BANKING

MODULE I: BANKING AND FINANCIAL INSTITUTIONS

Evolution of Banking Systems
 Banking has two important functions – one of accepting deposits and
other of lending monies and/ or investment of funds.
 Bankers in Vedic age were called Ratnagers. They lent money with 0%
interest. No deposit.
 In Mauryan civilization, deposit and lending both with interest.
 1770 – First bank, namely Bank of Hindustan was set up by Alexander
the Great in Kolkata. It was a Dutch company.
 1806 – First commercial Bank established by Great Britain – Presidency
Bank of Calcutta.
 1809 – Bank of Bengal.
 Portuguese and Dutch people followed the barter system in the ports.
Exchange of goods for currency.
 First melting of coin was started at Calcutta around 1807.
 1840 – Bank of Bombay.
 1843 – Bank of Madras
 Quasi Presidency Banks
 Bank of Calcutta – Melting of coins.
 Bank of Bombay – Trading
 Bank of Madras – Transaction.
 1863 – The first joint sector bank – Bank of Upper India at Benares – It
failed.
 1865 – The first joint sector bank which is still active – Allahabad Bank –
First Indian Bank.
 1894 – Punjab National Bank set up at Lahore – Later shifted to Delhi.
Investment was made by foreigners but fully managed by Indians.
 1911 – First Swadeshi Bank – Central Bank of India. Investment was
made by Indians and fully managed by Indians.
 1770 – 1911: Growth of Indian Banking
 1901 – 1911: Golden age of Banking
 1913 – 1918: Dark age of Banking – First World War.
 1921 – Imperial Bank of India – merging of all the three presidency
banks.

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  Hilton Young Commission (1926) – Royal Commission on Indian
Currency (Hilton Young Commission) recommended the establishment
of a central bank to be called the ‘Reserve Bank of India’.
 B.R. Ambedkar gave a suggestion that there should be a Central Bank
which will regulate all the banks in India.
 RBI Act of 1934 came into force on 1st April, 1935. RBI had it’s
headquarter at Calcutta. Shifted to Bombay in 1937.
 A Central Bank regulates all the laws of banking. It does not perform the
role of a bank. Central Bank is the banker of the banks.
 Banking Companies Act, 1944 was enacted. After independence, Banking
Regulation Act, 1949 which came into force in a full-fledged manner in
1966. There is a provision of licensing by the Central Bank. Its main
purpose is to smoothen the transaction.
Banking Structures and Classification of Financial Institutions
Scheduled Bank
 Banks included in the 2nd Schedule of the RBI Act.
 Fulfils the condition of paid-up capital.
 Adheres to the norms prescribed by the RBI.
 CRR (Cash Reserve Ratio) maintained with RBI.
Unscheduled Bank
 Banks not included in the 2nd Schedule of the RBI Act.
 Do not adhere to the norms of RBI.
 CRR not maintained with RBI. It is to be noted that Scheduled banks and
Non-scheduled banks both need to maintain the Cash Reserve Ratio
(CRR) but Scheduled banks have to deposit this amount in the RBI while
Non-scheduled banks can deposit this amount with themselves.
Key Differences between Scheduled Bank and Non-Scheduled Bank

 Scheduled banks follow the rules made by the RBI while Non-scheduled
banks do not follow the rules made by the RBI.
 Scheduled banks are eligible for inclusion in the second schedule to the
Reserve Bank of India Act, 1934 while Non-scheduled banks are not
included in the second schedule.
 Scheduled banks are allowed to borrow money from RBI for regular
banking purposes while Non-scheduled banks are not allowed so.

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  Scheduled banks can become a member of clearing house while Non-
scheduled banks can't.
 Scheduled banks and Non-scheduled banks both need to maintain the
Cash Reserve Ratio (CRR) but Scheduled banks have to deposit this
amount in the RBI while Non-scheduled banks can deposit this amount
with themselves.

Development Bank
 NABARD (National Bank for Agriculture and Rural Development)
 IDBI (Industrial Development Bank of India)
 SIDBI (Small Industries Development Bank of India)
 EXIM Bank – Export Import Bank

RBI
Scheduled Banks Unscheduled Banks Development Banks

Scheduled Banks
Scheduled Commercial Banks Scheduled Cooperative
Banks
Conditions to be fulfilled by a Scheduled Bank
 Minimum paid-up capital of Rs. 50 lakhs.
 Must serve the interest of the depositors.
 Must always have the requisite CRAR [Capital to Risk (Weighted) Assets
Ratio]. CRAR is also known as Capital Adequacy Ratio (CAR). In simple
terms, CRAR is the ratio of a bank’s capital to its risk. The banking
regulator tracks a bank’s CAR to ensure that the bank can absorb a
reasonable amount of loss and complies with statutory Capital
requirements. Higher CRAR indicates a bank is better capitalized. CRAR is
decided by central banks and bank regulators to prevent commercial
banks from taking excess leverage and becoming insolvent in the
process.
 Must maintain requisite CRR (Cash Reserve Ratio) and SLR (Statutory
liquidity ratio).

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Scheduled Banks
 Scheduled Commercial Banks
 Public Sector Banks – Nationalized Banks (e.g. SBI, Allahabad Bank,
Punjab National Bank, Canara Bank etc.)
 Private Sector Banks – ICICI Bank, HDFC Bank, Axis Bank etc.
 Foreign Banks
 Regional Rural Banks (RRB)
 Scheduled Cooperative Banks
 NAFSCOB (National Federation of State Cooperative Banks)
 Rural cooperative credit institutions – State Cooperative
Banks/ District cooperative banks/ Primary Agricultural
Credit Society (PACS)
 Urban cooperative Banks
 All India Financial Institutions
 NABARD
 IDBI
 SIDBI
 EXIM
Unscheduled Banks
 Local Area Banks
 Urban Cooperative Banks
Public Sector Banks
 First 7 banks with paid-up capital of 50 lakhs were formed. These were
nationalized.
 After that all nationalized banks are required to have a paid-up capital of
2 crores.
 As of now, a total of 19 nationalized banks are there.
 SBI has its own Act. Five associates of SBI were there which have been
merged now.
 State Bank of Bikaner and Jaipur.
 State Bank of Mysore.
 State Bank of Patiala.
 State Bank of Hyderabad.
 State Bank of Travancore.
 The nationalization was done in two phases – 1969 and 1980.

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Non-Banking Financial Companies
 Non-banking financial company (NBFC) is a company registered under
the companies Act. NBFCs are financial institutions that offer various
banking services but do not have a banking license. Generally, these
institutions are not allowed to take traditional demand deposits from
the public. This limitation keeps them outside the scope of conventional
oversight from federal and state financial regulators.
 NBFCs can offer banking services such as loans and credit facilities,
currency exchange, retirement planning, money markets, underwriting,
and merger activities.
 Two types of NBFCs:
 Registered and regulated by RBI – Loan companies, Asset finance
companies, Residuary Non-banking finance companies (RNBFCs).
Infrastructure Development Finance Company (IDFC) comes under
RNBFC.
 Not registered but regulated by RBI
 Chit Funds – A chit fund is a type of rotating savings and
credit association system. Chit fund schemes may be
organized by financial institutions, or informally among
friends, relatives, or neighbours.
 Nidhi Company – Their core business is borrowing and
lending money between their members.
National Agricultural Bank for Rural Development (NABARD)
 The importance of institutional credit in boosting rural economy has
been clear to the Government of India right from its early stages of
planning. Therefore, the Reserve Bank of India (RBI) at the insistence of
the Government of India, constituted a Committee to Review the
Arrangements for Institutional Credit for Agriculture and Rural
Development (CRAFICARD) to look into these very critical aspects. The
Committee was formed on 30 March 1979, under the Chairmanship of
Shri B. Sivaraman, former member of Planning Commission, Government
of India.
 NABARD came into existence on 12 July 1982 by transferring the
agricultural credit functions of RBI and refinance functions of the then
Agricultural Refinance and Development Corporation (ARDC).

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  NABARD does not give loans directly. It gives loans through the
following:
(i) RRB (Regional Rural Bank)
(ii) Cooperative Bank
(iii) Self Help Groups (SHG)
 NABARD’s activities are governed by a Board of Directors. The Board of
Directors are appointed by the Government of India in harmony with
NABARD Act 1981. It has it’s headquarters in Mumbai. Government of
India holds 99% stake and RBI holds 1% stake in NABARD.
 NABCONS – NABARD Consulting Services
NABFINS – NABARD Financial Services

RBI

NABCONS NABARD NABFINS

RRB Cooperative Banks SHG

Functions of NABARD
 Credit Functions:
 Framing policy and guidelines for rural financial institutions.
 Providing credit facilities to issuing organizations
 Monitoring the flow of ground level rural credit.
 Preparation of credit plans annually for all districts for
identification of credit potential.
 Development Functions:
 Help cooperative banks and Regional Rural Banks to prepare
development actions plans for themselves.
 Help Regional Rural Banks and the sponsor banks to enter into
MoUs with state governments and cooperative banks to improve
the affairs of the Regional Rural Banks.
 Monitor implementation of development action plans of banks.
 Provide financial support for the training institutes of cooperative
banks, commercial banks and Regional Rural Banks.

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  Provide financial assistance to cooperative banks for building
improved management information system, computerisation of
operations and development of human resources.
 Supervisory Functions:
 Undertakes inspection of Regional Rural Banks (RRBs) and
Cooperative Banks (other than urban/primary cooperative banks)
under the provisions of Banking Regulation Act, 1949.
 Undertakes inspection of State Cooperative Agriculture and Rural
Development Banks (SCARDBs) and apex non- credit cooperative
societies on a voluntary basis.
 Provides recommendations to Reserve Bank of India on issue of
licenses to Cooperative Banks, opening of new branches by State
Cooperative Banks and Regional Rural Banks (RRBs).
 Undertakes portfolio inspections besides off-site surveillance of
Cooperative Banks and Regional Rural Banks (RRBs).
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MODULE II: RBI – STRUCTURE AND FUNCTIONS (RBI Act, 1934)
Evolution of RBI
 The origin of the Reserve Bank of India (RBI) can be traced to 1926 when
the Royal Commission on Indian Currency and Finance (also known as
Hilton Young Commission) recommended the creation of a Central Bank
for India to separate the control of currency and credit from the
government and to augment banking facilities throughout the country. It
was established in response to economic troubles after the First World
War.
 Prior to the establishment of RBI, the functions of central bank were
virtually performed by the Imperial Bank of India.
 RBI started its operations from 1st April, 1935. It was established via the
RBI Act, 1934. Hence, it is a statutory body.
 RBI did not start as a Government owned bank but as a privately held
bank without major government ownership. It started with a share
capital of Rs. 5 crores divided into shares of Rs. 100 each fully paid-up.
 After independence, the government passed Reserve Bank (Transfer to
Public Ownership) Act, 1948 and took over RBI from private
shareholders after paying appropriate compensation. Thus, the
nationalization of RBI took place in 1949 and with effect from 1 st
January, 1949, RBI started working as a government owned bank.
 The RBI also acted as Burma’s central bank until April, 1947. After
partition in August, 1947 the Bank served as Central Bank of Pakistan
until June, 1948 when State Bank of Pakistan commenced operations.
 The headquarter of RBI was in Calcutta but moved to Bombay in 1937.
Major objectives of RBI
 Price stability or control of inflation.
 Economic growth of the country through ensuring adequate availability
of credit at lower cost.
 Stability of exchange rate.
 Proper arrangement of agricultural finance.
 Proper arrangement of industrial finance.
 Proper management of public debt.
 Centralization of cash reserves of commercial banks.
 Maintaining balance between demand and supply of currency.
 Development of organized money market in the country.
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Functions of RBI
The functions of RBI can be classified into three major parts:
1. Traditional functions.
2. Promotional functions.
3. Supervisory functions.
1.Traditional Functions
(a) Issuer of currency: RBI issues and exchanges currency. It also destroys
currency and coins not fit for circulation to ensure that the public has
adequate quantity of supplies of currency notes of good quality.
(b) Banker to the government: Performs all banking functions for the central
and state governments. It acts as their banker – maintains and operates
government deposits, collects or makes payment on behalf of the
government etc.
(c) Banker to Banks: An important function of the RBI is to maintain the
banking accounts of all scheduled banks covered under Schedule II of
the RBI Act, 1934.
(d) Custodian and Regulator of Foreign Currency Reserves : RBI manages
foreign exchange reserves under FEMA, 1999 in order to:
 Facilitate external trade and payment.
 Promote development of foreign exchange markets in India.
(e) Lender of last resort: As a banker to banks, the RBI acts as the lender of
last resort. It can come to the rescue of a bank that is solvent but faces
temporary liquidity problems by supplying it with much needed liquidity
when no one else is willing to extend credit to that bank.
(f) Controller of credit: Through quantitative and qualitative techniques, RBI
undertakes the responsibility of controlling credit by commercial banks.
(g) Formulation of monetary policy: The RBI formulates, implements and
monitors the monetary policy to:
 Maintain price stability
 Keep inflation under check.
(h) Agent of Government of India : The RBI acts as an agent of the
government of India as it issues govt. bonds, treasury bills on behalf of
the government. It also acts as an agent of the government of India in
the IMF (International Monetary Fund).
(i) Financial Advisor to the government : RBI acts as the financial advisor to
the government in all important economic and financial matters.
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2. Promotional Functions
 Promotion of banking habits
 Facilitating Agriculture (through NABARD)
 Facilitating small scale industries.
 Helps the cooperative sector.
 Adequate flow of credit to priority sectors. Institutions like NABARD,
IDBI, SIDBI, NHB etc. provide loans at concessional rate of interest.
3. Supervisory Functions:
 Granting license to banks
 Supervision and regulation of ATMs
 Regulating Bank branches
 Periodical review of the working of commercial banks
 Inspection and enquiry
 Supervision of the financial system
Monetary Policy – RBI
 GoI formulates the fiscal policy whereas the RBI formulates, implements
and monitors the monetary policy. There are two aspects of the
monetary policy:
 Qualitative
 Quantitative
 Qualitative aspect
 RBI guidelines
 Consumer credit – Priority sector lending at concessional rate of
interest
 Direct action by the RBI

 Quantitative aspect
CRR (Cash Reserve Ratio) – S. 24 (2) (b) of the RBI Act

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 Direct
SLR (Statutory Liquidity Ratio) – S. 24 (2) (e) of the RBI
Act
Repo Rate
Indirect
Reverse Repo Rate
Regulation of Indian Banking System
Credit control is most important function of Reserve Bank of India. Credit
control in the economy is required for the smooth functioning of the economy.
By using credit control methods, RBI tries to maintain monetary stability.
Measures of credit control by the RBI are as follows:
 Bank Rate: It is the interest rate at which RBI gives loans to commercial
banks without providing any security. The bank rate is the Official
interest rate at which RBI rediscounts the approved bills held by
commercial banks. For controlling the credit, inflation and money
supply, RBI will increase the Bank Rate.
 Repo Rate: It is the interest rate at which the RBI lends to commercial
banks by purchasing securities.
 Reverse Repo Rate: The interest rate at which RBI borrows from
commercial banks is called the reverse repo rate.
 Cash Reserve Ratio (CRR): Cash reserve ratio refers to that portion of
total deposits in commercial Bank which it has to keep with RBI as cash
reserves.
 Statutory Liquidity Ratio (SLR): SLR refers to that portion of deposits with
the banks which it has to keep with itself as liquid assets (Gold, approved
govt. securities etc.). If RBI wishes to control/ discourage credit, it would
increase CRR & SLR.
FERA & FEMA
 Foreign Exchange Regulation Act, 1973 (FERA) was enacted to regulate
inflow and outflow of foreign currency, foreign payments, securities and
purchase of fixed assets by the foreigners. The Act was implemented by
RBI. The FERA was promulgated in India at a time when it did not have

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 good foreign exchange reserve. It aimed at conserving foreign currency
and its optimum utilisation for the development of the economy.
 FERA was replaced by FEMA, Foreign Exchange Management Act, 1999.
Under the FEMA, provisions related to foreign exchange have been
modified and liberalised so as to simplify foreign trade and payments.
The important goal of FEMA is to amend and integrate all laws related to
foreign currency in India. In addition to this, FEMA aims to promote
foreign payments, export of the country and promote foreign capital and
investment in the country to promote holistic development of India.
FEMA also encourages the maintenance and improvement of the foreign
exchange market in India. FEMA provides complete independence to a
person living in India that he/she can buy property outside India.
Subsidiaries of RBI
1. National Housing Bank – established in 1988 – headquarter at New Delhi
– To regulate and control the loans under housing sector provided by
any bank, public or private.
2. DICGC – Deposit Insurance and Credit Guarantee Corporation of India –
headquarter at Mumbai – gives insurance cover over deposits – safety
net for Bank deposits in India
3. BRBNMPL – Bharatiya Reserve Bank Note Mudran Private Limited –
Headquarter at Bangalore – controls currency printing press at Mysore
(Karnataka), Salboni (West Bengal), Nashik (Maharashtra) and Devas
(Madhya Pradesh). One of the Deputy Governors of RBI is in-charge of all
the printing press.
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MODULE III: REGULATION OF BANKS (Banking Regulation Act, 1949)

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Social Control and Nationalization of Banks
Banking Scenario prior to Nationalization

 The private sector banks being predominantly urban oriented and

controlled by few large industrialists were not properly equipped to help
the achievement of the basic socio-economic objectives.
 The credit needs of agriculture, small scale industries and weaker
sections were totally neglected.
 The bulk of the deposits mobilized was advanced to the industry sector
and the priority sector agriculture received barely 1%.
 In absence of financial institutional protection, the agricultural credit
scene was dominated by private moneylenders charging exorbitant rate
of interest.
 All these compelled the imposition of social control over banks in 1968.

The Social Control Scheme

 Reconstitution of Board of Directors – i.e. 51% of them should have

specialized knowledge on accountancy, agriculture, rural economy,
banking, cooperation, economics, finance, law, small scale industries and
other matters useful to the banking company.
 Appointment of a whole-time chairman.
 Imposition of restriction on loans to be granted to the director’s
concern.
 The scheme also provided for take-over of banks by the Govt. under
certain circumstances.
 National Credit Council was setup to perform certain specific functions
relating to credit to priority sector.
 The major objectives of the social control scheme were:
 wider spread of bank credit,
 directing large volume of credit flow to the priority sector, and
 reducing the authority of the members of the managing
committee, since they acted as the representatives of the
industrialists.

Situation after social control scheme

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  Created the tempo of branch expansion initially.
 No significant achievement was made in channelizing adequate credit to
the priority and weaker sections.
 In many banks, the policies were controlled by those, who had
controlled these banks earlier.
 The directions issued by the Government were ignored by many banks.

The consequent impact

 The Government believed that social control was not sufficient to make
the commercial banking system meaningful for socio economic
development.
 Bank nationalization was considered as the alternative solution.

The Remedial move

 Demand for nationalization of commercial banks was raised quite
frequently in the past.
 12-point programme was placed in the Bhubaneswar session of the
congress party in 1964 to mitigate the entire range of economic and
Social evils.
 The Govt. did not accept that due to administrative difficulties and other
consequential effects in the economy. However, social control was
introduced on 1st February,1969 through the enforcement of legislative
measures.

Nationalization of Banks
 Part IV of the Indian Constitution contains Directive Principles of State
Policy (DPSP). The Constitution under DPSP obligates the State to build
an egalitarian society for the people of India. It is based on the principle
that all people are equal and deserve equal rights and opportunities.
 After independence, transport undertakings, electricity generation and
distribution, insurance sector, oil refineries etc. were nationalized in
order to achieve the goal of socialism which mandates that means of
production, distribution and exchange should be owned and regulated
by the community as a whole.

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  It was found that the distribution of credit in rural areas was abysmally
low because of inaccessibility of banks and other financial institutions in
rural areas.
 In this backdrop, the Imperial Bank was taken over under the SBI Act in
1955. In 1959, its subsidiaries were also taken over by the Government
as SBI subsidiaries.
 Further, as a result of the enactment of the Banking Companies
(Acquisition & Transfer of Undertaking) Act, 1969, 14 banks were
nationalized.
R. C. Cooper v. Union of India (Bank Nationalization Case) [1970]
Background/ Facts of the case
 The Preamble and various constitutional provisions of the Constitution
of India obligate the state to build an egalitarian society for the people
of India. These obligations are in detail discussed in Part IV of the
Constitution under the heading Directive Principles of State Policy
(DPSP). The Part IV starts with Article 37 declaring the part not
enforceable in the courts of law is however fundamental in the
governance of the country. Therefore, while making laws the Parliament
must apply these provisions. State control of industries was seen as a
great means to achieve the ends of Socialism. After Independence of the
nation, transport undertakings, electricity, insurance sector, oil refineries
etc., were nationalized in order to achieve the goals of Socialism.
 Since Independence the distribution of credit in rural areas was at a
great low. This was because of the inaccessibility of banks and other
financial institutions in the rural areas. Therefore, in order to target the
rural area, the government schemed a plan to target the needy sectors.
This solution they devised was Nationalization.
 Earlier in 1955, Imperial bank of India was taken under the SBI Act and
just in four years its 7 subsidiaries were also amalgamated into the SBI
branch.
 The Indira Gandhi government in 1969 promulgated the Banking
Companies (Acquisition & Transfer of Undertaking) Ordinance, 1969
nationalizing the 14 banks. These 14 banks were chosen on the basis
that they had deposits exceeding 50 crores. The ordinance w.e.f. 19 July
1969 brought more than 75% banking sector under state control along
with its assets, liabilities, entire paid-up-capital. Later when Parliament

15
 came in session it enacted the Banking Companies (Acquisition &
Transfer of Undertaking) Act, 1969 with the same provisions as were in
the Ordinance.
 The controversial part of the Act was the second schedule which
provided that:
1. Where an amount of compensation could be fixed by an
agreement; it would be determined by such agreement
2. Where no such agreement could be reached in the provided time,
the matter would be referred to tribunal. The compensation fixed
by the tribunal will be awarded after 10 years from the date when
the agreement failed.
 Rustom Cavasjee Cooper the majority shareholder of Central Bank of
India & Bank of Baroda filed a writ petition in Supreme Court u/a 32 for
the violation of his Fundamental Rights mentioned under articles 14,
19(1)(f) & 31(2) of the Constitution. As a result of nationalization of
banks, the Shareholders had to give up their shares at low values.
Issues
1. Whether a shareholder can file a petition for remedy against violation of
his fundamental rights when the company in which the shares are held is
taken over.
2. Whether the Parliamentary Act was within Parliamentary Competence.
3. Whether the impugned Parliamentary Act was violative of Article 19(1)
(f) & 31(2) of Constitution of India.
4. Whether the method of ascertaining compensation was valid.
Petitioner’s arguments
 The writ petition is maintainable because the petitioner has filed it for
enforcement of his Fundamental Rights and not that of company. Since
Company is not a citizen within the context of Indian Citizenship Act,
1955 and the Constitution of India, a company cannot claim the
protection of those FR’s which are solely available to citizens of India.
 The three lists under Schedule VII of the Constitution Union, State &
Concurrent List clearly demarcate the area of operation of Union
Parliament, State Legislature and areas where both can operate
respectively. The Parliament can only legislate in the matters of
“Banking” as defined in the Section 5(b)of Banking Regulation Act, 1949
by virtue of Entry 45 of List I. Further, the legislature by the virtue of
16
 Entry 42 of list III can only make laws for effectuating laws under List I.
Therefore, the Parliament did not possess the required valid
competence to initiate the acquisition process.
 The impugned act of 1969 is violative of Fundamental Rights mentioned
in Article 19(1)(f) and Article 31. Therefore, the Act is in direct
contravention of Article 13 which clearly provides that any law which is
in violation of the said provision will be unconstitutional and the courts
are bound to strike it down.
 The Schedule II of the impugned Act that provides for the procedure in
which the Compensation is to be given to the shareholders is draconian
in its entirety. The said provision is too irrational and vague. No valid law
can make a person realize the fruits of the agreement after 10 years.
Such illogical and illegal condition must be struck down.
Respondent’s (UoI) arguments
 The writ petition is not maintainable because the petitioner is seeking
the protection of Fundamental Rights of the Company which is not a
citizen as per the Indian Citizenship Act, 1955. The rights mentioned
under Article 19 are only available to the Citizens of the nation whereas
company is only a juristic person and not a citizen.
 The courts must see the Socialist obligations upon the state to make an
egalitarian society in which there is no sort of inequality. Therefore, the
court should, keeping in perspective these obligations, must construe
the word “Banking” under Entry 45 of List I to mean all the activities
which the respondent ought to undertake.
 The Act is not violative of Article 19(1)(f) since it falls within the
provisions of Article 31 and since in A. K. Gopalan v. Union of India
[1950], the court held that each Fundamental Right is exclusive of one
another and distinct.
Judgment
 The Supreme Court held that the shareholder or director cannot move
to the courts for the protection of infringement of Fundamental Rights
of the company unless it is proved that by the impugned action his rights
are also violated.
 The apex court overruled the 20 years law laid down by A. K. Gopalan
rejecting the mutual exclusivity theory. The court held that we cannot
overlook the violation of citizens of the nation on mere technicalities. If
17
 due to state action the fundamental rights of a citizen are violated the
court is bound to prohibit such violation. The court by holding this laid
down the Effect test and overruled the Object test. Therefore, now the
courts won’t look into the objects of the impugned act and rather they
will look into the effect of the impugned act. In case effect of such act
violates the FR’s of citizens it would be violative of Constitution and
liable to be struck down.
 The court rejected both the Petitioner’s & Respondent’s argument on
legislative competence to acquire banking Companies. The court held
that the term Property in itself constitutes the rights, liabilities,
organization etc. that accrue to the property. The power to acquire
property was held to be an independent power of Parliament and it
required no separate legislation under List II or List III.
 The court found the impugned Act was in contravention of the Article 31
which provides that the in case any property is acquired by the
government then they have to provide compensation to the property
owner. Since there was clear violation of the said provision therefore,
the court struck down the said Act.
 However, the court upheld the validity of the Act in the context of
Article 19(1)(f). The court said that the Act is not violative of the freedom
to carry trade & business. The justification for the said ruling is that the
state can always create a partial and absolute monopoly.
Aftermath of the Judgment in R. C. Cooper v. Union of India
 By a majority of 10:1, the Supreme Court of India struck down the
Banking Companies (Acquisition and Transfer of Undertaking) Act, 1969
mainly on the ground that the proposed compensation to be provided to
the 14 banks failed the test of Article 31(2).
 Thereafter, the Banking Companies (Acquisition and Transfer of
Undertaking) Act, 1970 was enacted by the Parliament but with inclusion
of a specific amount of compensation to be paid to each of the 14 banks.
 This amount was clearly specified in Schedule II of the 1970 Act unlike
the impugned Act of 1969 which provided for Constitution of a tribunal
by the Central Government in case compensation could not be arrived at
through consensus. Therefore, notwithstanding the striking down of the
Act of 1969, Nationalisation of Banks prevailed and subsequently in
1980, 6 additional banks were nationalized.

18
  The Supreme Court, in its judgement on Rustom Cavasjee Cooper v.
Union of India, popularly known as the Bank Nationalization case, held
that the Constitution guarantees the right to compensation, that is, the
equivalent money of the property compulsorily acquired. The Court also
held that a law which seeks to acquire or requisition property for public
purposes must satisfy the requirement of Article19(1)(f). To overcome
the restrictions imposed on the government by this ruling, the 25 th
Constitution Amendment was made.
 The Twenty-fifth Amendment of the Constitution of India, officially
known as The Constitution (Twenty-fifth Amendment) Act, 1971,
curtailed the right to property, and permitted the acquisition of private
property by the government for public use, on the payment of
compensation which would be determined by the Parliament and not by
the courts. The amendment also exempted any law giving effect to the
article 39(b) and (c) of Directive Principles of State Policy from judicial
review, even if it violated the Fundamental Rights.
Banking Regulation Act, 1949 (Ss. 11. 22, 35, 35A, 35AA, 36, 37, 38, 39, 45)
Banking companies in India is governed by two main legislations:

 Banking Regulation Act, 1949

 The Reserve Bank of India Act, 1934

Objectives of Banking Regulation Act, 1949

 To regulate the business of banking companies
 Control over the management of banks.
 Prohibition of certain activities in relation to banking companies.
 Acquisition of the undertaking of banking companies in certain cases.
 Suspension of business and winding up of banking companies.
 Speedy provision for disposal of winding up proceedings.
 Provision relating to certain operations of banking companies (Special
provisions)
 Application of the Act to cooperative banks.
Minimum Capital and Reserves (Sec. 11)
Sec. 11 of the Banking Regulation Act, 1949, provides that no banking company
shall commence or carry on business in India, unless it has minimum paid-up
capital and reserve of such aggregate value as is noted below:

19
 (a) Foreign Banking Companies: In case of banking company incorporated
outside India, its paid-up capital and reserve shall not be less than Rs. 15
lakhs and, if it has a place of business in Mumbai or Kolkata or in both,
Rs. 20 lakhs. It must deposit and keep with the R.B.I, either in Cash or in
unencumbered approved securities (i) the amount as required above,
and (ii) after the expiry of each calendar year, an amount equal to 20%
of its profits for the year in respect of its Indian business.
(b) Indian Banking Companies: In case of an Indian banking company, the
sum of its paid-up capital and reserves shall not be less than the amount
stated below:
(i) If it has places of business in more than one State, Rs. 5 lakhs, and
if any such place of business is in Mumbai or Kolkata or in both,
Rs. 10 lakhs.
(ii) If it has all its places of business in one State, none of which is in
Mumbai or Kolkata, Rs. 1 lakh in respect of its principal place of
business plus Rs. 10,000 in respect of each of its other places of
business in the same district in which it has its principal place of
business plus Rs. 25,000 in respect of each place of business
elsewhere in the State. No such banking company shall be
required to have paid-up capital and reserves exceeding Rs. 5
lakhs and no such banking company which has only one place of
business shall be required to have paid-up capital and reserves
exceeding Rs. 50,000.
In case of any such banking company which commences business
for the first time after 16th September 1962, the amount of its
paid-up capital shall not be less than Rs. 5 lakhs.
(iii) If it has all its places of business in one State, one or more of
which are in Mumbai or Kolkata, Rs. 5 lakhs plus Rs. 25,000 in
respect of each place of business outside Mumbai or Kolkata. No
such banking company shall be required to have paid-up capital
and reserve excluding Rs. 10 lakhs.
Licensing of Banking Companies (Section 22)

Section 22 of the Banking Regulation Act, 1949 provides that:

(1) No company shall carry on banking business in India unless it holds a

license issued in that behalf by the RBI.

20
 (2) Every banking company in existence on the commencement of this Act,
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 RBI for license under this section.
(3) Before granting any license under this section, the RBI may require to be
satisfied by an inspection of the books of the company or otherwise that
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 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
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.

(3A) 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
subsection (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
21
against banking companies registered in India and that the company complies
with all the provisions of this Act applicable to banking companies
incorporated outside India.

(4) RBI may cancel a license granted to a banking company under section 22
if
(i) the company ceases to carry on banking business in India.
(ii) If the company fails to comply with any of the condition imposed
upon it under sub section (1) or
(iii) If at any time any of the condition referred to in section (3) and
subsection (3A) is not fulfilled.
(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.
Inspection of Banking companies by Reserve Bank of India (Section 35)
Section 35 of the Banking Regulation Act 1949 have been incorporated to
check the malpractices in Banking Companies. Section 35 of the said Act, gives
powers to Reserve Bank of India (RBI) to undertake inspection of banks. The
work of inspection is carried by the department of banking operation and
development of Reserve Bank of India (RBI)
The department carries out two types of inspection -

(i) Financial
(ii) Annual appraisal

In the financial inspection, the Reserve Bank of India inspects the assets and
liabilities of the banking company and the method of operation.
Power of the Reserve Bank to give directions (Section 35A)
Where the Reserve Bank is satisfied that in the public interest or in the interest
of banking policy or to prevent the affairs of any banking company being
conducted in a manner detrimental to the interests of the depositors or in a
manner prejudicial to the interests of the banking company or to secure the
proper management of any banking company generally, it is necessary to issue
22
directions to banking companies generally or to any banking company in
particular, it may, from time to time, issue such directions as it deems fit, and
the banking companies or the banking company, as the case may be, shall be
bound to comply with such directions.
Power of Central Government to authorize Reserve Bank for issuing directions
to banking companies to initiate insolvency resolution process (Section 35AA)
The Central Government may, by order, authorize the Reserve Bank to issue
directions to any banking company or banking companies to initiate insolvency
resolution process in respect of a default, under the provisions of the
Insolvency and Bankruptcy Code, 2016.
Explanation- For the purposes of these section, “default” has the same
meaning assigned to it in clause (12) of section 3 of the Insolvency and
Bankruptcy Code, 2016.
Moratorium & Winding Up

Moratorium (Suspension of Business) – Section 37 and 45

Moratorium under the orders of a High Court
Section 37 of the Banking Regulation Act 1949, provides that when a banking
company is temporarily unable to meet its obligations, it may apply to the High
court praying for an order staying the commencement or continuance of all
actions and proceeding against it for a period not exceeding 6 months. Such
suspension of business is called a moratorium.
An application is required to be accompanied by a report of the Reserve Bank
indicating that, in its opinion, the banking company will be able to pay its debts
if the application is granted. During the period of moratorium, the High court
may appoint a special officer to take possession and control of the assets,
books, documents, effects and actionable claims of the company and confer on
him suitable power.
Moratorium under the orders of the Central Government
Section 45 of the Act provides that in fit cases, the Reserve Bank may apply to
the central Government for an order of moratorium in respect of a banking
company. On such order being passed, the commencement or continuance of
all action and proceedings against the banking company are stayed for a
specified period. During the period of moratorium, the Reserve Bank may

23
prepare a scheme for re-construction of the company or its amalgamation with
any other bank.
Winding Up – Section 38 to 44
Sections 38 to 44 of the Banking Regulation Act 1949 lay down the provisions
for winding up of a banking company.
Under Section 38 of the Act, the High court has to order the winding up of a
banking company, if it is unable to pay its debts, or if the company is under a
moratorium and the reserve bank applies to the high court for its winding up
on the ground that its affairs are being conducted in a manner detrimental to
the interests of the depositors. It must be noted here that a banking company
is deemed to be unable to pay its debts, if it has refused to meet any lawful
demand made at any of its offices within two days and the Reserve Bank
certifies that the company is unable to pay its debts.
The Reserve Bank is required to apply for the winding up of the banking
company if the Central Government directs it to do so after inspection under
section 35 of the Act.
The Reserve Bank may apply for winding up of a banking company if
(i) it fails to comply with the requirements as to minimum paid up capital
and reserves as laid down in section 11 or
(ii) is disentitled to carry on the banking business for want of license under
section 22 or
(iii) it has been prohibited from receiving fresh deposits by the Central
Government on the reserve Bank or
(iv) it has failed to comply with any requirement of the Act and continues to
do so, even after the Reserve Bank calls upon it to do so or
(v) the Reserve Bank thinks that compromise or arrangement sanctioned by
the court cannot be worked satisfactorily or
(vi) The Reserve Bank thinks that, according to the returns furnished by the
company it is unable to pay its debts or its continuance is prejudicial to
the interests of the depositors.

Under section 38 A of the Act, every High court has a court liquidator attached
to it, for the winding up of a banking company, in special cases under section
39, the reserve bank or the State Bank of India or any other notified Bank or

24
any individual can be appointed as the official liquidator on an application by
the Reserve Bank.
A banking company cannot be voluntarily wound up unless the Reserve Bank
certifies that it is able to pay its debts in full.
Banking Ombudsman Scheme

 Banking Ombudsman Scheme is a mechanism created by the RBI to

address the complaints raised by bank customers.
 It is run by the RBI directly to ensure customer protection in the banking
industry.
 The scheme was introduced under Section 35 A of the Banking
Regulation Act, 1949 by RBI with effect from 1995. The present
Ombudsman scheme was introduced in 2006.
 The Banking Ombudsman is a senior official appointed by the Reserve
Bank of India.
 He has the responsibility to redress customer complaints against
deficiency in certain banking services.
 All Scheduled Commercial Banks, Regional Rural Banks and Scheduled
Primary Co-operative Banks are covered under the Scheme.
 The Banking Ombudsman can receive and consider any complaint
relating to a number of deficiencies related to banking operations
including internet banking.

Internal Ombudsman Scheme, 2018 for Scheduled Commercial Banks

 The RBI has tightened the banking ombudsman scheme with the
objective to strengthen the grievance redressal mechanism for
customers.
 All Scheduled Commercial Banks in India having more than ten banking
outlets (excluding Regional Rural Banks), are required to appoint IO in
their banks to review customer complaints that are either partly or fully
rejected by the banks.
 The IO mechanism was set up with a view to strengthen the internal
grievance redressal system of banks and to ensure that the complaints
of the customers are redressed at the level of the bank itself by an
authority placed at the highest level of bank’s grievance redressal

25
 mechanism so as to minimize the need for the customers to approach
other fora for redressal.
 As a part of this customer-centric approach, to enhance the
independence of the IO while simultaneously strengthening the
monitoring system over functioning of the IO mechanism, RBI has
reviewed the arrangement and issued revised directions under Section
35 A of the Banking Regulation Act, 1949 in the form of ‘Internal
Ombudsman Scheme, 2018’. The Scheme covers, inter-alia,
appointment/ tenure, roles and responsibilities, procedural guidelines
and oversight mechanism for the IO.
 The IO shall, inter alia, examine customer complaints which are in the
nature of deficiency in service on the part of the bank, that are partly or
wholly rejected by the bank.
 As the banks shall internally escalate all complaints, which are not fully
redressed to their respective IOs before conveying the final decision to
the complainant, the customers of banks need not approach the IO
directly.
 The instructions are not applicable for Regional Rural Banks sponsored
by commercial banks.
 The Internal Ombudsman Scheme of 2018 mandates banks to grant a
fixed term of three to five years, which cannot be renewed, to the IO.
 The IO can be removed only with prior approval from RBI.
 The remuneration would have to be decided by the customer sub-
committee of the board and not by any individual.
 The Ombudsman Scheme of 2018 covers appointment/tenure, roles and
responsibilities, procedural guidelines and oversight mechanism for the
IO.
 The implementation of IO Scheme 2018 will be monitored by the bank’s
internal audit mechanism apart from regulatory oversight by RBI.

Banking Regulation and Basel Norms

 For an economy to remain healthy and going, it is important that the
banking system grows fast and yet be stable.

26
  Over a period of time, several indicators have been developed which
gauge the depth and stability of the banking system. Examples can be
Non-performing assets (NPAs), Capital adequacy ratio (CAR) etc.
 Similarly, mechanisms to ensure their stability have also been
developed. Some of the examples can be CRR; SLR; Basel conventions;
regular directions of the RBI; Financial Stability and Development Council
etc.
 Basel is a city in Switzerland which is also the headquarters of Bureau of
International Settlement (BIS). BIS fosters co-operation among central
banks with a common goal of financial stability and common standards
of banking regulations. Currently there are 27 member nations in the
committee.
 Basel guidelines refer to broad supervisory standards formulated by this
group of central banks called the Basel Committee on Banking
Supervision (BCBS). The set of agreement by the BCBS, which mainly
focuses on risks to banks and the financial system are called Basel
accord.
 The purpose of the accord is to ensure that financial institutions have
enough capital on account to meet obligations and absorb unexpected
losses. India has accepted Basel accords for the banking system.
 The Basel Committee makes certain norms. The Committee’s decisions
have no legal force. Rather, the Committee formulates supervisory
standards and guidelines and recommends statements of best practice
in the expectation that individual national authorities will implement
them.
Basel I
 In 1988, BCBS introduced capital measurement system called Basel
capital accord, also called as Basel 1. It focused almost entirely on credit
risk. It defined capital and structure of risk weights for banks. Naturally if
the capital with the banks is adequate to cover the risks (e.g. a power
plant) they have invested in, then the bank is safe.
 The minimum capital requirement was fixed at 8% of risk weighted
assets (RWA). RWA means assets with different risk profiles. For

27
 example, an asset backed by collateral would carry lesser risks as
compared to personal loans, which have no collateral.
 India adopted Basel 1 guidelines in 1999. The Basel norms are set up by
the Basel committee on Banking supervision.

Basel II
 In 2004, Basel II guidelines were published by BCBS, which were
considered to be the refined and reformed versions of Basel I accord.
The guidelines were based on three parameters.
1. Banks should maintain a minimum capital adequacy requirement
of 8% of risk assets. In India, such a practice is equivalent to
maintaining a Capital Adequacy ratio (CAR).
2. Banks were needed to develop and use better risk management
techniques in monitoring and managing all the risks through
increased disclosure requirements. Increased disclosure
requirements raise the confidence of investors and depositors in
the bank. The more transparent a bank is, the more stable it is
deemed to be.
3. Banks need to mandatorily disclose their risk exposure, etc to the
central bank. This is important so that the central bank (RBI in
India) is aware of the risks that the banking system is going
through.
 Basel II norms in India and overseas are yet to be fully implemented.
Basel III
 In 2010, Basel III guidelines were released. These guidelines were
introduced in response to the financial crisis of 2008.
 A need was felt to further strengthen the system as banks in the
developed economies were under-capitalized, over-leveraged and had a
greater reliance on short-term funding. Too much short-term funding
makes the banks prone to risks. Banks generally rely on short-term
funding because it is profitable.

28
 Also, the quantity and quality of capital under Basel II were deemed
insufficient to contain any further risk. This was because the banking
system was growing. The world economy was growing too. Hence, what
is sufficient earlier was not sufficient now.
 Following are some of the most important features of Basel III
guidelines:
1. Capital: The capital requirement (as weighed for risky assets) for
Banks was more than doubled. (e.g. 4.5% from 2% in Basel-II
accord for common equity)
2. Leverage: Leverage basically means buying assets with borrowed
money to multiply the gain. The underlying belief is that the asset
will return the investor more than the interest he has to pay on
the loan. Obviously doing so is risky business. Thus, the Basel III
puts a limit on the banks for doing this.
3. Funding and liquidity: Banks can be subjected to a lot of risk if all
depositors come and ask all their money at the same time. This is
a hypothetical situation but it has happened in real with Lehman
Brothers – the bank whose collapse gave us the 2008 recession.
So, Basel III puts a requirement for the banks to maintain some
liquid assets all the time. Liquid assets are those which can be
easily converted to cash. In India, this practice can be correlated
with that of maintaining CRR and SLR.
--------------------xx-------------------

29
MODULE IV: BANK AND CUSTOMER RELATIONSHIP
Customer
The word “customer” has been derived from the word “custom” which means
a “habit” or “tendency” to ascertain things in a particular manner. As per “KYC
guidelines” issued by RBI, Customer has been defined as a person or entity that
maintains an account and/ or has a business relationship with the bank. Banks
open accounts for various types of customers like individuals, partnership
firms, Trusts, companies etc. While opening the accounts, the banker has to
keep in mind the various legal aspects involved in opening and conducting
those accounts, as also the practices followed in conducting those accounts.
Types of Customer
Normally, the banks have to deal with following types of deposit customers:
1. Individuals: The depositors should be properly introduced to the bank
and KYC (Know your customer) norms are to be observed. Introduction
is necessary in terms of banking practice as also for the purpose of
protection under Section 131 of the Negotiable Instruments Act. Usually,
banks accept introductions from the existing customers, employees of
the bank, a locally known person or another bank.
A joint account may be opened by two or more individuals and the
account form etc. should be signed by all the joint account holders.
When a joint account is opened in the name of two persons, the account
operations may be done by:
a) Either or survivor
b) Both jointly
c) Both jointly or by the survivor
d) Former or survivor.

30
 When the joint account is opened in the name of more than 2 persons,
then the following operations are made:
a) All of them jointly or by survivors
b) Any one of them or more than one of them jointly.
2. Non-Resident Indians: Non-Resident Indian (NRI) means a person, being
a citizen of India or a person of Indian origin residing outside India. A
person is considered to be of Indian origin when he or his parents or any
of his grand parents were Indian nationals. A spouse of a person of
Indian origin shall also be deemed to be a person of Indian origin if at
any time he or she has held an Indian passport. Non-resident Indian falls
generally into the following two categories:
(a) A person who stays abroad for the purpose of employment or to
carry on business activities or vocation or for any other purpose
for an indefinite period of stay outside India.
(b) An Indian national working abroad for a specific period.
Facilities for maintaining bank accounts are available to NRIs. The
exchange control procedures relating to these facilities have been
simplified. Various types of deposit schemes available to NRIs are as
follows:
 Non-Resident (Ordinary) Rupee Accounts (NRO)
 Non-Resident (External) Rupee Accounts (NRE)
 Non-Resident (Non-Repatriable) Rupee Account (NRNR)
 Foreign Currency Non-Resident Account (Bank) Scheme [FCNR (B)]
While NRO and NRE accounts can be maintained in the form of current
account, savings account, recurring deposit or term deposits, under
NRNR and FCNR (B) scheme money can be kept in the form of term
deposits for periods ranging from six months to three years.
3. Joint Hindu Family (JHF): JHF, also known as Hindu Undivided Family
(HUF) is a legal entity and is unique for Hindus. It has perpetual
succession like companies; but it does not require any registration. The
head of the JHF/ HUF is the Karta and the members of the family are
called coparceners. The JHF business is managed by Karta.
4. Partnership Firms: A partnership is not a legal entity independent of
partners. It is an association of persons. Registration of a partnership
firm is not necessary under Partnership Act. However, many banks insist
on registration of a partnership firm. In any case, stamped partnership
deed or partnership letter should be taken when an account is opened

31
 for a partnership firm. The partnership deed shall contain the names of
partners, objective of the partnership and other operational details,
which should be taken note of by the bank in its dealings.
5. Joint Stock Companies: A company registered under the Companies Act
has a legal status independent of that of shareholders. A company is an
artificial person which has perpetual existence with limited liability and
common seal. MoA, AoA, Certificate of Incorporation, resolution passed
by the Board to open an account, name and designation of persons who
will operate the account with details of restrictions placed on them are
essential documents required to open an account in a Bank.
6. Clubs, Societies & Associations: The clubs, societies, associations etc.
may be registered or unregistered. Account may be opened only if
persons of high standing and reliability are in the managing committee
or organising body. Copy of certificate of registration, copy of bye-laws,
certified to be the latest, by the Secretary/ President of the entity,
certified copy of the resolution of the managing committee/ governing
body to open the bank account and details of office bearers etc. to
operate the account are to be obtained in order to open an account with
the bank.
7. Trust Account: Trusts are created by executing a Trust deed. A trust
account can be opened only after obtaining and scrutinizing the trust
deed. The trust account has to be operated by all the trustees jointly
unless provided otherwise in the trust deed. A trustee cannot delegate
the powers to other trustees except as provided for in the trust deed. A
cheque favouring the trust shall not be credited to the personal account
of the trustee.
Banker-Customer Relationship
 Relationship of Debtor and Creditor
 ,, ,, ,, ,, ,, Pledger and Pledgee
 ,, ,, ,, ,, ,, Lesser and Lessee
 ,, ,, ,, ,, ,, Bailor and Bailee
 ,, ,, ,, ,, ,, Hypothecator and Hypothecatee
 ,, ,, ,, ,, ,, Trustee and Beneficiary
 ,, ,, ,, ,, ,, Agent and Principal
 ,, ,, ,, ,, ,, Advisor and Client
 Other relationships – Custodian and Guarantor

32
It would thus be observed that banker customer relationship is transactional
relationship.
Bailee – Bailor relationship

 Sec.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 that they shall, when the purpose is
accomplished, be returned or otherwise disposed of according to the
directions of the person delivering them.
 The person delivering the goods is called the “Bailor”. The person to
whom they are delivered is called, the “Bailee”.
 Banks secure their advances by obtaining tangible securities. In some
cases, physical possession of securities goods (Pledge), valuables, bonds
etc., are taken. While taking physical possession of securities the bank
becomes bailee and the customer bailor. Banks also keeps articles,
valuables, securities etc., of its customers in Safe Custody and acts as a
Bailee. As a bailee the bank is required to take care of the goods bailed.

Lessor – Lessee relationship

 Sec.105 of the 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.”
Definition of Lessor, lessee, premium and rent:
 The transferor is called the lessor,
 The transferee is called the lessee,
 The price is called the premium, and
 The money, share, service or other thing to be so rendered is
called the rent.
 Providing safe deposit lockers is as an ancillary service provided by banks
to customers. While providing Safe Deposit Vault/locker facility to their

33
 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.

Agent – Principal relationship

 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 clearing house.

Termination of relationship between a banker and a customer

The relationship between a bank and a customer ceases on:
a) The death, insolvency and lunacy of the customer.
b) The customer closing the account i.e. voluntary termination

34
 c) Liquidation of the company.
d) Closing of the account by the bank after giving due notice.
e) Completion of the contract or the specific transaction.
Duties of a Banker
A ‘Banker’ has certain duties vis-à-vis his customer. These are:

(a) Duty to maintain secrecy/confidentiality of customers' accounts.

(b) Duty to honour cheques drawn by customers on their accounts and
collect cheque, bills on his behalf.
(c) Duty to pay bills etc., as per standing instructions of the customer.
(d) Duty to provide proper services.
(e) Duty to act as per the directions given by the customer. If directions are
not given the banker has to act according to manner in which he is
expected to act.
(f) Duty to submit periodical statements i.e. informing customers of the
state of the account.
(g) Articles/ items kept should not be released to a third party without due
authorization by the customer.

Rights of a Banker
It is not that the bank has only duties towards its customers, it too has certain
rights vis-à-vis his customers. The rights can broadly be classified as:
1. Right of General Lien (Banker’s Lien)
2. Right of Set-Off
3. Right of Appropriation
4. Act as per the mandate of customer
5. Right to Charge Interest, Commission, Incidental Charges etc.

Right of General Lien (Banker’s Lien)

 A lien is the right of a creditor in possession of goods, securities or any
other assets, belonging to the debtor to retain them until the debt is
repaid, provided that there is no contract, express or implied, to the
contrary. It is a right to retain possession of specific goods or securities
or other movables of which the ownership vests in some other person
and the possession can be retained till the owner discharges the debt or

35
 obligation to the possessor. The creditor (bank) has the right to maintain
the security of the debtor but not to sell it.

Right of Set-Off

 The banker has the right to set off the accounts of its customer. It is a
statutory right available to a bank, to set off a debt owed to him by a
creditor from the credit balances held in other accounts of the borrower.
The right of set-off can be exercised only if there is no agreement,
express or implied, to the contrary.
 This right is applicable in respect of dues that are due, are becoming due
i.e. certain and not contingent. It is not applicable on future debts. It is
applicable in respect of deposits that are due for payment.
 The right of set off enables bank to combine all kinds of credit and debit
balances of a customer for arriving at a net sum due.
 The right is also available for deposits kept in other branches of the
same bank.
 The right can be exercised after death, insolvency, and dissolution of a
company, after receipt of a garnishee/ attachment order. The right is
also available for time barred debts.
 Automatic right of set off: Depending on the situation, sometimes the
set off takes place automatically without the permission from the
customer. In the following events the set off happens automatically i.e.
without the permission from the customer.
a) On the death of the customer,
b) On customer becoming insolvent.
c) On receipt of a Garnishee order on customer’s account by court.
d) On receipt of a notice of assignment of credit balance by the
customer to the banker.
e) On receipt of notice of second charge on the securities already
charged to the bank.

Right of Appropriation
 It is the right of the customers to direct his banker against which debt
(when more than one debt is outstanding) the payment made by him
should be appropriated. In case no such direction is given, the bank can

36
 exercise its right of appropriation and apply it in payment of any debt.
Section 59,60 and 61 of Indian Contract Act, 1872 lays down the rules of
appropriation.

Banker's right to charge interest, commission, incidental charges etc.

 Banker has an implied right to charge for services rendered and sold to a
customer. Bank charges interest on amount advanced, processing
charges for the advance, charges for non-utilization of credit facilities
sanctioned, charges for commission, exchange, incidental charges etc.
------------------xx-------------------

MOBULE V/ VI – NEGOTIABLE INSTRUMENTS ACT/ LAW RELATING TO

CHEQUES
Negotiable Instruments (Section 13, Negotiable Instruments Act, 1881)
The word negotiable means transferable and the word instrument mean a
document. Thus, the term ‘negotiable instrument’ means a document, which is
transferable from one person to another.
Negotiable Instruments are written contracts whose benefit could be passed
on from its original holder to a new holder. In other words, negotiable
instruments are documents which promise payment to the assignee (the
person whom it is assigned to/given to) or a specified person. These
instruments are transferable signed documents which promises to pay the
bearer/holder the sum of money when demanded or at any time in the future.
These instruments are transferable. The final holder takes the funds and can
use them as per his requirements. That means, once an instrument is
transferred, holder of such instrument obtains a full legal title to such
instrument.
As per Section 13 of the Act, “negotiable instrument” means a promissory note,
bill of exchange or cheque payable either to order or to bearer.
Characteristics of a Negotiable Instrument (Section 13 of Negotiable
Instruments Act, 1881)

 Written Document: The term instrument or document necessarily

implies that it must be in writing.

37
  It should be signed: An instrument to pay money is not binding on a
person unless it is signed by him.
 Easy Negotiability: A negotiable instrument is freely transferable from
one person to another.
 Transferable Infinitum: A negotiable instrument can be transferred
infinitum i.e. it can be transferred any number of times till its
satisfaction.
 Promise or order to pay money: Every negotiable instrument must
contain either a promise or order to pay money. Also, the promise or
order must be unconditional.
 Payment of money only: The promise or order to pay must consist of
money only. Nothing should be payable, whether in addition or in
substitution of money. Also, the sum payable must be certain.
 Presumption: A negotiable instrument is subject to certain presumptions
as specified u/s 118. The presumptions specified u/s 118 shall prevail
unless a contrary evidence is produced. According to Section 118, until
contrary is proved, the following presumptions shall be made:
 Of consideration
 As to date
 As to time of acceptance.
 As to time of transfer
 As to order of indorsements
 As to stamp
 That the holder is a holder in due course.
Negotiation (Section 14, NI Act)
When a promissory note, bill of exchange or cheque is transferred to any
person, so as to constitute the person the holder thereof, the instrument is
said to be negotiated.

Promissory Note (Section 4, NI Act)

A promissory note is a promise in writing by a person to pay a certain sum of

money to a specified person.

Parties to a Promissory Note

Following are the two main parties in a promissory note –

38
 1. Maker – This is the person who makes the promissory note and
promises to pay the money stated therein.
2. Payee – This is the person to whom the amount of promissory note is
payable i.e. to whom the promise to pay is made.

Essentials of a Promissory Note

(a) In writing: Promissory note must be in writing, an oral promise cannot

constitute a promissory note.
(b) Promise to pay:
 It must contain an undertaking or promise to pay. Thus, a mere
acknowledgment of indebtedness is not sufficient.
 However, the word ‘promise’ need not be used, what is necessary
is that whatever language is used, it must clearly show that the
maker is making himself bound to pay the sum.
(c) Definite and unconditional promise:
 The promise must be definite and unconditional i.e. it must not be
vague or uncertain. In other words, the promise to pay must not
depend upon a contingency.
 A promise to pay is not conditional merely because of the fact that
the performance of promise is dependent upon an event which is
certain to happen even though the time of its occurrence may be
uncertain. e.g. Death.
 Similarly, a promise to pay money only at a particular place or at a
particular time is not conditional
(d) Promise to pay money only: The instrument must be payable in money
and money only. An instrument is not a promissory note if the promisor
promises to pay –
 Something other than money, or
 Something in addition to money.
(e) The sum payable must be certain : For a valid promissory note it is also
essential that the sum of money promised to be payable must be certain
and definite.
(f) Designated parties must be certain: The parties to the instrument must
be designated with reasonable certainty. There are two parties to a
promissory note, namely, the person who makes the note, known as the

39
 maker and the payee, with whom promise is made. Both the maker and
the payee must be indicated with certainty on the face of instrument.
(g) Signed by the maker: The promissory note must be signed by the maker,
otherwise, it is of no effect. Even if it is written by the maker himself and
his name appears in the body of the instrument, it shall not constitute a
valid promissory note, if it is not signed by the maker.
(h) Must be duly stamped under the Inian Stamp Act : It means that the
stamps of the required amount and description must have been affixed
on the instrument.

Bills of Exchange (Section 5, NI Act)

A ‘bill of exchange’ is an order in writing, directing a person to pay a certain
sum of money to a specified person.

Parties to a Bill of Exchange

Following are the three main parties in a bill of exchange –

1. Drawer – This is the person who makes/draws the bill of exchange.

2. Drawee – This is the person on whom the bill is drawn. In other words,
the person who is ordered to pay the amount of the bill of exchange.
When the drawee accepts the bill of exchange (i.e. when he gives his
consent to make the payment of the bill on its due date), he becomes
the acceptor.
3. Payee – This is a person to whom the amount of bill of exchange is
payable.

Essentials of Bill of Exchange

(a) In writing: It must be in writing.

(b) Order to Pay: It must contain an order to pay.
(c) Definite and unconditional: The order to pay must be definite and
unconditional.
(d) Certain Parties: The parties must be certain.
(e) Signed by the drawer: It must be signed by the drawer.
(f) Certain sum: The sum payable must be certain or capable of being made
certain.
(g) Order to pay money: The order must be to pay money and money alone.
40
 (h) Duly Stamped: It must be duly stamped as per the Indian Stamp Act.

Difference between Promissory Note and Bill of Exchange

Sl.No Basis Promissory Note Bill of Exchange

.
1. Definition A “Promissory Note” is an A “bill of exchange” is an
instrument in writing (not instrument in writing
being a bank-note or a containing an
currency-note) containing unconditional order,
an signed by the maker,
unconditional undertaking directing a certain
signed by the maker, to pay person to pay a certain
a certain sum of money sum of money only
only to, or to the order of, to, or to the order of a
a certain person, or to the certain person or to the
bearer of the instrument. bearer of the instrument
2. Nature of In a promissory note there In a bill of exchange
Instrument is a promise to pay money. there is an order for
making payment.
3. Parties In a promissory note there In a bill of exchange,
are only 2 parties namely: there are 3 parties which
(a) the maker and are follows:
(ii) the payee (i)the drawer
(ii)the drawee
(iii)the payee
4. Acceptance A promissory note does not The word acceptance is
require any acceptance, as relevant for a Bill. There
it is signed by the person are some bills which
who is liable to pay. must be accepted by
drawee.
5. Payable to A promissory note cannot On the other hand, a bill
the Bearer be made payable to bearer. of exchange can be
drawn payable to bearer.
However, it cannot be
payable to bearer on
demand

Cheque (Section 6, NI Act)

41
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 cheque in the electronic form.

As per RBI, with effect from 1 April 2012, the validity period of cheque is
3months from the date of its issue.

Parties to a Cheque

There are three main parties in a cheque

1. Drawer: This is the person who makes/draws the cheque.

2. Drawee: This is the banker who is directed to pay the amount of the
cheque. Drawee is the banker on whom the cheque is drawn.
3. Payee: This is the person to whom the amount of cheque is payable.

Essentials of a Cheque

(a) In writing: The cheque must be in writing.

(b) Express order to pay: It must contain an express order to pay.
(c) Definite and unconditional order: The order to pay must be definite and
unconditional.
(d) Certain sum of money: It must contain an order to pay a certain sum of
money.
(e) Signed by the drawer: It must be signed by the drawer.
(f) Drawn upon a banker: A cheque is always drawn upon a banker and is
always payable on demand.
(g) Does not require stamping: A cheque does not require stamping.
(h) Does not require acceptance: A cheque doesn’t require acceptance.

Types of Cheques

 Bearer Cheque:
 Payable in cash
 Endorsement is not required but can be endorsed.
 No identification is needed when the cheque is presented for
encashment.
 Risk factor is high.
 Order Cheque:

42
  When “Bearer” word is struck off it becomes an order cheque.
 Identification is necessary.
 The payee has to sign on the back of the cheque.
 Blank Cheque:
 Amount is not mentioned.
 Risk factor is very high.
 Can also bounce.
 Stale Cheque: Cheque presented after 90 days.
 Mutilated Cheque
 Post-dated Cheque
 Open Cheque: An open cheque is the bearer cheque. It is payable over
the counter on presentment by the payee to the paying banker.
 Crossed Cheque: A crossed cheque is not payable over the counter but
shall be collected only through a banker. The amount payable for the
crossed cheque is transferred to the bank account of the payee.
 General Crossing: Where a cheque bears across its face two
parallel, transverse lines drawn on the top left corner of the
cheque without any words or with words ‘and company’ or/and
‘not negotiable’ written in between these two parallel lines, it is
called general crossing. Thus, a cheque is said to have general
crossing when:
 There are two transverse parallel lines, marked across its
face OR
 The cheque bears an abbreviation “& Co.” between the two
parallel lines OR
 The cheque bears the words “Not Negotiable” between the
two parallel lines OR
 The cheque bears the words “A/c. Payee” between the two
parallel lines.
A crossed cheque can be made bearer cheque by cancelling the
crossing and writing that the crossing is cancelled and affixing the
full signature of drawer.
 Special Crossing: Where a cheque bears across its face an addition
of the name of the banker either with or without the words ‘not
negotiable’ the cheque is deemed to be crossed specially.

43
As a general rule, special crossing can made only once. However,
as an exception to this rule, a cheque containing special crossing
can be crossed specially again if following conditions are satisfied
 The second special crossing is made by the collecting
banker.
 The second special crossing is made for the purpose of
collection of the cheque.
Thus, a special crossing is used in order to further restrict the
negotiability of the cheque. If two parallel lines are drawn across
the cheque with the name of the bank, the lines are called special/
restrictive crossing. The special crossing has the following
essentials:
 Two transverse lines are not necessary for a special crossing
 The name of the banker must be necessarily specified
across the face of the cheque
 It must appear on the left-hand side of the cheque
 In addition to the name of the bank, the words “A/c. Payee
only”, “Not Negotiable” may also be written.
 The payment of such cheque is not made unless the bank
named in crossing is presenting the cheque.
The effect of special crossing is that the bank makes payment only
to the banker whose name is written in the crossing. Specially
crossed cheques are more safe than generally crossed cheques.

44
  Gift Cheque
 Traveller’s Cheque
 Self-Cheque
 Banker’s Cheque
 Cancelled Cheque
Distinction between a Bill of Exchange and a Cheque
Sl. Basis Bill of Exchange Cheque
No.
1. Definition A bill of exchange is an A cheque is a bill of
instrument in writing exchange drawn on a
containing an unconditional specified banker and not
order, signed by the maker expressed to be payable
directing a certain person to otherwise than on demand
pay a certain sum of money, and it includes the
only to, or to the order of a electronic image of a
certain person or to the truncated cheque and a
bearer of the instrument cheque in the electronic
form.
2. Drawee In case of a Bill of exchange, However, in case of a
the drawee can be any cheque, the drawee is a
person including banker banker (i.e. it is always
drawn on a banker)
3. Payable A bill of exchange cannot be A cheque can be drawn
to Bearer drawn ‘payable to bearer on ‘payable to bearer on
on demand’. In other words, a demand’. In other words, a
demand Bill of Exchange drawn cheque drawn payable to
‘payable to bearer on bearer on demand is
45
 demand’ is absolutely void. absolutely valid.
4. Liability In case of bill of exchange, In case of a cheque the
of Drawer the liability of drawer is liability of drawer is always
secondary and conditional. primary. The drawee bank
However, until a bill is is simply a custodian of
accepted, the liability of the money of the customer
drawer is primary.
5. Crossing A bill of exchange cannot be A cheque can be crossed
crossed. either generally or
specially.
6. Stamping Bill of Exchange requires Cheque does not require
payment of stamp duty. payment of stamp duty.

Endorsement/ Indorsement (Section 15/ 16, NI Act)

[Endorsement and indorsement are two similar words. Indorsement is the

rarer term, and it only appears in reference to certain financial documents.]

Section 15 of the NIA defines “Indorsement” as follows:

Section 15: Indorsement—When the maker or holder of a negotiable

instrument signs the same, otherwise than as such maker, for the purpose of
negotiation, on the back or face thereof or on a slip of paper annexed thereto,
or so signs for the same purpose a stamped paper intended to be completed as
a negotiable instrument, he is said to indorse the same, and is called the
“indorser”.

Essentials of Indorsement

 It must be on the instrument itself. If no space is left on the instrument

then, it must be on a separate slip of paper attached to the instrument,
called ‘alonge’. [Alonge – A piece of paper occasionally attached to a
negotiable instrument for the signing of endorsements once the original
instrument is filled with endorsements.]

46
  It must be signed by the endorser for the purpose of negotiation.
Signature of the endorser on the instrument without any additional
word is sufficient.

Kinds of Endorsement

 Blank or General Endorsement: An Endorsement is said to be blank or

general if the Endorser signs his name only on the face or back of the
instrument. A Blank Endorsement specifies, no Endorsee and the
instrument in consequences becomes payable to bearer even though
originally it was payable to order. (Section 16 & 54)
 Full or Special Endorsement: An Endorsement is called as special
Endorsement, if it specifies the name of the Endorsee. In other words,
where the Endorser adds a direction to pay the amount to a specified
person or to his order, it is called as Special Endorsement. (Section 16)
 Restrictive Endorsement: An Endorsement which, by express words,
restricts or excludes the rights of further negotiation to the Endorsee is
called restrictive endorsement. (Section 50)
 Partial Endorsement: Where an Endorsement purports to transfer to the
Endorsee a part only of the amount of the instrument, the Endorsement
is said to be partial. A partial Endorsement doesn’t operate as a
negotiation of the instrument.
 Conditional Endorsement: An Endorsement is conditional or qualified if it
contains any condition imposed by the Endorser. An Endorsement may
be conditional or qualified in one of the following ways:
 Sans recourse Endorsement: When the Endorser expressly
excludes his own liability on the negotiable instrument while
making Endorsement, to the Endorsee or any subsequent holder
in case of dishonour of the instrument, the Endorsement is known
as sans recourse or without recourse Endorsement. Such an
Endorsement is indicated by adding the words ‘sans recourse’ or
‘without recourse’.
 Sans Frias endorsement: Where endorser limits his liability during
negotiation, it is called Sans Frias Endorsement.
 Facultative Endorsement: Where an Endorser by express words
abandons some right or increases his liability under an instrument,

47
 the Endorsement is called the Facultative Endorsement. An
Endorsement ‘pay A or order, notice of dishonor waived’ is a
facultative Endorsement.
 Contingent Endorsement: An Endorser may Endorse an instrument
in such a way that his liability depends upon the happening of a
specified event which may or may not happen. E.g. Pay A on his
marriage.

Holder (Section 8, NI Act)

Section 8 0f the NIA defines “Holder” as follows:

Section 8: Holder – The “holder” of a promissory note, bill of exchange or

cheque means any person entitled in his own name to the possession thereof
and to receive or recover the amount due thereon from the parties thereto.

Where the note, bill or cheque is lost or destroyed, its holder is the person so
entitled at the time of such loss or destruction.

Conditions to be satisfied for becoming “Holder”

In order to be called a holder a person must satisfy the following conditions:

(i) He should be entitled in his own name to the possession of the

instrument, and
(ii) He should have the right to receive or recover the amount due thereon
from the parties thereto.

Holder means a de jure holder

If a person has possession of the instrument but doesn’t have a right to

recover the instruments then he is said to be a de-facto holder. However, if a
person has possession as well as a right to recover then he is said to be de-jure
holder.

Holder in case of lost or stolen instrument

Where a note, bill or cheque is lost or destroyed, its holder is the person so
entitled to the instrument at the time of such loss or destruction.

48
Holder in due course (Section 9, NI Act)

Section 9 of the NIA defines “Holder in due course” as follows:

Section 9: Holder in due course – “Holder in due course” means any person
who for consideration became the possessor of a promissory note, bill of
exchange or cheque if payable to bearer, or the payee or indorsee 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.

Conditions to be fulfilled for becoming a holder in due course

A person is a holder in due course, if he fulfills the following conditions:

 He should have acquired the instruments for some consideration.

 He should have obtained the instruments before its maturity. If the
instrument is taken after its maturity, the person taking it may become a
holder but he cannot be called a holder in due course.
 He should have obtained the instruments in good faith i.e. without
sufficient cause to believe that defect existed in the title of the person
from whom he derived his title.
 He must have received the negotiable instrument complete and regular
on the face of it. In other words, he should not receive an
inchoate/incomplete instrument.

Payment in due course: Rights & Duties of Paying Banker

Payment in due course (Section 10, NI Act)

According to section 10 of NIA, “Payment in due course” means payment in

accordance with the apparent tenor of the instrument in good faith and
without negligence to any person in possession thereof under circumstances
which do not afford a reasonable ground for believing that he is not entitled to
receive payment of the amount therein mentioned.

A paying banker does not get statutory protection under the NIA if he does not
make the payment of negotiable instrument in due course.

49
According to the above definition, following four conditions must be satisfied
to treat a payment as payment in due course.

1. Payment must be in accordance with the apparent tenor of the

instrument: For example, when a banker makes the payment of a post-
dated cheque, the payment is not in accordance with the apparent tenor
of the instrument. In this case the payment has been made before the
date apparent on the instrument. Since the payment made by the
banker is against the intention of the drawer of the cheque, such
payment cannot be treated as payment in due course.
2. Payment made must be to a legally entitled person in good faith and
without negligence: The banker must have made the payment on the
true belief that the person who received the payment is entitled to
receive payment of the amount mentioned therein. Besides, the drawee
(payer) should not be guilty of negligence in making such payment.
Guilty of negligence means when the drawee banker did not make
proper enquiry (like any person of normal prudence makes enquiry
under such circumstances) before making payment in doubtful situations
or when the endorsement on the instrument is not regular.
3. Payment made must be to a person who is in the possession of the
cheque.
4. Payment must be made only against presentation of the instrument for
payment: If the payment is made in the absence of presentation of the
instrument for payment, such payment shall not be treated as payment
in due course. The drawee shall receive and see the instrument (physical
or electronic image in clearing) presented to him before making
payment.

Rights & Duties of Paying Banker

The banker on whom a cheque is drawn or the banker who is required to pay
the cheque drawn on him by a customer is called the paying banker.

Mandatory functions of a Banker – Rights & Duties of a Paying Banker -

Precautions to be taken by paying banker while making payment of Cheques

 Cheque should be in proper form: the cheque presented for payment

should be in proper form. The banker should see that the cheque
50
 satisfies all the requirements of a valid cheque. The cheque must be in
printed form supplied by the banker.
 Physical conditions of the cheque: the cheque should be in good physical
condition. The instrument should not be torn, mutilated or cancelled.
 Crossing of cheque: if the cheque is a crossed one, the payment cannot
be made across the counter. The payment has to be made to the bank
account of the drawee i.e. the payment has to pass through the account
holder.
 Open/ Order 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.
 Office of drawing: the cheque should be presented for payment to the
same bank where the drawee has an account. If the customer presents a
cheque in a bank where he doesn’t hold an account, the manager cannot
make payment.
 Date of the cheque: the cheque should possess a date for payment and
only on that date or within three months from that date, the payment
should be made.
 Time of presentation: the cheque should be presented for payment
during the banking hours.
 Amount: the amount of the cheque presented for payment has to be
recorded in both words and figures and they should tally with each
other.
 Material alteration: if material alteration is apparent the banker should
get confirmation from the drawer by obtaining full signature at the place
of material alteration.
 Signature of the drawer: the banker has to examine the signature of the
drawer on the cheque with the specimen he has before he makes
payment.
 Proper Endorsement: Endorsement means signature of the holder (An
individual who has lawfully received possession) made with the object of
transferring the document. The signature & message on the back of a
cheque to either cash it, deposit it or to handover the rights of the

51
 cheque to someone else. 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.
 Legal Restrictions: in case of death, insolvency, lunacy.

Dishonour of Cheques
The penal provisions contained in Sections 138 to 142 of the Act have been
enacted to ensure that obligations undertaken by issuing cheques as a mode of
deferred payment are honoured. Section 138 of the Act provides for
circumstances under which a case for dishonour of cheques is filed.

Dishonour of Cheque for insufficiency etc. of funds in accounts (Section 138,

NI Act)
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.

Section 138 of the Act provides for circumstances under which a case for
dishonour of cheques is filed. The ingredients required for complying with
Section 138 are as follows:

 a person must have drawn a cheque for payment of money to another

for the discharge of any debt or other liability;
 that cheque has been presented to the bank within a period of three
months;
 that cheque is returned by the bank unpaid, either because insufficient
of funds or that it exceeds the amount arranged to be paid from that
account by an agreement made with the bank;
 the payee makes a demand for the payment of the money by giving a
notice in writing to the drawer within 15 days of the receipt of
information by him from the bank regarding the return of the cheque as
unpaid;

52
  The drawer fails to make payment to the payee within 15 days of the
receipt of the notice.

According to Section 138 of the Act, the dishonour of cheque is a criminal

offence and is punishable by imprisonment up to two years or with monetary
penalty or with both.

Presumption in favor of holder (Section 139, NI Act)

It shall be presumed, unless the contrary is proved, that the holder of a cheque
received the cheque of the nature referred to in section 138 for the discharge,
in whole or in part, or any debt or other liability.

Defense which may not be allowed in any prosecution under section 138
(Section 140, NI Act)

It shall not be a defense in a prosecution of an offence under section 138 that

the drawer had no reason to believe when he issued the cheque that the
cheque may be dishonored on presentment for the reasons stated in that
section.

Offences by companies (Section 141, NI Act)

If the person committing an offence under section 138 is a company, every

person who, at the time the offence was committed, was in charge of, and was
responsible to the company for the conduct of the business of the company, as
well as the company, shall be deemed to be guilty of the offence and shall be
liable to be proceeded against and punished accordingly. However, a person
shall not be liable to punishment if he proves that the offence was committed
without his knowledge, or that he had exercised all due diligence to prevent
the commission of such offence.

Cognizance of offences (Section 142, NI Act)

Notwithstanding anything contained in the Code of Criminal Procedure, 1973

(a) no court shall take cognizance of any offence punishable under section
138 except upon a complaint, in writing, made by the payee or, as the
case may be, the holder in due course of the cheque;
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 (b) such complaint is made within one month of the date on which the
cause -of- action arises under section 138;
(c) no court inferior to that of a Metropolitan Magistrate or a Judicial
Magistrate of the first class shall try any offence punishable under
section 138.

Recent Amendment in NI Act

The Negotiable Instruments (Amendment) Act, 2018 which came into effect
from September 1, 2018 allows the Court trying an offence related to cheque
bouncing, to direct the drawer to pay interim compensation not exceeding
20% of the cheque amount to the complainant within 60 days of the trial
court's order to pay such compensation. This interim compensation may be
paid either in a summary trial or a summons case where the drawer pleads not
guilty to the accusation made in the complaint; or upon framing of charge in
any other case. Furthermore, the Amendment also empowers the Appellate
Court, hearing appeals against conviction under s. 138, to direct the appellant
to deposit a minimum 20 % of the fine/compensation awarded, in addition to
interim compensation.

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MODULE VII: DEBT RECOVERY & SECURITISATION

Non-Performing Assets (NPA)

A Non-Performing asset (NPA) is a loan or advance for which the principal or

interest payment remained overdue for a period of 90 days.

Banks are required to classify NPAs further into Substandard, Doubtful and
Loss assets.

1. Substandard assets: Asset which has remained NPA for a period less
than or equal to 12 months.
2. Doubtful assets: An asset would be classified as doubtful if it has
remained in the substandard category for a period of 12 months.

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 3. Loss assets: As per RBI, “Loss asset is considered uncollectible and of
such little value that its continuance as a bankable asset is not
warranted, although there may be some salvage or recovery value.”
Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI Act, 2002)
Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002 is a legislation that helps financial
institutions to ensure asset quality in multiple ways. The Act was framed to
address the problem of NPAs (Non-Performing Assets) or bad assets through
different processes and mechanisms.
The SARFAESI Act gives detailed provisions for the formation and activities of
Asset Securitization Companies (ASCs) and Asset Reconstruction Companies
(ARCs). Scope of their activities, capital requirements, funding etc. are given by
the Act. RBI is the regulator for these institutions.
As a legal mechanism to insulate assets, the Act addresses the interests of
secured creditors (like banks). Several provisions of the Act give directives and
powers to various institutions to manage the bad asset problem.

Main objectives of the SARFAESI Act

 The Act provides the legal framework for securitization activities in India
 It gives the procedures for the transfer of NPAs to asset reconstruction
companies for the reconstruction of the assets.
 The Act enforces the security interest without Court’s intervention.
 The Act gives powers to banks and financial institutions to take over the
immovable property that is hypothecated or charged to enforce the
recovery of debt.

Methods of Recovery of NPAs

Major feature of SARFAESI is that it promotes the setting up of Asset

Reconstruction Companies (ARCs) and Asset Securitization Companies (ASCs)
to deal with NPAs accumulated with the banks and financial institutions. The
Act provides three methods for recovery of NPAs, viz:

(i) Securitization;
(ii) Asset Reconstruction; and
(iii) Enforcement of Security without the intervention of the Court.
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The Act, thus brings three important tools/powers into asset management of
financial banks and institutions – securitization of assets, reconstruction of
assets and powers for enforcement of security interests (means asset security
interests).

What is Securitization?

Securitization is the process of pooling and repackaging of financial assets (like

loans given) into marketable securities that can be sold to investors.

In the context of bad asset management, securitization is the process of

conversion of existing less liquid assets (loans) into marketable securities. The
securitization company takes custody of the underlying mortgaged assets of
the loan taker. It can initiate the following steps:

(i) Acquisition of financial assets from any originator (bank), and

(ii) Raising of funds from qualified institutional buyers by issue of security
receipts (for raising money) for acquiring the financial assets or
(iii) Raising of funds in any prescribed manner, and
(iv) Acquisition of financial asset may be coupled with taking custody of the
mortgaged land, building etc.

What is Asset Reconstruction?

Asset reconstruction is the activity of converting a bad or non-performing asset

into performing asset. The process of asset reconstruction involves several
steps including purchasing of bad asset by a dedicated Asset Reconstruction
Company (ARC) including the underlying hypothecated asset, financing of the
bad asset conversion into good asset using bonds, debentures, securities and
cash, realization of returns from the hypothecated assets etc.

Reconstruction, is to be done with the RBI regulations and the SARFAESI Act
gives the following components for reconstruction of assets: –

(a) taking over or changing the management of the business of the

borrower,
(b) the sale or lease of a part or whole of the business of the borrower;
(c) rescheduling of payment of debts payable by the borrower;

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 (d) enforcement of security interest in accordance with the provisions of
this Act;
(e) settlement of dues payable by the borrower;
(f) taking possession of secured assets in accordance with the provisions of
this Act.

What is mean by ‘Enforcement of Security Interests’?

The Act empowers the lender (banker), when the borrower defaults, to issue
notice to the defaulting borrower and guarantor, calling to repay the debt
within 60 days from the date of the notice. If the borrower fails to comply with
the notice, the bank or the financial institution may enforce security interests
(means interest of the bank/creditor) by following the provisions of the Act:

(a) Take possession of the security;

(b) Sale or lease or assign the right over the security;
(c) Appoint Manager to manage the security;
(d) Ask any debtors of the borrower to pay any sum due to the borrower.

If there are more than one secured creditors, the decision about the
enforcement of SARFEASI provisions will be applicable only if 75% of them are
agreeing.

Features of the amendment to the SARFAESI Act in 2016

 Government has amended the SARFAESI Act in August 2016 to empower

the ARCs (Asset Reconstruction Companies), to rejuvenate Debt
Recovery Tribunals (DRTs) and to enhance the effectiveness of asset
reconstruction under the new bankruptcy law.
 The amendment has given more regulatory powers to the RBI on the
working of ARCs. It was also aimed to empower asset reconstruction and
the functioning of Debt Recovery Tribunals (DRTs) in the context of the
newly enacted bankruptcy law.
 As per the amendment, the scope of the registry that contains the
central database of all loans against properties given by all lenders has
been widened to include more information.

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  RBI will get more powers to audit and inspect ARCs and will get the
freedom to remove the chairman or any director. It can also appoint
central bank officials into the boards of ARCs.
 RBI will get the power to impose penalties on ARCs when the latter
doesn’t follow the central bank’s directives. Similarly, it can regulate the
fees charged by ARCs from banks while dealing with NPAs. The penalty
amount has been increased from Rs 5 lakh to Rs 1 crore.
 The amendment has brought hire purchase and financial lease under the
coverage of the SARFAESI Act.
 Regarding DRTs, the amendment aims to speed up the DRT procedures.
Online procedures including electronic filing of recovery applications,
documents and written statements will be initiated.
 The amendments are important for DRTs as they can play an important
role under the new Bankruptcy law. DRTs will be the backbone of the
bankruptcy code and deal with all insolvency proceedings involving
individuals. The defaulter has to deposit 50 per cent of the debt due
before filing an appeal at a DRT.

Debt Recovery Tribunals: Powers & Appeals

The banks and financial institutions had been facing problems in recovery of
loans advanced by them to individual people or business entities. Due to this,
the banks and financial institutions started restraining themselves from
advancing out loans. There was a need to have an effective system to recover
the money from borrowers. This led to the formation of Debt Recovery
Tribunals (DRTs) after the passing of Recovery of Debts due to Banks and
Financial Institutions Act (RDDBFI), 1993. DRTs handle the cases in relation to
disputed loans above Rs. 10 lakhs. Debt Recovery Appellate Tribunals (DRATs)
deals with the appeals against the order passed by the DRTs. Presently, there
are 33 DRTs and 5 DRATs working all over India.

Pre-DRT Resolution Process

 In order to recover money from borrowers, the banks and financial

institutions had to file a suit in the civil court.
 The suit was tried and decided as per the provisions of Civil Procedure
Code (CPC), 1908 which used to be long and complicated.

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  A committee was formed in 1981 to suggest reforms under the
Chairmanship of Mr. T. Tiwari. It was observed by the committee that
since the court was burdened with so many cases, importance was not
given to cases in relation to the recovery of dues due to banks and
financial institutions. The committee suggested different measures one
of which was establishing quasi-judicial bodies that would deal only with
recovery matters.
 However, establishing of such bodies was not initiated for about a
decade later around Indian financial market and economic liberalization.

The 1993 RDDBFI Act

 In 1991, Narasimham Committee supported the perspectives of the

Tiwari Committee and suggested setting up Special Tribunals. The
recommendations of Narasimham Committee lead to the enactment of
Recovery of Debts Due to Banks and Financial Institutions Act (RDDBFI),
1993.
 The RDDBFI Act established two forms of agencies namely Debt
Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals
(DRATs) which were given powers of arbitration of debt recovery
matters. The first DRT was inaugurated in Kolkata on 27th April 1994.
 The DRT is especially created for fast and speedy recovery of debts due
to banks and financial institutions. It is stipulated that DRT is to decide
the applications as expeditiously as possible and endeavor should be
made to dispose off the application within 180 days.
 DRT is constituted u/s 3 of the RDDBFI Act to exercise the power and
jurisdiction as conferred by the State.
 Composition of DRT:
Presiding Officer

Staff of the Tribunal

Recovery Officer Registrar Assistant Registrar

 Presiding Officer (PO) – Appointed by the Central Government. The

government may authorize any other PO or judicial member of a DRT to
discharge the functions of a PO of another DRT.
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  Qualification: A person who is or has been qualified to be a District Judge
shall be qualified to be a PO.
 Term – 5 years or 65 years whichever is earlier. But there are conditions
where the central government can reappoint a PO in a DRT.

Powers of DRT

 summoning and enforcing the attendance of any person and examining

him on oath;
 requiring the discovery and production of documents;
 receiving evidence on affidavits;
 issuing commissions for the examination of witnesses or documents;
 reviewing its decisions;
 dismissing an application for default or deciding it ex-parte.
 make interim order by way of injunction, stay or attachment against the
defendant to debar from transferring, alienating or otherwise dealing
with the property or asset without permission of Tribunal.
 direct the defendants to provide security sufficient to satisfy the debt.
 Willful disobedience of powers of Tribunal are punishable under
Contempt of Court Act.

Appeal against the order of DRT

 Any person aggrieved on account of order passed by DRT may file an

appeal before DRAT.
 However, the DRAT does not entertain the appeal unless the Appellant
deposits with the Appellate Authority, 75% of the amount or such other
lesser amount as directed by DRAT.

Insolvency and Bankruptcy Code, 2016 (IBC, 2016)

What is IBC?

 Insolvency and Bankruptcy Code, 2016 is considered as one of the

biggest insolvency reforms in the economic history of India.
 This was enacted for reorganization and insolvency resolution of
corporate persons, partnership firms and individuals in a time bound
manner for maximization of the value of assets of such persons.

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Background

 The era before IBC had various scattered laws relating to insolvency and
bankruptcy which caused inadequate and ineffective results with undue
delays. For example,
 Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act (SARFAESI) –for security
enforcement.
 The Recovery of Debts Due to Banks and Financial Institutions Act,
1993 (RDDBFI) for debt recovery by banks and financial
institutions.
 Companies Act for liquidation and winding up of the company.
 Ineffective implementation, conflict amongst these laws and the time-
consuming procedure in the aforementioned laws, made the Bankruptcy
Law Reform Committee draft and introduce Insolvency and Bankruptcy
Law bill.

Objectives of IBC

 To consolidate and amend all existing insolvency laws in India.

 To simplify and expedite the Insolvency and Bankruptcy Proceedings in
India.
 To protect the interest of creditors including stakeholders in a company.
 To revive the company in a time-bound manner.
 To promote entrepreneurship.
 To get the necessary relief to the creditors and consequently increase
the credit supply in the economy.
 To work out a new and timely recovery procedure to be adopted by the
banks, financial institutions or individuals.
 To set up an Insolvency and Bankruptcy Board of India (IBBI).
 Maximization of the value of assets of corporate persons.

The Insolvency and Bankruptcy Code ecosystem

 National Company Law Tribunal (NCLT) – The adjudicating authority

(AA), has jurisdiction over companies, other limited liability entities.

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  Debt Recovery Tribunal (DRT) has jurisdiction over individuals and
partnership firms other than Limited Liability Partnerships.
 The Insolvency and Bankruptcy Board of India (IBBI) – It is the apex body
for promoting transparency & governance in the administration of the
IBC; will be involved in setting up the infrastructure and accrediting IPs
(Insolvency Professionals (IPs) & IUs (Information Utilities).
It has 10 members from Ministry of Finance, Law, and RBI.
 Information Utilities (IUs) - a centralized repository of financial and credit
information of borrowers; would accept, store, authenticate and provide
access to financial data provided by creditors.
 IPs - persons enrolled with IPA (Insolvency professional agency (IPA) and
regulated by Board and IPA will conduct resolution process; it will act as
Liquidator/ bankruptcy trustee; they are appointed by creditors and
override the powers of the board of directors.
IPs have the power to furnish performance bonds equal to assets of the
company under insolvency resolutions
 Adjudicating authority (AA) - would be the NCLT for corporate
insolvency; to entertain or dispose of any insolvency application,
approve/ reject resolution plans, decide in respect of claims or matters
of law/ facts thereof.
Key aspects of the Insolvency and Bankruptcy Code

 IBC proposes a paradigm shift from the existing “Debtor in possession”

to a “Creditor in control” regime.
 IBC aims at consolidating all existing insolvency related laws as well as
amending multiple legislation including the Companies Act.
 The code aims to resolve insolvencies in a strict time-bound manner -
the evaluation and viability determination must be completed within
180 days.
 Moratorium period of 180 days (extendable up to 270 days) for the
Company. For startups and small companies, the resolution time period
is 90 days which can be extended by 45 days.
 Introduce a qualified insolvency professional (IP) as intermediaries to
oversee the Process

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  Establishment of Insolvency and Bankruptcy board as an independent
body for the administration and governance of Insolvency & bankruptcy
Law; and Information Utilities as a depository of financial information.

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MODULE VIII: DEMONETIZATION

Demonetization means the withdrawal of a coin, note, or precious metal from
use as legal tender. In other words, Demonetization is a process of stripping a
currency unit of its status as a legal tender.

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On November 8, 2016, the Prime Minister Narendra Modi announced the
demonetization of the currency notes of Rs. 500 and Rs, 1,000. Further, the
government gave people a period of around 2 months to deposit all currency
notes of the said denomination with any bank.

Possible benefits of Demonetization

 Increased Savings – When currency is demonetized, people tend to

deposit their cash with a bank and store less physical currency at home.
This helps them save more.
 Lower lending rates – With currency demonetization, money moves
from people to banks and financial institutions. Therefore, there is a
better circulation of money. Further, banks and financial institutions
have a lower cost of funds which translates into lower lending rates.
 Better economy – Since demonetization induces people to deposit their
cash with the banks, there is a higher circulation of money in the
economy. The government receives more taxes and can undertake more
development projects. Eventually, this leads to a better-performing
economy.
 Curbing anti-social activities – Usually, anti-social elements like
smugglers or terrorists use cash as a mode of transaction. When the
government decided to demonetize 500 and 1000 rupees notes, they
were the highest denomination notes in circulation. By demonetizing
them, the government forced these anti-social units to find ways to get
rid of the old notes. This allowed the government an opportunity to get
a better control over the unaccounted money in the economy and curb
anti-social activities.
 Reducing counterfeit currency notes – During demonetization, people
deposit all old notes with banks who check if the notes are genuine or
counterfeit before accepting them. Therefore, this allows the
government to weed out counterfeit notes circulating in the market.

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