Banking Regulations and Laws

BANKING REGULATIONS
&
LAWS
(FOR PRIVATE CIRCULATION ONLY)

2019
PROGRAMME COORDINATOR
Prof. Prashant Ubarhande
COURSE DESIGN AND REVIEW COMMITTEE

Dr. Pramod Jogdeo Prof. Dalip Mehra
Prof. Avinash Tripathi Prof. Sudhir Gijre
Prof. Abhinav D. Jog Prof. Arun Vartak
Prof. Avinash Nene Dr. Bhama Venkataramani
Dr. N.M. Vechlekar Dr. Deepa Gupta
Dr. Ravi Chitnis Dr. Swati Oza
COURSE WRITER
Dr. Arwah Arjun Madan
EDITOR
Ms. Neha Mule
Published by Symbiosis Centre for Distance Learning (SCDL), Pune

July, 2011 (Revision 03, 2016)
Copyright © 2019 Symbiosis Open Education Society

All rights reserved. No part of this book may be reproduced, transmitted or utilised in any form or by any
means, electronic or mechanical, including photocopying, recording or by any information storage or retrieval
system without written permission from the publisher.
Acknowledgement
Every attempt has been made to trace the copyright holders of materials reproduced in this book. Should any
infringement have occurred, SCDL apologises for the same and will be pleased to make necessary corrections
in future editions of this book.
PREFACE
I am glad to write this book on “Banking Regulations and Laws” for students of SCDL. The Banking
sector in India has undergone a major change post 1991.
One sees a lot of changes in the existing legislation, at the same time, number of new legislations have
been enacted to deal with the changing times, for instance, the Prevention of Money Laundering Act
or the Securitization Act. The Reserve Bank of India too has ushered a number of regulatory changes
in the banking and financial system. These changes helped the Indian banking and financial system
to make the transition from a weak and poor capitalized setup to one which is strong setup; One that
can withstand the international environment as well as competition.
Each unit contains detailed presentation of concepts and generalisation. Each topic has been
supplemented with examples/cases to give the students a clear understanding of the topic. This book
mentions the objective, the summary followed by key words and a list of questions for self-assessment.
It also includes ‘activities’ for self-learning. Special stress has been laid on the simplicity of language
in all its explanation.
I sincerely hope that this book will be interesting and useful and will help students and readers to learn
this subject in a more meaningful and useful manner. I take this opportunity to sincerely extend my
thanks to the SCDL staff for believing in me and giving me an opportunity to write this book.
I thank all those, who directly or indirectly helped me in completing my work.
Dr. Arwah Madan
iii
ABOUT THE AUTHOR
Dr. Arwah Arjun Madan completed her B.A in Economics at the Goa University in the year 1993
and her M.A in Economics at the University of Pune in 1995.
She qualified the State Eligibility Test (SET) in July 1996- in the subject Economics- an eligibility test
for College Teachers conducted by University of Pune as the State Agency & accredited by University
Grants Commission.
She successfully completed her doctoral research in Financial Management and Quantitative Techniques
at the University of Pune in 2003. Her doctoral research was on the topic – “Performance of Initial
Public Offers (IPOSs) in the Indian Capital Market in the pre and post Liberalisation Era”.
She has more than 15 years experience at the under-graduate and the post graduate level. She had
been approved as a guide for M.Phil and Ph.D students by the University of Pune.
She has been teaching various areas under economics- Business Economics/ Managerial Economics,
Banking & Finance, Banking Law and Practice, Financial Institutions and Markets as well as Indian
Economic Policy.
She has also been a visiting faculty to various B-Schools in Pune.
iv
CONTENTS
Unit No. TITLE Page No.
1 The Reserve Bank of India Act, 1934 1-18
1.1 Introduction
1.2 Establishment & Incorporation
1.3 Management
1.4 Business of the Bank
1.5 Central Banking Functions
1.6 Scheduled Status
1.7 Collection & Furnishing of Credit Information
1.8 Changing Role of RBI
Summary
Key Words
Self-Assessment Questions
Answers to Check your Progress
Suggested Reading
2 Banking Regulation Act, 1949 19-32
2.1 Introduction
2.2 Definition, Functions, Restrictions on Business of Banks
2.3 Capital & Reserve Fund, Cash Reserve and Liquid Assets
2.4 Licensing and Branch Licensing
2.5 Management
2.6 Powers of RBI
2.7 Voluntary Amalgamation & Liquidation
2.8 P&L A/C and Balance Sheet
Summary
Key Words
Suggested Reading
3 Negotiable Instrument Act, 1881 33-58
3.1 Introduction
3.2 Definition
3.3 Characteristics & Presumptions of Negotiable Instruments
3.4 Types of Negotiable Instruments
3.5 Parties to Negotiable Instruments
3.6 Acceptance of a Bill
3.7 Endorsement
3.8 Presentment
3.9 Dishonour of Negotiable Instrument
3.10 Noting and Protesting
Summary
Key Words
Suggested Reading
v
4 Paying Banker & Collecting Banker 59-82
4.1 Introduction
4.2 Paying Banker
4.2.1 Responsibilities of Paying Banker
4.2.2 Material Alterations
4.2.3 Forgery of Customer’s Signature
4.2.4 Duties of Paying Banker
4.2.5 Statutory Protection to Paying Banker
4.3 Collecting Banker
4.3.1 Collecting Banker as Holder for Value
4.3.2 Collecting Banker as an Agent
4.3.3 Duties of Collecting Banker
4.3.4 Statutory Protection to Collecting Banker
Summary
Key Words
Suggested Reading
5 Relationship between Banker and Customer 83-96
5.1 Introduction
5.2 Definition of Customer
5.3 Relation between Banker and Customer
5.4 Rights of a Banker
5.5 Obligations of a Banker
5.6 Garnishee Order
5.7 Termination of Relationship
Summary
Key Words
Suggested Reading
6 Securities Against Advances and Secured Advances - Modes of 97-128
Creating Charge
6.1 Introduction
6.2 General Principles of Secured Advances
6.3 Precautions to be taken by the banker while advancing against
various securities
6.4 Lien
6.5 Pledge
6.6 Hypothecation
6.7 Assignment
6.8 Mortgage
6.9 Differences between Legal Mortgage and Equitable Mortgage
Summary
Key Words
Suggested Reading
vi
7 Recovery Measures 129-142
7.1 Introduction
7.2 Non – legal Measures
7.3 Legal Measures
Summary
Key Words
Suggested Reading
8 Policy Regulation since 1991 143-158
8.1 Introduction
8.2 Basel Norms
8.3 Capital Adequacy Ratio
8.4 Prudential Norms
8.5 Supervision and Regulation by Reserve Bank of India
Summary
Key Words
Suggested Reading
9 Foreign Exchange Management Act, 1999 159-172
9.1 Introduction
9.2 Definitions
9.3 Regulation & Management of Foreign Exchange
9.4 Powers of RBI
9.5 Penalties
9.6 Directorate of Enforcement
Summary
Key Words
Suggested Reading
10 Prevention of Money Laundering Act (PMLA), 2002 173-182
10.1 Introduction
10.2 Offence of Money Laundering
10.3 Definitions
10.4 Obligations of Banking Companies, Financial Institutions and
Intermediaries
Summary
Key Words
Suggested Reading
vii
11 Securitization and Reconstruction of Financial Assets and 183-194
Enforcement of Security Interest (SARFAESI) Act, 2003
11.1 Introduction
11.2 Objectives
11.3 Definitions
11.4 Basic Securitization Transaction Model
Summary
Key Words
Suggested Reading
12 Information Technology Act, 2000 and Laws relating to Banking 195-208
12.1 Introduction
12.2 Indian Penal Code
12.3 Indian Evidence Act
12.4 Bankers’ Books Evidence Act
12.5 Reserve Bank of India Act
Summary
Key Words
Suggested Reading
Annexure I
13 Banking Ombudsman 209-216
13.1 Introduction
13.2 Concept and Meaning
13.3 Objectives and Purpose
13.4 Reserve Bank of India Banking Ombudsman Schemes
Summary
Key Words
Suggested Reading
References 217-218
viii
The Reserve Bank of India Act, 1934
UNIT
1
Structure:
1.1 Introduction
1.2 Establishment & Incorporation
1.3 Management
1.4 Business of the Bank
1.5 Central Banking Functions
1.6 Scheduled Status
1.7 Collection & Furnishing of Credit Information
1.8 Changing Role of RBI
Summary
Key Words
Suggested Reading
The Reserve Bank of India Act, 1934 1

Notes
Objectives
----------------------
---------------------- After going through this unit, you will be able to:
• Define the role of a central bank as an apex institution
----------------------
• Discuss the working, operations and management of a central bank
----------------------
• Infer functions of Reserve Bank of India as the central bank of the country
---------------------- • Explain the meaning of a scheduled bank
---------------------- • Illustrate control and supervision of the central bank over the financial
system:
----------------------
---------------------- 1.1 INTRODUCTION

---------------------- The Reserve Bank of India Act was passed on the 6th day of March, 1934
to establish the Reserve Bank of India as the Central Bank of the country. The
---------------------- Reserve Bank was established as a body corporate under the Act and started
---------------------- functioning from the 1st day of April, 1935.
The Preamble of the Reserve Bank of India Act, 1934 lays down the object
----------------------
of the Reserve Bank, “to regulate the issue of bank notes and the keeping of
---------------------- reserves with a view to securing monetary stability in British India and generally
to operate the currency and credit system of the country to its advantage.”
----------------------
The financial system present in India before the establishment of the Reserve
---------------------- Bank has been utterly inadequate mainly because of the dual control of currency
to the government and of credit by the Imperial Bank of India.
----------------------
The Reserve Bank of India Act, 1934 is applicable to the whole of India.
---------------------- The word “the Bank” means the Reserve Bank of India constituted by this Act.
A “scheduled bank” means a bank included in the Second Schedule of this Act.
----------------------
---------------------- 1.2 ESTABLISHMENT AND INCORPORATION

---------------------- A Bank called Reserve Bank shall be constituted for the purpose of taking
over the management of the currency from the Central Government and for
---------------------- carrying on the business of banking in accordance with the provisions of this
Act. [U/s 3]
----------------------
The Bank called Reserve Bank was set up as a body corporate, having a
---------------------- common seal and perpetual succession, with a private shareholding of rupees five
---------------------- crores. The Reserve Bank of India was nationalized under the Reserve Bank of
India (Transfer to Public Ownership) Act, 1948 and the Reserve Bank became
---------------------- an arm of the government with effect from 1st day of January 1949. [U/s 4]
---------------------- The Reserve Bank is authorized to establish branches and agencies in India
or with the prior sanction of the Central Government, elsewhere. [U/s 6]
----------------------
2 Banking Regulations & Laws

The Central Government is empowered to give directions from time to time Notes
to the Bank considered necessary in the interest of the public. [U/s 7]
----------------------
1.3 MANAGEMENT ----------------------
The general superintendence and directions of the affairs and business of ----------------------
the bank shall be entrusted to the Central Board of Directors which may exercise
all powers and do all acts and things which may be exercised by the Bank ----------------------
Composition of the Central Board and the Term of Office of Directors [u/s 8] ----------------------
The Central Board consists of the following – ----------------------
 A Governor and not more that four Deputy Governors to be appointed by
the Central Government; ----------------------
 Four Directors to be nominated by the Central Government, one from each ----------------------
of the four local boards as constituted u/s 9;
----------------------
 Ten Directors to be nominated by the Central Government;
----------------------
 Two government officials to be nominated by the Central Government.
The Governor and the deputy Governors have a term of office not exceeding ----------------------
five years and are also eligible for re-appointment. ----------------------
The Directors nominated by the Central Government have a term of office
of four years and the Directors nominated from the local boards have a term of ----------------------
office related to the membership of the Board. ----------------------
The term of office of the government official is at the pleasure of the Central
----------------------
Government.
Constitution and Functions of the Local Boards [u/s 9] ----------------------
There is one local board for each of the four regional areas in the country. ----------------------
These are Mumbai, Kolkatta, Delhi and Chennai. The local boards give advice on
matters of local importance. The members of the local boards are well-informed ----------------------
about their regions.
----------------------
 A Local Board shall be constituted for each of the four areas and shall consist
of five members to be appointed by the Central Government to represent, ----------------------
as far as possible, territorial and economic interests and the interests of co- ----------------------
operative and indigenous banks.
 The members of the Local Board shall elect from amongst themselves one ----------------------
person to be the chairman of the Board. ----------------------
 Every member of a Local Board shall hold office for a term of four years
and thereafter until his successor shall have been appointed and shall be ----------------------
eligible for re-appointment. ----------------------
 A Local Board shall advise the Central Board on such matters as may be
----------------------
generally or specifically referred to it and shall perform such duties as the
Central Board may delegate to it. ----------------------

Notes  No person shall be a Director or a member of a local board- [u/s 10]
– Who is a salaried government official;
----------------------
– Who has been adjudicated as an insolvent;
---------------------- – Who has suspended payment;
---------------------- – Who had compounded with his creditors;
– Who is found to be a lunatic or a person of unsound mind;
----------------------
– Who is an officer or employee of any bank or a Director of a commercial
---------------------- or a cooperative bank.
Meeting of the Central Board [u/s 13]
----------------------
Meetings of the Central Board shall be convened by the Governor at least
---------------------- six times in a year and at least once in a quarter.
---------------------- Any four directors may require the Governor to convene a meeting of the
Central Board at any time and the Governor shall forthwith convene a meeting
---------------------- accordingly.
---------------------- The Governor, if for any reason, is unable to attend, the Deputy Governor,
authorized by the Governor, shall preside at the meetings of the Central Board
---------------------- and in the event of an equality of votes, shall have a second or casting vote.
----------------------
Check your Progress 1
----------------------
---------------------- Fill in the blanks.

1. As per the Reserve Bank of India Act, Local Board shall be constituted
----------------------
for each of the _____ areas and shall consist of _____ members to be
---------------------- appointed by the Central Government to represent
---------------------- 2. Meeting of the Central Board [u/s 13] shall be convened by the _____
at least six times in a year and at least _____ in a quarter.
----------------------
----------------------
Activity 1
----------------------
Read carefully The Reserve Bank of India Act, 1934 and write down
----------------------
names of five banks incorporated in Schedule II to the Act.
----------------------
---------------------- 1.4 BUSINESS OF THE BANK

---------------------- Business that the Bank may transact [u/s 17]
---------------------- The Bank shall be authorized to carry on and transact the several kinds of
business hereinafter specified, namely:-
----------------------
 The Bank is empowered to accept of money on deposit without interest
---------------------- from, and the collection of money for The Central Government, the State

Governments, local authorities, banks and any other persons Notes
 The Reserve Bank is empowered to purchase or discount bills of exchange
----------------------
or promissory notes and other eligible commercial paper.
 The Reserve Bank is permitted to grant loans and advances against certain ----------------------
specified securities.
----------------------
 The Reserve Bank is authorized to make to the Centre and State Governments,
ways and means of advances for a period not exceeding three months from ----------------------
the date of making the advances.
 The Reserve bank makes available loans and advances for purchase of ----------------------
foreign exchange for financing the import of capital goods or other such ----------------------
purposes, as approved by the Central Government to the Scheduled Bank,
IDBI, IFCI and other Financial Institutions ----------------------
Loans and advances are provided in times of emergency in addition to the
----------------------

credit facilities available in normal times.

Business which the Bank may not transact ----------------------
Otherwise provided in sections 17, 18, 42 and 45, the Bank may not— ----------------------
 engage in trade or otherwise have a direct interest in any commercial, ----------------------
industrial, or other undertaking except such interest as it may in any way
acquire in the course of the satisfaction of any of its claims : provided that ----------------------
all such interests shall be disposed of at the earliest possible moment;
----------------------
 purchase the shares of any banking company or of any other company, or
grant loans upon the security of any such shares; ----------------------
 advance money on mortgage of, or otherwise on the security of, immovable
----------------------
property or documents of title relating thereto, or become the owner of
immovable property, except so far as is necessary for its own business ----------------------
premises and residences for its officers and servants;
 make loans or advances; ----------------------
 draw or accept bills payable otherwise than on demand; ----------------------
 allow interest on deposits or current accounts.
----------------------
Check your Progress 2 ----------------------
----------------------
Multiple Choice Single Response
1. As per the provisions of The Reserve Bank of India Act, 1934, ----------------------
The Reserve Bank is authorised to make to the Centre and State ----------------------
Governments, ways and means of advances for how long from the
date of making the advances? ----------------------
i. One Year
----------------------
ii. Three months
iii. Six months ----------------------
iv. No time specified ----------------------

Notes
2. In India, the sole right to issue bank notes rests with:
---------------------- i. State Bank of India
---------------------- ii. Government of India
---------------------- iii. The Reserve Bank of India

iv. Controller of currency
----------------------
----------------------
Activity 2
----------------------
---------------------- Examine the one-rupee note and five hundred rupee note and find out the
characteristics of each. Write down the difference between the two.
----------------------
---------------------- 1.5 CENTRAL BANKING FUNCTIONS

----------------------
Obligation of the Bank to transact Government business [u/s 20 & 21]
----------------------
 The Bank has to transact the business of banking on behalf of the Central
---------------------- Government.

 The Bank has to accept money and carry out other banking operations
---------------------- including the management of public debt.
----------------------
 The Bank has the right to transact the government business in India.
----------------------
 The Bank may also transact government business of states under agreement.
Right to issue Bank Notes [u/s22]
----------------------

 The Bank shall have the sole right to issue bank notes in India.
----------------------

 The issue of bank notes shall be conducted by the Bank in an Issue
---------------------- Department which shall be separated and kept wholly distinct from the
Banking Department. The assets of the Issue Department shall not be subject
---------------------- to any liability other than the liabilities of the Issue Department.
----------------------
 The Issue Department shall not issue bank notes to the Banking Department
or to any other person except in exchange for other bank notes or for such
---------------------- coin, bullion or securities as are permitted by this Act to form part of the
---------------------- Reserve.

 The bank notes shall be of the denominational values of two rupees, five rupees,
---------------------- ten rupees, twenty rupees, fifty rupees, one hundred rupees, five hundred
---------------------- rupees, one thousand rupees, five thousand rupees and ten thousand rupees or
of such other denominational values, not exceeding ten thousand rupees, as the
---------------------- Central Government may, on the recommendation of the Central Board,
specify in this behalf.
----------------------

 The design, form and material of bank notes shall be such as may be approved
----------------------

by the Central Government after consideration of the recommendations Notes
made by the Central Board and of the special one-rupee notes shall be such
as the Central Government may think fit to adopt. ----------------------
 Every bank note shall be legal tender at any place in India in payment or on ----------------------
account for the amount expressed therein, and shall be guaranteed by the
Central Government. ----------------------
 The Bank shall not be liable to the payment of any stamp duty under the ----------------------
Indian Stamp Act, 1899 in respect of bank notes issued by it.
----------------------
 The assets of the Issue Department shall consist of gold coin, gold bullion,
foreign securities, rupee coin and rupee securities to such aggregate amount ----------------------
as is not less than the total of the liabilities of the Issue Department as
hereinafter defined. ----------------------
 The liabilities of the Issue Department shall be an amount equal to the total ----------------------
of the amount of the currency notes of the Government of India and bank
notes for the time being in circulation. ----------------------
 The Central Government shall undertake not to put into circulation any ----------------------
rupees, except through the Bank; and the Bank shall undertake not to dispose
of rupee coin otherwise than for the purposes of circulation. ----------------------
 The Bank shall issue rupee coin on demand in exchange for bank notes and ----------------------
currency notes of the Government of India, and shall issue currency notes
or bank notes on demand in exchange for coin which is legal tender under ----------------------
the Indian Coinage Act, 1906. ----------------------
Cash Reserves of Scheduled Banks to be kept with the Bank [u/s 42]
----------------------
 Every bank included in the Second Schedule shall maintain with the Bank
an average daily balance the amount of which shall not be less than three ----------------------
per cent of the total of the demand and time liabilities in India of such bank.
----------------------
The Bank may, by notification in the Gazette of India, increase the said rate
to such higher rate as may be specified in the notification so however that ----------------------
the rate shall not be more than twenty percent of the total of the demand and
time liabilities. For the purposes of this section, (a) “average daily balance” ----------------------
shall mean the average of the balances held at the close of business on each
----------------------
day of a fortnight and “fortnight” shall mean the period from Saturday to
the second following Friday, both days inclusive. ----------------------
 All scheduled banks are required to submit to the Reserve Bank a return ----------------------
to submit to the Reserve Bank a return signed by two responsible officers,
with the following information: ----------------------
– The amount of demand and time liabilities and the amount of borrowings ----------------------
from the banks in India.
– The amount of legal tender and coins held by banks in India. ----------------------
– The balance held by it with the Reserve Bank. ----------------------

– The balance held by it at other banks in a current account. ----------------------

Notes – The investment in central government and state government securities
including treasury bills and treasury deposit receipts.
----------------------
– The amount of advances in India.
---------------------- – The inland bills purchased and discounted in India and foreign bills
purchased and discounted.
----------------------
 If the average daily balance held at the bank by the scheduled bank is below
---------------------- the prescribed minimum, it is liable to pay to the Bank in respect of that
fortnight, a penal rate of interest, of three percent above the bank rate.
----------------------
 If the short fall continues, the penal rate of interest is raised to five percent
---------------------- over and above the bank rate in respect of that fortnight and each subsequent
---------------------- fortnight during which the default continues. Thereafter, the Bank may fine
the officials responsible for the default, or even prohibit the scheduled bank
---------------------- from receiving any fresh deposits.
----------------------
1.6 SCHEDULED STATUS
----------------------
The Bank shall, save as hereinafter provided, by notification in the Gazette
---------------------- of India,
---------------------- (a) direct the inclusion in the Second Schedule of any bank not already so
included which carries on the business banking in India and which-
----------------------
 has a paid-up capital and reserves of an aggregate value of not less than five
---------------------- lakhs of rupees, and
----------------------  satisfies the Bank that its affairs are not being conducted in a manner
detrimental to the interest of its depositors, and
----------------------  is a State co-operative bank or a company as defined in section 3 of the
---------------------- Companies Act, 1956 or an institution notified by the Central Government
in this behalf or a corporation or a company incorporated by or under any
---------------------- law in force in any place outside India.
---------------------- A Bank that fails to comply with these requirements is excluded from the
Second Schedule and is referred to as a non-scheduled bank
----------------------
Publication of Consolidated Statements [u/s 43]
---------------------- The Bank shall to be published each fortnight a consolidated statement
showing the aggregate liabilities and assets of all the scheduled banks together,
----------------------
based on the returns and information received under this Act or any other law
---------------------- for the time being in force.
Appointment of Agents
----------------------
Unless otherwise directed by the Central Government with reference
---------------------- to any place, the Bank may, having regard to public interest, convenience of
---------------------- banking, banking development and such other factors which in its opinion
are relevant in this regard, appoint the National Bank, or the State Bank, or a
---------------------- corresponding new bank constituted under section 3 of the Banking Companies

(Acquisition and Transfer of Undertakings) Act, 1970 or a corresponding new Notes
bank constituted under section 3 of the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1980, or any subsidiary bank as defined in the ----------------------
State Bank of India (Subsidiary Banks) Act, 1959, as its agent at all places, or
at any place in India for such purposes as the Bank may specify. ----------------------
----------------------
1.7 COLLECTION AND FURNISHING OF CREDIT
INFORMATION ----------------------
----------------------
“Credit information” means any information related to—
 The amounts and the nature of loans or advances and other credit facilities ----------------------
granted by a banking company to any borrower or class of borrowers.
----------------------
 The nature of security taken from any borrower or class of borrowers for
credit facilities granted to him or to such class. ----------------------
 The guarantee furnished by a banking company for any of its customers or ----------------------
any class of its customers.
----------------------
 The means, antecedents, history of financial transactions and the
creditworthiness of any borrower or class of borrowers; ----------------------
 Any other information which the Bank may consider to be relevant for the ----------------------
more orderly regulation of credit or credit policy.
----------------------
A “banking company” means a banking company as defined in section 5
of the [Banking Regulation Act, 1949 and includes the State Bank of India any ----------------------
subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act,
1959, any corresponding new bank constituted by section 3 of the Banking ----------------------
Companies (Acquisition and Transfer of Undertakings) Act, 1970, and any other
----------------------
financial institution notified by the Central Government in this behalf;
A “borrower” means any person to whom any credit limit has been sanctioned ----------------------
by any banking company, whether availed of or not, and includes-
----------------------
 In the case of a company or corporation, its subsidiaries.
----------------------
 In the case of a Hindu undivided family, any member thereof or any firm in
which such member is a partner. ----------------------
 In the case of a firm, any partner thereof or any other firm in which such ----------------------
partner is a partner.
----------------------
 In the case of an individual, any firm in which such individual is a partner
Power of Bank to collect credit information ----------------------
The Bank may- ----------------------
 Collect, in such manner as it may think fit, credit information from banking ----------------------
companies; and
 Furnish such information to any banking company in accordance with the ----------------------
provisions of section 45D.
----------------------

Notes Power to call for returns containing credit information
 To discharge its functions under this Chapter, the Bank may at any time direct
---------------------- any banking company to submit to it such statements relating to such credit
---------------------- information and in such form and within such time as may be specified by
the Bank from time to time.
----------------------  A banking company shall be bound to comply with any direction issued by
---------------------- the Reserve Bank as above.
Provisions related to Non-Banking Finance Companies (NBFCs) receiving
---------------------- deposits and Financial Institutions (FIs)
---------------------- Power of Bank to collect information from non-banking institutions as to
deposits and to give directions-
----------------------
 The Bank may at any time direct that every non-banking institution shall
---------------------- furnish to the Bank, in a prescribed form, at such intervals and within such
time, such statements, information or particulars relating to or connected
---------------------- with deposits received by the non-banking institution, as may be specified
by the Bank by general or special order.
----------------------
 The statements, information or particulars to be furnished as stated above
---------------------- may relate to all or any of the following matters, namely, the amount of the
deposits, the purposes and periods for which, and the rates of interest and
----------------------
other terms and conditions on which, they are received.
----------------------  The Bank may, if it considers necessary in the public interest so to do, give
directions to non-banking institutions either generally or to any non-banking
----------------------
institution or group of non-banking institutions in particular, in respect of
---------------------- any matters relating to or connected with the receipt of deposits, including
the rates of interest payable on such deposits, and the periods for which
---------------------- deposits may be received.
---------------------- Power of Bank to call for information from financial institutions and to give
directions-
----------------------
 If the Bank is satisfied that for the purpose of enabling it to regulate the credit
---------------------- system of the country to its advantage it is necessary so to do, it may—
– require financial institutions either generally or any group of financial
----------------------
institutions or financial institution in particular, to furnish to the Bank
---------------------- in such form, at such intervals and within such time, such statements,
information or particulars relating to the business of such financial
---------------------- institutions or institution, as may be specified by the Bank by general
or special order;
----------------------
– give to such institutions either generally or to any such institution in
---------------------- particular, directions relating to the conduct of business by them or by
it as financial institutions or institution.
----------------------
 the statements, information or particulars to be furnished by a financial
---------------------- institution may relate to all or any of the following matters, namely, the
paid-up capital, reserves or other liabilities, the investments whether in
----------------------

Government securities or otherwise, the persons to whom, and the purposes Notes
and periods for which, finance is provided and the terms and conditions,
including the rates of interest, on which it is provided. ----------------------
 while issuing directions to any financial institution, the Bank shall have due ----------------------
regard to the conditions in which, and the objects for which, the institution
has been established, its statutory responsibilities, if any, and the effect the ----------------------
business of such financial institution is likely to have on trends in the money
----------------------
and capital markets.
 If any non-banking institution fails to comply with any direction given by ----------------------
the Bank under sub-section (3), the Bank may prohibit the acceptance of
----------------------
deposits by that non-banking institution.
General Provisions [u/s 46 – 58A] ----------------------
Contribution by Central Government to the Reserve Fund ----------------------
The Central Government shall transfer to the Bank rupee securities of the ----------------------
value of five crores of rupees to be allocated by the Bank to the Reserve Fund.
Contribution to National Rural Credit (Long Term Operations) Fund and ----------------------
National Rural Credit (Stabilisation) Fund ----------------------
The Bank shall contribute every year such sums of money as it may
----------------------
consider necessary and feasible to do so, to the National Rural Credit (LongTerm
Operations) Fund and the National Rural Credit (Stabilisation)Fund established ----------------------
and maintained by the National Bank under sections 42.and 43, respectively, of
the National Bank for Agriculture and Rural Development Act, 1981. ----------------------
National Industrial Credit (Long term Operations) Fund ----------------------
The Bank shall establish and maintain a Fund to be known as the National ----------------------
Industrial Credit (Long Term Operations) Fund and credit an initial sum of ten
crores of rupees by the Bank and such further sums of money as the Bank may ----------------------
contribute every year.
----------------------
Allocation of surplus profits [u/s 47 & 48]
----------------------
After making provision for bad and doubtful debts, depreciation in assets,
contributions to staff and superanuation funds and for all other matters for which ----------------------
provision is to be made by or under this Act or which are usually provided for
----------------------
by bankers, the balance of the profits shall be paid to the Central Government.
The Bank shall not be liable to pay income-tax or super-tax on any of its income, ----------------------
profits or gains.
----------------------
Publication of bank rate [u/s 49]
The Bank shall make public from time to time the standard rate at which it ----------------------
is prepared to buy or re-discount bills of exchange or other commercial paper ----------------------
eligible for purchase under this Act.
----------------------
----------------------

Notes Returns [u/s 53]
The Bank shall prepare and transmit to the Central Government a weekly
----------------------
account of the Issue Department and of the Banking Department in such form as
---------------------- the Central Government may, by notification in the Gazette of India, prescribe.
The Central Government shall cause these accounts to be published in the Gazette
---------------------- of India at such intervals and in such modified form as it may deem fit.
---------------------- Penalties [u/s 58B -58F]
Whoever in any application, declaration, return, statement, information or
----------------------

particulars made, required or furnished by or under or for the purposes of

---------------------- any provisions of this Act, or any order, regulation or direction made or
given or in any prospectus or advertisement issued for or in connection with
---------------------- the invitation by any person, of deposits of money from the public, wilfully
makes a statement which is false knowing it to be false or wilfully omits
----------------------
to make a material statement shall be punishable with imprisonment for a
---------------------- term which may extend to three years and shall also be liable to fine.
----------------------  If any person fails to produce any book, account or other document or to
furnish any statement, information or particulars which, under this Act or
---------------------- any order, regulation or direction made or given, it is his duty to produce or
furnish or to answer any question put to him in pursuance of the provisions of
---------------------- this Act or of any order, regulation or direction made, he shall be punishable
---------------------- with fine which may extend to two thousand rupees in respect of each offence
and if he persists in such failure or refusal, with further fine which may
---------------------- extend to one hundred rupees for every day, after the first during which the
offence continues.
----------------------
 If any person discloses any credit information, the disclosure of which is
---------------------- prohibited under section 45E, he shall be punishable with imprisonment for
a term which may extend to six months, or with fine which may extend to
---------------------- one thousand rupees, or with both.
----------------------
----------------------
---------------------- Multiple Choice Single Response

1. “Banking company” means a banking company as defined in _________
----------------------
of the Banking Regulation Act, 1949.
---------------------- i. Section 3
---------------------- ii. Section 4
---------------------- iii. Section 5
----------------------
----------------------
----------------------

Notes
2. Power of Bank to call for information from financial institutions and
to give directions exercised by the Reserve Bank of India is used for ----------------------
______.
----------------------
i. Issuing renewal licences every year
ii. For providing subsidy ----------------------
iii. Enabling it to regulate the credit system ----------------------
3. If any person discloses any credit information, the disclosure of ----------------------
which is prohibited _______________, he shall be punishable with
imprisonment for a term, which may extend to six months, or with ----------------------
fine, which may extend to one thousand rupees or with both.
----------------------
i. Under Section 54 of the Act
----------------------
ii. Under Section 54 E of the Act
iii. Under section 45E ----------------------
----------------------
1.8 CHANGING ROLE OF RBI ----------------------
Currency Management ----------------------
Capacity Building of Printing Presses
----------------------
 There has been a severe supply constraint of currency due to poor/low
capacity of Note printing presses in the 1990s besides the need to withdraw ----------------------
soiled notes from circulation and fresh notes for circulation.
----------------------
 The Bharatiya Reserve Bank Notes Mudran Private Ltd. (BRBNMPL), a
wholly owned subsidiary of RBI was set up. Two printing presses having ----------------------
been set up, one in Mysore (Karnataka) and one in Salboni (West Bengal) ----------------------
operational since in 1999 and 2000 respectively.
 These printing presses are fully equipped with modern facilities for printing, ----------------------
process control, accounting and quality check in a secure environment. ----------------------
 These printing presses are capable of printing notes of all denominations.
----------------------
 There is a Shift toward higher Denominations notes in circulation.
----------------------
 BRBNMPL has been awarded the ISO 9001-2000 Certification, the first
ever bank notes printing press in the world to receive such certification. ----------------------
Clean Note Policy ----------------------
 The Bank is finding it difficult to tackle the problem of soiled and mutilated
notes, to expertly handle the process of withdrawal of such notes and at the ----------------------
same time put new notes in circulation ----------------------
 The setting up of BRBNMPL enabled RBI to embark on a ‘Clean Note
Policy’ in the year 1999. ----------------------
----------------------

Notes  The aim of the policy was to put fresh notes in circulation on the withdrawal
of non-issuable notes well in time.
----------------------
 The process was a long time consuming manual process of withdrawal of
---------------------- notes from circulation, collection by currency chest and then sorted at the
Issue Offices. The process was converted from a manual process to a fully
---------------------- mechanized note processing activity. RBI adopted the Currency Verification
and Processing Systems (CVPS) and Shredding and Briquetting System
----------------------
(SBS).
----------------------  The CVPS comprises of high speed fully automatic machines designed to
---------------------- sort currency notes into fit and unfit categories.
 The SBS consists of shredding unfit notes into very small pieces, to form
---------------------- compact briquettes to be disposed off in an environment friendly manner.
---------------------- Anti-counterfeiting Measures
---------------------- The challenge before the Reserve Bank is to improve the security features
on existing designs of notes in order to combat counterfeiting.
----------------------
 Attempts are made to incorporate a mixture of security features on a
---------------------- completely new series of notes.
Security features introduced are a changed watermark, windowed security
----------------------

thread, latent image and intaglio features for visually handicapped.

----------------------  Bank notes of the 2005 Series were designed with machine readable security
---------------------- features.
Supervisory Role
----------------------
The Board for Financial Supervision was constituted in November 1994
---------------------- as a committee of the Central Board of Directors of the Reserve Bank of India.
The Reserve Bank performs the supervisory function under the guidance of the
---------------------- Board for Financial Supervision (BFS). The Primary objective of the Board is to
---------------------- undertake consolidated supervision of the financial sector comprising commercial
banks, financial institutions and non-banking finance companies.
----------------------
 The Board is constituted by co-opting four Directors from the Central Board
---------------------- as members for a term of two years and is chaired by the Governor. The
Deputy Governors of the Reserve Bank are ex-officio members. One Deputy
---------------------- Governor, usually, the Deputy Governor in charge of banking regulation
and supervision, is nominated as the Vice-Chairman of the Board.
----------------------
 The Board is required to meet normally once every month. It considers
---------------------- inspection reports and other supervisory issues placed before it by the
supervisory departments.
----------------------
 The Board through the Audit Sub-Committee also aims at upgrading the
---------------------- quality of the statutory audit and internal audit functions in banks and
---------------------- financial institutions. The audit sub-committee includes Deputy Governor
as the chairman and two Directors of the Central Board as members.
----------------------  The BFS oversees the functioning of Department of Banking Supervision

(DBS), Department of Non-Banking Supervision (DNBS) and Financial Notes
Institutions Division (FID) and gives directions on the regulatory and
supervisory issues. ----------------------
 The functions of the Board are ----------------------
– To restructure the system of bank inspections
----------------------
– To introduction of off-site surveillance,
----------------------
– To strengthen the role of statutory auditors and
– To strengthen the internal defences of supervised institutions. ----------------------
 The current issues before the Board are ----------------------

– Supervision of financial institutions ----------------------
– Consolidated accounting
----------------------
– Legal issues in bank frauds
----------------------
– Divergence in assessments of non-performing assets and
– Supervisory rating model for banks. ----------------------
----------------------
Summary
----------------------
●● The Reserve Bank of India Act, 1934 confers upon the Bank the powers
to act as a note-issuing authority, bankers’ bank and banker to the ----------------------
Government. ----------------------
●● The Reserve Bank of India, as a central Bank of our country has over
the years moved from a passive role of that of a regulatory body to an ----------------------
active role as a participant/player in the banking and financial system. ----------------------
After 1991, the regulatory and supervisory policies of the Reserve Bank
of India have transformed significantly along with the structure of the ----------------------
Indian financial system as well as the global developments.
----------------------
Keywords ----------------------
●● Bank: The word Bank refers to the Reserve Bank of India. ----------------------
●● Central Board: A Board of 20 members entrusted with the general ----------------------
superintendence and direction of the affairs and business of the Bank.
●● Local Board: One local board each to be constituted for each of the four ----------------------
regional areas of the country for representing the territorial and economic
----------------------
interest of the region.
●● Monopoly of Note Issue: the exclusive / sole right to issue currency in ----------------------
the economy.
----------------------
●● Cash Reserve: an average daily balance not less than three percent of the
total demand and time liabilities of the Bank in India to be maintained ----------------------
with the Reserve Bank of India.
----------------------

Notes ●● Scheduled Bank: Every Bank included in the Second Schedule of the
Reserve Bank of India Act, 1934.
---------------------- ●● Credit Information: Information furnished by a banking company
---------------------- on amount and nature of loan and advances, nature of securities taken,
gurarantees furnished, history of financial transactions and any other
---------------------- information banks may consider relevant for credit policy.
---------------------- ●● Borrower: any person to whom any credit limit has been sanctioned by
any banking company.
----------------------
---------------------- Self-Assessment Questions
---------------------- 1. Discuss the functions of the Reserve Bank of India as the central bank of
the country.
----------------------
2. Write a note on the ‘Note Issue Function’ of the Reserve Bank of India
---------------------- 3. Explain in detail the composition and functions of the Central Board.
---------------------- 4. What is the role of the local board?
---------------------- 5. What is meant by Credit Information?

6. What is meant by Cash Reserve?
----------------------
7. Explain the concept of a Scheduled Bank
----------------------
8. Discuss the provisions of Section 42 of the Reserve Bank of India Act,
---------------------- 1934
9. How does the Reserve Bank control the advances of commercial banks?
----------------------
10. Write a note on the Board of Financial Supervision.
----------------------
----------------------
----------------------
---------------------- Check your Progress 1

Fill in the blanks.
----------------------
1. As per the Banking Regulation Act, Local Board shall be constituted for
---------------------- each of the four areas and shall consist of five members to be appointed
by the Central Government to represent
----------------------
2. Meeting of the Central Board [u/s 13] shall be convened by the Governor
---------------------- at least six times in a year and at least once in a quarter.
----------------------
----------------------
----------------------
1. As per the provisions of The Reserve Bank of India Act, 1934, The
---------------------- Reserve Bank is authorised to make to the Centre and State Governments,

ways and means of advances for how long from the date of making the Notes
advances?
----------------------
ii. Three months
2. In India, the sole right to issue bank notes rests with: ----------------------
iii. The Reserve Bank of India ----------------------
----------------------
----------------------
----------------------
1. “Banking Company” means a banking company as defined in _________
of the Banking Regulation Act, 1949. ----------------------
iii. Section 5
----------------------
2. Power of Bank to call for information from financial institutions and to
give directions exercised by the Reserve Bank of India is used for ______. ----------------------
iii. Enabling it to regulate the credit system ----------------------
3. If any person discloses any credit information, the disclosure of which is ----------------------
prohibited _______________, he shall be punishable with imprisonment
for a term, which may extend to six months, or with fine, which may ----------------------
extend to one thousand rupees or with both.
----------------------
iii. Under section 45E
----------------------
----------------------
Suggested Reading
----------------------
1. The Reserve Bank of India Act, 1934.
----------------------
2. The Reserve Bank of India (Board for financial supervision) Regulations,1984.
----------------------
3. Varshney, P.N. Banking Law and Practice, Sultan Chand & Sons.
4. Dharmadhikari, Mrs. Vandana. Banking Horizon. New Bharat Printers. ----------------------
5. Tannan, M.L. Banking Law and Practice in India. ----------------------
6. Lal Nigam, B.M. Banking Law and Practice. ----------------------
7. Sundaram and Varshaney. Banking Theory, Law & Practice.
----------------------
8. Gordon and Natarajan. Banking Law and Practice.
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Banking Regulation Act, 1949
UNIT
2
Structure:
2.1 Introduction
2.2 Definition, Functions, Restrictions on Business of Banks
2.3 Capital & Reserve Fund, Cash Reserve and Liquid Assets
2.4 Licensing and Branch Licensing
2.5 Management
2.6 Powers of RBI
2.7 Voluntary Amalgamation & Liquidation
2.8 P&L A/C and Balance Sheet
Summary
Key Words
Suggested Reading
Banking Regulation Act, 1949 19

Notes
Objectives
----------------------
• Explain the concept ‘banking’
----------------------
• Describe business of banking companies
----------------------
• Discuss the capital structure of banking companies
---------------------- • Elucidate on the management of banking companies
----------------------
---------------------- 2.1 INTRODUCTION
---------------------- The enactment of the Banking Regulation Act in 1949 [BR Act, 1949] has
been an important event in the history of Indian joint-stock banking. The BR
---------------------- Act, 1949 was passed to offer one common law to govern the banking sector,
consolidate all laws relating to the banking sector.
----------------------
Earlier, the Indian Companies (Amendment) Act, 1936 dealt with banking
---------------------- companies. A special part of the Act i.e. Part XA aimed at the protection of
depositors and included restrictions on banking companies regarding banking
----------------------
transactions. It also aimed at ensuring the maintenance of a proper reserve fund
---------------------- with adequate cash reserve. It also provided against the mushrooming of banking
companies with inadequate finance. But, it was found that this act was inadequate
---------------------- to curb the malpractices and frauds seen in the banking sector and to protect
the interest of depositors. There was large siphoning of funds and investments
----------------------
taking place in vested interests. And therefore, the Banking Companies Act, 1949
---------------------- was passed to consolidate and amend the laws relating to banking companies.
The need was felt for a separate regulation owing to the abuse of powers by
---------------------- management controlling banks; the absence of measures for safeguarding the
interest of depositors; of banking companies in particular and the economic
----------------------
interest of the country in general. With effect from March 1, 1966, the name of
---------------------- the Act has been changed to Banking Regulation Act, 1949.
Objectives of the Act
----------------------
 Enactment of specific legislation to govern banking companies, their working
---------------------- and operations. This is to do away with the control of Indian Companies
---------------------- Act, 1913 over banking companies.
 Prevent bank failures by prescribing certain norms, rules and regulation
---------------------- regards entry and commencement.
----------------------  Ensure a balanced and planned development of the banking system.
----------------------  Regulate the credit created by commercial banks through the central bank
of the country.
----------------------
 Safeguard the interest of depositors and ensure public confidence in the
---------------------- system.

2.2 DEFINITION, FUNCTIONS, RESTRICTIONS ON Notes
BUSINESS OF BANKS
----------------------
Definitions
----------------------
“Banking” and “Banking Companies” [Sec 5]
----------------------
“Banking Company” is defined by Sec 5(c) of the Act as “any company
which transacts the business of banking in India.” ----------------------
U/s 5(b), “Banking” is defined as “the accepting, for the purpose of lending ----------------------
of investment, of deposits of money from the public, repayable on demand or
otherwise, and withdrawable by cheque, draft, order or otherwise.” ----------------------
A company is defined as any company as defined u/s 3 of the Companies ----------------------
Act, 1956; and includes a foreign company within the meaning u/s 591 of the
Act. ----------------------
The acceptance of deposits is sine qua non (indispensable condition) for ----------------------
constituting banking business. Therefore, private money lending business and
indigenous bankers are excluded from the scope of banking. So also, trading and ----------------------
manufacturing companies that accept deposits are excluded from this definition.
----------------------
Forms/ Kinds of business in which Banking Company may engage [Sec 6]
----------------------
U/s 6, a banking company, in addition to banking business, is empowered
to engage in one or more forms of the following forms of business: ----------------------
 Borrowing, raising or taking up of money; ----------------------
 Lending or advancing of money either upon or without security;
----------------------
 Drawing, making, accepting, discounting, buying, selling, collecting and
dealing in bills of exchange, hundies, promissory notes, drafts, bills of lading, ----------------------
railway receipts, debentures and other instruments and securities whether
transferable or negotiable or not; ----------------------
 Granting and issuing of letters of credit, travelers cheques and circular notes; ----------------------
 Buying, selling and dealing in bullion; ----------------------
Buying and selling of foreign exchange including foreign bank notes;
----------------------

 Acquiring, holding, issuing on commission, underwriting and dealing

in stocks, funds, shares, debentures, bonds, obligations, securities and ----------------------
investments of all kinds; ----------------------
 Negotiating of loans and advances;
----------------------
 Receiving all kinds of bonds, scrips or valuables on deposit or for safe
custody or otherwise; ----------------------
 Providing safe deposit vaults; ----------------------
Collection and transmission of money and securities.
----------------------

Subsidiary functions- Besides, it can also perform the following functions

/ engage in the business listed below: ----------------------

Notes  Acting as agent for any government or local authority or any other person/s;
 Contracting for public and private loans and negotiating and issuing the same;
----------------------
 Effect, insure, guarantee, underwrite, participate in managing and carrying
---------------------- out of any issue, public or private of the State or Municipality, Company,
Corporation or Association;
----------------------
 Carrying on and transacting every kind of guarantee or indemnity business;
----------------------
 Managing, selling and realizing any property which may come into the
---------------------- possession of the banking company as part of its claims;
----------------------  Undertaking and executing trusts;

 Undertaking and administration of estates as executor, trustee or otherwise;
----------------------
 Establishing and supporting or aiding in the establishment and support of
---------------------- associations, institutions, funds, trusts and conveniences calculated to benefit
employees or ex-employees of the company or dependents, granting pension
----------------------
an allowances and making payments towards insurance granting money for
---------------------- charitable or benevolent purposes.
 Acquiring and undertaking the whole or any part of the business of any
----------------------
person or company;
----------------------  Any other form of business which the Central Government may specify by
---------------------- the notification in the Gazette of India.
Use of words “Bank”, “Banker” and “Banking” [Sec 7]
----------------------
U/s 7, the Act prohibits the use of the words bank, banker or banking by any
---------------------- company other than a banking company and makes it compulsory for a company
carrying on the business of banking in India to use one of these words as part of
---------------------- its name.
---------------------- No firm, individual or group of individuals can use as part of its name any
of the above-mentioned words for carrying on any business.
----------------------
Prohibition of Trading [Sec 8]
----------------------
U/s 8, a banking company cannot directly or indirectly deal in-
----------------------  The buying or selling or bartering of goods except in connection with the
---------------------- realization of security given to or held by it, or
 Engage in any trade or buy, sell or barter goods for others otherwise than in
---------------------- connection with bills of exchange received for collection or negotiation, or
----------------------  With the undertaking of the administration of estates as executors, trustees
or otherwise.
----------------------
As per the amendment (Feb, 1984), the Act has been made inapplicable to
---------------------- the business that the Central Government may specify as a form of business in
which it is lawful for a banking company to engage.
----------------------
U/s 19 of the Act, a banking company cannot carry on trading activities by
---------------------- acquiring a controlling interest in non-bank companies.

2.3 CAPITAL & RESERVE FUND, CASH RESERVE AND Notes
LIQUID ASSETS
----------------------
Capital ----------------------
Paid-up Capital & Reserves [Sec 11]
----------------------
U/s 11, all banking companies are required to follow a minimum standard of
paid-up capital and reserves as a condition for the commencement of business. ----------------------
These conditions apply to banking companies wherever incorporated, but
companies in existence at the time of the commencement of the Act were given ----------------------
a period of three years or such further period not exceeding one year as the RBI ----------------------
extended to comply with the provisions as mentioned.
----------------------
U/s Sec 12, the Act prohibits the carrying on of business in India by a banking
company unless it satisfies the following conditions: ----------------------
 Subscribed capital should not be less than half of its authorised capital and
----------------------
paid-up capital should not be less than half of its subscribed capital.
 If the capital is increased, the above requirement must be fulfilled within ----------------------
two years. ----------------------
 A banking company cannot issue any other type of shares except equity
shares i.e. it cannot issue preference shares. ----------------------
Certain unscrupulous bankers used to mislead the ignorant public by showing ----------------------
large figures of authorised capital as against very fractional amount of paid-up
capital. This section is to prevent such malpractices and ensure proper working ----------------------
of banking companies. ----------------------
 The voting rights of any one shareholder on roll do not exceed 10% (raised
----------------------
from 1% to 5% to 10%) of the total voting rights of all the shareholders.
The provision has been made to prevent any section of the shareholders of ----------------------
a banking company from securing control over the management or preferential
----------------------
rights on the assets of the company.
Aggregate Value of Paid-up Capital and Reserve ----------------------
Incorporated in India Rupees ----------------------

For a banking company incorporated in India having ----------------------
places of business more than one State 5,00,000
----------------------
If any such place/s of business is or are situated in the
City of Bombay or Calcutta or both 10,00,000 ----------------------
Incorporated outside India ----------------------
For a banking company incorporated outside India
having places of business more than one State 15,00,000 ----------------------
If any such place/s of business is or are situated in the ----------------------

City of Bombay or Calcutta or both 20,00,000
----------------------

Notes Banking companies incorporated outside India have to deposit the amount
required as above either in cash or in unencumbered approved securities or partly
---------------------- in cash and partly in such securities with the RBI. In addition, it has to deposit
at the end of every calendar year, 20% of its profit for that year in respect of all
---------------------- business transacted through its branches in India.
---------------------- Restriction on Payment of Dividend.
---------------------- No banking company shall pay any dividend on its shares until all its
capitalised expenses (including preliminary expenses, organisation expenses,
---------------------- share-selling commission, brokerage, amounts of losses incurred and any other
item of expenditure not represented by tangible assets) have been completely
----------------------
written off.
---------------------- Notwithstanding anything to the contrary contained in sub-section (1) or in
the Companies Act, 1956(1 of 1956), a banking company may pay dividends on
----------------------
its shares without writing off—
----------------------  the depreciation, if any, in the value of its investments in approved securities
---------------------- in any case where such depreciation has not actually been capitalised or
otherwise accounted for as a loss;
----------------------  the depreciation, if any, in the value of its investments in shares, debentures or
---------------------- bonds (other than approved securities) in any case where adequate provision
for such depreciation has been made to the satisfaction of the auditor of the
---------------------- banking company;
----------------------  the bad debts, if any, in any case where adequate provision for such debts
has been made to the satisfaction of the auditor of the banking company.]
----------------------
Reserve fund [Sec 17]
---------------------- U/s 17, every banking company incorporated in India must maintain a
reserve fund and transfer thereto at least 20% of its net profits, irrespective of
----------------------
whether or not its reserves have equaled the paid-up capital. This provision is
---------------------- intended to act as a brake on the policy of declaring large dividends to satisfy
their shareholders, thus undermining sound banking principles.
----------------------
Cash Reserve [Sec 18]
---------------------- U/s 18, every banking company [non-scheduled bank] is required to maintain
---------------------- cash reserve either with itself or in an account with RBI or SBI or any other bank
notified by the central government in this behalf a sum equivalent to at least 3%
---------------------- of its demand and time liabilities.
---------------------- Similarly, u/s 42(1) of the RBI Act, 1934, scheduled banks maintain cash
reserves with RBI.
----------------------
Maintenance of Percentage of Liquid Assets [Sec 24]
---------------------- U/s 24, every banking company is required to maintain gold, cash or
unencumbered securities valued at a price not exceeding current market price, an
----------------------
amount not less than 25% of its total demand and time liabilities. This provision
---------------------- is intended to ensure the liquidity of the assets of the bank so as to be able to

meet the demand of depositors. This provision is of particular importance since Notes
the main reason for bank failures in the past has been the negligence on the part
of bankers to maintain the liquidity of assets in their greed to earn more profits. ----------------------
As per the provision, every banking company is required to maintain a ----------------------
minimum liquidity ratio as fixed by the RBI from time to time. Liquidity ratio is
in addition to the cash reserve ratio required to be maintained by the non-schedule ----------------------
banks under Banking Regulation Act, 1949 and by scheduled banks under the
----------------------
Reserve Bank of India Act, 1934.
----------------------
2.4 LICENSING AND BRANCH LICENSING
----------------------
Licensing
----------------------
Bank License
----------------------
U/s 22, every banking company has to obtain a license from the RBI for
commencing or carrying on banking business in India. The purpose of licensing ----------------------
was to bring about the development of banking on sound lines and prevent
indiscriminate growth of banking companies. ----------------------
Before granting a license, RBI may require to be satisfied by an inspection ----------------------
of the books of the company or otherwise and be satisfied on the following
conditions: ----------------------
 the banking company is/will be in a position to pay its present as well as ----------------------
future depositors in full;
----------------------
 that the bank affairs are not conducted to the detriment of the interest of
present as well as future depositors. ----------------------
 that the company has appropriate capital structure as prescribed by the ----------------------
Reserve Bank from time to time;
----------------------
 that on granting the licence to the company to carry on banking business,
the public interest will be served; ----------------------
 any other condition laid down by the Reserve Bank from time to time, the
----------------------
fulfillment of which would be necessary to carry out banking business in
India. ----------------------
Before granting any licence to a banking company incorporated outside ----------------------
India, the RBI may require to be satisfied by an inspection of the books of the
company or otherwise that the conditions specified above are fulfilled and the ----------------------
carrying on of banking business by the company in India will be in the interest
of the public. ----------------------
RBI may cancel a license granted to a banking company if the banking ----------------------
company ceases to carry banking business in India or it fails to comply with any
of the conditions imposed. ----------------------
Branch License ----------------------

U/s 23, every banking company has to obtain permission of the RBI for ----------------------

Notes opening new branches either in India or abroad and also for change in location
of existing offices.
----------------------
This provision is to discourage the growth of concentration of branches in
---------------------- particular regions or localities. Control over branch expansion of commercial
banks is a part of the supervisory function of the RBI.
----------------------
Without the prior permission of the RBI, no banking company shall open a
---------------------- new place of business in India or change otherwise that the same city, town or
village; and no banking company incorporated in India shall open a new place
---------------------- of business outside India or change otherwise than within the same city, town
or village in any country outside India.
----------------------
Before granting any permission, the RBI may require to be satisfied by an
---------------------- inspection and the fulfillment of the following conditions:
----------------------  Financial condition and history of the banking company,
----------------------  The general character of the management of the banking company,

 The adequacy of capital of the banking company and the earning prospects
---------------------- and
----------------------  That the public interest is served by such a change in the location of the
place of business.
----------------------
---------------------- 2.5 MANAGEMENT

---------------------- Management [Sec 10]
---------------------- The failure of banks during the past has been attributed among other reasons,
to the defective management of the banks by persons untrained in the technique
---------------------- and ignorance of sound banking principles.
---------------------- Every banking company is required to constitute its board of Directors in
such a way to ensure that not less than 51% of the total number of members on
---------------------- it Board of Directors consists of persons having special knowledge or practical
knowledge in one or more matters such as accountancy, agriculture and rural
----------------------
economy, banking, cooperation, economics, finance, law, small scale sector and
---------------------- any other matter which can prove useful to a banking company.
---------------------- Out of the total number of directors as stated above, not less than two shall
be persons from the field or having special knowledge or practical experience
---------------------- in respect of agriculture and rural economy, cooperation or small scale industry.
---------------------- The members of the Board of Directors shall not have substantial interest
in, or be connected with
----------------------  any company not being a registered under Companies Act, 1956 or
----------------------  any firm which carries on any trade, commerce or industry, or
----------------------  are proprietors of any trading, commercial or industrial concern.
If the composition of the Board of Directors does not fulfill the above
----------------------

requirements, RBI may direct the banking company to reconstitute the Board. If Notes
the banking company does not comply with such directions within two months,
RBI may itself remove director/directors and appoint suitable persons in that ----------------------
place.
----------------------
Appointment of Chairman
----------------------
Every banking company is required to have one of its directors as the
Chairman of its Board of Directors who is entrusted with the management of ----------------------
the affairs of the banking company but he exercises his powers subject to the
superintendence, control and direction of the Board of Directors. The Chairman ----------------------
has to be to be a whole-time Chairman and Managing Director; he should be a
----------------------
professional banker with special and practical knowledge of banking and finance,
economics or business administration. ----------------------
A person is disqualified for appointment as Chairman it he –
----------------------
 is a director of a company registered u/s 25 of the Companies Act, 1956;
----------------------
 is a partner of any firm which carries any trade, business or industry;
 has substantial interest in any other company or firm; ----------------------
 is a director, manager, partner or proprietor of any trading, commercial or ----------------------

industrial concern;
----------------------
 is engaged in other business or vocation.
----------------------
2.6 POWERS OF RBI ----------------------
Powers to control advances ----------------------
U/s 21, the Act confer certain powers to the RBI to control and regulate the
----------------------
banking system as the Central Bank of our country. The RBI is given powers to
control the advances by banking companies in the interest of the public or in the ----------------------
interest of depositors. The powers are to decide the policy in relation to advances
of banking companies- ----------------------
The purpose for which advances may or may not be made; ----------------------
– The margins to be maintained in respect of secured advances; and ----------------------
– The rates of interest to be charged not only on advances but also on other
financial accommodation as well as commission on guarantees ----------------------
An amendment in 1963 extends the powers of the RBI to give directions ----------------------
to banks regarding the maximum amount of advances that may be granted to or
----------------------
the maximum amount up to which guarantees may be given on behalf of any
one company, firm, association of persons or individuals. ----------------------
A banking company cannot grant any loans or advances on the security
----------------------
of its own shares. It cannot also grant unsecured loans/advances to any of its
directors or to any firm or company where any of its directors have any interest ----------------------
as partner or guarantor. Similarly, loans cannot be given to any company in which
the chairman of the banking company has interest as managing director. ----------------------

Notes Powers to Inspect [Sec 35 & 36];
The RBI may at any time and on being directed so to do by the Central
----------------------
Government shall carry out an inspection to be made by one or more officers
---------------------- of any banking company and its books and accounts. The Reserve Bank will
provide a copy of its report on such inspection also to that banking company.
----------------------
It shall be the duty of every director or other officer of the banking company
---------------------- to produce to any officer making an inspection all such accounts and other
documents in his custody and furnish any information relating to the affairs of
---------------------- the banking company as the said officer may require within such time as the
said officer may specify. Any officer making such an inspection may or examine
----------------------
on oath any director or other officer of the banking company in relation to the
---------------------- business and may administer such oath accordingly.
The RBI is empowered to conduct scrutiny of the affairs of the banking
----------------------
companies in addition to conducting regular inspection under this section.
---------------------- Section 45-Q of Banking Regulation Act, 1949 and Sec 237 of Companies
---------------------- Act, 1956 deal with inspection in certain cases by the RBI and the Central
Government respectively. These sections have been incorporated in their
---------------------- respective acts with a view to check malpractices in companies generally and
particularly in banking companies. As a result of the inspection, quite a number
---------------------- of banks have been refused license by the RBI.
---------------------- The RBI has powers to issue directions to banking companies [ section 36A]
to issue direction to banking companies in general or to any banking company
---------------------- in particular, when it deem it as necessary-
----------------------  to do so in the interest of the public;
----------------------  to prevent the banking company from conducting its business in a manner
detrimental to the interest of the depositers;
----------------------
 for a better management of a banking company;
----------------------  in the interest of the broad banking policy.
---------------------- The RBI also has the powers to appoint or reappoint directors, chairman,
managing director or whole time director of a banking company. Likewise, the
---------------------- RBI also has the power to remove any director or chairman or managing director
---------------------- of a bank, if his actions are found to be detrimental to the interest of the public
or against broad banking policy.
----------------------
2.7 VOLUNTARY AMALGAMATION & LIQUIDATION
----------------------
Amalgamation - If two or more banks want to amalgamate, they must get
----------------------
the permission of the RBI. The RBI will grant permission if it is satisfied with
---------------------- the scheme of amalgamantion
---------------------- Voluntary Amalgamation - [Sec 44A]; This section lays down the procedure
for amalgamation of a banking company with another banking company. The
---------------------- scheme containing the terms of amalgamation has to be approved by a majority

in number representing 2/3rd the value of the shareholders in a General Meeting. Notes
A dissenting shareholder is entitled to receive the value of his share as may be
determined by the RBI. RBI has to sanction the scheme after the approval of the ----------------------
shareholders. The assets would then be transferred to the acquiring bank. The
RBI is empowered to order the dissolution of the first bank on a specified date. ----------------------
The RBI to apply to Central Government for an order of moratorium (Sec ----------------------
45). The Central Government may pass a moratorium after considering the
----------------------
application. During the moratorium the banking company cannot make any
payment to depositors or discharge any liabilities/obligations to any other creditor ----------------------
unless otherwise directed by the government.
----------------------
Further on, if the RBI is satisfied that the affairs of the banking company, in
respect of which moratorium has been granted, are being conducted in a manner ----------------------
detrimental to the interest of depositors, it may apply to the High Court for the
winding up of the company. The RBI can examine the records of proceedings ----------------------
and tender advice in winding up proceedings (Sec 45-P). The RBI has power to
----------------------
inspect and make its report on winding-up proceedings (Sec 45-Q). The RBI has
the power to call for Returns and information from the Liquidator of a banking ----------------------
company (Sec 45-R).
----------------------
2.8 P&L A/C AND BALANCE SHEET ----------------------
 At the close of last Friday of each quarter, every banking company carrying ----------------------
on business in India is required to have assets in India equivalent to at least
75% of its total liabilities. This applies to both Indian as well as foreign ----------------------
banking companies.
----------------------
 Every banking company is required to submit returns to RBI and prepare
the final account in a specified manner in terms of the provisions of the ----------------------
Banking Regulation Act.
----------------------
 The RBI can call for information and statement regarding the business of
the banking company, in the required forms-investment statements and ----------------------
classification of advances
----------------------
 Every banking company has to compile its accounts and balance sheet in
the prescribed format. ----------------------
 Every banking company has to get its reports audited by a duly qualified ----------------------
auditor. A banking company has no right to appoint, re-appoint or remove
any auditor without the prior permission of RBI. ----------------------
 The RBI is empowered to inspect any banking company at any time to ensure ----------------------
itself about the efficient performance of its responsibilities. When in doubt,
an assessment can be made of the financial position, method of operation, ----------------------
branch expansion, investments, region-wise performance, profit planning ----------------------
or man-power planning and other development activities.
----------------------
 The RBI is authorised to caution bank/s against a particular transaction or
a class of transactions or to offer advice. ----------------------

Notes
 The RBI is also empowered to inspect the branches of Indian banks abroad
in order to find out whether they are working on sound banking principles.
----------------------

 The accounts and the balance sheet along with the auditor’s report must be
---------------------- published in the prescribed manner and three copies must be furnished as
returns to the RBI within three months from the end of the period to which
---------------------- they refer. Three copies of the same have to be submitted to the Registrar of
Companies too.
----------------------

 The publication of accounts and balance sheet has to be made in a newspaper
---------------------- which is in circulation at the place where the banking company has its
principal office.
----------------------

----------------------
Fill in the blanks.
----------------------
1. “Banking” is defined as “the accepting, for the purpose of lending of
---------------------- investment, of deposits of money from the public, repayable on _____
or otherwise, and withdrawable by cheque, draft, order or otherwise”.
----------------------
2. U/s Sec 12 of the Banking Regulation Act, _____capital should not
---------------------- be less than half of its authorised capital and paid-up capital should
not be less than half of its subscribed capital.
----------------------
3. Aggregate Value of Paid-up Capital and Reserve for a banking
---------------------- company incorporated in India having places of business more than
one State should be minimum Rs. _____.
----------------------
----------------------
Activity 1
----------------------
---------------------- Study the balance sheet of any bank and find out the authorised, subscribed
and paid up capital of the bank.
----------------------
----------------------
Summary
----------------------
●● The basic purpose of the Banking Regulation Act, 1949 is to control,
---------------------- monitor and direct the banking companies, to prevent them from following
wrong practices/policies, fraudulent practices and protect the interest of
----------------------
the depositors in particular and the public in general.
---------------------- ●● Every aspect of a banking company is governed by the provisions of the
Act – business of banking, prohibition of trading, capital, management,
----------------------
etc. The Act also grants certain powers to the Reserve Bank to regulate
---------------------- and control banking companies and to protect the interest of depositors.
----------------------

Keywords Notes
----------------------
●● ‘Banking’: The accepting, for the purpose of lending of investment, of
deposits of money from the public, repayable on demand or otherwise, ----------------------
and withdrawable by cheque, draft, order or otherwise
●● ‘Banking Company’: A company under Companies Act, 1956 carrying ----------------------
out banking business. ----------------------
●● Prohibition of Trading: A banking company cannot directly or indirectly
deal in buying or selling or bartering of goods; engage in any trade or buy, ----------------------
sell or barter goods. ----------------------
●● Reserve Fund: Fund where at least 20% of its net profits, irrespective of
whether or not its reserves have equaled the paid-up capital ----------------------
●● Cash Reserve: A reserve equivalent to at least 3% of its demand and time ----------------------
liabilities maintained either with itself or in an account with RBI or SBI
or any other bank notified by the central government. ----------------------
●● Liquid Ratio: A minimum liquid ratio to be maintained in gold, cash or ----------------------
unencumbered securities valued at a price not exceeding current market
price, an amount not less than 25% of its total demand and time liabilities ----------------------
●● Scheduled Bank: A bank which is included in the Second Schedule of ----------------------
Reserve Bank of India(RBI) Act, 1934 on the fulfillment of the following
criteria laid down vide section 42 (6) (a) of the Act: ----------------------
– The paid capital and collected funds of bank should not be less than ----------------------
Rs.5 lakhs
----------------------
– Any activity of the bank will not adversely affect the interests of
depositors. ----------------------
●● Powers of RBI: Power to issue a license, power to control advances, power ----------------------
to inspect, power to appoint, terminate, reappoint Board of Directors, etc.
●● Order of Moratorium: An order where a banking company cannot make ----------------------
any payment to depositors or discharge any liabilities/obligations to any
----------------------
other creditor unless otherwise directed by the government.
----------------------
Self-Assessment Questions ----------------------
1. Define Banking Company. ----------------------
2. What is Reserve Fund?
----------------------
3. What is meant by Cash Reserves?
----------------------
4. Explain Liquidity Ratio
5. Discuss the business a banking company can engage in. ----------------------
6. What are the minimum capital requirements for banking companies? ----------------------
7. What are the provisions for licensing of banking companies? ----------------------

Notes 8. Discuss the powers of Reserve Bank under the Banking Regulation Act,
1949.
----------------------
9. Explain the provision regarding management of a banking company
---------------------- under Banking Regulation Act, 1949.
10. What are the provisions regarding amalgamation of a banking company
----------------------
under Banking Regulation Act, 1949?
----------------------
---------------------- Answers to Check your Progress

1. “Banking” is defined as “the accepting, for the purpose of lending of
----------------------
investment, of deposits of money from the public, repayable on demand
---------------------- or otherwise, and withdrawable by cheque, draft, order or otherwise”.
2. U/s Sec 12 of the Banking Regulation Act, subscribed capital should not
----------------------
be less than half of its authorised capital and paid-up capital should not be
---------------------- less than half of its subscribed capital.
---------------------- 3. Aggregate Value of Paid-up Capital and Reserve for a banking company
incorporated in India having places of business more than one State
---------------------- should be minimum Rs. 5,00,000.
----------------------
Suggested Reading
----------------------
1. Varshney, P.N. Banking Law and Practice, Sultan Chand & Sons
----------------------
2. Tannan, M.L. Banking Law and Practice in India.
---------------------- 3. Lal Nigam, B.M. Banking Law and Practice.
---------------------- 4. Sundaram and Varshaney. Banking Theory, Law & Practice.
---------------------- 5. Gordon and Natarajan. Banking Law and Practice.
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Negotiable Instrument Act, 1881
UNIT
3
Structure:
3.1 Introduction
3.2 Definition
3.3 Characteristics & Presumptions of Negotiable Instruments
3.4 Types of Negotiable Instruments
3.5 Parties to Negotiable Instruments
3.6 Acceptance of a Bill
3.7 Endorsement
3.8 Presentment
3.9 Dishonour of Negotiable Instrument
3.10 Noting and Protesting
Summary
Key words
Suggested Reading
Negotiable Instrument Act, 1881 33

Notes
Objectives
----------------------
• Explain the meaning of the concept ‘negotiability’ and a negotiable
----------------------
instrument
---------------------- • Describe types and features of negotiable instruments
---------------------- • Discuss characteristics of cheque, bill of exchange and promissory note
---------------------- • Define acceptance and endorsement
----------------------
3.1 INTRODUCTION
----------------------
The Negotiable Instrument Act does not define a negotiable instrument; it
---------------------- just states that a negotiable instrument means a promissory note, bill of exchange
or cheque payable to order or bearer (section 13). In other words, it does not
----------------------
state the characteristics or features of the instruments, but only mentions that the
---------------------- above mentioned are negotiable instruments. The three instruments – cheque, bill
of exchange and promissory note are negotiable instruments by statute. Section
---------------------- 13 does not prohibit any other instrument which satisfies the essential features
of negotiability to be treated as negotiable instruments.
----------------------
---------------------- 3.2 DEFINITION

---------------------- As defined by Thomas1, A Negotiable Instrument is one which is, by
a legally recognized custom of trade or law, transferable by delivery or by
----------------------
endorsement and delivery, in such circumstances that:
----------------------  The holder of it may sue on it in his own name, and
----------------------  The property in it passes, free from equities, to a bona fide transferee for
value, notwithstanding any defect in the title of the transferor.
----------------------
According to Justice K. C. Wills, “a negotiable instrument is one the
---------------------- property in which is acquired by anyone who takes it bonafide, and for value,
notwithstanding any defect of title in the person from whom he took it’.
----------------------
Negotiation
----------------------
 Negotiation means the transfer of the right, title and interest in a negotiable
---------------------- instrument, so as to give the transferee a good title, if he be a holder in due
course, even though the transferor has a bad or defective title.
----------------------
 Something, which is legally capable of being transferred.
----------------------  When a cheque, bill of exchange or promissory note is transferred to any
person, so as to constitute that person the holder thereof, the instrument is
----------------------
said to be negotiated.
----------------------

– In case of negotiable instruments payable to bearer, negotiation takes Notes
place by mere delivery.
----------------------
– In case of negotiable instruments payable to order, negotiation of the
instrument takes place by endorsement of holder’s signature and by ----------------------
delivery to the endorsee or the person to whom it is handed over.
----------------------
 The holder in due course of a negotiable instrument is not affected by the
defect in the title of his transferor or any previous party. ----------------------
 Once a bill is endorsed and delivered, the endorsee not only acquires the property ----------------------
in the instrument but also the rights to further negotiate the instrument.
----------------------
Negotiability & Assignability
----------------------
Negotiation Assignment
Consideration It is presumed It has to be proved ----------------------
How to effect In case of bearer instrument, With a written and registered ----------------------
by mere delivery and in document under the
case of order instrument, by provisions of the Transfer of ----------------------
endorsement and delivery. Property Act, 1882
----------------------
Where to effect In case of negotiable In case of negotiable
instruments only instruments as well as other ----------------------
documents
Notice Notice of transfer to the Does not bind the debtor ----------------------
debtor to the transferee not unless notice of assignment
----------------------
necessary is given by assignee to the
debtor ----------------------
Title Title of the holder in due Title of assignee is subject to
course is better than the all equities in the title of the ----------------------
transferor assignor ----------------------
3.3 CHARACTERISTICS & PRESUMPTIONS OF ----------------------

NEGOTIABLE INSTRUMENTS ----------------------
Characteristics of Negotiable Instrument ----------------------
Negotiability - Negotiability is an essential feature of a negotiable
----------------------
instrument. Negotiable instruments are easily transferable from person to person.
 The ownership of the property in the instrument may be passed by mere ----------------------
delivery in case of bearer instrument and by endorsement and delivery in ----------------------
case of order instruments.
 Transferability is the essential feature of the negotiable instrument however ----------------------
all transferable instruments are not negotiable instruments. ----------------------
 It should be very certain as to the amount being promised or ordered to pay.
The instrument should clearly mention the interest rate, commission, etc ----------------------
clearly on the face of the instrument. ----------------------

Notes  It should also be clear, unambiguous and concise.
 It should be in writing. An oral communication or promise does not make
----------------------
a negotiable instrument.
---------------------- Consideration - Every negotiable instrument is presumed to have been
made, drawn, accepted, endorsed, negotiated or transferred for consideration.
----------------------
Parties - It should specify the names of the persons to whom it is being
---------------------- made payable and the person making the payment.
---------------------- Holder in due course - Every holder of a negotiable instrument is presumed
to be a holder in due course.
----------------------
Good Title of Transferee - The endorsee or holder in due course or the
---------------------- transferee is not affected by defects of the transferor. The transferee of the
negotiable instrument gets a title free from defects and equities of the title of the
---------------------- transferer.
---------------------- Right of Action - The holder in due course has the right to sue in his own
name on the instrument.
----------------------
Presumptions of a Negotiable Instrument
---------------------- Consideration - A negotiable instrument is always drawn for consideration
unless it is proved otherwise. Every such instrument when it is accepted, endorsed,
----------------------
negotiated or transferred was accepted, endorsed, negotiated or transferred for
---------------------- consideration.
Date -Every negotiable instrument bearing a date was made as per drawn
----------------------
on such date;
---------------------- Time of Acceptance - Every accepted bill of exchange was accepted within
a rea sonable time after its date and before its maturity.
----------------------
Time of transfer - Every negotiable instrument was negotiated before its
---------------------- maturity;
---------------------- Time of endorsement - The endorsement appearing on the face, back or on
a paper attached to the instrument is done in the order it appears, unless proved
---------------------- otherwise;
---------------------- Stamp - A negotiable instrument is duly stamped;
Holder in due course- The holder of a negotiable instrument has obtained
----------------------
it in due course; provided that where the instrument has been obtained from its
---------------------- lawful owner;
Protest - In a suit upon an instrument which has been dishonoured, the
----------------------
Court shall, on proof of the protest, presume the fact of dishonour, unless and
---------------------- until such fact is disapproved.
---------------------- 3.4 TYPES OF NEGOTIABLE INSTRUMENTS

---------------------- Negotiable Instrument means a promissory note bills of exchange or a cheque
---------------------- payable either to order or to bearer. (S. 13) The Act mentions only the above three

negotiable instruments. In actual practice, other or new instruments introduced Notes
may come under the category of negotiable instruments. Other examples are:
government securities, dividend warrants, hundies, bank drafts, share warrants, ----------------------
circular notes.
----------------------
Bearer Instrument
----------------------
A promissory note, bill of exchange or cheque is payable to bearer if either
of the following conditions is fulfilled: (1) it must be expressed to be so payable, ----------------------
or (2) the only or last endorsement must be an endorsement in blank.
----------------------
 A promissory note cannot be made payable to bearer
 A bill of exchange cannot be made payable to bearer on demand [u/s 31 ----------------------
RBI Act, 1934) ----------------------
 A bearer instrument can be transferred by mere delivery
----------------------
For instance, “Pay to R or bearer”
----------------------
Order Instrument
A promissory note, bill of exchange or cheque is payable to order if either of ----------------------
the following two conditions is fulfilled: (1) it must be expressed to be payable
----------------------
to order or (2) it must be expressed to be payable to a particular person and it
must not contain words which prohibit transfer or indicate an intention that is ----------------------
shall not be transferable. An order instrument can be transferred by endorsement
on it and then its delivery. ----------------------
For instance, “Pay to R or order” ----------------------
Demand Bill ----------------------
Instrument payable on demand means the instrument in which no time for
payment is mentioned. ----------------------
----------------------
Time Instrument
Time instrument means the instrument in which time for payment is ----------------------
mentioned. A promissory note or bill of exchange is a time instrument when ----------------------
expressed to be payable-
 After a specified period ----------------------
 On a specific day ----------------------

 After sight ----------------------
On the happening of event which is certain to happen.
----------------------

The expression ‘after sight’ means –

----------------------
(a) in a promissory note, after presentment for sight;
----------------------
(b) in a bill of exchange, after acceptance or noting for non-acceptance or protest
for non-acceptance. ----------------------
----------------------

Notes A cheque cannot be a time instrument because the cheque is always payable
on demand.
----------------------
Ambiguous Instrument
---------------------- An ambiguous bill means an instrument which can be construed whether
it is a promissory note or a bill of exchange. Its holder may at his option treat it
----------------------
either as promissory note or a bill. Once he exercises his option the instrument
---------------------- shall be then treated accordingly.
For instance, “A bill drawn by an agent acting within his authority upon his
----------------------
Principal.”
---------------------- Inchoate Instrument
---------------------- When one person signs and delivers to another a paper stamped in accordance
with the law relating to negotiable instruments then in force in India, and wither
---------------------- wholly blank or having written thereon an incomplete negotiable instrument, he
---------------------- thereby gives prima facie authority to the holder thereof to make or complete,
as the case may be, upon it a negotiable instrument, for any amount specified
---------------------- therein and not exceeding that amount covered by the stamp. The person so
signing shall be liable upon such instrument, in the capacity in which he signed
---------------------- the same to any holder in due course for such amount.
----------------------  The principal of this rule is Estoppel (a restraint on a person to prevent him
from contradicting his own previous assertion).
----------------------
 The signer is liable if the following conditions are fulfilled:
----------------------
– The blanks must be filled in and the instrument must be completed;
---------------------- – The instrument must have been delivered to the transferee;
---------------------- – The instrument must be stamped one and the stamp affixed must be
sufficient to cover the amount filled in the instrument.
----------------------
 A holder in due course can recover in excess of the amount intended to be
---------------------- paid by the signer provided the amount is covered by the stamp affixed on
the instrument.
----------------------
 These provisions do not apply to a cheque as a cheque is not stamped
----------------------
Escrow
---------------------- A negotiable instrument which is delivered conditionally or for a special
purpose as a collateral secutiry or for safe custory only and not for the purpose
----------------------
of transferring absolutely the property therein, is called ‘Escrow’. The liability to
---------------------- pay in case of an escrow does not arise if conditions agreed upon are not fulfilled
or purpose for which the instrument was delivered is not satisfied. This however,
---------------------- does not affect the rights of a holder in due course.
---------------------- State with reasons whether the following instruments are Ambiguous
Instruments or Inchoate Instruments:
----------------------
1. A bill drawn by A, an agent acting within his scope of his authority, upon
---------------------- his principle.

2. X draws a bill on Y who is a minor. Notes
3. Y signs a stamped and black promissory note to Y.
----------------------
4. X signs and delivers an unstamped and blank promissory note to Y.
----------------------
Promissory Note, Bill of Exchange and Cheque: Features
Promissory Notes ----------------------
An instrument in writing containing an unconditional undertaking, signed ----------------------

by the maker, to pay a certain sum of money only to, or to the order of a certain
person or the bearer of the instrument. (S. 4) ----------------------
Features of a promissory note: ----------------------

 There must be an undertaking to pay and not merely an acknowledgement ----------------------
of indebtedness.
----------------------
 The promise to pay must be unconditional and definite.
 The payee must be a definite person. ----------------------
 The promise to pay must be in writing, not verbal. ----------------------
 The maker must sign the instrument. ----------------------
 The promise must be to pay a definite sum of money.
----------------------
 Must be payable either on demand or after a lapse of certain period;
----------------------
 It must be paid to, or to the order of a specified person or bearer;
 The pro-note should be properly stamped as per Indian Stamp Act, 1899. ----------------------
Parties to a Pro-Note ----------------------

 Maker ----------------------
– The person who executes or makes the pro-note.
----------------------
– By signing the note he not only executes but also accepts to be bound
by its contents. ----------------------
– Liable to pay only the amount which accrues to him as per the terms ----------------------
of the pro-note.
----------------------
 Payee
– The person in whose favour the pro-note is made. ----------------------
– The Payee may either be specified by name or designation or made ----------------------

payable to bearer.
----------------------
– May be made payable to alternative payees. (S. 4)
----------------------
Cheque
A bill of exchange, drawn on a specified banker, and not expressed to be ----------------------
payable otherwise than on demand. (S. 6) ----------------------
----------------------

Notes Features of a cheque:
 A cheque must be an instrument in writing.
----------------------
 A cheque must be an unconditional order.
----------------------
 Always drawn on a banker.
----------------------  Payable immediately on demand. It is not necessary that the words “on
---------------------- demand” be used.
 A cheque must be an order to pay a “specified sum of money only”.
----------------------
 Requires no acceptance.
----------------------
 No privity of contract b/wn banker and the payee.
----------------------  Not required to be noted or protested for dishonour.
----------------------  Three parties:
---------------------- – the drawer – one who draws the cheque, necessarily the customer of a
bank;
---------------------- – the drawee – a cheque is always drawn on a bank’
---------------------- – the payee – the person in whose favour it is made.
----------------------  A cheque that bears a date before the date of issue is antedated and a cheque,
which bears a date later than the date of issue, is post-dated.
----------------------
 A post-dated cheque is as much a negotiable instrument as a cheque for
---------------------- which payment is due immediately on presentation.
----------------------  The paying banker cannot refuse to honour it merely on the ground that it
being originally post-dated.
---------------------- Bills of Exchange
---------------------- 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. (S. 5)
---------------------- Features of Bill of Exchange
----------------------  Must be in writing.
 Must contain an unconditional order to pay.
----------------------
 The order must be to pay money only and in cash.
----------------------  Always drawn on a certain person.
 Payable to a certain person or to his order or to the bearer of the instrument
----------------------
 Always payable after a certain specified period of time.
----------------------  Must indicate clearly the time of payment.
----------------------  Name or identities of the parties should be certain.
 Must be signed by the drawer or the maker of the instrument.
----------------------
 Must be adequately stamped.
----------------------  Must be presented for acceptance to the drawee of the instrument.

 Must be noted or protested for dishonour. Notes
Classification of Bills of Exchange:
----------------------
On the basis of Due for Payment: Demand Bill & Time Bill
----------------------
Demand Bill
Instrument payable on demand means the instrument in which no time for ----------------------
payment is mentioned. ----------------------
Time Bill or Usance Bill
----------------------
 “Usance’ denotes the time fixed by custom within which bills drawn in one
country and made payable in another country are to be paid. ----------------------
 The period varies in different countries; however, most of the countries have ----------------------
a three-month period.
----------------------
On the basis of Documents attached: Documentary Bill & Clean Bill
----------------------
Documentary Bills
----------------------
A documentary bill means a bill to which the documents of title to the goods
and other documents are attached. ----------------------
Bills to which transport or other documents are attached such as bill of ----------------------
lading, airway bill, railway bill, postal receipt, invoice, insurance policy, etc.
----------------------
Such bills are negotiated through a bank, which is instructed to deliver
the documents to the consignee, either against payment of the bill or against ----------------------
acceptance of the bill.
----------------------
Clean Bill
A clean bill means a bill to which no document relating to the goods (for ----------------------
the transaction of which the bill is being drawn) is attached. ----------------------
On the basis of Place drawn: Inland and Foreign Instruments
----------------------
Inland Bill
A promissory note, bill of exchange or a cheque drawn or made in India and ----------------------
made payable in or drawn upon any person resident in India shall be deemed to ----------------------
be an inland instrument. (S. 11)
Foreign Bill ----------------------
Any such instrument not so drawn, made or made payable shall be deemed ----------------------
to be a foreign instrument. (S. 12)
----------------------
 Drawn outside India and made payable in or drawn on a resident in a country
other than India. ----------------------
 Drawn outside India and made payable in or drawn upon any person resident ----------------------
in India.
 Drawn in India upon person resident outside India and made payable out ----------------------
side India. ----------------------

Notes On the basis of transaction: Trade Bill & Accommodation Bill
---------------------- Trade Bill

A trade bill is a bill of exchange drawn by a merchant on another, though
----------------------
it might be used more broadly to cover any draft originating in the trade. Such
---------------------- a bill becomes the acceptance of a merchant or merchant house and not the
acceptance of a bank or an acceptance house. In most trade bills, documents are
----------------------
“for payment”.
----------------------
Accommodation Bill
----------------------
 A bill of exchange drawn without consideration, in other words, without
---------------------- any commercial transaction, is drawn, accepted or endorsed merely to help
a business associate, is referred to as an accommodation bill.
----------------------
 The acceptor lends his name as one party to the instrument so that the drawer
----------------------
can obtain credit.
---------------------- The accommodating party or acceptor is liable to the holder of the instrument
---------------------- for value even when the holder is aware that the bill was drawn merely for
accommodation consideration.
----------------------
The person who becomes the holder of such a bill in good faith and for
---------------------- consideration after maturity, may recover the amount from any prior party.
---------------------- Other Types of Bills of Exchange
---------------------- Supply Bills
---------------------- Businessmen who supply goods to government department/agencies on the
basis of previously submitted tender and contractors on partial or full completion
----------------------
of contract submit bills for the amount of goods supplied or the contract work
---------------------- done in accordance with the terms and condition of the contract. Such bills are
referred to as “Supply Bills’.
----------------------
These bills are passed for payment only after verification that goods supplied
----------------------
confirm to the terms of the contract. This procedure of verification and passing
---------------------- bills takes a couple of months. It is during this period that the party may approach
the bank for advances against such bills.
----------------------
Fictitious Bill
----------------------
A fictitious bill is a bill in which the name of the drawer or the payee or both
----------------------
is fictitious. When both the drawer and payee of a bill are fictitious persons, the
---------------------- acceptor is liable to a holder in due course if the holder in due course can show
that the signature of the supposed drawer and that of the first endorsee are in the
----------------------
same handwriting.
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
Indigenous Bills
Comparison between Cheque, Bill of Exchange and Promissory Note ----------------------
----------------------
3.5 PARTIES TO NEGOTIABLE INSTRUMENTS
----------------------
 The drawer is the person who draws the bill and he must sign it.
----------------------
 A drawee is a person on whom the bill is drawn.
----------------------
– He becomes the acceptor after he has given his assent to the order of
the drawer. ----------------------
– The drawee gives his acceptance by writing the word “accepted” right
----------------------
across the face of the bill with his signature and date.
 The payee is the person to whom or to whose order the specified sum of ----------------------
money directed by the instrument is to be paid. ----------------------
 The holder means any person entitled to the possession of the instrument
and to receive or recover the amount thereon from the parties thereto. ----------------------
Liability of a Drawer ----------------------

 The drawer of a BoE or cheque is bound in case of dishonour by the drawee or ----------------------
acceptor thereof, to compensate the holder, provided due notice of dishonour
has been given to or received by the drawer. (S. 30) ----------------------
 The drawer becomes liable when: ----------------------

Notes – The bill is payable on sight or demand;
– The bill is payable a certain period after sight or date; and
----------------------
– The bill is payable on or after a fixed date.
----------------------
Liability of a Drawee
----------------------  When the drawee refuses to accept the bill; and
----------------------  When the drawee accepts to honour the bill but later refuses to pay when it
is presented for payment.
----------------------
Holder
---------------------- · The holder of a negotiable instrument is any person who is for the time being
---------------------- entitled in his own name and right to the possession of the instrument and
to receive and recover the amount due on the instrument. (S. 8)
----------------------  The holder is competent to receive payment or recover the amount by filing
a suit in his own name against other parties, to negotiate the instrument and
----------------------
to give a valid discharge. (Section 8)
----------------------  The following are excluded from the definition of a holder even when they
might have the possession of the instrument, but do not have the right to
----------------------
recover the money due thereon:
---------------------- – The finder of a lost instrument
---------------------- – A thief
---------------------- – A payee prohibited by an order of the court from receiving the amount
– A person taking under a forged endorsement.
----------------------
Holder in due course
----------------------  A holder in due course is a person who holds a negotiable instrument in his
---------------------- own right for value and who acquired it before the maturity of the instrument
for payment, and without any notice of defect in the title of the transferor
---------------------- from whom he took the instrument. (S. 9)
----------------------  The following three conditions need to be satisfied:

– The instrument is negotiated for consideration and not accepted as a
---------------------- gift;
---------------------- – Must have taken the instrument in good faith and without negligence
or suspicion regarding any defect in the title of the transferor; and
----------------------
– The instrument must not have matured before the holder took it.
----------------------
 The holder in due course possesses a good title on the negotiable instrument,
---------------------- free from all defects.
 His title is better than that of his transferor or any of the previous parties.
----------------------
 He can pass on good title that he possesses to other parties.
----------------------
 A holder of a negotiable instrument, who derives title from a holder in due
---------------------- course, has the rights thereon of that holder in due course.

 Every party to a negotiable instrument is liable thereon to a holder in due Notes
course until the instrument is duly satisfied.
----------------------
 A person liable on a negotiable instrument cannot defend himself on the
ground that the instrument was lost or obtained from him by fraud or an ----------------------
unlawful consideration against a holder in due course.
----------------------
Other Parties to a Negotiable Instrument
 According to Section 26 every person capable to enter in to a contract can ----------------------
become a party to the negotiable instrument.
----------------------
 He may bind himself and be bound by the making, drawing, acceptance,
endorsement, delivery and negotiation of a promissory note, bill of exchange ----------------------
or cheque.
----------------------
 Minor: A negotiable instrument does not become void merely because a
minor is a party to it. ----------------------
– A minor may draw, endorse, deliver and negotiate an instrument so as ----------------------
to bind all parties except himself. (S. 26)
----------------------
 Corporation
 Agent: An agent can bind his principal only in the manner and to the extent he ----------------------
has been authorised. He should make it clear that he is representing his principal.
----------------------
 Partner: A firm can be held liable on a negotiable instrument drawn by a
partner only when the partner signs the bill in his capacity as a partner and ----------------------
the name of the firm appears on the face of the bill.
----------------------
 Legal Representative: Liable only when he signs an instrument in his own
name. ----------------------
----------------------
3.6 ACCEPTANCE OF A BILL
----------------------
 An acceptance is the signature of the drawee of a bill who has signed his
assent on the face of the bill and delivered it to the holder or to some person ----------------------
on his behalf.
----------------------
 Only the drawee can be acceptor. The acceptance may be general or qualified.
----------------------
 A general acceptance is effected when the drawee signs his name on the
bill with or without the word “accepted”, thereby signifying his assent to ----------------------
the bill.
----------------------
 As a rule, the bill must always be accepted generally, and if the acceptor
adds any qualification to it, it becomes a conditional acceptance or treat the ----------------------
bill as dishonoured by non-acceptance.
----------------------
 An acceptance may be qualified in various ways. i.e., qualified as to the
amount, time, place, etc. A qualified acceptance may be seen in the ----------------------
following cases:
----------------------
– Where it is conditional, declaring the payment to be dependent upon
the happening of an event stated therein; ----------------------

Notes – Where it undertakes the payment of only a part of the sum ordered to
be paid;
----------------------
– Where no place of payment being specified on the order, it undertakes
---------------------- the payment at a specified place; and
– Where it undertakes the payment at a time other than that at which
----------------------
under the order it would be legally due.
----------------------  The drawer or holder of the bill is not bound to agree to an acceptance that
is qualified. He can treat the bill as dishonoured.
----------------------
 If, however, the holder of a bill of exchange agrees to a qualified acceptance,
---------------------- all previous parties consent has to be obtained or all previous parties whose
---------------------- consent is not obtained to such acceptance are discharged as against the
holder.
----------------------  Acceptance by agent - The drawee’s agent on behalf of the drawee may
---------------------- accept a bill, but the agent so accepting must make that point clear, otherwise
he will be held personally liable.
----------------------  Acceptance for honour - When a bill has been noted or protested for non-
---------------------- acceptance, and any person accepts it for the honour of the drawer or of any
one of the endorsers, such acceptance is called “acceptance for honour”.
----------------------
----------------------
3.7 ENDORSEMENT
---------------------- “When the maker or holder of a negotiable instrument signs the same,
otherwise than as a maker, for the purpose of negotiation, on the back or face
---------------------- thereof, or on a slip of paper attached thereto (allonge), or 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.”
----------------------  The endorsement must be made with the object of negotiating the instrument.
----------------------  The endorsement of a promissory note, bill of exchange or cheque is
completed only by delivery, actual or constructive, made by the endorser
---------------------- or by his agent with the intention of passing the property therein.
----------------------  The maker or holder endorsing the instrument is the endorser and the person
in whose favour the instrument is endorsed is the endorsee.
----------------------
 An endorsement made on the face of an instrument is not wrong, but the
---------------------- time-honoured practice has been that of endorsing the instruments on their
back.
----------------------
Rules for Endorsement
---------------------- The essential requirements of a valid endorsement are:
----------------------  It must be on the back or face of the instrument or on a slip of paper (allonge)
attached thereto.
----------------------
 It must be signed by the endorser.
----------------------

 It must be completed by the delivery of the instrument. Notes
 It must be made by the holder of the instrument.
----------------------
Kinds of Endorsement
----------------------
 Blank Endorsement - A blank endorsement is when the endorser puts his
signature on the back of the instrument without mentioning the name of any ----------------------
person in whose favour the endorsement is made. This type of instrument
is payable to bearer and is negotiated by mere delivery ----------------------
 Special or Full Endorsement - Special or Full endorsement is one where ----------------------
the endorser mentions the name of the person or to the order of that person.
E.g. ----------------------
Pay to Sanjeev Kumar or order Sd/ Anoop Kumar ----------------------

 Partial Endorsement - Here, only a part of the amount of the instrument is ----------------------
transferred. This does not operate as a negotiation of the instrument; however,
it authorizes the endorsee to receive payment of the amount specified. The ----------------------
law says down that an endorsement must relate to the whole instrument.
----------------------
 Restrictive Endorsement - In case of restrictive endorsement, the endorser
restricts the further negotiation of the instrument or restricts the endorsee ----------------------
to deal with the bill as directed by the former. The restrictive endorsement
----------------------
must in express words restrict or exclude the rights of the endorsee. e.g.
Pay to Durga Prasad only Sd/ Anand Kumar ----------------------
Pay the contents to Mr. Sharma only. Sd/ A N Kapoor ----------------------
 Conditional Endorsement - The transfer of property in the instrument is ----------------------
made to depend on the fulfillment of a specified condition. According to
English Law, the payer may disregard the condition and the payment to the ----------------------
endorsee is valid, whether the condition has been fulfilled or not. However,
if the drawee accepts the bill after it was conditionally endorsed, he should ----------------------
respect the condition.e.g. ----------------------
Pay Nirmal Sharma on the arrival of the Ship “Star” Sd/ Niraj Khanna
----------------------
– Sans Recourse Endorsement - In case of sans recourse endorsement,
the endorser removes himself from his liability to the endorsee by ----------------------
making it clear that the endorsee, or any subsequent holder, should not
----------------------
look to him for payment in case the bill is dishonoured. e.g.
Pay to Harish Varma without recourse to me Sd/ Srikant Mathur ----------------------
– Facultative Endorsement - In case of facultative endorsements, the ----------------------
endorser waives some of his rights involved with the negotiation of the
instrument. e.g. Pay to Vishal Khurana. Notice of dishonour waived. ----------------------
The endorsee need not give him notice of dishonour in this case. ----------------------
– Sans Frais Endorsement - In case of sans frais endorsement, the ----------------------
endorser does not want any expense to be incurred on his account on
the bill. ----------------------

Notes e.g. Pay Beena Mehra or his order sans frais. Sd/ Seema Malhotra
– Contingency Based Endorsement - An endorsement is said to be
----------------------
contingency based if the endorser endorses the instrument in such a
---------------------- way that his liability depends upon the happening of an event which
may or may not happen.
----------------------
e.g. Pay Kareena or order on his marriage with Shahid. Sd/ Rani
----------------------  Negotiation Back
---------------------- An instrument is said to be negotiated back to the holder when an endorser,
after he has negotiated an instrument, again becomes its holder before its
---------------------- maturity.
----------------------  Party who cannot be sued. The holder cannot enforce payment against an
intermediate party to whom he was previously liable. This rule is made to
---------------------- prevent multiplicity of actions and it is an exception to the general rule that
---------------------- a holder in due course can sue all prior parties.
 Party who can be sued. The holder can enforce payment against an
---------------------- intermediate party to whom he was previously not liable.
----------------------
----------------------
----------------------
----------------------
The endorsement of F to B is a ‘negotiation back’. B cannot sue C, D, E or F
---------------------- but can sue A, because A is prior to B’s original endorsement. If B is allowed to sue
---------------------- F then, F could sue E who could sue D who could sue C who could sue B and this
will lead to multiplicity of legal actions. The law prohibits multiplicity of actions.
---------------------- If however, B in original endorsement had signed ‘sans recourse’, there
---------------------- could be no circle of action and B could sue F, E, D or C.
---------------------- 3.8 PRESENTMENT

----------------------  “A BoE payable after sight must, if no time or place is specified therein for
---------------------- presentment, be presented to the drawee thereof for acceptance, if he can,
after reasonable search be found, by a person entitled to demand acceptance,
---------------------- within a reasonable time after it is drawn, and during business hours on a
business day. In default of such presentment no party thereto is liable thereon
---------------------- to the person making such default.” (S. 61)
----------------------  Presentment of a negotiable instrument means taking it to the principal
obligator who may be the drawer, maker or acceptor and demanding that
---------------------- he accepts or makes payment.
----------------------  Presentment is of two kinds: (a) for acceptance and (b) for payment.
----------------------  Presentment for acceptance is necessary only in case of a bill of exchange

payable after sight i.e. a bill not payable on demand or at sight. This is done Notes
to prevent the parties secondarily liable from escaping their liability.
----------------------
 A bill payable on demand or a promissory note or cheque proceeds straight
for payment. The drawee decides to treat a demand bill as his obligation ----------------------
and decides to pay it forthwith. He takes immediate possession of the bill
and makes payment against the same. ----------------------
 In case of long or time bill, it is sometimes essential to seek acceptance and ----------------------
it is always advisable and in order.
----------------------
 Presentment for acceptance is necessary in order to fix the date of maturity of
the instrument. The date of acceptance becomes the date of sight or demand ----------------------
for which the due date is fixed.
----------------------
Rules for Presentment for acceptance
 Parties - The presentment must be made by or on behalf of the holder of the ----------------------
drawee or to some person authorized to accept or refuse acceptance. (S. 78) ----------------------
 Place - A bill of exchange payable after sight must be presented at a place
where it was specified to be presented. Usually it is taken for acceptance ----------------------
at the drawee’s residence or the place of business. If at the due date for ----------------------
presentment, the drawee after reasonable search cannot be found; the bill
is deemed to be dishonoured. ----------------------
 Presentment time - If some specific time has been prescribed for the ----------------------
acceptance of a bill, it must be presented within that time. If no such time
has been indicated, a usance bill must be presented within a reasonable time ----------------------
after it is drawn and during business hours or business day.
----------------------
 Drawee’s time for deliberation - A bill must be accepted within 48 hours
of its due presentation. If the bill is not accepted within these hours, the ----------------------
holder may treat it as dishonoured.
----------------------
 If there is a default in presentment of a bill that is required to be presented,
no party to the bill shall be liable thereon to the person making such default. ----------------------
 If the bill is not accepted within 48 hours of its due presentation, the holder ----------------------
may treat it as dishonoured.
----------------------
 A presentment by post office by means of a registered letter is sufficient if
authorized by agreement or usage. ----------------------
 When presentment is essential but presentment is not made, all parties liable ----------------------
on the instrument are discharged from the liability on the instrument to the
person making such default. ----------------------
When Presentment for Acceptance is excused ----------------------
A bill’s presentment for acceptance is further excused where:
----------------------

– The drawee is a fictitious person;

----------------------
– Presentment is impossible for instance, drawee cannot be found after
a reasonable search; ----------------------

Notes – The drawee is incompetent to contract for instance, he is a minor or a
lunatic;
----------------------
– The drawee becomes insolvent or is dead.
----------------------  In such cases, the bill may be treated as dishonoured by non-acceptance. But
the mere fact that the holder has reason to believe that the bill on presentment
----------------------
will be dishonoured does not excuse presentment.
---------------------- Presentment for Payment
----------------------  All promissory notes, bills of exchange and cheques must be presented for
payment to the maker, acceptor or drawee thereof respectively by or on
---------------------- behalf of the holder.
----------------------  The consequences of default in presenting an instrument for payment at
maturity is that it will make the maker or acceptor or drawee not liable to
---------------------- pay. They are discharged from their liability owing to this apparent mistake
---------------------- on part of the holder.
Rules of Presentment for Payment
----------------------
 Promissory Notes, BOE and cheque must be presented for payment to the
---------------------- maker, acceptor or drawee thereof respectively, by or on behalf of the holder.
In default of such presentment, the other parties thereto are not liable thereon
----------------------
to such holder. (S. 64)
----------------------  A “proper” presentment is one that is made at the time, the place and in the
manner prescribed by law as necessary to make the presentment serve as
----------------------
the first condition for charging the secondary parties with their liability.
----------------------  A technically improper presentment is wholly worthless for binding these
---------------------- parties.
 The failure to make proper presentment does not in any way affect the
---------------------- liability of the principal obligator. This liability endures until the statute of
---------------------- limitation brings it to an end.
 Hours for presentment - Presentment for payment must be made during
---------------------- the usual hours of business, and if it is a banker, within banking hours.
----------------------  At maturity - A negotiable instrument made payable at a specified period
after date or sight thereof, must be presented for payment at maturity.
----------------------
 At a specified place - An instrument made, drawn or accepted and payable
---------------------- at a specified place and not elsewhere, must, in order to charge any party
thereto, be presented for payment at that place.
----------------------
 If no such place has been specified, it must be presented for payment at the
---------------------- place of business.
----------------------  If not, it has to be presented at the usual place of residence of the maker,
drawee or acceptor thereof, as the case may be.
----------------------
----------------------

 Payable on demand - A negotiable instrument payable on demand must be Notes
presented for payment within a reasonable time after the holder receives it.
----------------------
 Presentment by or to an agent - Presentment for acceptance or payment
may be made: ----------------------
– to the duly authorized agent of the drawee, maker or acceptor as the
----------------------
case may be, or
– to his legal representative where the drawee, maker or acceptor has ----------------------
died or
----------------------
– to his assignee where he has been declared an insolvent.
----------------------
 Excuse for delay in payment. Delay in presentment for acceptance or
payment is excused if the delay is caused by circumstances beyond the ----------------------
control of the holder and not imputable to his default, misconduct or
negligence. When the cause for delay ceases to operate, presentment must ----------------------
be made within reasonable time.
----------------------
 However, the fact that the holder has reason to believe that the instrument
will on presentment be dishonoured does not dispense with the necessity ----------------------
of presentment.
----------------------
 When presentment is essential but presentment is not made, all parties (other
than the make, acceptor or drawee) liable as the instrument are discharged ----------------------
from their liability to the holder making such default. ----------------------
When Presentment for Payment is Unnecessary
----------------------
 No presentment for payment is necessary and the instrument is dishonoured
at the due date for presentment in any of the following cases: ----------------------
– When a promissory note is payable on demand and is not payable at a ----------------------
specified place;
– When the maker of a promissory note or the drawee or acceptor of a ----------------------
bill intentionally prevents the presentment of the instrument;
----------------------
– Where the instrument being payable at his place of business or at some
other specified place, the maker, the drawee or acceptor closes such a ----------------------
place on a business day during the usual business hours or cannot be
----------------------
found at such other specified place;
– Where the maker, drawee or acceptor makes a part payment or promise ----------------------
to pay in part or full after knowing that the instrument has not been
presented, although it has become mature. ----------------------
– Where the maker, drawee or acceptor has agreed to pay even if there ----------------------
is no presentment.
----------------------
– Where the drawer could not suffer damage for non-payment, any holder
can make the drawer liable without presentment. ----------------------
– Where the drawee is a fictitious person.
----------------------
----------------------

Notes 3.9 DISHONOUR OF NEGOTIABLE INSTRUMENT
----------------------  Dishonour follows presentment. If an instrument has been properly presented
and it has not been either accepted or paid for within the customary time,
---------------------- it shall be said to be dishonoured.
----------------------  Dishonour is either
– the refusal of a drawee to accept a bill, even if properly presented; or
----------------------
– the refusal of the principal obligator on a promissory note or an accepted
---------------------- bill, or a bill due without presentment for acceptance, to make payment
when it is presented for payment.
----------------------
The first is called dishonour for non-acceptance and the second dishonour
---------------------- for non-payment.
---------------------- Dishonour by non-acceptance (S. 91)
----------------------  A bill of exchange is said to be dishonoured by non-acceptance in any of

the following cases:
---------------------- – When the drawee or any one of several drawee, not being partners, fails
---------------------- to accept the bill within 48 hours of its due presentment for acceptance;
– When at the instance of the holder, the drawee or one of the several
---------------------- drawee, not being partners, gives a conditional acceptance;
---------------------- – When the presentment for acceptance is excused and the bill is not
accepted.
----------------------
– When the drawee is incompetent to contract.
---------------------- – When the drawee is a fictitious person
---------------------- – When the drawee cannot be found after reasonable search.
---------------------- Dishonour by non-payment (S. 92)
 A promissory note, a bill of exchange or cheque is said to be dishonoured
---------------------- by non-payment when the maker of the note, acceptor of the bill or the
---------------------- drawee of the cheque makes default in payment upon being duly required
by presentment to pay the same.
----------------------  When the presentment for payment is excused and the instrument when
---------------------- overdue remains unpaid.
In both the above cases-dishonour by non-acceptance and by non-payment,
---------------------- the holder can make the drawer and all previous holders of the bill liable, provided
---------------------- he gives them notice of dishonour.
 In case of dishonour by non-acceptance, the holder has no right against the
---------------------- drawee, as the latter is no party to the bill. He can proceed only against the
---------------------- drawer and all other previous endorsers.
 In case of dishonour by non-payment, the holder can sue the drawee, as by
---------------------- his acceptance the drawee has already become a party to the bill.
----------------------

 In the event of dishonour, to establish claim against earlier parties, the holder Notes
has to go through a number of formalities.
----------------------
 If he fails to observe the rules, he is prevented from recovering from the
earlier parties and they are discharged from their obligations. The formalities ----------------------
are:
----------------------
– Giving notice of dishonour to prior parties and
– Getting the fact of dishonour noted down by a notary public as an ----------------------
authentic proof of dishonour and to obtain a protest certificate if need
----------------------
be.
Notice (Ss. 93 & 94) ----------------------
 To bind parties secondarily liable on a bill of exchange, promissory note or ----------------------

cheque, it is necessary for the holder to give due notice of dishonour to all
those whom he wants to make liable. ----------------------
 Then any party receiving notice of dishonour must, in order to render any ----------------------
prior party liable to himself, gives notice of dishonour to such party within
a reasonable time. ----------------------
 Delay in notice is excused when the delay is caused by circumstances beyond ----------------------
the control of the holder and not imputable to his default, misconduct or
----------------------
negligence.
 It is not necessary to give notice (i) to the maker of the dishonoured ----------------------
promissory note who has himself created it and (ii) to the drawee or acceptor
----------------------
of a bill of exchange or cheque.
Rules for Notice of Dishonour ----------------------
 For Notice of dishonour to be effectively given the following rules are laid ----------------------
down:
----------------------
– Notice may be oral or written, may be sent by post; even a personal
communication would constitute a good notice. ----------------------
– The notice may be in any form; it is important that to inform the party ----------------------
to whom it is given, either in express terms or by reasonable intendment
that the instrument has been dishonoured. ----------------------
– It must be given within reasonable time after dishonour at the place of ----------------------
business or at the residence of the party from whom it is intended.
----------------------
– Notice of dishonour may be given to duly authorized agent.
– When the instrument is deposited with an agent for presentment, the ----------------------
agent is entitled to the same time to give notice to his principal as if he ----------------------
were the holder giving notice of dishonour and the principal is entitled
to the same time to further give notice of dishonour. ----------------------
– When the party to whom notice of dishonour is dispatched is dead, but ----------------------
the party dispatching the notice is ignorant of his death, the notice is
sufficient. ----------------------

Notes – If the person to whom the notice was required to be given has died, it
may be given to his legal representative.
----------------------
– If the person to whom the notice was to be given has been declared an
---------------------- insolvent, it should be given to his assignee.
Notice of Dishonour not necessary.
----------------------
 Notice of dishonour is not necessary in the following circumstances:
----------------------
– When it is dispensed with or waived by the party entitled thereto. (e.g.
---------------------- “Notice of dishonour not required”).
---------------------- – When the party has countermanded payment in order to charge the
drawer. (e.g. When drawer has sent damaged or wrong goods and this
---------------------- has caused difficulty to the drawee).
---------------------- – When the party charged could not suffer damage for want of notice.
(e.g. When the drawee draws a bill without sending any goods).
----------------------
– When the party entitled to notice cannot after due search be found.
---------------------- – When the acceptor is also a drawer i.e. the drawer has drawn a bill on
himself.
----------------------
– When the promissory note is not negotiable.
----------------------
– When the party entitled to notice, knowing the facts, promises
---------------------- unconditionally to pay the amount due on the instrument.
----------------------
3.10 NOTING AND PROTESTING
----------------------
Noting (Ss. 99 to 104A)
----------------------  The second step to be taken by the holder when an instrument has been
---------------------- dishonoured by non-acceptance or non-payment is to get the fact noted by
a notary public.
----------------------  Noting is a mode of authenticating the fact that a bill or note has been
---------------------- dishonoured.
 When so approached by a Notary, the notary makes a formal demand for
----------------------
acceptance or payment upon the drawee or acceptor either in person or by
---------------------- his clerk or where authorized by agreement or usage, by registered letter and
on his refusal makes a note on the instrument as evidence of an independent
---------------------- professional person.
----------------------  Noting therefore refers to the minute or note made on the instrument by the
Notary public on representation of the instrument to the drawee recording
---------------------- the fact of dishonour.
----------------------  Such a note specifies (i) the date of dishonour, (ii) the reason, if any, assigned
for such dishonour, (iii) if the instrument has not been properly dishonoured,
---------------------- the reason why the holder treats it as dishonoured and (iv) the notary charges.
----------------------

 Noting is compulsory in case of in case of foreign bills and is optional in Notes
case of inland bills. It is better to get the dishonoured bill noted as noting
provides an authentic evidence of dishonour. ----------------------
Protest ----------------------
 A protest is a formal certificate of dishonour and to protest means to secure
----------------------
this certificate. It creates evidence independent of the mere word of the
holder himself. ----------------------
As an extension of noting, the same notary is approached to issue the
----------------------

certificate of protest in which he cites the legally relevant facts of the

dishonour. ----------------------
 A protest is a notarial document issued by the Notary Public under his stamp ----------------------
and seal, certifying that the bill in question was presented to him and was
dishonoured by the drawee. ----------------------
 Protest is not technically necessary; it is often secured nevertheless to serve ----------------------
as better evidence of the facts of presentment and dishonour than the mere
affirmation of the holder himself. ----------------------
 A protest serves two purposes: (a) it establishes the actual fact of dishonour, ----------------------
by a disinterested party, the notary and (b) it gives notice of dishonour to
all interest parties. ----------------------
 Noting and protesting provide formal evidence of dishonour, which is ----------------------
universally recognized and accepted.
----------------------
Protest for better security
Protest can be made for better security. If the acceptor of the bill has become ----------------------
an insolvent or his credit has been publicly impeached, the holder may before ----------------------
the maturity of the bill and within a reasonable time cause a notary public to
demand better security of the acceptor. ----------------------
 If such better security is refused, he may within a reasonable time cause ----------------------
such facts to be noted and certified.
 A protest is a formal statement in writing that the described instrument was ----------------------
on its due date presented for payment or acceptance and that such payment ----------------------
or acceptance was refused.
----------------------
 A protest is required to contain the following:
– The instrument itself or its literal transcript and of everything written ----------------------
or printed thereon;
----------------------
– The name of the person for whom and against whom the instrument
has been protested; ----------------------
– A statement that payment or acceptance or better security as the case ----------------------
may be has been demanded of such person by the notary public, the
terms of his answer, if any, or a statement of refusal or that he could ----------------------
not be found; ----------------------

Notes – When the note or bill has been dishonoured, the place and the time of
dishonour and when better security has been refused the place and time
---------------------- of refusal;
---------------------- – The charges of the notary public;
– In the event of an acceptance for honour or of payment for honour, the
----------------------
name of the person by whom or the person for whom, and the manner
---------------------- in which such acceptance or payment was offered and effected.

----------------------
State True or False.
----------------------
1. Transferability is the essential feature of the negotiable instrument;
---------------------- however all transferable instruments are not negotiable instruments.
---------------------- 2. Every holder of a negotiable instrument cannot be presumed to be a
holder in due course.
----------------------
3. Unless it is proved otherwise, every negotiable instrument when it is
---------------------- accepted, endorsed, negotiated or transferred was accepted, endorsed,
negotiated or
----------------------
----------------------
Summary
----------------------
●● Negotiable Instruments are of great significance in modern businesses.
---------------------- These instruments have come into prominence as principal instruments
for making payment and discharging various business obligations. A
---------------------- negotiable instrument is a transferable document that satisfied certain
conditions.
----------------------
●● The Negotiable Instrument Act, 1881 contains the rules regarding the
---------------------- making, execution, negotiation, acceptance, endorsement as well as
payment of a negotiable instrument. The Act defines and explains the
----------------------
essential feature of a negotiable instrument- negotiability.
----------------------
Keywords
----------------------
●● Negotiability: the transfer of the right, title and interest in a negotiable
----------------------
instrument, so as to give the transferee a good title, if he be a holder in due
---------------------- course, even though the transferor has a bad or defective title.
●● A holder in due course: a person who holds a negotiable instrument in
----------------------
his own right for value and who acquired it before the maturity of the
---------------------- instrument for payment, and without any notice of defect in the title of the
transferor from whom he took the instrument.
----------------------
●● Acceptance: the signature of the drawee of a bill who has signed his
----------------------

assent on the face of the bill and delivered it to the holder or to some Notes
person on his behalf.
●● Endorsement: When the maker/holder signs the same, otherwise than as ----------------------
a maker, for the purpose of negotiation, on the back or face thereof, or on ----------------------
a slip of paper attached thereto (allonge).
●● Presentment: Taking a negotiable instrument to the principal obligator ----------------------
who may be the drawer, maker or acceptor and demanding that he accepts ----------------------
or makes payment.
●● Dishonour: the refusal of a drawee to accept a bill, even if properly ----------------------
presented; or the refusal of the principal obligator on a promissory note ----------------------
or an accepted bill, to make payment when it is presented for payment.
●● Noting: A mode of authenticating the fact that a bill or note has been ----------------------
dishonoured.
----------------------
●● Protest: a formal certificate of dishonour and to protest means to secure this
certificate. ----------------------
----------------------
----------------------
1. Define a Negotiable Instrument. What are the characteristics of negotiable
instruments? ----------------------
2. Explain the term ‘negotiability’. Bring out the difference between negotiation ----------------------
and assignment.
----------------------
3. Explain the concept ‘Holder in Due Course”. What is the difference between
Holder and Holder in Due Course? ----------------------
4. Distinguish between Cheque, Bill of Exchange and Promissory Note. ----------------------
5. What is meant by Noting and Protesting?
----------------------
6. What is meant by Endorsement? Explain with illustration the types of
endorsements. ----------------------
CASE STUDIES- Identify the parties to the negotiable instrument, draw the chain ----------------------
of negotiation and answer the question given below giving appropriate reasons:
----------------------
1. On January 1st 2010, Mr.A draws a bill on Mr. B for Rs.1000 payable to
Mr.C or order three months after date. Mr.B is not indebted to Mr.A nor ----------------------
has he agreed to honour A’s bill. On February 1st 2001, Mr. C negotiates
the bill to Mr. D who takes it as holder in due course. Mr.D does not ----------------------
present the bill for acceptance but presents it for payment on 4th April ----------------------
2001. On dishonour by Mr.B, Mr.D gives a notice of dishonour to Mr. A.
Can Mr. A claim to be discharged? ----------------------
[Hint: A cannot claim to be discharged] ----------------------
2. A, the holder of a bill endorses it to B. B endorses it to C, C to D and D to
----------------------
E and E again endorses it to A. From whom can A recover the amount of
----------------------

Notes the bill from B, C, D and E or any of them or all of them?
[Hint: The concept of Negotiation Back]
----------------------
3. A, the holder of a bill endorses it ‘sans recourse’ to B. B endorses it to C,
---------------------- C to D and D to E and E again endorses it to A. Can A recover the amount
of the bill from B, C, D and E or any of them?
----------------------
[Hint: The concept of Endorsement ‘sans recourse’]
----------------------
4. P, the holder of a bill of exchange, transfers it to Q without consideration.
---------------------- Q also transfers it to R without consideration. R transfers it to S for
consideration. S transfers it to T without consideration. State whether T
---------------------- can recover the amount on such instrument and from whom.
---------------------- [Hint: The importance of ‘consideration’ in a negotiable instrument]
---------------------- Suggested References Books:
Bare Act – Negotiable Instrument Act, 1881
----------------------
Banking Law and Practice in India - M.L. Tannan (Latest Edition)
----------------------
Mercantile Law - N. D. Kapoor
---------------------- Business Law - P. C. Tulsian0
---------------------- Answers to Check your Progress
----------------------
---------------------- State True or False.
---------------------- 1. True
---------------------- 2. False
3. True
----------------------
---------------------- Suggested Reading

---------------------- 1. The Reserve Bank of India Act, 1934.
---------------------- 2. The Reserve Bank of India (Board for financial supervision) Regulations,1984.
---------------------- 3. Varshney, P.N. Banking Law and Practice, Sultan Chand & Sons.
4. Dharmadhikari, Mrs. Vandana. Banking Horizon. New Bharat Printers.
----------------------
----------------------
6. Lal Nigam, B.M. Banking Law and Practice.
----------------------
----------------------

Paying Banker & Collecting Banker
UNIT
4
Structure:
4.1 Introduction
4.2 Paying Banker
4.2.2 Material Alterations
4.2.3 Forgery of Customer’s Signature
4.2.5 Statutory Protection to Paying Banker
4.3 Collecting Banker
4.3.2 Collecting Banker as an Agent
Summary
Keywords
Suggested Reading
Paying Banker & Collecting Banker 59

Notes
Objectives
----------------------
• Explain the concept paying banker & collecting banker
----------------------
• Define duties and responsibilities of paying banker & collecting banker
----------------------
• Describe statutory protection to paying banker & collecting banker
---------------------- • Specify the legal effect of Material Alteration
---------------------- • Elucidate on the concept of Payment in Due Course
----------------------
4.1 INTRODUCTION
----------------------
The cheque is the most important document. More importantly, it is mandate
---------------------- of the customer which the banker is under statutory obligation to carry out. It
is a written order by which the customer requires his banker (drawee) to refund
----------------------
the money lent out to him in the form of de-posits. The refund may be made
---------------------- either to the drawer (customer) himself or to some third party (payee). It is
this repayment to ‘third’ parties that has given rise to difficult legal problems.
---------------------- Bouncing of cheques (i.e., dishonouring because of in-sufficiency of funds at
the credit of the customer) is one such prominent problem. It is suggested that
----------------------
the issuance of bad cheques should be a cognizable offence.
---------------------- A cheque serve as a dual function: (i) it gives rise to the banker’s obligation
to pay away money to the debit of his customer, and (ii) it is a type of bill of
----------------------
exchange which in the absence of specific stipulations is not only transferable,
---------------------- but may also be fully negotiable.
---------------------- The customer frequently pays money into his account in the form of cheques
of which he is the holder. Often the instrument drawn on other bank is taken
---------------------- “for collection” only. This signifies that when a customer deposits the cheque
with the bank to receive the proceeds, it will receive the amount only after the
---------------------- drawee bank has made payment to the collecting bank.
---------------------- Banks receive cheques and drafts for collection. Banks do not make outright
purchases of the instruments. Generally, they await the payment from the drawee
---------------------- bank. However, in some cases, they may be willing to make a cash advance of an
---------------------- amount somewhat less than the expected returns from the instrument, especially
to a depositor who is a regular customer of good standing. While discharging this
---------------------- function, the bank is known as the collecting bank or banker as distinguished
from a drawee bank on which the cheques are drawn.
----------------------
Four parties are connecting in the collection of cheques, the customers as
---------------------- two principal parties and the two banks as their respective agents. No other party
is involved.
----------------------
----------------------

4.2 PAYING BANKER Notes
The paying banker is “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 so to do, and, in default of such payment, ----------------------
must compensate to the drawer for any loss or damage caused by such default.” ----------------------
The paying banker has to make payment and honour cheques of his customers
with utmost care avoiding any damage to the credit of the customer. The cheques ----------------------
should not be dishonoured by the paying banker except for valid reasons. In any ----------------------
such case, if he acts wrongly, he will have to compensate his customer.
----------------------
The banker has to be extremely vigilant while handling cheques for payment. ----------------------
1. Proper Form of the Cheque ----------------------

It is important that a cheque is drawn in the required form. Unless it is so ----------------------
drawn, the banker shall not consider it to have been presented in a proper state.
The law has not prescribed any particular format for a cheque that it should ----------------------
be drawn in such and such ink, paper, size sequence of items, etc. It is now a
practice among bankers to get printed their own cheque books. The customers ----------------------
are supplied these cheque books, and it is expected of them that they will make ----------------------
withdrawals only through the leaves of cheque books issued to them.
----------------------
Advantages of Using Printed Forms
 Convenient. The drawing of a cheque on the printed form is always ----------------------
convenient as the customer has to simply fill in the blanks. If the particulars
----------------------
are properly filled in, there is no chance of the cheque being dishonoured
for any reason. ----------------------
Record. The counterfoil of the cheque performs the useful purpose of serving
----------------------

as a record of the payments made. A particular payment can be traced.

 Stop Payment. After the issue of a cheque, if the customer wishes to stop ----------------------
its payment (called “to countermand” in banking terminology), he can very ----------------------
well instruct his banker by quoting the serial number. In the absence of
such a number, there might be an honest error of judgment on the part of ----------------------
the paying banker.
----------------------
 Forgery Minimized. Where cheques are drawn on printed forms where the
customer has to fill in the blanks and that it has a serial number, the chances ----------------------
of forgery are minimized. When presented for payment, it is easy for the
banker to verify the details, the signature as well as the serial number of the ----------------------
cheque . ----------------------
2. Date of the Cheque
----------------------
The order to pay in a cheque must be complied in accordance with the law
and the accepted practice and usage of the banking business. The date of the ----------------------
cheque is one such important point and the drawer should see that every cheque
----------------------

Notes bears a date before it leaves him. As a matter of fact, the order to pay becomes
effective only from the date mentioned in the cheque. The date further serves to
---------------------- indicate as to how long the cheque is going to be in circulation.
---------------------- Undated Cheques
In case a cheque is undated (i.e., the date is inadvertently omitted), it does
----------------------
not become invalid. Where the date is missing from the cheque, any holder or
---------------------- even the paying banker has the authority to fill up this omission and make it
regular for payment.
----------------------
The date again should be complete in respect to the number of the day, the
---------------------- month and the year, [(DD/MM/YY) format as it is called]. Though the day is not
required, August 2010 or August 30 or Friday 2010 are incomplete dates. The
---------------------- banker can return such cheques with the remark, ‘’Irregularly drawn.” Similarly
in case of a cheque which bears a date which is not in the calendar e.g., February
----------------------
30 or September 31 could be returned, but it is usual to pay it to a day earlier or
---------------------- after that date. Since the date is a material part of the cheque, any alteration of
it makes the instru-ment void unless the drawer’s assent is obtained.
----------------------
Stale Cheques
---------------------- A stale cheque is an overdue cheque, one that is presented long after it was
---------------------- drawn. The generally accepted banking custom is to treat a cheque as stale after
Three months of its issue, its circulation afterwards is considered unreasonable.
---------------------- It is usual for the banker, therefore, to return such a cheque with the remark “Out
of date”. It is important to note that the drawer’s liability on a cheque does not
---------------------- end on the chequebecoming stale is over, The drawer still remains liable to the
---------------------- holder up to three years from the date of issue of the cheque. It is only after three
years, that the Limitation Act will operate to prevent an action being brought on
---------------------- the cheque.
---------------------- Post-dated Cheques
The position is that a cheque is not invalid by reason only that it is ante-
----------------------
dated or post-dated.
---------------------- An ante-dated cheque is one which bears a day before its issue, while a
post-dated is one dated later than the date of issue. But both these cheques can
----------------------
be paid. The issuance of a post-dated cheque confers an advantage to the drawer
---------------------- that if he is short of funds in the bank, he can put them in before the date on the
cheque arrives.
----------------------
A post-dated cheque which bears a certain date subsequent to the date of
---------------------- issue is not to be presented for payment until the date upon it arrives, though
valid and negotiable (i.e., the transferee acquires a better title than that of the
---------------------- transferor). Such a cheque is not payable on demand and would be similar to an
---------------------- usance bill of exchange. The banker has to be careful not to pay it until the due
date is reached, since a payment before date would not be treated as payment
---------------------- in due course. The payment of a post-dated cheque is a clear violation of the
customer’s mandate. The customer may countermands the payment on that cheque
---------------------- or may exhausts the available funds in the intervening period. The drawer will

have a right to claim damages for its dishonour. Notes
3. Amount of the Cheque
----------------------
The amount of the cheque must be a sum certain and on the face of the
instrument. It should clearly be stated both in words as well as in figures. In ----------------------
case the two amounts differ, section 18 provides for the payment of the amount
----------------------
stated in words. However, the banker with-in his right may refuse payment and
return such a cheque with the remarks, “Amount in words and figures differ.” In ----------------------
case where the amount is stated only in words, the cheque must be paid, or else
he is held responsible for the wrongful dishonour and hence liable for any loss ----------------------
or damage to the customer.
----------------------
 Sufficient Balance. On the correctness of the amount in words and figures,
the next thing a banker should check on is whether the balance to the ----------------------
credit of the customer is sufficient. Unless arrangements have been made ----------------------
for example overdraft on the account, the banker is under no obligation to
honour the cheque with inadequate funds in the account of the drawer. This ----------------------
is important because a cheque has to be paid in full and never in part. If the
----------------------
banker honours a cheque when the customer maintains insufficient balance,
he may lose his money through failure to realise it from the customer. ----------------------
While computing the balance available for drawing by the customer, the ----------------------
uncleared items should not be taken into account. If the customer relying on
instruments deposited by him draws cheques and which have not yet been ----------------------
cleared, the banker is entitled to return them with the remarks, ‘’Effects not
----------------------
cleared.”
 Not an Assignment of Funds- A cheque is not an assignment of drawer’s ----------------------
funds in favour of the payee. The balance to the credit of a customer cannot ----------------------
be earmarked for the holder of any particular cheque.
 Chronological Order of Payment- When several cheques drawn on an ----------------------
account are presented for payment on the same day, the normal rule is that ----------------------
they should be paid in the chronological order of receipt. The problem arises
when several cheques are received in the same clearing and the balance to ----------------------
the credit of the customer is insufficient. If the balance is not adequate to
----------------------
meet even a single cheque, all of them may be returned.
However, the difficulty arises when the balance in the account is sufficient ----------------------
to meet one cheque or some of them, but not all. On one side, when all the ----------------------
cheques constitute one consolidated presentment, the banker can return all of
them. On the other, the banker should pay cheques as far as the state of the ----------------------
account permits, the banker would do so in order to protects the customer’s
----------------------
credit. While honouring the cheques in such a situation, he can certainly
give priority to those drawn earlier. ----------------------
 Mutilated Cheque. A mutilated cheque is one which has been torn in two ----------------------
or more pieces but pasted afterwards. Whether such a cheque should be paid
or not will depend upon the situation and circumstances and the extent of ----------------------

Notes legibility of the certain material facts. In case of such cheques, the banker
can pay it after obtaining confirmation from the drawer or else on getting
---------------------- the collecting bank’s guarantee. If none is available, the paying banker
must return it with the remark “Mutilated cheque,” or “cheque torn.” In
----------------------
case where the main contents of the cheque are so erased or concealed that
---------------------- the banker cannot make out the name of the payee, the amount, etc., he is
again justified in refusing payment. In case where a cheque is not exactly
---------------------- torn but is mutilated and spoilt only in some corner, the banker can exercise
---------------------- his discretion. He can pay it if he is satisfied with the parties, though there
is nothing to prevent him from dishonouring it.
----------------------
4. Banking Days and Hours
---------------------- The days and hours for the payment of cheques are also stipulated by the
banker as well as in the operation of the Clearing House.
----------------------
According to the Negotiable Instrument Act, a promissoy note or a bill is at
---------------------- maturity on a public holiday, the instrument shall be deemed to be due on the next
---------------------- preceding business day. Public holidays, under the section, include Sundays and
any other day declared by the Central Government by notification in the Official
---------------------- Gazette to be a public holiday. Banks generally remain closed on these public
holidays, although they are not obliged to be closed on these days. There is also
---------------------- no statutory prohibition on the banks remaining closed on any other days.
---------------------- The presentment for payment must be made during the usual hours of
business and within the banking hours; banking hours mean the period during
---------------------- which the bank transacts banking business with the public which are made
---------------------- known to the customer by express notice or by course of business. The banking
hours need be uniform for all the banks. However, banks may fix different hours
---------------------- of working, at even different branches of the same bank at different places
considering the convenience of the customers. What the law emphasises is the
---------------------- making of payment, and not the actual handing over of cash. If a customer reaches
---------------------- the bank premises within banking hours, he is generally paid even afterwards. A
payment made after business hours is not in the ordinary course of business.
---------------------- A payment out of the usual banking hours would not be considered a payment
---------------------- in due course. If the banker pays a cheque presented after banking hours, there is
a risk. This is because the customer may countermands the very cheque the next
---------------------- morning that the banker had honoured a day earlier after the scheduled hours.
---------------------- 4.2.2 Material Alterations
---------------------- The paying banker need observe utmost care with regard to material
alterations since the instruments carrying such alterations become invalidated
---------------------- unless the drawer gives his consent.
---------------------- A material alteration is a change that alters the business effect of an instrument
and cause it to speak a language different from what it originally spoke. An alteration
---------------------- changes the legal identity or whole character of the instrument either in its terms
or in the legal relation of the parties. The instrument becomes void as against all
---------------------- persons who were the parties to the instrument at the time the alteration was made

and who did not give their consent for such alteration. The person making such Notes
alteration remains responsible on the instru-ment, though the liability of a person
who becomes a party to it after the alteration has been made is not affected. ----------------------
According to the Negotiable Instrument Act, 1881, “Any material alteration ----------------------
of a negotiable instrument renders the same void as against any one who is a
party thereto at the time of making such alteration and does not consent thereto, ----------------------
unless it was made in order to carry out the common intention of the original
----------------------
parties. Any such alteration, if made, by an endorsee, discharges his endorser
from all liability to him in respect of the consideration thereof.” ----------------------
The Indian Act does not specify as to which alterations are material, however,
----------------------
the alterations with respect to the following are considered to be so:
(a) date (e.g., lengthening or shortening the period of limitation), (b) time ----------------------
of drawing, (c) place of payment, (d) amount payable,(e) medium of payment,
----------------------
(f) rate of interest, (g) number and name of parties to the instrument, (h) relation
of parties, (i) legal character (e.g., the words ‘order’ to ‘bearer* in cheques), and ----------------------
(j) crossing.
----------------------
However, when the alteration is material, it will not vitiate the instrument
in the following cases: ----------------------
 It is made before the actual issue of the instrument; ----------------------
 It is made merely to correct a mistake or to make the instru-ment what it
was originally intended to be; or ----------------------
 It is made with the consent of all the parties to the instru-ment, the consent ----------------------
being expressed or implied, prior to the alteration or thereafter.
----------------------
The burden of proof that a particular material alteration falls within the
above exception, and hence does not vitiate the instru-ment lies upon the party ----------------------
which claims it so. It is for the plaintiff to satisfy the court that the alterations,
----------------------
if any, were made subsequent to the issue of the instrument and not at the time
of issue. The party which wants to enforce the instrument has to accept the onus ----------------------
of proving that he has not been negligent.
----------------------
The Paying Banker’s Position in case of a Material Alterations
The paying banker’s position with regard to material altera-tions, between ----------------------
drawing and presentation, should be examined under two headings: ----------------------
 In a case where the Alteration is Apparent.
----------------------
In a situation where the banker realizes that there is an alteration on the
cheque, the banker must not make payment on the cheque. If the banker pays a ----------------------
cheque that has been materially altered without the drawer’s consent, he does so
----------------------
at his own risk unless the customer’s authority to the alteration has been obtained.
The paying banker should insist upon proper authentication by the drawer. ----------------------
As a rule, he should not accept authentication by mere initials of the drawer but
----------------------
insist upon the full signature of the drawer since he may not be familiar with the
drawer’s initials and there is every probability of a forgery. ----------------------

Notes  In a case where Alteration is Not Apparent.
When an alteration is fraudulently made, naturally without the consent of
----------------------
the parties to the instrument, and on the face of it, it does not appear to have been
---------------------- so altered, the paying banker is protected in terms of section 89.
The two conditions for granting such protection however are:
----------------------
– There is nothing on the face of the instrument to indicate that it was materially
---------------------- altered. That is the alteration has been so cleverly or skillfully done that he
would not have, with any amount of reasonable care and scrutiny, detected it
----------------------
out. The banker may require expert help to find out that there is an alteration
---------------------- on the cheque.
---------------------- – The payment has been made in due course, i.e., the banker has paid to the
holder of the cheque in good faith and with-out notice that his title to the
---------------------- cheque is defective.
---------------------- On the above conditions being satisfied, even if the material alterations
have been fraudulently effected, the paying banker can debit the drawer’s
---------------------- account and obtain a valid discharge on the instrument,
---------------------- 4.2.3 Forgery of Customer’s Signature
One of the most important responsibilities of the paying banker is to see that
----------------------
 the drawer’s signature is genuine,
----------------------
 that nobody has forged it or otherwise placed it on an instrument
----------------------  without the authority or consent of the person i.e. the drawer.
---------------------- In case the signature is not genuine, the instrument becomes wholly
inoperative. No person even if acting in good faith can acquire rights under it.
----------------------
The drawer is not liable on the such an instrument. A banker paying a cheque
---------------------- where the drawer’s signature has been forged or signed without his authorisation,
cannot prima facie debit the customers’s account.
----------------------
If the banker pays a forged cheque, he is in general bound to credit the amount
---------------------- again to his customer account. It is a heavy penalty for the banker to bear and it
is so becasue the very mandate of the customer is missing in such payments, and
---------------------- there is an obvious breach of duty of the banker towards the customer. The banker,
with reasonable care and scrutiny, finds that the drawer’s signature differs from the
----------------------
specimen supplied to him and he has reasonable cause to believe that the cheque
---------------------- might have been forged, it is the duty of the banker to return the cheque with the
remarks “Signature differs.” It is also the banker’s duty to immediately inform the
---------------------- customer as soon as he discovers that his signature has been forged by someone.
---------------------- A paying banker has no protection under the law if he pays a cheque on
which the drawer’s signature is forged. However, the banker is excused in case
---------------------- of the following exceptions:
----------------------  When the banker is in doubt about the signature of the drawer and for clarity
he seeks the drawer’s confirmation and the customer expressly represents
---------------------- that the signature is his own. The customer will not be permitted later to

make a plea that the signature was a forged one and as such the document Notes
was invalid.
----------------------
 When the customer by his conduct may have misled the banker, causing
him to pay the cheque when otherwise he might have refused. ----------------------
 When the customer, after he became aware of the forgery, fails or neglects
----------------------
to inform the banker that his signature has been forged. The banker too loses
his right of action against the forger. ----------------------
When the drawer may at times choose to adopt an unauthorised signature
----------------------

by recognising this signature (the forged one) as his own.

 In the above exceptions, the banker would get a valid discharge and he will ----------------------
be in a position to debit the amount from the customers account ----------------------
----------------------
When the cheque presented for payment is in order in all respects, the banker
is under an obligation to honour cheques, however under certain circumstances, ----------------------
the banker can refuse payment and the banker’s statutory duty to pay customers
----------------------
cheques comes to an end. The banker will have to refuse payment in the following
circumstances. ----------------------
By Countermand of Payment - Countermand is to stop the payment of a
----------------------

cheque by the customer; it is the withdrawal of his own mandate. The need
for such a stop payment order would arises when a cheque is stolen or lost ----------------------
or some dispute has cropped up between the drawer and the payee. Once a
countermand is communicated to the banker, he must not make payment of ----------------------
that cheque. The banker is liable for any damage suffered by the customer as
----------------------
a result of not following the order. It is, therefore, advisable for the banker
to properly note the countermand instructions in the customer’s account. ----------------------
 By Customer’s Death - The banker’s contract to pay is overruled by the ----------------------
death of the customer, and the account becomes inoperative. Notice of a
customer’s death determines the duty and authority of a banker to pay his ----------------------
customer’s cheques. As such as soon as the notice of death is received, the
banker must suspend all operations in the account. ----------------------
 By Customer’s Insolvency/Liquidation - The banker’s authority to pay ----------------------

third-party cheques gets terminated on the insolvency of the customer. When
the customer is being adjudicated as an insolvent, the law begins to operate ----------------------
and all his properties and monies vest in the Official Assignee or the Receiver ----------------------
for the benefit of his creditors. Naturally, the bank account of the customer as
well is vested with the official assignee/receiver, All cheques drawn by him ----------------------
either before or after the date of such petition should be stopped payment.
However, the cheques issued before the date of adjudication order shall be ----------------------
considered to have been properly paid. ----------------------
Likewise in case of a company customer, the payment of cheques should be
stopped on the making of a receiving order or winding-up order. It is the making ----------------------
of the order not notice of it, which termi-nates the bank’s authority to pay. ----------------------

Notes  By Customer’s Lunacy - A banker is also entitled to refuse payment if he
learns of the customer’s lunacy or any other mental incapacity. It, however,
---------------------- goes without saying that cheques issues during his lucid interval, i.e., when
he could reasonably understand the implications of his actions are not to be
---------------------- dishonoured. The banker should not suspend payment simply on hearsay
---------------------- or rumours of the customer’s insanity, he must collect information reliable
sources to confirm the news of his mental disorder.
----------------------
 By Service of a Garnishee Order - A garnishee order is an order of the
---------------------- Court attaching the balance to the credit of the customer, called judgment
debtor, in favour of some creditor (garnisher). The issuance of a garnishee
---------------------- order prevents the banker from making any payment unless the claim of the
judgment creditor has been satisfied.
----------------------
 By Breach of Trust - When some trustee/s is/are maintaining a bank account
---------------------- in the name, for the benefit of trust, the banker is entitled to refuse payment
as soon as he informed or it comes to his notice that the trustee may operate
----------------------
the account in breach of trust.
----------------------  Defective Title of the Holder - Another reason for refusing the payment
of a cheque could also be that the holder of the instrument, it appears to
----------------------
the bank that he has a defective title. If the banker is in doubt about the
---------------------- presenter’s title, he must refuse payment. Such a payment made may not
be in good faith and without negligence.
----------------------
 By Notice of the Closure of Account - When a customer wishes to close an
---------------------- account and gives notice to this effect to the Banker, all cheques presented
from or after the date given in the notice will have to be refused payment.
---------------------- Then banker’s duty to honour the cheques may also be determined in the
---------------------- following contingencies:
– When the funds at the credit of the customer are insufficient to honour
---------------------- the cheques.
---------------------- – When the amount in words and in figures differ;
---------------------- – When the cheque is presented after banking hours;

– When the cheque does not bear a proper date, i.e. undated, post-dated
---------------------- or bears an incomplete date;
---------------------- – When the endorsement is irregular;
– When the cheque is not drawn in a proper form;
----------------------
– When the cheque has alterations not authenticated by the drawer;
---------------------- – When the customer’s account is subject to bankers’ lien or set off.
---------------------- 4.2.5 Statutory Protection to Paying Banker
---------------------- When the cheque is paid to a wrong person, under a forged or unauthorized
endorsement, it amounts to a breach of duty and the banker is thereby liable to the
---------------------- drawer. The paying banker is always under a duty to satisfy himself that he pays
----------------------

the money with his customer’s authority and to the true owner of the instrument. Notes
However, the regular routine procedures in a bank gives no opportunity for the
investigation of details while making payment. If the banker does make enquiries ----------------------
about the title of the presenter, it would involve much cost in terms of time as
well as money and would, destroy the very “demand character” of the cheque. ----------------------
The law, therefore, has tried to come to the rescue of the busy banker and provide ----------------------
him statutory protection on the fulfilment of certain conditions in the familiar
expression “payment in due course”. ----------------------
Payment in Due Course ----------------------
Broadly payment in due course means the exercise of due care in dealing
----------------------
with his customer’s mandates.
Section 10 of the Act states, “Payment in due course means payment ----------------------
in accordance with the apparent tenor of the instrument in faith and without
----------------------
negligence to any person in possession thereof under circumstances which do
not afford a reasonable ground for believing that he is not entitled to receive ----------------------
payment of the amount therein mentioned.”
----------------------
In other words, a payment is in due course when it satisfies the following
conditions: ----------------------
 It must be a payment in accordance with the apparent tenor of the instrument; ----------------------
it means that the payment should be made taking in consideration the
necessary instruction on the face of the instrument and on maturity to the ----------------------
person who can give a valid discharge for the payment.
----------------------
 It must be a payment in good faith and without negligence, i.e., honestly and
with reasonable skill and care. There should be no lack of any bona fides, ----------------------
though some inadvertence might be.
----------------------
 It must be made in the ordinary course of business, i.e., according to current
banking practice and within normal banking hours. ----------------------
 It must be a payment to a person in possession of the instrument unless ----------------------
there is reason to believe that the holder is not entitled to receive payment
of the cheque. ----------------------
It is important to note that the statutory protection is granted in respect of the ----------------------
forged signature of the payee or the endorser, and not of the drawer. In case the
drawer’s signature is falsely made on a cheque, the instrument becomes totally ----------------------
inoperative. ----------------------
Protection in Order Cheques
----------------------
A bank is discharged in an order cheque if it pays to the payee or to the
endorsee. The banker is protected in case of payment of an order cheque with ----------------------
forged endorsements. The banker has to however satisfy certain condition: (i) the
endorsement is a regular one and (ii) the payment is in due course. The protection ----------------------
is on the ground that the drawee, i.e. the paying banker does not possess the ----------------------
specimen signature of the payee and hence it cannot be verified.
----------------------

Notes Protection in Bearer Cheques
A banker who in good faith and without negligence pays a bearer cheque to the
----------------------
person, who presents it, is discharged from all liability and can debit his customer.
---------------------- An uncrossed bearer cheque is an open cheque and can be paid to the person
in possession without any liability on the part of the banker so long as he pays
----------------------
it in the ordinary course and with due care. Even if the holder had no property
---------------------- in the cheque or had a defective title, the banker cannot be held responsible for
loss to the true owner unless he has been negligent.
----------------------
Section 85 (2) of the Negotiable Instruments Act states that “where a cheque is
---------------------- originally expressed to be payable to bearer, the drawee is discharged by payment
in due course to the bearer thereof notwithstanding any endorsement whether in
---------------------- full or in blank appear-ing thereon, and notwithstanding that any such endorsement
‘purports to restrict or exclude further negotiation.” The above provision indicates
----------------------
that drawee or paying banker is discharged from the liability by honouring a bearer
---------------------- cheque according to the principal ‘once a bearer, always a bearer”. It may further
be noted that a bearer cheque does not cease to be a bearer cheque even if there
---------------------- are subsequent endorsements on it, and even if any of these endorsements is one to
make it an order cheque or a non-negotiable one. However, once a bearer cheque
----------------------
is crossed, the bank cannot pay it across the counter.
---------------------- Protection in Crossed Cheques
---------------------- The whole purpose of crossing is to prevent anyone but the payee from
receiving payment on a cheque. The drawee bank must not pay it except through
---------------------- another bank in the case of general crossing, and the prescribed bank where the
---------------------- crossing is special.
If the banker ignores the directions conveyed by the type of crossing while
---------------------- paying, he cannot debit the customer’s account with the amount of the cheque
---------------------- and will otherwise be held liable for any loss which the true owner sustains as
a result of this payment.
----------------------
Section 128 of the Negotiable Instruments Act provides, “Where the banker
---------------------- on whom a crossed cheque is drawn has paid the same in due course, the banker
paying the cheque and (in case, such cheque has come to the hands of the payee)
---------------------- the drawer thereof, shall respectively be entitled to the same rights, and be placed,
in the same position in all respects, as they would respectively be entitled to and
----------------------
placed in if the amount of the cheque had been paid to and received by the true
---------------------- owner thereof.” The banker has to however satisfy certain condition to receive
statutory protection: (i) the payment is in due course and (ii) it is in accordance
---------------------- with the requirements of crossing
----------------------
----------------------
----------------------
----------------------

Notes
----------------------
Multiple Choice Single Response ----------------------
1. A stale cheque is an overdue cheque, one that is presented long after
----------------------
it was drawn. The generally accepted banking custom is to treat a
cheque as stale after _______ months. ----------------------
i. One Month
----------------------
ii. Two Months
----------------------
iii. Seven Months
iv. Three Months ----------------------
v. Twelve months ----------------------
----------------------
2. An ante-dated cheque means a cheque, which bears a date ----------------------
i. After issue ----------------------
ii. Before issue
----------------------
iii. before presentment
----------------------
iv. After acceptance
v. No date ----------------------
3. In case the amounts in words and figure stated on a cheque differ, ----------------------
section 18 provides for the payment of what amount?
----------------------
i. Amount stated in figures.
ii. Amount stated in words ----------------------
iii. Cheque should be dishonoured ----------------------

iv. Cheque should be paid for the amount at the discretion of bank ----------------------
v. Both the amounts should be paid
----------------------
----------------------
Activity 1 ----------------------
----------------------
As a paying cashier in a bank, observe carefully a cheque drawn on your
bank and write down its characteristic features. ----------------------
----------------------
4.3 COLLECTING BANKER ----------------------
When a banker collects the cheques of his customer, he acts either: (a) as a ----------------------

Notes holder for value, or (b) as an agent of the customer. The legal rights and liabilities
of a banker, therefore, are determined by the capacity in which he collects the
---------------------- cheques. While the statutory protection is extended in the latter, it is denied if
he collects in the former capacity. As a holder for value, the bank is governed
---------------------- by the common law rule.
---------------------- The law does not impose any duty on the bank to collect the cheques,
dividend warrants and other instruments. A bank may refuse to collect them
----------------------
if it feels so. However, collection of cheques has become a common practice
---------------------- of banks; it is almost a part of their normal functioning. One will hardly find a
bank which will decline to undertake this activity. In recent times, the business
---------------------- involved in collecting of cheques is enormous. The legal difficulties owing to
the risk that the customer may have no title or a defective title are also on a rise.
----------------------
----------------------
In the business of banking, the term ‘holder for value’ arises when the banker,
---------------------- who is collecting the proceeds of a cheque, credits the amount of the cheque and
allows the customer to draw against, or otherwise pays the amount thereof to the
---------------------- customer before the proceeds are actually realized from the drawee bank. There
---------------------- is a time gap between the presentment of the cheque up to the time proceeds
could be made available for drawing and hence the customer may be given this
---------------------- facility.
---------------------- According to Sir John Paget, a banker becomes a holder for value in any of
the following circumstances:
----------------------
 By lending further on the strength of the cheque;
----------------------  By paying over the amount of the cheque or part of it in cash or in account
before its effects are cleared;
----------------------
 By agreeing, either then or earlier, or as a course of business, that the
---------------------- customer may draw before the cheque is cleared;
----------------------  By accepting the cheque in avowed reduction of an existing overdraft or
some other indebtedness;
----------------------
 By giving cash over the counter for the cheque at the time it is paid in for
---------------------- collection.
---------------------- There may be other occasions where the banker is the payee or endorsee
of the cheque, or collects a cheque over which he has a lien on, or cashes or
---------------------- exchanges a cheque payable elsewhere for his customer. All these cases are
examples where the banker, in one way or another, has given value before the
---------------------- cheque proceeds have been collected.
---------------------- When the banker acts as holder for value, he is in the position of any other
such holder of a negotiable instrument. Automatically he becomes a holder in
----------------------
due course entitled to sue the parties liable on such cheques in his own name. He
---------------------- gets on alternative and perfect defence to an action for conversion of the cheque.
He becomes the true owner of the instrument.
----------------------

Similarly he also incurs liability on the instrument. If the last but one Notes
endorsement is proved to be forged, he will be held liable to the true owner of the
cheque. But he shall have the right to recover the money from the last endorser, ----------------------
i.e., his own customer. If the customer is unable to pay, the banker will have to
bear the loss. ----------------------
4.3.2 Collecting Banker as an Agent ----------------------

The banker acts as an intermediary when he sends the bills for collection. ----------------------
The banker, collecting a cheque paid into his customer’s account, credits the
amount only when he has actually realized it. When doing so, the bank acts as ----------------------
an agent or a channel to receive payment of the cheque from the bank on which ----------------------
it is drawn.
Like any other agent, the banker has to perform his duties diligently for the ----------------------
customer who deposited his cheques for collection. The banker has to present ----------------------
the cheques for payment within reasonable time for collection. If he delays or
does not exercise the normal skills expected, he is liable to his customer. ----------------------
It has been held that the reasonable time would be presenting the cheque ----------------------
within one day after the receipt where the cheque is drawn on a bank in the same
place, or forwarding it on the following day where the cheque is drawn on a ----------------------
bank in another place. After the expiry of reasonable time, the customer paying
in the cheque for collection is entitled to presume that it has been collected and ----------------------
the proceeds thereof credited to his account. ----------------------
The important point to be noted here is that the collecting banker does not
enjoy a better title than what is possessed by his principal i.e. his customer. If ----------------------
he collects a cheque to which his customer had no title or had defective title, for ----------------------
instance, a forged endorsement, he shall be held liable for ‘conversion of money’.
----------------------
Conversion by the Collecting Banker
----------------------
A bank acting as the collecting agent will always have to act in good faith
and without negligence in collecting the cheques. Failure to do so will hold the ----------------------
collecting banker liable for the charge of conversion to a third party who is the
true owner of the cheque. ----------------------
Conversion is a wrongful or unlawful interference without legal justification ----------------------
with another person’s property in a manner inconsistent with owner’s rights.
Conversion is committed where a person deals with property belonging to another ----------------------
in a manner which denies the owner the title and right to possess that property. It
----------------------
involves wrongful interference with the rights of the true owner of the property.
Though, the rightful owner is not legally dispossessed of them, but he is kept ----------------------
out of their enjoyment fraudulently in a manner inconsistent with his rights.
----------------------
Negotiable instruments are included in the term ‘property’ and hence
the banker also can be charged for conversion. A banker may be charged for ----------------------
conversion if he collects cheques for a customer who has no title or defective
title to the instrument. The rightful owner of the goods can recover the same ----------------------
from anyone who takes the property without his authority and in whose hands
----------------------

Notes it can be traced. The banker is held liable especially when the banker acts as an
agent of his customer for collection of cheques. The banker or any other person
---------------------- in possession of such ‘property’ is protected if he is holder in due course, i.e. he
has received it in good faith for value without knowledge that the other party had
---------------------- any authority on the instrument. The rightful owner can file a suit for conversion
---------------------- in all other circumstances other than the ones mentioned above.
----------------------
A collecting banker like any other agent is under obligation to follow the
---------------------- directions of his principal, i.e. his customer and discharge his duties with ordinary
skill and reasonable diligence. Certain duties have been specifically cast by the
----------------------
Negotiable Instruments Act as below:
---------------------- Presentment within Reasonable Time
---------------------- The collecting banker is required to keep track of the cheques right from
presentment to the time of payment. The banker is under obligation to present
---------------------- the cheques to the drawee bank within reasonable time. Reasonable time is
---------------------- referred to as “the earliest possible.” Even where the cheques may be forwarded
to another branch of the collecting bank or to an agent or correspondent bank,
---------------------- same time limit shall be available for presentation after the receipt of the cheque
for presentment.
----------------------
According to law and judicial pronouncements, this reasonable time would
---------------------- be:
---------------------- (a) Presentment of the cheque within one day after the receipt whether the
cheque is drawn on a bank in the same place, i.e., the collecting and drawee
---------------------- bank, both are locally situated.
---------------------- (b) Forwarding or presenting it on the following day in case where the cheque is
drawn on a bank in another town i.e. where the collecting and drawee banks
---------------------- are at different places. Here, the cheques should be presented / forwarded
by the collecting bank on the day after their receipt.
----------------------
Thus, in both the cases, the action of presentment or forwarding must
---------------------- normally be taken on the day after the instrument is received. After the expiry of
a reasonable time, the customer paying in the cheque for collection is entitled to
----------------------
presume that the cheque has been collected and the proceeds thereof have been
---------------------- credited to his account. The customer can, therefore, withdraw an amount not
exceeding the amount to be collected after the expiry of such reasonable time.
----------------------
If the bank has failed to collect the cheque, it cannot dishonour the cheque
---------------------- on the ground of shortage of funds. There would not have been any shortage
of funds if the banker had performed its duty of collecting the cheque on time.
---------------------- The customer can recover damages for wrongful dishonour. If the bank makes
---------------------- delay in presenting the cheque, the bank will also be liable to the customer for
any other loss which the customer may sustain, for instance, dishonour of the
---------------------- cheques issued in anti-cipation of the realization of some instruments sent for
collection.
----------------------

Serve Notice of Dishonour Notes
In case of non-payment/ dishonour of the cheques presented for collection,
----------------------
the collecting banker is required to give due notice of dishonour to the customer.
The bank generally conveys the notice of dishonour by returning the cheque to ----------------------
the customer. This is deemed a sufficient notice of dishonour. The bank can also
debit the customer account for the amount of the cheque if it was credited to his ----------------------
account amount prior to collection.
----------------------
As an agent for collection if the banker serves such notice to the customer,
it is taken that the banker has performed his duty. It is for the customer to give ----------------------
notice to the all other parties involved.
----------------------
In case the collecting banker is not the agent but a holder for value, he will
be required to give notice of dishonour to all the parties to the cheque so as to ----------------------
make all or any of them liable for the payment of the amount of the cheque. If he
----------------------
stops with giving notice only to his customer, then he may not be able to proceed
against any party other than the customer. In such a situation, all the parties ----------------------
secondarily liable will be discharged of their liability towards the instrument. He
himself will become responsible to his customer for any loss on the instrument. ----------------------
There are no prescribed formats for sending a notice. It is usual to return ----------------------
the cheque to the customer with a note indica-ting the reason for non-payment.
The collecting banker is entitled to the same time to give notice to his principal ----------------------
as if he were the holder giving notice of dishonour. ----------------------
----------------------
The Collecting Banker collects a great number of cheques on behalf of
innumerable customers every day. The banker finds it an uphill task to examine ----------------------
the validity of title in each such case. Such verification of title in every cheque
----------------------
to be collected will result in an incalculable delay.
The Negotiable Instrument Act, 1881 provides protection to the collecting ----------------------
banker, only to a certain extent. The provisions try to minimize the risks of
----------------------
conversion involved in collection of cheques. Section 131 of the Negotiable
Instrument Act, 1881 states, “A banker who has in good faith and without ----------------------
negligence received payment for a customer of a cheque crossed generally or
specially to himself shall not, in case the title of the cheque proves defective, incur ----------------------
any liability to the true owner of the cheque by reason only of having received
----------------------
such payment.”
A collecting bank is given statutory protection only on fulfillment of the ----------------------
following conditions: ----------------------
1. Crossed Cheques
----------------------
The collecting banker enjoys certain amount of protection only in case of
crossed cheques. To be entitled to pro-tection, the cheques have to be crossed ----------------------
generally or specially before it reaches the hands of the collecting banker.
----------------------
If a certain cheque was not crossed at the time deposited for collection, the
bank cannot secure protection by crossing it. It is a common practice among ----------------------

Notes bankers to cross cheques received for collection with a rubber stamp. This does
not help. In collecting an open cheque, the bank can be held liable for conversion.
---------------------- The banker will be answerable to the true owner for the value, if the customer
had no title or a defective title on the instrument.
----------------------
2. Person must be a Customer
----------------------
In order to claim the statutory protection, the person for whom the bank acts
---------------------- must be its customer. That is, the bank must receive payment as a mere agent on
behalf of his customer, and not of its own right as a holder or otherwise acquiring
---------------------- personal interest in the cheque. The statutory protection is available to the banker
if he collects the cheques as an agent and not as a holder for value. As holder for
----------------------
value, the collecting banker becomes the rightful owner of the instrument and
---------------------- does not get any statutory protection.
3. Receives Payment
----------------------
The protection granted u/s 131, Negotiable Instrument Act, 1881, is limited.
---------------------- It states that “a banker receives payment of a crossed cheque for a customer
---------------------- within the meaning of this section notwithstanding that he credits his customer’s
account with the amount of the cheque before receiving payment”. The collecting
---------------------- banker does not lose the statutory protection, if he credits his customer’s account
with the amount of the cheque before its actual realization, but the customer is
---------------------- allowed to draw the amount only after its realization.
---------------------- 4. Good Faith and Without Negligence
---------------------- An important condition for the protection to be available to a collecting
bank is that he should have acted in good faith and without negligence. If found
---------------------- to act otherwise, the banker loses the benefit u/s 131. This obligation of due care
is imposed on the collecting banker to safeguard the interest of the true owner.
---------------------- What is due or reasonable care and diligence is a question of fact, and has to be
---------------------- interpreted in the light of facts of the case and surrounding circumstances.
The test of significance u/s 131 is ‘’whether the transaction of paying in /
----------------------
collecting any given cheque in the said circumstances, antecedent and present,
---------------------- is so out of the ordinary course that it ought to arouse doubts in the banker’s
mind and cause him to make enquiry”. In general, the amount of care expected
---------------------- from a banker is the same as a reasonable man would have exercised to protect
himself and others against fraud.
----------------------
A collecting banker would be liable to the true owner only when he is
---------------------- negligent. The collecting banker has to exercise reasonable care and diligence
in the following cases:
----------------------
 Collecting Third Party Cheques
----------------------
If a bank collects cheques for agents and other third parties and pays the
---------------------- same fraudulently or without authority to their accounts, the banker shall
be liable to compensate the true owner for any loss or damage which he
---------------------- sustains thereby.
----------------------

 Cognizance of “Not Negotiable” Crossing Notes
A ‘not negotiable’ crossing though does not impede transferability of the
----------------------
cheque, but affects negotiability of the instrument. The transferor fails to
pass a better title than what he himself has; a holder takes the instrument ----------------------
subject to the defects of title in its transferor. The banker should be careful
in ascertaining the title of the previous parties, otherwise he will be charged ----------------------
of conversion of money.
----------------------
 Care in Account Payee Crossing
----------------------
It is the duty of the banker to make a careful and satisfactory inquiry before
collecting the crossed cheques in favour of a person other than the payee ----------------------
named therein. Failure to observe this precaution deprives the banker of the
statutory protection. To disregard a direction of that kind is referred to as ----------------------
prima facie negligence. ----------------------
 Proper Enquiries
----------------------
The collecting banker should not be satisfied about the genuineness of the
transaction merely by what appears on the face and the back of a cheque. He ----------------------
may have to make enquiries about the cheque and the underlying transaction ----------------------
in order to protect himself against a possible charge of negligence. The type
of enquiry to be made would depends upon the facts of each case. Some ----------------------
factors that need to be borne in mind by the banker are:
----------------------
– The amount of the cheque,
----------------------
– The history of the transaction in the account, in which the cheque is
paid in, ----------------------
– The antecedents of the customer, ----------------------
– The relationship between the customer and the drawer/ payee, etc.
----------------------
The banker should not hesitate to make enquiries for fear of offending the
customer. The banker should address his queries to his customer only in ----------------------
the first instance; however, in certain circumstances he can very well make ----------------------
enquiries of the drawer/payee of the cheque.
----------------------
 Check for Irregular Endorsement
If the banker is found negligent in verifying the regularity of endorsements ----------------------
on the cheques collected by him, he will lose the protection available u/s ----------------------
131. For instance, failure to see that the endorser has signed in the same
manner and with the same spellings (no matter incorrect) as they appear on ----------------------
the instrument in the name of the payee or endorsee.
----------------------
 Care while opening accounts
----------------------
Failure to obtain proper introduction in opening an account for a new
customer or to follow up a reference given by such customer would also ----------------------
amount to negligence. The banker may not be able to claim protection against
----------------------
a charge of conversion.

Notes
----------------------

1. When the banker acts as holder for value, he is in the position of
----------------------
any other such holder of a negotiable instrument. Automatically, he
---------------------- becomes a _________.
2. It has been held that the reasonable time would be presenting the
----------------------
cheque within _________ after the receipt where the cheque is drawn
---------------------- on a bank in the same place.
---------------------- 3. In collecting an _________ cheque, the bank can be held liable for
conversion.
----------------------
----------------------
Activity 2
----------------------
Study the procedure of a collecting banker and note down the precautions
----------------------
that the banker has to take as a collecting banker.
----------------------
----------------------
Summary
----------------------
●● The paying banker is responsible to his customer and is under duty to
---------------------- make payments to the rightful holder in accordance with the instructions
of the drawer. Any negligence on part of the banker while honouring
----------------------
of cheques in a manner inconsistent with the instructions given by the
---------------------- drawer, the banker will be held liable and will not be in a position to
debit the customer’s account for that amount of the cheque. The banker
---------------------- may also be held liable for damages or compensation to his customer and
also the true owner of the cheque as per the provisions of the Negotiable
----------------------
Instrument Act, 1881.
---------------------- ●● At the same time, the banker is under an obligation to make payment of
the cheques issued by the customer as long as there is sufficient balance
----------------------
available in the customers account. Failure to honour cheques with
---------------------- good reasons, the banker will be held liable and will have to pay for any
damages to the drawer/customer of the bank.
----------------------
●● Collection of cheques, bills of exchange, dividend warrants and other
---------------------- instruments on behalf of his customer is an important service rendered
by a modern banker to his customer. Though a banker is under no legal
---------------------- obligation to collect the cheques on behalf of his customer, it has become
an important function of the banker in recent times, especially in times
----------------------
where there is spread of the banking system, growth in the banking habit
---------------------- and a wider use of crossed cheques.

●● When a banker collects the cheques of his customer, he acts either as Notes
a holder for value, or as an agent of the customer. The legal rights and
liabilities of a banker, therefore, are determined by the capacity in which ----------------------
he collects the cheques.
----------------------
●● A collecting banker is deemed as holder for value when he pays the
customer the amount of the cheque or allows him to withdraw the same ----------------------
before the actual realization of the cheque. A collecting banker acts as an
agent of the customer if he credits the amount to the customer’s account ----------------------
only on actual realization of the amount from the drawee bank. While the ----------------------
statutory protection is extended in the latter, it is denied if he collects in
the former capacity. As a holder for value, the banker is governed by the ----------------------
common law rule.
----------------------
Keywords ----------------------
●● Paying Banker: The drawee of the cheque, the bank who will make ----------------------
payment on the cheque
----------------------
●● Ante-dated Cheque: One which bears a day before its issue,
●● Post-dated Cheque: One which bears a date later than the date of issue ----------------------
●● Stale Cheque: One which is long overdue, the validity of a cheque is ----------------------
stated as three months
----------------------
●● Mutilated Cheque: One which has been torn in two or more pieces but
pasted afterwards. ----------------------
●● Banking hours: The period during which the bank transacts banking
----------------------
business with the public
●● Material Alteration: A change that alters the business effect of an ----------------------
instrument and cause it to speak a language different from what it
----------------------
originally spoke
●● Forgery of Signature: The drawer’s signature is not genuine and ----------------------
somebody else has placed it on the instrument without the knowledge/
----------------------
consent of the drawer.
●● Payment in Due Course: Payment in accordance with the apparent ----------------------
tenor of the instrument in faith and without negligence to any person in
possession thereof under circumstances which do not afford a reasonable ----------------------
ground for believing that he is not entitled to receive payment of the ----------------------
amount therein mentioned.
●● Collecting Banker: The banker who collects the cheques on behalf of ----------------------
his customer as distinguished from a drawee bank on which the cheques ----------------------
are drawn.
●● Holder for Value: When the collecting banker pays the customer the ----------------------
amount of the cheque or allows his to draw on it before the amount has ----------------------
been actually realized from the drawee banker, the collecting banker is
deemed to be holder for value. ----------------------

Notes ●● Conversion: Wrongful or unlawful interference with another person’s
property inconsistent with the owner’s right of possession.
---------------------- ●● Reasonable time: Referred to as the ‘earliest possible’ wherein the
---------------------- cheques may be forwarded to the drawee bank for collection.

----------------------
1. Who is a Paying Banker?
---------------------- 2. Discuss the responsibilities of a paying banker.
---------------------- 3. What are the advantages of printed cheque forms?
---------------------- 4. Differentiate between a state cheque and a post-dated cheque.

5. Discuss the duties of a paying banker.
----------------------
6. Explain the Statutory protection received by the paying banker.
----------------------
7. Enumerate the circumstances under which a banker may and must refuse
---------------------- to honour a customer’s cheque.
8. Write a note on Material Alteration?
----------------------
9. What is the legal position in case of forgery of signature?
----------------------
10. Write a note on Payment in Due Course.
---------------------- 11. Who is a Collecting Banker?
---------------------- 12. Explain the position of Collecting Banker as Holder for Value.
---------------------- 13. Describe the role of Collecting Banker as an Agent.
14. What is meant by Conversion?
----------------------
15. Explain are the duties of the Collecting Banker.
----------------------
16. Describe the responsibilities of the Collecting Banker.
----------------------
17. What is the statutory protection provided to the Collecting Banker?
---------------------- 18. What are the conditions under which the Collection Banker can avail of
statutory protection?
----------------------
19. A cheque is drawn upon Arial Bank. Mr. X, on having stolen a cheque,
---------------------- hands it over to Y who accepts it in good faith & for valuable consideration.
Y deposits the cheque into his own account in Mercantile Bank. The Bank
----------------------
presents it and obtains payment from Arial Bank.
---------------------- 20. Discuss the legal position of paying banker, collecting banker, Mr. Y and
---------------------- the true owner in each of the following cases:
 If the cheque is payable to bearer and crossed generally.
----------------------
 If the cheque is payable to bearer and crossed specially with the
---------------------- words ‘non-negotiable’
----------------------  If the drawer’s signature is forged.

Answers to Check your Progress Notes
1. A stale cheque is an overdue cheque, one that is presented long after it
was drawn. The generally accepted banking custom is to treat a cheque as ----------------------
stale after _______ months. ----------------------
iv. Three Months
----------------------
2. An ante-dated cheque means a cheque, which bears a date
----------------------
ii. Before issue
3. In case the amounts in words and figure stated on a cheque differ, section ----------------------
18 provides for the payment of what amount? ----------------------
ii. Amount stated in words
----------------------
----------------------
Fill in the blanks.
1. When the banker acts as holder for value, he is in the position of any ----------------------
other such holder of a negotiable instrument. Automatically, he becomes
----------------------
a holder in due course.
2. It has been held that the reasonable time would be presenting the cheque ----------------------
within one day after the receipt where the cheque is drawn on a bank in
----------------------
the same place.
3. In collecting an open cheque, the bank can be held liable for conversion. ----------------------
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Suggested Reading
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Notes
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Relationship between Banker and Customer
UNIT
5
Structure:
5.1 Introduction
5.2 Definition of Customer
5.3 Relation between Banker and Customer
5.4 Rights of a Banker
5.5 Obligations of a Banker
5.6 Garnishee Order
5.7 Termination of Relationship
Summary
Key words
Suggested Reading
Relationship between Banker and Customer 83

Notes
Objectives
----------------------
• Clarify the meaning of ‘customer’ of a banking company
----------------------
• Describe the relation between banker and his customer
----------------------
• Name the peculiarities of the banker-customer relationship
---------------------- • Infer the rights and obligations of a banker
----------------------
---------------------- 5.1 INTRODUCTION

---------------------- The term ‘customer’ of a bank is not defined by law. In common parlance,
a person who has an account in a banker is considered to be the customer of
----------------------
the bank. However, the relationship between a banker and customer is of great
---------------------- practical significance. It arises out of a contract made between the two – the
banker and the customer and it involves obligations on both sides.
----------------------
---------------------- 5.2 DEFINITION OF CUSTOMER

---------------------- In general or ordinarily, a customer is one who has “some sort of an account
or some similar relation with the banker”. The relation between the two – banker
---------------------- and customer would exists as long as there is an account held with the bank;
once the account is closed, the relationship is terminated.
----------------------
According to Sir John Paget, “to constitute a customer, there must be some
---------------------- recognizable course or habit of dealing in the nature of regular banking business”.
In other words, just having an account with a bank is not enough. There has to be
----------------------
(i) a recognizable course or habit of transactions/dealings between the customer
---------------------- and banker and (ii) the connection or transaction should relate to some banking
business.
----------------------
A single transaction or rendering of some service will not turn a person
---------------------- into a customer. It is the continuity of the relation over a period of time that is
important. It is when one is accustomed to frequent a banker; he can become a
---------------------- client of the bank or be called the customer of the bank.
---------------------- Secondly, the dealing is of banking nature; there has to be regular transactions
or dealings such as money deposited and withdrawn from the account, cheques
---------------------- for payment and cheques for collection, loans and advances and the obligation
---------------------- to repay, all put together are the basics of banking business.
If a banker renders services not peculiar to the business of banking such as
----------------------
cash withdrawals across the counter, demand drafts, safe-custody, etc., the person
---------------------- who just avails such services for the time being does not become a customer.
These are causal dealings and are a part of the secondary functions of the bank
---------------------- referred to as the agency and general utility functions.

The relation between the banker and the customer begins as soon as the Notes
first cheque is paid issued for payment and/or accepted for collection. A single
transaction is the beginning of the banker-customer relationship. The duration ----------------------
of this relation is not of importance. Once deposits are accepted by the bank,
the bank accepts to honour cheques upon the amount standing to his credit, ----------------------
irrespective of whether his connection or relation is long or short standing. ----------------------
5.3 RELATION BETWEEN BANKER AND CUSTOMER ----------------------
There are several possible relationships between a banker and his customer. ----------------------
The primary one is that of the debtor and creditor. To begin with, when deposits ----------------------
are accepted from the customer, the customer is the creditor and the banker is the
debtor. This relationship however, would depend upon the state of the customers ----------------------
account at any particular point of time. When the account shows a credit balance,
the banker is the debtor and the customer is the creditor. When the customer takes ----------------------
a loan or overdraws on his account, the position will reverse; the customer will ----------------------
turn debtor and the banker the creditor.
There are other possible relationships depending upon the respective state ----------------------
of circumstances: (a) Bailor and Bailee (b) Principal and Agent and (c) Trustee ----------------------
and Beneficiary.
----------------------
Banker as a Debtor and Creditor
The contract of debt is the very base of the relation between the banker ----------------------
and customer. When a banker opens an account in favour of a person by
----------------------
accepting deposits of money, naturally he takes up the position of a debtor and
the customer is the creditor. But later if the account shows a debit balance, the ----------------------
roles are exchanged. The customer becomes a debtor and the banker a creditor.
This relationship i.e. banker as creditor and customer as debtor, continues till ----------------------
the loan is repaid. The banker is a secured creditor as the loan is granted to the
----------------------
customer against some securities. However, the customer, when he maintains
deposits with the banker, he is always an unsecured creditor. ----------------------
The money deposited left with the banker is property of the banker and ----------------------
completely at his disposal. The banker only undertakes to repay a sum equivalent
to the amount deposited with him. The customer does not have any right ----------------------
whatsoever to claim identical notes/coins deposited with him. The latter can pay
the amount in any kind of legal tender. ----------------------
The banker-customer in a debtor-creditor relationship is subject to the ----------------------
following peculiarities; it is not the same with similar commercial debts:
----------------------
 The deposits with a bank do not become time-barred on the expiry of three
years in India as in the case of other ordinary debts. ----------------------
 A banker is not an ordinary debtor, but a special one. The banker is under ----------------------
no obligation to refund the customer’s deposit unless demanded for by the
customer. Even when fixed deposit amount are maintained by the customer ----------------------
of a bank, the bank is not required to return the deposits, even on the expiry
----------------------

Notes of the deposit period. In all cases, the customer has to make a demand for the
repayment of funds/deposits maintained with the bank. The only exception is
---------------------- when the bank is winding up its business, it is such an event that the balance
becomes payable at once and without the need for a demand
----------------------
 The demand for repayment of the deposits has to be made at the proper
---------------------- place by the customer. The withdrawals are mainly affected at the branch
where the customer makes the deposit. The demand has to be presented only
----------------------
during banking hours and on working days.
----------------------  The demand for repayment of the deposits must be made in a certain
specified manner. This is usually done by a written an order or by cheque.
----------------------
The banker is not bound to return the sum on the basis of a verbal or a
---------------------- telephonic conversation.
Banker as Bailee
----------------------
When valuables such as jewellery, gold, stocks, bonds etc are deposited
---------------------- for safe-custody, the banker becomes the bailee and the depositor the bailor.
---------------------- However, when the banker takes charge of the customers’ property and maintains
the same in his strong rooms, he acts in the capacity of a custodian. He is in no
---------------------- case the insurer of the goods in possession. He is liable only for negligence on
his part and not for the goods stolen or fraudulently used by persons in his own
---------------------- employment. This issue generated a lot of debate. The banker now, charges for
---------------------- providing services as a custodian and hence is referred to as a paid bailee. He
must therefore safeguard the customers’ property by every possible way.
---------------------- Banker as Agent
---------------------- The Banker performs the role of a paying banker and a collecting banker:
----------------------  He performs/renders services of paying or collecting different instruments
such as cheques, demand drafts, dividend warrants and other credit
---------------------- instruments on behalf of his customer.
----------------------  He also purchases/sells securities, draws, accepts and endorses cheques,
payment of fees, premia, debts, etc, all on behalf of the customer.
----------------------
Here, the relationship between the two parties is that of Principal and Agent.
---------------------- The banker as an agent follows his customers’ orders. It is not necessary for
the banker to obtain the power to act on behalf of his customer in writing. The
---------------------- authority to do so can be obtained by words or by implication.
---------------------- Whenever the banker gets the authorization to do any special lawful act or
a series of acts by an instrument in writing, it is called the ‘Power of Attorney’.
---------------------- The power of attorney usually is under seal; the seal is not an essential ingredient.
---------------------- However, it is not necessary to mention that his power becomes void in case
of death or insanity or any such event. The power also becomes void in case of
---------------------- insolvency of his customer.
---------------------- The relation between an agent and the principal is entirely personal. The
ordinary rule is that an agent being a person enjoying the confidence of his
---------------------- principal cannot delegate his duties to another.

Banker as a Trustee Notes
The relationship as trustee and beneficiary between a banker and customer
----------------------
depends upon the specific instructions given by the latter. A trustee holds money
or assets and performs certain functions for the benefit of some other person called ----------------------
the beneficiary. There are cases where a banker places himself in the position of
a trustee and thereby restricts his freedom to use money or documents. The legal ----------------------
position of the banker as a trustee differs from that of a debtor of his customer.
----------------------
As a trustee, the banker cannot treat the money and documents as his own and
is also not available for distribution amongst his general creditors in case of ----------------------
liquidation.
----------------------
Rights of & Obligations on a Banker
The customer-banker relationship gives rise to certain definite claims and ----------------------
duties which are mutual in character. The banker’s rights are the customer’s
----------------------
duties and the banker’s responsibilities are the customer’s claims.
----------------------
5.4 RIGHTS OF A BANKER
----------------------
Right of General Lien
----------------------
Lien means a right exercised by one over someone else’s property. Lien is
defined as “a right in one man to retain that which is in his possession belonging ----------------------
to another, until certain demands of the person in possession are satisfied”. Right
----------------------
of lien enjoyed by a banker is a special feature of banker-customer relationship.
The peculiarities of a banker’s lien are: ----------------------
 The banker possesses the right of general lien on all the goods and securities ----------------------
entrusted to him in his capacity as a banker, hence it is called as the Bankers
Lien. Bankers have a general lien on all securities deposited with them unless ----------------------
there is an express contract or circumstances that show an implied contract, ----------------------
inconsistent with lien.
 Banker’s lien is an implied pledge which enables him to dispose of the ----------------------
goods in due course to adjust his dues. Where the customer makes a default ----------------------
in payment of the debt, the banker can straightway sell the goods on giving
reasonable notice of the sale. In other cases, the creditor has the right of ----------------------
retaining the things till the debt is repaid or the promise performed.
----------------------
 Lien can be either a general lien or a particular lien. A banker cannot
simultaneously have both a general and a particular lien; one defeats the ----------------------
other.
----------------------
A general lien is a blanket term entitling the person in possession to retain
the goods and securities until all his claims against the owner of goods have been ----------------------
satisfied. It extends to all the transactions arising out of the course of dealings
----------------------
between the owner and the lien-holder. Bankers are one of the parties which can
resort to general lien. They can retain the articles on account of debts which are ----------------------
not in any way connected with the articles in question.
----------------------

Notes A particular lien is a specific right to retain goods and securities till all the
charges in respect of those goods have been paid off. It is also known as specific
---------------------- lien as it applies to one transaction or certain transactions only. Here, it is a case
of specific securities being charged of a specific purpose.
----------------------
The exceptions to the right of lien:
----------------------
 The right of lien cannot be exercised where the securities and valuables are
---------------------- entrusted to the banker for safe-keeping. The reason is that he is a bailee for
a specific contract of bailment and he must perform his duties in accordance
---------------------- with the terms of contract contained therein.
----------------------  Where a cheque/bill has been left with the banker with clear instructions to
utilize it for a particular debt or purpose, the banker cannot exert his right
---------------------- of lien on the proceeds of such cheque/bill of a debt/purpose other than the
one indicated by the customer.
----------------------
 If money is deposited or the credit balance is earmarked for a specific purpose
---------------------- and the customer makes his intentions known that the said money or credit
---------------------- balance be so utilized, the banker cannot again exercise his right of lien.
 Where some documents/valuables have been left with the bank by mistake
---------------------- or negligence, the right of lien cannot be exercised.
----------------------  Where a person maintains an account as a trustee for someone else and the
banker has knowledge of it, the right of lien cannot be exercised.
----------------------
 Where some goods/securities have been deposited with a bank for raising
---------------------- a loan, the right of lien cannot be exercised till the loan is sanctioned.
---------------------- Right of Appropriation of Payments
---------------------- The banker receives deposits of money from his customer as part of the
regular banking business. The customer has the right to indicate to the banker
---------------------- the account to which a particular amount is to be credited, especially in case of
more than one account and/or loan account. If the customer has not appropriated
---------------------- i.e. not indicated the account from which the said money should be used, the
---------------------- creditor i.e. the banker is conferred upon the legal right to do so. The banker
may apply the payment to any debt of the debtor, including to the discharge of a
---------------------- debt barred by the Statute of Limitations. If neither the customer nor the banker
has made any specific appropriation, then the law appropriates the payment in
---------------------- the chronological order.
---------------------- Right to Set-off and Combine Accounts
---------------------- In case a customer happens to maintain more than one account in the same
capacity, the banker has the right, in the absence of an agreement to the contrary,
---------------------- of set-off. He can adjust the debit balance in one account against the credit
balance in another account/s. For the exercise of this right, the debt must be a
---------------------- sum certain, due and recoverable on the date of set-off. It must be due by and to
---------------------- the same parties under the same title and in their own right. It has always been
advisable for the banker to take an agreement from the customer authorizing him
---------------------- to combine the accounts at any time without notice. It is difficult for the bank

to rely on set-off in the absence of such an agreement. However, the banker is Notes
not entitled to retain moneys to meet a contingent liability or any other future
debt which has not yet matured. The debt has always to be due and certain on ----------------------
the date the right of set-off is to be exercised.
----------------------
Right to Close an Account
----------------------
A customer can close the account at any point of time without assigning
any reason/s for the same. He may however, cite the usual reasons that he (a) ----------------------
does not agree to the terms and conditions of the bank (b) feels unhappy with the
quality of service, (c) otherwise loses confidence in the bank. He may close the ----------------------
account by withdrawal the balance in his account simply by presenting a cheque
----------------------
for the balance in his favour. It is common to inform the banker of his intention
and return unused cheques and property belonging to the bank. ----------------------
However, the banker can also decide to close an account; account that the
----------------------
banker finds have been unsatisfactorily conducted. It can be so done by sending
a written intimation to the customer. He may state therein that he will not receive ----------------------
any further credits and may additionally request the customer to withdraw his
balance. The banker can inform that he will honour the cheques only till the ----------------------
balance is exhausted.
----------------------
Right not to Produce Books of Accounts
----------------------
Banks are no more compelled to produce actual books of account in any
legal proceeding to which it is not a party. The day books, cash books, ledgers ----------------------
and other books are so heavy and so much in continuous use that the banker was
being put to undue hardship and disruption in his regular business, whenever he ----------------------
was called upon to produce them. Under the Banker’s Books Evidence Act of ----------------------
1879 in England and 1891 in India, it has been laid down that a certified copy of
any entry in a banker’s book shall serve as prima facie evidence of the matters, ----------------------
transactions and accounts therein recorded and be admitted as an original entry.
The only condition is that an officer of the bank has to swear in courts or else ----------------------
file an affidavit that the copy was made form one of the ordinary books in the ----------------------
ordinary course of business. It is only for a special cause that the actual books
of accounts could be summoned by an order of the court or a judge. ----------------------
Right to Charge Interest & Commission ----------------------
At Common Law, a banker has no right to charge interest on loans sanctioned.
----------------------
However, there has been a universal custom or usage of trade to make such a
charge. Now-a-days, it is usual for the banker to have an express agreement to ----------------------
that effect. The banker has an implied authority to recover from the customer
all incidental charges in respect of current accounts. The practice of charging ----------------------
commission on such accounts has become so general that the banker could legally
----------------------
enforce a claim for it.
----------------------
----------------------
----------------------

Notes 5.5 OBLIGATIONS OF A BANKER
---------------------- Obligation to Maintain Secrecy of the Account
---------------------- The transaction between the banker and his customer are peculiarly private
in character. A banker therefore cannot divulge the state of his customer’s affairs
---------------------- and accounts to any third party except on reasonable and proper occasions.
Secrecy has always been a guarded tradition of bankers. This obligation to observe
---------------------- secrecy of the customer’s affairs applies to all the transactions that go through
---------------------- the account and to the securities given in respect of the amount. The obligation
does not end even with the closing of the account by the customer or the banker.
---------------------- Secrecy is maintained even after and the information is regarded as confidential.
The relation between the banker and customer and the contract between them
---------------------- makes the obligation of secrecy a legal one.
---------------------- There are exceptions to the client’s privilege of confidentiality:
----------------------  The banker may be called upon to give information to public authorities
about the transactions of his customers, especially as evidence in legal
---------------------- proceedings.
----------------------  There is a duty to the public to disclose the customer’s affairs, if it is realized
that the customer is carrying out illegal activities or activities not in national
---------------------- interest.
----------------------  The third exception is that where the disclosure is required in the interest
of the bank itself, for instance, the bankers has to effect recovery of dues
---------------------- from the customer.
----------------------  The customer may demand the banker to act as referees for trade purposes.
The banker gets a clear consent from the customer to furnish confidential
---------------------- information to other banks.
---------------------- Certain safeguards however, have to be observed:
---------------------- – Inquiries should always be routed through a bank. A request for a credit
report should not be entertained from anybody except a bank.
----------------------
– The contents of the credit report should be carefully worded; a general
---------------------- reputation and financial position to be presented; exact details should not
be divulged.
----------------------
– The covering letter to the report should be marked as ‘confidential’.
---------------------- In case where the banker makes an unwarranted or unjustifiable disclosure of
the customer’s account, he incurs the liability both towards the customer as well
----------------------
as the third parties involved where such information is furnished. The customer
---------------------- may sue the banker for damages suffered by him as a result of such disclosure
or wrongful disclosure. The banker is also liable to the third part if information
---------------------- provided was relied on and the party suffered losses and the banker was aware
that the information supplied was false.
----------------------
----------------------

Obligation to Honour Cheques Notes
The all-important obligation of a banker is to honour the customer’s cheques.
----------------------
The cheques of a customer have to be paid for if (a) the cheques are drawn in the
proper format and (b) the banker has funds belonging to his customer sufficient ----------------------
to pay them i.e, there is sufficient and available credit balance.
----------------------
In case there is an agreement between the banker and customer for instance,
an overdraft facility sanctioned by the banker, cheques can be paid even if the ----------------------
balance is short or nil. If the banker return cheques without reasonable grounds
even when there are sufficient funds of the customer, it may lead to an action ----------------------
for damages against the banker.
----------------------
The Credit of a customer is a very delicate and precious possession and the
banker should take proper care of the same. ----------------------
A banker however has the right to refuse payment in the following circumstances: ----------------------
(a) where a garnishee order has been issued, ----------------------
(b) where a cheque is issued against cheques sent for clearance and
----------------------
(c) where a cheque is presented at the branch other than the one in which he
keeps his account. ----------------------
The banker is bound to act according to the directions given by the customer. ----------------------
In the absence of such directions, he has to act according to the usage prevailing
at the place where the banker conducted his business. The banker is bound to ----------------------
use reasonable skill and diligence in his work.
----------------------
5.6 GARNISHEE ORDER ----------------------
A customer in course of his business/transactions may incur obligations ----------------------

which may give rise to money claims against him. As per law, there are different
----------------------
modes of enforcing money claims. They are (i) issuing a garnishee order requiring
the bank to pay directly in court or (ii) attachment order for attachment of money ----------------------
of a customer in his account. A banker accepts deposits of money from his
customer. These deposits can be required to settle money claims. ----------------------
The word ‘Garnish’ means ‘to warn’. A person asked to pay the debt ----------------------
directly into court is known as ‘the garnishee’ and the court’s order is called the
‘Garnishee Order’. Garnishee is the debtor to whom a direction is given to pay ----------------------
the debt directly into the court and a warning is given not to pay the debt to the
----------------------
creditor.
Garnishee means a third party which in the context of banking stands for ----------------------
the banker, the judgment debtor’s debtor. If a the court issues a garnishee order
----------------------
under Rule 46 of the Code of Civil Procedure, the banker who holds the funds
in favour of a person is thereby restrained from releasing such funds. ----------------------
A garnishee order is a process of law, i.e. an order of the court obtained by a ----------------------
judgment creditor, attaching funds in the hands of a third party, not to release the
money attached until directed by the court to do so. It is a procedure by which ----------------------

Notes a customer’ balance at his bank may be made available to satisfy his creditors
who have obtained a judgment against him. With the issuance of the garnishee
---------------------- order, the account of the said customer gets to be inoperative even as regards
cheques put into circulation before the date of the order.
----------------------
The following points need to be kept in mind while discussing garnishee
---------------------- proceedings:
----------------------  A garnishee order served on a banker attaches the whole of the customer’s
balance in the current account, irrespective of the amount of the judgment
---------------------- debt. The banker cannot make payment out of the account until the order
has been settled and the order withdrawn.
----------------------
 The garnishee proceedings affect only the debts actually due i.e. already
---------------------- incurred but payable at a definite future date, at the time of the order. The
order does not affect future debts.
----------------------
 The usual practice of bankers is, immediately on receipt of such an order,
---------------------- to inform the customer and to open a fresh account through which all future
---------------------- transactions should be done.
 The most powerful condition for the operation of the garnishee order is that
---------------------- the customer’s account must be in credit and it should belong to him in his
---------------------- own right. The account is to be regarded in credit if the balance is in the
customer’s favour.
----------------------  A garnishee order is issued in two stages:
---------------------- – When a creditor applies to the court for starting garnishee proceedings
against his debtor’s banker, the court would first issue the order nisi. It
----------------------
will call upon the bank to show cause as to why the balance in the said
---------------------- account should not be utilized for satisfying the claims of the petitioner.
It is a preliminary order asking the garnishee may appear before the
---------------------- court at a particular date and time and raise objections, if any.
---------------------- – If the banker does not appear or appears but does not take objections,
the court issues the final order called order absolute. The banker should
---------------------- not make any payment to the judgment creditor in the interval, till the
order nisi is made order absolute.
----------------------
 The money paid in after the service of the garnishee order nisi is not attatched
---------------------- and the bank is not bound to hand it over to the judgment creditor.
----------------------  A fixed deposit can also be attatched in as much as it is a present debt payable
at a future date.
----------------------
 Before paying the balance to the judgment creditor or into court, the banker
---------------------- is entitled to deduct from the balance any debts and charges due to him from
the customer which existed at the date of the order.
----------------------
The rule is that the debt garnishee must belong to the judgment debtor alone.
---------------------- A garnishee order cannot be issued in the following cases:-
----------------------  If the judgment debtor holds funds in trust or as an executor and the banker
is aware of this position, then the account cannot be attached.
 If the judgment debtor maintains the account jointly with other person or Notes
persons, it cannot attached by the garnishee order.
----------------------
The garnishee order is not applicable in the following cases too:
 The garnishee order does not apply to the amount of cheques, drafts, etc. ----------------------
sent for collection by the customer that remains uncleared at the time of the
----------------------
receipt of the order.
 It also does not attach the amounts deposited into the customers’ account ----------------------
after the order has been served.
----------------------
 The garnishee order is also not effective on the payments already made by
the banker before the order is served upon him. ----------------------
 The garnishee order does not apply to the money held abroad by the judgment ----------------------
debtor and securities held in the safe custody of the banker.
----------------------
5.7 TERMINATION OF RELATIONSHIP ----------------------
The relationship of a banker and customer may be terminated in any of the ----------------------
following ways:
----------------------
 On mutual agreement between the banker and the customer. The balance
at the credit of the customer will have to be paid off and overdraft if any ----------------------
cleared.
----------------------
 The banker can issue a notice to the customer. No such notice is necessary in
case of current account. The banker cannot close the account without giving ----------------------
reasonable notice. The length of such notice will depend on the character
of the account and the circumstances of the case. ----------------------
 The death of the customer is an obvious way in which the relationship ----------------------
will be terminated. A notice of death revokes the banker’s authority to pay
----------------------
cheques.
 The lunacy of a customer automatically terminates the relationship. Here ----------------------
too, the banker’s authority to pay cheques is revoked by notice of insanity.
----------------------
 Bankruptcy or winding is a sufficient ground for the termination of
relationship. ----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------

1. What is the very base of the relation between the banker and customer?
----------------------
i. Contract of debt
----------------------
ii. Contract of Deposit
---------------------- iii. Agreement between bank and customer
---------------------- iv. Contract between bank and customer
----------------------
---------------------- 2. The relationship as trustee and beneficiary between a banker and

customer depends upon
----------------------
i. Discretion of the banker
----------------------
ii. Discretion of the customer
---------------------- iii. Specific instructions given by the latter
---------------------- iv. Specific instructions given by the former
---------------------- 3. Banker’s lien, which enables him to dispose of the goods in due course
to adjust his dues where the customer makes a default in payment, is
---------------------- called:
---------------------- i. Implied pledge
---------------------- ii. Implied guarantee
iii. Banker’s right
----------------------
iv. Customers obligation
----------------------
----------------------
Summary
----------------------
●● The relation between the banker and the customer is a very special
----------------------
relationship. It begins as soon as the first cheque is paid issued for payment
---------------------- and/or accepted for collection. A single transaction is the beginning of
the banker-customer relationship. The duration of this relation is not of
---------------------- importance. Once deposits are accepted by the bank, the bank accepts to
honour cheques upon the amount standing to his credit, irrespective of
----------------------
whether his connection or relation is long or short standing.
---------------------- ●● The banker customer relation has its peculiarities. In the creditor-debtor
relation, the banker is a dignified borrower. A banker is under no obligation
----------------------
to repay his customer’s deposits unless the customer has made such a
---------------------- demand. The customer has to make such a demand in a proper manner.

At the same time, the amount does not become due unless demanded by Notes
the customer.
●● The banker customer relationship is established by mutual agreement ----------------------
between both the parties. Likewise, the relationship can also be ----------------------
terminated. The termination can be voluntary on part of the customer as
well as the banker or it can be terminated by law, i.e. when the customer ----------------------
goes insolvent, insane or on the death of the customer.
----------------------
Keywords ----------------------
●● Customer of a Bank: There is (i) a recognizable course or habit of ----------------------

transactions/dealings between the customer and banker and (ii) the
connection or transaction relate to some banking business. ----------------------
●● Bailor-Bailee: When valuables such as jewellery, gold, stocks, bonds etc ----------------------
are deposited for safe-custody, the banker becomes the bailee and the
depositor the bailor ----------------------
●● Lien: “A right in one man to retain that which is in his possession ----------------------
belonging to another, until certain demands of the person in possession
are satisfied”. ----------------------
●● General Lien: A blanket term entitling the person in possession to retain ----------------------
the goods and securities until all his claims against the owner of goods
have been satisfied. ----------------------
●● Particular Lien: A specific right to retain goods and securities till all the ----------------------
charges in respect of those goods have been paid off
----------------------
●● Right to set-off: When a banker adjusts the debit balance in one account
against the credit balance in another account/s. ----------------------
●● Garnishee Order: A procedure by which a customer’ balance at his
----------------------
bank may be made available to satisfy his creditors who have obtained a
judgment against him. ----------------------
●● Garnishee: The debtor to whom a direction is given to pay the debt
----------------------
directly into the court and a warning is given not to pay the debt to the
creditor. ----------------------
●● Order nisi: A preliminary order asking the garnishee may appear before
the court at a particular date and time and raise objections, if any. ----------------------
●● Order absolute: The final order issued by the court when the banker ----------------------
appears but does not take objections on the preliminary order
----------------------
1. What is meant by the customer of a bank? ----------------------

2. Discuss the conditions necessary to constitute a customer of a bank? ----------------------
3. What are the peculiarities of the banker-customer relationship? ----------------------

Notes 4. State and explain the various relations between banker and customer as a
debtor and a creditor.
----------------------
5. How does a banker act as (i) an agent and as (ii) a trustee?
---------------------- 6. “Banker’s Lien is an implied pledge”. Discuss.
---------------------- 7. “A Banker is bound to honour his customer’s cheques”. Discuss
---------------------- 8. Explain the rights of a banker.

9. Write a note on the disclosures permitted by bankers’ practices and usage.
----------------------
10. What is meant by Banker’s Lien? Bring out the difference between general
---------------------- lien and particular lien.
---------------------- 11. Explain “Garnishee Order”. What are the features of a garnishee order?
12. Write a note on ‘Termination of relationship’ between the banker and
----------------------
customer.
----------------------
----------------------
----------------------
----------------------
1. What is the very base of the relation between the banker and customer?
---------------------- i. Contract of debt
---------------------- 2. The relationship as trustee and beneficiary between a banker and customer
depends upon
----------------------
iii. Specific instructions given by the latter
----------------------
3. Banker’s lien, which enables him to dispose of the goods in due course to
---------------------- adjust his dues where the customer makes a default in payment, is called:
i. Implied pledge
----------------------

----------------------
---------------------- 4. Dharmadhikari, Mrs. Vandana. Banking Horizon. New Bharat Printers.

----------------------
----------------------
----------------------

Securities Against Advances and Secured Advances -
Modes of Creating Charge UNIT
Structure:
6.1 Introduction
6
6.2 General Principles of Secured Advances
6.3 Precautions to be taken by the banker while advancing against various
securities
6.4 Lien
6.5 Pledge
6.6 Hypothecation
6.7 Assignment
6.8 Mortgage
6.9 Differences between Legal Mortgage and Equitable Mortgage
Summary
Key words
Suggested Reading
Securities Against Advances and Secured Advances - Modes of Creating Charge 97

Notes
Objectives
----------------------
• Explain the need for a security against advances
----------------------
• Describe the features of a good security
----------------------
• Identify the different types of securities accepted by a banker
---------------------- • Discuss the characteristics of securities and risks involved
---------------------- • Enumerate the precautions to be taken by a banker while accepting securities
against advances
---------------------- • Explain the concept and detail out various modes of creating charge
---------------------- • Differentiate between pledge and mortgage and pledge and hypothecation
----------------------
----------------------
6.1 INTRODUCTION
----------------------
One of the most important functions of a bank is to advance money to
---------------------- its borrowers. The strength of a bank depends on the quality of its loans and
advances and their proportion to the total deposits. An important consideration
----------------------
of the banking business is the repayment of loans and the chance of getting the
---------------------- money back. The banker therefore cannot rely on the obligation of the borrower
alone. A banker therefore obtains a tangible security from the borrower. The
---------------------- banker can obtain repayment on disposing off the security in case the borrower
is unable to meet his obligations.
----------------------
Securities can be classified as under
----------------------
 Personal security- a personal right of action against the customer or the third
---------------------- party;
----------------------  Impersonal security- security to be realized through a sale or a transfer;

 Direct security- security deposited by a customer himself;
----------------------
 Indirect(third party) security- security deposited by another person;
----------------------
 Continuing security- the secured advance would be decreased by subsequent
---------------------- payment into the account and all payment to the customer will form new
advances, unsecured by the aforementioned security.
----------------------
Advances therefore can be stated as
---------------------- (a) Secured Advances and
---------------------- (b) Unsecured Advances. Unsecured advance is also termed as Clean Credit.
Unsecured advances form a small part of total advances.
----------------------
Advances are cover and supported by tangible securities/assets. However,
---------------------- it is important that a charge is created over them in favour of the banker. The

security has to be accompanied by the registration of a charge without which it Notes
would have no meaning.
----------------------
A charge is a right over some tangible asset of the borrower. It is legal
transaction; on creating a charge the lender acquires certain rights on the securities ----------------------
offered. The borrower is refrained from dealing with these securities as specified
----------------------
and as long as they remain as securities.
----------------------
The different modes by which a security is created in favour of a banker are
the following: Lien, Pledge, Mortgage and Hypothecation. ----------------------
----------------------
6.2 GENERAL PRINCIPLES OF SECURED ADVANCES
----------------------
1) Reasonable Margin: A banker should not lend equal to the full value of
the security. He must keep a margin i.e. a gap between the value of the ----------------------
security and the amount of loan. This is to guard against possible fluctuations ----------------------
in prices, shortage and depreciation, for interest or over withdrawals, etc.
There has to be some margin in order to cover cost of realizing the assets ----------------------
and interest accumulated in case the customer defaults.
----------------------
2) Basic characteristics of the Security: The banker will not entirely depend
on a margin for their protection. The banker will insist on a security of a ----------------------
satisfactory character. For the securities to be meaningful, the banker looks
for certain basic characteristics which are represented by the expression. ----------------------
“MAST”- Marketable, Ascertainable of value, Stable in prices and ----------------------
Transferable easily and inexpensively. These features add liquidity to the loan
as the banker cannot afford to waste time and money liquidating securities ----------------------
in case of default.
----------------------
3) Documentation: A task of practical importance under secured advances is
the execution of legal documents. There are no hard and fast rules about the ----------------------
documents to be taken; each bank has its won set of form/formalities. There
----------------------
is a general agreement on fundamentals. These documents should preferably
be in writing though not legally necessary. In case of any disagreement, the ----------------------
banker would always refer to the terms and conditions mentioned in the
agreement. ----------------------
4) Continuing Security: The banker must obtain a continuing security and not ----------------------
a specific security. Under continuing security, the memorandum creating a
charge on the assets of the borrower is so worded that it covers all existing ----------------------
as well as future debts.
----------------------
5) Integrity: The banker should always lend against the customers and not
against the security. It is the business integrity of the borrower that is very ----------------------
important to the banker. The banker has to enquire into the financial history
----------------------
of the borrower – overall character, business integrity, past track records of
financial accommodation with the bank or other banks, etc. ----------------------
----------------------

Notes 6) Diversification: The loan portfolio of the banker should be well-spread over
different regions, sectors, purposes, industries, businesses, borrowers, etc.
----------------------
----------------------
6.3 PRECAUTIONS TO BE TAKEN BY THE BANKER
WHILE ADVANCING AGAINST VARIOUS
----------------------
SECURITIES
----------------------
Advances against Goods
----------------------
Goods are movable and have been defined in the Indian Sale of Goods
---------------------- Act, 1930 as, “every kind of movable property other than actionable claims
and money and includes stocks and shares, growing crops, grass and things
---------------------- attached to or forming part of the land which are agreed to be severed before
sales or under the contract of sale”. It is a wide term; it even includes within
----------------------
its purview intangible articles like health, skill, etc.
---------------------- Advantages
---------------------- 1. Marketability of goods – There is a good market for goods, for instance,
foodgrain market, cloth markets, steel markets, etc. The value of goods is
---------------------- easily ascertainable on a day-to-day basis without any difficulty. Certain
goods may command an international market too.
----------------------
2. Relative Price Stability – Prices of goods are subject to changes, however,
---------------------- certain goods such as foodgrains, industrial raw material, etc. do not rise
---------------------- or fall to abnormal levels. In recent times, prices of goods have shown an
uptrend due to shortages as well as inflation.
---------------------- 3. Ready Market- Self-liquidating – Goods can be sold/ disposed without
---------------------- much difficulty due to a ready market. The banker need not hold on to
goods in an attempt to get a good deal when he has to dispose of the goods
---------------------- to realize his loan.
---------------------- 4. Easy repayment / recovery - In case of default on part of the borrower, the
loan can be easily realized by the sale of goods without any delay.
----------------------
5. Dependability – With the above advantages, goods are a dependable security.
---------------------- Goods are generally pledged with the banker; hence the banker can dispose
of the goods and realize his dues in case of default.
----------------------
6. Advances for short periods – Goods can be classified into different
---------------------- categories – natural produce and industrial produce; perishable and durable;
foodstuff and related goods (oil seeds, spices, tea, etc); minerals, fibres, etc.
---------------------- While accepting different type of goods, the banker has to keep in mind
the characteristics and classification of goods. Therefore, advances against
----------------------
goods are for shorter periods.
---------------------- Disadvantages
---------------------- 1. Risk of Frauds - There is risk of fraud about the quantity as well as the
quality of goods accepted as security.
----------------------

2. Risks of Deterioration of goods - Different types of goods are accepted as Notes
security against advances. There is a risk of deterioration of goods.
----------------------
3. Fluctuation in value - There are high fluctuations in the value of certain
goods, especially agricultural produce. ----------------------
4. Basic qualities/ Nature of commodities- Certain basic characteristics of
----------------------
goods may prove to be a disadvantage when goods are accepted as security
against advances –for instance, perishable, seasonal, fashionable, raw ----------------------
material, intermediate, etc.
----------------------
5. Transport & Storage of goods - Goods are bulky and cannot be handled
easily by the banker. There are transport and storage expenses that are to ----------------------
be borne by the banker.
----------------------
6. Cost of holding goods as security - The cost of holding goods as security
is quite high due to transport, storage, insurance, maintenance, etc. ----------------------
Precautions ----------------------
1. The integrity of the borrower is very important.
----------------------
2. It is important to know the purpose for which the loan is being taken.
----------------------
3. There is a need to ascertain the title of the borrower to goods.
4. It is necessary to study the price trends of goods accepted as security in ----------------------
the market. It is important for the banker to have knowledge of different
----------------------
markets.
5. Banker has to incur the cost involved in accepting goods as security- transport ----------------------
& storage costs, maintenance and care, etc ----------------------
6. It is the responsibility of the banker as Pledgee to get an insurance of the
goods accepted as security. ----------------------
7. The banker has to carry out periodic inspection and regular revaluation of ----------------------
goods accepted as security.
----------------------
8. Margins are to be maintained when accepting goods as a security. These
margins are prescribed by the Reserve Bank of India (Central bank) against ----------------------
such advances. In India, high margins are prescribed for agricultural goods
----------------------
especially as there is often a tendency to hoard goods to create scarcity of
goods and leading to a price rise situation. ----------------------
9. Creating of Charge- Pledge / Hypothecation. The banker must create a
----------------------
charge over the goods either a pledge or hypothecation. In case of pledge,
the goods are to be handed over to the banker and the banker is entitled to ----------------------
sell the goods on default.
----------------------
10. Supervision regarding release of goods. Any release of goods on request
of the borrower or on part payment of the loan should be done carefully by ----------------------
the banker.
----------------------
----------------------
Notes Advances against Documents of Title to Goods
A document of title of goods is a symbol of goods. Advances against
----------------------
the security of documents are often referred to as ‘Documentary Credits’.
---------------------- Documentary Credits are more often used in financing foreign trade, it may as
well be used for domestic trade. The delivery of such document, if endorsed, is
---------------------- equivalent to delivery of goods themselves. E.g. Postal receipts, Railway receipts,
Bill of Lading, Airway bill, Warehousing receipt, Dock warrant, delivery order,
----------------------
etc.
---------------------- It is referred to as tangible security. In case of default, the banker can fall
back upon the goods which are represented by documents. It is convenient as
----------------------
the banker does not have to worry about the transport, storage, insurance and
---------------------- care of such goods.
U/s 2(4) of the Indian Sale of Goods Act, 1930, documents of title to goods
----------------------
mention the following: a bill of lading, dock warrant, warehousing receipt/
---------------------- certificate, wharfingers’ certificate, railway receipt and a warrant or order for
the delivery of goods.
----------------------
Risks
---------------------- 1. Difficulty in identification of goods – The goods are not in possession
---------------------- of the borrower while he provides the same as security against advances.
Hence, it is difficult to identify the goods and make an assessment of the
---------------------- details mentioned on the document of title of goods provided.
---------------------- 2. Vulnerability to Frauds - The documents are considered prima facie

evidence of the goods that are delivered for transportation or for
----------------------
3. Absence of Negotiability - The documents of title to goods are not negotiable
---------------------- instruments. As a result, the transferee does not receive a better title than
the transferor.
----------------------
4. Wrongful Delivery - Though the documents of title to goods are in
---------------------- possession of the banker, the borrower may receive goods from the concerned
authorized, for instance, the railways or the warehouse, on furnishing a
---------------------- indemnity bond. The banker may be left in an helpless position.
---------------------- Precautions
---------------------- 1. The foremost consideration while granting advances against documents is to

ascertain the integrity of the customer. The customer/ party is one of trust,
---------------------- repute and reliable. The experience of the customer in his trade should also
be taken into account.
----------------------
2. There is a need to obtain a certificate from some reputed firm/packer about
---------------------- the contents of the goods. The document of title to goods does not ensure/
guarantee quality and value of goods.
----------------------
3. There is a need to find out the genuineness of the documents of title to goods.
----------------------
4. There is a need to differentiable between documents of title to goods and
---------------------- mere receipts.

5. The banker should avoid goods with any objectionable remarks on them. Notes
6. Care should be taken to see that the documents contain no onerous clause
----------------------
which make the document unfit to be a security. E.g. Broken packages
7. The banker should get the ‘documents’ endorsed in blank. ----------------------
8. The goods must be checked for insurance. ----------------------
9. The banker has to create a Charge over such documents. ----------------------
10. A proper Registration required in the name of the Banker.
----------------------
Bill of Lading- The banker should check that freight is already paid by the
consignee. The captain has a right of lien over goods in case of non-payment of ----------------------
freight/other charges
----------------------
Warehousing receipt- The warehouse should be a licensed one. An
undertaking from the borrower should be taken that he will not take delivery of ----------------------
the goods by furnishing an indemnity or otherwise. Strict instruction should be
----------------------
given to the warehouse not to release goods without the permission of the banker.
Railway receipt- The dates of the railway receipt should be seen to ensure ----------------------
that there is no undue time lag between the dispatch of the goods and the
----------------------
negotiation of the relative bill accompanied by the railway receipts. If the bill is
late, the banker should investigate the reason for tendering the bill late and satisfy ----------------------
itself to the same. Advances should be granted against freight paid; otherwise
the banker will have to pay the same. ----------------------
Advances against Real Estate ----------------------
The term ‘real estate’ refers to all types of immovable properties. It may ----------------------
be attached to land or unattached to land or forming a part of land. It includes
tangible assets such as land, buildings, plant, equipment, machinery attached to ----------------------
land, etc. Bankers have been generally averse in accepting real estate as security,
as it is considered to be a right type of security with complications and difficulties. ----------------------
Difficulties /Risks ----------------------

1. Ascertaining the title of the borrower – The main difficulty in real estate ----------------------
is the ascertainment of title and the establishment of the borrowers’ interest
in the property offered as security. It is also important to find out that the ----------------------
property is unencumbered i.e. no prior charge exists on the property offered
----------------------
as security. Bankers have to appoint solicitors to examine the documents of
title to property to ascertain the borrowers’ right to the property mortgaged. ----------------------
2. Valuation is extremely difficult - The valuation of property is another
----------------------
difficulty faced by the banker. The banker, while accepting property as
security is naturally interested in the realizable value of the property and not ----------------------
the book value or its cost of construction. Bankers will have to take expert
help such as valuers or brokers to value the property. ----------------------
3. Difficulty in ready realization of the security - In case of default, the banker ----------------------
will be required to sell off the property and realize his dues. Disposing off
property is an uphill task, it is time consuming and tedious. At the same ----------------------
Notes time, the banker does not really have the time to wait for the best price on
that property. Real estate is considered to be the most illiquid among all
---------------------- securities.
---------------------- 4. Advances for a long period - Generally, advances against real estate is for
a long duration. The banker finds that his investments/capital in locked in
---------------------- for long periods.
---------------------- 5. Legal Bars - The laws governing property especially land, restrict transfer
and sale. Hindu and Muslim laws in India impose many conditions on
---------------------- Succession and transfer of property.
---------------------- 6. Legal formalities – Acceptance of real estate in any form as security
requires the preparation of Mortgage Deed, its registration, etc. There are
---------------------- also expenses to be borne in the form of stamp duty, registration fee, etc.
---------------------- Precautions
---------------------- 1. Financial soundness of the borrower - It is important to scrutinize the

financial soundness of the borrower. The banker should be satisfied about
---------------------- the capacity and competence of the borrower to return the borrowed money
from his own resources. Though the banker has the mortgaged property to
---------------------- rely on in case of default, the banker would always like to avoid the situation.
---------------------- 2. Valuation of property -It is important that the banker takes expert help
to ascertain the value of the property offered as security. Banker’s interest
---------------------- would be safe if the property can fetch a value good enough to cover the
---------------------- liability of the borrower. The value of real estate also depends upon the
ownership rights i.e. whether the property is freehold or leasehold. Real
---------------------- estate prices are very much influenced by the location of the property. The
market value of the property is also ascertained by capitalizing at the rental
---------------------- value of the property
---------------------- 3. Examining the title deeds - The banker has to first ascertain the title of the
property, check whether the documents of title relating to it are in proper
----------------------
order, that the property is free from any encumbrance and that all taxes,
---------------------- charges, fees are properly paid.
4. Free hold v/s Lease hold - It is important to consider the ownership rights
----------------------
of the property under consideration as security. A freehold is the absolute
---------------------- owner of the estate and he has the power to deal with it as he likes while a
lease hold is one where the freeholder grants an estate in his hand or a part
---------------------- of it to another person called a lessee for a term of years. The lessee is free
to deal with the property within the terms of lease.
----------------------
5. Margins - Reasonable margins have to be maintained by the banker while
---------------------- advances loans against real estate. The Reserve Bank of India also indicates
---------------------- of the margins to be maintained against different types of securities offered.
6. Verification of tax receipts - It is important that the banker verify the tax
---------------------- receipts for the payment of various local or municipal taxes against property.
----------------------

7. Maintenance & Repairs - The banker may have to incur expenses on Notes
maintenance and repairs of property.
----------------------
8. Insurance - The banker also have insure the property against all events
such as fires, theft, etc. The banker has to inform the insurance company; ----------------------
the banker has to assign it in his favour.
----------------------
9. First Mortgage - Though second and third mortgages are created, it is
always advisable for the banker to create a first charge on the property and ----------------------
take possession of the relevant title deeds.
----------------------
10. Creating a charge - In case of an equitable mortgage, it is advisable to get
a memorandum of deposit from the borrower, in addition to the deposit of ----------------------
the title deeds. It can help execute a legal mortgage in favour of the banker
in case of default. ----------------------
11. Power to sell - The mortgage should provide for an express power to sell ----------------------
without any reference to the Court of Law. It should be exercised only after
serving a notice in writing to the mortgagor to pay the principal sum within ----------------------
a stipulated period of time, for instance, three months. ----------------------
Advances against Fixed Deposit Receipts (FDRs)
----------------------
Fixed Deposits refer to the deposits repayable after a certain specified period
of time. In case where the depositor feels the need to withdraw the deposit before ----------------------
the maturity of the deposit, the banker can allow him to get back his deposit on
charging a penalty for premature withdrawal. Otherwise, the banker can sanction ----------------------
an advance against fixed deposit receipts. The banker can charge a higher rate ----------------------
of interest on the amount withdrawn and the depositor can benefit by retaining
the interest accrued which he would otherwise loose for premature withdrawal. ----------------------
Precautions ----------------------
1. Loan on FDRs of own bank/branch – The bank that accepts the fixed
----------------------
deposit receipt has a lien over its receipts, hence, banks do not accept receipts
of deposits held with other banks. ----------------------
2. Deposit receipt in borrower’s name – The documents are to be signed by
----------------------
the individual in whose name the fixed deposit receipt is held. In case of
joint FDRs, a all depositors must sign the receipts across a revenue stamp ----------------------
and also sign a memorandum of pledge.
----------------------
3. Advances against deposit receipts held in the name of a minor should be
discouraged. ----------------------
4. No advance against third party receipt. In case such a situation arises, duly ----------------------
discharged fixed deposit receipts should be obtained from the borrower
along with the letter of authority of the person to allow the bank to grant ----------------------
such a loan.
----------------------
5. Only loans are to be granted against FDRs, no overdrafts or cashcredit
facilities should be provided. ----------------------
6. The banker should check for any prior assignment of FDRs ----------------------
Notes 7. Proper margin and rate of interest as prescribed by Central Bank should
be applicable against advances against FDRs. The Reserve Bank of India
---------------------- prescribes margins and rate of interest on loans against FDRs.
---------------------- 8. A proper discharge of the deposit receipt should be obtained i.e. signature
of the depositor across a revenue stamp.
----------------------
9. The banker should make a note of lien against the FDRs.
---------------------- 10. The fixed deposit receipts should be compulsorily pledged with the banker.
Mere possession is not enough, the fixed deposit receipts should be assigned
----------------------
and duly discharged in favour of the banker.
---------------------- 11. Incase of repayment before maturity, the banker should cancel discharge
---------------------- and return FDR to borrower; in case of maturity of FDR, adjust loan amount
and refund balance.
---------------------- Advances against Supply Bills
---------------------- Businessmen who supply goods to government department/agencies on the
basis of previously submitted tender and contractors on partial or full completion
---------------------- of contract submit bills for the amount of goods supplied or the contract work done
---------------------- in accordance with the terms and condition of the contract. Such bills are referred
to as “Supply Bills’. These bills are passed for payment only after verification that
---------------------- goods supplied confirm to the terms of the contract. This procedure of verification
and passing bills takes a couple of months. It is during this period that the party
---------------------- may approach the bank for advances against such bills.
---------------------- Features
---------------------- 1. Supply bills are not negotiable instruments - They do not enjoy the legal
status of negotiable instruments.
----------------------
2. Supply bills represent a debt arising out of a bonafide supply of goods or
---------------------- contact completed.
---------------------- 3. They are endorsed for payment to the bank and have to be receipted with
revenue stamp.
---------------------- Risks
---------------------- 1. The security available to the banker is by way of assignment of debt
represented by supply bills. There is always a possibility of a counter-claim/
----------------------
set-off against the debt.
---------------------- 2. The payment of such bills is made by the government departments/agencies
after a long time because of procedural delays.
----------------------
3. The amount of payment may be reduced or refused if there is default in
---------------------- observing the terms of contract by the supplier/ contractor.
---------------------- 4. The debtor (the government) might pay the amount directly to the creditor
(Supplier) unless the assignment has been registered with the debtor.
----------------------
----------------------

Precautions Notes
1. Advances against supply bills to be granted to supplier/contractor who
----------------------
has a long experience in the business. These suppliers/contractors can be
government approved/authorized. ----------------------
2. The banker should thoroughly scrutinize the contract between the two parties,
----------------------
supplier and government.
3. The banker should ask the supplier/contractor to execute an irrevocable ----------------------
power of attorney in its favour, authorizing the banker to receive the amount
----------------------
of the bill. The power of attorney should be filed with the department to
which the supply bill is submitted. ----------------------
4. The banker should ask the supplier/contractor to give an undertaking to repay ----------------------
any amount received by the later directly from the government department
in respect of the bills entrusted with the banker. ----------------------
Advances against Gold & Silver Bullion ----------------------
Advances against gold are profitable and dangerous too. Banks were
prohibited from lending against such security under the Gold Control Act, 1968. ----------------------
These restrictions are now relaxed and banks are freely allowed to accept such ----------------------
a security.
----------------------
Advances against gold ornaments should not be encouraged. There is a
possibility of spurious materials being dishonestly mixed or at times, the right ----------------------
of the borrower to pledge them being contested. There is also the danger of the
loan becoming sticky and difficult to realization. ----------------------
Features ----------------------
1. The soundest form of security for bankers advances; it satisfies the cannons
----------------------
of safety and liquidity.
2. The supply of these precious metals is relatively scarce and hence the value ----------------------
is high. ----------------------
3. These metals enjoy universal marketability and steady prices.
----------------------
4. Most attractive feature of these metals is their portability i.e. large value in
small bulk. ----------------------
5. These metals are issued in standard weights and fineness. ----------------------
6. There is very high acceptability of these metals in any shape /form and that
----------------------
is why these metals are ranked as the most liquid asset.
7. These metals can be easily stored in the strong rooms of banks ----------------------
8. Verification and valuation is easy without any problems. ----------------------
Precautions ----------------------
1. It is important to make an assessment of the quality and quantity of the bars;
----------------------
bankers generally appoint a local jeweler as authorized jeweler.
----------------------
Notes 2. Valuation has to be done either on the basis of conventional price or current
market price.
----------------------
3. Loans are to be granted on the basis of the integrity of the customer.
---------------------- 4. The banker should verify whether the person who is taking pledge is the
absolute owner of the gold. The customer may be required to produce a
----------------------
certificate to this effect.
---------------------- 5. Margins to be maintained, generally a 25% margins to be maintained on
such a security.
----------------------
6. It is important and compulsory to create a pledge on such a security.
----------------------
7. A demand promissory note to be obtained from the borrower in addition to
---------------------- the ornaments pledged
---------------------- 8. On repayment of the loan, security pledged to be returned and an
acknowledgement to the effect to be obtained.
----------------------
Advances against Life Insurance Policies
---------------------- Insurance policy is a common form of a security against advances. Insurance
policy is a good security against advances on the basis of its surrender value.
----------------------
A life insurance policy is a contract between the insured and the insurer
---------------------- wherein the latter promises to pay a specified amount after the expiry of a certain
---------------------- period or on the occurrence of death of assured.
The other consideration is the ‘insurable interest’; the banker is to make
---------------------- sure that the policy was affected by the person himself on his own life. In case
---------------------- the policy is affected on another party, it is necessary to ascertain the insurable
interest. If there is no insurable interest, then the contract may become void.
---------------------- Advantages
---------------------- 1. Guaranteed Surrender value - An insurance policy has a guaranteed
surrender value. Surrender value is that value of the life policy which the
----------------------
insurer pays to the insured if the policy is surrendered or discontinued
---------------------- according to the terms of the policy. The surrender value is payable after
a minimum prescribed period has lapsed. The minimum surrender value
---------------------- happens to be a portion of the total amount of the premium paid. The banker
can safely grant a loan to the extent of the surrender value of the policy.
----------------------
This amount can be recovered by the banker in case the borrower defaults
---------------------- in repayment.
2. No depreciation in value - The amount realizable from an insurance policy
----------------------
is not subject to fluctuations. The surrender value is also a guaranteed sum
---------------------- which goes on increasing as more and more premiums are paid in the future.
3. Easy Documentation - The legal formalities for mortgaging life policies are
----------------------
few and simple. There are no complications involved such as investigation
---------------------- of title as with other deeds. The cost of supervision is also very low as the
policies remain with the banker.
----------------------

4. Easily realizable asset - A life insurance policy can be easily assigned to Notes
any person including a banker. The insurance company also duly registers
such an assignment with itself. If the borrower defaults in repayment of the ----------------------
loan, the banker can easily realize the amount on the insurance policy from
the insurance company. ----------------------
Disadvantages ----------------------
1. Insurable Interest - In case of insurance, it is necessary that there is ----------------------
insurable interest. In case of life insurance, it is necessary that such an
insurable interest is present at the time of the offer. Insurance interest is ----------------------
defined as a pecuniary or monetary interest in the life assured, i.e. the person
----------------------
securing the insurance policy will suffer monetary loss or hardship in the
absence of the person assured. The banker must ascertain whether insurable ----------------------
interest exists at the time the policy was issued.
----------------------
2. Disclosure of Facts - A contract of insurance is one of utmost good faith. It
is important that the would-be-insured discloses all the material facts within ----------------------
his knowledge that is likely to influence the judgment of a prudent insurer
in taking the risk and deciding the premium. Any concealment, negligence, ----------------------
misrepresentation or fraud entitles the insurer to cancel the contract and
----------------------
deprive the assured of the benefits of the insurance.
3. Age Admittance - The insurance company requires proof of age of the life ----------------------
assured as the amount of premium depends upon the age of the assured. ----------------------
The banker should see that the age has been admitted by the insurance
company and recorded the same on the policy document. If not done, the ----------------------
banker must insist upon the customer to do the same before accepting the
policy document as security against loan. ----------------------
4. Restrictions - The banker has to look for restrictions, if any, mentioned in ----------------------
the policy document. For instance, incase of the insurer coming suicide; in
case of murder of the insured, etc. the policy may become invalid and the ----------------------
amount will not be payable. In recent times, most policies have a suicide ----------------------
clause that states that in such an event, the rights of the third party acquired
by assignment for value will not be adversely affected. The insurer may also ----------------------
restrict the policy being offered as a security against loan.
----------------------
5. Non-payment of premiums - There is a danger that the policy holder does
not pay the insurance premiums in the near future. The policy lapses for ----------------------
non-payment and the banker himself may have to pay the unpaid premium
to keep the policy active. ----------------------
Precautions ----------------------
1. Admittance of age - the banker must check whether age admittance has been ----------------------
done on the policy document; if not done, the banker must insist upon the
customer to do the same before accepting the policy document as security ----------------------
against loan.
----------------------
2. Ascertain insurable interest - The banker must ascertain whether insurable
interest exists at the time the policy was issued. ----------------------
Notes 3. Type of Polices - There are several kinds of insurance policies to suit the
needs of different people: life policies, endowment policies, money-back
---------------------- policies multipurpose policies, etc. Money back polices are not welcome.
Policies in the name of a minor should not be accepted as a security.
----------------------
4. Study of policy for clauses, restrictions and conditionalities - The banker
---------------------- should carefully study the policy document for any clauses, restrictions or
conditions. For instance, suicide clause, restrictive clause, etc.
----------------------
5. Check any previous encumbrance - The banker should ascertain that the policy
---------------------- is without any previous encumbrance. Especially when the insured is raising a
loan on the duplicate copy of the life insurance policy, there is a danger that the
----------------------
original copy has been pledged elsewhere with some other lender.
---------------------- 6. Payment of premiums – The banker should secure a letter of declaration
from the customer that the policy is valid and that he shall be paying the
----------------------
premium regularly to keep the policy in force. The banker should ask for
---------------------- premium receipts on a regular basis for his own record. The banker can
also take standing instructions from the borrower to make payment of the
---------------------- premiums in order to keep the policy alive.
---------------------- 7. Ascertain the surrender value – The banker should ascertain the surrender
value of the policy from the insurance company before granting the loan.
---------------------- He should keep a reasonable margin on such surrender value.
---------------------- 8. Creation of charge- A simple deposit of policy does not constitute
assignment. The assured should assign the policy in favour of the banker on
---------------------- the policy document itself or on a separate stamped paper. The assignment
---------------------- has to be then registered with the insurance company.
9. Assignment- Equitable mortgage and registration of mortgage – The
---------------------- policy document is deposited with the banker with an undertaking stating
---------------------- the mortgagor’s promise to assign it to the banker on request. The insurance
company should be intimated about the creating of an equitable assignment
---------------------- on the policy.
---------------------- Advances against Stock Exchange Securities
The term ‘Stock Exchange Securities’ refers to those securities which are
----------------------
dealt with on the Stock Exchange. Stock Exchange securities include
---------------------- 1. Securities issued by the Central and State Governments
---------------------- 2. Semi-government securities such as municipal corporations, electricity
boards, etc
----------------------
3. Industrial securities- shares, debentures and bonds.
----------------------
Merits
---------------------- 1. Stock exchange securities are paper documents, referred to as tangible
security with easy marketability.
----------------------
2. The prices of stock do not fluctuate widely in normal times.
----------------------

3. The stock exchange provides for a ready market for the securities. Notes
4. These securities can be disposed off easily, quickly and conveniently.
----------------------
5. These securities yield income by way of interest or dividend; such income
can be used by the banker in the adjustment of dues. ----------------------
6. The title of the holder can be easily ascertained by the banker. ----------------------
7. The market prices of these securities can be easily ascertained by referring ----------------------
to the stock exchange data/ newspapers / periodicals, etc.
8. A transfer of title can be easily affected in the name of the banker. ----------------------
Demerits ----------------------
1. The Articles of Association of a company provides that the company will ----------------------
have a lien on its shares.
----------------------
2. In case of shares that are partly paid-up, the company may make calls for
payment of share capital. The shareholder loses his right over the shares if ----------------------
he fails to make such payment.
----------------------
3. The securities may be ‘non-negotiable’. In such a case, the banker cannot
get a title better than that of the transferor of such securities. ----------------------
Precautions ----------------------
1. The following factors should be considered in the selection of shares
----------------------
a. Nature of business of company
----------------------
b. Management of company
c. Financial history & performance of company ----------------------
d. Study of Balance Sheet of company ----------------------
e. Study of share prices of company over a period of time ----------------------
2. The following factors should be considered in the selection of securities
type ----------------------
a. Debenture over Shares ----------------------

b. Preference over Equity ----------------------
c. Shares of ‘Blue Chip’ companies ----------------------
d. Securities with safety rating
----------------------
3. The following factors should be considered in the valuation of securities
----------------------
a. Study of price quotes in stock markets, newspapers & financial
periodicals ----------------------
b. Dividend Income
----------------------
c. Risks involved
----------------------
4. While creating a charge over securities,
a. Check whether securities are bearer or order ----------------------
Notes b. By giving legal title- transfer to be registered in the books of the issuing
company OR
----------------------
c. By an equitable title- by depositing the security with the later without
---------------------- the registration of transfer
i. by memorandum of deposit or
----------------------
ii. by blank transfer
----------------------
5. It has to be ascertained whether the shares are partly-paid or fully-paid;
---------------------- generally partly-paid shares not to be accepted.
---------------------- 6. The banker should not provide advances against securities if the purpose is
to acquire a controlling interest in the company
---------------------- 7. The banker should grant no advances against its own shares.
---------------------- 8. The banker should check for any existing charge over securities.
---------------------- 9. It is important that the transferor sign on the share transfer form before the
banker to avoid any forgery of signature.
----------------------
10. Advances against shares of private companies are generally discouraged.
---------------------- 11. Banks have to exercise due caution and restraint in lending against shares.
---------------------- 12. Banks have to maintain adequate and proper margin as prescribed by RBI
from time to time while granting against shares.
----------------------
13. Banks have to exercise particular care and precaution while advances are
---------------------- sought against large blocks of shares.
---------------------- 14. Banks have to ensure that a single borrower or a group of borrowers do not
obtain large credit against share/debentures from different banks.
----------------------

----------------------
Fill in the blanks.
----------------------
1. Security, which is Marketable, Ascertainable of value, Stable in prices
---------------------- and Transferable easily and inexpensively is called _________
---------------------- 2. In case of security when the goods are to be handed over to the banker
and the banker is entitled to sell the goods on default is called _______
----------------------
3. Ownership of a property when a person is the absolute owner of the
---------------------- estate and he has the power to deal with it as he likes is called _______
----------------------
----------------------
----------------------
----------------------

Notes
Activity 1
----------------------
Examine the securities portfolio of a bank and write down what are the ----------------------
various kinds of securities accepted by the bank.
----------------------
----------------------
6.4 LIEN
----------------------
Lien is a right in one man to withhold that which is in his possession
belonging to another, until certain demands of the person in possession are ----------------------
satisfied. A lien is a claim/ authority exercised over the property of somebody
else. ----------------------
“A lien comes into existence when a person having the possession of ----------------------
another’s goods or securities is entitled to retain such possession until the owner
discharges a debt owing to him”. ----------------------
It is a right over property exercisable in respect of a debt and arises by ----------------------

implication and not by specific charge or agreement.
----------------------
This method of providing security does not arise from any express contract
between the parties; it is conferred by law. It arises from certain events and not ----------------------
from any express contract with the customer.
----------------------
It is a defensive right and cannot be enforced by a suit or by sale of the assets
over which the lien is claimed. The sole right which a holder of the lien enjoys ----------------------
is to hold back the goods till the dues are cleared. The borrower continues as
----------------------
owner but the lender has possession. The lender has no right to sell the property
and the borrower cannot get the property back until he pays his debt. Section ----------------------
171 of the Indian Contract Act confers the right of general lien on the banker;
hence Lien is often referred to as Banker’s Lien. The banker is empowered to ----------------------
retain all securities of the borrower/ customer, in respect of the general balance
----------------------
due to him by the borrower.
The peculiarities of a banker’s lien are: ----------------------
1. The banker possesses the right of general lien on all the goods and securities ----------------------
entrusted to him in his capacity as a banker, hence it is called as the Bankers
Lien. Bankers have a general lien on all securities deposited with them unless ----------------------
there is an express contract or circumstances that show an implied contract, ----------------------
inconsistent with lien.
2. Banker’s lien is an implied pledge which enables him to dispose of the ----------------------
goods in due course to adjust his dues. Where the customer makes a default ----------------------
in payment of the debt, the banker can straightway sell the goods on giving
reasonable notice of the sale. In other cases, the creditor has the right of ----------------------
retaining the things till the debt is repaid or the promise performed.
----------------------
----------------------
Notes Negative Lien
Negative lien is different from lien. Under the negative lien, the banker
----------------------
does not get the right to retain any asset of the borrower. The borrower gives
---------------------- a declaration to the banker that his assets mentioned therein are free from any
charge or encumbrance. It is an undertaking by the borrower that he shall not
---------------------- create any charge over them or dispose them off without the permission of the
banker. The banker on the other hand is not entitled to realize his dues from the
----------------------
said assets of the customer. By way of a negative lien, the banker’s interests are
---------------------- partly protected.
---------------------- 6.5 PLEDGE

----------------------
Pledge is the mortgage of movable property accompanied by delivery of
---------------------- possession. It is specie of hypothecation as also a specific kind of bailment where
the subject matter of the pledge is actually or constructively delivered by the
---------------------- pledgee. It occurs when goods are deposited by one person with another to be
held as security. The person who offers the security is known as the ‘pawnor’ or
----------------------
‘pledger’ and the bailee is called the ‘pawnee’ or ‘pledgee’.
---------------------- The essence of a pledge is that the possession of goods or assets passes to
the pledgee, while the legal ownership remains with the pledgor.
----------------------
Section 172 of the Indian Contract Act defines Pledge as “the bailment of
---------------------- goods as security for payment of a debt or performance of a promise is called
pledge”. The bailor/pledgor is the borrower and the bailee/pledgee is the lender-
----------------------
the bank in this case.
---------------------- In case of a pledge, there should be (i) bailment of goods and (ii) the objective
---------------------- of such bailment should be to hold the goods as security for the payment of a
debt or the performance of a promise.
---------------------- Features of a Pledge
---------------------- 1. Bailment of goods - It is the bailment of goods where the security given
is always some movable property-goods, negotiable instruments or other
---------------------- kinds of movable assets. As in other kinds of bailment, the basis here is
---------------------- delivery of goods i.e. transfer of possession by the borrower to the lender.
Delivery of goods is essential for a contract of bailment. The delivery may
---------------------- be either actual or constructive or symbolic. Physical transfer of goods from
the custody of the bailor to that of the bailee is not necessary. A constructive
---------------------- or symbolic delivery means ‘anything having the legal effect of putting
---------------------- the goods in possession of the bailee or any person authorized to do so”.
A pledge indicates the goods are to be kept under the lock and key by the
---------------------- lender.
---------------------- 2. Purpose of Security - The purpose for which goods are bailed in a pledge
is to secure the discharge of a liability or performance of a promise. An
---------------------- article delivered simply for safe custody or any other use will not constitute
a pledge.
----------------------

3. Transfer of ownership - The general property in goods i.e. the ownership Notes
remains with the pledgor. The right of retaining the goods for his security
is passed on to the lender until payment of the debt ----------------------
4. Return of Goods - It is essential that the bailee returns the same goods to ----------------------
the bailor after the purpose for which the goods were delivered is fulfilled
or disposes them off according to the instructions of the bailor. ----------------------
Who can pledge goods? ----------------------
Goods can be pledged by any one who is in legal possession of the same.
----------------------
1. The owner of the goods himself;
----------------------
2. The mercantile agent with the consent of the owner who is in possession of
the goods/documents of title to goods; ----------------------
3. Joint owner with the consent of co-owners ----------------------
4. A person who has obtained possession of goods by fraud, misrepresentation,
----------------------
coercion or undue influence under two conditions (i) the contract has not been
rescinded before he enters into the contract of pledge and (ii) the pledgee ----------------------
acts in good faith and without notice of the defective title of the pledgor.
----------------------
5. A seller who is in possession of the goods or documents of title to goods
even after the sale where the buyer has left them, if (i) the pledgee acted in ----------------------
good faith and (ii) the pledgee had no notice of sale of goods to the buyer.
----------------------
6. A pledgee of the goods to the extent he himself has interest in them.
Rights of a Banker as a Pledgee ----------------------
1. File a suit and retain goods - If the pledgor makes default in payment of ----------------------
the debt or the performance of the promise at the stipulated time, the banker
may bring a suit against the pledgor and retain the goods pledged as security. ----------------------
This right of the banker to retain the goods pledged is available not only for ----------------------
payment of the debt or performance of a promise, but also for interest due
on the debt and all necessary expenses incurred by the banker on the goods. ----------------------
2. Sell goods in possession - The banker has the right to sell the goods pledged ----------------------
with him (i) if the borrower fails to redeem his debt within the time fixed
or (ii) where no time is fixed after the expiry of the time within which he is ----------------------
required to repay by a notice given by the banker fixing a reasonable time
----------------------
within which he is required to pay. If the proceeds of such a sale are less
than the amount due, the borrower is still liable to pay the balance. If the ----------------------
proceeds of the sale are greater than the amount due, the pledgee will have
to pay over the surplus to the pledgor. ----------------------
3. Receive extraordinary expenses - The banker is entitled to receive from ----------------------
the pledgor extraordinary expenses incurred by him for the preservation of
the goods pledged. ----------------------
Duties of a Banker as a Pledgee ----------------------
1. Take good care - The pledgee is bound to take as much care of the ----------------------
Notes goods pledged to him as a man of ordinary prudence would under similar
circumstances take care of his own goods of the same bulk, quality and
---------------------- value of the goods bailed.
---------------------- 2. Return goods - The pledgee is bound to return, deliver or tender the goods
pledged on payment of debt/performance of promise. If he fails to do so,
---------------------- he is responsible to the pledgor for any loss, destruction or deterioration of
the goods from that time.
----------------------
3. Compensate for loss - The pledgee is under obligation to compensate for
---------------------- the loss of the pledgor if the loss is caused due to some act not authorized
by the contract of pledge.
----------------------
4. Use of goods - The pledgee is bound to use the goods according to agreement
---------------------- between the two parties. If he contravenes any of the conditions of the pledge,
the contract could be voidable at the option of the pledgor.
----------------------
5. Return the profits - The pledgee is also bound to deliver to the pledgor
---------------------- any increase of profit which may have accured from the goods pledged.
----------------------
6.6 HYPOTHECATION
----------------------
Hypothecation is a mode of creating a charge over movable property/goods
---------------------- without the surrender of possession of ownership. It may be noted that neither
the Transfer of Property Act, 1882 nor the Indian Contract Act deals with the
----------------------
concept of hypothecation of moveable property. However, it is valid and has been
---------------------- recognized by the Indian Law. No particular formality is necessary for creating
hypothecation of moveable property in India.
----------------------
 Hypothecation is a mortgage of moveable property without delivery of
---------------------- possession of the goods / assets.
----------------------  A charge is given on property or goods for the amount of the debt, the owner
retaining the ownership of the goods/assets as well as the possession.
----------------------  Here, the security is granted by means of a letter of hypothecation or also
---------------------- referred to as a letter of lien.
 It is a legal transaction wherein movables are made available as security for
----------------------
a debt without transferring either their ownership or possession.
----------------------  The charge created is equitable i.e. not by any express enactment but by
equity and reason.
----------------------
 It is a floating charge on the borrower’s assets, present as well as future.
----------------------
 Hypothecation is considered to be an extended idea of pledge. The creditor
---------------------- permits the debtor to retain possession of the goods/ assets either on behalf
of or in trust for himself.
----------------------
 The property is said to be hypothecated when the possession is not transferred
---------------------- to the lender; a mere charge is given on property retained by the owner.
On the other hand, Pledge is said to be incomplete without the transfer and
---------------------- possession of the goods/assets to the creditor.

 It is a very convenient mode of creating a charge over the movable assets Notes
since neither there is transference of ownership not the possession.
----------------------
 The position of a banker under in hypothecation is not considered to be very
safe. It is rather precarious. Great care and caution have to be exercised in ----------------------
accepting hypothecation as a charge.
----------------------
 Hypothecation facility is also called an ‘Open Loan Facility’. It is a
convenient method of borrowing for some concerns. For instance, ----------------------
manufacturing concern cannot pledge its raw materials required for day-to-
day production, instead it can hypothecate them. The company can continue ----------------------
its production and avail of a credit facility. Being only an equitable charge
----------------------
on movable property without possession, hypothecation facility is risky as
clean advances. ----------------------
The banker should observe the following precautions while creating a charge
----------------------
via the hypothecation mode:
a) Such facilities are granted only to those parties with financial stability and ----------------------
integrity.
----------------------
b) Periodical inspection of the goods hypothecated is necessary
c) The banker must ascertain that specific goods are hypothecated. ----------------------
d) Insurance of goods must be insisted upon. ----------------------
e) An undertaking should be taken from the borrower that he would not borrow
elsewhere. ----------------------
f) A board stating the hypothecation of goods to the bank should be placed on ----------------------
the goods.
----------------------
6.7 ASSIGNMENT ----------------------
Assignment is another mode of creating charge over securities offered to ----------------------
the lender/banker.
----------------------
 Assignment means transfer of a right, property or a debt, existing as well
as future. ----------------------
 The borrower may assign any of his rights, property or debts to the lender/ ----------------------
banker to secure a loan from the latter.
----------------------
 The transferor is caller the ‘assignor’ and the transferee as the ‘assignee’
 The borrower generally assigns the ‘actionable claims’1 to the banker. ----------------------
Section 130 of the Transfer of Property Act, 1882 permits such assignment ----------------------
to anyone except in certain cases- a judge, a lawyer or an officer of the Court
of Justice. ----------------------
 In the business of banking, the following may be assigned by the borrower ----------------------
to the banker (i) the book debts (ii) money due from the government
organizations or semi-government bodies and (iii) life insurance policies ----------------------
 Assignment may be either (i) a legal assignment or (ii) an equitable ----------------------
Notes assignment.
– A legal assignment is an absolute transfer of actionable claim and must
----------------------
be in writing, signed by the assignor.
---------------------- – The assignor informs his debtor (for instance, the insurance company
---------------------- when insurance polices are assigned) also in writing intimating the
assignee’s name and address.
----------------------
– The assignee also serves a notice on the debtor of the assignor and
---------------------- seeks a confirmation of the balance so assigned.
----------------------  If all these requirements are not fulfilled, the assignment is called an equitable
assignment.
----------------------
6.8 MORTGAGE
----------------------
When a borrower offers immovable property such as land, buildings, etc
----------------------
as security against advances, the charge created is by means of a mortgage. The
---------------------- term mortgage is composed of two French words ‘mort’ meaning death or dead
and ‘gage’ meaning pledge. It conveys the idea of a pledge of some real estate
---------------------- as security for the payment of debt or discharge of some other obligation.
---------------------- Section 58 pf the Transfer of Property Act, 1882 defines the term mortgage
as “the transfer of an interest in specific immovable property for the purpose of
----------------------
securing the payment of money advanced or to be advanced by way of loan, an
---------------------- existing or future debt or the performance of an engagement which may give
rise to a pecuniary liability.
----------------------
The borrower who raises funds against some immovable property is called
---------------------- the mortgagor and the lender who so makes available the funds the mortgagee.
It is a conveyance of an interest in property as security for the payment of a debt
----------------------
or for discharge of some other obligation.
---------------------- Features of a Mortgage
---------------------- 1. Conveyance of an interest in the property. This is the all important
attribute of a mortgage charge. It is transfer of an interest in the specific
---------------------- immovable property. The owner transfers some interests of the property on
---------------------- to the mortgagee while the remaining are still being retained by the owner.
2. Specific property. The immovable property being mortgaged must be
---------------------- specific, i.e. it should be one which could be clearly identified and described
---------------------- by its location, size, boundaries, etc.
3. Secure Debt Performance. The object of a mortgage must be to (a) secure a
---------------------- debt or (b) secure the performance of an obligation of a monetary character.
---------------------- The property thus may be mortgaged to provide security to the creditor in
respect of loans already taken by the mortgagor. If the purpose is something
---------------------- else then as the transfer of a property in discharge of a debt, it will not
constitute a mortgage.
----------------------

4. Sale of Property. Subject to the provisions of the Transfer of property Act, 1882 Notes
and the terms of the mortgage deed, the mortgagee gets the right to recover the
amount of the loan out of the sale proceeds of the mortgaged property. ----------------------
5. Re-conveyance of property. The interest in the property mortgaged is re- ----------------------
conveyed to the owner on his paying the debt or performing the engagement
agreed upon. ----------------------
6. Each owner. Where an immovable property is owned by more than one ----------------------
owner, each of the co-owners is entitled to mortgage his share in the property.
----------------------
Forms of Mortgage
1. Simple Mortgage ----------------------
– Here, the mortgagor binds himself personally to pay the mortgage ----------------------
money. He remains in the possession of the mortgaged property.
----------------------
– In the event of his failing to pay according to the contract, the mortgagor
gives an undertaking, expressly or impliedly that the mortgagee shall ----------------------
have a right to cause the property to be sold. The proceeds of sale are
to be applied in payment of the mortgage money. ----------------------
– Under simple mortgage there is a personal obligation of the mortgagor ----------------------

to pay the debt.
----------------------
– The mortgagee acquires (i) the right to sell the property only on applying
to the court or (ii) to file a suit for recovery of the whole amount without ----------------------
the sale of the property.
----------------------
2. Mortgage by conditional sale
----------------------
– Here, the mortgagor sells the mortgaged property to the mortgagee
under any one of the following conditions: ----------------------
(i) that on default of payment of the mortgage money on a certain ----------------------
date, the sale shall become absolute;
----------------------
(ii) that on such payment being made, the sale shall become void or
(iii) that on such payment being made, the mortgagee shall re-transfer ----------------------
the mortgaged property to the mortgagor.
----------------------
The above three conditions imply the same thing i.e. the mortgaged property
shall be treated to be sold on default of payment of the mortgaged money. ----------------------
– The sale and ownership of the mortgagee is qualified and becomes ----------------------
absolute only in the event the mortgagor fails to carry out his
commitment. ----------------------
– Mortgage by conditional sale differs from conditional sale. In case of ----------------------

a conditional sale, the sale stands cancelled if the purchaser demands
back the sale price within a specified period of time while in case of ----------------------
mortgage by conditional sale, the right tot claim back the property rests ----------------------
with the mortgager. The mortgagee has the right to foreclosure, i.e. the
mortgager loses his right to redeem his mortgaged property in case of ----------------------
Notes non-payment of the mortgaged money. He can exercise this right with
the permission from the court.
----------------------
3. Usufructuary Mortgage
---------------------- – The mortgagor here delivers or agrees to deliver the possession of the
mortgaged property to the mortgagee.
----------------------
– The mortgagee is authorized to retain his possession over the property
---------------------- until the payment of the mortgage money is made.
---------------------- – He further authorizes the mortgagee to retain the possession, collect the
usufruct, i.e. the rents and profits accruing therefrom and appropriate
---------------------- such rents and profits towards the payment of the principal money and
---------------------- interest owing on the mortgage debt until payment of the mortgage
money.
---------------------- – A chief feature of usufructuary mortgage is the transfer of the possession
---------------------- over the mortgaged property to the mortagagee, who is entitled to
receive rent or profits and appropriate the same in the repayment of
---------------------- mortgage money and interest thereon. It reduces the liability of the
mortgagor.
----------------------
– The mortgaged is said to be placed in a disadvantaged position in case of
---------------------- usufructuary mortgage. This is so because the mortgagor does not bind
himself personally to repay the mortgage money; no suit can be filed
---------------------- against him and there is no possibility of foreclosure. The mortgagee
---------------------- can only retain the possession over the property and recover debts due
to him from the income accrued through the mortgage property.
----------------------
4. English Mortgage
---------------------- – The mortgagor here binds himself to repay the mortgage money on
a certain date and transfers the mortgaged property absolutely to the
----------------------
mortgagee.
---------------------- – The condition however is that the mortgagee will re-transfer the property
---------------------- to the mortgagor upon payment of the mortgage money as agreed.
– The mortgagee is entitled to immediate possession of the property
----------------------
which he can keep till his discharges all his dues.
---------------------- – The mortgagor there incurs personal liability to pay and at the same
---------------------- also transfers all rights and interests of the property to the mortgagee.
– In case of default, the mortgagee is entitled to sell the property without
----------------------
seeking the permission of the court.
---------------------- 5. Equitable Mortgage
---------------------- – It is called ‘mortgage by deposit of the title deeds”.
---------------------- – Equitable mortgage is called so as the borrower merely lodges title

deeds of his immovable property to secure payment of debt.
----------------------

– An equitable mortgage does not convey a legal estate to the mortgagee Notes
and hence the rights of ownership, of possession and of absolute power
of disposal are not transferred to him. Only an equitable interest in the ----------------------
property is passed on to the mortgagee as security for the debt.
----------------------
– In equitable mortgage, (i) there is delivery of title of deeds to the
mortgagee; and (ii) the mortgagor must give in writing his intention to ----------------------
hand over the title deeds to the mortgagee as security against advances. ----------------------
– The principal advantage of equitable mortgage is that quick loans in
----------------------
urgent cases can be sought with the simple legal formality of depositing
the title deeds with the lender. However, much care has to be taken to ----------------------
see that no other person takes advances against the same property and
the mortgagee is unaware of a pervious right of the same property. ----------------------
6. Anamolous Mortgage ----------------------

– A mortgage which does not belong to any of the above five classes is ----------------------
called an anomalous mortgage.
----------------------
– It is generally a combination of different classes of mortgages.
– It is a type of mortgage which strictly does not confirm to the features ----------------------
specified in the above types of mortgage. ----------------------
– Here, the rights and liabilities of the parties would be determined by
----------------------
the contract between them as stated in the mortgaged deed
Rights of the Mortgagee ----------------------
The mortgagee (who is a banker if he lends the money against some ----------------------
immovable property) has the following rights:
----------------------
1. Foreclosure - In case of mortgage by conditional sale, where the mortgagor
fails to pay the debt long after it becomes due, the mortgagee can file a suit ----------------------
and obtain a decree for foreclosure. ----------------------
2. Sell the property without Court’s Intervention - In case of an English
----------------------
mortgage/ mortgage which specially confers this power, the mortgagee
can sell the property if the principal money with interest is not paid by ----------------------
the mortgagor after it has become due. The dues can be realized from the
proceeds of sale. The right of sale however cannot be exercised in the case ----------------------
of usufructuary mortgage and mortgage by conditional sale.
----------------------
3. Suit File for Repayment - The mortgagee can sue on the personal covenant
to repay mortgage money where ----------------------
a. The mortgagor has bound himself personally to pay the money, as in ----------------------
simple mortgage.
----------------------
b. The mortgaged property has become insufficient to pay for the debt.
c. The security whether property or title deeds, has been partially or totally ----------------------
lost due to the mortgagor’s fault. ----------------------
Notes d. The mortgagor is not giving an undisturbed possession of the mortgaged
property where the mortgagee is entitled to its possession as in mortgage
---------------------- by conditional sale or English mortgage.
---------------------- 4. Take Possession - A legal mortgagee can also enforce his security by
taking possession of the property. Possession should be obtained peacefully,
---------------------- failing which the mortgagee may auction the property for recovery. Where
the mortgagor is in physical occupation of the property, the possession is
----------------------
obtained by evicting him.
---------------------- 5. Recover the Money spent - A mortgagee may also recover the money
spent for such purposes as (a) the preservation of the mortgaged property
----------------------
from destruction, forfeiture or sale (b) supporting the mortgagor’s title to
---------------------- the property (c) making his own title and (d) the renewal of the lease, if
the mortgaged property is on renewable leasehold. Interest money is also
---------------------- payable by the mortgagor.
---------------------- Rights of the Mortgagor
---------------------- 1. Equity of Redemption: So long as a mortgage remains outstanding, the

mortgagor has a right to redeem his property by paying off the principal,
---------------------- interest and costs. He can at any time after the mortgage debt has become
due get back the mortgaged property provided he has paid or offered to pay
---------------------- the mortgagee the full amount of the mortgage debt. The mortgagee must
---------------------- deliver the possession of the property to the mortgagor.
2. Inspection of Documents: He can inspect and make copies of the deeds at
---------------------- his own expenses, where the mortgagor has deposited his title deeds with
---------------------- the mortgagee.
3. Entitlement of Improvements: He is entitled to the improvements where
---------------------- the mortgagee effects improvements on the mortgaged property while it is
---------------------- in his possession.
4. Renewed Lease: He is entitled to the renewed lease where the mortgagee
----------------------
in possession of the mortgaged property renews lease.
---------------------- 5. Entitled to Additions: He is entitled to the accretion, where the mortgagee
---------------------- in possession of the mortgaged property makes addition to the property.
---------------------- 6.9 DIFFERENCES BETWEEN LEGAL MORTGAGE AND

---------------------- EQUITABLE MORTGAGE
---------------------- Mortgages are divided into two categories: (i) Legal Mortgage and (ii)
Equitable Mortgage.
----------------------
Legal Mortgage
----------------------
 The mortgagor transfers legal title to the mortgaged property in favour of
---------------------- the mortgagee by a deed.
----------------------  U/s 59, Transfer of Property Act, 1882, a legal mortgage can be effected

only by a registered instrument if the mortgage money is Rs.100 or more. Notes
On repayment, the title is mortgaged property is re-transferred to the
----------------------

mortgagor.
----------------------
 The transfer of legal title to the mortgage involves expenses in the form of
stamp duty and registration charges. ----------------------
Equitable Mortgage ----------------------
 The mortgagor transfers the documents of title to the mortgagee for the ----------------------
purpose of creating an equitable interest of the mortgagee on the property/
assets. ----------------------
 The legal title is not passed on to the mortgagee. The mortgagor gives an ----------------------
undertaking, through a Memorandum of Deposit, to execute a legal mortgage
in case he fails to pay the mortgage money. ----------------------
 The mortgagee is empowered to apply to the Court of Law to convert the ----------------------
equitable mortgage into a legal mortgage if the mortgagor fails to pay the
----------------------
mortgage money on the specified date
----------------------
 The merits of an equitable mortgage over a legal mortgage are as follows:
– Registration in not necessary, hence no expenses have to be incurred ----------------------
on stamp duty and registration. ----------------------
– The mortgage remains between the two parties- the banker and the
----------------------
customer.
----------------------
– On repayment, the documents of title are returned back to the
customer. The same documents can be re-deposited for effecting ----------------------
another mortgage. In case of legal mortgage, a new deed is required
for every mortgage. ----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
Notes
----------------------
---------------------- 1. Banker’s lien, which enables him to dispose of the goods in due course
to adjust his dues where the customer makes a default in payment of
---------------------- the debt, is called
---------------------- i. Implied pledge
---------------------- ii. Implied warrantee
---------------------- iii. Implied guarantee
---------------------- iv. Implied security
---------------------- 2. Mortgage of movable property accompanied by delivery of possession

is called
----------------------
i. Hypothecation
----------------------
ii. Lien
---------------------- iii. Pledge
---------------------- iv. Security
---------------------- 3. The objective of bailment to hold the goods for the payment of a debt
---------------------- or the performance of a promise is called
i. Security
----------------------
ii. Earnest Money
----------------------
iii. Advance money
----------------------
iv. Bait money
----------------------
----------------------
Summary
----------------------
●● One of the primary functions of a bank is to grant advances and loans
---------------------- to its borrowers. The strength of a bank depends on the quality of its
---------------------- loans and advances. Secured advances form a major part of the total bank
advances.
---------------------- ●● The banker therefore cannot rely on the obligation of the borrower alone.
---------------------- Therefore, he always obtains a tangible security from the borrower. The
banker can obtain repayment on disposing off the security in case the
---------------------- borrower is unable to meet his obligations. Acceptance of security acts
as an insurance for the lending activity of the bank in incase of certain
---------------------- unforeseen circumstances due to which the borrower is unable to repay his

dues. The security furnished by the customer provides the safety aspect Notes
to the lending and investment policy of the banker. Though the banker
has the security to fall back on, he always is interested in the continual ----------------------
prosperity and growth of his customer.
----------------------
●● The banker accepts a wide variety of securities against advances on
making a complete assessment of the merits and demerits of the security ----------------------
along with the risk associated. Accordingly, the banker takes proper
precautions while accepting the concerned security against advances. ----------------------
●● One of the important principles of a sound banking policy is to ensure the ----------------------
safety of funds lend by the banker to his customers. The banker lends on
the basis of principles; he relies primarily on the character, capital and ----------------------
capability of the borrower in ensuring the safety of his funds. ----------------------
●● The banker however, cannot afford to take any risk in this regard and
hence, he relies on the tangible security/assets owned by the borrower ----------------------
and provided as security against advances. These secured advances are ----------------------
the advances that provide safety of its funds to the banker, as a charge
is created on the tangible assets of the borrower in favour of the banker. ----------------------
Several modes of creating charge – lien, pledge, hypothecation, mortgage-
are used to provide certain rights over the tangible assets provided as ----------------------
security. ----------------------
Keywords ----------------------
●● Continuing security : A charge on the assets of the borrower is so worded ----------------------

that it covers all existing as well as future debts. ----------------------
●● Goods : Every kind of movable property other than actionable claims and
money. ----------------------
●● Documentary credit : Credit granted against the security of documents ----------------------
of title to goods such as bill of lading, railway receipt, etc.
----------------------
●● Real estate : All types of immovable property; attached/unattached to
land or forming a part of land. ----------------------
●● Supply bills : Bill present to the government for payment on completion
----------------------
of a contract or for work done on certain terms and conditions by the
contractor. ----------------------
●● Insurable Interest : A pecuniary or monetary interest in the life assured,
----------------------
i.e. the person securing the insurance policy will suffer monetary loss or
hardship in the absence of the person assured. ----------------------
●● Surrender Value : Value of the life policy which the insurer pays to the
insured if the policy is surrendered or discontinued according to the terms ----------------------
of the policy. ----------------------
●● Stock exchange securities : Those securities which are dealt with bought
and sold on the Stock Exchange. ----------------------
●● Lien: A claim / authority exercised over the property of somebody else. ----------------------
Notes ●● Pledge: A mortgage of movable property accompanied by delivery of
possession.
---------------------- ●● Hypothecation: A mode of creating a charge over movable property/
---------------------- goods without the surrender of possession of ownership.
●● Fixed charge: A charge attached to specific assets i.e. land, property,
---------------------- buildings, plant and equipment attached to land, etc.
---------------------- ●● Floating charge: A security interest over fund of changing assets, which
‘floats’ or ‘hovers’ until conversion into a fixed charge, for instance, loose
---------------------- plant and equipment, raw materials, stock in trade, items of transient
---------------------- nature.
●● Assignment: A transfer of a right, property or a debt, existing as well as
---------------------- future.
---------------------- ●● Mortgage: A transfer of an interest in specific immovable property for the
purpose of securing the payment of money advanced or to be advanced
---------------------- by way of loan.
---------------------- ●● Conveyance of interest in property: Transfer of an interest in the specific
immovable property.
----------------------
●● Simple Mortgage: Where a mortgagor binds himself personally to pay
---------------------- the mortgage money
●● Mortgage by conditional sale: Where the mortgaged property shall be
---------------------- treated to be sold on default of payment of the mortgaged money.
---------------------- ●● Usufructuary Mortgage: Where the mortgagee is authorized to retain
the possession, collect the usufruct, i.e. the rents and profits accruing from
---------------------- the property mortgage for repayment of advance
---------------------- ●● English Mortgage: Where the mortgagor binds himself to repay the
mortgage money on a certain date and transfers the mortgaged property
---------------------- absolutely to the mortgagee.
---------------------- ●● Equitable Mortgage: Where the mortgagor merely lodges title deeds of
his immovable property to the mortgagee to secure payment of debt.
----------------------

---------------------- 1. Explain the precautions to be taken by the banker while accepting goods
as security against advances.
----------------------
2. What care should the banker take while advancing loans against documents
---------------------- of title to goods?
---------------------- 3. Discuss the merits and demerits of insurance policies as a security against
advances.
----------------------
4. What safeguards should a banker observe while accepting gold and silver
---------------------- jewels as security against advances?
---------------------- 5. Discuss the advantages and disadvantages of making advances against

Stock exchange securities and real estate. What are the precautions the Notes
banker should take while making such an advance?
----------------------
6. Why do banks not regard immovable property as a good security against
advances? ----------------------
7. What are the dangers in accepting government supply bills as security
----------------------
against advances?
8. Write a note on Fixed Deposit receipts as security against advances. ----------------------
9. What are the features of Lien? ----------------------
10. Define Pledge. What are the essential ingredients of a Pledge? ----------------------
11. What is meant by Hypothecation? What is the difference between
----------------------
Hypothecation and Pledge? As a banker, which one would you prefer and
why? ----------------------
12. Explain the concept of Mortgage?
----------------------
13. Explain the rights of the Mortgagor and the Mortgagee.
----------------------
14. Explain the various types of Mortgage.
15. Bring out the difference between Legal Mortgage and Equitable Mortgage. ----------------------
16. Bring out the difference between Fixed Charge and Floating Charge. ----------------------
----------------------
Answers to Check your Progress ----------------------
Fill in the blanks. ----------------------
1. Security, which is Marketable, Ascertainable of value, Stable in prices
----------------------
and Transferable easily and inexpensively is called MAST.
2. In case of security when the goods are to be handed over to the banker and ----------------------
the banker is entitled to sell the goods on default is called Pledge.
----------------------
3. Ownership of a property when a person is the absolute owner of the estate
and he has the power to deal with it as he likes is called Freehold. ----------------------
1. Banker’s lien, which enables him to dispose of the goods in due course
to adjust his dues where the customer makes a default in payment of the ----------------------
debt, is called ----------------------
i. Implied pledge
----------------------
2. Mortgage of movable property accompanied by delivery of possession is
called ----------------------
iii. Pledge ----------------------
Notes 3. The objective of bailment to hold the goods for the payment of a debt or
the performance of a promise is called
----------------------
i. Security
----------------------
Suggested Reading
----------------------
----------------------
---------------------- 5. Tannan, M.L. Banking Law and Practice in India.
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Recovery Measures
UNIT
7
Structure:
7.1 Introduction
7.2 Non-legal Measures
7.3 Legal Measures
Summary
Key words
Suggested Reading
Recovery Measures 129

Notes
Objectives
----------------------
• State different types of recovery measures
----------------------
• Explain the concept of SHG-Bank linkage
----------------------
• Describe the Lok Adalats
---------------------- • Discuss the meaning and purpose of debt recovery tribunals
----------------------
----------------------
7.1 INTRODUCTION
---------------------- Banks follow the principle of sound bank lending. Banks follow a two-
pronged approach- (1) Pre-sanction appraisal – to decide upon the ‘bankability’
---------------------- of the each loan proposal received. (2) Post-sanction appraisal – to ensure
proper documentation, follow-up and supervision.
----------------------
In the pre-sanction appraisal, a careful assessment of the loan proposal and
---------------------- the creditworthiness of the borrower is made and then credit is disbursed. At
the same time, the post-sanction appraisal is as important as the pre-sanction
---------------------- appraisal. The banks however have to monitor the end-use of these loans
---------------------- sanctioned by them.
It is the responsibility of the bank to verify the end-use of credit and ensure
----------------------
that it is according to the purpose for which the credit was granted. A post-
---------------------- sanction appraisal can help the bank can reduce the risk of default, to control
any loan turning into a non-performing asset, to take preventive measures for
---------------------- improvements in cash flows and keep track of the business trends- an uptrend
or a downtrend. Lack of monitoring in the post-disbursement period can lead to
----------------------
diversion of funds by the borrowers and misuse of credit facilities.
----------------------
7.2 NON-LEGAL MEASURES
----------------------
Monitoring, Follow-up, Supervision and Control
----------------------
The Reserve Bank of India constituted a Study Group, know popularly as
---------------------- the Tandon Committee (1974) for framing guidelines for commercial banks for
follow up and supervision of bank credit to ensure proper end-sue of funds. The
----------------------
main recommendations of the Committee relate to the norms for inventory and
---------------------- receivables, the approach to lending, style of credit, follow-up and information
system. In the year 1979, the Reserve Bank constituted the Chore Committee to
---------------------- review the operations of the cash credit system of lending with reference to the
gap between sanctioned credit limits and the extent of their utilization. The Chore
----------------------
Committee recommendations are an improvement on the norms prescribed by
---------------------- the Tandon Committee1.
----------------------

The Objectives of monitoring and follow-up are: Notes
 To ensure the end-use of funds is the same as the purpose for which
----------------------
sanctioned.
 To ensure the compliance of the terms and conditions of sanction in order ----------------------
to avoid time lag and cost over-runs.
----------------------
 To evaluate the performance of the borrower in terms of production, sales,
etc., on a on-going basis in order to ensure timely repayment of the loan. ----------------------
 To monitor the health of the business and to detect early signals of weakness ----------------------
and initiate timely action for recovery or rehabilitation.
----------------------
The Reserve Bank of India has issued guidelines from time-to-time to
monitor advances. As per the guidelines, the monitoring of advances can be ----------------------
done through various statements documents submitted by the borrower:
----------------------
(a) Monthly statement of Select Operational Data.
----------------------
(b) Quarterly statements of the estimates and performance.
(c) Half yearly funds flow and operating statement. ----------------------
(d) Annual review of large borrowers made compulsory. ----------------------
The Reserve Bank of India requests for information in a prescribed format ----------------------
about the monthly and cumulative figures on sales and production, on outstanding
selected current assets and liabilities. ----------------------
At an individual level, the banks can take the following measures to control ----------------------
and monitor advances:
----------------------
(a) Supervision through monitoring of transactions in loan amount.
(b) Scrutiny of periodical statements submitted by the borrower. ----------------------
(c) Submission of Credit Reports in prescribed formats ----------------------
(d) Physical inspection of securities and books of accounts of the borrower. ----------------------
Periodic review of loan accounts can highlight the weaknesses of such
accounts and timely remedial action can be initiated in the interest of both the ----------------------
borrower as well as the bank. ----------------------
Rescheduling of Loans
----------------------
“Rescheduling of loans” refer to loans: (i) that have been restructured and
re-negotiated between banks/financial institutions and borrowers because of a ----------------------
deterioration in the financial position of the borrower or of the inability of the
----------------------
borrower to meet the original repayment schedule and (ii) for which the revised
repayment terms, either of interest or the repayment period, are non-commercial. ----------------------
A loan as being rescheduled on non-commercial terms if one of the
----------------------
following conditions exists: (a) a reduction in the principal amount of the loan;
(b) a reduction of accrued interest (i.e. forgiveness of interest); (c) a reduction ----------------------
of interest rate to a level that is lower than the current market rate for a new
loan with a similar risk. Loans should be rescheduled where there is reasonable ----------------------

Notes assurance that the borrowers will be able to service all future principal and interest
payments on the loans in accordance with the revised repayment terms.
----------------------
The most objective and simplest way to determine whether the financial
---------------------- position of a borrower has deteriorated, or the borrower is unable to meet the
original repayment schedule, is the current status of the loan (i.e. whether it is
---------------------- still performing). In most cases, a bank will not regard a borrower as being in
financial difficulty if there is no default in repayment.
----------------------
 For regular repayment of a loan, the borrower/s must earn income.
----------------------
 The bank generally fixes a schedule for repayment for a term loan keeping
---------------------- in view the borrowers ability to generate income.
----------------------  If the borrower is unable to repay as expected, the loan installments can be
rescheduled.
----------------------  The bank may, in consultation with the borrower can reschedule the
---------------------- repayment. It will do so only when it expects to get the repayment after the
rescheduling.
----------------------  Banks make an attempt to reduce the Non Performing Assets by rescheduling
---------------------- of loans.
Compromise with Borrowers
----------------------
Among the non-legal remedies, one of the important measures to reduce the
---------------------- level of non-performing assets is compromise. Compromise according to Oxford
dictionary, is ‘an agreement attained by mutual concession’. As compared to
----------------------
the slow legal process, a compromise offers a quick solution to settle bad debts
---------------------- and overdues. Compromise can be reached at all the three stages: pre-litigation,
post-litigation and post-decree.
----------------------
 Banks can also recover dues from the debtors through compromise on a
---------------------- voluntary basis.
----------------------  The borrowers or guarantors can voluntarily come forward to settle bank’s
dues so that legal action against them is not taken by the bank.
----------------------  In case of a compromise, the matter can be discussed with the bank’s lawyer
---------------------- and legal opinion can be sought by the borrower.
 The bank can negotiate in order to protect its own interest and the dues can
----------------------
be settled through compromise.
----------------------  In a compromise, the borrower/s may agree to pay a certain amount to the
banker in return for some concessions.
----------------------
 Since the problem of overdues is large in India, banks try to work out a
---------------------- compromise with the borrower so that NPAs can be reduced and funds can
be recovered without resorting to legal action.
----------------------
 The bank should take due precautions in a compromise settlement. The
---------------------- following aspects should be taken into consideration:
---------------------- – A proper distinction should be made between willful defaulters and the

borrowers defaulting in repayments due to circumstances beyond their Notes
control.
----------------------
– In case where security is available, an assessment should be made
of the realizable value taking into consideration the location, present ----------------------
condition, marketable title and possession of the property.
----------------------
– In case where recovery is to be made in installments, the borrowers’
credibility and source of income should be assessed. ----------------------
– In case of presence of the guarantor, an assessment should be made
----------------------
whether recovery is possible. It is possible to recover the amount with
the help of the guarantee available. ----------------------
– A compromise proposal should be made and accepted by a bank within ----------------------
the broad purview of the Loan Recovery Policy of the Bank.
Advantages: ----------------------
1. Compromise is one of the alternatives before the banks to recover their dues ----------------------
before resorting to any legal methods.
----------------------
2. Banks are able to recover dues faster by way of a compromise.
----------------------
3. Blocked funds will be at the disposal of the bank for further lending and
investment. ----------------------
4. Banks are able to bring down the level of non-performing assets. ----------------------
5. It is a time-saving and cost-effective method. Heavy expenses on litigation
are saved. ----------------------
Disadvantages: ----------------------
1. In a compromise, the bankers may have to accept a deal where actual amount ----------------------
recovered may be less than the actual amount due. Bankers’ often have to
suffer a loss in a compromise proposal. ----------------------
2. Till the time full payment is received after compromise deal and the account ----------------------
closed, the banker may have to incur expenses on various heads including
litigation expenses. ----------------------
Recovery Camps ----------------------
 This is a method used by banks to recover loans in rural areas. ----------------------
 Recovery camps are organized with onset of the harvest season. This helps
banks to collect overdues from farmers. ----------------------
 It is a collective effort to recover loans on the part of bank officials, ----------------------

government officers and the Gram Panchayat.
----------------------
 Recovery camp can be organized in a village or in a group of villages. Such
camps are publicized in the village so that the farmers can approach the ----------------------
bank.
----------------------
 These camps generally organized by the land Revenue officer of the state
government to collects the land revenue. The bank officer gives the list of ----------------------

Notes farmers whose loans are due to the Revenue officer. Both land revenue and
bank dues are collected by the Revenue officer along with the bank officer.
---------------------- A certain percentage of the amount recovered goes to the government. Land
revenue officer has wide powers, which are not available to the banker. He
---------------------- can use his powers if the dues are not being paid by the farmers.
---------------------- One- Time Settlement
----------------------
 The One-time Settlement Scheme has been in operation for a very long time.
A one-time settlement (OTS) scheme for small loan accounts with
----------------------

outstanding principal balance upto Rs.25,000 has been in operation.

----------------------
 A special One-Time Settlement (OTS) scheme for loans up to Rs.50,000 to
---------------------- small and marginal farmers by Public Sector Banks has been in operation.
They were extended up to March 2003 in view of requests received from
---------------------- banks and the drought/flood situation in various parts of the country.
----------------------
 The guidelines for settlement of chronic Non Performing Assets (NPAs)
upto Rs.5 crores were issued in July 2000. Subsequent to the introduction
---------------------- of the SARFAESI Act, 2002, the Reserve Bank issued fresh guidelines for
one-time settlement scheme in January 2003 for compromise settlement of
---------------------- chronic NPAs up to Rs.10 crore in Public Sector Banks. These guidelines
---------------------- cover: (a) all NPAs in all sectors, irrespective of the nature of business,
which have become doubtful or loss assets as on March 31, 2000 with
---------------------- outstanding balance of Rs.10 crore and below on the cut-off date; (b) NPAs
classified as sub-standard as on March 31, 2000, which have subsequently
---------------------- become ‘doubtful’ or ‘loss’ assets; and (c) cases in which the banks have
---------------------- initiated action under the SARFAESI Act, 2002 and also cases pending
before Courts/Debt Recovery Tribunals (DRTs)/Board for Industrial and
---------------------- Financial Reconstruction (BIFR), subject to consent decree being obtained
from the Courts/DRTs/ BIFR.
----------------------

 The guidelines also cover suit-filed and decreed debts. After the settlement
---------------------- is reached, the banks may take appropriate steps for closure of cases in
respective courts. The scheme will not, however, cover cases of fraud,
---------------------- malfeasance and willful defaults.
----------------------
 The amount that should be recovered as settlement amount under these
guidelines would be the balance outstanding towards principal in the loan
----------------------
account.
----------------------
 The amount of settlement arrived at as above, should normally be paid in one
lump sum. In deserving cases, banks may consider recovering the settlement
----------------------
amount in installments with down payment of at least 25% to be received
---------------------- at the time of settlement. The balance amount should be recovered within
one year from the date of settlement.
----------------------

 The Reserve Bank of India revises /upgrades the schemes from time-to-time.
----------------------
 These settlement schemes or compromise schemes are of great help for
---------------------- recovery of overdues and reduction of the level of NPAs of banks.

Recovery through Self- Help Groups Notes
A Self Help Group (SHG) is a group of about 10 to 20 people, usually women,
----------------------
from a similar class and region, who come together to form savings and credit
organization. A SHG is a non- formal agency for finance to the rural poor. They ----------------------
pool financial resources to make small interest bearing loans to their members.
----------------------
SHG is a homogeneous group of rural poor, voluntarily formed to save small
amounts out of their earnings, which is convenient to all the members and agreed ----------------------
upon by, all to form a common fund of the group to be lent to the needy members
for meeting their productive credit needs. SHGs may be organized in a village ----------------------
or in a group of villages by Non-Governmental organizations (NGOs) or at the
----------------------
initiative of branch managers of banks. NGOs/Banks even provide training and
support facilities to the group in the beginning years. ----------------------
NABARD (National Bank for Agriculture and Rural Development) initiated
----------------------
SHG-Bank Linkage programme in the year 1992 with the objective of uplifting
the rural poor. The project for linking SHGs with commercial banks was also ----------------------
extended to co-operative banks and RRBs. The central government and state
governments have provided supported for the growth of SHGs. ----------------------
The bank, the NGO and the NABARD together identify the SHG to be ----------------------
covered under the project. The size of the group is upto 20 members. The banker
provides credit directly to the group. The group in turn lends to the members. The ----------------------
amount of credit given to the group is linked with the savings mobilized by the ----------------------
group. The rate of interest is as decided by the RBI but the SHG can decide the
rate of interest while lending to its members. The SHG can decide the repayment ----------------------
period for its members.
----------------------
 The SHG- Bank linkage serves the interest of SHGs as well as the banks.
 The SHG- Bank linkage helps SHGs to have access to large source of funds. ----------------------
 The SHG- Bank linkage helps banks to lend via the SHG route to those ----------------------
sections which they otherwise cannot cater to. The Linkage helps the banks
----------------------
to reduce their work of credit assessment, appraisal supervision etc.
 It has been observed that recovery is easier and more certain with the help ----------------------
of SHGs.
----------------------
 The SHG- Bank linkage programme has helped income generation among
low income households. ----------------------
 The SHG- Bank linkage has helped strengthen the commercial and ----------------------
cooperative banking system with extension of their services to unbanked
groups. ----------------------
 Microfinance is on a rise in India. The SHG- Bank linkage has emerged as ----------------------
a major source of finance and assistance to the rural poor.
----------------------
7.3 LEGAL MEASURES ----------------------
When it is not possible to recover the advances through non-legal measures, ----------------------

Notes a bank will have to file a suit in the court for recovering the amount. Though
advances are against security, it is not possible to sell the security without
---------------------- obtaining the court’s order. The main aim behind filing a suit by the bank is to
recover the advance.
----------------------
Summary suits are normally filed in case of negotiable instruments and/or
---------------------- Guarantee and/or where there is no other security or even there is a security, it
has no value. Summary suits are filed in situations where the plaintiff only seeks
----------------------
to recover a debt or ascertained sum of money with or without interest arising;
---------------------- on a written contract or on a guarantee or on an enactment where the sum sought
to be recovered is a fixed amount of money or in the nature of a debt.
----------------------
The legal process is a long process involving a number of steps: (i) File a
---------------------- suit in the court of law (ii) Obtain a decree; a decree can also be obtained for
the compromised amount, if there is compromise proposal during the pendency
---------------------- period of the suits and (iii) Execution of Decree.
---------------------- Recovery through Lok Adalats
---------------------- Lok Adalats, to mean ‘People’s Courts’ is an alternative dispute resolution

developed in India. India has had a long history of resolving disputes through
---------------------- the mediation of village elders. The system of Lok Adalats is an improvement
and is based on the principles of Mahatma Gandhi. The concept of Lok Adalat
---------------------- was formally introduced in the year 1982. The Legal Services Authorities Act,
---------------------- 1987, provided the legal basis for Lok Adalats.
In the Lok Adalat, the two parties are heard, then their legal position is
---------------------- explained to them and advice given on their case. (a) If the two parties arise at
---------------------- a consensus, a compromise is signed between them. (b) The two parties do not
sign the compromise deed, then it is to be filed in the court to obtain a consent
---------------------- decree. (c) If the parties do not adhere to the compromise, than the suit in the
court will proceed as per the law. (d) If the parties to the dispute are absent at
---------------------- the time of Lok Adalat session then they have to be present in the court in order
---------------------- to execute the compromise which is arrived at in the Lok Adalat.
 Lok Adalat is a forum for mediation and conciliation between the parties
----------------------
 Lok Adalats are autonomous bodies.
----------------------
 The initial guidelines for Lok Adalats included bank suits involving claims
---------------------- upto Rs. 2 lakhs. This limit has been raised from time to time.
----------------------  The settlement is done at a fast pace because lawyers are not required in
Lok Adalats.
----------------------  Lok Adalats are based on social movements. Generally Lok Adalats are
---------------------- presided over by persons of status and experience like retired senior 3
bureaucrats, Defence Personnel or Judicial officers. Even social workers
---------------------- can put some pressure in the compromise.
----------------------  The long time-consuming the procedures of court can be avoided. There
are no court fees for accessing Lok Adalats.
----------------------

Corporate Debt Restructuring (CDR) Notes
The scheme of Corporate Debt Restructuring (CDR) was introduced with
----------------------
the objective of ensuring a mechanism for restructuring the corporate debts of
viable entities. ----------------------
The CDR was institutionalized in 2001 to provide a transparent system of
----------------------
restructuring corporate debts of Rs.20 crores and above with banks and Financial
Institutions. In August 2001, the Reserve Bank of India advised banks and FIs ----------------------
to implement the CDR system.
----------------------
The CDR mechanism has a three-tier structure:
(A) CDR Standing Forum and its core Group (the policy making body) - The ----------------------
CDR Standing Forum would be the representative general body of all ----------------------
financial institutions and banks participating in CDR system. All financial
institutions and banks should participate in the system in their own interest. ----------------------
CDR Standing Forum will be a self- empowered body, which will lay
down policies and guidelines, and monitor the progress of corporate debt ----------------------
restructuring. ----------------------
(B) CDR Empowered Group (the functional group), The CDR Empowered
Group would be mandated to look into each case of debt restructuring, ----------------------
examine the viability and rehabilitation potential of the Company and ----------------------
approve the restructuring package within a specified time frame of 90 days,
or at best within 180 days of reference to the Empowered Group. ----------------------
(C) The CDR Cell (the Secretariat to the CDR system). The CDR Standing ----------------------
Forum and the CDR Empowered Group will be assisted by a CDR Cell in
all their functions. ----------------------
 The scheme will not apply to accounts involving only one financial institution ----------------------
or one bank. The CDR mechanism will cover only multiple banking accounts
/ syndication / consortium accounts with outstanding exposure of Rs.20 ----------------------
crore and above by banks and institutions.
----------------------
 CDR will be a non-statutory mechanism which will be a voluntary system
based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement ----------------------
(ICA). The Debtor-Creditor Agreement (DCA) and the Inter-Creditor
----------------------
Agreement (ICA) shall provide the legal basis to the CDR mechanism.
 One of the most important elements of Debtor-Creditor Agreement would ----------------------
be ‘stand still’ agreement binding for 90 days, or 180 days by both sides.
----------------------
Under this clause, both the debtor and creditor(s) shall agree to a legally
binding ‘stand-still’ whereby both the parties commit themselves not to ----------------------
taking recourse to any other legal action during the ‘stand-still’ period, this
would be necessary for enabling the CDR System to undertake the necessary ----------------------
debt restructuring exercise without any outside intervention, judicial or
----------------------
otherwise. The CDR- empowered group looks into each case to examine
the viability and rehabilitation of the company and approve the restructuring ----------------------
package within a period of 90 days or 180 days.
----------------------

Notes Debt Recovery Tribunals
The Banks and Financial Institutions were finding it difficult to recover their
----------------------
dues and enforcement of securities charged with them due to the delays involved
---------------------- in the legal procedures in India. It was felt necessary by the banks and financial
institutions that special courts or tribunals be constituted which can deal with
---------------------- cases of banks against their borrowers for the recovery of dues.
---------------------- In 1981, the Tiwari Committee suggested the setting up of Special Tribunals
for recovery of dues of banks and financial institutions by following the summary
---------------------- procedure. Later, the Vesuvalla Committee submitted a draft bill called ‘Recovery
of Dues (Public Sector Banks and Financial Institutions) Bill in the year 1986 for
----------------------
consideration of the Government of India. In 1991, The Narasimham Committee
---------------------- reiterated the need for the setting up of the Special Tribunals for the Recovery of
due of the banks and financial Institutions. In 1992, the Hegde Committee was
---------------------- appointed to examine the existing legal framework relating to recovery of due
of banks and financial institutions. The banks suffered on account of the delays
----------------------
due to technical rules of evidence followed by civil courts, provisions of appeals
---------------------- and revisions at different stages of the suit and intentional delay tactics on part
of borrowers. The huge backlog of cases added to the problems of banks and
---------------------- financial institutions.
---------------------- The Recovery of Debts due to Banks and Financial Institutions Act, 19932,
was passed to provide for the establishment of Tribunals for quick adjudication
---------------------- and recovery of debts due to banks and financial institutions. The Act became
effective from 24th June, 1993. In accordance with the Act, Debt Recovery
----------------------
Tribunals can be set up in different places in the country- Calcutta, Delhi, Jaipur,
---------------------- Bangalore, Ahmedabad, Chennai, Guwahati, Patna, Jabalpur and Bombay. The
objective is to speed up the process of recovery of debts which, otherwise takes
---------------------- a long time to be settled by the courts.
----------------------  The Central Government may establish one or more Tribunals, known as the
Debt Recovery Tribunals to exercise the jurisdiction, powers and authority
---------------------- conferred on such tribunals.
----------------------  The Central Government shall also specify the area of jurisdiction in which
it operates.
----------------------
 A Tribunal consists of one person only who is referred to as the Presiding
---------------------- Officer, appointed by the Central Government.
----------------------  The Presiding Officer shall not be qualified for appointment as the Presiding
Officer of a Tribunal unless he is qualified to be a District Judge. He shall
---------------------- hold office for a term of five years or until the age of sixty-two.
----------------------  A Tribunal has jurisdiction to handle cases involving claims of Rs. 10 lakhs
and above.
----------------------
 Only banks and financial institutions can approach the Tribunals for recovery
---------------------- of dues and related matters.
----------------------  The Tribunals charge a fee for the suits.

 They are guided by the Principal of Natural Justice and (not bound by Civil Notes
Procedure Code).
----------------------

 They are required to decide the claim within a period of six months. If any
party wants to file an appeal against the orders of the Tribunals, it can do ----------------------
so within 45 days.
----------------------
----------------------
Fill in the blanks.
1. While entering into a compromise, proper distinction should be made ----------------------
between _________ and the borrowers defaulting in repayment due ----------------------
to circumstances _________.
----------------------
2. Settlement scheme in January 2003 was meant for compromise and
settlement of chronic NPAs up to Rs. _________ in Public Sector ----------------------
Banks.
----------------------
3. National Bank for Agriculture and Rural Development is popularly
known as _________. ----------------------
----------------------
Summary ----------------------
●● The post-disbursement appraisals have been ineffective; as a result, ----------------------
banks were unable to take timely action on weak loan accounts. This
has brought into focus the need for monitoring of advances, appropriate ----------------------
follow-up and supervision. The Reserve Bank of India has time and
----------------------
again up with guidelines for monitoring of advances. Recovery has been
a big problem to banks and financial institutions; the judicial system ----------------------
in India has been slow in delivering justice due to a huge backlog of
pending court cases. Banks, as far as possible, try to resort to non- ----------------------
legal measures to recover overdues. Banks either reschedule weak loan
----------------------
account or settle down to a compromise. The Reserve Bank of India has
designed One-Time Settlement (OTS) Scheme to cater to loan account ----------------------
of small borrowers, small and marginal farmers and in recent times,
small and marginal enterprises (SMEs). ----------------------
●● When it is not possible to recover loan through the non legal measures, the ----------------------
banks have to file a suit to recover the loan amount. The legal procedure
is a long drawn one. The Government of India under the Legal Services ----------------------
Authorities Act 1987 has set up Lok Adalats. Lok Adalats is a forum for
----------------------
mediation and conciliation between the parties. The long time-consuming
procedures of court can be avoided. There are no court fees and no need ----------------------
for lawyers to access a Lok Adalat. It is not only small loan accounts
that are a problem to banks; large corporate borrowers are difficult to ----------------------
handle as well. The Reserve Bank therefore proposed the Corporate Debt
----------------------

Notes Restructuring mechanism and advised banks and financial institutions to
implement it.
---------------------- ●● There was a need for a separate mechanism for settlement of cases
---------------------- involving banks and financial institutions. On the strong recommendation
of the Narasimham Committee in the year 1991, the Recovery of Debts
---------------------- due to Banks and Financial Institutions Act was passed in 1993. The Act
provide for the establishment of Tribunals for quick adjudication and
---------------------- recovery of debts due to banks and financial institutions.
----------------------
Keywords
----------------------
●● Pre-sanction appraisal: To decide upon the ‘bankability’ of each loan
---------------------- proposal.
---------------------- ●● Post-sanction appraisal: To ensure proper documentation, follow-up
and supervision of loan disbursed.
----------------------
●● Reschedule Loans: Restructure and re-negotiate between banks/financial
---------------------- institutions and borrowers due to deterioration in the financial position of
the borrower.
----------------------
●● Compromise: Voluntarily action on part of borrowers to settle bank’s
---------------------- dues to avoid legal action.
●● Self Help Group (SHG): A non- formal agency or a group of people who
----------------------
come together to form saving and credit organization.
---------------------- ●● SHG-Bank Linkage - Provision of bank credit via the SHG route to
those sections of population banks are unable to cater to.
----------------------
●● Micro Finance: Provision of financial services to low income groups
---------------------- who lack access to banking and related services.
---------------------- ●● Lok Adalats: Literally ‘People’s Courts’, alternative dispute resolution
for mediation and conciliation between the parties.
---------------------- ●● Corporate Debt Restructuring (CDR): A mechanism for restructuring
---------------------- the corporate debts of viable entities; a voluntary and a non-statutory
mechanism in India.
---------------------- ●● Debt Recovery Tribunals (DRTs): Special tribunals set up under the
---------------------- Recovery of Debts due to Banks and Financial Institutions Act, 1993 to
help in fast recovery of overdues.
----------------------
---------------------- 1. Bring out the importance of monitoring and supervision of Loans.

2. What are the measures adopted by a bank before resorting to legal action?
----------------------
3. Discuss the advantages and disadvantages of a Compromise proposal.
----------------------
4. Explain the SHG-Bank Linkage Programme. What are the benefits of
---------------------- such programme?

5. Explain the role of SHGs in Bank Lending. Notes
6. What are Lok Adalats? Are they effective in the recovery of loans?
----------------------
7. Discuss the features of the Corporate Debt Restructuring Mechanism.
----------------------
8. State and explain the features of a Debt Recovery Tribunal.
9. What are the objectives of the Recovery of Debts due to Banks and ----------------------
Financial Institutions Act, 1993? ----------------------
10. Bring out the role of Debt Recovery Tribunals in Bank Lending.
----------------------
----------------------
Answers to Check your Progress ----------------------
Fill in the blanks.
----------------------
1. While entering into a compromise, proper distinction should be made
between willful defaulters and the borrowers defaulting in repayment due ----------------------
to circumstances beyond their control.
----------------------
2. Settlement scheme in January 2003 was meant for compromise and
settlement of chronic NPAs up to Rs. 10 crore in Public Sector Banks. ----------------------
3. National Bank for Agriculture and Rural Development is popularly known ----------------------
as NABARD.
----------------------
----------------------
Suggested Reading
----------------------
----------------------
----------------------

----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
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----------------------
----------------------
----------------------
----------------------
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----------------------
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----------------------

Policy Regulation since 1991
UNIT
8
Structure:
8.1 Introduction
8.2 Basel Norms
8.3 Capital Adequacy Ratio
8.4 Prudential Norms
8.5 Supervision and Regulation by Reserve Bank of India
Summary
Key words
Suggested Reading
Policy Regulation since 1991 143

Notes
Objectives
----------------------
• Explain the concept behind the Basel accord
----------------------
• Explain the meaning of ‘capital adequacy ratio’
----------------------
• Discuss what ‘non-performing asset’ and prudential norms mean
---------------------- • Describe the process of bank supervision in India
----------------------
8.1 INTRODUCTION
----------------------
---------------------- The New Economic Policy (NEP) was initiated by the then Congress
Government with Prime Minister P.V. Narasimha Rao with Dr. Manmohan
---------------------- Singh as Prime Minister in June 1991. The NEP with its structural adjustment
and stabilization programme had one of its main focus areas – the reforms of
---------------------- the financial system in India. At that point of time, the financial system in India
---------------------- was in very bad shape with total lack of productivity, profitability, efficiency and
competition.
---------------------- The Government of India (the Congress-led Government in power) appointed
a high level committee on the Indian Financial System under the Chairmanship of
----------------------
Shri M. Narasimham to examine all aspects relating to the structure, organization,
---------------------- functions and procedures of the financial system. The Committee presented its
report in November 1991. The Committee made major recommendations on
---------------------- various aspects on the Indian Financial system. Major reforms are seen on the
acceptance of the report of the Committee and its implementation by the Reserve
----------------------
Bank of India.
---------------------- The chapter discusses the reforms and changes seen on the following aspects
-capital adequacy, prudential regulation and banking supervision. These have
----------------------
brought about major structural as well as regulatory policy changes in the Indian
---------------------- banking system.
---------------------- 8.2 BASEL NORMS

---------------------- Basel I was the round of deliberations by central bankers from around the
---------------------- world. In 1988, the Basel Committee (BCBS) in Basel, Switzerland, published
a set of minimal capital requirements for banks. This is also known as the 1988
---------------------- Basel Accord. It was enforced by law in the Group of Ten (G-10) countries in
1992, with Japanese banks permitted an extended transition period.
----------------------
Background
---------------------- The Basel Committee was formed in response to the messy liquidation of
---------------------- a Cologne-based Bank in the year 1974. On 26 June 1974, a number of banks
had released Deutschmark to the Bank Herstatt in exchange for dollar payments
---------------------- deliverable in New York. On account of differences in the time zones, there was

a lag in the dollar payment to the counter-party banks, and during this gap, and Notes
before the dollar payments could be effected in New York, the Bank Herstatt
was liquidated by German regulators. ----------------------
This incident prompted the G-10 nations to form the Basel Committee on ----------------------
Banking Supervision, under the auspices of the Bank of International Settlements
(BIS) located in Basel, Switzerland. This was done towards the end of 1974. ----------------------
Basel I, that is, the 1988 Basel Accord, primarily focused on credit risk.
----------------------
Assets of banks were classified and grouped in five categories according to
credit risk, carrying risk weights of zero (for example home country sovereign ----------------------
debt), ten, twenty, fifty, and up to one hundred percent (this category has, as an
example, most corporate debt). Banks with international presence are required ----------------------
to hold capital equal to 8 % of the risk-weighted assets.
----------------------
Since 1988, this framework has been progressively introduced in member
countries of the G-10. Most other countries, currently over 100, have also adopted, ----------------------
at least in name, the principles prescribed under Basel I. The efficiency with
----------------------
which they are enforced varies, even within nations of the Group of Ten. Basel I
is now widely viewed as outmoded, and a more comprehensive set of guidelines, ----------------------
known as Basel II are in the process of implementation by several countries.
The New Basel Capital Accord often referred to as the Basel II Accord or ----------------------
simply Basel II, was approved by the Basel Committee on Banking Supervision ----------------------
of the Bank for International Settlements in June 2004. It suggested that banks
and supervisory bodies implement the principles by the beginning of the year ----------------------
2007. A transition time of 30 months was been provided for. It was estimated
that the Accord would be implemented in over 100 countries, including India. ----------------------
Basel II is the second of the Basel Accords with recommendations on ----------------------
banking laws and regulations issued by the Basel Committee on Banking
Supervision, initially published in June 2004. ----------------------
The purpose of Basel II was to create an international standard that banking ----------------------
regulators can use while drafting regulations about how much capital banks need
to put aside to guard against the types of financial and operational risks banks ----------------------
face. Advocates of Basel II believe that such an international standard would
----------------------
help protect the international financial system from the types of problems that
might arise should a major bank or a series of banks collapse. ----------------------
In practice, Basel II attempts to accomplish the above objective by setting up
rigorous risk and capital management requirements designed to ensure that a bank ----------------------
holds capital reserves appropriate to the risk the bank exposes itself to through its ----------------------
lending and investment practices. Generally speaking, these rules mean that the
greater risk to which the bank is exposed, the greater the amount of capital the ----------------------
bank needs to hold to safeguard its solvency and overall economic stability.
----------------------
Basel II Accord
Pillar 1: Minimum Capital Requirements: ----------------------
It specifies new standards for minimum capital requirements, along with the ----------------------
methodology for assigning risk weights on the basis of credit risk and market
risk. It also specifies the capital requirement for operational risk. ----------------------

Notes Pillar 2: Supervisory Review:
It enlarges the role of banking supervisors and gives them power to them
----------------------
to review the banks’ risk management systems.
---------------------- Pillar 3: Market Discipline:
---------------------- It defines the standards and requirements for higher disclosure by banks on
capital adequacy, asset quality and other risk management processes.
----------------------
The Basel I accord dealt with only parts of each of these pillars. For example:
---------------------- with respect to the first Basel II pillar, only one risk, credit risk, was dealt with
in a simple manner while market risk was an afterthought; operational risk was
---------------------- not dealt with at all.
---------------------- The first pillar
---------------------- The first pillar deals with maintenance of regulatory capital calculated for
three major components of risk that a bank faces: credit risk, operational risk
---------------------- and market risk. Other risks are not considered fully quantifiable at this stage.
---------------------- (a) The credit risk component can be calculated in three different ways of varying
degree of sophistication, namely standardized approach, Foundation IRB
---------------------- and Advanced IRB. IRB stands for “Internal Rating-Based Approach”.
---------------------- (b) For operational risk, there are three different approaches - Basic Indicator
Approach or BIA, Standardized Approach or STA, and Advanced
---------------------- Measurement Approach or AMA.
---------------------- (c) For market risk, the preferred approach is VaR (value at risk).
---------------------- The second pillar

The second pillar deals with the regulatory response to the first pillar, giving
---------------------- regulators much improved ‘tools’ along with those available to them under Basel
---------------------- I.
It also provides a framework for dealing with all the other risks a bank
----------------------
may face, such as systemic risk, pension risk, concentration risk, strategic risk,
---------------------- reputation risk, liquidity risk and legal risk, which the accord combines under
the title of residual risk.
----------------------
The third pillar
---------------------- The third pillar greatly increases the disclosures that the bank must make.
This is designed to allow the market to have a better picture of the overall risk
----------------------
position of the bank and to allow the counterparties of the bank to price and deal
---------------------- appropriately.
---------------------- Approach of the Reserve Bank of India to Basel II Accord

The Reserve Bank of India has asked banks to move in the direction of
---------------------- implementing the Basel II norms and identify the areas that need strengthening
---------------------- in the process. In anticipation of Basel II, the Reserve Bank has requested banks
to examine the choices available to them and draw a roadmap for migrating to
---------------------- Basel II.

In implementing Basel II, the Reserve Bank is in favour of gradual Notes
convergence with the new standards and the best practices. The aim is to reach the
global best standards in a phased manner, taking a consultative approach rather than ----------------------
a directive one.
----------------------
The Reserve Bank has set up a steering committee to suggest migration
methodology to Basel II. Based on recommendations of the Steering Committee, ----------------------
in February 2005, the Reserve Bank has proposed the “Draft Guidelines for
----------------------
Implementing New Capital Adequacy Framework” covering the capital adequacy
guidelines of the Basel II accord. The Reserve Bank expects banks to adopt ----------------------
the Standardized Approach for the measurement of Credit Risk and the Basic
Indicator Approach for the assessment of Operational Risk. ----------------------
The Reserve Bank of India has also specified that the migration to Basel II ----------------------
will be effective March 31, 2007 and has suggested that banks should adopt the
new capital adequacy guidelines and parallel run effective April 1, 2006. Over time, ----------------------
when adequate risk management skills have developed, some banks may be allowed
to migrate to the Internal Ratings Based approach for credit risk measurement. ----------------------
The Reserve Bank of India introduced risk assets ratio system as a capital ----------------------
adequacy measure in 1992, in line with the Basel accord of 1988. It takes into
account the risk element in various types of funded balance sheet items as well ----------------------
as non-funded off balance sheet exposures. In fact, the norms on capital adequacy ----------------------
at 9% as implemented by the Reserve Bank are more stringent than the Basel
Committee stipulation of 8%. ----------------------
The initial capital accord of 1988 [Basel I] was hugely successful with more ----------------------
than 100 countries accepting it as a benchmark. One of the major reasons for
the success of this framework was its being simple. It brought in uniformity and ----------------------
attempted to make regulatory capital requirement consistent with the economic
capital. At the same time, it was criticized as being inflexible due to its focus on ----------------------
primarily credit risk. It treated all types of borrowers under one risk category ----------------------
regardless of their credit worthiness. It focused only on credit risk and did not
covering operational risk. There was lack of incentives for the adoption of the ----------------------
techniques of credit risk mitigation processes.
----------------------
Basel III
‘Basel III’ is a comprehensive set of reform measures, developed by the Basel ----------------------
Committee on Banking Supervision, to strengthen the regulation, supervision
----------------------
and risk management of the banking sector.
These measures aim to: ----------------------
i) improve the banking sector’s ability to absorb shocks arising from financial ----------------------
and economic stress, whatever the source
----------------------
ii) improve risk management and governance
iii) strengthen banks’ transparency and disclosures. ----------------------
The targeted reforms are: ----------------------
i) bank-level, or micro-prudential, regulation, which will help raise the
resilience of individual banking institutions to periods of stress. ----------------------

Notes ii) micro-prudential, system wide risks that can build up across the banking
sector as well as the pro-cyclical amplification of these risks over time.
----------------------
Basel III presented tighter capital requirements in comparison to Basel I and
---------------------- Basel II. Banks’ regulatory capital is divided into Tier 1 and Tier 2, while Tier 1 is
divided into Common Equity Tier 1 and additional Tier 1 capital. The distinction is
---------------------- important because security instruments included in Tier 1 capital have the highest
level of subordination. Common Equity Tier 1 capital includes equity instruments
----------------------
that have discretionary dividends and no maturity, while additional Tier 1 capital
---------------------- comprises securities that are subordinated to most subordinated debt, have no
maturity, and their dividends can be cancelled at any time. Tier 2 capital consists
---------------------- of unsecured subordinated debt with an original maturity of at least five years.
---------------------- Basel III left the guidelines for risk-weighted assets largely unchanged from Basel
II. Risk-weighted assets represent a bank’s assets weighted by coefficients of risk set
---------------------- forth by Basel III. The higher the credit risk of an asset, the higher its risk weight.
Basel III uses credit ratings of certain assets to establish their risk coefficients.
----------------------
In comparison to Basel II, Basel III strengthened regulatory capital ratios, which
---------------------- are computed as a percent of risk-weighted assets. In particular, Basel III increased
minimum Common Equity Tier 1 capital from 4% to 4.5%, and minimum Tier 1
----------------------
capital from 4% to 6%. The overall regulatory capital was left unchanged at 8%.
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
8.3 CAPITAL ADEQUACY RATIO
----------------------
One of the universally accepted/ recognized measures of strength and
---------------------- stability of banks is a reasonably high ratio of capital funds in relation to their
deposits or assets. Over the years, Indian banks have not been able to add
----------------------
sufficiently to their own resources in the form of reserves because of declining
---------------------- profitability. Consequently, the ratio of capital funds to risk-weighted assets of
banks is low even on the basis of published balance sheets which do not reflect
---------------------- uniform accounting practices. Some banks are seriously under-capitalized. In

recent years, there has been injection of capital from the Government in respect Notes
of public sector banks.
----------------------
The Basel Committee on Banking Regulations and Supervisory practices
appointed by the Bank of International Settlements (BIS) prescribed certain ----------------------
capital adequacy measures to be followed by commercial banks and several
countries have accepted these measures for implementation. The BIS stan-dard, ----------------------
as it is popularly known, seeks to measure capital adequacy as the ratio of
----------------------
capital to risk-weighted assets. The Basle Committee on Banking regulations
and supervisory practices of the Bank for International Settlements (BIS) had ----------------------
agreed in Dec. 1987 on a frame-work of capital standards for banks.
The basic objectives of such a frame-work are: ----------------------
 To strengthen the soundness and stability of the banking system. ----------------------

 To remove the inequality amongst the banks operating internationally and
----------------------
competing with each other.
 To devolve a common minimum capital standard to be achieved and ----------------------
maintained by banks operating internationally.
----------------------
The Committee on the Indian Financial System (1991), popularly referred to
as the Narasimham Committee, recommended the adoption of the capital norm ----------------------
in a phased manner; the 8% international standard as prescribed by the Basle
Committee. The Reserve Bank of India issued a detailed circular to banks in ----------------------
April 1992 on the subject and directed that they should achieve the prescribed ----------------------
8% ratio of capital to risk-weighted assets within the prescribed time-frame.
Time Frame for achieving Capital Adequacy ratio of 8% by banks: ----------------------
Indian Banks Time Schedule ----------------------

Having branches abroad 31st March 1994©
I laving no branches abroad 31st March 1996 ----------------------
@ since revised to 31st March 1995 ----------------------
Foreign Banks Operating in India 31st March 1993.
In case of both (a) and (b), 4% ratio should be achieved by March 1993. ----------------------
Capital Adequacy Ratio: Composition ----------------------
(I) Capital: For the purpose of capital adequacy norm, capital is divided into ----------------------
two tiers-Tiers I and Tier II.
(a) Tier I capital, also known as ‘Core Capital’ provides the most permanent and ----------------------
readily available support to a bank against unexpected losses. It comprises ----------------------
of the following elements and calculated as under:
(i) Paid-up Capital ----------------------
(ii) Statutory Reserves ----------------------
(iii) Other disclosed free reserves, if any
----------------------
(iv) Capital reserves representing surplus arising out of sale proceeds of assets
----------------------
Total (i) to (iv) = X
(v) Equity investments in subsidiaries ----------------------

Notes (vi) Intangible assets and losses in the cur-rent period and those brought for-ward
from previous periods.
---------------------- Total (v) to (vi) = Y
---------------------- Total capital = X - Y
(b) Tier II capital, also known as ‘Supplemen-tary Capital’, consists of elements
---------------------- that are less permanent in nature or are less readily avail-able. It may include
---------------------- any/all of the following.
(i) Undisclosed reserves and cumula-tive perpetual preference shares:
---------------------- (ii) Revaluation Reserves- These arise from revaluation of assets that are
---------------------- undervalued on the bank’s books, typi-cally bank premises and marketable
securities. Such reserves, to be pru-dent, should be discounted by 25%,
---------------------- before inclusion in Tier II capital.
(iii) General Provisions and Loss Reserves- These will be admitted up to a
----------------------
maximum of 1.25 per cent of weighted risk-assets.
---------------------- (iv) Hybrid debt capital instruments- number of capital instruments which have
characteristics of debt as well as capital fall in this category.
----------------------
(v) Subordinate Debt- Instruments with an initial maturity of less than 5 years
---------------------- or with a remaining maturity of one year should not be included in Tier II
Capital. These should be limited to 50 per cent of Tier I Capital.
----------------------
(c) The sum total of Tier I and Tier II constitutes the total capital, of which Tier
---------------------- I should be at least 50%. That is to say, since 8% is the minimum capital
adequacy requirement, Tier I capital should be at least 4%.
---------------------- (II) Risk-weighted Assets:
---------------------- (a) Both on-balance sheet and off-balance sheet items are assigned risk-weights,
based on which the total of risk-weighted assets is arrived at.
---------------------- (b) Capital Adequacy is calculated as follows
---------------------- X = [Capital/risk-weighted Assets] x 100
---------------------- Minimum requirements of Capital Adequacy Ratio in India : Jan 2010

Existing Banks 09 %
---------------------- New Private Sector Banks 10 %
Banks undertaking Insurance business 10 %
---------------------- Local Area Banks 15%
---------------------- The Reserve Bank of India has further plans to raise the capital adequacy
ratio to further higher levels.
----------------------
---------------------- 8.4 PRUDENTIAL NORMS

---------------------- The private and public sector commercial banks, co-operative, banks,
national and state level financial organizations have come to suffer from
---------------------- dangerously high level of Non Performing Assets (NPAs). The level of NPAs
differs from institution to institution, the high level of NPAs are eating into
----------------------
the vitals of Indian financial system; they have weakened the credit allocation,
---------------------- delivery and recovery systems.

Reasons for the high level of NPAs in India Notes
 Diversion of funds - One of the reasons for high level of NPAs is the
diversion of funds from the banking sector, i.e. from short term to long term, ----------------------
into sectors restricted by the RBI/monetary policy, etc. ----------------------
 Improper and inadequate credit appraisal - Banks are supposed to carry
out proper and systematic pre as well as post credit appraisal. ----------------------
 Poor post-loan supervision and follow-up - Banks are supposed to keep ----------------------
track of borrowers after loans have been sanctioned. Banks have to ensure
that the end-use of the loan is the same as the very purpose that it was taken. ----------------------
 Industrial sickness - Industrial sickness is on a rise in India. It is rampant ----------------------
at all level –small scale, medium as well as large scale industries. Corporate
debts form a good part of banks NPAs. ----------------------
 The slow and inefficient legal system - Loan recovery is a very difficult
----------------------
process due the legal system in India. Court cases remain pending for years
together with banks ending up with mounting losses. ----------------------
 Moral degradation – One sees an ethical deficit in today’s society; it afflicts our
social fibre and value system. Banks provide loans/make investments in areas/ ----------------------
sectors much against the policy of the central bank (RBI). In the temptation of ----------------------
making some quick money, banks get involved in scams and frauds.
 Product obsolescence - There is need for product innovation and ----------------------
diversification in the services provided by banks and financial institutions.
----------------------
New avenues of business need to be explored and novel products can provide
the opportunity to earn interest, commissions, fees, etc. Public sector banks ----------------------
are typically involved in providing the traditional functions of banks.
 Inefficient management and/ or strained labour relations- As in any ----------------------
organization, management-worker relations have a great influence on the ----------------------
performance of the firm. Trade unions are as active in the banking sector
as in any other sector. ----------------------
 Political compulsions and corruption – Political pressure and interference
----------------------
is very strongly seen on the credit policies of the banking system. Loan
melas and loan waivers are weapons used by political parties to please the ----------------------
vote bank.
----------------------
 Time/cost overrun during the project implementation stage - Repayment/
recovery gets delayed because there is delay in the completion of the project/s ----------------------
sanctioned by banks.
 Adverse changes in govt. policies such as excise/import duties, pollution ----------------------
control orders, etc. - Changes in government policies make businesses ----------------------
favourable or unfavourable and also lead to the ups and downs in the market.
Banking business is also affected by the ups and downs of the market. ----------------------
Income Recognition, Asset Classification and Provisioning
----------------------
The Narasimham Committee recommended the introduction of prudential
norms for improving the productivity and profitability of the Indian Banking ----------------------
System. The prudential norms cover the following: income recognition,
classification of assets and provisioning of bad debts. ----------------------

Notes Due to the introduction of these new norms, the scheduled commercial banks
had to make large provisions for bad and doubtful advances in their portfolio. As
---------------------- the resulting losses would erode the already inadequate capital of the banks, the
viability and financial health of the banking system was supported and promoted
---------------------- by the Government of India through budgetary support. The Union Government
---------------------- made budgetary provisions till 1994-95 for the purpose of recapitalization of
weakest public sector banks. These banks simultaneously agreed with the Reserve
---------------------- Bank to strengthen the bank management and improve efficiency.
---------------------- An Amendment was also initiated in the Banking Companies (Acquisition
and Transfer of Undertakings) Act, 1970/1980 authorizing SBI and other
---------------------- nationalized banks to approach the capital market to raise fresh equity to meet
shortfalls in their capital requirements. The Government would, however,
----------------------
continued to retain effective control on the public sector banks.
---------------------- The Health Code System
---------------------- In an attempt to revitalize the ailing banking system in India, the Reserve
Bank prescribed that all advances of a bank should be classified under the
---------------------- following health codes.
---------------------- The ‘Health Code System’ is a system used to conceptualize, recognize
and monitor the problem loans of banks and financial institutions. The system
---------------------- was introduced by the Reserve Bank in 1985-86. It asked banks to classify their
---------------------- advances in 8 categories as stated below:
1. Satisfactory: all terms and conditions are complied with and safety of
---------------------- advance not in doubt,
---------------------- 2. Irregular: although safety of the advance is not suspect, there are short-term
and occasional irregularities in meeting terms and conditions,
---------------------- 3. Sick-viable: advances to sick but viable units in respect of which nursing
---------------------- and revival programmes are introduced,
4. Sick-non-viable or sticky: the irregularities continue to persist,
----------------------
5. Recalled accounts: those in case of which repayment is highly doubtful,
---------------------- nursing is not considered worthwhile, and decision has been taken to recall
the advances,
---------------------- 6. Suit-filed accounts: accounts where legal action has been initiated,
---------------------- 7. Decreed debts; where decrees have been obtained,
8. Bad and doubtful accounts: recovery of dues has become doubtful.
----------------------
The Reserve Bank of India had directed that in respect of advances covered
---------------------- by the Health Code 5 to 8, interest should not be recognized until it is realized.
---------------------- The Narasimham Committee (1991) observed that the policy of income
recognition should be objective and based on the record of recovery rather than on
---------------------- any subjective considerations. However, the health code system or classification
was not useful as an enforcement tool. It was characterized by an absence of
---------------------- a transparent, objective and uniform yardstick for measurement of problem
---------------------- advances.

Therefore, on the recommendation of the Narasimham Committee, the Notes
Reserve Bank of India introduced prudential regulations relating to income
recognition, asset classification and provisioning. The new norms brought about ----------------------
the necessary quantification and objectivity into the assessment of NPAs which
was absent in the earlier ‘health code system’. ----------------------
Income Recognition- Income should not be recognized on NPAs on accrual ----------------------

basis but should be booked only when it is actually realized.
----------------------
Asset Classification- Assets should be classified as NPA, substandard,
doubtful, and loss. ----------------------
Provisioning- Based on the asset classification, the banks should make ----------------------
provision against NPAs at 100 per cent for loss assets.
----------------------
Non-Performing Asset
The Non-Performing Advance / Asset (NPA) is an advance where payment ----------------------
of interest and/or repayment of installment of principal remain unpaid for a period ----------------------
of two quarters or more. The advance is treated as “past due” if it remains unpaid
for 30 days beyond due date. ----------------------
Standard Assets ----------------------
 Standard assets are the ones in which the bank is receiving interest as well
----------------------
as the principal amount of the loan regularly from the customer.
 Here, the arrears of interest and the principal amount of loan do not exceed ----------------------
90 days at the end of financial year.
----------------------
 If asset fails, i.e. the amount is due for more than 90 days, then it is NPA.
----------------------
NPAs are further need to classify in sub categories: Sub-standard Assets;
Doubtful Assets and Loss Assets ----------------------
Sub-standard Assets: ----------------------
 A sub-standard asset would be one, which has remained NPA for a period
----------------------
less than or equal to 12 month (with effect from 31 March 2005).
 In case of sub standard assets: ----------------------
 the current net worth of the borrowers / guarantor or the current market ----------------------
value of the security charged is not enough to ensure recovery of the dues
to the banks in full; ----------------------
 the asset has a well-defined credit weaknesses that jeopardize the liquidation ----------------------
of the debt
----------------------
 At the same time, there is a distinct possibility that the banks will sustain
some loss, if deficiencies are not corrected. ----------------------
Doubtful Assets: ----------------------
An asset would be classified as doubtful if it remained in the sub-standard
----------------------
category for 12 months (with effect from March 31, 2005).
----------------------

Notes  A loan classified as doubtful has all the weaknesses inherent in assets that
were classified as sub-standard.
----------------------  It also shows the added characteristic that the weaknesses make liquidation
---------------------- of the asset and collection of debt in full highly questionable and improbable.
 Doubt assets are also classified as
----------------------
– Doubtful 1 (upto 1 year)
---------------------- – Doubtful 2 (one to three years)
---------------------- – Doubtful 3 (three years & More)
Loss Assets:
----------------------
A loss asset is one
----------------------  That is considered uncollectible;
----------------------  That it is of such little value that its continuance as a bankable asset is not
warranted- although there may be some salvage or recovery value.
----------------------
 These assets would have been identified as ‘loss assets’ by the bank or
---------------------- internal or external auditors or the RBI inspection. However, the amount
would not have been written-off wholly.
----------------------
Loss advance is an advance which is considered uncollectible or only marginally
---------------------- collectible.
---------------------- Net Advance = Gross Advance - Total Deductions as mentioned under net NPA.
Gross NPA is an advance which is considered irrecoverable, for which bank has
---------------------- made provisions, and which is still held in bank’s books of account.
---------------------- Net NPA = Gross NPA – [Balance in interest suspense account +
DICGC/ECGC claims received and held pending +
----------------------
Adjustment part payment received & kept in suspense account + total
---------------------- provisions held, if any]
---------------------- Provisioning Norm. (i) Standard Assets: 0.25 % for all type of
---------------------- (w. e. f from April 1st, 2010) standard advances.
(ii) Sub standard- 10%
----------------------
(iii) Doubtful (up to one year): 100% of
---------------------- unsecured portion plus 20% of secured
portion (iv) Doubtful (one to three
----------------------
years): 100% of unsecured portion plus
---------------------- 30% of secured portion (v) Doubtful
for more than 3 years D-III) : 100% of
---------------------- unsecured portion plus 50% of secured
portion (vi) Loss: 100%.
----------------------
Source: www.rbi.org.in
----------------------
----------------------

8.5 SUPERVISION AND REGULATION BY RESERVE Notes
BANK OF INDIA
----------------------
The Board for Financial Supervision was constituted in November 1994
as a committee of the Central Board of Directors of the Reserve Bank of India. ----------------------
The Reserve Bank performs the supervisory function under the guidance of the ----------------------
Board for Financial Supervision (BFS). The Primary objective of the Board is to
undertake consolidated supervision of the financial sector comprising commercial ----------------------
banks, financial institutions and non-banking finance companies. [Refer Unit 1]
----------------------
Focus on ‘On-site’ supervision and ‘off-site’ monitoring & surveillance
----------------------
The Working Group to Review the System of On-site supervision over
Banks (S. Padmanabhan, Feb 1995) reemphasized on the primacy of on-site ----------------------
inspection and recommended switching over to a system of ongoing supervision.
The Working Group recommended a strategy of periodical full-scope ‘on-site ----------------------
examinations’ supplemented by and in-house ‘off-site monitoring’ system and
----------------------
linked exercises in between two statutory examinations.
An On-site Inspection system focuses on statutorily mandated areas ----------------------
of solvency, liquidity and operational health of the banks. It is stated that a ----------------------
periodic and full-scope statutory examinations should concentrate on core
areas of assessment: (i) financial condition and performance; (ii) management ----------------------
and operating condition; and (iii) compliance and summary assessment. This
should fall in line with the internationally adopted bank-rating system where ----------------------
bank supervisory authorities rate institutions according to six factors. ----------------------
For Indian Banks: CAMELS (Capital adequacy, Asset quality, Management,
Earnings, Liquidity and System) ----------------------
For Foreign Banks: CALCS (Capital adequacy, Asset quality, Compliance, ----------------------
Systems and Controls)
----------------------
Bank supervisory authorities assign each bank a score on a scale of one
(best) to five (worst) for each factor. If a bank has an average score less than two ----------------------
it is considered to be a high-quality institution, while banks with scores greater
----------------------
than three are considered to be less-than-satisfactory establishments. The system
helps the supervisory authority identify banks that are in need of attention. ----------------------
The off-site Monitoring and Surveillance (OSMOS) system was
----------------------
operationalized in 1995 as part of crisis management framework for early warning
system and as a trigger for on-site inspections of vulnerable institutions. ----------------------
The primary objective of the off site surveillance is to monitor the financial
----------------------
health of banks between two on-site inspections, identifying banks which show
financial deterioration and would be a source for supervisory concerns. This acts ----------------------
as a trigger for timely remedial action.
----------------------
The Banks were required to increase the level of utilization of the INFINET
for regulatory-cum-supervisory reporting. The Role of External auditors in bank ----------------------
supervision has also been strengthened.
----------------------

Notes
----------------------

1. According to Basel II Accord, new standards for minimum capital
---------------------- requirements, along with the methodology for assigning risk weights
---------------------- on the basis of credit risk and market risk are specified by
i. Pillar III
---------------------- ii. Pillar II
---------------------- iii. Pillar I
iv. Minimum Capital Requirement
----------------------
2. As per the Basel Accord, the sum total of Tier I and Tier II constitutes
---------------------- the total capital, of which Tier I should be at least this much percentage.
i. 100%
----------------------
ii. 75%
---------------------- iii. 50%
---------------------- iv. 25%
3. Which committee recommended for the first time the introduction of
---------------------- prudential norms for improving the productivity and profitability of
---------------------- the Indian Banking System?
i. Tandon Committee
---------------------- ii. Talwar Committee
---------------------- iii. The Narasimham Committee
iv. Narayan Moorthy Commitee
----------------------
----------------------
Activity 1
----------------------
---------------------- Study the Balance Sheet of any bank of your choice and calculate the Capital
Adequacy Ratio (CAR) achieved by the bank over a period of 3 years.
----------------------
---------------------- Summary
---------------------- ●● The Narasimham Committee (1991) aimed at achieving three major
changes/improvements in the banking system in India: (i) A degree
----------------------
of operational flexibility; (ii) Internal autonomy for the banks in their
---------------------- decision-making process; and (iii) Greater degree of professionalism in
banking operations. The Government of India along with the Reserve
---------------------- bank of India has introduced a number of changes/ reforms in the Indian
financial sector in the light of the Narasimham Committee report.
----------------------
●● Reforms in the financial sector has had a positive impact on the working
---------------------- and operations of the banking system in particular; it is reflecting in the

reduction in non-performing assets, rise in operating profits, strengthening Notes
the capital base and a cleaner balance sheet. These reforms have improved
the health of the crippling Indian Financial system. ----------------------
●● The Government of India and the Reserve Bank of India now have to ----------------------
march ahead and further the process of reforms in the financial sector.
The reforms process initiated since 1991 have helped strengthen the weak ----------------------
financial system and rekindle the process of growth. Further reforms have
to be introduced to achieve high quality growth. The future of reform, it is ----------------------
said has to focus on the improvement of the organizational effectiveness ----------------------
of banks and other financial institutions. There are a few challenges
for the financial sector in India: improvement of the risk management ----------------------
systems, complete the process of implementation of new accounting
standards, improve upon the level of transparency and disclosures, focus ----------------------
on customer service and application of technology. ----------------------
Keywords ----------------------
●● Basel Accord: Round of deliberations of central bankers around the ----------------------

world. ----------------------
●● Basel I: The first 1988 Basel Accord focusing only on credit risk of banks.
----------------------
●● Basel II: The second round of deliberations held in 2004 focusing on
market discipline and disclosure requirements along with capital adequacy ----------------------
requirements.
----------------------
●● Basel III: The guidelines aim to promote a more resilient banking system
by focusing on four vital banking parameters viz. capital, leverage, ----------------------
funding and liquidity.
----------------------
●● Capital Adequacy Ratio: The ratio of capital funds to risk-weighted
assets of banks. ----------------------
●● Non-performing asset: an advance where payment of interest and/or
----------------------
repayment of installment of principal remain unpaid for a specified period.
●● Standard asset: Ones in which the bank is receiving interest as well as ----------------------
the principal amount of the loan regularly from the customer.
----------------------
●● Sub-standard asset: One which has remained NPA for a period less than
or equal to 12 month. ----------------------
●● Doubtful asset: One, which has remained in the sub-standard category ----------------------
for a period of 12 month.
●● Loss asset: An asset that is considered to be irrecoverable or incollectible. ----------------------
●● Camels: Capital adequacy, Asset quality, Management, Earnings, ----------------------

Liquidity & System.
----------------------
----------------------
----------------------

Notes
----------------------
1. Discuss in detail the Basel Accord.
---------------------- 2. Discuss in detail the Basel II Accord.
---------------------- 3. Bring out the difference between Basel I and Basel II Accord.
4. What are the causes for the high level of Non-performing Assets in India?
----------------------
5. Give the Classification of Non-performing Assets.
---------------------- 6. What are Prudential Norms?
---------------------- 7. What is meant by Income Recognition and Asset Classification?
---------------------- 8. Explain Capital Adequacy Ratio.

9. Write a note of Banking Supervision in India.
----------------------
10. What is meant by ‘On-site’ and ‘off-site’ Supervision?
----------------------
----------------------
----------------------
---------------------- 1. According to Basel II Accord, new standards for minimum capital
requirements, along with the methodology for assigning risk weights on
----------------------
the basis of credit risk and market risk are specified by
---------------------- iii. Pillar I
---------------------- 2. As per the Basel Accord, the sum total of Tier I and Tier II constitutes the
total capital, of which Tier I should be at least this much percentage.
----------------------
iii. 50%
----------------------
3. Which committee recommended for the first time the introduction of
---------------------- prudential norms for improving the productivity and profitability of the
Indian Banking System?
----------------------
iii. The Narasimham Committee
----------------------
Suggested Reading
----------------------
----------------------
----------------------
----------------------

Foreign Exchange Management Act, 1999
UNIT
9
Structure:
9.1 Introduction
9.2 Definitions
9.3 Regulation & Management of Foreign Exchange
9.4 Powers of RBI
9.5 Penalties
9.6 Directorate of Enforcement
Summary
Key words
Suggested Reading
Foreign Exchange Management Act, 1999 159

Notes
Objectives
----------------------
• Explain the concept ‘authorised person’ and ‘foreign exchange’
----------------------
• Define the concept of ‘person resident in India’
----------------------
• Detail out the activities permitted involving foreign exchange
----------------------
---------------------- 9.1 INTRODUCTION

---------------------- The main objective of the Foreign Exchange Regulation Act, 1973 (FERA)
was to consolidate and amend the existing laws that regulated certain payments
---------------------- and dealings in foreign exchange and securities; transactions, indirectly affecting
foreign exchange; the import and export of currency, the conservation of the
----------------------
foreign exchange resources and finally, the proper utilization of this foreign
---------------------- exchange so as to promote the economic development of the country. The FERA
has been repealed and replace by FEMA i.e. Foreign Exchange Management Act,
---------------------- 1999.
---------------------- The objective behind the Foreign Exchange Management Act, 1999
(FEMA) is to consolidate and amend the law relating to foreign exchange with
---------------------- the objective of facilitating external trade and payments and for promoting the
---------------------- orderly development and maintenance of foreign exchange market in India.
The provisions of the FEMA extends to all over India and also applies to
---------------------- all branches, offices and agencies outside India owned or controlled by a person
---------------------- resident in India and also to any contravention committed outside India by any
such person to whom this Act applies.
----------------------
9.2 DEFINITIONS
----------------------
---------------------- Authorized Person: The term ‘authorized person’ is defined under Section
2(c) as to mean an authorized dealer, money changer, offshore banking unit or
---------------------- any other person for the time being authorized to deal in foreign exchange or
foreign securities.
----------------------
Capital Account Transaction: ‘Capital account transaction’ has been
---------------------- defined under Section 2(e) as to mean any transaction which alters the assets or
liabilities including contingent liabilities, outside India of persons resident in
---------------------- India or assets or liabilities in India of person resident outside India and includes
---------------------- the transactions referred in sub-section (3) of Section 6.
Currency: The term Currency as defined under Section 2(h) includes
---------------------- all currency notes, postal notes, postal orders, money orders, cheques, drafts,
---------------------- travellers cheques, letters of credit, bills of exchange and promissory notes, credit
cards or such other similar instruments, as may be notified by the Reserve Bank.
----------------------

Current Account Transactions: Section 2(j) of the Act defines the term Notes
Current Account Transactions as to mean a transaction other than a Capital
Account Transaction and includes payments due in connection with foreign trade, ----------------------
other current business, services, short term banking and credit facilities in the
ordinary course of business; payment due as interest on loans and as net income ----------------------
from investments, remittance for living expenses of parents, spouse and children ----------------------
residing abroad; and expenses in connection with foreign travel, education and
medical care of parents, spouse and children. ----------------------
Foreign Exchange: Clause (n) of Section 2 defines the term ‘foreign ----------------------
exchange’ as to mean foreign currency and includes deposits, credits, balances
payable in foreign currency, drafts, travellers cheques, letters of credits, bills ----------------------
of exchange expressed or drawn in Indian currency but payable in any foreign
----------------------
currency. Any draft, travellers cheque, letters of credit or bills of exchange drawn
by banks, institutions or persons outside India but payable in Indian currency ----------------------
have also been included in the definition of foreign exchange.
----------------------
Foreign Security: In terms of clause (o) of Section 2, Foreign Security
has been defined as to mean any security in the form of shares, stocks, bonds, ----------------------
debentures or any other instrument denominated or expressed in foreign currency
and includes securities expressed in foreign currency but where redemption or ----------------------
any form of return such as interest or dividend is payable in Indian currency.
----------------------
Under the FEMA ‘security’ is defined to include shares, stocks, bonds and
debentures, Government securities, savings certificates, deposit receipts and ----------------------
units of any mutual fund etc. However, it does not include bills of exchange
----------------------
or promissory notes other than Government promissory notes or any other
instruments which may be notified by the RBI. ----------------------
Person: Under Section 2(u) includes, a ‘person’ is defined to include ----------------------
the following entities: (i) an individual; (ii) a Hindu Undivided Family; (iii)
a company; (iv) a firm; (v) an association of persons or a body of individuals, ----------------------
whether incorporated or not; (vi) every artificial juridical person; and (vii) any
agency, office or branch owned or controlled by such person. ----------------------
Person Resident in India; Under section 2(v), ‘Person resident in India’ ----------------------
means the following:
----------------------
(i) A person residing in India for more than one hundred and eighty-two days
in the preceding financial year but does not include ----------------------
(A) A person who has gone out of India or who stays outside India: ----------------------
(a) for taking up employment outside India, or
----------------------
(b) for carrying on a business or vocation outside India, or
----------------------
(c) for any other purpose, in such circumstances as would indicate his
intention to stay outside India for an uncertain period; ----------------------
(B) A person who has come to India or stay in India, otherwise than: ----------------------
(a) for taking up employment in India, or
----------------------

Notes (b) for carrying on a business or vocation in India; or
(c) for any other purpose, in such circumstances as would indicate his
----------------------
intention to stay in India for an uncertain period;
---------------------- (ii) Any person or body corporate registered or incorporated in India;
---------------------- (iii) An office, branch or agency in India owned or controlled by a person resident
outside India;
----------------------
(iv) An office, branch or agency outside India owned or controlled by a person
---------------------- resident in India. Accordingly, a ‘person resident outside India’ means a
person who is not resident in India as above.
----------------------
‘Repatriate to India’ means bringing into India, foreign exchange and
---------------------- selling it to an authorized person in India in exchange for rupees.
----------------------
9.3 REGULATION AND MANAGEMENT OF FOREIGN
---------------------- EXCHANGE
----------------------
Prohibits dealing in Foreign Exchange (Section 3)
----------------------  The Act prohibits any person other than an authorized person from dealing
---------------------- in or transferring any foreign exchange or foreign security to any person or
make any payment to or for the credit of any person resident outside India in
---------------------- any manner; or receive otherwise through an authorized person any payment
by order or on behalf of any person resident outside India in any manner
---------------------- except as provided in the Act, rules or regulations made there under or with
---------------------- the general or special permission of the Reserve Bank of India.
 Any person in or resident in India receives any payment by order or on behalf
---------------------- of any person resident outside India through any other person (including
---------------------- an authorized person) without a corresponding inward remittance from any
place outside India, then such person shall be deemed to have received such
---------------------- payment otherwise than through an authorized person.
----------------------  A person, other than the authorized person, is prohibited to enter into any
financial transaction in India as consideration for or in association with
---------------------- acquisition or creation or transfer of rights to acquire, any asset outside
India by any person, except as otherwise provided in the Act and Rules
----------------------
or Regulations made there under. For this purpose, financial transaction
---------------------- has been defined to mean making any payment to or for the credit of any
person or receiving any payment for by order or on behalf of any person or
---------------------- drawing, issuing or negotiating any bill of exchange or promissory note or
transferring any security or acknowledging any debt.
----------------------
Any person who wants to carry out the following activities has to do so in
---------------------- accordance with the provisions of the FEMA.
----------------------  To deal/transfer any foreign exchange or foreign security to any person other
than an authorized person;
----------------------

 To make any payment to any person resident outside India; Notes
 To receive (otherwise through an authorized person) any payment on behalf
----------------------
of any person resident outside India.
 To enter into any financial transaction in India in relation to a right to acquire ----------------------
any asset outside India by any person.
----------------------
At any point of time, if the Act prescribes the approval of the RBI, it has to
be obtained. ----------------------
A person resident in India can hold, own, transfer or invest in foreign ----------------------
currency, foreign security or any immoveable property situated outside India
if it was acquired, held or owned by such person when he was resident outside ----------------------
India. ----------------------
There is no bar on a person resident outside India to hold, own, transfer or
invest in foreign currency, foreign security or any immoveable property situated ----------------------
outside India. ----------------------
Every exporter of goods and services has to furnish the necessary data by
way of a declaration to the RBI. Such export proceeds cannot be held in foreign ----------------------
countries and has to be repatriated to India. Non-repatriation is a violation of the ----------------------
provisions of the FEMA.
----------------------
Current Account Transactions: Section 5 of the Act allows any person
to sell or draw foreign exchange to or from an authorized person if such sale or ----------------------
withdrawal is a current account transaction. However, the Central Government
may, in the public interest and in consultation with the Reserve Bank impose ----------------------
such reasonable restrictions for current account transactions.
----------------------
Capital Account Transaction: Section 6 allows capital account transactions
as specified by the Reserve Bank of India. Reserve Bank of India may in ----------------------
consultation with the Central Government specify any class or classes of capital
----------------------
account transactions permissible and the limit upto which foreign exchange shall
be permissible for such transactions. However, Reserve Bank shall not impose ----------------------
any restrictions on the withdrawal of foreign exchange for payments due on
account of amortization of loans or for depreciation of direct investments in the ----------------------
ordinary course of business.
----------------------
9.4 POWERS OF RBI ----------------------
Powers of Reserve Bank of India (Section 6(3)) ----------------------

 RBI is empowered to make regulations to prohibit, restrict or regulate the ----------------------
transfer or issue of any foreign security by a person resident in India or by
a person resident outside India. ----------------------
 RBI may also regulate, prohibit or restrict transfer or issue of any security ----------------------
or foreign security through any branch, office, or agency in India of a person
resident outside India. Any borrowing or lending in foreign exchange ----------------------
in whatever form or by whatever name called may also be regulated or ----------------------
prohibited by the Reserve Bank.

Notes  RBI may prohibit or restrict any borrowing or lending in rupees in whatever
form or by whatever name called between a person resident in India and a
---------------------- person resident outside India. Deposits between persons’ resident in India
and person resident outside India may also be restricted, prohibited by the
---------------------- Reserve Bank of India.
----------------------  RBI may also regulate the export, import or holding of currency or currency
notes.
----------------------
 RBI may also prohibit acquisition or transfer of immovable property in India
---------------------- other than a lease not exceeding five years by person outside India
----------------------  RBI has also been empowered to prohibit or regulate giving of guarantee
or surety in respect of any debt, obligation or other liability incurred by a
---------------------- person resident in India and owed to a person resident outside India or by
a person resident outside India.
----------------------
 RBI under section 6(6) has been empowered to prohibit, restrict or regulate
---------------------- establishment in India of a branch, office or other place of business by a
---------------------- person resident outside India, for carrying on any activity relating to such
branch, office or other place of business.
---------------------- Requirement under the Act regards Export of Goods & Services (Section 7)
----------------------  Every exporter is required to furnish to Reserve Bank or any other authority
as prescribed, a declaration containing true and correct particulars regarding
---------------------- the amount representing the full export value or if the full export value of
---------------------- the goods is not ascertainable at the time of export, the value which the
exporter having regard to prevailing market conditions expects to receive
---------------------- on sale of the goods in a market outside India.
----------------------  Every exporter is also required to furnish to the Reserve Bank such other
information as may be required by the Reserve Bank for the purpose of
---------------------- ensuring the realization of the export proceeds.
----------------------  The Reserve Bank may, for the purpose of ensuring that the full export
value of the goods or such reduced value of the goods as the Reserve Bank
---------------------- determines having regard to the prevailing market conditions, is received
without delay, direct any exporter to comply with such requirements as it
----------------------
deems fit.
----------------------  The exporters of services are required to submit to the Reserve Bank or any
---------------------- other authorities as may be prescribed, a declaration containing the true and
correct particulars in relation to payment for such services.
---------------------- Exemptions to hold Foreign Exchange (Section 9)
---------------------- The exemptions in respect of holding of foreign exchange, realization and
repatriation of foreign exchange in certain circumstances are as follows:
----------------------
 Possession of foreign currency or coins by any person up to such limit as
---------------------- the Reserve Bank may specify is not prohibited.
----------------------

 A person or class of persons may hold and operate foreign currency account Notes
within the prescribed limits as may be specified by the Reserve Bank.
----------------------

 Foreign exchange acquired or received before 8th July 1947, or any income
arising or accruing thereon, which is held outside India, in pursuance of a ----------------------
general or special permission of RBI, is also exempted.
----------------------

 Provisions relating to holding of foreign exchange shall not be applicable to
person resident in India upto such limit as the Reserve Bank may specify, ----------------------
if such foreign exchange was acquired by way of gift or inheritance from
certain persons mentioned above and any income arising therefrom. ----------------------

 Reserve Bank may also specify the exemption limit upto which the foreign ----------------------
exchange earned by a person from employment, business, trade, vocation
services, honorarium, gifts, inheritance or other legitimate means. Reserve ----------------------
Bank may also exempt such other receipts as it thinks fit.
----------------------
Power of Reserve Bank to appoint Authorized Person (Section10)
----------------------

 The Act empowers the RBI to authorize any person, on an application made
to be known as authorized person. The person is permitted to deal in foreign ----------------------
exchange or in foreign securities as an authorized dealer, money changer or
offshore banking unit or in any other manner as the RBI deems fit. ----------------------

 The authorization shall be in writing and subject to the conditions laid down ----------------------
by the RBI.
----------------------

 The Act also empowers the Reserve Bank of India to revoke the authorization
granted to any person at any time in the public interest. ----------------------

 It may also revoke the authorization in case the authorized person failed to ----------------------
comply with the conditions subject to which the authorization was granted or
contravened any of the provisions of the Act, rules, regulations, notifications ----------------------
or directions.
----------------------

 The RBI gives the authorized person an opportunity to present his case,
prior to revoking such authorization. ----------------------
Duties of the Authorized person ----------------------

 Authorized person is required to comply with the directions of the Reserve ----------------------
Bank with regard to all his dealing in foreign exchange or foreign security.
----------------------

 Authorized person shall not engage in any transaction involving any foreign
exchange or foreign security, which is not in conformity with the terms of ----------------------
his authorization.
----------------------

 An authorized person, before undertaking any transaction in foreign
exchange on behalf of any person, shall require that person to make ----------------------
such declaration and give such information as will reasonably satisfy the
authorized person. The declaration should state that the transaction will ----------------------
not involve or is not intended to violate or contravene any provisions of
----------------------
the Act, rules, notifications or directions. In case, the person refuses to
comply with such requirement or makes only unsatisfactory compliance, ----------------------

Notes the authorized person shall refuse in writing to act on behalf of such person
in such transaction and report the matter to RBI.
----------------------

 Any person, other than an authorized person, who has acquired or purchased
---------------------- foreign exchange for any purpose mentioned in the declaration made by
him to the authorized person does not use it for such purpose or does not
---------------------- surrender it to authorized person within the specified period, or uses the
foreign exchange for any other purpose, which is not permitted under the
----------------------
provisions of the Act, such person shall be deemed to have committed
---------------------- contravention of the provisions of the Act.
Power of Reserve Bank to issue Directions to Authorized Person (Section 11)
----------------------

 The Act empowers the RBI to issue directions to authorized person in
---------------------- regard to making of payment or doing or desist from doing any act relating
to foreign exchange or foreign security.
----------------------

 The Reserve Bank has also been empowered to issue directions to the
---------------------- authorized persons to furnish such information in such manner as it deems
---------------------- fit.

 An authorized person contravening any direction given by the RBI or fails
---------------------- to file the return as directed by RBI, shall be liable to a fine not exceeding
---------------------- Rs. 10,000/- and in the case the contravention continues, with an additional
penalty which may extend to Rs. 2,000 for every day during which such
---------------------- contravention continues.
---------------------- Power of Reserve Bank to Inspect Authorized Person (Section12)

 The Act empowers the RBI to inspect the business of any authorized person
----------------------
for the purpose of verifying the correctness of any statement, information
---------------------- or particulars furnished.

 In case the authorized person fails to furnish the information sought, the
----------------------
RBI can initiate inspection of the authorized person for obtaining such
---------------------- information.
----------------------
 The RBI may also inspect the business of an authorized person for securing
compliance with the provisions of the Foreign Exchange Management Act
---------------------- or any of the Rules, Regulations or directions.
----------------------
 The Reserve Bank may make an order in writing authorizing any of its
officers for this purpose.
----------------------
 When an inspection is initiated by the Reserve Bank, it shall be the duty
---------------------- of every authorized person, (where the authorized person is a company or
firm, every director, partner or officer of such a company or firm) to produce
---------------------- before the inspecting officer such books, accounts and other documents
in his custody and to furnish any statement or information relating to the
---------------------- affairs of such person, company or firm within such time and the manner
---------------------- as directed by the inspecting officer.
----------------------

9.5 PENALTIES Notes

 If any person contravenes any provisions of the Act, rules, regulations etc. ----------------------
or contravenes any condition subject to which the authorization is granted
by the RBI, he shall be liable for penalty upon adjudication. ----------------------

 The penalty may extend upto thrice the sum involved in such contravention ----------------------
where such amount is quantifiable or upto two lakh rupees where the amount
is not quantifiable. If the contravention continues, the penalty of Rs. 5,000 ----------------------
per day after the first day during the period in which the contravention ----------------------
continues shall be imposed.

 The Adjudicating Authority adjudging any contravention is empowered to ----------------------
confiscate any currency, security or any other money or property in respect ----------------------
of which the contravention has taken place.
----------------------

 It may further direct that the foreign exchange holdings if any, of the persons
committing the contravention shall be brought back either to India or retained ----------------------
outside India.
----------------------

 The property shall include deposits in a bank, where such property has been
converted into such deposits; Indian currency, where the said property is ----------------------
converted into such currency; and any other property, which has resulted
out of the conversion of that property. ----------------------
----------------------
9.6 DIRECTORATE OF ENFORCEMENT
----------------------

 The Central Government shall establish a Directorate of Enforcement with
a director and such other officers or class of officers as it thinks fit, who ----------------------
shall be called officers of Enforcement.
----------------------

 An officer of Enforcement may exercise the powers and discharge the duties
conferred or imposed on him under this Act. ----------------------

 The Director of Enforcement and other officers not below the rank of an ----------------------
Assistant Director shall take up for investigation on the contravention of
any provisions of s.13. ----------------------

 In addition, the Central Government may by notification authorize any officer ----------------------
or class of officers in the Central Government, State Government, Reserve
Bank of India, not below the rank of under-secretary to Government of India ----------------------
to investigate any such contravention. ----------------------

 The officer so appointed shall exercise the like powers which are conferred
on the income-tax authorities under the Income-tax Act, 1961, subject to ----------------------
such conditions and limitation as the Central Government may impose. ----------------------
Powers of the Directorate
----------------------

 The director of enforcement and other officers of enforcement, not below
the rank of an assistant director can investigate contraventions. ----------------------
----------------------

Notes
 The Central Government can also authorize any class of officers in the Central
Government, State Government or the RBI to investigate contraventions.
----------------------

 The Central Government can (subject to conditions and limitations),
---------------------- authorize any customs officer/ central excise officer/any police officer/any
other officer of the Central Government or a State Government to exercise
---------------------- the powers and discharge the duties of the director of enforcement or any
other officer of enforcement.
----------------------

----------------------
Fill in the blanks.
----------------------
1. RBI may prohibit or restrict any borrowing or lending in rupees, in
---------------------- whatever form or by whatever name, called between a person ______
and a person ______.
----------------------
2. An authorised person contravening any direction given by the RBI or
---------------------- one who fails to file the return as directed by RBI, shall be liable to a
fine not exceeding Rs. ______.
----------------------
3. The primary difference between FERA and FEMA lies in the fact that
---------------------- offences under FEMA are not regarded as ______ offences and only
invite penalties, not prosecution and imprisonment.
----------------------
4. A Person Resident in India is a person residing in India for more than
---------------------- ______ in the preceding financial year.
----------------------
---------------------- Summary
---------------------- ●● FERA was introduced at a time when foreign exchange) reserves of the
country were abnormally low and considered to be a scarce commodity.
----------------------
FERA therefore worked on the presumption that all foreign exchange
---------------------- earned by Indian residents rightfully belonged to the Government of
India and had to be collected and surrendered to the Reserve bank of
---------------------- India. It regulated not only transactions in foreign exchange, but also
all financial transactions with non-residents. FERA primarily prohibited
----------------------
all transactions, except to the extent permitted by general or specific
---------------------- permission by RBI. Violations under the FERA were referred to as a
criminal offence.
---------------------- ●● With the winds of liberalization blowing in the early 1990’s, many
---------------------- changes came in - foreign exchange reserves swelled, the rupee was
made convertible on current account and the Government relaxed the
---------------------- harsh provisions of FERA by issuing notifications. In the changing
atmosphere, it was realized by the Government of India that possession
---------------------- of forex could no longer be regarded as a crime. There was a need to refer
---------------------- it to as an economic offence and the more appropriate punishment was a

penalty. As a result came the need for the amendment of the FERA. So the Notes
FERA was repealed and was replaced by FEMA. The primary difference
between FERA and FEMA therefore lies in the fact that offences under ----------------------
FEMA are not regarded as criminal offences and only invite penalties, not
prosecution and imprisonment. ----------------------
●● The FEMA emphases on the management of foreign exchange; it is much ----------------------

need in times when the foreign exchange reserves have swelled, controls
are no longer needed. There is no need to seek permission in case of ----------------------
remittances regards external trade except for transactions in terms of ----------------------
foreign exchange. Similarly, restrictions on all drawal of foreign exchange
transactions on current account transactions have been relaxed. Likewise, ----------------------
capital account transactions are also permitted by the Reserve Bank as
specified and upto permissible limits. Violations under the FEMA are ----------------------
treated as a civil offence, unlike under FERA, with certain penalties and ----------------------
fines.
----------------------
Keywords ----------------------
●● Authorized Person - An authorized dealer, money changer, offshore ----------------------
banking unit or any other person for the time being authorized to deal in
foreign exchange or foreign securities. ----------------------
●● Currency - All currency notes, postal notes, postal orders, money orders, ----------------------
cheques, drafts, travellers cheques, letters of credit, bills of exchange and
promissory notes, credit cards or such other similar instruments, as may ----------------------
be notified by the Reserve Bank.
----------------------
●● Foreign Exchange – It means foreign currency and includes deposits,
credits, balances payable in foreign currency, drafts, travellers cheques, ----------------------
letters of credits, bills of exchange expressed or drawn in Indian currency
but payable in any foreign currency. Any draft, travellers cheque, letters ----------------------
of credit or bills of exchange drawn by banks, institutions or persons ----------------------
outside India but payable in Indian currency have also been included in
the definition of foreign exchange. ----------------------
●● Foreign Security - Any security in the form of shares, stocks, bonds, ----------------------
debentures or any other instrument denominated or expressed in foreign
currency and includes securities expressed in foreign currency but where ----------------------
redemption or any form of return such as interest or dividend is payable
in Indian currency. ----------------------
●● Person – Includes (i) an individual; (ii) a Hindu Undivided Family; (iii) a ----------------------
company; (iv) a firm; (v) an association of persons or a body of individuals,
whether incorporated or not; (vi) every artificial juridical person; and (vii) ----------------------
any agency, office or branch owned or controlled by such person.
----------------------
– Person Resident in India - A person residing in India for more than
one hundred and eighty-two days in the preceding financial year but ----------------------
does not include
----------------------

Notes – A person who has gone out of India or who stays outside India for
taking up employment outside India, or for carrying on a business or
---------------------- vocation outside India, or for any other purpose, in such circumstances
as would indicate his intention to stay outside India for an uncertain
---------------------- period;
---------------------- – Aperson who has come to India or stay in India, otherwise than for
taking up employment in India, or for carrying on a business or vocation
----------------------
in India; or for any other purpose, in such circumstances as would
---------------------- indicate his intention to stay in India for an uncertain period;
– Any person or body corporate registered or incorporated in India;
----------------------
– An office, branch or agency in India owned or controlled by a person
---------------------- resident outside India; (iv) an office, branch or agency outside India
owned or controlled by a person resident in India.
----------------------

----------------------
1. Who is an Authorized Person? What are the functions of an Authorized
---------------------- Person?
2. Explain in detail the meaning of a ‘Person Resident in India’.
----------------------
3. State the activities permitted / allowed under the Foreign Exchange
---------------------- Management Act, 1999.
---------------------- 4. Briefly explain what is meant by current account and capital account
transactions. How are these transactions connected to the Foreign
---------------------- Exchange Management Act, 1999?
---------------------- 5. What are the provisions of the Foreign Exchange Management Act, 1999
with reference to export of goods and services?
----------------------
6. Explain the powers of the Reserve Bank with reference to regulation and
---------------------- management of foreign exchange.
---------------------- 7. Explain the powers of the Reserve Bank with reference to the Authorized
Persons.
----------------------
8. Discuss the duties of the Authorized Person.
---------------------- 9. What are the exemptions available under the Foreign Exchange Management
---------------------- Act, 1999?
10. State the penalties for violating the provisions of the Foreign Exchange
---------------------- Management Act, 1999.
----------------------
----------------------
----------------------
----------------------

1. RBI may prohibit or restrict any borrowing or lending in rupees, in
whatever form or by whatever name, called between a person resident in ----------------------
India and a person resident outside India. ----------------------
2. An authorised person contravening any direction given by the RBI or one
----------------------
who fails to file the return as directed by RBI, shall be liable to a fine not
exceeding Rs. 10,000/-. ----------------------
3. The primary difference between FERA and FEMA lies in the fact that
----------------------
offences under FEMA are not regarded as criminal offences and only
invite penalties, not prosecution and imprisonment. ----------------------
4. A Person Resident in India is a person residing in India for more than one
----------------------
hundred and eighty-two days in the preceding financial year.
----------------------
----------------------
Suggested Reading
----------------------
----------------------
----------------------

----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
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----------------------

Prevention of Money Laundering Act (PMLA), 2002
UNIT
10
Structure:
10.1 Introduction
10.2 Offence of Money Laundering
10.3 Definitions
10.4 Obligations of Banking Companies, Financial Institutions and
Intermediaries
Summary
Key words
Suggested Reading
Prevention of Money Laundering Act (PMLA), 2002 173

Notes
Objectives
----------------------
• Explain the concept and meaning of ‘money laundering’
----------------------
• Describe the role of banks and financial institutions in the prevention of
---------------------- money laundering
----------------------
---------------------- 10.1 INTRODUCTION

---------------------- The Prevention of Money Laundering Act, 2002 was enacted to prevent
money laundering and to provide for the confiscation of property derived from,
---------------------- or involved in, money laundering. The banking machinery has been used by the
---------------------- persons indulging in money laundering. In order to prevent the misuse of the
banking machinery, a separate Chapter, viz., Chapter TV dealing with Obligations
---------------------- of Banking Companies, Financial Institutions and Intermediaries has been
included in the Act, The Central Government in consultation with the Reserve
---------------------- Bank of India has framed the rules, viz., The Prevention of Money Laundering,
---------------------- Maintenance of Records of the Nature and Value of Transactions etc., Rules,
2004.
---------------------- The process of money laundering can be analyzed into three stages; First,
---------------------- the stage of ‘placement’ when the proceeds, more often in cash form, are placed
into the financial system; Second, the stage of ‘layering’ where the proceeds are
---------------------- moved, through a series of transactions to make it difficult to trace the origin of
the funds; and Third, the stage of ‘integration’ when the criminal resumes control
---------------------- of the resources, these proceeds now appear free from any link to a criminal
---------------------- source. The process of money laundering would be largely impossible without
the network of banks and financial institutions.
---------------------- The extent of criminal activity as well as the incentive to finance such
---------------------- activity can be brought under control while attempting to curb money launderings.
Detection and control of such activity at the first stage can help identify the very
---------------------- offence that generated the proceeds and can also lead to confiscation of such
proceeds.
----------------------
Objectives of the PMLA
----------------------
 To prevent, combat and control money laundering.
----------------------  To monitor and report suspicious transactions.
----------------------  To identify money laundering or terrorist financing activities and to
discourage the same.
----------------------
 To confiscate and seize the property obtained from the laundered money.
----------------------
 To undertake periodic Due Diligence measures which are sensitive to money
---------------------- laundering and terrorist financing risks.

 To comply with applicable laws as well as norms adopted internationally Notes
with reference to money laundering.
----------------------
 To deal with any other issue connected with money laundering in India.
 To take adequate and appropriate measures to follow the spirit of the PMLA. ----------------------
----------------------
10.2 OFFENCE OF MONEY LAUNDERING
----------------------
Offence of Money Laundering is where a person directly or indirectly
attempts to indulge or knowingly assists or knowingly be a party or actually ----------------------
involves in any process or activity connected with the proceeds of crime and
----------------------
projecting it as untainted property. Whosoever commits the offence of money
laundering shall be punishable with rigorous imprisonment for a term which shall ----------------------
not be less than three years but may extend to seven years and also be liable to
a fine which may extend to five lakh rupees. If the offence relates to offences ----------------------
under the Narcotic Drugs and Psychotropic Substances Act, 1985 the maximum
----------------------
punishment could extend to imprisonment for ten years.
----------------------
10.3 DEFINITIONS
----------------------
There is no definition of money laundering in the Act. The meaning of
“Money Laundering” is assigned in Section 3; it states that “whosoever directly ----------------------
or indirectly attempts to indulge or knowingly assists or knowingly is a party or ----------------------
is actually involved in any process or activity connected with the proceeds of
crime and projecting it as untainted property shall be guilty of offence of money ----------------------
laundering”.
----------------------
“Attachment” means prohibition of transfer, conversion, disposition or
movement of property by an order issued under Chapter III; ----------------------
“Person” includes- (i) an individual, (ii) a HUF, (iii) a company, (iv) a firm, ----------------------
(v) an association of person or a body of individuals, whether incorporated or
not; (vi) every artificial juridical person not falling within any of the preceding ----------------------
sub clauses, and (vii) any agency, office or branch owned or controlled by any
----------------------
of the above persons mentioned in the preceding sub-clauses;
“Proceeds of crime” means any property derived or obtained, directly or ----------------------
indirectly, by any person as a result of criminal activity relating to a scheduled ----------------------
offence or the value of any such property;
“Property” means any property or assets of every description, whether ----------------------
corporeal or incorporeal, moveable or immovable, tangible or intangible and ----------------------
includes deeds and instruments evidencing title to, or interest in, such property
or assets, wherever located; ----------------------
“Records” include the records maintained in the form of books or stored ----------------------
in a computer or such other form as may be prescribed;
----------------------
----------------------
Prevention of Money Laundering Act (Pmla), 2002 175

Notes 10.4 OBLIGATIONS OF BANKING COMPANIES,
FINANCIAL INSTITUTIONS AND INTERMEDIARIES
----------------------
Every banking company, financial institution and intermediary is required to
----------------------
 To maintain a record of all transactions, of the nature and value specified
---------------------- in the rules whether such transactions comprise of a single transaction or a
series of transactions integrally connected to each other, and where such a
---------------------- series of transactions take place within a month;
----------------------  To furnish information of the transactions to the director within the prescribed
time; and
----------------------
 To verify and maintain records of the identity of all its clients.
----------------------
 The records shall be maintained for ten years from the date of cessation
---------------------- of the transactions between the clients and the banking company, financial
institution or intermediary.
---------------------- The Director, appointed by the Central Government, has the right to call for
---------------------- the records and make such inquiry or cause an enquiry to be made.
 If he finds that the banking company, financial institution or intermediary
---------------------- has not complied with the requirements he may impose a fine on the banking
---------------------- company which shall not be less than ten thousand rupees but may extend
to one lakh rupees.
----------------------  The Act also specifically provides that the banking companies and their
---------------------- officers shall not be liable to any civil proceedings against them for furnishing
information.
---------------------- The Central Government in consultation with the Reserve Bank of India has
---------------------- framed ‘The Prevention of Money Laundering Maintenance of Records of the
Nature and Value of Transactions, the Procedure and Manner of Maintaining and
---------------------- Time for Furnishing Information and Verification and Maintenance of Records
of the Identity of the Clients of the Banking Companies, Financial Institutions
---------------------- and Intermediaries Rules, 2004’.
---------------------- Every banking company, financial institution and intermediary is
required to maintain the following records -
----------------------
 All cash transactions of the value of more than rupees ten lakh or its
---------------------- equivalent in foreign currency;
All series of cash transactions integrally connected to each other which
----------------------

have been valued below rupees ten lakh or its equivalent in foreign currency
---------------------- where such series of transactions have taken place within a month;
All cash transactions where forged or counterfeit currency notes or bank
----------------------

notes have been used as genuine and where any forgery of a valuable security
---------------------- has taken place,
 All suspicious transactions, whether or not made in cash and by way of:
----------------------
(i) Deposits and credits, withdrawals into or from any accounts in whatsoever
---------------------- name they are referred to in any currency maintained by way of:

– cheques including third party cheques, pay orders, demand drafts, Notes
cashiers cheques or any other instruments or payment of money
including electronic receipts or credits and electronic payments or ----------------------
debits; or
----------------------
– travellers cheque; or
----------------------
– transfer from one account within the same banking company, financial
institution and intermediary, as the case may be, including from or to ----------------------
Nostro and Vostro accounts; or
----------------------
– any other mode in whatsoever name it is referred to;
----------------------
(ii) Credits or debits into or from any non-monetary accounts such as a demat
account, security account in any currency maintained by the banking ----------------------
company, financial institution and intermediary, as the case may be;
----------------------
(iii) Money transfer or remittances in favour of own clients or non-clients from
India or abroad and to third party beneficiaries in India or abroad including ----------------------
transactions on its own account in any currency by any of the following: ----------------------
– payment orders, or
----------------------
– cashier cheques; or
----------------------
– demand drafts; or
– telegraphic or wire transfer or electronic remittances or transfer; or ----------------------
– interest transfers; or ----------------------

– automated clearing house remittances; or ----------------------
– lock box driven transfers or remittances; or ----------------------
– remittances for credit or loading to electronic cards; or (i) any other mode
----------------------
of
– money transfer by whatsoever name it is called; ----------------------
(iv) Loans and advances including credit or loan substitutes, investments and ----------------------
contingent liability by way of:
----------------------
– subscription to debt instruments such as commercial paper, certificate
of deposits preferential shares, debentures, securitised participation, ----------------------
inter-bank participation or any other investments in securities or the
----------------------
like whatever form and name it is referred to; or
– Purchase and negotiation of bills, cheques and other instruments; or ----------------------
– Foreign exchange contracts, currency, interest rate and commodity and ----------------------
any other derivative instrument in whatsoever name it is called; or
----------------------
– Letters of credit, standby letters of credit, guarantees, comfort letters,
solvency certificates and any other instruments for settlement and/or ----------------------
credit support. ----------------------

Notes (v) Collection service in any currency by way of collection of bills, cheques,
instruments or any other mode of collection in whatsoever name it is referred
---------------------- to.
required to maintain the following information in the records -
----------------------
 the nature of the transaction
----------------------
 the amount of the transaction and the currency in which it was denominated
----------------------  the date on which the transaction was conducted; and
----------------------  the parties to the transaction.
required to maintain the information in the following manner -
----------------------
 The information as to the transactions shall be maintained in hard and soft
---------------------- copies in accordance with the procedure and manner as may be specified
by the RBI or SEBI.
----------------------
 Banking company shall have to evolve a mechanism for maintaining such
---------------------- information in such form and at such intervals as may be specified by the
RBI or SEBI.
----------------------
 It is the duty of the banking company to observe the procedure and manner
---------------------- of maintaining the information is specified by the RBI or SEBI.
required to follow the following procedure for furnishing Information -
----------------------
 The principal officer of a banking company shall furnish the information
---------------------- in respect of the transaction every month to the director by the seventh day
---------------------- of the succeeding month.
 Information has to be furnished on the transactions that relate to (a) forged
----------------------
or counterfeit currency notes or bank notes or forgery of valuable security
---------------------- or (b) all suspicious transactions, whether or not made in cash shall be
promptly furnished in writing or by way of fax or electronic mail to the
---------------------- director not later than three working days from the date of occurrence of
---------------------- such transactions.
Every banking company, financial institution and intermediary is
----------------------
required to verify the Records of the Identity of Clients
---------------------- There are rules that prescribe the type of records to be obtained or verified
---------------------- in respect of various types of clients.
The rules mandate that every banking company shall at the time of opening
---------------------- an account or executing any transaction with it, verify and maintain the record
---------------------- of identity and current address or addresses including permanent address of the
client, the nature of business of the client and his financial status.
----------------------

If it is not possible to verify the identity at the time of opening the account Notes
or executing the transaction, the banking company shall verify the identity of
the client within a reasonable time after the account has been opened or the ----------------------
transaction has been executed.
----------------------
The documents required to be taken for verification of the identity of clients
differ from the type of client. They are listed below: ----------------------
 Individual ----------------------
One certified copy of an officially valid document containing details of his ----------------------
permanent address, current address including in respect of the nature of business
and financial status. ----------------------
 Company ----------------------
– Certificate of Incorporation ----------------------
– Memorandum and articles of association
----------------------
– Board resolution or the power of attorney
----------------------
– Officially valid document in respect of the person, operating the account
----------------------
 Partnership firm
– Registration certificate ----------------------
– Partnership deed ----------------------

– Officially valid document in respect of the person acting in the ----------------------
transaction
----------------------
 Trust
----------------------
– Registration certificate
– Trust deed and ----------------------
– Officially valid document in respect of the person acting in the ----------------------
transaction
----------------------
 Unincorporated association
----------------------
– Resolution of the managing body
– Power of attorney granted to the person conducting the transaction; ----------------------
and ----------------------
– Information as may be required by the banking company to establish
----------------------
the legal existence of the association or body of individuals.
The records related to the identity of clients shall be maintained for a period ----------------------
of ten years from the date if cessation of the transactions between the client and ----------------------
the banking company.
----------------------
----------------------

Notes
----------------------

1. As per the Prevention of Money Laundering Act (PMLA) Act, 2002,
----------------------
the banking companies and their officers shall not be liable for this
---------------------- type of proceedings against them for furnishing information.
i. Criminal
----------------------
ii. Civil
----------------------
iii. Contractual
---------------------- iv. Pecuniary
---------------------- 2. As per the Prevention of Money Laundering Act (PMLA) Act 2002,
all suspicious transactions, whether or not made in cash, shall be
----------------------
promptly furnished in writing or by way of fax or electronic mail to
---------------------- the director not later than how many days from the date of occurrence
of such transactions?
----------------------
i. On the same day
---------------------- ii. Two working days
---------------------- iii. Three working days
---------------------- iv. Within one week
----------------------
---------------------- Summary
---------------------- ●● A sudden acquisition of a large sum of money especially in cash invites

suspicion that its source is some illegitimate activity. In general terms,
---------------------- money laundering is a term used to describe the manner in which the
source of money gets disguised. Money Laundering can be broadly
----------------------
defined as engaging in financial transactions involving income derived
---------------------- from criminal activity; the transactions are so designed to conceal the true
original source of criminality derived proceeds and appears to have been
---------------------- received through legitimate sources/origins. This is done in three phases
– placement, layering and integration.
----------------------
●● The process of money laundering would be difficult and largely impossible
---------------------- without the network of banks and financial institutions. The banks and
financial institutions therefore have to follow necessary procedures and
---------------------- guidelines prescribed by the authorities in order to prevent any such
---------------------- activity. The Know Your Customer (KYC) norm followed by the banking
system is one such measure to check on the offence of money laundering.
---------------------- Banks and Financial Institutions/Intermediaries have to fulfill the KYC
requirements before allowing customers to open bank accounts or make
---------------------- investments with/in the financial system.

●● There is a need to control the extent of criminal activity as well as the very Notes
incentive to finance such activity; at the same time attempting to curb
money launderings. Detection of such activity at the appropriate time and ----------------------
further on the control of such activity can help identify and trace the very
offence that generated the proceeds thus leading to the confiscation of ----------------------
such proceeds. ----------------------
Keywords ----------------------
----------------------
●● Money laundering : literal meaning ‘washing money’ free from illegal
or criminal associations. ----------------------
●● Offence of money laundering : whosoever directly or indirectly attempts
to indulge or knowingly assists or knowingly is a party or actually ----------------------
involved in any process or activity connected with the proceeds of crime ----------------------
and projecting it as untainted property.
●● Proceeds of crime : It means any property derived or obtained, directly ----------------------
or indirectly, by any person as a result of criminal activity relating to a ----------------------
scheduled offence or the value of any such property.
----------------------
1. What is meant by Money Laundering? ----------------------
2. How are Banks and Financial Institutions concerned with the offence of
----------------------
Money Laundering?
3. Explain the information/records to be maintained by the Banks and Financial ----------------------
Institutions under the Prevention of Money Laundering Act, 2002. ----------------------
4. In what form and how is the information to be maintained by the Banks and
Financial Institutions under the Prevention of Money Laundering Act, 2002? ----------------------
5. Why is the identity of the Client important? How does a Bank/Financial ----------------------
Institution verify the identity of the Client?
----------------------
6. Discuss the following in the context of the Prevention of Money
Laundering Act, 2002: (a) Black Money (b) Terrorism and (c) Criminal ----------------------
Activity such as Drug Trafficking etc.
----------------------
----------------------
----------------------
----------------------
----------------------
1. As per the Prevention of Money Laundering Act (PMLA) Act, 2002, the
banking companies and their officers shall not be liable for this type of ----------------------
proceedings against them for furnishing information.
----------------------
ii. Civil

Notes 2. As per the Prevention of Money Laundering Act (PMLA) Act 2002, all
suspicious transactions, whether or not made in cash, shall be promptly
---------------------- furnished in writing or by way of fax or electronic mail to the director not
later than how many days from the date of occurrence of such transactions?
----------------------
iii. Three working days
----------------------
----------------------

----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Securitization and Reconstruction of Financial Assets
and Enforcement of Security Interest (SARFAESI) UNIT
Act, 2003
Structure:
11
11.1 Introduction
11.2 Objectives
11.3 Definitions
11.4 Basic Securitization Transaction Model
Summary
Key words
Suggested Reading
Securitization and Reconstruction of Financial Assets and Enforcement of Security 183

Interest (SARFAESI) Act, 2003
Notes
Objectives
----------------------
• State the meaning of the concept ‘securitisation’
----------------------
• Explain the concepts ‘asset reconstruction’ and ‘financial asset’
----------------------
• Define the role of an asset reconstruction or a securitisation company;
---------------------- • Elaborate on the working of a securitisation model and the need and
purpose of such a legislation
----------------------
----------------------
11.1 INTRODUCTION
----------------------
The Banks and Financial Institutions provide advances against security,
---------------------- however, the lender’s right over the securities, both moveable and immoveable, is
---------------------- limited and the legal setup was found to be ineffective to help banks recover loans
from the borrowers. The Securitization and Reconstruction of Financial Assets
---------------------- and Enforcement of Security Interest Act (hence forth referred as SARFAESI
Act) was passed in order to enable banks to recover the loans quickly. It came
---------------------- into force on 21st June, 2002. (Co-operative banks, UTI and some other financial
---------------------- institutions are not covered under the Act; they can be covered by the Notification
of the Government under the Act).
---------------------- The SARFAESI Act can be broadly divided into 4 parts: (a) securitisation
---------------------- of assets, (b) enforcement of security, (c) setting up of central registry, and (d)
establishment of Assets Reconstruction Company (ARC). Under this Act, banks
---------------------- and financial institutions can seize the assets of any defaulter after serving a 60-
days notice period and sell the assets to recover the dues.
----------------------
This Act is meant to provide an exit route for the banks from their bad loans.
---------------------- It empowers banks to change or takeover the management, take possession of the
secured assets of the borrower, sell or lease out the business of the borrower, take
----------------------
over the immovable property of the borrower without intervention of the court,
---------------------- claim future receivables, even supersede the Board of Directors of a defaulting
company by a simple notice in the newspaper. No court other than Debt Recovery
---------------------- Tribunals can entertain any appeal in such situations. Once the steps are initiated
under the Act, any existing reference to the BIFR by the company would abate.
----------------------
The preamble of the SARFAESI Act,2002, states ‘An Act to regulate
---------------------- securitization and reconstruction of financial assets and the enforcement of
security interest and for the matters connected therewith or incidental thereto.’
----------------------
---------------------- 11.2 OBJECTIVES

---------------------- 1. The most important objective of the Act is to empower the banks to recover
bad debts. Banks and Financial Institutions had no power, unlike banks in
----------------------

other countries, to take possession of securities and sell them. This resulted Notes
in slow pace of recovery of defaulted loans.
----------------------
2. To help recovery of overdues - The provisions of the Act help in the
realization of long-term assets, in management of problems of liquidity, ----------------------
asset-liability mismatch and improve recovery of stressed assets by taking
possession and selling securities without intervention of the Courts. ----------------------
3. To meet international banking standards - With the changing commercial ----------------------
practice and the reforms in the financial sector, there was a need for a
legislation that streamlines the recovery procedure. ----------------------
4. To enact a new legislation - As per recommendation of Narasimham ----------------------
Committee, legislation for securitization was necessary to empower banks
to take possession of securities and to sell them without the intervention of ----------------------
the court.
----------------------
11.3 DEFINITIONS ----------------------
 An Asset Reconstruction is the acquisition of any right or interest, of any ----------------------
bank or financial institution, in any financial assistance, by Securitization
Company or reconstruction company, for the purpose of realization of such ----------------------
financial assistance, is called as asset reconstruction. In simple words, it is
----------------------
the takeover of loans or advances from the bank or financial institution for
the purpose of recovery. ----------------------
 An originator is the owner of a financial asset that is acquired by a
----------------------
securitisation company or reconstruction company for the purpose of
securitisation or asset reconstruction. In other words, the banks and financial ----------------------
institutions lending money are originators.
----------------------
 An obligor means a person liable,
– To pay to the originator, whether under a contract or otherwise, or ----------------------
– To discharge any obligation in respect of a financial asset, whether ----------------------
existing, future, conditional or contingent, or and includes a borrower.
----------------------
 A financial asset means debt or receivables and includes:
– A claim to any debt or receivables or part thereof whether secured or ----------------------
insecured, or ----------------------
– Any debt or receivable secured by mortgage of or charge in immoveable
property, ----------------------
– A mortgage charge, hypothecation or pledge of moveable property, or ----------------------

– Any right or interest in the security, whether full or part, securing debt, ----------------------
or
----------------------
– Any beneficial interest in any moveable or immoveable property or in
debt, receivables, whether such an interest is existing, future, accruing, ----------------------
conditional or contingent, or
----------------------

Interest (Sarfaesi) Act, 2003
Notes – Any financial assistance.
 Securitisation means acquisition of financial asset by the securitisation or
----------------------
reconstruction company from the originator. Such an acquisition may be by
---------------------- raising of funds by such a securitisation or reconstruction company from
the qualified institutional buyers by issue of security receipts representing
---------------------- undivided interest in the financial assets or otherwise.
---------------------- Securitization is a process wherein non-liquidated financial assets are
converted into marketable securities, i.e., security receipts that can be sold to
---------------------- the investors. It is also a process of converting the receivables and other assets
into securities, i.e., security receipts that can be placed in the market for trading.
----------------------
There were no provisions for such transfer of claims that are secured by
---------------------- any security in the earlier legislation in India. The SARFAESI Act has made it
possible; the loans secured by mortgage or other charges are now transferable.
----------------------
On acquisition of a financial asset, the securitisation or reconstruction
---------------------- company becomes the owner of the financial asset and steps into the shoes of
---------------------- the lender bank or financial institution. This acquisition can also be said to be,
as a sale of asset without recourse to the bank or financial institution.
----------------------  A Securitization Company is a company formed for the purpose
---------------------- of securitization and registered under the Companies Act, 1956. The
securitisation company also needs a registration from the Reserve Bank as
---------------------- per the SARFAESI Act.
----------------------  A Reconstruction Company is a company formed for the purpose of asset
reconstruction and registered under the Companies Act, 1956.
----------------------
 A Security agreement means an agreement, instrument or any other
---------------------- document or arrangement under which security interest is created in favour
of the secured creditor; it also includes the creation of mortgage by deposit
---------------------- of title deeds with the secured creditor;
----------------------  A Secured asset means the property on which a security interest is created.
Under the SARFAESI Act, the enforcement of securities is against the
---------------------- secured assets only. If the borrower has any property over which no security
interest is created, such a property does not come under the purview of the
----------------------
SARFAESI Act.
----------------------  A secured Creditor is any bank or financial institution or any consortium or
---------------------- group of banks or financial institutions in whose favour the security interest
is created by the borrower for due repayment. It included (i) debenture
---------------------- trustee appointed by any bank or financial institution; or (ii) securitisation
company or reconstruction company, whether acting as such or managing a
---------------------- trust set up by such securitisation company or reconstruction company for
---------------------- the securitisation or reconstruction, as the case may be; or (iii) any other
trustee holding securities on behalf of a bank or financial institution, in
---------------------- whose favour security interest is created for due repayment by any borrower
of any financial assistance;
----------------------

 A Secured Debt means a debt which is secured by any security interest. Notes
 A Security Interest is any right, title and interest of any kind whatsoever
----------------------
upon the property created in favour of any secured creditor. It includes any
mortgage charge, hypothecation, assignment other than those specified in ----------------------
Section 31 of the SARFAESI Act.
----------------------
 A Security Receipt is a receipt or other security, issued by a securitization
company or reconstruction company to any qualified institutional buyer ----------------------
pursuant to a scheme, evidencing the purchase or acquisition by the holder
thereof, of an undivided right, title or interest in the financial asset involved ----------------------
in securitisation.
----------------------
OTHER RELEVANT DEFINITIONS
----------------------
A Bank refers to al1 the banking companies, nationalized banks, the State
Bank of India as well as its subsidiary banks and co-operative banks are within ----------------------
the meaning of the word bank for the purpose of this Act. This definition has
excluded the Regional Rural Banks (RRBs); hence it is important to note that ----------------------
the Act is not applicable to RRBs. ----------------------
A borrower means, (i) any person, who has been granted financial assistance
by any bank or financial institution, or (ii) who has given any guarantee, or (iii) ----------------------
who has created any mortgage or pledge as a security for the financial assistance ----------------------
granted by any bank or financial institution, or (iv) a person who becomes the
borrower of a securitization company or reconstruction company, consequent ----------------------
upon acquisition by it of any right or interest of any bank or financial institution,
in relation to such financial assistance. ----------------------
A Default is when the borrower does not pay any principal debt or any ----------------------
interest on the principle debt or any other amount payable to the secured creditor.
----------------------
Such non-payment is classified as a non-performing asset (NPA) as per the
Reserve Bank Guidelines in the books of accounts of the secured creditor. In ----------------------
order to avail of the right of security enforcement under the Act, it is important
----------------------
that there is default on part of the borrower. The creditor must also be a secured
creditor. An unsecured creditor has no right of any nature under this Act. ----------------------
Property means (i) Immoveable property, (ii) Moveable property, (iii) Any
----------------------
debt or any right to receive payment of money whether secured or insecured,
(iv) Receivables, whether existing or future, (v) Intangible assets such as; know- ----------------------
how, patents, copyright, trademarks, licence, franchise or any other business or
commercial right of a similar nature. ----------------------
The definition of property put forth by the SARFAESI Act is much wider. ----------------------
The Transfer of Property Act 1882 and other legislations have given the definition
of property. Under this Act, sub-clauses (iii), (iv) and (v) here above have been ----------------------
added. As a result, security interest can also be created against these properties ----------------------
for raising loans from the banks and financial institutions.
A “financial institution means: ----------------------
----------------------

Notes (i) A public financial institution within the meaning of the Companies Act, 1956.
ii) Any institution specified by the Central Government under the Recovery
----------------------
of Debts due to Bank and Financial Institutions Act, 1993.
---------------------- iii) The ‘International Finance Corporation’, established under the International
Finance Corporation (Status, Immunities and Privileges) Act, 1958.
----------------------
iv) Any other institution or non-banking financial company as defined in the
---------------------- Reserve Bank of India Act, 1934, which the Central Government may specify
as a financial institution for the purpose of this Act.
----------------------
A Qualified Institutional Buyer is a financial institution or an insurance
---------------------- company or a bank or a state financial corporation or state industrial development
---------------------- corporation or trustee or any asset management company making an investment
on behalf of a mutual fund or provident fund or gratuity fund or pension fund
---------------------- or a foreign institutional investor, registered under the SEBI Act, 1992 or any
other body corporate as may be specified by SEBI.
----------------------
This definition covers several categories of institutional investors but does
---------------------- not include a company registered under the Companies Act, 1956. If any company
wants to become a qualified institutional buyer then it will have to get such a
---------------------- registration from SEBI.
---------------------- Financial assistance is whenever any bank or financial institution grants a
loan or advance or makes subscription of debenture or bonds or gives guarantee
---------------------- or issues letters of credit or extends other credit facility.
---------------------- Hypothecation means a charge in or upon any moveable property, existing
or future, created by a borrower, in favour of a secured creditor without delivery
----------------------
of possession of the moveable property to such creditor as a security for financial
---------------------- assistance and includes floating charge and crystallization of such charge into
fixed charge on moveable property.
----------------------
Prior to this Act no Indian Law has defined the term hypothecation though
---------------------- hypothecation is a very common type of charge on a security for a banks’ lending.
---------------------- A ‘Central Registry’ means the registering office, set up or caused to be set
up by the Central Government. With this proposed set up, all the transactions of
---------------------- asset securitisation, reconstruction as well as transactions of creation of security
interests, will have to be registered with this authority. The registration system
---------------------- will operate on a priority of registration basis, i.e., first in time to register gets
---------------------- priority over the person doing registration at a later time. The registry will also
serve the purpose of maintaining credit information for the lenders.
---------------------- MAIN FEATURES OF THE SARFAESI ACT, 2002
----------------------  To set up asset reconstruction companies empowered to take possession
of the secured assets of the borrower including right to transfer by way of
---------------------- lease, assignment or sale and realize the secured assets.
----------------------  To empower the banks and Financial Institutions to take possession of assets
given as security for financial assistance; to sell or lease the same or to
----------------------
take over management of assets or business in the event of default subject

to compliance with certain formalities like classification of the borrower’s Notes
account as non-performing asset under RBI guidelines.
----------------------
 To exercise the rights of a secured creditor in accordance with the rules
made by the Central Government; ----------------------
 To make provision of appeal against the actions of Banks or Financial
----------------------
Institutions to the concerned Debt Recovery Tribunal and a second appeal
to the Appellate Debt Recovery Tribunal; ----------------------
To register and regulate the financial assets of Banks and Financial
----------------------

Institutions with or without the benefit of underlying securities;

 To facilitate easy transferability of financial assets by the Securitization ----------------------
Company or reconstruction company to acquire financial assets to Banks and ----------------------
Financial Institutions by issue of debentures or bonds or any other security
in the nature of buyers; ----------------------
 To empower securitization companies or reconstruction companies to raise ----------------------
funds by issue of security receipts to qualified institutional buyers;
The Act provides for the establishment of a Central Registry by the ----------------------
Central Government for the purpose of registration of transactions relating to ----------------------
securitization, asset reconstruction and creation of security interests.
----------------------
The Act also provides exemptions in certain categories of stressed assets,
viz., security interests in agricultural lands, loans not exceeding Rs.1 lakh and ----------------------
cases where 80% of the loans have been paid.
----------------------
11.4 BASIC SECURITIZATION TRANSACTION MODEL ----------------------
This is how a securitization transaction model works- ----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------

---------------------- 1. Securitisation and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2003 in short is called
----------------------
i. Securities Act
---------------------- ii. Recovery Act
---------------------- iii. Sarfaesi Act
iv. Contract Act
----------------------
2. The owner of a financial asset that is acquired by a securitisation
---------------------- company or reconstruction company for the purpose of securitisation
or asset reconstruction is called
----------------------
i. The issuer
---------------------- ii. The lender
---------------------- iii. The originator
---------------------- iv. The middleman

3. On acquisition of a financial asset, the securitisation or reconstruction
---------------------- company becomes the owner of the financial asset and steps into the
---------------------- shoes of
i. Creditor
----------------------
ii. Lender bank or financial institution
---------------------- iii. Debtor
---------------------- iv. Lender
----------------------
---------------------- Summary
---------------------- ●● With advent of the Recovery of Debts Due To Banks and Financial
Institutions Act, 1993 there was a great hope for the banking sector in
---------------------- the recovery of the Non Performing Assets (NPA). The banks, under the
---------------------- conventional system of recovery of loans, had a considerable amount of
money blocked in form of unproductive assets referred as the NPA. This
---------------------- act intended to provide for expeditious adjudication and recovery of debts
due to banks and financial institutions. However, this effort on part of
---------------------- the government was not enough. To tackle the problem of the NPAs, the
---------------------- Indian banks required more powers to recover the NPA and clear the bad
debts on their balance sheet. The Securitisation and Reconstruction of
---------------------- Financial Assets and Enforcement of Security Interest Act was passed
in 2002 in an attempt to provide these powers to the banks and financial
---------------------- institutions.

●● The Securitisation and Reconstruction of Financial Assets and Enforcement Notes
of Security Interest Act, 2002 has been enacted with an intention to strengthen
the creditors (banks/FIs) rights through foreclosure and enforcement of ----------------------
securities by the banks and financial institutions by conferring on the creditors
the right to seize the secured asset and sell of the same in order to recover dues ----------------------
promptly without have to go through the costly and very time consuming ----------------------
legal process involving courts. The Act empowers the banks/FIs to move
on its own against a borrower whose assets are secured, and who has made ----------------------
some kind of default in repayment of the same. Thus after complying with the
statutory provisions in the said act the banks can (i) to take possession of the ----------------------
secured assets of the borrower. This includes the right to transfer by way of ----------------------
lease, assignment or sale of the same for realization of the secured debt. And/
or (ii) to take over the management of the secured asset including the right to ----------------------
transfer by way of lease, assignment or sale of the same for realization of the
secured debt; and (iii) Appoint any person to manage the secured asset. ----------------------
●● Though the Securitisation and Reconstruction of Financial Assets and ----------------------

Enforcement of Security Interest Act, 2002 is an important legislation for
India, there are certain problems faced by the Banks/FIs in their attempt ----------------------
to implement such as ineffective foreclosure laws, ambiguity in tax laws ----------------------
concerning mortgaged based securities, etc.
----------------------
Keywords ----------------------
●● “Securitisation” means acquisition of financial assets by any securitization ----------------------
company or reconstruction company from any originator, whether
by raising of funds by such securitisation company or reconstruction ----------------------
company from qualified institutional buyers by issue of security receipts
representing undivided interest in such financial assets or otherwise. ----------------------
●● “Securitisation company” means any company formed and registered ----------------------

under the Companies Act, 1956 (1 of 1956) for the purpose of securitisation.
----------------------
●● “Asset reconstruction” means acquisition by any securitisation company
or reconstruction company of any right or interest of any bank or financial ----------------------
institution in any financial assistance for the purpose of realisation of such
financial assistance. ----------------------
●● “Financial asset” means debt or receivables and includes- (i) a claim to ----------------------
any debt or receivables or part thereof, whether secured or unsecured;
or (ii) any debt or receivables secured by, mortgage of, or charge on, ----------------------
immovable property; or (iii) a mortgage, charge, hypothecation or pledge ----------------------
of movable property; or (iv) any right or interest in the security, whether
full or part underlying such debt or receivables; or (v) any beneficial ----------------------
interest in property, whether movable or immovable, or in such debt,
receivables, whether such interest is existing, future, accruing, conditional ----------------------
or contingent; or (vi) any financial assistance. ----------------------
●● “Originator” means the owner of a financial asset which is acquired by
----------------------

Notes a securitisation company or reconstruction company for the purpose of
securitisation or asset reconstruction.
---------------------- ●● “Obligor” means a person liable to the originator, whether under a contract
---------------------- or otherwise, to pay a financial asset or to discharge any obligation in
respect of a financial asset, whether existing, future, conditional or
---------------------- contingent and includes the borrower.
---------------------- ●● “Secured asset” means the property on which security interest is created.
●● “Secured debt” means a debt which is secured by any security interest.
----------------------
●● “Security interest” means right, title and interest of any kind whatsoever
---------------------- upon property, created in favour of any secured creditor and includes any
mortgage, charge, hypothecation, assignment other than those specified
---------------------- in section 31;
---------------------- ●● “Security agreement” means an agreement, instrument or any other
document or arrangement under which security interest is created in
---------------------- favour of the secured creditor including the creation of mortgage by
deposit of title deeds with the secured creditor;
----------------------
●● “Secured creditor” means any bank or financial institution or any
---------------------- consortium or group of banks or financial institutions.
---------------------- ●● “Security receipt” means a receipt or other security, issued by a
securitization or reconstruction company to any qualified institutional
---------------------- buyer pursuant to a scheme, evidencing the purchase or acquisition by the
holder thereof, of an undivided right, title or interest in the financial asset
----------------------
involved in securitisation.
----------------------
----------------------
1. What is meant by Securitization?
----------------------
2. Explain “Financial Asset”.
----------------------
3. What is the purpose behind the SARFAESI Act, 2002?
---------------------- 4. State the objectives of the SARFAESI Act, 2002.
---------------------- 5. Explain how the basic securitization model works.
---------------------- 6. Explain the various concepts in the process of Securitization – Originator,
Obligor, Security agreement, Secured asset, secured creditor, and security
---------------------- interest.
----------------------
----------------------
----------------------
----------------------
----------------------

----------------------
1. Securitisation and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2003 in short is called ----------------------
iii. Sarfaesi Act ----------------------
2. The owner of a financial asset that is acquired by a securitisation company
----------------------
or reconstruction company for the purpose of securitisation or asset
reconstruction is called ----------------------
iii. The originator
----------------------
3. On acquisition of a financial asset, the securitisation or reconstruction
company becomes the owner of the financial asset and steps into the ----------------------
shoes of
----------------------
ii. Lender bank or financial institution
----------------------
Suggested Reading ----------------------
1. The Reserve Bank of India Act, 1934. ----------------------
----------------------
----------------------
----------------------
7. Sundaram and Varshaney. Banking Theory, Law & Practice. ----------------------
8. Gordon and Natarajan. Banking Law and Practice. ----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Information Technology Act, 2000 and Laws relating to
Banking UNIT
Structure:
12.1 Introduction
12
12.2 Indian Penal Code
12.3 Indian Evidence Act
12.4 Bankers’ Books Evidence Act
12.5 Reserve Bank of India Act
Summary
Key words
Suggested Reading
Annexure I
Information Technology Act, 2000 and Laws relating to Banking 195

Notes
Objectives
----------------------
• Explain the meaning of the concept ‘electronic record’ and ‘digital
----------------------
signature’
---------------------- • Discuss the important concepts relating to information technology
---------------------- • Elaborate on the relevance of Information Technology Act, 2000 to
other legislations
----------------------
---------------------- 12.1 INTRODUCTION

---------------------- In the digital technology and electronic communication, computers help us
---------------------- in creating, transmitting, storing and retrieving information in electronic form
rather than in the traditional form, i.e. on paper. Business transactions via the
---------------------- electronic form have become popular and is referred as electronic commerce or
e-commerce.
----------------------
The Information Technology Act, 2000 was passed based on the UNCITRAL
---------------------- Model Law on Electronic Commerce. A resolution was passed in the General
---------------------- Assembly of the United Nations in the year 1997 in order to adopt the Model
Law on Electronic Commerce adopted by the United Nations Commission on
---------------------- International Trade Law. Therefore in May 2000, both the houses of the Indian
Parliament passed the Information Technology Bill. The Bill received the assent
----------------------
of the President in August 2000 and came to be known as the Information
---------------------- Technology Act, 2000. Cyber laws are contained in the IT Act, 2000. This Act
aims to provide the legal infrastructure for e-commerce in India.
----------------------
With the enactment of the Information Technology Act, 2000, appropriate
---------------------- amendments had to be made with other existing legislations. The Indian Penal
Code, the Indian Evidence Act, 1872, the Bankers’ Books Evidence Act, 1891
----------------------
and the Reserve Bank of India Act, 1934 are some of the legislations where
---------------------- amendments have been made to adopt the concept of ‘electronic form’ and its
usage. The Act provides the legal framework to accord the legal sanctity to all
---------------------- electronic records and other activities carried out by electronic means/form.
---------------------- IMPORTANT DEFINITIONS IN THE ACT
---------------------- ‘Access’ means gaining entry into, instructing or communicating with the
logical, arithmetical, or memory function resources of a computer, computer
---------------------- system or computer network.
---------------------- ‘Asymmetric crypto system’ means a system of a secure key pair consisting
of a private key for creating a digital signature and a public key to verify the
----------------------
digital signature.
----------------------

‘Computer’ means any electronic magnetic, optical or other high-speed Notes
data processing device or system which performs logical, arithmetic, and
memory functions by manipulations of electronic, magnetic or optical impulses, ----------------------
and includes all input, output, processing, storage, computer software, or
----------------------
communication facilities which are connected or related to the computer in a
computer system or computer network. ----------------------
‘Computer network’ means the interconnection of one or more computers ----------------------
through -(i) the use of satellite, microwave, terrestrial line or other communication
media; and (ii) terminals or a complex consisting of two or more interconnected ----------------------
computers whether or not the interconnection is continuously maintained.
----------------------
‘Computer resource’ means computer, computer system, computer network,
data, computer data base or software. ----------------------
‘Computer system’ means a device or collection of devices, including input ----------------------

and output support devices and excluding calculators which are not programmable
----------------------
and capable of being used in conjunction with external files, which contain
computer programmes, electronic instructions, input data and output data, that ----------------------
performs logic, arithmetic, data storage and retrieval, communication control
and other functions. ----------------------
‘Data’ means a representation of information, knowledge, facts, concepts ----------------------

or instructions which are being prepared or have been prepared in a formalized
----------------------
manner, and is intended to be processed, is being processed or has been processed
in a computer system or computer network, and may be in any form (including ----------------------
computer printouts magnetic or optical storage media, punched cards, punched
tapes) or stored internally in the memory of the computer. ----------------------
‘Affixing digital signature’ means adoption of any methodology or ----------------------

procedure by a person for the purpose of authenticating an electronic record by
----------------------
means of digital signature.
‘Digital signature’ means authentication of any electronic record by a ----------------------
subscriber by means of an electronic method or procedure in accordance with ----------------------
the provisions of section 3.
‘Digital Signature Certificate’ means a Digital Signature Certificate issued ----------------------
under the sub-Section (4) of Section 35. ----------------------
‘Electronic form’ with reference to information means any information
----------------------
generated, sent, received or stored in media, magnetic, optical, computer memory,
micro film, computer generated micro fiche or similar device. ----------------------
‘Electronic record’ means data, record or data generated, image or sound ----------------------
stored, received or sent in an electronic form or micro film or computer generated
micro fiche. ----------------------
‘Function’, in relation to a computer, includes logic, control arithmetical ----------------------
process, deletion, storage and retrieval and communication or telecommunication
from or within a computer. ----------------------

Notes ‘Information’ includes data, text, images, sound, voice, codes, computer
programmes, software and databases or micro film or computer generated micro
---------------------- fiche.
---------------------- ‘Certifying authority’ means a person who has been granted a licence to
issue a Digital Signature Certificate under Section 24.
----------------------
‘Certification practice statement’ means a statement issued by a Certifying
---------------------- Authority to specify the practices that the Certifying Authority employs in issuing
Digital Signature Certificates.
----------------------
‘Intermediary’ with respect to any particular electronic message means
---------------------- any person who on behalf of another person receives, stores or transmits that
message or provides any service with respect to that message.
----------------------
‘Addressee’ means a person who is intended by the originator to receive
---------------------- the e lectronic record but does not include any intermediary.
---------------------- ‘Originator’ means a person who sends, generates, stores or transmits any
electronic message or causes any electronic message to be sent, generated, stored
---------------------- or transmitted to any other person but does not include an intermediary.
---------------------- ‘Prescribed’ means prescribed by the rules made under this Act.
‘Private key’ means the key of a key pair used to create a digital signature.
----------------------
‘Public key’ means the key of a key pair used to verify a digital signature
---------------------- and listed in the Digital Signature Certificate.
---------------------- ‘Key pair’, in an asymmetric crypto system, means a private key and its
mathematically related public key, which are so related that the public key can
---------------------- verify a digital signature created by the private key.
---------------------- ‘Secure system’ means computer hardware, software, and procedure that
(a) are reasonably secure from unauthorised access and misuse; (b) provide a
---------------------- reasonable level of reliability and correct operation; (c) are reasonably suited to
---------------------- performing the intended functions; and (d) adhere to generally accepted security
procedures.
---------------------- ‘Security procedure’ means the security procedure prescribed under the
---------------------- Section 16 by the Central Government.
‘Subscriber’ means a person in whose name the Digital Signature Certificate
----------------------
is issued.
---------------------- ‘Verify’ in relation to a digital signature, electronic record or public key,
with its grammatical variations and cognate expressions means to determine
----------------------
whether - (a) the initial electronic record was affixed with the digital signature
---------------------- by the use of a private key corresponding to the public key of the subscriber;
(b) the initial electronic record is retained intact or has been altered since such
---------------------- an electronic record was so affixed with the digital signature.
----------------------
----------------------

12.2 INDIAN PENAL CODE Notes
The Indian Penal Act is a legislation that deals with the law of crimes ----------------------
that deals with offences relating to documents. Two things that are of utmost
importance on a document are the written matter and signature/s. With the onset ----------------------
of electronic communication, an electronic record is in focus and the manner ----------------------
in which writing and signing is done is quite different. What purpose a paper
document serves in a paper-based communication, the electronic record serves ----------------------
in an electronic communication.
----------------------
With the enactment of the Information Technology Act, 2000, the Indian
Penal Code had to be amended so as to recognize ‘electronic record’ along with ----------------------
the expression “document”.
----------------------
A new section 29A defines the expression “electronic record” as having the
meaning assigned to it in section 2(l)(s) of the Information Technology Act, 2000. ----------------------
In the list of “book, paper, writing” as appearing in section 477A is included
----------------------
electronic record.
The following sections have been amended are: 167, 172, 173, 175, 192, 204, ----------------------
463, 464, 466, 468, 469, 470, 471, 474, 476 with reference to the Information
----------------------
Technology Act, 2000. [See Annexure I]
----------------------
12.3 INDIAN EVIDENCE ACT
----------------------
Documents are executed for the purpose of evidence in a tangible form
----------------------
i.e. it involves the use of paper. The expression “document” has been defined
in section 3 of the Indian Evidence Act, 1872, as to mean any matter expressed ----------------------
or described upon any substance by means of letters, figures, or marks, or by
more than one of those means, intended to be used, or which may be used, for ----------------------
the purpose of recording the matter.
----------------------
When it is required to express or describe a matter, it could be done in writing
letters, figures or marks. However, in electronic communication, the expression ----------------------
or description is not in writing and not on a paper. An electronic message is not
----------------------
a document as per the definition given in the Evidence Act.
The Evidence Act is based on paper documents and hand written signatures. ----------------------
Therefore, the expression “document” is now been extended to cover computer- ----------------------
based communication. The expression ‘electronic record’ and ‘digital signature’
appears along with the expression “document”. ----------------------
The Evidence Act has been amended to incorporate the definitions under ----------------------
the Information Technology Act, 2000 such electronic concepts and notions
as “certifying authority”, “digital signature”, “digital signature certificate”, ----------------------
“electronic form”, “electronic records”, “information”, “secure electronic record”,
“secure digital signature” and “subscriber”. ----------------------
The following provisions have been amended under the Indian Evidence ----------------------
Act: (i) Documentary evidence includes electronic records (Sec. 3) (ii) Admission
of Statement made in electronic form (Sec. 17) (iii) Oral admissions as to the ----------------------

Notes contents of electronic records are not relevant, unless the genuineness of the
electronic records produced is in question (Sec. 22A) (iv) Entries in the books
---------------------- of account include those maintained in an electronic form (Sec. 34) (v) The
opinion of the certifying authority is a relevant fact when the court has to form
---------------------- an opinion as to the digital signature. (Sec. 47A); (vi) The contents of electronic
---------------------- record are not to be proved by oral evidence. (Sec. 59):
A computer output of any information contained in an electronic record is
----------------------
deemed to be a document [Sec. 65B (1) and (2)] and is admissible as evidence
---------------------- of any contents of the original on the fulfillment of certain conditions in relation
to the information and the computer during the period over which the computer
---------------------- was used regularly to store or process information.
---------------------- The computer should be operating properly; and information produced during
that period or as contained in the electronic record/form is derived from such
---------------------- information fed into the computer in the ordinary course of the said activities.
---------------------- A statement in a certificate signed by a person occupying responsible official
position is taken as evidence in respect of the following matters (Sec. 656(4) :
---------------------- (i) Identifying the electronic record; (ii) Giving particulars of device involved in
the production of the said electronic record; and (iii) Dealing with any matters
----------------------
to which conditions mentioned in section 65B (2) relate.
---------------------- The digital signature is required to be provided as of the subscriber, if the
---------------------- digital signature is not a secure digital signature (Sec. 67A). The court may
direct production of a digital signature certificate, in order to ascertain whether
---------------------- the digital signature is of the person by whom it purports to have been affixed
(Sec. 73A).
----------------------
---------------------- 12.4 BANKERS’ BOOKS EVIDENCE ACT

---------------------- Banks maintain their accounts in various ledgers, registers, etc. Whenever
any account/ information in the books of accounts of the bank is required to be
---------------------- established or proved in the Court of Law, the books of accounts were required
to be produced in the original form. It caused a lot of difficulty for the banks to
----------------------
produce these day-to-day books and ledgers that are so heavy and in continuous
---------------------- use. The Bankers’ Books Evidence Act, 1891 was passed and the banks were
no longer forced to produce actual books of accounts in any legal proceeding,
---------------------- especially where the bank itself is not a party. A certified copy of any entry in
the bankers’ books shall serve as prima facie evidence of the transactions and
----------------------
accounts recorded therein and can be admitted as original entry. An official of the
---------------------- bank has to swear in the court of Law or an affidavit to that effect has to be filed
stating that the copy was made from one of the ordinary books in the ordinary
---------------------- course of business.
---------------------- The Bankers’ Books Evidence Act, 1891 has also been amended to give legal
sanctity for books of account maintained in the electronic form by the banks.
----------------------
The definition of ‘Bankers’ books’ includes ledgers, day books, cash books,
---------------------- account books and all other records used in the ordinary business of a bank.

The definition has been modified to include printouts of data stored in a floppy, Notes
disc, tape or any other form of electro-magnetic storage device. The Certified
copy may consist of printouts of data stored in an electro-magnetic data storage ----------------------
device, or a printout of such entry or copy of such printout together with such
statements certified in accordance with the amendment. ----------------------
In case the books of the banks are not handwritten and copies are taken by ----------------------
way of printout, the copy should be accompanied by the following-
----------------------
 A certificate stating that it is a printout of such entry or a copy of such
printout by the principal accountant or branch manager. ----------------------
 A certificate by a person in-charge of the computer system containing a brief ----------------------
description of the computer system and the particulars of:
– the safeguards adopted by the system to ensure that the data message is ----------------------
entered or any other operation performed only by authorized persons; ----------------------
– the safeguards adopted to prevent and detect unauthorized change of
data; ----------------------
– the safeguards available to retrieve data that is lost due to systemic ----------------------
failure or any other reason;
– the manner in which data is transferred from the system to removable ----------------------
media like floppies, discs, tapes, or other electromagnetic data storage
device; ----------------------
– the mode of verification in order to ensure that data has been accurately ----------------------
transferred to such removable media;
----------------------
– the mode of identification of such data storage devices;
– the arrangement for the storage and custody^ of such storage devices; ----------------------
– the safeguards to prevent and detect any tampering with the system;
----------------------
– any other factor which will vouch for the integrity and accuracy of the
system. ----------------------
 A further certificate from the person in-charge of the computer system to ----------------------
the effect that to the best of his knowledge the computer system operated
properly at material time, he was provided with all the relevant data and the ----------------------
printout in question represents correctly, or is appropriately derived from,
the relevant data. ----------------------
----------------------
12.5 RESERVE BANK OF INDIA ACT
----------------------
The Reserve Bank of India Act, 1934 has been amended to facilitate
electronic fund transfers between the financial institutions and the banks. ----------------------
A new clause (pp) has been inserted in section 58(2) regarding the regulation ----------------------
of fund transfer through electronic means between the banks or between the
banks and other financial institutions including the laying down of the conditions ----------------------
subject to which banks and other financial institutions shall participate in such ----------------------
fund transfers, the manner of such fund transfers and the rights and obligations
of the participants in such fund transfers. ----------------------

Notes
----------------------
---------------------- 1. ‘Electronic record’ means data, record or data generated, image or

sound stored, received or sent in an ______ or micro film or computer
---------------------- generated micro fiche.
---------------------- 2. As per the Information Technology Act, 2000, the ______ Code had
to be amended so as to recognise ‘electronic record’ along with the
---------------------- expression “document”.
---------------------- 3. Under Information Technology Act, the ______ is authorised to
issue licenses to certifying authorities for issuing Digital Signature
----------------------
Certificates.
----------------------
----------------------
Summary
----------------------
●● Legislations referring to communications and information technology
---------------------- are referred to as Cyber Laws. The Information Technology Act, 2000
regulates the transactions relating to computers and the internet. In the
----------------------
era of digital technology and electronic communication, e-business or
---------------------- e-commerce as it is popularly referred to, is on a rise. The legislations
have supported and encouraged the growth in e-commerce.
---------------------- ●● The objectives of the Act is to provide legal recognition for transactions
---------------------- carried out with the help of electronic data interchange and other
relation means of electronic communication. Such transactions aim
---------------------- at the use of alternatives to paper-based methods of communications
and storage of information. It helps secure electronic transactions to
---------------------- facilitate e-commerce. The Act has provides for granting a legal status to
---------------------- electronic signature and electronic records. This facilitates the electronic
filing of documents with government agencies. The Act provides for the
---------------------- appointment of a Controller of Certifying Authorities; the Controller is
authorized to issue licenses to certifying authorities for issuing Digital
---------------------- Signature Certificates.
---------------------- ●● At the same time, offences regarding electronic records, for instance,
tampering with computer source documents, hacking, obscenity, breach of
---------------------- confidentiality and privacy, publishing false digital signature certificates,
---------------------- cheating, false messages, etc are on a rise. In other words, cyber crime
is also on a rise. Though these offences would be tried under the Code
---------------------- of Criminal Procedures, there are provisions for a Cyber Regulations
Appellate Tribunal and a Cyber Regulations Advisory Committee along
---------------------- with the Controller of Certifying Authorities. Adequate safeguards have to
---------------------- be developed and maintained while using the computers and the internet.

●● The Information Technology Act however is not applicable to the Notes
following: (i) a negotiable instrument other than a cheque (ii) a power of
attorney; (iii) a trust; (iv) a will; (v) any contract for the sale/conveyance of ----------------------
immovable property or any interest in such property and (vi) any such class
of documents or transactions as may be notified by the Central Government ----------------------
in the Official Gazette. ----------------------
Keywords ----------------------
----------------------
●● ‘Access’ means gaining entry into, instructing or communicating with
the logical, arithmetical, or memory function resources of a computer, ----------------------
computer system or computer network.
●● ‘Data’ means a representation of information, knowledge, facts, concepts ----------------------
or instructions which are being prepared or have been prepared in a ----------------------
formalized manner, and is intended to be processed, is being processed or
has been processed in a computer system or computer network, and may ----------------------
be in any form (including computer printouts magnetic or optical storage
media, punched cards, punched tapes) or stored internally in the memory ----------------------
of the computer. ----------------------
●● ‘Affixing digital signature’ means adoption of any methodology or
procedure by a person for the purpose of authenticating an electronic ----------------------
record by means of digital signature. ----------------------
●● ‘Digital signature’ means authentication of any electronic record by a
subscriber by means of an electronic method or procedure in accordance ----------------------
with the provisions of section 3. ----------------------
●● ‘Digital Signature Certificate’ means a Digital Signature Certificate
issued under the sub-Section (4) of Section 35. ----------------------
●● ‘Electronic form’ with reference to information means any information ----------------------
generated, sent, received or stored in media, magnetic, optical, computer
memory, micro film, computer generated micro fiche or similar device. ----------------------
●● ‘Electronic record’ means data, record or data generated, image or sound ----------------------
stored, received or sent in an electronic form or micro film or computer
generated micro fiche. ----------------------
●● ‘Information’ includes data, text, images, sound, voice, codes, computer ----------------------
programmes, software and databases or micro film or computer generated
micro fiche. ----------------------
●● ‘Certifying authority’ means a person who has been granted a licence to ----------------------
issue a Digital Signature Certificate under Section 24.
●● ‘Certification practice statement’ means a statement issued by a ----------------------
Certifying Authority to specify the practices that the Certifying Authority ----------------------
employs in issuing Digital Signature Certificates.
●● ‘Intermediary’ with respect to any particular electronic message means ----------------------
any person who on behalf of another person receives, stores or transmits ----------------------
that message or provides any service with respect to that message.

Notes ●● ‘Addressee’ means a person who is intended by the originator to receive
the electronic record but does not include any intermediary.
---------------------- ●● ‘Originator’ means a person who sends, generates, stores or transmits
---------------------- any electronic message or causes any electronic message to be sent,
generated, stored or transmitted to any other person but does not include
---------------------- an intermediary.
---------------------- ●● ‘Secure system’ means computer hardware, software, and procedure
that (a) are reasonably secure from unauthorized access and misuse; (b)
---------------------- provide a reasonable level of reliability and correct operation; (c) are
reasonably suited to performing the intended functions; and (d) adhere
---------------------- to generally accepted security procedures.
---------------------- ●● ‘Subscriber’ means a person in whose name the Digital Signature
Certificate is issued.
----------------------
●● ‘Verify’ in relation to a digital signature, electronic record or public
---------------------- key, with its grammatical variations and cognate expressions means to
determine whether - (a) the initial electronic record was affixed with the
---------------------- digital signature by the use of a private key corresponding to the public
key of the subscriber; (b) the initial electronic record is retained intact or
----------------------
has been altered since such an electronic record was so affixed with the
---------------------- digital signature.

---------------------- 1. What are the objectives of the Information Technology Act, 2000?
---------------------- 2. Explain the concepts relating to the word ‘computer’ as stated and discussed
in the Information Technology Act, 2000.
----------------------
3. What is meant by ‘electronic form’? What is its relevance in today’s times?
---------------------- 4. Define the following terms w.r.t. the Information Technology Act, 2000: (i)
---------------------- Data, (ii) Digital signature (ii) verify (iv) addressee (v) originator and (vi)
subscriber
---------------------- 5. Write a note on digital signature.
---------------------- 6. Bring out the amendments made in the Indian Penal Code with reference
to the Information Technology Act, 2000.
----------------------
7. Bring out the amendments made in the Indian Evidence Act with reference
---------------------- to the Information Technology Act, 2000.
---------------------- 8. Bring out the amendments made in the Bankers’ Book Evidence Act, 1891
with reference to the Information Technology Act, 2000.
----------------------
----------------------
----------------------
----------------------

1. ‘Electronic record’ means data, record or data generated, image or sound
stored, received or sent in an electronic form or micro film or computer ----------------------
generated micro fiche. ----------------------
2. As per the Information Technology Act, 2000, the Indian Penal Code
----------------------
had to be amended so as to recognise ‘electronic record’ along with the
expression “document”. ----------------------
3. Under Information Technology Act, the Controller of Certifying
----------------------
Authorities is authorised to issue licenses to certifying authorities for
issuing Digital Signature Certificates. ----------------------
----------------------
Suggested Reading ----------------------
----------------------
2. The Reserve Bank of India (Board for financial supervision) Regulations,1984. ----------------------
3. Varshney, P.N. Banking Law and Practice, Sultan Chand & Sons. ----------------------
----------------------
----------------------
8. Gordon and Natarajan. Banking Law and Practice. ----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Notes ANNEXURE I
(Amendments to the Indian Penal Code w.r.t. the Information Technology Act,
----------------------
2000)
---------------------- In section 167, for the words “such public servant, charged with the preparation
or translation of any document, frames or translates that document”, the words
----------------------
“such public servant, charged with the preparation or translation of any document
---------------------- or electronic record, frames, prepares or translates that document or electronic
record” shall be substituted.
----------------------
In section 172, for the words “produce a document in a Court of Justice”, the
---------------------- words “produce a document or an electronic record in a Court of Justice” shall
be substituted.
----------------------
In section 173, for the words “to produce a document in a Court of Justice”, the
---------------------- words “to produce a document or electronic record in a Court of Justice” shall
be substituted.
----------------------
In section 175, for the word “document” at both the places where it occurs, the
---------------------- words “document or electronic record” shall be substituted.
---------------------- In section 192, for the words “makes any false entry in any book or record, or
makes any document containing a false statement”, the words “makes any false
---------------------- entry in any book or record, or electronic record or makes any document or
electronic record containing a false statement” shall be substituted.
----------------------
In section 204, for the word “document” at both the places where it occurs, the
---------------------- words “document or electronic record” shall be substituted.
---------------------- In section 463, for the words “Whoever makes any false documents or part of a
document with intent to cause damage or injury”, the words “Whoever makes
---------------------- any false documents or false electronic record or part of a document or electronic
record, with intent to cause damage or injury” shall be substituted.
----------------------
In section 464,
----------------------
a) for the portion beginning with the words “A person is said to make a false
---------------------- document” and ending with the words “by reason of deception practised upon him,
he does not know the contents of the document or the nature of the alteration”,
---------------------- the following shall be substituted, namely:—
---------------------- “A person is said to make a false document or false electronic record— First—
Who dishonestly or fraudulently—
----------------------
(a) makes, signs, seals or executes a document or part of a document; (b) makes
---------------------- or transmits any electronic record or part of any electronic record; (c) affixes
any digital signature on any electronic record; (d) makes any mark denoting the
----------------------
execution of a document or the authenticity of the digital signature, with the
---------------------- intention of causing it to be believed that such document or part of document,
electronic record or digital signature was made, signed, sealed, executed,
---------------------- transmitted or affixed by or by the authority of a person by whom or by whose
authority he knows that it was not made, signed, sealed, executed or affixed; or
----------------------

Secondly—Who, without lawful authority, dishonestly or fraudulently, by Notes
cancellation or otherwise, alters a document or an electronic record in any material
part thereof, after it has been made, executed or affixed with digital signature ----------------------
either by himself or by any other person, whether such person be living or dead ----------------------
at the time of such alteration; or
Thirdly—Who dishonestly or fraudulently causes any person to sign, seal, execute ----------------------
or alter a document or an electronic record or to affix his digital signature on any ----------------------
electronic record knowing that such person by reason of unsoundness of mind
or intoxication cannot, or that by reason of deception practised upon him, he ----------------------
does not know the contents of the document or electronic record or the nature
of the alteration. “ ; ----------------------
(b) after Explanation 2, the following Explanation shall be inserted at the end, ----------------------
namely:— ‘Explanation 3.—For the purposes of this section, the expression
“affixing digital signature” shall have the meaning assigned to it in clause (d) of ----------------------
subsection (1) of section 2 of the Information Technology Act, 2000.’. ----------------------
In section 466,— (a) for the words “Whoever forges a document”, the words
----------------------
“Whoever forges a document or an electronic record” shall be substituted; (b) the
following Explanation shall be inserted at the end, namely:— ‘Explanation.—For ----------------------
the purposes of this section, “register” includes any list, data or record of any
entries maintained in the electronic form as defined in clause (r) of sub-section ----------------------
(1) of section 2 of the Information Technology Act, 2000.’.
----------------------
In section 468, for the words “document forged”, the words “document or
electronic record forged” shall be substituted. ----------------------
In section 469, for the words “intending that the document forged”, the words ----------------------
“intending that the document or electronic record forged” shall be substituted.
----------------------
In section 470, for the word “document” in both the places where it occurs, the
words “document or electronic record” shall be substituted. ----------------------
In section 471, for the word “document” wherever it occurs, the words “document ----------------------
or electronic record” shall be substituted.
In section 474, for the portion beginning with the words “Whoever has in his ----------------------
possession any document” and ending with the words “if the document is one ----------------------
of the description mentioned in section 466 of this Code”, the following shall
be substituted, namely: — “Whoever has in his possession any document or ----------------------
electronic record, knowing the same to be forged and intending that the same
shall fraudulently or dishonestly be used as a genuine, shall, if the document ----------------------
or electronic record is one of the description mentioned in section 466 of this ----------------------
Code.”.
----------------------
In section 476, for the words “any document”, the words “any document or
electronic record” shall be substituted. ----------------------
In section 477A, for the words “book, paper, writing” at both the places where they
----------------------
occur, the words “book, electronic record, paper, writing” shall be substituted.
----------------------

Notes
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

Banking Ombudsman
UNIT
13
Structure:
13.1 Introduction
13.2 Concept and Meaning
13.3 Objectives and Purpose
13.4 Reserve Bank of India Banking Ombudsman Schemes
Summary
Key words
Suggested Reading
Banking Ombudsman 209

Notes
Objectives
----------------------
• Explain the meaning of the concept ‘ombudsman’
----------------------
• Enumerate the functions and role of banking ombudsman
----------------------
• Analyse RBI’s Banking Ombudsman Scheme
----------------------
---------------------- 13.1 INTRODUCTION

---------------------- The Ombudsman institution which evolved in the Scandinavian countries.
It was aimed at giving the common people a tribunal to which they can readily
---------------------- ventilate their grievances against the government. King Charles XII of Sweden is
generally credited with initiating the office of the ombudsman. An official with the
----------------------
title of Hogsta Ombudsman (Supreme Royal Ombudsman) was appointed in 1713.
---------------------- He was assigned to “keep an eye on royal officials” and supervise observance
of the laws. Sometimes he was even commissioned to represent the king in
---------------------- some official functions. Introduced in the Constitution of 1809, an Ombudsman
was appointed by Swedish Parliament, making the office independent from the
----------------------
King. Ombudsman comes from the Norwegian word Umbodhsmadhr, meaning
---------------------- Administration Man or King’s Representative. As a Swedish word, it literally
means one who represents another.
----------------------
The Banking Ombudsman Scheme was sponsored by banks through
---------------------- a voluntary scheme and it started functioning w.e.f. 1986. The system of
Ombudsman is in vogue in various countries like U.K., New Zealand and
---------------------- Australia. The Government of India also considered the idea of introducing the
---------------------- system of appointing a Banking Ombudsman to redress the grievances of the
customers against the banks.
----------------------
13.2 CONCEPT AND MEANING
----------------------
An ‘Ombudsman’ is-
----------------------
 A man who investigates complaints and mediates fair settlements, especially
---------------------- between aggrieved parties such as consumers or students and an institution
or organization.
----------------------
 An individual charged with the duty of investigating and redressing the
---------------------- sources of complaints lodged by private citizens against businesses,
institutions, and officials.
----------------------
 A government official, especially in Scandinavian countries, who investigates
---------------------- citizens’ complaints against the government or its functionaries.
----------------------  A commissioner who acts as independent referee between individual

citizens and their government or its administration (Government, Politics
---------------------- & Diplomacy)

 An official, without power of sanction or mechanism of appeal, who Notes
investigates complaints of maladministration by members of the public
against national or local government or its servants (as in Britain) ----------------------
13.3 OBJECTIVES AND PURPOSE ----------------------
----------------------
 To provide expeditious and inexpensive forum to bank customers for
resolution of their complaints relating to deficiency in banking services. ----------------------
To resolve the complaints relating to banking services and to facilitate the
----------------------

satisfaction or settlement of such complaints.

 To promote, through conciliation or mediation, a settlement of the complaint ----------------------
by agreement between the complaint and the bank named in the complaint. ----------------------
13.4 RESERVE BANK OF INDIA BANKING OMBUDSMAN ----------------------
SCHEMES
----------------------
The Reserve Bank of India framed the Banking Ombudsman Scheme, 1995
and issued the same u/s 35-A of the Banking Regulation Act, 1949. The objective ----------------------
of the scheme was to enable resolution of complaints relating to provision of ----------------------
banking services and to facilitate the satisfaction or settlement of complaints.
The Banking Ombudsman had only administrative powers and no quasi-judicial ----------------------
authority. And hence, the Banking Ombudsman had no authority to enforce the
awards passed by it against the complainant. ----------------------
The Reserve Bank had first introduced the Banking Ombudsman Scheme in ----------------------
1995. The Scheme was revised in 2002 mainly to cover Regional Rural Banks
and to permit review of the Banking Ombudsmens’ awards against banks by the ----------------------
Reserve Bank. ----------------------
Banking Ombudsman is a quasi judicial authority functioning under India’s
----------------------
Banking Ombudsman Scheme 2006, and the authority was created pursuant to
the a decision by the Government of India to enable resolution of complaints ----------------------
of customers of banks relating to certain services rendered by the banks. The
current scheme became operative from the 1 January 2006, and replaced and ----------------------
superseded the banking Ombudsman Scheme 2002. The Banking Ombudsman
----------------------
Scheme 2006 permits banks and complainants to appeal against the decisions
of the Banking Ombudsman. ----------------------
The scheme is applicable to the whole of India. It is applicable to all the
----------------------
banks in India.
The Banking Ombudsman has the following powers and duties: ----------------------
(i) to receive complaints relating to banking services ----------------------
(ii) to consider such complaints relating to the deficiencies in the banking and ----------------------
other services
(iii) to facilitate their satisfaction or settlement by agreement through mediation ----------------------
and conciliation between the bank and the person making such complaint ----------------------
or to pass an award in accordance with the scheme.

Notes The Banking Ombudsman Scheme provides for the expeditious and
inexpensive resolution of complaints relating to banking activities. The Banking
---------------------- Ombudsman is empowered to act as an arbitrator in specified disputes.
---------------------- The Banking Ombudsman: The Mechanism
Any customer who has a grievance against a bank can complain to the
---------------------- Banking Ombudsman in whose jurisdiction the branch of the bank complained
---------------------- against is located. Some banks have centralized certain transactions, like housing
loans, credit cards, etc. If there are complaints regarding such transactions,
---------------------- complaints would have to be made to the Banking Ombudsman in the State in
which the customer of the bank receives the bill. Complaints can only be filed
---------------------- with the Banking Ombudsman after customers have initially raised them with the
---------------------- bank. Where there has been no reply received from the bank after one month, the
bank rejects the complaint, or the complainant is not satisfied with the reply given
---------------------- by the bank then a complaint can be submitted to the Ombudsman. Complaints
can be submitted in writing (post or email) or through the online complaint form.
---------------------- Complaints can be lodged at the office of the Banking Ombudsman under whose
---------------------- jurisdiction; the bank branch complained against is situated.
If a complaint is not settled by an agreement within a period of one month,
---------------------- the Banking Ombudsman proceeds further to pass an award. Before passing
an award, the Banking Ombudsman provides reasonable opportunity to the
----------------------
complainant and the bank, to present their case. It is up to the complainant to
---------------------- accept the award in full and final settlement of your complaint or to reject it.
The Banking Ombudsman can award compensation not exceeding Rupees
----------------------
one lakh to the complainant in the case of complaints arising out of credit card
---------------------- operations, taking into account the loss of the complainant’s time, expenses
incurred by him as also, harassment and mental anguish suffered. The amount, if
---------------------- any, to be paid by the bank to the complainant by way of compensation for any
loss suffered by the complainant is limited to the amount arising directly out of
----------------------
the act or omission of the bank or Rs.10 lakhs, whichever is lower.
---------------------- Both the customers and the bank are able to appeal to the Reserve Bank
against the awards given by the Banking Ombudsmen. The Banking Ombudsman
----------------------
Scheme 2006 permits banks and complainants to appeal against the decisions of
---------------------- the Banking Ombudsman. The appeal option is, exercised by banks on grounds
that the Award appears to be patently in conflict with the Reserve Bank’s
---------------------- instructions and/ or the law and practice relating to banking. Complainants can
appeal against the decision of the Banking Ombudsman in respect of complaints
----------------------
falling on such grounds specified in the Scheme. The Appellate Authority is the
---------------------- Deputy Governor in charge of the Banking Ombudsman Scheme. The Appellate
Authority either dismisses the appeal or, allows the appeal and setting aside
---------------------- the Award or, it might remand the matter to the Banking Ombudsman for fresh
disposal in accordance, with such directions as the Appellate Authority may
----------------------
consider necessary or proper or modify the Award and pass directions as may
---------------------- be necessary.
The Banking Ombudsman can receive and consider any complaint related
----------------------
to the following deficiency in banking services (including internet banking):

 non-payment or inordinate delay in the payment or collection of cheques, Notes
drafts, bills etc.
----------------------
 non-acceptance of small denomination notes /coins tendered for any purpose,
and for charging of commission in respect thereof. ----------------------
 non-payment or delay in payment of inward remittances.
----------------------
 failure to issue or delay in issue of drafts, pay orders or bankers’ cheques.
----------------------
 non-adherence to prescribed working hours.
 failure to provide or delay in providing a banking facility other than loans ----------------------
promised in writing by a bank or its direct selling agents. ----------------------
 non-payment of deposit or non-observance of the Reserve Bank directives,
if any, applicable to rate of interest on deposits in any savings, current or ----------------------
other account maintained with a bank. ----------------------
 complaints from Non-Resident Indians having accounts in India in relation
----------------------
to their remittances from abroad, deposits and other bank-related matters.
 refusal to open deposit accounts without any valid reason for refusal. ----------------------
 levying of charges without adequate prior notice to the customer. ----------------------
 non-adherence by the bank or its subsidiaries to the instructions of Reserve ----------------------
Bank on ATM/Debit card operations or credit card operations.
 non-disbursement or delay in disbursement of pension (to the extent the ----------------------
grievance can be attributed to the action on the part of the bank concerned, ----------------------
but not with regard to its employees).
----------------------
 refusal to accept or delay in accepting payment towards taxes, as required
by Reserve Bank/Government. ----------------------
 refusal to issue or delay in issuing, or failure to service or delay in servicing
----------------------
or redemption of Government securities.
 forced closure of deposit accounts without due notice or without sufficient ----------------------
reason.
----------------------
 refusal to close or delay in closing the accounts.
----------------------
A customer can also lodge a complaint on the following grounds of deficiency
in service with respect to loans and advances: ----------------------
 non-observance of Reserve Bank Directives on interest rates. ----------------------
 delays in sanction, disbursement or non-observance of prescribed time
----------------------
schedule for disposal of loan applications.
 non-acceptance of application for loans without furnishing valid reasons to ----------------------
the applicant; and
----------------------
 non-adherence to the provisions of the fair practices code for lenders as
adopted by the bank or Code of Bank’s Commitment to Customers, as the ----------------------
case may be. ----------------------

Notes  non-observance of any other direction or instruction of the Reserve Bank as
may be specified by the Reserve Bank for this purpose from time to time.
----------------------
The Banking Ombudsman may also deal with such other matter as may be
---------------------- specified by the Reserve Bank from time to time. All commercial banks, regional
rural banks, scheduled primary cooperative banks having business in India and
---------------------- internet banks are covered by the Scheme.
---------------------- However, the following complaints will not be considered:
Where the bank has not been approached to redress the grievance first.
----------------------

 The complaint has not been submitted to the Ombudsman within one year
---------------------- from the date of last communication with the bank.
----------------------  The subject matter of the complaint is pending for disposal / has already
been dealt with at any other forum like court of law, consumer court etc.
----------------------
 The complaint is frivolous.
----------------------
 The institution complained against is not covered under the scheme.
----------------------  The subject matter of the complaint is not within the ambit of the Banking
Ombudsman.
----------------------
 The complaint relates to the same subject matter that was settled through
---------------------- the office of the Banking Ombudsman in any previous proceedings.
----------------------
----------------------

---------------------- 1. The Banking Ombudsman Scheme, 1995 is framed with the objective
of enabling resolution of complaints relating to provision of
----------------------
i. Monetary services
---------------------- ii. Banking services
---------------------- iii. Negotiation services
---------------------- iv. Legal Services
2. Under the Ombudsman Scheme, the amount, if any, to be paid by
----------------------
the bank to the complainant by way of compensation for any loss
---------------------- suffered by the complainant is limited to the amount arising directly
out of the act or omission of the bank or such amount, whichever is
---------------------- lower.
---------------------- i. Rs.10 lakh
---------------------- ii. Rs. 20 lakh

iii. Rs. 50 lakh
----------------------
iv. Rs. 25 lakh
----------------------

Summary Notes
●● The Banking Ombudsmen have been generally effective in redress of ----------------------

complaints of bank customers. During the year 2007-08, the Banking
Ombudsmen received 47887 complaints as against 38638 received in ----------------------
the previous year (an increase of 24%) and disposed of 89% of the total ----------------------
complaints (84% in the previous year), with only 11% carried forward to
the next year. Out of the 11% of complaints carried forward to the next ----------------------
year, only 6 % were more than 2 months old.
----------------------
Keywords ----------------------
●● Ombudsman: An individual charged with the duty of investigating and ----------------------
redressing the sources of complaints lodged by private citizens against
businesses, institutions, and officials. ----------------------
●● Banking Ombudsman: A person appointed to resolve the complaints ----------------------
relating to banking services and to facilitate the satisfaction or settlement
of such complaints. ----------------------
●● Banking Ombudsman Scheme, 1995: First scheme launched by the ----------------------
Reserve Bank in 1991 – a scheme where the body had only administrative
powers. ----------------------
●● Banking Ombudsman Scheme, 2006: A revised banking ombudsman ----------------------
scheme launched in 2006 where the ombudsman is a quasi judicial body.
----------------------
----------------------
1. Give the meaning of Ombudsman.
----------------------
2. What are the objectives of a Banking Ombudsman?
3. Briefly explain the Banking Ombudsman Scheme, 1995 of the Reserve ----------------------
Bank of India. ----------------------
4. How is the Banking Ombudsman Scheme, 2006 an improvement over the
----------------------
earlier schemes of Reserve Bank of India?
5. What is the procedure of registering a complaint with the Banking ----------------------
Ombudsman?
----------------------
6. What kind of complaints can be registered with the Banking Ombudsman?
----------------------
7. Discuss the powers of the Banking Ombudsman.
----------------------
----------------------
1. The Banking Ombudsman Scheme, 1995 is framed with the objective of ----------------------
enabling resolution of complaints relating to provision of
----------------------
ii. Banking services

Notes 2. Under the Ombudsman Scheme, the amount, if any, to be paid by the
bank to the complainant by way of compensation for any loss suffered by
---------------------- the complainant is limited to the amount arising directly out of the act or
omission of the bank or such amount, whichever is lower.
----------------------
i. Rs.10 lakh
----------------------

----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------
----------------------

References Notes
----------------------
Bare Act – Banking Regulation Act, 1934
Website of Reserve Bank of India – www.rbi.org.in ----------------------
Banking Law and Practice in India - M.L. Tannan (Latest Edition) ----------------------
Bhole, L.M. (2004) “Financial Institutions and Markets” Tata McGraw Hill. ----------------------
Bhasin, Niti (2006) “Banking Developments in India 1947 to 2007” New Century
----------------------
Publications.
Kapila Raj & Kapila Uma “Banking & Financial Sector Reforms in India” Academic ----------------------
Foundation, New Delhi
----------------------
Bare Act – Banking Regulation Act, 1949
----------------------
Bare Act – Negotiable Instrument Act, 1881
Mercantile Law - N. D. Kapoor ----------------------
Business Law - P. C. Tulsian ----------------------

Banking Law and Practice - B. M. Lal Nigam ----------------------
Banking Theory, Law & Practice - Sundaram and Varshaney
----------------------
Banking Law and Practice - Gordon and Natarajan
----------------------
Bhole L.M. “Financial Institutions and Markets” TataMcGraw Hill, 5th edition
Bare Act – The Recovery of Debts due to Banks and Financial Institutions Act, 1993 ----------------------
Website – www.rbi.org.in ----------------------

Bhole, L.M. (2004) “Financial Institutions and Markets” Tata McGraw Hill. ----------------------
Kapila Raj & Kapila Uma “Banking & Financial Sector Reforms in India” Academic
----------------------
Foundation, New Delhi
Sundharam & Varshney “Banking Theory, Law & Practice” Sultan Chand & Co. ----------------------
Report of the Committee on the Indian Financial System (Narasimham Committee I) ----------------------
Report of the Committee on the Banking Sector Reforms (Narasimham Committee II) ----------------------
Bare Act “Foreign Exchange Management Act, 1999
----------------------
Gulshan SS (2006) “Business Law” 3rd edition, Excel Books
----------------------
Bare Act – The Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2002 ----------------------
Bare Act “The Information Technology Act, 2000 ----------------------
Banking Ombudsman Scheme, 2006 - www.rbi.org.in
----------------------
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References 217
Notes
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Banking Regulations and Laws

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Banking Regulations and Laws

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BANKING REGULATIONS

(FOR PRIVATE CIRCULATION ONLY)

COURSE DESIGN AND REVIEW COMMITTEE

Published by Symbiosis Centre for Distance Learning (SCDL), Pune

Copyright © 2019 Symbiosis Open Education Society

I thank all those, who directly or indirectly helped me in completing my work.

Dr. Arwah Madan

She has also been a visiting faculty to various B-Schools in Pune.

The Reserve Bank of India Act, 1934 1

---------------------- 1.1 INTRODUCTION

---------------------- 1.2 ESTABLISHMENT AND INCORPORATION

2 Banking Regulations & Laws

The Reserve Bank of India Act, 1934 3

---------------------- Fill in the blanks.

---------------------- 1.4 BUSINESS OF THE BANK

4 Banking Regulations & Laws

credit facilities available in normal times.

Check your Progress 2 ----------------------

The Reserve Bank of India Act, 1934 5

---------------------- iii. The Reserve Bank of India

---------------------- 1.5 CENTRAL BANKING FUNCTIONS

6 Banking Regulations & Laws

– The balance held by it with the Reserve Bank. ----------------------

The Reserve Bank of India Act, 1934 7

8 Banking Regulations & Laws

The Reserve Bank of India Act, 1934 9

10 Banking Regulations & Laws

The Reserve Bank of India Act, 1934 11

particulars made, required or furnished by or under or for the purposes of

---------------------- Multiple Choice Single Response

12 Banking Regulations & Laws

The Reserve Bank of India Act, 1934 13

thread, latent image and intaglio features for visually handicapped.

14 Banking Regulations & Laws

 The current issues before the Board are ----------------------

The Reserve Bank of India Act, 1934 15

---------------------- Self-Assessment Questions

---------------------- 5. What is meant by Credit Information?

---------------------- Check your Progress 1

16 Banking Regulations & Laws

The Reserve Bank of India Act, 1934 17

18 Banking Regulations & Laws

Banking Regulation Act, 1949 19

---------------------- 2.1 INTRODUCTION

20 Banking Regulations & Laws

 Acquiring, holding, issuing on commission, underwriting and dealing

Subsidiary functions- Besides, it can also perform the following functions

Banking Regulation Act, 1949 21

----------------------  Undertaking and executing trusts;

22 Banking Regulations & Laws

Incorporated in India Rupees ----------------------

If any such place/s of business is or are situated in the ----------------------

Banking Regulation Act, 1949 23

24 Banking Regulations & Laws

Branch License ----------------------

Banking Regulation Act, 1949 25

----------------------  The general character of the management of the banking company,

---------------------- 2.5 MANAGEMENT

26 Banking Regulations & Laws

 is a director, manager, partner or proprietor of any trading, commercial or ----------------------

Banking Regulation Act, 1949 27

28 Banking Regulations & Laws

Banking Regulation Act, 1949 29