is good for you to know of the CRR prevailing in the market that ensures
that regardless of the performance of the bank, a certain percentage of your cash is safe with
the RBI.
STATUTORY LIQUIDITY RATIO (SLR)

SLR - Statutory Liquidity Ratio - Every bank is required to maintain at the close of business
every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in
the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to
demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is
empowered to increase this ratio up to 40%. An increase in SLR also restricts the bank's
leverage position to pump more money into the economy.
The liquid assets are the assets readily convertible into cash, includes government bonds, or
government approved securities, gold, and cash reserve. The objective of statutory liquidity
ratio is to prevent the commercial banks from liquidating their liquid assets during the time
when CRR is raised.
The statutory liquidity ratio is determined by the central bank as the percentage of total
demand and time liabilities. The time liabilities refer to the liabilities of a bank which is to
be paid to the customer anytime the demand arises and are the deposits of the customers which
are to be paid on demand.
The statutory liquidity ratio is determined and maintained by the central bank to control the
bank credit, ensure the solvency of commercial banks and compel banks to invest in the
government securities. By changing the SLR, the flow of bank credit in the economy can be
increased or decreased. Such as, when the central bank decides to curb the bank credit so as to
control the inflation will raise the SLR. On the contrary, when the economy faces recession,
and the central bank decides to increase the bank credit will cut down the SLR.
A penalty at a rate of 3% per annum above the bank rate is imposed if any commercial bank
fails to maintain the statutory liquidity ratio. Further, a penalty at a rate of 5% per
annum above the bank rate is imposed on a defaulter bank if it continues to default on the
next working day. The central bank imposes such a restriction on the commercial banks so
that the funds are readily made available to the customers on their demand.
Statutory Liquidity Ratio (SLR): Statutory Liquidity Ratio (SLR): SLR is also the mandatory
reserves to be maintained by banks held in the form of prescribed securities. This is also based
on certain percentage of their demand and time liabilities of a bank. As per Section 24 of the
Banking Regulation Act, every banking company in India is required to maintain in India, in
cash, gold or unencumbered approved securities an amount which should not at close of
business on any day be less than the percentage prescribed by RBI of the total of its demand
and time liabilities in India. This is known as “Statutory Liquidity Ratio”.
How does Statutory Liquidity Ratio work?

In India, the RBI is responsible for regulating the supply of money and stability of prices in
order to ensure a progressive economy. It uses the monetary policy for achieving these
objectives. Amongst other tools, SLR happens to be one of the important instruments of the
monetary policy aimed at ensuring the solvency of the banks and money flow in the economy.
At the close of every business day, every bank is required to maintain a minimum portion of
their Net Demand and Time Liabilities (NDTL) in the form of gold, cash, or any liquid asset
form. The ratio of these liquid assets to the demand and time liabilities is referred to as the
Statutory Liquidity Ratio. The Reserve Bank of India has the authority to increase this ratio up
to 40%. The increase in this ratio constricts the ability of the bank to inject money into the
economy.
What are the components of Statutory Liquidity Ratio?
All the commercial banks in India are required to maintain the Statutory Liquidity Ratio as per
Section 24 and Section 56 of the Banking Regulation Act 1949. It becomes pertinent to know
in detail about the components of the SLR as follows:
a. Liquid Assets: These are assets that can be easily converted into cash. These include
gold and cash reserve, treasury bills, the government approved securities, government
bonds. Additionally, it also consists of securities which are eligible under Market
Stabilisation Schemes and those falling under the market borrowing programmes.
b. Net Demand and Time Liabilities (NDTL) (as mentioned above in the Topic: CRR)
c. SLR Limit: The SLR has an upper limit of 40% and a lower limit of 23%.
Objectives of Statutory Liquidity Ratio
a. The prime objective of Statutory Liquidity ratio is to curtail the commercial banks from
liquidating their liquid assets when the Cash Reserve Ratio is raised. This ratio is
determined and used by the Reserve Bank of India to have control over the bank credit. It
helps to ensure that there is solvency in commercial banks and assures that banks invest in
government securities.
b. The flow of bank credit can be increased or decreased in the economy by means of altering
the Statutory Liquidity Ratio. The Reserve Bank of India raises the SLR to control the
bank credit during the time of inflation and inversely it decreases the SLR during the time
of recession to increase the bank credit.
Impact of Statutory Liquidity Ratio on the Investor
In order to determine the base rate, the Statutory Liquidity Ratio acts as one of the reference
rates. Base rate means the minimum lending rate which is determined by the Reserve Bank of
India (RBI) and no bank is allowed to lend funds below this rate. This rate is fixed to ensure
transparency with respect to borrowing and lending in the credit market. The Base Rate also
helps the banks to cut down on their cost of lending so as to be able to extend affordable loans.
When a reserve requirement is imposed on banks, it ensures that a certain portion of the
deposits are safe and are always available to be redeemed by the customers. But this condition
also restricts the banks capacity for lending. In order to keep the demand in control, the lending
rates have to be increased.
What happens if SLR is not maintained?
In India, every bank including scheduled commercial bank, state cooperative bank, central
cooperative banks, and primary co-operative banks shall maintain the statutory liquidity ratio
according to RBI’s mandate. For computation and maintenance of SLR, the net demand and
time liabilities are calculated and reported every fortnight Friday by banks.
If any commercial bank fails to maintain the required Statutory Liquidity Ratio, they are fined
a penalty of 3% per annum over the bank rate. If the bank continues to default on the following
working day as well, then they are penalized 5% per annum over the bank rate. The Reserve
Bank of India does this to make sure that commercial banks do not fail to have ready cash
available when customers demand them.
Difference between SLR & CRR
Both SLR and CRR are the components of the monetary policy. However, there are a few
differences between them. The following table gives a glimpse into the dissimilarities:
Statutory Liquidity Ratio (SLR) Cash Reserve Ratio (CRR)
In case of SLR, banks are asked to have reserves The CRR requires banks to have only cash
of liquid assets which include both cash and reserves with the RBI
gold.
Banks earn returns on money parked as SLR Banks don't earn returns on money parked as
CRR
SLR is used to control the bank's leverage for The Central Bank controls the liquidity in the
credit expansion. Banking system with CRR.
In case of SLR, the securities are kept with the In CRR, the cash reserve is maintained by the
banks themselves which they need to maintain in banks with the Reserve Bank of India.
the form of liquid assets.
FOREIGN EXCHANGE DEALINGS
Foreign exchange, or forex, is the conversion of one country's currency into another. In a free
economy, a country's currency is valued according to the laws of supply and demand.
When the foreign currency denominated assets and liabilities are held, by the banks or the
business concern, two types of risks are faced. Firstly, the risk that the exchange rates may vary
and the change may affect the cash flows/profits. This is known as exchange risk. Secondly,
the interest rate may vary and it may affect the cost of holding the foreign currency assets and
liabilities. This is known as interest rate risk.
Dealing Position: Foreign exchange is such a sensitive commodity and subject to wide
fluctuations in price that the bank which deals in it would like to keep the balance always near
zero. The bank would endeavour to find a suitable buyer wherever it purchases so as to dispose
of the foreign exchange acquired and be free from exchange risk. Likewise, whenever it sells
it tries to cover its position by a corresponding purchase. But, in practice, it is not possible to
match purchase and sale for each transaction. So, the bank tries to match the total purchases of
the day to the day’s total sales. This is done for each foreign currency separately.
If the amount of sales and purchases of a particular foreign currency is equal, the position of
the bank in that currency is said to be ‘square’. If the purchases exceed sales, then the bank is
said to be in ‘overbought’ or ‘long’ position. If the sales exceed purchases, then the bank is
said to be in ‘oversold’ of ‘short’ position. The bank’s endeavour would be to keep its position
square. If it is in overbought or oversold position, it is exposing itself to exchange risk.
There are two aspects of maintenance of dealing positions. One is the total of purchase or sale
or commitment of the bank to purchase or sell, irrespective of the fact whether actual delivery
has taken place or not. This is known as the exchange position. The other is the actual balance
in the bank’s account with its correspondent abroad, as a result of the purchase or sale made
by the bank. This is known as the cash position.
Exchange Position and Cash Position
Exchange Position: Exchange position is the new balance of the aggregate purchases and sales
made by the bank in particular currency. This is thus an overall position of the bank in a
particular currency. All purchases and sales whether spot or forward are included in computing
the exchange position. All transactions for, which the bank has agreed for a firm rate with the
counterparty are entered into the exchange position when this commitment is made. Therefore,
in the case of forward contracts, they will enter into the exchange position on the date the
contract with the customer is concluded. The actual date of delivery is not considered here. All
purchases add to the balance and all sales reduce the balance.
The exchange position is worked out every day so as to ascertain the position of the bank in
that particular currency. Based on the position arrived at, remedial measures as are needed may
be taken. For example, if the bank finds that it is oversold to the extent of USD 25,000. It may
arrange to buy this amount from the interbank market. Whether this purchase will be spot or
forward will depend upon the cash position. If the bank has commitment of deliver foreign
exchange soon, but it has no sufficient balance in the nostro account abroad, it may purchase
spot. If the bank has no immediate requirement of foreign exchange, it may buy it forward.
Examples of sources for the bank for purchase of foreign currency are:
• Payment of DD, MT, TT, travellers’ cheques, etc.

• Purchase of bills,
• Purchase of other instruments like cheques.
• Forward purchase contracts (entered to the position of the date of contracts).
• Realisation of bills sent for collection.
• Purchase in interbank/international markets.
Examples of avenues of sale are:
• Issue of DD, MT, TT, travelers cheques, etc.

• Payments of bills drawn on customers.

• Forward sale contract (entered in the position on the date of contracts).
• Sale to interbank/international markets
Exchange position is also known as ‘dealing position’.
Cash Position: Cash position is the balance outstanding in the bank’s nostro account abroad.
The stock of foreign currency is held by the bank in the form of balances with correspondent
bank in the foreign centre concerned. All foreign exchange dealings of the bank are routed
through these nostro accounts. For example, an Indian bank will have an account with Bank of
America in New York. If the bank is requested to issue a demand draft in Us dollars. It will
issue the draft on Bank of America, New York. On presentation at New York the bank’s
account with Bank of America will be debited. Likewise, when the bank purchases a bill in US
dollars, it will be sent for collection to Bank of America. Alternatively, the bill may be sent to
another bank in the USA, with instructions to remit proceeds of the bill are credited, on
realisation, to the bank’s account with Bank of America. The purchase of foreign exchange by
the bank in India increases the balance and sale of foreign exchange reduces the balance in the
bank’s account with its correspondent bank abroad.
MERCHANT BANKING
Merchant Banking is a combination of Banking and consultancy services. It provides

consultancy to its clients for financial, marketing, managerial and legal matters. Consultancy
means to provide advice, guidance and service for a fee. It helps a businessman to start
a business. It helps to raise (collect) finance. It helps to expand and modernize the business. It
helps in restructuring of a business. It helps to revive sick business units. It also helps
companies to register, buy and sell shares at the stock exchange.
Merchant banking was first started in India
in 1967 by Grindlays Bank. It has made
rapid progress since 1970.
The functions of merchant banking are listed as follows:

1) Raising Finance for Clients: Merchant Banking helps its clients to raise finance through
issue of shares, debentures, bank loans, etc. It helps its clients to raise finance from the
domestic and international market. This finance is used for starting a new business or
project or for modernization or expansion of the business.
2) Broker in Stock Exchange: Merchant bankers act as brokers in the stock exchange. They
buy and sell shares on behalf of their clients. They conduct research on equity shares. They
also advise their clients about which shares to buy, when to buy, how much to buy and
when to sell. Large brokers, Mutual Funds, Venture capital companies

and Investment Banks offer merchant banking services.
3) Project Management: Merchant bankers help their clients in the many ways. For e.g.
Advising about location of a project, preparing a project report, conducting feasibility
studies, making a plan for financing the project, finding out sources of finance, advising
about concessions and incentives from the government.
4) Advice on Expansion and Modernization: Merchant bankers give advice for expansion
and modernization of the business units. They give expert advice on mergers and
amalgamations, acquisition and takeovers, diversification of business, foreign
collaborations and joint-ventures, technology up-gradation, etc.
5) Managing Public Issue of Companies: Merchant bank advice and manage the public
issue of companies. They provide following services:
(i) Advise on the timing of the public issue.
(ii) Advise on the size and price of the issue.
(iii)Acting as manager to the issue, and helping in accepting applications and allotment
of securities.
(iv) Help in appointing underwriters and brokers to the issue.
(v) Listing of shares on the stock exchange, etc.
6) Handling Government Consent for Industrial Projects: A businessman has to get

government permission for starting of the project. Similarly, a company requires
permission for expansion or modernization activities. For this, many formalities have to
be completed. Merchant banks do all this work for their clients.
7) Special Assistance to Small Companies and Entrepreneurs: Merchant banks advise

small companies about business opportunities, government policies, incentives and
concessions available. It also helps them to take advantage of these opportunities,
concessions, etc.
8) Services to Public Sector Units: Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of securities,
foreign collaborations and arranging long-term finance from term lending institutions.
9) Revival of Sick Industrial Units: Merchant banks help to revive (cure) sick industrial
units. It negotiates with different agencies like banks, term lending institutions, and BIFR
(Board for Industrial and Financial Reconstruction). It also plans and executes the full
revival package.
10) Portfolio Management : A merchant bank manages the portfolios (investments) of its
clients. This makes investments safe, liquid and profitable for the client. It offers expert
guidance to its clients for taking investment decisions.
11) Corporate Restructuring: It includes mergers or acquisitions of existing business units,

sale of existing unit or disinvestment. This requires proper negotiations, preparation of
documents and completion of legal formalities. Merchant bankers offer all these services
to their clients.
12) Money Market Operation : Merchant bankers deal with and underwrite short-
term money market instruments, such as:
(i) Government Bonds.
(ii) Certificate of deposit issued by banks and financial institutions.
(iii)Commercial paper issued by large corporate firms.
(iv) Treasury bills issued by the Government (Here in India by RBI).
13) Leasing Services: Merchant bankers also help in leasing services. Lease is a contract
between the lessor and lessee, whereby the lessor allows the use of his specific asset such
as equipment by the lessee for a certain period. The lessor charges a fee called rentals.
14) Management of Interest and Dividend: Merchant bankers help their clients in the
management of interest on debentures / loans, and dividend on shares. They also advise
their client about the timing (interim / yearly) and rate of dividend.
THE BANKING OMBUDSMAN
The Banking Ombudsman Scheme was implemented by the RBI to redress the complaints of
customers on certain types of banking services provided by banks and to facilitate the
settlement of those complaints.
The scheme was introduced under the Banking Regulation Act of 1949 by RBI with effect from
1995. Later it was legally refined and modified through the introduction of regulations under
Banking Ombudsman Scheme 2006. The latest revision was made in 2017.
An ombudsman is an official, usually appointed by government, who investigates complaints
(usually lodged by private citizens) against businesses, financial institutions or government
departments or other public entities, and attempts to resolve the conflicts or concerns raised.
Depending on jurisdiction, an ombudsman's decision may or may not be legally binding. Even
if not binding, the decision typically carries considerable weight. When appointed, the
ombudsman is typically paid via levies and case fees.
Ombudsmen are in place across a wide variety of countries and organizations within those
countries. They may be appointed at national or local level, and are often found within large
organizations too. They may focus exclusively on and deal with complaints regarding a
particular organization or public office, or they may have wider ranges. For example, an
industry ombudsman such as a consumer or insurance ombudsman may deal with consumer
complaints about unfair treatment the consumer has received from a private company that
operates within that industry. A large public entity or other organization may have its own
ombudsman (for example, the California Department of Health Care Services has its own
ombudsman). Depending on the appointment, an ombudsman may investigate specific
complaints about the services or other interaction a consumer has had with the entity
concerned; an ombudsman within an organization may also have a primary function of dealing
with internal issues (such as complaints by employees, or if an educational institution
complaint of its students.) Ombudsmen may be called by different names in some countries,
including titles such as public advocate or national defender.
The Banking Ombudsman actually is a senior official appointed by the RBI to redress customer
complaints against pitfalls in the stipulated banking services covered by the Banking
Ombudsman Scheme 2006 (modifications were made in 2017). As on end April 2018, twenty
Banking Ombudsmen have been appointed with their offices located mostly in state capitals.
Areas of customer redressal available with the Ombudsman mechanism
The RBI has listed around 25 areas where the customers can raise complaints with the Banking
Ombudsman. Some of them are:
• Non-payment/ inordinate delay in the payment or collection of cheques, drafts,
bills etc.;
• Non-payment/delay in payment of inward remittances;
• Failure/delay to issue drafts, pay orders or bankers’ cheques;
• Non-adherence to prescribed working hours;
• Refusal to open deposit accounts without any valid reason for refusal;
• Levying of charges without adequate prior notice to the customer;
• Refusal/delay in closing the accounts;
• Non-observance of Reserve Bank guidelines on engagement of recovery agents
by banks;
Procedure for making complaint with Banking Ombudsman
A bank customer can file a complaint with the Banking Ombudsman simply by writing on a
plain paper or through online. The customer can file a complaint with the Banking Ombudsman
in the following grounds:
• The bank fails to provide reply to the customer’s complaint in one
month
• The bank rejects the complaint,
• The complainant is not satisfied with the reply given by the bank.
Limit on the amount of compensation: As per the present regulations, the ombudsman
redressal is allowed for complaints where the compensation amount for any loss suffered by
the complainant is limited to Rs 20 lakh. Similarly, the Banking Ombudsman may award
compensation not exceeding Rs 1 lakh to the complainant for mental agony and harassment.
The Banking Ombudsman will consider the loss of the complainant’s time, expenses incurred
by the complainant, harassment and mental anguish suffered by the complainant while passing
the compensation.
Ombudsman Scheme for Non-Banking Financial Companies, 2018
The RBI introduced an NBFC Ombudsman scheme to redress complaints with regard to
NBFCs in 2018. The NBFC Ombudsman is a senior official appointed by the RBI to redress
customer complaints against NBFCs for deficiency in certain services covered under the
grounds of complaint specified under Clause 8 of the Scheme. Four NBFC Ombudsman have
been appointed with their offices located at Chennai, Kolkata, New Delhi and Mumbai.
MODULE 4
Banker-Customer Relationship - Duty of Confidentiality – Account of Customers - Deposits -

Joint Accounts - Trust Accounts – Special Type of Customers. Payment of Customers' Cheques
- Protection of Paying and Collecting Banker.
BANKER – CUSTOMER RELATIONSHIP
The legal relationship arises between two parties when they conclude contract through proposal
and acceptance. In the case of banking where a person asks the banker to open an account for
him and the banker’s acceptance thereof, involved implied contractual relationship. According
to Dr. Hart, “a customer is one who has an account with a banker or for whom a banker
habitually undertakes to act as such”. Today, the banking business is diversified. The banker
has to function in various ways to meet the requirements of the customer. He is entitled to use
the money deposited by the customer without being called upon to account for such use, his
only liability being to return the amount in accordance with the terms agreed to between him
and the customer. The banker provides different services to the customers in commercial
transactions. Based on the functions of banking, these are the general relationships between the
banker and customer:
1. Debtor and Creditor
The general relationship between banker and a customer is that of a debtor and a creditor i.e.
Borrower and lender. He is not a depository or trustee of the customer’s money because the
money handed over to the banker becomes a debt due from him to the customer. A depository
accepts something for the safe custody on the condition that it will not be opened or replaced
by similar commodity. A banker does not accept money of the depositor on such condition.
The money deposited by the customer with the banker is, in legal terms, lent by the customer
to the banker, who makes use of the same according to his discretion. The creditor has the right
to demand back his money from the banker, and the banker is under obligation to repay the
debt as and when he is required to do so. But it is not necessary that the repayment is made in
terms of the same currency note and coins.
A depositor remains a creditor of his banker so long as his account carries a credit balance. But
he does not get any charge over the assets of his debtor/banker and remains an unsecured
creditor of the banker. Since the introduction of deposit insurance in India in 1962, the element
of risk to the depositor is minimized as the Deposit Insurance and Credit Guarantee Corporation
undertakes to insure the deposits up to a specified amount.
Banker’s relationship with the customer is reversed as soon as the customer’s account is
overdrawn. Banker becomes creditor of the customer who has taken a loan from the banker
and continues in that capacity till the loan is repaid. As the loans and advances granted by a
banker are usually secured by the tangible assets of the borrower, the banker becomes a secured
creditor of his customer.
Though the relationship between a banker and his customer is mainly that of a debtor and a
creditor, this relationship differs from similar relationship arising out of ordinary commercial
debts in following respects:
(i) The creditor must demand payment. In case of ordinary commercial debt, the debtor pays
the amount on the specified date or earlier or whenever demanded by the creditor as per the
terms of the contract. But in case of deposit in the bank, the debtor/ banker is not required to
repay the amount on his own accord. It is essential that the depositor (creditor) must make a
demand for the payment of the deposit in the proper manner. This difference is due to the fact
that a banker is not an ordinary debtor; he accepts the deposits with an additional obligation to
honour his customer’s cheques. If he returns the deposited amount on his own accord by closing
the account, some of the cheques issued by the depositor might be dishonoured and his
reputation might be adversely affected. Moreover, according to the statutory definition of
banking, the deposits are repayable on demand or otherwise. The depositor makes the deposit
for his convenience, apart from his motives to earn an income (except current account).
Demand by the creditor is, therefore, essential for the refund of the deposited money. Thus the
deposit made by a customer with his banker differs substantially from an ordinary debt.
(ii) Proper place and time of demand. The demand by the creditor must be made at the proper
place and in proper time as prescribed by a bank. For example, in case of bank drafts, travellers’
cheques, etc., the branch receiving the money undertakes to repay it at a specified branch or at
any branch of the bank.
(iii) Demand must be made in proper manner. According to the statutory definition of banking,
deposits are withdrawable by cheque, draft, and order or otherwise. It means that the demand
for the refund of money deposited must be made through a cheque or an order as per the
common usage amongst the bankers. In other words, the demand should not be made verbally
or through a telephonic message or in any such manner.
2. Trustee and Beneficiary
Ordinarily, a banker is a debtor of his customer in respect of the deposits made by the latter,
but in certain circumstances he acts as a trustee also. A trustee holds money or assets and
performs certain functions for the benefit of some other person called the beneficiary. For
example, if the customer deposits securities or other valuables with the banker for safe custody,
the latter acts as a trustee of his customer. The customer continues to be the owner of the
valuables deposited with the banker. The legal position of the banker as a trustee, therefore,
differs from that of a debtor of his customer. In the former case the money or documents held
by him are not treated as his own and are not available for distribution amongst his general
creditors in case of liquidation.
The position of a banker as a trustee or as a debtor is determined according to the circumstances
to each case. If he does something in the ordinary course of his business, without any specific
direction from the customer, he acts as a debtor (or creditor). In case of money or bills, etc.,
deposited with the bank for specific purpose, the bankers’ position will be determined by
ascertaining whether the amount was actually debited or credited to the customer’s account or
not. For example, in case of a cheque sent for collection from another banker, the banker acts
as a trustee till the cheques is realized and credited to his customer’s account and thereafter he
will be the debtor for the same account. If the collecting banks fails before the payment of the
cheque is actually received by it from the paying bank, the money so realized after the failure
of the bank will belong to the customer and will not be available for distribution amongst the
general creditors of the bank.
On the other hand, if a customer instructs his bank to purchase certain securities out of his
deposit with the latter, but the bank fails before making such purchase, the bank will continue
to be a debtor of his customer (and not a trustee) in respect of amount which was not withdrawn
from or debited to his account to carry out his specific instruction.
The relationship between the banker and his customer as a trustee and beneficiary depends
upon the specific instructions given by the latter to the farmer regarding the purpose of use of
the money or documents entrusted to the banker. In New Bank of India Ltd. v. Pearey Lal
(AIR 1962, Supreme Court 1003), the Supreme Court observed in the absence of other
evidence a person paying into a bank, whether he is a constituent of the bank or not, may be
presumed to have paid the money to be held as banker ordinarily held the money of their
constituent. If no specific instructions are given at the time of payment or thereafter and even
if the money is held in a Suspense Account the bank does not thereby become a trustee for the
amount paid. In case the borrower transfers to the banker certain shares in a company as a
collateral security and the transfer is duly registered in the books of the issuing company, no
trust is created in respect of such shares and the banks’ position remains that of a pledge rather
than as trustee. Pronouncing the above verdict, in New Bank of India vs. Union of India
(1981) 51 Company Case p. 378, the Delhi High Court observed that a trustee is generally not
entitled to dispose of or appropriate trust property for his benefit. “In the present case the banker
was entitled to dispose of the shares and utilize the amount thereof for adjustment to the loan
amount if the debtor defaults. The banker’s obligation to transfer back the shares can arise only
when the debtor clears dues of the bank was not considered as trustee.
3. Bailee and Bailor
Section 148 of Indian Contract Act, 1872, defines bailment, bailor, and bailee. A bailment is
the delivery of goods by one person to another for some purpose upon a contract. As per the
contract, the goods should when the purpose is accomplished, be returned or disposed of as per
the directions of the person delivering the goods. The person delivering the goods is called the
bailer and the person to whom the goods are delivered is called the Bailee.
Banks secure their loans and advances by obtaining tangible securities. In certain cases banks
hold the physical possession of secured goods (pledge) – cash credit against inventories;
valuables – gold jewels (gold loans); bonds and shares (loans against shares and financial
instruments) In such loans and advances, the collateral securities are held by banks and the
relationship between banks and customers are that of bailee (bank) and bailer.(borrowing
customer)
4. Lessee and Lessor
Sec.105 of ‘Transfer of property Act 1882’ defines lease, Lessor, lessee, premium and rent. As
per the section “A lease of immovable property is a transfer of a right to enjoy such property,
made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or
promised, or of money, a share of crops, service or any other thing of value, to be rendered
periodically or on specified occasions to the transferor by the transferee, who accepts the
transfer on such terms.
Providing safe deposit lockers is as an ancillary service provided by banks to customers. While
providing Safe Deposit Vault/locker facility to their customers, bank enters into an agreement
with the customer. The agreement is known as “Memorandum of letting” and attracts stamp
duty. The relationship between the bank and the customer is that of lessor and lessee. Banks
lease (hire lockers to their customers) their immovable property to the customer and give them
the right to enjoy such property during the specified period i.e. during the office/ banking hours
and charge rentals. Bank has the right to break-open the locker in case the locker holder defaults
in payment of rent. Banks do not assume any liability or responsibility in case of any damage
to the contents kept in the locker. Banks do not insure the contents kept in the lockers by
customers.
5. Agent and Principal
Sec.182 of ‘The Indian Contract Act, 1872’ defines “an agent” as a person employed to do any
act for another or to represent another in dealings with third persons. The person for whom
such act is done or who is so represented is called “the Principal”.
Thus an agent is a person, who acts for and on behalf of the principal and under the latter’s
express or implied authority and the acts done within such authority are binding on his principal
and, the principal is liable to the party for the acts of the agent. Banks collect cheques, bills,
and makes payment to various authorities, viz., rent, telephone bills, insurance premium etc.,
on behalf of customers. . Banks also abides by the standing instructions given by its customers.
In all such cases bank acts as an agent of its customer, and charges for these services. As per
Indian contract Act agent is entitled to charges. No charges are levied in collection of local
cheques through clearing house. Charges are levied in only when the cheque is returned in the
clearinghouse. The range of such agency functions has become much wider and the banks are
now rendering large number of agency services of diverse nature. For example, some banks
have established Tax Services Departments to take up the tax problems of their customers.
Obligations of a banker
Though the primary relationship between a banker and his customer is that of a debtor and
creditor or vice versa, the special features of this relationship, impose the following additional
obligations on the banker:
Obligations to honour the cheques
The deposits accepted by a banker are his liabilities repayable on demand or otherwise. The
banker is, therefore, under a statutory obligation to honour his customer’s cheques in the usual
course. Section 31 of the Negotiable Instruments Act, 1881, lays down that:
“The drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable
to the payment must compensate the drawer for any loss or damage caused by such default.”
Obligations to maintain Secrecy of Account

The account of the customer in the books of the banker records all of his financial dealings
with the latter and depicts the true state of his financial position. If any of these facts is made
known to others, the customer’s reputation may suffer and he may incur losses also. The banker
is, therefore, under an obligation to take utmost care in keeping secrecy about the accounts of
his customers. By keeping secrecy is meant that the account books of the bank will not be
thrown open to the public or Government officials and the banker will take all necessary
precautions to ensure that the state of affairs of a customer’s account is not made known to
others by any means.
The banker is thus under an obligation not to disclose – deliberately or intentionally – any
information regarding his customer’s accounts to a third party and also to take all necessary
precautions and care to ensure that no such information leaks out of the account books.
The nationalized banks in India are also required to fulfil this obligation. Section 13 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, specially requires
them to “observe, except as otherwise required by law, the practices and usages customary
amongst bankers and in particular not to divulge any information relating to the affairs of the
constituents except in circumstances in which they are, in accordance with law or practices and
usages or appropriate for them to divulge such information.”
Thus, the general rule about the secrecy of customer’s accounts may be dispensed with in the
following circumstances:
A. When the law requires such disclosure to be made; and
B. When practices and usages amongst the bankers permit such disclosure.
A banker will be justified in disclosing information about his customer’s account on reasonable
and proper occasions only as stated below:
(A) Disclosure of Information required by Law.
A banker is under statutory obligation to disclose the information relating to his customer’s
account when the law specially requires him to do so. The banker would, therefore, be justified
in disclosing information to meet statutory requirements:
(i). Under the Income – Tax Act, 1961.
According to Section 131, the income tax authorities possess the same powers as are vested in
a Court under the Code of Civil Procedure, 1908, for enforcing the attendance of any person
including any offer of banking company or any offer thereof, to furnish information in relation
to such points or matters, as in the opinion of the income-tax authorities will be useful for or
relevant to any proceedings under the Act. The income-tax authorities are thus authorized to
call for necessary information from the banker for the purpose of assessment of the bank
customers.
Section 285 of the Income-tax Act, 1961, requires the banks to furnish to the Income-tax
Officers the names and addresses of all persons to whom they have paid interest exceeding Rs.
400 mentioning the actual amount of interest paid by them.
(ii). By order of the Court under the Banker’s Books Evidence Act, 1891.
When the court orders the banker to disclose information relating to a customer’s account, the
banker is bound to do so. In order to avoid the inconvenience likely to be caused to the bankers
from attending the Courts and producing their account books as evidence, the Banker’s Books
Evidence Act, 1891, provides that certified copies of the entries in the banker’s book are to be
treated as sufficient evidence and production of the books in the Courts cannot be forced upon
the bankers. According to Section 4 of the Act, “ a certified copy of any entry in a banker’s
book shall in all legal proceedings be received as prima facie evidence of the matters,
transitions and accounts therein recorded in every case where, and to the same extent, as the
original entry itself is now by law admissible, but not further or otherwise.” Thus if a banker is
not a party to a suit, certified copy of the entries in his book will be sufficient evidence. The
Court is also empowered to allow any party to legal proceedings to inspect or copy from the
books of the banker for the purpose of such proceedings.
(iii) Under the Reserve Bank of India Act,1934.
The Reserve Bank of India collects credit information from the banking companies and also
furnishes consolidated credit information from the banking company. Every banking company
is under a statutory obligation under Section 45-B of the Reserve Bank. The Act, however,
provides that the Credit information supplied by the Reserve Bank to the banking companies
shall be kept confidential. After the enactment of the Reserve Bank of India (Amendment) Act,
1974, the banks are granted statutory protection to exchange freely credit information mutually
among themselves.
(iv) Under the Banking Regulation Act, 1949.
Under Section 26, every banking company requires to submit a return annually of all such
accounts in India which have not been operated upon for 10 years. Banks are required to give
particulars of the deposits standing to the credit of each such account.
(v) Under the Gift Tax Act, 1958.
Section 36 of the Gifts Tax Act, 1958, confers on the Gift Tax authorities’ powers similar to
those conferred on Income- Tax authorities under Section 131 of the Income Tax Act
[discussed above (i).]
(vi) Disclosure to Police.
Under Section 94 (3) of the Criminal Procedure Code, the banker is not exempted from
producing the account books before the police. The police officers conducting an investigation
may also inspect the banker’s books for the purpose of such investigations (section 5. Banker’s
Books Evidence Act).
(vii) Under the Foreign Exchange Management Act, 1999, under section 10.
Banking companies dealing in foreign exchange business are designated as ‘authorized
persons’ in foreign exchange. Section 36, 37 and 38 of this Act empowers the officer of the
Directorate of Enforcement and the Reserve Bank to investigate any contravention under the
Act.
(viii) Under the Industrial Development Bank of India Act, 1964.

After the insertion of sub-section 1A in Section 29 of this Act in 1975, the Industrial
Development Bank of India is authorized to collect from or furnish to the Central Government,
the State Bank, any subsidiary bank, nationalized bank or other scheduled bank, State Co-
operative Bank, State Financial Corporation, credit information or other information as it may
consider useful for the purpose of efficient discharge of its functions. The term ‘credit
information’ shall have the same meaning as under the Reserve Bank of India Act, 1934.
(B) Disclosure permitted by the Banker’s Practices and Usages.
The practices and usages customary amongst bankers permit the disclosure of certain
information under the following circumstances:
(i) With Express or Implied Consent of the Customer. The banker will be justified in disclosing
any information relating to his customer’s account with the latter’s consent. In fact the implied
term of the contract between the banker and his customer is that the former enters into a
qualified obligation with the latter to abstain from disclosing information as to his affairs
without his consent (Tourniers vs.National Provincial and Union Bank of India). The
consent of the customer may be expressed or implied. Express consent exists in case the
customer directs the banker in writing to intimate the balance in his account or any other
information to his agent, employee or consultant. The banker would be justified in furnishing
to such person only the required information and no more. It is to be noted that the banker must
be very careful in disclosing the required information to the customer or his authorized
representative. For example, if an oral enquiry is made at the counter, the bank employee should
not speak in louder voice so as to be heard by other customers. Similarly, the pass-book must
be sent to the customer through the messenger in a closed cover. A banker generally does not
disclose such information to the customer over the telephone unless he can recognize the voice
of his customer; otherwise he bears the risk inherent in such disclosure.
In certain circumstances, the implied consent of the customer permits the banker to disclose
necessary information. For example, if the banker sanctions a loan to a customer on the
guarantee of a third person and the latter asks the banker certain questions relating to the
customer’s account. The banker is authorized to do so because by furnishing the name of the
guarantor, the customer is presumed to have given his implied consent for such disclosure. The
banker should give the relevant information correctly and in good faith.
Similarly, if the customer furnishes the name of the banker to a third party for the purpose of a
trade reference, not only an express consent of the customer exists for the discloser of relevant
information but the banker is directed to do so, the non – compliance of which will adversely
affect the reputation of the customer. Implied consent should not be taken for granted in all
cases even where the customer and the enquirer happen to be very closely related. For example,
the banker should not disclose the state of a lady’s account to her husband without the express
consent of the customer.
(ii) The banker may disclose the state of his customer’s account in order to legally protect his
own interest. For example, if the banker has to recover the dues from the customer or the
guarantor, disclosure of necessary facts to the guarantor or the solicitor becomes necessary and
is quite justified.
(iii) Banker’s Reference. Banker follows the practice of making necessary enquires about the
customers, their sureties or the acceptors of the bills from other bankers. This is an established
practice amongst the bankers and is justified on the ground that an implied consent of the
customer is presumed to exist. By custom and practice necessary information or opinion about
the customer is furnished by the banker confidentially. However, the banker should be very
careful in replying to such enquiries.
Precautions to be taken by the banker.
The banker should observe the following precautions while giving replies about the status and
financial standing of a customer:
(i) The banker should disclose his opinion based on the exact position of the customer as is
evident from his account. He should not take into account any rumour about his customer’s
creditworthiness. He is also not expected to make further enquiries in order to furnish the
information. The basis of his opinion should be the record of the customer’s dealings with
banker.
(ii) He should give a general statement of the customer’s account or his financial position
without disclosing the actual figures. In expressing his general opinion he should be very
cautious—he should neither speak too low about the customer nor too high. In the former case
he injures the reputation of the customer; in the latter, he might mislead the enquirer. In case
unsatisfactory opinion is to be given, the banker should give his opinion in general terms so
that it does not amount to a derogatory remark. It should give a caution to the enquirer who
should derive his own conclusions by inference and make further enquiries, if he feels the
necessity.
(iii) He should furnish the required information honestly without bias or prejudice and should
not misrepresent a fact deliberately. In such cases he incurs liability not only to his own
customer but also to the enquirer.
(c) Duty to the public to disclose:
Banker may justifiably disclose any information relating to his customer’s account when it is
his duty to the public to disclose such information. In practice this qualification has remained
vague and placed the banks in difficult situations. The Banking Commission, therefore,
recommended a statutory provision clarifying the circumstances when banks should disclose
in public interest information specific cases cited below:
(i) when a bank asked for information by a government official concerning the commission
of a crime and the bank has reasonable cause to believe that a crime has been committed
and that the information in the bank’s possession may lead to the apprehension of the
culprit,
(ii) Where the bank considers that the customer’ is involved in activities prejudicial to the
interests of the country.
(iii)Where the bank’s books reveal that the customer is contravening the provisions of any
law, and
(iv) Where sizable funds are received from foreign countries by a constituent.
Risks of Unwarranted and Unjustifiable Disclosure. The obligation of the banker to keep
secrecy of his customer’s accounts – except in circumstances noted above – continue even after
the account is closed. If a banker discloses information unjustifiably, he shall be liable to his
customer and the third party as follows:
(a) Liabilities to the customer. The customer may sue the banker for the damages suffered by
him as a result of such disclosure. Substantial amount may be claimed if the customer has
suffered material damages. Such damages may be suffered as a result of unjustifiable disclosure
of any information or extremely unfavourable opinion about the customer being expressed by
the banker.
(b) Liabilities to third parties. The banker is responsible to the third parties also to whom
such information is given, if –
(i) The banker furnishes such information with the knowledge that it is false, and
(ii) Such party relies on the information and suffers losses.
Such third party may require the banker to compensate him for the losses suffered by him for
relying on such information. But the banker shall be liable only if it is proved that it furnished
the wrong or exaggerated information deliberately and intentionally. Thus he will be liable to
the third party on the charge of fraud but not for innocent misrepresentation. Mere negligence
on his part will not make him liable to a third party.
The general principles in this regard are as follows:
(1) A banker answering a reference from another banker on behalf of the latter’s constituent
owes a duty of honesty to the said constituent.
(2) If a banker gives a reference in the form of a brief expression of opinion in regard to
creditworthiness, it does not accept and is not expected to accept any higher duty than
that of giving an honest answer.
(3) If the banker stipulates in its reply that it is without responsibility, it cannot be held
liable for negligence in respect of the reference.
Garnishee Order
The obligation of a banker to honour his customer’s cheques is extinguished on receipt of an
order of the Court, known as the Garnishee order, issued under Order 21, Rule 46 of the code
of Civil Procedure, 1908. If a debtor fails to pay the debt owed by to his creditor, the latter may
apply to the Court for the issue of a Garnishee Order on the banker of his debtor. Such order
attaches the debts not secured by a negotiable instrument, by prohibiting the creditor the
creditor from recovering the debt and the debtor from the making payment thereof. The account
of the customer with the banker, thus, becomes suspended and the banker is under an obligation
not to make any payment from the account concerned after the receipt of the Garnishee Order.
The creditor at whose request the order is issued is called the judgement- creditor, the debtor
whose money is frozen is called judgement- debtor and the banker who is the debtor of the
judgement debtor is called the Garnishee.
The Garnishee Order is issued in two parts. First, the Court directs the banker to stop payment
out of the account of the judgement- debtor. Such order, called Order Nisi, also seeks
explanation from the banker as to why the funds in the said account should not be utilized for
the judgement- creditor’s claim. The banker is prohibited from paying the amount due to his
customer on the date of receipt of the Order Nisi. He should, therefore, immediately inform the
customer so that dishonour of any cheque issued by him may be avoided. After the banker files
his explanation, if any, the Court may issue the financial order, called Order Absolute where
the entire balance in the account or a specified amount is attached to be handed over to the
judgement- creditor. On receipt of such an order the banker is bound to pay the garnished funds
to the judgement- creditor. Thereafter, the banker liabilities towards his customer are
discharged to that extent. The suspended account may be revived after payment has been made
to the judgement- creditor as per the directions of the Court. The following points are to be
noted in this connection:
I. The amount attached by the order. A garnishee order may attach either the amount of the
judgement debtor with the banker irrespective of the amount which the judgement-debtor owes
to the creditor or a specified amount only which is sufficient to meet the creditor’ claim from
the judgement-debtor. In the first case, the entire amount in the account of the customer in the
bank is garnished or attached and if banker pays any amount out of the same which is in excess
of the amount of the debt of the creditor plus cost of the legal proceedings, he will render
himself liable for such payment.
For example, the entire to the credit of X, the principal debtor, Rs. 10,000 is attached by the
Court while the debt owed by him to his creditor Y is only Rs. 6,000. If the banker honours the
cheque of the customer X to the extent of Rs. 5,000 and thus reducing the balance to Rs. 5,000
he will be liable for defying the order of the Court. On the other hand, if he dishonours all
cheques, subsequent to the receipt of the Garnishee Order, he will not be liable to the customer
for dishonouring his cheques. It is to be noted that the Garnishee Order does not apply to the
amount of the cheque marked by a bank as a good for payment because the banker undertakes
upon himself the liability to pay the amount of the cheque. On the other hand, if the judgement
debtor gives to the bank a notice to withdraw, it does not amount withdrawal, but merely his
intention to withdraw. The Garnishee Order will be applicable to such funds. In the second
case, only the amount specified in the order is attached and the amount is excess of that may
be paid to the customer by the banker. For example, X is customer of SBI and his current
account shows a credit balance of Rs. 10,000. He is indebted to Y for Rs. 5,000. the latter
applies to the Court for the issue of a Garnishee Order specifies the amount (Rs. 5,000) which
is being attached, the banker will be justified in making payment after this amount, i.e., the
balance in the customer’s account should not be reduced below Rs. 5,000. Usually in such
cases, the attached amount is transferred to a suspense account and the account of the customer
is permitted to be operated upon with the remaining balance.
II. The order of the Court restrains the banker from paying the debts due or accruing
due. The word ‘accruing due’ mean the debts which are not payable but for the payment of
which an obligation exists. If the account is overdrawn, the banker owes no money to the
customer and hence the Court Order ceases to be effective. A bank is not a garnishee with
respect to the unutilized portion of the overdraft or cash credit facility sanctioned to its
customer and such utilized portion of cash credit or overdraft facility cannot be said to be an
amount due from the bank of its customer. The above decision was given by the Karnataka
High Court in Canara Bank vs. Regional Provident Fund
Commissioner. In his case the Regional Provident Fund Commissioner wanted to recover the
arrears of provident fund contribution from the defaulters’ bankers out of the utilized portion
of the cash credit facility. Rejecting this claim, the High Court held that the bank cannot be
termed as a Garnishee of such unutilized portion of cash credit, as the banker’s position is that
of creditor. For example, PNB allows it as customer to overdraw to the extent of Rs. 5,000.
The customer has actually drawn (Rs. 3,000) cannot be attached by a Garnishee Order as this
is not a debt due from the banker. It merely indicates the extent to which the customer may be
the debtor of the bank.
The banker, of course, has the right to set off any debt owed by the customer before the amount
to which the Garnishee Order applies is determined. But it is essential that debt due from the
customer is actual and not merely contingent. For example, if there is an unsecured loan
account in the name of the judgement-debtor with a balance of Rs. 5,000 at the time of receipt
of Garnishee Order, such account can be set off against the credit balance in the other account.
But if the debt due from the judgement- debtor is not actual, i.e., has not actually become due,
but is merely contingent, such set off is not permissible. For example, if A, the judgement-
debtor, has discounted a bill of exchange with the bank, there is contingent liability of A
towards the bank, if the acceptor does not honour the bill on the due date. Similarly, if A has
guaranteed a loan taken from the bank by B, his liability as surety does not arise until and
unless B actually makes default in repaying the amount of the loan.
The banker is also entitled to combine two accounts in the name of the customer in the same
right. If one account shows a debit balance and the other a credit one, net balance is arrived at
by deducting the former from the latter.
III. The Garnishee Order attachés the balance standing to the credit of the principal
debtor at the time the order is served on the banker. The following points are to be noted
in this connection:
(a) The Garnishee Order does not apply to: (1) the amounts of cheques, drafts, bills, etc.., sent
for collection by the customer, which remain uncleared at the time of the receipt of the order,
(2) the sale proceeds of the customer’s securities, e.g., stocks and shares in the process of sale,
which have not been received by the banker. In such cases, the banker acts as the agent for the
customer for the collection of the cheques or for the sale of the securities and the amounts in
respect of the same are not debts due by the banker to the customer, until they are actually
received by the banker and credited to the customer’s account. But if the amount of such
uncleared cheque, etc., is credited to the customer’s account, the position of the banker changes
and the garnishee order is applicable to the amount of such uncleared cheques. Similarly, if one
branch of a bank sends its customer’s cheque for realization to its another branch and the latter
collects the same from the paying banker before the receipt of the Garnishee Order by the first
branch, the amount so realized shall also be subject to Garnishee Order, even though the
required advice about realization of cheque is received after the receipt of the Garnishee Order.
Giving this judgement in Gerald C.S. Lobo v.
Canara Bank (1997) 71 Comp. Cases 290, the Karnataka high Court held that the branch which
collects money on behalf of another branch is to be treated as agent of the latter and
consequently the moment a cheque sent for collection by the other branch has been realized by
the former, the realization must be treated as having accrued to the principal branch.
(b) The Garnishee Order cannot attach the amounts deposited into the customer’s account after
the Garnishee
Order has been served on the banker. A Garnishee Order applies to the current balance at the
time the order is served, it has no prospective operation. Bankers usually open a new account
on the name of customer for such purpose.
(c) The Garnishee Order is not effective in the payments already made by the banker before
the order is served upon him. But if a cheque is presented to the banker for payment and its
actual payment has not yet been made by the banker and in the meanwhile a Garnishee Order
is served upon him, the latter must stop payment of the said cheque, even if it is passed for
payment for payment. Similarly, if a customer asks the banker to transfer an amount from his
account and the banker has already made necessary entries of such transfer in his books, but
before the intimation could be sent to the other account-holder, a Garnishee
Order is received by the banker, it shall be applicable to the amount so transferred by mere
book entries, because such transfer has no effect without proper communication to the person
concerned.
(d) In case of cheques presented to the paying banker through the clearing house, the
effectiveness of the
Garnishee Order depends upon the fact whether time for returning the dishonoured cheques to
the collecting banker has expired or not. Every drawee bank is given specified time within
which it has to return the unpaid cheques, if any, to the collecting bank. If such time has not
expired and in the meanwhile the bank receives a Garnishee Order, it may return the cheque
dishonoured. But if the order is received after such time over, the payment is deemed to have
been made by the paying banker and the order shall not be applicable to such amount.
(e) The Garnishee Order is not applicable to:
(i) Money held abroad by the judgement- debtor; and
(ii) Securities held in the safe custody of the banker,
(f) The Garnishee Order may be served on the Head Office of the bank concerned and it will
be treated as sufficient notice to all of its branches. However, the Head Office is given
reasonable time to intimate all concerned branches. If the branch office makes payment out of
the customer’s account before the receipt of such intimation, the banker will not be held
responsible for such payment.
Rights of a Banker
1. Right of Appropriation (Rule in Clayton’s case)
In case of his usual business, a banker receives payments from his customer. If the latter has
more than one account or has taken more than one loan from the banker, the question of the
appropriation of the money subsequently deposited by him naturally arises. Section 59 to 61 of
the Indian Contract Act, 1872 contains provisions regarding the right of appropriation of
payments in such cases. According to Section 59 such right of appropriation is vested in the
debtor, who makes a payment to his creditor to whom he owes several debts. He can appropriate
the payment by (i). An express intimation or (ii) under circumstances implying that the payment
is to be applied to the discharge of some particular debt. If the creditor accepts such payment,
it must be applied accordingly. For example, A owes B several debts, including Rs. 1,000 upon
a promissory note which falls due on 1st December, 1986. He owes B no other debt of that
amount. On 1-12-1986 A pays B Rs. 1,000. The payment is to be applied to the discharge of
the promissory note.
If the debtor does not intimate or there is no other circumstances indicating to which debt the
payment is to be applied, the right of appropriation is vested in the creditor. He may apply it as
his discretion to any lawful debt actually due and payable to him from the debtor (Section 60)
Further, where neither party makes any appropriation, the payment shall be applied in discharge
of each proportionately (Section 61).
In M/s. Kharavela Industries Pvt. Ltd. v. Orissa State Financial Corporation and Others
[AIR 1985 Orissa 153 (A)], the question arose whether the payment made by the debtor was
to be adjusted first towards the principal or interest in the absence of any stipulation regarding
appropriation of payments in the loan agreement. The Court held that in case of a debt due with
interest, any payment made by the debtor is in the first instance to be applied towards
satisfaction of interest and thereafter toward the principal unless there is an agreement to the
contrary.
In case a customer has a single account and he deposits and withdraws money from it
frequently, the order in which the credit entry will set off the debit entry is the chronological
order, as decided in the famous Clayton’s Case. Thus the first item on the debit side will be the
item to be discharged or reduced by a subsequent item on the credit side. The credit entries in
the account adjust or set-off the debit entries in the chronological order. The rule derived from
the Clayton’s case is of great practical significance to the bankers. In a case of death, retirement
or insolvency of a partner of a firm, the then existing debt due from the firm is adjusted or set-
off by subsequent credit made in the account. The banker thus loses his right to claim such debt
from the assets of the deceases, retired or insolvent partner and may ultimately suffer the loss
if the debt cannot be recovered from the remaining partners.
Therefore, to avoid the operation of the rule given in the Clayton’s case the banker closes the
old account of the firm and opens a new one in the name of the reconstituted firm. Thus the
liability of the deceased, retired or insolvent partner, as the case may be, at the time of his
death, retirement or insolvency is determined and he may be held liable for the same.
Subsequent deposits made by surviving/ solvent partners will not be applicable to discharge
the same.
Clayton’s Case
Devaynes v Noble (1816) 35 ER 781, best known for the claim contained in Clayton's case,
created a rule, or rather common law presumption in relation to the distribution of monies from
a bank account. The rule is based upon the deceptively simple notion of first-in, first-out to
determine the effect of payments from an account, and will normally apply in the absence of
evidence of any other intention. Payments are presumed to be appropriated to debts in the order
in which the debts are incurred. Mr Clayton had an account with a banking firm, a partnership
named Devaynes, Dawes, Noble, and Co. One of the partners, William Devaynes, died. The
amount then due to Clayton was £ 1,717. The surviving partners, thereafter paid out to Mr
Clayton more than that amount while Clayton himself, on his part, made further deposits with
the firm. The banking firm subsequently went bankrupt. And Mr Clayton also claimed the
money.
Sir William Grant MR held that the estate of the deceased partner was not liable to Clayton, as
the payments made by the surviving partners to Clayton must be regarded as completely
discharging the liability of the firm to Clayton at the time of the particular partner’s death.
Sometimes quoted as Devaynes v. Noble, which is always referred to as the leading authority
upon what is known as the “appropriation of payments”. If a debtor owes more than one debt
to his creditor, and pays him a sum of money insufficient to liquidate the whole of the debts, it
is sometimes a matter of importance, in view of the Statutes of Limitations, to know to which
debts the payment is to be appropriated.
From Clayton's case the following rules are derived mainly taken from the Roman law: ---
(1) A debtor making a payment has a right to appropriate it to the discharge of any debt due to
the creditor,
(2) if at the time of payment there is no express or implied appropriation thereof by the debtor,
then the creditor has a right to make the appropriation;
(3) in the absence of any appropriation by either debtor or creditor, an appropriation is made
by presumption of law, according to the items of account, the first item on the debit side being
the item discharged or reduced by the first item on the credit side.
The Earl of Selborne, L.C., in In re Sherry, London and County Banking Company v. Terry
(1884, 25 Ch. D. 692), said:
"The principle of Clayton's case, and of the other cases which deal with the same subject, is
this, that where a creditor having a right to appropriate moneys paid to him generally, and not
specifically appropriated by the person paying them, carries them into a particular account kept
in his books, he prima facie appropriates them to that account, and the effect of that is, that the
payments are de facto appropriated according to the priority in order of the entries on the one
side and on the other of that account. It is, of course, absolutely necessary for the application
of those authorities that there should be one unbroken account, and entries made in that account
by the person having a right to appropriate the payment to that account; and the way to avoid
the application of Clayton's case, where there is no other principle in question, is to break the
account and open a new and distinct account. When that is done, and the payment is entered to
that new and distinct account, whatever other rule may govern the case, it certainly is not the
rule of Clayton's case.” The principle of Clayton's case does not apply where a person has
mixed trust moneys with his own moneys in his account. The money which he first withdraws
from the account is taken to be his own money, leaving the trust funds intact.
2. Right of General Lien
One of the important rights enjoyed by a banker is the right of general lien. Lien means the
right of the creditor to retain the goods and securities owned by the debtor until the debt due
from him is repaid. It confers upon the creditor the right to retain the security of the debtor and
not the right to sell it . Such right can be exercised by the creditor in respect of goods and
securities entrusted to him by the debtor with the intention to be retained by him as security for
a debt due by him (debtor).
Lien may be either (i) a general lien or, (ii) a particular lien. A particular lien can be exercised
by a craftsman or a person who has spent his time, labour and money on the goods retained. In
such cases goods are retained for a particular debt only. For example, a tailor has the right to
retain the clothes made by him for his customer until his tailoring charges area paid by the
customer. So is the case with public carriers and the repair shops. A general lien, on the other
hand, is applicable in respect of all amounts due from the debtor to the creditor. Section 171 of
the Indian Contract Act, 1872, confers the right of general lien on the bankers as follows:
“Bankers… may, in the absence of a contract to the contrary, retain as a security for a general
balance of account, any goods bailed to them.”
Special Features of a Banker’s Right of General Lien
(i) The banker possesses the right of general lien on all goods and securities entrusted to him
in his capacity as a banker and in the absence of a contract inconsistent with the right of lien.
Thus, he cannot exercise his right of general lien if –
(a) The goods and securities have been entrusted to the banker as a trustee or an agent of the
customer; and
(b) A contract – express or implied – exists between the customer and the banker which is
inconsistent with the banker’s right of general lien. In other words, if the goods or securities
are entrusted for some specific purpose, the banker cannot have a lien over them. These
exceptional cases are discussed later on.
(ii) A banker’s lien is tantamount to an implied pledge: As noted above the right of lien does
not confer on the creditor the right of sale but only the right to retain the goods till the loan is
repaid. In case of pledge the creditor enjoys the right of sale. A banker’s right of lien is more
than a general lien. It confers upon him the power to sell the goods and securities in case of
default by the customer. Such right of lien thus resembles a pledge and is usually called an
‘implied pledge’. The banker thus enjoys the privileges of a pledge and can dispose of the
securities after giving proper notice to the customer.
(iii) The right of lien is conferred upon the banker by the Indian Contract Act: No separate
agreement or contract is, therefore, necessary for this purpose. However, to be on the safe side,
the banker takes a letter of lien from the customer mentioning that the goods are entrusted to
the banker as security for a loan(existing or future)taken from the banker and that the latter can
exercise his right of lien over them. The banker is also authorized to sell the goods in case of
default on the part of the customer. The latter thus spells out the object of entrusting the goods
to the banker so that the same may not be denied by the customer later on.
(iv) The right of lien can be exercised on goods or other securities standing in the name of the
borrower and not jointly with others. For example, in case the securities are held in the joint
names of two or more persons the banker cannot exercise his right of general lien in respect of
a debt due from a single person.
(v) The banker can exercise his right of lien on the securities remaining in his possession after
the loan, for which they are lodged, is repaid by the customer, if no contract to contrary exists.
In such cases it is an implied presumption that the customer has re-offered the same securities
as a cover for any other advance outstanding on that date or taken subsequently. The banker is
also entitled to exercise the right of general lien in respect of a customer’s obligation as a surety
and to retain the security offered by him for a loan obtained by him for his personal use and
which has been repaid. In Stephen Manager North Malabar Gramin Bank vs.
ChandraMohan and State of Kerala, the loan agreement authorized the bank to treat the
ornaments not only as a security for that loan transaction, but also for any other transaction or
liability existing or to be incurred in future. As the liability of the surety is joint and several
with that of the principal debtor, such liability also came within the ambit of the above
provision of the agreement. Section 171 of the Contract Act entitles a banker to retain the goods
bailed to him for any other debt due to him, i.e., any debt taken prior to the debt for which the
goods were entrusted as security. But in a lien there should be a right of possession because,
lien is a right of one man to retain that which is in his possession belonging to another.
Possession of the goods by the person claiming right of lien, is anterior to the exercise of that
right and for which possession whether actual or conductive is a must. (Syndicate Bank
Vs.Davander Karkare (A.I.R. 1994 Karnataka 1)
Exceptions to the Right of General Lien
As already noted the right of lien can be exercised by a banker on the commodities entrusted
to him in his capacity as a banker and without any contract contrary to such right. Thus the
right of lien cannot be exercised in the following circumstances:
(a) Safe custody deposits. When a customer deposits his valuables – securities, ornaments,
documents, etc. – with the banker for safe custody, he entrusts them to the banker s a bailee or
trustee with the purpose to ensure their safety from theft, fire, etc. A contract inconsistent with
the right of lien is presumed to exist. For example, if he directs the banker to collect the
proceeds of a bill of exchange on its maturity and utilize the same for honouring a bill of
exchange on his behalf, the amount so realized will not be subject to the right of general lien.
Similarly, if a customer hands over to the banker some shares with the instruction to sell them
at or above a certain price and the same are lying unsold with the banker, the latter cannot
exercise his right of lien on the same, because the shares have been entrusted for a specific
purpose and hence a contract inconsistent with the right of lien comes into existence.
But if no specific purpose is mentioned by the customer, the banker can have lien on bills or
cheques sent for collection or dividend warrants, etc. If the security comes into the possession
of the banker in the ordinary course of business, he can exercise his right of general lien.
(c) Right of General Lien becomes that of Particular Lien. Banker’s right of general lien is
displaced by circumstances which show an implied agreement inconsistent with the right of
general lien. In Vijay Kumar v. M/s. Jullundur Body Builders, Delhi and Others (A.I.R.
1981, Delhi 126), the Syndicate Bank furnished a bank guarantee for Rs. 90,000 on behalf of
its customer. The customer deposited with it as security two fixed deposit receipts, duly
discharged, with a covering letter stating that the said deposits would remain with the bank so
long on any amount was due to the Bank from the customer. Bank made an entry on the reverse
of Receipt as “Lien to BG 11/80.” When the bank guarantee was discharged, the bank claimed
its right of general lien on the fixed deposit receipt, which was opposed on the ground that the
entry on the reverse of the letter resulted in the right of a particular lien, i.e., only in respect of
bank guarantee.
The Delhi High Court rejected the claim of the bank and held that the letter of the customer
was on the usual printed form while” the words written by the officer of the bank on the reverse
of the deposit receipt were specific and explicit. They are the controlling words, which
unambiguously tell us what was in the minds of the parties of the time. Thus the written word
which prevail over the printed “word”. The right of the banker was deemed that of particular
lien rather than of general lien.
(d) Securities left with the banker negligently. The banker does not possess the right of lien on
the documents or valuables left in his possession by the customer by mistake or by negligence.
(e) The banker cannot exercise his right of lien over the securities lodged with him for securing
a loan, before such loan is actually granted to him.
(f) Securities held in Trust. The banker cannot exercise his right of general lien over the
securities deposited by the customer as a trustee in respect of his personal loan. But if the
banker is unaware of the fact that the negotiable securities do not belong to the customer, his
right of general lien is not affected.
(g) Banker possesses right of set-off and not lien on money deposited. The banker’s right of
lien extends over goods and securities handed over to the banker. Money deposited in the bank
and the credit balance in the accounts does not fall in the category of goods and securities. The
banker may, therefore, exercise his right of set-off rather the right of lien in respect of the
money deposited with him. The Madras High Court expressed this view clearly as follows:
The lien under Section 171 can be exercised only over the property of someone else and not
own property. Thus when goods are deposited with or securities are placed in the custody of a
bank, it would be correct to speak of right of the bank over the securities or the goods as a lien
because the ownership of the goods or securities would continue to remain in the customer.
But when moneys are deposited in a bank as a fixed deposit, the ownership of the moneys
passes to the bank and the right of the bank over the money lodged with it would not be really
lien at all. It would be more correct speak of it as a right to set-off or adjustment.”
(Brahammaya v. K.P. Thangavelu Nadar,AIR (1956), Madras 570)
3. Right of set-off
The right of set-off is a statutory right which enables a debtor to take into account a debt owed
to him by a creditor, before the latter could recover the debt due to him from the debtor. In
other words, the mutual claims of debtor and creditor are adjusted together and only the
remainder amount is payable by the debtor. A banker, like other debtors, possesses this right
of set-off which enables him to combine two accounts in the name of the same customer and
to adjust the debit balance in one account with the credit balance in the other. For example, A
has taken an overdraft from his banker to the extent of Rs. 5,000 and he has a credit balance of
Rs. 2,000 in his savings bank account, the banker can combine both of these accounts and claim
the remainder amount of Rs. 3,000 only. This right of set-off can be exercised by the banker if
there is no agreement – express or implied – contrary to this right and after a notice is served
on the customer intimating the latter about the former’s intention to exercise the right of set-
off. To be on the safer side, the banker takes a letter of set-off from the customer authorizing
the banker to exercise the right of set-off without giving him any notice. The right of set-off
can be exercised subject to the fulfilment of the following conditions:
(i) The accounts must be in the same name and in the same right. The first and the most
important condition for the application of the right of set-off is that the accounts with the banker
must not only be in the same name but also in the same right. By the words ‘the same right’
meant that the capacity of the accountholder in both or call the accounts must be the same, i.e.,
the funds available in one account are held by him in the same right or capacity in which a
debit balance stands in another account. The underlying principle involved in this rule is that
funds belonging to someone else, but standing in the same name of the account – holder, should
not be made available to satisfy his personal debts. The following examples, make this point
clear:
(a) In case of a sole trader the account in his personal name and that in the firm’s name are
deemed to be in the same right and hence the right of set-off can be exercised in case either of
the two accounts is having debit balance.
(b) In case the partners of a firm have their individual accounts as well as the account of the
firm with the same bank, the latter cannot set-off the debt due from the firm against the personal
accounts of the partners. But if the partners have specially undertaken to be jointly and severally
liable for the firm’s debt due to the banker, the latter can set-off such amount of debt against
the credit balances in the personal accounts of the partners.
(c) An account in the name of a person in his capacity as a guardian for a minor is not be treated
in the same right as his own account with the banker.
(d) The funds held in Trust account are deemed to be in different rights. If a customer opens a
separate account with definite instructions as regards the purpose of such account, the latter
should not be deemed to be in the same right. The case of Barclays Bank Ltd. v. Quistclose
Investment Limited may be cited as an illustration. Rolls Rozer Ltd .borrowed an amount
from Quistclose Investment Ltd. With the specific purpose of paying the dividend to the
shareholders and deposited the same in a separate account ‘Ordinary Dividend No. 4 Account
with Barclays Bank Ltd. and the latter was also informed about the purpose of this deposit. The
company went into liquidation before the intended dividend could be paid and the banker
combined all the accounts of the company, including the above one.
Quistclose Investment Ltd., the creditors of the company, claimed the repayment of the balance
in the above account which the bank refused. It was finally decided that by opening an account
for the specific purpose of paying the dividend a trust arose in favour of the shareholders. If
the latter could not get the funds, the benefit was to go to the Quistclose Investment Ltd. and
to the bank. The banker was thus not entitled to set-off the debit balance in the company’s
account against the credit balance in the above account against the credit balance in the above
account. The balance held in the clients’ account of an advocate is not deemed to be held in the
same capacity in which the amount is held in his personal account.
(e) In case of a joint account, a debt due from one of the joint account- holders in his individual
capacity cannot be set-off against an amount due to him by the bank in the joint account. But
the position may appear to be different if the joint account is payable to ‘former or survivor’.
Such an account is deemed to be primarily payable to the former and only after his death to the
survivor. Thus the former’s debt can be set-off against the balance in the joint account.
(ii) The right can be exercised in respect of debts due and not in respect of future debts or
contingent debts.
For example, a banker can set-off a credit balance in the account of customer towards the
payment of a bill which is already due but not in respect of a bill which will mature in future.
If a loan given to a customer is repayable on demand or at a future date, the debt becomes due
only when the banker makes a demand or on the specified date and not earlier.
(iii) The amount of debts must be certain. It is essential that the amount of debts due from both
the parties to each other must be certain. If liability of any one of them is not determined
exactly, the right of set- off cannot be exercised. For example, if A stands as guarantor for a
loan of Rs. 50,000 given by a bank to B, his liability as guarantor will arise only after B defaults
in making payment. The banker cannot set- off the credit balance in his account till his liability
as a guarantor is determined. For this purpose it is essential that the banker must first demand
payment from his debtor. If the latter defaults in making payment of his payment of his debt,
only then the liability of the guarantor arises and the banker can exercise his right of set-off
against the credit balance in the account of the guarantor. The banker cannot exercise this right
as and when he realizes that the amount of debt has becomes sticky, i.e., irrecoverable.
(iv) The right may be exercised in the absence of an agreement to the contrary. If there is
agreement – express or implied – inconsistent with the right of set-off, the banker cannot
exercise such right. If there is an express contract between the customer and the banker creating
a lien on security, it would exclude operation of the statutory general lien under Section 171 of
the Indian Contract Act, 1872. In Krishna
Kishore Kar v. Untitled Commercial Bank and Another (AIR 1982 Calcutta 62), the UCO
Bank, on the request of its customer K.K. Kar, issued guarantee for Rs. 2 lakhs in favour of the
suppliers of coal guaranteeing payment for coal supplied to him. The customer executed a
counter- guarantee in favour of the Bank and also paid margin money Rs. 1.83 lakhs to the
Bank. After fulfilling its obligations under the guarantee, the Bank adjusted Rs. 76,527 due
from the customer under different accounts against the margin money deposited by the
customer in exercise of its lien (or alternatively the right of set-off). The
High Court held that the bank was not entitled to appropriate or adjust its claims under Section
171 of the Contract Act in view of the existence of the counter- guarantee, which constituted a
contract contrary to the right of general lien.
(v) The Banker may exercise this right at his discretion. For the purpose of exercising this right
of the bank, all branches of a bank constitute one entity and the bank can combine two or more
accounts in the name of the same customer at more than one branch. The customer, however,
cannot compel or pursue the banker to exercise the right and to pay the credit balance at any
other branch.
(vi) The banker has right to exercise this right before the garnishee order is made effective. In
case a banker receives a garnishee order in respect of the funds belonging to his customer, he
has the right first to exercise his right of set-off and thereafter to surrender only the remainder
amount to the judgement-creditor.
4. Right to charge Interest and Incidental Charges, etc.
As a creditor, a banker has the implied right to charge interest on the advances granted to the
customer. Bankers usually follow the practice of debiting the customer’s account periodically
with the amount of interest due from the customer. The agreement between the banker and the
customer may, on the other hand, stipulate that interest may be charged at compound rate also.
In Konakolla Venkata Satyanarayana & Others vs. State Bank of India (AIR,1975 A.P.
113) the agreement provided that “interest shall be calculated on the daily balance of such
amount and shall be charged to such account on the last working day of each month.” For
several years the customer availed the overdraft facilities and periodical statements of accounts
were being sent to the customer showing that interest was being charged and debited at
compound rate and no objection was raised at any time. The High Court, therefore, held that
there was no doubt that the customer had agreed to the compound rate of interest being charged
and debited to his account. The customer need not pay the amount of interest in cash. After
making a debit entry in the account of the customer, the amount of interest is also deemed as a
debt due from the customer to the banker and interest accrues on the same in the next period.
The same practice is followed in allowing interest on the savings accounts. Banks also charge
incidental charges on the current accounts to meet the incidental expenses on such accounts.
ACCOUNTS AND DEPOSITS
Deposits of banks are classified into three categories:

(1) Demand deposits are repayable on customers’ demand. These comprise of:
– Current account deposits
– Savings bank deposits
– Call deposits
(2) Term deposits are repayable on maturity dates as agreed between the customers and the
banker. These comprise of:
– Fixed deposits
– Recurring deposits
(3) Hybrid deposits or flexi deposits combine the features of demand and term deposits. These
deposits have been lately introduced in by some banks to better meet customers’ financial needs
and convenience and are known by different names in different banks.
The demand and time deposits of a bank constitute its demand and time liabilities that the bank
reports every week (on every Friday) to the RBI.
Demand Deposits
(a) Current account:
A current account is a running and active account that may be operated upon any number of
times during a working day. There is no restriction on the number and the amount of
withdrawals from a current account. Current accounts can be opened by individuals, business
entities (firms, company), institutions, Government bodies / departments, societies, liquidators,
receivers, trusts, etc. The other main features of current account are as under:
– Current accounts are non-interest bearing and banks are not allowed to pay any interest or
brokerage to the current account holders.
– Overdraft facility for a short period or on a regular basis up to specified limits – are permitted
in current accounts. Regular overdraft facility is granted as per prior arrangements made by the
account holder with the bank. In such cases, the bank would honour cheques drawn in excess
of the credit balance but not exceeding the overdraft limit. Prescribed interest is charged on
overdraft portion of drawings.
– Cheques/ bills collection and purchase facilities may also be granted to the current account
holders.
– The account holder periodically receives statement of accounts from the Bank.
– Normally, banks levy charges for handling such account in the shape of “Ledger Folio
charges”. Some banks make no charge for maintenance of current account provided the balance
maintained is sufficient to compensate the Bank for the work involved.
– Third party cheques and cheques with endorsements may be deposited in the current account
for collection and credit.
(b) Current Deposits Premium Scheme:
This is a deposit product which combines Current & Short deposit account with ‘ sweep-in’
and ‘sweep-out’ facility to take care of withdrawals, if any. Besides containing all features of
a current account, the product is aimed at offering current account customers convenient
opportunity to earn extra returns on surplus funds lying in account which may not normally be
utilized in the near future or are likely to remain unutilized. The automated nature of facility
for “Sweep In or Sweep Out” of more than a specified limit of balance to be maintained and
creating fixed deposits for desired period, would save lot of operational hassles and add-on
value in such accounts. Thus, with this facility the customer shall be able to deploy his funds
which in ordinary current account were not attracting any interest. Sweep out from current to
short deposits may be automatically when balance in the account is more than a specified limit
or weekly or on specific days which may be on 1st & 16th of every month or once within a
month as prescribed by an individual bank.
(c) Savings Account
Savings bank accounts are meant for individuals and a group of persons like Clubs, Trusts, and
Associations, Self Help Groups (SHGs) to keep their savings for meeting their future monetary
needs and intend to earn income from their savings. Banks give interest on these accounts with
a view to encourage saving habits. Everyone wants to save for something in the future and their
savings should be safe and accessible anytime, anyplace to help meet their needs. This account
helps an individual to plan and save for his future financial requirements. In this account
savings are completely liquid.
Main features of savings bank accounts are as follows:
– Withdrawals are permitted to the account-holder on demand, on presentation of cheques or
withdrawal form/letter. However, cash withdrawals in excess of the specified amount per
transaction/day (the amount varies from bank to bank) require prior notice to the bank branch.
– Banks put certain restrictions on the number of withdrawals per month/quarter, amount of
withdrawal per day, minimum balance to be maintained in the account on all days, etc. A
fee/penalty is levied if these are violated. These rules differ from bank to bank, as decided by
their Boards. The rationale of these restrictions is that the Savings Bank account should not be
used like a current account since it is primarily intended for attracting and accumulating
savings.
– The Bank pays interest on the products of balances outstanding on daily basis. Rate of interest
is decided by bank from time to time.
– No overdraft in excess of the credit balance in savings bank account is permitted as there
cannot be any debit balance in savings account.
– Most banks provide a passbook to the account-holder wherein date-wise debit credit
transactions and credit balances are shown as per the customer’s ledger account maintained by
the Bank.
– Cheque Book Facility Accounts in which withdrawals are permitted by cheques drawn in
favour of self or other parties. The payees of the cheque can receive payment in cash at the
drawee bank branch or through their bank account via clearing or collection. The account
holder may also withdraw cash by submitting a withdrawal form along with Pass Book, if
issued.
– Non-cheque Book Facility accounts where account holders are permitted to withdraw only
at the drawee bank branch by submitting a withdrawal form or a letter accompanied with the
account passbook requesting permission for withdrawal. In such cases third parties cannot
receive payments.
– Almost all banks which provide ATM facility, give ATM cards to their accounts holder, so
that they avail withdrawal facility 24 hours and all days at any place.
(d) Basic Savings Bank Deposit Account
With a view to making the basic banking facilities available in a more uniform manner across
banking system, RBI has modified the guidelines on opening of basic banking ‘no-frills’
accounts. Such accounts are now known as
“Basic Savings Bank Deposit” Account which offers the minimum common facilities as
under:-
– The account should be considered as a normal banking service available to all;
– No requirement of minimum balance;
– Facilitate deposit and withdrawal of cash at bank branch as well as ATMs;
– Receipt/credit of money through electronic payment channels or by means of cheques/
collection of cheques drawn by Central/State Government Agencies and departments;
– Account holders are permitted a maximum of four withdrawals in a month including ATM
withdrawals;
– Facility of ATM card or ATM-cum Debit Card
– Facilities are free of charge and no charge would be levied for non-operation/activation of
in-operative ‘Basic Savings Bank Deposit Account’;
– Holders of ‘Basic Savings Bank Deposit Account’ are not eligible for opening of any other
savings bank accounts and existing such accounts should be closed down within a period of 30
days from the date of opening of ‘Basic Savings Bank Deposit Account’.
– Existing ‘no frills’ accounts can be converted to ‘Basic Savings Bank Deposit Account’
(e) Premium or Savings Bank plus Account:
Premium Savings Account provides an enriched version of Savings Bank account consisting
of various concessions and add-ons. It is suitable for High Net worth Individual/ Mass Affluent
customers. The account will be linked to Multi
Option Deposit (MOD) account, for auto sweep, for issue of Term Deposits and unitized break-
up facilities. Any surplus funds in the account exceeding the threshold limit, for a minimum
amount of Rs. 10,000 and in multiple of
Rs. 1000 in any one instance, are transferred as Term Deposit and earns interest as applicable
to Term Deposits.
The account is useful to those persons who have surplus funds for an uncertain period and by
keeping the fund in this Savings Bank account, they may get interest of term deposit. This
account provides a customer the convenience of a Savings Bank Account along with higher
return of Term Deposit.
(f) Deposit at Call Accounts:
Call deposits or deposit at call accounts are maintained by fellow banks with another bank
which are payable on demand only. Some banks have put restriction of giving advance notice
of a week or less than that when depositor requires payment of call deposits. These accounts
may or may not fetch interest, as per the rules framed by the
RBI or Indian Banks Association (IBA) from time- to-time.
Term Deposits
(a) Recurring Deposits or Cumulative Deposits:
In Recurring Deposits accounts, a certain amount of savings are required to be compulsorily
deposited at specified intervals for a specific period. These are intended to inculcate regular
and compulsory savings habit among the low/ middle income group of people for meeting their
specific future needs e.g. higher education or marriage of children, purchase of vehicles etc.
The main features of these deposits are:
– The customer deposits a fixed sum in the account at pre-fixed frequency (generally
monthly/quarterly) for a specific period (12 months to 120 months).
– The interest rate payable on recurring deposit is normally the applicable rate of fixed deposits
for the same period.
– The total amount deposited is repaid along with interest on the date of maturity.
– The depositor can take advance against the deposits up to 75% of the balance in the account
as on the date of advance or have the deposits pre-paid before the maturity, for meeting
emergent expenses. In the case of pre-mature withdrawals, the rate of interest would be lower
than the contracted rate and some penalty would also be charged. Similarly, interest is charged
on advance against the deposits, which is normally one or two per cent higher than the
applicable rate of interest on deposits.
(b) Monthly-Plus Deposit Scheme / Recurring Deposit Premium account
It is a recurring deposit scheme with flexibility of “Step-up and Step-down” options of monthly
instalments. The scheme is available to individuals, institutions, corporate, proprietorship or
partnership firms, trusts, HUF, etc.
Under the scheme, the customer selects the “core amount” at the time of opening the account
and deposits the same initially. Minimum core amount may be Rs.100 and maximum
Rs.1,00,000. Period of deposit will be pre-decided by the customer himself. The depositor can
deposit instalment in excess of the minimum core amount (but not exceeding ten times of the
core amount) in the multiples of Rs.100 in any month. Like stepping up the instalment amount,
a customer can also reduce the same (Step-down) in any subsequent months but no below the
core amount. The interest on this scheme will be as per the term deposit rate applicable for the
fixed period. Interest will be calculated on the monthly product basis, for the minimum balance
between the 10th and the last day of the month and will be credited quarterly.
(c) Fixed Deposits
Fixed deposits are repayable on the fixed maturity date along with the principal and agreed
interest rate for the period and no operations are allowed to be performed by the customer
against the deposit, as is permitted in demand deposits. The depositor foregoes liquidity on the
deposit and the bank can freely deploy such funds for loans/advances and earn interest.
Hence, banks pay higher interest rates on fixed deposits as compared to savings bank deposits
from which he can withdraw, requiring banks to keep some portion of deposits always at the
disposal of the depositors. Another reason for banks paying higher interest on fixed deposits is
that the administrative cost in the maintenance of these accounts is very small as compared to
savings bank accounts where several transactions take place in cash, transfer or clearing, thus
increasing the administrative cost. Main Features of Fixed Deposits are as follows:
– Fixed deposits are accepted for specific periods at specified interest rates as mutually agreed
between the depositor and the banker at the time of opening the account. Since the interest rate
on the deposit is contractual, it cannot be altered even if the interest rate fluctuates - upward or
downward - during the period of the deposit.
– The interest rates on fixed deposits, which were earlier regulated by the RBI, have been
deregulated and banks offer varying interest rates for different maturities as decided by their
boards. The maturity- wise interest rates in a bank will, however, be uniform for all customers
subject to two exceptions - high value deposits above certain cut-off value and deposits of
senior citizens (above the specified age normally 60 years); these may be offered higher interest
rate as per specified Basis Points. However, specific directions are issued by the bank’s board
with regard to the differential rate and the authority vested to allow such differential rate of
interest, to prevent discrimination and misuse at branch level.
– Minimum period of fixed deposit is 7 days, as per the directive of the RBI. The maximum
term and band of term maturities are determined by each bank along with the respective interest
rates for each band.
– A deposit receipt is issued by the bank branch accepting the fixed deposit- mentioning the
depositor’s name, principal amount, maturity period and interest rate, dates of the deposit and
its maturity etc. The deposit receipt is not a negotiable instrument, nor is it transferable, like a
cheque. However, a term deposit receipt evidences contract for the deposit on the specified
terms.
– On maturity of a deposit, the principal and interest can be renewed for another term at an
interest rate prevalent at that time and a fresh deposit receipt is issued to the customer,
evidencing a fresh contract.
Alternatively, the deposit can be paid up by obtaining the discharge of the depositor on the
reverse of the receipt.
– Many banks prepay fixed deposits, at their discretion, to accommodate customers’ request
for meeting emergent expenses. In such cases, interest is paid for the period actually elapsed
and at a rate generally 1 per cent lower than that applicable to the period elapsed. Banks also
may grant overdraft/ loan against the security of their fixed deposits to meet emergent liquidity
requirements of the customers. The interest on such facility will be 1 per cent - 2 per cent higher
than the interest rate on the fixed deposit.
(d) Special Term Deposits
Special Term Deposit carries all features of Fixed Deposit. In addition to these, interest gets
compounded every quarter resulting higher returns to the depositors. Now-a-days, 80% of the
term deposits in banks is under this scheme.
Higher Interest payable to Senior Citizens:
Persons who have attained the age of 60 years are “Senior Citizens” in regard to the payment
of higher interest not exceeding 1% over and above the normal rates of term deposits. Each
bank has prepared its own scheme of term deposits for senior citizens.
(e) Certificate of Deposit:
Banks also offer deposits to attract funds from corporate companies and banks and other
institutions. One such important deposit product offered by banks is called as Certificate of
Deposit (CD). Special features of a Certificate of Deposit (CD):
1. Certificate of Deposit is issued at a discount to mature for the face value at maturity
2. Minimum amount for a CD is Rs. 100,000.00 (Rupees One lakh only) and multiples thereof
3. Minimum and maximum period a CD with banks are 7 days and 365 days respectively
4. CDs differs from Banks’ Fixed Deposits (FDs) in respect of (i) prepayment and (ii) loans.
While banks allows the fixed deposit holder the facility to withdraw before maturity
(prepayment) and if required allows the fixed deposit holder to avail of a loan, both of them
are not permissible in case of certificate of deposits.
i.e., In case of Certificate of Deposits prepayment of CDs and loans against CDs are not
allowed.
Hybrid Deposits or Flexi Deposits or Multi Option Deposit Scheme (MODS)
These deposits are a combination of demand and fixed deposits, invented for meeting
customer’s financial needs in a flexible manner. Many banks had introduced this new deposit
product some years ago to attract the bulk deposits from individuals with high net- worth. The
increasing competition and computerization of banking has facilitated the proliferation of this
product in several other banks in the recent past. Banks have given their own brand names to
such deposits e.g. Quantum Deposit Scheme of ICICI Bank, Multi Option Deposit Scheme
(MODS) of SBI.
The flexi deposits show a fusion of demand and fixed deposits as reflected from the following
features of the product:
– Only one savings/current account (Current Premium account or Savings Bank Premium a/c
as already discussed above) is opened and the term deposits issued under the scheme are
recorded only on the bank’s books as no term deposit receipts are issued to the customer.
However, the term deposits issuance and payment particulars would be reflected in the
statement of the savings/current account for customer’s information/record.
– Once the quantum of deposits in savings/current account crosses a pre-agreed level, such
surplus amount is automatically transferred to the term deposit account of a pre-determined
maturity (usually one- year) in the customer’s name for increasing the interest earning.
– In the event of a shortfall in the current/savings account, the cheques drawn on the account
are honoured by automatically transferring back the required amount to the savings/current
account from the fixed deposit account (reverse sweep). In such a case, the term deposit is
broken and the amount of the reverse sweep earns lower interest rate due to the pre-mature
payment of that portion of the term deposit. However, the remaining amount of the term deposit
continues to earn the original interest rate.
Main Advantages of Flexi-Deposits to a Customer Are:
– Advantage of Convenience: The customer opens only one account (savings or current) under
the scheme and need not come to the bank branch each time for opening term deposit accounts
or for pre- paying/ breaking term deposit for meeting the shortfall in the savings /current
account.
– Advantage of Higher Interest Earning: The customer earns higher interest on his surplus
funds than is possible when he opens two separate accounts: savings and term deposits.
– Withdrawals through ATMs can also be conveniently made.
Exclusive Features:
– Complete Liquidity.
– Convenience of Overdraft.
– Earns a higher rate of interest on deposit, without the dilemma of locking it for a long period.
– At the time of need for funds, withdrawals can be made in units of Rs.1,000/- from the
Deposits by issuing a cheque from Savings Bank Account or through overdraft facility from
Current account.
– Flexibility in period of Term Deposit from 1 year to 5 years.
KYC
KYC establishes the identity and residential address of the customers by specified documentary
evidences. One of the main objectives of KYC procedure is to prevent misuse of the banking
system for money laundering and financing of terrorist activities. The ‘KYC’ guidelines also
reinforce the existing practices of some banks and make them compulsory, to be adhered to by
all the banks with regard to all their customers who maintain domestic or non-resident rupee
or foreign currency accounts with them. All religious trust accounts and non-religious trust
accounts are also subjected to KYC procedure. RBI had advised banks that:
(a) No account is opened in anonymous or fictitious/benami name (s)
(b) Bank will not open an account or close an existing account if the bank is unable to verify
the identity or obtain documents required by it due to non-cooperation of the customer.
Customer Identification Procedure
Customer identification means identifying the customer and verifying his/her identity by using
reliable, independent source documents, data or information. Banks need to obtain sufficient
information necessary to establish, to their satisfaction, the identity of each new customer,
whether regular or occasional, and the purpose of the intended nature of banking relationship.
Being satisfied means that the bank must be able to satisfy the competent authorities that due
diligence was observed based on the risk profile of the customer in compliance with the extant
guidelines in place. Such risk based approach is considered necessary to avoid disproportionate
cost to banks and a burdensome regime for the customers. Besides risk perception, the nature
of information/documents required would also depend on the type of customer (individual,
corporate etc.). For customers that are natural persons, the banks should obtain sufficient
identification data to verify the identity of the customer, his address/ location, and also his
recent photograph. For customers that are legal persons or entities, the bank should (i) verify
the legal status of the legal person/entity through proper and relevant documents; (ii) verify
that any person purporting to act on behalf of the legal person/entity is so authorized and
identify and verify the identity of that person; (iii) understand the ownership and control
structure of the customer and determine who are the natural persons who ultimately control the
legal person.
Customer Identification Requirements
(i) Trust/Nominee or Fiduciary Accounts
There exists the possibility that trust/nominee or fiduciary accounts can be used to circumvent
the customer identification procedures. Banks should determine whether the customer is acting
on behalf of another person as trustee/nominee or any other intermediary. If so, banks should
insist on receipt of satisfactory evidence of the identity of the intermediaries and of the persons
on whose behalf they are acting, as also obtain details of the nature of the trust or other
arrangements in place. While opening an account for a trust, banks should take reasonable
precautions to verify the identity of the trustees and the settlers of trust (including any person
settling assets into the trust), grantors, protectors, beneficiaries and signatories. Beneficiaries
should be identified when they are defined. In the case of a ‘foundation’, steps should be taken
to verify the founder managers/ directors and the beneficiaries, if defined.
(ii) Accounts of companies and firms
Banks need to be vigilant against business entities being used by individuals as a ‘front’ for
maintaining accounts with banks. Banks should examine the control structure of the entity,
determine the source of funds and identify the natural persons who have a controlling interest
and who comprise the management. These requirements may be moderated according to the
risk perception e.g. in the case of a public company it will not be necessary to identify all the
shareholders.
(iii) Client accounts opened by professional intermediaries
When the bank has knowledge or reason to believe that the client account opened by a
professional intermediary is on behalf of a single client, that client must be identified. Banks
may hold ‘pooled’ accounts managed by professional intermediaries on behalf of entities like
mutual funds, pension funds or other types of funds. Banks also maintain ‘pooled’ accounts
managed by lawyers/chartered accountants or stockbrokers for funds held ‘on deposit’ or ‘in
escrow’ for a range of clients. Where funds held by the intermediaries are not co-mingled at
the bank and there are ‘sub-accounts’, each of them attributable to a beneficial owner, all the
beneficial owners must be identified. Where such funds are co-mingled at the bank, the bank
should still look through to the beneficial owners.
Where the banks rely on the ‘Customer Due Diligence’ (CDD) done by an intermediary, they
should satisfy themselves that the intermediary is regulated and supervised and has adequate
systems in place to comply with the KYC requirements. It should be understood that the
ultimate responsibility for knowing the customer lies with the bank.
(iv) Accounts of Politically Exposed Persons (PEPs) resident outside India
Politically exposed persons are individuals who are or have been entrusted with prominent
public functions in a foreign country, e.g., Heads of States or of Governments, senior
politicians, senior government/judicial/military officers, senior executives of state-owned
corporations, important political party officials, etc. Banks should gather sufficient information
on any person/customer of this category intending to establish a relationship and check all the
information available on the person in the public domain. Banks should verify the identity of
the person and seek information about the sources of funds before accepting the PEP as a
customer. The decision to open an account for a PEP should be taken at a senior level which
should be clearly spelt out in Customer Acceptance Policy.
Banks should also subject such accounts to enhanced monitoring on an ongoing basis. The
above norms may also be applied to the accounts of the family members or close relatives of
PEPs.
(v) Accounts of non-face-to-face customers
With the introduction of telephone and electronic banking, increasingly accounts are being
opened by banks for customers without the need for the customer to visit the bank branch. In
the case of non-face-to-face customers, apart from applying the usual customer identification
procedures, there must be specific and adequate procedures to mitigate the higher risk involved.
Certification of all the documents presented should be insisted upon and, if necessary,
additional documents may be called for. In such cases, banks may also require the first payment
to be effected through the customer’s account with another bank which, in turn, adheres to
similar KYC standards. In the case of cross-border customers, there is the additional difficulty
of matching the customer with the documentation and the bank may have to rely on third party
certification/introduction. In such cases, it must be ensured that the third party is a regulated
and supervised entity and has adequate KYC systems in place.
(vi) Basic Savings Bank Deposit Accounts (No-Frills Savings Bank accounts)
(i) Persons those belonging to low income group both in urban and rural areas are not able to
produce such documents to satisfy the bank about their identity and address. This may lead to
their inability to access the banking services and result in their financial exclusion.
Accordingly, the KYC procedure also provides for opening accounts for those persons who
intend to keep balances not exceeding Rupees Fifty Thousand (Rs. 50,000/-) in all their
accounts taken together and the total credit in all the accounts taken together is not expected to
exceed Rupees One Lakh (Rs. 1,00,000/-) in a year. In such cases, if a person who wants to
open an account and is not able to produce documents mentioned as mentioned in the chart
below, banks should open an account for him, subject to:
Introduction from another account holder who has been subjected to full KYC procedure. The
introducer’s account with the bank should be at least six months old and should show
satisfactory transactions. Photograph of the customer who proposes to open the account and
also his address need to be certified by the introducer, or any other evidence as to the identity
and address of the customer to the satisfaction of the bank.
(ii) While opening accounts as described above, the customer should be made aware that if at
any point of time, the balances in all his/her accounts with the bank (taken together) exceeds
Rupees Fifty Thousand (Rs. 50,000) or total credit in the account exceeds Rupees One Lakh
(Rs. 1,00,000) in a year, no further transactions will be permitted until the full KYC procedure
is completed. In order not to inconvenience the customer, the bank must notify the customer
when the balance reaches Rupees Forty Thousand (Rs. 40,000) or the total credit in a year
reaches Rupees Eighty thousand (Rs. 80,000) that appropriate documents for conducting the
KYC must be submitted otherwise operations in the account will be stopped.
The necessity of knowing your customer is to,
(i) Check financial frauds
(ii) Identify money laundering and other suspicious activities,
(iii)Scrutiny and monitoring of large value transactions and,
(iv) Check opening of benami accounts.
Before establishing any banking relationship Bank will carry out due diligence as required
under “Know Your Customer” (KYC) guidelines issued by the Reserve Bank of India (RBI)
and/or such other norms or procedures adopted by the Bank. Due diligence basically means
that bank takes reasonable efforts to verify the customer’s antecedents and understand his
purpose of opening account with the bank. The due diligence process that the Bank follows,
includes obtaining recent photographs, verifying identity, verifying address, and other
information on occupation or business and source of fund for the person opening the account.
As part of the due diligence process the Bank may also require an introduction from a person
acceptable to the Bank if they so deem necessary. The objective of KYC framework is to ensure
appropriate customer identification and monitor transactions of suspicious nature. Different

means to identify customer’s antecedents could be from documents like passport, driving
license and verification from exiting account holders including the introduction of accounts by
bank customer. A valid introduction can be obtained from documents like PAN card, Income
Tax Authority, Election ID, Adharar Card etc. And the Proof of residence and verification
could be done through personal visits, ration cards, utility bills etc. The Reserve Bank of India
has stipulated that issuance of Demand Draft, Traveller’s Cheques, Mail Transfers or
Telegraphic Transfers (last two are no more in use due to technology improvement in banks),
beyond Rupees 50,000 and above it should be done only through the debit to the account or
through cheque deposit and not against cash. Some close relatives, e.g. wife, son, daughter and
parents etc. who live with their husband, father/ mother and son, as the case may be, are finding
it difficult to open account in some banks as the utility bills required for address verification
are not in their name. In such cases, banks can obtain an identity document and a utility bill of
the relative with whom the prospective customer is living along with a declaration from the
relative that the said person (prospective customer) wanting to open an account is a relative
and is staying with him/her. Banks can use any supplementary evidence such as a letter received
through post for further verification of the address. The Information collected from the
customer under KYC requirements while opening account is to be kept confidential, cannot
divulge information with any outsider, cannot use for cross-selling or any other purpose and
should be used for bank’s internal purposes. It is to be noted that KYC information normally
cannot be part of the account opening form. It could be collected on voluntary basis only from
customers.
Closing of a Bank Account
Banker-customer relationship is a contractual relationship between two parties and it may be

terminated by either party on voluntary basis or involuntarily by the process of law. These
two modes of termination are described below.
A. Voluntary Termination:
The customer has a right to close his demand deposit account because of change of residence
or dissatisfaction with the service of the banker or for any other reason, and the banker is bound
to comply with this request. The banker also may decide to close an account, due to an
unsatisfactory conduct of the account or because it finds the customer undesirable for certain
reasons.
However, a banker can close an account only after giving a reasonable notice to the customer.
However, such cases of closure of an account at the instance of the banker are quite rare, since
the cost of securing and opening a new account is much higher than the cost of closing an
account. If a customer directs the banker in writing to close his account, the banker is bound to
comply with such direction. The latter need not ask the reasons for the former’s direction. The
account must be closed with immediate effect and the customer be required to return the unused
cheques.
B. If the Bank desires to close the account:
If an account remains un-operated for a very long period, the banker may request the customer
to withdraw the money. Such step is taken on the presumptions that the customer no longer
needs the account. If the customer could not be traced after reasonable effort, the banker usually
transfers the balance to an “Unclaimed Deposit Account”, and the account is closed. The
balance is paid to the customers as and when he is traced. The banker is also competent to
terminate his relationship with the customer, if he finds that the latter is no more a desirable
customer. The banker takes this extreme step in circumstances when the customer is guilty of
conducting his account in an unsatisfactory manner, i.e. if the customer is convicted for forging
cheques or bills or if he issues cheques without sufficient funds or does not fulfill his
commitment to pay back the loans or overdrafts, etc. The banker should take the following
steps for closing such an account:
(a) The banker should give to the customer due notice of his intention to close the account and
request him to withdraw the balance standing to his credit. This notice should give sufficient
time to the customer to make alternative arrangements. The banker should not, on his own,
close the account without such notice or transfer the same to any other branch.
(b) If the customer does not close the account on receipt of the aforesaid notice, the banker
should give another notice intimating the exact date by which the account be closed otherwise
the banker himself will close the account. During this notice period the banker can safely refuse
to accept further credits from the customer and can also refuse to issue fresh cheque book to
him. Such steps will not make him liable to the customer and will be in consonance with the
intention of the notice to close account by a specified date. The banker should, however, not
refuse to honour the cheques issued by the customer, so long as his account has a credit balance
that will suffice to pay the cheque. If the banker dishonours any cheque without sufficient
reasons, he will be held liable to pay damages to his customer under Section 31 of the
Negotiable Instruments Act, 1881. In case of default by the customer to close the account, the
banker should close the account and send the money by draft to the customer. He will not be
liable for dishonouring cheques presented for payment subsequently.
C. Termination by Law: The relationship of a banker-customer can also be terminated by the
process of law and by the occurrence of the following events:
(a) Death of customer: On receiving notice or information of the death of a customer, the bank
stops all debit transactions in the account. However, credits to the account can be permitted.
The balance in the account is given to the legal representative of the deceased after obtaining
the letters of administration, or succession certificate, or indemnity bond as per the prescribed
procedure, and only then, the account is closed.
(b) Bankruptcy of customer: An individual customer may be declared bankrupt, or a company
may be wound up under the provisions of law. In such an event, no drawings would be
permitted in the account of the individual/company. The balance is given to the Receiver or
Liquidator or the Official Assignee and the account is closed thereafter.
(c) Garnishee Order: After receiving a garnishee order from a court or attachment order from
income tax authority, the account can be closed as one of the options after taking the required
steps.
(d) Insanity of the customer: A lunatic/person of unsound mind is not competent to contract
under Section 11 of the Indian Contract Act, 1872. Since banker-customer relationship is
contractual, the bank will not honour cheques and can close the account after receiving notice
about the insanity of the customer and receiving a confirmation about it through medical
reports.
TRUST ACCOUNT
A trustee is a person in whom confidence is repose. He is given control of an estate, usually of

the deceased, for the benefit of certain person. The person reposing the trust is called trustees.
The person for whose benefit the trust is created is called beneficiary. The document creating
the trust is called the ‘trust deed’. The formation and operation of trusts in India are governed
by the Indian Trusts Act of 1882. As per Section 3, “A trust is a commitment attached to the
responsibility for, and emerging out of a trust in and acknowledged by the proprietor, or
proclaimed and acknowledged by him, for the advantage of another, or of another and the
proprietor.” Bank opens trust accounts for good parties. A trust can be public or private. All
public trusts are required to be registered with the Charity Commissioner of the respective state
under Public Trust Act. A charity commissioner has various duties to perform before the bank
opens the account for a trust. Before registering an open trust, the Charity Commissioner makes
important inquiries with regards to the trust, its trustees, and the method of progression of
trusteeship and so on. After appropriate inquiries, it makes sections in the register, which are
definitive and are official for all concerned. Banks open trust accounts after taking all possible
precautionary measures.
While opening account for a trust, the bank obtains the following documents from the trust:
1. A duplicate of the constitution of the trust
2. The trust deed, if available
3. Testament of enrolment and an affirmed duplicate of the passage of the general population
trust’s register
4. Open Trust Register Number.
5. A rundown of the present trustees and the power designating them as trustees.
6. The vital determination went by the trustees for opening the record with the bank.
7. Attested duplicate of the determination marked by every one of the trustees on the behaviour
of the record. For Trusts which have no constitution, instruments of trust or plan is required.
While opening records of such trusts, the bank receives after reports:
1. A testament of enrolment issued by the workplace of the Deputy/Assistant Charity
Commissioner (Where it is so conceivable, under the relative law).
2. A guaranteed duplicate of the most recent passage in the general population trusts registers
(Public Trust Registration), which demonstrates the name of the trust, the Public Trust
enrolment No. of the Trust, at which it is enlisted and name/s of the trustee/s.
3. A presentation and a repayment from are gotten every one of the trustees.
4. A determination went by the trustees identifying with the opening of the record
Trust accounts must be opened and led entirely as per the terms of the trust deed. Every one of
the trustees is required to act jointly with the persons so approved by the enrolled trust deed.
Trustees have no forces to delegate their power to one or more unless the force of appointment
is approved by the trust deed or is as per the bearings of the court on an application made by
the trustees. Trustees have no inferred power to acquire or vow trust property unless such a
provision is incorporated in the trust deed. On the demise of one of the trustees, the trust
property goes to alternate trustees according to the procurement of the trust deed. On the off
chance that the perished person was the sole trustee, his agent has no privilege to recoup the
trust cash. The agent, be that as it may, has the privilege to designate another trustee, gave the
expired trustee has, in his will, particularly approved such an arrangement.
A banker should take the following precautions while having business dealings with the
trustees:
(i) The banker should thoroughly study the trust deed. The trust contains the names of the
trustee, their powers, the details of the trust property and other terms.
(ii) In case of several trustees, all trustees must act jointly unless the trust deed provides for
delegation of powers to some of the trustees.
(iii) In case an account is opened for two or more trustees, the bank should obtain clear
instructions as regards the person or persons who shall sign the cheques or other instruments.
In the absence of such instructions all trustees must sign on each occasion.
(iv) In the case of death or retirement of one or more of the trustees, the powers of surviving
or remaining trustees will depend on the provisions of the trust deed.
(v) In the event of retirement of all the trustees, the new trustees may be appointed by the court.
(vi) The insolvency of one or more trustees does not in any way affect trust property since if
cannot be utilized for payment of the personal debt of the trustee.
(vii) The banker should not knowingly permit the misuse of trust funds, otherwise it can be
held liable to the beneficiaries of the trust. For example, in a case, where the banker who had
knowledge of the trust character of an account allowed the customer to transfer funds standing
to the credit of the trust account to his personal account which was overdrawn, it was held that
the banker was liable to pay the money to the account to which it really belonged.
(viii) In case of charitable trust, the banker should examine the registration certificate issued
by the charity commissioner or such other authority as may be prescribed by the state
Government concerned under the Public Trust Act.
JOINT ACCOUNT
A joint account is an account by two or more persons. At the time of opening the account all
the persons should sign the account opening documents. Operating instructions may vary,
depending upon the total number of account holders. In case of two persons it may be (i) jointly
by both account holders (ii) either or survivor (iii) former or survivor In case no specific
instructions is given, then the operations will be by all the account holders jointly, The
instructions for operations in the account would come to an end in cases of insanity, insolvency,
death of any of the joint holders and operations in the account will be stopped. All Savings
Bank Accounts irrespective of their mode of operations must comply with KYC standards/Anti
Money Laundering Measures (AML)/ combating Financing of Terrorism (CFT) and
Modifications to customer Identification Procedure (CIP).
1) An Account in the names of two or more persons operated upon by any one or more or all
of them, and the balance made payable to any one or more or all of them or anyone or more or
all of the survivors of them or to the last survivor, as applicable.
2) The mode of operation of a joint account should be specified at the time of opening the
account and cannot be changed subsequently, without the written consent of all the joint
account-holders.
3) In a joint account of two persons to be operated upon by 'Either or Survivor' on the death of
any one of them the surviving account-holder alone can operate on and will be entitled to the
balance in the account, the heirs of legal representatives of the deceased account-holder will
have no claim against the Bank. On the death of the surviving account-holder, his heirs or legal
representatives alone will be entitled to claim the balance from the Bank. Example: Mother and
daughter can open a joint-account. On death of anyone of them, the surviving person can
continue the account or get the account balance transferred to her name.
4) A joint account to be operated upon by 'Former or Survivor' can also be opened. Where the
special instructions relating to the operation of an account reads 'Former or Survivor' the
account shall be operated upon and the cheques/withdrawal forms shall be drawn by and the
balance shall be repayable to the former i. e. the first named account-holder during his/her life
time and only after his/her death by and to the second named account-holder if then surviving.
5) Anyone (Or) Survivor – This is similar to “either or survivor” option. The only difference
is, more than two individuals can operate the account. If you want your father, mother and
spouse to be able to access and operate your bank account then this is the best option. In case
of death of anyone of the account holders, the remaining survivors can continue to operate the
account.
6) Latter (Or) Survivor – This is similar to “former/survivor” option. The main difference is,
only the second account holder can access and operate the account till the time he/she is alive.
The primary/first account holder can operate the account only on death of the secondary
account holder. Example: Husband and wife are the joint-account holders. Wife is a second
account holder. Then in this case, only wife can operate the account. Only after she is no more,
can the husband have access to operate the account.
7) Jointly – In this type of account, all the transactions need to be signed and mandated by all
the account holders. If any of the account holder dies then the account cannot be further
operated. The balance proceeds shall be payable to survivor.
8) Jointly or Survivor –This is similar to “jointly” option. The only difference being, the
survivor can continue to operate the account. Alternatively, the proceeds of the account can be
transferred to his/her name. Along with the above options there is another type which is “Minor
Account.” If the primary account holder is less than 18 years of age then there should be an
adult guardian, as a joint account holder.
Addition or Deletion of name(s) of Joint account holder(s)

You can request the bank to add a new joint account holder or delete any of the existing joint
account holder’s names. But, all the existing account holders have to sign on the request form
if the mode of operation is “either or survivor” or “jointly “.
Let’s say two brothers (A & B) opened a joint account with “Either or Survivor” option. B
(Second account holder) started misusing the account funds. A decides to delete the name of B
from joint account. But, the banker says that they require B’s consent for the deletion.
Primary/First applicant can restrict internet banking access for other joint account holders (if
required). Some banks provide this option in Account opening form itself. By choosing these
options, one can provide limited access to other joint account holders. It must be noted that
there are chances that your banker may treat the interest income on joint-account as income of
Primary account holder only (unless the primary holder mandates the bank about the specific
percentages). The various types of joint accounts provide lot of advantages like ease of
operating the account, convenience, rights of survivorship etc.
SPECIAL TYPE OF CUSTOMERS
Special types of customer means are those who are distinguished from other types of ordinary
customers by some special features. Hence, they are called a special type of customers. The
capacity of certain classes of person, to make valid agreement is subject to certain legal
restrictions, as is the case with minors, lunatics, drunkards, married women, undischarged
insolvents, trustees, executors, administrators etc.
1.) Minors: A minor is a person who has not completed 18 years of age. In case a guardian of
his person or property is appointed by a court of law before he completes his 18 years, the
period of minority is extended to the completion of 21 years.
Accounts of Minor: As per The Contract Act a minor is not capable to enter into any contract.
So minor is not allowed to open a bank account by himself. As per The Guardian and Wards
Act (Act. VIII of 1980) there are three types of guardian who can open bank account in the
name of minor viz Natural Guardian, Testamentary Guardian and Guardian appointed by the
Court.
1. Natural Guardian: Father or Mother or husband of a married minor girl
2. Testamentary Guardian: Those guardians who are appointed by the natural guardian
(father or mother) who will act as guardian after the death of the Natural Guardian.
3. Guardian appointed by the Court: If the natural guardian is not alive or is not fit for
becoming guardian for insanity, changing the religion, etc.
A Bank account can be opened and operated by the Guardian in the name of minor till
becoming the maturity of the minor (upto 18- or 21-years age). Also, the guardian may continue
operation after majority of the minor subject to getting written consent of the major in this
respect (preferably submitting written request to the Bank)
Banker’s precaution:
1. Recording the date of birth and date majority of the minor in the AOF, SS Card and in
the ledger/computer.
2. Recording the date of death of the guarding of the minor. The date of death to the
informed to the Bank. The close relation of the minor will introduce him to the bank.
3. No overdraft can be allowed in this account.
4. Who opens the account in favour of minor will introduce him/her to the bank after his
majority.
2.) Lunatics, Drunkard or Intoxicated Person
All contracts made by lunatics are void except those made during lucid intervals. A customer
may become a lunatic after opening his account with the bank. In such a case the bank will not
be responsible if it honours a cheque or bill duly drawn accepted or endorsed by the lunatic
unless it is proved that it knew of his lunacy at the time of honoring or discounting. The bank
should, therefore, suspend all operations on the account of a person who to its knowledge has
become lunatic till it receives a proof of his sanity or gets an order of the court to that effect. A
banker should treat a customer as sane till there is fairly conclusive evidence in support of his
insanity.
The banker should take the following steps on receiving notice of customer’s insanity.
1. It should return all cheques on customer’s account with the words refer to drawer and not
‘customer insane’.
2. It should make a careful note of the lunacy order as and when received from the court.
3. It should allow the operation of the account only as per the lunacy order.
4. It should not allow the customer to operate the account till he is certified by the court to be
sane.
3.) Illiterate Person: An illiterate person may open an account with a bank. The banker should
take the following steps:
1. Thumb impression: The left hand for man and right hand for
woman thumb impression of the depositor should be obtained on the account opening
form and the specimen signature sheet in the presence of an authorized supervising
official.
2. Identification mark: Where possible, brief details of one or two identification marks
of the depositor should be noted on the account opening form and the specimen
signature sheet under authentication of an authorized officials.
3. Photograph: Two copies of passport size of the depositor should be obtained and got
renewed every three years.
4. General Implication and conditions for operation of the account should explained to
the depositor by an authorized official. Withdrawals the account should generally be
allowed only when the person comes personally and produces his or her passbook /
balance confirmation certificate and put thumb impression on the cheque in the
presence of bank officials.
4.) Trustees: A trustee is a person in whom confidence is repose. He is given control of an
estate, usually of the deceased, for the benefit of the certain person. The person reposing the
trust is called trustees. The person for whose benefit the trust is created is called beneficiary.
The document creating the trust is called the ‘trust deed’
A banker should take the following precautions while having business dealings with the
trustees:
• The banker should thoroughly study the trust deed. The trust contains the names of the
trustee, their powers, the details of the trust property and other terms.
• In case of several trustees, all trustees must act jointly unless the trust deed provides for
delegation of powers to some of the trustees.
• In case an account is opened for two or more trustees, the bank should obtain clear
instructions as regards the person or persons who shall sign the cheques or other
instruments. In the absence of such instructions all trustees must sign on each occasion.
• In the case of death or retirement of one or more of the trustees, the powers of surviving
or remaining trustees will depend on the provisions of the trust deed.
• In the event of retirement of all the trustees, the new trustees may be appointed by the
court.
• The insolvency of one or more trustees does not in any way affect trust property since if
cannot be utilized for payment of the personal debt of the trustee.
• The banker should not knowingly permit the misuse of trust funds, otherwise it can be held
liable to the beneficiaries of the trust. For example, in a case, where the banker who had
knowledge of the trust character of an account allowed the customer to transfer funds
standing to the credit of the trust account to his personal account which was overdrawn, it
was held that the banker was liable to pay the money to the account to which it really
belonged.
• In case of the charitable trust, the banker should examine the registration certificate issued
by the charity commissioner or such other authority as may be prescribed by the state
Government concerned under the Public Trust Act.
5.) Executors and Administrators: Executors and Administrators, both are persons appointed
to settle the accounts of a person after his death. Executor is appointed by the deceased himself,
before his death. The person appointing him is called ‘testator’’ The executor has to act
according to the directions given in the will. However, he must get the official confirmation of
the will technically called as probate, from the court.
The ‘Administrator’ is appointed by Court in those cases where the deceased has not given the
name Executor in his will or person named as executor has died or refuses to act. He disposes
of the assets and makes payment of the liabilities of the deceased as per the directions given in
the will or in its absence in the letter of Administration issued by the Court appointing him as
Administrator.
The Banker should observe the following precautions while dealing with Executors
or Administrators.
• The bank should examine the Letter of Probate’ (i.e. official confirmation of the will) in
case of Executors and Letter of Administration in case of Administrators to acquaint itself
with be powers and functions of the executors or the administrators.
• An account in the following style may be opened in the name of executors or administrators.
• ABC executors (or administrators) of the estate of X, the deceased’’
• In case of joint executors or administrators, the banker should get clear instructions, from
then regarding the executors, administrators who will operate the account.
• The executors may borrow money for discharging some urgent obligations of the deceased.
The executors or administrators are personally liable for such loans unless the banker has
given loan on the specific asset of the deceased. In case of joint executors or administrators
the power to mortgage or pledge is available to all of them jointly. Moreover, they cannot
exercise such power if the probate or letter of administration specifically forbids it.
6.) Married Woman: A married woman is competent to enter into a valid contract. The banker
may, therefore, open an account in the name of a married woman.
In case of a debt taken by a married woman, her husband shall not be liable except in the
following circumstances:
If the loan is taken with his consent or authority; and
If the debt is taken for the supply of necessaries of life to the wife, in case the husband defaults
in supplying the same to her. The husband shall not be liable for the debts taken by his wife in
any other circumstances. The creditor may in that case recover his debt out of the personal assets
of the married woman. While granting a loan to a married woman, the banker should, therefore,
examine her own assets and ensure that the same are sufficient to cover the amount of the loan.
7.) Joint Hindu Families: The concept of joint Hindu Family is recognized by law. A business,
according to law is a distinct heritable asset. Where a Hindu die, leaving a business it passes on
the heirs. If he leaves male issues it descends to them and the property becomes joint Hindu
Family property. The members of the family are called coparceners and the eldest male member
is the manager or the karta. When an account in the name of the JHF is opened all the adult co-
parceners are to sign the account opening form, even though the karta would operate on the
account. In addition, the bankers also obtain a letter of undertaking signed by all the adult
coparceners stating that the business carried on by the family through births and deaths will be
advised to the banker. If the business is ancestral, the coparceners are liable to the extent of
their share in the family property, whereas if the business is not ancestral, coparceners will be
personally liable for the family from the bank.
The main problem in dealing with a JHF arises in respect of loans. In the JHF governed by
Mitakshara law, all the members acquire a right in the property by birth and this right starts
from the date of conception in the womb and so there is always the danger of a loan being
repudiated by a member who was not even born on the date of the transactions. The burden of
proving this necessity lies on the banker and the banker has to not only prove the legal necessity,
but also prove that he made reasonable inquiries and was satisfied as to the existence of the legal
necessity.
To avoid these and several other difficulties, some banks requires a Hindu customer opening an
account, to furnish a statement to this effect that the money deposited is his self-acquired
property and not that of JHF.
• The account should clearly indicate that it is a JHF.

• The JHF letter should be signed by all the coparceners.
• The letter should clearly indicate the powers of the karta.
• All coparceners should sign the documents for loans.
• Death/Lunacy/Insolvency of coparceners does not dissolve the JHF. It continues till
partition of property.
8.) Partnership: A bank should take the following precautions in the course of having business
dealing with the firm:
1) The banker should open an account in the name of partnership firm only when one or
more partners make an application to the effect.
2) The bank should ask for a copy of the partnership agreement and thoroughly acquaint
itself with its clauses.
3) The banker should take a letter signed by all the partners containing the following:
a) The name and address of all partners
b) The nature of the firm’s business
c) The names of the partners authorized to operate the account in the name of the
firm.
4) The banker should not credit a cheque in the firm’s name to the personal account of a
partner without enquiring from other partners.
5) In the absence of any contract to the contrary, a partnership firm stands dissolved on
the death of a partner.
6) In case the firm continues to carry on the business, the estate of the deceased is not
liable for any act of the firms after his death.
9.) Co – Operative Societies: These are established under Co – operative societies act in force
in various states. They are governed by their respective rules and by – laws. Before opening
the accounts, these have to be scrutinized to see if there are any restrictions on opening bank
accounts. In some states, the cooperative societies cannot open accounts with commercial
banks without permission from the registrar of cooperative societies and the registrar may
also impose certain conditions like maximum balances. All such conditions should be observed
while opening also impose certain conditions like maximum balances. All such conditions
should be observed while opening and operating the accounts
PAYMENT OF CUSTOMERS’ CHEQUE
The Negotiable Instruments Act, 1881 defines the “Cheque‟ as under: A “cheque‟ is a bill of
exchange drawn on a specified Banker and not expressed to be payable otherwise than on
demand.
The above provision has been substituted by the Negotiable Instruments (Amendment and
Miscellaneous Provisions) Act 2002, as under: A “cheque‟ is a bill of exchange drawn on a
specified banker and not expressed to be payable otherwise than on demand and it includes the
electronic image of a truncated cheque and a cheque in the electronic form.
A “bill of exchange‟ is an instrument in writing containing an unconditional order, signed by
the maker, directing a certain person to pay a certain sum of money only to, or to the order of
a certain person or to the bearer of the instrument. It will be thus seen that cheque is a special
kind of bill of exchange in the sense that it is drawn in the name of a specified Banker.
Black’s Law Dictionary defines cheque as a draft drawn upon a bank and payable on demand
signed by the maker or drawer, containing an unconditional promise to pay a sum certain in
money to the order of the payee.
To open a checking account, a person deposits a sum of money in a bank. The bank gives him
a check-book with blank check forms, and provides him with a means of keeping a record of
the checks he writes and the amount of money he still has on deposit. The bank gives him a
receipt for each new deposit and sends him a statement (usually monthly) showing a complete
record of all transactions. All concealed checks (checks that have been cashed by the bank) are
returned with the statement, providing the depositor with proof that payment was received. The
bank usually makes a small service charge on every account, and perhaps also a charge for
each check written. Ordinarily, no interest is paid on checking accounts.
To make out a check, the depositor writes the date, the name of the payee (the person or firm
who is to receive the money), and the amount. He then signs his name. Before cashing the
check, the payee must endorse it by signing his name on the back. He then either deposits it in
a bank or exchanges it for cash by giving the check to a bank, currency exchange, business
firm, or individual. The new owner can endorse the check to someone else or can deposit it in
a bank. When a check reaches a bank, it is forwarded through a clearing-house back to the bank
on which it was drawn. After making sure the depositor’s signature is genuine, this bank in
turn pays the cashing bank through the clearinghouse. The biggest danger in accepting a check
is that the person writing it may not have enough money (or any money) in the bank to cover
it. Forgery is another danger. The best defence against “bad checks” is to refuse to accept
checks from strangers.
Hundi – There is no legal definition either statutory or otherwise of a hundi, though such
documents are in common use. Hundis are of several kinds the chief being Shahjogi Hundi
Jokhmi Hundi, Namjag Hundi.
In fact, the word ‘hundi’, a generic term used to denote instruments of exchange in vernacular,
is derived from the Sanskrit root ‘hund’ meaning ‘to collect’ and well express the purpose to
which such instruments were utilised in their origin.
Hundis or indigenous bills of exchange came into use from the 12th century, and it appears
from the writing of a few Muslim historians, European travellers, State records and the Ain-i-
Akbari that both under the early Muslim and Mogul rulers in India indigenous bankers played
a prominent part in lending money, financing internal and foreign trade with cash or bills, and
giving financial assistance to rulers during periods of stress. No exact information is available
regarding the rates of interest charged by them, but it appears from the evidence that is
available, that they were higher than those prescribed in Kautilya’s Arthashastra.
The Reserve Bank of India describes the Hundi as "an unconditional order in writing made by
a person directing another to pay a certain sum of money to a person named in the order."
ESSENTIALS OF A CHEQUE
Cheque is by far one of the important negotiable instruments. It is frequently used by the people
and business community in the course of their personal and business transactions. The essential
requisites of cheque are as under:
A) Must be in Writing – The cheque may be scribed by hand by using ink or ballpoint pen,
typed or it may even be printed. However, the customer should not make use of pencil to fill
up the cheque form. Even though other columns may be permitted to be filled up in hand or
printed or typed, the signatures should be made in ink by the drawer.
B) Must be Unconditional – The order to pay the amount must be absolute and unconditional.
If any condition is imposed to pay the amount to the holder of the cheque then it will not be
considered to be a valid cheque. A cheque made payable on the happening of some contingent
event is void ab-initio.
C) Must be Drawn on a Specified Banker – For a cheque to be validly recognized under law
it must be drawn on a specified banker. If there is no mention in the cheque about the banker it
would not be a valid cheque. In addition to it, it must contain mention all the three parties i.e.
Drawer, Drawee and Payee.
D) Certain Sum of Money – It is one of the essential requirements of the cheque that it must
be payable in terms of money and money only. If not in terms of money but some other
quantifiable units then it will not be a valid one. Also, the sum mentioned in it must be certain
and quantified exactly y.
E) Certain Payee – The parties of the Cheque must be certain and not vague like “wife of Mr.
Ashok”. There are three parties of the cheque i.e. Drawer, Drawer and Payee. In a valid Cheque
the names of all three must be certain and specific. It must contain an order, which must be
unconditional.
F) Date – A cheque must be signed by the drawer with date otherwise it would not be a valid
cheque. The date on which the cheque is drawn must be specific because as per the guidelines
of Reserve Bank of India, cheque is valid for presentment only within three months from the
date on which it is drawn.
Aspect of Negotiability
In accordance with Section 5 and 6 of the Indian Negotiable Instruments Act, 1881, cheques
are regarded as negotiable. A stud y of the cheque, thus, requires a study of the negotiable
instrument. An instrument, to be negotiable must conform to the following requirements:
(i) It must be in writing and signed by the maker or drawer;
(ii) It must contain an unconditional promise or order to pay certain sum in money;
(iii) It must be payable on demand; or at a fixed or determinable future time;
(iv) It must be payable to order or to bearer; and
(v) Where the instrument is addressed to a drawee, he must be named or otherwise
indicated the rein with reasonable certainty.
When the holder of a negotiable instrument who is entitled to receive its payment, transfers the
same to another person so that the transferee now becomes entitled to receive the payment
thereof, the instrument is said to have been negotiated. When a promissory note, bill of
exchange or a cheque is endorsed to any person, so as to constitute that person the holder
thereof, the instrument is said to be negotiated. In other words, negotiation means in simple
words, a transfer of negotiable instrument from one person to another in accordance with the
provisions of the Negotiable Instrument Act, so that the rights in an instrument are transferred
from one person to another. It is necessary that the transfer of the instrument must have been
effected with an intention to transfer the rights
A negotiable instrument may be negotiated in two ways: (i) if the instrument is a bearer
instrument, the rights in it can be transferred by mere delivery from one person to another. It is
however, necessary that the delivery of the negotiable instrument must be made with an
intention to transfer ownership, i.e. constitute the transferee as the holder of the instrument, as
required by section 1421 (ii) If the instrument is an order one the rights in it can be transferred
by endorsement and delivery
PARTIES TO THE CHEQUE
The maker of a cheque is called the ‘Drawer’, the person thereby directed to pay is called
‘Drawee’ and the person named in the instruments, to whom or to whose order the money is
by the instrument direct to be paid, is called the “Payee.” [Section 7 of the Negotiable
Instruments Act, 1881]
The person entitled in his own name to the possession of the cheque and to receive or recover
the amount due is called the “Holder of the cheque.” [Section 8 of the Negotiable
The person who for consideration becomes the possessor of the cheque if payable to bearer, or
the payee or endorsee thereof, if payable to order, before the amount mentioned in it became
payable and without having sufficient cause to believe that any defect existed in the title of the
person from whom he derived his title is called the “Holder in due course.” [Section 9 of the
Negotiable Instruments Act, 1881]
The maker or the holder of the cheque signs his name (endorse) on the back of the cheque for
the purpose of negotiable and he is said to be the ‘Endorser.’ [Section 15 of the Negotiable
The endorser who signs his name and directs to pay the amount mentioned in the cheque to, or
the order of, a specified person, and the person so specified is called the “Endorsee” of the
cheque. [Section 16 of the Negotiable Instruments Act, 1881]
HOLDER AND HOLDER IN DUE COURSE
Every instrument initially belongs to the payee and he is entitled to its possession. The payee
can transfer it to any person in payment of his own debt. This transfer is known as
“negotiation‟.
Negotiation takes place in two ways. A bearer instrument passes by simple delivery and the
person to whom it is delivered becomes the holder. An order instrument, on the other hand, can
be negotiated only by endorsement and delivery and the endorsee becomes the holder. Hence
the holder means either the bearer or endorsee of an instrument. Accordingly, Section 2 of the
English Bills of Exchange Act, 1882, provides that “holder means the payee or endorsee of a
bill or note who is in possession of it or the bearer thereof”. The definition contained in Section
8 of the Indian Act is to the same effect, although expressed in different words. It says that
holder “means any person entitled in his own name to the possession” of an instrument “and to
receive and recover the amount”. Now, no one can be entitled to the possession of a bill or note
unless he becomes either the bearer or endorsee thereof
The holder must be entitled in his own name to the possession of the instrument. A person may
be entitled to possession of the Instrument although he does not have actual possession. The
definition seems to suggest that the term holder means only adejure holder and does not
necessarily apply to a defacto holder. A person may be operation of law become the holder of
a negotiable Instrument although he is not the bearer, payee or indorsee there of, the heir or
legal representative of a deceased payee can claim as the holder. A holder must have the right
to receiver or recover the amount due on the instrument from the parties there to. To qualify as
a holder, a person should have derived title to the instrument in a lawful manner.
Holder in Due Course – Section 9 of the Negotiable Instruments Act, 1881 defines ‘Holder
in Due Course’ which reads as under: - “ ‘Holder in due course’ means any person who for
consideration became the possessor of the a promissory note, bill of exchange or cheque if
payable to bearer, or the payee of endorsee thereof, if payable to order, before the amount
mentioned in it became payable, and without having sufficient cause to believe that any defect
existed in the title of the person from whom he derived his title.”
In order that a person can be called a holder in due course, he must show:
(a) that he is the holder of the negotiable instrument,
(b) he has obtained it for consideration,

(c) he has obtained it before the maturity of the negotiable instrument, and
(d) that he has obtained the negotiable instrument in good faith.
Until contrary is proved the holder of a negotiable instrument is presumed to be a holder in due
course.
In India it has been seen above the payee can also be a holder in due course but in England the
payee of a negotiable instrument cannot be holder in due course as was decided by the house
of Lords in Jones v. Waring and Gillow. If a person gets an instrument under a forged
endorsement, he cannot be called a holder in due course. A transferee under a forged
endorsement gets no title to the instrument and if such a transferee has been able to get the
amount of the instrument, he is bound to account for the same to the owner of the instrument.
ENDORSEMENT
When the maker or holder of a negotiable instruments signs the same otherwise than as maker,
for the purpose of negotiating the same, on the back or face thereof, or on a slip of paper
annexed there to or so signs for the same purpose a stamped paper intended to be completed as
negotiable instrument, he is said to endorse the same, and is thereby called the “endorser.” The
endorsement therefore means signatures of the person which are generally made at the back of
the instrument, for the purpose of transfer of rights consisted therein to another person. An
endorsement is completed by the delivery of the instrument to the endorsee.
Types of Endorsements
1. Blank or genera endorsement:
If the endorser signs his name only and does not specify the name of the endorsee, the
endorsement is said to be in blank Sec. 16(1). The effect of a blank endorsement is to convert
the order instrument into bearer instrument (Sec. 54), which may be transferred merely by
delivery.
2. Endorsement in full or special endorsement:
If the endorser, in addition to his signature, also adds a direction to pay the amount mentioned
in the instrument to, or to the order of, a specified person the endorsement is said to be in full
[Sec. 16(1)].
If, for example, A, the holder of a bill of exchange, wants to make an endorsement in full to B,
he would write thus: “Pay to B or order, SdA4.” After such an endorsement it is only the
endorsee, i.e., B, who is entitled to receive the payment of the instrument and to further
negotiate the instrument by his endorsement.
A blank endorsement can easily be converted into an endorsement in full, According to Section
49, the holder of a negotiable instrument endorsed in blank may, without signing his own name,
by writing above the endorser’s signature a direction to pay to any other person as endorsee,
convert the endorsement in blank into an endorsement in full; and since such holder does not
sign himself on the instrument he does not thereby incur the responsibility of an endorser.
3. Partial Endorsement:
Section 56 provides that a negotiable instrument cannot be endorsed for a part of the amount
appearing to be due on the instrument. In other words, a partial endorsement which transfers
the rights to receive only a part payment of the amount due on the instrument is invalid.
Such an endorsement has been declared invalid because it would subject the prior parties to
plurality of actions (one action by holder for part value and another action by endorsee for part
value) “and will thus cause inconvenience to them.
Moreover, it would also interfere with the free circulation of negotiable instruments. It may be
noted that an endorsement which purports to transfer the instrument to two or more endorses
separately, and not jointly is also treated as partial endorsement and hence would be invalid.
Thus, where A holds a bill for Rs 2,000 and endorses it in favour of B for Rs 1,000 and in
favour of C for the remaining Rs 1,000, the endorsement is partial and invalid.
Section 56, however, further provides that where an instrument has been paid in part, a note to
that effect ma; be endorsed on the instrument and it may then be negotiated for the balance.
Thus, if in the above illustration the acceptor has already paid Rs 1,000 to A, the holder of the
bill, A can then make an endorsement saying “Pay B or order” Rs 1,000 being the unpaid
residue of the bill.” Such an endorsement would be valid.
4. Restrictive endorsement:
Stating the effect of endorsement, Section 50 provides that “the endorsement of negotiable
instrument followed by delivery transfers to the endorsee the property herein with the right of
further negotiation.” However, Section 50 permits restrictive endorsement.
An endorsement which, by express words, prohibits the endorsee from further negotiating the
instrument or restricts the endorsee to deal with his instrument as directed by the endorser is
called ‘restrictive’ endorsement.
The endorsee under a restrictive endorsement gets all the rights of an endorser except the right
of further negotiation. In other words, such an endorsement entitles the endorsee to receive the
payment on due date and sue the parties for it but he cannot further negotiate the instrument.
Illustrations:
(a) B, the holder of the bill, makes an endorsement on the bill saying “Pay C only.” It is a
restrictive endorsement as C cannot negotiate the bill further.2
(b) B, the holder of the bill, makes an indorsement on the bill, saying “Pay C for my use or
“Pay C or order for the account of B.” In either case there is a restrictive endorsement as the
right of further negotiation by C has been excluded thereby.
The person liable on the hill must pay by drawing a cheque in the name of the holder (or the
endorser) B. If he makes the payment to C on C’s own account, he will still be liable to B, the
endorser; Hence C cannot endorse the bill further in his own name.
5. Conditional endorsement:
If the endorser of a negotiable instrument, by express words in the endorsement, makes his
liability, dependent on the happening of a specified event, although such event may never
happen, such endorsement is called a ‘conditional’ endorsement (Sec. 52).
The law permits a conditional endorsement and therefore it does not in any way affect the
negotiability of the instrument. Thus, endorsements can validly be made in the following terms:
(i) “Pay B or order on his marriage;”
(ii) “Pay B on the arrival of Pearless ship at Bombay.”
In the case of a conditional endorsement the liability of the endorser would arise only upon the
happening of the event specified. But the endorsee can sue other prior parties, e.g., the maker,
acceptor, etc., if the instrument is not duly met at maturity, even though the specified event did
not happen.
6. Sans recourse endorsement (Sec. 52):
When the endorser expressly excludes his own liability on the negotiable instrument to the
endorsee or any subsequent holder in case of dishonour of the instrument, the endorsement is
known as ‘sans recourse’ endorsement.
Such an endorsement is generally made by adding the words ‘sans recourse’ or ‘without
recourse.’ Thus, “Pay X or order sans recourse” or “Pay X without recourse to me” or “Pay X
or order at his own risk” is examples of this type of endorsement.
7. Facultative endorsement:
When the endorser expressly gives up some of his rights under the negotiable instrument, the
endorsement is called a ‘facultative’ endorsement. Thus, “Pay X or order, notice of dishonour
waived” is a facultative endorsement.
As a result of such an endorsement the endorsee is relieved of his duty to give notice of
dishonour to the endorser and the latter remains liable to the endorsee for the non-payment of
the instrument, even though no notice of dishonour has been given to him.
DISHONOUR OF CHEQUE
Advancement and progress of society a nd concomitant increase of commerce and various

activities of trade, lead to increased complexity in transaction of money between human beings
and the ancient law givers were also forced by the circumstances to evolve new rules for
regulating such monetary transactions.
The present-day economies of the world which are functioning beyond the international
boundaries without being inhibited by territorial limits are relying to a very great extent on the
mechanism of negotiable instruments such as cheques and bank drafts. Since business activities
have increased, the attempt to commit crimes and indulge in activities for making easy money
has also accelerated. Thus, besides civil law, an important development both, in internal and
external trade is the growth of criminality and we find that banking business is every day being
confronted with criminal actions which has led to an increase in the number of criminal cases
pertaining to banking transactions. 75 Whenever a cheque is dishonoured, the legal machinery

pertaining to the dishonour of a cheque comes into motion.
Thus, if on presentation the banker does not pay the cheque amount then dishonour takes place
and the holder acquires at once the right of recourse against the drawer and the ot her parties
on the cheque.
Ingredients of Liability: Under Section 138 In order to constitute the offence punishable under
section 138 of the Act, the following ingredients are mandatory:
A) The cheque is drawn on a bank for the discharge of any legally enforceable debt or
other liability.
B) The cheque is returned by the bank unpaid.
C) The cheque is returned unpaid because the amount available in the drawer’s account is
insufficient for paying the cheque.
D) The payee has given a notice to the drawer claiming the amount within 30 days of the
receipt of the information by the bank.
E) The drawer has failed to pay the cheque amount within 15 days from the date of receipt
of notice.
Causes of Dishonour of a Cheque
The most common reasons for dishonour of a cheque are enumerated below: -
1.) Refer to Drawer In the Dictionary of Banking by Perry and Ryder, “Refer to drawer” is
described as under: - “Refer to drawer”: The answer put upon a cheque by the drawer banker
when dishonouring a cheque in certain circumstances. The most usual circumstance is where
the drawer has no available funds for payment or has exceeded any arrangement for
accommodation. The use of the phrase is not confined to this case; however, it is the proper
answer to put on a cheque which is being returned on account of the service of a Garnishee
Order, and it is likewise properly used when a cheque is returned on account of the drawer
being involved in bankruptcy proceedings.”
It is doubtful whether the unjustified use of the phrase, however, will involve a banker in an
action for libel, in addition to that for breach of contract. Where a non-trading customer is
concerned he has to prove loss to get more than nominal damages for breach of contract, but
not for libel. A trading customer can obtain substantial damages without proving specific
damages, although by doing so he can increase the amount awarded.
In Plunkett v. Barclays Bank Ltd, it has been held that the words “Refer to Drawer” were
not libellous Scrutton J., saying on this point that in his opinion the words in their ordinary
meaning amounted to a statement by the bank, “We are not paying; go back to the drawer and
ask why”, or else, “Go back to the drawer and ask him to pay”.
In another case captioned as Jaya Lakshmi v. Rashida, the Court held that the endorsement
refer to drawer is a euphemistic way of informing the payee that the drawer of the cheque has
got no amount to his credit to honour the cheque. Similarly, in Manohar v. Mahalingam,
Justice Padmini Jesudurai has held that the answer “Refer to Drawer” after adopted by the
bankers‟ could mean anything from shortage of funds to death or insolvency of the drawer and
could also include insufficiency of funds.
2) Exceeds Arrangement: This term is commonly meant to convey that the drawer has credit
limit but the amount exceeds the drawing power. Not arranged means no overdraft facility
exceeding the limit already sanctioned is existing or overdraft facility not sanctioned.
3) Full Cover not Received: It is generally meant to show that adequate funds to honour the
cheque do not exist or that the customer has not given adequate security to cover the over draft
which might be created by paying the cheque.
4) Effects not Cleared: It is meant to convey that the drawer has paid the cheques or bills, which
are in course of collection but their proceeds are not available for meeting the cheque. If there
is an agreement express or implied such as would arise out of a course of business to pay against
uncleared effects, a banker would be bound to honour cheques drawn against such effects and
he cannot arbitrarily and without notice withdraw or undo such facilities.
5) Not Sufficient or Funds Insufficient: When the funds in a customer‟s account are insufficient
to meet a cheque, which has been presented to the banker through the clearing or otherwise,
the cheque, on being returned unpaid, is usually marked with the words “not sufficient”,
“insufficient funds” or “not sufficient funds”
6) Not Provided for: An answer sometimes written by a banker on an instrument, which is being
returned unpaid for the reason that the drawer has failed to provide funds to meet the cheque
amount. A better answer in these circumstances is “Refer to Drawer”.
7) Present Again: These words are sometimes written by a banker upon a cheque, which is
returned unpaid because of insufficient funds in the customer’s account to meet it. It is not,
however, by itself a correct answer to give, as it does not afford any reasonable explanation
why the cheque has been returned.
8) Payment Stopped by Drawer: One of the reasons on account of which the Banker can refuse
to make the payment of a cheque is that the drawer has stopped the payment. The customer has
an indefeasible right to give notice his bankers to stop payment of a cheque which he has issued.
The notice should be in writing and should bear accurate particulars of the cheque and should
be signed by the drawer. In case a Bank passes a cheque after such stop payment directions has
been received, it shall be liable for so doing.
9) Account Closed: This term essentially means that on the day of the presentment of the cheque,
the account of the drawer has been closed, thereby the cheque drawn on the said cheque cannot
be encashed. Hon’ble Kerala High Court observed that the contention for attracting penal
liability for the offence under Section 138 of the Act the account must have been alive at the
time of presentation of the cheque is unsound. If the contention gains acceptance it could open
a safe escape route for those who fraudulently issue cheques and close the account immediately
thereafter to deprive the payees of the cheque proceeds. It would thus defeat the very object of
innovation made through Act No. 66 of 1988 by which Section 138 and its allied provisions
were inserted in the Act. Closing the account is one the modes by which a drawer can render
his account inadequate to honour the cheque issued by him. The drawer of the cheque who
closes his account with the bank before the cheque reaches the bank for presentation, is actually
causing insufficiency of money „standing to the credit of that account.
Issuance of Notice Clause (b) of the proviso of Section 138 states that the payee or the holder
in due course of the cheque makes a demand by giving a notice within 15 days of the receipt
of information by him regarding the dishonour of the cheque. Now the period of 15 days has
been increased to that of 30 days by the Amendment Bill No. 55 of 2002. In this way this
proviso stipulates – A) The payee is the holder in due course. B) A demand in made by giving
a notice by the payee to the drawer. C) The notice is given within a period of 15 days (now 30
days as per new provisions) from the date of receipt of the information about dishonour. The
provision of a notice in the Act has been enacted so as to give an opportunity to the person who
has drawn the cheque to make the payment in case there is no mala fide on his part.
PAYING & COLLECTING BANKER
PAYING BANKER
Meaning of Paying Banker: Paying banker refers to the banker who holds the account of the
drawer of the cheque and is obliged to make payment, if the funds of the customer are sufficient
to cover the amount of his cheque drawn.
Precautions to be taken by paying banker while making payment of Cheques: The banker
has to take the following precautions while honouring the cheques of his customers:
1. Crossed Cheque: The most important precaution that a banker should take is about crossed
cheques. A banker has to verify whether the cheque is open or crossed. He should not pay cash
across the counter in respect of crossed cheques. If the cheque is a crossed one, he should see
whether it is general crossed or special crossed. If it is general crossing, the holder must be
asked to present the cheque through some banker and should be paid to a banker. If the cheque
bears a special crossing, the banker should pay only the bank whose name is mentioned in the
crossing.
2. Open Cheque: If it is an open cheque, a banker can pay cash to the payee or the holder
across the counter. If the banker pays against the instructions as indicated above, he is liable to
pay the amount to the true owner for any loss sustained. Further, a banker loses statutory
protection in case of forged endorsement.
3. Proper Form: A banker should see whether the cheque is in the proper form. That means
the cheque should be in the manner prescribed under the provisions of the Negotiable
Instruments Act. It should not contain any condition.
4. Presentment of Cheque: Presentation of the cheque should be in right format and right
place. A banker can honour the cheques provided it is presented with that branch of the bank
where the drawer has an account or another branch if it is multi-city cheque.
5. Date of the Cheque: The paying banker has to see the date of the cheque. It must be properly
dated. It should not be either a post-dated cheque or a stale-cheque. If a cheque carries a future
date, it becomes a post-dated cheque. If the cheque is presented on the date mentioned in the
cheque, the banker need not have any objection to honour it. If the banker honours a cheque
before the date mentioned in the cheque, he loses statutory protection. If the drawer dies or
becomes insolvent or countermands payment before the date of the cheque, he will lose the
amount. The undated cheques are usually not honoured.
6. Words and Figures: The amount of the cheque should be expressed in words, or in words
and figures, which should agree with each other. When the amount in words and figures differ,
the banker should refuse payment. However, Section 18 of the Negotiable Instruments Act
provides that, where there is difference between the amount in words and figures, the amount
in words is the amount payable. If the banker returns the cheque, he should make a remark
‘amount in words and figures differ’.
7. Alterations and Overwriting: The banker should see whether there is any alteration or
overwriting on the cheque. If there is any alteration, it should be confirmed by the drawer by
putting his full signature. The banker should not pay a cheque containing material alteration
without confirmation by the drawer. The banker is expected to exercise reasonable care for the
detection of such alterations. Otherwise, he has to take risk. Material alterations make a cheque
void.
8. Proper Endorsements: Cheques must be properly endorsed. In the case of bearer cheque,
endorsement is not necessary legally. In the case of an order cheque, endorsement is necessary.
A bearer cheque always remains a bearer cheque. The paying banker should examine all the
endorsements on the cheque before making payment.
STATUTORY PROTECTION FOR PAYING BANKER:
The paying banker should take the following protection, in order to protect himself and
customer’s interest, while making the payment of his customer’s cheques:
(i) Protection regarding the order cheque In case of an order cheque, Section 85(1) of the
NI Act provides statutory protection to the paying banker as follows, where a cheque payable
to order purports to be endorsed by or on behalf of the payee, the drawee is discharged by
payment in due course.
(ii) Protection in case of bearer cheques Section 85 (2) of the Negotiable Instruments Act,
1881 states, “Whereas a cheque is originally expressed to be payable to bearer, the drawee is
discharged by payment in due course to the bearer thereof, notwithstanding any endorsement
whether in full or in blank appearing thereon, notwithstanding that any such endorsement
purports to restrict or exclude further negotiation.”
(iii) Protection in case of crossed cheques Regarding payment of crossed cheque, the paying
banker gets the protection under Section 128 of the Negotiable Instruments Act, 1881:
“Whereas the banker on whom a crossed cheque is drawn has paid the same in due course, the
banker paying the cheque and the drawer thereof (in case such cheque has come to the hands
of the payee) shall be entitled respectively to the same rights and placed in the same position if
the amount of the cheque had been paid to and received by the true owner thereof.”
(v) Protection in case of draft Section 85A of the NI Act states that, Drafts drawn by one
branch of a bank on another payable to order where any draft, that is an order to pay money,
drawn by one office of a bank upon another office of the same bank for a sum of money payable
to order on demand, purports to be endorsed by or on behalf of the payee, the bank is discharged
by payment in due course.
Dishonour of Cheque: A cheque is said to be dishonoured when it is refused to accept or pay
when presented to the bank. It is a condition in which the paying banker does not pay the
amount of the cheque to the payee.
Circumstances or reasons for dishonour of Cheques A paying banker must refuse payment
on cheques, issued by his customers, in the following circumstances:
1. Insufficiency of funds: When adequate funds are not available in the account of a customer,
then the cheque can be dishonoured. If the banker pays a countermanded cheque, he will not
only be required to reverse the entry but also be held liable to pay damages for dishonouring
the cheques presented subsequently which would have been honoured otherwise.
2. Notice of the Customer’s Death: The banker should not make payments on cheques
presented after the death of the customer. He should return the cheque with the remark ‘Drawer
Deceased’.
3. Notice of the Customer’s Insolvency: A banker should refuse payment on the cheques soon
after the customer is adjudicated as insolvent.
4. Receipt of the Garnishee Order: Where Garnishee order is received attaching the whole
amount, the banker should stop payment on cheques received after the receipt of such an order.
But if the order is for a specific amount, leaving the specified amount, cheques should be
honoured if the remaining amount is sufficient to meet them.
5. Presentation of a post-dated cheque: The banker may refuse the cheque when the cheque
is presented before the valid date.
6. Stale Cheques: When the cheque is presented after a period of three months from the date
it bears, the banker may refuse to make payment.
7. Material Alterations: When there is material alteration in the cheque, the banker may refuse
payment.
8. Drawer’s Signature: If the signature of the drawer on the cheque does not tally with the
specimen signature, the banker may refuse to make payment.
Types of Dishonour: Dishonour of cheque can be divided into two categories i.e.:
1. Rightful Dishonour: Dishonour of cheque by the drawee banker for any of the reasons
specified above or for any other rightful reason. In this case there is no remedy available against
the banker but the holder in due course has remedy both civil and criminal against the drawer.
2. Wrongful Dishonour: Dishonour of cheque by the banker due to negligence or carelessness
by its employees. The drawer may bring an action against the bank for losses suffered by him.
The payee has no action against the banker in this case.
Consequences of wrongful dishonour of Cheque
(i) Wrongful dishonour of the customer's cheque makes the Bank liable to compensate the
customer on contractual obligations as well as for injury to his creditworthiness. A return of a
cheque would cause injury to the drawer’s reputation.
(ii) Quantum of Damages is not limited to the actual pecuniary loss sustained by reason of such
dishonour. When the customer is a trader he is entitled to claim substantial damages even if he
had suffered no actual pecuniary loss sustained by such dishonour, if he can show that his
creditworthiness had suffered by the dishonour of the cheque.
(iii) A non-trader is not entitled to recover substantial damages unless the damage he has
suffered is alleged and proved as special damages, otherwise he would be entitled to nominal
damages.
(iv) The Plaintiff's evidence on the transaction was vague, ill-defined and indeterminate and
further he had not proved any actual or special damages, unless special damages are claimed
and proved nominal damages will be awarded.
COLLECTING BANKER
Meaning of Collecting Banker: A Collecting banker is one who undertakes to collect cheques,
drafts, bill, pay order, traveller cheque, letter of credit, dividend, debenture interest, etc., on
behalf of the customer. For undertaking this collection, the collecting banker will be charging
commission. Examples: ICICI Bank, HDFC Bank, SBI Bank etc.
Duties and Responsibilities of a Collecting Banker: The duties and responsibilities of a
collecting banker are discussed below:
1. Due Care and carefulness in the Collection of Cheques: The collecting banker is bound
to show due care and carefulness in the collection of cheques presented to him. In case a cheque
is entrusted with the banker for collection, he is expected to show it to the drawee banker within
a reasonable time.
2. Serving Notice of Dishonour: When the cheque is dishonoured, the collecting banker is
bound to give notice of the same to his customer within a reasonable time. It may be noted
here, when a cheque is returned for confirmation of endorsement, notice must be sent to his
customer.
3. Agent for Collection: In case a cheque is drawn on a place where the banker is not a member
of the ‘clearing-house’, he may employ another banker who is a member of the clearing-house
for the purpose of collecting the cheque. In such a case the banker becomes a substituted agent.
4. Payment of Interest to the Customer: In case a collecting banker has realised the cheque,
he should pay the interest to the customer as per his (customer’s) direction.
5. Collection of Bills of Exchange: There is no legal obligation for a banker to collect the bills
of exchange for its customer. But, generally, bank gives such facility to its customers.
Holder Definition: Holder is an individual who has lawfully received possession of a
Commercial Paper, such as a cheque and who is entitled for payment on such instrument.
Holder for Value: Holder for value is a holder to whom an instrument is issued or transferred
in exchange for something of value as a promise of performance or a negotiable instrument.
Example: A banker becomes a holder for value when: The value of cheque is paid before
collection of the cheque.
Holder in Due Course: A holder in due course is the holder of negotiable instruments who
has given value in good faith without notice of any previous dishonour in taking the bill, which
appears to be complete and regular.
STATUTORY PROTECTION TO COLLECTING BANKS
The protection provided by Section 131 is not absolute but qualified. A collecting banker can
claim protection against conversion if the following conditions are fulfilled:
1. Good Faith and Without Negligence Statutory protection is available to a collecting
banker when he receives payment in good faith and without negligence. The phrase in “good
faith” means honestly and without notice or interest of dishonesty or fraud and does necessarily
require carefulness. Negligence means failure to exercise reasonable care. The banker should
have exercised reasonable care and deligence.
2. Collection for a Customer: Statutory protection is available to a collecting banker if he
collects on behalf of his customer only. If he collects for a stranger or noncustomer, he does
not get such protection. A bank cannot get protection when he collects a cheque as holder for
value
3. Acts as an Agent: A collecting banker must act as an agent of the customer in order to get
protection. He must receive the payment as an agent of the customer and not as a holder under
independent title. The banker as a holder for value is not competent to claim protection from
liability in conversion. In case of forgery, the holder for value is liable to the true owner of the
cheque.
4. Crossed Cheques: Statutory protection is available only in case of crossed cheques. It is not
available in case uncrossed or open cheques because there is no need to collect them through a
banker. Cheques, therefore, must be crossed prior to their presentment to the collecting banker
for clearance.
MODULE 5
Lending by Banks - Principles of Good Lending - Security for Loans -Contractual Security -
Immovable Property and Intangible Property- As Security. Recovery of Debts - Transaction -
Constitutional Principles - Limitation Act, DRT, Etc.
LENDING BY BANKS
Lending of funds is the main business of a bank. The major portion of bank fund is employed
by way of lending. Meaning of lending banker is the banker who lends funds to trade,
commerce and industry etc. to meet their financial requirements.
PRINCIPLES OF GOOD OR SOUND LENDING
Lending is one the primary function of a bank. The banks

accept deposits from people and then lend that money to the needy people in the form of loans,
advances, cash credit and overdraft. Interest received from these lending is the main source of
income for the bank. So, a bank should examine the security offered against loan, credit
worthiness of the borrower and the purpose of the loan. Therefore, a bank uses these following
principles for smooth running of the business.
1) Liquidity – Liquidity is an important principle of bank lending. Banks lend money for short
periods only because they lend public money (money accept as deposits from people) which
can be withdrawn at any time by depositors. They, therefore, advance loans on the security
of such assets which can be easily converted into cash at a short notice. A bank chooses
such securities because if the bank needs cash to meet the urgent requirements of its
customers, it should be in a position to sell some of the securities at a very short notice
without disturbing their price much. There are certain securities such as central, state and
local government bonds which are easily saleable without affecting their market prices.
2) Safety – The safety of funds lent is another principle of lending. Safety means that the
borrower should be able to repay the loan and interest in time at regular intervals without
default. The repayment of the loan depends upon the nature of security, the character of the
borrower, his capacity to repay and his financial standing. Like other investments, bank
investments involve risk. But the degree of risk varies with the type of security. Securities
of the central government are safer than those of the state governments and local bodies.
From the point of view, the nature of security is the most important consideration while
giving a loan. Even then, it has to take into consideration the creditworthiness of the
borrower which is governed by his character, capacity to repay, and his financial standing.
Above all, the safety of bank funds depends upon the technical feasibility and economic
viability of the project for which the loan is advanced.
3) Diversity – A commercial bank should follow the principle of diversity. It should not invest
its surplus funds in a particular type of security but in different types of securities. It should
choose the shares and debentures of different types of industries situated in different regions
of the country. The same principle should be followed in the case of state governments and
local bodies. Diversification aims at minimizing risks of the investment portfolio of a bank.
The principle of diversity also applies to the advancing of loans to varied types of firms,
industries, businesses and trades. A bank should follow the maxim: “Do not keep all eggs
in one basket.” It should spread it risks by giving loans to various trades and industries in
different parts of the country.
4) Stability in the Value of Investments – The bank should invest its funds in those stocks
and securities the prices of which are more or less stable. The bank cannot afford to invest
its funds in securities, the prices of which are subject to frequent fluctuations.
5) Profitability – A commercial bank by definition is a profit hunting institution. The bank

has to earn profit to pay salaries to the staff, interest to the depositors, dividend to the
shareholders and to meet the day-to-day expenditure. Since cash is the least profitable asset
to the bank, there is no point in keeping all the assets in the form of cash on hand. The bank
has got to earn income. Hence, some of the items on the assets side are profit yielding assets.
They include money at call and short notice, bills discounted, investments, loans and
advances, etc. Loans and advances, though the least liquid asset, constitute the most
profitable asset to the bank. Much of the income of the bank accrues by way of interest
charged on loans and advances. But, the bank has to be highly discreet while advancing
loans.
6) Saleability of Securities – Further, the bank should invest its funds in such types of
securities as can be easily marketed at a time of emergency. The bank cannot afford to invest
its funds in very long-term securities or those securities which are unsaleable. It is necessary
for the bank to invest its funds in government or in first class securities or in debentures of
reputed firms. It should also advance loans against stocks which can be easily sold.
7) Margin Money – in case of secured loans (A secured advance is one which is made on the
security of either assets or against personal security or other guarantees. An advance which
is not secured is called an unsecured advance), the bank should carefully examine and value
of security. There should be sufficient margin between the amount of loan and value of the
security. If adequate margin is not maintained, the loan might become unsecured, in case
the borrower fails to pay the interest and return the loan. Margin means a sufficient gap
between loan value and security value for ex if security market value is Rs 1000 then bank
may offer Rs 800 as loan.
8) Principle of Purpose – At the time of granting an advance the banker must ask about the
purpose of the loan. If it is for unproductive purposes, then there is less chances of
repayment of loan. On the other hand, If it is for productive purposes then there is more
chances of repayment loan value with the interest.
9) Secured Advance-A secured advance is one which is made on the security of either assets
or against personal security or other guarantees. An advance which is not secured is called
an unsecured advance.
Other principles of lending
Purpose: A banker should grant advance for productive purposes such as financing trade,
commerce and industry. He should not grant advances for unproductive purposes.
Income generating potentiality of the project: The banker has to see whether the project for
which money is lent will generate necessary funds to repay the loan.
Term of loan: Generally, a banker prefers to grant short term loans as it cannot lock up its
funds by granting loans for a long period.
Public interest: The banker should grant advances to those industries which require
development in the countries planning program.
TYPES OF BANK LOAN
1. Clean loans/term loans - It used to grant loans or advances in lump sum usually on the basis
of some acceptable securities. Under this system credit is given for a definite purpose and for
a predetermined period at an agreed rate of interest.
2. Overdraft: A customer is allowed to draw cheque up to an agreed limit over and above the
credit balance in the account. It is a short-term credit facility. The interest is calculated on the
amount actually utilized by the customer at regular intervals.
3. Cash Credit: Cash credit is a flexible system of lending under which the borrower has the
option to withdraw the funds as and when required and to the extent of his needs. Under this
arrangement, the banker specifies a limit of loan for the customer up to which the customer is
allowed to draw.
4. Discounting of bill: It is an arrangement under which a banker takes a bill of exchange
before its due date and pays to the customer. Then on the due date the banker receives the face
value of the bill from the drawee.
5. Purchasing of bill: It is a financial arrangement under which a banker takes a bill and pays
to the credit of the customer (the face value of the bill minus the discount charges).
6. Letter of credit: It is a guarantee by the bank to the suppliers of the goods that there bill
will be honoured by the bank behalf of the customer.
Types of Letter of Credit - Revocable letter of credit -Irrevocable letter of credit
Confirmed letter of credit: Confirmed letter of credit is a special type of letter of credit in
which another bank apart from the issuing bank has added its guarantee.
SECURITY FOR LOANS
Types of securities for bank leaning or methods of creating charge creating a charge on a
security or charging a security refers to the procedure by which a banker establishes his right
as a lender on the particular security offered by the borrower. Bank may grant loan to the
customer on the basis of personal security or on guarantee of a third person or both. Personal
security can be of the following:
1.) BANKERS’ LIEN
Lien is one of the traditional security available to a bank. The word lien in layman’s language
means right to retain property belonging to another until a certain debt due from the owner of
the property is paid, and whose debt or claim is secured by a lien on particular property as
distinguished from a general creditor, who has no such security is called lien creditor.
A. TYPES OF LIEN: Lien is a generic term and includes both statutory lien and contractual
lien. A lien may be possessory, equitable or maritime. A possessory lien may further be
classified into particular lien or general lien. A particular lien like say, right of finder of goods
under section 168 or right of a bailee under section 170 of Indian Contract Act is a particular
lien. Such lien arises out of possession and is lost if the possession is lost.
A banker’s lien is different from bank’s right to set off. Lien is confined to securities and
property in bank’s custody. Set off is in relation to money and may arise from contract or from
mercantile usage or by operation of law.
B. NECESSARY CONDITIONS FOR OPERATION: A lien does not require any special
agreement, written or oral and it arises by operation of law provided the following conditions
are fulfilled
a) The creditor is in possession of goods, securities etc. and has come in possession thereof
in ordinary course of business.
b) The owner of goods, lawfully owes some amount to be paid to person in possession
thereof.
c) The exercise of such right is not barred by express or implied right to the contrary.
C. PRINCIPLES GOVERNING BANKER’S LIEN: Section 171 of the Contract Act does
not lay down any specific conditions in the matter of banker’s lien. Several disputes have
however arisen requiring interpretation of ambit and scope of banker’s lien. Money can be the
subject of banker’s lien but if the money is held under a special contract, it cannot come under
purview of lien. Over a period of time, the decided court cases have settled the position of
banker's lien on following points
1) The banker’s lien is a right of retaining things delivered into his possession as a banker if
and so long as customer to whom they belonged is indebted to the bank and the right was
not expressly excluded.
2) The banker’s lien can extend only over things which belong to the customer.
3) The Courts and jurists have distinguished between banker’s right of lien and setoff. Lord
Halsbury has expressed a view that money is usually not subject of lien unless there is
specific earmarking and bank ordinarily has no lien on the funds in account of individuals
with them.
4) In case of money deposited the bank, itself becomes the owner of the money. The purpose
of lien in such cases is attained only by exercise of right of setoff.
5) The lien is subject to a contract to the contrary. The onus of proving that such contract exists
is on the party who alleges it. The Delhi High Court held that when a Fixed Deposit was
given as specific security for bank guarantee, the bank cannot hold it for other liabilities.
6) The terms on which securities are deposited may create merely a particular lien and not a
general lien. In such case the banker is not entitled for general lien.
7) Where securities have been charged for an advance which is repaid and securities are left
with banker, the banker will have a lien on them for any advance subsequently or existing
unless it is expressly excluded by original memorandum of charge.
8) It is customary practice of the banks to insist for execution of separate letter of lien from
customer by way of abundant caution enabling them to enjoy the security for all the
liabilities of the borrower arising in any manner. It is taken to defend the argument that the
securities were given only for specific purpose.
9) Unless an agreement not to set off is conclusively established by oral or documentary
evidence, the bank was entitled to set off the balance in one account against other.
10) A banker does not have lien when the contract by its very nature leads to contrary inference.
D. CASES WHERE BANK CAN NOT CLAIM LIEN: a) Safe custody deposits. b)
Borrower does not have title on the movables. c) Bonds and coupons attached to bonds given
in safe custody. d) Documents given for raising fresh loan. e) Bills entrusted for special
purpose. f) If amount is not due no lien can be claimed. g) Funds in trust account where the
banker has notice of trust. **18 h) Title deeds deposited for a specific obligation are beyond
purview of lien.
2.) RIGHT OF SET OFF
A. MEANING: The banker maintains several accounts of a customer in one form or other. In
its simplest sense the right to set off means the right of combination of several accounts. English
law does not recognise much difference between set off and counter claim. Black’s Law
Dictionary defines set off as counter claim demand which defendant holds against plaintiff
arising out of transaction extrinsic of plaintiff’s cause of action. It is a remedy employed by
defendant to discharge or reduce plaintiff’s demand by opposite one which is extrinsic to
plaintiff’s cause of action.
The banker exercises right of set off, in most cases before filing of suit and claims only the net
amount due after adjusting and appropriating the amount lying to the credit of customer.
B. PRINCIPLES GOVERNING SET OFF: The right of setoff available to a banker was in
dispute in several cases under English Law and Indian Law. The settled position on this point
now seems to be as under
(i) The bank is entitled to combine accounts with its various branches without any notice
to customer.
(ii) if a specific security is provided say for property loan and there is another current
account, both the accounts cannot be combined and if because of such combination loss
occurs banker is liable.
(iii) Bank has a right to set off a customer’s deposit against a bank loan advanced to him.
(iv) The right of setoff can .be exercised even if the debt has become time barred. Though
bank may not be able to institute suit on basis of same, the right is available. There is
thus a difference between right of setoff exercised by the banker under mutual credit
clause and the right of setoff which a defendant can exercise under order 8 rule 6 of
Civil Procedure Code.
(v) A separate debt cannot be set off against a joint debt whether at law or in equity.
(vi) Lien will be operative against surplus amount after the sale of securities remaining in
hands of banker, and can be utilised for discharging the liability of constituent even in
capacity of guarantor.
C. NECCESARY CONDITIONS:
a) The amount of debt claimed by both parties against each other are certain.
b) They are due to same parties.
c) Such amounts are payable in the same right (i.e. not as trustee etc.)
d) There is no contract, express or implied to the contrary excluding or curtailing exercise of
such right.
3.) PLEDGE
"Pledge” has been accepted traditionally as security by the banks particularly in respect of the
commodities which can be readily sold. Under section 172 of Indian Contract Act, pledge is a
bailment of goods as security for repayment of a debt or performance of a promise. Hence the
basic transaction in the case of a pledge is bailment and by virtue of the same the pledgee
derives the special interest in the property and has a right to be paid in priority to the unsecured
creditors.
A pledge is deposit of personal property to creditor as security for some debt or engagement.
It is a security interest in a chattel or on tangible represented by on indispensable formal
instrument as written evidence of an interest in such property.
B. INGREDIENTS OF PLEDGE
1. There is a contract where under the banker agrees to lend the money and borrower agrees
to pledge specified chattel.
2. Goods pledged should be actually or constructively delivered to the pledgee.
3. Pledgee has only a special property in the goods while general property remains in the
pledger and which wholly reverts to him on discharge of debt.
C. RIGHTS OF PLEDGEE
A pledgee is entitled to continue with him the possession of the goods pledged till such time
the debt is repaid with interest or the promise is performed. If a default is committed the pledgee
can, (1) sue the pledger returning the goods pledged as a collateral security or (2) sell the goods
after giving reasonable time to the pledger. What is reasonable time will depend on facts and
circumstances of each case.
If the sale proceeds are not sufficient to discharge the debt pledger will be liable to discharge
the debt, and if there is any surplus, pledgee must pay such surplus. The pledgee has no right
to retain the goods pledged for any of the liability of the borrower unless he has agreed
otherwise. The banks usually ensure the same by inserting additional conditions in the
document of pledge.
4) HYPOTHECATION
A. THE CONCEPT: Hypothecation is not defined under any Indian laws but that in no way
reduces its significance from banker’s point of view. There are several obligations to be
complied by the pledgee and hence security in form of pledge has certain inherent limitations
and risks.
The concept of hypothecation has therefore assumed importance. A pledge in strict sense,
presupposes delivery given by pledger to the pledgee and the pledgee is expected to release the
materials as and when approached by pledger with proportionate payment. In
manufacturing/trading units’ bankers finance working capital and the goods/raw materials
undergo constant process of transformation which make it difficult for creditor to exercise
physical control on the movement of goods. It will be next to impossible for the banker to
supervise the day to day activities of the borrower.
Hypothecation therefore is a convenient and practical solution to the problem of operational
difficulties involved. In hypothecation possession of the property in goods and other movables
remain with the borrower and only an equitable charge is created in favour of the lender. The
concept of hypothecation of property is however well recognised under the Indian Law.
The charge is normally created by written instrument known as DEED OF
HYPOTHECATION. Such charge is shifting and ambulatory in nature without being attached
to any fixed property. It hovers over and floats with the property and the borrower has every
freedom and right to deal with such property until some event like default in compliance of
conditions agreed between the bank and the borrower, causes it to settle and seize on the
hypothecated assets.
B. FLOATING CHARGE: Hypothecation is recognised as floating charge on movable assets.
It is a continuing charge on the assets of the company creating it, but permitting the company
to deal freely with the property in the usual course of business until the security holder shall
intervene to enforce the claim.
The concept of reputed ownership also therefore becomes applicable. The charge by way of
hypothecation is equitable because the borrower who is in possession of goods sells such goods
and if bonafide purchaser who has no notice of charge of the bank purchases such goods or
creates pledge of such goods in favour of another innocent lender.
The Hypothecation documents apart from movables like goods/machineries etc. also cover the
amount to be realised by the borrower in form of book debts. The bank acquires additional
powers to realise the book debts and appropriate the same towards the outstanding liability.
C. DISTINCTION BETWEEN PLEDGE AND HYPOTHECATION ‘Pledge’ and

‘Hypothecation’ are considered to be the modes of charging security in favour of the bank. The
Jammu and Kashmir High Court distinguished between pledge and hypothecation and stated
the position of law in following words
"Transaction of pledge and hypothecation do have a common ingredient in as much as both of
them create security in hypothecated or pledged goods for repayment of goods and ownership
of goods remains with person hypothecating or pledging. Nevertheless, there is distinction
between two transactions and unlike a pledge where possession of goods must pass on the
pawnee, no possession passes on to the creditor in case of hypothecation.
In case of pledged goods, the goods are stored in the godown under the lock and key of the
bank under the bank's supervision. Thus, pledged goods remain under physical possession of
bank and no withdrawal or addition of stocks is allowed without bank's permission. The
position with regard to hypothecated goods is however different because those goods strictly
speaking are not under the lock and key of bank as such but are supposed to be under
constructive possession of the bank by virtue of deed of hypothecation under which the
borrower is obliged to submit regular returns to bank indicating increase and decrease in value
of said goods."
5.) MORTGAGE
'Mortgage’ is the transfer of an interest in specific immovable property for the purpose of
securing the payment of money advanced or to be advanced by way of loan, or an existing or
future debt, or the performance of an engagement which may give rise to pecuniary liability.
Mortgage is a concept of ancient origin which can be traced back to earliest phases of human
civilisation and commercial transactions. The Transfer of Property Act, defines mortgage in
terms of transfer of interest in immovable property. It is a right in rem which enables the person
entitled to it to secure the payment of a pecuniary claim through the medium of property itself
which is pledged to him
Under Indian Law 6 types of mortgages have been recognised. The same are as under
A. Simple mortgage.
B. Mortgage by conditional sale.
C. Usufructuary mortgage.
D. English Mortgage
E. Equitable Mortgage
F. Anomalous Mortgage
Each type of mortgage has specific legal attributes.
No possession is given to the mortgagee in simple mortgage. Loan prima facie involved a
personal liability. Liability is not displaced by mere fact that security is given for repayment.
Nature and terms of the documents may exclude personal liability
In case of mortgage by conditional sale, there is an ostensible sale and the condition operates
as security for the debt. In case, payment is made as stipulated the sale becomes void and
mortgage will re-convey the property.
in usufructuary mortgage, mortgagee is placed in possession of property and also has a right to
enjoy the rent and profits until debt is paid. The possession may be passed on symbolically say
by directing the tenants in the property to pay the rent to mortgagee. Possession of the
mortgagee is a distinguishing feature. A usufructuary mortgagee may even lease back the
property to the mortgagor himself. In this mortgage the mortgagor does not incur personal
liability.
In English mortgage there is a transfer of property to mortgagee with a covenant to repay the
debt on a given date and a provision that on this condition being performed, the mortgagor will
be entitled for re-conveyance.
In case of equitable mortgage, the titles have been deposited with an intention to create
security. The concept originates from English Law which has over a period of time recognised
a well-established rule of equity that a deposit of document of title without anything more,
without writing, without even word of mouth will create in equity a charge on the property
referred
Anomalous mortgage is a mortgage which does not fall within any of specific categories
mentioned earlier. It may be in form of simple mortgage usufructuary or usufructuary mortgage
by conditional sale.
6.) CHARGES
The Transfer of Property Act defines charges in following words ‘Where immovable property
of one person is by act of parties or operation of law made security for the payment of money
to another, and the transaction does not amount to a mortgage, the later person is said to have
a charge on the property. The practical difference between charge and mortgage is that a
mortgage being a right in rem is good against all subsequent transferees while a charge is good
against only subsequent transferee for value with notice or a volunteer with or without notice.
A. FIXED AND FLOATING CHARGE: A charge may be fixed or floating. Fixed charge,
right from its inception binds the company by an obligation to deal with the property only
subject to such charge. It is a specific charge on a specific asset.
A floating charge need not cover the whole of the property of the company but may be confined
to specific portion of assets. The Kerala High Court has held that a floating charge is an
equitable charge which does not fasten on any specific property but covers the whole of the
company’s property whether, it is or is not subject to fixed charge. Only upon happening of the
events set out in deed of floating charge, it crystallises or becomes fixed and thereafter the
assets comprised in the charge are subject to the same restrictions and affected in the same
manner as under specific charge.
A floating charge gets crystallised i.e. gets converted into fixed charge upon happening of
following events
(i) When Company ceases to be a going concern and charge holder intervenes by
appointing receiver.
(ii) Upon happening of event of default as specified in document creating charge
(iii) When winding up of the company commences
B. FORMALITIES FOR CREATION OF CHARGE: A charge can be created by operation
of law and in such case the provision of the statute by itself constitutes sufficient legal validity
for the charge without any further act or deed. Such charge may be created in favour of the Tax
Authorities for recovery of tax arrears or in favour of any other authorities or individuals as per
the provisions. A charge by act of the parties is generally created by written instrument. It is
customary among the banks to obtain deed of hypothecation which creates floating charge on
the property. As against this the documents like indenture of mortgage/equitable mortgage
creates fixed charge on the assets of the borrower
Such charge is required to be registered within a period of 30 days. Further extension of 30
days can be given by registrar. The charge if not registered is void against the registrar and
against creditor of company. An equitable mortgage or charge created by deposit of title deeds
also requires registration. The duty of charge holder is to send particulars of charge for
registration along with relevant instrument and if charge is not registered the charge holder is
not responsible. In such case charge is deemed to be registered.
C. RIGHTS OF CHARGE HOLDERS: When the charge is created by operation of law the
ambit and scope of such charge is defined under the concerned statute. If the statute itself lays
down some formalities it has to be complied.
In case of charge by act of parties, the document creating the charge lays down the rights of
charge holders. In case it is a floating charge, the events under which it can be converted into
fixed charge are also narrated in the document. To some extent, floating charge appears to be
an illusory charge in the sense that the charge holder neither has the possession nor the
ownership of goods.
The company can deal with the property but is prevented from transferring the properties under
charge. The Supreme Court in a recent case dealt with debentures secured by floating charge
and held that. -
(i) Debenture is usually secured only by floating charge.
(ii) The company which creates floating charge has a right to create future securities
which rank superior.
(iii) This right may be restricted by agreement.
(iv) In absence of evidence to the contrary, the charges will be enforced in chronological
order
1. Lien: A banker has a general lien. It refers to his right to retain any property of his customer
for the debt due from the customer.
2. Pledge/Pawn: A contract where by a borrower offers his tangible property to his lender as
a security for the amount borrowed on the understanding that the property pledged will be
returned when the debt is repaid. The person who transfers such property is called
pledger/pawner. Person to whom the goods are transferred is called pledgee/pawnee. E.g. gold
loan. Rights and liabilities of pledger and pledgee are laid down in Sec.172-179 of Contract
Act. If loan is not repaid, pledgee can sell the pledged property.
3. Hypothecation: It is a transfer of interest in movable property from one person to another
as security for a debt. It is to be noted that there is no transfer of possession. Possession remains
with the hypothecated property. But the hypothecate will have a charge over the hypothecated
property. At the time of repayment, this charge gets crystallised. If the hypothecator does not
repay the loan, the hypothecate can take over or sell the hypothecated property. Hypothecation
is usually done in case of raw materials, stock –in-trade etc. In case of car loan usually the car
itself is hypothecated.
4. Mortgage: It is the transfer of interest (with or without possession) in immovable property
from one person to another as security for a loan. The condition is that the interest in immovable
property should be re-transferred to the debtor (mortgagor) on repayment of the loan. Rights
and liabilities of mortgagor and mortgagee depend upon the types of mortgage. There are
several types of mortgage laid down in the Transfer of property Act. E.g. English mortgage,
mortgage by conditional sale, mortgage by deposit of title deeds, usufructuary mortgage etc.
5. Documents to title of goods: loan may be obtained on the security of documents to the title
of goods. E.g. Railway receipt, wharfing’s certificate, bill of lading issued by a ship company
etc. The creditor can take possession or charge over the goods of the debtor by producing these
documents as soon as the goods arrive by rail, ship etc. or reach the go down or wharf.
6. Guarantee (Secs.126-147 of the Contract Act); A contact of guarantee is a promise to
perform something or to pay the debt of a third person default. The person who gives guarantee
on behalf of such third person is called guarantor or surety. The person to whom the guarantee
is given is called creditor. The person whom the guarantee is given is called principal debtor.
The transaction between them is called a contract of guarantees or surety ship. In case of bank
loan, bank is the creditor. There are two types of guarantee-specific and continuing guarantee.
Specific guarantee is given for a single debt or single transaction guarantees may also be
prospective or retrospective. There is also counter guarantee. A counter-guarantor is a surety
of the original guarantor.
ADVANTAGES OF SECURITY
1. If default is committed by the borrower, the banker as secured creditor can take
possession of security, sell the same and recover loan from the proceeds.
2. Charging of assets to an extent operates as control on behaviour of the borrower.
3. By specific charging of security, a borrower is prevented from raising finance against
the same security.
4. It ensures continuous involvement of the borrower and he cannot leave the business at
his will.
5. The charging of a security exhibits confidence of borrower in business.
6. End-use of funds for the purpose of lending is also secured by the same
Contractual Security-Immovable property and tangible property-as security
Immovable property:
1. The immovable property cannot easily be transported from one place to another. If
transported, it will lose its original shape, capacity, quantity or quality.
2. Examples: Land, houses, trees attached to the ground; so long they are so attached.
3. Mango trees, if sold for nourishment and for fruits, they are deemed as immovable property.
4. Gutting the bamboos for a number of years under a contract comes under Immovable
property.
5. Whenever the immovable property is transferred, it must compulsorily be registered under
the Indian Registration Act, 1908, subject to its value if exceeds Rs. 100.
6. The immovable property is not liable to sales tax. But stamp duty is to be paid under the
Indian Stamp Act 1899 and registration fee is to be paid under the Indian Registration Act
1908.
7. Mere delivery does not sufficient for a valid transfer. The property must be registered in the
name of the transferee,
8. Immovable property only forms and accretion ‘to an ancestral impartible estate.
(Case-law: Mahindra Singji vs. Iswar Singji 1952 B. 243)
Intangible property, also known as incorporeal property, describes something which a person
or corporation can have ownership of and can transfer ownership to another person or
corporation, but has no physical substance, for example brand identity or
knowledge/intellectual property.
RECOVERY OF DEBTS
Origin of Recovery of Debts due to bank and Financial Institutions (RDDBFI)Act

Banks and financial institutions duly registered with Reserve Bank of India (RBI) provide loan
facility to legal entities and individuals (borrowers). In the event where the borrower fails to
repay loan amount or any part thereof which also includes unpaid interests and other charges
and/or debt becomes Non-Performing Asset (NPA), banks and financial institutions can
recover the debt by approaching appropriate judicial forums.
Before, the enactment of the RDDBFI Act, banks, and financial institutions were facing huge
challenges in recovering debts from the borrowers as the courts were overburdened with large
numbers of regular cases due to which courts could not accord priority to recovery matters of
the banks and financial institutions. The Government of India in 1981 constituted a committee
headed by Mr T. Tiwari, this committee suggested a quasi-judicial setup exclusively for banks
and financial institutions which by adopting a summary procedure can quickly dispose-off the
recovery cases filed by the banks and financial institutions against the borrowers.
Again in 1991, a committee was set up under Mr Narashmam, which endorsed the view of the
Mr T. Tiwari Committee and recommended the establishment of quasi-judicial for the speedy
recovery of debts. Pursuant to which Government of India enacted the RDDBFI Act. Through,
the RDDBFI Act quasi-judicial authorities were constituted, and the procedure was specified
for the speedy recovery of debt.
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT,

1993 (DRT ACT)
Recovery of the dues of loans from the borrowers through courts was a major issue for the
banks and financial institutions due to huge back log of cases and the time involved. The Act
came into operation from 24th June 1993. Important highlights of DRT Act 1993:
1) This Act constituted the special ‘Debt Recovery Tribunals’ for speedy recovery
2) This Act is applicable for the debt due to any bank or financial institution or a consortium
of them, for the recovery of debt above Ten lakhs
3) This Act is applicable to the whole of India except the State of Jammu & Kashmir 4. The
term ’debt’ covers the following types of debts of the banks and financial institutions
(a) any liability inclusive of interest, whether secured or unsecured
(b) any liability payable under a decree or order of any Civil Court or any arbitration
award or Otherwise or
(c) any liability payable under a mortgage and subsisting on and legally recoverable
on the date of application
Some examples of interpretation of the term ‘debt’ by different courts
(a) In the case of United Bank of India vs DRT (1999) 4 SCC 69, the Supreme Court held
that if the bank had alleged in the suit that the amounts were due to it from respondents as the
liability of the respondents had arisen during the course of their business activity and the same
was still subsisting, it is sufficient to bring such amount within the scope of definition of debt
under the DRT Act and is recoverable under that Act
(b) In G.V. films vs UTI (2000) 100 Compo Cases 257 (Mad) (HC), it was held that payment
made by the bank by mistake is a debt
(c) In the case of Bank of India vs Vijay Ramniklal AIR 1997 Guj.75. it was held that, if an
Employee commits fraud and misappropriation of money, the amount recoverable from him is
not a debt within the meaning of DRT Act.
The Limitation Act, 1963
The Limitation Act, 1963 specifies certain period prescribed within which any suit appeal or
application can be made. The ‘prescribed period’ means the period of limitation computed in
accordance with the provisions of the Limitation Act. A banker is allowed to take legal action
by filing a suit, prefer an appeal and apply for recovery only when the documents are within
the period of limitation. On the other hand, if the documents expired or are time barred, the
banker cannot take any legal course of action to recover the dues. Therefore, banks should be
careful to ensure that all legal loan documents held are valid and not time barred. In other
words, it is the responsibility of lenders to ensure that all loan documents are properly executed
and they are all within the required limitation period as per the limitation act. This is one of the
crucial aspects in credit management of banks.
Period of limitation for certain documents
Period of limitation and the time from which the period begins to run is shown below:
NATURE OF DOCUMENTS LIMITATION PERIOD
A Demand Promissory Note Three years from the date of DP Note.
A Bill of exchange payable at sight or upon Three years when the bill is presented
presentation
An Usance Bill of exchange Three years from the due date
Money payable for money lent Three years from the loan was made.
A guarantee Three years from the date of invocation of the

guarantee
A mortgage - enforcement of payment of Twelve years from the date the money sued
money becomes due
A mortgage – foreclosure Twelve years from the money secured by the

mortgage becomes due
A mortgage - possession of Immovable Thirty years when the mortgagee becomes

property entitled to possession
Revival of Documents
Banks are expected to hold valid legal documents as per the provisions of the limitation act. If
the limitation period expires, then the bank should arrange to obtain fresh set of documents.
Such situations are to be discouraged. In certain situations, the limitation period can be
exceeded. A limitation period can be extended in the following manners:
1. Acknowledgement of debt: As per Section 18 of Limitation Act, obtaining
acknowledgement of debt in writing across the requisite revenue stamp from the borrower
before expiration of the prescribed period of limitation, can extend limitation period.
2. Part payment: When part repayment of the loan is made by the borrower himself or his
duly authorized agent, before expiry of the documents (Sec 19 of Limitation Act). Evidence of
such payments should be in the handwriting or under the signature of the borrower or his
authorized agent.
3. Fresh set of documents: When the bank obtains the fresh set of documents before the expiry
of the original document, fresh period of limitation will start from the date of execution of the
fresh documents. A time-barred debt can be revived under Sec 25 (3) of the Indian Contract
Act only by a fresh promise in writing and signed by the borrower or his authorized agent,
generally or specially authorized in that behalf. A promissory note/ fresh documents executed
for the old or a barred debt will give rise to a fresh cause of action and a fresh limitation period
will be available from the date of execution of such documents.
Court Holiday
In case, if the court is closed on the prescribed period of any suit, appeal or application falls on
a date, then the suit appeal or application may be instituted, preferred or made, on the day when
the court reopens. (Sec 4 of the limitation act)
Limitation Period – Precautions to be taken by bank:
1. Banks should preserve all the relevant loan documents in a secured place
2. The documents should be under dual control of authorized persons
3. Banks should not allow any document to become time barred as per the provisions of
Law of Limitation
4. Banks internal control and monitoring system should be very effective in the sense that
the renewal of documents should be done well in advance.
Authorities under RDDBFI Act
The Debts Recovery Tribunals (DRTs) and Debts Recovery Appellate Tribunal (DRATs) were
established under the Recovery of Debts Due to Banks and Financial Institutions Act (RDDBFI
Act), 1993 with the specific objective of providing expeditious adjudication and recovery of
debts due to Banks and Financial Institution. Presently 38 DRT's and 5 DRAT's are functioning
in India.
Keeping in line with the international trends on helping financial institutions recover their bad
debts quickly and efficiently, the Government of India has constituted thirty-three Debts
Recovery Tribunals and five Debts Recovery Appellate Tribunals across the country.
THE DEBTS RECOVERY TRIBUNAL
The Debts Recovery Tribunal enforces provisions of the Recovery of Debts Due to Banks and
Financial Institutions (RDDBFI) Act, 1993 and also Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002.
Under the Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993
banks approach the Debts Recovery Tribunal (DRT) whereas, under Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act,
2002 borrowers, guarantors, and other any other person aggrieved by any action of the bank
can approach the Debts Recovery Tribunal (DRT).
Debts Recovery Tribunal are located across the country. Some cities have more than one Debts
Recovery Tribunals.
The setting up of a Debts Recovery Tribunal is dependent upon the volume of cases. Higher
the number of cases within a territorial area, more Debts Recovery Tribunal would be set up.
Each Debts Recovery Tribunal (DRT) is presided over by a Presiding Officer. The Presiding
Officer is generally equivalent to the rank of Dist. & Sessions Judge. A Presiding Officer of a
Debts Recovery Tribunal is assisted by a number of officers of other ranks, but none of them
need necessarily have a judicial background. Therefore, the Presiding Officer of a Debts
Recovery Tribunal is the sole judicial authority to hear and pass any judicial order.
Each Debts Recovery Tribunal has two Recovery Officers. The work amongst the Recovery
Officers of a Debts Recovery Tribunal (DRT) is allocated by the Presiding Officer of the
Tribunal. Though the Recovery Officer of the Tribunal need not be a judicial Officer, but the
orders passed by a Recovery Officer are judicial in nature, and are appealable before the
Presiding Officer of the Debts Recovery Tribunal (DRT).
The Debts Recovery Tribunal are governed by provisions of the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993, also popularly called as the RDDBFI Act. Rules
have been framed and notified under the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993.
After the enactment of Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interests (SARFAESI) Act any aggrieved person can approach a Debts Recovery
Tribunal (DRT). Earlier only Banks were entitled to approach the Debts Recovery Tribunal
(DRT).
The Debts Recovery Tribunal (DRT) are fully empowered to pass comprehensive orders and
can travel beyond the Civil procedure Code to render complete justice. A Debts Recovery
Tribunal (DRT) can hear cross suits, counter claims and allow set offs. However, a Debts
Recovery Tribunal (DRT) cannot hear claims of damages or deficiency of services or breach
of contract or criminal negligence on the part of the lenders. In addition, a Debts Recovery
Tribunal (DRT) cannot express an opinion beyond its domain, or the list pending before it.
The Debts Recovery Tribunal can appoint Receivers, Commissioners, pass ex-parte orders, ad-
interim orders, interim orders apart from powers to Review its own decisions and hear appeals
against orders passed by the Recovery Officers of the Tribunal.
The recording of evidence by Debts Recovery Tribunal is somewhat unique. All evidences are
taken by way of an affidavit. Cross examinations are allowed only on request by the defense,
and that too if the Debts Recovery Tribunal (DRT) feels that such a cross examinations are in
the interest of justice. Frivolous cross examination is denied is the same can be brought on
record by way of affidavit. There are a number of other unique features in the proceedings
before the Debts Recovery Tribunal all aimed at expediting the proceedings.
Section 3, provides for the establishment of Debt Recovery Tribunal (DRT), by notification to
be issued by the Central Government, for exercising, jurisdiction, powers, and authority
conferred on such tribunal under the RDDBFI Act. First DRT was established in Kolkata in
the year 1994. As per section 4, DRT consists of sole member only, known as Presiding Officer.
Section 5, provides that a person who has been or is qualified to become District Judge can be
appointed as Presiding Office of DRT. Section 6 provides that the terms of the Presiding Office
shall end after the expiry of the period of 5 years from the date he enters the office and he will
be eligible for reappointment provided he has not attained the age of 65 years.
DRT – other important aspects:

(a) When DRT has jurisdiction in such matters the Civil Courts are debarred from handling any
case.
(b) The Tribunal and Appellate Tribunal function from the appointed day, which is declared in
notification.
Their duties, powers and jurisdiction are well defined. From the date of establishing the
Tribunal, i.e., the appointed day, no court or other authority should have any jurisdiction,
powers or authority to deal with in any way in recovery cases above Rupees ten lakh. High
Courts and Supreme Courts, however, have jurisdiction under Constitution Articles 226 and
227.
Recovery Procedure:
Bank has to file an application for recovery of loan taking into consideration the jurisdiction
and cause of action. Other bank or financial institution can also jointly apply. Application can
be filed with fees, documents and evidence. The Limitation Act is also applicable on the DRT
cases; therefore, the application must be filed by the bank or the financial institution within
limitation period from cause of action. In case when the defendant against whom the DRT has
passed recovery order, wants to prefer appeal to the Appellate Tribunal, he is required to
deposit 75% or the prescribed percent of the amount as decided by the Tribunal. Without such
payment an appeal cannot be filed.
The tribunal issues Recovery Certificate to the applicant. Recovery officers attached to the
tribunal, have adequate powers for recovery under the Act. On receiving the recovery
certificate, the recovery officer has to proceed for the recovery by attachment and sale of
movable and immovable property. Defendant is debarred from disputing the correctness of the
amount given in recovery certificate. Orders of recovery officer are applicable within thirty
days to the Tribunal.
Special features of DRT: The provisions of this Act have overriding effect when there is
inconsistency with any other law or in any instrument by virtue of any other law for the time
being in force.
Case laws:
DRT is a special Act for recovery of debt due to banks and financial institutions. DRT has
overriding effect over the provisions of Companies Act,1956, hence leave of the company court
is not required even if the company is under winding up proceedings (Allahabad Bank vs
Canara Bank AIR 2000 SC 1535)
Money realized under DRT Act and distribution between bank and other secured creditors, in
cases where winding up proceedings are pending in company court, priority of secured
creditors is subject to provisions of 529 A of Companies Act (as per the said section, priority
of secured creditors and workman over other dues and distribution inter se between secured
creditors and workmen should be pari-passu)
Debt Recovery Appellate Tribunal
Sections 8 -11 deals with the establishment, qualification, and term of the Chair Person of the
Debt Recovery Appellate Tribunal (DRAT). DRAT is established to exercise control and
powers conferred under the RDDBFI Act. DRAT consist of sole member to be known as Chair
Person. A person is eligible to become a Chair Person, if he has been an or qualified to become
a High Court Judge, or has been a member of the Indian Legal Services and held a Grade 1
post as such member for the minimum period of three years or has held office of Presiding
Officer of Tribunal for period of at least three years. The Chair Person of DRAT can hold his
office for the period of five years and is also eligible for reappointment, provided, that he has
not attained the age of seventy years. Presently there are 5 DRATs in India in Delhi, Chennai,
Mumbai, Allahabad, and Kolkata. DRAT has appellate and supervisory jurisdiction over
DRTs.
Who can recover money from DRT under RDDBFI Act
As per section 1(4), the provisions of RDDBFI Act does not apply where the amount of debt
due to the bank or financial institution or the consortium of banks and financial institutions is
less than Rupees Ten Lakh or any other amount not below Rupees One Lakh, cases where the
central government may by notification specify. Thus, in essence, minimum debt which is to
be recovered from DRT should not be less than Rupees Ten Lakh. In the case of SARFESAI
Act, if the asset has been declared as Non-Preforming Asset (NPA), eligible banks and financial
institutions after enforcing security can recover remaining amount under RDDBFI Act which
is in excess, of Rupees One Lakh.
What type of debt can be recovered under the RDDBFI Act
As per section 2 (g) debt is any liability inclusive of interest, which is claimed to due from any
person by any bank or financial institution or consortium thereof. Such liability may be secured
or unsecured or assigned, whether payable under the order of court or arbitration award or
under the mortgage. Such a liability shall be subsisting and validly recoverable on the date of
application.
The debt also includes liability towards debt securities which remains unpaid in full or part
after notice of ninety days served upon the borrowers by the debenture trustees or any authority
in whose favor a security interest is created for the benefit of the holder of the debt security.
Clause 2(ga) defines debt security as securities listed in accordance with regulations defined
by SEBI under Securities and Exchange Board of India Act, 1992.
Jurisdiction, Powers, and Authority of DRT and DRAT
As per section 17 of RDDBFI Act, vests jurisdiction, power and authority on DRT to entertain
and decide application from banks and financial institutions to recover a debt due to such banks
and financial institutions. Further, section 17A confers on DRAT power of general
superintendence and control and confers appellate jurisdiction on DRAT. DRAT is also
empowered to transfer a case from one DRT to another DRT. DRAT is also empowered to call
for information from DRT, about cases pending and disposed of them. DRAT is also
empowered to convene the meeting of Presiding Officers. It also empowered to conduct an
inquiry of Presiding Officer and recommend suitable action to the Central Government.
Section 18 bars the jurisdiction of any civil court or authority for recovery of debt, except High
Court and Supreme Court in the exercise of their writ jurisdiction under Article 226 and 227
of the Constitution of India. Thus, in essence order of DRAT can be challenged in writ
jurisdiction of High Court or Supreme Court
Interim Order by DRT: In cases where the applicant apprehends that the borrower may take
steps which may frustrate attempt of execution may make an application to DRT along with
details of property to be attached and value thereof, and on such application may pass an interim
order directing respondent/defendant, directing him to deposit before it amount equivalent to
property value or amount which may be sufficient to recover the debt or as and when required
by DRT to place before it disposal the property.
Wherever DRT finds it fit, it may also pass following orders;
1) appoint a receiver of the property, before or after the grant of Recovery Certificate
(RC);
2) remove any persons from possession or custody of any property;
3) commit the same to custody, management of the receiver;
4) confer power on the receiver to file/defend the suit on behalf of property, or to act in
any manner for the improvement of the property;
5) appoint a commissioner for collecting details of defendant/respondent’s property or sale
thereof.
Judgment and Recovery Certificate by DRT
DRT after giving both the parties opportunity of hearing and hearing their submissions will
within 30 days of the conclusion of such hearing pass its interim or final order. Within 15 days
of the passing of the order, DRT will issue RC and forward the same to Recovery Officer. RC
will contain the details of the amount to be paid by recovered by the borrower debtor. RC shall
have the same effect as the decree of the civil court.
Appeal
An appeal by any aggrieved party against the order of DRT can be filed within the period of
30 days from the date of receipt of the order. No appeal can be filed against any order which
has been filed with the consent of the parties. DRAT shall endeavour to dispose-off appeal
finally within the period of six months.
Amount to be deposited for filing an appeal – Where the appeal is being preferred by the debtor,
who as per the order of DRT is liable to pay money to bank or financial institution at the time
of filing appeal is required to deposit before DRAT 50% of the amount he is required to pay as
per the order of the DRT. However, with the permission of DRAT, this amount can be reduced
by DRAT, but reduced amount should not below 25% of the debt amount which Borrower is
required to pay as per DRT order.
Recovery of debt by Recovery Officer: After receipt of RC from DRT, Recovery Office
will initiate recovery by one or more of following modes:
1) Attachment and sale of movable or immovable property of defendants/debtors;
2) Taking possession of property over which security interest was created or any other
property of defendant/debtor and appointing receiver for the management of the same;
3) Arrest of defendant/debtor and his detention in prison;
4) Appointment of receiver for management of movable or immovable property of
defendant/debtor;
5) Any other mode as may be prescribed by the central government.
Apart from above modes Recovery Officer may also, direct any person who is liable to pay any
amount to defendant/borrower, deduct from such amount the recovery amount, and transfer to
the credit of Recovery Officer the amount so deducted. However, Recovery Officer will not
deduct any such amount which is exempt from attachment under Code of Civil Procedure,
1908.

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GOVERNMENT LAW COLLEGE, KOZHIKODE

NATIONALIZATION OF BANKS FOR IMPLEMENTING GOVT. POLICIES

STRUCTURE OF BANKS IN INDIA

DIFFERENT TYPES OF BANKS IN INDIA

I.) COMMERCIAL BANKS:

The functions of banks are mainly divided into two:

Core (Centralized Online Real-time Exchange) banking is a banking service provided by a

These are as herein follows:-

o To deposit a cheque for credit into his account.

Advantages of Core Banking

An investment bank is a financial institution that assists individuals, corporations, and

Merchant Banking is a combination of Banking and consultancy services. It provides

MULTI- FUNCTIONAL BANKS (For Details Refer Module 2)

“International Banking” can be defined as a sub-set of commercial banking transactions and

Examples of international banking

CENTRAL BANKING - FUNCTIONS OF CENTRAL BANKS

Functions of RBI can be classified into following categories:

4) Exchange Rate Management: It is an essential function of the RBI. In order to

MONETARY POLICIES OF RBI

• Margin requirements – RBI prescribes a certain margin against collateral, which in

• Moral suasion – By way of persuasion, RBI convinces banks to keep money in

RBI AS BANKER’S BANK

ROLE OF RESERVE BANK OF INDIA (RBI)/ SUPERVISION OVER

appointed on a whole-time basis or a Managing Director, be deemed to be a Director of the

(iii) Cash Reserve: - According to Section 18 of the Act,

(iva) Regulation of acquisition of Shares or voting rights:- (1) No person (hereinafter

Establishment of Depositor Education and Awareness Fund:

LICENSING OF BANKING COMPANIES

B) COMPANY INCORPORATED OUTSIDE INDIA- Before granting any license, under

(5) Appeal and remedy against cancellation (Section 22(5))

d. Discounting of Bill of Exchange: The bank can advance money by discounting or by

(2) Any person appointed as additional Director in pursuance of this section-

(c) shall not be required to hold qualification-shares in the banking company.

ACCOUNTS AND BALANCE SHEET [Section 29]

AUDIT [Section 30]

WINDING UP OF BANKING COMPANIES

(A). Winding up by High Court (S 38)

B.) Voluntary winding up (S.44)

RECONSTRUCTION AND AMALGAMATION

Power of Reserve Bank to apply to Central Government for suspension of business by a

Procedure for amalgamation of banking companies (Section 44A). -

CONTROL OVER BANKING OPERATIONS

CASH RESERVE RATIO (CRR)

Objectives of Cash Reserve Ratio

STATUTORY LIQUIDITY RATIO (SLR)

How does Statutory Liquidity Ratio work?

FOREIGN EXCHANGE DEALINGS

• Payment of DD, MT, TT, travellers’ cheques, etc.

• Issue of DD, MT, TT, travelers cheques, etc.

• Payments of bills drawn on customers.

Merchant Banking is a combination of Banking and consultancy services. It provides

The functions of merchant banking are listed as follows:

when to sell. Large brokers, Mutual Funds, Venture capital companies

6) Handling Government Consent for Industrial Projects: A businessman has to get

7) Special Assistance to Small Companies and Entrepreneurs: Merchant banks advise

11) Corporate Restructuring: It includes mergers or acquisitions of existing business units,

THE BANKING OMBUDSMAN

Banker-Customer Relationship - Duty of Confidentiality – Account of Customers - Deposits -

BANKER – CUSTOMER RELATIONSHIP

Obligations to maintain Secrecy of Account

(viii) Under the Industrial Development Bank of India Act, 1964.