JAI NARAIN VYAS

UNIVERSITY, JODHPUR

SESSION 2021-2022

Subject- Banking Law

TOPIC- An Overview on Banking System in India

CLASS- BBA. LLB. X SEMESTER

Submitted By- Submitted To-

ROUNAK TANWER Advocate Kuldeep
Purohit Roll NO.- 17BBL51039

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 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my teacher Advocate Kuldeep

Purohit as well as our Dean Dr. Chandanbala who gave me the golden opportunity to do
this wonderful Project on the topic of An Overview on Banking System in India which
also helped me in doing a lot of research and I came to know about so many new things I
am thankful to them.

Secondly, I would also like to thank my parents and friends who helped me a lot
in finding and finalizing this project within the limited time frame.

Rounak Tanwer

(17BBL51039)

B.B.A. L.L.B X SEMESTER

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BANKING- DEFINITION

According to some economists, the word 'Bank' has been derived from the German word
'BANC' which means a joint stock firm. But some other economists say that it has been
derived from the Italian word 'BANCO' which means a heap or mound. As the matter of
fact, at the time of establishment of Bank of Venice in 1157, the Germans were
influential and hence, perhaps the word ‘Banc’ or 'Banco' was used by Italians to denote
the accumulation of securities or money with a joint stock firm which later on with the
passage of time came to be known as 'Bank'.

Definitions:

First of all, we discuss the definition given under Banking Regulation Act 1949.
Sec. 5 (b) "Banking" means the accepting for the purpose of lending or investment, of

deposit of money from public, repayable on demand or otherwise, and withdraw able by
cheque, draft, order or otherwise.

According to, Sir John Paget "No person or body, corporate or otherwise, can be a banker
who does not (1) take deposit accounts (2) take current account (3) issue and pay cheque
and (4) collect cheques, crossed and uncrossed, for his customers."

COMMERCIAL BANKS

Meaning: A Banking company is one which transacts the business of banking which
means the accepting for the purpose of lending all investments, of deposits of money
from the public, repayable on demand or otherwise and withdrawable by cheque, draft or
otherwise.

The discussion in the preceding pages indicate that commercial banks provide useful
services in all walks of life. They function as a catalytic agent for bringing about
economic, industrial and agricultural growth and prosperity of the country. The banking
can therefore be conceived as a 'a sector of economy on the one hand and as a lubricant
for the whole economy on the other'.

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FUNCTIONS

The functions of the commercial banks are now wide and diverse. They have assumed
great significance in the role of an agent for economic renaissance and social
transformation because of their vital role in mobilization of resources well as their
deployment for meeting the said objectives. They are no longer considered as institutions
only for affluent sections of the population. They have acquired broad base and have
emerged as effective catalytic agents of social economic change.

In order to understand better the functions of commercial banks, it will be better to study
them under the following two categories.

• (I) Primary Functions of commercial Banks.

• (II) Secondary Functions of commercial Banks.

I. Primary Functions of Commercial Banks

The primary functions of commercial banks are: (i) Accepting of deposits, and (ii)
Lending of money.

Accepting of Deposits: Deposits are an important source of banks funds. They can
broadly be classified into three categories.

1.) Savings Deposits: These deposits are of small amounts and are accepted by banks to
encourage persons of small means to make savings; frequent withdrawals are not
allowed.

2.) Fixed Deposits: These deposits are made with the banks for fixed periods specified in
advance. They are also known as term deposits.
3.) Current Deposits: These deposits are repayable on demand. The banks undertake the
obligation of paying all cheques drawn against these deposits by the customers till they
have adequate funds of the customer. The banks usually do not pay any interest in respect
of such deposits. These deposits accounts are usually kept by large business houses.

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 4.) Lending of Money: A major portion of the deposits received by a bank is lent by it.
This is also the major source of a bank's income. However, lending money is not without
risk and, therefore, a banker must take proper precautions in this process. The lending
may be in any of the following forms:

• Loan: It is a kind of advance made with or without security. It is given for a fixed
period at an agreed rate of interest. The amount of loan is usually credited to the
credit of the customer's account who may withdraw from there as per his
requirements. The loan may be secured or unsecured.

• Cash Credit: It is an arrangement by which a banker allows his customer to borrow

money up to a certain limit against security of goods.

• Overdraft: It is an arrangement whereby a customer has been allowed temporarily

to overdraw his current account. It is without any security.

• Discounting and Purchasing of Bills: Time bills are discounted while demand bills
are purchased by the banks. In both the cases the banks credit the account of their
customers by the amount of bills less any discount or commission charged for
such discounting or purchasing of the bills.

II. Secondary Functions of Commercial Banks

These functions can be classified into the following two categories:

(a) Agency Service: In many cases the commercial banks act as the agents of their
customers. As agents they provide the following services:

• (i) Collection of drafts, bills, cheques, dividend etc. on behalf of customers.

• (ii) Execution of standing orders of the customers viz-payment of subscription,

rent, bills, promissory notes, insurance premium etc.

• (iii) Conducting stock exchange transactions i.e., purchasing and selling of securities
for the customers.

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• (iv) Acting as a correspondent on representative of customers, other banks and
financial corporations.

• (v) Functioning as an executor, trustee or administrator of an estate of a customer.

• (vi) Preparation of income tax return, claiming of tax refunds and checking of
assessments on behalf
of the customers.

(b) General Utility Services: Commercial banks provide a variety of general utility
services viz. issue of letters of credit, travellers cheques, accept valuables for safe
custody, acting as a referee as to the respectability and financial standing of the
customers, providing specialized advisory services to customer, issue of credit cards,
providing of information through regular bulletins about general trade and economic
conditions both inside and outside the country etc.

With the opening up of the insurance sectors, banks can now take up insurance business.
In the discussion paper issued by the RBI in 1999, it was stated that insurance comes
within the scope of universal banking. However, as per the guidelines issued by the
Reserve Bank of India, banks are not allowed to conduct insurance business
departmentally. They cannot also set up separately subsidiary companies for this purpose.
However, they can set up joint venture companies for insurance as per government or
insurance regulatory and development authority guidelines and with prior permission of

SYSTEMS OF BANKING UNIT BANKING: TYPES OF BANKS-

Unit banking is a system where the operations of a bank are confined to a single office
located in a particular area. A unit bank has virtually no branches. In order to provide
facilities to its customers in remittance and collection of funds, a unit bank resorts to
correspondent banking system. In case of this system small banks serving small
communities place deposits in nearby city banks which in turn hold deposits in giant
banks located in giant cities. The giant banks also hold reciprocal deposits of one another.
Consequently, every bank gets connected directly or indirectly with each other and it can
safely make payment on behalf of other banks.

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Branch Banking-

Branch Banking is a system where a bank with a network of branches throughout the
country carries out its banking operations. Sometimes branches are also opened outside
the country. However, small banks may like to restrict their branches or offices to a
certain region of the country.

Features: The main features of branch banking system are as follows:

• (i) The bank is owned by a group of shareholders and controlled by a single

Board of Directors.

• (ii) The bank has a central office popularly termed as the Head Office of the bank
which controls the operations of different branches.

• (iii) Each branch is managed by a branch manager who manages the affairs of the
branch as per the directives and policies of the Head office.

• (iv) For external reporting the assets and liabilities of the branches and the Head
Office are aggregated.

The branch banking system which developed in England is prevalent in most countries of
the world including Australia, Canada, South Africa, India, Pakistan etc. In India the
public sector banks, numbering 27 in all have more than 90% of the branches of all
commercial banks. The also control more than 90% of the banking business in all.

Advantages of Brach Banking: The protagonist of branch banking put forward the
following arguments in favour of branch banking:

1. Economies of Scale: In case of branch banking the level of operations is quite large as
compared to unit banking. As such the cost per unit of service in case of the former is
lower as compared to the latter. Moreover, under branch banking system it is possible to
hire more competent and qualified staff and have better division of work resulting in
increase in overall efficiency.

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2. Lower Cash Reserves: A large bank with a number of branches can manage its
business with lower cash reserves since each of its branch can draw upon the resources of
another branch or branches, if an emergency arises. However, a unit bank cannot
confidently depend upon the resources of another unit bank. Hence, it may be required to
keep higher cash reserves to run its operations smoothly.

3. Diversification of Risk: In branch banking industrial as well geographical

diversification of loan risks is possible. As a result, the loss suffered by branches on
account of fall in industrial activity in a particular area may be more than compensated on
account of profit made by branches in areas where there may be boom in business and
industrial activity. This is not possible in case of unit banking where a bank is having its
operation only in a particular area.

4. Better Customer Service: Branch banking provides better service to customers in

remittance and collection of funds. Moreover, the objective of opening branches is to take
banking service to the doors of the people who need them. Thus, service is cheap as well
as convenient. Each branch has to handle a limited number of customers of the locality;
hence the branch manager can personally look to their problems.

5. Greater Mobility of Capital: Branch banking permits better mobility of capital and
thus bring more uniformity in interest rates. Surplus funds can be transferred from one
area to another with convenience and speed and thus bring equilibrium in demand and
supply of funds resulting in better returns to the investors.

Disadvantages of Branch Banking: The protagonists of unit banking raise the

following objections against branch banking:

1. Individual Needs Ignored: In case of branch banking the branches are guided by the
policies laid down by the Head Office which is quite unaware of the individual needs.
The Branch Manager has not much role to play, while a unit bank operates only in a
limited area and hence it is possible for it to take personal care of the individual
needs of each of its customers.

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2. Red Tapism: In branch banking, a branch manager is required to take the
instructions of the Head office from time to time. He cannot take several decisions at
this level. Thus, there is bound to be red tapism and delay in processing loan
applications etc. In unit banking all matters are decided at the unit bank level itself.
Thus, there is quicker and better service.

3. Lack of Effective Control: In case of branch banking, the banks sometimes become
unmanageable due to large increase in the number of branches. As a result, the
control gets slackened, and it increases the chances of frauds and manipulations.

4. Local Needs Ignore: Branch banks do not have attachment with a particular place.
Branch managers are also not local people. They are subject to frequent transfers.
The funds collected from local sources may be used for meeting the requirements of
other places where the bank may find the investment more lucrative. Thus, local
needs are not given that much of attention in case of branch banking as is done in
case of unit banking.

5. Failure of Banks: In branch banking unremunerated and inefficient branches

continue to exist at the expense of remunerative and efficient branches. In case this
practice goes too far, it may cause failure of banks having repercussions throughout
the country.

6. Concentration of Economic Power: The branch banks have huge resources raised
from a wide spectrum of people. The Boards of Directors of these banks, therefore,
possess immense economic power which they may use for promoting their own
business interests. It may thus cause concentration of economic power in a few
hands. As a matter of fact, this was one of the important reasons for the first phase of
nationalisation of 14 major commercial banks in India.

Unit Banking

In the unit banking system, the bank’s operations are generally confined to a single office
only. It is a corporation that operates from one office and that is not related to other banks
through either ownership or control. USA is the birth place of unit banking.

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Advantages of Unit Banking-

1.) The funds of the locality are utilized for the local

development 2.) The management and supervision are much

easier and effective

3.) There are less chances of fraud and irregularities in the management

4.) They are in a better position to solve problems as they know the local problems better.

5.) There is no possibility of generating monopolistic tendencies

6.) There will be no inefficient banks as weak and inefficient banks are automatically
eliminated

7.) Unit banking is free from the diseconomies and problems of large scale operations.

Disadvantages

1. Cut throat competition.

2. Lack the benefits of specialization and division of labour

3. No banking development in backward areas as banking activity is

uneconomical and no bank is opened there.

4. Limited resources restrict its ability to face financial crises.

5. There is little possibility of distribution and diversification of risks under the

localized unit banking system.

6. The interest rates tend to vary at different places as there is no movement

of funds from place to place.

7. The transfer of funds is very expensive as there are no branches at other

places.

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 8. There will be high local pressure and interference which disrupt their normal
functioning.

GROUP BANKING

It is a system where two or more banks are controlled by a holding company. Thus, group
banking is similar to chain banking except with the difference that instead of an
individual or group of individuals or members of family, an incorporated company
having a separate legal entity holds majority of the voting power in the companies of the
group. Such holding company mayor may not be engaged in the banking business.

CHAIN BANKING

Chain Banking is a system where an individual or group of individuals or members of a

family control the operations of two or more banks. The control is exercised either
through holding majority of shares in each bank or inter-locking directorships. However,
each bank retains its individual entity. However, it has the disadvantages of lack of
effective control over member units, and mutualisation of resources of the member units
particularly by the holding company. Moreover, it leads to concentration of economic
power in a few hands. Due to these disadvantages, the system of chain banking or group
banking is considered to be unworthy of adoption.

Relationship between a banker and customer-

Definition of banker

According to section 3 of the NI Act, 1881, banker includes any person acting as a banker
and any post office savings bank.

1. According to section 5(b) of the Banking Regulation Act, 1949, banking means the
accepting, for the purpose of lending or investment, of deposits of money from the

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 public, repayable on demand or otherwise, and withdrawable by cheque, draft, order
or otherwise.

2. Money lender is not considered as a banker as mere lending does not constitute
banking business. Banker is an institution which borrows money by accepting
deposits from the public for the purpose of lending to those who are in need of
money.

Definition of customer

The term customer is not defined by law. Ordinarily, a person who has an account in a
bank is called a customer.

Acc to Dr. Hart, a customer is one who has an account with a banker or for whom a
banker habitually undertakes to act as such.

Thus, to constitute a customer, the following essential requisites must be fulfilled:

• 1) He must have some sort of an account.

• 2) Even a single transaction constitutes a customer.

• 3) The dealing must be of a banking nature.

A customer need not be a person. A firm, joint stock company, a society or any separate
legal entity may be a customer. Explanation to section 45-Z of the BR Act clarifies that a
customer includes a Government department and a corporation incorporated by or under
any law.

Relationship between a banker and customer- Relation of a debtor and a creditor

The general relationship between banker and a customer is that of a debtor and a creditor
i.e., borrower and lender. In Foley v. Hill, Sir John Paget remarks, the relation of a banker
and a customer is primarily that of debtor and creditor, the respective positions being

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determined by the existing state of account. Instead of the money being set apart in a safe
room, it is replaced by the debt due from the banker. The money deposited with him
becomes his property, and is absolutely, at his disposal, and save as regards the following
of the trust funds into his hands, the receipt of money by a banker from or on account of
his customer constitutes him merely the debtor of the customer with super added
obligation to honour his customer’s cheques drawn upon his balance, in so far, the same
is sufficient and available.

In Shanthi Prasad Jain v. Director of Enforcement, Foreign Exchange Regulation, the

SC held that the banker and customer relationship in respect of the money deposited in
the account of a customer with the bank is that of a debtor and a creditor.

On the opening of an account a banker assumes the position of a debtor. The money
deposited by the customer with the bank is in legal terms lent by the customer to the
banker who males use of the same according to his discretion. The creditor has the right
to demand back his money from the banker, and the banker is under an obligation to
repay the debt as and when he is required to do so.

Banker’s relation with the customer is reversed as soon as the customer’s account is
overdrawn. Banker becomes creditor of the customer who has taken a loan from the
banker and continues in that capacity till the loan is repaid. As the loans and advances
granted by a banker are usually secured by the tangible assets of the borrower, the baker
becomes a secured creditor of his customer.

Various legal relationships of banker and customer-

1) Agent and Principal- Sec.182 of the Indian Contract Act, 1872 defines an agent as a
person employed to do any act for another or to represent another in dealings with third
persons. The person for whom such act is done or who is so represented is called the
principal. One of the important relationships between a banker and customer is that of an
agent and principal. The banker performs various services of the customer, where he acts
as the agent. Buying and selling securities of customer, Collection of cheques, bills of
exchange, promissory notes on behalf of customer, Acting a trustee, executor or
representative of a customer Payment of insurance premium, telephone bills etc.

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2) Trustee and Beneficiary- to whom property is entrusted to be administered for the
benefit of another called the beneficiary. A banker becomes a trustee under special
circumstances. When a customer deposits securities or other valuables with the banker for
safe custody, the banker acts as trustee of customer.

3) Bailee and bailor- during certain circumstances banker becomes Bailee. When he
receives gold ornaments and important documents for safe custody, he takes charge of
it as Bailee and not trustee or agent. He cannot make use of them as he is bound to return
the identical articles on demand.

4) Pawnee and pawned- pawn is a sort of bailment in which the goods are delivered to
another as a pawn, to be a security for money borrowed. Thus, a banker acts as a Pawnee
where a customer delivers the goods to him to be kept as security till the debt is
discharged. The banker can retain the goods pledged till the debt is paid.

5) Mortgagee and mortgagor- the relation between a banker as mortgagee and his
customer as mortgagor arises when the latter executes a mortgage deed in respect of his
immovable property in favour of the bank or deposits the title deeds of his property with
the bank to create an equitable mortgage as security for an advance.

6) Lessee and lessor- when a customer hires a locker in the bank’s safe deposit vault, the
bank undertakes to take necessary precaution for the safety of the articles in the locker.
The relation between the parties is that of a lessor and lessee.

7) Guarantor and guarantee- a bank as guarantor gives guarantee to its customer by

issuing a letter of credit. It is a kind of credit facility to its customer to facilitate
international trade. A bank guarantee contains an undertaking to pay the amount without
any demur on mere demand of the principal amount on the ground for non-performance
or breach of contract.

8) Fiduciary relationship-every relation of trust and confidence is a fiduciary relation. A

banker who receives a customer’s money is under a duty not to part with it which is
inconsistent with the customers’ fiduciary character and duty. In Official Assignee v.
Rajaram Aiyar, it was held that where banks old money for a specific purpose of sending
it somebody the money is impressed with trust.

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