Banking and Insurance Law Notes

Chanderprabhu Jain College of Higher Studies
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An ISO 9001:2008 Certified Quality Institute
(Recognized by Govt. of NCT of Delhi, Affiliated to GGS Indraprastha University, Delhi)
Class :BALLB& BBALLB -VIII
Paper Code : LLB -409 (A)
Subject :BANKING AND INSURANCE LAWS
UNIT I : BANKING SYSTEM IN INDIA
A. KINDS OF BANKS AND THEIR FUNCTIONS
Various Types of Banks and Their Functions – Banking Study Material & Notes
Broadly, banks are classified either into commercial banks or as central bank. they are also
classified as Scheduled and Non-scheduled Banks.
Scheduled banks have been included in the second schedule of the Reserve Bank, and fulfils the
following three criteria:
1. It must have a paid up capital of at least Rs. 5 lakhs.

2. It must fulfil the RBI norms about no activity that may be detrimental to the depositors
interests.
3. It must be a Corporation (not a partnership or a single ownership firm).
Non-Scheduled Banks are excluded from the Second schedule of RBI. The Reserve Bank does
not exercise much control over them, but they report monthly to RBI.
Now, We shall first look into Central Bank first. The central bank has the primary function of
regulating commercial banks and other economic activities in the economy. It acts as a Banker’s
Bank. In India, the central Bank is the Reserve Bank of India. It is the apex bank who controls all
other banks by regulating and supervising their activities.
Now, lets talk about Commercial banks. These are those banks which provide banking services
to people with a profit motive. They charge a certain prescribed amount for the services they
provide.
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There are several types of commercial banks functioning in India based upon different categories:
I. Public Sector Banks – Majority stake is held by Government
• State Bank of India and its associate banks: These associate banks are State Bank of
Bikaner & Jaipur, State Bank of Hyderabad, State Bank of Mysore, State Bank of Patiala,
and State Bank of Travancore.
• Nationalised Banks– These are those commercial banks that have been nationalized for
fulfilling the social objectives of the government. There are 20 Nationalised banks in
India. These are – Allahabad Bank, Andhra Bank, Bank of Maharashtra, Bank of Baroda,
Canara Bank, Central Bank of India, Bank of India, , Corporation Bank, Dena
Bank, Indian Overseas Bank, IDBI Bank Ltd., Oriental Bank of Commerce, Indian Bank,
Punjab & Sind Bank, Punjab National Bank, Union Bank of India, Syndicate Bank,
United Bank of India,UCO Bank, and Vijaya Bank.
• Regional Rural Banks(RRB)– These banks have been established to strengthen the rural
economy. They facilitate the credit and deposit flow for farmers, artisans, labourers in
their limited local area. These banks are jointly owned by the central and state government
along with a sponsor commercial bank.
II. Private Sector Banks – Majority share capital is with private individuals & corporates
• Old Private Banks – There are fourteen old private banks operating in India. These banks
were not nationalised when other banks were nationalised in 1969 and 1980. These
are- Catholic Syrian Bank Ltd., Dhanalakshmi Bank Ltd., City Union Bank Ltd., Federal
Bank Ltd., Lakshmi Vilas Bank Ltd., ING Vysya Bank Ltd., Karur Vysya Bank Ltd.,
Karnataka Bank Ltd., , Nainital Bank Ltd., Ratnakar Bank Ltd., Jammu & Kashmir Bank
Ltd., South Indian Bank Ltd., SBI Commercial & International Bank Ltd, and Tamilnad
Mercantile Bank Ltd.
• New Private Banks- There are seven new private banks functioning in the Indian
economy. These are- Axis Bank Ltd., Development Credit Bank Ltd, ICICI Bank Ltd.,
IndusInd Bank Ltd., Kotak Mahindra Bank Ltd., HDFC Bank Ltd., and Yes Bank Ltd.
• Foreign Banks- These banks have their registered head offices in a foreign country, while
they operate their branches in India. They can operate in India either through wholly-
owned subsidiaries or through branches. There are 32 foreign banks operating their
various branches in India.
• Co-operative Banks – Cooperative banks are those scheduled banks that are regulated by
RBI, under a cooperative structure to provide credit to all actegories of businesses. Their
ownership structure is unique where like minded individuals and companies pool in
money together to support credit facilities to businesses. These can operate in either Urban
or Rural setting. That is another criteria to differentiate these co-operative banks.
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• The types of banks in India can be understood from the following table, which explains
what kind of customer base different types of banks have.
This classification of various types of banks in India is highly useful for solving the banking
awareness questions asked in exams conducted by IBPS, SBI, RBI, and other recruiters in the
banking industry. This knowledge also helps in facing interviews confidently. As an aspirant for
banking exams, one must have updated knowledge of these classifications about the types of
banks.
UNIT II B.
HISTORY OF BANKING IN INDIA
Indian Banking System for the last two centuries has seen many developments. An indigenous
banking system was being carried out by the businessmen called Sharoffs, Seths, Sahukars,
Mahajans, Chettis, etc. since ancient time. They performed the usual functions of lending moneys
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to traders and craftsmen and sometimes placed funds at the disposal of kings for financing wars.
The indigenous bankers could not, however, develop to any considerable extent the system of
obtaining deposits from the public, which today is an important function of a bank. Modern
banking in India originated in the last decades of the 18th century. The first banks were The
General Bank of India which started in 1786, and the Bank of Hindustan. Thereafter, three
presidency banks namely the Bank of Bengal (this bank was originally started in the year 1806 as
Bank of Calcutta and then in the year 1809 became the Bank of Bengal) , the Bank of Bombay
and the Bank of Madras, were set up. For many years the Presidency banks acted as quasi-central
banks. The three banks merged in 1925 to form the Imperial Bank of India. Indian merchants in
Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the
economic crisis of 1848-49. Bank of Upper India was established in 1863 but failed in 1913. The
Allahabad Bank, established in 1865 , is the oldest survived Joint Stock bank in India . Oudh
Commercial Bank, established in 1881 in Faizabad, failed in 1958. The next was the Punjab
National Bank, established in Lahore in 1895, which is now one of the largest banks in India. The
Swadeshi movement inspired local businessmen and political figures to found banks of and for
the Indian community during 1906 to 1911. A number of banks established then have survived to
the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank
and Central Bank of India. A major landmark in Indian banking history took place in 1934 when
a decision was taken to establish ‘Reserve Bank of India’ which started functioning in 1935. Since
then, RBI, as a central bank of the country, has been regulating banking system.
UNIT II C: BANKING REGULATION LAWS

(I) RESERVE BANK OF INDIA ACT, 1934
Reserve Bank of India as a Central Bank of the Country
The Reserve Bank, as the central bank of the country, started their operations as a private
shareholder’s bank. RBI replaced the Imperial Bank of India and started issuing the
currency notes and acting as the banker to the government. Imperial Bank of India was
allowed to act as the agent of the RBI. RBI covered all over the undivided India. In order
to have close integration between policies of the Reserve Bank and those of the
Government, It was decided to nationalize the Reserve Bank immediately after the
independence of the country. From 1st January 1949, the Reserve Bank began functioning
as a State-owned and State-controlled Central Bank.. To streamline the functioning of
commercial banks, the Government of India enacted the Banking Companies Act,1949
which was later changed as the Banking Regulation Act 1949. RBI acts as a regulator of
banks, banker to the Government and banker’s bank. It controls financial system in the
country through various measures.
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Banking industry in India is mainly governed by the Reserve Bank of India Act,1934 and the
Banking Regulation Act,1949. There are other legal frame work like the Companies Act,1956,
the Negotiable Instruments Act,1881, the Indian Contract Act,1872, the DRT Act,1993, the Law
of Limitation, FEMA,1999, etc. which are supplementary to the RBI Act,1934 and the BR
Act,1949. Reserve Bank of India and the Government of India have been empowered to exercise
control over banks from its opening to winding up. At the end of the chapter, the reader would
be able to: – Appreciate the role of banks and their regulatory and compliance requirements –
Understand the Government and RBI’s Powers to control and regulate banks – Know the
important provisions of RBI Act, 1934, Banking Regulation (BR) Act, 1949 and PML Act, 2002
– Distinguish between the concepts of CRR and SLR This chapter covers the Regulation and
Control on banking in India by the Government of India and the Reserve Bank of India it also
highlights the features of various legal frame work like the RBI Act, 1934 and the BR Act,1949
the provisions of which are applicable to banking. Apart from the above Acts, different laws and
their provisions have also been discussed. RBI as the central bank of the nation and its role as
regulator, supervisor and facilitator have also been covered.
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The Reserve Bank of India Act,1934 was enacted to constitute the Reserve Bank of India with an
objective to (a) regulate the issue of bank notes (b) for keeping reserves to ensure stability in the
monetary system (c) to operate effectively the nation’s currency and credit system The RBI Act
covers: (i) the constitution (ii) powers (iii) functions of the Reserve Bank of India. The act does
not directly deal with the regulation of the banking system except for few sections like Sec 42
which relates to the maintenance of CRR by banks and Sec 18 which deals with direct discount
of bills of exchange and promissory notes as part of rediscounting facilities to regulate the credit
to the banking system. The RBI Act deals with: (a) incorporation, capital, management and
business of the RBI (b) the functions of the RBI such as issue of bank notes, monetary control,
banker to the Central and State Governments and banks, lender of last resort and other functions
(c) general provisions in respect of reserve fund, credit funds, audit and accounts (d) issuing
directives and imposing penalties for violation of the provisions of the Act.
Banking Regulation Act, 1949
The Banking Regulation Act, 1949 is one of the important legal frame works. Initially the Act
was passed as Banking Companies Act,1949 and it was changed to Banking Regulation Act 1949.
Along with the Reserve Bank of India Act 1935, Banking Regulation Act 1949 provides a lot of
guidelines to banks covering wide range of areas. Some of the important provisions of the
Banking Regulation Act 1949 are listed below. – The term banking is defined as per Sec 5(i) (b),
as acceptance of deposits of money from the public for the purpose of lending and/or investment.
Such deposits can be repayable on demand or otherwise and withdraw able by means of cheque,
drafts, order or otherwise – Sec 5(i)(c) defines a banking company as any company which handles
the business of banking – Sec 5(i)(f) distinguishes between the demand and time liabilities, as the
liabilities which are repayable on demand and time liabilities means which are not demand
liabilities – Sec 5(i)(h) deals with the meaning of secured loans or advances. Secured loan or
advance granted on the security of an asset, the market value of such an asset in not at any time
less than the amount of such loan or advances. Whereas unsecured loans are recognized as a loan
or advance which is not secured – Sec 6(1) deals with the definition of banking business – Sec 7
specifies banking companies doing banking business in India should use at least on work bank,
banking, banking company in its name – Banking Regulation Act through a number of sections
restricts or prohibits certain activities for a bank. For example:
(i) Trading activities of goods are restricted as per Section 8
(ii) Prohibitions: Banks are prohibited to hold any immovable property subject to certain terms
and conditions as per Section 9 . Further, a banking company cannot create a charge upon any
unpaid capital of the company as per Section 14. Sec 14(A) stipulates that a banking company
also cannot create a floating charge on the undertaking or any property of the company without
the prior permission of Reserve Bank of India.
(iii) A bank cannot declare dividend unless all its capitalized expenses are fully written off as per
Section 15. Other important sections of Banking Regulation Act, 1949 Sections 11 and 12 deals
with the Paid up Capital, Reserves and their terms and conditions, Sec 18 specifies the Cash
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Reserve Ratio to be maintained by Non-scheduled banks and Sec 19 (2) clarifies about the share
holding of a banking company. No banking company shall hold shares in any company, (either
as pledge, or mortgagee or absolute owners of any amount exceeding 30% of its own paid up
share capital plus reserves (or) 30% of the paid up share capital of that company whichever is less
Section 24 specifies the requirement of maintenance of Statutory Liquidity Ratio (SLR) as a
percentage (as advised by Reserve Bank of India from time to time) of the bank’s demand and
time liabilities in the form of cash, gold, unencumbered securities Other compliance requirements
Section 29 – Every bank needs to publish its balance sheet as on March 31st Section 30(i) – Audit
of Balance sheet by qualified auditors Section 35 gives powers to RBI to undertake inspection of
banks Other various sections deal with important returns which are to be submitted by banks to
Reserve Bank of India – Return of bank’s liquid assets and liabilities (Monthly) – Return of bank’s
assets and liabilities in India (Quarterly) – Return of unclaimed deposits of 10 years and above
(Yearly) With changing time and requirements from time to time, various other compliance issues
which need to be handled by banks, have been amended/incorporated relating to: – Nomination
facilities – Time period for preservation of bank books/record.
Unit I d. Bank Nationalization and Social Control over Banking
Modern banking in India originated in the last decade of the 18th century. Among the
first banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829–
32; and the General Bank of India, established in 1786 but failed in 1791.
The largest and the oldest bank which is still in existence is the State Bank of India (S.B.I). It
originated and started working as the Bank of Calcutta in mid-June 1806. In 1809, it was renamed
as the Bank of Bengal. This was one of the three banks founded by a presidency government, the
other two were the Bank of Bombay in 1840 and the Bank of Madras in 1843. The three banks
were merged in 1921 to form the Imperial Bank of India, which upon India's independence,
became the State Bank of India in 1955. For many years the presidency banks had acted as quasi-
central banks, as did their successors, until the Reserve Bank of India was established in 1935,
under the Reserve Bank of India Act, 1934.
In 1960, the State Banks of India was given control of eight state-associated banks under the State
Bank of India (Subsidiary Banks) Act, 1959. These are now called its associate banks. In 1969
the Indian government nationalized 14 major private banks; one of the big banks was Bank of
India. In 1980, 6 more private banks were nationalized. These nationalized banks are the majority
of lenders in the Indian economy. They dominate the banking sector because of their large size
and widespread networks.
The Indian banking sector is broadly classified into scheduled and non-scheduled banks. The
scheduled banks are those included under the 2nd Schedule of the Reserve Bank of India Act,
1934. The scheduled banks are further classified into: nationalized banks; State Bank of India and
its associates; Regional Rural Banks (RRBs); foreign banks; and other Indian private sector
banks.[7] The term commercial banks refers to both scheduled and non-scheduled commercial
banks regulated under the Banking Regulation Act, 1949.
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Generally the supply, product range and reach of banking in India is fairly mature-even though
reach in rural India and to the poor still remains a challenge. The government has developed
initiatives to address this through the State Bank of India expanding its branch network and
through the National Bank for Agriculture and Rural Development (NABARD) with facilities
like microfinance.
History
Ancient India
The Vedas (2000–1400 BCE) are the earliest Indian texts to mention the concept of usury, with
the word kusidin translated as "usurer". The Sutras (700–100 BCE) and the Jatakas (600–400
BCE) also mention usury. Texts of this period also condemned
usury: Vasishtha forbade Brahmin and Kshatriya varnas from participating in usury. By the 2nd
century CE, usury became more acceptable. The Manusmriti considered usury an acceptable
means of acquiring wealth or leading a livelihood. It also considered money lending above a
certain rate and different ceiling rates for different castes a grave sin.
The Jatakas, Dharmashastras and Kautilya also mention the existence of loan deeds,
called rnapatra, rnapanna, or rnalekhaya.
Later during the Mauryan period (321–185 BCE), an instrument called adesha was in use, which
was an order on a banker directing him to pay the sum on the note to a third person, which
corresponds to the definition of a modern bill of exchange. The considerable use of these
instruments has been recorded. In large towns, merchants also gave letters of credit to one
another.
Medieval era
The use of loan deeds continued into the Mughal era and were called dastawez. Two types of
loans deeds have been recorded. The dastawez-e-indultalab was payable on demand
and dastawez-e-miadi was payable after a stipulated time. The use of payment orders by royal
treasuries, called barattes, have been also recorded. There are also records of Indian bankers using
issuing bills of exchange on foreign countries. The evolution of hundis, a type of credit
instrument, also occurred during this period and remain in use.
Colonial era
During the period of British rule merchants established the Union Bank of Calcutta in 1929 first
as a private joint stock association, then partnership. Its proprietors were the owners of the earlier
Commercial Bank and the Calcutta Bank, who by mutual consent created Union Bank to replace
these two banks. In 1840 it established an agency at Singapore, and closed the one at Mirzapore
that it had opened in the previous year. Also in 1840 the Bank revealed that it had been the subject
of a fraud by the bank's accountant. Union Bank was incorporated in 1845 but failed in 1848,
having been insolvent for some time and having used new money from depositors to pay its
dividends.
The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock
bank in India, it was not the first though. That honour belongs to the Bank of Upper India, which
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was established in 1863 and survived until 1913, when it failed, with some of its assets and
liabilities being transferred to the Alliance Bank of Simla.
Foreign banks too started to appear, particularly in Calcutta, in the 1860s. Grindlays Bank opened
its first branch in Calcutta in 1864.[18] The Comptoird'Escompte de Paris opened a branch in
Calcutta in 1860, and another in Bombay in 1862; branches followed in Madras and Pondicherry,
then a French possession. HSBC established itself in Bengal in 1869. Calcutta was the most
active trading port in India, mainly due to the trade of the British Empire, and so became a banking
centre.
The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881
in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in
1894, which has survived to the present and is now one of the largest banks in India.
Around the turn of the 20th Century, the Indian economy was passing through a relative period
of stability. Around five decades had elapsed since the Indian rebellion, and the social, industrial
and other infrastructure had improved. Indians had established small banks, most of which served
particular ethnic and religious communities.
The presidency banks dominated banking in India but there were also some exchange banks and
a number of Indian joint stock banks. All these banks operated in different segments of the
economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign
trade. Indian joint stock banks were generally under capitalised and lacked the experience and
maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon
to observe, "In respect of banking it seems we are behind the times. We are like some old
fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome
compartments."[citation needed]
The period between 1906 and 1911 saw the establishment of banks inspired by
the Swadeshi movement. The Swadeshi movement inspired local businessmen and political
figures to found banks of and for the Indian community. A number of banks established then have
survived to the present such as Catholic Syrian Bank, The South Indian Bank, Bank of
India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India.
The fervour of Swadeshi movement led to the establishment of many private banks in Dakshina
Kannada and Udupi district, which were unified earlier and known by the name South Canara
(South Kanara) district. Four nationalised banks started in this district and also a leading private
sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian
Banking".[citation needed]
The inaugural officeholder was the Britisher Sir Osborne Smith(1 April 1935), while C. D.
Deshmukh(11 August 1943) was the first Indian governor.On December 12, 2018,Shaktikanta
Das, who was the finance secretary with the Government of India, begins his journey as the new
RBI Governor, taking charge from Urjit R Patel.
During the First World War (1914–1918) through the end of the Second World War (1939–
1945), and two years thereafter until the independence of India were challenging for Indian
banking. The years of the First World War were turbulent, and it took its toll with banks simply
collapsing despite the Indian economy gaining indirect boost due to war-related economic
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activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following
table:
Number of banks Authorised Capital Paid-up Capital

Years
that failed (₹ Lakhs) (₹ Lakhs)
1913 12 274 35
1914 42 710 109
1915 11 56 5
1916 13 231 4
1917 9 76 25
1918 7 209 1
Post-Independence
During 1938-46, bank branch offices trebled to 3,469 and deposits quadrupled to ₹962 crore.
Nevertheless, the partition of India in 1947 adversely impacted the economies
of Punjab and West Bengal, paralysing banking activities for months.
India's independence marked the end of a regime of the Laissez-faire for the Indian banking.
The Government of India initiated measures to play an active role in the economic life of the
nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged
a mixed economy. This resulted in greater involvement of the state in different segments of the
economy including banking and finance. The major steps to regulate banking included:
• The Reserve Bank of India, India's central banking authority, was established in April 1935,
but was nationalized on 1 January 1949 under the terms of the Reserve Bank of India
(Transfer to Public Ownership) Act, 1948 (RBI, 2005b).
• In 1949, the Banking Regulation Act was enacted, which empowered the Reserve Bank of
India (RBI) to regulate, control, and inspect the banks in India.
• The Banking Regulation Act also provided that no new bank or branch of an existing bank
could be opened without a license from the RBI, and no two banks could have common
directors.
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Nationalisation in 1969 and 1980
Despite the provisions, control and regulations of the Reserve Bank of India, banks in India except
the State Bank of India (SBI), remain owned and operated by private persons. By the 1960s, the
Indian banking industry had become an important tool to facilitate the development of the Indian
economy. At the same time, it had emerged as a large employer, and a debate had ensued about
the nationalisation of the banking industry. Indira Gandhi , the then Prime Minister of India,
expressed the intention of the Government of India in the annual conference of the All India
Congress Meeting in a paper entitled Stray thoughts on Bank Nationalization.
Thereafter, the Government of India issued the Banking Companies (Acquisition and Transfer of
Undertakings) Ordinance, 1969 and nationalised the 14 largest commercial banks with effect
from the midnight of 19 July 1969. These banks contained 85 percent of bank deposits in the
country.[21] Within two weeks of the issue of the ordinance, the Parliament passed the Banking
Companies (Acquisition and Transfer of Undertaking) Bill, [23] and it
received presidential approval on 9 August 1969.
The following banks were nationalised in 1969:
• Allahabad Bank
• Bank of Baroda
• Bank of India
• Bank of Maharashtra
• Central Bank of India
• Canara Bank
• Dena Bank
• Indian Bank
• Indian Overseas Bank
• Punjab National Bank
• Syndicate Bank
• UCO Bank
• Union Bank
• United Bank of India
A second round of nationalisations of six more commercial banks followed in 1980. The stated
reason for the nationalisation was to give the government more control of credit delivery. With
the second round of nationalisations, the Government of India controlled around 91% of the
banking business of India.
The following banks were nationalised in 1980:
• Punjab and Sind Bank

• Vijaya Bank
• Oriental Bank of India
• Corporate Bank
• Andhra Bank
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• New Bank of India
Later on, in the year 1993, the government merged New Bank of India with Punjab National
Bank. It was the only merger between nationalised banks and resulted in the reduction of the
number of nationalised banks from 20 to 19. Until the 1990s, the nationalised banks grew at a
pace of around 4%, closer to the average growth rate of the Indian economy.
Unit I (e).
Relationship between Banker and Customer
An Overview
Introduction
The relationship between the banker and the customer arises out of the contract between
them and cannot be created except by mutual consent. A contract that exists between a banker
and its customer is a loan contract because if the customer’s account is in credit, the bank owes
him that money and vice-versa if the account is overdrawn. The relationship between a banker
and his customer is basically the contractual relationship of debtor and creditor and is regulated
by the provisions contained in the Negotiable Instruments Act, 1881, and the Indian Contract Act,
1872.
Types of Services
(a) Traditional Services
(b) New Services
Traditional services
i. Maintenance of different types of deposit accounts, e.g., savings, fixed and current deposit
accounts;
ii. Grant of advances through cash credit, overdraft and loan accounts and through
purchasing/discounting demand and usance bills;
iii. Collection of cheques, bills of exchange and other instruments (inland and foreign);
iv. Issue of performance and financial guarantees;
v. Provision of remittance facilities by issue of drafts, mail transfers, and telegraphic
transfers;
vi. Provision of facilities of safe deposit and safe custody; and
vii. Purchase and sale of securities.
New services
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The banks have introduced a number of new services with an emphasis on deposit
mobilization and grant of credit to weaker sections of society in recent years.
The banker and the customer.
Meaning and Definition of a Banker.

The term ‘banker’ refers to a person or company carrying on the business of receiving
moneys, and collecting drafts, for customers subject to the obligation of honouring cheques drawn
upon them from time to time by the customers to the extent of the amounts available on their
current accounts.
There are differences of opinion regarding the meaning of the term banker. The following
are some of the important definitions given by the eminent authors:
Sheldon H.P. defined banker as, “the function of receiving money from his customers
and repaying it by honouring their cheques as and when required is the function above all other
functions which distinguishes a banking business from any other kind of business”.
Sir John Pagetdefined banker as, “No person or body corporate or otherwise can be a
banker who does not take deposit accounts, take current accounts, issue and pay cheques and
collect crossed and uncrossed and uncrossed for his customers”.
G. Crowtherdefined banker as, “A banker is a dealer in debt, his own and other
people”.
Macleod defined banker as, “The essential business of banker is to buy money and debts,
by creation of other debts. A banker is therefore essentially a dealer in debts or credit”.
The late Dr. Hartdefined a banker or banks as:

…… a person or company carrying on the business of receiving moneys, and collecting
drafts, for customers subject to the obligation of honouring cheques drawn upon them from time
to time by the customers to the extent of the amounts available on their current accounts.
Likewise, Halsbury’s laws of England defines a banker as:
An individual, partnership or corporation, whose sole or pre-dominating business is

banking, that is, the receipt of money on current or deposit account and the payment of cheques
drawn by and the collection of cheques paid in by a customer.
Statutory Definitions
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Section 2 of the Bills of Exchange Act, 1882, provides that ‘in this Act, unless the context
otherwise requires… “banker” includes a body of persons, whether incorporated or not who carry
on the business of banking. This curious ‘definition’ has been the subject of derisive comment for
many years.
The Banking Act, 1979, introduced the concept of ‘recognized’ banks, that is to say, banks
recognized by the Bank of England. Recognition was, however, solely for the purposes of this
Act. The Banking Act, 1987, repealed the Banking Act, 1979, and all deposit-taking institutions
are now known as ‘authorized institutions’.
A Banking company is defined by section 5(1)(c) of the Banking Regulation Act, 1949, as
one which transacts the business of banking in India and the business of banking is defined by
section 5(b) of the Act, which says as “accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise, of deposits of money from
the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or
otherwise”.
Views expressed by the courts

The opinions expressed by judges concerning the essential characteristics of banking have
changed over the years. The traditional view is that no one may be considered a banker unless he
pays cheques drawn on himself.
In Bank of Chettinad case, it was explained that the words ‘banker’ and ‘banking’ may
‘bear different shades of meaning at different periods of history’ and that their meaning ‘may not
be uniform today in countries of different habits of life and different degrees of civilization’. In
the case of Re-Bottomgate Industrial Cooperative Society, Smith, J. defined the business of
banker thus:
“the principal part of the business of a banker is receiving money on

deposit, allowing the same to be drawn against as and when the depositor desires, and
paying interest on the amounts standing on deposit”.
The traditional view, namely, that no one may be considered a banker unless he pays
cheques drawn on himself, was re-affirmed by Mocatta J., and by the Court of Appeal in United
Dominions Trust Ltd. The decision of the Court of Appeal was by a majority, but all three
members of the court shared the view that the usual characteristics of banking at the present time
are :
(a) the acceptance of money from, and collection of cheques for customer and the placing of
them to the custoemrs’ credit;
(b) the honouring of cheques or orders drawn on the bank by their customers when presented
for payment; and
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(c) the keeping of some form of current or running accounts in their books in which the credits
and debits are entered. In addition to these three usual characteristics, there are, of course,
others, for example, the lending of money.
Thus, to constitute a customer, the following prerequisites are a must:
i. a bank account – savings, current or fixed deposit – must be opened in his name by making
necessary deposit of money, and
ii. the dealing between the banker and the customer must be of the nature of banking
business.
A customer of a banker need not necessarily be a person. A firm, joint stock Company, a
society or any separate legal entity may be a customer. According to Section 45-Z of the Banking
Regulation Act, 1949, “Customer” includes a government department and a corporation
incorporated by or under any law.
Special Types of Customers

Special types of customers are those who are distinguished from other types of ordinary
customers by some special features. Hence, they are called special types of customers. They are
to be dealt with carefully while operating and opening the accounts. The following are some of
the examples of special types of customers.
The Banker-Customer Relationship

The relationship between the banker and the customer arises out of the contract entered
into between them. This contract is created by mutual consent. A contract that exists between a
bank and its customer is a loan contract. This is because if the customer’s account is in credit, the
bank owes him that money and vice versa if the account is overdrawn. This contractual
relationship between banker and customer is regulated by the rules contained in the Negotiable
Instruments Act, 1881, and the Indian Contract Act, 1972. The relationship between the banker
and the customer is vital. The relationship start right from the moment an account is opened and
it comes to an end immediately on closure of the account. This relationship is of two types.
General relationship
Special relationship
General Relationship
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The general relationship between banker and customer can be classified into two types,
viz.,
Primary relationship, and
Secondary relationship.
(a) Primary Relationship

The basic and most important relationship between the bank and its customer is
that of debtor and creditor respectively and vice-versa, as the essential business of banking
is to receive money on deposit account from a customer and lend part of it to another
customer. A banker also acts as an agent or trustee of his customer if the latter entrusts the
former with agency or trust work. In such cases, the banker acts a debtor, an agent and a
trustee simultaneously but in relation to the specified business.
(i) Relationship as Debtor and Creditor

The legal relationship between banks and their customers, who by depositing
money with the banks provide them with the major part of their resources with which they
carry on their activities, is a simple contractual one giving rise to rights and obligations
on both sides. When a bank receives money from a customer in current account, the
relationship primarily of debtor (the banker) and creditor (the cutomer) with the roles
reversed when the banker advances money to the customer. The banker can use the money
deposited with him by his customer in any manner according to his discretion, his only
obligation being to repay the deby as and when he is required to do so by his customer.
He is not a depository or trustee of the customer’s money because a depository accepts
something for safe custody on the condition that it will not be opened or replaced by
similar commodity. A banker does not accept the depositor’s money on such conditions.
The true relationship between the two parties was admirably described by Lord
Cottenham in 1848 in the following famous case and it is worthwhile quoting it in some
detail.
In Foley v. Hill, “Money, when paid into a bank, ceases altogether to be the money
of the principal; it is then the money of the banker, who is bound to return an equivalent
by paying a similar sum to that deposited with him when he is asked for it; therefore, he
is known to deal with it as his own; he makes what profit he can, which profit he retains
for himself paying back only the principal according to the custom of bankers in some
places, or the principal and a small rate of interest according to the custom of bankers at
other places.
(ii) Demand for Repayment Necessary

The general rule that demand for repayment by creditor is unnecessary and
applicable in case of ordinary commercial debts, does not apply in case of banks. the
customer must make an express demand for repayment ot make the debt actually due for
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payment by the bank. This is because if the banker offers money to the customer without
any demand from him, it would amount to summarily closing the customer’s account
without notice. This may damage his customer credit on account of possible dishonor of
cheques already issued by him.
(iii) Demand should be made at Proper Time and Place

The demand for repayment should be made during normal working hours of the
bank on a working day. In case a banker makes payment during any other time, it shall
not be taken to be a payment in due course and he may be held liable to the customer for
loss.
Apart from this, the demand should be made at the branch of the bank where the
customer has his account unless otherwise agreed. Though branch forms part of one legal
entity, yet the banker’s obligation to repay is confined to the place where the account is
kept.
(iv) Incidence of Statute of Limitation

Under Limitation Act, the limitation period for filing a suit for recovery of money
payable on demand is three years from the date of demand. In case of fixed deposit,
normally production of deposit receipt is necessary for repayment on maturity. Thus, the
period of three years will be calculated from the date on which the deposit receipt has
been presented.
(v) Demand must be made in a Proper Manner

The demand for repayment fo money should be made through a cheque or any
other written order as per the common usage among the bankers. A verbal or telephonic
demand will not be taken as a proper demand.
According to the statutory definition of banking vide Section 5(b) of the Banking
Regulation Act, 1949, deposits are withdrawable by cheque, draft, order or otherwise.
This means that the demand for refund of money deposited with a bank must be made
through a cheque or an order in common use among the bankers.
(b) Secondary Relationship

It will be in the form of: -
Banker as Trustee and Beneficiary

Banker as Agent and Principal
Banker as Bailee and Bailor
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Banker as Mortgagee and Mortgagor
Banker as Lessee and Lessor
(i) Relationship as Trustee and Beneficiary
A trustee is the person to whom property is entrusted to deal with it in accordance
with the directions of the creator of the trust. A trustee must take as much care of the trust
property as a reasonable man would do of his own property and he must not make a profit
out of the trust. The essence of a trust account is that the trustee must not mix the trust
money with his won or us it to his advantage.
The difference between a banker as a debtor and a banker as a trustee may be as

under:
Illustration- Suppose Indira deposits Rs. 500 in coins in her saving bank account,
the banker becomes Indira’s debtor and is liable to pay to Indira Rs. 500 on demand, but
until the demand is made, the banker van us the money in any way he likes and the Rs.
500 which are ultimately paid to Indira are not, of course, the same coins a were originally
handed over by him to the banker. If Indira gives to the to the banker a sealed bag
containing coins of Rs. 500 and leaves it for safe custody, the banker becomes a trustee or
bailee and must take care of the bag and return it, with contents untouched, to Indira when
required.
A banker acts as a trustee in holding money or documents and performing certain

functions for the benefit of the customer, called the beneficiary. He cannot treat the trust
money as his own and it is not available for distribution among his general creditors in
case of liquidation.
In case of cheques sent for collection from another bank, the collecting bank acts
as a trustee for the customer till the cheque is realized and credited to his account.
In New Bank of India Ltd. V. Pyare Lal,the Supreme Court of India observed that
some common instances where trust result are : (i) where the money is paid to a bank with
special instructions to retain the same pending further instructions, or (ii) to pay over the
same to another person, who has no banking account with the bank accepts the instructions
and hold and holds the money pending instructions from that other person, or (iii) where
instructions are given by a customer to his banker that a part, of the amount lying in his
account be forwarded to another bank to meet a bill to become due and payable by him
and the amount is sent by the banker as directed.
In New Bank of India’s case, the Supreme Court observed that a trustee is generally
not entitled to dispose of or appropriate trust property for his benefit. In the present case,
that banker was entitled to dispose of the shares and utilize the amount thereof for
adjustment to the loan account if the debtor defaults. The banker’s obligation to transfer
back the shares can arise only when the debtor clears dues of the bank. Hence, the bank
was not considered as trustee.
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(ii) Relationship as Agent and Principal

A banker acts as an agent of his customer and performs a number of agency
functions for the convenience of his customer. For example, he buys or sells securities
on behalf of his customer, collects cheques on his buys or sells securities on behalf of his
customer ,collects cheques on his behalf and makes payment of various dues of his
customers, e.g. insurance premium, etc. In all such cases the duties of the bank are laid
down by Section 211 of the Indian Contract Act, 1872, under which an agent is bound to
conduct the business of his principal according to the directions given by the principal or
in the absence of such directions according to the custom which prevails in doing
business of the same kind at the place where the agent conducts such business. When the
agent acts otherwise and if any loss result, he must make it good to his principal and if
any profit accrues, he must account for it. According to Section 212 of the same Act, an
agent is bound to conduct the business of agency with as much skill as is generally
possessed by the person engaged in similar business unless the principal has notice of his
want of skill. The banker will no doubt have to carefully ensure that the standard of care
and skill expected of his are duly exercised.
(iii) Relationship as Bailee and Bailor

When a customer deposits articles or securities with a bank for safe custody, a
contract of bailment arises and a bank becomes a bailee, i.e., a person (or corporation) to
whom goods are entrusted for specific purpose. The person depositing the goods is called
the bailor.
English law has drawn a distinction between a gratuitous bailee (someone who is
not paid a fee) and a bailee for reward (someone who is paid a fee) and the main
difference between the two is in the degree of responsibility involved. The former is
expected to take only the same care of the deposited goods as he would take care of his
own, but a bailee for reward is expected to go beyond this and to use the best possible
safeguards and to exercise care and skill, reflecting the fact that he is being paid for the
services. A bailee for reward is liable for loss caused by ordinary negligence, whereas a
gratuitous bailee will only be liable if gross negligence has taken place. From this it can
be seen that a greater degree of responsibility rests on the bailee for reward.
The Indian law draws no distinction between the liability of a gratuitous bailee and
that of a bailee for reward. Section 151 of the Indian Contract Act, 1872, lays down a
uniform standard of care. The provision reads:
“in all cases of bailment that bailee is bound to take as much care of the
goods bailed to him as a man of ordinary prudence would under similar
circumstances take of his own goods of the same bulk, quality and value as the
goods bailed.”
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Section 152 exempts a bailee from liability in respect of loss, destruction or
deterioration of the goods bailed, when he has taken the same amount of care as laid
down in Section 151 provided no contract exists between him and the bailor to make his
liability absolute. A bailee may, by special contract, undertake a greater liability but he
cannot by contract reduce the liability imposed by Section 151 of the Act.
(iv) Relationship as Morgagee and Mortgagor

The relationship between a banker as mortgagee and his customer as mortgagor is
established when the latter executes a mortgage deed in respect of his immovable
property in favourfo the bank or deposits the title deeds of his property with the bank to
create an equitable mortgage as security for an advance.
(v) Relationship as Lessee and lessor

When a customer hires a locker in the bank’s safe deposit vault, the bank
undertakes to take necessary precaution for the safety of the articles left in the locker.
The relationship between the parties is that of a lessor and a lessee.
The legal relationship created between the cutomer as lessor and the bank as lessee
in respect of the locker taken on hire is not that of a bnaker and customer, but of a bailee
and bailor.
Relationship Defined by the Rules of Banking Practice

The rules of banking practice that have developed over the years are generally enforced
by courts of law; for instance, a bank that failed to follow the practice of taking references or
other appropriate procedures when opening a current account woul be held to be negligent.
Special Features of the Relationship

The special relationship between banker and customer takes the form of rights which the
banker can exercise and the obligations which he owes to his customers.
Following are the rights enjoyed by the banker with regard to the customer’s account:
Banker’s Lien
Right of Appropriation
Right of Set-off
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Right of incidental charges
Right of Closing an Account
Banker’s Rights: Banker’s Lien

The banker has a general lien upon any of the customer’s securities, which come into his
hands in the ordinary course of business. Section 171 of the Indian Contract Act confers the right
of general lien on the banker. The banker is empowered to retain all securities of the customer in
respect of the general balance due from him. The ownership of such securities is not transferred
from the customer to the banker. The latter gets the rights to retain the securities handed over to
him in his capacity as a banker. A banker’s lien is considered tantamount to an implied pledge
and he gets the right to sell the securities in certain circumstances.
Right of Appropriation
The rules laid down in Indian Contract Act, 1872, in this behalf apply. These rules relate
to how funds may be earmarked for appropriation to particular accounts or meet particular
cheques; and who has priority as between the customer and the bank, if no specific appropriation
is made by the customer or the bank, the rule in Clayton’s casewill apply to any credit paid into
a running account.
Rule in Clayton’s case

In the case of a current or running account, provided there is no specific appropriation by
the debtor or the creditor, the rule in Clayton’s case-Devaynes v. Noble, - appropriates the
payments. According to this rule, it is the first item on the debit side that is discharged or reduced
by the first item on the credit side. In other words, the credit entries in the account will adjust or
set off the debit entries in chronological order. This rule vitally affects all current accounts,
whether in credit or debit, though the banker is naturally more concerned with the effect of the
rule on overdrawn accounts.
Right of Set-off
Set-off is the legal right by which a debtor is entitled to take into account a debt owing to
him by a creditor, before the latter could recover the debt due to him from the debtor. In other
words, the mutual claims of debtor and creditor are adjusted and only the remainder amount is
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payable by the debtor. But before a bank can exercise his right of set-off the three requirements,
as given below, must apply:
a) Both the debts must be due by and to the same parties and in the same right.
b) The amount of both or all the debts must be certain, i.e., a known or calculable sum.
c) There must not be any agreement-express or implied-to the contrary. For example, if a
customer has taken an overdraft of Rs. 5,000 from his banker and he has a credit balance
of Rs. 1,000 in his saving bank account, the banker is entitled to combine both these
accounts and claim the remainder amount of Rs. 4,000. The right is, of course, subject to
the bank’s obligation to pay his customer’s cheques and avoid causing any injury to the
customer’s credit. The exercise of the right of set-off is optional with the bank. Thus, a
customer with money on his deposit account may be permitted to overdraw his current
account on the basis of the right of set-off.
Incidental Charge
The bank has a right, in the absence of a contract to the contrary, to charge reasonable
commission for the services rendered to customers and interest on the accounts kept by them.
Banks make their scale of charges for normal banking services available on enquiry, and a
customer who instructs a bank to undertake business with knowledge of such charges for doing
so, would be taken to have agreed to pay them.
Closing an Account
A banker has the right to close an account, though he must give the current account holder
reasonable notice of doing so. Though the relationship is contractual one, but there is no provision
in the contract that the relationship between the bank and its customer shall continue for an
indefinite period. It is apparent, therefore, that either party is free at any time to terminate the
contractual relationship by closing the account.
Period of Limitation
Deposits are repayable on demand made by the customer. Under article 22 of the Part II
of the schedule to the Limitation act, 1963, the period of limitation for the refund of bank deposits
is three years with effect from the date a customer makes a demand for his money.
Banker’s Duty to Honour Cheques

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There are certain noticeable aspects of banker and customer relationship, which have an
important hearing on the day-to-day business of banking. A number of duties are implied on the
part of a bank under the contract between it and its customer and this can be modified by express
agreement. The customer has rights and duties too. As stated before, these rights and duties are
reciprocal-the banker’s duties are the customer’s right and the banker’s rights are the customer’s
duties.
A banker has a duty to honour cheques drawn on a customer’s account if the account is in
credit or if the cheque is within an expressly or impliedly agreed limit. A bank, which wrongfully
fails to honour a customer’s cheque, will be liable for breach of contract, and the damages may
be substantial if the customer is a trader whose financial reliability is thereby put in doubt. The
terms of Section 31 of the Instruments Act 1881, limit the banker’s duty to pay cheques on the
existence of:
(i) Sufficiency of fund, of the drawer in the hands of the banker, or as per agreed
borrowing facilities on the account;
(ii) Availability of funds, that is, the funds are properly available to the payment of
such cheques and there is no legal bar prohibiting payment; and
(iii) Technical regularity of the cheque, that is, the cheques are drawn in the regular
form and properly presented for payment in the ordinary course of business.
All these conditions must be satisfied for honouring a cheque. If any of these conditions
is not fulfilled, the paying banker would be within his right to return the cheque as unpaid.
Banker’s Duty for Collection of Cheques and Other Instruments

It is the duty of the banker to collect amounts payable to the customer in respect of cheques
and other normal banking instruments delivered to it for collection and to credit these amounts to
his account.
Banker’s Duty to supply Bank Statement

The bank owes a duty to provide statements of accounts periodically or as occasion
requires, but the customer is not under a duty to check them. This means that the customer
can challenge their accuracy at a much later stage.
Banker’s Duty to Maintain secrecy

The bank owes a duty of secrecy in respect of its customer’s affairs, but there are
exceptions to this general duty.
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The general rule about the secrecy of customer’s accounts may be dispensed with in the
following circumstances:
(i) When the law requires such disclosure to be made; and

(ii) When the practices and usages amongst the bankers permit such disclosue.
Disclosure of Information Required by Law

A banker will be justified in disclosing information about his customer’s account on
reasonable and proper occasions and is under statutory obligation to disclose the information
relating to his customer’s account when the law specifically requires him to do so. The banker
would, therefore, be justified in disclosing information to meet the following statutory
requirements:
Under the Income Tax Act, 1961

According to section 131, the Income Tax authorities possess the same powers as are
vested in a court under the Code of Civil Procedure, 1908 for enforcing the attendance of any
person including any officer of banking company and examining him on oath and compelling the
production of books of accounts and other documents and issuing commissions. Section 133
empowers the income tax authorities to require any person, including a banking company or any
officer thereof, to furnish information in relation to such points or matter, or to furnish statements
of accounts and affairs giving information in relation to such points or matters, as in the opinion
of the income tax authorities will be useful for or relevant to any proceedings under the act. The
income tax authorities are thus authorized to call for necessary information from the banker for
the purpose of assessment of the bank’s customers.
Section 285 of the Income Tax Act, 1961, requires the banks to furnish to the income tax
officers the names and addresses of all persons to whom they have paid interest exceeding Rs.
10,000 mentioning the actual amount of interest paid by them.
Under the Companies act, 1956

When the Central Government appoints an inspector to investigate the affairs of any joint
stock company under Section 235 or 237 of the Companies act, 1956, it shall be the duty of all
officers and other employees and agents (including the bankers) of the company to-
(a) Produce all books and papers of, or relating to, the company which are in their custody
or power, and
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(b) Otherwise to give to the inspector all assistance in connection with investigation which
they are reasonably able to give.
Thus, the banker is under an obligation to disclose all information regarding the company
but not of any other customer for the purpose of such investigation.
By Order of the Court under the Banker’s Book Evidence Act, 1891
When the court orders the banker to disclose information relating to a customer’s account,
the banker is bound to do so. In order to avoid the inconvenience likely to be caused to the bankers
from attending the courts and producing their account books as evidence, the banker’s Books
Evidence act, 1891, provides that certified copies of the entries in the banker’s books are to be
treated as sufficient evidence and production of the books in the courts cannot be forced upon the
bankers.
Under the Reserve Bank of India Act, 1934

The Reserve Bank of India collects credit information from the banking companies and
also furnishes consolidated credit information from the banking company. Every banking
company is under a statutory obligation under Section 45-B of the Reserve Bank of India Act,
1934, to furnish such credit information to the Reserve bank. The Act, however, provides that the
credit information supplied by the Reserve Bank ot the banking companies shall be kept
confidential.
Under the banking Regulation Act, 1949

Under section 26 of the Banking Regulation Act, every banking company is required to
submit a return annually of all such accounts in India, which have not been operated upon for 10
years. Banks are required to give particulars of the deposits standing to the credit of each such
account.
Under the Gift Tax Act, 1958

Section 36 of the Gift Tax Act, 1958, confers on the Gift Tax authorities powers similar
to those conferred on income tax authorities under Section 131 of the Income Tax Act.
Disclosure to Police
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Under Section 94(3) of the Criminal Procedure Code, 1973, the banker is not exempted
from producing the account books before the police. The police officers conducting an
investigation may also inspect the banker’s books for the purpose of such investigations.
Under the Foreign Exchange Management Act, 1999

Banking companies dealing in foreign exchange business are designated as authorized
dealers in foreign exchange. Section 43 of this Act empowers the officer of the Directorate of
Enforcement and the Reserve Bank to inspect the books and accounts and other documents of any
authorize3d dealer and also to examine on oath such dealer or its Director or officials in relation
to its business.
Under the Industrial Development Bank of India Act, 1964

After the insertion of sub-section 1A in section 29 of this Act in 1975, the Industrial
Development Bank of India is authorized to collect from or furnish to the Central Government,
the State Bank, any subsidiary bank, nationalized bank or other scheduled bank, State Cooperative
bank, State Financial Corporation credit information or other information as is may consider
useful for the purpose of efficient discharge of its functions. The term ‘credit information’ shall
have the same meaning as under the Reserve Bank of India Act, 1934.
Liability under Consumer Protection Act, 1986

According to the act, “Consumer”, section 2(1)(d) of the Act, includes a person who hires or
avails of any service for a consideration. Therefore in banking transactions, a customer of a bank
who has a bank account with the bank or a person who purchases a bank draft, hires locker facility
or obtains bank guarantee from a bank are all “consumers” and can prefer complaints under the
Act for “deficiency in service” on the part of the bank or for “restrictive trade practice” or “unfair
trade practice” adopted by the bank. A person who has applied for shares is a consumer, contrary
to the general misconception that an applicant for shares prior to their allotment cannot be a
consumer. The reason for this misconception is the judgment of the Supreme Court in the case of
Morgan Stanley where the Supreme Court interpreted the provisions of the Consumer Protection
Act prior to its amendment in June 1993, and held that an applicant cannot enjoy the status of a
consumer prior to allotment. Fortunately, the CP Act, was amended in 1993 so that prospective
consumers, who have agreed to purchase any goods, would also have a right to file a complaint.
Applications for shares are mostly made by tendering the application to specified banks appointed
by a company for that purpose. These banks are required to process the applications by presenting
the applicant’s cheque for clearance and then crediting the proceeds to the company’s account.
Subsequently, the company allots the shares or sends the refund order in accordance with the
scheme of allotment. Many times, during this processing, the bank misplaces or loses some
application forms. In other cases, the bank appoints some computer agency for processing the
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data. Due to a mistake in feeding the details, some cheques are returned for re-presentation after
correcting the relevant mistakes. Instead for making the necessary correction and re-presenting
the cheque, the bank sleeps over the matter, and by the time the applicant comes to know of this
fact, the issue has already closed. In such cases, the applicant’s money has not been received by
the company floating the shares, and hence he would not be entitled to allotment of shares by the
company. Here, action would lie against the bank and not against the company. Can the bank take
a stand that the applicant has not paid any service charges to the bank for accepting and processing
the application and hence the services rendered being free are outside the ambit of the Consumer
Protection Act? No, the bank cannot wriggle out by raising such an excuse. The bank is doing
this work on a commercial basis and is being paid by the company to accept applications on its
behalf. Hence, even though the applicant may not be paying service charges to the bank, the
service is not free. The applicant thus becomes a beneficiary of the services hired by the company,
and hence is entitled to file a complaint against the bank for its negligence and deficiency in
service. A complaint against the bank can be filed. To provide more attention to the definition of
the word consumer, let us study the following cases in the court. These cases are in the favor of
customer 1) In Punjab and Sind Bank vs. Manpreet Singh [1994 (3) CPJ 532], it was held by the
Punjab State Commission that a savings bank account holder is a consumer under the Act. It was
observed that difference in the landing and borrowing rates is the consideration for rendering
service by the bank. It was also observed that even if the bank does not charge for providing
cheque facility to the account holder, it cannot be said that the same is given without
consideration. Actually, the cheque book facility is obtained by the depositor in consideration of
his putting funds at the disposal of the bank. 2) In Vimal Chandra Grover vs. Bank of India [2000
(2) CPJ 11 (SC): AIR 2000 SC 2181], it was argued before the Supreme Court on behalf of the
bank that the appellant, who took overdraft facility from the bank by pledging shares, is not a
consumer within the meaning of the consumer Protection Act. The Supreme Court repelled the
arguments of the bank and held that bank is rendering service by providing overdraft facilities to
a consumer, which is not without consideration. Bank is charging interest and other charges as
well in providing the service. Provision for overdraft facility is certainly a part of the banking and
falls within the meaning of “service” as provided in section 2(1)(o) of the Act. 3) In
ShobhataiDaulatraoTalekar vs. Maharashtra Rajya Shahakari Krishi &Gramin Development
Bank [2004 (2) CPJ 349], the issue before the Maharashtra State Commission was the
justifiability of the order of the District forum holding that the Forum had no jurisdiction to
entertain the dispute since the complainant was a member of the defendant bank which was
registered under the Maharashtra Cooperative Societies Act, 1961 and that being so, the
jurisdiction would lay before the co-operative court and not before the consumer court. The State
Commission did not agree with this view. It held that the nature of service hired by the
complainant pertains to the banking business which is permissible by the bank to undertake under
the provisions of the Reserve Bank of India Act and the Banking Regulation Act, 1949 and as
such, would be squarely amenable to the jurisdiction of a consumer forum as per the definition of
“service” under section 2(1)(o) of the Act. The State Commission further held that the jurisdiction
of the consumer for a is also not ousted in view of the provisions of section 3 of the Act, which
provides an additional remedy over and above those available in the other statutes to the parties.
At the same time we must study the following cases which are oust by the court. These cases are
held under the Consumer Protection Act does not apply to banks. Some of such specific instances
are enumerated below a) In T.A. Abrahim vs. RBI [2001 (3) CPJ 293], RBI also came within the
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purview of the Consumer Protection Act. The issue before the Kerala State Commission was that
the complainant had applied for a loan under the Housing Facility Scheme of the RBI, of which
he was the employee. He claimed that he suffered loss and inconvenience due to delay in
sanctioning of loan, which amounted to deficiency of service and for which he was entitled to
compensation. The District Forum held that the complaint was not maintainable, but the State
Commission before whom appeal was preferred by the complainant, held that availing a loan
from an institution like RBI could be treated as “service” within the meaning of section 2(1)(o)
of the Act as the opposite party’s character as a banking institution cannot be in dispute. Further,
as per the definition of “consumer” in section 2(1)(d)(ii), it is not necessary that actual
consideration should pass to the opposite party simultaneously with the availing of service. The
said definition envisages the consideration as the one, which is promised also. The State
Commission observed that when a person applied for loan and get the loan on sanctioning the
same, the amount would carry interest. The same should be treated as consideration. b) In
Virendra Prashad vs. Reserve Bank of India [1991 (1) CPJ 336(NC)], a complaint was filed before
the National Commission stating that the complainant was eligible for certain advantages in his
foreign currency/ rupee bank accounts but these facilities were denied by his bankers on the
instructions from the RBI. The National Commission held that here was no contract of service
between the complainant and the RBI and the RBI was merely discharging its statutory function.
Therefore, it was outside the purview of the Consumer Protection Act. c) The issue before the
National Commission in IDBI vs. Krishnendu Ghosh [1996 (2) CPR 155] was that the
complainant applied for the post of Deputy Manager (legal) along with a D.D. of Rs. 50/- as
examination fee. The interview letter was received by him on the same day on which interview
was to be held. The bank rejected the request for escheduling. A complaint was filed claiming
compensation for injury and mental shock. The National Commission held that payment of Rs.
50/- as examination fee was not consideration for hiring or availing of the services of the bank.
Therefore, the complainant was not “consumer”. d) Tenant-Landlord dispute: In UCO Bank vs.
R. Chimanlal& Co. [1994 (1) CPR 526], a dispute with the bank-landlord was sought to be settled
under the Consumer Protection Act which was turned down by the Commission. e) In D.
Yeshodharan vs. Canara Bank [1994 (3) CPJ 63], a complaint was lodged for denial of service
benefits to an employee of the bank. National Commission held that the Consumer Court is not
the correct forum for settling employer-employee dispute as an employee is not a consumer.
Following are the cases in which bank held liable for deficiency in service. In a large number of
cases, banks have been pulled up for deficiency in service and compensation has been awarded
to complainants by the Consumer Courts. Some of the important cases are analysed hereunder a)
Refund of Bank deposit : : P. Nabhushanrao vs The Union Bank of India (App dat 28/1990 Result
9/11/90), By the state forum, Hydrabad, Andra Pradesh in this the applicant applies for the refund
of money of the deposit certificate, the bank delayed the payment of the same. The forum declares
that the Bank was delayed the payment so this is consider as negligence of the service by the
bank. b) Wrongful dishonor of Bank Draft: SBI vs. N. Raveendran Nair [1992 (2) CPR 400], the
issue before the National Commission was that the bank refused to en-cash the demand draft on
the ground that the signature of one of the two officials of the bank was missing. The State
Commission held that the dishonor of the draft was due to the fault of the bank, and therefore,
there was deficiency in service by the bank. A compensation of Rs.19,500/- was awarded by the
Commission for the inconvenience and mental agony caused. The National Commission
dismissed the appeal of the bank against the judgment of the State Commission. c) Non-credit of
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cheque collected: In Sovintorg (India) Ltd. vs. SBI [1999 (2) CPJ 4 (SC)], the issue before the
Supreme Court was that the proceeds of the cheque deposited with the bank for collection were
not credited to the account of the complainant though the same were collected by the bank. The
State Commission awarded only interest of 12 per cent for withholding of the customer’s money
against the complainant’s claim of 24 percent interest and payment of compensation. The National
Commission, on appeal by the complainant, confirmed the order of the State Commission. On
further appeal before the Supreme Court by the complainant, the Apex Court partly allowed the
appeal by directing the payment of interest at the rate of 15 per cent but refused the claim of
payment of compensation on the ground that the allegation of negligence was not proved. d) Non-
issuance of proper receipt: Where the bank did not adjust the loan repaid in its books nor issue
proper receipt to the complainant, the award of compensation by the District Forum for deficiency
in service was confirmed by the Chattisgarh State Commission in JilaSahakariKendriya Bank vs.
Sarda Ram Nayak [2004 (2) CPJ 534]. d) Payment of lower rate of interest: In AbhaBhanthia vs.
SBI [2004 (2) CPJ 138], the complainant had made an F.D. with the bank, which carried interest
at the rate of 11.25 per cent as per the receipt issued. On maturity, bank paid lower interest @
10.5 per cent. It was stated by the bank that the said rate of interest was the prevailing rate as per
the directives of the RBI. The District Forum held that there was no deficiency in service by the
bank as it followed the RBI directive. On appeal by the complainant, the State Commission held
that the bank was obliged and under liability to pay interest as agreed by it and any omission or
inadvertence on the part of the bank employees would not adversely affect the rights of the
appellant depositor. e) Default by bank’s agent: In Uco Bank vs. Surendra Kumar Bara [2004 (3)
CPJ 472], the issue before the Orissa State Commission was that the complainant had opened and
account with the bank under a scheme called LaghuBachat Yojana. An agent of the bank used to
collect the deposits from the complainant periodically and make entries in the passbook issued by
the bank under his initial. The agent of the bank misappropriated a part of the money. The
Commission directed the bank to refund the amount misappropriated by its agent along with
interest and also to pay compensation for mental agony, harassment and cost of litigation. f)
Interest not paid on excess amount deposited in violation of PPF rules: In a rather interesting case
in SBI vs. P.S. Krishnan [2004 (2) CPJ 579], the Tamil Nadu State Commission was asked to
adjudicate upon a case where the complainant had deposited a sum of Rs. 8,50,000/- in his PPF
a/c during the F.Y. 1995-96. After a lapse of time, the bank informed the complainant that interest
on the PPF a/c would be given on a total sum of Rs. 60,000/- only. The bank returned Rs.
7,90,000/- to the depositor without any interest. It was contended on behalf of the bank that the
deposits in the PPF account are credited to the government account and do not form part of the
bank’s deposits. As per the rules of the PPF account, the maximum limit of deposit is Rs. 60,000/-
. The bank is bound by the rules and is not liable for the alleged deficiencies in service. It was
held by the Commission that the brochure issued by the Directorate of small savings clearly stated
that the deposits up to Rs. 50,000/- will qualify for deduction of income tax under section 88 of
the I.T. Act and the interest on the balance held in the public provident fund account is absolutely
free from tax. The act of the bank in retaining a huge sum of Rs. 7,90,000/- for nearly a year and
returning it without interest is definitely an unjustified act. The Commission also held that the
banks entrusted with the public money are in the position of a bailey and they have to function
with caution and care that is expected of a bailey. Even if the complainant was ignorant of the
rules, the bank authorities ought to have been more vigilant when such a huge deposit was
received by them. The Commission went to the extent of saying that the banking authorities had
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gone against the professional ethics in denying the interest, which the complainant was
legitimately entitled to. The Commission also held that to retain one’s money and deny that person
the right of interest on that amount would definitely amount to “unfair trade practice” and fall
within the purview of the Consumer protection Act even otherwise.
Analysis of the various judgments of the Consumer Courts reveals that they have not only been
awarding the value of the goods or services for the defect and deficiency in service but also the
compensation for the mental agony and harassment. It is seen that in these cases against the
injustice consumers are in problem against the bank. But the justice seems to have prevailed under
the aegis of the Consumer Protection Act. It has been found that there is a positive justice to the
consumers against the faulty banking services.
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UNIT-II- : LENDING, SEURITIES AND RECOVERY BY

BANKS
LENDING, SECURITIES AND RECOVERY BY BANKS
Important Principles of Lending in

Banking | Principles of Credit
A banker follow certain basic principles of lending while doing carrying out their
lending and credit operations. Banks deals with public money accepting deposit and
lend to their borrowers to earn profit. Banks follow some fundamental principles of
lending in order to ensure safety, security and profitability on money it lend.
Lending is one of the most important functions performed by the commercial banks
and is major source of income of bank.
Borrower may differ in terms of their purpose of advance, activities, financial

health, repayment capacity, risk so some important principles / considerations are
followed by bank before taking lending decision.
The principles of lending revolve mainly around the concepts of safety, profitability
and liquidity of advance. The criteria for lending get changed or modified from time
to time in response to changing the state of the economy. Traditionally commercial
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banks in India used to provide security oriented finance to trade and industry. Big
industrial houses and traders were beneficiaries of security oriented lending concept
and a large chunk of bank finance was enjoyed by them. The concept of lending
radically changed in 1969 after the nationalisation of fourteen commercial
banks. The concept of security based bank finance changed to the concept of need
based finance, albeit wherever collateral securities are available continued to be
accepted. Thus the focus is on the viability of project while entertaining the credit
proposals and not merely on the availability of security. However basic principles
that govern bank lending remain unchanged on safety, profitability and liquidity of
advance. The banks all over the world scrutinise following details with care before
acceding to a loan request.
Identification of borrower: Selection of a borrower is a most important factor to

be considered at care. There are numerous instances of parties indulge in various
types of frauds and forgeries to cheat banks and avail finance. Banks can avoid most
of such instances by sticking to principles of KYC (Know Your Customer) in letter
and spirit. While entertaining new proposals, as a matter of rule and without fail,
caution advice and defaulter list of RBI/ECGC caution list/CIBIL Report/Reports
from other banks must be verified. Trade circle enquiry, information from
Newspapers and magazines may sometimes supply important information which is
a matter of concern to the bank. Since the safety of funds lent will be the main
concern of a bank, the advance should be granted to a reliable borrower who can
repay the loan in the ordinary course of business.
The Purpose of loan: The proposal may be for a new venture or for expansion or
diversification of existing unit or for a renewal/ revival/ enhancement of existing
limits. Though the request for advance may be safe and secured, still bank should
concentrate whether the advance is for productive purpose and it is needed for
legitimate activity from the standpoint of Government guidelines.
Quantum of Loan: A prudent banker ensures that finance made available to the
borrower is neither over financed nor under financed. Inadequate finance kills the
project and thereby sinks the bank finance. Over finance enables the borrower to
divert the funds for the activities other than the purpose he had availed the facility,
which ultimately jeopardises the repayment plan. Hence proper appraisal is a must
before sanctioning a quantum of loan or credit limit.
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Period of Loan: A Bank would remain liquid if its advances are also liquid. A type
of loan and maturity pattern bank entertains is essential for its asset liability
management. The repayment period (short/long term) fixed on loans shall be
adequate to match the demand of depositors.
Source of repayment: The repayment of advance is of paramount importance to a

bank. When a borrower approaches the bank for finance, he must have a clear idea
of how he is repaying the loan/advance and indicate the same to the bank. The
source of repayment may be from income generated out of business/salary or any
other source. In the cases of working capital account like Cash Credit or bills
purchase/discount facilities, it may be self-liquidating on the realisation of sale
proceeds.
Security for advance: The type of security offered to the bank is an important
criterion while entertaining a loan proposal. The prime security can be
hypothecation/pledge of stock, book debts or other assets created out of bank
finance. Bank may insist for a charge on immovable property as a collateral security
in addition to prime security and a third party guarantee (which is also treated as
security to bank finance). The main concern is that security available to the bank
should be good enough to fall back upon in the event of adverse circumstances. The
value of security accepted should be steady and easy to ascertain. All precaution to
be taken while accepting the immovable property as security that the security
offered has a clear marketable title. It is also inevitable to ascertain and confirm
through legal opinion from an experienced advocate so that bank could easily take
possession of such security with very little expenses and dispose-off the same to
recover its dues when the account goes bad.
Profitability: Credit risk is always associated with any type of lending Interest rate
charged to an advance must be commensurate with risk entailed, the amount of
work and also expenses involved in the facility.
Pre-Sanction Inspection:
Branch Manager should visit the borrower at his place of business and make the
preliminary report on prime/collateral security offered. The purpose is to see that
the business exists at the address given. It is also useful to ascertain the
infrastructure available and level of activity of the unit. Further, it helps the
Manager to familiarise himself the borrower’s business and attendant trade
practices.
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Appraisal of credit proposal:
Poor quality of credit appraisal both technical and financial viability, contribute to
the accretion of Non-Performing Assets (NPA). Accepting unrealistic projection
and fixing unduly short repayment schedule may cause problems at the time of
recovery. The credit officer would consider all the information collected from
internal and external investigation sources to support the credit decision. Promoter’s
educational, professional qualification, experience, management capability, history
of payment record and fulfilment of financial obligations etc, are the matter of
importance while appraising the proposals. The general documents, apart from the
exclusive set of financial papers which depends upon nature of finance, required by
banks are as under.
In conclusion, appraisal of credit proposal can be called as the assessment of the
Techno-economic feasibility of the business and also satisfying ‘Three C’s of the
borrower i.e. the Character of the borrower, Capital/margin brought by the
borrower and his Capacity to run the business. The appraisal should also
be free from Complacency, Carelessness, Communication gap and
unhealthy Competition.
Sanction: The essence of a sanction is adequate credit given to a borrower in time.
Bankers should be sensitive to the difficulties of the borrower. Many a time, we
hear that Credit officers/Managers do not exhibit the sense of urgency while
considering the borrower’s request. Although it is necessary to function within
broad framework provided by the bank for credit assessment and disbursement, the
sanction should not be delayed under the guise of rules and regulations.
Documentation: The execution of documents according to the law in the proper

form is called documentation. Documentation is the most important part of a bank
lending. The role of documentation is to establish a legal relationship between the
lending banker and borrower when the dispute goes to the court of law. The official
in charge must be thoroughly conversant with the type of securities and legal nature
of charges to be created while preparing the documents.
Stamping: Under section 17 of Indian Stamp Act 1899, all the documents
chargeable with stamp duty shall be properly and duly stamped before or at the
time of execution in India. In the cases of Demand Promissory Note (pro-note),
acknowledgement of debts, bill of exchange etc, if under stamped, is ab-initio void
and same can not be admitted in evidence even by paying penalty. The revenue
stamps on the document should be effectively cancelled at the time of execution.
The best way of cancellation of revenue stamp is by the sign over all the stamps in
such a manner that signature extends even beyond the stamps.
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Execution: The document should be executed in the presence of

Manager/Authorised official of the bank. The documents should not be given to
borrower for obtaining signature/s from other borrowers or guarantors. The
documents should be executed in one sitting and also ensure that the executants read
the content of documents prior to execution. The borrower should sign in full on all
the documents and not by initials. The cutting, overwriting, interlineations must be
authenticated under the full signature of the executants/s. Any instrument
chargeable with stamp duty executed out of India must be stamped within 3
months after it has been first received in India.
Attestation: Attestation means witnessing the execution of a document which is

required to be attested under law. In the case of documents like the assignment of
LIC policies one witness is required and in the case of mortgage deed there should
be two witnesses. Some documents like demand promissory note need not be
attested. The executants are the party to the deed and they should not be attesting
persons. The attesting person need not know the contents of the document.
Registration of Mortgage/Memorandum of mortgage: In the case of mortgage

deed or memorandum of title deeds to be registered the original deed must be
presented for registration with Registrar of Assurance (Commonly known as Sub-
Registrar office) under whose jurisdiction property is situated. The registration
should be done within four months of execution of documents.
Registration with Registrar of Companies (ROC): In the case of limited
companies, charge on company’s assets like hypothecation of stocks and
machinery, book debts, mortgages etc shall be recorded with ROC within 30 days
of execution of documents in terms of Sec.125 of the companies Act. The
registration should be done with the Registrar of Companies under whose
jurisdiction the company’s Registered Office is situated.
Post disbursement follow up: Direct payment shall be made towards
goods/machinery purchased as per invoice made by way of demand draft in favour
of the supplier. It is wrong to credit the loan proceeds to borrower’s SB/CD account,
as it is observed that many a time bank finance was diverted by the borrower for the
purpose other than loan was actually sanctioned. The inspection shall be conducted
for the purpose of ascertaining end use/creation of assets from bank finance. Care
shall be taken by the inspecting official that old/defunct machinery are not shown
to him as new machinery. Bank’s board of hypothecation/pledge shall be
prominently displayed where the stocks/machinery are placed. The working capital
limits sanctioned, are usually valid for one year, hence proposals for ‘Renewal
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/Enhancement of limits’ should be taken up well in time. The documents obtained
while releasing the limits shall be properly maintained, revival letters,
acknowledgement of debts etc. to be obtained at the periodical interval, to keep the
documents alive. Asset created by bank finance shall be fully insured with bank
clause. In some cases, the company holds inventory over and above the working
capital limit and go for insurance only to the extent of credit limits. Banks shall not
accept such proposal of the borrower, as it amounts to under insurance. In such an
event of under insurance, the insurance company will settle proportionately to the
extent of total stock holding vis-à-vis insurance cover although damage claimed is
within the insurance cover amount. In view of avoiding claim complications banks
normally insist for comprehensive insurance for not less than 120% of the inventory
holding.
Important Principles of Lending in Banking | Credit Principles
These basic principles of bank lending affect bank’s loan policies, credit operations
to a great extent. Here are some important principles of lending :
• Safety
• Liquidity
• Purpose
• Diversity or Risk Spread
• Profitability
• Security
Safety
Safety is the most important fundamental principle of lending. Banks deal with
public money so safety of money from public is first priority of bank. When a
banker lends, he must be sure about that the money is in safe hand and will definitely
come back at regular interval as per repayment schedule without any default. Safety
of funds depends on nature of security, character of borrower, repayment
capabilities and financial health of the borrower.
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A banker must ensure that finance extended by him goes to right type of borrower
and is being used for the intended purpose. And also after utilizing it for right
purpose it should be repaid with interest.
Liquidity
Liquidity is also an important principle of lending in banking. Bank lend public

money which is repayable on demand by depositors so bank lends for a short period.
A banker must ensure that money will come back on demand or as per repayment
schedule. The borrower must be able to repay the loan within a reasonable time
after demand for repayment is made.
‘Liquidity’ has as much importance as ‘safety’ of funds. The reason behind it is that
a bulk of their deposit is repayable on demand or at a very short notice. Banker must
ensure that money is locked up for a long time. If loan becomes illiquid, it may not
be possible for bankers to meet their obligations vis a vis depositors.
Purpose
The underlying purpose for which an applicant is seeking a loan should be

productive. The purpose of loan helps in determining level of risk and also impact
interest rate on loan.
Purpose of loan should be productive in order to ensure safety of funds while it

should be extended for short term to ensure liquidity.
Diversity / Risk Spread
Do not put all eggs in one basket – Bank follow this approach (principle of
diversity) while creating its advances portfolio. Risk is always present while
extending any kind of advance to any type of borrower. To minimize the risk, bank
should lend to borrowers from different trades, industries like agriculture,
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education, IT, pharma, educational etc. Lending surplus to a particular sector may
have adverse affect on bank in time of slump.
A banker must follow principle of diversity also while choosing its investment
portfolio. He must invest the funds over different share and debentures of different
industries rather than investing in particular type of security.
Profitability
Banks accept deposits from public and lend it to make profit. Banks also incur
expenses to maintain deposits such as rent, stationary, premises rent, provision for
depreciation of their fixed assets, bad loans. After incurring such expenditures, a
bank must earn some profit like other financial institutions.
So a banker must extend the advance in such a way that it is profitable for bank and
also at competitive lending rate.
Security
A banker avoid lending to a borrower without any security. Security act as an

insurance to lender bank in case of default by the borrower. The banker carefully
scrutinizes all the different aspects of an advance before granting it. At the same
time, he provides for an unexpected change in circumstances which may affect the
safety and liquidity of the advance. It is only to provide against such contingencies
that he takes security so that he may realize it and reimburse himself if the well-
calculated and almost certain source of repayment unexpectedly fails.
POSITION OF WEAKER SECTIONS
The weaker sections of our society are the socially backward/ minority communities
at national level or the people belonging to economically low income group.
Normally, such people may not easily get timely and adequate credit without the
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priority credit dispensation of RBI. As per RBI’s priority sector approved plan,
Banks have to achieve weaker section target of 10 percent of ANBC (Adjusted Net
Banking Credit) or Credit Equivalent Amount of Off-Balance Sheet Exposure,
whichever is higher.
The Priority sector loans to the following category borrowers will be considered as
Loans to ‘Weaker Sections’.
Small and marginal farmers: As per RBI definition, a farmer cultivating more than
1 hectare up to 2 hectares(5 Acres) and a farmer who is cultivating agriculture
land up to 1 hectare (2.5 Acres) are respectively called Small and marginal farmers.
For the purpose of priority sector advance that includes landless agriculture
labourers, tenant farmers or a lessee and share croppers whose share of land holding
is within the above limits. The loan granted to a farmer for investment up to
Rs.50000/- for allied activities irrespective of size of the land holding is considered
as advances to small and marginal farmer under weaker section.
Besides small and marginal farmers the advance made to Artisans, village and
cottage industries where individual credit limit does not exceed Rs.1 lakh is
classified as advances to weaker section category. DRI Loans, loans to Self Help
Groups, loans to SC/STs, persons with disabilities, loans to minority Communities
such as Muslims, Christians, Sikhs, Jains, Buddhist, Parsis (The Muslims in J&K,
and Lakshadweep, Sikhs in Punjab, the Christians in Nagaland, Mizoram and
Meghalaya who are minority population at national level and majority population
in the states are not considered as minority category in those states), Beneficiaries
of Government sponsored schemes such as NRLM, NULM and SRMS are also
considered as weaker section.
Overdrafts up to Rs.5000/- under Pradhan Mantri Jan-DhanYojana (PMJDY)
accounts wherein the borrowers’ household annual income does not exceed
Rs.100,000/- for rural areas and Rs.1,60,000/- for non-rural areas, loan granted to
distressed farmer to clear his/her indebtedness to non-institutional lender, other
distressed persons to whom loans are granted to prepay the loan amount to the non-
institutional lenders up to Rs.1 lakh per borrower and individual women
beneficiaries up to Rs.1 lakh per borrower is considered as loan to weaker section.
We may sum up that Priority sector loans to the following borrowers will be
considered as loans under Weaker Sections category:
No. Category
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1 Small and Marginal Farmers
2 Artisans, village and cottage industries where individual credit limits do not
exceed ₹ 1 lakh
3 Scheduled Castes and Scheduled Tribes
4 Self Help Groups
5 Distressed farmers indebted to non-institutional lenders
6 Distressed persons other than farmers, with loan amount not exceeding ₹ 1 lakh
per borrower to repay their debt to non-institutional lenders
7 Women
8 Persons with disabilities
9 Overdrafts upto ₹ 5,000/- under Pradhan Mantri Jan-Dhan Yojana (PMJDY)

accounts, provided the borrowers’ household annual income does not exceed ₹
100,000/- for rural areas and ₹ 1,60,000/- for non-rural areas
10 Minority communities as may be notified by Government of India from time

to time
Note: In States, where one of the minority communities notified is, in fact, in
majority, item (10) will cover only the other notified minorities. These States /
Union Territories are Jammu & Kashmir, Punjab, Meghalaya, Mizoram, Nagaland
and Lakshadweep.
NATURE OF SECURITIES AND RISK INVOLVED

Loans and Advances
LEARNING OBJECTIVES
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Banks’ main source of funds is deposits. These deposits are repayable on demand or after a specific time.
Hence, banks should deploy such funds very carefully. Generally, banks use their funds for (i) loan assets
and (ii) investments. While deploying funds as loans and advances, banks should ensure that certain
lending principles are followed by them. Banks should give importance to the principles of lending based
on the following concepts: Safety, Liquidity, Purpose, Diversity, Security and Profitability. Banks should
also ensure that a good credit monitoring system is in place both at pre-sanction and post-sanction levels.
After going through this chapter, the reader would be able to: – Understand various types of credit facilities
granted by banks – Legal frame work and regulatory applications in lending by banks – Importance of
priority sector lending to Agriculture, SMEs, Women Entrepreneurs, etc. – Deployment of funds to various
loans and advances.
PRINCIPLES OF LENDING
The business of lending, which is main business of the banks, carry certain inherent risks
and bank cannot take more than calculated risk whenever it wants to lend. Hence, lending
activity has to necessarily adhere to certain principles. Lending principles can be
conveniently divided into two areas
(i) activity, and

(ii) individual.
(i) Activity:
(a) Principle of Safety of Funds
(b) Principle of Profitability
(c) Principle of Liquidity
(d) Principle of Purpose
(e) Principle of Risk Spread
(f) Principle of Security
(ii) Individual :
(a) Process of Lending
(b) 5 ‘C’s of the borrower = Character, Capacity, Capital, Collateral, Conditions Sources
of information available to assess the borrower – Loan application – Market reports –
Operation in the account – Report from other Bankers – Financial statements, IT returns
etc. – Personal interview – Unit inspection prior to sanction
(c) Security Appraisal Primary & collateral security should be ‘MASTDAY’ M –

Marketability A – Easy to ascertain its title, value, quantity and quality. S – Stability of
value. T – Transferability of title. D – Durability – not perishable. A – Absence of
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contingent liability. I.e. the bank may not have to spend more money on the security to
make it marketable or even to maintain it. Y – Yield. The security should provide some
on-going income to the borrower/ bank to cover interest & or partial repayment.
The traditional principles of bank lending have been followed with certain modifications.
The concept of security has undergone a radical change and profitability has been
subordinated to social purpose in respect of certain types of lending. Let us now discuss
the principles of lending in details:
Safety
As the bank lends the funds entrusted to it by the depositors, the first and foremost
principle of lending is to ensure the safety of the funds lent. By safety is meant that the
borrower is in a position to repay the loan, along with interest, according to the terms of
the loan contract. The repayment of the loan depends upon the borrower’s (a) capacity to
pay, and (2) willingness to pay. The former depends upon his tangible assets and the
success of his business; if he is successful in his efforts, he earns profits and can repay the
loan promptly. Otherwise, the loan is recovered out of the sale proceeds of his tangible
assets. The willingness to pay depends upon the honesty and character of the borrower.
The banker should, therefore, taken utmost care in ensuring that the enterprise or business
for which a loan is sought is a sound one and the borrower is capable of carrying it out
successfully. He should be a person of integrity, good character and reputation. In addition
to the above, the banker generally relies on the security of tangible assets owned by the
borrower to ensure the safety of his funds.
Liquidity
Banks are essentially intermediaries for short term funds. Therefore, they lend funds for
short periods and mainly for working capital purposes. The loans are, therefore, largely
payable on demand. The banker must ensure that the borrower is able to repay the loan on
demand or within a short period. This depends upon the nature of assets owned by the
borrower and pledged to the banker. For example, goods and commodities are easily
marketable while fixed assets like land and buildings and specialized types of plant and
equipment can be liquidated after a time interval. Thus, the banker regards liquidity as
important as safety of the funds and grants loans on the security of assets which are easily
marketable without much loss.
Profitability
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Commercial banks are profit-earning institutions; the nationalized banks are no exception
to this. They must employ their funds profitably so as to earn sufficient income out of
which to pay interest to the depositors, salaries to the staff and to meet various other
establishment expenses and distribute dividends to the shareholders (the Government in
case of nationalized banks). The rates of interest charged by banks were in the past
primarily dependent on the directives issued by the Reserve Bank. Now banks are free to
determine their own rates of interest on advances.. The variations in the rates of interest
charged from different customers depend upon the degree of risk involved in lending to
them. A customer with high reputation is charged the lower rate of interest as compared
to an ordinary customer. The sound principle of lending is not to sacrifice safety or
liquidity for the sake of higher profitability. That is to say that the banks should not grant
advances to unsound parties with doubtful repaying capacity, even if they are ready to pay
a very high rate of interest. Such advances ultimately prove to be irrecoverable to the
detriment of the interests of the bank and its depositors.
Purpose of the Loan
While lending his funds, the banker enquires from the borrower the purpose for which he
seeks the loan. Banks do not grant loans for each and every purpose—they ensure the
safety and liquidity of their funds by granting loans for productive purposes only, viz., for
meeting working capital needs of a business enterprise. Loans are not advanced for
speculative and unproductive purposes like social functions and ceremonies or for
pleasure trips or for the repayment of a prior loan. Loans for capital expenditure for
establishing business are of long-term nature and the banks grant such term loans also.
After the nationalization of major banks loans for initial expenditure to start small trades,
businesses, industries, etc., are also given by the banks.
Principle of Diversification of Risks
This is also a cardinal principle of sound lending. A prudent banker always tries to select
the borrower very carefully and takes tangible assets as securities to safeguard his
interests. Tangible assets are no doubt valuable and the banker feels safe while granting
advances on the security of such assets, yet some risk is always involved therein. An
industry or trade may face recessionary conditions and the price of the goods and
commodities may sharply fall. Natural calamities like floods and earthquakes, and
political disturbances in certain parts of the country may ruin even a prosperous business.
To safeguard his interest against such unforeseen contingencies, the banker follows the
principle of diversification of risks based on the famous maxim “do not keep all the eggs
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in one basket.” It means that the banker should not grant advances to a few big firms only
or to concentrate them in a few industries or in a few cities or regions of the country only.
The advances, on the other hand, should be over a reasonably wide area, distributed
amongst a good number of customers belonging to different trades and industries. The
banker, thus, diversifies the risk involved in lending. If a big customer meets misfortune,
or certain trades or industries are affected adversely, the overall position of the bank will
not be in jeopardy.
Bank Credit, National Policy and Objectives
Banking institutions are amongst the commanding heights of an economy. They must
serve the national policy and objectives. Twenty major banks in India were nationalized
“to serve better the needs of development of the economy in conformity with the national
policy and objectives.” Necessary changes in the banking policies and practices were
urgently necessitated in the wake of nationalization to serve wider social purpose of
established democratic socialism in the country. Significant changes have taken place in
the concept of security observed by the bankers in their attitude towards the hitherto
weaker and neglected sections of society during the last two decades. Banks have been
directed to finance on a large scale agriculturists, small industrialists, professional persons
and transporters, etc. Banks have also been asked to help in the implementation of the 20-
Point Programme and have been directed to ensure that banks’ advances within the priority
sectors are given increasingly to the weaker and underprivileged sections at concessional
rate of interest. Security of funds lent is not sought exclusively in the tangible assets of
the borrower but also in his technical competence, managerial ability, honesty and
integrity. Loans are being given in large numbers for the setting up of small businesses
and for starting practice by professional persons. It is to be noted that bank credit has to
act as an important instrument for achieving wider social purpose, national policies and
objectives. However, the basic principles of sound lending are fundamental and are
observed even by the nationalized banks. The ways in which the basic principles are
followed, of course, may be modified to suit the needs of the times. Public Sector Banks
are also required, under Section 8 of the Banking Companies (Acquisition and Transfer
of Undertakings) Act, 1970 in the discharge of their functions, to be guided by such
directions in regard to matters of policy involving public interest as the Central
Government give. The Central Government and the Reserve Bank have issued a number
of directions in this regard, highlighting the social purpose which they have to sub serve.
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TYPES OF CREDIT FACILITIES
The business of lending is carried on by banks offering various credit facilities to its
customers. Basically various credit facilities offered by banks are generally repayable on
demand. A bank should ensure proper recovery of funds lent by him and acquaint itself
with the nature of legal remedies available to it and also law affecting the credit facilities
provided by it. Credit facilities broadly may be classified as under: (a) Fund Based Credit
Facilities Fund based credit facilities involve outflow of funds meaning thereby the money
of the banker is lent tothe customer. They can be generally of following types: (i) Cash
credits/overdrafts (ii) Demand Loans/Term loans (iii) Bill finance (b) Non-Fund Based
Credit Facilities In this type of credit facility the banks funds are not lent to the customer
and they include: (a) Bank Guarantees (b) Letter of Credit.
CASH CREDIT
Cash credit is the main method of lending by banks in India and accounts for about 70 per
cent of total bank credit. Under the system, the banker specifies a limit, called the cash
credit limit, for each customer, up to which the customer is permitted to borrow against
the security of tangible assets or guarantees. Cash credit is a flexible system of lending
under which the borrower has the option to withdraw the funds as and when required and
to the extent of his needs. Under this arrangement the banker specifies a limit of loan for
the customer (known as cash credit limit) up to which the customer is allowed to draw.
The cash credit limit is based on the borrower’s need and as agreed with the bank. Against
the limit of cash credit, the borrower is permitted to withdraw as and when he needs money
subject to the limit sanctioned. It is normally sanctioned for a period of one year and
secured by the security of some tangible assets or personal guarantee. If the account is
running satisfactorily, the limit of cash credit may be renewed by the bank at the end of
year. The interest is calculated and charged to the customer’s account. Cash credit, is one
of the types of bank lending against security by way of pledge or /hypothecation of goods.
‘Pledge’ means bailment of goods as security for payment of debt. Its primary purpose is
to put the goods pledged in the possession of the lender. It ensures recovery of loan in case
of failure of the borrower to repay the borrowed amount. In ‘Hypothecation’, goods
remain in the possession of the borrower, who binds himself under the agreement to give
possession of goods to the banker whenever the banker requires him to do so. So
hypothecation is a device to create a charge over the asset under circumstances in which
transfer of possession is either inconvenient or impracticable.
Overdrafts
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When a customer is maintaining a current account, a facility is allowed by the bank to
draw more than the credit balance in the account; such facility is called an ‘overdraft’
facility. At the request and requirement of customers temporary overdrafts are also
allowed. However, against certain securities, regular overdraft limits are sanctioned.
Salient features of this type of account are as under (i) All rules applicable to current
account are applicable to overdraft accounts mutatis mutandis. (ii) Overdraft is a running
account and hence debits and credits are freely allowed. (iii) Interest is applied on daily
product basis and debited to the account on monthly basis. In case of temporary overdraft,
interest should be applied as and when temporary overdraft is adjusted or at the end of the
month, whichever is earlier. (iv) Overdrafts are generally granted against the security of
government securities, shares & debentures, National Savings Certificates, LIC policies
and bank’s own deposits etc. and also on unsecured basis. (v) When a current account
holder is permitted by the banker to draw more than what stands to his credit, such an
advance is called an overdraft. The banker may take some collateral security or may grant
such advance on the personal security of the borrower. The customer is permitted to
withdraw the amount as and when he needs it and to repay it by means of deposit in his
account as and when it is feasible for him. Interest is charged on the exact amount
overdrawn by the customer and for the period of its actual utilization. (vi) Generally an
overdraft facility is given by a bank on the basis of a written application and a promissory
note signed by the customer. In such cases an express contract comes into existence. In
some cases, in the absence of an express contract to grant overdraft, such an agreement
can be inferred from the course of business. For example, if an account-holder, even
without any express grant of an overdraft facility, overdraws on his account and his cheque
is duly honoured by the bank, the transaction amounts to a loan. In Bank of Maharashtra
vs. M/s. United Construction Co. and Others (AIR 1985 Bombay 432), the High Court
concluded that there was an implied agreement for grant of overdraft or loan facility. (vii)
Banks should, therefore, obtain a letter and a promissory note incorporating the terms and
conditions of the facility including the rate of interest chargeable in respect of the overdraft
facility. This is to be complied with even when the overdraft facility might be temporary
in nature. Overdraft facility is more or less similar to ‘cash credit’ facility. Overdraft
facility is the result of an agreement with the bank by which a current account holder is
allowed to draw over and above the credit balance in his/her account. It is a short-period
facility. This facility is made available to current account holders who operate their
account through cheques. The customer is permitted to withdraw the amount of overdraft
allowed as and when he/she needs it and to repay it through deposits in the account as and
when it is convenient to him/her. Overdraft facility is generally granted by a bank on the
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basis of a written request by the customer. Sometimes the bank also insists on either a
promissory note from the borrower or personal security of the borrower to ensure safety
of amount withdrawn by the customer. The interest rate on overdraft is higher than is
charged on loan.
TERM LOANS
The loan is disbursed by way of single debit/stage-wise debits (wherever sanction so

accorded) to the account. The amount may be allowed to be repaid in lump sum or in
suitable installments, as per terms of sanction. Loan is categorized Demand Loan if the
repayment period of the loan is less than three years, in case the repayment of the loan is
three years and above the loan be considered as Term Loan. Under the loan system, credit
is given for a definite purpose and for a predetermined period. Normally, these loans are
repayable in installments. Funds are required for single non-repetitive transactions and are
withdrawn only once. If the borrower needs funds again or wants renewal of an existing
loan, a fresh request is made to the bank. Thus, a borrower is required to negotiate every
time he is taking a new loan or renewing an existing loan. Banker is at liberty to grant or
refuse such a request depending upon his own cash resources and the credit policy of the
central bank. Advantages of Loan System 1. Financial Discipline on the borrower: As the
time of repayment of the loan or its installments is fixed in advance, this system ensures
a greater degree of self-discipline on the borrower as compared to the cash credit system.
2. Periodic Review of Loan Account: Whenever any loan is granted or its renewal is
sanctioned, the banker gets as opportunity of automatically reviewing the loan account.
Unsatisfactory loan accounts may be discontinued at the discretion of the banker. 3.
Profitably: The system is comparatively simple. Interest accrues to the bank on the entire
amount lent to a customer. Drawbacks 1. Inflexibility: Every time a loan is required, it is
to be negotiated with the banker. To avoid it, borrowers may borrow in excess of their
exact requirements to provide for any contingency. 2. Banks have no control over the use
of funds borrowed by the customer. However, banks insist on hypothecation of the asset/
vehicle purchased with loan amount. 3. Though the loans are for fixed periods, but in
practice the roll over, i.e., they are renewed frequently. 4. Loan documentation is more
comprehensive as compared to cash credit system.
Types of Term Loans:

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Term loans are granted by banks to borrowers for purchase of fixed assets like land and
building, factory premises, embedded machinery etc., to enable their manufacturing
activities, and their business expansion, if the amounts are repayable after a specific period
of time, they are all called as term finance. On the basis of the period for which the funds
are required by the borrowers, these loans are classified as short, medium and long term
loans. Banks have been given freedom to fix their own interest rate for loans and advances.
As per bank’s lending and interest rate policies applicable interest and other charges would
be applicable to CC, OD, Term loan accounts. Each bank should decide “base rate” of
interest on advances as per RBI directives.
BANK GUARANTEE
As part of Non-fund based facilities, banks issue guarantees on behalf of their clients. A
Bank Guarantee is a commitment given by a banker to a third party, assuring her/ him to
honour the claim against the guarantee in the event of the non- performance by the bank’s
customer. A Bank Guarantee is a legal contract which can be imposed by law. The banker
as guarantor assures the third party (beneficiary) to pay him a certain sum of money on
behalf of his customer, in case the customer fails to fulfill his commitment to the
beneficiary.
LETTERS OF CREDIT
A Letter of Credit is issued by a bank at the request of its customer (importer) in favour
of the beneficiary (exporter). It is an undertaking/ commitment by the bank,
advising/informing the beneficiary that the documents under a LC would be honoured, if
the beneficiary (exporter) submits all the required documents as per the terms and
conditions of the LC.
Weaker Sections
Priority sector loans to the following borrowers will be considered under Weaker Sections
category:- (a) Small and marginal farmers; (b) Artisans, village and cottage industries
where individual credit limits do not exceed ` 50,000; (c) Beneficiaries of Swarnjayanti
Gram Swarozgar Yojana (SGSY), now National Rural Livelihood Mission (NRLM); (d)
Scheduled Castes and Scheduled Tribes; (e) Beneficiaries of Differential Rate of Interest
(DRI) scheme; (f) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY);
(g) Beneficiaries under the Scheme for Rehabilitation of Manual Scavengers (SRMS); (h)
Loans to Self Help Groups; (i) Loans to distressed farmers indebted to non-institutional
lenders; (j) Loans to distressed persons other than farmers not exceeding `50,000 per
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borrower to prepay their debt to non-institutional lenders; (k) Loans to individual women
beneficiaries up to `50,000 per borrower; (l) Loans sanctioned to persons from minority
communities as may be notified by Government of India from time to time. In States,
where one of the minority communities notified is, in fact, in majority, item (l) will cover
only the other notified minorities. These States/Union Territories are Jammu & Kashmir,
Punjab, Meghalaya, Mizoram, Nagaland and Lakshadweep.
Guarantees
Banks grant loans and advances (fund based) and provide other credit facilities (non fund
based) such as, bank guarantee and letters of credit. Non fund based limits are granted by
banks to facilitate the customers to carry on with the trading and business activities more
comfortably. Bankers can earn front end fees and these non fund based items become
contingent liabilities for banks. A contract of guarantee is covered under the Indian
Contract Act,1872. Sec 126 defines a guarantee as contract to perform the promise or
discharge a liability of a third person in case of his default. The contract of guarantee may
be oral or in writing. Banks, however insist on written guarantees. There are 3 parties to
the contract of guarantee. They are called Surety, Principal Debtor and the Creditor. These
parties are also called as the guarantor, borrower and the beneficiary. Banks deal with two
types of guarantees: (i) Accepted by the bank, and (ii) Issued by the bank
(1) Guarantees accepted by the Bank:
At the time of lending money, banks accept securities. In addition to the tangible assets a
borrower arranges to furnish a personal security given by surety (guarantor). This is called
third party guarantee, who undertakes to pay the money to the bank inclusive of interest
and other charges, if any, in case the principal borrower fails to repayor if the borrower
commits default. Banks also obtain Corporate guarantees issued by companies who
execute corporate guarantee as authorized by the Board of Directors’ resolution. As per
Sec 128 of the Contract Act,1872, the surety’s liability is co-extensive with that of the
principal debtor. For example, Bank MNC has sanctioned a term loan of Rs 10 lakhs to P
on the personal guarantees of Q and S. In this case Bank MNC is the creditor. P is the
borrower or the principal debtor. Both Q&S are the sureties or guarantors. In case P
commits a default, in repaying the debt to the Bank MNC ( as per the terms and conditions
of bank’s sanction letter) then both Q&S (as sureties/guarantors) are liable to pay the dues
to the bank.
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(2) Guarantees issued by the Bank:
A Bank Guarantee is a commitment given by a banker to a third party, assuring her/ him
to honour the claim against the guarantee in the event of the non- performance by the
bank’s customer. A Bank Guarantee is a legal contract which can be imposed by law. The
banker as guarantor assures the third party (beneficiary) to pay him a certain sum of money
on behalf of his customer, in case the customer fails to fulfill his commitment to the
beneficiary.
Default
Bank Default means any of the following events:
(i) the Bank shall fail, wholly or partially, to make a payment when and as required
under the provisions of the Letter of Credit;
(ii) the Letter of Credit is surrendered, cancelled or terminated (other than through
normal expiration in accordance with its terms), or amended or modified in any
material respect, without the Trustee’s prior written consent;
(iii) a court of competent jurisdiction enters a final nonappealable judgment that the
Letter of Credit is not valid and binding on or enforceable against the Bank ; or
(iv) the occurrence and continuation of one or more of the following:
(A) the liquidation or dissolution of the Bank;
(B) the commencement by the Bank of a voluntary case or other proceeding
seeking liquidation, reorganization or other relief with respect to itself or its
debts under any bankruptcy, insolvency or other similar law now or hereafter
in effect, including without limitation the appointment of a trustee, receiver,
liquidator, custodian or other similar official for itself or any substantial part of
its property;
(C) the consent of the Bank to or the acquiescence by the Bank in any case or
proceeding described in the preceding clause (B) that is commenced against it;
(D) the making by the Bank of an assignment for the benefit of creditors;
(E) the failure of the Bank or the admission by the Bank in writing of its inability
generally to pay its debts or claims as they become due;
(F) the initiation by the Bank of any actions to authorize any of the foregoing;
(G) the commencement of an involuntary case or other proceeding against the
Bank seeking liquidation, reorganization or other relief with respect to it or its
debts under any bankruptcy, insolvency or other similar law now or hereafter
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in effect or seeking the appointment of a trustee, receiver, liquidator, custodian
or other similar official of it or any substantial part of its property, and such
involuntary case remaining undismissed and unstayed for a period of 60 days;
or
(H) the entering of an order for relief against the Bank under the federal
bankruptcy law as now or hereafter in effect.
Banking Law and Debt Recovery

The social construct of earlier times ensured that borrowing was an act which was frowned
upon. In fact, stringent measures were often taken if the person failed to honour his debt,
often resulting in imprisonment, and at times, physical punishment. In the times that
followed, the zamindari system reared its ugly head. One needs to look merely at the fairy
tales and popular stories, all of which had one character which was a poor person who was
unable to pay off his debts. With rising interest rates, often generations of one family were
deemed to be forever in servitude to the landlord or the money lender.
Then, the Industrial Revolution took place. This period in history came with the realisation
that often business ventures needed greater capital than that that could be put together by
merely the proprietors. It dawned upon enterprising businessmen that the only way to raise
such vast amounts of money was to involve every day parties and use their money and if
need be, make them part owners and then reward them for the permission to use the money
in achieving the ends of their organisations. This mentality, along with the limited liability
regime and the final cog, of altering the penal provisions in case of non – repayment,
finally changed the debtor – creditor relationship for once and for all.
Unfortunately, with the dawn of this new relationship, along came the problem of debt
recovery. With lax laws regarding non–repayment, it got tougher and tougher for the
creditor to ensure timely repayment. The increase in non-performing assets rendered this
relationship tumultuous. It basically boiled down to the health of public banks and
extending credit to nascent industries of free India. Often loans were applied for one
purpose, but then diverted for another. Loans extended towards infrastructure projects
were never paid back on time because invariably, the budget would be exceeded,
inordinate delays would occur and the banks’ inability to enforce securities ensured further
delays which would reduce the sale prices of collaterals.
In 2001-02, the gross non- performing assets of the Indian banking sector were to the tune
of Rs. 70,905 crores which in effect means, that on advances to the tune of the mentioned
amount, the banking sector makes no money whatsoever.
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Even the Narasimhan Committee on the Financial System warned that unless and until
positive steps were taken, the entire financial health of the country could be affected. The
Reserve Bank of India responded with the implementation of stricter accounting
standards, greater reporting requirements and asked banks to hold a higher proportion of
outstanding loans so as to guard themselves from possible default. While this can be done
through loan restructuring or writing off these loans, the real improvement in the balance
sheet of the bank will occur only when the loan amount is recovered.
Obviously there have been attempts. Some banks offered concessions and rescheduled
the repayment of debts. After this method was met with limited success, there was an
attempt to ensure that all relevant financial information was to be presented before a loan
could be granted. This moved on to the practice of lending only if one had an asset which
could be used as collateral. However, this has not turned into an effective and efficacious
remedy as one might have hoped.
Unfortunately for India, the judiciary is something which it cannot be proud of. Some
academicians have even gone on to say that “the most effective method of dispute
resolution in these courts may well be the out of court settlements, withdrawals and
compromises by litigants attempting to avoid the inefficiencies in processing legal
suits.” Procedural loopholes in the Civil Procedure Code, which is an antique piece of
legislation allows for numerous applications, counter applications, special leaves by both
parties etc. Evidence rules allow for further delays. Numerous attempts have been made
to rectify this but to no avail.
To recover a loan, the creditor needs a money decree i.e. a decree by a court relating to
money matters. A suit needs to be filed in a civil court requesting the court to direct the
debtor to pay back the money borrowed. If the loan is secured, then the court will need to
enforce the security and sell the collateral to realise the money and return the amount
owed. If the loan is unsecured, then the court will have to liquidate the firm’s assets and
wind up the company and distribute according to the priority of the claim. The Indian
judiciary has taken its own sweet time and thus, the success rate of such an attempt by the
creditor has been low and cost has been high.
II
The Recovery of Debts due to Banks and Financial Institutions Act (hereinafter referred
to as the ‘DRT Act’) was the result of the findings of the Tiwari Committee of 1981 and
the Narasimhan Committee of 1991, both of which endorsed the idea that since banks
faced numerous legal difficulties in recovering their money, a special tribunal should be
established for the recovery of debt and these tribunals shall be governed by the principles
of natural justice. This Act allows for the establishment of Debt Recovery Tribunals
(DRTs). The Act itself in its Statement of Objects and Reasons mentions the fact that as
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of 1990, there were around fifteen lakh cases pending which had been filed by public
banks and a further 304 cases which had been filed by different financial institutions.
These cases put together had resulted in the locking up of Rs. 6013 crores which could
have been otherwise utilised for other purposes.
Debt Recovery Tribunals are quasi legal in nature. They do nothing but deal with the
recovery of debt as the name of the Act suggests. The presiding officer of the DRT is one
who is the qualified to be a district judge and lawyers qualified to appear in civil courts
are the ones who can appear here as well. Well, the aim of the DRT was to provide for an
alternate forum in which the recovery of debts could be expedited and this would be
rendered in fructuous if the procedure followed was the same as the normal courts. Hence,
in order to avoid this obstacle, a procedure was developed which sought to ensure that the
parties were acting quickly along with greater accountability and there was no need to
restrict the working of the Tribunal by applying the Civil Procedure Code of 1904.
This summary procedure included a thirty day period in which the defendant had to
respond to the summons, counter claims had to be raised at the first hearing itself and also,
the verdict would be carried out as soon as possible by the recovery officer since he had
the power to attach and sell any property, appoint a receiver who would be the guardian
of the defendant’s property and even at times, arrest and detain the non- complying
defendant. The DRT also had the powers to issue interim measures to ensure that the
parties do not dispose the impugned asset and render the proceedings in fructuous.
Appeals could be made to the Debt Recovery Appellate Tribunal (DRAT). However,
before one sought to exercise this option, 75% of the amount was to be deposited with the
DRAT as a security.
While this Act was a welcome step in the area of debt recovery, it was not long before it
met its first hurdle. The Delhi Bar Association challenged the constitutionality of this Act
on several grounds. It was argued, inter alia, that since the Ministry of Finance appointed
the presiding officer, such a procedure was in violation of ‘separation of powers’ which
was part of the Basic Structure Doctrine. While the Delhi High Court passed an
interlocutory measure asking for the DRT to cease from operating, the special leave
petition filed by Central Government was decided in the favour of the government by the
Supreme Court. Along with certain amendments, notably one of which ensured that the
Chief Justice of India would be the ex- officio Chair of the selection committee for the
presiding officer post, the Act would side step the alleged violation of the separation of
powers, and the executive would not be unduly interfering with the workings of the
judiciary.
While one cannot argue that the DRT Act was not beneficial, it did not achieve its full
potential. Undoubtedly, the DRT Act showed that the legislature was heading in the right
direction, but a little more was demanded. This need heralded in the Ordinance which was
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later made into an Act, called the Securitisation, Asset Reconstruction and Enforcement
of Security Interests Act (hereinafter referred to as the ‘SARFESI Act’). As mentioned
earlier, the rapid rise in non- performing assets was a situation to worry about. This Act
marked a new turning point for the recovery of debt.
So what exactly is securitisation? It is a process which involves the pooling and

repackaging of homogenous but non- liquid assets into securities which can be marketed
and have a claim over the incoming cash inflows. The basic process of securitisation has
been clearly laid down in Vinod Kothari’s book on the SARFESI on page 27 as follows:
The originator (creditor) selects the receivables it wants to be securitised.
A special purpose vehicle (SPV) is formed for this purpose to which the receivable are
transferred to at their discounted value.
This SPV will issue securities to the investors, either publicly or through private
placement.
A servicer is appointed (usually the originator) who collects the receivables and pays the
collection to the SPV. It also takes action against the debtor in case of default as an agent
of the SPV.
The SPV may either choose to pay off the investors or reinvest the same and pay off the
investors when it becomes due.
Usually at the end when only a few receivables are left outstanding, the originator buys
back the leftovers to clean up the transaction.
Now arises the question why would anyone resort to securitisation? There are several
reasons which back this process. A company may want to raise finance when other
avenues of financing are shut, iprove the return on their assets, reduce credit exposure,
reduce risk and even achieve a regulatory advantage.
To determine whether an account is a non- performing asset or not, the Reserve Bank of
India (RBI) issues guidelines on the same. Thus, the Securitisation Companies and
Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003 classifies an
account as a non- performing one if a default has been made on the repayment of a debt
(whether on the principal amount, interest or even any portion of the two) for a period of
180 days or more.
The SARFESI Act in its aim to achieve “expedient and efficacious legal means of
enforcing the security with the least possible judicial interference” dictates that once a
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notice has been issued to the defaulter, and a waiting period of sixty days elapses, the
creditor can without even approaching a court, take physical possession of the security
and then take steps which allow for the recovery of debt.
While the Indian scenario is ideal for securitisation since there is a huge potential for this
process, major investors are actually willing to invest in the same, there exists a large debt
market and data exists on economic cycles, there are also certain cons for the same like
the fact that the legal system is still oblivious to this process, the stamp duty remains high
and the tax inefficiency of the SPV remains a matter of concern holding back
securitisation.
Though this Act is often termed as revolutionary for providing a cheaper alternative to
debt recovery, it has its own share of criticisms. First, it is believed that one single act
cannot and has not done justice to securitisation, asset reconstruction and enforcement of
security interests. All the three are vastly different from each other in several aspects and
expecting one act to cover all the three cannot be termed as prudent. Secondly, the Act
fails to provide for a mechanism in which the defaulter can challenge the sale of the asset
in cases where the creditor might have sold the asset at a price below the true market value
causing a loss to the defaulter. Thirdly, there is no distinction between wilful and non-
wilful defaults. It is often argued that the two should be treated differently. Fourthly, there
is no guarantee that once the creditor takes over the business of the defaulter, the creditor
may actually be qualified to do the same. On the contrary, the creditor might cause
irreparable damage to the business.
It was also felt at a certain level that political pressure hinders the application this Act to
large defaulters and hence, it is only the small debtors who seem to be caught consistently
in the net of the SARFEASI Act. And finally, this Act while promoting debt recovery,
fails to address the root of the issue which is to prevent and reduce industrial sickness and
non- performing assets. This short sighted vision might cause India dear, especially in
light of the economic meltdown.
The abject lack of provisions of appeal was the ground on which the SARFESI Act was
challenged in Mardia Chemicals v. Union of India. While the defaulter is entitled to
repossession as well as compensation in cases in which the creditor has wrongfully
exercised his rights under this Act, the Supreme Court ruled that it was mandatory for
allowing a fair hearing to the defaulter. Thus, physical possession of the assets can be
undertaken only after the defaulter has received a notice and has been given a fair
opportunity to be heard and then the defaulter has to be intimated that his representation
has been rejected. It is only then that the creditor can take physical possession.
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It is believed that such a judgment along with the requirements of certain amendments to
the SARFESI Act will severely weaken and curtail the rights the banks and financial
institutions which they enjoyed earlier.
IV
The SARFESI Act was a positive move undoubtedly. It attempts to create a stronger legal
regime for creditors along with the fact; it reduces interference by the judiciary. However
one needs to note that the Act is not meant to merely allow creditors to walk in and take
over the management or the assets. It has even at times been referred to as the “POTA of
Indian Banking” which may be a tad too harsh a label. One should realise that the Act
attempts to promote recovery of debts rather than penalise the defaulters.
After the amnesty scheme in which creditors allowed for large discounts so atleast a part
of the debt could be recovered, and the attempt to create alternate forum in the form of the
DRT, the SARFESI Act was the third trial and error method opted for, by the Government.
The SARFESI Act sought to radically change the relationship between the debtors and
creditors and did have an effect in its early years. The percentage of NPAs in overall assets
came down from 14% in 1999-2000 to 9% in 2002-2003.
While the ruling of the Supreme Court in the Mardia Chemicals Case has diluted its affect
to a certain level, it is imperative that the government while amending the Act does not
change the structure of the Act but merely ensures it removes the flaws which as
enumerated above, seem quite a few.
However, as mentioned earlier, one needs to note the fact that debt recovery is still the
second stage in improving the financial conditions of the Indian economy. The primary
still remains in ensuring that NPAs itself are not encouraged and this can be done solely
by ensuring there exists greater transparency and accountability. It remains to be seen
what the government has in store in that aspect of policy making, especially after taking
into consideration the N. L. Mitra Committee Report which discussed overhauling the
bankruptcy code.
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UNIT II. (e)RECOVERY OF DEBT WITH AND WITHOUT

INTERVENTION OF COURTS/TRIBUNALS
RECOVERY OF DEBTS
Credit is a delicate plant which flourishes under favourable conditions and is exceedingly
quick to whither in adversity. It bears the seed of its own destruction. Hence when
banks/financial institutions are going to lend, the foremost point before them is that the
loan will, in the first place be repaid when due and in the second that it be used for
legitimate purposes. However, recovery of loans is one of the most difficult problems, to
be tackled by these institutions, irrespective of whether the loan is a short, medium or
long-term or to whom the loan is disbursed i.e. the types of borrowers which may either
he large, medium or small-scale industries, transporters,, exporters, traders, agriculturists,
professionals etc. To ease the problem, certain safeguards must be kept in view and proper
steps, if taken in time, will help in speedy recovery.
The common causes for low recovery of loans by banks and financial institutions
may be summed up as under:
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(a) At times, the credit-worthiness of the borrowers is not assessed properly
which depends upon "willingness" ' of the borrower to repay i.e. his
character and integrity and also his capacity to earn and repay
(b) Improper appraisal of the project.
(c) Lack of proper follow-up and supervision after the loan is, sanctioned.
(d) Diversion of funds by borrowers for purposes other than for which they are
sanctioned.
(e) Lack of assistance from Sponsoring and Government agencies in

recovering the loans.
(f) Lack of effective administrative mechanism to supervise the proceedings

of the recovery and utilisation of advances.
(g) Unhealthy trend of shielding of defaulters by the political heavyweights.
(h) Lack of co-ordination and follow-up when more than one financing
institutions are involved.
(i) Lack of proper and timely guidance when the borrower is in adversity.
G) Time-consuming process of recovery if litigation is resorted to, which

generally becomes expensive too.
(k) Deteriorating integrity, sincerity, dedication and morality.
Steps for Recovery
Recovery of loans/debts is a ticklish problem. Therefore, concerted efforts should

be made to ensure speedy recovery which will lead to better recycling of funds.
Following can be the short and long term measures for ensuring timely recovery
1. Rescheduling the repayment period and to take rehabilitation measures, if

required. A proper and timely study of the units for ascertaining the causes
of sickness and for assessing their liability becomes imperative inasmuch
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as, if the units are found potentially viable, they must be put immediately
under nursing programme, so that when out of adversity, they may start
repaying the loans.
2. Improving organisational set up by appointing trained professionals to look

after recovery.
3. Reducing wilful defaults by resorting to greater emphasis on recovery,

proper education and training to staff, black-listing of intentional defaulters
and by providing faster and more effective legal support.
4. Providing incentives to staff members if they help in recovering sticky

advances, on the same lines if they happen to fetch deposits.
5. By bringing about healthy changes in the behaviour of branch managers

towards recovery of such loans which have not been sanctioned during their
tenure. Instead resorting to filing of suits in such cases the managers/
officers may be made to understand by proper education and training that,
if the unit can be revived back to health, it should be so done, in the interest
of borrower, financing institution and the nation, at large.
6. Timely lodging of claims with Export Credit and Guarantee Corporation

(ECGC) and with all such agencies who have guaranteed the loan like
'Credit Guarantee Fund Trust for Small Industries'.
7. Taking resort to Public Debt Recovery Act in the states where such Acts
are in force, for here, in these States bank dues are treated as arrears of
land revenue and can be recovered effectively with the help and
assistance provided by respective State Governments.
8. Recovery through out of court settlements and through compromises, as it

is less expensive and more fast technique of recovery.
9. Resorting to legal action when it is well established that the borrower is a

habitual or wilful defaulter and his integrity is doubtful though he has
repaying capacity. The following points must he- ensured before taking any
legal action :
(i) The debt is not time-barred and within the period of limitation.
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(ii) The debt against which proceedings are to be initiated in the
court, must be reduced to minimum, by Sadjusting the amount of
securities available. This will help in siphoning off less amount on
court fee, counsel's fee etc.
(iii) The securities like hypothecated goods, must be effectively

and legally possessed beforehand and preserved in such a way that
their quality is not deteriorated.
(iv) The property, which can be attached a ' s security must be

valued properly (i.e. not to be overvalued) so that presentation before
court is on the sound lines.
(v) It must be ensured that all the relevant legal documents are on
record and have been properly examined by the legal counsel and
further the counsel must be explained all the facts of the case so that
he may file a proper and well-drafted plaint.
10. Take action under the Securitisation and Reconstruction of Financial

Assets and Enforcement of Security Interest Act, 2002.
11. Effecting recovery of loans through Debt Recovery Tribunals (DRTs)

established under "The Recovery of Debts due to Banks and Financial
Institutions Act, 1993".
Recovery of Debts Due to Banks and Financial Institutions Act, 1993
Legal process of recovery of dues is a time consuming and expensive mode which,
even if awards decrees in favour of financial institutions, may not be that much
useful because of the inordinate delay involved in securing decrees during which
time the assets charged as securities get deteriorated and commercial value
diminished. A significant portion of the funds of the Banks and Financial
Institutions thus gets blocked in unproductive assets.
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Realising this problem, the Parliament enacted "The Recovery of Debts Due to
Banks & Financial Institutions Act, 1993' which came into force with effect from
24th June, 1993.
Salient Features of the Act
(i) The Act applies to all banks including Regional Rural Banks and all India
Financial Institutions. However, State Level Financial Institutions are
outside the purview of this Act.
(ii) The provisions of the Act shall not apply where the amount of debt due to
any bank or financial institution or to a consortium of banks or financial
institutions is less than Rs.10 lakh or as specified by the Central
Government.
(iii) The Central Government shall establish 'Debt Recovery Tribunals (DRTs)'
with pre-defined areas of jurisdiction. The Tribunal will consist of
one person only designated as 'Presiding Officer'. The Tribunal will be
provided with one or more 'Recovery, Officers' and such other officers and
employees who will work under the general superintendence of the
Presiding Officer. Central Government will also establish "Debt Recovery
Appellate Tribunal (DRAT)" which shall also consist of one person only
designated as 'Chairperson'.
(iv) The Tribunals shall exercise powers and authority to entertain and decide
applications from banks & financial institutions for recovery of debts and
no court or other authority shall have any jurisdiction (except the Supreme
Court and a High Court exercising jurisdiction under Articles 226 & 227 of
the Constitution).
(v) Where the bank or a financial institution has to recover a debt, application
in the prescribed form, will have to be filed with Tribunal. The Tribunal
will issue summons requiring the defendant to show cause within 30 days
of the service of summons. Before passing any order including interim order
both the applicant and defendant will be given the opportunity of being
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heard. The Tribunal may also consider counter claims/set off from the
defendant.
(vi) The Tribunal may, after being satisfied, consider to exclude counterclaim
of the defendant and dispose of the same independently, if an application in
this respect is filed by the applicant.
(vii) The Tribunal may make an interim order by way of injunction/stay/

attachment, debarring defendant from transferring, alienating or disposing
of any property and assets without its prior permission.
(viii) At any stage of the proceedings, if the Tribunal is satisfied that the
defendant intends to obstruct or delay or frustrate the execution of the
recovery order, he may be ordered to furnish security of specified sum
failing which attachment orders may follow.
(ix) The Tribunal may appoint Receiver of any property and confer upon him
all such powers like bringing and defending suit in the courts of filing;
defending application before the Tribunal; realisation, management,
protection, preservation and improvement of the property; collection of
rents and profits arising from the property and application and disposal of
such rents an profits; execution of documents; or other powers which the
Tribunal thinks fit.
(x) The Tribunal may also appoint Commissioner for the preparation of an
inventory of the properties of the defendant or the sale thereof.
(xi) Disobedience of or breach of any of the terms of the order of the Tribunal
made under clauses (vii), (viii), (ix) and (x) above, may result in detention
of the guilty person in civil prison for a term not exceeding three months.
(xii) The application shall be disposed of, as far as possible, within 180 days
from the date of its receipt. A certificate will be issued to the Recovery
Officer for recovery of amount of debt specified in the certificate.
(xiii) The Tribunal may order to distribute the sale proceeds among the secured
creditors in accordance with the provisions of section 529A of the
Companies Act, 1956 and to pay the surplus, if any, to the company, where
a recovery certificate is issued against a company.
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(xiv) The Tribunal, issuing recovery certificate, if satisfied that the property is
situated within the jurisdiction of two or more Tribunals, may send the
copies of recovery certificate for execution to such other Tribunals also.
(xv) An appeal may be preferred to an 'Appellate Tribunal' within a period of

45 days from the date of order. However, the Appellate Tribunal may
condone the delay in preferring an appeal beyond 45 days, if sufficient
causes are shown. On receipt of an appeal, an order confirming, modifying
or setting aside the order appealed against may be passed by the 'Appellate
Tribunal'. Appeal can be filed by depositing seventy five percent of the
amount of debt as determined by the Tribunal. Appellate Tribunal may,
however, waive or reduce the amount of deposit. No appeal shall lie against
an order which is passed by the Tribunal with the consent of the parties.
(xvi) The provisions of the Limitation Act, 1963 shall apply to an application
made to a Tribunal.
(xvii) The Recovery Officer, after issuance of certificate by the Tribunal, shall
recover the amount of debt by one or more of the following modes:
(a) attachment and sale of the movable or immovable property of the

defendant;
(b) arrest of the defendant and his detention in prison.,
(c) appointing a receiver for the management of the movable or

immovable properties of the defendant.
The modes of recovery include requiring any person who is indebted to the
defendant, to deduct the amount of debt due from defendant from the
amount payable to the defendant. Recovery Officer is authorised to issue
notice to any person from whom money is due or may become due to the
defendant. Such person will be required to deposit the amount with
Recovery Officer, who shall grant a receipt for any amount so paid in
compliance with the notice issued. The person so paying will be fully
discharged from his liability to the defendant to the extent of amount so paid.
While executing certificate of recovery, the Recovery Officer may require
any person and any of the officers of a company against whom or which the
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recovery certificate is issued, to declare on affidavit the particulars of his or
its assets.
(xviii) Notwithstanding anything contained in clause (xix) below, any person

aggrieved by an order of the Recovery Officer may prefer an appeal to the
Tribunal within thirty days from the date on which order is issued to him
and the Tribunal may, after giving an opportunity to the appellant of being
heard and after making necessary enquiry, confirm, modify or set aside the
order made by the Recovery Officer.
(xix) The provisions of the Second and Third Schedules to the Income-tax Act,
1961 and Income-tax (Certificate Proceedings) Rules, 1962, as in force from
time to time shall, as far as possible, apply with necessary modifications as
if the said provisions and the rules referred to the amount of debt due under
this Act instead of the income-tax.
(xx) The provisions of this Act are in addition to, and not in derogation of, the
Industrial Finance Corporation Act, 1948, the State Financial Corporations
Act, 195 1, the Unit Trust of India Act, 1963, the Industrial Reconstruction
Bank of India Act, 1984, the Sick Industrial Companies (Special Provisions)
Act, 1985 and the Small Industries Development Bank of India Act, 1989.
However, in other matters, the provisions of this Act shall have effect
notwithstanding anything inconsistent there with contained in any other law
for the time being in force or in any
instrument - having effect by virtue of any law other than this Act.
(xxi) The term 'Debt', can be expressed to mean any liability inclusive of interest
which is claimed as due by a bank, financial institution or consortium of
banks and financial institutions during the course of any business activity
undertaken by them. Such debt may be in cash or otherwise, secured or
unsecured, or assigned, or payable under a decree or order of any civil court
or any arbitration award or otherwise, or under a mortgage. It is further to
be noted that the debt must be subsisting on the date of filing of application
with the Tribunal and is legally recoverable.
Banks to Reveal Loan Defaulters

The Reserve Bank of India has advised banks to incorporate a condition in the loan
agreement for obtaining the consent of borrowers to disclose their names in the
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event of their becoming defaulters. The banks were asked to put in place the system
for obtaining the consent of borrowers by 30.9.2001.
Banks and financial institutions are required to submit to RBI a list of names of
defaulters of Rs. one crore and above against whom suits have been filed to recover
defaulted loans or non-performing assets (NPAs) and the RBI publishes a complete
list as on 31st March every year. Another scheme for collection and dissemination
of information of wilful defaulters with outstanding balance of Rs.25 lakh and
above was also introduced in February 1999 on a quarterly basis. Wilful defaults
can be defined as failure to repay loans where either the defaulter has a sound net
worth and adequate cash flows, or where the promoter has siphoned off funds from
a sick unit or where the promoters/borrowers have either clandestinely sold assets
or not purchased them at all, although they are charged to the bank. For details,
refer to Chapter 'Role of Commercial Banks'.
Fresh Limit/Renewal/Enhancement to Wilful Defaulters

In the case of wilful defaulters, only the Board of Directors, should consider any
fresh limit, renewal or enhancement on merits of each case.
Banks, FIs to Set up Debt Restructuring Cell

Various banks and financial institutions have agreed to form a corporate debt
restructuring cell with the objective of shortening the time for taking decisions on
big defaulter accounts above Rs.20 crore.
The cell will be headed either by a senior banker or a retired banker. It would be a
voluntary organisation. Under the cell, committees on separate defaulter companies
would comprise the bankers and institutions that are part of the consortium of
funding agencies for the company.
The bankers have also agreed that the cell would decide on whether to opt for
restructuring the debt or go in for legal action against the defaulters, within a
maximum time frame of 180 days.
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Credit Information Bureau (CIB)
Indian Bankers' Association (IBA) has set up a Credit Information Bureau which
shall develop information on habitual as well as potential defaulters. To nab
defaulters all member banks will share the information so built up.
The managing committee of IBA will deliberate on the amount/capital needed to

set up such a bureau. Reserve Bank of India has advised the banks to make the
necessary in-house arrangement for gathering and collection of credit and other
information in one place for transmitting it to the Credit Information Bureau.
State Bank of India has already entered into an MOU with HDFC to set up a
Credit Information Bureau.
Lok Adalats for Small Loan Cases

The RBI has advised banks to use Lok Adalats to settle disputes involving small
loans upto Rs.5 lakh. The RBI has issued detailed guidelines for settlement of dues
through Lok Adalats. The scheme includes all NPA accounts (both suit filed and
non-suit filed accounts), which are in "doubtful" and "loss" category, with
outstanding balance of Rs.5 lakh.
New Arbitration Scheme to speed up Recovery Process

With a view to speed up recovery process of all disputed and sticky loans upto
Rs.10 lakhs, RBI is bringing out a new banking arbitration scheme under the
Arbitration and Conciliation Act, 1996. It is proposed to settle the disputes under
the scheme in one hearing without challenging the award given by the panel in a
court of law.
For the purpose of referring cases, the banks will be required to incorporate a new
clause in all loan agreements stating that, in case of any dispute, the case will be
referred to the banking arbitration panel. According to the scheme, once a case is
filed, the hearing will be held after three months, to be settled on the spot.
Recording of evidences will be done only in selected cases.
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The arbitration scheme will provide the banks with a third option to speed up the
recovery process of sticky loans upto Rs.10 lakh in addition to Lok Adalats and
settlement advisory panels. Sticky loans beyond Rs.10 lakh are required to be
referred to Debt Recovery Tribunals.
Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 was passed by the Parliament in December 2002 and it
came into force w.e.f. 21.6.2002 as per an Ordinance promulgated earlier.
The Government from time to time has taken various steps to curb the problem of
Non-Performing Assets (NPAs) and to expedite their recovery but the results have
not been very encouraging.
The new Act will enable the secured creditor to realise more easily the security
given for a loan which has become an NPA. This Act will definitely bring a cultural
change among the defaulters.
The Act can be broadly divided into two parts:
(a) Enforcement of security interest by secured creditor (Banks/Financial

institutions).
(b) Regulation of Securitisation and Reconstruction of Financial Assets of

Banks and Financial Institutions.
These are discussed in the following paragraphs
A. Enforcement of Security Interest
(a) Secured Creditors
(Banks/Financial Institutions) now have a remedy for enforcing

security directly, without intervention of the court or Tribunal. This
remedy is available to Banks/FI, if the following conditions are
satisfied:
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(i) The borrower must have made a default in respect of the
secured debt.
(ii) The debt must have been classified as NPA by the secured
creditor.
(iii) The secured creditor must have given a notice in writing to

the borrower to discharge its liabilities within 60 days.
(b) In case the borrower fails to discharge his liability in full, the
secured creditor can take the possession or management of the
secured assets (whether provided by borrowers or guarantors) and
can transfer them by way of lease, assignment or sale.
(c) The secured creditor can also proceed against the guarantors or sell
the pledged assets directly.
(d) If dues are not fully recovered, the secured creditor can fill
application with Debt Recovery - Tribunal for balance amount.
(e) Banks/FI can, at their discretion-band over the asset to

securitisation or reconstruction company, which in turn can am as a
'secured creditor'.
(f) The borrower can file an appeal with Debt Recovery Tribunal (DRT)
within 45 days of taking over of asset or management by the
secured creditor. The borrower will have to deposit 75% of the
amount claimed in the notice with DRT before its appeal is
entertained. It means no appeal can be filed by the borrower at the
stage of receiving notice.
(g) Appeal against DRT's order can be filed with Debt Recovery
Appellate Tribunal (DRAT).
(h) Civil courts shall have no jurisdiction in respect of the matters on

which a DRT or DRAT is empowered by this Act to determine.
(i) Overriding effect has been given to this 'Act' to avoid conflict
between various laws.
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(j) The Act also has provision for compensation in case of wrongful
action by the secured creditor.
(k) The following securities have been exempted from the provisions of
the Act.
(i) lien on goods, money or security,
(ii) pledge of movables,
(iii) creation of security in aircraft under the Aircraft Act,
(iv) creation of security in a vessel,
(v) conditional sale, hire purchase or lease or any other

contract where no security interest has been created,
(vi) where amount due is less than 20% of the principal amount
and interest,
(vii) in case financial asset does not exceed Rs.1,00,000/-
(viii) Agricultural land
(ix) Rights of unpaid seller
(x) Properties exempted from attachment under the Civil

Procedure Code.
B. Securitisation and Asset Reconstruction

The Act has introduced the concept of a securitisation company and' a
reconstruction company which may acquire right or interest in financial assets
from Banks/FIs. Once the securitization company acquires 'financial asset' from
Banks/F1s, it becomes 'secured creditor' for all purposes. In brief the Act has
provided legal framework for securitisation of assets.
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UNIT-III--- : BANKING FRAUDS
A. Nature of Banking Frauds
The Indian banking sector has experienced considerable growth and changes since
liberalisationofeconomyin1991.Thoughthebankingindustryisgenerallywellregulatedand
supervised,these ctor suffers from its own set of challenges whenit comes to ethical practices,
financial distress and corporate governance. This study endeavours to cover issues such as
banking frauds and mounting credit card debt, with a detailed analysis using secondary data
(literature review and case approach) as well as an interview-based approach, spanning across
all players involved in reporting financial misconduct. The report touches upon the case of
risingNPAsinthepastfewyearsacrossvariousscheduledcommercialbanks,especiallypublic
sector banks. The study finally proposes some recommendations to reduce future occurrence
of frauds in Indian banking sector. The credibility of third parties such as auditing firms and
credit rating agencies is also questioned in the study and is believed to be a significant
contributor amongst other causes, such as oversight by banks and inadequatediligence.
Introduction and Issues

In recent years, instances of financial fraud have regularly been reported in India. Although
banking frauds in India have often been treated as cost of doing business, post liberalisation the
frequency, complexity and cost of banking frauds have increased manifold resulting in a
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veryseriouscauseofconcernforregulators,suchastheReserveBankofIndia(RBI).RBI,the
regulator of banks in India, defines fraud as “A deliberate act of omission or commission by
any person, carried out in the course of a banking transaction or in the books of accounts
maintained manually or under computer system in banks, resulting into wrongful gain to any
person for a temporary period or otherwise, with or without any monetary loss to thebank”.
Inthelastthreeyears,publicsectorbanks(PSBs)inIndiahavelostatotalofRs.22,743crore, on
account of various banking frauds. With various measures initiated by the RBI, numbersof
banking fraud cases have declined, but amount of money lost has increased in these years.
Prima facie, an initial investigation in these cases has revealed involvement of not only mid-
level employees, but also of the senior most management as was reflected in the case of
Syndicate Bank and Indian Bank. This raises serious concern over the effectiveness of
corporategovernanceatthehighestechelonsofthesebanks.Inaddition,therehasbeenarising trend
of non-performing assets (NPAs), especially for the PSBs, thereby severely impacting their
profitability. Several causes have been attributed to risky NPAs, including global and domestic
slowdown, but there is some evidence of a relationship between frauds and NPAs as well.
Therobustnessofacountry’sbankingandfinancialsystemhelpsdetermineitsproductionand
consumptionofgoodsandservices.Itisadirectindicatorofthewell-beingandlivingstandards of its
citizens. Therefore, if the banking system is plagued with high levels of NPAs then it is a cause
of worry, because it reflects financial distress of borrower clients, or inefficiencies in
transmission mechanisms. Indian economy suffers to a great extent from these problems, and
this served as the prime motivation for the authors to carry out this detailed study of frauds in
the Indian banking system and examining frauds from differentangles.
Thisstudytakesintoconsideration,differentaspectsofIndianbankingsector.Specificallyfor
thisstudy,primarysemi-structuredinterviewswereconductedwithbankersandindustry
veterans to better understand sector dynamics. Finally, an attempt has been made to give possible
recommendations that can help mitigate these problems.
The rest of the paper is organized into three major sections. Section 2 is a review of existing
literature on the global and domestic banking sector. It talks of the evolution of the regulatory
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landscape governing the banking system as well as a discussion of existing literature on the
issuesofNPAsinbanksandincidenceofbankingfraud.Section3providesadetailedanalysis of
banking frauds in India. It broadly covers two categories of studies carried out – secondary
researchfromliteratureandcasestudiesandprimaryresearchfrominterviewsspanningacross all
players involved in reporting of financial misconduct. Section 4 provides a detailed set of
recommendations for prevention and early detection of frauds in bankingsystem.
The study intends to fulfil the following two objectives – a) to understand and analyse
underlying causes contributing to increasing trend in frauds committed in Indian banking
sector; and b) to suggest appropriate and suitable measures that can help the system in
addressing these issues. A dual approach was undertaken to accomplish the above mentioned
objectives:a)Secondarysources:Thiswasbasedonliteraturereviewandcasestudyapproach. It also
relied heavily on trend analysis of frauds based on past data available with the RBI and various
other entities. Also, it seeks to uncover the broader trends within public sector banks (PSBs)
and private sector banks (PVBs) in India; b) Primary sources: A 360 degree analysis
wasconductedbyinterviewingbankingofficials,retiredbankers,practitioners,policymakers,
crime and compliance officers, andauditors.
Section 2: Brief Literature Review

The aftermath of the great depression in 1930s in the USA saw enforcement of Glass-Steagall
act (GSA) with an objective to reduce risks to financial system and tackle conflict of interests
that exist in banking, by separating commercial banking functions from ‘risky’ investment
bankingfunctions.Howeverovertime,aseriesofdilutionsgraduallyrenderedGSAineffective
which was finally repealed in1999.
With globalization, Kohler (2002) in his speech at a conference on humanizing the global
economy stressed the need to increase transparency of financial structures as well as to raise
the surveillance of international capital markets. In mid 1990’s, World Bank laid out a well-
defined strategy to combat different types of frauds and corruption, and jointly with the IMF
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created financial sector assessment program (FSAP), to assess, diagnose and address potential
financial vulnerabilities. FSAP has undergone several transformations and wider acceptance
over the years, since its inception in 1999.
Mergers of giants in the banking industry gave birth to the concept of “too big to fail”, which
eventually led to highly risky financial objectives and financial crisis of 2008. In response to
the2008crisis,Dodd-Frankwall-streetreformandconsumerprotectionact(DFA)wasenacted in
2010. DFA gave birth to various new agencies to help monitor and prevent fraudulent practices.
Volcker rule, a part of DFA, banned banks from engaging in proprietary trading operations
forprofit.
Post crisis, IMF has worked towards making risk and vulnerabilities assessment framework
effective, by advocating greater transparency and information sharing, along with empowered
supervisory and regulatory bodies, as well as greater international collaboration towards
regulation and supervision of financial institutions. Gaps were identified under financial
surveillanceaswellasonthefrequencyofsuchsurveillanceespeciallyineconomieswithtruly
systemicfinancialsectors,whosefailuremighttriggerafinancialcrisis.Accordingtoliterature,
approximately one in three banking crises followed a credit boom, which shows a correlation
between relaxed credit expansion policies by banks andcrises.
Another major sector distraught with fraudulent practices is the credit card market. However,
given that credit card usage in India is predominantly for transactional purposes, the
macroeconomic impact of fraudulent practices is less significant and is not considered further
in this study.
Indian banking system has remained plagued with growth in NPAs during recent years,which
resulted in a vicious cycle affecting its sustainability. Chakrabarty (2013) noted in his speech
that, while most numbers of frauds have been attributed to private and foreign banks, public
sector banks have made the highest contribution towards the amountinvolved.
Key findings in RBI (2014b) included the stress of asset quality and marginal capitalization
faced by public sector banks, and various recommendations to address these issues. Rajan
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(2014)stressedongoodgovernanceandmoreautonomytobeconferredtopublicsectorbankstoincre
asetheircompetitivenessandtobeabletoraisemoneyfrommarketseasily.Inresponse to the
common perception that increasingly strict regulations will make businessopportunities take a
hit, Raju (2014) stated that, regulations do not seem to be a bar in functioning of banks after
the crisis. Subbarao (2009) was of the opinion that without broad-based trust and presumption
of honest behaviour, there wouldn’t be a financial sector of the current scale and
size.Hecalledtheemergenceofamoralhazardprobleminthebankingsystemasprivatization of
profit and socialization ofcosts.
To maintain uniformity in fraud reporting, frauds have been classified by RBI based on their
typesandprovisionsoftheIndianpenalcode,andreportingguidelineshavebeensetforthose
according to RBI (2014a and 2015a). Towards monitoring of frauds by the board of directors,
acircularwasissuedasperRBI(2015b)tocooperativebankstosetupacommitteetooversee internal
inspection and auditing, and plan on appropriate preventive actions, followed by review of
efficacy of those actions. Impartial policy guidelines and whistle-blower policy are vital to
empower employees to handle frauds. RBI also issued a circular and introduced the concept of
red flagged account (RFA), based on the presence of early warning signals (EWS), into the
current framework, for early detection and prevention of frauds. Gandhi (2014) discussed the
prime causes of growing NPAs and recognised the absence of robust credit appraisal system,
inefficient supervision post credit disbursal, and ineffective recovery mechanism as key
barriers addressing those aspects. Gandhi (2015) stressed on the basic principles that can go a
long way in preventing fraud, namely the principles of knowing the customer and employees
as well as partners. He also pointed out the significance of a robust appraisal mechanism and
continuousmonitoring.
Lokare(2014)revealsthattheshareofretailloansegmentintotalNPAscontinuestostayhigh, of
which credit card loans (2.2 percent) have the third-highest contribution after personal and
housing loans. Livshits, MacGee, Tertilt (2015) empirically suggest that the rise in consumer
bankruptcycanlargelybeaccountedbytheextensivemarginandlowerstigmaassociatedwith it. It
also suggests that financial innovations have led to higher aggregate borrowings, which has
resulted in higher defaults. A study by Assocham (2014) finds strong correlation between
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sustainable credit growth, leading to healthy asset creation, and GDP growth. It emphasizes
robust credit assessment and use of early warning systems to monitor asset quality of
institutions.
Section 3:
AnalysisSecondary
Research
As per the RBI, bank frauds can be classified into three broad categories: deposit related
frauds, advances related frauds and services related frauds.
Deposit related frauds, which used to be significant in terms of numbers but not in size, have
come down significantly in recent years, owing to a new system of payment, and introduction
of cheque truncation system (CTS) by commercial banks, use of electronic transfer of fund,
etc. Advances related fraud continue to be a major challenge in terms of amount involved
(nearly 67 percent of total amount involved in frauds over last 4 years), posing a direct threat
to the financial stability of banks. With ever-increasing use of technology in the banking
system, cyber frauds have proliferated and are becoming even more sophisticated in terms of
use of novel methods. Also, documentary credit (letter of credit) related frauds have surfaced
causing a grave concern due to their implications on trade and related activities.
The data reveals that more than 95 percent of number of fraud cases and amount involved in
fraud comes from commercial banks. Among the commercial banks, public sector banks
accountforjustabout18percentoftotalnumberoffraudcases,whereasintermsoftheamount
involved,theproportiongoesashighas83percent.Thisisinstarkcontrastwithprivatesector banks,
with around 55 percent of number of fraud cases, but just about 13 percent of the total amount
involved in such cases (Figure 1). The PSBs are more vulnerable in case of big-ticket advance
related frauds (1 crore or above) in terms of both number of fraud cases reported and total
amount involved (Figure2).
The correlation between rising level of NPAs of public sector banks and frauds probably
indicateslackofrequisitestandardsofcorporategovernanceleadingtomoreinstancesofhigh value
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bank loan default and possible collusion between corporate entities and high echelon bank
officials. Also, in case of private banks, high number of fraud cases with relatively low
costoffraudindicatesverynatureoffraud-online/cyber/technologyrelatedfraudswithahigh
frequency of occurrence and relatively low associatedcost.
Figure 1: Group wise summary of bank

fraud cases
Bank Group Wise No. of Cases of Frauds Bank Group Wise Total Amount Involved in
17.53% Frauds
4.13%
27.31%
55.16%
83.01%
Nationalised Banks including SBI Group
Private Sector Banks Private Sector Banks
Foreign Banks
Note: Data pertains to the period from March 31, 2010 to March 31, 2013.
Source: Chakrabarty (2013).
Figure 2: Group wise summary of

advance related fraud cases
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No. of Fraud Cases in loan advances worth 1 Crore Amount Involved in Fraud Cases in loan advances
or Above worth 1 Crore or Above
17%
2%
19%
65%
87%

Private Sector Banks
Private SectorBanks
Foreign Banks
Note: Data pertains to the period from March 31, 2010 to March 31, 2013.
Source: Chakrabarty (2013).
AccordingtofindingsofDeloitte(2015),numberandsophisticationoffraudsinbankingsector
haveincreasedoverthelasttwoyears.Around93percentofrespondentssuggestedanincrease
infraudincidentsandmorethanhalfsaidthattheyhadwitnesseditintheirownorganizations. Retail
banking was identified as the major contributor to fraud incidents, with many respondents
saying that they had experienced close to 50 fraudulent incidents in the last 24 months and had
lost, on an average of Rupees ten lakhs per fraud. In contrast,survey
respondentsindicatedthatthenon-retailsegmentsawanaverageof10fraudincidentswithan
approximate loss of Rupees two crore per incident. Many respondents could not recover more
than 25 percent of theloss.The risks undertaken by banks are still a cause of worry although it
has moderated a bit. This is indicated by the bank stability indicator. Similarly, banks were
worried by poor asset quality. System level credit risk is determined by gross NPA ratio which
is expected to be around 5.4 percent by September 2016 and 5.2 percent in March 2017 as per
RBI (2015c). Further, the ratio of stressed assets has increased significantly in the last few
years. As of September 2015, stressed and written off assets (SWA) are at 14.1 percent. The
trends however are divergent, with public sector banks having an SWA of 17 percent and
private sector banks having an SWA of 6.7 percent according to Mundra (2016).
As far as credit risk is concerned, 16 out of 60 banks (26.5 percent market share) were not
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able to cover their expected losses from their currentframework.
RBI states that NPAs from retail banking are just 2 percent, whereas NPAs from corporate
banking are 36 percent. Giventhesizeoftransactionsincorporatebanking,itisimportantthat banks
implement a robust monitoring mechanism post sanction and disbursement of facilities, and be
vigilant to early signs of stress in the borrower accounts.
Indiahaswitnessedamassivesurgeincybercrimeincidentsinthelasttenyears-fromjust23 in 2004 to
72,000 in 2014-15 (Figures 3 and 4). As per the government's cyber security arm, computer
emergency response team-India (CERT-In), 62,189 cyber security incidents were reported in
just the first five months of2015-16.
Figure 3: Cyber Frauds

Growing trend of cyber frauds with growth in NEFT/RTGS transactions
1000000 1
0 0
2011-12 2012-13 2013-14 2014-15
NEFT/RTGS Value (in Billion INR)
Source: PWC India and ASSOCHAM (2014).
Figure 4: Identity Theft Fraud

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Common types of identity theft frauds/Complaint percentages in 2013
Attempted identity theftfraud 6.6

18.5
Other
5.4
identitytheftfraudEmploy
9.7
mentrelatedfraudPhone
46.4
or utilitiesfraud
2.4
Government document or benefitsfraud 6.4
13.5
Loanfraud
Source: PWC India and ASSOCHAM (2014).
Interview Based
Asemi-structuredinterviewwasconductedbytheauthorswithvariousofficialsofthebanking
industry and investigating agencies. Detailed projects can be made available on request. Thus,
fromthestudy,theauthorswereabletocomeupwiththefollowinginsightsandkeyfindings:-
1. Frauddetectionprocedureinpublicsectorbanks:Theauthorsanalyzedtheprocessoffraud
detectionandreportinginapublicsectorbankandwhoarethevariousplayersinvolvedin this
process. Following is a step by step illustration of the same (Figure5).
a) First,afraudisinternallyreportedtoseniormanagementofabank.Thesemayinclude chief
general managers, executive directors, chairman and managing director. They may also
be reported to vigilance department of thebank.
b) If reported to the vigilance department of the bank, it investigates the fraud and then
reportsittobothseniormanagementaswellasthecentralvigilancecommission(CVC) to
whom they are required to reportmonthly.
c) AlthoughCVCcanreportfrauddirectlytoinvestigatingagencieslikeCBI,usuallyfinal
decisiontoeitherreportfraudtoanexternalagencyortodealwithitinternallyismade
byseniormanagementofthebank.Dependinguponsizeofthebank,amountofmoney
involved in fraudulent activity and number of third parties involved, senior
managementmaychoosetodealwiththefraudinternallyorfileanFIRand reportit to either
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local police orCBI.
d) AcommitteeoftheRBIalsoindependentlymonitorsfraudulentbehaviourinbanksand
reportsitsobservationsonquarterlybasistocentralboardoftheRBI.Theboardmay
then report the matter to either central vigilance commission or ministry of finance
(MoF).
e) Auditors, during the course of their audit, may come across instances where transactions
in accounts or documents point to possibility of fraudulent transactions in accounts. In
such a situation, auditor may immediately bring it to the notice of top
managementandifnecessarytoauditcommitteeofboard(ACB)forappropriateaction.
f) Employees can also report fraudulent activity in an account, along with the reasons in
support of their views, to the appropriately constituted authority (Table 1), under the
whistle blower policy of the bank, who may institute a scrutiny through the fraud
monitoring group (FMG). The FMG may ‘hear’ the concerned employee in order to
obtainnecessaryclarifications.Protectionshouldbeavailabletosuchemployeesunder the
whistle blower policy of the bank so that fear of victimization does not act as a deterrent.
Figure 5: Flow Chart depicting procedures

post Fraud Detection and Reporting in PSBs
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Source: Author’s line-chart.

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Table 1: Current Structure for filing

Police/CBI complaints
Agency to whom
Category of Amount involved in the
complaint shouldbe Other Information
bank fraud
lodged
Private Rs.1 lakh and above State police
Sector/ Rs.10000 and above if State police
ForeignBanks committed bystaff
Rs.1 crore and above Serious fraud In addition to state police
investigation office
(Ministry ofCorporate
Affairs)
Public Sector Below Rs. 3 crore State police
Banks Rs.3 crore and above and up CBI Anti-corruption branch of CBI (where
to Rs.25 crore staff involvement is prima facie evident)
Economic offences wing of CBI (where

staff involvement is prima facienot evident)
More than Rs.25 crore CBI Banking Security and Fraud Cell (BSFC)
of CBI
(irrespective of the involvement of apublic
servant)
Source: Reserve Bank of India.
2. Reason for higher advance related frauds in public sector banks and rising NPAs: Higher
advance related frauds of above Rs. one crore loans (87 percent of total amount involved
inloanworthRs.onecroreoraboveinvalue)(Figure2)inpublicsectorbanksascompared
toprivatesectorbanks(11percentoftotalamountinvolved)couldbeduetotheproportion of the
loan advanced by both PSBs (~ 70 percent) and private sector banks (~ 30 percent)
especially in large and long gestation projects like infrastructure, power or mining sectors.
Also,thehighernumberoffraudcasesreportedbyPSBs(65 percentoftotal)ascompared to
PVBs (19 percent of total) may be attributed to stringent oversight of CVC in PSBs. It
mayalsobeduetoapossibleunderreporting/evergreeningofloansonthepartofthePVBs,
evidenced by RBI’s measures to curb such practices in recenttimes.
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The reason for large NPA’s of PSBs could be attributed to greater amount of
lending/exposure to mining, infrastructure and power sector projects, whose performance
and associated cash flows closely follow the economic cycle of boom and recession. Also,
in India, post - 2008 global crisis, a number of governance and other external issues such
aspolicyparalysis,inordinatedelayonaccountofstringentenvironmentallaws/regulation,
Supreme Court decision on coal mines as well as weak demand crippled these sectors and
resulted into weaker cash flows. These developments severely affected the ability of such
firms to service their loans leading to higherNPAs.
There is an ongoing debate on the nexus between rising NPAs in the banking system and
theincreasingincidenceoffraud.AformerCBIdirector,in2013,hadraisedthepointthat, amount
involved in bank frauds had increased almost 324 percent in last three years while
largeticketfraudcasesinvolvingamountsofRs.50croreandabovehadincreasedtenfold. He also
pointed to reluctance on part of banks to declare bad accounts as frauds despite there being
clear-cut manifestation of malfeasance CBI(2014).
There are some limitations that emerged in the discussion. One limitation is that bankers
take the project at their face value during inspection. Even today due diligence across
several public sector banks is weak. The banks keep the outstanding amount as current
assets and hence the original costing basis of asset valuation shows no loss of money.
Shareholders are hence not aware for a long time. The classification of bad debts is also
delayedconsiderablyforalongtimeacrossallbanksinIndia.Also,duediligenceinvolves
whether the project has got all necessary approvals, illustratively, a selling agreement as
power-purchase agreement with the state government electricity board. Receivables from
the government are taken for granted by the bankers but when the project goes sick these
cash-flows are notrealizable.
3. Third party agencies involved: Big loan advance frauds are not so easy to commit and it
often results because bank officials collude with borrowers and sometimes even with
officials of third parties such as advocates or chartered accountants (CAs). In such cases,
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the third parties such as the CAs or the advocates often get away as it is nearly impossible
for the banks to prove criminal intent on the part of such persons due to various reasons
such as lack of clear understanding of legal matters to bankers, and lack of expertise and
legal advice on this subject, and unwillingness to reveal some sensitive data to courts/
public domain. Also, self-regulatory bodies of advocates, auditors or accountants like bar
council and the institute of chartered accountants of India do not generally bar their errant
members.Also,inthiscontext,costofpursuingsuchindividualsanddelaycausedbycourts often
deter thePSBs.
The role of auditors was further analysed in order to identify gaps and loopholes that exist
in the current system. Auditors can be classified into three main types:
a) Bank auditors – There are two main types of auditors that work for a bank to look into
financialstatementsofitsborrowers.Theyworkindifferentcapacitiesintermsoftheir scope
and knowledge. They can be held responsible for any misreporting under common legal
framework due to faith placed on them by banks. The two types of auditorsare:
i. Statutory auditor – These look into financial statements of all borrowers that
borrow from a bank. These are externalauditors.
ii. Concurrent auditor – These help supplement the functioning of bank in terms
ofinternalchecksandcheckonfinancialstatementsofitsborrowers.Thesemay be
external/internal auditors
b) Statutoryauditorsoftheborrower–Theseauditorsworkfortheborrowerfirmandhelp in
reporting their financialstatements.
c) Special auditors – These auditors work on a case by case basis independently and are
notassociatedwithanyfirmorbank.Theyhelpprovideanexternalviewonstatements
reported by the borrower to thebank.
In our discussions, one factor that emerged was that there is a lack of competent auditors in
India. The reasons were:
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a) Staffingofauditorsinbanks:Thestaffingofauditorsisgenerallyverycompetitiveand
pricedriven. Itisarelativelylowpayingjobwhichmeansonlysomucheffortisputin by
auditors to do their work. Also, the skill-set of many young auditors is low. This
coupledwithlowstandardsoftrainingmetedouttothemleavesthematadisadvantage in
terms of the benefit of observation and experience. In addition, the auditors have
clerks/articleship students working with them, who can be easilymanipulated.
b) Traininggiventoauditors:Thestandardsoftrainingimpartedtobankauditorsarevery low.
Unlike as in the case of forensic auditing, they are not generally questioned regarding
the veracity of documents they produce and no one challenges the financial information
that they generate. In some cases, they are not equipped with the working knowledge
of different instruments used by banks and are technicallyhandicapped.
c) Attention to early warning signals: As a consequence of low pay benefits and training
standards, it has been observed that auditors do not generally pay attention to the
variousearlywarningsignsthatcanhelpanorganizationrecognizepotentialfraudulent
malpractices inexistence.
d) Weaker enforcement of laws in our country: Law enforcement agencies in India are
burdened with excessive work pressure and therefore have to choose betweendifferent
assignments. This is due to insufficient resources and manpower available at their
disposal.Insuchsituations,auditorshappentobemostdependentforlawenforcement
agencies. Moreover, according to discussions, many officials in law enforcement agencies lack
necessary skill-sets and financial expertise to identify and deal with fast moving financial
frauds.
4. Poor appraisal system and monitoring mechanism in PSBs: The initial project appraisal
processinPSBsisasgoodasthatofPVBs.Butmonitoringpostsanctionofloanisweaker in PSBs
compared to the PVBs on account of diverse loan portfolio, lack of expertise and
moderntechnologicalresources,andlackofmanpowerandmotivatedemployees,whoare not
appropriately incentivized to detect early frauds or preventthem.
5. Corporate governance and other HR issues: The root cause of weak corporate governance
at highest level is directly linked to the very process of appointment of highest level of
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officials and poor compensation structure of highest level functionaries. The weakness in
selectionprocessfortoplevelmanagementasdocumentedinRBI(2014b)resultsintoweak
governance at the highest level. Also, there is a serious issue in terms of pay structure in
higher echelons of PSBs, which is markedly lower than their counterparts in PVBs. The
only good factor in PSBs is prestige of a post that a personholds.
Theinabilitytohirecompetentprofessionalsandexpertisefrommarket(lateralhiring)due to
existing recruitment policy, flight of officials to greener pastures and private or foreign
banks, poor compensation structure, unionization challenges as well as lack of adequate
training in contemporary fraud prevention techniques are key HR issues, which indirectly
contribute to bankfrauds.
6. Senior management and board of directors: At times, senior management themselves may
like to cover-up some cases to meet their short term targets and goals, and create a good
picture for the shareholders. In fraud cases, within the banks, with suspected involvement
of senior management, there is significant resistance while prosecuting officers in level 4
or above. Most of the officers retire before they can be booked for a fraud. Once retired,
pension regulations apply to them making them immune to any financialpenalty.If the case
is finally taken up in the court of law, a public prosecutor represents the bank. The public prosecutor
is usually overburdened with pending cases. Additionally, from the bank’s perspective, having
already lost substantial amount in fraud, they allocate limited budget for prosecutions, making it
easier for the guilty to escape.
7. Bank employees: Incentive structure for employees needs a re-evaluation and gives too
much importance to short term targets. This incentivizes the employees to give preference
toshorttermtargetsonlyandnotexerciseproperduediligence.Hence,theytakemorerisk than is
usually the norm or resort to unethical means. There have been instances of frauds involving
collusion of staff with third party agents like auditors to indulge in fraudulent activities on
customers. Detection of such frauds takes a long time, and is only discovered when there
are customer complaints of fraudulent cases. The customers who are victim of fraudulent
activities by the bank, due to identity theft etc., could have avoided so, by following
appropriate preventive measures and customer awareness guidelines. Political
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reasonsmayalsoberesponsibleforindulgenceinloansproceedwhichhassubstantialrisk of
being defaulted or defrauded, especially when a red flag is raised on the loan. As legal
opinion is not the strength of a banker, advocate’s directions in that matter assume
importance.
Frauds also result from lack of awareness of staff towards appropriate procedures in place
and red flags they should be aware of. Technology related frauds are primarily due tonon-
adherence to standard procedures and systems in place, by the employees. Even when any
employeedetectssomefraudulentactivitiesinexistenceinvolvingpeopleinpower,whistle
blower protection policy does not guarantee adequatesafety.
PSBsinIndiahadpreparedafivepointactionplantomakethemmorecompetitive,which
includedsuggestionslikeintroductionofperformancemanagementsystemsandincentives in
banks. Smaller banks should focus on the areas of their strength (to optimize capital
utilization) among other reform plans. The banks demanded creation of bank boardbureau
and bank investment committee and empowerment of banks on certain decision making
capabilities,inlinewithRBI(2014b).Additionally,theydemandedsimplificationofcredit
insuranceprocessandstrengtheningoflegalframeworkfordebtrecovery,apartfrommore usage
oftechnology. Borrowers and clients of banks: Frauds may also arise solely from the
borrower’s side. Companies have been found to take part in ‘high sea sales’ with investment
from Indian banks but the funds are either routed for other purpose or are not repaid after
the sale has been made and instead, routed to other channels, resulting in a NPA. Such
breach of contract is another instance of fraud since the funds are not utilized for the purpose
they were initially set out and based on the project evaluated by thebanker.
8. Legal aspects of frauds and role of investigative agencies: Investigating and supervisory
bodies like central vigilance commission (CVC) or central bureau of investigation (CBI)
are already overburdened with many pending investigations and have limited resources at
their disposal.
Thebiggesthurdleinpursuingfraudstersisprovingcriminalintentontheirpartinthecourt of law.
Most of the bank frauds are detected very late and by that time, fraudsters get
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enoughtimetowipeouttrailsanditbecomesverydifficulttoestablishcriminalintentdue to loss
of relevant documents and non-availability ofwitnesses.
Also, while pursuing fraudsters, banks and investigation agencies face many operational
issues.Bankersarenotexpertsinlegalpaperwork,andformalcomplaintsagainstfraudsters
drafted by them often lack incisiveness. Also, in absence of a dedicated department
handling fraud matters, investigating officers (CBI/police) have to deal with multiple
departments and people within the bank, which often results into poor coordination and
delay in investigation. This results in very low conviction rate for fraudsters (less than 1
percent of total cases). Even after conviction in fraud cases, there is no legal recourse to
recover the amount lost in the bank frauds and the country’s legal system is perceived to
beverysoftondefaulters.Also,lackofstrongwhistle-blowerprotectionlawinhibitsearly
detection in case of involvement of internalemployees.
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9. Judicialsystem:Thelongandelaboratejudicialprocessisanothermajordeterrenttowards timely redressal
of fraud cases. The delay in judiciary to prosecute those guilty of
fraudulentpractices,couldleadtodilutionofevidenceaswellassignificantcostbuilding on part of the
victimbank.
Also, wilful default is still not considered as a criminal offence in India. Fraudsters, both big and small,
take undue advantage of these means of evasion and commit maligned activities without risk of
conviction.
10. Technological and coordination perspective: RBI has an elaborate set of early warning signals (EWS)
for banks to curtail frauds. However as of now, there are inadequate tools and technologies in place to
detect early warning signals and red flags pertaining to
differentfrauds.Theauthors’interactionwithaformerchairmanofabigpublicsectorbank shockingly
revealed that there is only one provider of vigilance and monitoring software
forbanksandpricediscoveryispoor.Eventhebiggestofpublicsectorbankscannotafford to buy that
software. Also, lack of coordination among different banks on fraud related information sharing is
another majorroadblock.
Section 4: Conclusion and Recommendations

It is observed that PSBs fare better than PVBs in terms of total number of bank frauds.
However,thetotalamountinvolvedismuchhigherinPSBsascomparedtotheprivatesector. This can be
attributed to large size of loans which PSBs offer tocustomers.
Credit related frauds have the maximum impact in all the banking frauds in India because of the high amount
involved and the cumbersome process of fraud detection followed by CVC.
The frauds may be primarily due to lack of adequate supervision of top management, faulty incentive
mechanism in place for employees; collusion between the staff, corporateborrowers
andthirdpartyagencies;weakregulatorysystem;lackofappropriatetoolsandtechnologiesin place to detect
early warning signals of a fraud; lack of awareness of bank employees and
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customers;andlackofcoordinationamongdifferentbanksacrossIndiaandabroad.Thedelays in legal procedures
for reporting, and various loopholes in system have been considered some of the major reasons of frauds
andNPAs.
here have been several banking frauds in the last two years and NPAs continue to be a pain
point even as the economy faces a slowdown. Here are some major scandals:
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Legal Regime to Control Banking Frauds

Fraud is any dishonest act and behaviour by which one person gains or intends to gain advantage over another
person. Fraud causes loss to the victim directly or indirectly. Fraud has not been described or discussed clearly
in The Indian Penal Code but sections dealing with cheating. concealment, forgery counterfeiting and breach
of trust has been discusses which leads to the act of fraud.
In Contractual term as described in the Indian Contract Act, Sec 17 suggests that a fraud means and includes
any of the acts by a party to a contract or with his connivance or by his agents with the intention to deceive
another party or his agent or to induce him to enter in to a contract.
Banking Frauds constitute a considerable percentage of white-collar offences being probed by the police.
Unlike ordinary thefts and robberies, the amount misappropriated in these crimes runs into lakhs and crores
of rupees. Bank fraud is a federal crime in many countries, defined as planning to obtain property or money
from any federally insured financial institution. It is sometimes considered a white collar crime.
The number of bank frauds in India is substantial. It in increasing with the passage of time. All the major
operational areas in banking represent a good opportunity for fraudsters with growing incidence being reported
under deposit, loan and inter-branch accounting transactions, including remittances.
Bank fraud is a big business in today's world. With more educational qualifications, banking becoming
impersonal and increase in banking sector have gave rise to this white collar crime. In a survey made till 1997
bank frauds in nationalised banks was of Rs.497.60 crore.
This banking fraud can be classified as:
Fraud by insiders
Fraud by others
Fraud by Insiders
Rogue traders
A rogue trader is a highly placed insider nominally authorized to invest sizeable funds on behalf of the bank;
this trader secretly makes progressively more aggressive and risky investments using the bank's money, when
one investment goes bad, the rogue trader engages in further market speculation in the hope of a quick profit
which would hide or cover the loss.
Unfortunately, when one investment loss is piled onto another, the costs to the bank can reach into the
hundreds of millions of rupees; there have even been cases in which a bank goes out of business due to market
investment losses.
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Fraudulent loans
One way to remove money from a bank is to take out a loan, a practice bankers would be more than willing
to encourage if they know that the money will be repaid in full with interest. A fraudulent loan, however, is
one in which the borrower is a business entity controlled by a dishonest bank officer or an accomplice; the
"borrower" then declares bankruptcy or vanishes and the money is gone. The borrower may even be a non-
existent entity and the loan merely an artifice to conceal atheft of a large sum of money from the bank.
Wire fraud
Wire transfer networks such as the international, interbank fund transfer system are tempting as targets as a
transfer, once made, is difficult or impossible to reverse. As these networks are used by banks to settle accounts
with each other, rapid or overnight wire transfer of large amounts of money are commonplace; while banks
have put checks and balances in place, there is the risk that insiders may attempt to use fraudulent or forged
documents which claim to request a bank depositor's money be wired to another bank, often an offshore
account in some distant foreign country.
Forged or fraudulent documents
Forged documents are often used to conceal other thefts; banks tend to count their money meticulously so
every penny must be accounted for. A document claiming that a sum of money has been borrowed as a loan,
withdrawn by an individual depositor or transferred or invested can therefore be valuable to a thief who wishes
to conceal the minor detail that the bank's money has in fact been stolen and is now gone.
Uninsured deposits
There are a number of cases each year where the bank itself turns out to be uninsured or not licensed to operate
at all. The objective is usually to solicit for deposits to this uninsured "bank", although some may also sell
stock representing ownership of the "bank". Sometimes the names appear very official or very similar to those
of legitimate banks. For instance, the "Chase Trust Bank" of Washington DC appeared in 2002 with no license
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and no affiliation to its seemingly apparent namesake; the real Chase Manhattan bank, New York. There is a
very high risk of fraud when dealing with unknown or uninsured institutions.
Theft of identity
Dishonest bank personnel have been known to disclose depositors' personal information for use in theft of
identity frauds. The perpetrators then use the information to obtain identity cards and credit cards using the
victim's name and personal information.
Demand draft fraud
DD fraud is usually done by one or more dishonest bank employees that is the Bunko Banker. They remove
few DD leaves or DD books from stock and write them like a regular DD. Since they are insiders, they know
the coding, punching of a demand draft. These Demand drafts will be issued payable at distant town/city
without debiting an account. Then it will be cashed at the payable branch. For the paying branch it is just
another DD. This kind of fraud will be discovered only when the head office does the branch-wise
reconciliation, which normally will take 6 months. By that time the money is unrecoverable.
Fraud By Others
Forgery and altered cheques
Thieves have altered cheques to change the name (in order to deposit cheques intended forpayment to someone
else) or the amount on the face of a cheque (a few strokes of a pen can change 100.00 into 100,000.00, although
such a large figure may raise some eyebrows).
Instead of tampering with a real cheque, some fraudsters will attempt to forge a depositor's signature on a
blank cheque or even print their own cheques drawn on accounts owned by others, non-existent accounts or
even alleged accounts owned by non-existent depositors. The cheque will then be deposited to another bank
and the money withdrawn before the cheque can be returned asinvalid or for non-sufficient funds.
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Stolen cheques
Some fraudsters obtain access to facilities handling large amounts of cheques, such as a mailroom or post
office or the offices of a tax authority (receiving many cheques) or a corporate payroll or a social or veterans'
benefit office (issuing many cheques). A few cheques go missing; accounts are then opened under assumed
names and the cheques (often tampered or altered in some way) deposited so that the money can then be
withdrawn by thieves. Stolen blank cheque books are also of value to forgers who then sign as if they were
the depositor.
Accounting fraud
In order to hide serious financial problems, some businesses have been known to use fraudulent bookkeeping
to overstate sales and income, inflate the worth of the company's assets or state a profit when the company is
operating at a loss. These tampered records are then used to seek investment in the company's bond or security
issues or to make fraudulent loan applications in a final attempt to obtain more money to delay the inevitable
collapse of an unprofitable or mismanaged firm.
Bill discounting fraud
Essentially a confidence trick, a fraudster uses a company at their disposal to gain confidence with a bank, by
appearing as a genuine, profitable customer. To give the illusion of being a desired customer, the company
regularly and repeatedly uses the bank to get payment from one or more of its customers. These payments are
always made, as the customers in question are part of the fraud, actively paying any and all bills raised by the
bank. After certain time, after the bank is happy with the company, the company requests that the bank settles
its balance with the company before billing the customer. Again, business continues as normal for the
fraudulent company, its fraudulent customers, and the unwitting bank. Only when the outstanding balance
between the bank and the company is sufficiently large, the company takes the payment from the bank, and
the company and its customers disappear, leaving no-one to pay the bills issued by the bank.
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Cheque kiting
Cheque Kiting exploits a system in which, when a cheque is deposited to a bank account, themoney is made
available immediately even though it is not removed from the account on which the cheque is drawn until
the cheque actually clears.
Deposit 1000 in one bank, write a cheque on that amount and deposit it to your account in another bank; you
now have 2000 until the cheque clears.
In-transit or non-existent cash is briefly recorded in multiple accounts.
A cheque is cashed and, before the bank receives any money by clearing the cheque, the money is deposited
into some other account or withdrawn by writing more cheques. In many cases, the original deposited cheque
turns out to be a forged cheque.
Some perpetrators have swapped checks between various banks on a daily basis, using each to cover the
shortfall for a previous cheque.
What they were actually doing was check kiting; like a kite in the wind, it flies briefly but eventually has to
come back down to the ground.
Credit card fraud
Credit card fraud is widespread as a means of stealing from banks, merchants and clients. A credit card is
made of three plastic sheet of polyvinyl chloride. The central sheet of the card is known as the core stock.
These cards are of a particular size and many data are embossed over it. But credit cards fraud manifest in a
number of ways.
They are:
Genuine cards are manipulated
Genuine cards are altered
Counterfeit cards are created
Fraudulent telemarketing is done with credit cards.
Genuine cards are obtained on fraudulent applications in the names/addresses of other persons and used.
It is feared that with the expansion of E-Commerce, M-Commerce and Internet facilities being available on
massive scale the fraudulent fund freaking via credit cards will increase tremendously.
Counterfeit credit cards are known as white plastics.

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Booster cheques
A booster cheque is a fraudulent or bad cheque used to make a payment to a credit card account in order to
"bust out" or raise the amount of available credit on otherwise-legitimate credit cards. The amount of the
cheque is credited to the card account by the bank as soon as the payment is made, even though the cheque
has not yet cleared. Before the bad cheque is discovered, the perpetrator goes on a spending spree or obtains
cash advances until the newly-"raised" available limit on the card is reached. The original cheque then
bounces, but by then it is already too late.
Stolen payment cards
Often, the first indication that a victim's wallet has been stolen is a 'phone call from a credit card issuer asking
if the person has gone on a spending spree; the simplest form of this theft involves stealing the card itself and
charging a number of high-ticket items to it in the first few minutes or hours before it is reported as stolen.
A variant of this is to copy just the credit card numbers (instead of drawing attention by stealing the card itself)
in order to use the numbers in online frauds.
Duplication or skimming of card information
This takes a number of forms, ranging from a dishonest merchant copying clients' credit card numbers for
later misuse (or a thief using carbon copies from old mechanical card imprint machines to steal the info) to
the use of tampered credit or debit card readers to copy the magnetic stripe from a payment card while a hidden
camera captures the numbers on the face of the card.
Some thieves have surreptitiously added equipment to publicly accessible automatic teller machines; a
fraudulent card stripe reader would capture the contents of the magnetic stripe while a hidden camera would
sneak a peek at the user's PIN. The fraudulent equipment would then be removed and the data used to produce
duplicate cards that could then be used to make ATM withdrawals from the victims' accounts.
Impersonation and theft of identity
Theft of identity has become an increasing problem; the scam operates by obtaining information about a
victim, then using the information to apply for identity cards, accounts and credit in that person's name. Often
little more than name, parents' name, date and place of birth are sufficient to obtain a birth certificate; each
document obtained then is used as identification in order to obtain more identity documents. Government-
issued standard identification numbers such as "Social security numbers, PAN numbers" are also valuable to
the identity thief.
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Unfortunately for the banks, identity thieves have been known to take out loans and disappear with the cash,
quite content to see the wrong persons blamed when the debts go bad.
Fraudulent loan applications
These take a number of forms varying from individuals using false information to hide a credit history filled
with financial problems and unpaid loans to corporations using accounting fraud to overstate profits in order
to make a risky loan appear to be a sound investment for the bank.
Some corporations have engaged in over-expansion, using borrowed money to finance costly mergers and
acquisitions and overstating assets, sales or income to appear solvent even after becoming seriously financially
overextended. The resulting debt load has ruined entire large companies, such as Italian dairy conglomerate
Parmalat, leaving banks exposed to massive losses from bad loans.
Phishing and Internet fraud
Phishing operates by sending forged e-mail, impersonating an online bank, auction or payment site; the e-mail
directs the user to a forged web site which is designed to look like the login to the legitimate site but which
claims that the user must update personal info. The information thus stolen is then used in other frauds, such
as theft of identity or online auction fraud.
A number of malicious "Trojan horse" programmes have also been used to snoop on Internet users while
online, capturing keystrokes or confidential data in order to send it to outside sites.
Money laundering
The term "money laundering" dates back to the days of Al Capone Money laundering has since been used to
describe any scheme by which the true origin of funds is hidden or concealed.
The operations work in various forms. One variant involved buying securities (stocks and bonds) for cash; the
securities were then placed for safe deposit in one bank and a claim on those assets used as collateral for a
loan at another bank. The borrower would then default on the loan. The securities, however, would still be
worth their full amount. The transaction served only to disguise the original source of the funds.
Forged currency notes
Paper currency is the usual mode of exchange of money at the personal level, though in business, cheques and
drafts are also used considerably. Bank note has been defined in Section 489A.If forery of currency notes
could be done successfully then it could on one hand made the forger millionaire and the other hand destroy
the economy of the nation. A currency note is made out of a special paper with a coating of plastic laminated
on both sides of each note to protect the ink and the anti forgery device from damage. More over these notes
have security threads, water marks. But these things are not known to the majority of the population. Forged
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currency notes are in full circulation and its very difficult to catch hold of such forgers as once such notes are
circulated its very difficult to track its origin.
But the latest fraud which is considered as the safest method of crime without making physical injury is the
Computer Frauds in Banks.
Computerization of banks had started since 1994 in India and till 2000 4000 banks were completely and 9000
branches have been partially computerised. About 1000 branches had the facilities for International bank
Transaction. Reserve Bank Of India has evolved working pattern for Local area Network and wide area
Network by instituting different microwave stations so that money transactions could be carried out quickly
and safely.
The main banking tasks which computers perform are maintaining debit-credit records of accounts, operating
automated teller machines, and carry out electronic fund transfer, print out statements of accounts create
periodic balance sheets etc.
Internet facilities of computer have revolutionized international banking for fund transfer and for exchanging
data of interest relating to banking and to carry out other banking functions and provides certain security to
the customers by assigning different pin numbers and passwords.
Computer depredations have by some been classified as:
Computer frauds; and
Computer crimes
Computer frauds are those involve embezzlement or defalcations achieved by tampering with computer data
record or proggramme, etc.Where as computer crimes are those committed with a computer that is where a
computer acts as a medium. The difference is however academic only.
Bank computer crimes are committed mainly for money, however other motive or The Mens rea can be:
Personal vendetta;
Black mail;
Ego;
Mental aberrations;
Mischief
Bank computer crimes have a typical feature, the evidence relating to crime is intangible. The evidences can
be easily erased, tampered or secreted. More over it is not easily detectable. More over the evidence connecting
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the criminal with the crime is often not available. Computer crimes are different from the usual crimes mainly
because of the mode of investigation. There are no eyewitness, no usual evidentiary clues and no documentary
evidences.
It is difficult to investigate for the following reasons:
Hi-tech crime
The information technology is changing very fast. the normal investigator does not have the proper
background and knowledge .special investigators have to be created to carry out the investigations. the FBI of
USA have a cell, even in latest scenario there has been cells operating in the maharashtra police department
to counter cyber crimes.C.B.I also have been asked to create special team for fighting cyber crimes.
International crime
A computer crime may be committed in one country and the result can be in another country. there has been
lot of jurisdictional problem an though the Interpol does help but it too has certain limitations. the different
treaties and conventions have created obstructions in relation to tracking of cyber criminals hiding or operation
in other nations"
No-scene crime:
The computer satellite computer link can be placed or located any where. The usual crime scene is the cyber
space. The terminal may be anywhere and the criminal need not indicate the place. the only evidence a criminal
leaves behind is the loss to the crime.
Faceless crime:
The major advantage criminal has in instituting a computer crime is that there is no personal exposure, no
written documents, no signatures, no fingerprints or voice recognition. The criminal is truly and in strict sense
faceless.
There are certain spy software's which is utilized to find out passwords and other vital entry information to a
computer system. The entry is gained through a spam or bulk mail.
The existing enacted laws of India are not at all adequate to counter cyber crimes. The Indian Penal code,
evidence act, and criminal procedure code has no clue about computers when they were codified. It is highly
required to frame and enact laws which would deal with those subjects which are new to the country specially
cyber law; Intellectual property right etc.
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The Reserve Bank of India has come up with different proposals to make the way easier, they have enacted
electronic fund transfer act and regulations, have amended, The Reserve Bank of India Act, Bankers Book
Evidence Act etc., experience of India in relation to information and technology is limited and is in a very
immature state. It is very much imperative that the state should seek the help of the experienced and developed
nations.
Modus operandi:
The method of alterations of cheques drafts receipts and other fiduciary documents are comparatively simple
both manually and with the help of technology.
Illustration:
A classic case is the recent loan racket busted by the Uppal police in State Bank of India (SBI)'s Chikkadpally
branch. The modus operandi adopted by the racketeers was interesting. A gang of four members approached
owner of a newly-constructed apartment building saying they were interested in buying the flats.
The gang took xerox copies of the building documents after entering into an oral agreement of sale with the
builder by paying Rs. 2 lakhs as an advance. Later, they created forged documents in the name of building's
owner establishing that the latter had sold five flats to five defence employees.
Incidentally, the salary slips and other documents submitted by the loan seekers were found to be genuine.
"This was made possible because the gang paid money to the defence employees to utilise their documents,"
says an investigator. The gang hired an impostor who executed the sale deed posing as the original building
owner.
"We could not establish criminal negligence on the part of the bank manager and hence he was not arrested,"
say the detectives. The police learnt that the main lapse in the system is that the banks never asked for the
original documents at any stage except for the sale deed for execution of which the offenders planted an
impostor.
Bank rules
After receiving xerox papers (which were actually forged by the offenders) of the property, the bank passed
the same on to the legal section. After scrutiny, the legal consultant told the bank that the xerox documents
were `perfect' and to release loan after execution of sale deed.
The bank rules state that loan applications can be examined "even with xerox copies of documents. The alleged
greediness of employees to give their salary slips and other documents on payment of some money made the
job of the cheats easier.
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This is not an isolated case. With a similar modus operandi, a gang cheated three banks to the tune of Rs. 1
crore in Saroornagar police station area. The police opine that unless bankers evolve a foolproof system, the
offenders continue to take advantage of the lapses.
Though computer based banking crimes are yet limited but it is increasing with a huge pace. Their
investigation is highly intricate and daunting. Prevention is the best alternative. It is comparatively easier,
though even with the best laws, efficient investigation team the successful conclusion of most cyber crimes
will remain a remote possibility .There fore emphasis is more on prevention. In bank administration, one feels
that not much attention is paid to preventive measures. Bank managements must direct their orientation
towards preventive rather than detective or punitive measures. Preventive vigilance must be the prime agenda
to bring down the occurrence of fraud in banks.
Banking Fraud – Prevention and Management

Banking Fraud is posing menace to Indian Financial system. Its vibrant impact will be understood be
the truth that within the yr 2004 variety of Cyber Crime had been 347 in India which rose to 481 in
2005 exhibiting a rise of 38.5% whereas I.P.C. class crime stood at 302 in 2005 together with 186
instances of cyber fraud and 68 circumstances cyber forgery. Thus it turns into crucial that incidence
of such frauds ought to be minimized. Extra upsetting is the truth that such frauds are coming into in
Banking Sector.
Within the current day, World State of affairs Banking System has acquired new dimensions. Banking
did unfold in India. In the present day, the banking system has entered into aggressive markets in
areas protecting useful resource mobilization, human useful resource improvement, buyer companies
and credit score administration as properly.
Indian’s banking system has a number of excellent achievements to its credit score, essentially the
most placing of which is its attain. In reality, Indian banks are actually unfold out into the remotest
areas of our nation. Indian banking, which was working in a extremely comfy and guarded
surroundings until the start of 1990s, has been pushed into the uneven waters of intense competitors.
A sound banking system ought to possess three fundamental traits to guard depositor’s curiosity and
public religion. Theses are (i) a fraud free tradition, (ii) a time examined Finest Apply Code, and (iii)
an in home fast grievance remedial system. All these circumstances are their lacking or extraordinarily
weak in India. Part 5(b) of the Banking Regulation Act, 1949 defines banking… “Banking is the
accepting for the aim of lending or funding, deposits of cash from the aim of lending or funding,
deposits of cash from the general public, repayable on demand or in any other case and withdraw in
a position by cheque, draft, order or in any other case.” But when his cash has fraudulently been drawn
from the financial institution the latter is underneath strict obligation to pay the depositor. The
financial institution due to this fact has to make sure always that the cash of the depositors shouldn’t
be drawn fraudulently. Time has come when the safety features of the banks must be handled on
precedence foundation.
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The banking system in our nation has been caring for all segments of our socio-economic arrange.
The Article incorporates a dialogue on the rise of banking frauds and varied strategies that can be
utilized to keep away from such frauds. A financial institution fraud is a deliberate act of omission or
fee by any individual carried out in the midst of banking transactions or within the books of accounts,
leading to wrongful achieve to any particular person for a short lived interval or in any other case,
with or with none financial loss to the financial institution. The related provisions of Indian Penal
Code, Prison Process Code, Indian Contract Act, and Negotiable Devices Act referring to banking
frauds has been cited within the current Article.
EVOLUTION OF BANKING SYSTEM IN INDIA
Banking system occupies an essential place in a nation’s financial system. A banking establishment
is indispensable in a contemporary society. It performs a pivotal function in financial improvement
of a rustic and kinds the core of the cash market in a complicated nation.
Banking business in India has traversed an extended approach to assume its current stature. It has
undergone a significant structural transformation after the nationalization of 14 main business banks
in 1969 and 6 extra on 15 April 1980. The Indian banking system is exclusive and maybe has no
parallels within the banking historical past of any nation on this planet.
RESERVE BANK OF INDIA-ECONOMIC AND SOCIAL OBJECTIVE
The Reserve Financial institution of India has an necessary position to play within the upkeep of the
alternate worth of the rupee in view of the shut interdependence of worldwide commerce and
nationwide financial progress and nicely being. This side is of the broader responsibly of the central
financial institution for the upkeep of financial and monetary stability. For this the financial institution
is entrusted with the custody and the administration of nation’s worldwide reserves; it acts
additionally because the agent of the federal government in respect of India’s membership of the
worldwide financial fund. With financial growth the financial institution additionally performs a wide
range of developmental and promotional features which previously had been registered being
outdoors the conventional purview of central banking. It additionally acts an essential regulator.
BANK FRAUDS: CONCEPT AND DIMENSIONS
Banks are the engines that drive the operations within the monetary sector, which is significant for
the economic system. With the nationalization of banks in 1969, additionally they have emerged as
engines for social change. After Independence, the banks have handed by three phases. They’ve
moved from the character based mostly lending to ideology primarily based lending to right this
moment competitiveness primarily based lending within the context of India’s financial liberalization
insurance policies and the method of linking with the worldwide financial system.
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Whereas the operations of the financial institution have turn into more and more vital banking frauds
in banks are additionally rising and fraudsters have gotten increasingly refined and ingenious. In a
bid to maintain tempo with the altering occasions, the banking sector has diversified it enterprise
manifold. And the previous philosophy of sophistication banking has been changed by mass banking.
The problem in administration of social duty with financial viability has elevated.
DEFINITION OF FRAUD
Fraud is outlined as “any conduct by which one particular person intends to achieve a dishonest
benefit over one other”. In different phrases , fraud is an act or omission which is meant to trigger
wrongful acquire to at least one individual and wrongful loss to the opposite, both by means of
concealment of details or in any other case.
Fraud is outlined u/s 421 of the Indian Penal Code and u/s 17 of the Indian Contract Act. Thus
important components of frauds are:
1. There have to be a illustration and assertion;
2. It should relate to a truth;
three. It should be with the data that it’s false or with out perception in its fact; and
four. It should induce one other to behave upon the assertion in query or to do or to not do sure act.
BANK FRAUDS
Losses sustained by banks on account of frauds exceed the losses attributable to theft, dacoity,
housebreaking and theft-all put collectively. Unauthorized credit score amenities are prolonged for
unlawful gratification akin to case credit score allowed towards pledge of products, hypothecation of
products in opposition to payments or towards guide money owed. Frequent modus operandi are,
pledging of spurious items, inletting the worth of products, hypothecating items to a couple of
financial institution, fraudulent removing of products with the information and connivance of in
negligence of financial institution workers, pledging of products belonging to a 3rd occasion. Items
hypothecated to a financial institution are discovered to include out of date shares packed in between
items shares and case of scarcity in weight shouldn’t be unusual.
An evaluation manufactured from instances brings out broadly the underneath talked about 4 main
parts answerable for the fee of frauds in banks.
1. Energetic involvement of the staff-both supervisor and clerical both impartial of exterior
components or in connivance with outsiders.
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2. Failure on the a part of the financial institution workers to observe meticulously laid down
directions and pointers.
three. Exterior parts perpetuating frauds on banks by forgeries or manipulations of cheques, drafts
and different devices.
four. There was a rising collusion between enterprise, prime banks executives, civil servants and
politicians in energy to defraud the banks, by getting the foundations bent, rules flouted and banking
norms thrown to the winds.
FRAUDS-PREVENTION AND DETECTION
A detailed research of any fraud in financial institution reveals many widespread fundamental options.
There could have been negligence or dishonesty at some stage, on a part of a number of of the financial
institution workers. One among them could have colluded with the borrower. The financial institution
official could have been placing up with the borrower’s sharp practices for a private acquire. The
correct care which was anticipated of the employees, as custodians of banks curiosity could not have
been taken. The financial institution’s guidelines and procedures laid down within the Guide
directions and the circulars might not have been noticed or might have been intentionally ignored.
Financial institution frauds are the failure of the banker. It doesn’t imply that the exterior frauds don’t
defraud banks. But when the banker is upright and is aware of his job, the duty of defrauder will
develop into extraordinarily troublesome, if not doable.
Detection of Frauds
Regardless of all care and vigilance there should still be some frauds, although their quantity,
periodicity and depth could also be significantly decreased. The next process could be very useful if
considered:
1. All related data-papers, paperwork and many others. Needs to be promptly collected. Unique
vouchers or different papers forming the premise of the investigation ought to be saved beneath lock
and key.
2. All individuals within the financial institution who could also be realizing one thing in regards to
the time, place a modus operandi of the fraud must be examined and their statements needs to be
recorded.
three. The possible order of occasions ought to thereafter be reconstructed by the officer, in his
personal thoughts.
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four. It’s advisable to maintain the central workplace knowledgeable in regards to the fraud and
additional developments in regard thereto.
Classification of Frauds and Motion Required by Banks
The Reserve Financial institution of India had set-up a excessive stage committee in 1992 which was
headed by Mr. A… Ghosh, the then Dy. Governor Reserve Financial institution of India to inquire
into numerous points regarding frauds malpractice in banks. The committee had observed/noticed
three main causes for perpetration of fraud as given hereunder:
1. Laxity in observance of the laid down system and procedures by operational and supervising
employees.
2. Over confidence reposed within the shoppers who indulged in breach of belief.
three. Unscrupulous shoppers by taking benefits of the laxity in observance of established, time
examined safeguards additionally dedicated frauds.
To be able to have uniformity in reporting circumstances of frauds, RBI thought of the query of
classification of financial institution frauds on the idea of the provisions of the IPC.
Given under are the Provisions and their Remedial measures that may be taken.
1. Dishonest (Part 415, IPC)
Remedial Measures.
The preventive measures in respect of the dishonest could be targeting cross-checking concerning
identification, genuineness, verification of particulars, and many others. in respect of assorted devices
in addition to individuals concerned in encashment or coping with the property of the financial
institution.
2. Legal misappropriation of property (Part 403 IPC).
Remedial Measure
Prison misappropriation of property, presuppose the custody or management of funds or property, so

subjected, with that of the particular person committing such frauds. Preventive measures, for this
class of fraud needs to be taken on the degree the custody or management of the funds or property of
the financial institution typically vests. Such a measure must be adequate, it’s prolonged to those
individuals who’re truly dealing with or having precise custody or management of the fund or
movable properties of the financial institution.
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three. Prison breach of belief (Part 405, IPC)
Remedial Measure
Care needs to be taken from the preliminary step when an individual involves the financial
institution. Care must be taken on the time of recruitment in financial institution as nicely.
four. Forgery (Part 463, IPC)
Remedial Measure
Each the prevention and detection of frauds by way of forgery are essential for a financial institution.
Forgery of signatures is essentially the most frequent fraud in banking enterprise. The financial
institution ought to take particular care when the instrument has been introduced both bearer or order;
in case a financial institution pays cast instrument he could be accountable for the loss to the real
costumer.
5. Falsification of accounts (Part 477A)
Remedial Measure
Correct diligence is required whereas filling of kinds and accounts. The accounts needs to be
rechecked on every day foundation.
6. Theft (Part 378, IPC)
Remedial Measures
Encashment of stolen’ cheque will be prevented if the financial institution clearly specify the age,
intercourse and two seen establish motion marks on the physique of the particular person traveler’s
cheques on the again of the cheque leaf. This can assist the paying financial institution to simply
determine the cheque holder. Theft from lockers and protected deposit vaults aren’t straightforward
to commit as a result of the master-key stays with the banker and the person key of the locker is
handed over to the costumer with due acknowledgement.
7. Legal conspiracy (Part 120 A, IPC)
Within the case of State of Andhra Pradesh v. IBS Prasad Rao and Different, the accused, who have
been clerks in a cooperative Central Financial institution have been all convicted of the offences of
dishonest underneath Part 420 learn together with Part 120 A. all of the 4 accused had conspired
collectively to defraud the financial institution by making false demand drafts and receipt vouchers.
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eight. Offences regarding forex notes and banks notes (Part 489 A-489E, IPC)
These sections present for the safety of currency-notes and financial institution notes from forgery.
The offences beneath part are:
(a) Counterfeiting foreign money notes or banks.
(b) Promoting, shopping for or utilizing as real, cast or counterfeit foreign money notes or financial
institution notes. Figuring out the identical to be cast or counterfeit.
(c) Possession of solid or counterfeit foreign money notes or bank-notes, realizing or counterfeit and
intending to make use of the identical as real.
(d) Making or passing devices or supplies for forging or counterfeiting forex notes or banks.
(e) Making or utilizing paperwork resembling currency-notes or financial institution notes.
Many of the above provisions are Cognizable Offences underneath Part 2(c) of the Code of Prison
Process, 1973.
FRAUD PRONE AREAS IN DIFFERENT ACCOUNTS
The next are the potential fraud inclined areas in Banking Sector. Along with these areas I’ve
additionally given sorts of fraud which might be widespread in these areas.
Financial savings Financial institution Accounts
The next are a number of the examples being performed in respect of financial savings financial
institution accounts:
(a) Cheques bearing the cast signatures of depositors could also be offered and paid.
(b) Specimen signatures of the depositors could also be modified, notably after the demise of
depositors,
(c) Dormant accounts could also be operated by dishonest individuals with or with out collusion of
financial institution workers, and
(d) Unauthorized withdrawals from buyer’s accounts by worker of the financial institution
sustaining the financial savings ledger and later destruction of the current vouchers by them.
Present Account Fraud

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The next varieties are prone to be dedicated in case of present accounts.
(a) Opening of frauds within the names of restricted firms or corporations by unauthorized
individuals;
(b) Presentation and cost of cheques bearing solid signatures;
(c) Breach of belief by the workers of the businesses or companies possessing cheque leaves duly
signed by the licensed signatures;
(d) Fraudulent alteration of the quantity of the cheques and getting it paid both on the counter or
although one other financial institution.
Frauds In Case Of Advances
Following sorts could also be dedicated in respect of advances:
(a) Spurious gold ornaments could also be pledged.
(b) Sub-standard items could also be pledged with the financial institution or their worth could also
be proven at inflated figures.
(c) Identical items could also be hypothecated in favour of various banks.
LEGAL REGIME TO CONTROL BANK FRAUDS
Frauds represent white-collar crime, dedicated by unscrupulous individuals deftly benefit of

loopholes present in techniques/procedures. The best state of affairs is one there isn’t any fraud,
however taking floor realities of the nation’s atmosphere and human nature’s fragility, an
establishment ought to at all times wish to preserve the overreach of frauds on the minimal prevalence
stage.
Following are the related sections referring to Financial institution Frauds
Indian Penal Code (45 of 1860)
(a) Part 23 “Wrongful acquire”.-
“Wrongful achieve” is acquire by illegal technique of property to which the particular person
gaining just isn’t legally entitled.
(b) “Wrongful loss”

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“Wrongful loss” is the loss by illegal technique of property to which the individual shedding it’s
legally entitled.
(c) Gaining wrongfully.
Dropping wrongfully-An individual is alleged to realize wrongfully when such individual retains
wrongfully, in addition to when such particular person acquires wrongfully. An individual is alleged
to lose wrongfully when such individual is wrongfully stored out of any property, in addition to
when such individual is wrongfully disadvantaged of property.
(d) Part 24. “Dishonestly”
Whoever does something with the intention of inflicting wrongful acquire to at least one particular
person or wrongful loss to a different particular person, is alleged to do this factor “dishonestly”.
(e) Part 28. “Counterfeit”
An individual is claimed to “counterfeit” who causes one factor to resemble one other factor,
intending via that resemblance to observe deception, or understanding it to be probably that
deception will thereby be practiced.
BREACH OF TRUST
1. Part 408- Felony breach of belief by clerk or servant.
2. Part 409- Legal breach of belief by public servant, or by banker, service provider or agent.
three. Part 416- Dishonest by personating
four. Part 419- Punishment for dishonest by personation.
OFFENCES RELATING TO DOCMENTS
1) Part 463-Forgery
2) Part 464 -Making a false doc
three) Part 465- Punishment for forgery.
four) Part 467- Forgery of beneficial safety, will, and so on
5) Part 468- Forgery for goal of dishonest

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6) Part 469- Forgery for function of harming status
7) Part 470- Cast doc.
eight) Part 471- Utilizing as real a solid doc
9) Part 477- Fraudulent cancellation, destruction, and so on., of will, authority to undertake, or
priceless safety.
10) Part 477A- Falsification of accounts.
THE RESERVE BANK OF INDIA ACT, 1934
Challenge of demand payments and notes Part 31.
Supplies that solely Financial institution and besides supplied by Central Authorities shall be
approved to attract, settle for, make or situation any invoice of alternate, hundi, promissory word or
engagement for the fee of cash payable to bearer on demand, or borrow, owe or take up any sum or
sums of cash on the payments, hundis or notes payable to bearer on demand of any such individual
THE NEGOTIABLE INSTRUMENTS ACT, 1881
Holder’s proper to duplicate of misplaced invoice Part 45A.
1. The finder of misplaced invoice or notice acquires no title to it. The title stays with the true
proprietor. He’s entitled to get better from the true proprietor.
2. If the finder obtains cost on a misplaced invoice or word in the end, the payee could possibly get
a sound discharge for it. However the true proprietor can get better the cash due on the instrument
as damages from the finder.
Part 58
When an Instrument is obtained by illegal means or for illegal consideration no possessor or indorse
who claims via the one who discovered or so obtained the instrument is entitled to obtain the quantity
due thereon from such maker, acceptor or holder, or from any occasion previous to such holder, except
such possessor or indorse is, or some particular person by means of whom he claims was, a holder
thereof sooner or later.
Part 85:
Cheque payable to order.

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1. By this part, bankers are positioned in privileged place. It offers that if an order cheque is indorsed
by or on behalf of the payee, and the banker on whom it’s drawn pays it sooner or later, the banker is
discharged. He can debit his buyer with the quantity so paid, although the endorsement of the payee
may change into a forgery.
2. The declare safety below this part the banker has to show that the fee was a cost in the end, in
good religion and with out negligence.
Part 87. Impact of fabric alteration
Below this part any alteration made with out the consent of social gathering could be void. Alteration
can be legitimate provided that is made with frequent intention of the get together.
Part 138. Dishonour of cheque for insufficiency, and many others., of funds within the account.
The place any cheque drawn by an individual on an account maintained by him with a banker for fee
of any sum of money to a different particular person from out of that account for the discharge, in
entire or partially, of any debt or different legal responsibility, is returned by the financial institution
unpaid. both due to the sum of money standing to the credit score of that account is inadequate to
honour the cheque or that it exceeds the quantity organized to be paid from that account by an
settlement made with that financial institution, such particular person shall be deemed to have
dedicated an offence and shall, with out prejudice.
Part 141(1) Offences by corporations.
If the particular person committing an offence underneath Part 138 is an organization, each one that,
on the time the offence was dedicated, was accountable for, and was accountable to, the corporate for
the conduct of the enterprise of the corporate, in addition to the corporate, shall be deemed to be
responsible of the offence and shall be liable to be proceeded in opposition to and punished
accordingly.
SECURITY REGIME IN BANKING SYSTEM
Safety implies sense of security and of freedom from hazard or anxiousness. When a banker takes a
collateral safety, say within the type of gold or a title deed, towards the cash lent by him, he has a way
of security and of freedom from anxiousness in regards to the attainable non-payment of the mortgage
by the borrower. These must be communicated to all strata of the group by way of acceptable means.
Earlier than employees managers ought to analyze present practices. Safety process must be
acknowledged explicitly and agreed upon by every person within the particular setting. Such practices
guarantee data safety and improve availability. Financial institution safety is basically a protection in
opposition to unforced assaults by thieves, dacoits and burglars.
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PHYSICAL SECURITY MEASURES-CONCEPT
A big a part of banks safety will depend on social safety measures. Bodily safety measures could be
outlined as these particular and particular protecting or defensive measures adopted to discourage,
detect, delay, defend and defeat or to carry out any a number of of those features towards culpable
acts, each covert and covert and acclamations pure occasions. The protecting or defensive, measures
adopted contain building, set up and deployment of constructions, tools and individuals respectively.
The next are few tips to examine malpractices:
1. To rotate the money work inside the employees.
2. One particular person shouldn’t proceed on the identical seat for greater than two months.
three. Daybook shouldn’t be written by the Cashier the place an different individual is on the market
to the job
four. No money withdrawal must be allowed inside passbook in case of withdrawal by pay order.
5. The department supervisor ought to be sure that all employees members have recorder their
presence within the attendance registrar, earlier than beginning work.
Execution of Paperwork
1. A financial institution officer should undertake a strict skilled method within the execution of
paperwork. The ink and the pen used for the execution have to be maintained uniformly.
2. Financial institution paperwork shouldn’t be typed on a typewriter for execution. These must be
invariably handwritten for execution.
three. The execution ought to at all times be executed within the presence of the officer liable for
get hold of them,
four. The debtors needs to be requested to sign up full signatures in similar model all through the
paperwork.
5. Except there’s a particular requirement within the doc, it shouldn’t be received attested or
witnessed as such attestation might change the character of the devices and the paperwork might
topic to advert volrem stamp responsibility.
6. The paper on which the financial institution paperwork are made ought to be pilfer proof. It needs
to be distinctive and out there to the banks solely.
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7. The printing of the financial institution paperwork ought to have extremely inventive intricate
and sophisticated graphics.
eight. The paperwork executed between Banker and Debtors should be stored in secure custody,
CHANGES IN LEGISLATIONS AFTER ELECTRONIC TRANSACTIONS
1. Part 91 of IPC shall be amended to incorporate digital paperwork additionally.
2. Part 92 of Indian Proof Act, 1872 shall be amended to incorporate commuter based mostly
communications
three. Part 93 of Bankers E-book Proof Act, 1891 has been amended to offer authorized sanctity for
books of account maintained within the digital kind by the banks.
four. Part 94 of the Reserve Financial institution of India Act, 1939 shall be amended to facilitate
digital fund transfers between the monetary establishments and the banks. A brand new clause (pp)
has been inserted in Part 58(2).
RECENT TRENDS OF BANKING SYSTEM IN INDIA
Within the banking and monetary sectors, the introduction of digital expertise for transactions,
settlement of accounts, book-keeping and all different associated capabilities is now an crucial. More
and more, whether or not we prefer it or not, all banking transactions are going to be digital. The
thrust is on commercially necessary facilities, which account for 65 p.c of banking enterprise by way
of worth. There are actually a lot of absolutely computerized branches throughout the nation.
A switchover from cash-based transactions to paper-based transactions is being accelerated. Magnetic

Ink character recognition clearing of cheques is now operational in lots of cities, beside the 4 metro
cities. In India, the design, administration and regulation of electronically-based funds system have
gotten the main focus of coverage deliberations. The imperatives of growing an efficient, environment
friendly and speedy cost and settlement methods are getting sharper with introduction of recent
devices akin to bank cards, telebanking, ATMs, retail Digital Funds Switch (EFT) and Digital
Clearing Providers (ECS). We’re shifting in direction of sensible playing cards, credit score and
monetary Digital Information Interchange (EDI) for straight by means of processing.
Monetary Fraud (Investigation, Prosecution, Restoration and Restoration of property) Invoice, 2001
Additional the Monetary Fraud (Investigation, Prosecution, Restoration and Restoration of property)
Invoice, 2001 was launched in Parliament to curb the menace of Financial institution Fraud. The Act
was to ban, management, examine monetary frauds; get well and restore properties topic to such
fraud; prosecute for inflicting monetary fraud and issues linked therewith or incidental thereto.
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Below the mentioned act the time period Monetary Fraud has been outlined as underneath:
Part 512 – Monetary Fraud
Monetary frauds means and contains any of the next acts dedicated by an individual or along with
his connivance, or by his agent, in his dealings with any financial institution or monetary
establishment or every other entity holding public funds;
1. The suggestion, as a truth, of that which isn’t true, by one who doesn’t consider it to be true;
2. The lively concealment of a reality by one having information or perception of the very fact;
three. A promise made with out any intention of performing it;
four. Another act fitted to deceive;
5. Any such act or omission because the regulation specifically declares to be fraudulent.
Offered that whoever acquires, possesses or transfers any proceeds of economic fraud or enters into
any transaction which is expounded to proceeds of fraud both instantly or not directly or conceals or
aids within the concealment of the proceeds of monetary fraud, commits monetary fraud.
513(a) – Punishment for Monetary Fraud
Whoever commits monetary fraud shall be: (a) Punished with rigorous imprisonment for a time
period, which can lengthen to seven years and shall even be liable to tremendous.
(b)Whoever commits severe monetary fraud shall be punished with rigorous imprisonment for a time
period which can lengthen to 10 years however shall not be lower than 5 years and shall even be
responsible for advantageous as much as double the quantity concerned in such fraud.
Offered that in each (a) and (b) all funds, financial institution accounts and properties acquired
utilizing such funds subjected to the monetary fraud as could fairly be attributed by the investigating
company shall be recovered and restored to the rightful proprietor based on the process established
by legislation.
CONCLUSION
The Indian Banking Trade has undergone large development since nationalization of 14 banks within
the yr 1969. There has an virtually eight instances enhance within the financial institution branches
from about 8000 throughout 1969 to mote than 60,000 belonging to 289 business banks, of which 66
banks are in non-public sector.
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It was the results of two successive Committees on Computerization (Rangarajan Committee) that set
the tone for computerization in India. Whereas the primary committee drew the blue print in 1983-84
for the mechanization and computerization in banking business, the second committee arrange in
1989 paved the best way for built-in use of telecommunications and computer systems for making
use of technogical breakthroughs in banking sector.
Nevertheless, with the unfold of banking and banks, frauds have been on a continuing improve. It
might be a pure corollary to extend within the variety of prospects who’re utilizing banks lately.
Within the yr 2000 alone we have now misplaced Rs 673 crores in as many as three,072 variety of
fraud circumstances. These are solely reported figures. Although, that is zero.075% of Rs eight,96,696
crores of whole deposits and zero.15% of Rs four,44,125 crores of loans & advances, there are any
numbers of circumstances that aren’t reported. There have been almost 65,800 financial institution
branches of a complete of 295 industrial banks in India as on June 30, 2001 reporting a complete of
practically three,072 financial institution fraud circumstances. This makes practically 10.four frauds
per financial institution and roughly zero.47 frauds per department.
An Knowledgeable Committee on Financial institution Frauds (Chairman: Dr.N.L.Mitra) submitted

its Report back to RBI in September 2001. The Committee examined and urged each the preventive
and healing elements of financial institution frauds.
The necessary suggestions of the Committee embody:
o A necessity for together with monetary fraud as a legal offence;
o Amendments to the IPC by together with a brand new chapter on monetary fraud;
o Amendments to the Proof Act to shift the burden of proof on the accused particular person;
o Particular provision within the Cr. PC for properties concerned within the Monetary Fraud.
o Confiscating illegal positive aspects; and preventive measures together with the event of Greatest
Code Procedures by banks and monetary establishments.
Thus it may be concluded that following measures ought to essentially be adopted by the Ministry
of Finance to be able to cut back circumstances of Fraud.
o There have to be a Particular Courtroom to attempt monetary fraud instances of significant nature.
o The legislation ought to present separate structural and restoration process. Each financial
institution should have a home enquiry officer to investigate in regards to the civil dimension of
fraud.
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o A fraud involving an quantity of ten crore of rupees and above could also be thought of severe and
be tried within the Particular Court docket.
The Twenty-ninth Report of the Regulation Fee had dealt some classes of crimes considered one of
which is “offences calculated to forestall and impede the financial growth of the nation and endanger
its financial well being.” Offences referring to Banking Fraud will fall beneath this class. An
important function of such offences is that ordinarily they don’t contain a person direct sufferer.
They’re punishable as a result of they hurt the entire society. It’s clear that cash concerned in Financial
institution belongs to public. They deposit there entire life’ safety in Banks and in case of Dacoity or
Theft in banks the general public shall be al misplaced. Thus it is necessary that adequate efforts needs
to be taken on this regard.
There exists a brand new sort of menace in cyber world. Writers are referring it as “Salami Assault”
beneath this a particular software program is used for transferring the quantity from the account of
the person. Therefore the culprits of such crimes needs to be discovered shortly and needs to be given
strict punishment. Furthermore there may be requirement of extra variety of IT professionals who will
assist in discovering an answer towards all these safety threats.
Unit III Banking Frauds

c. Recent Trends in Banking: Automatic Teller Machine and Internet Banking , Smart
Cards, Credit Cards
ATM:
Automated Teller Machine (ATM) ATM is an electronic machine, which is operated by the customer himself
to make deposits, withdrawals and other financial transactions. ATM is a step in improvement in customer
service. ATM facility is available to the customer 24 hours a day. The customer is issued an ATM card. This
is a plastic card, which bears the customer’s name. This card is magnetically coded and can be read by this
machine. Each cardholder is provided with a secret personal identification number (PIN). When the customer
wants to use the card, he has to insert his plastic card in the slot of the machine. After the card is a recognized
by the machine, the customer enters his personal identification number. After establishing the authentication
of the customers, the ATM follows the customer to enter the amount to be withdrawn by him. After processing
that transaction and finding sufficient balances in his account, the output slot of ATM give the required cash
to him. When the transaction is completed, the ATM ejects the customer’s card.
Internet Banking:
Internet banking enables a customer to do banking transactions through the bank’s website on the Internet. It
is a system of accessing accounts and general information on bank products and services through a computer
while sitting in its office or home. This is also called virtual banking. It is more or less bringing the bank to
your computer. In traditional banking one has to approach the branch in person, to withdraw cash or deposit
a cheque or request a statement of accounts etc. but internet banking has changed the way of banking. Now
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everyone can operate all these type of transactions on his computer through website of bank. All such
transactions are encrypted; using sophisticated multi-layered security architecture, including firewalls and
filters. One can be rest assured that one’s transactions are secure and confidential.
Smart Cards
A smart card, chip card, or integrated circuit card (ICC) is a physical electronic authorization device, used to
control access to a resource. It is typically a plastic credit card sized card with an embedded integrated
circuit (IC) chip. Many smart cards include a pattern of metal contacts to electrically connect to the internal
chip. Others are contactless, and some are both. Smart cards can provide personal
identification, authentication, data storage, and application processing. Applications include identification,
financial, mobile phones (SIM), public transit, computer security, schools, and healthcare. Smart cards may
provide strong security authentication for single sign-on (SSO) within organizations. Numerous nations have
deployed smart cards throughout their populations.
The universal integrated circuit card, or SIM card, is also a type of smart card. As of 2015, 10.5 billion smart
card IC chips are manufactured annually, including 5.44 billion SIM card IC chips.
Smart cards serve as credit or ATM cards, fuel cards, mobile phone SIMs, authorization cards for pay
television, household utility pre-payment cards, high-security identification and access badges, and public
transport and public phone payment cards.
Smart cards may also be used as electronic wallets. The smart card chip can be "loaded" with funds to pay
parking meters, vending machines or merchants. Cryptographic protocols protect the exchange of money
between the smart card and the machine. No connection to a bank is needed. The holder of the card may use
it even if not the owner. Examples are Proton, Geldkarte, Chipknip and Moneo. The German Geldkarte is also
used to validate customer age at vending machines for cigarettes.
These are the best known payment cards (classic plastic card):
• Visa: Visa Contactless, Quick VSDC, "qVSDC", Visa Wave, MSD, payWave
• Mastercard: PayPass Magstripe, PayPassMChip
• American Express: ExpressPay
• Discover: Zip
• Unionpay: QuickPass
Roll-outs started in 2005 in the U.S. Asia and Europe followed in 2006. Contactless (non-PIN) transactions
cover a payment range of ~$5–50. There is an ISO/IEC 14443 PayPass implementation. Some, but not all,
PayPass implementations conform to EMV.
Non-EMV cards work like magnetic stripe cards. This is common in the U.S. (PayPass Magstripe and Visa
MSD). The cards do not hold or maintain the account balance. All payment passes without a PIN, usually in
off-line mode. The security of such a transaction is no greater than with a magnetic stripe card transaction.
EMV cards can have either contact or contactless interfaces. They work as if they were a normal EMV card
with a contact interface. Via the contactless interface they work somewhat differently, in that the card
commands enabled improved features such as lower power and shorter transaction times.
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Credit Card
A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay
a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for the
amounts plus the other agreed charges. The card issuer (usually a bank) creates a revolving account and grants
a line of credit to the cardholder, from which the cardholder can borrow money for payment to a merchant or
as a cash advance.
A credit card is different from a charge card, which requires the balance to be repaid in full each month. In
contrast, credit cards allow the consumers to build a continuing balance of debt, subject to interest being
charged. A credit card also differs from a cash card, which can be used like currency by the owner of the card.
A credit card differs from a charge card also in that a credit card typically involves a third-party entity that
pays the seller and is reimbursed by the buyer, whereas a charge card simply defers payment by the buyer
until a later date.
A credit card issuing company, such as a bank or credit union, enters into agreements with merchants for them
to accept their credit cards. Merchants often advertise which cards they accept by displaying acceptance
marks – generally derived from logos – or this may be communicated in signage in the establishment or in
company material (e.g., a restaurant's menu may indicate which credit cards are accepted). Merchants may
also communicate this orally, as in "We take (brands X, Y, and Z)" or "We don't take credit cards".
Visa, MasterCard, American Express are card-issuing entities that set transaction terms for merchants, card-
issuing banks, and acquiring banks.
The credit card issuer issues a credit card to a customer at the time or after an account has been approved by
the credit provider, which need not be the same entity as the card issuer. The cardholders can then use it to
make purchases at merchants accepting that card. When a purchase is made, the cardholder agrees to pay the
card issuer. The cardholder indicates consent to pay by signing a receipt with a record of the card details and
indicating the amount to be paid or by entering a personal identification number (PIN). Also, many merchants
now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a card
not present transaction (CNP).
UNIT-IV -- : INSURANCE LAW
A) NATURE OF INSURANCE CONTRACTs
What is insurance?
Insurance may be described as a social device to reduce or eliminate risk

of life and property. Under the plan of insurance, a large number of people
associate themselves by sharing risk, attached to individual. The risk,
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which can be insured against include fire, the peril of sea, death, incident,
& burglary. Any risk contingent upon these may be insured against at a
premium commensurate with the risk involved.
Insurance is actually a contract between 2 parties whereby one party called

insurer undertakes in exchange for a fixed sum called premium to pay the
other party ON happening of a certain event.
Insurance is a contract whereby, in return for the payment of premium by

the insured, the insurers pay the financial losses suffered by the insured as
a result of the occurrence of unforeseen events. With the help of Insurance,
large number of people exposed to similar risks makes contributions to a
common fund out of which the losses suffered by the unfortunate few, due
to accidental events, are madegood.
An insurer is a company selling the insurance; an insured or policyholder

is the person or entity buying the insurance. The insurance rate is a factor
used to determine the amount to be charged for a certain amount of
insurance coverage, called the premium.
According to J.B. Maclean, ―Insurance is a method of spreading over a

large number of persons a possible financial loss too serious to be
conveniently borne by an individual.
What is insurance law?
Insurance law is the name given to practices of law surrounding insurance,

including insurance policies and claims. Insurance regulation that governs
the business of insurance is typically aimed at assuring the solvency of
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insurance companies. Thus,this type of regulation governs capitalization,
reserve policies, rates and various other "back office" processes.
Need for insurance
All assets have some economic value attached to them. There is also a
possibility that these assets may get damaged/destroyed or become non-
operational due to risks like breakdowns, fire, floods, earthquake etc.
Different assets are exposed to different types of risks like a car has a risk
of theft or meeting an accident, a house is exposed to risk of catching fire,
a human is exposed to risk of death/accident. Hence insurance is required
for the followingreasons:
• Insurance acts as an important tool in providing a sense of security

to the society on a whole. In case the bread earner of a family dies,
the family suffers from direct financial loss as family's income
ceases. Life insurance is one alternate arrangement that offers some
respite to the family from financial distress.
• The basic need of insurance arises as risks are uncertain and

unpredictable in nature. Getting insurance for an asset does not mean
that the asset is protected against risks or its exposure to risk is
reduced, but it actually implies that in case the asset suffers any loss
in value due to such risk, the insurance company bears the loss and
compensates the insured by making payment to him.
• Insurance acts as a useful instrument in promoting savings and

investments, particularly within the lower income and middle
income families. These savings are used as investments to fuel
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economicgrowth.
Types of insurance
Insurance business is divided into following types of business namely:
1) Life Insurance,and
2) GeneralInsurance
a. Marineinsurance
b. Fire insurance
c. Motor vehicleinsurance
d. Miscellaneousinsurance
3) Reinsurance
HISTORICAL BACKGROUND OFINSURANCE
Early methods of transferring or distributing risk were practiced by

Chinese and Babylonian traders as long ago as the 3rd and 2nd millennia
BC, respectively. Chinese merchants travelling treacherous river rapids
would redistribute their wares across many vessels to limit the loss due to
any single vessel's capsizing. The Babylonians developed a system which
was recorded in the famous Code of Hammurabi, c. 1750 BC, and practiced
by early Mediterranean sailing merchants. If a merchant received a loan to
fund his shipment, he would pay the lender an additional sum in exchange
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for the lender's guarantee to cancel the loan should the shipment be stolen.
Achaemenian monarchs of Ancient Persia were the first to insure their

people and made it official by registering the insuring process in
governmental notary offices. The insurance tradition was performed each
year in Nowruz (beginning of the Iranian New Year); the heads of different
ethnic groups as well as others willing to take part, presented gifts to the
monarch. The most important gift was presented during a special
ceremony. When a gift was worth more than 10,000 Derrik (Achaemenian
gold coin) the issue was registered in a special office. This was
advantageous to those who presented such special gifts. For others, the
presents were fairly assessed by the confidants of the court. Then the
assessment was registered in special offices.
A thousand years later, the inhabitants of Rhodes (an island in Greece)

created the 'general average', which allowed groups of merchants to pay to
insure their goods being shipped together. The collected premiums would
be used to reimburse any merchant whose goods were jettisoned during
transport, whether to storm or sinkage.
The ancient Athenian "maritime loan" advanced money for voyages with
repayment being cancelled if the ship was lost. In the 4th century BC, rates
for the loans differed according to safe or dangerous times of year,
implying an intuitive pricing of risk with an effect similar to insurance.
The Greeks and Romans introduced the origins of health and life insurance
c. 600 BCE when they created guilds called "benevolent societies" which
cared for the families of deceased members, as well as paying funeral
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expenses of members. Guilds in the Middle Ages served a similar purpose.
The Talmud deals with several aspects of insuring goods. Before insurance
was established in the late 17th century, "friendly societies" existed in
England, in which people donated amounts of money to a general sum that
could be used for emergencies.
Separate insurance contracts (i.e., insurance policies not bundled with

loans or other kinds of contracts) were invented in Genoa (a city and
important seaport in northern Italy) in the 14th century, as were insurance
pools backed by pledges of landed estates. The first known insurance
contract dates from Genoa in 1343, and in the next century maritime
insurance developed widely and premiums were intuitively varied with
risks. These new insurance contracts allowed insurance to be separated
from investment, a separation of roles that first proved useful in marine
insurance. The first printed book on insurance was the legal treatise On
Insurance and Merchants' Bets by Pedro de Santarém (Santerna), written
in 1488 and published in1552.
Insurance as we know it today can be traced to the Great Fire of London,

which in 1666 devoured 13,200 houses. In the aftermath of this disaster,
Nicholas Barbon opened an office to insure buildings. In 1680, he
established England's first fire insurance company, "The Fire Office," to
insure brick and frame homes.
The concept of health insurance was proposed in 1694 by Hugh the Elder
Chamberlen from the Peter Chamberlen family. In the late 19th century,
"accident insurance" began to be available, which operated much like
modern disability insurance. This payment model continued until the start
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of the 20th century in some jurisdictions (like California), where all laws
regulating health insurance actually referred to disabilityinsurance.
The first insurance company in the United States underwrote fire insurance
and was formed in Charles Town (modern-day Charleston), South Carolina
in 1732, but it provided only fire insurance.
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The sale of life insurance in the U.S. began in the late 1760s. The Presbyterian Synods in Philadelphia
and New York founded the Corporation for Relief of Poor and Distressed Widows and Children of
Presbyterian Ministers in 1759; Episcopalian priests created a comparable relief fund in 1769. Between
1787 and 1837 more than two dozen life insurance companies were started, but fewer than half a
dozensurvived.
1. INSURANCE SCENARIO IN INDIA

Classification of Insurance industry in India
Insurance Industry - India
Life Insurance Non-life Insurance / General Insurance
Motor Fire Health Marine
Insurance Insurance Insurance Insurance
In life insurance business, India ranked 9th among the 156 countries, for which data are published
by Swiss Re. During 2010-11, the estimated life insurance premium in India grew by 4.2 per cent
(inflation adjusted). However, during the same period, the global life insurance premium expanded
by 3.2 per cent. The share of Indian life insurance sector in global market was 2.69 per cent during
2010, as against 2.45 per cent in2009.
The non-life insurance sector witnessed significant growth of 8.1 per cent during 2010. Its
performance is far better when compared to global non-life premium, which expanded by 2.1 per
cent during the same period. The share of Indian non-life insurance premium in global non-life
insurance premium increased slightly to 0.58 per cent, thereby improvising its global ranking to
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19th in comparison to 26th in last year. The measure of insurance penetration and density reflects
the level of development of insurance sector in a country. While insurance penetration is measured
as the percentage of insurance premium to GDP, insurance density is calculated as the ratio of
premium to population (per capita premium). Since opening up of Indianinsurance
sector for private participation, India has reported increase in insurance density. The insurance
density of life insurance sector had gone up from USD 9.1 in 2001 to USD
55.7 in 2010. Similarly, insurance penetration had gone up from 2.15 per cent in 2001 to 4.60 in
2009, before slipping to 4.40 per cent in 2010.
As on September 2012, there are 24 insurance companies in the life insurance business and 27
companies in general insurance business. In addition, GIC is the sole nationalre-insurer.
Life insurance industry recorded a premium income of Rs.2,91,605 crore during 2010- 11 as
against Rs.2,65,447 crore in the previous financial year, registering a growth of
9.85 per cent. While private sector insurers posted 11.04 per cent growth (23.06 per cent in
previous year) in their premium income, LIC recorded 9.35 per cent growth (18.30 per cent in
previous year). While renewal premium accounted for 56.66 per cent (58.60 per cent in 2009-10)
of the total premium received by the life insurers, first year premium contributed the remaining
43.34 per cent (41.40 per cent in 2009- 10).
On the basis of total premium income, the market share of LIC declined marginally from 70.10
per cent in 2009-10 to 69.78 per cent in 2010-11. Accordingly, the market share of private insurers
has gone up marginally from 29.90 per cent in 2009-10 to
30.22 per cent in 2010-11.
During 2010-11, life insurers issued 482 lakh new policies, out of which, LIC issued 370 lakh
policies (76.91 per cent of total policies issued) and the private life insurers issued 111 lakh policies
(23.09 per cent). While LIC suffered a decline of 4.70 per cent (8.21 per cent increase in 2009-10)
in the number of new policies issued against the previous year, the private sector insurers reported
a significant decline of 22.61 per cent (4.32 per cent decline in 2009-10) in the number of new
policies issued.
The total capital of the life insurance companies as on 31st March, 2011 was Rs.23,662 crore.
During 2010-11, an additional capital of Rs.2,642 crore was brought in by the industry. The
incremental capital during 2010-11 was brought in by the private sector insurers as there was no
addition in the capital of LIC, the public sector insurancecompany.
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The life insurance industry paid higher gross benefits of Rs.1,42,524 crore in 2010-11 (`95,820
crore in 2009-10) constituting 48.88 per cent of the gross premium underwritten (36.10 per cent in
2009-10). The benefits paid by the private insurers which stood at Rs.31,251 crore (Rs.16,658
crore in 2009-10), showed an increase of
87.60 per cent constituting 35.46 per cent of the premium underwritten (20.99 per cent in 2009-
10).
During the financial year 2010-11, the life insurance industry reported net profit of Rs.2,657 crore
as against net loss of Rs.989 crore in 2009-10. Out of the 23 life insurers in operations during
2010-11, twelve companies reportedprofits.
The non-life insurance industry underwrote total premium of Rs.42,576 crore in 2010- 11 as
against Rs.34,620 crore in 2009-10, registering an impressive growth of 22.98 per cent as against
an increase of 14.06 per cent recorded in the previous year. The public sector insurers exhibited
impressive growth in 2010-11 at 21.84 per cent; over the previous year‘s growth rate of 14.49 per
cent. The private general insurers registered growth of 24.67 per cent, which is much higher than
13.44 per cent achieved during the previousyear.
The Motor business continued to be the largest non-life insurance segment with a share of 42.70
per cent (43.46 per cent in 2009-10). It reported growth rate of 20.82 per cent (12.83 per cent in
2009-10). The premium collection in Health segment continued to surge ahead at Rs.9,944 crore
in 2010-11 from Rs.7,311 crore of 2009-10, registering growth of 36.01 per cent. This resulted in
increase in share of health segment to the total premium to 23.35 per cent in 2010-11 (21.12 per
cent in 2009- 10).
The growth in the Health segment far out-paced the growth rate achieved by the non- life industry
as a whole.
The premium collection from Fire and Marine segments increased by 17.72 per cent and 16.20 per
cent respectively in 2010-11 after remaining stagnant in 2009-10.
The total paid-up capital of non-life insurers as on 31st March, 2010 was `5,684 crore. During
2010-11, the non-life insurers added Rs.1,021 crore (all in the private sector)
totheirequitycapitalbase.Withthis,thetotalpaidupcapitalofthenon-life
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insurance sector has gone upto Rs.6,706 crore as on 31st March, 2011 The paid-up capital of the
public sector companies remained unchanged at `550 crore in 2010-11. The non-life insurers
underwrote 793.41 lakh policies in 2010-11 as against 674.88 lakh in 2009-10, reporting an
increase of 17.56 per cent over 2009-10. Public sector
insurerswitnessedmajorturnaroundinthenumberofpoliciesissued.Theyreported
16.52 per cent increase in number of policies issued during 2010-11 compared to 2009-10
(negative growth at -3.84 per cent). Similarly, private sector insurers reported growth in number
of policies issued at 19.44 per cent (9.86 per cent in 2009- 10).
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2. EVOLUTION OF INSURANCE LAW

ININDIA
In India, insurance has a deep-rooted history. It finds mention in the writings of Manu
(Manusmrithi ), Yagnavalkya (Dharmasastra) and Kautilya (Arthasastra). The writings talk in
terms of pooling of resources that could be re-distributed in times of calamities such as fire, floods,
epidemics and famine. This was probably a pre-cursor to modern day insurance. Ancient Indian
history has preserved the earliest traces of insurance in the form of marine trade loans and carriers‘
contracts. Insurance in India has evolved over time heavily drawing from other countries, England
inparticular.
1818 saw the advent of life insurance business in India with the establishment of the Oriental Life
Insurance Company in Calcutta. This Company however failed in 1834. In 1829, the Madras
Equitable had begun transacting life insurance business in the Madras Presidency. 1870 saw the
enactment of the British Insurance Act and in the last three decades of the nineteenth century, the
Bombay Mutual (1871), Oriental (1874) and Empire of India (1897) were started in the Bombay
Residency. This era, however, was dominated by foreign insurance offices which did good
business in India, namely Albert Life Assurance, Royal Insurance, Liverpool and London Globe
Insurance and the Indian offices were up for hard competition from the foreigncompanies.
In 1914, the Government of India started publishing returns of Insurance Companies in India. The
Indian Life Assurance Companies Act, 1912 was the first statutory measure to regulate life
business. In 1928, the Indian Insurance Companies Act was enacted to enable the Government to
collect statistical information about both life and non-life business transacted in India by Indian
and foreign insurers including provident insurance societies. In 1938, with a view to protecting the
interest of the Insurance public, the earlier legislation was consolidated and amended by the
Insurance Act, 1938 with comprehensive provisions for effective control over the activities of
insurers.
The Insurance Amendment Act of 1950 abolished Principal Agencies. However, there were a large
number of insurance companies and the level of competition was high.
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There were also allegations of unfair trade practices. The Government of India, therefore, decided
to nationalize insurance business.
An Ordinance was issued on 19th January, 1956 nationalizing the Life Insurance sector and Life
Insurance Corporation came into existence in the same year. The LIC absorbed 154 Indian, 16
non-Indian insurers as also 75 provident societies—245 Indian and foreign insurers in all. The LIC
had monopoly till the late 90s when the Insurance sector was reopened to the private sector.
The history of general insurance dates back to the Industrial Revolution in the west and the
consequent growth of sea-faring trade and commerce in the 17th century. It came to India as a
legacy of British occupation. General Insurance in India has its roots in the establishment of Triton
Insurance Company Ltd., in the year 1850 in Calcutta by the British. In 1907, the Indian Mercantile
Insurance Ltd was set up. This was the first company to transact all classes of general
insurancebusiness.
1957 saw the formation of the General Insurance Council, a wing of the Insurance Association of
India. The General Insurance Council framed a code of conduct for ensuring fair conduct and
sound business practices.
In 1968, the Insurance Act was amended to regulate investments and set minimum solvency
margins. The Tariff Advisory Committee was also set up then.
In 1972 with the passing of the General Insurance Business (Nationalization) Act, general
insurance business was nationalized with effect from 1st January, 1973. 107 insurers were
amalgamated and grouped into four companies, namely National Insurance Company Ltd., the
New India Assurance Company Ltd., the Oriental Insurance Company Ltd and the United India
Insurance Company Ltd. The General Insurance Corporation of India was incorporated as a
company in 1971 and it commenced business on January 1st 1973.
In December 2000, the GIC subsidiaries were restructured as independent insurance companies.
At the same time, GIC was converted into a national re-insurer. In July 2002, Parliament passed a
bill, delinking the four subsidiaries from GIC.
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Legislative Regime
The principal legislation regulating the insurance business in India is the Insurance Act of 1938.
Some other existing legislations in the field are – the Life Insurance
Corporation (LIC) Act, 1956, the Marine Insurance Act, 1963, the General Insurance Business
(GIB) (Nationalization) Act, 1972 and the Insurance Regulatory and Development Authority
(IRDA) Act, 1999. The provisions of the Indian Contract Act, 1872 are applicable to the contracts
of insurance, whether for life or non-life. Similarly, the provisions of the Companies Act, 1956 are
applicable to the companies carrying on insurance business.
The subordinate legislation includes Insurance Rules, 1939 and the Ombudsman Rules, 1998
framed by the Central Government under Sec.114 of the principal Act as also 32 regulations made
by the IRDA under Sec.114 A of the principal Act and Sec.26 of the IRDA Act 1999.
Background to recent legislative changes

The announcement of the new industrial policy in 1991, envisaged the transition of the economy
from a regulated to a liberalized and deregulated regime leading to the privatization of insurance
sector to provide a better coverage to citizens and to augment the flow of long-term financial
resources. This transition also meant that competition was bound to intensify in future with the
entry of several private players in the field, particularly the foreign companies in joint venture with
Indian partners. In order to prevent misuse by insurers of policyholders‘ and shareholders‘ funds
and to ensure accountability, it was imperative to have in place an effective regulatory regime.
Insurers being repositories of public trust, efficient regulation of their business became necessary
to ensure that they remained worthy custodians of this trust. Further, insurance cash flows
generated funds needed for investment in the social sector and for the development of
infrastructure. Therefore, the regulation of insurance required a paradigm shift from just
supervisory and monitoring role to development role so that the insurance business promoted
economicgrowth.
Malhotra Committee Report

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In the backdrop of new industrial policy, the Government of India set up in 1993 a high-powered
committee headed by Mr. R. N. Malhotra to examine the structure of the insurance industry, to
assess its strength and weaknesses in terms of the objective of providing high quality services to
the public and serving as an effective instrument for mobilization of financial resources for
development, to review the thenexisting
structure of regulation and supervision of insurance sector and to suggest reforms for strengthening
and modernizing regulatory system in tune with the changing economic environment.
The Malhotra Committee submitted its report in 1994. Some of the major recommendations made
by it were as under:-
(a) the establishment of an independent regulatory authority (akin to Securities and Exchange
Board ofIndia);
(b) allowing private sector to enter the insurancefield;
(c) improvement of the commission structure for agents to make it effective instrument for
procuring business specially rural, personal and non-obligatory lines ofbusiness;
(d) insurance plans for economically backward sections, appointment of institutionalagents;
(e) setting up of an institution of professional surveyors/lossassessors;
(f) functioning of Tariff Advisory Committee (TAC) as a separate statutorybody;
(g) investment on the pattern laid down ins.27;
(h) marketing of life insurance to relatively weaker sections of the society and specified
proportion of business in ruralareas;
(i) provisions for co-operative societies for transacting life insurance business in states;
(j) the requirement of specified proportion of the general business as rural non- traditional
business to be undertaken by the newentrants;
(k) welfare oriented schemes of generalinsurance;
(l) technology driven operation of General Insurance Corporation of India (GICI); GIC to
exclusively function as a reinsurer and to cease to be the holding company;
(m) introduction of unlinked pension plans by the insurance companies;and
(n) restructuring of insuranceindustry.
Milestones
Year Of Insurance Regulations
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Significant Regulatory Event
1912 The Indian Life Insurance Company Act

1938 The Insurance Act: Comprehensive Act to regulate insurance business in India
1956 Nationalization of life insurance business in India

1972 Nationalization of general insurance business in India
1993 Setting up of Malhotra Committee
1994 Recommendations of Malhotra Committee
1995 Setting up of Mukherjee Committee
1996 Setting up of (interim) Insurance Regulatory Authority (IRA)
1997 Mukherjee Committee Report submitted but not made public
1997 The Government gives greater autonomy to LIC, GIC and its subsidiaries with regard to
the restructuring of boards and flexibility in investment norms
aimed at channeling funds to the infrastructure sector
1998 The cabinet decides to allow 40% foreign equity in private insurance companies-26% to
foreign companies and 14% to NRI‘s, OCB‘s and FII‘s 1999. The Standing Committee
headed by Murali Deora decides that foreign equity
inprivateinsuranceshouldbelimitedto26%.TheIRAbillisrenamedthe
Insurance Regulatory and Development Authority (IRDA) Bill.
1999 Cabinet clears IRDA Bill
2000 President gives Assent to the IRDA Bill
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3. PRINCIPLES OFINSURANCE
Human life is exposed to many risks, which may result in heavy financial losses.
Insurance is one of the devices by which risks may be reduced or eliminated in exchange for
premium.
―Insurance is a contract in which a sum of money is paid by the assured in consideration of the
insurer's incurring the risk of paying larger sum upon a given contingency‖.
In its legal aspects it is a contract whereby one person agrees to indemnify another against a loss
which may happen or to pay a sum of money to him on the occurring of a particularevent.
The seven principles of insurance are :-
1) Principle of Uberrimae fidei (Utmost

GoodFaith)
Principle of Uberrimae fidei (a Latin phrase), or in simple English words, the Principle of Utmost
Good Faith, is a very basic and first primary principle of insurance. According to this principle,
the insurance contract must be signed by both parties(i.e. insurer and insured) in an absolute good
faith or belief or trust.
The person getting insured must willingly disclose and surrender to the insurer his complete true
information regarding the subject matter of insurance. The insurer's liability gets void (i.e. legally
revoked or cancelled) if any facts, about the subject matter of insurance are either omitted, hidden,
falsified or presented in a wrong manner by the insured.
The principle of Uberrimae fidei applies to all types of insurance contracts.
LIC v. G.M.CHannabsemma, (AIR 1991 SC 392) - In a landmark decision the SC has held that
the onus of proving that the policy holder has failed to disclose information on material facts lies
on the corporation. In this case the assured who suffered from
tuberculosis and died a few months after the taking of the policy, the court observed that it is well
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settled that a contract of insurance is contract uberrimae fides, but the burden of proving that the
insured had made false representation or suppressed the material facts is undoubtedly on the
corporation.
New India Insurance Company v. Raghava Reddy (AIR1961 AP 295) - It was held that a policy
cannot be avoided on the ground of misrepresentation unless the following are established by the
insurernamely,
a. The statement was inaccurate orfalse.
b. Such statement was on a material matter or that the statement suppressed facts which it was
material todisclose.
c. The statement was fraudulentlymade
d. The policy holder knew at the time of making the statement that it was false or that fact which
ought to be disclosed has beensuppressed.
LIC v. Janaki Ammal (AIR 1968 Mad 324) – it was held that if a period of two years has expired
from the date on which the policy of life insurance was effected, that policy cannot be called in
question by an insurer on the ground that a statement made in the proposal for insurance or on any
report of a medical officer or referee, or a friend of the insured, or in any other document leading
to the assure of the policy, was inaccurate orfalse.
2) Principle of InsurableInterest
Insurable interest means - A relation between the insured and the event insured against, such that
the occurrence of the event will cause substantial loss or injury of some kind to the insured.
The principle of insurable interest states that the person getting insured must have insurable interest
in the object of insurance. A person has an insurable interest when the physical existence of the
insured object gives him some gain but its non-existence
will give him a loss. In simple words, the insured person must suffer some financial loss by the
damage of the insuredobject.
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For example: - The owner of a taxicab has insurable interest in the taxicab because he is getting
income from it. But, if he sells it, he will not have an insurable interest left in thattaxicab.
From above example, we can conclude that, ownership plays a very crucial role in evaluating
insurable interest. Every person has an insurable interest in his own life. A merchant has insurable
interest in his business of trading. Similarly, a creditor has insurable interest in his debtor.
3) Principle ofIndemnity
Indemnity means security, protection and compensation given against damage, loss or injury.
According to the principle of indemnity, an insurance contract is signed only for getting protection
against unpredicted financial losses arising due to future uncertainties. Insurance contract is not
made for making profit else its sole purpose is to give compensation in case of any damage or loss.
In an insurance contract, the amount of compensations paid is in proportion to the incurred losses.
The amount of compensations is limited to the amount assured or the actual losses, whichever is
less. The compensation must not be less or more than the actual damage. Compensation is not paid
if the specified loss does not happen due to a particular reason during a specific time period. Thus,
insurance is only for giving protection against losses and not for makingprofit.
However, in case of life insurance, the principle of indemnity does not apply because the value of
human life cannot be measured in terms of money.
4) Principle ofContribution
Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of
indemnity, if the insured has taken out more than one policy on the same
subject matter. According to this principle, the insured can claim the compensation only to the
extent of actual loss either from all insurers or from any one insurer. If one insurer pays full
compensation then that insurer can claim proportionate claim from the otherinsurers.
For example: - If a house is insured with company X for Rs.5,000 and with company Y for
Rs.10000 and the damage amounts to Rs.1200, company X will apparently be liable to contribute
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Rs.400 and company Y Rs.800.
So, if the insured claims full amount of compensation from one insurer then he cannot claim the
same compensation from other insurer and make a profit. Secondly, if one insurance company
pays the full compensation then it can recover the proportionate contribution from the other
insurance company.
Essential conditions of Contribution –
i. All the insurance must relate to the samesubject-matter.
ii. The policies concerned must all cover the same interest of the sameinsured.
iii. The policies concerned must all cover the same peril which caused theloss.
iv. The policies must have been in force and all of them should be enforceable at the time
ofloss.
5) Principle ofSubrogation
Subrogation means substituting one creditor for another.
Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also
applies to all contracts of indemnity. It is generally applicable to contract of fire insurance and
marine insurance.
According to the principle of subrogation, when the insured is compensated for the losses due to
damage to his insured property, then the ownership right of such property shifts to the insurer.
This principle is applicable only when the damaged property has any value after the event causing
the damage. The insurer can benefit out of subrogation rights only to the extent of the amount he
has paid to the insured as compensation. The principle of subrogation prevents an insured who
holds a policy of indemnity from recovering from the insurer the sum greater than the economic
loss he has sustained.
For example :- Mr. John insures his house for $ 1 million. The house is totally destroyed by the
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negligence of his neighbourMr.Tom. The insurance company shall settle the claim of Mr. John for
$ 1 million. At the same time, it can file a law suit against Mr.Tom for $ 1.2 million, the market
value of the house. If insurance company wins the case and collects $ 1.2 million from Mr. Tom,
then the insurance company will retain $ 1 million (which it has already paid to Mr. John) plus
other expenses such as court fees. The balance amount, if any will be given to Mr. John, the
insured.
Limitations to this doctrine are –
• Does not apply to life and personal accidentpolicies;
• Insurer must pay before he claimsubrogation;
• Assured must have been able to bringaction.
For example - where two ships belonging to the same owner collided by fault of one of them, the
insurers of the ship not at fault have been held not to be entitled to make any claim on the owner
of the ship at fault, though the insurers of cargo owned by a third party can claimsubrogation.
Difference between the doctrines of Contribution and Subrogation are –
• In contribution the purpose is to distribute the loss while in subrogation theloss is shifted
from one person toanother.
• Contribution is between insurers but subrogation is against thirdparty.
• In contribution there must be more than one insurer but in subrogation there may be one
insurer and onepolicy.
• In contribution the right of the insurer is claimed but in
subrogation the right of the insured isclaimed.
6) Principle of LossMinimization
According to the Principle of Loss Minimization, insured must always try
his level best to minimize the loss of his insured property, in case of
uncertain events like a fire outbreak or blast, etc. The insured must take all
possible measures and necessary steps to control and reduce the losses in
such a scenario. The insured must not neglect and behave irresponsibly
during such events just because the property is insured. Hence it is a
responsibility of the insured to protect his insured property and avoid
furtherlosses.
For example :- Assume, Mr. John's house is set on fire due to an electric
short-circuit. In this tragic scenario, Mr. John must try his level best to stop
fire by all possible means, like first calling nearest fire department office,
asking neighbours for emergency fire extinguishers, etc. He must not
remain inactive and watch his house burning hoping, "Why should I worry?
I've insured my house."
7) Principle of Causa Proxima

(NearestCause)
Principle of Causa Proxima (a Latin phrase), or in simple English words,
the Principle of Proximate (i.e. Nearest) Cause, means when a loss is caused
by more than one causes, the proximate or the nearest or the closest cause
should be taken into consideration to decide the liability of the insurer.
The principle states that to find out whether the insurer is liable for the loss
or not, the proximate (closest) and not the remote (farest) must be looked
into.
For example: - A cargo ship's base was punctured due to rats and so sea
water entered and cargo was damaged. Here there are two causes for the
damage of the cargo ship -
(i) The cargo ship getting punctured because of rats, and (ii) The sea water
entering ship through puncture.The risk of sea water is insured but the first
cause is not. The nearest cause of damage is sea water which is insured and
therefore the insurer must pay the compensation.
However, in case of life insurance, the principle of Causa Proxima does not
apply. Whatever may be the reason of death (whether a natural death or an
unnatural death) the insurer is liable to pay the amount ofinsurance.
CONCEPT OF INSURANCE: Hardy Ivamy writes in his work - “General

Principles of insurance Law” that33 – A contract of insurance is a contract
whereby one person called the ‘insurer’, undertakes in return for the agreed
consideration called the ‘premium’ to pay to another person , called the
‘insured’ a sum of money or its equivalent on the happening of a specified
event. In Prudential Insurance Company v. Inland Revenue
Commissioner34 , Channel J. said There must be either some uncertainty
whether the event will ever happen or not, or if the event is one which must
happen at some time or another, there must be uncertainty as to the time at
which it will happen. Generally an insurance agreement to be a valid
contract must be35 – i. A contract between an ‘insurer’ and the ‘insured’;
ii. The contract is based on the loss due to happening or not happening of a
future incident; iii. A consideration in the form of payment of an amount by
the insured and iv. The insurer promises to make good the loss in so far
money can do it, in case the loss occurs on the happening of the contingency.
Thus one can observe that in a contract of insurance, one can insure ship or
house but cannot ensure that the ship shall not be lost or the house shall not
burnt, but what one can insure is that a sum of money shall be paid on the
happening of a certain event. Thus the subject matter of insurance is the
compensation in the form of money to be paid to the assured on happening
of a risk. 33 Law of Insurance, MBL –Part II, (Distance Education
Department, National Law School of India University, Bangalore) at page
13 34 (1904)2KB658 35 Law of Insurance, MBL –Part II, (Distance
Education Department, National Law School of India University,
Bangalore) at page 14 29 2.3 NATURE OF INSURANCE: Insurance means
the act of securing the payment of a sum of money in the event of loss or
damage to property, life, a person etc., by regular payment of premiums.
Insurance is a method of spreading over a large number of persons, a
possible financial risk too serious to be conveniently sustained by an
individual. The aim of all types of insurances is to protect the owner from a
variety of risks which he anticipates. The happening of the specified event
must involve some loss to the insured or at least should expose him to
adversity which is, in the law of insurance, called commonly the ‘risk’.36
The nature of insurance depends on the nature of the risk required to be
protected. An insurance contract makes available the risk coverage to the
insured. The buyer of insurance pays a fixed premium in exchange for a
promise of compensation in the event of some specified loss. Insurance is
bought because it gives peace of mind to the holders. This comfort stage is
important in personal and business life.37 Though the most important
purpose of insurance is to provide risk coverage, when the contract period
extends over a long time, as in the case of life insurance, premium payments
comprise of two components – one for buying risk coverage and the other
towards savings. The joining together of risk coverage and savings is
peculiar with the life insurance and is more common in developing countries
like India.38 In the industrially superior countries, the short duration life
insurance contracts without a savings component are equally popular. In the
developing economies because of the savings component and the long
nature of the contract, life insurance has become an important instrument of
activating the long-term. The savings component puts the life insurance in
straight competition with other financial institutions and savings
instruments. 39 In many developed countries, citizens are to a certain extent
protected by social security schemes provided by the government. These
schemes offer financial aid to citizens who are eligible on grounds of
unemployment, old age, sickness, disability, etc. The social security
scenario in India is quite different, having traditionally been the
responsibility of the family or community. However, with industrialization,
urbanization, breakup of the joint family system and weakening of family
bondage, it has become necessary to provide social security arrangements
that are institutionalized and regulated by the state rather than the society.40
The issues relating to social security are listed in the ‘Directive Principles
of State Policy’ of the Constitution of India. While the subject of ‘social
security insurance’, ‘employment and unemployment’ form Item 23 of the
Concurrent List, and the subject of ‘the welfare of labour including
conditions of work’, ‘provident fund’, ‘employee’s liability’, ‘workmen’s
compensation’, ‘invalidity and old age pension’ and ‘maternity benefits’
form Item 24, also of the Concurrent List.41 During the initial years of
development and planning, it was believed that with the process of
development, a greater number of workers would join the organized sector
and eventually get covered by formal social security arrangements.
However, the actual experience has proved otherwise. There is now almost
a stagnation of employment in the organized sector with increase in the
inflow of workers into the informal sector. The unorganized workforce is
characterized by scattered and fragmented areas of employment,
seasonality, lack of job security and low legislative protection. Currently,
out of an estimated workforce of nearly 400 million, only less than 10
percent have the benefits of formal social security protection. Although the
government has a few centrally funded social assistance programmes like
National Old Age Schemes and National Family Benefit Schemes, the
number of people covered as well as the benefits is very meager.
Furthermore, in a country like India, where there is no provision for
unemployment benefits, the concept of insurance becomes extremely
important. Legal nature of insurance contract - The concept of insurance as
an effective mechanism for risk transference was first introduced in the
marine trade. Later on, the utility of the concept was realized in its
expansion to the non-marine types like life and fire insurance. Almost until
the middle of the nineteenth century these were the three types which
obtained prominence in insurance law. The applicability of the principle of
insurance has been found to be wider and today, besides the various types
like motor, accident and fidelity insurance, its scope is extended to crop and
cattle insurance. Insurance has become the usual mode of ensuring security
against future contingencies and it plays a significant role in the social and
commercial life of all modern communities.43 The law of insurance forms
part of the general law of contract and whatever type of contract of
insurance may be, it always represents the agreement between the assured
and the insurer. The essential ingredients of a contract under law, for
example, offer and acceptance, consideration, capacity of the parties,
mutuality of understanding and legality of object are of equal application to
a contract of insurance. But there is the existence of a separate set of
principles of insurance that furnishes the correct appraisal of the nature of
insurance contract.
Basic principles of insurance - Though insurance has been differentiated

into marine, fire, life etc., there are certain general principles applicable to
all forms of insurance. These general principles serve as a guide to the sound
interpretation of the purpose of the insurance contracts in their diversified
forms. The principles of indemnity, insurable interest, uberrima fides
(utmost good faith) and the existence of risk are some of the principles
having common application. Following are the some of the important
principles of insurance: (a) Existence of risk: It is vital to every contract of
insurance that the subject matter should be exposed to the contingency of
loss or risk. Risk involves the happening of an uncertain event adverse to
the interest of the assured. In marine insurance the ship or cargo is exposed
to the loss by perils of the sea. In fire insurance the risk is in the destruction
of property by fire. In life insurance, the risk is in the death of the assured,
though a certainty, but uncertain as to the time of its happening. In an
abstract sense, risk may be defined as the chance of loss. It can either be an
uncertainty as to the outcome of some event or events, or loss as the result
of at least one possible outcome. In any case, the promise of the insurer is
to save the assured against the uncertain consequences.
(c) Principle of indemnity: Insurance is essentially a contract of indemnity. All

the claims of the assured will be adjusted only with reference to the actual
loss sustained by him. Thus, it is implied in every contract of insurance that
the assured in case of a loss against which the policy has the actual loss, is
to prevent fraud on the part of the assured. It checks the temptation to gain
by unfair means and the willful causing of loss. However, the factual basis
for the application of the principle of indemnity is not the prevention of
crime or consideration of public policy but it derives from the inherent
nature of the bargain. In assessing the amount payable on a contract of
insurance, the principle of indemnity is a guiding principle. It is common
that insurers limit their liability to a particular amount of money known as
the ‘sum assured.’ In case of loss, the ‘sum assured’ is all that the assured
is entitled to even if the value of the premium paid is less than it. But in all
other cases, except in the valued policies (in Marine Insurance) the insurer
is liable to indemnify only to the tune of the actual loss, even though the
‘sum assured’ is a higher amount. In ‘valued policies,’ the parties agree that
the value of the subject-matter shall be agreed. The object of the valued
policies is to avoid dispute after the loss occurs as to the quantum of the
assured’s interest.48 In contracts of life insurance, personal accident and
sickness insurances and in some forms of emergency insurance, the loss is
frequently measured in monetary terms. They are to be distinguished from
contracts of indemnity like marine and fire insurance. It is now well
established that life insurance in no way resembles a contract of indemnity.
Not seldom the contract of life insurance is considered as an arrangement
for profitable investment. It is because the assured by paying the premiums
is effecting a saving, the cumulative sum which he can recover after the
expiry of the fixed period.49 Life insurance may properly be considered as
an investment of money because it enables to secure an ultimate fund to
those persons who have no greater opportunity of making savings or which
left to themselves, they would have found it beyond their means. Yet, the
objective of a contract of life insurance is mainly to provide compensation
for the risk of death happening at an uncertain time. Though, it is considered
as a sort of investment, it holds good in some cases, it is departing from the
essential feature of insurance security against risk. It is, therefore observed
that a life policy is not a contract of indemnity.50 Generally; a contract of
indemnity is entered into for the sole purpose of making good a loss
incurred. The value of a life, however, is incapable of estimation and except,
in a limited sense, cannot be “made good” by insurance. The important
distinction which thus arises between life insurance and the other forms of
insurance is that the principle of “subrogation,” under which the insurer
(i.e., the company) takes the right of recovery against the third party causing
the loss, has no application to life insurance.51 (c) Difference between the
contract of insurance and wager agreement: The basic principle of
indemnity on which the greater part of the law of insurance is based, prima
facie, negatives any treatment of insurance on par with wagering contracts.
The wagering contracts are those, wherein “two persons, professing to hold
opposite views touching the issue of a future uncertain event, mutually
agree that, dependent upon the determination of that event, one shall win
Again, the difference between a wagering agreement and a contract depends
upon whether the person making it has or has not an interest in the subject
matter of the contract. That means, “if the event happens the party will gain
an advantage, if it is frustrated he will suffer a loss”. Probably, the common
feature of the two types of agreement – the element of uncertainty, gave rise
to the misconception of insurance in terms of gamble. According to Sir
William Anson54, the Father of the “Law of Contract”— Insurance was
placed on a different ground from a pure wager merely because it is
permitted by law. Insurance was regarded as no better than a wagering
contract despite the presence of insurable interest. But this view has been
modified by him later on and now he affirms insurance is described as
having only a ‘superficial resemblance’ to a wager. Though the distinction
is subtle, it is the intention of the parties rather than the form of the contract
that distinguishes insurance from wager. A wagering contract is made
normally with a view to secure profit. The probability of the happening of
an event is completely irrelevant to the interests of the parties except for the
chance of gain. A wager is concerned with the happening of an event per se
and the consequential determination of the conflicting interests. The
purpose is to win or lose in lieu of the mere probability of an event. In
insurance, the interest of the assured in the subject matter of risk known as
the insurable interest and is of the utmost importance in the insurance
contract.55 A contract of insurance is described as aleatory contract. It is
speculative to such an extent that the parties may not know whether the
event insured against will occur or not, thus involving a case of mutual risk.
The insurer in turn, for a comparatively small sum in the form of a premium
undertakes to compensate against a heavy loss. But such undertakings will
normally be with reference to actuarial practice and therefore insurance
always stands apart from a mere speculative venture. The insurance can
only be with reference to a previously existing risk and unlike a wager does
not create risk with its inception. In the case of insurance, the individual
subjected to the risk before negotiations, obtains security and to that extent
there will be a shifting of risk rather than creation of it. Therefore, it can be
said that the insurance accomplishes the reverse of a wagering contract.57
At one time the life insurance was considered to be immoral, as “gambling
in human life”. This idea arose because policies were taken where no
insurable interest existed and where the insurance was affected solely for
speculative purposes. Life insurance, however, is now chiefly used and
properly regarded as an economic and social necessity and when properly
understood cannot be considered as a “wager”, even though a large financial
gain may result from the early death of an insured.58 On the other hand, a
wagering contract is one where profit is sought to be made through chance,
while the true object of life insurance is rather the opposite, the avoidance
of loss arising through chance. A life insurance policy therefore is not a
wagering contract, which would be unenforceable on grounds of public
policy. The life insurance was regarded as a contract of indemnity similar
to the other contracts of insurance even during “Essentials and Legalities of
an insurance contract” Therefore, following are the differentiable points
between the life insurance and other forms of insurance:
1. Most of the contracts of insurance are frequently annual contracts and the
insurers have the option to refuse renewal at the end of each and any period
of insurance. In some cases the insurer reserves the right to terminate the
insurance anytime on a proportionate return of premium in respect of the
unexpired period of the risk. Life assurance contracts are, in the main, long-
term contracts and in the absence of any fault or any flaw the insurer has no
option to cancel the insurance.
2. The risk insured against under a fire, accident or marine insurance

contract may or may not occur but the event insured against under life
assurance contract is bound to happen.
3. The general contract of insurance continues to be a contract of indemnity,

but life insurance is considered as an assurance contract.
C. MOTOR VEHICLE INSURANCE (WITH SPECIAL REFERENCE TO

THIRD PARTY INSURANCE)
Motor insurance gives protection to the vehicle owner against – damages to his/her
vehicle and pays ofr any Third Party liability determined as per law against the owner
of the vehicle. Third Party insurance is a statutory requirement. The owner of the
vehicle is legally liable for any injury or damage to third party life or property caused
by or arising out of the use of the vehicle in a public place. Driving a motor vehicle
without insurance in a public place is a punishable offence in terms of the Motor
Vehicles Act, 1988.
There are two types of insurance policies that offer motor insurance cover –
a) Liability Only Policy (statutoryrequirement)
b) Package Policy (liability only policy + damage to owner‘s
vehicle usually called O.Dcover)
The damages to the vehicle due to the following perils are usually covered under the
OD section of the Motor Insurance policy –
a. Fire, explosion, self-ignition,lightning
b. Burglary /theft
c. Riot andstrike
d. Earthquake
e. Flood, storm, cyclone, hurricaneetc.
f. Accidental externalmeans
g. Maliciousact
h. Terrorismacts
i. While in transit by rail/road, inland waterways,etc.
j. Landslide /rockslide
Third Party Insurance?

There are two quiet different kinds of insurance involved in the damages system. One is third
party liability insurance, which is just called liability insurance by insurance companies and the
other one is first party insurance.
A third party insurance policy is a policy under which the insurance company agrees to
indeminify the insured person, if he is sued or held legally liable for injuries or damage done to a
third party. The isured is one party, the insurance company is the second party, and the person
you (the isured) ijure who claims damages against you is the third party.
Section 145(g) "third party" includes the Government. National Insurance Co. Ltd. v. Fakir Chand,
AIR 1995 J&K 91 third party should include everyone (other than the contracting parties to the
insurance policy), be it a person traveling in another vehicle, one walking on the road or a
passenger in the vehicle itself which is the subject matter of insurance policy.
Salient Features of Third Party Insurance
Ø Third party insurance is compulsory for all motor vehicles. In G. Govindan v. New India
Assurance Co. Ltd, AIR 1999 SC 1398 Third party risks insurance is mandatory under the statute
.This provision cannot be overridden by any clause in the insurance policy.
Third party insurance does not cover injuries to the insured himself but to the rest of the world
who is injured by the insured.
Ø Beneficiary of third party insurance is the injured third party, the insured or the policy holder is
only nominally the beneficiary of the policy. In practice the money is always paid direct by the
insurance company to the third party (or his solicitor) and does not even pass through the hands of
the insured person.
Ø In third party policies the premiums do not vary with the value of what is being insured because
what is insured is the legal liability' and it is not possible to know in advance what that liability
will be.
Ø Third party insurance is almost entirely fault-based.(means you have to prove the fault of the
insured first and also that injury occurred from the fault of the insured to claim damages from him)
Ø Third party insurance involves lawyers aid
Ø The third party insurance is unpopular with insurance companies as compared to first party
insurance, because they never know the maximum amounts they will have to pay under third party
policies.
Motor Vehicles Acts,1939 and 1988

Motor Vehicles Act,1939 (4 of 1939) consolidates and amends the law relating to
motor vehicles. This has been amended several times to keep it up to date.The need
was, however felt that this Act should, now interalia take into account also changes
in the road transport technology, pattern of passenger and freight movements,
development of the road network in the country and particularly the improved
techniques in the motor vehicles management.
The Motor Vehicles Act,1988 which came into force on 1st July,1988 and which is
divided into XIV Chapters, 217 Sections and two schedules, makes it compulsory
for every motor vehicle to be insured. Chapters X,XI and XII of the 1988 Act deals
with compensation provisions. Sections 140 to 144 (Ch.X) deal with liability with
out fault in certain cases. Chapter XI (Ss. 145 to 164) deal with insurance of motor
vehicles against third party risks.
Historical Background of third Party Insurance

Chapter VIII of the 1939 Act and Chapter XI of the 1988 Act have been enacted on
the pattern of several English statutes which is evident from the report of Motor
Vehicles Insurance Committee,1936-1937'In order to find out the real intention for
enacting Ss.96 of the 1939 Act which corresponds to Ss.149 of the 1988 Act, it is
relevant to trace the historical development of the law for compulsory third –party
insurance in England. Prior to 1930, there was no law of compulsory insurance in
respect of third party rights in England. As and when an accident took place an
injured used to bring action against the motorist for recovery of damages.
But in many cases it was found that the owner of the offending vehicle had no means
to pay to the injured or the dependant of the deceased and in such a situation the
claimants were unable to recover damages. It is under such circumstances that
various legislations were enacted. To meet the situation it is for the first time the
Third Parties' Rights Against Insurance Act,1930' was enacted in England. The
provision of this Act found place in S.97 of the 1939 Act which gave to the third
party a right to sue insurer directly. Subsequently, the road traffic Act,1930' was
enacted which provided for compulsory insurance for Motor Vehicles. The
provisions of this Act were engrafted in S.95 of the 1939 Act and S.146 of the 1988
Act. It is relevant that under S.38 of the English Act of 1930, certain conditions of
insurance policy were made ineffective so far as third parties were concerned .The
object behind the provision was that the third party should not suffer on account of
failure of the insured to comply with those terms of the insurance policy.
Subsequently in 1934, the second Road Traffic Act was enacted. The object of this
legislation was to satisfy the liability of the insured. Under this enactment three
actions were provided .The first was to satisfy the award passed against the insured.
The second was that, in case the insurer did not discharge its liability the claimant
had the right to execute decree against the insurer. However, in certain events,
namely, what was provided in section Ss.96(2)(a) which corresponds to section 149
(2)(a) of the 1988 Act, the insurer could defend his liability.
The third action provided for was contained in S.10(3) of the Road Traffic Act.
Under this provision, the insurer could defend his liability to satisfy decree on the
ground that insurance policy was obtained due to misrepresentation or fraud. This
provision also found place in S.149 (2)(b) of the 1988 Act. While enacting the 1939
Act and the 1988 Act, all the three actions were engrafted in S.96 of the 1939 Act
and Section 149 of the 1988 Act. However neither the 1939 Act, nor the 1988 Act
conferred greater rights on the insurer than what had been conferred in English Law.
Thus, in common law, an insurer was not permitted to contest a claim of a claimant
on merits, i.e. offending vehicle was not negligent or there was contributory
negligence. The insurer could contest the claim only on statutory defences specified
for in the statute. Thus while enacting Chapter VIII of the 1939 Act or Chapter XI
of the 1988 Act, the intention of the legislature was to protect third party rights and
not the insurers even though they may be nationalized companies.
Prohibition on use of motor vehicles without statutory insurance policy, object of is

to enable the third party suffering injuries from use of the motor vehicle to get
damages irrespective of the financial capacity or solvency of the driver or the owner.
Relevant Provisions of Motor Vehicles Act,1988

Chapter 11 (Section 145 to 164) provides for compulsory third party insurance,
which is required to betaken by every vehicle owner. It has been specified in Section
146(1) that no person shall use or allow using a motor vehicle in public place unless
there is in force a policy of insurance complying with the requirement of this
chapter.[3] Contravention of the provisions of section 146 is an offence and is
punishable with imprisonment which may extend to three months or with fine which
may extend to one thousand rupees or with both (section 196).Section 147 provides
for the requirement of policy and limit of liability. Every vehicle owner is required
to take a policy covering against any liability which may be incurred by him in
respect of death or bodily injury including owner of goods or his authorized
representative carried in the vehicle or damage to the property of third party and also
death or bodily injury to any passenger of a public service vehicle. According to this
section the policy not require covering the liability of death or injuries arising to the
employees in the course of employment except to the extent of liability under
Workmen Compensation Act. Under Section 149 the insurer have been statutorily
liable to satisfy the judgment and award against the person insured in respect of third
party risk.
Insurance Companies have been allowed no other defence except the

following:
(1) Use of vehicle for hire and reward not permit to ply such vehicle.
(2) For organizing racing and speed testing;
(3) Use of transport vehicle not allowed by permit.
(4) Driver not holding valid driving license or have been disqualified for holding
such license.
(5) Policy taken is void as the same is obtained by non-disclosure of material fact.
Section152. Settlement between insurers and insured persons.

(1) No settlement made by an insurer in respect of any claim which might be made
by a third party in respect of any liability of the nature referred to in clause (b) of
sub-section (1) of section 147 shall be valid unless such third party is a party to the
settlement.
(2) Where a person who is insured under a policy issued for the purposes of this
Chapter has become insolvent, or where, if such insured person is a company, a
winding up order has been made or a resolution for a voluntary winding up has been
passed with respect to the company, no agreement made between the insurer and the
insured person after the liability has been incurred to a third party and after the
commencement of the insolvency or winding up, as the case may be, nor any waiver,
assignment or other disposition made by or payment made to the insured person after
thecommencement aforesaid shall be effective to defeat the rights transferred to the
third party under this Chapter, but those rights shall be the same as if no such
agreement, waiver, assignment or disposition or payment has been made.
Legal defence available to the Insurance Companies towards third party:

The Insurance Company cannot avoid the liability except on the grounds and not any
other ground, which have been provided in Section 149(2). In recent time, Supreme
Court while dealing with the provisions of Motor Vehicle Act has held that even if
the defence has been pleaded and proved by the Insurance Company, they are not
absolve from liability to make payment to the third party but can receive such
amount from the owner insured. The courts one after one have held that the burden
of proving availability of defence is on Insurance Company and Insurance Company
has not only to lead evidence as to breach of condition of policy or violation of
provisions of Section 149(2) but has to prove also that such act happens with the
connivance or knowledge of the owner. If knowledge or connivance has not been
proved, the Insurance Company shall remain liable even if defence is available.
Driving License:
Earlier not holding a valid driving license was a good defence to the Insurance
Company to avoid liability. It was been held by the Supreme Court that the Insurance
Company is not liable for claim if driver is not holding effective & valid driving
licence. It has also been held that the learner's licence absolves the insurance
Company from liability, but later Supreme Court in order to give purposeful
meaning to the Act have made this defence very difficult.
In Sohan Lal Passi's v. P. Sesh Reddy, AIR 1996 SC 2627 it has been held for the
first time by the Supreme Court that the breach of condition should be with the
knowledge of the owner. If owner's knowledge with reference to fake driving licence
held by driver is not proved by the Insurance Company, such defence, which was
otherwise available, can not absolve insurer from the liability. Recently in a dynamic
judgment in case of Swaran Singh, the Supreme Court has almost taken away the
said right by holding;
(i) Proving breach of condition or not holding driving licence or holding fake licence
or carrying gratuitous passenger would not absolve the Insurance Company until it
is proved that the said breach was with the knowledge of owner.
(ii) Learner's licence is a licence and will not absolve Insurance Company from
liability.
(iii) The breach of the conditions of the policy even within the scope of Section
149(2) should be material one which must have been effect cause of accident and
thereby absolving requirement of driving licence to those accidents with standing
vehicle, fire or murder during the course of use of vehicle.
This judgment has created a landmark history and is a message to the Government
to remove such defence from the legislation as the victim has to be given
compensation.
Nature and Extent of Insurer's Liability (section 147)

According to the provisions of this section the policy of insurance must be issued by
an authorized insurer.It must be as per requirements as specified in subsection (2).It
must insure against liability in respect of death or bodily injury or damage to
property of a third party. Third party includes owner of the goods or his authorized
representative carried in the vehicle and any passenger of a public service vehicle.
The policy of insurance must cover:
1.Liability under the Workmen's compensation Act,1923 in respect of death or

bodily injury to any such employee
(a) engaged in driving the vehicle, or
(b) the conductor or ticket examiner if it is a public service vehicle ,or
2. any contractual liability.
Section 147 has to be given wider, effective and practical meaning so that it may
benefit various categories of persons entitling them to claim compensation from the
insurer or the insured or both. Insurer's liability commences as soon as the contract
of insurance comes into force. The liability remains in existence during the operation
of the policy. If the existing policy is renewed the risk is covered from the moment
the renewal of the policy comes into force. If the accident occurs before the renewal
comes into existence, the insurer cannot be made liable. It is the primary duty of the
vehicle owner to prove that his vehicle was insured with a particular company. If he
fails to comply with it he will have to pay the entire amount of compensation in the
case. In case where there is a dispute in respect of the vehicle having been insured
by an assurance company, the tribunal must give its finding in the matter, it is its
duty to do so. After a certificate of insurance is issued it does not lie in the mouth of
the insurer to deny his liability. If the insurer has been a victim of fraud he can
recover the amount from the insured by a separate action against him.
Oriental Insurance Co. v. Inderjit Kaur, AIR1998 SC 588

If the insurer has issued a policy to cover the bus without receiving the premium
therefore, he has to indemnify third parties in respect of the liability covered by the
policy. He cannot avoid the liability arguing that he was entitled to avoid or cancel
the contract.
Liability for injury to certain persons or class of persons (other than gratuitous
passengers and pillion riders)
The policy under the Act covers only third party risks. Insurer is not liable for any
harm suffered by a passenger traveling in a private car neither for hire nor for reward.
Similar is the position of a pillion rider on a scooter.
K. Gopal Krishnan v. Sankara Narayanan, AIR 1968 Mad 438
In this case Madras High Court observed that a scooter-owner is not bound to take
out a third party risk policy to cover the claim of the pillion rider that is carried
gratuitously. If he is injured , the insurance company would not be liable unless
policy covering such risk is obtained by the scooter-owner. A private carrier
registered as such with R.T.O. and also in insurance policy , cannot be used for
carrying any passenger or goods for hire or reward. However if it is so used and the
employees of a party hiring the private vehicle belonging to the insured are injured
in an accident the insurance company will not be liable.
Insurer's liability to Vehicle-owner
A contract of insurance is a personal contract between the insurer and the insured. It
is for the purpose of indemnifying the insured for damage caused due to accident by
the vehicle , to a third party. To make the insurer liable the policy of insurance must
be in the name of the owner of the vehicle. Raj Chopra v. Sangara Singh, 1985 ACJ
209 (P & H) Owner of the vehicle as defined in Section 2(30) is a person in whose
name the motor vehicle stands registered.
A person in possession of a vehicle under a hire-purchase agreement or an agreement

of lease or hypothecation is also covered by the definition, no matter he has exercised
his option to purchase the vehicle or not.
Section 157(1) makes it clear that when the owner of a vehicle transfers the
ownership of the vehicle , the policy of insurance and the certificate of insurance
shall be deemed to have been transferred in favour of the purchaser of the vehicle
with effect from the date of its transfer.This deemed transfer shall include transfer
of rights and liabilities of the said certificate of insurance and policy of insurance.
According to subsection (2) the transferee has to apply within 14 days from the date
of transfer to the insurer for effecting necessary changes in the certificate and in the
policy of insurance.
If the certificate of insurance and the policy are not transferred , the insurer could
not be made liable even though the vehicle is transferred. It is to be remembered that
an insurance policy is a personal contract between the parties for indemnifying the
insured in case of an accident covered under the policy. If the vehicle is transferred
by an insured to another person, the insurance policy lapses upon the transfer. In
such a case the benefit of the policy is not available to the transferee, without an
express agreement with the insurance company. When the insurance policy lapses it
would not be available to cover the liability of the purchaser of the vehicle.
S.Sudhakaran v. A.K.Francis, AIR 1997 Ker 26

There was an agreement for sale of a vehicle. The owner did not comply with the
statutory provisions regarding transfer of a vehicle.He, however ,allowed the vehicle
to be used by the transferee .The owner had retained the insurance policy with him.
Held— The insurance company was not liable to indemnify the owner.
Liability in respect of damage to property [S.147(2)]

For damage to property of a third party under 1939 Act the limit of liability is Rs
6000 in all, irrespective of the class of the vehicle. Under 1988 Act the position as
laid down by section 147 (2) in regard to liability is as under:
(i) For death or personal injury to a third party, the liability of the insurer is the
amount of liability incurred, i.e. for the whole amount of liability.
(ii) For damage to property of a third party the liability of the insurer is limited to
Rs. 6000 as was under the 1939 Act.
Liability of Insurer beyond the limits mentioned in the Act

Section 147 lays down the limits of liability of the insurer. However there is no bar
for the insurer undertaking a higher liability i.e. liability for a greater amount than
that mentioned in the Act. Thus the insured and the insurer can contract and can
provide for a higher liability.
Conclusion
The third party liability insurance under the motor Vehicles Act, 1988.Third party
insurance protects the interest of a third party who becomes the victim of accident
or injury caused by the fault of the insured. So any liability arising on the insured by
the third party is mitigated by the insurance company. Third party insurance is
compulsory under the motor vehicles Act,1988. As the third party insurance is
mandatory so it cannot be overridden be any clause in the insurance policy.
It is the duty of insurers to satisfy the judgments and awards against persons insured
in respect of third party risks. The insurance company is a State' within the meaning
of article 12 of the Constitution. For this reason it cannot deny , discriminate or
refuse third party insurance cover to State run vehicles because their actions are
guided by Article 14 of the Constitution.
The compulsory nature of third party insurance is justifiable as it makes the process
more easy for the injured person to recover money from the insured. The defendant
or wrongdoer cannot be exempted on the ground that he has become insolvent. If he
owns a vehicle he bound to pay to the injured directly or through his insurance
company.
Unit IV C: Constitution, Functions and Powers of Insurance Regulatory and

Development Authority
IRDA | Powers | Composition | Duties | Functions

IRDA ACT
In order to control private sector insurance companies, the Government of
India passed the IRDA Act (Insurance Regulatory and Development Authority
Act, 1999) which enabled it to regulate the private sector companies in
insurance business. What was the sole monopoly of the LIC is now thrown
open to the private sector for covering the life and property of individuals.
Now, the IRDA controls the entire insurance business in India.
POWERS OF IRDA
The following are the powers of IRDA
1. All insurance companies have to register with IRDA compulsorily.
2. Companies can undertake only insurance business.
3. The capital structure of the companies will be determined by IRDA.
4. Companies have to deposit with RBI the amount stipulated by IRDA.
5. Accounts and balance sheets of companies have to be submitted to IRDA.
6. Insurance companies have to appoint actuaries and they will value the
liabilities of the insurance companies and report the same to IRDA.
7. Investment of assets will be prescribed by IRDA in the form of approved

securities.
8. The nature of general insurance business will be prescribed by IRDA.
9. Statements of investment assets to be submitted to IRDA every financial

year.
10. All insurance companies have to devote certain percentage of their business
including insurance for crops. This should cover unorganized sector including
the economically weaker sections.
11. The appointment of chief executive officer requires prior permission of the
IRDA.
12. All insurance agents must obtain license from IRDA.
13. IRDA has powers for levying penalty on companies which fail to comply
with the rules and regulations.
COMPOSITION OF IRDA
One chairperson and not more than 9 members of whom not more than 5 would
be full time members and they are appointed by the government. Those who
have experience in life and general insurance, actuarial service, finance,
economics etc., are appointed.
DUTIES OF IRDA
1. Regulates insurance companies
The working of insurance companies will be regulated in the following aspects
▪ the persons to be employed,

▪ the nature of business,
▪ covering of risks,
▪ terms and agreements for covering risks etc., will be prescribed by IRDA.
2. Promotes insurance companies
Corporate set-up is a must for establishing an insurance company and they have
to submit periodical reports to IRDA. Different kinds of policies and different
types of insurance are also suggested by IRDA to these insurance companies.
3. Ensures growth of insurance and reinsurance companies

Here, the promotion of new companies is encouraged. Even banks are also
permitted to promote insurance companies as a subsidiary.
FUNCTIONS OF IRDA
1. Issuing certificate of registration.
2. protecting the interest of policy holders.
3. issuing license to agents.
4. Specifying code of conduct for surveyors and loss assessors.
5. Promoting efficiency in the insurance business.
6. Undertaking inspection, conducting enquiries etc., on insurance companies.
7. Control and regulations of rates, terms and conditions by insurance company

to policy holders.
8. Adjudication of disputes between insurance company and others in the
insurance business.
9. Fixing the percentage of insurance business to rural and social sectors.
Insurance Ombudsman by IRDA:

On the lines of Bank ombudsman, an insurance ombudsman was created by
IRDA. The main purpose of the creation of the ombudsman is to cover disputes
arising between the insured and the insurer. Any complaint made on insurance
companies will be settled by the insurance ombudsman. It is more a watch dog
by which the functioning of the insurance company will be disciplined.
Insurance Ombudsman is basically a consumer protection exercise. The

insured need not worry about their policy amount as any complaint lodged with
the ombudsman will have legal sanctity and even criminal action can be
initiated against the erring insurance company.
Thus, enough judiciary powers are given to insurance ombudsman by which

speedy settlement of cases connected with individual policy holder is possible.
Section 14 of IRDAI Act, 1999 lays down the duties, powers and
functions of IRDAI..
Subject to the provisions of this Act and any other law for the time being
in force, the Authority shall have the duty to regulate, promote and
ensure orderly growth of the insurance business and re-insurance
business.
1. Without prejudice to the generality of the provisions contained in sub-
section (1), the powers and functions of the Authority shall include, -
o issue to the applicant a certificate of registration, renew, modify,

withdraw, suspend or cancel such registration;
o protection of the interests of the policy holders in matters
concerning assigning of policy, nomination by policy holders, insurable
interest, settlement of insurance claim, surrender value of policy and
other terms and conditions of contracts of insurance;
o specifying requisite qualifications, code of conduct and practical
training for intermediary or insurance intermediaries and agents
o specifying the code of conduct for surveyors and loss assessors;
o promoting efficiency in the conduct of insurance business;
o promoting and regulating professional organisations connected
with the insurance and re-insurance business;
o levying fees and other charges for carrying out the purposes of this
Act;
o calling for information from, undertaking inspection of,
conducting enquiries and investigations including audit of the insurers,
intermediaries, insurance intermediaries and other organisations
connected with the insurance business;
o control and regulation of the rates, advantages, terms and
conditions that may be offered by insurers in respect of general insurance
business not so controlled and regulated by the Tariff
Advisory Committee under section 64U of the Insurance Act, 1938 (4 of
1938);
o specifying the form and manner in which books of account shall
be maintained and statement of accounts shall be rendered by insurers
and other insurance intermediaries;
o regulating investment of funds by insurance companies;
o regulating maintenance of margin of solvency;
o adjudication of disputes between insurers and intermediaries or
insurance intermediaries;
o supervising the functioning of the Tariff Advisory Committee;
o specifying the percentage of premium income of the insurer to
finance schemes for promoting and regulating professional organisations
referred to in clause (f);
o specifying the percentage of life insurance business and general
insurance business to be undertaken by the insurer in the rural or social
sector; and
o exercising such other powers as may be prescribed
Unit IV (i) Application of Consumer Protection Act, 1986
The industrial revolution and the development in the international trade and
commerce has led to the vast expansion of business and trade, as a result of which a
variety of consumer goods have appeared in the market to cater to the needs of the
consumers and a host of services have been made available to the consumers like
insurance, transport, electricity, housing, entertainment, finance and banking. A
well organised sector of manufacturers and traders with better knowledge of markets
has come into existence, thereby affecting the relationship between the traders and the
consumers making the principle of consumer sovereignty almost inapplicable. The
advertisements of goods and services in television, newspapers and magazines
influence the demand for the same by the consumers though there may be
manufacturing defects or imperfections or short comings in the quality, quantity and the
purity of the goods or there may be deficiency in the services rendered. In addition, the
production of the same item by many firms has led the consumers, who have little time
to make a selection, to think before they can purchase the best. For the welfare of the
public, the glut of adulterated and sub-standard articles in the market have to be
checked. In spite of various provisions providing protection to the consumer and
providing for stringent action against adulterated and sub-standard articles in the
different enactments like Code of Civil Procedure, 1908, the Indian Contract Act, 1872,
the Sale of Goods Act, 1930, the Indian Penal Code, 1860, the Standards of Weights
and Measures Act, 1976 and the Motor Vehicles Act, 1988, very little could be achieved
in the field of Consumer Protection. Though the Monopolies and Restrictive Trade
Practices Act, 1969 arid the Prevention of Food Adulteration Act, 1954 have provided
relief to the consumers yet it became necessary to protect the consumers from the
exploitation and to save them from adulterated and sub-standard goods and services and
to safe guard the interests of the consumers. In order to provide for better protection of
the interests of the consumer the Consumer Protection Bill, 1986 was introduced in
the Lok Sabha on 5th December, 1986.
STATEMENT OF OBJECTS AND REASONS

The Consumer Protection Act, 1986 seeks to provide for better protection of the
interests of consumers and for the purpose, to make provision for the establishment of
Consumer councils and other authorities for the settlement of consumer disputes and
for matter connected therewith.
It seeks, inter alia, to promote and protect the rights of consumers such as-
(a) the right to be protected against marketing of goods which are

hazardous to life and property;
(b) the right to be informed about the quality, quantity, potency, purity,
standard and price of goods to protect the consumer against unfair trade
practices;
(c) the right to be assured, wherever possible, access to an authority
of goods at competitive prices;
(d) the right to be heard and to be assured that consumers interests will
receive due consideration at appropriate forums;
(e) the right to seek redressal against unfair trade practices or unscrupulous
exploitation of consumers; and
(f) right to consumer education.
3. These objects are sought to be promoted and protected by the Consumer

Protection Council to be established at the Central and State level.
4. To provide speedy and simple redressal to consumer disputes, a quasi-judicial
machinery is sought to be setup at the district, State and Central levels. These quasi-
judicial bodies will observe the principles of natural justice and have been empowered
to give relief of a specific nature and to award, wherever appropriate, compensation to
consumers. Penalties for noncompliance of the orders given by the quasi-judicial bodies
have also been provided.

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Chanderprabhu Jain College of Higher Studies

Paper Code : LLB -409 (A)

Subject :BANKING AND INSURANCE LAWS

UNIT I : BANKING SYSTEM IN INDIA

A. KINDS OF BANKS AND THEIR FUNCTIONS

1. It must have a paid up capital of at least Rs. 5 lakhs.

I. Public Sector Banks – Majority stake is held by Government

HISTORY OF BANKING IN INDIA

UNIT II C: BANKING REGULATION LAWS

Banking Regulation Act, 1949

(i) Trading activities of goods are restricted as per Section 8

Unit I d. Bank Nationalization and Social Control over Banking

Number of banks Authorised Capital Paid-up Capital

1914 42 710 109

• Punjab and Sind Bank

The banker and the customer.

Meaning and Definition of a Banker.

The late Dr. Hartdefined a banker or banks as:

Likewise, Halsbury’s laws of England defines a banker as:

An individual, partnership or corporation, whose sole or pre-dominating business is

Views expressed by the courts

“the principal part of the business of a banker is receiving money on

Thus, to constitute a customer, the following prerequisites are a must:

Special Types of Customers

The Banker-Customer Relationship

Primary relationship, and

(a) Primary Relationship

(i) Relationship as Debtor and Creditor

(ii) Demand for Repayment Necessary

(iii) Demand should be made at Proper Time and Place

(iv) Incidence of Statute of Limitation

(v) Demand must be made in a Proper Manner

(b) Secondary Relationship

Banker as Trustee and Beneficiary

The difference between a banker as a debtor and a banker as a trustee may be as

A banker acts as a trustee in holding money or documents and performing certain

(ii) Relationship as Agent and Principal

(iii) Relationship as Bailee and Bailor

(iv) Relationship as Morgagee and Mortgagor

(v) Relationship as Lessee and lessor

Relationship Defined by the Rules of Banking Practice

Special Features of the Relationship

Right of Closing an Account

Banker’s Rights: Banker’s Lien

Rule in Clayton’s case

Banker’s Duty to Honour Cheques

Banker’s Duty for Collection of Cheques and Other Instruments

Banker’s Duty to supply Bank Statement

Banker’s Duty to Maintain secrecy

(i) When the law requires such disclosure to be made; and

Disclosure of Information Required by Law

Under the Income Tax Act, 1961

Under the Companies act, 1956

Under the Reserve Bank of India Act, 1934

Under the banking Regulation Act, 1949

Under the Gift Tax Act, 1958

Under the Foreign Exchange Management Act, 1999

Under the Industrial Development Bank of India Act, 1964

Liability under Consumer Protection Act, 1986

UNIT-II- : LENDING, SEURITIES AND RECOVERY BY

LENDING, SECURITIES AND RECOVERY BY BANKS

Important Principles of Lending in

Borrower may differ in terms of their purpose of advance, activities, financial

Identification of borrower: Selection of a borrower is a most important factor to