BANKING LAW

SEM: VII [4TH YEAR]

Banking Companies Act, 1949

The Banking Regula on Act, 1949 is one of the key regulatory laws governing banking opera ons in
India. Despite being related to banking companies, it is not named the Banking Companies Act
because it applies to all types of banks, including co-opera ve banks, not just banking companies. This
act was passed to regulate and manage the ac vi es of banks, ensuring their sound func oning,
transparency, and adherence to certain standards.

‘Salient Features’ & ‘Reasons’ for the Name "Banking Regula on Act, 1949"

The reason the Act is not named the Banking Companies Act is because it was intended to apply to a
wider range of financial ins tu ons than just banking companies. The Act governs both commercial
banks and co-opera ve banks, providing a unified legal framework for all types of banks. It ensures
that there are uniform rules for the func oning of these banks, making it more inclusive and
comprehensive.

The Banking Regula on Act, 1949 lays out a comprehensive framework for regula ng banking
companies in India, detailing the requirements for their establishment, opera on, and overall
management. It includes provisions for licensing banks, se ng out their responsibili es, and
establishing rules for the control of their opera ons. At the core of this Act is the role of the Reserve
Bank of India (RBI), which is granted central authority to regulate and supervise commercial banks
across the country. The RBI holds the power to issue direc ves and impose penal es, ensuring that
banks adhere to sound banking prac ces and maintain financial stability. Another crucial aspect of the
Act is the capital requirement rules it enforces. These s pulate the minimum levels of capital and
reserves that banks must hold, which helps to keep them financially sound and able to withstand
poten al losses. The Act also includes provisions on the governance and management of banks, such
as the appointment of directors and the structuring of bank boards, which aim to ensure that bank
management is both responsible and aligned with the interests of customers and shareholders.

The Banking Regula on Act, 1949 also covers provisions for amalgama on and liquida on of banks,
allowing for mergers, amalgama ons, or even liquida on if a bank is found to be financially unstable.
In such cases, the RBI has the authority to take correc ve ac on to safeguard the interests of the
banking system and its stakeholders. Protec ng customer interests is another core feature, as the Act
mandates transparency in bank opera ons, with specific provisions for account maintenance, deposit
returns, and the disclosure of financial informa on. These protec ons help ensure that customers'
interests are safeguarded and that they are not misled. The Act manages the supervision and control
of bank branches by regula ng the number of branches a bank can open. This approach ensures that
banks expand their services in a controlled and stable manner. The RBI is also authorised to inspect
banking companies’ opera ons, monitoring compliance and implemen ng necessary steps to
maintain the health of the banking sector. Through these provisions, the Act seeks to protect both
customers and the broader financial system, crea ng a sound, transparent, and stable banking
environment.

The Banking Regula on Act, 1949, is like a rulebook for how banks in India should operate. It helps
make sure that banks are run properly, safely, and fairly. The Act ensures that banks don’t get into
trouble with their money, and that customers' deposits are safe. The Reserve Bank of India, or RBI, is
the main authority overseeing this law. It tells banks how to manage their money, who should run
them, and what happens if a bank goes out of business.

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

IMPORTANT PROVISIONS OF THE ACT

Sec on 6 (Form of business in which banking companies may engage)

The main business of banking, a banking company can engage in a variety of addi onal ac vi es.
These include:

 A bank may borrow or raise money and also lend money, with or without any collateral security. It
can handle and trade different financial instruments like bills of exchange, promissory notes,
dra s, and bonds. The bank can issue le ers of credit, traveller’s cheques, and similar financial
documents. It can buy, sell, and manage foreign currency and foreign banknotes and also invest in
various forms of securi es, including shares, stocks, and bonds. Banks may also purchase and sell
bonds and securi es on behalf of others, and they can collect and transfer money or valuables for
customers.
 Banks can act as agents for government authori es or private individuals, providing agency
services such as clearing goods, issuing receipts, or ac ng on behalf of customers, though they
cannot serve as managing agents for companies. Banks are also allowed to arrange, nego ate, and
issue both public and private loans and assist in underwri ng public or private financial issues
such as state bonds, or shares of companies.
 A bank can provide guarantees and transact insurance-type business to indemnify or cover against
losses. If a bank acquires any property to sa sfy a claim, it is permi ed to manage, sell, or
otherwise realise that property. It can acquire and handle property as security for loans or other
business-related transac ons.
 Banks are also allowed to perform trustee services and administer estates on behalf of customers.
Furthermore, they may support or help establish welfare schemes, funds, or associa ons for the
benefit of employees, re rees, and their dependents, and can contribute to charitable causes and
general public interests.
 Banks may acquire, construct, and maintain buildings or any works that serve the bank’s
opera onal needs. They can manage or sell any part of the bank’s property or assets, and may
also take over another business if it aligns with the ac vi es allowed for banking companies.
 Banks can perform other ac vi es that support or promote the business objec ves of the bank. If
the Central Government deems any new business form suitable for banks, it may allow them to
engage in that ac vity through an official no fica on.

Sec on 7 (“bank”, “banker”, “banking” or “banking company”)

 Only a recognised banking company can use terms like "bank," "banker," or "banking" in its name
or business descrip on. No other company can use these words unless it is actually engaged in
the business of banking, and any legi mate banking company must include at least one of these
words in its name if it operates in India.
 Similarly, individuals, groups, or firms cannot use "bank," "banking," or "banking company" as part
of their business name if they are not engaged in actual banking ac vi es.
 There are a couple of excep ons to this rule. If a subsidiary company is set up by a banking
company specifically to carry out certain func ons, and its name shows it is a subsidiary of that
bank, it is allowed to use these terms. Any associa on of banks created to protect mutual interests
and registered under sec on 25 of the Companies Act, 1956, may also use these words.

Sec on 8 (Prohibi on of trading)

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

 A banking company is generally not allowed to trade or engage in buying, selling, or bartering
goods. This restric on applies to any type of direct or indirect involvement in the trading of
goods, except in specific cases.
 The excep ons include situa ons where the bank needs to handle goods to recover a security
or as part of its services related to bills of exchange or other specified banking func ons.
Essen ally, banks can only engage with goods if it is necessary to realise security held by them
or if the transac on is connected to their main banking services, such as handling bills for
collec on or nego a on.
 This rule does not restrict banks from engaging in certain business ac vi es that may be
authorised by the Central Government under clause (o) of sec on 6, which allows addi onal
banking func ons if no fied.
 The term "goods" here includes all kinds of movable property except ac onable claims, stocks,
shares, money, bullion, and certain financial instruments as specified in sec on 6.

Sec on 9 (Disposal of non-banking assets)

 A banking company is not permi ed to hold any immovable property—such as land or

buildings—that is not required for its own opera onal use, for more than seven years from
the date it was acquired or from the date this Act commenced, whichever is later. Within this
period, the bank must sell or otherwise dispose of such property.
 The bank may deal with or trade this property within the seven-year period, but only to
facilitate its eventual disposal. In certain cases, if it is in the best interest of the bank’s
depositors, the Reserve Bank of India (RBI) may grant an extension beyond the ini al seven
years. However, this extension cannot exceed an addi onal five years.

Sec on 10A (Board of directors to include persons with professional or other experience.)

 Banking companies must ensure that their Board of Directors includes individuals with
relevant professional knowledge and experience. This requirement applies to all banks,
whether they were established before or a er the 1968 Banking Laws (Amendment) Act.
Banks that existed prior to the Act are given a three-month grace period to comply.
 More than 51% of the Board members must possess exper se in areas beneficial to banking,
such as accountancy, agriculture and rural economy, banking, co-opera on, economics,
finance, law, or small-scale industry. The Reserve Bank of India (RBI) can approve other fields
of exper se if they are seen as useful to the bank. At least two directors must have specialised
knowledge in agriculture, rural economy, co-opera on, or small-scale industry.
 Board members must not have significant interests or connec ons with larger companies or
commercial and industrial concerns that are not small-scale industries. Nor can they be the
owners of large trading, commercial, or industrial businesses.
 Directors, except for the chairman or a full- me director, cannot serve for more than eight
consecu ve years. If a chairman or whole- me director is removed, they cannot be
reappointed to the Board for four years.
 If a bank’s Board does not meet these requirements, it must be restructured to comply. To do
this, the Board may randomly select members to re re to meet the guidelines. If the bank
does not make the necessary changes, the RBI can order it to do so, and if the bank s ll fails to
act within two months, the RBI can remove non-compliant members and appoint
replacements through a random selec on process. This process is designed to maintain a
Board composi on aligned with legal and regulatory standards.

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

 If a Board member is removed, the RBI can appoint a new director in their place. This
appointed individual is then considered duly elected by the banking company as its
director.
 All actions of appointment, removal, reconstitution, or elections under this section
are final and cannot be challenged in court. The term of the newly elected or
appointed director will last until the original term of their predecessor would have
ended if no changes had occurred.
 Any actions or decisions made by the Board will remain valid, even if later it is found
that the Board's composition was flawed or that certain members did not meet the
specified requirements. This ensures that banking companies’ operations are not
disrupted due to procedural or compliance issues with Board composition.

Sec on 10B (Banking company to be managed by whole me chairman)

 Sec on 10B, every banking company must have one of its directors appointed as the chairman
of the Board. The chairman, if appointed on a whole- me basis, manages the company’s
opera ons, following the direc ons of the Board. However, if the chairman is part- me, the
Reserve Bank of India (RBI) must approve this, and a managing director will handle the daily
affairs of the bank under the Board's supervision.
 For whole- me chairmen or managing directors, they must work exclusively for the bank.
Their term is limited to five years but can be extended through reappointment. They may
serve as directors of subsidiaries or certain non-profit companies but should not hold interests
in other companies, firms, or industries.
 It should be a managing director’s role end (by resigna on, term expira on, or otherwise), the
Reserve Bank’s approval allows them to stay on un l a successor is appointed. The RBI can
also intervene if it finds someone unsuitable for the role, removing and appoin ng a
replacement if the bank fails to do so within two months. Decisions about removals can be
appealed to the Central Government, whose decision is final.
 In certain cases, with RBI’s permission, chairmen or managing directors may take on part- me
honorary work that doesn’t interfere with their du es. If the whole- me chairman or
managing director is unable to perform their role temporarily (due to illness or absence), the
bank can arrange for a replacement for up to four months, subject to RBI approval.

Sec on 11 (Requirement as to minimum paid-up capital and reserves.)

 Sec on 11 specifies requirements regarding minimum paid-up capital and reserves for
banking companies to operate in India, ensuring financial stability and depositor security. For
any banking company established before this Act's commencement, it must meet these
requirements within three years, though the Reserve Bank of India (RBI) can extend this
period by up to one addi onal year for depositor protec on. New banking companies must
comply immediately.
 Foreign banking companies (those based outside India) are required to maintain a minimum
capital and reserves of fi een lakhs rupees, or twenty lakhs if they have branches in Mumbai
or Kolkata. They must keep a deposit with the RBI, either in cash or approved securi es, equal
to this minimum. Annually, they must deposit 20% of their profit from their Indian branches.
However, the Central Government, based on RBI’s recommenda on, can waive this
requirement if the current deposit level is deemed sufficient. For Indian banking companies
that don’t fall under foreign banking company provisions, the required minimum capital
depends on their opera onal loca on. If the company operates in mul ple states, it needs at
Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

least five lakhs rupees, and ten lakhs if in Mumbai or Kolkata. If all branches are within one
state (excluding Mumbai and Kolkata), it must have one lakh rupees for its primary branch and
an addi onal amount for each other loca on within or outside its main district, with a
maximum limit of five lakhs. Companies opera ng within one state, with at least one branch
in Mumbai or Kolkata, must have at least five lakhs, with an addi onal amount for each
branch outside these ci es, up to a ten-lakh maximum.
 In the event that a foreign banking company stops opera ons in India, the amount deposited
with the RBI becomes an asset priori sed for its Indian creditors. If there's any dispute
regarding the total capital and reserves for a banking company, the RBI's determina on is
final.
 The terms "place of business" covers all loca ons accep ng deposits, cashing cheques, or
lending money, while "value" refers to the real or exchangeable worth, not the nominal or
book value of the banking company's assets.

Sec on 12

(Regula on of paid-up capital, subscribed capital & authorised capital & vo ng rights of shareholders.)

 The rules related to a banking company's paid-up, subscribed, and authorised capital, along
with shareholder vo ng rights. A banking company can only operate if it meets specific capital
requirements. Firstly, its subscribed capital must be at least half of the authorised capital, and
the paid-up capital must be at least half of the subscribed capital. If the company increases its
capital, it must fulfil these condi ons within a period not exceeding two years, as permi ed by
the Reserve Bank of India (RBI).
 The structure of capital, the banking company’s capital must consist only of equity shares or a
combina on of equity and preference shares. If preference shares are issued, they must
follow RBI guidelines, specifying the type, amount, and terms for each preference share class.
Holders of preference shares cannot exercise certain vo ng rights specified in the Companies
Act. There are also limits on vo ng rights for shareholders. A person holding shares in a
banking company cannot exercise more than ten percent of the total vo ng rights during a
poll, although the RBI may increase this limit to twenty-six percent in stages.
 Any person registered as the holder of a share in a banking company is recognised as the
official holder, even if the share tle belongs to someone else. However, there are excep ons:
a transferee of the share can sue if they have legally acquired it from the registered holder, or
a suit can be filed if the registered holder holds shares on behalf of a minor or someone
unable to make decisions, like a person with a mental health condi on.
 The chairman, managing director, or CEO of a banking company must report their
shareholding details to the RBI through the banking company. This report should include the
amount and value of their shares, whether held directly or indirectly, along with any changes
in the extent or rights a ached to these shares. The RBI specifies the format and ming for
submi ng this informa on.

Sec on 17(1) {Reserve Fund}

Sec on 17 (1) Every banking company incorporated in India to set up a reserve fund. The bank must
allocate at least 20% of its annual profit, as shown in the profit and loss account, to this reserve fund
before any dividends are declared. This ensures that a por on of the bank’s profits is kept aside for
future use or to cover unexpected expenses, rather than being en rely distributed to shareholders.

Sec on 18 (Cash reserve)

Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

 Every banking company, except for scheduled banks, to maintain a cash reserve in India. This
reserve must be equivalent to a certain percentage of the bank’s total demand and me
liabili es in India, as calculated on the last Friday of the second preceding fortnight. The
Reserve Bank will specify the exact percentage from me to me, depending on the needs of
the country’s monetary stability. The banking company is also required to submit a return to
the Reserve Bank before the 20th of each month. This return must show the amount held in
the cash reserve on alternate Fridays and provide details of the liabili es on those Fridays.
 The liabili es of the banking company in India do not include paid-up capital, reserves, credit
balances in the profit and loss account, advances taken from certain ins tu ons, or loans from
sponsor banks in the case of regional rural banks.
 If a bank’s reserve falls below the required amount on any given day, it must pay penal
interest. The rate is set at 3% above the bank rate for the first day of the shor all, and it
increases to 5% above the bank rate for each day the shor all con nues. However, if the bank
can prove a valid reason for the shor all, the Reserve Bank may waive the penal interest. The
Reserve Bank can grant exemp ons from these provisions for specific periods or condi ons.
 The Reserve Bank can also determine whether certain transac ons should be considered
liabili es in India for the purposes of this sec on, and its decision on such ma ers will be final.

Sec on 19 (2) {Restric on on nature of subsidiary companies}

the types of subsidiary companies a banking company can form. A banking company is not allowed to
create a subsidiary unless it meets specific condi ons.

The subsidiary can be formed for one of the following reasons:

 To carry out any business that is allowed for a banking company, as outlined in Sec on 6.

 To carry out banking business exclusively outside India, but only if the banking company has
received wri en permission from the Reserve Bank.

 To engage in other types of business that the Reserve Bank, with the approval of the Central
Government, believes will help spread banking in India or is beneficial for public interest.

Only because a banking company forms a subsidiary, it will not be considered as indirectly involved in
the subsidiary's business, as per Sec on 8.

Sec on 20 (Restric ons on loans and advances)

A banking company cannot grant loans or advances against the security of its own shares. It cannot
enter into any commitment to provide loans or advances to certain par es. These par es include:

 Any of the bank’s directors.

 Any firm where a bank director is involved as a partner, manager, employee, or guarantor.

 Any company, other than a subsidiary or certain government companies, where a bank
director holds a significant posi on such as a director, manager, employee, or guarantor, or
has substan al interest in it.

 Any individual for whom a bank director is a partner or guarantor.

If a loan or advance was made before the law came into effect, or if it was made following a prior
commitment, the bank must take steps to recover the amount owed, along with any interest, within a
specified me. If the loan or advance cannot be recovered within that me, the bank can apply to the
Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

Reserve Bank for an extension, but the extension cannot exceed three years. However, this rule does
not apply if the director of the banking company leaves their posi on for any reason.

The Reserve Bank’s approval is required for the remission (cancella on or reduc on) of any loan or
advance, and any remission without this approval is invalid. If a loan has not been repaid within the
specified me, and the borrower is a director of the bank, they will be deemed to have vacated their
posi on as director.

Sec on 21 (Power of Reserve Bank to control advances by banking companies.)

The Reserve Bank the power to control the lending prac ces of banking companies if it believes that
doing so is necessary for the public interest, the protec on of depositors, or the overall stability of the
banking system. Once the Reserve Bank has set a policy on lending, all banking companies must follow
it.

The Reserve Bank can issue specific direc ons to banks on a range of ma ers. These include:

 Deciding which purposes banks can or cannot lend money for.

 Se ng the margins (the amount of security) that must be maintained for secured loans.

 Determining the maximum amount a bank can lend to a single company, firm, group, or
individual, considering factors such as the bank's capital, reserves, and deposits.

 Limi ng the maximum amount a bank can guarantee for any individual or en ty, based on
similar considera ons.

 Se ng the interest rates and other terms under which loans or guarantees can be given.

Sec on 24 (Maintenance of a percentage of assets.)

 Banking companies, including scheduled banks, to maintain a certain percentage of assets in

India. This percentage is based on the total demand and me liabili es of the bank and is set
by the Reserve Bank of India (RBI). The percentage can go up to a maximum of 40% of the
bank's liabili es, as determined by the RBI.
 The daily cash reserves a bank is required to maintain under Sec on 42 of the Reserve Bank of
India Act, each bank must also maintain assets in a specific form, as per the RBI's instruc ons.
This is to ensure the bank’s financial stability. Banks are required to submit a monthly return
to the RBI showing the value of the assets they have maintained and their liabili es. This
return should be submi ed no later than 20 days a er the end of the month.
 If a bank fails to meet the required asset levels on a specific day, they will face a penalty. If the
shor all happens on an alternate Friday or the preceding working day, the penalty is 3%
above the bank rate. If the shor all con nues for the next alternate Friday or working day, the
penalty rate increases to 5% above the bank rate.
 The bank must pay this penalty within 14 days of receiving a no ce from the RBI. If the
penalty is not paid on me, the RBI can apply to the civil court for enforcement. If the bank
con nues to fail in maintaining the required assets and the higher penalty rate applies, the
directors or managers responsible for the default may face a fine.
 If the bank can show that the default was due to a valid reason, it can apply to the RBI to
waive the penalty.

Sec on 35 (Inspec on)

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

 The inspec on and scru ny powers that the Reserve Bank of India (RBI) has over banking
companies. The RBI can inspect any banking company’s books and accounts at any me. If the
RBI is directed by the Central Government, it must carry out such an inspec on. The banking
company is then provided with a copy of the inspec on report.
 The RBI can also conduct a scru ny of a bank’s affairs and books. If the bank requests it or if
any nega ve ac on is being considered, the RBI will share the scru ny report. Bank directors,
officers, and employees must assist in the inspec on or scru ny. They must provide all
required documents and informa on, and cooperate fully with the officers conduc ng the
inspec on. The RBI officers can also ques on these individuals under oath to gather further
details about the bank’s opera ons.
 If an inspec on or scru ny reveals that a bank is ac ng against the interests of its depositors,
the Reserve Bank will report to the Central Government. If the Central Government agrees
with this assessment, it can take ac ons such as prohibi ng the bank from accep ng new
deposits or ordering the RBI to start the process of winding up the bank.
 The Central Government may also publish the inspec on or scru ny report a er no fying the
bank, if it considers it necessary. In the case of regional rural banks, the powers of the RBI
regarding inspec ons and scru ny can also be exercised by the Na onal Bank. This ensures
that the same inspec on and scru ny procedures apply to these banks as well.

Sec on 36AA (Power of Reserve Bank to remove managerial and other persons from office)

 The Reserve Bank of India (RBI) the power to remove key individuals from posi ons in a
banking company, such as the chairman, directors, or any chief execu ve officer (CEO), or
other officers and employees, if it believes that it is necessary for the public interest, to
prevent harm to depositors, or to ensure the proper management of the bank. The RBI can
issue such an order, but it must provide reasons in wri ng and specify a date for the removal.
 Before issuing the order, the individual in ques on must be given a chance to present their
case and explain why they should not be removed. However, if the RBI believes that any delay
in the decision would harm the bank or its depositors, it can immediately prevent the
individual from con nuing in their role, pending the final decision.
 If the person disagrees with the removal order, they can appeal to the Central Government
within 30 days. The decision made by the Central Government is final and cannot be
ques oned in any court.
 Once the removal order is made, the individual will no longer be able to hold any posi on in
the bank, directly or indirectly, for a period not exceeding five years, as stated in the order. If
the individual disobeys this order, they can be fined up to 250 rupees for each day they
con nue to break the rules. A er a person is removed from office, the RBI has the authority to
appoint someone else to take their place. This appointed person holds the posi on at the
pleasure of the RBI, typically for up to three years, with the possibility of extensions.
 A person who is removed from their posi on under this sec on cannot claim compensa on
for losing their job, even if their removal goes against their contract or any legal agreements.

FOREIGN EXCHANGE MANAGEMENT ACT (FEMA), 1999

The Foreign Exchange Management Act (FEMA), 1999, was enacted to replace the earlier Foreign
Exchange Regula on Act (FERA), 1973, and to facilitate the development and maintenance of a foreign
exchange market in India. The primary objec ve of FEMA is to promote the orderly development and
Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

maintenance of the foreign exchange market in India, thereby facilita ng external trade and
payments. One of the central goals of the Act is to ease and liberalise India's external sector, moving
from a restric ve framework under FERA to a more open and market-oriented regime. It aims to
ensure that foreign exchange transac ons, especially concerning current account dealings, are carried
out smoothly and in a regulated manner. FEMA supports India's integra on with the global economy
by providing a clear legal framework that governs foreign exchange dealings, while also ensuring that
such transac ons do not nega vely impact India’s monetary policy or economic stability. The act also
aligns India's regulatory framework with interna onal best prac ces, promo ng economic growth,
trade, and investment. It is not just about managing foreign exchange but also balancing the needs for
capital movement and maintaining India's economic sovereignty.

One of the salient features of FEMA is its focus on the liberalisa on of the Indian economy, specifically
in the context of foreign exchange management. It encourages the free flow of capital and permits
non-residents to invest in India and vice versa, under specific condi ons. This framework is designed
to strike a balance between facilita ng capital inflows and safeguarding the country from the adverse
effects of excessive capital ou lows. FEMA provides a regulatory structure for current account
transac ons, allowing for easy movement of goods, services, and payments for normal trade
purposes. However, it con nues to restrict capital account transac ons unless authorised by the
Reserve Bank of India (RBI), maintaining control over poten ally destabilising financial transac ons.
This segmenta on of current and capital account transac ons is one of the unique features of FEMA,
ensuring that the Indian financial system remains protected from specula ve or excessively risky
transac ons. While FEMA is a more liberal framework than FERA, it does not completely remove
regulatory oversight. The Act retains stringent controls over certain transac ons, par cularly those
involving non-resident Indians (NRIs) and foreign investors, to ensure that they do not adversely
impact India’s foreign exchange reserves or financial markets.

FEMA's enforcement mechanisms and penal es for infringement are crucial for maintaining its
integrity and effec veness. The Act empowers the RBI to regulate foreign exchange transac ons and
provides clear authority for enforcement through a dedicated legal framework. Individuals or
businesses that violate FEMA provisions are liable to penal es, which can range from monetary fines
to more severe ac ons in the case of repeat offenders. One of the dis nc ve features of FEMA,
compared to FERA, is the introduc on of an administra ve framework for adjudica ng viola ons and
imposing penal es, rather than involving criminal prosecu on in most cases. This approach
encourages compliance and focuses on rec fica on rather than punishment. Another feature of FEMA
is its provision for authorisa on and approval of transac ons related to foreign exchange. The Act also
lays down a clear framework for the repatria on of foreign exchange, making it easier for Indian
residents and non-residents to exchange currencies and remit money in and out of the country. These
mechanisms ensure that India’s foreign exchange market remains secure, compliant with interna onal
norms, and efficient in managing cross-border transac ons. Together, the objec ves and features of
FEMA make it an essen al tool for India’s economic growth in the global arena, allowing for robust
foreign exchange management while keeping the na onal economic interest intact.

The Foreign Exchange Management Act (FEMA) includes specific provisions that outline its core
func ons and regulatory structure. The main aim of FEMA is to manage external trade and payments
and to facilitate a more organised and regulated flow of foreign exchange. Here are some of the key
provisions under FEMA:

Sec on 3 of FEMA

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

It restricts certain foreign exchange transac ons. It prohibits transac ons involving foreign exchange
unless permi ed by the Act, thereby controlling foreign exchange dealings in India. Sec on 4 prohibits
anyone in India, unless specifically allowed, from holding foreign exchange outside India, ensuring that
foreign assets are declared and regulated. Sec on 5 provides for liberalisa on in current account
transac ons, allowing most current account dealings unless specifically restricted, suppor ng ease of
trade and interna onal transac ons.

Sec ons 6 and 7 focus on capital account transac ons and the export of goods and services. Sec on 6
gives the Reserve Bank of India (RBI) the authority to regulate capital account transac ons, which
involve the movement of capital across borders. This sec on ensures that while interna onal
investments and borrowing can occur, they remain under central oversight. Sec on 7 mandates that
exports of goods and services are conducted in a way that ensures mely payments and compliance
with FEMA regula ons.

Sec on 13 of FEMA deals with penal es for non-compliance with its provisions. If any person
contravenes the rules, they may be subject to penal es, ensuring that the Act is enforced effec vely.

Sec on 14 further allows for any unpaid penal es to be treated as recoverable debt, strengthening
FEMA’s enforcement capabili es.

Sec on 37 of FEMA provides the power to conduct searches and inves ga ons. This ensures that all
foreign exchange transac ons and dealings are regularly scru nised, allowing the government to
prevent unauthorised transac ons and detect possible misuse.

THE NEGOTIABLE INSTRUMENTS ACT, 1881,

The Nego able Instruments Act, 1881, is a founda onal piece of legisla on in India that governs the
legal framework for nego able instruments like promissory notes, bills of exchange, and cheques. This
Act provides a systema c approach to the recogni on, endorsement, and transfer of these
instruments, crea ng a reliable method for conduc ng transac ons. The primary objec ve of the Act
is to facilitate smooth commercial transac ons by establishing clear rules around the transferability
and nego ability of such instruments. It outlines the rights and liabili es of par es involved, thereby
enabling individuals and businesses to engage in financial dealings with certainty and trust. By defining
the legal standing of nego able instruments, the Act also offers protec on to the par es involved,
ensuring that transac ons are secure and enforceable. This Act has been a pivotal element in
modernising India’s commercial law, especially as the economy has expanded and adapted to more
complex.

Sec on 4 (Promissory note)

A promissory note is a wri en document where one person promises to pay a specific amount of
money to another person, either directly or to their order. This promise must be clear, uncondi onal,
and made by the person who is signing the document. Importantly, a promissory note is not a
banknote or currency note; it’s more like a formal promise of payment for a future date or upon
request.

Sec on 5 (Bill of Exchange)

A bill of exchange is a wri en document that includes an instruc on from one person to another,
direc ng them to pay a specific sum of money. This instruc on, called an order, is uncondi onal,
Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

meaning it’s clear and not dependent on any condi ons. The maker, or person who issues the bill,
must sign it to make it valid. This document instructs a par cular person to pay a certain amount
either directly to someone or to whomever that person may appoint, or even to the bearer of the
document, depending on how it is wri en.

In a bill of exchange, even if the payment is set to happen a er a par cular event, it is s ll considered
an uncondi onal order as long as the event is something that is expected to happen sooner or later,
even if the exact me isn’t known. For example, a bill could specify that payment will be made a
certain number of days a er an event that everyone knows will take place, just not exactly when.The
amount men oned in a bill of exchange is considered “certain,” even if there are some variables, like
addi onal interest that might be due in the future, or if it’s payable in a different currency based on
the rate at that me. Some mes, if the person being directed to pay misses an instalment, the
remaining amount might become due immediately. This doesn’t affect the certainty of the sum to be
paid, as these are understood condi ons in such transac ons.

The person who is directed to make the payment should be iden fiable, even if they’re named
incorrectly or described in general terms. As long as the bill makes it clear to whom the instruc on is
given, it sa sfies the requirement for being a bill of exchange.

Sec on 6 (Cheque)

A cheque is essen ally a special type of bill of exchange, but it is drawn specifically on a bank account.
Unlike other bills of exchange, it is always payable on demand, meaning it can be cashed or paid as
soon as it is presented to the bank. A cheque includes both physical forms and electronic versions,
which are commonly used today. The electronic versions include a digital image of the cheque, and
even a cheque in electronic form can be considered a valid cheque, provided it meets certain
requirements. The term "electronic cheque" refers to a cheque that is created digitally using a secure
system. This system might involve the use of digital signatures or other forms of electronic signatures
to confirm its authen city. This form of cheque is legally recognised if it follows the proper technical
steps and security measures outlined by the law.

A truncated cheque is a more modern concept. It happens when a physical cheque is converted into
an electronic image during the process of clearing, meaning the physical cheque no longer needs to
be moved from one bank to another. This helps speed up the process and reduces the need for
physical paperwork. The clearing house, o en run by the Reserve Bank of India or a recognised
ins tu on, is responsible for managing the transmission of these electronic images to ensure that the
transac on happens smoothly.

In the case of electronic cheques, the Informa on Technology Act, 2000, provides guidelines on what
cons tutes a digital signature, electronic form, and other technical terms that are necessary for the
process of crea ng and verifying these modern versions of cheques.

Sec on 7 (“Drawer”, “Drawee”. “Drawee in case of need.” “Acceptor.” “Acceptor for honour.” “Payee.”)

A bill of exchange or cheque, different terms are used to iden fy the par es involved. The person who
creates and issues the bill or cheque is known as the “drawer.” The drawer instructs a second person,
called the “drawee,” to pay a specific amount. Some mes, an addi onal name is listed on the bill as a
“drawee in case of need.” This person can be turned to for payment if the primary drawee cannot fulfil
the payment.

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

Once the drawee agrees to the bill and signs it, they become the “acceptor.” If another person steps in
to accept the bill on behalf of the drawer or an endorser, par cularly if the bill was previously refused
or protested, they are known as an “acceptor for honour.” Finally, the individual who is meant to
receive the payment, as specified in the bill or cheque, is called the “payee.” These roles and terms
help clarify the responsibili es and rights of each party involved in the transac on.

Sec on 8 (Holder)

The term “holder” in rela on to a promissory note, bill of exchange, or cheque refers to the individual
who has the right to possess the document and claim the payment from the relevant par es. The
holder is the person en tled to collect the money owed under the terms of the note, bill, or cheque. If
the document is lost or destroyed, the holder remains the individual who held that en tlement at the
me of its loss or destruc on.

Sec on 9 (Holder in Due Course)

A “holder in due course” refers to a person who, in exchange for a payment or considera on, acquires
a promissory note, bill of exchange, or cheque. If the document is payable to the bearer, the holder in
due course is the person who possesses it; if it is payable to order, it is the payee or indorsee. To be a
holder in due course, the individual must obtain the instrument before its amount is due and without
any reason to suspect any flaw or defect in the ownership of the person from whom they received it.
This status gives the holder certain protec ons and rights under the law.

Sec on 13 (Nego able Instrument)

A nego able instrument is defined as a promissory note, bill of exchange, or cheque that can be
transferred to another party. It is payable either to a specific person or to the bearer, meaning anyone
holding the instrument. An instrument is payable to order when it explicitly states that it is payable to
a par cular person or when there are no words preven ng its transfer. In contrast, it is payable to
bearer if it is marked as such or if the last endorsement is blank, meaning it can be paid to whoever
presents it. An instrument expressed to be payable to the order of a specified person can s ll be paid
to that person or their order, giving them the choice. Furthermore, a nego able instrument can be
made payable to two or more people jointly or to any one or more of mul ple payees.

Sec on 14 (Nego a on)

Nego a on occurs when a promissory note, bill of exchange, or cheque is transferred to another
person in such a way that it makes the recipient the holder of that instrument. Nego a on is the
process by which ownership of the instrument is passed to someone else, allowing them to claim
payment as the new holder.

Sec on 15 (Indorsement)

Indorsement happens when the maker or holder of a nego able instrument, like a promissory note,
bill of exchange, or cheque, signs it for the purpose of transferring ownership or nego a on. This
signature can be placed on the back, front, or on a separate slip of paper a ached to the instrument.
By doing this, the signer becomes the indorser, allowing someone else to become the holder and
claim the payment on the instrument.

Sec on 85 (Cheque Payable to Order)

A cheque payable to order refers to a cheque intended to be paid to a specific person or as per their
order. Under the law, when the drawee bank pays this type of cheque in due course, meaning it pays
Notes Prepared by--
Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

to the proper party as intended, the bank is considered discharged of liability. This holds even if the
cheque is later endorsed, either in full or in blank, with restric ons on further transfer.

If a cheque was originally issued as payable to bearer which means it can be cashed by anyone who
presents it, the bank is discharged of its duty by paying whoever holds it, despite any endorsements
appearing on it that might otherwise restrict or prevent its further nego a on. This provision ensures
the drawee’s liability is cleared once payment is made correctly, regardless of any added instruc ons
on transfer a er the cheque is drawn.

Sec on 128 (Payment in due course of crossed cheque)

It protects the paying banker for payments on a bearer cheque in due course, as long as it is made to
the bearer of the cheque.

Sec on 131 (Non-liability of banker receiving payment of cheque.)

A banker who has acted in good faith and without negligence when receiving payment for a customer
on a cheque that is crossed: Either generally or specifically to the bank is not liable to the true owner
of the cheque if the tle (ownership) of the cheque later proves to be defec ve. This rule protects the
banker from liability simply for receiving payment under these circumstances.

 [A banker is considered to have received payment on a crossed cheque on behalf of a customer,

even if the bank credits the customer’s account with the cheque amount before actually receiving
the funds.]
 [The banker’s duty regarding electronic images of truncated cheques (images used in place of
physical cheques in processing). In such cases, the banker must verify the genuineness of the
cheque and check for any fraud, forgery, or visible tampering that could be detected through
normal care and diligence. It provides addi onal guidelines for maintaining care in cheque
transac ons while limi ng liability if these condi ons are met.]

Sec on 138 (Dishonour of cheque for insufficiency of funds in the account)

Dishonour of a cheque due to insufficient funds or if the amount surpasses the agreed payment limit
with the bank. If a person issues a cheque from their account to pay off a debt or liability, but the bank
returns it unpaid because of insufficient funds or an exceeded limit, the person who issued the
cheque is considered to have commi ed an offence.

The punishment for this offence includes imprisonment for up to two years, a fine up to twice the
cheque amount, or both. This sec on only applies if certain condi ons are met:

1. The cheque must be presented to the bank within six months of the date it was drawn or
within its validity period, whichever is shorter.

2. The payee (person who receives the cheque) or holder in due course (someone legally holding
the cheque) must send a wri en no ce to the cheque issuer within thirty days of receiving
informa on from the bank about the cheque’s return as unpaid.

3. The cheque issuer must fail to make the payment within fi een days of receiving the no ce.

The term “debt or other liability” here refers to a debt or obliga on that is legally enforceable.

RIGHTS AND LIABILITIES OF PAYING AND COLLECTING BANKER

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

The rights and liabili es of paying and collec ng bankers are crucial in ensuring the smooth
func oning of the banking system, par cularly when dealing with nego able instruments such as
cheques. A paying banker has the right to honour a cheque if it meets the necessary condi ons, such
as the cheque being properly signed by the account holder and there being sufficient funds in the
account. If the paying banker follows these condi ons, they are protected from liability, even if the
cheque is later found to be invalid or fraudulent. But if the banker pays a cheque with insufficient
funds or fails to properly verify the authen city of the cheque, they may be held liable for any losses
suffered by the payee.

The collec ng banker, on the other hand, is responsible for collec ng payments on behalf of the
customer who has deposited a cheque. Their primary duty is to act in good faith, ensuring that the
cheque is properly endorsed and that the customer has the right to deposit it. If the collec ng banker
collects the payment without negligence or fraudulent intent, they are protected from liability, even if
the tle to the cheque is later found to be defec ve. However, if the collec ng banker fails to verify
endorsements or accepts a cheque that appears suspicious, they may be held responsible for any
resul ng loss.

Both paying and collec ng bankers are generally protected by law if they act in good faith and with
due diligence. The law provides protec ons for ac ons taken in good faith, such as Sec on 10 of the
Nego able Instruments Act, which shields the paying banker when payments are made honestly and
without negligence. Sec on 131 protects the collec ng banker under similar condi ons. If either
banker fails to perform their du es with care, such as by accep ng a fraudulent cheque or paying out
on a cheque with insufficient funds, they may be liable for the resul ng damages. In this way, both
types of bankers have the responsibility to act honestly and protect their customers' interests while
following the proper procedures.

ENDORSEMENT, ASSIGNABILITY & NEGOTIABILITY

Endorsement, assignability, and nego ability are fundamental concepts in the law of nego able
instruments, such as promissory notes, bills of exchange, and cheques.

Endorsement refers to the act of signing a nego able instrument, usually on the back, to transfer
ownership or to authorise further transfer. The person making the endorsement is called the
endorser, and the person to whom the instrument is transferred is the endorsee. By endorsing an
instrument, the endorser either guarantees the payment or makes themselves liable for any non-
payment. This allows the instrument to be transferred from one person to another, making it an
important feature in commercial transac ons.

Assignability refers to the ability to transfer rights or obliga ons from one person to another. In the
context of nego able instruments, assignability allows the holder of an instrument to transfer their
rights to someone else. However, not all instruments are automa cally assignable; for an instrument
to be assignable, it must meet the criteria outlined in the law, such as being signed and endorsed
properly. An instrument that is assignable allows the holder to legally transfer their right to receive
payment to another person, thus making it an effec ve tool for conduc ng business transac ons.

Nego ability is closely linked to endorsement and assignability. A nego able instrument is one that is
freely transferable, allowing the holder to pass the instrument along to others in a legally recognised
manner. The defining characteris c of nego ability is that the instrument can be transferred from one
person to another, and the transferee has the same rights as the original holder. This means that the
transferee can demand payment and, in the case of a dishonoured instrument, can pursue legal ac on

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj
 BANKING LAW
SEM: VII [4TH YEAR]

against the previous holder or maker. The nego ability of an instrument ensures its u lity in the
financial and business world, as it allows the instrument to be easily traded or used as collateral.

DISHONOUR OF NEGOTIABLE INSTRUMENTS INCLUDING CRIMINAL LIABILITY OF DRAWER &

PROTECTION OF COLLECTING BANKER

The dishonour of nego able instruments, such as a cheque, occurs when the instrument is presented
for payment but is not paid by the bank. This o en happens due to insufficient funds in the drawer’s
account or if the account has been closed. In India, under Sec on 138 of the Nego able Instruments
Act, 1881, dishonouring a cheque can a ract criminal liability for the drawer. When a cheque bounces,
the payee or holder in due course must send a formal no ce to the drawer, demanding payment. If
the drawer fails to pay within the s pulated period, they may face legal consequences, including
imprisonment for up to two years or a fine up to twice the cheque’s amount, or both. This provision
aims to maintain trust in commercial transac ons by holding drawers accountable for their financial
commitments.

Criminal liability of the drawer arises under specific condi ons, such as failure to make the payment
a er receiving no ce from the payee. The criminal liability is intended as a deterrent against issuing
cheques without adequate funds, providing a level of security to recipients in business transac ons. If
the drawer responds by fulfilling the payment within the legal meframe a er the no ce, they can
avoid prosecu on. However, if they neglect this obliga on, the law permits the payee to pursue
criminal charges, thereby enforcing a strong penalty system against negligence and dishonesty in
financial dealings.

The protec on of collec ng bankers is a provision that shields banks from liability when they act in
good faith while processing cheques on behalf of customers. According to Sec on 131 of the
Nego able Instruments Act, a collec ng banker who accepts a cheque crossed for payment, and acts
without negligence, is not liable to the true owner if there is an issue with the cheque's tle. This
protec on allows banks to perform their du es without the fear of being liable for wrongful claims,
provided they act prudently and with due diligence. This safeguard helps the banking system operate
smoothly by giving banks confidence to process transac ons, knowing that they will not be penalised
for their role in simply facilita ng payment collec on for their customers.

Notes Prepared by--

Mr. Manu Kashyap Asst. Professor SIL, Prayagraj