BBA 4th SEMESTER (2019-2020)

BANKING REGULATIONS AND OPERATIONS

UNIT-1
COMMERCIAL BANK: A commercial bank is a financial institution which performs the
functions of accepting deposits from the general public and giving loans for investment with
the aim of earning profits.

FUNCTIONS OF COMMERCIAL BANKS.

PRIMARY FUNCTIONS
1. Accepting Deposits: Deposits constitute the major source of funds for banks. Hence,
the main function of a commercial bank is acceptance of deposits from the public.
This function is important because banks mainly depend on the funds deposited with
them by the public. The banks collect money from those who have surplus and lends
to those who require loans.
Types of Deposits-
 Fixed Deposits Account: Fixed deposits are also known as term deposits or time
deposits. Cash is deposited in this account for a fixed period. On such deposit, the
banks pay higher rate of interest depending on the length of time period and amount
of deposit. They have different maturity periods.
 Current Deposit Account: In this account a depositor can deposit and withdraw his
funds any number of times he likes. Generally, no interest is paid by the bank on the
current deposit account.
 Saving Deposit Account: This account is meant for small savings. There is a limit on
total weekly withdrawals. Banks pays interest on this account. But the rate of interest
is less than rate of interest paid on fixed deposit account.
 Recurring deposit account: Under this account a specified amount is deposited
every month for a specified period e.g. for 12, 24, 36 or 60 months. The amount
cannot be withdrawn before the expiry of the given period except under exceptional
circumstances (in the event of any direction from any statutory &/or regulatory
authority or deceased claim settlement cases).
2. Advancing loans: A certain part of the cash received by the banks as deposits is kept
in the reserve and the remaining is given as loan. Banks advance loans mostly for
productive purposes against approved security. The amount of loan is generally less
than the value of security.
Banks advance following types of loans-
 Money at call: It is the money lent for a very short period generally from 1 to 14
days. Such advances are usually made to other banks and financial institutions only.
Money at call ensures liquidity.
 Overdraft: Overdraft means allowing the borrower to over draw his current balance.
The drawee has to pay interest on extra amount withdrawn. The amount has to be
repaid within short period. The facility of overdraft is available for short-term to
reliable customers only. It is a short term and temporary accommodation.
 Cash credit: It is also very popular form of advancing loan. Under this system, the
bank advances loans to the customer on the basis of his current assets, receivables or
fixed assets by hypothecating them in favour of the banker. These loans are given in
the form of a fixed amount. Bank enters the amount of loans in the account books of
the debtor.
  Discounting of bills: Discounting a bill of exchange means advancing a loan against
a promise of repayment in future. It is the most favoured method of lending by the
commercial banks because such loans are self-liquidating in character.
 Credit to government: The commercial banks provide indirect credit to the central
government or state governments by investing in their securities.
 Creation of credit: This is also called the credit creation. When a bank advances a
loan or credit, it does not lend cash but opens an account in favour of the customer
and credits the amount to the account. Only a part of the deposits is required to be
kept in cash.
 Cheque system of payment of funds: A cheque as a negotiable instrument is the
popular credit instrument used by the customer to make payments. The cheque system
was evolved in very early stages of banking and now it has become the main credit
instrument in the banking world. Through a cheque, the customer directs the bank to
make payment to the payee.

SECONDARY FUNCTIONS
1. Agency Functions
 Collection and payment of credit: The commercial banks collect and pay the
various negotiable instruments like cheques, bills of exchange, promissory notes,
hundis etc. Banks also make payment on behalf of the customers like payment of
rents, income tax, fees, insurance premium etc.
 Purchase and sale of securities: The modern commercial banks also undertake the
purchase and sale of various securities like shares, stocks, bonds units and debentures
etc. on behalf of the customers. Banks perform the functions of a broker and do not
give any advice regarding the suitability of a security.
 Trustee and Executor: Banks also act as trustees and executors of the property of
their advice. Banks undertake administration of will or settlements and trusteeship
functions through its expert staff and specialised departments. Sometimes banks also
undertake income-tax services on behalf of the customer.
 Remittance of Money: Banks also remit money from one place to the other. The
commercial banks remit funds on behalf of customer from one place to another
through cheques, drafts, mail transfers, telegraphic transfer etc.
 Representation and correspondence: Sometimes commercial banks act as
representatives and/ or correspondents of the clients, especially in obtaining passports,
travel tickets, booking of vehicles, plots etc.
 Bullion trading: The commercial banks trade in bullions like gold and silver in many
countries. Commercial banks like SBI, IOB, Canara Bank and Allahabad Bank have
been allowed import of gold which has been put under open general license category
in October 1997.

2. General Utility Services

 Locker facilities: Banks provide locker facilities to their customers. People can keep
their gold or silver jewellery or other important documents in these lockers at a very
nominal annual rent. In this way bank accepts the valuable articles and documents for
safe custody.
 Acting as a referee: Banks also act as a referee. Banks give information about the
economic position of their customers to domestic and foreign traders. Bank can be
referred by the third parties for getting information regarding the financial position of
the customer. The bank will act as referee only if it is desired by the customer;
otherwise the secrecy of a customer’s account is maintained very carefully.
 Issuing Letter of Credit: Letter of credit is a very popular document in foreign trade.
Banks certify the credit worthiness of his customers in a way by issuing letter of
credit. Issuing of letter of credit to their customers to enable them to go abroad.
  Acting as Underwriters: Banks also underwrite the new issues of Government and
Corporate bodies for a commission. The name of a bank as an underwriter encourages
investors to have faith in the shares of company.
 Acting as Information Banks: Commercial banks also act as information bureau as
they collect the financial, economic and statistical data relating to industry, trade and
commerce. The information is made available to various interested parties.
 Issuing of Traveller’s Cheques: Banks have been rendering great service by issuing
traveller’s cheques which enable a person to travel without fear of theft or loss of
money. Now, some banks have started credit card system under which a credit card
holder can avail credit from the listed outlets without any additional cost or effort. So,
a credit cardholder needs not to carry cash all the time.
 Issuing of Gift Cheques: Certain banks issue gift cheques of various denominations
e.g. some Indian banks issue gift cheques of the denominations of Rs. 11, 21, 31, 51,
101, 501, etc. These are generally issued free of charge.
 Dealing in Foreign Exchange: Major commercial banks also transact business of
foreign exchange through their main branches. Commercial banks are the main
authorised dealers of foreign exchange in India.
 Merchant Banking Services: Commercial banks also render merchant banking
services to the customers. They help in availing loans from non-banking financial
institutions. However, in recent past most of the banks have transferred the merchant
banking services to their separate subsidiaries.

DEVELOPMENTAL FUNCTIONS
1. Mobilization of Savings: Banks collect idle saving of the people and invest the same
in productive activities. Banks help in accelerating the rate of capital formation in
country by mobilizing the saving. The most important role in mobilizing of the
savings of the society is played by the commercial bank.
2. Extension of banking services in rural area: Commercial banks have opened their
branches in rural areas and small towns to provide banking facilities to the people
living therein. Banks also give loans at low rate of interest to finance programme
meant for rural development and removal of unemployment.
3. Providing loans to weaker section: Banks give loans to weaker sections of the
society at low rate of interest. Small artisans, landless agricultural labourers and poor
classes get cheap loans from the banks.
4. Assistance to Capital Market: Banks also take part in capital market by giving long-
term loans to industry, agriculture, small scale industry, trader, transporters, etc.

MODERN FUNCTIONS
1. Automatic Teller Machines (ATM) Cum Debit Cards: Many bankers have
introduced ATMs to assist their customers to withdraw and deposit cash without any
waiting time. The debit and credit cardholders of a bank can also withdraw cash in
emergency from the ATMs at any time.
2. Credit Cards: Many bankers have introduced credit cards in India among their
customers. Credit card is plastic money which acts as an instrument of credit. Credit
card replaces the paper currency. The credit cardholders need not carry cash in their
pockets. The cardholder may purchase goods from many authorised dealers by using
the credit card.
3. Mail Transfer and Telegraphic Transfer: In mail/telegraphic transfer techniques
the customer requests the bank to transfer some part of the balance in the payee’s
account kept in a different place in the same bank for a nominal commission. The
bank manager, after receiving the instruction of customer, arranges to send an advice
to the concerned bank manager through a mail telegram to credit the payee’s account
with certain sum as desired by the customer.
 4. Tele-banking: Tele-banking is increasingly used as a delivery channel for marketing
banking services. A customer can do entire non-cash related banking over the phone
anywhere and at any time. Automatic Voice Recorders (AVR) or ID numbers are used
for rendering tele-banking services which have added convenience to customers.
5. Internet banking: Internet has enabled banking at the click of a mouse. Internet
banking is a platform for electric delivery of banking services to the customers. In
Internet banking, customer of a bank with a PC and a browser, can have accounts to
his bank’s website, and thereafter perform various banking functions.
6. Round the clock banking: The modern banking system facilitates performing of
basic banking transactions by customers round the clock globally. World-wide 24
hours and 7 days a week banking services are made possible.

MODERN SERVICES PROVIDED BY BANKER:

 Centralized Banking Solution (CBS) : CBS, an inter-branch networking and data-
sharing platform helps the customers to operate their account from any city in India
having CBS networked branches, changing the status of customer from ‘Customer of
the Branch’ to ‘Customer of the Bank’.
 Online Tax Payment: Banks provide the facility of online payment of service tax,
excise duty, Custom duty and all charges under MCA 21 through internet banking.
 Corporate Internet Banking: Online funds transfer, trade finance management, fund
management, global access with unmatched benefits through banks corporate internet
banking.
 Online Shopping: This service facilitates the customers to book hotels, buy gifts,
send flowers, and buy books and lot of activities by making payments online.
 Retail internet banking: Internet banking assists the customers to have an online
access to bank account anytime and anywhere.
 Foreign Exchange: Banks have several branches authorized for handling foreign
exchange business and these branches.
 E-Money India: Internet banking helps the customer in sending money to their loved
ones in India through PNB’s e-Money India service.
 Online Railway Reservation: Say goodbye to long queues. Banks offer the
customers online booking and information through IRCTC payment gateway. Just
click and travel comfortably.
 Depository Service: Banks Depository service provides the facility of having shares
and securities in D-mat form and executes transactions of sales and purchase hassle
free electronically to the customers through internet banking.
 Electronic Clearing Service and Electronic Funds Transfer (EFT): Internet
banking assists the customers in electronic clearing service for quick movement of
funds in a paperless mode and EFT to ensure an expeditious transfer of funds by using
electronic media.
 Online Bill Payment: No more queues to pay customer’s bills. Now the customers
can pay their telephone, mobile, electricity, insurance and several other bills 24 hours,
365 days, from the desktop of customer.
 Online Air Ticket Booking: Banks provide facility of online airline ticket booking of
domestic as well as international airlines to their customers through internet banking.
 Online Trading: Banks provide online trading facilities to customers having account
with bank and trading account with approved brokers.
 Customer Care Facility: Banks present 24 hours customer care facility for
all customers’ queries and problems.
 Online Insta Remit-RTGS Service: Instant remittance by customer himself now
made possible, from one bank to another bank at different centres on the same day
with the help of Online Real Time Gross Settlement (RTGS)/ National Electronic
Fund Transfer (NEFT) at modest charges.
ROLE OF COMMERCIAL BANKS IN ECONOMIC DEVELOPMENT.
1. Helpful in Mobilization of saving: Banks convert savings into capital formation by
extending credit facilities to the investors and entrepreneurs. These savings must be
mobilized and put into productive investments to create real wealth. The most
important role in mobilization of the savings of the society is played by the
commercial banks.
2. Assist in Innovations: Innovations are the off-shoots of research and development.
Commercial banks facilitate in innovation of new and advanced technology across
different sectors of the economy by offering judicious financial help.
3. Role in implementation of Monetary Policy: The monetary policy must be
implemented effectively and efficiently to manage the crucial factors of sound health
of economy. It would not be possible to carry out effective implementation of any
monetary policy in the country without the active co-operation of commercial banks.
4. Banks influence the Interest Rates: Banks influence the rate of interest and structure
of interest rates by means of credit creation. Banks influence the volume and pattern
of investment which is very important in the context of growth and development in
less developed countries like India.
5. Helpful in the Development of Priority Sectors: Commercial banks are often
engaged in advancing loans on priority basis to farmers, small scale industrialists and
artisan with a view to improving the rate of production, attaining self-sufficiency in
food grain production and achieving equitable distribution of income and property.
6. Directing funds into Desired Channels: Banks ensure balanced growth of the
economy by directing the funds into productive channels. The balanced growth of the
country is only achieved through proper distribution of money with the help of
commercial bank.
7. Helpful in Productive activities and export: Productive activities both in
agricultural sector and industrial sector can be sustained and stimulated only when
financial needs of these sectors are fulfilled by commercial banks at reasonably low
rate of interest. Commercial banks also provide easy finance facilities to the exporters.
8. Implementation of the policies of the Government: The commercial banks also
play an important role in the proper implementations of economic policies of the
government relating to the development of various sectors of the economy.

CREDIT CREATION OF COMMERCIAL BANKS

Credit creation refers to the power of commercial banks to expand secondary deposits either
through the process of making loans or through investment in securities.

Difference between Primary Deposits and Secondary Deposits

The basis of credit creation is bank deposits. Prof. Halm has classified these bank deposits in
two types, i.e.
1. Primary deposits: Primary Deposit is also known as cash deposit. A deposit which is
created by depositing cash or coins is called a primary deposit. The creation of
primary deposits is not creation of money, but it provides the basis for creation of
money or credit.
2. Derivative or Secondary deposits: A derivative deposit is the result of primary
deposit because the bank creates derivative deposit by keeping a part of the primary
deposit in reserve. The creation of derivative deposit is credit creation. That is why it
is said, “Loans create deposits and deposits create loans”.
Techniques of credit creation.
Let us assume bank is required by law to keep 20% reserve against the deposit liabilities.
On a day, the Balance Sheet of State Bank of India appears as follows:
STATE BANK OF INDIA
BALANCE SHEET
Liabilities Rs. Assets Rs.
Deposits 5,000 Cash 5,000
Total 5,000 Total 5,000

Next day, one Mr. Y deposits Rs. 5,000 with the bank. The balance sheet of the bank after the
new deposit of Rs. 5,000 is made would be as follows:

STATE BANK OF INDIA

BALANCE SHEET
Liabilities Rs. Assets Rs.
Deposits 10,000 Cash 10,000
Total 10,000 Total 10,000

The deposit of Rs. 10,000 is a liability to the bank and it has an obligation to repay whenever
demanded. This is also an asset because the bank can lend or invest to earn income, but after
keeping 20% reserve against the deposit liabilities.
Another day, Mr. Z comes with an application for a loan of Rs. 8,000 to buy a printing
machine. The loan is sanctioned. Now, the Balance Sheet would appear as follows:

STATE BANK OF INDIA

BALANCE SHEET
Liabilities Rs. Assets Rs.
Deposits 10,000 Cash 2,000
Loan 8,000
Total 10,000 Total 10,000

Mr. Z has the right to withdraw up to Rs. 8,000. Let us extend our chain of transactions.
Supposing Mr. Z issues a cheque for Rs. 8,000 to Rajan and Company towards buying a
machine. M/s Rajan and Company deposits the cheque with its bank, Indian Bank. The
Indian Bank will collect the amount from the State Bank. After the cheque is collected, the
Balance Sheet of the bank would stand as follows:
INDIAN BANK
BALANCE
SHEET
Liabilities Rs. Assets Rs.
Deposits 8,000 Cash 8,000
Total 8,000 Total 8,000
Indian Bank has an excess of Rs. 6,400 after keeping 20% cash reserve, which it can lend or
invest. Let us further assume that the bank buys securities worth Rs. 6,400 from Mr. J. After
this transaction, the Balance Sheet of the bank would be:

INDIAN BANK
BALANCE
SHEET
Liabilities Rs. Assets Rs.
Deposits 8,000 Cash 1,600
Investment 6,400
Total 8,000 Total 8,000

The bank may give a cheque for Rs. 6400 to Mr. J which may be deposited in his bank or the
account of Mr. J will be credited with Rs. 6,400 which he may draw at any time.
In the above illustration, the initial cash of Rs. 10,000 has created a loan of Rs. 8,000 which
has become a deposit in another bank. The new deposit has generated another deposit of Rs.
6,400 and this process would continue till the original deposit is exhausted completely.
The final sum would be arrived at as follows:
Rs. 10,000 + Rs. 8,000 + Rs. 6,400 + Rs. 5120 + Rs. 4,096 + Rs. 3,276.8 + = Rs. 50,000.
Thus, Rs. 10,000 cash are able to create a new deposit of Rs. 50,000. In this way, the deposit
becomes loan or investment and in turn becomes a new deposit and it goes on. This is the
process of multiple creation of credit by commercial banks.

LIMITATIONS OF CREDIT CREATION.

 Amount of cash: The capacity of bank to create Credit mainly depends upon the
availability of cash or on the primary deposits of the bank. The volume of primary
deposits itself is restricted by several factors.
 Banking Habits: If people of a country transact most of their business by cheques,
they require very little cash for the purpose. As a result, cash balances with the banks
will increase as also their capacity to create credit.
 Cash Reserve Ratio: Credit creation has an inverse relationship with the Cash
Reserve Ratio, the lesser will be credit creation potential of the banks. An increase in
the cash reserves requirements will decrease the credit creation capacity.
 Policy of Other Banks: The credit creation ability of a bank greatly depends upon the
credit policy of other banks. If all banks function in unison they will have more power
to create credit. If one bank expands credit and other bank do not co-operate with him,
then there will be little credit creation.
 Availability of good borrowers: The credit creation abilities of the bank also depend
on the availability of credit worthy borrowers. If such borrowers are available in good
number, there will be large creation of credit. If good borrowers are not available, the
banks will be reluctant to advance loans and so there will be little credit creation.
 Market situation: During the period of depression there is little demand for loans on
the part of traders and industrialists. As such very little credit is created by the banks.
Whereas during boom period banks create large credit.
 CONCEPT OF “INVESTMENT POLICY OF COMMERCIAL BANKS”
Introduction
According to Section 29 of the Banking Regulation Act 1949, the banks investments in
securities are shown under the following six categories:
 Government Securities
 Other Approved Securities
 Shares
 Debentures and Bonds
 Subsidiaries and/ or Joint Ventures
 Others (e.g. mutual funds & certificate of deposits)
Investment Decision Making Process
 Determination of funds available for investment (Surplus funds available or funds
to be arranged/ mobilized for attractive investments)
 Listing of alternative investment opportunities
 Evaluation of various alternatives
 Ranking of investment opportunities
 Financing investment decisions
 Reporting to Board of Directors about actions taken

TYPES OF INVESTMENTS MADE BY BANKS

 Short- term investments: Banks make short-term investments in the various
instruments in money market. Money market is essentially an over-the-phone market,
where the deals are put through on phones/telexes with or without the involvement of
brokers. The other characteristics of money market are: short-term duration,
deregulated interest rates, safety and large volume.
 Investments in Treasuries and Other Securities: Government Bonds are also
known as ‘Treasuries’. Banks over the last years have invested very heavily in
government treasuries. The biggest investors in the past were nationalised banks
followed by State Bank group.
 Investment in Fixed and Other Assets: Banks have been traditionally financing
projects of various sectors. Banks give loans and advances to various sectors. Banks
have started financing infra-structure projects.
 Investment in Foreign Exchange: The foreign exchange market has become
deregulated and more efficient. The major participants in the foreign exchange market
are commercial banks, foreign exchange brokers in the interbank market, commercial
customer’s especially multinational corporations and central banks.

PROFITABILITY OF BANKS
List out the Causes for Low Productivity.
 Undue branch expansion without consideration for costs and returns.
 Mounting over dues and rising bad debts.
 Resorting to mass banking with social obligations.
 Granting loans at concessional rates, e.g., under DRI scheme; loans are granted at 4%
interest.
 High servicing cost of widespread small loans.
 Indiscriminate lending to sick industries.
 Merger of smaller banks with big ones.
 Lower capital asset ratio than the international standard.
 Deregulation of interest rates, call money rates, etc.
 Keen competition from private as well as foreign banks.
 Rising wage bills and declining productivity of bank employees.
 Mounting frauds and high cost of operation.
RECENT DEVELOPMENTS MADE BY COMMERCIAL BANKS TO IMPROVE
PROFITABILITY

 Managing their asset portfolio in a more profitable way with a mix of

new instruments.
 Diversify their activities from fund-based to fee-based transactions.
 Encouraging upon mutual funds, factoring and forfeiting services.
 Adopting asset-liability management and risk management techniques to a greater
extent.
 Rationalizing the interest rate structure completely.
 Making adequate provisions for loans and advances as per the statutory provisioning
requirements.
 Supporting weak public sector banks through budgetary support.
 Strengthening the capital base through public issue of shares.
 Enforcing prudential norms for income recognition, asset classification as
per international standards.
 Adopting the new technology to render e-banking services through off-site delivery
channels like ATM counters.

REGULATION AND CONTROL OF COMMERCIAL BANKS BY RBI

Central Bank: A central bank is one which issues the currency of the country, facilitates,
permits and regulates the creation of secondary money (derivate deposits), which acts as the
banker of the Government, and as the bankers bank and which is the under of the last resort
to the banks.
Functions of Central Bank.
1. Bank of Notes Issue: In modern time, Central bank enjoys monopoly over printing or
issuing of currency notes. The central bank in every country has the exclusive
privilege of note issue. No commercial bank can issue its own currency notes.
2. Banker, Agent and Advisor to the Government: Central Bank receives and makes
all payments on behalf of the Government. It accepts the deposits from Central or
State Government or governments, makes collections and payment on their behalf,
make short term and long-term loans to government.
3. As an agent to government, the Central bank manages national debts and issue of
securities and loans on behalf of the government.
4. It gives advice to the government on important matters of economic policy like deficit
financing in a planning programme, devaluation of the currency, foreign exchange
policy, trade policy, etc.
5. Cash Reserve Ratio Management: The Central bank keeps the cash reserves of the
commercial banks with it and acts as the custodian of these cash reserve. The Central
bank fixes a rate of cash reserve ratio (CRR) which means that percentage of the term
deposits, savings deposits and current deposits is to be kept with the Central Bank.
6. Custodian of Foreign Exchange Reserve of Nation: Central bank acts as the
custodian of foreign exchange reserves of the nation. All the foreign exchange that
comes in the country is required to be kept with the Central Bank. As the custodian of
foreign exchange reserves, the Central bank tries to manage it judiciously to
overcome the problems of balance of payments.
7. Lender of the Last Resort: It means that if a commercial bank fails to get financial
help from anywhere, it approaches the central bank as a last resort. Central bank
advances loan to such a bank against approved securities.
 8. Clearing house function: All banks have their account with the Central bank; the
claims of banks against another are settled by simple transfers from one bank to
another through mere bookkeeping entries. As the claims are settled through transfer
entries, actual currency and coins are not used. The clearing function has become a
necessary service to be rendered by the central bank.
9. Controller of credit: More expansion of credit money than necessary leads to the
situation of inflation. On the other hand, greater contraction of credit money may
create a situation of deflation. With central bank keeping credit under proper control,
stability in general price-level and increase in output and employment can be achieved
in the country.
10. Collection of data: Central bank collects a variety of statistical data and publishes the
same periodically. Data and information relating to banking, currency and foreign
exchange position of the country reflect the rate of economic progress. It also plays an
important role in the formulation of planning and decision-making activities for the
proper functioning of banking system of the country.
11. Agricultural credit: Central Banks of many countries, like RBI in India, also provide
credit facilities for the development of agricultural sector of the country.
12. Maintaining International Relations: Central Bank represents their countries in
International conferences like IMF, World Bank. In the interest of international
liquidity and economic growth of the country it becomes essential for central bank to
maintain relations with these institutions and international development agencies.

VARIOUS SOURCES OF FUNDS FOR COMMERCIAL BANKS.

Commercial bank uses various categories of sources to raise the funds. The major source of
commercial bank funds is summarized as follows:
1. Capital
2. Deposit
3. Borrowings
1. CAPITAL: The bank capital represents the net worth of the bank or its value to
investors. A bank’s capital can be thought of as the margin to which creditors are
covered if a bank liquidates its assets.
2. DEPOSITS: Deposits from public are the most powerful source of fund to a bank.
These deposits are key to a bank’s potential growth. These funds are liabilities of the
bank, because these must be returned to the owners on demand. Therefore, keeping
the needs and interests of various sections of society, banks formulate various deposit
schemes.
Generally, there are four types of deposits which are as follows:
 Current Deposits: The depositors of such deposits can withdraw and deposit money
whenever they desire. Since banks must keep the deposited amount of such accounts
in cash always, they carry either no interest or very low rate of interest. Such deposit
accounts are highly useful for traders and big business firms because they have to
make payments and accept payments many times in a day.
 Fixed Deposits: These are the deposits which are deposited for a definite period of
time. These deposits generally carry a higher rate of interest because banks can use
these deposits for a definite time without having the fear of being withdrawn.
 Saving Deposits: In such deposits, money up to a certain limit can be deposited and
withdrawn once or twice in a week. On such deposits, the rate of interest is very
less. These deposits are generally done by salaries people and the people who have
fixed and less income.
 Recurring Deposits: Under this account a specified amount is deposited
every month for a specified period e.g. for 12, 24, 36 or 60 months. The
amount cannot be withdrawn before the expiry of the given period except
under exceptional circumstances (in the event of any direction from any
statutory &/or regulatory authority or deceased claim settlement cases).

3. BORROWINGS: Borrowings from Central Bank and other banks or

institutions are also source of raising funds of commercial bank. But, by
nature those are emergency sources and are restored only when the bank is
unable to meet the commitments of its own.
Therefore, the sources of borrowings are –

i. Central Bank: The Central Bank will provide liquidity to the banks and
other institutions when sources dry up. They may grant accommodation to
scheduled banks by way of –
 Rediscounting or purchase of eligible bills.
 Loans and advances against certain securities.
ii. Borrowing from interbank: The interbank lending market is a market in
which banks extend loans to one another for a specified term. Most
interbank loans are for maturities of one week or less, the majority being
overnight. Such loans are made at the interbank rate (also called the
overnight rate if the term of the loan is overnight).
iii. Borrowing from international financial institution: These are
provided by the international institutions like,
 International Monetary Fund (IMF)
 World Bank and its affiliated bodies,
 ADB (Asian Development Bank),
 IDB (Islamic Development Bank) and
 Other foreign agencies/development partners.
 UNIT-2
Banker and Customer Relationship

BANKER
Banker includes a body of persons whether incorporated or not who carry on the business of
banking. In other words, “A banker is one who in the ordinary course of his business honours
cheques drawn upon him by persons from and for whom he receives money on current
accounts.”

CUSTOMER
A customer is one who has an account with a banker or for whom a banker habitually
undertakes to act as such. The word customer signifies a relationship in which duration is not
of essence. A person whose money has been accepted by the bank on the footing that the
bank undertakes to honour cheques up to the amount standing to his credit, is a customer of
the bank irrespective of whether his connection is of long or short standing.

THE BANKER AND CUSTOMER RELATIONSHIP.

GENERAL RELATIONSHIP
 Banker as a Bailee: The customer can keep his valuables or any secret documents in
the bank for safe custody. When the banker accepts the same, he will be accepting it
as a ‘Bailee’. As a bailee, he should protect the valuables in his custody with
reasonable care. If the customer suffers any loss due to the negligence of the banker in
protecting the valuables, the banker is liable to pay such loss.
 Banker as a Trustee: When the banker accepts securities and other valuables for safe
custody, he acts as a trustee for his customer. Banker as a trustee retains money or
other assets and performs for the benefit of his customer called beneficiary. Customer
continues to be the owner of his assets deposited with banker. As a trustee, it is the
duty of banker to take care of the lockers and their contents.
 Banker as an Agent: Banker also acts as an agent of his customer. It performs a
number of agency functions like buying and selling of securities on behalf of the
customers, collection of cheque and makes payment of various dues on behalf of his
customer. Hence, a banker performs as agent of his customer who becomes principal
while rendering an agency function.
 Debtor and Creditor relationship: When a person deposits some money to open an
account, the banker assumes the position of a debtor and customer becomes a creditor.
But on the other hand, when a customer avails the facility of overdraft, banker takes
the position of a creditor and customer becomes his debtor.

SPECIAL RELATIONSHIP/ SPECIAL FEATURES OF BANKER-CUSTOMER

RELATIONSHIP

i. Bank’s Right of General Lien : ‘Lien’ is a term used to identify the right to retain a
property belonging to a debtor till such time he discharges the debt due to the retainer
of the property. Lien is simply a right to possess a property. Lien will be lost when the
possession of the property is lost. The lien may be a Particular lien or General lien.
 Particular lien – This lien refers to a particular property which is retained by the
lender or creditor against the specific or particular loan. The particular property will
be retained until the particular debt is cleared by the debtor. Ex. A transport operator
can retain the property sent for transhipment till such time the customer pays his
transport charges.
 General lien – General lien is a right of the banker (creditor) to retain all the
properties of debtors (customers) till the entire sum due to the bank are recovered. In
the absence of any agreement to the contrary, banker may retain any goods and
securities bailed to him as a security for general balance of accounts. The Indian
Contract Act (u/s 171) provides this right, and this right is called ‘General Lien’.

ii. Right to charge Interest, Commission, Incidental Charges, Commitment Charges

Interest – Bank enters into an express agreement to charge interest on outstanding
balances. It is the normal practice of every bank to calculate interest at every quarter
or half-year and debit the same to the loan account. The customer is expected to pay
this interest as and when it is due.
 Commission – The banker has an implied right to charge commission for the services
provided to the customers.
 Incidental Charges – Incidental charge is a levy imposed by the bank on
unremunerative current accounts. Normally, it is not charged on the current accounts
whose balances can be profitably employed by the bank. These charges need not be
paid in cash but will be debited to the customer’s current account.
 Commitment charges - It is a charge made by the banker on overdrafts and cash
credit accounts. The commitment charge is charged on the unused part of the
sanctioned limit which does not earn any profit to the bank besides charging interest
on the used part of overdraft.

iii. Right to set-off or right to combine bank accounts: Right to set-off is a right to
adjust the accounts of one against the other between the debtor and creditor to
determine the net balance due to either debtor or creditor. Supposing X must pay Rs.
10,000 and Y must pay X Rs. 4,000. After adjusting Rs. 4,000 to X’s account, as Y
must pay a net balance of Rs. 6,000.
If a customer holds two accounts in the same capacity, the account can be adjusted
one against the other or the accounts can be combined as per the right to set-off. The
right to set off facilitates the banker to know the net amount due to him from the
customer and ensures the safety of funds.

iv. Right to appropriate payments: The need of appropriation arises in case a customer
raises more than one loan account. The payment made by the customer may not be
enough to clear all debts due to the customer. Similarly, when a customer holds more
than one current account and regularly operates these accounts by depositing funds
and making withdrawals simultaneously in all the accounts he holds, it creates a
problem for the bank to appropriate which fund to which account. In such
circumstances, he must follow the rules governing the appropriation.
The general rule is that the debtor (customer) has the first choice and he can
appropriate the funds according to his desire. If the debtor does not take any decision
regarding appropriation at the time of payment, then the creditor (bank) has the
choice. The right of appropriation is made should be informed to the customer.
 v. Right to produce books of accounts: The banker need not produce the original
books of Accounts as evidence in the cases in which the banker is not a party. He can
issue only an attested copy of the required portion of the account which can be
utilized as evidence before the court. When the court is not satisfied with the certified
copy, the court can summon the original books. But when a banker is a party to the
suit, the court can force the banker to produce the original records in support of his
claim.

vi. Right under Garnishee order: A garnishee order is an order issued by a court
addressed to banker instructing to stop or withhold payment of money belonging to a
specified person who has an account with the banker and who has committed a default
in satisfying the claim of his creditors. The creditor on whose request the order is
issued is called judgement creditor and the person to whom it is issued is known as
the garnishee.

OBLIGATIONS FOR A BANKER

 To honour customer’s cheques.
 To maintain secrecy of customer’s account.
 Give reasonable notice before closing the customer’s account.

PROCEDURE TO OPEN AN ACCOUNT WITH THE BANKER.

i. Application form: The person wants to open a current account or a saving bank
account must apply to the bank concerned on the prescribed form. Printed application
forms are available in the bank free of cost. The application form contains various
information relating to the name of the applicant, his occupation, full address, and
specimen signatures. Banks provide different application forms for opening a savings
or current account.
ii. Introduction: The bank may also ask for references and introduction who would be
consulted about the integrity, honesty, financial standing and responsibility of an
applicant. The bank insists on such person or business enterprise being introduced to
the bank by an existing customer of the bank or a reputed businessman. Introduction
and references reduce the scope for fraud and risk. Though any person may apply for
opening an account in his name but the bank reserve the right to do so on being
satisfied about the identity of the customer.
iii. Specimen signature: When the bank is satisfied with the introductory references it
proceeds with the opening of the account. The applicant is asked to give his two or
three specimen signatures on a prescribed form, generally card, for the purpose bank’s
record. These specimen signature cards are preserved by the bank and are
alphabetically filed for ready reference to verify the signatures whenever the need
arises. The specimen signatures are compared with the signatures on the cheques of
the customer. If the two signatures differ, the bank can refuse to honour the cheque.
iv. Photographs: Banks require four copies of photographs of the account holders. These
photographs are required for all types of account opening. If a customer has a savings
account or current with a bank’s branch, he may open fixed deposit account without
photographs. When a customer comes to a branch he can be easily identified. The
identity of the customer is very clearly established with the help of photographs.
v. Initial deposit: After the above formalities are fulfilled, the applicant deposits the
initial amount and the banker opens an account in the name of the applicant. The
minimum amount to be deposited initially differs from bank to bank.
OPERATION OF BANK ACCOUNTS.
When the banker opens the account in the name of the applicant, it provides him with –
 Pay-in-slip books: A pay-in-slip book contains several printed slips. This slip is to be
filled in by the depositor or by his agent at the time of depositing cash or cheque etc.
The pay-in-slip contains information relating to the date of deposit, the name of the
depositor, the amount to be deposited, the name and account number to be credited,
and the details of currency notes in case of cash, cheque number and name of the
drawee in case of cheques. After filling the pay-in-slip, the depositor hands over the
same to the counter along with cash or cheques to be deposited.
 Cheque book: A cheque book contains blank forms of cheque. Cheques are used to
withdraw money from bank. The blank forms of cheques and their counter foils are
serially numbered. When a customer wants to withdraw money or to make payments
to others, he must fill in the cheque and sign it.
 Passbook: This is a book issued by the bank to the customer in which all transactions
between them are recorded. The main aim of issuing a passbook to the customer is to
acquaint him periodically with the state of affairs of his account with the bank.

ADVANTAGES OF HAVING A BANK ACCOUNT

Following are the advantages of opening an account with bank –
i. Safety of money: The money with the bank remains in safe custody. There is always
a risk in keeping cash with one’s own self. It may be lost or stolen.
ii. Cultivate habit of savings: Banks cultivate the habit of savings in the public. Savings
in the bank on the one hand are safe and on the other earn interest for its depositors
who are prompted to save and deposit some money in their bank accounts.
iii. Avail loans facilities: Banks allow loans and overdraft facilities to their customers.
This provides financial help to the customers.
iv. Collection of cheques: The bank collects on behalf of the customers the amount of
cheques, drafts, bill of exchange etc. deposited in the bank.
v. Facility in making payments: It is always easy to make payment through bank
accounts. Payments are greatly facilitated by means of cheques. The cheques serve
as proof of payment in case of disputes.
vi. Safe custody of valuable articles: Valuable articles, deeds, securities etc. can also be
deposited in the bank for safe custody. Safe vaults are provided by banks for storing
these valuables.
vii. Providing credit information: Banks provide information relating to the credit
worthiness of the customer. Banks also issue letter of credit for their customers which
are very useful in foreign trade.

THE SPECIAL TYPES OF BANKER’S CUSTOMER.

Minor: A minor is a person who has not completed 18 years of age. If a guardian is
appointed by a court before a person completes 18 years, he remains minor till he completes
his 21 years. According to the Indian Contract Act, 1872 – “A minor is not capable of
entering into a valid contract and a contract entered into by a minor is void”.

BANKER’S DUTY:
i. He can allow a minor to open a Savings Bank account provided the minor is 10 years
of age or above and can sign uniformly. In the case of a current account, he must see
that the account always shows a credit balance.
ii. It is advisable to open the account in the name of a guardian, who is an adult or a joint
account in the name of the minor and the guardian. In that case, the banker can make
the guardian liable for all the transactions of the minor.
The guardian may be,
  Testamentary guardian - A father, may, by a will appoint a guardian for his minor
child and such a guardian is called a testamentary guardian. He can act only after the
death of the father/mother.
 Legal guardian - A person appointed by the Court of Law
 Natural guardian - Father or Mother of the Minor
iii. In case a banker is compelled to grant a loan to a minor, he must see that, a) it is
granted either for the necessaries of his life against sufficient securities, or b) against
a joint promissory note in which one of the parties is an adult. (That joint promissory
note is enforceable against the adult), or c) against an indemnity bond given by an
adult.
iv. If the minor dies, the amount of his credit is to be paid to his next of kin on the
production of a letter of administration.

Married Woman: A banker may open an account in the name of a married woman. Like any
other customer, she has the power to operate her account herself and the bona fide dealing
with the account cannot be questioned.

BANKER’S DUTY:
i. A banker can very well open an account in the name of a married woman. A banker
is safe if her account shows a credit balance.
ii. But, in case she applies for an OD, the banker should see that she owns
separate property in her own name.
iii. In addition to this, he must see that her husband is also made liable for the repayment
of the loan for which he should obtain his consent.
iv. In the case of illiterate women, their left-hand thumb impression should be obtained
on the account opening form.

Lunatic: A lunatic is a person of unsound mind. He cannot form a rational judgement on

matters. Hence, he has no capacity to enter into a contract. According to Section 12 of the
Indian Contract Act, 1872, persons of unsound mind are disqualified from entering into a
valid contract.

BANKER’S DUTY
i. Since a lunatic has no capacity to enter a contract, no banker will knowingly open an
account in a lunatic’s name.
ii. But it may so happen that, an existing customer may become insane. Under such
circumstances, a banker must immediately stop the operation of the account. It is
so because the banker has no right to debit his account for payment made out of his
account. From the moment the banker knows the fact about the lunacy of his
customer, the contract between him and the lunatic becomes void.
iii. A banker must not be carried away by hearsay information’s or rumours. He must get
a definite proof for the lunacy of his customer. When a banker is informed that a
customer has been detained in a lunatic asylum, he can presume that the customer is
insane. In doubtful cases, it is advisable to wait till he gets a written proof. If a
customer is judicially declared as insane, it is an official proof.
iv. So long as a banker has no knowledge of his customer’s insanity, he can go on
honouring his cheques and the operation of the account cannot be questioned. If a
banker dishonours a cheque in a hurry, without having any proof of the lunacy, he
will be liable for wrongful dishonour of the cheque.
 v. Usually, the court appoints a receiver when a customer becomes insane. The banker
can safely deal with that receiver and can honour the cheques drawn by him. It is the
usual practice to pay the balance to the guardian/receiver appointed by the
competent court.
vi. If the alleged insane customer is declared to be sane by a competent authority, the
banker can allow him to operate his account and the temporary suspension of the
account should be removed.

Partnership Firm: A partnership firm is an association of two or more persons called

partners who undertake a venture for a mutual benefit. According to Sec. 4 of the Indian
Partnership Act, 1932, a partnership is the “relationship between the persons who have
agreed to share the profits of a business carried on by all or any one of them acting for all of
them”.
BANKER’S DUTY

i. Opening of an account: Generally speaking, a banker will open an account for a

partnership firm only when an application in writing is submitted by any two or more
partners. A single partner has no power to open an account in his own name on behalf
of a partnership firm. If he does so, then, it will be a private account and so it will not
bind the other partners. Therefore, it is advisable to open the account only in the name
of the firm.
ii. Consent of all partners: To be on the safe side, a banker should get a written
request from all the partners jointly for opening an account.
iii. Partnership deed: Further, the banker should go through the Partnership Deed and
carefully study its objects, capital, borrowing powers etc. The banker should enquire
about the details of the organization, description of the business, the names and
addresses of all the partners and their powers. The banker should get a copy of the
duly stamped Partnership Deed. He should further see whether it is a registered firm
or not.
iv. Mandate: In the absence of a mandate, the partnership account cannot be operated
effectively and easily. So, the banker should ask for a mandate duly signed by all the
partners. The mandate must contain information’s regarding –
a. The name of the person who is authorized to operate the account – In the interest of
the firm and for the safety of the partnership funds, it is advisable that the account is
operated by more than one partner.
b. The extent of authority given to such persons – A banker should know whether the
authority given includes the powers to draw, endorse and accept bills, mortgage and
sell properties of the firm, overdraw the partnership account and so on. The nature and
extent of authority delegated to the authorized person must be put down in writing in
clear-cut terms.

Personal account and a firm’s account: Usually, a banker has the personal account of a
partner side by side with the partnership account. These two accounts are different in nature.
Hence, the banker should note the following:
a. He should not mix one account with another and the right of set-off and lien will not
be available against each other.
b. A cheque payable to the firm must not be accepted for collection to the private
account of the partner without proper enquiry and the consent of all other
partners.
c. But, if a cheque is drawn against the partnership account and is payable to the
personal account of a partner, then the banker should honour the cheque. As he acts in
the capacity of a paying banker, the question of wrongful dishonour will arise if, he
fails to honour such a cheque.
 d. With the consent of the partner concerned, the banker can have no objection in
transferring the funds from the private account of a partner to the partnership account
but in any case, the reverse is not permitted.

Creation of mortgage: According to Section 19 of the Partnership Act, no partner has an

implied power to sell or mortgage the property of his firm.

The retirement of a partner: When a partner retires from business, notice of retirement
should be given to the banker. If no notice is served, he will continue to be liable even for
advances made after his retirement.

The death of a partner: The death of a partner may or may not dissolve the partnership firm.
If it does not dissolve the firm, and if the account shows a credit balance, the banker can have
no objection to allow the other partners to continue the operation of the account. But, he must
have obtained a fresh mandate from the remaining partners. A cheque drawn in the name of a
deceased partner can be honoured after getting the confirmation of the other partners.

The insolvency/insanity of a partner: The insolvency of a partner may dissolve a firm.

Likewise, the insanity of a partner can be taken as a ground for the court’s intervention to
dissolve it. In such cases, the banker may allow the other partners to continue to operate the
account for the purpose of the dissolution of the firm. The official receiver or the assignee of
the insolvent partner cannot interfere in the day-to-day affairs of the firm and all that they can
do is to demand an account from the solvent partners and the share of the insolvent in the
business.

Joint Stock Company: A joint stock company is an artificial person created by law. It has a
separate existence different from that of the members who constitute it. It has a common seal.
It can sue others and can be sued. From birth to death, it is governed by law.

BANKER’S DUTY
a. Preliminary step
 Before opening an account, the banker should find out whether the company has a
legal existence or not. It can be ascertained by referring to the Certificate of
Incorporation which is a proof for the birth of the company.
 Then, the banker should obtain the latest copies of the Memorandum of Association
and Articles of Association.
 In addition to the above, the banker must get a copy of the prospectus of the company.
A public limited company will have to obtain yet another certificate, namely,
Certificate of Commencement of Business. The banker should verify that document
also.
 In case, the company is a new one, the banker should carefully note whether
the names of the first directors have been mentioned in the document or not.
 If the company happens to be an existing one, the banker should demand copies of
recent balance sheet and profit and loss account which will reflect the growth of
the company and its financial soundness. After having satisfied himself with these
precautionary steps, the banker can safely open an account.

b. The board resolution: The first step in connection with the opening of a bank
account is taken by the Board of Directors. They pass a resolution authorizing the
secretary to supply the necessary documents to the proposed banker and open an
account. The banker must get a certified copy of the resolution and scrutinize it. He
must see whether the resolution has been signed by the chairman of the Board of
Directors and countersigned by the secretary.
c. Mandate: Along with the resolution, the banker must call for a mandate from the
company. The mandate must contain the following matters –
 The names of persons who are authorized to operate the account and their specimen
signatures must be specifically given.
 The nature and the extent of the powers delegated to the authorized persons must be
clearly laid down in the mandate. The banker should find out whether the authority
given is extended to bill transactions, advances, securities and safe custodies as well.
 It contains a provision that it will be in force until it is replaced by another
resolution. So, whenever the company wants to introduce any change in the
operation of the account, it must be done by passing a fresh resolution and giving a
fresh mandate to the banker.
 Generally, the mandate provides that whenever there is a change in the Board of
Directors or in the post of the secretary, the banker would be duly informed. If he
is not informed, he cannot be made liable for any consequences arising out of such
changes.
 A banker should not arbitrate in clients disputed regarding the operation of the
account.

d. Borrowing powers: A prudent banker will look into the borrowing powers of a
company before lending money. Every trading company has an implied power to
borrow and mortgage its property. This power is exercised by the Board of
Directors. Generally, the Articles of Association of the company puts a limit on the
borrowing powers of the directors as well as the company.
e. The purpose of loan: If the money borrowed seemingly for the purpose of the
company’s business is misappropriated for a different purpose, unauthorized by the
Memorandum of Association, and if it is unknown to the bank, the bank is not liable
for it. But, if the banker has knowledge of it, he must immediately stop the
operation of the account.
f. Internal procedure: The Articles of Association of a company may impose some
internal procedures to be carried out before obtaining a loan. The banker need not
worry about it, because, a stranger dealing with a company is entitled to assume that
the internal regulations of the company have been duly complied with.
g. Registration of charges: A prudent banker should pay considerable attention to
Section 125 of the Companies Act, 1956 which gives a list of charges to be registered
within 30 days of signing those charges. Therefore, when a banker creates a charge on
the assets of the company, he must register it immediately.
h. Director’s personal account and the company account: If a banker has the
personal account of the authorized director, side by side with the company’s account,
then the banker must handle the personal account very carefully. He should not
combine both the accounts and the right of set off and right of lien will not be
available against each other, since they are in different capacities.
i. Old company: If a company that has applied is an old one, then the banker must ask
for certified copies of the annual accounts and reports of the previous years. These
documents contain the financial position and the progress of the company and thus,
the banker can know it earning capacity.
j. Winding up of the company: Once the winding up procedure commences; the
powers of the directors and all the officers of the company cease. A company may be
wound up voluntarily by the members or the creditors or compulsorily by the court.
In all these cases, the liquidator will have the power to operate the account for the
purpose of winding up of the company. So, any cheque drawn by the directors must
not be honoured. Hence, when the banker has knowledge of the passing of the
resolution authorizing the winding up of the company, he must stop the operation of
the account. Thereafter, he must act according the instructions of the liquidator.
Clubs, Societies and Non-Trading Associations
 Opening of account: Clubs like ‘Sports Club’, ‘Friends Club’, etc. and associations
and societies may approach a banker for the purpose of opening an account. The
banker should first see whether they are registered bodies or not. If they are not
incorporated, it will be difficult to make all the members liable for the banking
transactions. In the case of registered clubs, the banker can open the account in the
name of the club.
 Mandate and resolution: The banker then gets a mandate from the customer along
with an authenticated copy of a resolution appointing the banker as the banker to the
association or club and requesting the banker to open an account. It also contains the
names of the different officials, who are authorized to operate the account, their
powers and their specimen signatures. The resolution ought to have been signed by
the chairman and countersigned by the secretary.
 Rules of the club: If a copy of the rules of a club or the constitution of an association
is available, the banker should get a copy of it and file it for his reference.
 Change in the officials’: Should there be any change in the officials of the club or
society and in particular in the one who is authorized to operate, the banker must be
notified to the change through an authenticated copy of the resolution making the
change. It must contain the specimen signatures of the new officials.
 Borrowings: These associations do not have an implied power to borrow. However,
the rules may permit them to borrow after fulfilling the necessary formalities. For
instance, the rules may provide that the club may borrow after getting the necessary
sanction from the general body. In that case, the banker will demand a certified copy
of the resolution passed in the general body.
 Security: To safeguard his position, the banker should grant loan either against the
guarantee of a financially sound person or against the property of a club. Usually, the
property of clubs will be vested in the names of trustees. Hence, the banker must note
the powers of the trustees to charge the property for the borrowings of the club.
 A club account and a personal account: If the club account and the personal
account of the authorized person exist side by side, the banker should consider the
following –
a. He cannot combine both the accounts.
b. The right of lien and set off will not be available against each other.
c. A cheque payable to the club must not be collected to the private account of the
individuals operating that account.

Executors, Administrators and Trustees: An executor is a person to whom the execution of

a will is entrusted by the testator (maker of the will).

BANKER’S DUTY
 Familiarity with the Terms and Conditions of appointment: First of all, the banker
must go through the probate or the letter of administration or the trust deed as the case
may be. He must be thoroughly conversant with the terms mentioned in the document
appointing the executors or trustees. A careful scrutiny of the documents will reveal
the genuineness of their appointments.
 Joint executors and trustees: In case there are two or more executors or trustees, the
banker should get clear instructions about the nature of the powers delegated to each
of them. If there are no instructions, one executor can deal with the funds of the estate
on behalf of the others. But, in the case of joint trustees, in the absence of any
instructions, all of them should deal with the funds and all must sign the documents,
cheques etc.
  Breach of trust: A banker should be very careful whenever an account of this type is
opened. It is so because, whenever something goes wrong the banker will be held
liable for not protecting the interest of the beneficiaries. If a banker comes to know
that the funds are misapplied, he cannot escape from his liability. A banker will be
justified in dishonouring a cheque drawn by a trustee, if a breach of trust is intended.
 Powers to borrow: Trustees and executors have no implied power to borrow. Hence,
they can borrow only in their personal capacity. However, if they are authorized to
borrow to discharge the debts of a deceased, the banker must get the specific assets of
the deceased, as security. Here again, the banker must note that the creditors of the
deceased will have prior rights over the assets of the deceased. To safeguard his
position, he must get the personal assets of the executor also as security.
 Trust account and personal account of a trustee: If a banker maintains the personal
account of the trustee or executor side by side with the trust account –
i. The banker cannot combine both the accounts.
ii. The right to set off and the right of lien will not be available against each other.
iii. A cheque payable to the trust should not be collected to the private account of the
trustee. If a banker does so, he will lose the statutory protection.
 Specific indication: The banker should specifically indicate in the title of the account,
that, it is a trust account and its purpose so that he can easily recognize it. It also
prevents any breach of trust.
 Delegation of power: The trustees and executors cannot delegate their powers to an
outsider. Executors can delegate their powers to one of themselves. But trustees
cannot do so. All of them should act together. Therefore, any delegation of power to
any third party should not be accepted.
 Executrix: A married woman may be appointed as an executrix. But she cannot bind
her husband for her acts unless; he interferes in her duties in the capacity of an
executrix.

Joint Account
i. Mandate: A joint account is one which is opened by two or more individuals. While
opening a joint account, the banker must get a clear mandate in writing, containing
instructions as to, how the account is to be operated. Generally, a mandate should
contain the following details –
 Drawing of cheques: A banker should get very clear instructions as to whether all of
them or some of them or any one of them can draw on the account. Usually, bankers
put down such conditions in the application form itself which should be signed by all.
There will be clauses like “Either or Survivor” clause, “Former or Survivor” clause
and “All to sign without the right of survivorship” clause, etc.
 Power to overdraw: The mandate must contain clear instructions as to whether the
authorized persons have the right to overdraw the joint account and withdraw the
articles under safe custody. If such an authority has been delegated, the banker must
necessarily establish joint and several liabilities. Then only, he can proceed against all
of them together or any one of them and realize his dues.
ii. Survivorship: The mandate should also deal with the problem of survivorship. As per
ordinary rules, on the death of any one of the joint account holders, the survivor is
entitled to get the entire amount. This right is an implied term of the contract between
the banker and customer. The banker is not answerable to the representative of the
deceased person. As a practice, the name of the deceased person will be struck off the
heading of the account. It is only the survivors who are accountable to the personal
representatives of the deceased party.
iii. Delegation of power: joint account holders can delegate jointly the authority to
operate the account to an outsider also. But that outsider cannot further delegate such
authority.
 iv. Insolvency/ insanity/ death of the joint deposit holders: In the case of bankruptcy or
insanity of one of the joint account holders, the banker should stop the operation of the
account. He should act according to the instructions given to him by the solvent/ sane
person along with the official receiver/ court as the case may be. The rule of survivorship
is not applicable to such cases.
v. Borrowings: In the case of borrowings, all the joint account holders must make a joint
demand, signed by all. No banker will accommodate them in the absence of such a joint
request letter.
vi. Joint account in the name of husband and wife: A joint account can be opened in the
name of a husband and wife. Difficulty always arises if one of them dies.

Joint Hindu Family: The HUF carries out ancestral business and possesses ancestral properties.
The eldest male member is called as a Karta. The right to manage HUF property vests in the
‘Karta’ of the family. All other male members are called coparceners.

Procedure and practice in opening HUF account

The following documents to be obtained for opening accounts of HUF –
a. Declaration from the Karta.
b. Proof of Identification of Karta.
c. Prescribed Joint Hindu Family Letter signed by all the audit coparceners.
d. Banker’s duty
e. The account may be opened in the name of Karta or in the name of family business and
should be duly introduced.
f. The account opening form should be signed by all adult coparceners, even though the
Karta would operate the account.
g. The declaration signed by all the members as to who is the Karta and who are the
other coparceners including minor coparceners should be obtained.
h. If there are minor coparceners, the other adult coparceners should sign for self and as
guardians of minors.
i. Authority should be given to the Karta to operate the account of all concerned under
their joint signature.
j. On attaining majority, the minor coparceners should be asked to join with other
coparceners in signing the existing account opening form in ratification of previous
transactions.
k. Any member of the HUF can stop payment of a cheque drawn by Karta. When the bank
receives a notice about any dispute amongst the family members of the HUF, the
operations in the account should be stopped till further instructions from a competent
court.
l. The burden of proof that loan was taken by Karta for purposes beneficial to the family lies
on the banker. Thus, before granting loans necessary enquiries should be made to ensure it.
Otherwise, the bank may not be able to succeed in a suit for recovery of debt.
 UNIT-3
NEGOTIABLE INSTRUMENTS

INTRODUCTION
The term “negotiable instrument” consists of two words – ‘negotiable’ and ‘instrument’. The
word negotiable means ‘transferable by delivery’, and the word instrument means ‘a written
document by which a right is created in favour of some person’. Thus, the term “negotiable
instrument” literally means “a written document transferable by delivery”.

According to Section 13 (1) of the Negotiable Instruments Act, “A negotiable instrument means
a promissory note, bill of exchange, or cheque payable either to order or to bearer”.

CHARACTERISTICS OR FEATURES OF NEGOTIABLE INSTRUMENTS

 Easily Transferable: The negotiable instruments are easily and freely transferable
from one person to another. The ownership of the property in the instrument may be
passed on by mere delivery. Transferability is an essential feature of negotiable
instruments.
 Title free from Defects: A person who takes a negotiable instrument from another
person, who had stolen it from somebody else, will have absolute and indisputable
title to the instrument provided he receives the same for value and in good faith
without knowing that the transferor was not the true owner of the instrument. Such a
person is called the holder in due course and his interest in the instrument is well
protected by the law.
 Right to Sue: The transferee who is legally called the holder in due course is entitled
to sue upon the instrument in his own name. Thus, he can recover the amount of the
instrument from the party liable to pay thereon.
 No notice to transfer: A negotiable instrument can be transferred any number of
times till the date of its maturity. The holder of the instrument need not give any
notice of transfer to the transferor or any other person liable for payment of the
instrument.
 Presumptions: A negotiable instrument is always subject to certain presumptions
which are applicable unless contrary is proved. For instance, it is presumed that the
instrument has been always obtained for consideration. Likewise, there are other
presumptions regarding date, time of acceptance, time of transfer, order of
endorsements, stamp, and holder to be a holder in due course, etc.
 Credit of the Party: The credit of the party who signs the instrument is pledged to
the instrument. Therefore, such instrument will never be dishonoured normally.

KINDS OF NEGOTIABLE INSTRUMENTS.

1. Promissory Note: A promissory note is an instrument in writing containing an

unconditional undertaking, signed by the maker, to pay a certain sum of money only
to or to the order of a certain person or to the bearer of the instrument.
Specimen of a Promissory Note

Rs. 2000/- Place: Bangalore

Date: March. 1, 2020

On demand, I promise to pay Mr. Mahesh or order the sum of Rupees two thousand
only for value received.

To Witnesses
Mr. Mahesh (1)
(2)

Stamp

Signature

2. Bill of Exchange : A bill of exchange is an instrument in writing containing an

unconditional order, signed by the maker, directing a certain person to pay a certain
sum of money only to or to order of, a certain person of to the bearer of the
instrument”.
Specimen of a bill of exchange

Rs. 2,000 Place: Bangalore

Date: March 1, 2020

Three months after date, pay to Mr. Varathan or order the sum of Rupees Two
Thousand Only, for value received.

To
Mr. Bhargava, Accepted

65, Church Street, Mahesh

Stamp
Mysore.
Signature
FEATURES OF A BILL OF EXCHANGE AND A PROMISSORY NOTE

 Instrument in Writing: A bill or a promissory note must be in writing only. Oral

orders or promise do not make a valid instrument.
 Unconditional order/ promise: The ‘order’ that is stated in the bill and the ‘promise’
that is given in a promissory note must be unconditional. If there is any condition, it
will affect the validity of the instrument. For example, in the following cases, the
instrument loses its characteristic feature of negotiability:
a. Mr. Rajesh IOU Rs. 6,000/-
b. I promise to pay Miss Rekha Rs. 6,000/- provided she marries Mr. X.
However, Sections 4 and 5 lay down that, the order/ promise is not conditional by reason
of the time for repayment of the amount.
 Drawn on a certain person: A bill is always drawn on a certain person, preferably,
by the seller on his customer (creditor). Hence, the drawee must be a certain person.
 A certain sum of money: The ‘order’ or the ‘promise’ must be to pay a certain sum
of money. The amount to be paid must be definite. According to Section 5 of the
Negotiable Instruments Act, the sum payable may be certain, in spite of the fact that,
a. It includes future interest, or
b. It is payable at an indicated rate of exchange, or
c. It is payable according to the course of exchange.
 Payee to be certain: A bill or a promissory note is drawn payable to a certain person
or to his order or to the bearer of the instrument. However, promissory notes/ bills
cannot be made payable to bearer on demand. This high privilege has been given only
to the RBI for issuing bank notes making them payable to bearer on demand.
 Payable on Demand or After a Certain Date: A bill of exchange or a
promissorynote may be payable at sight (demand bill) or after the expiry of a certain
period specified therein (time bill). In the case of time bill, acceptance is essential and
usually three day’s graces are allowed in the case of payment of such a bill.
 Signed by the Drawer/ Maker: A bill or the promissory note must be signed by the
drawer or the maker respectively.
 Delivery Essential: A bill or a promissory note is deemed to be drawn only when the
person who has prepared it delivers it to the other party to whom it is meant. Hence,
delivery is essential to constitute a negotiable instrument.

3. CHEQUE: A cheque is a bill of exchange drawn on a specified banker and not

expressed to be payable otherwise than on demand. All cheques are bills of exchanges
but bills are not cheques.

Features of a Cheque
i. Instrument in writing: A cheque must necessarily be an instrument in writing. Oral
orders do not constitute a cheque. There is no specific rule regarding the writing
materials to be used.
ii. An unconditional order: A cheque is an unconditional order to pay and it is not a
request. If any condition is attached to the order, the instrument can no longer be
called a cheque.
iii. On a specified banker: A cheque is always drawn only on a particular banker.
Usually the name and address of the banker is clearly printed on the cheque leaf itself.
A cheque drawn on a particular branch of a particular bank cannot be encashed at
another branch of the same bank unless there is an agreement between the parties.
iv. Payee must be certain: In order that a cheque must be a valid one, it must be made
payable to the order of a certain specified person or to his agent or the bearer thereof.
v. A certain sum of money: A cheque is usually drawn for a definite sum of money.
Indefiniteness has no place in monetary transactions.
 vi. Payment on demand: A cheque is always payable on demand although the drawer of
a cheque has not specified the time or period of such payment in the cheque.
vii. Signed by the drawer: A cheque should be signed by the drawer or any person duly
authorized by him. In case of an illiterate person, his left hand thumb impression is to
be affixed on the cheque in lieu of his signature.
viii. Date of the cheque: A cheque should be dated as the payment will be made by the
banker on or after such date. A cheque may be post-dated or antedated. In case of
undated cheque, the customer himself may write the current date.
ix. Amount: The amount of the cheque should be clearly mentioned in words and
figures. The banker will return the cheque if there is difference in words and figures.
x. No acceptance required: A cheque does not require acceptance and it needs not be
stamped.

Parties to a Cheque
 Drawer: The person who draws a cheque is called the drawer. The drawer is always
the customer of that bank which has issued the cheque book to him.
 Drawee: The drawee is the person on whom a cheque is drawn. It is none other than
the ‘paying banker’ with whom the customer has an account.
 Payee: The payee is the person to whom the amount of the cheque is payable. In the
case of a cheque drawn in favour of ‘self’, i.e. the customer himself, the drawer and
the payee are one and the same. In case, the payee is not mentioned, it is payable to
the bearer in case the cheque is a bearer cheque.

Types of Cheque
 Open cheque: An open cheque is one which is payable across the counter of the
bank. It needs not be paid through a bank. It can be encashed at the counter of the
bank. An open cheque is of two types,
 Bearer cheque – A bearer cheque is that cheque in which amount is payable to a
person named in the cheque or to the bearer there of who present to the bank.
Example. “Pay to Smt. Sruthi or Bearer”.
 Order cheque – The bank is obliged to make sure that only the right claimant in
whose name the cheque is issued gets the payment. Example. “Pay to Smt. Sruthi or
order”.
 Crossed cheque: A crossed cheque is not payable across the counter of the bank. It
must be collected through a bank. It is paid into the bank account of a person and
cannot be encashed at the counter of the bank.
Crossing of Cheque: The drawing of two transverse parallel lines with or without any words
across the face of the cheque is known as Crossing of Cheques.
Types of Crossing
 General crossing: Where a cheque bears across its face, an addition of the words
‘And Company’ or any abbreviation, thereof, between two parallel transverse lines or
of two parallel transverse lines simply, either with or without the words ‘Not
Negotiable’, that addition shall be deemed to be a crossing, and the cheque shall be
deemed to be crossed generally.
Forms of General Crossing

(1)(2)(3)
 Special crossing: Where a cheque bears across its face, an addition of the name of
banker, with or without the words ‘Not Negotiable’ that addition shall be deemed a
crossing and the cheque shall be deemed to be crossed specially, and to be crossed to
that banker.
Forms of Special Crossing

(1)
 Not Negotiable Crossing: Not Negotiable Crossing is that it makes the cheque non-
transferable. Not Negotiable Crossing does not affect either the paying banker or the
collecting banker. The primary objective of ‘Not Negotiable Crossing’ is to safeguard
the interest of the true owner of the cheque.
Forms of Not Negotiable Crossing

(1)
 Account Payee Crossing: A/c payee crossing is an instruction to the collecting
banker to collect the amount of the cheque for the benefit of the payee’s account only
and give credit of the amount to the account of the payee only and nobody else.
Forms of A/c Payee Crossing

(1)(2)
 Double Crossing: Where a Cheque is crossed specially, the banker to whom it is
crossed, may again cross it specially to another banker, his agent for collection.

(1)
Endorsement: It means “writing of a person’s name on the back of the instrument or on any
paper attached to it for the purpose of negotiation”. The person who signs the instrument for
the purpose of negotiation is called the “endorser”. The person to whom the instrument is
endorsed or transferred is called the “endorsee”.

ESSENTIALS OF A VALID ENDORSEMENT.

(1) On the backside of Instrument: Endorsement is to be made on the backside of the
instrument. If there is no sufficient space left on the backside, then a separate piece of
paper known as along is attached to it for making the endorsement.
(2) Written in Ink: Endorsement should always be made in ink not in pencil or by a
rubber stamp.
(3) Endorsement of entire instrument: Endorsement must be of the entire instrument. A
partial endorsement, i.e. and endorsement which proposes to transfer to the endorsee a
part only of the amount payable, or which proposes to transfer the instrument to two
or more endorsees separately does not operate as a valid endorsement.
(4) Two or more Payees: When a negotiable instrument is payable to two or more
payees or endorsees, they must all endorse unless they are partners, when one of the
endorsees can sign or behalf of all.
(5) No use of Honourable Words: While making an endorsement, the use of the words
showing respect such as honourable, babu, lala, messers, etc. should not be used.
(6) Endorsement by Illiterate Person: If any illiterate person wants to endorse a
negotiable instrument, he can do so by imprinting the impression of his left thumb.
(7) Delivery of Instrument: The endorsement of the instrument is not completed merely
by putting one’s signature upon it. The delivery of the instrument is also equally
important.

KINDS OR TYPES OF ENDORSEMENT.

(1) Blank Endorsement or General Endorsement: The endorser simply puts his
signature on the back of instrument. He does not mention the name of anyone else as
the endorsee. The idea here is to convert it into a bearer instrument. Therefore, it can
be transferred from one person to the other by mere delivery. Anyone can add his
name above the signature.
Example: Sd/-

(Bunty)
(2) Full endorsement or Special endorsement: In this case, the endorser writes the
name of a specific person to whom the title is being transferred. Then, he puts his
signature below that
Example: Pay to Babloo or Order
Sd/-

(Bunty)
As the name of the endorsee is written as Babloo and signed by Bunty, it becomes full endorsement.

(3) Restrictive Endorsement: A restrictive endorsement is an endorsement in which the

endorser restricts the endorsee from further negotiation (i.e. transferability) of the
instrument.
Example: Pay to Vikrant Only
Sd/-
(Virat)
 (4) Sans Recourse Endorsement: Generally when an instrument is endorsed, the
endorser undertakes to compensate the endorsee in case the instrument is
dishonoured. But in the case of a sans recourse endorsement, the endorser
frees himself from such a liability by writing the words “Sans Recourse” or
“without recourse to me” after writing the name of the endorsee.
Example 1: Pay to Sujay, Sans Recourse
Sd/- (Ajay)
Example 2: Pay to Sujay, without recourse to me
Sd/- (Ajay)

(1) Facultative Endorsement: In case of dishonour of a bill, the

holder should give notice of the dishonour to the endorser. If the
notice is not given to the endorser, then he will not be liable to the
holder. But in the case of facultative endorsement, the endorser
waives or surrenders his right of receiving the notice of dishonour. In
case of dishonour, the holder need not give notice to such endorser.
However, he can be held liable.
Example: Pay to Dharoowala, Notice of dishonour waived
Sd/- (Peenewala)

(2) Sans Frais Endorsement: A Sans frais endorsement is an

endorsement in which, by writing the words “Sans Frais” (meaning
“without expense”). The endorser makes his intention clear that he
does not want to incur any expenses on the bill. No one else should
also incur any expense on his account.
Example: Pay to Bemisal, Sans Frais
Sd/-
(Domisal)
(3) Conditional Endorsement or Qualified Endorsement: A
Conditional endorsement is an endorsement in which the endorser
makes his liability on the instrument or the right of the endorsee to
receive the payment of the instrument depend upon the happening of
a specified event.
Example 1: “Pay to Ganesh on the arrival of the ship grandfather at
Mangalore port”.
Sd/-
(Sunder)
Example 2: “Pay to Ganesh or Order on the arrival of S.S.
Nethravathi at New Mangalore Port by 31st April, 2018”.

(4) Partial Endorsement: If only a part of the amount of the

instrument is endorsed, it is a case of partial endorsement.
Example 1: A cheque for Rs. 500 is endorsed by D. David as follows
– “Pay to Chandran Rs. 100 only” – D. David

Example 2: Supposing the same cheque is endorsed as follows –

“Pay to Chandran Rs. 100 only and pay to Rajapandian Rs. 400 only.
 Unit - 4
PAYING AND COLLECTING BANKER
Paying Banker: The banker on whom the cheque is drawn is called the paying banker
or drawee banker. Paying banker is the banker of the drawer of the cheque.

Precautions to be taken by a paying banker while honouring his customer’s cheque

(OR) duties of a paying banker (or) various mandatory functions of the paying banker.

Paying banker should take the following precautions in order to safeguard himself against the
risks –
1. Nature of Cheque: The paying banker must look into the nature of cheque.
 If it’s a bearer cheque, he can pay cash across the counter.
 An order cheque can be paid only after getting the signature of the payee identified.
 A crossed cheque can be credited to the account of the payee, if he has an account with
the paying banker. Otherwise, it should be paid only to another bank where the payee
has the account.
 A specially crossed cheque should be paid only to the banker whose name is included in
the crossing.
2. Branch: The cheque should be drawn on the branch at which the account is kept. If it
is on other branches, he can only send them for collection. Fully computerized and
networked banks issue cheque payable at any branch of the bank. In such a case, it
need not be verified whether it is drawn on the branch.
3. Working hours: The cheque must be presented during banking hours. The banking
hours are fixed by the bank and are notified to the public by a general notice. Banking
hours can differ from bank to bank and from one branch to another in case of the
same bank. Banking hours are fixed depending upon the convenience of the public.
4. Unmutilated Cheques: A mutilated cheque is one that is torn into two or more
pieces. The cheques should not be torn to pieces or damaged. When a cheque
presented for payment is mutilated, the banker verifies whether the mutilation is
accidental or intentional. If the mutilation is accidental, he should insist on the
confirmation of the drawer. If the mutilation is intentional, the paying banker should
refuse payment on such mutilated cheque.
5. Dating of the cheque: Every cheque should be dated. The drawer normally fills up
the date while drawing cheque. If he does not, any subsequent holder can fill up the
date. If a cheque is presented with the date not being written, the banker has to
dishonour the cheque. However, the banker normally informs the holder that the
cheque is not dated. When the holder dates it, the banker can honour the cheque
where the cheques are post-dated, he should dishonour the cheque.
6. Amount of cheque: The amount of the cheque should be written both in figures and
in words. If the amount written in figures is different from amount in words, the
banker has three options –
 Dishonour the cheque on the ground that words and figures differ.
 Pay the amount which is lesser of the two.
 Pay the amount written in words.
According to Negotiable Instruments Act, amount stated in words shall be treated as the
amount ordered to be paid. However, the banker usually dishonours such cheques to avoid
any future complication.
 7. Material alteration: Alteration of an important aspect of a cheque like date, amount,
payee’s name, crossing etc, is material alteration. The paying banker should refuse
payment in respect of a materially altered cheque. If payment is made on a materially
altered cheque, the banker will be liable to the drawer. Every material alteration must
bear the full signature of the drawer below it. If there is an alteration without such a
signature, the cheque should be dishonoured.
8. Balance in the account: The banker should verify whether there is sufficient balance
in the account. If there is no sufficient balance in the account of the drawer to pay the
cheque in full, the banker must return the cheque with the remark “Not Sufficient” or
“Refer to Drawer”. He should not make part payment for a cheque.
9. Signature of the drawer: The banker should see whether the cheque is signed by the
drawer. He should verify whether the drawer’s signature on the cheque tallies with his
specimen signature obtained from him at the time of opening the account. If the
drawer’s signature on the cheque does not tally with his specimen signature, he
should return that cheque unpaid with the remark “Drawer’s Signature differs”.
10. Regularity of Endorsement: Endorsement on the back of the cheque should be
proper and regular.

STATUTORY PROTECTION AVAILABLE TO THE PAYING BANKER.

1. Protection in case of order cheque bearing forged endorsement of the payee: In
the case of order cheques, Sec 85 (1) provides statutory protection to the paying
banker. The protection is available if he makes payment of an order cheque with
forged endorsement on behalf of the payee. This protection is given to the paying
banker only on the fulfilment of two conditions. They are –
 The endorsement of the payee must be regular or correct.
 The payment must be a payment in due course.
 This protection is granted to the paying banker, because it is difficult for him
to verify the signature of the payee, as he does not have the payee’s specimen
signature.

2. Protection in case of order cheque bearing forged endorsement of the endorsee:

In case of order cheque bearing forged endorsement of the endorsee, Section 85 (1)
provides statutory protection to the paying banker. This protection is given to the
paying banker only on the fulfilment of two conditions. They are –
 The endorsement of the endorsee must be regular or correct.
 The payment must be a payment in due course.

This protection is granted to the paying banker, because it is difficult for him to verify
the signature of all the endorsees of a cheque, as he does not have their specimen
signature.

3. Protection in the case of bearer cheques: Section 85 (2) of the Act provides
protection to the paying banker in respect of bearer cheques. Where a cheque is issued
as a bearer cheque, it always retains its character as a bearer cheque. It is not
necessary for the banker to verify the regularity of endorsements on bearer cheques,
even in the case of a full endorsement. The banker is discharged from his liability if
he makes payment of a bearer cheque to the bearer ‘in due course’. Accordingly,
where such a cheque is stolen and if the banker makes payment without the
knowledge of such theft, he will be discharged of his obligation. This way, the
protection is available under this section.
 4. Protection in case of material alteration: Sec 89 gives protection to the paying
banker in case of materially altered cheques. This protection is given regarding
material alteration involving erasing the crossing on the cheque. If the erasing is done
skilfully and the banker cannot find it, he is given statutory protection. However, to
get the protection, the payment must be in due course as defined in Sec 10.
5. Protection in case of crossed cheque: Section 128 gives protection to the paying
baker in case of a crossed cheque, if he makes payment in accordance with the
instruction of the drawer conveyed through the crossing. Accordingly, a banker is
discharged from liability if he makes payment in due course. The protection is
however not available under this section, if the paying banker makes payment of a
crossed cheque with irregular endorsement, or a material alteration, or a forged
signature of the drawer.

DISHONOUR OF CHEQUE: Refusal of the banker to make payment on a cheque and its
return to the holder or collecting banker is called dishonour of cheques. In other words, “A
cheque is said to be dishonoured when it is not paid by the paying banker on presentation”.

Circumstances under which a customer’s cheques can be dishonoured (or) reasons for
dishonour of cheques or grounds of dishonour.

1. Countermanding: Countermanding is an instruction from the customer not to pay the

cheque. The instruction must be clear and it should be in writing. Only the drawer can
countermand the payment. When the customer countermands (i.e. stops) the payment
of any cheque, the banker must refuse to make payment.
2. Receiving notice of death of a drawer: On receipt of a notice of the drawer’s death,
the banker must stop the payment of cheques issued by the drawer. The death of a
person automatically cancels the contractual relation between the banker and the
customer. On receiving the information, he should verify the fact with any of the
close relatives of the deceased and insist on getting a notice from them. Until then, he
is justified in operating the account.
3. Receiving notice of insolvency: When the banker receives a notice of the drawer’s
insolvency, he must dishonour the cheque issued by the customer.
4. Receiving notice of insanity: On receipt of the notice of the drawer’s insanity, the
banker must refuse payment for the cheques issued by the insane drawer. However,
the notice should be authentic and reliable. On mere rumours or mere unsupported
suspicion, he should not stop the operation. He should get documented proof from a
competent authority like a medical practitioner and then he can stop the operation of
the account.
5. Receipt of notice of assignment: The customer can give a notice of assignment to the
banker to transfer the balance to any account or to any person. Once it is done, there is
no balance in the account. Naturally, the banker has to dishonour the cheque drawn on
that account. All the cheques presented for payment after the notice of assignment are
dishonoured by the banker.
6. Prohibitive order from government departments: When a banker receives a
prohibitive order from any government authorities like income-tax authority, sales tax
authority etc, the banker has to stop all debit transactions in the account. He can
receive the credits to the account.
7. Receipt of garnishee order: When a garnishee order is served on the banker by a
court attaching the customer’s funds, the banker is bound to comply with the
garnishee order. So, he must refuse payment for the cheques of the customer
presented after the receipt of garnishee order.
8. Signature difference: When the signature on the cheque is different from the
customer’s signature as in the specimen signature, the banker can dishonour the
cheque.
 9. When a cheque is not signed by the drawer, the banker must not make the payment
for such a cheque.
10. If a cheque bears any material alteration, the banker may refuse payment.
11. If a cheque is presented for payment after the customer’s account is closed, the banker
must refuse payment for a cheque.
12. Other grounds: There are plenty of other grounds for the dishonour of the cheque –
 Where a condition is attached to the payment.
 Where the cheque is a stale one i.e. bearing a date more than six months old. 
A post-dated cheque.
 Cheque is substantially damaged.
 The cheque is drawn on some other branch (where it is not a multi-city cheque). 
Where the cheque is presented after banking hours.
 Where the amount of the cheque written in words and figures differs. 
Where there is lack of sufficient balance in the account.
 If the signature of the drawer is forged. 
Where there is irregular endorsement.
 Where crossed cheques are presented across the counter.

COLLECTING BANKER: The collecting banker is the banker who collects cheques drawn
upon other bankers for and on behalf of his customers. He is called the collecting banker, as
he undertakes the work of collection of cheques.

Duties/ responsibilities of collecting banker.

 TOWARDS CUSTOMER
1. Prompt presentation of cheque: The cheque should be presented without any delay.
Collecting banker should present the cheque to the paying banker for encashment
within a reasonable time. According to the practice of bankers, if the collecting
banker and the paying banker are in the same place (i.e., if the cheque is a local
cheque), the collecting banker should present the cheque to the paying banker at least
by the next day after he receives it. If the collecting banker and the paying banker are
in different places (i.e. if the cheque is an outstation cheque), the collecting banker
should despatch the cheque to the paying banker by post.
2. Prompt credit to customer’s account: The customer’s account should be credited as
quickly as possible on the cheques being cleared.
3. Prompt notice of dishonour: Any dishonour of the cheque should be informed to the
customer as early as possible. The information should be sent the same day or next
day to the customer.

General duties/ responsibilities

1. Proper opening of every account: The opening of every current account and savings
bank account should be done with a lot of care. There should be a proper introduction
by an existing customer or by a person well known to the banker.
In order to prevent money-laundering, the World Bank and IMF have been making
the opening of the account very serious. Apart from introduction, there should be
identity proof and also proof of residence or business through proper documents. This
has come to be known as, “Know your customer” or KYC Concept.
2. Collection for customer: The collection should be made only for the customers of
the bank. Collecting for others, whatever may be his position must be avoided.
3. Regularity of endorsements: All the endorsements should be regular and in proper
form. On the face of the cheque, there should be no irregularity.
 4. Title of the customer: It should also be verified whether customer has a title to the
instrument. The name of the payee or the last endorsee must tally with the name of
the customer including initials.
5. Multiple accounts: Sometimes, a customer may have many accounts and also in
many capacities. It may be an account of the individual and that of a firm where he is
a partner or as the officer of a Joint Stock Company. He may also be operating a Trust
A/c. The banker should be careful in crediting the proceeds to the correct account.
6. Crossing of cheques: He can encourage customers to cross the cheques before
depositing them for collection. As he gets protection for crossed cheques, this is
advisable.
7. No suspicious circumstances: The banker should be alert in identifying anything
abnormal. If there are suspicious circumstances, he must get the perfect explanations
for them before collecting the cheque.

Statutory protection available to the collecting banker.

Sec 131 of Negotiable Instrument Act gives protection to the collecting banker when it lays
down that, “A banker who has in good faith and without negligence, received payment for a
customer of a cheque crossed generally or specially to himself, shall not, in case the title to
the cheque proves defective, incur any liability to the true owner of the cheque by reason of
only having received payment.”
The definition brings out clearly the stipulations or conditions to be satisfied for availing the
protection.
1. Good faith and without negligence: Statutory protection can be claimed only if the
collecting banker has collected the cheque in good faith and without negligence.
Collecting a cheque in good faith means that the collecting banker should collect the
cheque honestly collecting a cheque without negligence means that the collecting
banker should collect the cheque with reasonable care.
2. Payment for a customer: He should have collected the cheque only for his customer.
He should not collect if for a person, who does not have an account with the banker.
3. Crossed cheque: This protection is available only for a crossed cheque. No
protection is granted for an uncrossed cheque, as it need not be collected through a
banker. The cheque should have been crossed generally, where it is a special crossing,
it must have been crossed to the collecting banker.
4. Agent for collection: This protection can be claimed only when the collecting banker
has collected the cheque as an agent for his customer. Acting as a holder for value, he
does not get this protection. In order to prove this point, the banker must credit the
account of the customer with the proceeds of the cheque only after receiving it from
the paying banker. Directly or indirectly, he should not give the benefit of the amount
to the customer before he actually receives it from the paying banker.
5. Prior crossing: The crossing of the cheque must have been done before it is
deposited for collection. As it gives him the statutory protection, he can suggest to the
customer that it is in the interest of both of them to cross the cheque. Though the
collecting banker can cross the cheque himself to avoid any unscrupulous
development, he cannot get the statutory protection if he himself crosses it. Therefore,
the collecting banker should not do the crossing.
 Unit - 5
PRINCIPLES OF BANK LENDING
Lending: it is also known as financing, is the temporary giving of money to another person
with the expectation that it will be repaid.
Kinds of borrowing facilities granted by banks with their advantages and
disadvantages.
7. Loans: A loan is a kind of advance made with or without security. It is given for a
fixed period at an agreed rate of interest. The entire amount is paid on an occasion
either in cash or by credit in customer’s current account, which a person can draw at
any time. Re-payments may be made in instalments or at the expiry of a certain
period.
Types of Loans:-
 Secured Loans – It is a loan in which the borrower pledges some asset (e.g. a car or
property) as collateral for the loan.
 Unsecured loans – They are monetary loans that are not secured against the
borrower’s assets. These may be available from financial institutions under many
different guises or marketing packages,
11. Credit card debt,
12. Personal loans,
13. Bank overdrafts,
14. Credit facilities or lines of credit, and
15. Corporate bonds.
3. Demand loans – A demand loan is that loan which can be recalled on demand. The
salient feature of this loan is that the entire amount of the loan allowed is paid to the
bank at one time. It is paid either in cash or by transfer to the account of the borrower.
This loan is sanctioned against the security. Interest is charged on the debt balance.
4. Term loans – A term loan is a loan which is sanctioned for a specified period.
The specified period will be more than one year but less than ten years. These
types of term loans are advanced against the security.
Advantages of granting loans
4. Simplicity – The method is very simple. Interest is payable on the entire amount of
the loan.
5. Better recovery of interest and loan – The customer knows in advance the time of
return of the loan. Therefore, he makes arrangement for its return. In case he does not
return the loan in time, the bank will not grant loans and advances to him in future. It
acts as an automatic regulator to discipline the borrower.
6. Profitability – From the point-of-view of the bank, the method is economical. The
customer has to pay interest on the entire amount of the loan even if he has not
withdrawn the entire loan. To that extent funds can be used by the bank.
Disadvantages of granting loans
6. Inflexibility – The method is simple but inflexible. Borrower has to make a fresh
request for the loan every time he requires the loan.
7. Over borrowing – Since the loan method is inflexible a customer takes a loan in
excess of his needs to meet any contingency. This results in over borrowing.
8. More formalities – As compared to cash credit and overdraft methods, loan
documentation is more complicated
 9. OVERDRAFT- it means overdrawing the current account up to the sanctioned limit.
This is a temporary financial arrangement made for a short period. In order to get the
facility, the customer has to apply to the banker for the sanction of the overdraft limit
necessary security is also offered. Once sanctioned, the customer can draw from his
current account up to the limit, even if there is no balance in it.

Advantages of overdraft
13. Bank overdrafts are flexible, they are permanently available in your account and you
can avail it as per the need arises.
14. Interest is to be paid only for the funds that people use.
15. Bank overdrafts are arranged quickly.
16. There are no additional expenses for pre-payment of bank overdraft.

Disadvantages of overdraft
 Bank overdraft can be called in by the lender at any time.
 Bank overdraft has to be rearranged regularly and an arrangement fee is usually
payable when the credit is extended.
 If the agreed limit is extended, administration fees can be charged.
 Secured overdrafts need business assets as the security, which may be lost if you are
unable to repay the amount.
 Maintaining a current account is necessary for overdraft facility.

4. CASH CREDIT- A cash credit is a financial arrangement under which a borrower is

allowed an advance under a separate account called cash credit account up to a
specified limit called the cash credit limit.
Cash credit is a financial arrangement that works like an overdraft, overdraft is
granted only to current account holder. But cash credit is granted to all types of
customers. This is sanctioned against the hypothecation or pledge of the goods like
agricultural or industrial products or against the guarantee of the individuals.

Advantages of cash credit

4. Flexibility – The greatest advantage of cash credit method is that it is flexible. A
customer can withdraw and deposit money any number of times.
5. Economical – The scheme is economical. A borrower has to pay interest only on the
amount borrowed and that too for the period the amount is actually withdrawn. Unlike
a loan he is not required to pay interest on the entire amounts of the loan.
6. Less formalities – As compared to the loan method, there are fewer formalities, and
frequent documentation is avoided. Moreover, documentation in this method is less
complicated.

Disadvantages of cash credit

8. Over borrowing – Credit limits are fixed one in a year. It gives rise to the tendency
of fixing higher limits to cover contingencies. Thus, it encourages over borrowing.
9. Division of funds – The bank has control over the amount of credit sanctioned. It
does not have any control over the use of such funds. Consequently, the borrower
diverts the funds, without the knowledge of the bank, for unapproved purposes.
10. Non-utilization of funds – In practice, a large amount of sanctioned cash credit limit
remains unutilized. Levy of commitment charges has failed to put an end to this
weakness because it is levied on cash credit limit of Rs. 1 crore or more.
6. DISCOUNTING OF BILLS AND PURCHASING OF BILL OF EXCHANGE.
Discounting of bill of exchange – On the dispatch of goods to the buyer, the seller
draws a bill of exchange on the buyer. A bill of exchange is an order by the seller
(creditor) to the buyer (debtor) to pay a certain sum of money after a specified period.
When such an order is accepted, by writing on the face of the order itself, it becomes
a valid bill of exchange. The holder of a bill of exchange cannot demand payment
from the acceptor before the maturity of the bill. However, if he is in need of money
he may sell the bill to the bank or to others. This process of encashing a bill with a
bank or others is called discounting. Banker deducts discount from the face value of
the bill and pays the balance of amount to the holder. The banker secures payment of
the bill from the drawee on the maturity date of the bill. So, it is loss to the seller and
a gain to the banker.
Advantages of bills discounting
 Certainty of payment – In case the banker takes due precautions in selecting his
customers, he is almost certain of getting the payment of bills on the due dates.
This is because the drawee in order to maintain his credit will see that the bill is paid
on maturity. In case the drawee refuses to honour the bill, the banker can get the
payment from the customer for whom he has discounted the bill.
 Safety of funds – The funds of the banker are safe because of double security. The
drawee is liable to pay the bill and in the event of his inability to meet the bill, the
banker can recover the money with all expenses from the customer. In the event of
dishonour of the bill, the bank immediately debits the account of the customer with
the amount, under intimation to him.
 Employment of funds for a definite period – Since the bills are drawn for a definite
period, the banker by making a judicious selection of bills can invest his surplus funds
for the period he considers appropriate. For example, if a banker has received a fixed
deposit for the period of three months, he can invest this money in discounting those
bills which are to mature after three months.
 Refinance facility – The banker can obtain refinance facility from the approved
financial institutions of the country in respect of bills discounted and purchased by
him. Thus, bills discounted are as good as liquid assets.
 No fluctuations in prices – Bills are better than other securities because they do not
fluctuate in their value while other securities such as goods or property are affected by
fluctuations in their market prices. However, sometimes a banker might have to get
the bills rediscounted at a higher rate than the rate at which he might have discounted
the bills, but such fluctuations are quite marginal.
 Higher yield – The discounting of bills gives a higher rate of return than loans and
cash credits even when the rate of interest is uniform. This is because in case of
discounting the bills, the bank charges interest known as discount, right at the time of
discounting the bill by deducting the amount from the value of the bill. While in case
of loans and cash credits, interest is charged only after the expiry of a period viz., a
quarter or half-year or a year as the case may be. Thus, the effective rate of interest is
more in case of discounting of bills than loans or cash credits.
Disadvantages of bills discounting
 Lack of uniformity in the documents to be submitted for availing bill discounting
facility.
 Wide geographical spread of the buyers.
 Delay on the part of drawer’s bank in sending the bills for presentation/ acceptance.
 Delay on the part of drawee in accepting the bills within a reasonable time frame.
 Delay in remittance of proceeds by the bank at the drawee’s end.
 Delay in the approval of new customers (drawees) in the absence of reliable credit
information especially in respect of small and medium size enterprises as well as
unlisted and un-incorporated entities.
 8. Bills purchased – Bills are the written instructions of a seller of goods to the
purchaser for the payment of a stipulated amount at a particular date. It is approved by
the purchaser. If the holder of the bill requires the amount of the bill before its
maturity, the bills are purchased by the bank from its approved customers in whose
favour regular limits are sanctioned. The bank holds the bill as security for the
advance.
9. Letter of credit: is a document of guarantee issued by a banker on behalf of his
customer (buyer of goods or equipment) assuring payment for the goods supplied.
The assurance is given to the supplier (exporter). Normally, this is required when the
goods or equipment are being imported from a foreign country. Once the goods or
equipment are delivered by the supplier, he can get payment from his banker on
surrendering the letter of credit and bill of lading (shipping document). The
supplier’s banker will collect the amount from the banker of the buyer by exchanging
the bill of lading.

Advantages of letter of credit

i. Letter of credit is an off balance sheet transaction. Therefore the applicant’s
borrowing capacity will not be affected.
ii. The cost of goods need be paid only on receipt of the documents.
iii. Letter of credit is a form of guarantee. Therefore, the seller will be protected against
default by the buyer.
iv. The LC deals with only documents. Therefore, if the documents are in order the
seller gets the payment immediately.
v. The buyer can refuse the payment if the documents are not in order. This gives
better bargaining power to the buyer.

Disadvantages of letter of credit

i. Banks insist on cash margin which is immediate cash outflow for the buyer.
ii. Banks charge commission on LCs which is cost to the buyer.
iii. The buyer can refuse payment on petty reasons like the spelling of the name of
the buyer in the invoice and other document does not tally.
iv. If the opening bank is not stable, the payment can be defaulted. For example,
certain Indian banks open the LC and by the time the documents reach them,
change their name.

NON-PERFORMING ASSETS
Non-Performing Assets (NPAs) as “an asset or account of a borrower, which has been classified
by a bank or financial institution as sub-standard, doubtful or loss assets in accordance with the
direction or guidelines relating to asset classification issued by the RBI”.
TYPES OF SECURITIES
Security – A security is a right possessed by a creditor in property or anything to convert
the same into cash, if the debtor fails to refund the amount advanced with the interest.
There are four types of securities which are as under:
i. Lien
ii. Pledge
iii. Hypothecation
iv. Mortgage
 i. Lien: Lien refers to retain the property of customer by banker to recover the dues
from customer.
a. Lien is provided by law and no agreement between banker and customer is essential.
b. No transfer of ownership is necessary from the customer.
c. The banker can sell the property of his customer after giving due notice to the
customer, when he does not clear the loan.
d. The proceeds can be appropriated towards the dues.
Example: Gold loan.
ii. Pledge: The Indian Contract Act, 1872 defines the term ‘pledge’ as a bailment of
goods as a security for payment of debt or performance of a promise. The person who
pledges the property is called ‘pledger’ or ‘pawner’ and the person in whose name the
property is pledged is called ‘pledgee’ or ‘pawnee’.
A valid pledge has the following requisites:
a. It is a charge on movable property.
b. The borrower and lender should have either oral or written contract between
themselves to pledge the property against advance. Normally it will be written
agreement.
c. The pledge contains another statement which comprises of the pledged property, the
amount borrowed and the reason for borrowing.
d. The physical delivery of the pledged property is essential.
e. The ownership of the property will be retained with the pledger.
iii. Hypothecation: Hypothecation is a charge against property for an amount of debt
where neither ownership nor possession is passed to the creditor. Hypothecation is a
charge against movable property. But the goods will be retained by the borrower. The
borrower gives only a letter stating that the goods are hypothecated to the banker as
security for the loan granted. The letter is called ‘Letter of Hypothecation’. This
document empowers the banker to take possession of the property whenever he
wishes to do so and sell the property to clear the dues whenever the borrower will be
at default.
iv. Mortgage: Section 58 of the Transfer of Property Act defines the term ‘Mortgage’ as
‘the transfer of the interest in a specific immovable property by one person to another
for the purpose of securing an advance of money’. The person who transfers the
interest of a specific property is transferred is called the ‘Mortgagee’. The principal
money and interest of which payment is secure for the time being are called
‘Mortgage Money’ and document through which the interest of the property is
transferred is called ‘Mortgage Deed’.

Mortgage: It is a method of charging which can be created only in respect of

immovable properties like land and building.

KINDS OF MORTGAGES – The Transfer of Property Act recognises the following

types of mortgages:-
a. Simple mortgage
b. Mortgage by conditional sale
c. Usufructuary mortgage
d. English mortgage
e. Mortgage by deposit of title deeds
f. Anomalous mortgage
a. Simple mortgage: Under this type,
 The mortgager does not transfer the possession of the property. But, he promises
to pay the mortgage money.
 In the event of his failure, he permits his property to be sold through the
intervention of the court. Hence, no power of sale is available, in this case, without
the intervention of the court.

b. Mortgage by Conditional Sale: This type of mortgage is created subject to

certain conditions. The essential features are:
 The mortgager ostensibly sells the property to the mortgagee, on condition that this
sale would become void on payment of the mortgage money.
 This sale would become absolute, if the mortgager fails to pay the mortgage amount
within a specified period.
 When the loan is repaid, the mortgagee retransfers the property to the mortgager.
 In the event of non-payment, the mortgagee has a right to sue for foreclosure only
and not for the sale of the property. The right of foreclosure means the right to
institute a suit for a decree, whereby, the mortgager will be absolutely debarred from
his right to redeem the property. Thus, the mortgager will lose his right of possession.

c. Usufructuary mortgage: Under this type of mortgage:

 The mortgagee is authorized to retain the possession of the property till the loan is
repaid.
 He is also authorized to receive the income like rents and profits arising from that
property. It is appropriated towards the loan amount. So, the liability of the
mortgager is gradually reduced under this type.
 In the event of non-payment, the mortgagee can sue neither for the mortgage money
nor for the sale of the property. Even the right of foreclosure is not available.
 The only remedy available is, to retain the possession of the property, and receive the
income arising there from, till the loan is settled.
 However, if the mortgager fails to redeem the property within 60 years, the
mortgagee becomes the absolute owner.

d. English Mortgage Under English mortgage:

 The mortgager transfers the property absolutely in favour of the mortgagee.
 This transfer is subject to a condition that the property will be retransferred to
the mortgager on repayment of the mortgage money.
 In addition to this absolute transfer, the mortgager binds himself personally liable
to repay the mortgage money.

e. Mortgage by Deposit of Title Deeds

 There is a mere deposit of title deeds to property.
 The intention of the deposit is to secure a loan.

f. Anomalous Mortgage: If any mortgage does not come under any one of the above
mortgages discussed above, it is a case of Anomalous Mortgage. In real practice, it
usually takes the form of a combination of any two mortgages discussed above.
PRINCIPLES OF BANK LENDING (Or) CONSIDERATION OF SOUND BANK LENDING
(Or) FACTORS TO BE CONSIDERED BY A BANKER WHILE SANCTIONING A LOAN

While lending money, a banker has to take into account certain considerations or principles, the
principles of lending are –
1. Profitability: A commercial bank is essentially a profit-making institution. They must employ
their funds profitably. So as to earn sufficient profits to meet its expenses and to pay dividends
to its shareholders, to pay interest to the depositors, salaries to the staff. In order to derive
sufficient profits, a bank should ensure that its advances fetch not only fair returns, but also
steady returns.
2. Liquidity: Liquidity means possibility of converting loans into cash without loss of time and
money. Liquidity should be the primary consideration. That means, to meet the demands of the
depositors, a commercial bank is required to maintain adequate liquidity of its funds, i.e., keep
sufficient funds in hands. This does not mean that they should hold all the deposits they receive
in the form of cash. Only a portion is held to meet the demand and major portion is lent.
3. Safety: Safety has been the most important principle of sound lending, because the very
existence of a bank depends upon the safety of its funds. Therefore, while lending his funds, a
banker has to see that the funds lent out by the banker should come back to the banker within
the stipulated time without resorting to legal action.
4. Security: A banker should grant secured loans only. In case the borrower fails to return the
loan, the banker may recover his loan after realizing the security. In case of unsecured loans, the
chances of bad debts will be very high. Thus, the banker should also bear in mind the ‘security’
principle while lending.
5. Diversification: According to the principle of diversification, the bank should diversify its
investments in different industries and should give loans to different borrowers. This means that
advances should not be concentrated in one industry. In case that industry fails, the banker will
not be able to recover his loans. Hence, the bank may also fail. Hence, while lending the banker
should keep in mind the concept of diversification.
6. Object of loan: A banker should thoroughly examine the object for which his client is taking
loans. Banks do not grant loans for each and every purpose. A banker should not grant loan for
unproductive purposes like social functions and ceremonies or for pleasure trips or for the
repayment of a prior loan or to buy fixed assets, speculation etc. if he advances for unproductive
purposes, the repayment of loan may be delayed and recovery will be slow.
7. Public or National interest: Banking industry has a significant role to play in the economic
development of a country. Therefore, the banker should keep in mind the national policies and
programmes while lending. He should grant advances to those industries which require
development in the country’s planning programmes.
8. Assured repayment: A banker should come forward to lend only when the repayment is
assured. When there is default in repayment, a banker’s ability to create further credit is
affected. Hence, while advancing money, he should see the source of repayment.