Prof. V.

VINAYAGAMOORTHY
M.COM, M.Phil, B.Ed, M.B.A, SET
Assistant professor in Commerce
 BANKING THEORY, LAW AND PRACTICE
UNIT-1
Origin of banks:

The world is derived from the Italian word banco, means a bench. European money lender and money
changers during the medieval period had used bench to display coins and transacted business and money changing
was the most important function of the bank.

Banking in the ancient times was mainly confined to money changing and money lending. Money lenders
were called bankers and Seths or Shroffs who had carried on the business of money lending and banking activities.
Many evidences were shown that taking and giving credits were found as early as 1400 BC during Vedic period.

Many banks in early days dealt in coin and bullion and their business being money changing and supplying
of foreign and domestic coins. Another group called as merchant bankers dealt both in goods and in bills of
exchange, providing for the remittance of money and payment of accounts.

Banking system has many similarities and differences in organization and techniques. It may be classified
by its structure-unit banking, branch banking, hybrid banking. Unit banking prevails in large areas of the United
States. In other countries, it is more usual to found in very big commercial banks operating a highly developed
network of branches. In England and Wales, there were clearing banks, which carried out all the domestic banking
business through branch offices.
Banking Regulation Act, 1949

The Banking Regulation Act has conferred so much of powers to the RBI to control the banking control all
banking companies. The Banking Regulation Act has undergone many changes and modified through necessary
amendments. Ranking Regulation Act of 1949 applies of all banking companies other than private banks in India.
The Banking Regulation Act has comes into force on 16th March 1949. A banking company transacts banking
business under section 5 (C) of the Act. The Banking Regulation Act is aimed to regulate the abuse power by
management of banks and to safeguard the interests of depositors. It is not applicable to the nationalized banks as
they are established under the under the Banking companies Acquisition and Transfer of undertakings Act, 1970.

Provision of Banking Regulation Act:

The provision of the Banking Regulation Act 1949 are classified into

i. Built in safeguard and powers.

ii. Functions and responsibilities of the Reserve banks of India
iii. Provision pertained to suspension of business and winding up of banking companies.

Organisational Safeguards:

a) Primary Functions
b) Agency Functions
c) General utility Functions

Primary Functions

 Acceptance and deposits

 Lending of money with or without security
 Borrowing money
 Making investment

Agency Functions

 Collection and payment of cheques, bill of exchange and other investments.

 Purchase and sale of securities, shares.
 Remittance of funds.
General utility Functions

 Issuing various types of letter of credit.

 Buying, selling and dealing bills.
 Buying and selling of foreign exchange.
 Acceptance of articles and valuables
 Running safe deposit values
 Underwriting
 Guarantee and indemnity business.
 Undertaking and executing trusts.
 Acquiring, holding and dealing

Roles of Banks and Economic Development

Banking and economic development are intertwined and inseparable to each other. Banking organizations
occupy a key position in the economic development of country. They constitute the core of the country’s financial
structure and money supply. The bankers are lending, investing money and other activities which facilitate the
process of production, distribution and consumption. The banks encourage investments and help capital formation
by mobilizing savings and lending those funds to prospective entrepreneurs and industrial venture.

Indian banking system has achieved steady during the post-independence period. The nationalization of
major commercial banks in 1969 and 1980 and its resultant progress in purveying institutional financial to rural
areas are commendable. Banks have helped the nation for prosperity and progress at the macro level.

According to former Prime Minister Smt. Indira Gandhi of the many structure and institutional changes that are
necessary in developing countries, not the least important is the adaptation of the financial institution to serve the
objectives of development and to bring about greater mobility of resources to meet the emerging needs of the
economy.

In the words of Dr. Manmohan Singh, Prime Minister of India, the financial system of a country has a crucial role to
play in the mobilization of savings and their allocation to the most productive uses if it is to serve as an essential
adjunct to economic growth.

Commercial banks and Economic Development:

The commercial banks provide funds to meet short term, and medium tern financial requirement of
industries and encouraging to facilitating investment activity. They participate in promoting most of the country.
They participate in promoting most of the economic development programs of the country. They facilitate an
accelerate growth of the capital market as brokers, underwriters and guaranteeing the issue of shares and debentures.

The commercial banks cater banking education to people by the introduction of varied banking services
besides widespread about the utility of bank. They provide direct assistance to agriculturist and assist the co-
operatives by participating their share capital and granting direct loans to deserving public.

Banks play a vital role in a country’s economic development by taking money from some people and
lending it to many people with certain terms and conditions. The credit services of the banking institutions promote
economic growth of the country. The commercial banks change the economic trends by frequently changing their
lending policies. They are also functioning as financial intermediaries and risk management help in risk
transformation, maturity
Central banking and Role of RBI and their Functions:

RBI

The RBI acts provided for the appointment of the governor and deputy governors by the central
government. Another important provision which sought to safeguard the public interest, the central government is
empowered to supersede the central board of the RBI and the local boards constitutes by the RBI.

Reserve bank of India Act was passed in 1934 and the RBI started functioning from 1 st April, 1935. At the
time of establishment, the reserve Bank was a shareholder bank with the share capital RS.5 crores.

Administrative Setup of the RBI:

The reserve bank of India is well administered by a team of expert’s expertise in banking and finance. The
organizational setup of the RBI is mentioned as follows.

Central Board of Directors

Governor
Deputy Governor
Executive Governor
Principal Chief General Manager
Chief General Managers
General Managers
Deputy General Managers
Assist General Managers
Managers
Assistance Managers
Supporting Staff

Various Department of RBI

 Department of Information Technology

 Department of Economic analysis and policy
 Department of Statistical analysis and computer services
 Monetary policy department
 Premises department
 Secretary’s department
 Press Relation Division
 Exchange control department
 Rural planning and credit department
 Financial Institutions Division
 Department of Banking supervision
 Department of banking operations and development
 Department of financial companies
 Department of non-banking supervision
 Department of Administration and personal management
 Human resource development department
 Deposit Insurance and credit guarantee corporation
 Inspection Department
 Urban Banks Department
  Department of currency management
 Department of External investment and operation
 Department of Expenditure and Budgetary control
 Department of Government and banks account
 Internal department management cell
 Industrial and Export credit department and
 Legal Department

Central banking Functions

Monopoly of Note Issue

Custodian of foreign
exchange reserve Bankers to the Governments

Central banking Functions Agent and Advisor to

Controller of Credit the Government

Lender of Last Resort Banker Government

to Banks

Clearing house of India

Monopoly of Note issue

RBI has the exclusive right to issue bank notes of all denominations expert one Rupee note being issued by
the Government of India. In India, note issue was originally based on proportional reserve system. Then the
minimum reserve system replaced the proportional reserve system. Then the minimum reserve system replaced the
proportional reserve system.

Section 22 of the RBI Act made the statutory provision of note issue on a monopoly basis. As per the
amendment of RBI Act, in 1957, a bank should maintain Rs.200 crore worth of Gold coins, Gold bullion and foreign
securities of which the value of Gold coin and bullion should not be less than Rs.115 crore as a minimum reserve.

Bankers to Government

Under section 20 of the RBI Act, the RBI has been acting as banker to both the central as well as state
government. Section 21 provides that government should entrust its money remittance, exchange and banking
transactions to the RBI. Section 21A provides similar transactions can be same with state governments. The RBI
extends ways and means advances (WMA) to both the central and state Governments, for meeting their temporary
financial crisis.
Agent and Advisor to Governments

The RBI is acting as agent and adviser to governments by rendering the following functions. On behalf of
the governments, it accepts loans and manages the public debts. The RBI issues Government bonds and treasury
bills etc. It is also acting as a financial adviser to the Government in the important monetary, economic and financial
aspects.

Bankers to Banks

RBI for various banking operations ensures the following functions.

 Regulation of supply of credit.

 Custodian of cash reserves of commercial banks.
 Strengthen the banking system
 Effective control over banks in liquidity management.
 Ensures financial assistance to the banks.
 Giving proper directions in lending policies.
 Transfer of funds between member banks.

Clearing house of India

RBI is acting as a national clearance center for settlement of banking transactions. It enables other banks to
settle their interbank claims. The Interbank cheques clearing settlement is carried out twice a day by computer
based.

Lender to last report

 Commercial banks mature within 90 days from the date of purchase.

 Bills for financing, agricultural operations maturing within 15 months from the date of purchase.
 Bills for financing cottage and small scale industries within 12 months from the date of discount.
 Bills for holding or traditional in Government securities mature within 90 days from the date of purchase.
 Foreign bills mature within 180 days from the date of shipment of goods. As a lender of the last resort, the
RBI can exercise complete control over the commercial banks.

Control of Credit

The reserve bank of India controls the credit creation of the commercial banks by using both the
quantitative and qualitative credit control measures. By controlling credit creations by the commercial banks,

 The RBI can achieve to maintain the desired level of money supply
 Stability in the price level
 Control the effects of trade
 Controls the functions of foreign exchange rate
 Diversity the describe volume of credit to productive sectors of the economy.
Custodian of Foreign Exchange Reserves

The reserve bank of India is acting as a custodian of foreign exchange reserves, to maintain foreign
exchange rates. The RBI engages buying and selling foreign currencies in international market depending upon the
circumstances.

The value of India’s foreign exchange reserves held by RBI as on June 1998 amounted of Rs. 115001
crore. It comprises of gold Rs. 12826 crore, foreign currency assets and value of IMF currency, viz., Special
Drawing Rights (SDRs). The reserves are increased to Rs.138005 crore in March, 1999.

The value of foreign currency assets of RBI, which form the largest portion of India’s foreign currency
reserve, is subjected to change depending on prevailing exchange rates inflow and outflow of currencies,
intervention policy of the RBI.

Credit control Measures of Central Bank.

Credit control is the most important function of the central bank. According to Dekock, it is the function
which embraces the most important question of central banking policy and the one throughout which practically all
the functions are untied and made to serve a common purpose. By controlling the credit effectively, the central bank
can stabilize both the internal prices and foreign exchange rates.

The most important function of the central bank is to control the credit created by the commercial banks.
The duty of the central bank is to ensure that money and credit are properly managed to control inflationary and
deflationary pressures in the economy.

The central bank as several methods to control the volume of credit. It has been classified into two methods

Credit Control Methods

Qualitative Credit
Control Methods
Quantitative Credit
(or)
Control Methods
Selective Credit
Control Methods
Quantitative Credit Control Methods

The quantitative methods aim to control the total quantity and cost of credit created by banks, while the
qualitative methods are controlling the use and direction of credit. The quantitative methods are traditional and
indirect. It includes

 Bank rate policy

 Open Market operations
 Variable Cash reserve ratio.

Bank rate policy

The bank rates or discount rate is the rate at which the central bank is prepared to discount the bills of
exchange and government securities. The commercial banks rediscount their bill of exchange with the central bank
and also borrow from the central bank against the approved securities.

Open Market operation

 There should be well organized securities market.

 The central bank should have adequate stock securities.
 The commercial banks must maintain stable cash reserve ratio.
 The existence of board and active market.
 The existence of fixed cash reserve ratio by the banks.
 The absence of rediscounting and borrowing from the central bank .

Variables Cash Reserve Ratio

 The centralization of reserve is a great source of strength to the banking system in the country.
 The central bank can use the funds effectively during financial crisis in the market.
 The bank central can provide additional funds on a temporary basis to commercial banks to overcome the
financial difficulties.
 The central bank can control the credit creation by commercial banks because it is an effective tool of
credit control.

Qualitative Credit Control Methods (or) Selective Credit Control Methods

Qualitative credit control or selective credit control is mean to regulate the terms on which credit is granted
in specific sectors. It controls the demand for credit in different uses by determining minimum down payment and
regulating the period of time over which the loan is to be repaid.

The selective credit control methods (qualitative credit control) are explained as follows.

 Margin requirements
 Regulation of consumer credit
 Rationing of credit
 Moral suasion
 Publicity
 Direct action
Margin Requirement

The marginal requirement is the different between the market value of the security and its maximum loan
value. It means control over down payments that must be made in buying securities on credit. This method was first
used in the United States.

Regulation of Consumer Credit

The central bank can control the consumer credit

a) By changing the amount that can be borrowed for the purchase of the consumer durable.
b) By changing the maximum period and which the installments can be extended.

Credit Rationing

It is to control and regulate credit granted by the commercial banks. The rationing of credit may be in two
types:

 The central bank may fix its rediscounting facilities for any particular banks.
 The central bank can fix a very minimum ratio take into consideration of the volume of capital assets
of commercial banks.

Moral Suasion

It means advising, requesting and persuading the commercial banks to co-operate with the central bank in
implementing the monetary policy. The effectiveness of this method depends upon the favorable response of the
commercial banks.

Publicity

The commercial banks to educate the people about the economic and monetary conditions of the country.
The central bank publishes the statement of assets and liabilities, review the credit, business conditions, money
market and capital. The methods are very useful to disseminate information relating to banks and financial
information.

Direct Action

The central bank may refuse to rediscount the bills of exchange of the commercial banks whose credit
policy is found not in line with the general monetary policy of the central banks. The central bank can charge a penal
rate of interest may refuse to grant more credit to the banks whose borrowings are found in excess of the capital and
reserves.
 UNIT-II
Commercial Banks

An important rational for public sector banking in India is to meet a social objectives like credit access to
weaker sections, development of background regions, strengthening small scale industry sector. Public sector banks
find it difficult to compete with private sector banks both domestic and foreign banks. Foreign banks maintain a
minimum balance stipulation for maintaining an account, which is several times a multiple of what the PSBs are
stipulated. It is partly responsible for the lower profitability of PSBs

Functions of Commercial Banks

Primary Functions of Commercial Banks

Acceptance of Investment Credit Creations Foreign

Deposits Functions Exchange
Dealings
Functiona
Advancing Loans

Time Deposits Demand Deposits

Overdraft

Cash credit

Fixed Deposits Saving Bank Discounting of Bills

Recurring Deposits Current Account Operations Loans and Advances

Cash Certificates Other Advances

Others
 Secondary Functions of Commercial Banks

Agency Services General Utility Services

 Collection of cheques, dividends  Safety locker facility.
 Payments of Rents, Insurance premium.  Transfer of Money
 Purchase and Sale of securities  Travelers cheques
 Trustees and executor  Letters of credit
 Acts as correspondent  Acting as referees
 Preparation of Income Tax returns  Trade information
 Other services  ATM facility
 Credit cards
 Underwriting
 Gift cheques
 Advice on financial matters.
 Other services.

E-Banking

Electronic Banking id defined as delivery of a bank’s services to a customer at his office or home by using
electronic technology. Electronic technology is being used in banking to handle wide customer base, reduce the cost
of handling payments, introduce new products and services, and liberate the banks from traditional barriers etc.,
Electronic banking services delivered online or through other mechanisms have spread widely. E-banking has
offered many new business opportunities. E-banking implies provision of banking products and services through
electronic delivery channels in the form of automatic teller machines (ATMs) and telephone transaction. The
internet offers faster access, more convenient and available in 24 hours irrespective of the customers’ location. It is
more efficient and cost saving channel for banks.

The impact of E-banking is not limited to industrial and advances economies. E-banking not only cutting
down the costs of delivery and transactions but also provides many benefits to customer and banks minimize
traditional banking risks.

E banking has created many new challenges for bank management and regulatory authorities. It has
increased potential for cross border transactions and lack of adequate cross border supervision. The small and
medium scale enterprises continue to have generic problems like inadequate quality data, assets covers etc., with the
emergency of a digital divide, poor people are excluded from the internet and from the clutches of financial system.
The lack of adequate investors’ protection is the important challenges of e-banking.
Risks in E-banking

Risks involved in e-banking are mentioned as below:

1) Operational risk due to changes in procedures,

2) Reputation risk due to failure to deliver, secure accurate and timely service
3) Legal risk due to uncertainty about legislation applies to e-banking.
4) Other risks such as business risks and credit risks.

Delivery channels are devised focusing mainly on time and place advantage to the customers. Successful
adoption of wireless technology would help banks to offer not only anytime, anywhere but also any devise banking.
An appropriate system should be developed in such manner that a customer can use his ATM card and his own
ATM Personal Identification Number (ATM PIN) for customer authentication in a web transaction. Banks should
have a comprehensive system to allow to delivering end to end customer service that can reshape the customer base,
maximize cross selling opportunities and generate a positive return on investment in banking business.

ATM Cards

It is a very user-friendly system and the customer does not require any training to use it. It is totally menu
driven which displays instructions to the customers step by step as to how to operate the ATM. The hardware and
software used in ATMs are proprietary that is the software used in one machine cannot be used in the used in
another machine. Further in the manufacture of ATMs, there are no specific standards and each of the vendors
follows his own specifications. So each model is different. However, the functionality aspects of the ATMs are
uniform.

Types of ATM

ATMs are two types:

1. Cash Dispensers
2. Full Function ATMs

Cash Dispensers

The cash dispensers will have limited functions when compared to the full function ATMs. Cash dispensers
can be made on-line with branch systems.

The limitation of cash dispensers are

 Accept cash
 Cannot dispense non currency instrument like issue of cheques books, gift cheques or traveler’s cheques.

Full Function ATMs

The full-fledged functions performed by ATMs are

1. Deposit of cheques or cash

2. Sale of stamps
3. Account balance enquiry.
4. Update pass book
5. Generate statement of accounts
6. Request for a cheques book.
Advantages of ATMs

 Customers can choose his transaction according to his convenience.

 The banking hours are effectively increased from a minimum of 4 hours to the maximum of 24 hours.
 As it is menu driven, the customer knows how to operate the ATM in a simple manner.
 The different behavior of employees because of inexperience, job stress and ignorance could be avoided, as
there is no personal content between the banker and the customer.

Limitations of ATM

 Cash withdrawals for large amount are not permitted.

 Other banking activities like for credit limits and locker facilities, the customer has to contact the banker in
person.
 Cash dispensation is restricted to certain denominations only.

DEBIT CARDS

Debit card is basically a better way to carrying cash or cheques book. It is an electronic card that one can
use as a convenient payment mechanism. The card is generally issued by the bank and connected through ATM.

Debit card allows the holder to spend only what is in his account and purchases should be kept track of just
as if one is writing a cheques. Debit card usually offers some protection against loss, theft or unauthorized use,
which the stored value card does not.

There are two types of debit card:

 Direct debit card

 Deferred debit card

Direct Debit Card

Direct debit card allow only “on-line” transactions, also called point of sale. It is an immediate electronic
transfer of money from your bank account to the merchants’ account. The system will check whether one has
necessary funds in his account for the purchase.

Deferred Debit Card

Deferred debit card looks similar to the credit card bearing a Visa or master card logo, and can be used
whenever your cards name is displayed; it is not a credit card. Rather, this card allows “off-line” transactions as well
as on-line. The merchant’s terminal reads your account immediately, the transactions is stored for processing later-
usually within two or three days.

Benefits of Debit cards

 Obtaining a debit card is very easy. If you open a bank account, you can get a debit card.
 Debit cards are more readily accepted than cheques.
 It frees you from carrying cheques book or cash.
 When using debit card on does not have to show identification papers or given out personal information
during the course of transaction.
 This is of great use to international travelers from having to stock up on travelers cheques or cash
during their journeys.
 Difference between Credit Card and Debit Card:

Objectives Debit Card Credit Card

Definition Deducts money directly from your Allows you to borrow funds to pay for goods
saving’s bank account or your current and services.
account.

Source of funds Your savings bank account or current Credit extended to you by your card issuer. It
account. gives you access to money you otherwise do
not have (like a very short-term loan).

Spending advantage You can only spend how much you have. Can spend more than what you have.

Who pays for the You pay for your purchase. The credit card company pays the vendor for
purchase your purchase. You pay the credit card
company.

Bill There is no bill or statement You get a bill or statement each month with
details of the transactions you have made.

Payment There is no payment that needs to be made A bill needs to be paid each month since it is
since you are using your own money. being borrowed.

Fees and charges Annual fees and PIN regeneration fees are Credit cards have multiple fees applicable.
applicable. These include joining fees, annual fees, late
payment fees, and bounced cheque fees among
others.

Interest There is no interest that is charged. Interest is charged on the outstanding amount if
it hasn’t been paid by the due date.

Limit to funds that You can access any amount up to what is You can use the card only up to the pre-set
can be accessed currently available in your savings bank or credit limit on your card.
current account.

Rewards Typically, the rewards you get are minimal Get to enjoy cashback, air miles, and reward
points which can be redeemed.

Privileges Doesn’t come with many privileges. Come with numerous dining, retail,
entertainment, and travel privileges (depending
on the type of card you have).

Lost card liability Protection from theft or loss of the card is Most cards offer 100% lost liability protection.
minimal. So, you are not liable for any unauthorized
transactions made.
PERSONAL IDENTIFICATION NUMBER (PIN)
Personal identification number (PIN) is a numerical code used in many electronic financial transactions.
Personal identification numbers are usually issued in association with payment cards and may be required to
complete a transaction. The purpose of a personal identification number (PIN) is to add additional security to the
electronic transaction process.
 A personal identification number (PIN) is a numerical code issued with a payment card that is required to
be entered to complete various financial transactions.
 The core purpose of a personal identification number (PIN) is to provide an additional layer of security to
the electronic transaction process.
 Debit cards are the most common instance in which individuals will need to use a personal identification
number (PIN), primarily when they withdraw money from their bank account.
 As PINs are used to verify an individual's identity, they are also used in many other instances, such as home
security and mobile phones.
 It is recommended to choose a personal identification number (PIN) that is longer than shorter, hard to
guess, and not related to personal information, such as a birthday or Social Security Number.
 As merchant transactions are easy to complete with a card, the use of a personal identification number
(PIN) guards against any fraudulent behavior.

Personal identification numbers provide additional security on an account and are most commonly used with
debit cards linked to a person’s bank account. When a person is issued a debit card, they are required to choose a
unique personal identification number (PIN) that they will need to enter every time they wish to withdraw money
from an ATM and oftentimes when they make payments at various merchant stores.
As PIN is like passwords, they are also used in many other instances, such as home security and mobile phones.
A PIN is basically any numerical method used to verify an individual's identity.

ELECTRONIC FUND TRANSFER

The transfer of funds in India is practically done through Telegraphic transfer, Mail transfer and Drafts.
However, the courier services changed the situation but it is restricted to certain areas like, cities and metros.
Normally, the TT credit to be credited to the beneficiary account after 2 to 4 days. With the improved
technology in communication coupled with the privatization of banks necessitated the government to feel the
importance of Electronic Fund Transfer.

 The standard procedure for sending a TT electronically is as follows.

 Application should be obtained according to the standard procedure.
 Transmission of data will take place after inputting the data into the system.
 Interpreting the message at the received end.
 Downloading the data into the system for processing.

The advantage that one can get out of EFT is once the data is feed into the system, no manual intervention
takes place. However, for this the adoption of technology should be of very high level.
ELECTRONIC CLEARING SYSTEM

The introduction of MICR clearing in the Metropolitan Cities has paved the way for Credit Clearing, Debit
Clearing and Floppy Input Clearing Systems in the banking industry. The pre-requisite for a true Electronic Fund
Transfer (EFT) system is the full automation of the clearing house, the central settlement institutions as well the use
of electronic media for message transmission. Some progress has been made with the introduction of ECS and EFT
system in India.

RBI has introduced a special variant of Electronic Funds Transfer System in the form of an electronic
Clearing System (ECS). This is an up gradation to the paper based payment system and involves both the credit
transfer and the debit transfers. However, it is not true EFT system, as the processing is not entirely based on the
principles of EFT in the absence of proper infrastructure.

There are two types of Electronic Clearing Services called:

 Electronic Clearing Services Credit

 Electronic Clearing Services Debit

Electronic Clearing Services Credit

Electronic Clearing Services Credit is used for affording credit to a large number of beneficiaries by raising
a single debit to an account, such as dividend, interest or salary payment.

The cheques are generally issued by the corporate body that makes the payment to the same set of
beneficiaries on a periodical basis. This kind of transaction involves a single debit but multiple credit the
beneficiaries. The details of the payment are furnished on a magnetic tape or a floppy. The corporate body has to
pay service charges through their sponsor banks, to the bank maintaining the accounts of the beneficiaries. The bank
does not recover any additional charges from the beneficiaries.

Electronic Clearing Services Debit

Electronic Clearing Services Debit is used for raising debits to a number of accounts of consumers/account
holders for crediting a particular institution.

This service is operated on the principle of authorized debit. This system involves multiple debits and a
single credit. The customers who would like to utilize this service give a mandate to debit their accounts on receipt
of debit, clearing advice from Debit Clearing System. The consumer has an option to indicate a maximum limit for
each debit entry. The Telephone Department submits the details on magnetic media. The inter-bank funds settlement
is effected by debiting various banks and crediting the accounts of the Telephone Department.

CREDIT CREATION

Credit creation separates a bank from other financial institutions. In simple terms, credit creation is the expansion
of deposits. And, banks can expand their demand deposits as a multiple of their cash reserves because demand deposits
serve as the principal medium of exchange

Demand deposits are an important constituent of money supply and the expansion of demand deposits means the
expansion of money supply. The entire structure of banking is based on credit. Credit basically means getting the
purchasing power now and promising to pay at some time in the future. Bank credit means bank loans and advances.
Two most important aspects of credit creation are:

1. Liquidity – The bank must pay cash to its depositors when they exercise their right to demand cash
against their deposits.
2. Profitability – Banks are profit-driven enterprises. Therefore, a bank must grant loans in a manner
which earns higher interest than what it pays on its deposits.

Basic Concepts of Credit Creation

 Bank as a business institution – Bank is a business institution which tries to maximize profits through
loans and advances from the deposits.
 Bank Deposits – Bank deposits form the basis for credit creation and are of two types:
 Primary Deposits – A bank accepts cash from the customer and opens a deposit in his name. This
is a primary deposit. This does not mean credit creation. These deposits simply convert currency
money into deposit money. However, these deposits form the basis for the creation of credit.
 Secondary or Derivative Deposits – A bank grants loans and advances and instead of giving cash
to the borrower, opens a deposit account in his name. This is the secondary or derivative deposit.
Every loan crates a deposit. The creation of a derivative deposit means the creation of credit.
 Cash Reserve Ratio (CRR) – Banks know that all depositors will not withdraw all deposits at the same
time. Therefore, they keep a fraction of the total deposits for meeting the cash demand of the depositors and
lend the remaining excess deposits. CRR is the percentage of total deposits which the banks must hold in
cash reserves for meeting the depositors’ demand for cash.
 Excess Reserves – The reserves over and above the cash reserves are the excess reserves. These reserves
are used for loans and credit creation.
 Credit Multiplier – Given a certain amount of cash, a bank can create multiple times credit. In the process
of multiple credit creation, the total amount of derivative deposits that a bank creates is a multiple of the
initial cash reserves.

CREDIT CONTROL

 Credit control is a business strategy that promotes the selling of goods or services by extending credit to
customers.
 Most businesses try to extend credit to customers with a good credit history so as to ensure payment of the
goods or services.
 Companies draft credit control policies that are restrictive, moderate, or liberal.
 Credit control focuses on the following areas: credit period, cash discounts, credit standards, and collection
policy.
 A business's success or failure primarily depends on the demand for products or services. As a rule of
thumb, higher sales lead to bigger profits, which in turn leads to higher stock prices? A sale, a clear metric
in generating business success, in turn, depends on several factors.
 Some, like the health of the economy, are exogenous, or out of the company’s control, other factors are
under a company’s control. These major controllable factors include sales prices, product quality,
advertising, and the firm’s control of credit through its credit policy.
 In general, credit control seeks to extend credit to a customer to make it easier for them to purchase a good
or service. This strategy delays payment for the customer, making the purchase more attractive, or it breaks
the purchase price into installments, also making it easier for a customer to justify the purchase, though
interest charges will increase the overall cost.
Credit Control Factors

Credit policy or credit control primarily focuses on the four following factors:

 Credit period: Which is the length of time a customer has to pay

 Cash discounts: Some businesses offer a percentage reduction of discount from the sales price if the
purchaser pays in cash before the end of the discount period. Cash discounts present purchasers an
incentive to pay in cash more quickly.
 Credit standards: Includes the required financial strength a customer must possess to qualify for credit.
Lower credit standards boost sales but also increase bad debts. Many consumer credit applications use a
FICO score as a barometer of creditworthiness.
 Collection policy: Measures the aggressiveness in attempting to collect slow or late paying accounts. A
tougher policy may speed up collections, but could also anger a customer and drive them to take their
business to a competitor.

ROLE OF BANKS IN ECONOMIC DEVELOPMENT OF INDIA

Banking system is the driving force for all economic activities. Banks through their control over the volume
of money in circulation influence production, consumption and distribution. Banks play an active role in the
economic progress of a country, as they are the major instruments behind the mobilization of resources, investment
and on the operational efficiency of the various segments of the economy. The significance of the Banking System
in the process of Economic Development it as follows.

 Creation and controlling the circulation money.

 Promoting infrastructural facilities.
 Capital Formation.
 Rural Development.
 Providing long term loans and micro credits.
 Entrepreneurial development.
 Balancing international trade.
 Facilitating with a good medium of exchange.
 Assistance to agricultural and SSI.
 Acting as a bridge between various sectors.
 Instrument to implement monetary policy.
 Catalyst to social change.
 Mobilizing savings
 Incentive to investment
 Controlling trade cycle

Creation and controlling the circulation money.

Bank money forms a large part of the total quantity of money supply and forms the easiest means of
payment. Banks are popularly known s factories of credit, which in turn facilitates investment and there by leads to
economic progress.

Promoting infrastructural facilities.

Banks are playing vital role in developing comprehensive infrastructural facilities including the social,
educational, fiscal etc., in the country which is the lifeblood of economic development.
Capital Formation.

The capital formation depends upon the mobilisation of savings. The banks nowadays have brought out
novel schemes to encourage the habits of thrift. This capital mobilised by the banks is made available for productive
purposes, which in turn gives lots of scope for economic development.

Rural development

India is a land of villages. Banks adopt certain measures to improve rural areas and developmental
activities, which in turn, will develop the whole nation.

Provides long-term Loans and Micro Credits

Industrial development, which is the indicator for the economy, is made possible by the banks by giving
long-term loans to industries. This will develop the underdevelopment areas and empower women. It is the signal
for the economic development of a country.

Entrepreneurial Development

Banks have special schemes for encouraging entrepreneurial skill. This help the country in various ways
like increasing employment opportunities, improving production centers etc.

Balancing International Trade

Banks by helping entrepreneur increasing the export surplus and thereby improve the balance trade of the
country. The banks help the exporters by quickly obtaining money from foreign buyers and also by providing easy
credit to the exporters.

Acting as a Bridge between Various Sectors.

Banking system acts as a bridge between various sectors and thereby helps for overall economic
development of the country.

Instrument to Implement the Monetary Policy

The monetary policy of every country, which regulates the economy, is possible only with the help of a
well-organised banking system.

Incentive to Investment

Banks encourage the people in investing in all development activities like housing development, Industrials
development, Infrastructural development etc., by giving loans through various schemes, which lead to rapid
economic development.

Control of Trade Cycle

With the help of the effective banking system the government can control and regulate the circulation of
money and thereby controls the effect of the trade cycle to a certain level.
 UNIT – 3
Types of Bank Account

Savings Salary
Accounts Accounts

Current Bank
Fixed
Accounts Accounts Deposit
s Accounts

Recurring
NRI
Deposit
Accounts
Accounts

Current account
Current account is a deposit account for traders, business owners, and entrepreneurs, who need to make and
receive payments more often than others. These accounts hold more liquid deposits with no limit on the number of
transactions per day. Current accounts allow overdraft facility, that is withdrawing more than what is currently
available in the account. Also, unlike savings accounts, where you earn some interest, these are zero-interest bearing
accounts. You need to maintain a minimum balance to be able to operate current accounts.
Savings account
Savings bank account is a regular deposit account, where you earn a minimum rate of interest. Here, the
number of transactions you can make each month is capped. Banks offer a variety of Savings Accounts based on the
type of depositor, features of the product, age or purpose of holding the account, and so on.
Salary account
Among the different types of bank accounts, your salary account is the one you have opened as per the tie-
up between your employer and the bank. This is the account, where salaries of every employee are credited to at the
beginning of the pay cycle. Employees can pick their type of salary account based on the features they want. The
bank, where you have a salary account, also maintains reimbursement accounts; this is where your allowances and
reimbursements are credited to.
Fixed deposit account
To park your funds and earn a decent rate of interest on it, there are different types of accounts like fixed
deposits and recurring deposits. A fixed deposit account allows you to earn a fixed rate of interest for keeping a
certain sum of money locked in for a given time, that is until the matures
Recurring deposit account
A recurring deposit has a fixed tenure. You need to invest a fixed sum of money in it regularly -- every
month or once a quarter -- to earn interest. Where you need to make a lump sum deposit, the sum you need to invest
here is smaller and more frequent.
NRI accounts
There are different types of bank accounts for Indians or Indian-origin people living overseas. These
accounts are called overseas accounts.
SAVINGS ACCOUNT

Savings account refers to an account that is meant for people who keep their saving to fulfill their financial
requirements in future. It allows earning interest on the balance maintained.

Savings bank account is a regular deposit account, where you earn a minimum rate of interest. Here, the
number of transactions you can make each month is capped. Banks offer a variety of Savings Accounts based on the
type of depositor, features of the product, age or purpose of holding the account, and so on.

Features of saving account

Account Opening
In nationalized banks, the minimum amount for account opening is Rs.100/- and for many of the private
banks is Rs.500/-.
Number of Applicants
The account can be either opened individually or jointly with another individual. The cheques can be
signed by any of the joint holders for withdrawal of funds, however, the account closure form has to be signed
jointly by all the account holders.
Rate of Interest
Initially banks used to pay interest on the lowest balances in the savings account between the 11th and last
day of the month. From April 2010, the interest is calculated on a daily basis on the balances in the account and the
bank interest paid, varies from 3.5% to 6%. The RBI monitors interest rate only upto Rs.2lacs. Over Rs.2 lacs, the
bank can decide the rate of interest to be paid to the account holder.
Transaction Limitations
The transaction refers to the withdrawals or the deposits made in the account. There are usually no
limitations on transactions in savings account but few banks do assign limitations.
Minimum Amount in Account
All banks specify a minimum average balance to be maintained in the account. However, some banks
immediately penalize the holders for withdrawals below the minimum required balances.
ATM/Debit Card facility
On opening of the account, the ATM/debit card is provided to each of the account holders. This card can be
used withdrawing money from the bank at any time 24x7 and also enables purchases from stores.
Online Services
With all banks having online services now, it is easier to access account balances or carry out transactions
online.
 CURRENT ACCOUNT

An investor is also given the option of having a current account in the bank for maintaining liquidity. A
current account is usually opened by a business house of this current account; the account holder is permitted to
draw according to a fixed limit provided by the banker in agreement with the account opening association. In India,
it is not only prestigious but also convenient to open a current account. This does not carry the benefit of any
interest. In fact, interest is charged by the bank for using this facility.

Features of Current Account

The main features of current account are as follows:-

 Current bank accounts are operated to run a business.

 It is a non-interest bearing bank account.
 It needs a higher minimum balance to be maintained as compared to the savings account.
 Penalty is charged if minimum balance is not maintained in the current account.
 It charges interest on the short-term funds borrowed from the bank.
 It is of a continuing nature as there is no fixed period to hold a current account.
 It does not promote saving habits with its account holders.
 Banker requires KYC (Know your Customers) norms to be completed before opening a current account.
 The main objective of current bank account is to enable the businessmen to conduct their business
transactions smoothly.
 There is no restriction on the number and amount of deposits.
 There is also no restriction on the number and amount of withdrawals made, as long as the current account
holder has funds in his bank account.
 Generally, bank does not pay any interest on current account. Nowadays, some banks do pay interest on
current accounts.
Types of Current Accounts:

Standard Current Foreign Currency

Accounts Account

Types of Current Package Current

Single Column Cash
Accounts Account
Book

Premium Current Basic Current

Account Accounts
  Standard Current Accounts
 Basic Current Accounts
 Premium Current Account
 Package Current Account
 Foreign Currency Account
 Single Column Cash Book

Standard Current Accounts

This type of account requires the customer to maintain a minimum monthly average balance. The account
does not provide any interest on the deposited amount. However, it provides cheque book facility, debit card,
overdraft facility etc. to its customers.
Basic Current Accounts
It is ideal for customers with low wage income like pensioners, young people etc. It helps the customers to
manage their finances rather easily. However, there are some restrictions on the daily cash withdrawal limit.
Premium Current Accounts
This is a kind of account that comes with exclusive offers and benefits to the customers. This account is
best suited for carrying out large value transactions.

Packaged Current Accounts

This current account type provides the account holders with lots of perks and benefits. It comes with
exclusive features like medical support, travel insurance and more.
Foreign Currency Accounts
Foreign Currency Accounts are offered to NRIs or individuals who want to carry out frequent transactions
in foreign currencies.
Single Column Cash Book

This type is more of a cashbook that allows transaction but doesn’t offer other features such as overdraft
facility. It records daily transactions under separate debit and credit columns.

Difference between Saving Account & Current Account

BASIS FOR SAVING ACCOUNT CURRENT ACCOUNT

DIFFERENCE
Saving bank account is an account
Current account refers to a running account,
meant for individuals who like to
Meaning in which there is no limit on the operation,
save for meeting their future
during a working day.
financial requirements.
To support frequent and regular
Objective To encourage savings of a person.
transactions.
Suitable for Individual Businessman or company
Interest Paid Not paid
Withdrawals Limited Unlimited
Passbook Provided by banks Not issued by banks.
Overdraft Not allowed Allowed
Less amount is required to open a High amount is required for opening a
Opening balance
savings bank account Current account
TYPES OF DEPOSIT ACCOUNT

Fixed Deposit Account

 The account which is opened for a particular fixed period (time) by depositing particular amount (money)
is known as Fixed (Term) Deposit Account.
 The term 'fixed deposit' means that the deposit is fixed and is repayable only after a specific period is over.
 Under fixed deposit account, money is deposited for a fixed period say six months, one year, five years or
even ten years. The money deposited in this account cannot be withdrawn before the expiry of period.
 The rate of interest paid for fixed deposit vary (changes) according to amount, period and from bank to
bank.
 A Fixed Deposit Receipt (FDR) is nothing but a document provided by the bank after the applicant
procures a FD scheme from their bank. This document contains details such as the individual’s name, age,
address, details of the scheme chosen by them such as deposit amount, tenure and interest rate applicable
on the deposit and so on.
Features of Fixed Deposit Account
The main features of fixed deposit account are as follows:-
1. The main purpose of fixed deposit account is to enable the individuals to earn a higher rate of interest on
their surplus funds (extra money).
2. The amount can be deposited only once. For further such deposits, separate accounts need to be opened.
3. The period of fixed deposits range between 15 days to 10 years.
4. A high interest rate is paid on fixed deposits. The rate of interest may vary as per amount, period and from
bank to bank.
5. Withdrawals are not allowed. However, in case of emergency, banks allow to close the fixed account prior
to maturity date. In such cases, the bank deducts 1% (deduction percentage many vary) from the interest
payable as on that date.
6. The depositor is given a fixed deposit receipt, which depositor has to produce at the time of maturity. The
deposit can be renewed for a further period.
Advantages of Fixed Deposit Account
 The advantages of fixed deposit account are as follows:-
 Fixed deposit encourages savings habit for a longer period of time.
 Fixed deposit account enables the depositor to earn a high interest rate.
 The depositor can get loan facility from the bank.
 On maturity the amount can be used to make purchases of assets.
 The bank can get the funds for a longer period of time.
 The bank can lend such funds for short term loans to businessmen.
 Fixed deposits indirectly boost economic development of the country.
 The bank can also invest such funds in profitable areas.

Recurring deposit Account:

Recurring deposit account is opened by those who want to save regularly for a certain period of time and
earn a higher interest rate. In recurring deposit account certain fixed amount is accepted every month for a specified
period and the total amount is repaid with interest at the end of the particular fixed period.
Features of Recurring Deposit Account:
 The main features of recurring deposit account are as follows:-
 The main objective of recurring deposit account is to develop regular savings habit among the public.
 In India, minimum amount that can be deposited is Rs.10 at regular intervals.
 The period of deposit is minimum six months and maximum ten years.
 The rate of interest is higher.
 No withdrawals are allowed. However, the bank may allow closing the account before the maturity period.
 The bank provides the loan facility. The loan can be given up to 75% of the amount standing to the credit
of the account holder.
 The bank can utilize such funds for lending to businessmen.
 The bank may also invest such funds in profitable areas.
 The Recurring Deposit can be funded periodically through Standing Instructions which the instructions are
given by the customer to the bank to credit the Recurring Deposit account every month from his/her
Savings or Current account.

Procedure for opening of an account:

Following precaution must be adopted by the banker while opening an account:

 Examination of trust deed.
 A banker should study the deed carefully.
 Objectives of the trust.
 Appointments and powers of the trustees, rights of trustees.
 Names of trustees, and their limitation of powers.
 A banker must open the account in the name of trust.
 All the trustees should sign on the application form and signatures card.
 The banker should get clear instructions that who will operate the account.
 A banker must study the provisions related to delegation of powers of trustees.
 The banker must study the legal provisions also in regard to the advancing loan.
Types of Bank deposit customers:
Minor
Lunatics
Types of Deposit Customers
Illiterate Persons
Blind Persons

Individual Customers
Joint Hindu Firm

Partnership Firm
Firm Customers

Companies
Joint Stock
Companies

Individual Customer
It is an account opened by one person in his/her own and individual capacity. Such type of accounts are maintained
and operated upon only by the single person who has opened the account. This sole and single person is the
customer of the bank.
 Minors.
 Lunatics.
 Illiterate Persons.
 Blind Persons.

Minor Customers:
A minor is a person who has not completed 18 years of age. In case a guardian of his person or property is
appointed by a court of law before he completes his 18 years, the period of minority is extended to the completion of
21 years. As per section 11 of the contract act a minor is incompetent to contract but section 26 of the Negotiable
Instrument Act allows a minor to draw, endorse, deliver and negotiate a negotiable instrument .
However, a contact on behalf of a minor can be, entered into by his guardian.
The Guardian to a minor can be:
 Natural Guardian.
 Legal Guardian.
 Testamentary Guardian

Lunatics
A person of unsound mind cannot make a valid contract. So, the bankers should not open an account in the name of
a person of unsound mind. But a customer may become lunatic after opening an account with the bank.
Illiterate persons
An illiterate person means a person who can’t sign his name. While opening of an account of such a person
is unavoidable, the banker should obtain. Left thumb impression on the account opening form and specimen
signature card in the presence of an authorized bank official (2) Details of identification marks should be noted on
the account opening form and specimen signature card (3) At least two copies of photograph duly attested by any
account holder/authorized bank official.

Blind Customer:
A blind person can be literate and also illiterate but there is no bar for these persons to open an account
with any bank. The Banks take some extra precautions while opening the accounts of blind persons as they cannot
see. In case of blind persons all the terms and conditions of KYC norms are adhered to very strictly. Besides
obtaining thump impression or signatures of such persons in the account opening form and on the specimen
signature slips the words BLIND PERSON are written very boldly.

Firm Customers

 Joint Hindu Families.

 Partnership Firms.
Joint Hindu Family
Joint Hindu Family also known as Hindu Undivided family is a legal entity and is unique for Hindus. It has
perpetual succession like companies; but it does not require any registration. The head of Joint Hindu Family is the
Karta and members of the family are called co-percenters. The Joint Hindu Family business is managed by Karta.
Partnership firms
A partnership is not a legal entity independent of partners. It is an association of persons. Registration of a
partnership is not compulsory under Partnership Act. However, many banks insist on registration of a partnership. In
any case, i.e., stamped partnership deed or Partnership letter should be taken when an account is opened for a
partnership. The partnership deed will contain names of the partners, objective of the partnership, and other
operational details, which should be taken note of by the bank in its dealings.
While opening the partnership account following precautions must be taken by the banker:

 The account must be opened in the name of firm.

 Partnership deed and changes made in it time to time must be studied carefully by the banker.
 It is necessary that all the partners should sign on all the documents.
 All the instructions about the operation of the account must be signed by all the partners.
 The specimen signatures on cards must be taken from the partners and authorized person who will operate
the accounts.
 In case of advancing loan and execution of guarantee deed the banker will obtain the signatures of all the
partners.
 A banker must observe the various provisions of Partnership Act in case of death, entry or withdrawal of
any partner.
 A declaration and consent must be taken by the banker from all the partners in regard to the drawing and
disbursement.
Companies

Joint stock companies

A company is registered under companies Act has a legal status independent of that of the share-holders. A
company is an artificial person who has perpetual existence with limited liability and common seal. Memorandum
and Articles of Association, Certificate of Incorporation, Resolution passed by the Board to open account, name and
designations of persons who will operate the account with details of restriction placed on them are the essentials
documents required to open an account.
Precautions to be taken:
1. Checking of documents

 A banker must check the following documents of the certificates of incorporation. It is issued by the
registrar of Joint Stock Company
 Certificate of business commencement.
 Memorandum of Association.
 Articles of Association.

2. Checking of resolution
Resolution of the company must be checked. It must be signed by the chairman and secretary of
the company. It must contain the following documents: i. the name of authorized persons who will operate
the account of the company. ii. The name of persons who will execute the documents on behalf of the
company. iii. All types of conditions related to powers about borrowing lending, mortgaging delegated by
the company must be checked carefully by the banker.

3. Directors accounts in the same bank

 Accounts of company and personal accounts of the directors should be in the same bank.
 Bankers should keep an eye that there should be no wrongful conversion of funds between the two.

4. Checking of Limit
A banker must check that a company may not use the power of borrowing than the fixed limit.

5. Winding up Case
If company is wound up and liquidator is appointed the banker will stop the payments till the
instructions of the liquidator.

6. Charges with in prescribed limit

The banker of a company will also check that company has got the charges of mortgages within the
prescribed limit or not.
 Importance of Customer Relationship Management
 Improved Customers Retention

Gaining a new customer is a critical job for banks. In this tough market conditions, retaining the existing
customer becomes crucial to have a grip on this competitive sector. Customers’ retention can be accomplished
through enhanced customer satisfaction and loyalty. Customer relationship management in banking is capable of
retaining customers. It can convert a mere account holder into a loyal, satisfied and fruitful customer.
 Boosted Sales

Sales have become an important part of banks with the Customer relationship management evolution.
Customer relationship management assists banks in sales management with its sales module. It helps you identify
and convert leads into prospective customers. Customer relationship management assists in the acquisition of new
customers through the use of past track records and value they brought to the bank.
 More Effective Marketing Efforts

Customer relationship management makes the efforts of marketing department more productive. Customer
relationship management generates report highlighting customers’ touch and data points, purchase behavior,
engagement channels and much more. With this information, marketing teams can develop new marketing
opportunities for engagement and retention. Customer relationship management strengthens marketing strategies
through proper segmentation, focused targeting and automation.
 Increased Productivity

With a complete data of customers on a single screen, bankers now can spend more time on strengthening
their customer relationships than spending on gathering and organizing data. Customer relationship management
increases productivity by reducing cost through minimizing or eliminating repetitive tasks. With the right
technology in place, bankers are able to handle more customers account in less time than before, making them
more productive.
 Personalized Customer Relationships

The Customer relationship management ultimate objective is to handle customers on a personalized level,
as apparent identity. It is difficult to keep track of and follow up each individual customer data and look at trends.
Customer relationship management overcomes this difficulty, by letting bankers provide personalized services to
its every customer. You can see about need, preferences and the behavior of each customer on a single platform
and then plan your marketing strategy.
 Efficient Communication

Bank call centers are using Customer relationship management software for many purposes. Customer
relationship management is automating communication and interactions with customers. A Customer relationship
management also helps banks to monitor conversations about their brand and products across different online
media. It is also assisting in inter-department communication.
 Better Customer Service and Experience

Customer relationship management provides deeper insights into customers’ data, thus enabling greater
customer support service. It provides better customer service via quick automated response to customers’ queries,
facilitating services relevant to them. Customer relationship management aids in improving customer experience.
Customer relationship management and banks together create better customer experience through assisting in
knowing what customer desires, furnishing quick support, building personal relationships and then maintaining an
ongoing journey.
Ombudsman

 The Banking Ombudsman Scheme is an expeditious and inexpensive forum for bank customers for
resolution of complaints relating to certain services rendered by banks. The Banking Ombudsman Scheme
is introduced under Section 35 A of the Banking Regulation Act, 1949 by RBI with effect from 1995.
 The Banking Ombudsman is a senior official appointed by the Reserve Bank of India to redress customer
complaints against deficiency in certain banking services covered under the grounds of complaint specified
under Clause 8 of the Banking Ombudsman Scheme 2006.
 All Scheduled Commercial Banks, Regional Rural Banks and Scheduled Primary Co-operative Banks are
covered under the Scheme.
 UNIT-4
Negotiable Instrument

Justice K.C. Wills, in his book on ‘Negotiable Securities’ defines “negotiable instrument as one the
property which is acquired by anyone who takes it benefice and for value now with standing any defect in the title of
person from whom he took it and from which it follows.” An instrument cannot be termed as negotiable unless it is
such a state that the true owner could transfer that contract or engagement contained therein by simple delivery of
the instrument.
Major features of negotiable instruments

Easy Transferability
A negotiable instrument is freely transferable. Usually, when we transfer any property to somebody, we are
required to make a transfer deed, get it registered, pay stamp duty, etc. But, such formalities are not required while
transferring a negotiable instrument. The ownership is changed by mere delivery (when payable to the bearer) or by
valid endorsement and delivery (when payable to order). Further, while transferring it is also not required to give a
Notice to the previous holder.
Title
Negotiability confers absolute and good title on the transferee. It means that a person who receives a
negotiable instrument has a clear and undisputable title to the instrument. However, the title of the receiver will be
absolute, only if he has got the instrument in good faith and for a consideration. Also the receiver should have no
knowledge of the previous holder having any defect in his title. Such a person is known as holder in due course.
Must be in writing
A negotiable instrument must be in writing. This includes handwriting, typing, computer printout and
engraving, etc.
Unconditional Order
In every negotiable instrument there must be an unconditional order or promise for payment.
Payment-
The instrument must involve payment of a certain sum of money only and nothing else. For example, one
cannot make a promissory note on assets, securities, or goods.
The time of payment must be certain
It means that the instrument must be payable at a time which is certain to arrive. If the time is mentioned as
‘when convenient’ it is not a negotiable instrument. However, if the time of payment is linked to the death of a
person, it is nevertheless a negotiable instrument as death is certain, though the time thereof is not.
The payee must be a certain person
It means that the person in whose favor the instrument is made must be named or described with reasonable
certainty. The term ‘person’ includes individual, body corporate, trade unions, even secretary, director or chairman
of an institution. The payee can also be more than one person.
Signature
A negotiable instrument must bear the signature of its maker. Without the signature of the drawer or the
maker, the instrument shall not be a valid one.
Delivery
Delivery of the instrument is essential. Any negotiable instrument like a cheques or a promissory note is
not complete till it is delivered to its payee. For example, you may issue a cheques in your brother’s name but it is
not a negotiable instrument till it is given to your brother.
Stamping
Stamping of Bills of Exchange and Promissory Notes is mandatory. This is required as per the Indian
Stamp Act, 1899. The value of stamp depends upon the value of the promote or bill and the time of their payment.
Right of file suit
The transferee of a negotiable instrument is entitled to file a suit in his own name for enforcing any right or
claim on the basis of the instrument.
Notice of transfer
It is not necessary to give notice of transfer of a negotiable instrument to the party liable to pay.

Promissory Note

Definition

A Promissory Note, as the name itself gives a brief description, is a legal financial instrument issued by one
party, promising to pay the debt owed to another party. It is a written negotiable instrument duly signed by the
maker that contains an unconditional promise to pay the stated sum of money to a particular person or to any other
person, on the order of that particular person, either on-demand or on a specified date, under given terms. It is a
short-term credit instrument which does not amount to a banknote or a currency note.

Essential features of promissory note

The essential elements of promissory notes are as follows:
 In writing
A promissory note must be in writing. It cannot be verbal promise to pay or in any other way.
 Promise to pay
It is a promise to pay it cannot be an order or request for the payment of money
 Unconditional promise
A promissory note contains an unconditional promise to pay.
 Signed by the maker
This document must be signed by the maker. If it is not signed by the maker it cannot become a
promissory note. If the maker cannot sign he can put his thumb mark.
 Fixed amount
The amount of a promissory note is fixed and certain. A document containing the words promise
to pay B a sum of money which shall be due to him” is not a promissory note.
 Payable in money
The amount of promissory note is payable in money and money only. It cannot be paid in goods or
something else.
 Payment period
The promissory note is payable on demand or at some determinable future time.
  Maker must be certain person
The maker must be a certain person. The maker may be one or more persons. When promisors are
more than one, they may bind themselves jointly or jointly and severally.
 Payee must be certain
A promissory note must be payable to a certain person whose name is written on the document or
to his order. If it is endorsed by him, it becomes payable to the bearer. It cannot be payable to the maker of
the note himself.
 Place and date
The place and date of issue are usually given on the instrument, but they are not essential in the
eyes of law.

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 the order of, a certain person, or to the bearer of the
instrument.
Section 5 of the Negotiable Instruments Act, 1881.

Features of Bills of Exchange

The features of bills of exchange are:

 It should be in writing.
 It is an order to make payment.
 The order of payment is unconditional.
 It should contain a certain amount to be paid.
 The date of payment should be certain.
 The amount must be payable either to a certain person or to his order or to the bearer of the bills of
exchange.
 It should be paid either on the expiry of a fixed period of time or on demand.
 Bill of exchange must be signed by its maker.
 In certain cases, it must be stamped also.

Contents of Bills of Exchange:

The contents of bills of exchange are as under:

 Date
The date of the bill on which it is drawn should be written on the top right comer of the bill. This aspect is
very important to determine the maturity date of the bill.
 Term
This is the tenure of the bill and runs from the date of the bill. This should be specified in the body of the
bill. Grace period of three days should be given after the expiry of the term from the date of the bill.
 Amount
Amount of the bill should be given both in figures and words. Amount in figures should be mentioned on
the top left corner of the bill and amount in words should be mentioned in the body of the bill.
 Stamp
Stamp of proper value which depends on the amount of bill shall be affixed on the bills of exchange.
 Parties
There may be three parties to the bills of exchange, drawer, drawee and payee. However, in some cases
drawer and payee may be the same person. All the names of the parties and their addresses should also be
invariably mentioned in the bills of exchange.
 For Value Received
This aspect is most important in the sense that law does not consider those agreements which have been
made without consideration. Consideration means in lieu of and in the context of bills of exchange, it means that
the bill has been issued in exchange of some consideration i.e., benefit has already been received.
CHEQUE

Cheques is an instrument in writing containing unconditional order, drawn on a banker, sign by the drawer,
and payable on demand. It is used to withdraw money deposited in the bank.

Following are the essentials of a cheque.

 It must be in writing.
 It must be drawn on a banker.
 It must be in the form of an order.
 The order must be unconditional.
 It must be signed by the drawer.
 It must be payable on demand.
 The amount in the cheques must be certain sum of money.
 The payment must be made to a person, bearer, or self.

Parties to a Cheque:

Drawer

Parties
of
Cheque

Payee Drawee
  Drawer
Drawer is the person who draws the cheque, i.e., the depositor of money in the bank.
 Drawee
Drawee is the drawer’s banker on whom the cheque has been drawn.
 Payee
Payee is the person who is entitled to receive the payment of a cheque.

Types of Cheques

 Bearer Cheque
When the words "or bearer" appearing on the face of the cheque are not cancelled, the cheque is called a
bearer cheque. The bearer cheque is payable to the person specified therein or to any other else who presents it to the
bank for payment. However, such cheques are risky, this is because if such cheques are lost, the finder of the cheque
can collect payment from the bank.
 Order Cheque
When the word "bearer" appearing on the face of a cheque is cancelled and when in its place the word "or
order" is written on the face of the cheque, the cheque is called an order cheque. Such a cheque is payable to the
person specified therein as the payee, or to any one else to whom it is endorsed (transferred).
 Uncrossed / Open Cheque
When a cheque is not crossed, it is known as an "Open Cheque" or an "Uncrossed Cheque". The payment
of such a cheque can be obtained at the counter of the bank. An open cheque may be a bearer cheque or an order
one.
 Crossed Cheque Crossing of cheque means drawing two parallel lines on the face of the cheque with or without
additional words like "& CO." or "Account Payee" or "Not Negotiable". A crossed cheque cannot be encased at the
cash counter of a bank but it can only be credited to the payee's account.
 Anti-Dated Cheque
If a cheque bears a date earlier than the date on which it is presented to the bank, it is called as "anti-dated
cheque". Such a cheque is valid up to three months from the date of the cheque.
 Post-Dated Cheque
If a cheque bears a date which is yet to come (future date) then it is known as post-dated cheque. A
postdated cheque cannot be honored earlier than the date on the cheque.
 Stale Cheque
If a cheque is presented for payment after three months from the date of the cheque it is called stale cheque.
A stale cheque is not honored by the bank.
 Mutilated Cheque
A cheque which is torn into pieces is called Mutilated cheque.
 Pay Order
When a bank orders another bank to pay a certain sum of money to a third party it is called pay order. It is
applicable for payment within a city. The bank issues a pay order to the person who request for it and deposits sum
equal to pay order plus bank charges. Pay order provides guarantee that payment will be made by bank. It is also
known as banker’s cheque.
 Demand Draft
It is a cheque issued by one bank in one city or country to another city’s or country’s bank in favor of a
third person. It cannot be dishonored as the amount is paid before. It is generally used to make payment outside a
city
DRAFTS
The term bank draft refers to a negotiable instrument that can be used as payment just like a check. Unlike
a check, though, a bank draft is guaranteed by the issuing bank. The total amount of the draft is drawn from the
requesting payer's account—their bank account balance decreases by the money withdrawn from the account—and
is usually held in a general ledger account until the draft is cashed by the payee. Bank drafts provide the payee with
a secure form of payment.

 A bank draft is a negotiable instrument where payment is guaranteed by the issuing bank.
 Banks verify and withdraw funds from the requester's account and deposit them into an internal account to
cover the amount of the draft.
 A seller may require a bank draft when they have no relationship with the buyer.
 Banks normally charge a fee for a bank draft.

Definition

 A check is a written, dated, and signed instrument that directs a bank to pay a specific sum of money to
the bearer.
 It is another way to instruct a bank to transfer funds from the payer’s account to the payee or that person's
account.
 Check features include the date, the payee line, the amount of the check, the payer’s endorsement, and a
memo line.
 Types of checks include certified checks, cashier’s checks, and payroll checks, also called paychecks.
 Features

1. Must be in Writing

The cheque may be written in hand by using ink or ballpoint pen, typed or even it may be printed. But the
customer should not use pencil to fill up the cheque form. Even though other columns may be permitted to be
written in hand or printed or typed, the signatures should be made by ink pen or ballpoint pen by the maker.

2. Must be Unconditional

The order to pay the amount must be unconditional. If there is any condition imposed to pay the amount to
the holder of the cheque then it will not be considered as a cheque. A cheque made payable on the happening of a
contingent event is void ab-initio.

3. Must be Drawn on a Specified Banker

For the validity of a Cheque it must be drawn on a specified banker. If there is not mentioned in the cheque
about the banker it would not be a valid cheque. In addition to it, it must contain all the three parties i.e. Drawer,
Drawee and Payee.

4. Certain Sum of Money

It is one of the essential requirement of the Cheque that it must be payable in money and money only. If is
not in term of money then it will be a valid one. The sum mentioned in it must be certain.

5. Certain Payee

The parties of the Cheque must be certain. There are three parties of the cheque i.e. Drawer, Drawer and
Payee. In a valid Cheque the name of the must contain in other words they must be certain. It must contain an order,
which must be unconditional. If any condition were imposed then it would not be a valid cheque.

6. Date

In a valid cheque it must be signed by the drawer with date otherwise it would not be a valid cheque. It
must be written in hand by using ink or ball point pen, typed or even it may be printed as it becomes conclusive
proof i.e. presumption under Section 118(b) unless contrary is proved.

Crossing

Crossing a cheque means direction given by the drawer (maker) of the cheque to the drawee bank, not to pay the
cheque at the counter of the bank, but to pay it to a person who presents it through a banker. The purpose of crossing
is to make possible to trace the person to whom the payment has been made. Thus, it makes the cheque safe. So let
us discuss the various crossing tools to safeguard a cheque in India.

 GENERAL CROSSING
In this type of crossing the cheque must contain two parallel transverse lines. They could be put anywhere
on the cheque. Generally we put it on top left of the cheque. The effect of this crossing is that the cheque must be
paid only to the banker.
 SPECIAL CROSSING
The cheque must contain the name of the banker. It may be made only once. The effect of this crossing is
that the cheque must be paid only to the banker to whom it is crossed. Please note that special crossing cannot be
converted into general crossing.
 NOT NEGOTIABLE CROSSING
In this type of crossing, the cheque must contain the words ‘not negotiable’. The cheque must be crossed
generally or specially. The effect of this crossing is that the cheque nevertheless remains negotiable
(transferrable) and the title of the transferee shall not be better than title of transferor.
 ACCOUNT PAYEE CROSSING
This is also called restrictive crossing. The cheque must contain the words ‘account payee’ or ‘account
payee only’. The cheque must be crossed generally or specially. The effect of this type of crossing is that the
cheque does not remain negotiable anymore.

Endorsement
Endorsement means signing at the back of the instrument for the purpose of negotiation. The act of the
signing a cheque, for the purpose of transferring to the someone else, is called the endorsement of Cheque. Section
15 of the Negotiable Instrument Act 1881 defines endorsement. The endorsement is usually made on the back of the
cheque. If no space is left on the Cheque, the Endorsement may be made on a separate slip to be attached to the
Cheque.

There are six Kinds of Endorsement

 Endorsement in Blank / General
 Endorsement in Full / Special
 Conditional Endorsement
 Restrictive Endorsement
 Endorsement Sans Recourse
 Facultative Endorsement.

Definition of Endorsement
Endorsement When the maker or holder of a negotiable instrument signs the same, otherwise than as such
maker, for the purpose of negotiation on the back or face thereof or on a slip of paper annexed thereto, or so signs
for the same purpose a stamped paper intended to be completed as a negotiable instrument, he is said to endorse the
same, and is called the “endorser”.
Kinds of Endorsement -
Endorsement is essentially is of two kinds - Endorsement in Blank and Endorsement in full. According to
Section 16 of the Negotiable Instrument Act, 1881, If the endorser signs his name only, the endorsement is said to be
“in blank”, and if he adds a direction to pay the amount mentioned in the instrument to, or to the order of, a specified
person, the endorsement is said to be “in full”, and the person so specified is called the “endorsee” of the instrument.
There are some other kinds which are constitutional but not very popular which are given below
Endorsement in Blank / General -
An endorsement is said to be blank or general when the endorser puts his signature only on the instrument
and does not write the name of anyone to whom or to whose order the payment is to be made.
Endorsement in Full / Special -
An endorsement is 'special' or in 'full' if the endorser, in addition to his signature also mention the name of
the person to whom or to whose order the payment is to be made. There is direction added by endorse to the person
specified called the endorsee, of the instrument who now becomes its payee entitled to sue for the money due on the
instrument.
Conditional Endorsement -
The conditional endorsement is negotiation which takes effect on the happening of a stated event, or not
otherwise. Section 52 of the Negotiable Instrument Act 1881 provides – The endorser of a negotiable instrument
may, by express words in the endorsement, exclude his own liability thereon, or make such liability or the right of
the endorsee to receive the amount due thereon depend upon the happening of a specified event, although such event
may never happen. Where an endorser so excludes his liability and afterwards becomes the holder of the
instrument all intermediates endorsers are liable to him.
Restrictive Endorsement -
Restrictive endorsement seeks to put an end the principal characteristics of a Negotiable Instrument and
seals its further negotiability. This may sound a little unusual, but the endorsee is very much within his rights if he
so signs that its subsequent transfer is restricted.
Endorsement sans Recourse -
Sans Recourse which means without recourse or reference. As such a when the property in a negotiable
instrument is transferred sans recourse, the endorser, negatives his liability and excludes him from responsibility to
all subsequent endorsees. It is one of the commonest forms of qualified endorsement and virtually prohibits
negotiation since the endorser says in effect.
Facultative Endorsement -
Facultative Endorsement is an endorsement where the endorser waives some right to which he is entitled.
For example, the endorsee is liable to give notice of dishonor to the endorser and normally failure to give notice will
absolve the endorser from his liability.

Material Alternation

Material alteration means to make any change or alter some material parts of the instrument and try to
make it a valid created with the purpose of the nature of that instrument. Any alteration in the original state of a
cheque such as date, amount, payee’s name, changing the word ‘order’ to bearer appearing after payee’s name or in
endorsement is called material alteration.
Material alteration is one aspect of a negotiable instrument. Material alteration may change the character of
the instrument or the rights and obligations of the parties. An original instrument can be said to be an altered
instrument after it has been altered.
Material alteration occurs when changes have occurred to the instrument without the drawer’s knowledge,
and changes made after the cheque has been issued. Where the nature of the instrument has changed by alterations
made in the instrument, it is equivalent to a physical change. All physical changes must have the approval of the
drawer with his full signature where the changes are made. Without the permission and consent of the drawer, a
blank cheque cannot be enforced.

DISHONOR OF CHEQUE
Bank can dishonor the cheque due to following reasons.
Irregular signature:
When the drawer signature does not match with the signature bank has in its record. The bank will not accept the
cheque for payment.
Insufficient Amount:
When the fund is not enough in drawer’s account to meet the cheque for payment, the cheque will be bounced.
However, in case of overdraft facility, bank can accept the cheque.
Insanity:
The bank will not accept the cheque, if the accountholder gets insane and bank receives notice of insanity.
Bankruptcy:
When the accountholder is unable to pay of his debts in full, and this bankruptcy is declared by the court of law, the
bank will not honor a cheque presented on behalf of such accountholder.
Post-dated Cheque:
When a cheque is presented to the bank for payment before the date written on it is called posted-dated cheque. This
kind of cheque cannot be cashed till that date arrives.
Stale Cheque:
The cheque which is older than six months is known as stale cheque. The bank does not accept such a cheque.
Death:
When the accountholder draws a cheque, and before it is presented to the bank, he dies, and bank receives such
information, the bank will dishonor the cheque.
Frozen Account:
If the customer account is frozen by the court of law, the bank will not honor the cheque on behalf of that customer.
Drawer’s Revocation
If the accountholder draws a cheque and issues it, after he directs bank not to make payment for such a cheque, the
bank will not accept it.
Alteration
If any alteration in the cheque is made and is not confirmed by the drawer by his signature, the bank will dishonor it.

PAYING BANKER

Paying banker is a banker, who actually pays a cheque to his customer or to the order of his customer.
For example, a customer draws a cheque on his banker. How it is done?
 First, he writes the date
 Then he indicates the name of the person to whom the cheque is to be paid.
 Then he writes the amount to be paid, in words (Eg: Rupees one Thousand Only ….etc.,)
 Then, the amount in figures is filled in the box
 Lastly, the account holder puts his signature (Account Holder is the Bank Customer)
 The bank customer hands over the cheque to his Trade customer (Cheque is valid for three months from
date of drawing)
 When the trade customer i.e., person who received the cheque, take efforts to present the same to his bank
for collection (or) to the Drawer’s banker to receive payment, the payment process is said to have started.

DUTIES AND RESPONSIBILITIES OF A PAYING BANKER:-

A banker has an obligation to honor cheques of its customer, drawn on him and presented for payment;
subject to the condition that there are sufficient funds in the accounts and the cheque is in order.

Section 31 of the Negotiable Instruments Act 1881, provides that “The drawee of a cheque, having
sufficient funds of the drawer in his hands properly applicable to the payment of such cheque, must pay the cheque
when duly required to do so and in default of such payment must compensate the drawer for any loss or damage
caused by such fault.
So, it is the bounden duty of a bank to honor its customer cheques, after taking some precautions. In other
words, the paying banker is under an obligation to honor cheque subject to some conditions, being satisfied.
They are,
 There must be sufficient funds in the customer’s account on which cheque is drawn.
 The funds should be properly applicable to the payment of such cheque.
 Cheque should be properly drawn and should not be irregular (or) ambiguous
 Cheque should be presented during the banking hours of the bank
 Cheques should be presented for payment within the validity period.
Now, the validity period for a cheque is three months from the date of issue. So cheques should be presented within
three months of their issue.

STATUTORY PROTECTION TO THE PAYING BANKER

Sec. 85 of the Negotiable Instruments Act, 1881 gives statutory protection to the paying banker.
When protection is needed to a paying banker and why?

When? - Protection is needed when the paying banker dishonors cheque of his customer, on genuine grounds.

Why? - It is the bounden duty of the banker to honor the cheques, drawn on him and duly presented for payment.
So, if he dishonors the cheque or makes any wrong payments, the paying banker is liable to be sued for damages.
Condition to get statutory protection by the paying banker / situations at which a Paying

Banker can dishonor a cheque

The banker before honoring the cheques presented to him/her for payment should look into the following
points in order to safeguard himself/herself against the risk of losing the customer’s money. They are,

 Open or crossed cheques:

When a cheque is presented for payment, the banker should verify as to whether it is an open
cheque or a crossed one and whether the cheque is in printed form. There is no provision in the Banking
Regulations Act, preventing a customer from drawing his own cheque. But the banks prefer the printed
form as it is easy for verification and filing. An open cheque, if it is otherwise valid, can be paid across the
counter. If it is crossed, the holder is required to present it only through another banker. The specific
instruction in case of a crossed cheque is that, it should be paid through an account and not across the
counter.
 Drawn on the specific branch:

Cheques should be drawn on the particular branch at which they are presented. In olden days a
cheque cannot be presented at a different branch, even of the same bank, where account is not maintained.
Because the banker will refuse payment, as he doesn’t know the state of the drawer’s account and cannot
verify the signature of the customer. This was the position, up to the period, where all bank works were
done manually. Then banks were computerized one after one. At the initial stage of computerization also,
only partial (or) no inter-branch transactions taken place. Then the banks switched over to CBS (Core
Banking Solutions) system.

Some example are,

IFSC (Indian Financial System Code) followed by Society for Worldwide Interbank Financial Telecommunication
(SWIFT)
UTR (Unique Transaction Reference) this is the transaction identification number in the electronic transfer of money
vide
NEFT (National Electronic Fund Transfer)
RTGS (Real Time Gross Settlement)
IMPS (Instant Money Payment System)

 Mutilated Cheque
If the banker finds the cheque presented to him is already mutilated or torn, the banker is having a
right to return the cheque, with the remark “Mutilated Cheque”.
When a cheque is torn accidentally, the banker can pass it for payment after obtaining the drawer’s
confirmation on the cheque.
 Date of the Cheque
Date of a cheque is the most material matter in the cheque, as the legal validity of the cheque; itself is
decided by the date. As per law, a cheque is valid for payment, for three months from the date written on
the cheque i.e., from the date of the cheque.
Rules Regarding Date:-

 A cheque should bear a date in the column meant for it on the cheque
 Date should not be incomplete
 It should contain the day, month and year in a proper form
 It should not be ambiguous in any manner
Collecting Banker

A Collecting banker is one who undertakes to collect cheques, drafts, bill, pay order, traveler cheque, letter
of credit, dividend, debenture interest, etc., on behalf of the customer. For undertaking this collection, the collecting
banker will be charging commission. Examples: ICICI Bank, HDFC Bank, SBI Bank etc. Duties and
Responsibilities of a Collecting Banker

The duties and responsibilities of a collecting banker are discussed below:

 Due Care and carefulness in the Collection of Cheques:

The collecting banker is bound to show due care and carefulness in the collection of cheques
presented to him. In case a cheque is entrusted with the banker for collection, he is expected to show it to
the drawee banker within a reasonable time.

 Serving Notice of Dishonor:

When the cheque is dishonored, the collecting banker is bound to give notice of the same to his
customer within a reasonable time. It may be noted here, when a cheque is returned for confirmation of
endorsement, notice must be sent to his customer.

 Agent for Collection:

In case a cheque is drawn on a place where the banker is not a member of the ‘clearing-house’, he
may employ another banker who is a member of the clearing-house for the purpose of collecting the
cheque. In such a case the banker becomes a substituted agent.

 Payment of Interest to the Customer:

In case a collecting banker has realized the cheque, he should pay the interest to the customer as
per his (customer’s) direction.

 Collection of Bills of Exchange:

There is no legal obligation for a banker to collect the bills of exchange for its customer. But,
generally, bank gives such facility to its customers.
 UNIT -5
Principles of Lending

Lending of money is an important function and most risky business of banks. The borrowers are
individuals, partnerships firms, joint stock companies, institutions, corporations. Banks have to follow certain
principles to lending money, such as safety, purpose of advance, borrower’s character, capacity and capital, nature
of business, security, location of business, liquidity and safety margin etc., Lending of money by banks helps in
financing of agricultural, industrial and commercial activities of the country. It promotes exports and imports, A part
from the consumer loans creating demand for house, furniture, appliances etc.,

The major sources of funds are:

 Paid-up capital
 Reserves
 Deposits and other accounts
 Borrowings from the Reserve Bank of India
 Participation certificates, certificates of deposits, commercial papers.
 Undistributed profits.
 Refinance Loans
 Loans from in financial institution and
 Other sources.

Credit Facilities:

 Cash Credits
 Overdrafts
 Demand loans
 Term loans
 Bills purchased
 Bills discounted
 Packing Credit
 Import Finance
 Consumer credit
 Clean Advances
 Hire Purchase
 When a loan application is received by a bank, it has to allot a serial number and enter the details in the
Loan Application register the particulars such as serial number, date of receipt of the application form, name of the
applicant, nature of loan applied for and the category like priority sectors, export finance to SSI etc., the manner of
disposal of the application.

The banker has to follow certain guidelines:

 Particular of borrower

The place of business, nature of business, location of offices, his experience and expertise in his
area of business, the period during which he has been engaged in that business.

 Purpose of Loan

Bankers normally lend to the business community to meet the working capital requirements and
for productive purposes. He should find out the end uses of the credit for which he has applied for the loan.

 Security

Bank advances are supports by well-defined collateral security which has high liquidity. They do
not lending against securities such as real estate which are not highly liquid.

 Amount of Loan

Bankers will examine the relationship between the amount requires by the client for the project
and the amount asked for. Normally borrowers apply for loans even more than what is required. The
bankers had taken precautions measures while granting huge amounts. A borrower may approach a bank of
three types of loans viz.,

 Short term loan

 Medium term loan
 Long term loan
 Types of loan:

Bank loan / advance are specific sum of money lent by a bank to customers. Bank credit includes a cash
loan and any other form of financial accommodation. Moreover an advance is a payment on account or before a
contract is completed or legally due. Bank loan/ advance may be varied on the basis of nature; documents & period
are given below.

TYPES OF LOAN

Credit the Basis of Credit the Basis on Credit the Basis on

nature Objectives Period

Credit from Commercial Short term

Bank Funds Loan
loan

Documentary Non-Commercial Mid-term

Credit Loan
loan

Long term
loan

 Credit on the basis of Nature:

Bank loan may be following two categories on the basis of nature.
 Credit from Banks Fund.
 Documentary Credit.

 Credit from Banks Fund:

The credit which is given from banks owns account with various accounts is called Credit from Banks Fund. Credit
from Banks Fund can be three categories. Such as)
 Loan.
 Cash credit.
 Overdraft.
  Loan
Loan is the sum being made available by transfer from loan account to the customers’ current account. It is made to
a customer whom a cheque accounts at a bank, in which the account is allowed to go into debit, usually up to a
specified limit. The loan is sanctioned against mortgage and the total loan amount is given back to bank at a time
with interest. The rate of interest of loan is relatively less than other.

Cash Credit
A cash credit is an arrangement by which the customer is allowed to borrow money through a current
account up to a certain limit against mandatory mortgage. The loan can withdraw up to the sanctioned limit at a time
or partially. The interest of this credit is quarterly payable and yearly adjustable wit interest. The loan has to pay the
interest on only the withdrawn amounts have been user for how many days. The interest rate of this credit is high but
less than overdraft.
Overdraft
An overdraft occurs when a cheque is written on uncollected funds. It's usually a temporary arrangement
and is granted to the customers having current account. At high interest rate this credit is given against personal
mortgage that means the person who has intimate relation with bank and given back to bank as soon as on short call
of bank.
 Documentary Credit
Issuing, transferring and certifying the valuable documents bank gives such credit. It's two categories. such as

 Commercial documentary credit.

 Non-commercial documentary credit.
 Commercial documentary credit
Bank disburses which loan to its clients by issuing commercial & business documents such as
 Bank draft,
 Bank guarantee
 Credit card
 Non Commercial documentary credit.

Bank draft
It's a bill of exchange payable on demand drawn by the banker on the head office at the request of a customer.
Moreover it is a draft which is payable immediately upon sight or presentation to the drawee.

Bank Guarantee
It's one kind of debenture by which the certainty of paying the specified limit of loan amount is given from bank.

Credit Card
Client can purchase goods and services from specified individual or organization, even can withdraw cash, moreover
can perform national & international trade using which card provided by bank is called credit card.

Non-commercial documentary credit

Bank disburses which loan to its clients by issuing non-commercial & non-business documents such as – travelers
cheque, circular note, circular letter of credit, debit & credit card is called noncommercial documentary credit.

 Credit Based on Objective

Credit based on objective may be two categories.

 Commercial loan.
 Non-commercial loan.

Commercial loan

Bank provides which loan for commercial sectors is called commercial loan. Such credit is given through loan, cash
credit, overdraft or documents.
 Non-commercial loan

Bank provides which loan for non-commercial sectors is called non-commercial loan. Such credit is given for
household development, accommodation facilities, or travelling sectors.

 Credit Based on Period

Credit on the basis of period may be differentiating by three categories.

 Short-term loan.
 Mid-term loan.
 Long-term loan.

Short- term loan

Which lone is issued by bank for short while that means the duration of this loan may be from a few hours
to maximum one years is called short- term loan.

Mid- term loan

Which lone is issued by bank against mortgage at higher rate of interest than short term loan for a mid
while that means the duration of this loan may be from one year to maximum 5 years is called short- term loan.

Long -term loan

Which lone is issued by bank for long time that means the duration of this loan may be for more than 5
years at the high interest rate against valuable mortgage convertible in cash due to house & industry establishment is
called short- term loan.

Features of term loan:

 Security
Term loans are secured loans. Assets which are financed through term loans serve as primary security and
the other assets of the company serve as collateral security.

 Obligation
Interest payment and repayment of principal on term loans is obligatory on the part of the borrower.
Whether the firm is earning a profit or not, term loans are generally repayable over a period of 5 to 10 years in
installments.

 Interest
Term loans carry a fixed rate of interest but this rate is negotiated between the borrowers and lenders at the
time of dispersing of loan.

 Maturity
As it is a source of medium-term financing, its maturity period lies between 5 to 10 years and repayment is
made in installments.

 Restrictive Covenants
Besides asset security, the lender of the term loans imposes other restrictive covenants to themselves.
Lenders ask the borrowers to maintain a minimum asset base, not to raise additional loans or to repay existing loans,
etc.,
 Convertibility
Term loans may be converted into equity at the option and according to the terms and conditions laid down
by the financial institutions.

Difference between Secured and Unsecured Loan:

Difference between Loans & Advances

The Basis Of
LOANS ADVANCES
Comparison

Funds lent by one entity to another for a Lent by a bank to firms to meet their short-term
About
purpose. (Usually for a Capital purpose) financial requirements

Nature A loan is a debt by nature Advances are a credit facility by nature

Time Duration Loans are for a long-term Advances are for a short-term(maximum one year)

Collateral A loan may or may not be secured Facilitated only against primary security or a

Security (Secured and Unsecured Loans) guarantee

Legal Formality Many legal procedures needed Compared to Loans, low on legal formality

Commercial Loan, Education Loan, Car

Example Short-Term Loan, Cash Credit, Over Draft
Loan, Home Loan

Difference between Overdraft & Loan

BASIS FOR OVERDRAFT LOAN

COMPARISON

Meaning Overdraft is an arrangement under which the Loan refers to the fixed sum of
customer is allowed to withdraw in excess of money borrowed for a definite
the balance standing as credit in the current period, against collateral, which is
account, but only up to a certain limit. expected to be repaid with interest.

What is it? Credit facility Borrowed capital

Source of Short-term funds Long-term funds

Interest Charged on amount overdrawn. Charged on loan sanctioned.

Calculation of interest Daily basis Monthly basis

Repayment Through deposits in the bank account. Either on demand or on fixed

monthly installments.

Is it necessary for a person Yes, he/she should have a current account in No, it is not compulsory.
to be the bank account the respective bank.
holder to avail this service?