1

Law of Banking for BALLB and LLB

Study Material
As on 5th September 2023

Compiled by:
A. Chandra Sekhar., M.B.A., LLM.,
UGCNET-Law, TSSET-Law, TSSET-Management
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Sl No. Topic Page No.

Unit I
1.1 History of Banking Regulation Act 3
1.2 Salient Features of the Banking Regulation Act, 1949 6
1.3 Banking Business and its importance in Modern times 8
1.4 Different Kinds of Banking 10
1.5 Impact of Information Technology on Banking 12
1.6 RBI’s role in controlling credit of Commercial Banks 14
Unit II
2.1 Relationship between Banker and Customer 21
2.2 Relationship of Debtor and Creditor 24
2.3 Fiduciary Relationship 26
2.4 Trustee and Beneficiary 28
2.5 Principal and Agent 31
2.6 Bailor and Bailee 33
2.7 Guarantor-Beneficiary relationship 35
Unit III
3.1 Cheque 46
3.2 Crossed cheques 48
3.3 Account Payee cheque 51
3.4 Banker’s Drafts 52
3.5 Dividend Warrant 55
3.6 Negotiable Instruments 59
3.7 Deemed Negotiable Instruments 72
3.8 Salient features of the NI Act, 1881 77
3.9 The Negotiable Instruments (Amendment) Act, 2018 82
Unit IV
4.1 The Paying Banker 84
4.2 Statutory protection to Paying Bankers 86
4.3 Rights and Duties of a Paying Banker 90
4.4 Collecting Banker-Statutory protection to Collecting Banker 92
4.5 Rights and Duties of a Collecting Banker 94
Unit V
5.1 Banker’s lien and set-off 96
5.2 Advance 99
5.3 Pledge 106
5.4 Land 108
5.5 Stocks 111
5.6 Shares 114
5.7 Life policies 116
5.8 Document of Title to Goods 118
5.8.1 Document of Title to Goods as Security for Advances 120
5.9 Bank Guarantees 122
5.10 Letters of Credit 126
5.10.1 Uniform Customs & Practice for Documentary Credit 128
5.10.2 Parties to LC 130
5.11 Differences between LC and BG 134
5.12 Recovery of Bank Loans and Position under Securitization Act, 2002 135
5.13 Jurisdiction and Powers of DRT 139
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Law of Banking for BALLB and LLB 3 YDC

Unit I Syllabus
History of Banking Regulation Act – Salient Features – Banking Business and its importance in
Modern Times – Different Kinds of Banking – Impact of Information Technology on Banking.

1.1 History of Banking Regulation Act

Introduction
The provisions of law relating to banking companies at present form a subsidiary portion of the
general law applicable to companies and are contained iin Part XA of the Indian Companies Act,
1913. These provisions, which were first introduced in 1936, and which have undergone two
subsequent modifications, have proved inadequate and difficult to administer. Moreover which
the primary objective of Companies Law is to safeguard the interests of the stock-holder, that
of banking legislation should be the protection of the interests of the depositor.

Therefore, it has been felt for some time that a separate legislation was necessary for the
regulation of banking in India. This need has become more insistent on account of the
considerable development that has taken place in recent years in banking, especially the rapid
growth of banking resources and of the number of banks and branches. Regard must also be
had to the fact that the banking system is likely to be more vulnerable by reason of the great
expansion, both quantitatively and relatively, that has taken place in demand deposits, as
compared with time deposits, during the war years.

Hence the enactment of a separate comprehensive measure has in consequence now become
imperative.

With the above object in view, a Bill to amend the law relating to Banking Companies was
introduced in the legislative assembly in November, 1944, and was subsequently circulated for
eliciting public opinion through the Provincial Governments. In the ensuing Budget Session of
the Assembly, the Bill was referred to a Select Committee which was due to meet in October,
1945, but it lapsed before its consideration by the Committee. A fresh Bill with certain
modifications which suggested themselves on consideration of the opinions and criticisms
received on the 1944 – Bill was introduced in the Legislative Assembly in March, 1946 and was
referred to a Select Committee in April, 1946.

The report of the Select Committee was presented to the Assembly on the 17 th February 1947.
As it was the original intention of the Government that the Bill should be taken up for disposal
by the Constituent Assembly (Legislative) in the form in which it emerged from the Select
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Committee and that the changes necessitated in the Bill as a result of the passing of the Indian
Independence Act, 1947, and other developments should be moved in the House as separate
amendments, a motion for the continuation of that Bill was adopted on the 17th November,
1947. However, in view of a fairly large number of amendments, Government considered that
the passage of the measure would be facilitated if the Bill as reported upon by the Select
Committee were withdrawn and a fresh Bill incorporating all amendments were introduced and
referred to a Select Committee.

The bill was accordingly withdrawn on 30th January, 1948. The present Bill is the result of long
and detailed considerationn by expert Committees, the Reserve Bank, the public, including the
representatives of Banks, the Government and the legislature.

Note: It may be noted that originally the enactment was titled, Banking Companies Act, 1949.
Later in the year 1965, an amendment changed the title of the enactment to Banking
Regulation Act, 1949.

Main features of the Bill

1. A comprehensive definition of “banking” so as to bring within the scope of the
legislation all institutions which receive deposits, repayable on demand or otherwise, for
lending or investment;
2. Prohibiting non-banking companies from accepting deposits repayable on demand;
3. Prohibition of trading (by banks) with a view to eliminating non-banking risk;
4. Prescription of minimum capital standards;
5. Limiting the payment of dividends;
6. Inclusion in the scope of legislation of banks incorporated and registered outside the
Provinces of India;
7. Introduction of the comprehensive system of licensing of banks and their branches;
8. Prescription of a special form of balance sheet and conferring of powers on the Reserve
Bank to call for periodical returns;
9. Provisions for bringing the Reserve Bank of India into closer touch with Banking
Companies;
10. Provision for expeditious procedure for liquidation;
11. Inspection of books and accounts of a bank by the Reserve Bank;
12. Empowering the Central Government to take action against Banks conducting their
affairs in a manner detrimental to the interests of the depositors;
13. Bringing the Imperial Bank of India within the purview of some of the provisions of the
Bill;
14. Widening the powers of the RBI so as to enable it to come to the aid of Banking
Companies in times of emergency;
15. Provision for the extension of the Act to the acceding States;
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Important Amendments to the Banking Regulation Act, 1949

1. Amendment Act 20 of 1950: The Banking Companies (Amendment) Ordinance, 1949 was
promulgated on 19th September, 1949. This Act now incorporates the provisions contained
therein in the Banking Companies Act, 1949 as a permanent basis. In addition, this Act also
amends the said Act for the following purpose:

a) To incorporate special provisions for facilitating quick amalgamation between banking

companies.
b) To empower the Reserve Bank to control opening of branches by Indian banks in foreign
countries etc.

2. Amendment Act 95 of 1956: This Amendment Act aims to –

a) enable the RBI to obtain statements and information over a wider range than hitherto
for the performance of the functions under the Act;
b) enable the RBI to give directions to banking companies in relation to matters of policy or
administration affecting the public interest, and to make failure to observe such
directions liable to specified penalties;

3. Amendment Act 23 of 1965: The name, Banking Companies Act, 1949 has been changed to
Banking Regulation Act, 1949 by this Amendment.

4. Amendment Act 24 of 2004: The Hon’ble Supreme Court in the case of Apex Cooperative
Bank of Urban Bank of Maharashtra & Goa Ltd vs. Maharashtra State Cooperative Bank Ltd. &
Others, held that RBI is not empowered under Section 22 of the Banking Regulation Act, 1949
to issue licence to Multi-state cooperative bank. In order to remove this hurdle this amendment
was passed to provide that the licences granted to the existing Multi-State cooperative banks
by the RBI shall be deemed to have been validly granted. And also to enable the RBI to issue in
future the licences to cooperative societies registered under the Multi-State Cooperative
Societies Act, 2002 to carry on the Banking business.
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1.2 Salient Features of the Banking Regulation Act,

1949
The Banking Regulation Act, 1949, is a significant piece of legislation that governs the banking
sector in India. It lays down the legal framework for the functioning, regulation, and supervision
of banking companies. Here are the salient features of the Banking Regulation Act, 1949:

1. Licensing of Banks: The act introduced a licensing system for banks, making it mandatory for
any banking company to obtain a license from the Reserve Bank of India (RBI) before
commencing banking business in India. This provision grants the RBI the authority to control the
entry of new banks into the market.

2. Central Banking Authority: The act establishes the RBI as the central banking authority with
extensive regulatory powers over the banking sector. The RBI's role is to regulate, supervise,
and control the functioning of banks to maintain financial stability and protect the interests of
depositors.

3. Regulation of Banking Operations: The act provides detailed regulations for various aspects
of banking operations. It covers the acceptance of deposits, types of accounts, lending
practices, investment restrictions, and other banking activities. These regulations are meant to
ensure transparency, accountability, and fair practices within the banking industry.

4. Capital and Reserve Requirements: The act prescribes the minimum capital requirements for
banks. Banks are required to maintain a specified percentage of their demand and time
liabilities as statutory reserves with the RBI. These reserve requirements aim to ensure the
financial stability of banks and the availability of sufficient funds to meet depositor demands.

5. Control over Management: The act grants the RBI control over the appointment, removal,
and remuneration of directors and top executives of banking companies. This provision is
designed to prevent undue influence, ensure competent leadership, and maintain the integrity
of bank management.

6. Branch Licensing: The act regulates the opening and closing of bank branches. Banks are
required to seek prior approval from the RBI before establishing new branches. This control
over branch expansion helps in maintaining the systematic growth of the banking sector.

7. Inspections and Supervision: The act empowers the RBI to conduct inspections and audits of
banking companies to ensure compliance with regulatory guidelines. The RBI can examine the
books, accounts, and other records of banks to assess their financial health and adherence to
prudential norms.
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8. Banking Business Restrictions: The act prohibits banking companies from engaging in certain
activities not related to banking, thus limiting their scope of operations to core banking
functions.

9. Disclosure and Transparency: The act mandates banking companies to disclose financial
statements, balance sheets, and profit and loss accounts regularly. This promotes transparency
and helps stakeholders, including depositors, investors, and the public, to assess the financial
health of banks.

10. Amalgamation and Reconstruction: The act provides provisions for the amalgamation and
reconstruction of banking companies with the prior approval of the RBI. These provisions
enable the RBI to oversee the consolidation and restructuring of banks for the overall benefit of
the banking sector.

The Banking Regulation Act, 1949, has undergone several amendments over the years to adapt
to the changing dynamics of the banking industry and to address emerging challenges. It
remains a critical piece of legislation that forms the backbone of the banking regulatory
framework in India.
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1.3 Banking Business and its Importance in Modern

times
The importance of banking business in modern times cannot be overstated. Banks play a vital
role in the functioning of economies and societies around the world. They provide a range of
essential financial services that contribute to economic growth, financial stability, and
individual well-being. Here are some key reasons why banking business is crucial in modern
times:

1. Financial Intermediation: Banks act as intermediaries between savers and borrowers. They
collect deposits from individuals and businesses and then lend these funds to individuals,
businesses, and governments that need capital for various purposes, such as investment,
consumption, or infrastructure projects. This process of financial intermediation facilitates the
efficient allocation of resources in the economy.

2. Facilitating Economic Growth: Access to credit and financial services is essential for
economic growth and development. Banks provide the necessary financial resources to
entrepreneurs and businesses, enabling them to invest in new projects, expand operations, and
create job opportunities. A healthy banking sector supports economic activity and fosters
innovation and entrepreneurship.

3. Payment Systems: Banks facilitate the smooth functioning of payment systems, allowing
individuals and businesses to conduct transactions efficiently. The use of checks, debit cards,
credit cards, online banking, and electronic fund transfers enables secure and convenient
payment methods for day-to-day activities and business operations.

4. Safekeeping of Funds: Banks offer a safe and secure environment for individuals and
businesses to keep their money. By depositing funds in banks, people can reduce the risk of loss
due to theft or accidents, and they can earn interest on their deposits, encouraging savings and
financial planning.

5. Financial Inclusion: Banking business plays a critical role in promoting financial inclusion,
ensuring that all individuals and businesses have access to financial services. Banks reach out to
unbanked and underbanked populations, providing them with access to savings accounts,
loans, insurance, and other financial products that empower them economically.

6. Monetary Policy Transmission: Central banks, which are at the core of the banking system,
use monetary policy tools to control the money supply, interest rates, and inflation. These
policies influence borrowing costs, consumer spending, and investment decisions, impacting
overall economic conditions.
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7. Risk Management: Banks offer a variety of risk management services, such as insurance,
hedging instruments, and investment advice. These services help individuals and businesses
mitigate financial risks associated with uncertainties in the market.

8. Capital Market Functions: Banks facilitate capital market activities by underwriting

securities, providing advisory services, and offering brokerage services. These functions
contribute to the efficient functioning of capital markets and enable businesses to raise funds
through debt and equity issuances.

9. International Trade and Commerce: Banks play a pivotal role in facilitating international
trade and commerce by providing trade finance, letters of credit, and foreign exchange
services. They bridge the gap between buyers and sellers from different countries and facilitate
the movement of goods and services globally.

10. Government Banking: Banks also serve as bankers to governments, helping manage public
finances, issuing government securities, and providing a channel for government transactions.

In summary, the importance of banking business in modern times lies in its role as a catalyst for
economic growth, a provider of financial services, a promoter of financial inclusion, and a
crucial component of the overall stability and functioning of modern economies. Banks are at
the heart of financial systems, acting as engines that drive economic activity and prosperity.
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1.4 Different Kinds of Banking

There are several different kinds of banking, each serving specific needs and purposes in the
financial system. Here are some of the main types of banking:

1. Retail Banking: Retail banking, also known as consumer banking, focuses on providing
financial services and products to individual customers. This includes basic services such as
savings accounts, checking accounts, personal loans, credit cards, and mortgages. Retail banks
have a widespread network of branches and ATMs to serve the general public.

2. Commercial Banking: Commercial banking primarily serves businesses and corporations.

Commercial banks offer services like business loans, working capital financing, trade finance,
cash management solutions, and treasury services. They cater to the financial needs of
companies, helping them with their day-to-day operations and growth.

3. Investment Banking: Investment banking involves providing financial advisory services and
facilitating capital-raising activities for businesses, governments, and institutions. Investment
banks assist in mergers and acquisitions (M&A), underwrite securities issuances, offer
corporate finance advice, and manage capital market transactions.

4. Private Banking: Private banking caters to high-net-worth individuals (HNWIs) and provides
personalized banking and wealth management services. These services often include
investment management, estate planning, tax planning, and specialized financial advice tailored
to the unique needs of affluent clients.

5. Islamic Banking: Islamic banking operates in accordance with Islamic principles, which
prohibit the charging or payment of interest (riba) and promote ethical financial practices.
Instead of traditional loans, Islamic banks use profit-sharing arrangements, lease-based
financing, and other Sharia-compliant products.

6. Central Banking: Central banks are the apex monetary authorities responsible for issuing and
regulating a country's currency, implementing monetary policy, and ensuring overall financial
stability. They also act as bankers to the government and provide essential regulatory oversight
to commercial banks.

7. Development Banking: Development banks are specialized financial institutions that provide
long-term financing for projects with economic and social development objectives. They often
support sectors such as infrastructure, agriculture, education, and small and medium-sized
enterprises (SMEs).

8. Cooperative Banking: Cooperative banks are owned and operated by their members, who
are usually individuals or organizations with a common interest. These banks focus on serving
their members' financial needs and often promote financial inclusion in local communities.
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9. Online Banking (Digital Banking): Online banking, also known as digital banking or internet
banking, enables customers to conduct financial transactions and access banking services
through online platforms or mobile applications. It offers convenience and accessibility for
customers, allowing them to manage their finances from anywhere with an internet
connection.

10. Microfinance Institutions: Microfinance institutions (MFIs) provide financial services,

including small loans and savings accounts, to low-income individuals and underserved
communities. These institutions aim to promote financial inclusion and empower marginalized
populations economically.

These different types of banking institutions play critical roles in the financial system,
collectively contributing to economic development, financial stability, and the well-being of
individuals and businesses. Each type of banking serves unique customer segments and
addresses specific financial needs and preferences.
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1.5 Impact of Information Technology on Banking

Information Technology (IT) has had a profound and transformative impact on the banking
industry. It has revolutionized the way banking services are delivered, improving efficiency,
accessibility, and customer experience. Here are some key ways in which information
technology has influenced banking:

1. Online Banking: Information technology has enabled the development of online banking
platforms, allowing customers to access their accounts, make transactions, and manage
finances from the comfort of their homes or through mobile devices. Online banking has
increased convenience, reduced the need for physical branches, and facilitated real-time
transactions.

2. Mobile Banking: The rise of mobile technology has given birth to mobile banking
applications, which have become increasingly popular. Mobile banking allows customers to
conduct various banking activities, such as transferring funds, paying bills, and checking
balances, using their smartphones or tablets. This level of accessibility has revolutionized the
customer-bank relationship.

3. Digital Payments: Information technology has facilitated the proliferation of digital payment
methods, such as mobile wallets, contactless payments, and online payment gateways. These
payment options have made transactions faster, more secure, and more convenient for
customers and merchants alike.

4. Data Analytics and Personalization: Banks leverage data analytics to gain insights into
customer behavior, preferences, and needs. By analyzing customer data, banks can offer
personalized services and targeted product recommendations, enhancing customer satisfaction
and loyalty.

5. Automation and Efficiency: IT has enabled automation of various banking processes,

reducing manual intervention and streamlining operations. Automated systems handle tasks
like account opening, loan processing, and customer support, leading to improved efficiency
and reduced turnaround times.

6. Improved Security Measures: Information technology has driven the implementation of

advanced security measures in banking systems. Multi-factor authentication, biometric
verification, and encryption technologies help protect customer data and prevent fraud.

7. Digital Transformation: IT has prompted a broader digital transformation within the banking
sector. Banks are increasingly adopting technologies like artificial intelligence (AI), machine
learning, blockchain, and robotic process automation (RPA) to enhance operational efficiency,
risk management, and decision-making.
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8. Fintech Collaboration: Information technology has facilitated collaborations between

traditional banks and fintech startups. Fintech companies bring innovative solutions and agile
technology to the table, helping banks improve their offerings, expand their services, and reach
new customer segments.

9. 24/7 Banking: With IT-enabled services, customers can access banking facilities 24/7,
allowing them to manage their finances at any time of the day or night. This flexibility enhances
customer satisfaction and responsiveness.

10. Enhanced Customer Service: IT has revolutionized customer service in banking. Chatbots,
virtual assistants, and AI-driven support systems can handle customer queries promptly,
providing quick resolutions and reducing wait times.

11. Global Connectivity: IT has facilitated global connectivity, enabling international banking
and cross-border transactions. Swift communication channels and real-time settlement systems
have made it easier for banks to operate globally.

In summary, the impact of information technology on banking has been transformative. IT has
reshaped the banking landscape, providing enhanced services, greater accessibility, improved
security, and increased operational efficiency. As technology continues to advance, the banking
industry is likely to see even more innovations and improvements in the way financial services
are delivered and experienced by customers.
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1.6 RBI’s Role in Controlling Credit of Commercial

Banks
The Reserve Bank of India (RBI) controls the advances (loans and credit) of commercial banks
through various monetary policy tools and regulatory measures. The objective is to influence
the flow of credit in the economy, ensure financial stability, and achieve the broader economic
goals set by the government. Here's how RBI controls the advances of commercial banks:

1. Cash Reserve Ratio (CRR): The RBI mandates that commercial banks maintain a certain
percentage of their net demand and time liabilities (deposits) as cash reserves with the central
bank. This is known as the Cash Reserve Ratio (CRR). By adjusting the CRR, the RBI can control
the amount of funds that banks must keep with it, thereby influencing the amount of money
available for lending.

- If the RBI increases the CRR, banks have to hold a higher proportion of their deposits with
the RBI, leaving them with lesser funds available for lending. This reduces the overall credit
supply in the economy.
- If the RBI decreases the CRR, banks are required to keep less money with the RBI, resulting in
a higher availability of funds for lending, which boosts credit in the economy.

2. Statutory Liquidity Ratio (SLR): The RBI mandates that banks maintain a certain percentage
of their net demand and time liabilities in the form of specified liquid assets like government
securities. This is known as the Statutory Liquidity Ratio (SLR). By adjusting the SLR, the RBI can
influence the liquidity position of banks and their ability to extend credit.

- A higher SLR requirement means banks must hold more liquid assets, leaving them with
lesser funds for lending.
- A lower SLR requirement gives banks more flexibility to lend since they have to hold fewer
liquid assets.

3. Repo Rate and Reverse Repo Rate: The RBI sets the Repo Rate, which is the interest rate at
which it lends money to commercial banks for short durations. The Reverse Repo Rate is the
rate at which banks can park their excess funds with the RBI. These rates act as policy rates and
help the RBI influence the cost of borrowing and lending in the economy.

- If the RBI raises the Repo Rate, borrowing becomes more expensive for commercial banks,
leading to higher lending rates for borrowers. This curtails borrowing and reduces credit growth
in the economy.
- If the RBI lowers the Repo Rate, borrowing becomes cheaper for commercial banks, leading
to lower lending rates for borrowers. This encourages borrowing and boosts credit growth in
the economy.
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4. Open Market Operations (OMO): Through OMOs, the RBI buys or sells government
securities in the open market. By doing so, the RBI injects or absorbs liquidity from the banking
system, impacting the availability of funds for lending.

- When the RBI buys government securities from banks, it releases money into the banking
system, increasing the funds available for lending.
- When the RBI sells government securities to banks, it absorbs money from the banking
system, reducing the funds available for lending.

5. Prudential Norms: The RBI sets prudential norms, such as Capital Adequacy Ratio (CAR) and
loan classification guidelines, which banks must follow. These norms ensure that banks
maintain sufficient capital and manage their loan portfolios prudently, reducing the risk of
defaults and maintaining a healthy lending environment.

6. Credit Policy and Guidelines: The RBI issues periodic credit policy statements that outline the
broad monetary and credit stance of the central bank. These policies provide guidance to
commercial banks on their lending activities and credit growth targets.

By utilizing these tools and measures, the RBI can effectively control the advances of
commercial banks, influencing the flow of credit in the economy and maintaining financial
stability. The ultimate goal is to support economic growth and control inflation within a
targeted range.
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Unit I: S.A. Type Questions

Meaning of Banking
Banking refers to the system of financial intermediation that involves the acceptance of
deposits from individuals, businesses, and other entities and providing them with various
financial services. Banks play a central role in the economy by facilitating the flow of funds,
allocating resources, and supporting economic activities. They act as custodians of money,
offering a safe and secure environment for individuals and businesses to store their savings.

Through the process of financial intermediation, banks channel funds from savers to borrowers,
allowing businesses to invest in growth and individuals to access credit for consumption or
other purposes. Banking services include deposit accounts, such as savings and checking
accounts, where customers can hold their money, and loans, where banks extend credit to
borrowers.

Over time, the banking sector has evolved, embracing technological advancements and offering
digital banking services, mobile applications, and electronic payment systems, making financial
transactions more convenient and accessible.

Regulated by central banks and government authorities, the banking industry adheres to
stringent prudential norms to ensure stability and protect depositors' interests. In summary,
banking plays a crucial role in the economy, providing essential financial services, supporting
economic growth, and fostering financial inclusion and stability.

Reserve Bank of India

The Reserve Bank of India (RBI) is the central banking institution of India and holds the
paramount responsibility for formulating and implementing the country's monetary policies.
Established on April 1, 1935, under the Reserve Bank of India Act, the RBI plays a critical role in
maintaining financial stability, controlling inflation, and promoting economic growth.

As India's central bank, the RBI regulates and supervises the banking sector, overseeing the
operations of commercial banks, cooperative banks, and other financial institutions. It issues
licenses to banks, sets prudential norms, conducts inspections, and ensures adherence to
regulatory guidelines to protect depositors and maintain the health of the banking system.

The RBI also manages the country's foreign exchange reserves, playing a crucial role in
stabilizing the rupee's value in the foreign exchange market. It formulates and implements
foreign exchange policies to facilitate international trade and maintain exchange rate stability.
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Moreover, the RBI acts as the banker to the central and state governments, managing their
accounts, handling public debt, and facilitating government transactions.

One of the primary objectives of the RBI is to control inflation within a targeted range while
supporting economic growth. It uses various monetary policy tools like the repo rate, reverse
repo rate, cash reserve ratio (CRR), and statutory liquidity ratio (SLR) to influence money supply
and credit availability in the economy.

Overall, the RBI plays a pivotal role in India's economic development and financial stability,
acting as the guardian of monetary and financial systems, and ensuring the nation's economic
well-being.

IDBI – Industrial Development Bank of India

IDBI, short for Industrial Development Bank of India, is a prominent financial institution in India
that specializes in providing long-term finance and credit for industrial and infrastructure
projects. Established in 1964 under the Industrial Development Bank of India Act, IDBI was
initially set up as a wholly-owned subsidiary of the Reserve Bank of India (RBI) to promote and
finance industrial development in the country.

As a development finance institution (DFI), IDBI played a crucial role in supporting the growth of
the Indian economy during its early years. It provided financial assistance to various sectors,
including manufacturing, infrastructure, and small and medium-sized enterprises (SMEs). Its
mission was to catalyze industrial progress, encourage entrepreneurship, and foster economic
development.

Over time, IDBI's role evolved, and in 2004, it transformed into a full-fledged commercial bank,
IDBI Bank Limited. This transition was aimed at expanding its scope of operations and
embracing a more comprehensive banking model while continuing to focus on industrial
finance.

IDBI Bank offers a wide range of banking and financial services, including retail banking,
corporate banking, trade finance, and treasury operations. It operates a network of branches
and ATMs across India and provides digital banking services to cater to the diverse needs of its
customers.

Despite becoming a commercial bank, IDBI retains its emphasis on financing infrastructure and
development projects. It continues to support crucial sectors with long-term funding and
contributes to the nation's infrastructure development.

IDBI remains an essential institution in the Indian financial landscape, combining its
developmental legacy with modern banking services, striving to contribute to India's economic
growth and industrial progress.
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NABARD – National Bank for Agriculture and Rural Development

NABARD, or the National Bank for Agriculture and Rural Development, is a specialized financial
institution in India established in 1982 with the aim of promoting rural development and
agriculture in the country. It was set up as a response to the urgent need for credit and financial
support in rural areas, where the majority of India's population depends on agriculture and
allied activities for their livelihood.

NABARD operates under the overall guidance of the Reserve Bank of India (RBI) and the
Government of India. Its primary focus is to provide credit and financial assistance to
agriculture-related activities, rural development projects, and various rural industries. NABARD
acts as a refinancing agency for financial institutions, rural banks, and cooperative banks,
channeling funds to the rural sector through them.

Some key functions of NABARD include:

1. Providing Financial Assistance: NABARD extends financial support through direct lending and
refinance to banks and financial institutions for agriculture, rural infrastructure, and rural
development projects.

2. Promoting Sustainable Agriculture: NABARD supports eco-friendly and sustainable

agricultural practices by financing projects related to watershed development, irrigation, and
agricultural research and development.

3. Rural Infrastructure Development: NABARD funds various rural infrastructure projects, such
as rural roads, bridges, and market yards, to improve connectivity and market access for
farmers and rural communities.

4. Institutional Development: NABARD plays a pivotal role in strengthening rural financial

institutions by providing training, technical assistance, and capacity building to cooperative
banks and rural banks.

5. Microfinance and Rural Entrepreneurship: NABARD promotes microfinance institutions

(MFIs) and self-help groups (SHGs) to enhance financial inclusion and support rural
entrepreneurship.

6. Rural Development Programs: NABARD collaborates with the government and other
agencies to implement rural development schemes, such as watershed management, rural
employment programs, and rural infrastructure projects.

NABARD's interventions have significantly contributed to rural upliftment, poverty reduction,

and agricultural development in India. By channeling credit and financial resources to rural
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areas, NABARD supports inclusive growth and empowers rural communities, making it a crucial
institution in India's efforts towards balanced and sustainable development.

Law relating to Banking

The law relating to banking is a comprehensive legal framework that governs the functioning,
regulation, and operations of banks and financial institutions. In most countries, including India,
banking law encompasses a set of statutes, regulations, and guidelines established by the
central bank or the financial regulatory authority to ensure the stability of the financial system,
protect depositors' interests, and foster responsible banking practices.

Key aspects covered by banking law include:

1. Licensing and Regulation: Banking law sets out the requirements for obtaining a banking
license and the conditions that banks must meet to operate legally. It also outlines the
regulatory authority's powers to supervise and inspect banks to ensure compliance with
prudential norms and guidelines.

2. Capital Adequacy and Reserve Requirements: Banking law prescribes the minimum capital
requirements that banks must maintain to safeguard against financial risks and insolvency. It
also sets reserve requirements, such as the Cash Reserve Ratio (CRR) and Statutory Liquidity
Ratio (SLR), to control the amount of funds banks hold in reserves with the central bank.

3. Consumer Protection: Banking law includes provisions to protect customers' rights and
interests, covering areas like fair lending practices, transparency in fees and charges, resolution
of customer complaints, and privacy of financial information.

4. Prudential Norms: Banking law establishes prudential regulations to manage risk, prevent
money laundering, and ensure sound corporate governance within banks. It may include
guidelines for asset classification, provisioning, and exposure limits to reduce risks.

5. Payment Systems and Electronic Banking: Banking law addresses the legal aspects of
payment systems, electronic funds transfer, and online banking to facilitate secure and efficient
financial transactions.

6. Bankruptcy and Resolution: Banking law includes provisions for handling bank failures and
financial crises, outlining resolution mechanisms to protect depositors and manage distressed
financial institutions.

7. Cross-Border Banking: Banking law may deal with cross-border banking activities, foreign
bank entry, and regulations for international transactions.
 20

8. Financial Inclusion: Banking law often incorporates measures to promote financial inclusion,
encouraging banks to reach underserved and unbanked populations.

The main objective of banking law is to ensure the stability, integrity, and efficiency of the
banking sector while protecting the interests of depositors and consumers. As the financial
landscape evolves, banking law continues to adapt to emerging challenges, technological
advancements, and changes in global financial markets to maintain a robust and well-regulated
banking system.
 21

Unit II
Syllabus: Relationship between Banker and Customer – Debtor and Creditor Relationship –
Fiduciary Relationship – Trustee and Beneficiary – Principal and Agent – Bailor and Bailee –
Guarantor.

2.1 Relationship between Banker and Customer

Introduction
The relationship between a Banker and a Customer is based on trust. In today’s world, banks
are considered a pivotal element for the economy of the country. It is an effective banking
system that paves the way for the proper growth of the economy. Customers avail different
kinds of services from the bank. This article critically analyses different types of relationship
between customer and banker. It also discusses different legislations that protect the interest
of the banker and customer and also provide proper remedies to them.

1. Relationship of debtor and creditor

 When a customer opens a bank account with the bank, he fills the form and other
requisites compulsory for the same. When he deposits money in his bank account, he
becomes a creditor to the bank. The bank becomes the debtor. The obligations of the
bank to carry further business from the deposits of the consumer are solely dependent
on their own choice. The bank can invest that money according to their own
convenience. If the consumer wants to take back that money, then he needs to follow a
procedure of withdrawal. He can either present a cheque during banking hours to
withdraw money from his account or he may withdraw from ATM anytime. The
relationship of banker as a debtor and customer as creditor remains as long as the
customer’s account is in credit. If the banker allows overdraft and customer’s account
shows a negative outstanding balance, the relationship changes to that of a banker as a
creditor and the customer as a debtor.

2. Relationship of pledger and pledgee

 When a customer pledges an article (goods and documents) with the banker as a
security for the payment of debt or performance of the promise, the customer becomes
a pledger and the banker becomes the pledgee. Pledge is one of the forms of creating
charge in favour of the banker, along with other modes of charge like hypothecation
and mortgage.
 22

3. Relationship of bailor and a bailee

 Section 148 of the Indian Contract Act, 1872 defines Bailment, bailor and bailee. A
“Bailment” is the transfer of goods from one person to another for some purpose, upon
a contract that they shall return the goods after completion of the purpose or will
dispose of the goods according to the direction agreed as per the terms and conditions
of the contract. The person delivering the good is called the bailor and the person to
whom the good is delivered is called the bailee. Banks secure their advances by taking
some tangible assets as securities. Sometimes they keep valuable items, or land and
other things as security. By doing so, the bank becomes the bailee and the customer
becomes the bailor.
 When banker receives gold ornaments and important documents for safe custody
banker becomes a bailee. The banker takes charge of the goods, articles etc as bailee
and not as a trustee or agent. In that case, he cannot make use of them to his
advantage because he is bound to return the same article on demand. The banker does
not allow any interest on these articles. It is only the customer who have to pay rent for
the lockers offered by banker on rent for the safe custody of these articles.

4. Relationship of Mortgagor and Mortgagee

 Mortgagor is the person who conveyances an estate by way of pledge for security of a
debt obtained from the creditor. A mortgagee is the creditor having a lien or charge on
immovable properties like lands and buildings, with or without the right for possession.
Mortgagor is one who transfers an interest in specific immovable property by creating a
mortgage. The relationship of customer being mortgagor and banker being mortgagee
comes into existence when customer deposits, for example the title deeds of his house
property as security with the banker, for the housing loan obtained from the banker.

5. Relationship of lesser and lessee

 Section 105 of Transfer of Property Act, 1882 defines lease, lessor, lessee, premium and
rent.
 A lease of immovable property is transferred to the right to enjoy the property for a
certain period of time. The transferor is the lessor. The transferee is called the lessee.
 When banker offers a locker on rent he becomes a lessor and the customer becomes a
lessee.

6. Relationship of trustee and beneficiary

 When a bank receives money or other valuable securities, then the banker’s position is
of a trustee. On the other hand, when a bank receives money and uses it in various
sectors, the bank becomes the beneficiary.
Example: Banker receives money with specific instruction to hold it till further
instructions. In this case the banker has no choice other than keeping such cash in
 23

suspense account till he receives instructions from the customer in what manner the
cash given may be used.

7. Relationship of pawnor and pawnee

 A pawn is defined to be the bailment or delivering of goods by a debtor to his creditor to

be kept till the debt is discharged. Here the pawnor is the borrower and the pawnee is
is the creditor or Bank.
 Example: The debtor Mr.A deposits (pledges) his stock in trade with the banker for
availing working capital facility. According to section 177 of the Contract act, 1872 it is
the duty of the banker to return the valuable goods, securities etc to the pawnor/debtor
after receiving the same plus interest on it. The pawnor has the right to redeem. It is
the duty of the pawnee/banker to safeguard the securities pledged.
 Rights of the pawnee: As per Sec.175 of the Contract Act, the pawnee (banker) has the
right to receive payment from the pawnee-borrower towards the extra ordinary
expenses incurred in safe guarding the pledged goods. Sec.176 of the Contract Act gives
the right to sell the pledged goods if the pawnor makes default of the loan.
 24

2.2 Relationship of Debtor and Creditor

The relationship between a banker and a customer can take two primary forms: when the
banker is a creditor and when the banker is a debtor. These relationships are distinct and come
into play based on the nature of the transactions between the two parties:

1. Banker as a Creditor:
When the banker acts as a creditor, it means that the customer owes money or has taken a
loan from the bank. In this scenario, the customer is a borrower, and the bank has extended
credit to the customer. The key aspects of this relationship include:

a. Loan and Credit Facilities: The bank provides various loan and credit facilities to its
customers, such as personal loans, home loans, business loans, and credit cards. The customer
is obligated to repay the borrowed amount along with any applicable interest and charges. On
default, the Bank can initiate proceedings to recover debts under Recovery of Debts and
Bankruptcy Act, 1993 and Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (shortly called – SARFAESI Act, 2002).

b. Security and Collateral: In many cases, banks require customers to provide collateral or
security against the loans to mitigate the risk of default. The customer's assets may serve as
security for the loan. In case of default, the customer’s assets can be sold by the banker and
sale proceeds can be appropriated to the balance in the loan accounts.

c. Repayment Terms: The terms of the loan, including the repayment schedule, interest rate,
and other conditions, are agreed upon between the bank and the customer. The Bank issues a
Sanction Letter enumerating Terms and Conditions and documents to be submitted by the
borrower to release the loan. Only after obtaining all the necessary documents from the
customer, the bank releases the loan amount.

d. Obligation to Repay: The customer has a legal obligation to repay the loan as per the
agreed-upon terms. Failure to do so may result in default and potentially adverse consequences
for the customer, such as a negative impact on credit history. Banks peruse the CIBIL rating of
the borrower before releasing loans. CIBIL – Credit Information Bureau of India Limited is one
of the four Credit information companies licensed by RBI. It maintains the credit history of bank
borrowers and maintains ratings for the borrowers. If the borrower makes default his rating
will be bad and banks will not further lend to such borrower.
 25

2. Banker as a Debtor:
When the banker acts as a debtor, it means that the customer has deposited money with the
bank, and the bank holds the funds on behalf of the customer. The key aspects of this
relationship include:

a. Deposit Accounts: Customers hold various types of deposit accounts with the bank, such as
savings accounts, current accounts, fixed deposits, etc.

b. Fiduciary Duty: The bank holds the customer's funds in trust and has a fiduciary duty to
safeguard and manage the deposits responsibly.

c. Right to Withdraw: Customers have the right to withdraw their funds from the bank
subject to the terms and conditions of the deposit account. Usually the Current and Savings
accounts are called the Demand Deposits because customer can withdraw from these accounts
by presenting a cheque or from ATM machines. Term Deposits cannot be easily withdrawn
because there involves a maturity date for them. For withdrawing Term Deposits before
maturity date banks charge penal interest. As there is “time factor” involved restricting free
withdrawal from Term Deposit accounts, these accounts are called Time Deposits.

d. Interest on Deposits: Banks may pay interest on certain types of deposits, providing
customers with a return on their deposits. There is no obligation to pay interest on Current
Accounts but Banks pay interest on Savings Accounts and Term Deposit accounts.

e. Deposit Insurance: In many countries, bank deposits are insured up to a certain limit,
providing an added layer of protection to customers in case of bank failure. In India, DICGC –
Deposit Insurance and Credit Guarantee Corporation provides insurance cover for the deposits
of the Customers for maximum amount of Rs.5.00 lacs.

Overall, the relationship between a banker and a customer is multi-faceted, depending on

whether the bank is acting as a creditor or a debtor. The relationship is governed by contractual
agreements, regulatory guidelines, and legal obligations, aiming to ensure fairness,
transparency, and trust between the parties involved.
 26

2.3 Fiduciary Relationship

Fiduciary, in law, a person who occupies a position of such power and confidence with regard to
the property of another that the law requires him to act solely in the interest of the person
whom he represents. Examples of fiduciaries are agents, executors and administrators,
trustees, guardians, and officers of corporations. They may be contrasted with persons in an
ordinary business relationship, in which each party is free to seek purely personal benefits from
his transactions with the other. In the relationship between Banker and Customer, the Banker
acts as a Fiduciary. A person who holds assets in trust for a beneficiary is called a Fiduciary.
Banker holds various assets of the customer in Savings account, Current Account, Term Deposit
account and also as creditor when he obtains various kinds of movables and immovable
property as security for the loan disbursed.

The fiduciary relationship between a banker and a customer is a legal and ethical obligation
that imposes a high standard of trust, good faith, and loyalty upon the banker when handling
the customer's financial affairs. This relationship arises primarily from the customer's
depositing of money or valuable assets with the bank, which the bank holds in trust on behalf
of the customer. As a fiduciary, the banker is expected to act in the best interests of the
customer and exercise utmost care and prudence in managing the customer's funds. Key
aspects of the fiduciary relationship include:

1. Duty of Confidentiality: The banker is bound by a duty of confidentiality and must not
disclose the customer's financial information or transactions to unauthorized parties. This duty
ensures the privacy and security of the customer's financial affairs.

2. Duty of Loyalty: The banker must act with undivided loyalty and prioritize the customer's
interests over their own or that of the bank. Any conflicts of interest must be disclosed, and the
customer's needs must take precedence.

3. Duty of Care: The banker is expected to exercise due care, skill, and diligence in managing
the customer's funds and financial transactions. They must act prudently to minimize risks and
protect the customer's assets.

4. Duty to Safeguard: The banker is responsible for safeguarding the customer's deposits and
valuables, ensuring that they are not misused or subject to unauthorized access.

5. Duty to Provide Accurate Information: The banker must provide accurate and complete
information to the customer about their accounts, transactions, charges, and other relevant
matters.

6. Duty of Good Faith: The banker must act in good faith, being honest and transparent in all
dealings with the customer.
 27

7. Duty of Disclosure: The banker must disclose any material information that may impact the
customer's financial decisions or interests.

8. Duty to Avoid Self-Dealing: The banker must refrain from using the customer's funds or
assets for their own benefit without the customer's explicit consent.

9. Duty to Avoid Unauthorized Transactions: The banker must not engage in unauthorized
transactions or use the customer's funds for purposes not agreed upon by the customer.

The fiduciary relationship places a significant responsibility on the banker to act ethically,
professionally, and with the customer's best interests in mind. Any breach of this relationship
can lead to legal consequences and damage the bank's reputation. Establishing and maintaining
a strong fiduciary relationship is essential to building trust between the banker and the
customer, forming the foundation for a successful and enduring banking relationship.
 28

2.4 Trustee and Beneficiary

The trustee-beneficiary relationship between a banker and a customer arises when the
customer deposits securities or valuables with the banker for safe custody. In this case, the
banker becomes a trustee of his customer, and the customer is the beneficiary. The banker is
legally obligated to keep the securities or valuables safe and to return them to the customer on
demand. The banker cannot use the securities or valuables for their own purposes, and they
cannot sell them without the customer's permission.

The trustee-beneficiary relationship is based on the principle of trust. The customer trusts the
banker to keep their securities or valuables safe, and the banker trusts the customer to not ask
for them to be returned too often or for unreasonable purposes. This relationship is important
because it helps to protect the customer's assets.

Here are some of the key duties of a trustee in a banker-customer relationship:

 Keep the securities or valuables safe

 Return them to the customer on demand
 Not use the securities or valuables for their own purposes
 Not sell the securities or valuables without the customer's permission
 Keep accurate records of the securities or valuables
 Provide the customer with an account of their assets

The trustee-beneficiary relationship is a fiduciary relationship, which means that the trustee has
a duty to act in the best interests of the beneficiary. The banker is liable to the customer for any
losses that the customer suffers if the banker fails to discharge their duties as a trustee.

Here are some examples of when the trustee-beneficiary relationship between a banker and a
customer might arise:

 When a customer deposits securities or valuables in a bank safe deposit box

 When a customer gives a bank a power of attorney to manage their financial affairs
 When a customer opens a trust account with a bank

The trustee-beneficiary relationship is an important one in banking, and it helps to protect the
customer's assets.
 29

The trustee-beneficiary relationship between a banker and a customer refers to a situation

where the banker, acting as a trustee, holds the customer's assets or funds in trust and
manages them for the benefit of the customer, who is the beneficiary of the trust. In this
relationship, the banker acts as a fiduciary, owing a duty of loyalty, care, and prudence to the
customer, the beneficiary of the trust. The trustee-beneficiary relationship is governed by the
principles of trust law and imposes specific legal and ethical obligations on the banker.

Circumstances when the trustee-beneficiary relationship comes into existence include:

1. Deposit Accounts: When a customer deposits money in a bank account, the banker becomes
the trustee, holding the funds in trust for the customer. The customer is the beneficiary of this
trust, and the banker must manage the funds responsibly and ensure they are readily available
for withdrawal as per the customer's instructions.

2. Safe Deposit Lockers: If a customer rents a safe deposit locker from the bank to store
valuable assets or documents, the banker acts as the trustee of the locker and must safeguard
its contents for the benefit of the customer.

3. Trust Accounts: In certain cases, a customer may open a trust account with the bank,
designating the bank as the trustee. The banker is responsible for managing the trust assets and
making distributions according to the terms of the trust for the benefit of the beneficiaries.

4. Escrow Services: In real estate transactions or other contractual arrangements, the bank may
act as an escrow agent, holding funds on behalf of the parties involved until specific conditions
are met. The bank acts as a trustee, ensuring that the funds are used appropriately as per the
terms of the agreement.

5. Pension and Retirement Accounts: When a customer contributes to a pension or retirement

account, the bank, as the trustee, holds and manages the funds on behalf of the customer. The
bank must invest the funds prudently to generate returns for the customer's benefit during
retirement.

In each of these scenarios, the banker assumes the role of a trustee, and the customer becomes
the beneficiary. The banker is legally obligated to act in the best interests of the customer,
prudently manage the assets, and avoid any conflicts of interest that could compromise the
customer's benefits. The trustee-beneficiary relationship is built on trust and fiduciary duty,
forming the basis for a strong and responsible banking relationship. Any breach of this
relationship can result in legal consequences and damage to the bank's reputation as a trusted
financial institution.

(Escrow Agent: An escrow agent is a neutral third party, often a financial institution or a lawyer,
entrusted with holding and managing funds or assets on behalf of two parties involved in a
transaction. The agent ensures that agreed-upon conditions are met before releasing the funds
or assets to the intended recipient. This arrangement provides security and transparency in
 30

various transactions, such as real estate deals, mergers, or large purchases. The escrow agent
acts as a safeguard, preventing either party from gaining access to the funds or assets until all
contractual obligations are fulfilled.)
 31

2.5 Principal and Agent

The Principal-Agent relationship between a customer and a banker refers to a situation where
the customer (principal) appoints the banker (agent) to act on their behalf in specific financial
matters. In this relationship, the banker represents the interests of the customer and
undertakes certain actions on their behalf, guided by the customer's instructions and best
interests. This relationship is governed by the principles of agency law.

Key elements of the Principal-Agent relationship between a customer and a

banker include:

1. Fiduciary Duty: The banker owes a fiduciary duty to the customer, meaning they must act in
the customer's best interests and with utmost loyalty and care. The customer places trust in the
banker to make decisions on their behalf.

2. Representation: The banker acts as the customer's representative and possesses the
authority to perform specific tasks or transactions on their behalf, such as processing payments,
executing trades, or managing investments.

3. Limited Authority: The banker's authority is limited to the scope of the agency agreement or
the specific instructions provided by the customer. The banker cannot act outside the
boundaries of this authority without the customer's consent.

4. Customer's Control: Although the banker acts on behalf of the customer, the ultimate
control and decision-making authority remain with the customer. The customer can revoke the
agency relationship at any time and give new instructions to the banker.

5. Duty of Care: The banker must exercise reasonable care, skill, and diligence in carrying out
the customer's instructions and ensuring their best interests are protected.

Examples of the Principal-Agent relationship between a customer and a banker:

1. Power of Attorney: A customer may grant a banker a power of attorney, giving the banker
the authority to manage their financial affairs, conduct transactions, and make decisions on
their behalf. For instance, an elderly customer might appoint a banker as their attorney-in-fact
to handle their financial matters if they become unable to do so themselves.

2. Investment Management: When a customer engages a banker or a financial advisor to

manage their investment portfolio, the banker becomes the customer's agent in making
investment decisions and executing trades in line with the customer's investment goals and risk
tolerance.
 32

3. Corporate Banking: In corporate banking, a company may authorize a banker as its agent to
negotiate loan terms, conduct financial transactions, or manage treasury functions on behalf of
the company.

4. Escrow Services: In real estate transactions, the bank may act as an escrow agent. The
customer (buyer) deposits the purchase funds with the bank as the escrow agent. The bank
holds the funds until all conditions of the sale are met, such as successful property inspection or
title clearance. Once the conditions are satisfied, the bank releases the funds to the seller,
acting as an agent for both parties.

5. Trustee Services: A customer may appoint the bank as a trustee to manage assets on behalf
of beneficiaries. The bank, as the trustee, administers the trust in accordance with the terms
set by the customer (settlor) for the benefit of the beneficiaries.

6. Letters of Credit: In international trade, a customer (importer) may request the bank to issue
a letter of credit in favor of the exporter. The bank, as the agent, ensures that the exporter
complies with the terms and conditions to receive payment once the goods are shipped and
documents are provided.

In these scenarios, the banker acts as the agent, carrying out specific tasks and decisions on
behalf of the customer, who remains the principal with ultimate control over the agency
relationship. The Principal-Agent relationship is vital for building trust between the customer
and the banker, ensuring that the customer's interests are protected, and financial transactions
are conducted in a responsible and transparent manner.
 33

2.6 Bailor and Bailee

The Bailor-Bailee relationship between a customer and a banker refers to a legal arrangement
where the customer (bailor) entrusts their property, assets, or valuables to the bank (bailee) for
safekeeping or other specific purposes. This relationship is governed by the Indian Contract Act,
1872, which sets out the rights and duties of both parties involved.

Key aspects of the Bailor-Bailee relationship between a customer and a banker:

1. Bailment: Bailment is the act of delivering personal property to another person for a specific
purpose, with the expectation that the property will be returned or dealt with as agreed upon.
In this relationship, the customer is the bailor, and the bank is the bailee.

2. Delivery of Possession: The customer delivers possession of their property, such as cash,
jewelry, documents, or valuable assets, to the bank. The bank accepts the property as a bailee
and holds it on behalf of the customer.

3. Care and Responsibility: The bank, as the bailee, has a duty to exercise reasonable care and
diligence in safeguarding the customer's property while it is in their custody. The bank must
ensure that the property is returned to the customer in the same condition as it was received.

4. Limited Use: The bank can only use the property for the specific purpose for which it was
entrusted or as agreed upon between the parties. It cannot use the property for its own benefit
without the customer's consent.

5. Return of Property: Once the purpose of bailment is fulfilled or upon the customer's request,
the bank must return the property to the customer or deal with it as per the customer's
instructions.

Examples of Bailor-Bailee relationship between a customer and a banker:

1. Safe Deposit Lockers: When a customer rents a safe deposit locker from the bank, they
become the bailor, and the bank becomes the bailee. The customer deposits their valuables
into the locker for safekeeping, and the bank holds the locker on the customer's behalf until the
customer retrieves the valuables.

2. Fixed Deposit Accounts: When a customer opens a fixed deposit account with the bank, they
become the bailor, and the bank becomes the bailee. The customer deposits money into the
fixed deposit, and the bank holds the funds on behalf of the customer until the maturity of the
deposit.
 34

3. Document Custody Services: In some cases, customers may entrust important documents,
such as property deeds or wills, to the bank for safekeeping. The bank becomes the bailee,
responsible for the secure custody of the documents until the customer requires them.

The Bailor-Bailee relationship is essential for providing secure and trustworthy banking services,
and it ensures that the customer's property is protected while in the bank's possession. The
Indian Contract Act governs this relationship, providing legal rights and remedies to both
parties in case of any breach or dispute.
 35

2.7 Guarantor-Beneficiary Relationship

The Guarantor-Beneficiary relationship between a banker and a customer refers to a legal
arrangement where the customer (beneficiary) seeks a guarantee from the bank (guarantor) to
assure the performance of a financial obligation or transaction. In this relationship, the bank
takes on the role of a guarantor, providing a promise to be liable for the customer's debt or
obligations in case the customer defaults. This arrangement is governed by specific terms and
conditions agreed upon between the parties, and it plays a crucial role in facilitating various
financial transactions and credit facilities.

Key aspects of the Guarantor-Beneficiary relationship between a banker and a

customer:

1. Guarantee Agreement: The customer and the bank enter into a written guarantee
agreement, defining the scope and terms of the guarantee. The agreement outlines the extent
of the bank's liability and the conditions under which the guarantee comes into effect.

2. Liability of the Bank: As a guarantor, the bank assumes a contingent liability to fulfill the
customer's obligations if the customer fails to do so. The bank's liability is secondary to the
primary obligation of the customer.

3. Credit Facilities: The guarantee is commonly used in various credit facilities, such as loans,
credit cards, and overdrafts. When a customer applies for credit, the bank may require a
guarantee from the customer's parent company or a third-party guarantor to secure the credit
facility.

4. Trade Transactions: In international trade, the bank may issue a letter of credit, acting as a
guarantor, to ensure payment to the beneficiary (seller) upon fulfilling the terms and conditions
of the trade contract.

5. Performance Guarantee: The bank may issue performance guarantees on behalf of the
customer, assuring the beneficiary that the customer will fulfill contractual obligations as per
agreed terms.

6. Rental Guarantees: In real estate transactions, the bank may act as a guarantor for the
tenant (customer), providing a rental guarantee to the landlord (beneficiary) to secure the lease
agreement.

7. Loan Guarantees: The bank may offer loan guarantees to support small and medium-sized
enterprises (SMEs) or individuals who lack sufficient collateral but have a creditworthy project
or business idea.
 36

Example of Guarantor-Beneficiary relationship:

Let's consider a scenario where a customer wants to rent a commercial property for their
business. The landlord requires a security deposit or a rental guarantee to ensure that the rent
will be paid on time and to cover any damages or breaches of the lease agreement. The
customer approaches their bank and requests a rental guarantee. The bank agrees to act as the
guarantor and issues a rental guarantee to the landlord, stating that the bank will be liable for
the rental payments if the customer defaults.

In this example, the customer is the beneficiary, as they benefit from the rental guarantee, and
the bank is the guarantor, providing the guarantee to the landlord on behalf of the customer.

The Guarantor-Beneficiary relationship is essential in providing financial support and facilitating

various transactions, enabling customers to access credit facilities, enter into contracts, and
conduct business transactions with enhanced confidence and security.

Banks also seek Personal Guarantee and Third Party Guarantee from borrowers
for granting Loan facilities

In the context of banks seeking personal guarantees and third-party guarantees from borrowers
for releasing loans, the provisions of the Indian Contract Act, 1872, play a crucial role in
governing the legality and enforceability of such guarantees. Let's explore how the Act applies
to these types of guarantees:

1. Personal Guarantee: A personal guarantee is a commitment made by an individual

(guarantor) to be personally liable for the borrower's obligations in case of default. In this
scenario, the borrower (principal debtor) and the guarantor (surety) enter into a guarantee
agreement with the bank. The relevant provisions of the Indian Contract Act that apply to
personal guarantees are as follows:

- Section 126: This section defines a contract of guarantee, where the surety promises to be
responsible for the debtor's debt or performance of an obligation in case of default. The
contract of guarantee is a tripartite agreement between the bank, borrower, and guarantor.

- Section 127: According to this section, a guarantee must be in writing and signed by the
guarantor. This ensures that the guarantee agreement is legally valid and enforceable.

- Section 128: This section emphasizes that the liability of the guarantor is co-extensive with
that of the principal debtor unless otherwise agreed. This means that the guarantor's liability is
equivalent to that of the borrower. If the borrower defaults on the loan, the guarantor
becomes liable to the creditor (the bank) for the entire debt amount, along with any interest
and costs, just as if they were the principal debtor.
 37

- Section 130: If there are multiple sureties (guarantors) for the same debt, and the guarantee
does not specify the proportion of liability for each surety, they are jointly and severally liable.
This means that the creditor can proceed against any one or all of the sureties to recover the
full amount of the debt.

2. Third-Party Guarantee: A third-party guarantee involves a person or entity other than the
borrower stepping in as the guarantor. The bank seeks a guarantee from this third party to
secure the loan. The provisions of the Indian Contract Act that apply to third-party guarantees
are similar to those for personal guarantees:

- Sections 126, 127, 128, and 130, as mentioned above, apply to third-party guarantees as well.

It's important to note that while personal guarantees and third-party guarantees are widely
used in loan transactions, banks need to ensure compliance with the provisions of the Indian
Contract Act to make these guarantees legally enforceable. By obtaining guarantees in writing
and signed by the guarantor, the bank can establish the validity and enforceability of these
agreements in case of default by the borrower. Additionally, clear communication and
understanding of the terms and obligations of the guarantee are essential to prevent disputes
and ensure a smooth execution of the guarantee contract.
 38

Unit II: S.A. Type

Special Customers of a Bank
1. Married Women: In Indian banking law, a married woman can open and operate a bank
account independently, irrespective of her marital status. The Hindu Succession Act, 1956,
grants married women equal inheritance rights as men. Therefore, they can hold and manage
their assets, including bank accounts, in their own name. Married women can avail various
banking services, apply for loans, and make investments without the need for consent from
their spouses.

2. Lunatics: Lunatics, also known as persons of unsound mind, are individuals who lack the
capacity to understand the consequences of their actions due to mental illness or disability.
Indian banking law recognizes the protection of the rights of lunatics. A lunatic cannot enter
into contracts, including banking transactions, on their own. In such cases, a legal guardian or a
person appointed by the court as a manager of the lunatic's property must handle financial
matters on their behalf.

3. Minors: Minors, individuals below the age of 18 years, are generally not eligible to enter into
contracts, including bank account agreements. However, banks may offer specialized savings
accounts for minors, which are operated jointly with a parent or guardian. In such accounts, the
parent or guardian acts as the custodian of the account until the minor reaches the age of
majority. Once the minor turns 18, they can convert the account to a regular account.

4. Illiterate Persons: Illiterate persons are not barred from availing banking services. However,
due to their inability to read and understand written documents, banks need to take extra
precautions. Banks may offer assisted banking services where bank staff or representatives help
illiterate customers with their banking needs, including filling out forms and explaining terms
and conditions.

5. Joint Hindu Family: A Joint Hindu Family (HUF) is a unique type of customer that exists
primarily among Hindus in India. An HUF consists of members from the same family lineage,
sharing a common ancestor. The eldest male member, known as the Karta, manages the
family's affairs, including financial matters. HUFs can open and operate bank accounts and
engage in various financial transactions as a distinct legal entity.

6. Co-operative Societies: Co-operative societies are associations of individuals who come

together voluntarily to address common economic, social, and cultural needs. These societies
operate on co-operative principles, where each member has equal voting rights and shares the
responsibilities and benefits of the society. Co-operative societies can avail banking services,
including opening bank accounts and applying for loans.
 39

7. Partnership: Partnership firms are associations of two or more individuals who jointly run a
business for profit. Each partner in the firm is jointly and severally liable for the debts and
obligations of the partnership. Partnership firms can open bank accounts in the firm's name and
conduct financial transactions related to the business.

8. Trustees: Trustees are individuals or entities appointed to manage assets or property on

behalf of beneficiaries. In Indian banking law, trustees can open and operate bank accounts on
behalf of the trust. The bank deals with the trustees as representatives of the trust and holds
them responsible for managing the trust's financial affairs as per the trust deed.

In all these special types of customers, Indian banking law recognizes their distinct
characteristics and takes into account their specific needs and circumstances. Banks must
comply with relevant legal provisions to ensure fair treatment and appropriate banking services
for each category of customers.

Banker as a Trustee
The trustee-beneficiary relationship between a banker and a customer arises when the
customer deposits securities or valuables with the banker for safe custody. In this case, the
banker becomes a trustee of his customer, and the customer is the beneficiary. The banker is
legally obligated to keep the securities or valuables safe and to return them to the customer on
demand. The banker cannot use the securities or valuables for their own purposes, and they
cannot sell them without the customer's permission.

The trustee-beneficiary relationship is based on the principle of trust. The customer trusts the
banker to keep their securities or valuables safe, and the banker trusts the customer to not ask
for them to be returned too often or for unreasonable purposes. This relationship is important
because it helps to protect the customer's assets.

Here are some of the key duties of a trustee in a banker-customer relationship:

 Keep the securities or valuables safe

 Return them to the customer on demand
 Not use the securities or valuables for their own purposes
 Not sell the securities or valuables without the customer's permission
 Keep accurate records of the securities or valuables
 Provide the customer with an account of their assets

The trustee-beneficiary relationship is a fiduciary relationship, which means that the trustee has
a duty to act in the best interests of the beneficiary. The banker is liable to the customer for any
losses that the customer suffers if the banker fails to discharge their duties as a trustee.
 40

Fiduciary Relationship
A fiduciary relationship between a banker and a customer refers to a special legal and ethical
relationship where the banker acts as a fiduciary, holding a position of trust and confidence,
while managing the customer's financial affairs and assets. In this relationship, the bank is
obligated to act in the best interests of the customer and exercise the highest standard of care,
loyalty, and prudence.

Key elements of the fiduciary relationship between a banker and a customer

include:

1. Duty of Loyalty: The banker owes the customer a duty of undivided loyalty and must act
solely in the customer's best interests. This means avoiding conflicts of interest and refraining
from self-dealing or personal gains at the customer's expense.

2. Duty of Care: The bank must exercise reasonable care, skill, and diligence in carrying out the
customer's instructions and managing their financial affairs. The bank is expected to possess
the expertise necessary to handle the customer's transactions competently.

3. Duty of Confidentiality: The banker is bound to maintain strict confidentiality regarding the
customer's financial information and transactions. Information shared by the customer with the
bank should not be disclosed to third parties without the customer's consent, except in cases
where required by law or regulatory authorities.

Examples of the Fiduciary Relationship between a Banker and a Customer:

1. Investment Management: When a customer appoints the bank as their investment manager,
the bank assumes a fiduciary duty. The bank must make investment decisions in the customer's
best interests, considering their risk tolerance, financial goals, and time horizon.

2. Trust Services: A customer may establish a trust and appoint the bank as the trustee. As a
trustee, the bank holds and manages the trust assets for the benefit of the beneficiaries,
adhering to the terms and conditions of the trust.

3. Safe Deposit Lockers: When a customer rents a safe deposit locker from the bank, the bank
acts as a fiduciary, safeguarding the customer's valuables stored in the locker.

4. Financial Advisory Services: When providing financial advice or recommendations, the bank
is expected to act in the customer's best interests, taking into account their financial needs and
objectives.
 41

5. Estate Planning: In estate planning, the bank may act as an executor or administrator,
managing the assets and distributing them to beneficiaries as per the customer's will or the
applicable laws.

6. Power of Attorney: If a customer grants a power of attorney to the bank, the bank is
entrusted with handling the customer's financial matters, and it must act in the customer's best
interests while exercising the granted authority.

The fiduciary relationship between a banker and a customer is founded on trust, integrity, and
professionalism. The bank's fiduciary duty extends to acting with the highest standards of
honesty, loyalty, and care while managing the customer's financial interests. Breach of this
fiduciary relationship can lead to legal consequences and damage the bank's reputation as a
trusted financial institution.

Customer
A customer of the bank may be defined as a person who avails banking services such as deposit
accounts (Savings, Current Account and Term Deposits), or Loan accounts (Term Loan or
Working Capital Account), miscellaneous services such as Demand Drafts, ATM, Bank
guarantees, Letters of Credit etc.

The rights and duties of bank customers in India are governed by various laws, regulations, and
agreements between the customer and the bank.

Rights of Bank Customers:

1. Right to Open and Operate Accounts: Customers have the right to open and operate various
types of bank accounts, such as savings accounts, current accounts, fixed deposit accounts, etc.,
subject to the bank's terms and conditions.

2. Right to Information: Customers have the right to receive clear and accurate information
about the products, services, charges, and terms offered by the bank. Banks are obligated to
provide transparency in their dealings with customers.

3. Right to Privacy and Confidentiality: Banks must maintain the confidentiality of the
customer's financial information and transactions. Customers have the right to privacy and
expect their information to be kept secure.

4. Right to Redressal: Customers have the right to seek redressal for any grievances or
complaints they may have regarding the bank's services. Banks are required to have a grievance
redressal mechanism in place to address customer complaints promptly.
 42

5. Right to Account Statements: Customers have the right to receive periodic account
statements showing the details of transactions, balances, and charges related to their accounts.

6. Right to Access to Funds: Customers have the right to access their funds in their accounts as
and when they need them, subject to the terms and conditions of the account.

Duties of Bank Customers:

1. Providing Accurate Information: Customers are responsible for providing accurate and up-
to-date information to the bank when opening and maintaining accounts. This includes
providing valid identification documents and contact details.

2. Complying with Terms and Conditions: Customers must adhere to the terms and conditions
set forth by the bank for various products and services. This includes maintaining the minimum
balance in the account, honoring loan repayment schedules, etc.

3. Safeguarding Account Information: Customers are responsible for safeguarding their

account information, including passwords, PINs, and other security credentials, to prevent
unauthorized access to their accounts.

4. Reporting Lost or Stolen Cards: In case of lost or stolen debit/credit cards or any other
account-related information, customers must inform the bank immediately to prevent
unauthorized transactions.

5. Reporting Unauthorized Transactions: If customers notice any unauthorized transactions or

discrepancies in their account statements, they must report them to the bank promptly for
resolution.

6. Following Regulatory Compliance: Customers must comply with all applicable banking and
financial regulations as specified by the Reserve Bank of India (RBI) and other relevant
authorities.

It's essential for customers to be aware of their rights and responsibilities while dealing with
banks. Being informed and responsible helps build a healthy and trustworthy relationship
between the bank and its customers. Additionally, as banking laws and regulations may evolve
over time, customers should stay updated with any changes that may affect their rights and
duties in the banking sphere.
 43

Garnishee Order
In Indian banking law, a garnishee order is a legal directive issued by a court to a bank, requiring
the bank to withhold funds in a customer's account to satisfy a debt or liability owed by the
customer. The garnishee order allows a judgment creditor (the party to whom money is owed)
to recover the debt from the judgment debtor (the bank's customer) directly through the bank.
This legal process helps creditors enforce court-awarded judgments and recover unpaid debts
from their debtors.

Key aspects of the garnishee order in the light of Indian banking law:

1. Issuance and Execution: A garnishee order is issued by a competent court after the judgment
creditor successfully obtains a decree against the judgment debtor. The order is then served on
the bank, and the bank is legally bound to comply with the order.

2. Freezing Funds: Upon receiving the garnishee order, the bank must immediately freeze the
amount specified in the order in the customer's account. The bank cannot allow any
withdrawals or transfers from the frozen funds until further instructions from the court.

3. Limitations: The amount that can be garnished depends on the judgment debtor's account
balance at the time of service of the order. The bank can only withhold the specific amount
mentioned in the order or the account balance, whichever is lower.

4. Notice to the Customer: The bank must inform the customer about the garnishee order,
including the amount being withheld and the reason for the order. The customer has the right
to challenge the garnishee order in court if they believe it was wrongly issued.

5. Priority: Garnishee orders have a priority in payment over other creditors, except in certain
cases where specific assets are secured against the debt.

6. Exemptions: Some funds in a customer's account may be exempt from garnishment under
specific laws, such as funds meant for essential living expenses or those received from certain
government benefits.

7. Timeframe: The bank must remit the frozen funds to the court within the stipulated
timeframe mentioned in the garnishee order.

It's important to note that garnishee orders are legal mechanisms designed to facilitate the
recovery of debts owed to creditors. Banks are obliged to comply with these orders strictly and
promptly. Failure to comply with a garnishee order can lead to legal consequences for the bank.
Customers facing garnishee orders should seek legal advice to understand their rights and
explore options for resolution. Banks also have a duty to maintain customer confidentiality
while implementing garnishee orders.
 44

Difference between Overdraft and Cash Credit facilities

Overdraft and cash credit are two distinct credit facilities offered by banks in India. While they
both allow customers to borrow funds beyond their account balance, they have some key
differences in terms of nature, usage, and features. Let's distinguish between overdraft and
cash credit facilities:

1. Nature of Credit:

- Overdraft: An overdraft is a form of short-term credit where the bank allows the customer to
withdraw more money from their account than the available balance; the extent to which
customer can withdraw is as per the discretion of the Bank. The bank decides the extent to
which customer can overdraw depends on his creditworthiness, his networth, character,
capacity to repay etc. It is usually unsecured, meaning customers do not need to provide
collateral.
- Cash Credit: Cash credit is also a short-term credit facility, but it is typically offered to
businesses rather than individuals. It is a form of secured credit, where the bank grants a loan
against the security of assets like stocks, receivables, or inventory.

2. Usage:

- Overdraft: Overdrafts are often used for personal financial needs, such as managing
temporary cash flow shortages, unexpected expenses, or urgent financial requirements.
- Cash Credit: Cash credit is primarily used by businesses to manage working capital
requirements, such as purchasing raw materials, maintaining inventory, or meeting operational
expenses.

3. Interest Calculation:

- Overdraft: Interest is charged only on the amount overdrawn from the account. The customer
is charged interest on the excess amount withdrawn beyond the available balance.
- Cash Credit: Interest is charged on the entire credit limit sanctioned by the bank, irrespective
of whether the borrower fully utilizes the credit or not. The borrower pays interest on the
entire credit facility, whether they use it in full or partially.

4. Security:

- Overdraft: Overdrafts are generally unsecured, meaning customers do not need to provide
collateral or security to avail the facility. The bank relies on the customer's creditworthiness for
approval.
- Cash Credit: Cash credit is a secured facility, and the bank requires the borrower to provide
collateral, such as inventory, accounts receivable, or other assets, to secure the credit.
 45

5. Type of Customers:

- Overdraft: Overdraft facilities are typically offered to individual customers, including

salaried individuals and account holders.
- Cash Credit: Cash credit facilities are primarily offered to businesses, especially small and
medium-sized enterprises (SMEs), to meet their short-term working capital needs.

In summary, while both overdraft and cash credit facilities provide short-term credit
solutions, overdrafts are generally unsecured and available to individuals, while cash credit
is secured and aimed at meeting the working capital needs of businesses. The usage,
interest calculation, and customer segments for each facility differ, making them suitable for
distinct financial requirements.
 46

Unit III Law of Banking

Syllabus: Cheques – Crossed Cheques – Account Payee Cheques – Banker’s Drafts –
Dividend warrants etc., - Negotiable Instruments and Deemed Negotiable Instruments –
Salient features of the Negotiable Instruments Act – [New topic as per New Syllabus : THE
NEGOTIABLE INSTRUMENTS (AMENDMENT) ACT, 2018]

3.1 Cheque

A cheque is a bill of exchange drawer a specified banker not expressed to be payable

otherwise than on demand. It is an instrument in writing, containing an unconditional order,
signed by the maker (depositor), directing a certain banker to pay a certain sum of money to
the bearer of that instrument. Some other instruments have acquired the character of
negotiability by customs or usage of trade.

Cheque [Section 6]

According to section 6 of Negotiable Instruments Act, 1881- A cheque is defined as 'a bill of
exchange drawn on a specified banker and not expressed to be payable otherwise than on
demand’.

Thus, a cheque is a bill of exchange with two added features, viz.:

# it is always drawn on a specified banker; and

# It is always payable on demand and not otherwise.
 47

Essentials Of Cheque:

1. In Writing: The cheque must be in writing. It cannot be oral.

2. Unconditional: The language used in a cheque should be such as to convey an
unconditional order.
3. Signature of the Drawer: It must be signed by the maker.
4. Certain Sum of Money: The amount in the cheque must be certain.
5. Payees Must be certain: It must be payable to specified person.
6. Only Money: The payment should be of money only.
7. Payable on Demand: It must be payable on demand.
8. Upon a Bank: It is an order of a depositor on a bank. [5]

Parties To A Cheque

# Drawer: Drawer is the person who draws the cheque.

# Drawee: Drawee is the drawer‟s banker on whom the cheque has been drawn.
# Payee: Payee is the beneficiary of the cheque. He receives the proceeds of the cheque.

 A negotiable instrument is defined as a signed document that can be transferred

unconditionally in trading as a substitute for money. It is a written contract that is
passed from the original holder to the new one and is a promise to pay to the
assignee.

 Negotiable instruments are transferrable, and that means that the holder has the full
legal title and can use the funds as per his requirements.

 It is a negotiable instrument in writing that is addressed to the bank to pay the

specified amount to the bearer of the cheque. It is a complete order where the
drawer instructs the drawee or the bank to pay the sum to the payee from the
amount that has been already deposited with the drawee or the bank.

 The various types of the cheque are crossed cheque, open cheque, bearer cheque,
marked cheque, order cheque, post-dated cheque, etc. Cheques at one time were
the most preferred medium of numerous types of bill payment, but with time they
have lost some of its charms as people now prefer online banking instead of cheque
payments. The cheque must have these essential features-

1. The cheque is payable on demand

2. It is an order to pay the specific written amount
3. A cheque is a written negotiable instrument
4. It is an express order to pay
5. The drawer must sign the cheque
6. It is an unconditional as well as a definite order
 48

3.2 Crossed cheques

Cross Cheque

The process referred to as Crossing of Cheques specifies a general instruction to a cheque

which is about to be deposited to a bank account. According to Section 123 of the Negotiable
Instruments Act, 1881 about Crossing of Cheques, the instruction stated above defines that the
amount specified in the cheque will be deposited directly unto the account of the Cheque
holder and will not be immediately delivered as cash to the holder over the bank counter. In
this article, we look at cross cheques in detail.

Reasons to Cross Cheque

 Crossing a Cheque provides precise instructions to a financial organisation regarding the

handling of funds.
 Crossed cheques are usually identified by drawing either two parallel transverse lines
either vertically across the cheque or on the top left-hand corner of the cheque.
 Two or more words like ‘and company’ or ‘not negotiable’ may be placed between the
lines. While just drawing the lines with no words also would not alter the purpose of the
crossed cheque.
 With Crossed cheques, the cheque writers may protect the amount transferred from
being cashed by the unauthorized person or from being stolen.
 This format for Crossed cheques may differ between various countries in the nature of
its format or statements.
 Since the Crossed Cheques can only be paid through a bank account, the beneficiaries
transaction record may be traced later for further queries and clarifications.
Types of Cross Cheque

General Crossing (Section 123)

As mentioned earlier, the general crossing of cheques means including some words in between
the two lines drawn which symbolizes a crossed cheque. This depicts that the bank on which it
is drawn shall not permit the amount of payment in any other banks. Hence, the payment can
be made only in the collecting bank.
 49

Special or Restricted Crossing (Section 124)

In the case of special crossing, the cheque bears the name of the bank, either with or without
the words ‘not negotiable’. This means that the payment can be made only to that specific
bank.

Not negotiable crossing (Section 130)

This type of cheque crossing means that the cheque can be transferred but cannot be
negotiated. In such cases, the ‘cheque holder’ will bear the title of a transferor only.

Non- Negotiable Crossing

Section 130 in The Negotiable Instruments Act, 1881

130. Cheque bearing “not negotiable”.—A person taking a cheque crossed generally or
specially, bearing in either case the words “not negotiable”, shall not have and shall not be
capable of giving, a better title to the cheque than that which the person from whom he took it
had.
 50

Illustration

For example; Mr.Panjwani issues a crossed cheque in favour of Mr.Khubchandani which does
not bear the words ‘not negotiable’ therein. One Mr.Nowani steals it from the office of
Mr.Khubchandani and endorses it to Mr.Gulabani who receives it for value in good faith
without having an idea that the cheque is stolen by Mr.Nowani from Mr.Khubchandani’s office.
In this case Mr.Gulabani who satisfies all the conditions to be a holder in due course, acquires a
good title and he as a holder in due course is empowered with the right to recover the money
not only from the thief Mr.Nowani, but also from all prior parties like Mr.Panjwani and
Mr.Khubchandani.

In the above example, if the cheque bears the words “Not Negotiable” then Mr.Gulabhani will
not get better title than Mr.Nowani from whom he acquired the cheque. In the other words, if
Mr.Gulabani accepts a stolen cheque marked with ‘Not Negotiable’ and encashes it, then he is
liable to refund encashed money to the true owner of the cheque.

Account Payee Crossing

The above term depicts that the amount cannot be paid in any other bank account apart from
the one mentioned in the cheque. Practicing Account payee crossing also ensures that, the
money is transferred to the bank account only and is not given in the form of liquid cash.

Cheque Validity

The validity of a cheque is estimated to be within a period of three months from the date on
which it is drawn. After this period, it becomes stale, and it may result in the drawee bank
refusing to pay the amount. However, if the cheque has become obsolete due to the expiry of
the period of validity, then it can be re-validated by the drawer.
 51

3.3 Account Payee Cheque

An account payee cheque is a type of cheque that can only be encashed by the named payee.
This means that the cheque cannot be transferred to another person. The concept of account
payee cheque was introduced in India in 1988 to prevent cheque fraud.

Features of an account payee cheque:

* The words "A/c Payee" are written between two parallel lines in the top left corner of the
cheque.
* The cheque must be made payable to the name of the payee only.
* The payee cannot endorse the cheque to another person.
* The cheque can only be encashed by the payee at the bank on which it is drawn.

Caselaws

There are a few case laws that have upheld the validity of account payee cheques. In the case
of State Bank of India v. Suresh Chand, the Supreme Court held that an account payee cheque
cannot be transferred to another person. The Court held that the words "A/c Payee" are a
restrictive condition on the negotiability of the cheque, and that the payee cannot endorse the
cheque to another person.

In the case of Indira Gandhi Cooperative Housing Society v. Dinesh Chandra Tyagi, the Delhi
High Court held that an account payee cheque cannot be encashed by a person other than the
payee. The Court held that the words "A/c Payee" are a clear indication that the cheque can
only be encashed by the payee, and that any attempt to encash the cheque by another person
would be a violation of the terms of the cheque.

Account payee cheques are a secure way to make payments. They help to prevent cheque
fraud and ensure that the money is paid to the intended recipient. If you are writing a cheque,
it is always a good idea to make it an account payee cheque.

Here are some of the benefits of using an account payee cheque:

* It is a secure way to make payments.

* It helps to prevent cheque fraud.
* It ensures that the money is paid to the intended recipient.
* It is a legal requirement in some cases.
 52

3.4 Banker’s Drafts

A banker's draft is a negotiable instrument that is drawn by a bank on itself. It is a guarantee of
payment by the bank and it is considered to be a safe and secure way to make payments. There
are three types of banker's drafts:

Demand drafts (DDs) are payable on demand. This means that the payee can cash the DD as
soon as they receive it. They are payable in other cities/towns.

Pay orders are payable on demand but in the same city/town. This means that the payee can
only cash the pay order in the same city.

Banker’s cheques are similar to the Pay Orders. They are payable in the same city or town like
Pay Order. Pay Order and Banker’s Cheque are synonymously used by Banks as a matter of
usage or practice. There is no difference between them conceptually.

If a customer requests the amount to be paid to the payee in some other city or town, Bank
issues DD and if the customer request the amount to be paid to the payee located in the same
city or town where the customer resides, Banker issue Pay order or Banker’s Cheque. Banker's
drafts are governed by the Banking Regulation Act, 1949. The Act states that a banker's draft
must be payable in cash, and that it must be drawn on the bank's own funds. However the
Applicant of the DD/PO/Banker’s cheque first remits the amount to Bank so that Bank makes
DD/PO/Banker’s Cheque.

Pay orders and bankers' cheques are both issued for payment within the same city or town.
They are both pre-paid instruments, which means that the money is paid to the bank when the
instrument is issued. This makes them a safe and secure way to make payments.

Demand drafts (DDs), on the other hand, are issued for payment in other cities or towns. They
are also pre-paid instruments, but they can be cleared at any branch of the issuing bank. This
makes them a more flexible way to make payments, but they can also be more expensive.

Case laws that have upheld the validity of banker's drafts:

 State Bank of India v. Suresh Chand (1994): The Supreme Court held that a banker's
draft is a negotiable instrument, and that it is payable on demand.

 Central Bank of India v. Usha Devi (1999): The Supreme Court held that a banker's draft
is a guarantee of payment by the bank, and that the payee can recover the amount of
the draft from the bank if the drawer does not have sufficient funds in their account.
 53

 Oriental Bank of Commerce v. K.K. Soundararajan (2005): The Supreme Court held that
a banker's draft is a negotiable instrument, and that it can be transferred by
endorsement.

Benefits of using banker's drafts:

* They are a safe and secure way to make payments.

* They are a convenient way to make payments.
* They are a traceable way to make payments.
* They are a flexible way to make payments.

Limitations of using banker's drafts:

* They can be expensive.

* They can be time-consuming to obtain.
* They may not be accepted by all merchants.

Relevance of Banker’s Drafts in Technology driven World

Banker’s drafts have lost relevance with the advent of the UPI Payments technology which
helps people to transfer payments to any place in the world within few seconds. As on date, it
is outdated mode of transfer of funds from one place to another. Only the institutions which
cannot update their knowledge to streamline their work using Information Technology are
using the Banker’s Drafts almost causing agony to the people who got used to quickly and easily
transfer funds using Mobile Phones. Many people criticize Banks for keeping the business of
Banker’s drafts even though it has become outdated. Many institutions seek Banker’s drafts
because their staff is not aware of how to tabulate the received amounts in accordance with
the names of payers.
 54

Difference between Pay Order, DD and Banker’s Cheque

Feature Pay order Banker’s Cheque Demand Draft

Payment Location Same City or Town Same City or Town Other City or Town

Negotiability Not negotiable Not negotiable Negotiable

Can only be cleared at

Clearing Can be cleared at any Can be cleared at any
the issuing bank's
Branch of Issuing Branch of Issuing branch in the city
Bank Bank where the payee
resides

Cost Less Expensive Less Expensive More expensive

Flexibility Less flexible Less flexible More flexible

 55

3.5 Dividend Warrant

The dividend warrant is a written order issued by the company (the drawer) to the paying bank
(the drawee), instructing the bank to pay the specified dividend amount to the named
shareholder or holder of the warrant. The paying bank acts upon this order and disburses the
dividend amounts to the entitled shareholders as per the instructions mentioned in the
warrant.

Upon receiving the dividend warrants, shareholders can present them to the paying bank for
encashment or deposit. The bank verifies the warrant details and pays the dividend amount to
the entitled shareholder.

The correct terminology in the context of a dividend warrant is indeed "drawer" for the
company and "drawee" for the paying bank.

Parties to the Dividend Warrant

Drawer (Company): The drawer is the company that issues the dividend warrant. It is the entity
declaring dividends to its shareholders. The company instructs the paying bank to pay a
specified dividend amount to the entitled shareholders.

Drawee (Paying Bank): The drawee is the paying bank, which is the financial institution
responsible for disbursing the dividend payments on behalf of the company. The paying bank is
obligated to honor the dividend warrants presented by the entitled shareholders and pay them
the specified dividend amount.

Payee (Shareholder): The payee is the shareholder or the recipient of the dividend warrant.
Shareholders are entitled to receive dividends based on their shareholding in the company. The
dividend warrant serves as a payment instrument for the shareholders to receive the dividend
amount from the paying bank.

Some of the key features of dividend warrants:

* They are negotiable instruments. This means that they can be transferred to another person
by endorsement.
* They are payable to the shareholder or their nominee.
* They must be issued within 30 days of the declaration of dividends.
* They must be stamped with a prescribed stamp duty.
 56

Caselaws:

Hindustan Steel Ltd. v. Ram Lal (1959): The Supreme Court held that a dividend warrant is a
negotiable instrument, and that it can be transferred by endorsement.
Union Bank of India v. Shriram Investments (1998): The Supreme Court held that a dividend
warrant is a valid mode of payment of dividends, and that a company cannot refuse to pay
dividends in the form of a dividend warrant.
Essar Steel Ltd. v. Manoj Kumar Jain (2013): The Supreme Court held that a dividend warrant is
a negotiable instrument, and that it can be enforced by the holder in a court of law.

Here are some of the benefits of using dividend warrants:

* They are a safe and secure way to pay dividends.

* They are a convenient way to pay dividends.
* They are a traceable way to pay dividends.
* They are a flexible way to pay dividends.

Dividend warrants are used by Joint Stock Companies to ensure a safe and secure way to pay
dividends. Here are some of the limitations of using dividend warrants:

* They can be expensive.

* They can be time-consuming to obtain.
* They may not be accepted by all shareholders.

A bank is involved in dividend warrants in the following ways:

1. Issuing dividend warrants: Banks are often appointed by companies to issue dividend
warrants on their behalf. This is because banks have the infrastructure and expertise to
handle large volumes of transactions.
2. Clearing dividend warrants: Banks also clear dividend warrants through the clearing
house. This ensures that the warrants are processed quickly and efficiently.
3. Storing dividend warrants: Banks may also store dividend warrants on behalf of
companies. This is a secure way to store the warrants and it also makes it easier for
shareholders to redeem them.
4. Providing information about dividend warrants: Banks can provide information about
dividend warrants to shareholders. This includes information about the amount of the
dividend, the date on which the warrant is payable, and the terms and conditions of the
warrant.
 57

Some of the benefits of using a bank to handle dividend warrants:

* It is a safe and secure way to handle dividend warrants.

* It is a convenient way to handle dividend warrants.
* It is a traceable way to handle dividend warrants.
* It is a flexible way to handle dividend warrants.

A company looking to issue dividend warrants or a sharehold looking to redeeem a dividend

warrant can avail the services of Banks. However there is some difference between the role of a
Bank as Merchant Banker and the role as Paying Banker of Dividend Warrants.

Merchant Banks

Merchant banks can help companies to issue shares, bonds, and other securities. They can also
help companies to raise capital through mergers and acquisitions. Merchant banks also provide
financial advisory services to businesses and high-net-worth individuals. This includes providing
advice on investment strategies, risk management, and corporate finance. Merchant banking is
a specialized field of financial services that requires a deep understanding of the financial
markets and the needs of businesses. Merchant banks typically have a team of experienced
professionals who can provide a wide range of services to their clients.

Merchant Banker Role:

As a merchant banker, the bank provides specialized financial services to corporations and
governments, including underwriting, advisory, and capital-raising activities. It assists
companies in conducting IPOs, raising funds through the issue of securities, handling mergers
and acquisitions, providing project financing, and offering investment management services.

Paying Banker Role:

As a paying banker, the bank is responsible for disbursing dividend payments to entitled
shareholders on behalf of a company that has declared dividends. The bank acts as the drawee
of the dividend warrants issued by the company (the drawer) and makes the dividend
payments to the shareholders (the payees) as per the instructions mentioned in the warrants.

In some cases, banks that offer a wide range of financial services, including merchant banking,
may also provide dividend payment services as a part of their regular banking operations. When
the same bank acts as a merchant banker for a company and also manages its banking
operations, it can serve as both the facilitator for capital-raising activities and the entity
responsible for distributing dividends to shareholders.

The dual role of a bank as a merchant banker and a paying banker may offer certain
advantages, such as streamlining the financial services provided to corporate clients and
 58

maintaining a consistent relationship with the company throughout various financial

transactions.

However, it is important to ensure that there is no conflict of interest between the bank's role
as a merchant banker and its responsibilities as a paying banker. Banks must maintain
transparency, follow regulatory guidelines, and adhere to best practices to avoid any potential
conflicts and ensure fair treatment of shareholders in dividend distribution.
 59

3.6 Negotiable Instruments

Negotiable instruments are freely transferable commercial documents, and each type of
negotiable instrument has unique functions and features.

Negotiable instruments are commercial document that satisfies certain conditions and is
transferable either by applying the law or the custom of bleed concerned. This instrument
can be transferred freely from hand to hand and has a legal life transferred by more delivery
or endorsement.

Most Common Types of Negotiable Instruments are –

 Promissory notes.
 Bill of exchange.
 Cheque.

Most negotiable instruments fall under the following two categories; the Negotiated
instrument by statute and Negotiated instruments by custom or usages.
A negotiable instrument act states three instruments; check bill of exchange and promissory
notes.

They are therefore called negotiable instruments by statute. Following is the specimen of
the Promissory Note.

The promissory note is a signed document of written promise to pay a stated sum to a
specified person or the bearer at a specified date or on-demand. The promissory note is an
instrument in writing containing an unconditional rule signed by one party to pay a certain
sum of money only to or to the order of a certain person or the bearer of the instrument.
Thus a promissory note contains a promise by the debtor to the creditor to pay a certain
sum of money after a certain date. The debtor is the maker of the instrument.
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Promissory Note [Section 4]:

 Definition According to section 13 of Negotiable Instruments Act, 1881- A promissory

note is an instrument in writing (not being a bank note or a currency note)
containing an unconditional undertaking, signed by the maker to pay a certain sum
of money to, or to the order of, a certain person or to the bearer of the instrument.
 A promissory note is a promise in writing by a person to pay a sum of money to a
specified person or to his order.
 Maker: The person who makes the promissory note and promises to pay is called the
maker. He is a debtor.
 Payee: The person to whom the payment is to be made is called the payee. He is
creditor.

Essentials or Characteristics of a Promissory Note:

1. In writing - A promissory note must be in writing. Writing includes print and typewriting.
2. Promise to pay - It must contain an undertaking or promise to pay. Thus, a mere
acknowledgement of indebtedness is not sufficient. Notice that the use of the word
‘promise’ is not essential to constitute an instrument as promissory note.
3. Unconditional - The promise to pay must not be conditional. Thus, instruments payable
on performance or non- performance of a particular act or on the happening or non-
happening of an event are not promissory notes.
4. Signed by the Maker – The promissory note must be signed by the maker, otherwise it is
of no effect.
5. Certain Parties - The instrument must point out with certainty the maker and the payee
of the promissory note.
6. Certain sum of money - The sum payable must be certain or capable of being made
certain.
7. Promise to pay money only - If the instrument contains a promise to pay something in
addition money, it cannot be a promissory note.
8. Number, place, date etc. - These are usually found in a promissory note but are not
essential in law. If a promissory note does not bear a date, it is deemed to have been made
when it was delivered.
9. Installments - It may be payable in installments.
10. It may be payable on demand or after a definite period - Payable 'on demand' means
payable immediately or any time till it becomes time-barred. A demand promissory note
becomes time barred on expiry of 3 years from the date it bears.
11. Cannot be payable to bearer - It cannot be made payable to bearer on demand or even
payable to bearer after a certain period. (Only RBI Governor can issue PN to bearer)
12. It must be duly stamped under the Indian Stamp Act - It means that the stamps of the
requisite amount must have been affixed on the instrument and duly cancelled either
before or at the time of its execution. A promissory note, which is not so stamped, is a
nullity.
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Parties to Bill of Exchange

The Bill of Exchange contains an order from the creditor to the debtor to pay a certain
person after a certain period.

The person who draws it is called a drawer (the creditor) and the person on whom it is
drawn is called drawee (the debtor) or acceptor.

The person to whom the amount is payable is called the payee.

Bill Of Exchange [Section 5]:

According to section 5 of Negotiable Instruments Act, 1881- A 'bill of exchange' is an

instrument in writing, containing an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money only to or to the order of a certain person, or
to the bearer of the instrument.

Characteristic Features of a bill of exchange:

1. It must be in writing.
2. It must contain an order to pay and not a promise or request.
3. The order must be unconditional.
4. There must be three parties, viz., drawer, drawee and payee.
6. It must be signed by the drawer.
7. The sum payable must be certain or capable of being made certain.
8. The order must be to pay money and money alone.
9. It must be duly stamped as per the Indian Stamp Act.
10. Number, date and place are not essential.

Parties To A Bill Of Exchange:

# Drawer: The maker of a bill of exchange is called the drawer.

# Drawee: The person directed to pay the money by the drawer is called the drawee
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Cheque

 A cheque is a bill of exchange drawn by a drawer on a specified banker not

expressed to be payable otherwise than on demand.
 It is an instrument in writing, containing an unconditional order, signed by the maker
(depositor), directing a certain banker to pay a certain sum of money to the bearer
of that instrument.
 Some other instruments have acquired the character of negotiability by customs or
usage of trade.

Cheque [Section 6]

According to section 6 of Negotiable Instruments Act, 1881- A cheque is defined as 'a bill of
exchange drawn on a specified banker and not expressed to be payable otherwise than on
demand’.

Thus, a cheque is a bill of exchange with two added features, viz.:

# it is always drawn on a specified banker; and

# It is always payable on demand and not otherwise.

Essentials Of Cheque:

1. In Writing: The cheque must be in writing. It cannot be oral.

2. Unconditional: The language used in a cheque should be such as to convey an
unconditional order.
3. Signature of the Drawer: It must be signed by the maker.
4. Certain Sum of Money: The amount in the cheque must be certain.
5. Payees Must be certain: It must be payable to specified person.
6. Only Money: The payment should be of money only.
7. Payable on Demand: It must be payable on demand.
8. Upon a Bank: It is an order of a depositor on a bank.
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Parties To A Cheque

# Drawer: Drawer is the person who draws the cheque.

# Drawee: Drawee is the drawer‟s banker on whom the cheque has been drawn.
# Payee: Payee is the beneficiary of the cheque. He receives the proceeds of the cheque.

A negotiable instrument is defined as a signed document that can be transferred

unconditionally in trading as a substitute for money. It is a written contract that is passed
from the original holder to the new one and is a promise to pay to the assignee.
Negotiable instruments are transferrable, and that means that the holder has the full legal
title and can use the funds as per his requirements.
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Meaning of negotiable instruments

 A negotiable instrument is always in a written form and is generally considered a mode

of paying a debt from one person to another. In other words, it is a type of promise to
pay the bearer the stipulated money.
 The negotiable instrument is presumed to be drawn, accepted, made, negotiated,
endorsed and transferred voluntarily to the bearer. These are generally used in
monetary dealings or commercial transactions.
 The negotiable instruments are considered reliable with an unconditional right to
recover the stipulated money either on a date or on-demand and hence people find it
easy and comfortable using them in transactions.

Types of negotiable instruments (Statutory and Deemed)

A negotiable instrument is a commercial document with different kinds and unique functions. It
has a legal life of its own that satisfies specific conditions and can be transferred by
endorsement or delivery. There are two types of negotiable instruments:

1. Instruments Negotiable by Statute for instance cheques, bills of exchange and promissory
notes
2. Instruments Negotiable by Customs or Usage, for example, banknotes or currencies,
share warrants, bearer debentures, exchequer bills, dividend warrants, and circular
notes. They are called Deemed Negotiable Instruments.

(Note: See next page for specimens of two types of Bills of Exchange)
 65

Types of Bill of Exchange

Usance Bill of Exchange

Sight Bill of Exchange

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Difference between Cheque and Bill of Exchange in Commercial Transactionss

A cheque is used very widely and its usage goes much beyond commercial transactions. A
cheque can be issued by father directing the bank to make payment to his son. This is not a
commercial transaction. So, it can be said that cheque has wider usage. On the other hand, Bill
of Exchange is used only in commercial transactions. Therefore the first difference between
Cheque and Bill of Exchange is the utility factor. However, the fundamental difference between
cheque and the bill of exchange in commercial transactions is that, the cheque is issued by the
buyer of goods (Drawer) directing his bank (Drawee) to make payment to the seller of goods
(Payee), who is the payee of the cheque, in consideration of the goods received by him. For
local transactions where buyer and seller are located in the same city or town, cheque issuance
and goods receipt can be done simultaneously.

However, if the buyer and seller are located in different countries, cities or towns, the buyer
cannot issue cheque without receiving goods, and the seller cannot deliver goods without
receiving cheque. There is risk for both these parties. If buyer sends cheque without receipt of
goods, the seller may withdraw cheque proceeds and may not send goods to the buyer. If the
seller trusts the buyer by first sending goods, there is no guarantee that buyer will send the
cheque. So, this commercial transaction must be facilitated using Bill of Exchange and usually a
Bank is involved.

Therefore, in Bill of Exchange, the Drawer is the seller who sends bill of exchange to the
Drawee’s bank for collection along with the Transport Document (Railway Receipt, Airway Bill,
Lorry Receipt of Bill of lading). The Drawee’s Bank informs the buyer of goods to pay the
proceeds of the bill of exchange and get the Transport Document released so that the buyer
takes the delivery of goods. So, the fundamental difference between Cheque and Bill of
Exchange in commercial transactions is, when it comes to Cheque the Drawer is the Buyer,
whereas for a Bill of Exchange, the Drawer is the Seller.

After collection of proceeds of Bill of Exchange from the buyer, the Drawee’s Bank forwards the
proceeds to the Seller/Seller’s Bank. The intervention of bank makes both parties i.e., the
buyer and seller, risk free. The seller is happy that transport document is delivered only after
the amount of goods/billl of exchange is paid by the buyer. Buyer, on the other hand is assured
that, he now has possession of goods by virtue of the Transportation document in his hands
with the help of which he can immediately take delivery of the goods.

In simple words, Cheques are used in local transactions, and the Bills of Exchange are used
where the buyer and seller are separated by Geographical distances, and to address the
problem of trust deficit, they use Bill of Exchange for safety.

(Note: Refer next page for better understanding of the parties involved in Cheque transaction
and Bill of Exchange transaction)
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Parties to a Cheque
(Drawer is the buyer of goods, whereas the Drawee is the Drawer’s Bank, and Payee is the
seller of goods)

Parties to Bill of Exchange(Drawer is the seller, Drawee is the buyer, Payee is

usually the drawer himself or his bank or some third party)
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Other differences between Cheque and Bill of Exchange

Cheque and bill of exchange are both negotiable instruments used in financial transactions, but
they have some key differences in terms of usage, parties involved, and mode of payment. Let's
explore the differences between a cheque and a bill of exchange:

1. Definition:

Cheque: A cheque is a written order from an account holder (the drawer) to their bank (the
drawee) to pay a specific amount of money to a named person or entity (the payee). It is a type
of instrument used for making payments from a bank account.

Bill of Exchange: A bill of exchange is a written unconditional order from one person (the
drawer) to another person or entity (the drawee) to pay a specific amount of money to a
named person or entity (the payee) either on demand or at a future date. It is a form of
negotiable instrument used in trade transactions.

2. Parties Involved:

Cheque: The parties involved in a cheque transaction are the drawer (account holder), the
drawee (bank), and the payee (recipient of the payment).

Bill of Exchange: The parties involved in a bill of exchange transaction are the drawer (the
person who issues the bill), the drawee (the person who is directed to make the payment), and
the payee (the person who will receive the payment).

3. Nature of Payment:

Cheque: A cheque is an instrument used for making payments to the payee from the drawer's
bank account. The payment is made on demand when the payee presents the cheque to the
drawee bank for encashment.

Bill of Exchange: A bill of exchange is a trade-related instrument used for effecting payments
between parties engaged in commercial transactions. The payment can be made either on
demand (called a "sight bill") or at a specified future date (called a "term bill").

4. Acceptance:

Cheque: A cheque does not require acceptance by the drawee (the bank). Once the payee
presents the cheque to the bank, the bank is obligated to pay the amount mentioned on the
cheque to the payee.
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Bill of Exchange: A bill of exchange requires acceptance by the drawee (the person or entity
directed to make the payment) to become a legally binding document. Acceptance signifies the
drawee's agreement to pay the amount mentioned on the bill on the specified date.

5. Types:

Cheque: There are various types of cheques, including bearer cheques, order cheques, crossed
cheques, and post-dated cheques, each with specific features and usage.

Bill of Exchange: There are mainly two types of bills of exchange: sight bills (payable on
demand) and term bills (payable at a specified future date). Term bills are also called Usance
Bills.

In summary, both cheques and bills of exchange serve as instruments for making payments, but
they differ in terms of their usage, acceptance requirements, and the parties involved in the
transaction. Cheques are primarily used for general payments from bank accounts, while bills of
exchange are more trade-oriented and involve specific parties in commercial transactions.
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What is ACCEPTANCE of a Bill of Exchange?

There is no need for the drawee of a Cheque to accept to pay the proceeds. Immediately on
sight the Drawee of the Cheque (the Bank of Drawer) must pay the proceeds. Whereas for a
Bill of Exchange, acceptance of drawee is required if it is a Term/Usance Bill of Exchange. There
are two types of bill of exchange, viz., the Bill of Exchange payable on Sight and another the Bill
of Exchange payable after a certain period of time which is normally after sight or after the date
of bill of exchange. This bill of exchange which is payable after some time is called Term or
Usance Bill of Exchange. This is usually issued to allow credit to the buyer for certain period. In
accounting practice, it is called Credit Sales or Sale on Credit. Sale on credit is offered by the
seller to motivate the buyer to purchase goods from him. The benefit to the buyer is, he will
have advantage of receiving goods and make payment after certain period of time. In the
meanwhile the goods may be sold off by him before making the payment to the seller. He can
profitably hold such sale proceeds in his Bank account, earning interest till he is obligated to
pay as per Term Bill of Exchange. To enjoy this advantage, buyers of goods show interest to
receive goods on Credit from the sellers. Sellers, therefore draw Term Bill of Exchange instead
of Sight Bill of Exchange, so as to allow the buyer to make payment after certain time period,
say, one month, two months, three or four months to motivate buyers to buy from them. The
longer the time period, the greater the advantage for the buyer.

The Sight Bill of Exchange is almost like a Cheque wherein the buyer who is a drawee, must
make immediate payment to take delivery of the transport document from his Bank who
receives the Bill of Exchange along with Transport Document from the seller. On the other
hand, the Term Bill of Exchange or Usance Bill of Exchange does not demand immediate
payment from the buyer as sale is made on credit allowing buyer to make payment after certain
period. Therefore, for the Term Bill of Exchange, the buyer instead of making immediate
payment can ACCEPT to pay the bill by endorsing on the face of the Bill his ACCEPTANCE.
Immediately after such acceptance, the Bill of Exchange becomes a Negotiable Instrument.

This acceptance conveys an assurance from the buyer to the seller that he will make the
payment of bill of exchange as per the contractual terms between them. This assurance is a
contractual obligation for the buyer, and after acceptance he cannot go back on it and deny
making payment to the seller. It is same as the promisee in a contract conveying his acceptance
for the proposal made by the promisor. Without such acceptance, the Bill of Exchange does not
carry the legal status of a Negotiable Instrument. Whereas, when it comes to the Sight Bill of
Exchange, which obligates the buyer to make immediate payment on sight, it is considered
Negotiable instrument the moment it is drawn by the Seller.
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When Bill of Exchange is used

A bill of exchange is used instead of a cheque in specific trade-related transactions or

situations where parties involved in commercial activities prefer an instrument with certain
advantages over a cheque. Here are some occasions when a bill of exchange is commonly
used instead of a cheque:

1. International Trade: In international trade transactions, where parties may be located in

different countries with different currencies and banking systems, bills of exchange (also
known as "trade bills" or "trade drafts") are often preferred. They provide a secure method
of payment and allow for negotiation and acceptance between parties in different
countries. It may also be noted that in transactions between domestic traders located in
different cities or towns, the bill of exchange is used because of trust deficit between the
buyer and seller.

2. Credit Terms: When a seller extends credit to a buyer and allows them to make payment
at a future date, a bill of exchange may be used to formalize the credit terms and provide a
legally binding payment commitment.

3. Security: Bills of exchange can offer more security to the payee compared to a cheque.
Since a bill of exchange requires acceptance by the drawee, it provides a form of assurance
that payment will be made at the specified future date.

4. Documentary Credit: In certain international trade transactions, banks may issue

documentary credits, which are bills of exchange backed by specific documents, such as
shipping documents or other trade-related papers. Documentary credits provide additional
security and assurance of payment for the parties involved.

5. Export-Import Transactions: Bills of exchange are commonly used in export-import

transactions, especially in cases where the buyer and seller are not familiar with each other
or when there is a time lag between the shipment of goods and the actual payment.

6. Negotiability: Bills of exchange are negotiable instruments, which means they can be
transferred from one party to another through endorsement. This feature makes bills of
exchange more suitable in certain trade and financial transactions where transferability is
essential.

7. Customary Practice: In some industries or regions, bills of exchange are more commonly
used for trade-related payments due to customary practices and historical reasons.

It's important to note that while bills of exchange have certain advantages in trade-related
transactions, cheques remain a popular and widely used method for general payments
within the same country or banking system. The choice between a bill of exchange and a
cheque depends on the specific requirements of the transaction, the relationship between
parties, and the legal and regulatory framework in place.
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3.7 Deemed Negotiable Instruments

As per the Negotiable Instruments Act, 1881, Promissory Notes, Cheques and Bills of
Exchange are the negotiable instruments. They are legally full fledged negotiable
instruments as they have the full fledged statutory status of negotiable instruments.
However, there are certain negotiable instruments who are not considered legally full
fledged negotiable instruments like Promissory Note, Cheque and Bill of Exchange, but
they have the status of “deemed negotiable instrument” by virtue of customs or usages of
trade.

Negotiable instruments by customs or usages are mainly the demand drafts, government
promissory notes, fixed deposit receipts, share warrants, bearer bonds, railway receipts,
hundis, delivery orders have been held by Courts to be negotiable by usage or custom of the
trade.

The following are the deemed negotiable instruments as per the Negotiable Instruments
Act, 1881:

1. Bank Drafts: Bank drafts, also known as demand drafts, are instruments issued by banks
for the purpose of making payments. They are considered negotiable instruments and are
commonly used for secure payments.

A demand draft is a negotiable instrument similar to a bill of exchange. A bank issues a

demand draft to a client (drawer), directing another bank (drawee) or one of its own
branches to pay a certain sum to the specified party (payee)
A demand draft can also be compared to a cheque. However, demand drafts are difficult to
countermand. Demand drafts can only be made payable to a specified party, also known as
pay to order. But, cheques can also be made payable to the bearer. Demand drafts are
orders of payment by a bank to another bank, whereas cheques are orders of payment from
an account holder to the bank.

Essential features of DD:

 It is also called as Banker’s cheque because the drawer of the instrument is the
Banker himself, not the customer
 There is no way a DD can be returned on the ground of “Insufficient Funds”.
 If the beneficiary properly presents it to the collecting banker, he will get the
payment with 100 percent surety which may not be the case if it is cheque drawn by
an individual.
 It is used to send money from one place to another place when the purchaser of the
DD and the beneficiary have accounts in different banks
 Demand draft may be issued on the same place also, and if they are drawn by the
banker on his own city or town, it is called Pay Order or Banker’s cheque.
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2. Government Promissory Notes: Certain government-issued promissory notes and bonds,

such as Treasury Bills and Savings Bonds, are recognized as deemed negotiable instruments.

Government promissory note is a kind of Government Security under Government

Securities Act, 2006. a Government Promissory Note (GPN) may be payable to or to the
order of a certain person; Government security (G-Sec) means a security created and issued
by the Government for the purpose of raising a public loan or any other purpose as notified
by the Government in the Official Gazette.

The Government Promissory Notes are issued by the Union or State Governments in the
form of promissory notes payable to order or a bearer bond payable to bearer. In
HiraLalChatterji vs. Raj Kumar Mukherjee (12 CIJ 470), it was held that the Government
Promissory notes are negotiable instruments with the definition of Section 13 of the
Negotiable Instruments Act, 1881.

Essential features:

 Issued by the Governments

 Issued by government for the purpose of borrowing from public

3. Fixed Deposit Receipts: Fixed deposit receipts issued by banks for fixed deposit accounts
are also considered deemed negotiable instruments. They represent a time deposit with a
bank and are often transferable. Fixed deposit receipts are not usually paid on demand
except by way of pre-closure applying the penal interest. The beneficiary of the fixed
deposit receipt can transfer the receipt in favour of another person, thus giving it the
feature of a negotiable instrument.

4. Share Warrants: Share warrants are documents issued by companies, representing shares
of stock. They are recognized as deemed negotiable instruments.

5. Bearer Bonds: Bearer bonds are bonds that are not registered in the name of the owner,
and ownership is determined by physical possession. They are considered deemed
negotiable instruments.

6. Railway Receipts: Railway receipts are documents issued by railway authorities to

acknowledge the receipt of goods for transportation by rail. They serve as evidence of the
consignment, include details about the goods, and are transferable by endorsement and
delivery. Railway receipts are recognized as deemed negotiable instruments under the
Negotiable Instruments Act, 1881.

These deemed negotiable instruments play crucial roles in various sectors of the Indian
economy, facilitating trade, commerce, finance, and transportation. They are subject to the
legal framework provided by the Act, which governs their transfer, negotiation, and the
rights and liabilities of parties involved in transactions related to these instruments.
 74

In Amarchand& Co vs. Ram Das Vithal Das (38 Bom.255), the Bombay HC had taken the view
that the Railway receipts are negotiable instruments. They fulfil all the essential
characteristics of a negotiable instrument like “freely transferable”, when the transferee get
it for value and in good faith, the title of the holder in due course is free from all previous
defects in title and can use all parties to recover the money of the instrument in his own
name.

Essential features

 It is issued by the Railways after noting the contents of the goods to be delivered to
the consignee named by the Consignor in the application.
 It is issued only for domestic transactions (delivery of goods within the country)
 It is also known as quasi-negotiable instrument.
 Loans can be obtained on the basis of Document of title to goods from banks and
financial institutions. Railway receipt being a document of title to goods can be
useful to get loans.

7. Hundies

Hundis refer to financial instruments evolved on the Indian sub-continent used in trade and
credit transactions. They were used

 as remittance instruments (to transfer funds from one place to another),

 as credit instruments (to borrow money [IOUs]),
 for trade transactions (as bills of exchange).

Technically, a Hundi is an unconditional order in writing made by a person directing another

to pay a certain sum of money to a person named in the order. Hundis, being a part of the
informal system have no legal status and are not covered under the Negotiable Instruments
Act, 1881. Though normally regarded as bills of exchange, they were more often used as
equivalents of cheques issued by indigenous bankers.

8. Delivery Order

According to the Uniform Commercial Code (UCC) a delivery order refers to an "order given
by an owner of goods to a person in possession of them (the carrier or warehouseman)
directing that person to deliver the goods to a person named in the order."

A delivery order is a legal document that instructs the recipient, the bailee, to release
supplies or goods to the designated individual or organization named in the order. It’s
defined by the Uniform Commercial Code, and it’s also described in each region’s contract
law. The industry term for a delivery order is D/O, and it’s commonly used in international
trade, authorizing the release of imported cargo. Businesses often use standard order forms
that can be printed from the Internet or legal software programs. The person who
completes a delivery order is often called the consignor.
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A simple form consisting of one page is often used by the owner of the goods to complete
the order, and it’s similar to a packing slip. The main difference between a packing slip and
the delivery order is the additional requirement of the bailee to ship the goods. The
information on the order includes the container that’s to be delivered or the product and
quantity. It also includes the name and address of the person who will receive the shipment
and the name of the representative who will make the payment if it’s to be collected upon
delivery. The delivery date is included so that the carrier knows when to ship the goods and
to ensure that the designated party receives the goods on time.

Essential features:

 Relate to international trade transactions

 Delivery instructions are given by the Consignor to the Shipping company or the Air
Carrier as the case may be
 The Consignor is the owner of goods
 Defined under Uniform Commercial Code
 The bailee to whom the instructions are given by the owner of the goods is carrier of
goods who has the responsibility to deliver the goods to the consignee to whom the
owner of goods sold the goods that are to be delivered.
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Specimen of Delivery Order

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3.8 Salient Features of the Negotiable Instruments Act,

1881
The Negotiable Instruments Act, 1881, is a significant legislation in India that governs the legal
framework for various negotiable instruments, including promissory notes, bills of exchange,
and cheques. Here are some of the salient features of the Negotiable Instruments Act, 1881:

1. Definition of Negotiable Instruments: The Act provides clear definitions of negotiable

instruments, including promissory notes, bills of exchange, and cheques. It outlines their
characteristics and the legal framework governing their transfer and enforcement.

2. Negotiability: One of the central features is negotiability, which means that these
instruments can be freely transferred from one person to another, often through endorsement,
making them valuable and convenient for commerce.

Negotiability, in the context of negotiable instruments, refers to the ease with which an
instrument can be transferred from one person to another, often by endorsement or delivery,
and the rights associated with that transfer. A negotiable instrument is a document that
represents a promise to pay a specific sum of money to a specified person or bearer. These
instruments are considered valuable and transferable, and they possess certain key
characteristics:

 Transferability: A negotiable instrument can be easily transferred from one party to

another. This transfer can occur by endorsement (signing on the back of the instrument)
and delivery. The person who holds a negotiable instrument is generally entitled to its
payment.

 Bearer or Order Form: Negotiable instruments can be in "bearer form" or "order form."
Bearer instruments are payable to the bearer, meaning whoever holds the instrument
can receive payment. Order instruments are payable to a specific person or their order,
and they can be transferred by endorsement to another party.

 Unconditional Promise: Negotiable instruments typically contain an unconditional

promise to pay. The promise to pay is not subject to any conditions or contingencies.

 Fixed Amount: The instrument specifies a fixed amount of money to be paid. This
amount is certain and determinable.

 Date and Time: Negotiable instruments often include a specified date or a time frame
for payment, making it clear when the payment is due.
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 Signed by the Maker or Drawer: The instrument must be signed by the person making
the promise to pay (the maker or drawer).

Negotiability allows these instruments to circulate in the marketplace much like currency.
When a negotiable instrument is transferred from one party to another, the transferee
generally acquires the same rights to payment as the transferor had. This ease of transferability
and the associated rights make negotiable instruments valuable tools in commerce and finance.

3. Presumption of Consideration: The Act presumes that every negotiable instrument is made
or drawn for consideration, which is a fundamental requirement for the validity of such
instruments.

4. Parties Involved: The Act identifies the primary parties involved in negotiable instruments,
including the drawer, drawee, payee, and endorser, and defines their roles and responsibilities.

5. Acceptance and Payment: The Act specifies the rules for the acceptance of bills of exchange
and the payment of promissory notes and cheques. It establishes legal obligations for the
parties involved.

6. Presentment: It outlines the rules for presenting bills of exchange for acceptance and
payment and specifies the consequences of non-acceptance or non-payment.

7. Crossing of Cheques: The Act provides for the crossing of cheques as a security measure to
prevent misuse or fraudulent alteration.

8. Liability of Parties: It defines the liability of parties to negotiable instruments, including the
drawer's and endorser's liability in case of dishonor.

9. Discharge and Discharge of Parties: The Act explains the circumstances under which a
negotiable instrument can be discharged and the consequences of such discharge.

10. Limitation Period: It establishes a limitation period for initiating legal action in case of
dishonor of a negotiable instrument. The Limitation Act, 1963 prescribes the time limit within
which a legal action can be initiated for the dishonor of a negotiable instrument. The limitation
period for such an action is 3 years from the date on which the negotiable instrument was
dishonored. A negotiable instrument is a document that can be transferred from one person to
another and that can be used to demand payment of money. Some examples of negotiable
instruments include cheques, bills of exchange, and promissory notes.

11. Holder in Due Course: The Act recognizes the concept of a "holder in due course," who
acquires the instrument for value, in good faith, and without notice of any defects, and enjoys
certain legal privileges.
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12. Penalties: The Act contains provisions for penalties in case of offenses related to negotiable
instruments, such as dishonor or fraud.

13. Amendments: Over the years, the Act has been amended to reflect changing banking and
financial practices, including the introduction of electronic clearing systems.

The Negotiable Instruments Act, 1881, plays a critical role in facilitating commercial
transactions, ensuring the enforceability of negotiable instruments, and providing a legal
framework for their use in India. It has evolved over time to adapt to modern banking practices
while preserving the essential principles of negotiability and enforceability.

Holder in Due course

The concept of a "Holder in Due Course" (HDC) is an important legal principle under the
Negotiable Instruments Act, 1881, and it pertains to negotiable instruments like promissory
notes, bills of exchange, and cheques. A Holder in Due Course is a person who acquires a
negotiable instrument for value, in good faith, and without notice of any defects or
irregularities. This status provides certain legal advantages and protections to the holder.

Here are the key elements and implications of being a Holder in Due Course:

1. Acquisition for Value: To become an HDC, a person must acquire the negotiable instrument
by giving value for it. This value could be money, goods, services, or any consideration agreed
upon by the parties involved in the transaction.

2. Good Faith: The holder must acquire the instrument in good faith, meaning they must
genuinely believe that the instrument is valid and free from any legal defects. Good faith
implies an honest intention in the transaction.

3. Absence of Notice: An HDC should acquire the instrument without notice of any problems or
irregularities related to it. This includes not having knowledge of any disputes, fraud, forgery, or
other issues that could affect the instrument's validity or the rights of the parties involved.

Implications of Holder in Due Course Status:

1. Rights and Defenses: An HDC obtains the instrument with certain rights and is generally
protected against most defenses that could be raised against the instrument. This means that
even if there are disputes or problems between prior parties in the chain of the instrument's
ownership, the HDC can typically enforce payment without being hindered by these disputes.

2. Clean Title: Being an HDC gives the holder a "clean" or "unencumbered" title to the
instrument. The instrument is often considered as if it is free from any defects or claims by prior
parties.
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3. Value Received: An HDC who acquires the instrument for value can enforce payment of the
instrument against the party liable to pay it, even if that party has defenses against prior
parties.

It's important to note that the concept of HDC is a legal protection to encourage the circulation
and acceptance of negotiable instruments. It provides a level of security to those who acquire
these instruments in good faith and for value, without having to be concerned about prior
disputes or issues that may have occurred in earlier transactions. However, not all parties who
hold a negotiable instrument automatically qualify as HDCs; they must meet the specific criteria
outlined under the law.

Illustration

A gave a cheque in favour of B, B endorsed it in favour of C. D had stolen the cheque and
endorsed it in favour of E. E receives it in good faith and for consideration. E becomes the
holder in cue course.

State Bank of India v. Suresh Chand (1994). In this case, the Supreme Court held that the
drawer of a cheque is liable to pay the HDC even if the cheque was forged by the payee. The
Court held that the HDC is a holder for value and without notice of any defect in the title of the
person from whom he acquired the cheque.

Central Bank of India v. Usha Devi (1999). In this case, the Supreme Court held that the drawer
of a bill of exchange is liable to pay the HDC even if the bill of exchange was fraudulently
endorsed. The Court held that the HDC is a holder for value and without notice of any defect in
the title of the person from whom he acquired the bill of exchange.

The rationale behind these cases is that the HDC is a person who has acquired the negotiable
instrument in good faith and for value. They should not be penalized for the fraud of someone
else in the chain. The drawer of the negotiable instrument is the first party to the instrument
and they are ultimately responsible for its payment.

However, it is important to note that these cases are not always followed by the courts. In
some cases, the courts may decide to first resolve the issues of forgery or other defects in the
title before they order the drawer to pay the HDC. This is because the courts want to ensure
that the drawer is not being held liable for something that they did not do.

Ultimately, the decision of whether or not to pay the HDC is up to the court. However, the case
laws that are mentioned above provide a strong argument in favor of the HDC being paid.
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Discharge of Negotiable Instrument

A negotiable instrument can be discharged under the following circumstances:

1. Payment: The most common way to discharge a negotiable instrument is by payment.

When the amount due on the instrument is paid in full, the instrument is discharged.

2. Cancellation: Another way to discharge a negotiable instrument is by cancellation. This

can be done by the holder of the instrument by writing "cancelled" across the face of
the instrument and then signing their name.

3. Impairment: A negotiable instrument can also be discharged by impairment. This

happens when the instrument is damaged or destroyed in such a way that it cannot be
used to demand payment.

4. Accord and satisfaction: Accord and satisfaction is a legal term that means that the
parties to a dispute have agreed to settle the dispute by exchanging something of value.
If the parties to a dispute agree to settle a dispute by exchanging something of value,
then the negotiable instrument that was the subject of the dispute is discharged.

5. Waiver: Waiver is the intentional giving up of a right. If the holder of a negotiable

instrument waives their right to demand payment on the instrument, then the
instrument is discharged.

6. Estoppel: Estoppel is a legal principle that prevents someone from denying something
that they have previously admitted to. If the holder of a negotiable instrument is
estopped from demanding payment on the instrument, then the instrument is
discharged.

7. Bankruptcy: If the maker or drawer of a negotiable instrument files for bankruptcy, the
instrument may be discharged. The specific circumstances under which a negotiable
instrument will be discharged in bankruptcy will depend on the laws of the country
where the bankruptcy is filed.
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3.9 The Negotiable Instruments (Amendment) Act, 2018

The Negotiable Instruments Act, 1881, had undergone significant amendments in 2018 to
address various issues related to dishonor of cheques and streamline legal procedures.
However, it's important to note that legislative changes may have occurred since then. Here are
some of the key amendments introduced in 2018:

1. Section 143A - Compensation for Delay in the Discharge of Liability:

- A new provision, Section 143A, was inserted into the Act. It allows the payee or holder of a
dishonored cheque to seek interim compensation from the drawer (the person who issued the
dishonored cheque).
- This provision aims to provide relief to the payee while the legal proceedings are underway,
allowing for quicker resolution of disputes involving dishonored cheques.

2. Section 148 - Power to Exempt:

- Section 148 was amended to give the Reserve Bank of India (RBI) the authority to exempt any
bank or a class of banks from the provisions of Section 142 and Section 143 (which pertain to
the jurisdiction of courts for cases related to dishonored cheques).
- This amendment was introduced to allow the RBI to regulate and manage the jurisdiction of
courts in cases involving dishonored cheques effectively.

3. Section 147 - Offenses to be Compoundable:

- An amendment was made to Section 147 to make certain offenses related to dishonored
cheques compoundable. This means that parties involved in such cases may reach a settlement,
and the complainant can withdraw the case under certain conditions.
- The amendment aimed to reduce the burden on courts and encourage settlements in cases
of dishonored cheques.

4. Section 138 - Enhanced Punishment:

- The punishment for offenses related to dishonored cheques under Section 138 was
enhanced. The drawer of a dishonored cheque may face imprisonment for a term which may
extend to two years or with a fine which may extend to twice the amount of the cheque, or
with both.
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The Negotiable Instruments Act underwent significant amendments in 2018. The primary
objective of these amendments was to promote a digital economy, reduce instances of
fraudulent practices, and streamline the legal framework governing negotiable instruments.
Here are some of the salient features and legal implications of the 2018 amendments:

1. Cheque Truncation System (CTS): The amendments introduced the concept of the Cheque
Truncation System (CTS) for faster and more efficient clearing of cheques. Under CTS, physical
cheques are not required to be presented at the bank. Instead, images of the cheque and its
electronic data are used for clearing, reducing the time and cost associated with paper-based
clearing.

2. Dishonor of Electronic Funds Transfer (EFT): The Act now includes provisions for penalizing
the dishonor of electronic funds transfers. This helps address issues related to the dishonor of
electronic payments and digital transactions.

3. Liability for Drawer of Dishonored Cheque: The amendments clarified that the liability for a
drawer of a dishonored cheque can be pursued in the jurisdiction where the drawer's branch is
located, which simplifies the legal process for recovery.

4. Protection for Payees: The amendments strengthened the protection of payees by

introducing stricter penalties for issuing dishonored cheques, both paper and electronic. This
was aimed at deterring fraudulent practices.

5. Revisions to Definitions: The definitions of various terms, including "cheque," "payee," and
"banker's duty of care," were revised and updated to align with modern banking practices and
technology.

6. Digital Signatures: The Act now recognizes the use of digital signatures on cheques and other
negotiable instruments, facilitating the move toward digital transactions.

7. Legal Implications: The amendments have significant legal implications for both individuals
and businesses. They promote digital transactions, provide legal protection for electronic
payments, and establish a more efficient mechanism for handling cheques through the CTS.
They also reinforce the legal consequences of issuing dishonored cheques.
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Unit IV Law of Banking

Syllabus: The Paying Banker – Statutory protection to Bankers – Collecting Banker – Statutory
protection – Rights and obligations of paying and collecting Bankers.

4.1 The Paying Banker

A paying banker is a bank that pays a cheque drawn on it by its customer. The banker is said to
be paying the cheque in due course if it pays the cheque in good faith and without notice of any
defect in the title of the drawer or the endorser.

The Negotiable Instruments Act, 1881 (NI Act) provides statutory protection to paying bankers.
Section 85 of the NI Act states that a paying banker is discharged by paying a cheque in due
course. This means that the banker is not liable to the drawer or any other person for any loss
that they may suffer if the cheque is subsequently dishonored.

The statutory protection available to paying bankers is subject to certain conditions. These
conditions are:

* The banker must have paid the cheque in good faith.

* The banker must have paid the cheque without notice of any defect in the title of the drawer
or the endorser.
* The banker must have paid the cheque in accordance with the instructions of the drawer.

If the banker fails to comply with any of these conditions, then he may not be able to claim the
statutory protection available to him.

Statutory Protection available to the Paying Bankers

Here are some of the important points to remember about the statutory protection available to
paying bankers:

* The protection is only available to paying bankers. It is not available to other types of financial
institutions, such as non-banking financial companies (NBFCs).
* The protection is only available if the banker pays the cheque in due course. If the banker
does not pay the cheque in due course, then they may be liable to the drawer or any other
person for any loss that they may suffer.
* The protection is subject to certain conditions. If the banker fails to comply with any of these
conditions, then they may not be able to claim the protection.
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For a banker, it is important to be aware of the statutory protection that is available to him
when he pay cheques. He should also be aware of the conditions that must be met in order to
claim this protection.

Difference between Paying Banker and the Collecting Banker

In banking parlance, the paying banker concept is applicable to the payment of cheques in cash,
or in transfer (when both the payee and drawers' accounts are with drawee bank), or in
clearing. Whereas, the collecting banker concept is applicable only to clearing cheques.

A paying banker is the bank that is drawn upon by the drawer of a cheque. The paying banker is
responsible for paying the cheque if it is presented for payment in good faith. The collecting
banker is the bank that collects a cheque on behalf of the payee. The collecting banker is not
responsible for paying the cheque, but it is responsible for presenting the cheque for payment
and collecting the proceeds.

The distinction between paying banker and collecting banker is important because it affects the
liability of the banker in case of a cheque dishonor. A paying banker is generally not liable for
the dishonor of a cheque if it pays the cheque in good faith and without notice of any defect in
the title of the drawer or the endorser. However, a collecting banker may be liable for the
dishonor of a cheque if it does not take reasonable care in collecting the cheque.
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4.2 Statutory Protection to Paying Bankers

Statutory protection is available to paying bankers under the law to ensure that they can fulfill
their duties and responsibilities in handling negotiable instruments, such as cheques, in a
secure and efficient manner. The primary statutory protection available to paying bankers
includes:

1. Protection for Honoring Payment:

The Negotiable Instruments Act, 1881, provides legal protection to paying bankers when they
honor payments on properly presented negotiable instruments. If a banker makes payment on
a cheque that is in due course (properly drawn, genuine, and within legal requirements), they
are protected from any legal liability for that payment.

2. Right to Dishonor:

The law allows paying bankers to dishonor negotiable instruments in specific situations, such as
when there are insufficient funds in the drawer's account, the signature is forged, the
instrument is post-dated, or there are other irregularities that make the payment unauthorized
or unlawful.

3. Notification of Dishonor:

Paying bankers are required by law to provide prompt notification of dishonor to the payee or
holder of the cheque, along with reasons for the dishonor. This notification is typically in the
form of a "cheque return memo." By providing timely and legally required notifications, the
banker complies with the law and protects themselves from potential disputes.

4. Right to Verify and Examine:

The law recognizes the right of paying bankers to thoroughly examine and verify the
authenticity of the negotiable instrument, the payee's identity, and the drawer's account
balance before making a payment. This right helps protect the bank from fraudulent or
unauthorized payments.

5. Duty of Care:

While the law protects paying bankers when they act diligently and in accordance with legal
requirements, it also places a duty of care on them to exercise reasonable care and diligence
when handling negotiable instruments. Bankers must adhere to industry standards and best
practices to avoid negligence.
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6. Legal Defenses:

The Negotiable Instruments Act, 1881, provides certain legal defenses that paying bankers can
invoke when faced with legal actions related to dishonored cheques. These defenses may
include the lack of proper notice of dishonor, discharge of the instrument, or other lawful
reasons for dishonor.

7. Statutory Protections Against Frivolous Claims:

To discourage frivolous litigation, the law may provide for statutory protections against
baseless claims or attempts to hold the paying banker liable without legal merit.

It's important to note that while statutory protections exist, bankers are still expected to act
diligently, follow best practices, and adhere to regulatory requirements to ensure the proper
handling of negotiable instruments. Compliance with banking regulations and ethical conduct
remains essential to maintaining the trust and integrity of the banking system.

-------

"In good faith, without negligence" are two important terms in banking which protect the
paying banker....elaborate these terms with suitable exampless.

The terms "in good faith" and "without negligence" are indeed crucial in banking and financial
transactions, particularly in protecting the rights and interests of paying bankers. Let's
elaborate on these terms with suitable examples:

1. In Good Faith:

Definition: Acting "in good faith" means that a person or institution, such as a paying banker, is
acting honestly, without fraudulent intent, and with a genuine belief that their actions are
proper and legitimate.

Example: Suppose a customer presents a cheque drawn on their account at a bank. The paying
banker examines the cheque and verifies the customer's signature, but the customer's account
balance is insufficient to cover the cheque. If the paying banker processes the cheque, believing
it to be genuine and not knowing about the insufficient funds, he is acting in good faith. In such
a case, the paying banker can debit the customer's account for the cheque amount.

2. Without Negligence:
Definition: "Without negligence" means that the paying banker has taken reasonable care and
diligence in examining and processing the financial instrument. They have not been careless or
negligent in their duties.
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Example: Consider a scenario where a customer presents a cheque that appears to have been
altered. The paying banker notices the alteration but fails to investigate or report it. If it's later
discovered that the cheque was indeed altered, the bank may be held liable for the loss
because it acted negligently. However, if the paying banker promptly raises concerns about the
cheque's alteration and follows proper procedures, he can be considered to have acted without
negligence.

These terms are especially important because they determine the extent of legal protection
and liability for paying bankers. When a paying banker acts in good faith and without
negligence, they are generally protected from claims and losses related to the payment of
cheques or other financial instruments. However, if they fail to meet these standards and act
negligently or with fraudulent intent, they may be held liable for any resulting losses.

It's worth noting that specific legal standards and regulations regarding "good faith" and
"negligence" can vary by jurisdiction and can be subject to interpretation in court. As such,
banks and financial institutions often have detailed internal procedures and compliance
measures to ensure that their actions meet the legal standards of good faith and due diligence.

Few examples of Banker’s negligence

 Payment of Cash for a crossed cheque

 Payment of a materially altered cheque
 Payment of a cheque when funds are insufficient in the accout of drawer
 Payment of a cheque drawn on other branch
 Payment without verifying inconsistency in drawer’s signature
 Material alteration not confirmed by another signature of drawer
 Making payment when Stop Payment instruction is given by the drawer
 Payment of a post-dated instrument
 Payment when the amount in words and figures differ etc.
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Cheque Return Memo

 90

4.3 Rights and Duties of a Paying Banker

A paying banker, also known as the drawee banker, is the bank or financial institution upon
which a negotiable instrument, such as a cheque or a draft, is drawn. The paying banker is
responsible for honoring the payment obligation mentioned in the instrument when it is
presented for payment by the payee or the holder.

Here are the rights and duties of a paying banker:

Rights of a Paying Banker:

1. Right to Verify: The paying banker has the right to carefully examine the presented
instrument to ensure its genuineness, authenticity, and conformity with the legal requirements.

2. Right to Payment Instructions: The paying banker is entitled to clear and unambiguous
payment instructions on the instrument. If the instructions are unclear or contradictory, the
paying banker may seek clarification from the drawer (account holder) before making payment.

3. Right to Funds Confirmation: The paying banker has the right to verify that the drawer's
account has sufficient funds to cover the amount mentioned in the instrument. If there are
insufficient funds, the paying banker may dishonor the instrument.

4. Right of Set-off: If the drawer has multiple accounts with the paying banker, the bank may
exercise the right of set-off. This means that the bank can use funds from one account to cover
payments on another account if needed.

5. Right to Protect Customer's Interests: While the paying banker's primary duty is to the
drawer, they also have a duty to protect the customer's interests. If there are any doubts or
irregularities in the presentation of the instrument, the paying banker may contact the
customer to ensure the legitimacy of the transaction.

Duties of a Paying Banker:

1. Honoring Payment: The primary duty of the paying banker is to honor the payment
obligation mentioned in the instrument when it is presented in due course and is in proper
order. The banker must make the payment promptly and without delay.

2. Duty of Care: The paying banker has a duty to exercise reasonable care and diligence when
verifying the authenticity of the instrument and the identity of the payee.
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3. Dishonor in Specific Cases: The banker may dishonor the instrument if there are insufficient
funds, if the signature of the drawer is forged, if the instrument is post-dated, or if it is
presented after its expiry or before its maturity.

4. Notification of Dishonor: If the banker decides to dishonor the instrument, they are
obligated to notify the payee or holder promptly, providing reasons for the dishonor. This
notification is typically in the form of a "cheque return memo" or a similar communication.

5. Customer's Protection: The banker must also protect the interests of the customer (the
drawer) by ensuring that their account is not debited without proper authorization and that the
instrument is not paid in case of fraud or forgery.

6. Safekeeping of Records: The paying banker should maintain proper records of all
transactions and related documents for auditing and regulatory purposes.

The relationship between a paying banker and their customer is built on trust, and the banker is
expected to act in accordance with banking regulations, legal requirements, and the best
interests of both the drawer and the payee.
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4.4 Collecting Banker – Statutory Protection available to

the Collecting Banker
A collecting banker is a bank that acts as an intermediary or collecting agent for its customer in
the process of presenting, collecting, and crediting funds from financial instruments such as
cheques, drafts, or promissory notes. The collecting banker receives these instruments on
behalf of its customer and submits them for payment to the bank on which the instrument is
drawn. The primary role of a collecting banker is to facilitate the collection of funds for its
customers.

Statutory Protection Available to Collecting Banker:

In many jurisdictions, including India, the law provides certain statutory protections to
collecting bankers to encourage and facilitate the smooth functioning of the banking system
and to promote the collection of funds. These statutory protections are outlined in the
Negotiable Instruments Act, 1881 (in the context of India), and they include:

1. Protection for Honoring Customer's Cheques: When a collecting banker presents a cheque
or negotiable instrument for payment on behalf of its customer, and the paying banker (the
bank on which the instrument is drawn) honors the instrument, the collecting banker is
protected. This means that the collecting banker can credit the collected amount to the
customer's account without being held liable if any issues arise later.

2. Protection from Paying Out-of-Order Cheques: The law protects the collecting banker from
paying cheques or instruments that are marked as "not negotiable" or "account payee only" if
the paying banker fails to honor such markings. The collecting banker is not liable for any losses
in such cases.

3. Protection for Acts in Good Faith: Similar to the paying banker, the collecting banker is also
protected when it acts in good faith and without negligence. If the collecting banker follows
proper procedures and acts honestly in the collection process, it is generally protected from
liability.

4. Notice of Discharge: The collecting banker is not held responsible if it receives an instrument
without any notice of discharge. This means that if the instrument appears to be legally valid
and has not been marked as discharged or canceled, the collecting banker can proceed with the
collection process.

It's important to note that these statutory protections are designed to ensure that collecting
bankers can carry out their role of collecting funds on behalf of customers efficiently and
without undue liability. However, if a collecting banker acts negligently, fraudulently, or in a
 93

manner that does not meet the legal standards of good faith, it may be held liable for any
resulting losses.
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4.5 Rights and Duties of a Collecting Banker

A collecting banker is a bank or financial institution that collects or receives a cheque or other
negotiable instrument for and on behalf of its customer (the depositor or holder). The
collecting banker's primary role is to facilitate the process of depositing funds into the
customer's account and ensuring the safe and efficient collection of negotiable instruments.

Here are the rights and duties of a collecting banker:

Rights of a Collecting Banker:

1. Receive Deposits: The collecting banker has the right to accept deposits from customers in
various forms, including cheques, drafts, and other negotiable instruments.

2. Verification of Endorsements: The collecting banker has the right to verify the endorsements
on the cheque or negotiable instrument to ensure that they are genuine and in proper order.
This verification is important for determining the legitimacy of the instrument.

3. Clearing House Access: Collecting bankers have access to clearinghouses or clearing systems
where they can present the collected cheques for payment or settlement. This facilitates the
process of clearing and settlement of funds.

4. Credit to Customer's Account: Once the cheque is cleared and funds are received, the
collecting banker has the right to credit the collected amount to the customer's account,
making it available for withdrawal or other transactions.

5. Legal Protection: Collecting bankers are entitled to legal protection when they act in good
faith and in accordance with banking regulations and legal requirements. They are protected
from legal liability when they follow established procedures.

Duties of a Collecting Banker:

1. Verification of Endorsements: The collecting banker has a duty to verify the endorsements
on the cheque or negotiable instrument to ensure that they are genuine and in proper order.
This includes checking the signature of the payee or endorser.

2. Exercise Due Care: Collecting bankers are required to exercise due care and diligence when
accepting deposits and processing negotiable instruments. This includes adhering to Know Your
Customer (KYC) and anti-money laundering (AML) regulations.
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3. Notification of Dishonor: If a cheque or negotiable instrument is dishonored (not paid)

during the clearing process, the collecting banker has a duty to promptly notify the customer or
depositor and provide reasons for the dishonor.

4. Safekeeping of Instruments: Collecting bankers are responsible for the safekeeping of

deposited instruments and related records. They must maintain proper records for audit and
regulatory purposes.

5. Customer's Protection: The collecting banker has a duty to protect the interests of the
customer, ensuring that funds are not debited from the customer's account without proper
authorization.

6. Compliance with Regulatory Requirements: Collecting bankers must comply with banking
regulations, customer protection laws, and other legal requirements governing the handling of
negotiable instruments and deposits.

7. Provision of Statements: Collecting bankers typically provide periodic account statements to

customers, detailing transactions, including deposits, withdrawals, and any returned or
dishonored items.

8. Customer Service: Providing customer support and assistance is an essential duty of

collecting bankers. They are responsible for addressing customer inquiries and concerns related
to deposits and collected funds.

It's important to note that the specific rights and duties of a collecting banker may vary
depending on the jurisdiction and banking regulations. Additionally, banks often have their own
policies and procedures that govern the collection and processing of negotiable instruments.
Customers should be familiar with their bank's terms and conditions and seek clarification
when necessary.
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Unit V
Syllabus: Banker’s lien and set off – Advances – Pledge – Land – Stocks – Shares – Life policies –
Document of title to Goods – Bank Guarantees – Letters of Credit – Recovery of Bank loans and
position under the SARFAESI Act, 2002 – Jurisdiction and powers of Debts Recovery Tribunal
(DRT).

5.1 Banker’s lien and set off

Banker's Lien:
A banker's lien is a legal right that allows a bank to retain possession of a customer's property
(typically financial assets or valuables) held in the bank's custody until the customer's debt or
obligation to the bank is discharged. In essence, it serves as security for the customer's
indebtedness to the bank. The right of lien is one of the legal safeguards that banks have to
protect their interests and ensure the recovery of owed amounts.

Circumstances Under Which a Banker Can Exercise the Right of Lien:

1. Unpaid Debts: The primary circumstance under which a banker can exercise the right of lien
is when a customer has unpaid debts or obligations to the bank. These debts may include
overdrafts, unpaid loans, outstanding credit card balances, or other financial liabilities.

2. General Lien: Banks often have a "general lien" that covers all the customer's assets held by
the bank in any account or capacity. This means that the bank can exercise its lien over any
funds or valuables belonging to the customer, not just those directly related to the unpaid debt.

3. Specific Lien: In addition to a general lien, banks may also have a "specific lien" over specific
assets or accounts. For example, if a customer has a loan account with the bank, the bank may
have a specific lien over the funds in that account to secure the repayment of the loan.

4. Customer's Default: The right of lien can be exercised when a customer defaults on their
obligations to the bank. This typically involves the customer failing to make payments on time
or breaching the terms of an agreement.

5. Notice of Exercise: Before exercising the right of lien, banks often provide notice to the
customer, informing them of the outstanding debt and the bank's intention to use the lien to
recover the owed amount. This notice allows the customer an opportunity to rectify the
situation.
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6. Legal Requirements: The exercise of a banker's lien is subject to legal and regulatory
requirements in the relevant jurisdiction. Banks must follow applicable laws and contractual
agreements when invoking their lien rights.

7. Applicability to All Accounts: The right of lien can apply to various types of accounts,
including savings accounts, current accounts, fixed deposits, and lockers. However, the specific
terms and conditions may vary by account type and bank policy.

It's important to note that while banks have the right of lien, they must exercise this right
judiciously and within the bounds of the law. Unjustified or excessive use of lien rights can lead
to legal disputes and regulatory consequences. Customers, on the other hand, should be aware
of their contractual obligations with the bank and take prompt action to address any unpaid
debts to avoid the exercise of lien rights by the bank.

Banker's Right to Set-Off:

The banker's right to set-off is a legal principle that allows a bank to offset or deduct money
owed by a customer from the customer's account(s) with the bank. This right is typically
exercised by the bank when the customer has multiple accounts, and there are both debit
(amounts owed to the bank) and credit (amounts deposited by the customer) balances across
these accounts. Set-off is used to settle outstanding debts or obligations the customer may
have with the bank.

Circumstances Warranting a Set-Off:

1. Multiple Accounts: Set-off is often exercised when a customer maintains multiple accounts
with the same bank. These accounts can include savings accounts, current accounts, fixed
deposits, or loans.

2. Customer's Debt to the Bank: The primary reason for invoking the right of set-off is when the
customer has an outstanding debt or obligation to the bank. This debt can arise from various
sources, such as unpaid loans, credit card balances, overdrafts, or any other financial liabilities
owed to the bank.

Examples of Circumstances for Set-Off:

Few examples to illustrate when and how the banker's right to set-off might be exercised:

1. Loan Repayment: Suppose a customer has taken out a personal loan from the bank. Over
time, the customer has made regular payments on the loan, reducing the outstanding balance.
However, the customer also maintains a savings account with the bank. If the customer misses
a few loan payments and has a credit balance in their savings account, the bank may exercise
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the right to set-off. They can deduct the overdue loan payments from the savings account to
cover the outstanding debt.

2. Overdraft on Current Account: A business maintains a current account with a bank for its
day-to-day operations. The current account has an overdraft facility, which means the business
can withdraw more than the available balance up to a specified limit. If the business exceeds
this limit and incurs an overdraft, the bank can use funds from other accounts held by the
business, such as a savings account or fixed deposit, to offset the overdraft amount.

3. Credit Card Debt: A customer has a credit card issued by the bank and accumulates a
significant outstanding balance on the card. The bank can exercise the right to set-off by
deducting the credit card debt from any savings or deposit accounts held by the customer,
ensuring that the overdue amount is covered.

4. Loan Against Fixed Deposit: A customer has a fixed deposit account with the bank. The bank
offers a loan against this fixed deposit. If the customer defaults on the loan repayment, the
bank can use the fixed deposit balance to set off the outstanding loan amount.

It's important to note that the right to set-off should be exercised in accordance with
contractual agreements and applicable laws and regulations. Banks typically inform customers
in advance when invoking set-off and provide details of the outstanding debt and the source of
funds used for the set-off. Customers have the right to dispute the set-off if they believe it has
been incorrectly applied.
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5.2 Advance
An "advance" in banking and finance refers to a loan or credit extended by a financial
institution, typically a bank, to a borrower. It involves the provision of funds to the borrower,
and the borrower agrees to repay the borrowed amount along with any applicable interest or
fees within the agreed-upon terms and conditions.

Key characteristics of an advance include:

1. Lending Institution: Advances are typically provided by financial institutions, such as banks or
credit unions, to individuals, businesses, or other entities.

2. Borrower Agreement: The borrower enters into an agreement with the lending institution,
outlining the terms and conditions of the advance. This agreement specifies the loan amount,
interest rate, repayment schedule, and any collateral or security requirements.

3. Purpose: Advances can be used for various purposes, including personal expenses, business
expansion, working capital needs, purchasing assets (such as a home or vehicle), or any other
financial requirement.

4. Repayment: Borrowers are required to repay the advanced amount according to the agreed-
upon schedule. Repayment may be made in installments or as a lump sum, depending on the
terms of the advance.

5. Interest and Fees: Advances often incur interest charges or fees, which are additional costs
borne by the borrower. The interest rate can be fixed or variable, depending on the type of
advance and prevailing market conditions.

6. Security: Depending on the size and type of advance, the lending institution may require the
borrower to provide collateral or security to mitigate the risk of non-repayment.

7. Credit Evaluation: Lending institutions assess the creditworthiness of borrowers before

granting an advance. This evaluation considers factors such as the borrower's credit history,
income, capacity to repay, and overall financial stability.

Advances play a crucial role in the financial system by providing individuals and businesses with
access to necessary funds for various purposes. They can take the form of personal loans,
business loans, lines of credit, credit cards, and more.
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Secured and Unsecured Advances

Advances can be secured or unsecured, short-term or long-term, depending on the specific
needs and circumstances of the borrower and the terms established by the lending institution.

Secured Advances:

Secured advances refer to loans or credit facilities provided by a bank or financial institution to
a borrower with the condition that the borrower provides collateral or security to back the
loan. The collateral serves as a form of protection for the lender in case the borrower fails to
repay the loan according to the agreed-upon terms. In the event of default, the lender can seize
and sell the collateral to recover the outstanding debt.

Key characteristics of secured advances include:

1. Collateral: The borrower is required to pledge assets or valuables as collateral to secure the
loan. Common forms of collateral include real estate (such as a home or property), vehicles,
inventory, accounts receivable, or other valuable assets.

2. Lower Risk for Lender: Secured advances are considered lower risk for the lender because
they have a means to recover their funds through the sale of the collateral in case of default. As
a result, lenders may offer lower interest rates for secured loans compared to unsecured loans.

3. Loan Amount: The loan amount that can be obtained through secured advances is often
determined by the value of the collateral. Lenders may offer a higher loan amount if the
collateral has significant value.

4. Examples: Common examples of secured advances include mortgages (home loans), auto
loans, and secured personal loans.

Unsecured Advances:

Unsecured advances, on the other hand, are loans or credit facilities provided without requiring
collateral or security from the borrower. These types of loans are approved based primarily on
the borrower's creditworthiness, income, and ability to repay the loan.

Key characteristics of unsecured advances include:

1. No Collateral: Unsecured advances do not require the borrower to pledge assets or valuables
as collateral. Borrowers are approved based on their credit history and financial stability.
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2. Higher Risk for Lender: Unsecured advances are considered riskier for lenders because they
lack collateral to recover their funds in case of default. Consequently, lenders often charge
higher interest rates for unsecured loans to offset the increased risk.

3. Loan Amount: The loan amount for unsecured advances is typically determined by the
borrower's creditworthiness and income. Lenders may offer smaller loan amounts compared to
secured loans.

4. Examples: Common examples of unsecured advances include credit cards, personal loans,
and certain types of business loans.

Difference Between Secured and Unsecured Advances:

1. Collateral Requirement: The primary difference between secured and unsecured advances is
the requirement for collateral. Secured advances necessitate collateral, while unsecured
advances do not.

2. Risk Profile: Secured advances are lower risk for lenders because they have collateral as
security, while unsecured advances are higher risk for lenders due to the lack of collateral.

3. Interest Rates: Interest rates for secured advances tend to be lower compared to unsecured
advances because of the reduced risk to the lender.

4. Loan Amount: Secured advances may offer higher loan amounts based on the value of the
collateral, whereas unsecured advances often have lower loan limits determined by the
borrower's creditworthiness.

5. Examples: Different types of loans fall into these categories. Mortgages and auto loans are
examples of secured advances, while credit cards and personal loans are examples of
unsecured advances.

Borrowers should carefully consider their financial situation and loan terms when choosing
between secured and unsecured advances, as each option has its advantages and
considerations.
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Difference between the Primary Security and Collateral Security

Primary Security:

Primary security refers to the main or primary asset or source of repayment that is used to
secure a loan or credit facility. It is the primary means by which a lender can recover its funds in
case the borrower defaults on the loan. Primary security is typically the most significant and
valuable asset associated with the loan.

Examples of Primary Security:

1. Mortgage for Home Loan: When a borrower takes out a mortgage to purchase a home, the
home itself serves as the primary security. If the borrower defaults on the loan, the lender can
initiate foreclosure proceedings and sell the property to recover the outstanding debt.

2. Auto Loan: In the case of an auto loan, the primary security is the vehicle being financed. If
the borrower fails to make payments as agreed, the lender can repossess and sell the vehicle to
recoup the loan amount.

3. Business Loan with Business Assets: For a business loan, primary security could be the
business assets, such as inventory, equipment, or accounts receivable. If the business defaults
on the loan, the lender can take possession of these assets to satisfy the debt.

Collateral Security:

Collateral security, also known as secondary security or additional security, is an additional

asset or guarantee provided by the borrower to further secure a loan beyond the primary
security. It provides an extra layer of protection for the lender in case the value of the primary
security is insufficient to cover the loan amount.

Examples of Collateral Security:

1. Personal Guarantees: In some cases, a borrower may provide a personal guarantee, which is
a form of collateral security. If the primary security is insufficient to cover the loan, the lender
can seek repayment from the individual who provided the personal guarantee.

2. Additional Assets: A borrower may offer additional assets, such as savings accounts,
investments, or valuable personal property (e.g., artwork or jewelry), as collateral security to
strengthen their loan application. These assets can be used to satisfy the loan if needed.

3. Co-Signer: When a co-signer is added to a loan agreement, they become a form of collateral
security. If the borrower defaults, the co-signer is legally obligated to repay the loan on behalf
of the borrower.
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Key Differences:

1. Role: Primary security is the primary asset used to secure the loan, while collateral security is
additional security provided alongside the primary security.

2. Priority: In the event of default, the lender will typically first use the primary security to
recover its funds. Collateral security comes into play if the primary security is insufficient.

3. Examples: Primary security examples include the home in a mortgage or the vehicle in an
auto loan. Collateral security can include personal guarantees, additional assets, or co-signers.

4. Importance: Primary security is the most critical asset for loan security, while collateral
security provides an extra layer of protection but is not as significant as the primary asset.

In summary, primary security is the primary asset that directly secures a loan, while collateral
security is additional security provided to further protect the lender's interests. Both types of
security play a role in ensuring that loans are repaid in case of default.
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Modes of Charge of Securites

Banks and financial institutions can obtain various modes of charge over securities, depending
on the type of security, the purpose of the charge, and the legal and regulatory requirements.
These modes of charge help secure loans and credit facilities. Here are some common modes of
charge for securities:

1. Mortgage:

Mortgage is a legal charge created over real property (e.g., land, buildings, or real estate) to
secure a loan or credit facility. The property serves as collateral, and if the borrower defaults,
the lender can foreclose on the property and sell it to recover the loan amount.

2. Pledge:

Description: Pledge involves the borrower offering specific securities (e.g., stocks, bonds, or
certificates of deposit) as collateral to secure a loan. The borrower retains ownership of the
securities, but the lender has a legal claim over them. If the borrower defaults, the lender can
sell the pledged securities to recover the loan.

3. Hypothecation:

Hypothecation is a charge created over assets, such as inventory, equipment, or accounts

receivable, to secure a loan. The borrower retains possession and use of the assets while
granting the lender a charge over them. If the borrower defaults, the lender can take
possession of and sell the hypothecated assets.

4. Lien:

A lien is a legal claim or charge on an asset that secures a debt. There are various types of liens,
such as mechanic's liens (for unpaid construction work), judgment liens (for unpaid court
judgments), and tax liens (for unpaid taxes). Liens give creditors the right to seize and sell the
property to satisfy the debt.

5. Assignment:

Assignment involves transferring rights, such as future income streams or contractual

obligations, to the lender as security for a loan. The lender has a legal interest in the assigned
rights, and if the borrower defaults, the lender can claim the assigned assets or income. Best
example for Assignment is the LIC Policies against which the insured persons can obtain Bank
loans.
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6. Charge over Bank Accounts:

A lender can obtain a charge over a borrower's bank account or funds held in a bank account.
This allows the lender to withdraw funds from the account to satisfy the outstanding debt in
the event of default.

7. Floating Charge:

A floating charge is a charge created over a class of assets that change in quantity and value,
such as inventory or accounts receivable. The charge "floats" until it crystallizes upon the
occurrence of certain events, such as default. Once crystallized, the lender gains control over
the specified assets.

8. Right of Set-Off:

In some cases, banks may have the right of set-off, which allows them to use funds from a
borrower's deposit account to offset or repay a loan or credit facility that the borrower owes to
the bank.

These modes of charge help lenders secure their interests and mitigate risk when extending
credit to borrowers. The specific mode chosen depends on factors such as the type of assets
involved, the nature of the loan, and legal and regulatory considerations. Additionally, the
terms and conditions of the charge are typically outlined in loan agreements and legal
documents.
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5.3 Pledge
Pledge is a financial arrangement where a borrower (often referred to as the "pledgor")
provides specific assets or properties as collateral to secure a loan or credit facility from a
lender (the "pledgee"). In a pledge, the borrower retains ownership of the pledged assets but
grants the lender a legal interest in those assets. This arrangement allows the lender to claim
and sell the pledged assets to recover the outstanding loan amount if the borrower defaults.

Common types of properties or assets that are pledged by borrowers include:

1. Stocks and Securities:

Borrowers can pledge publicly traded stocks, bonds, mutual funds, or other financial securities
as collateral. These assets have a market value that can be easily determined.

Example: A business owner may pledge a portfolio of publicly traded stocks to secure a business
expansion loan from a bank. If the business fails to repay the loan, the bank can sell the stocks
to recover the outstanding debt.

2. Savings and Certificates of Deposit (CDs):

Borrowers can pledge savings accounts or certificates of deposit held with a bank as collateral
for a loan. These assets provide a guaranteed source of repayment.

Example: An individual may pledge a high-value certificate of deposit as collateral to obtain a

personal loan. In case of loan default, the bank can use the CD to cover the outstanding loan
amount.

3. Jewelry and Valuables:

Borrowers can pledge valuable personal items such as jewelry, art, antiques, or collectibles as
collateral.

Example: Someone may pledge a valuable piece of artwork to secure a short-term loan. If they
fail to repay the loan, the lender can take ownership of the artwork and sell it to recover the
loan amount.

4. Accounts Receivable:

Businesses often pledge their accounts receivable (unpaid invoices) as collateral to secure
working capital loans or lines of credit. This is known as "accounts receivable financing" or
"invoice factoring."
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Example: A manufacturing company might pledge its outstanding invoices to a factoring

company. The factoring company advances funds against these invoices, and once the invoices
are paid by customers, the factoring company collects the funds.

5. Life Insurance Policies:

Borrowers may pledge the cash value of a life insurance policy as collateral for a loan. However,
the agreement to pledge must also be followed by assignment of life policies in favour of the
bank. Mere pledge is not sufficient when it comes to LIC Policies.

Example: An individual may pledge the cash value of their whole life insurance policy to obtain
a loan for a major purchase. If they default on the loan, the lender can access the policy's cash
value.

6. Equipment and Machinery:

Businesses can pledge machinery, equipment, or other valuable assets used in their operations
as collateral for business loans.

Example: A construction company may pledge its fleet of construction vehicles as collateral to
secure a business expansion loan. If the loan is not repaid, the lender can take possession of the
vehicles.

The choice of assets or properties pledged as collateral depends on the type of loan, the
lender's policies, and the borrower's financial situation. Pledging assets provides lenders with a
level of security, making it less risky to extend credit to borrowers. If a borrower defaults, the
lender can seize and sell the pledged assets to recover the loan amount, reducing the lender's
potential loss.
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5.4 Land
Land is a valuable and commonly used asset for securing loans in various financial transactions,
such as real estate loans, mortgages, and land development projects. It can serve as both
primary security, where the loan is primarily secured by the land itself, or as collateral security,
where the land is offered as additional security to support the repayment of a loan. While land
can be a valuable and stable form of security, there are credit risks associated with using it as
collateral:

Credit Risks of Using Land as Security:

1. Market Value Fluctuations: The value of land can fluctuate over time due to various factors,
including changes in the real estate market, economic conditions, and local development
trends. If the market value of the land decreases significantly, the lender may face challenges
recovering the full loan amount in case of default.

2. Liquidity Concerns: Land is generally less liquid than other forms of collateral, such as stocks
or cash. It may take time to sell land to recover funds in case of borrower default. During this
period, the lender may incur holding costs, such as property taxes and maintenance expenses.

3. Legal and Regulatory Issues: Land transactions often involve complex legal and regulatory
considerations, including property rights, land use regulations, and zoning laws. Lenders must
ensure that the land serves as an appropriate form of collateral and that there are no legal
encumbrances that could affect their ability to recover the loan amount.

4. Environmental Risks: The lender may be exposed to environmental risks associated with the
land, such as soil contamination or hazardous materials. These risks can lead to cleanup costs or
legal liabilities, affecting the land's value and the lender's ability to recover the loan amount.

5. Default and Foreclosure Process: Foreclosing of a loan account relying on land can be a
lengthy and costly process, involving legal proceedings and potential challenges. Lenders must
be prepared for the legal complexities of taking possession of the land and selling it to recover
the loan. Though SARFAESI Act provides for a quicker remedy for banks, the banks still face
litigation from the borrowers and the verdict of Civil Court/DRT takes several years to come.

6. Location and Development Risks: The location and potential for development of the land can
impact its value. Lenders may face risks if the land is in an area with limited development
potential or if there are obstacles to development, such as legal restrictions or infrastructure
limitations.

7. Economic Downturns: Economic downturns can negatively affect the real estate market and
land values. If borrowers face financial difficulties during such periods, lenders may encounter
challenges in recovering the loan amount through the sale of land.
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To mitigate these credit risks, lenders typically conduct thorough due diligence before accepting
land as security. This includes property appraisals, title searches, environmental assessments,
and legal reviews to ensure that the land is suitable collateral. Additionally, lenders may
consider loan-to-value (LTV) ratios to limit their exposure.

Despite the credit risks, land can still be a valuable form of security when used wisely. Its
stability and potential for appreciation make it an attractive option for securing loans, especially
in real estate and property development financing. However, lenders must carefully assess the
specific risks associated with each land transaction and implement risk management strategies
accordingly.

Over-valuation
Overvaluation of land can also pose significant problems, especially in the context of securing
loans or mortgages. Overvaluation occurs when the appraised or estimated value of a piece of
land is inflated or inaccurately represented, often intentionally. This can lead to several issues:

1. Higher Loan Amounts: If land is overvalued, borrowers may secure larger loan amounts than
they can realistically afford based on the actual value of the property. This can increase the risk
of default, as borrowers may struggle to make repayments on the inflated loan.

2. Lender's Exposure: Lenders may find themselves exposed to higher risks if the land is
overvalued. In the event of default, the lender may have difficulty recovering the full loan
amount through the sale of the property, as the actual market value may be lower than the
loan balance.

3. Legal and Ethical Concerns: Overvaluation of land is not only financially risky but also raises
ethical and legal concerns. It may involve fraudulent activities, misrepresentation, or collusion
between borrowers, appraisers, and other parties. Such practices can lead to legal
consequences for all involved parties.

To address the issue of overvaluation, lenders typically employ several risk mitigation
measures, including:

Independent Appraisals: Lenders often require independent and qualified appraisers to assess
the value of the land objectively. This reduces the likelihood of overvaluation. Banks rely on the
system of “Government approved valuers” to make fair valuation of properties.

Market Analysis: Lenders may conduct thorough market analyses to cross-verify the appraised
value with local real estate market conditions. This is done by sending their own executives to
the area where land is located to have “on the ground” feedback about the value of the
property. Merely relying on documents to assess land value may not be advisable in all cases.
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Loan Reviews: Periodic reviews of loan portfolios help lenders identify potential issues with
overvalued properties and take corrective actions. CIBIL provides a platform for banks to verify
the authenticity of the property mortgages.

Compliance and Due Diligence: Lenders must adhere to regulatory and compliance standards
that aim to prevent fraudulent practices, including overvaluation.

Risk Assessment: Lenders assess the overall credit risk of borrowers, including their ability to
repay the loan based on their financial capacity.

Overvaluation of land can lead to financial losses, legal complications, and damage to a lender's
reputation. Therefore, lenders must remain vigilant and take steps to ensure that the valuation
of collateral, including land, is accurate and in line with market realities.
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5.5 Stocks
The concept of "stocks" used as primary or collateral security for advances made by banks
refers to the practice of borrowers offering shares of publicly traded stocks and securities as
assets to secure loans or credit facilities from financial institutions. Stocks, in this context, are
ownership interests in companies that are publicly traded on stock exchanges. Here's how the
use of stocks as security works:

1. Primary Security:

In some cases, banks may extend loans or credit lines where the primary security is the shares
of stocks themselves. This means that the loan is primarily secured by the value of the stocks.

Example: An entrepreneur seeking capital for a new business venture may approach a bank.
Instead of offering physical assets, the entrepreneur may pledge a significant number of their
own publicly traded shares as the primary security for the loan.

2. Collateral Security:

More commonly, borrowers provide stocks as collateral security to support the repayment of a
loan or credit facility. Collateral security is additional security offered alongside other primary
forms of security.

Example: A business owner may seek a business expansion loan from a bank. While their
primary security might be the assets of the business, they may also offer a portfolio of publicly
traded stocks as collateral to strengthen their loan application.

Key Points to Consider:

Valuation: The value of the stocks used as security is determined based on their market price,
which can fluctuate. Banks typically assess the value of the stocks and may apply a "haircut" or
discount to account for potential market volatility.

Ownership: While the stocks are used as security, the borrower retains ownership and may
continue to receive dividends and exercise voting rights associated with those shares.

Risk Mitigation: Banks carefully assess the creditworthiness of borrowers and the stability of
the stocks offered as security. They may set limits on the loan-to-value (LTV) ratio to ensure
that the loan amount does not exceed an acceptable percentage of the collateral's value.

Default and Sale: In the event of a default by the borrower, the bank has the right to sell the
pledged stocks to recover the outstanding loan amount. The sale process is typically conducted
in accordance with regulatory and legal requirements.
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Diversification: Banks often encourage borrowers to provide diversified collateral, reducing

concentration risk. Borrowers may be asked to pledge stocks from various sectors or industries
to spread risk.

Using stocks as security provides borrowers with a way to access financing while retaining
ownership of their assets. It allows banks to mitigate credit risk by holding valuable and liquid
assets as collateral. However, it's essential for both borrowers and lenders to carefully evaluate
the terms and conditions of such arrangements, including the potential consequences of
market fluctuations on the value of the pledged stocks.

Another type of Stocks: Stock-in-trade

The term "Stocks" in the context of banking and lending can also refer to a borrower's
inventory or stock in trade, which can be used to obtain a Cash Credit (CC) limit. This type of
financing is often called "inventory financing" or "stock-in-trade financing." Stocks in trade are
generally obtained as security by banks as a collateral security. The reason being the
fluctuations in the levels of the stocks maintained by the borrower. For example, the bank may
fix a CC limit of Rs.1.00 assuming that as on 31 January, 2000 the value of the stock is Rs.1.5
lacs. Due to heavy sales, next month the stock in godown of the customer as on 28 February,
2000 is only Rs.50000 and the borrower has fully availed the limit and his debit balance in CC
account shows Rs.1.00. This exposes the bank to the risk because the credit exposure of
Rs.1.00 lac is not sufficiently covered by the value of stocks (Rs.50000) as on 28 february, 2000.

As the stocks in trade are subject to sales and fluctuations, banks generally use them as
collateral security while obtaining some property like house or factory building as primary
security.

Stocks as Collateral for CC Limit:

In this scenario, businesses that hold physical inventory, such as retail stores, manufacturers, or
wholesalers, can use their existing stock in trade as collateral to secure a Cash Credit (CC) limit
from a bank or financial institution.

Example: Consider a retail clothing store with a substantial inventory of clothing items. The
store owner can approach a bank for a CC limit. In this case, the stocks refer to the clothing
items held by the store as part of its inventory.

Key Points:

Valuation: The value of the stocks (inventory) is assessed based on factors such as cost, market
value, and the type of inventory. Banks may also consider the turnover rate of the inventory
when determining its suitability as collateral.
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Monitoring: Banks often require periodic inventory checks to ensure that the collateral remains
adequately valued. Borrowers may need to provide regular reports on the status of their
inventory.

Usage: Borrowers can draw from their CC limit to fund various business expenses, such as
purchasing additional inventory, covering operating costs, or managing cash flow. The amount
available depends on the value of the pledged inventory.

Risk Mitigation: Banks may implement safeguards to mitigate risks associated with fluctuations
in inventory value. This can include setting maximum LTV ratios or requiring borrowers to
maintain insurance on their inventory.

Using stocks (inventory) as collateral for a CC limit allows businesses to access flexible financing
based on their existing assets. It provides a way for businesses to manage seasonal fluctuations,
maintain sufficient working capital, and meet short-term financial needs. Banks benefit by
having a tangible and liquid asset as collateral, reducing credit risk.

It's important to note that the specific terms and conditions of inventory financing can vary
depending on the lender's policies and the borrower's industry. Borrowers should carefully
consider the cost of financing and the potential impact on their operations when using
inventory as collateral for a CC limit.
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5.6 Shares
The concept of "shares" as a security for advances made by banks refers to the practice of
borrowers offering their ownership interests in publicly traded companies, known as shares or
stocks, as collateral to secure loans or credit facilities from financial institutions. Shares are
essentially certificates of ownership in a corporation and represent a claim on the company's
assets and earnings. As the value of shares is subject to market fluctuations, banks do not solely
rely on the the shares as security. They merely use the shares as “collateral security”, thereby
ensuring that there remains a “primary security” such as house property or factory building or
any other land (open plot) which sufficiently covers the credit risk as per the credit policy of the
bank. It may be noted that every bank has its own individual credit policy which must conform
with the credit policy of the Reserve Bank of India periodically announced by it.

1. Collateral for Loans:

Borrowers pledge their shares of publicly traded stocks to a bank as collateral for a loan or
credit line. These shares serve as security for the repayment of the loan.

Example: An individual may pledge a portfolio of shares in various publicly traded companies to
obtain a personal loan from a bank.

2. Margin Loans:

Margin loans are a specific type of loan where investors use their existing shares as collateral to
borrow funds to purchase additional securities. The value of the shares determines the amount
that can be borrowed. In India generally banks avoid lending for the speculative purposes.

Example: An investor who owns a substantial number of shares in a brokerage account can use
those shares as collateral to borrow funds for additional investments.

3. Securing Business Loans:

Business owners may pledge shares of their company's stock as collateral when seeking
financing for business purposes, such as expansion, working capital, or investment in new
projects.

Example The founder of a startup company may pledge their ownership shares in the company
to secure a business loan for scaling operations.

Key Points to Consider:

Valuation: The value of the shares used as security is determined based on their current market
price. Lenders may apply a discount or haircut to account for potential market volatility.
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Ownership: While the shares are used as collateral, the borrower generally retains ownership
rights, including the ability to receive dividends and exercise voting rights associated with the
shares.

Loan-to-Value (LTV) Ratio: Lenders often set an LTV ratio to ensure that the loan amount does
not exceed a certain percentage of the market value of the pledged shares. This helps mitigate
potential risks.

Default and Sale: In the event of a default by the borrower, the lender has the right to sell the
pledged shares to recover the outstanding loan amount. The sale process typically follows
regulatory and legal requirements.

Using shares as security provides borrowers with a way to access financing while retaining
ownership of their assets. It allows banks to mitigate credit risk by holding liquid and
marketable assets as collateral. However, both borrowers and lenders should carefully consider
the terms and conditions of such arrangements, including the potential consequences of
market fluctuations on the value of the pledged shares. Additionally, regulations and policies
related to share pledging may vary by jurisdiction and financial institution.
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5.7 Life Policies

The concept of "life policies" as security for advances made by banks refers to the practice of
borrowers using life insurance policies as collateral to secure loans or credit facilities from
financial institutions. Life policies, in this context, are insurance contracts that provide coverage
in the event of the policyholder's death or, in some cases, other events like disability or critical
illness. Here's how life policies are used as security:

1. Collateral for Loans:

Borrowers pledge their life insurance policies as collateral to secure a loan from a bank. The
policy serves as security for the repayment of the loan.

Example: An individual may have a whole life insurance policy with a cash surrender value. They
can pledge this policy as collateral to obtain a personal loan from a bank.

2. Business Loans:

Business owners may use their life insurance policies as collateral when seeking financing for
business purposes, such as expansion, working capital, or investment in new projects.

Example: A business owner may have a life insurance policy with cash value and assign it to the
bank as collateral when applying for a business loan.

Key Points to Consider:

Cash Surrender Value: Life insurance policies with cash value, such as whole life or universal life
policies, are typically the ones that can be used as collateral. These policies accumulate a cash
value over time, which can be accessed by the policyholder.

Valuation: The value of the life insurance policy used as security is based on its cash surrender
value, which can be determined by the insurance company. This value may increase over time
as premiums are paid and interest is credited.

Ownership: While the policy is used as collateral, the borrower typically retains ownership
rights and beneficiary designations. In the event of the borrower's death, the insurance
proceeds would still go to the designated beneficiaries.

Loan-to-Value (LTV) Ratio: Lenders may set an LTV ratio to ensure that the loan amount does
not exceed a certain percentage of the policy's cash surrender value. This helps mitigate
potential risks.
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Premium Payments: Borrowers must continue paying premiums on the life insurance policy to
keep it in force. Failure to pay premiums could result in the policy lapsing, which may trigger
repayment of the loan.

Default and Payout: In the event of a loan default, the lender may have the right to access the
cash surrender value of the policy to recover the outstanding loan amount. If the policy's cash
value is insufficient to cover the debt, the borrower may be responsible for the shortfall.

Using life insurance policies as security allows borrowers to access financing while leveraging
the cash value of their policies. It provides banks with a relatively secure form of collateral, as
the cash surrender value typically grows over time. However, borrowers should be aware of the
potential implications, such as the need to continue premium payments and the risk of policy
lapse in the event of default. Additionally, the terms and conditions of such arrangements may
vary among financial institutions.

Modes of Charge: Pledge & Assignment

Borrowers may pledge the cash value of a life insurance policy as collateral for a loan. However,
the agreement to pledge must also be followed by assignment of life policies in favour of the
bank. Mere pledge is not sufficient when it comes to LIC Policies. While pledge involves the act
of the borrower handing over the policy documents to the banker, the assignment creates a
first charge in favor of the bank on the cash surrender value of the policy.
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5.8 Document of Title to Goods

Documents of title to goods are legal documents that represent ownership or control over
goods in transit or storage. These documents are crucial in trade and commerce and can be
used as collateral to secure loans or credit facilities. Here are some examples of documents of
title to goods:

1. Bill of Lading (B/L):

A bill of lading is a document issued by a carrier (typically a shipping company or carrier) to a

shipper or consignor. It serves as evidence of the receipt of goods for shipment, the contract of
carriage, and the title to the goods.

Use: Bill of ladings are used in shipments by sea, and sometimes by air, to confirm that goods
have been loaded onto a vessel and are in transit. They can be transferred, endorsed, or
assigned to others and are often used in trade finance transactions.

2. Airway Bill (AWB):

An airway bill is similar to a bill of lading but is specific to air cargo. It represents a contract of
carriage and evidence of receipt for goods transported by air.

Use: Airway bills are used in international airfreight shipments. They facilitate the movement of
goods and may be used in trade finance transactions.

3. Railway Receipt (RR):

A railway receipt is a document issued by a railway company or carrier to acknowledge the

receipt of goods for transport by rail. It provides details about the goods, their destination, and
the terms of carriage.

Use: Railway receipts are primarily used for shipments transported by rail. They are important
for both domestic and international rail shipments, and they can serve as proof of ownership or
control over goods in transit.

4. Lorry Receipt (LR):

A lorry receipt, also known as a truck receipt or road receipt, is a document issued by a trucking
company or carrier to acknowledge the receipt of goods for transport by road (by truck).

Use: Lorry receipts are commonly used for land-based transportation of goods. They serve as
proof that the goods have been received by the carrier and are in transit. Lorry receipts may be
used in domestic and cross-border road transport.
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5. Warehouse Receipt:

A warehouse receipt is issued by a warehouse operator to acknowledge the receipt and storage
of specific goods in a warehouse. It confirms the ownership or control of goods held in storage.

Use: Warehouse receipts are often used in financing and commodities trading. Borrowers can
pledge warehouse receipts as collateral to obtain loans.

6. Delivery Order:

A delivery order is issued by the owner or operator of a warehouse, storage facility, or terminal
to authorize the release of goods to a specific party. It can be used to transfer control or
possession of goods.

Use: Delivery orders are commonly used in logistics and transportation to facilitate the release
or delivery of goods. They can also be used as collateral in financial transactions.

7. Dock Receipt:

A dock receipt is issued by a carrier or terminal operator to acknowledge the receipt of goods at
a specific dock or terminal location. It is typically issued when goods arrive for shipment or
storage.

Use: Dock receipts are used in conjunction with other transport documents and are important
for tracking and accounting for goods in transit.

8. Warehouse Warrant:

A warehouse warrant is similar to a warehouse receipt and represents ownership or control of

goods stored in a warehouse. It can be used as collateral for loans.

Use: Warehouse warrants are often associated with commodities and agricultural products.
They allow the owner to pledge the goods for financing.

These documents play a crucial role in facilitating the movement of goods, trade transactions,
and securing financing for businesses involved in trade and logistics. They provide proof of
ownership or control over goods and are essential for tracking and verifying the status of goods
during transportation and storage.
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5.8.1 Document of title to Goods as a Security for

Advances
The concept of a "document of title to goods" as security for advances made by banks refers to
the practice of borrowers using specific legal documents that represent ownership or control
over goods or commodities as collateral to secure loans or credit facilities. These documents
provide evidence of the borrower's right to possess or transfer the goods and are typically used
in trade and commerce. Here's how documents of title to goods are used as security:

1. Collateral for Loans:

Borrowers pledge documents of title to goods, such as bills of lading, warehouse receipts, or
delivery orders, as collateral to secure a loan from a bank. These documents represent
ownership or control over goods in transit or storage.

Example: A manufacturer may have a shipment of goods in transit, represented by a bill of

lading. The manufacturer can pledge this bill of lading as collateral to obtain a working capital
loan from a bank.

2. Trade Finance:

Businesses involved in international trade often use documents of title to goods to secure trade
finance facilities, such as letters of credit or documentary collections. These documents ensure
the release of goods to the buyer upon payment or fulfillment of other trade-related
conditions.
Example: An exporter may present a bill of lading and other documents to a bank to request
payment under a letter of credit, with the understanding that the bank will release the
documents to the importer upon payment.

Key Points to Consider:

Types of Documents: Common documents of title to goods include bills of lading (for shipments
by sea or air), warehouse receipts (for goods stored in warehouses), and delivery orders (for
goods in the possession of a carrier or logistics provider).

Control and Possession: These documents represent control or possession of the goods. When
pledged as collateral, the lender may hold the documents until the loan is repaid or other
conditions are met.

Verification: Banks often verify the authenticity and legality of the documents of title to goods
to ensure that they represent valid and genuine transactions. This includes confirming the
existence and condition of the goods.
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Default and Release: In the event of a default by the borrower, the bank may have the right to
take possession of the goods or release the documents to a third party, depending on the terms
of the agreement.

Trade Finance: In international trade, documents of title to goods play a crucial role in
facilitating the movement of goods and the settlement of trade transactions. Banks provide
financing based on the security represented by these documents.

Using documents of title to goods as security allows borrowers to access financing while
leveraging the value of goods in their possession or control. It provides banks with a tangible
and secure form of collateral, particularly in trade finance transactions. However, both
borrowers and lenders should carefully review the terms and conditions of such arrangements,
including the procedures for default and release of the goods or documents. Additionally,
regulations governing these transactions may vary by jurisdiction and may involve international
trade rules and conventions.
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5.9 Bank Guarantees

A Bank Guarantee is a financial instrument issued by a bank on behalf of its customer (the
applicant) to guarantee a specific payment or performance obligation. In the Indian context,
bank guarantees are widely used in commercial transactions, contracts, and international trade
to provide assurance to the beneficiary (the party receiving the guarantee) that a financial
commitment will be fulfilled. There are several types of bank guarantees issued by banks in
India, each serving a distinct purpose:

1. Financial Bank Guarantee:

Purpose: These guarantees are issued to ensure the financial obligations of the applicant are
met. They are often used in business transactions where one party needs assurance that the
other party can fulfill a financial commitment.

Example: A supplier may request a financial bank guarantee from a buyer to ensure payment
for goods or services delivered.

2. Performance Bank Guarantee

Purpose: These guarantees are used to ensure the performance of a contractual obligation. If
the applicant fails to fulfill the agreed-upon terms, the beneficiary can claim the guarantee
amount.

Example: In a construction contract, the contractor may provide a performance bank

guarantee to the client to guarantee the completion of the project as per the contract terms.

3. Bid Bond Bank Guarantee:

Purpose: These guarantees are issued when a company submits a bid or tender for a project.
They assure the client that the bidder will enter into a contract and provide the required
performance guarantee if their bid is accepted.

Example: A construction firm may provide a bid bond bank guarantee when bidding for a
government infrastructure project.
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4. Advance Payment Bank Guarantee:

Purpose: When a buyer makes an advance payment to a seller, an advance payment bank
guarantee may be required. It ensures that if the seller does not fulfill the agreement, the
advance payment is refunded.

Example: An importer may request an advance payment bank guarantee when making an
upfront payment to a foreign supplier.

5. Deferred Payment Bank Guarantee:

Purpose: These guarantees are used in international trade when a buyer defers payment for
goods. The guarantee assures the seller that payment will be made on a specified future date.

Example: An Indian importer may provide a deferred payment bank guarantee to a foreign
exporter for goods received with payment due in several months.

6. Counter-Guarantee (Counter-Guarantee Issued on behalf of Other Banks):

Purpose: Banks may issue counter-guarantees on behalf of other banks to support their
guarantees. This facilitates transactions between banks and enhances the creditworthiness of
the issuing bank.

Example: A foreign bank may request an Indian bank to issue a counter-guarantee in favor of
its customer to support a transaction in India.

7. Customs Duty Bank Guarantee:

Purpose: Importers may require customs duty bank guarantees when importing goods. These
guarantees are submitted to customs authorities as security for payment of customs duties and
taxes.

Example: An importer in India may provide a customs duty bank guarantee to the Indian
Customs Department when importing goods from abroad.

Bank guarantees are a crucial tool in facilitating trade and commercial transactions, ensuring
the fulfillment of contractual obligations, and managing financial risk. Banks in India provide
various types of guarantees to cater to the diverse needs of businesses and individuals engaged
in domestic and international trade and commerce. The terms and conditions of these
guarantees are typically outlined in formal agreements between the bank, the applicant, and
the beneficiary.
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Bank Guarantees – Advantages

Bank guarantees offer several advantages to both the parties involved—the applicant (the party
requesting the guarantee) and the beneficiary (the party receiving the guarantee). These
advantages make bank guarantees a valuable financial instrument for various business and
trade transactions. Here are some of the key advantages of bank guarantees:

1. Risk Mitigation:

Bank guarantees provide a secure way to mitigate financial and performance risks in
transactions and contracts. They offer assurance to the beneficiary that the applicant will meet
their obligations.

2. Credibility and Trust:

Having a bank's backing enhances the credibility and trustworthiness of the applicant in the
eyes of the beneficiary. This can help businesses secure contracts and trade deals.

3. International Trade Facilitation:

In international trade, bank guarantees play a crucial role by assuring foreign counterparts of
payment or performance. This facilitates cross-border transactions and trade relationships.

4. Bid Acceptance:

Bid bond guarantees support companies when submitting bids or tenders for projects. They
demonstrate the bidder's seriousness and financial capability, increasing the chances of winning
contracts.

5. Customized Solutions:

Banks offer a variety of guarantee types tailored to specific needs, such as performance
guarantees, advance payment guarantees, and customs duty guarantees. This flexibility allows
businesses to structure deals effectively.

6. Preservation of Cash Flow:

Using a bank guarantee can help applicants preserve their cash flow. Instead of making a cash
deposit or tying up funds, they can utilize bank guarantees as collateral.
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7. Compliance with Legal Requirements:

In many industries, government regulations or contractual agreements may require the

provision of guarantees. Bank guarantees help businesses meet these obligations.

8. Cross-Industry Applicability:

Bank guarantees are utilized across various industries, including construction, international
trade, manufacturing, real estate, and more. They are not limited to a specific sector.

9. Efficient Dispute Resolution:

In the event of disputes between parties, bank guarantees can facilitate dispute resolution. The
beneficiary can make a claim on the guarantee to seek compensation.

10. Financial Flexibility:

Bank guarantees do not affect the applicant's credit lines or borrowing capacity. This allows
businesses to secure financing independently of guarantee requirements.

11. Facilitation of Payment:

Bank guarantees ensure that payments are made to the beneficiary promptly when contractual
obligations are not met. This can be especially important in cases of default.

It's important to note that while bank guarantees offer numerous advantages, they also come
with costs and responsibilities for the applicant, such as fees and the need to maintain
adequate creditworthiness. Therefore, individuals and businesses should carefully consider
their specific needs and obligations before requesting or providing bank guarantees and should
consult with financial and legal advisors as necessary.
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5.10 Letters of Credit

A Letter of Credit (LC), also known as a documentary credit, is a financial instrument commonly
used in international trade to facilitate secure and reliable transactions between buyers and
sellers across borders. It provides assurance to both parties that the terms of the trade
agreement will be met. There are several types of Letters of Credit in international trade:

1. Sight Letter of Credit (Sight LC):

- In a Sight LC, payment is made to the seller (beneficiary) immediately upon presentation of
compliant documents to the issuing bank. The seller receives payment as soon as they fulfill the
terms and conditions of the LC.

2. Deferred Payment Letter of Credit (Usance LC):

- A Deferred Payment LC allows the buyer (applicant) to defer payment for the goods or
services to a specified future date after the documents have been presented and accepted by
the issuing bank. The seller extends credit to the buyer until the payment due date.

3. Confirmed Letter of Credit:

- In a Confirmed LC, the beneficiary's bank (usually a local bank) adds its confirmation to the
LC issued by the buyer's bank (issuing bank). This confirmation provides an additional layer of
assurance to the beneficiary that payment will be made, even if there are issues with the
issuing bank.

4. Transferable Letter of Credit:

- A Transferable LC allows the original beneficiary (first seller) to transfer all or a portion of the
credit to one or more secondary beneficiaries (second sellers). This is often used when the
original beneficiary acts as an intermediary in the transaction.

5. Revocable Letter of Credit:

- A Revocable LC can be modified or canceled by the issuing bank without notice to the
beneficiary. However, revocable LCs are rarely used in international trade due to the lack of
security they provide to the seller.

6. Irrevocable Letter of Credit:

- An Irrevocable LC cannot be modified or canceled without the consent of all parties involved
(buyer, seller, and banks). It offers more security to the beneficiary than a revocable LC.
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7. Back-to-Back Letter of Credit:

- A Back-to-Back LC is used when an intermediary, such as a trader or middleman, needs to

establish a new LC in favor of its supplier. It is backed by an original LC received from the buyer.

8. Red Clause Letter of Credit:

- A Red Clause LC includes a special clause (the "red clause") that allows the beneficiary to
receive a partial advance payment from the issuing bank before shipment. This is often used in
commodity trade.

9. Green Clause Letter of Credit:

- A Green Clause LC is similar to a Red Clause LC but includes an additional clause (the "green
clause") that allows for the storage and pre-shipment inspection of goods.

10. Standby Letter of Credit (SBLC):

- SBLCs serve as a form of financial guarantee, often used in non-trade transactions. They
ensure that the applicant's financial or performance obligations will be met. SBLCs are
frequently used in real estate, construction, and investment projects.

Each type of LC serves different purposes and provides various levels of security and flexibility
to both buyers and sellers engaged in international trade. The choice of LC type depends on the
nature of the transaction and the preferences of the parties involved.
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5.10.1 Uniform Customs & Practice for Documentary

Credit
The UCPDC, or Uniform Customs and Practice for Documentary Credits, is a set of
internationally recognized rules and guidelines developed by the International Chamber of
Commerce (ICC) for the use of Letters of Credit (LCs) in international trade. UCPDC helps
standardize the interpretation and application of LC terms and conditions, making trade
transactions smoother and more reliable.

1. Standardization: UCPDC provides a common set of rules that banks and businesses
worldwide follow when issuing, amending, or honoring LCs. This standardization reduces
misunderstandings and disputes in international trade.

2. Legal Framework: While not a law or regulation itself, UCPDC is widely accepted and
referenced in international trade contracts and finance agreements. It provides a legal
framework that defines the rights and responsibilities of all parties involved in LC transactions.

3. Roles and Responsibilities: UCPDC outlines the roles of key participants in LC transactions,
including the buyer (applicant), seller (beneficiary), issuing bank, advising bank, and confirming
bank. It clarifies their respective responsibilities and obligations.

4. Documentary Requirements: UCPDC specifies the types of documents that can be used to
fulfill LC requirements, such as invoices, bills of lading, certificates of origin, and inspection
certificates. It sets standards for document content and presentation.

5. Payment and Shipment: UCPDC addresses payment terms, including when payment should
be made (sight or deferred), the currency of payment, and the conditions for payment. It also
covers the shipment of goods, including the timeline and shipping terms.

6. Amendments and Corrections: The rules provide guidance on amending or correcting LCs,
ensuring that changes are made in a way that is fair and acceptable to all parties.

7. Dispute Resolution: UCPDC offers guidance on how to handle disputes related to LCs,
emphasizing negotiation and consultation among the parties. It promotes efficient and fair
dispute resolution procedures.

8. Electronic LCs: UCPDC has been updated to accommodate electronic LCs (eUCP) to reflect
the digitalization of trade finance. These rules apply to LCs issued and presented electronically.

UCPDC is periodically updated to align with changing practices and technology in international
trade. It provides a framework that enhances the security and reliability of international trade
transactions, giving confidence to both buyers and sellers that contractual obligations will be
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met in accordance with agreed-upon terms. Uniformity in customs and practices ensure that
several terms, conditions and expressions used in LCs are understood by the parties to LC in the
same sense. It's an essential tool for international trade professionals, including bankers,
exporters, and importers, ensuring smoother and more predictable trade transactions.
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5.10.2 Parties to LC
A letter of credit (LC), also known as a documentary credit or bankers commercial credit,
or letter of undertaking (LoU), is a payment mechanism used in international trade to provide
an economic guarantee from a creditworthy bank to an exporter of goods. Letters of credit are
used extensively in the financing of international trade, when the reliability of contracting
parties cannot be readily and easily determined. Its economic effect is to introduce a bank as
an underwriter that assumes the counterparty risk of the buyer paying the seller for goods.
(Note: Counterparty risk is the probability that the other party in an investment, credit, or
trading transaction may not fulfil its part of the deal and may default on the contractual
obligations.)
UCP 600 (2007 Revision) regulates common market practice within the letter of credit market.
It defines a number of terms related to letters of credit which categorise the various factors
within any given transaction. These are crucial to understanding the role financial institutions
play within. These include:

 The Applicant is the person or company who has requested the letter of credit to be issued;
this will normally be the buyer or importer.
 The Beneficiary is the person or company who will be paid under the letter of credit; this
will normally be the seller or exporter (UCP600 Art.2 defines the beneficiary as "the party in
whose favour a credit is issued").
 The Issuing Bank is the bank that issues the credit, usually following a request from an
Applicant (buyer or importer).
 The Nominated Bank is a bank mentioned within the letter of credit at which the credit is
available (in this respect, UCP600 Art.2 reads: "Nominated bank means the bank with
which the credit is available or any bank in the case of a credit available with any bank") . A
Nominated bank is a bank with which an LC is available. An LC may be available by Sight
Payment, Deferred Payment, Acceptance, or by Negotiation. Negotiation is one of four
methods of availability
 The Advising Bank is the bank that will inform the Beneficiary or their Nominated Bank of
the credit, send the original credit to the Beneficiary or their Nominated Bank, and provide
the Beneficiary or their Nominated Bank with any amendments to the letter of credit.
 Confirmation is an undertaking from a bank other than the issuing bank to pay the
Beneficiary for a Complying Presentation, allowing the Beneficiary to further reduce
payment risk, although Confirmation is usually at an extra cost.
 Confirming Bank is a bank other than the issuing bank that adds its confirmation to credit
upon the issuing bank's authorization or request thus providing more security to the
beneficiary. Article Two of the Uniform Commercial Practice (“UCP”) 600 defines
“Confirmation” as a definite undertaking of the confirming bank, in addition to that of the
issuing bank, to honor or negotiate a complying presentation. This article defines a
“Confirming Bank” as any bank that adds its confirmation to a letter of credit upon the
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issuing bank’s authorization or request. In its simplest terms, a confirmed Letter of Credit
(“LC”) can be defined as a second guarantee by the confirming bank.
 It may be noted that confirming bank and the issuing bank are located in the importer’s
country, whereas the advising bank, and nominated bank are located in the exporter’s
country.
 A Complying Presentation is a set of documents that meet with the requirements of the
letter of credit and all of the rules relating to letters of credit. In simple words the
beneficiary presents all documents as per the terms of LC issued and also complies with the
UCPDC norms.
 Negotiating bank is one of the main parties involved under Letter of Credit. Negotiating
Bank,is the one who negotiates documents delivered to bank by beneficiary of LC.
Negotiating bank is the bank that verifies documents and confirms the terms and
conditions under LC on behalf of beneficiary to avoid discrepancies. The bank after
satisfying itself that the documents conform with the letter of credit, agrees to either credit
or pay the seller immediately under the terms of the letter of credit, or credit or pay the
seller once it has received payment from the issuing bank.

Difference between Advising bank and Confirming bank

 The advising bank has no payment obligations under the letter of credit rules. ... On the
other hand the confirming bank has to pay the letter of credit amount to the beneficiary
against a complying presentation, even if nominated bank or issuing bank refrain to pay.
 Confirming Bank: Is a bank that adds its commitment or undertaking to that of the
issuing bank guaranteeing that the exporter will be paid. ... Advising bank: This is simply
the bank that advises(informs) the exporter that the Letter of credit has been issued by
the importer.
 In a letter of credit transaction, the confirming bank, also known as the confirmer, is a
bank that, at the request of the issuing bank, agrees to perform the principal duties of
the issuing bank.

A letter of credit, also known as a bank credit letter, payment guarantee letter, or documentary
credit, is a legal financial instrument issued by a bank or a financial institution to guarantee the
buyer’s payment to the seller. In the event, if the buyer is unable to make the payment or
perform the terms and conditions of the contract, the full or remaining amount will be covered
by the buyer’s issuing bank to pay the exporters. An LC is a highly-secured and effective form
of assuring on-time payment to the exporter while initiating an international transaction.
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Steps involved in the LC process:

1. There is a contract between Importer (in India) and Exporter (in USA) for sale of Machinery.

2. As per the terms of the contract the Importer must provide Letter of Credit to the
Beneficiary (Exporter). So he applies for LC with issuing bank which issues LC in favour of the
Beneficiary. In simple words, if the Importer fails to make the payment after receiving the
Machinery, the Issuing bank through LC, undertakes to make the payment.

3. LC issued by the issuing bank in India (which is normally the Banker of the Importer), may (or
may not) further be confirmed by a Confirming Bank. This is like counter guarantee provided by
some other bank to the BG already issued by some bank. This confirmation by a confirming
bank boosts the confidence of the beneficiary that if Importer fails to pay, the Issuing bank will
pay and if the Issuing bank also fails to pay, the Confirming Bank will pay.

4. Issuing Bank on behalf of the Importer forwards documents to the Advising Bank with which
it normally has arrangement in the country of Exporter. For instance if SBI has a foreign branch
located in USA, and if SBI itself is the issuing Bank, then the importer’s Branch of SBI will
forward documents of LC to the foreign branch of SBI in USA (which acts as Advising Bank). In
the absence of any foreign branch, banks normally have tie up arrangement with some bank to
act as Advising bank.

5. Advising Bank notifies the beneficiary directly or his banker about the availability of LC. His
Banker is the Nominated Bank generally. Nominated bank comes into picture as a Negotiating
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bank only if the Exporter negotiates for advance payment of sale proceeds of Machinery
involved in the LC which is guaranteed by the Issuing Bank and Confirming Bank in the
Importer’s country. It is not necessary that the Exporter always seek advance payment. If he
wants to wait, he may not prefer to negotiate about advance payment with the nominated
bank. In such case, the nominated bank (which is usually the banker of the exporter) merely
examines the veracity, genuineness and correctness of documents on behalf of the Exporter so
that Exporter can make arrangements to export machinery to the importer’s country.

6. Negotiating Bank is the Bank which gives credit to the Exporter on the basis of the
Documentary LC issued by the Issuing Bank. For example, if the LC is a deferred payment LC,
then the exporter may receive the sale proceeds from importer after 3 months. If the exporter
needs that money (of sale proceeds) immediately, he can negotiate with his banker or any
other banker for immediate payment/advance payment. In such case, the negotiating bank
relying on the Documents provided by the issuing bank, and the credit worthiness of both the
Exporter and the Issuing Bank releases advance payment to the Exporter. In other words, it is
assuming credit risk. It is important to note that nominated bank and negotiating bank may or
may not be same bank. Where the exporter negotiates for advance payment with the
nominated bank, and nominated bank makes advance payment, then the nominated bank and
negotiating bank are one and same. Sometimes, the exporter may approach a different bank
for negotiation of advance payment. In such case, the nominated bank is different from the
negotiating bank. In simple words, the nominated bank’s role is merely to examine the
correctness of the documents of the LC on behalf of the exporter, whereas the negotiating
bank’s role is to release advance payment thereby assuming credit risk, in case the exporter
negotiates for advance payment.

7. Exporter exports Machinery from USA to India, he sends Bill of Exchange, Bill of Lading/Air
Way Bill to the Advising Bank so that the advising bank receives payment from the beneficiary
and forwards it to the nominated bank (the exporter’s banker).

8. The importer accepts the bill of exchange, and takes the bill of lading/AWB, as the case may
be, to take delivery of the Machinery.

9. When the beneficiary makes the payment through the advising bank, it may be taken by the
nominated bank (if it made advance payment to the exporter) or by the beneficiary exporter (if
the nominated bank merely acted as an agent of the exporter to verify the documents). Usually
the cost of making advance payment to the exporter is higher (in terms of fee or interest) and
the cost of merely acting as agent of the exporter is lower.

10. If beneficiary pays the sale proceeds, the issuing bank has no obligation to pay. If
beneficiary fails to pay or does not pay due to any dispute, then the issuing bank has to pay to
the beneficiary/nominated bank, as the case may be.

5.11 Differences between Letter of Credit & Bank
Guarantee
Sl.No. Letter of Credit
1. Purpose Facilitates trade transactions by
providing payment assurance to the
seller (beneficiary) upon complying
with terms and conditions.
2.Types Various types, including Commercial
LCs, Standby LCs, Revocable LCs, and
Irrevocable LCs, tailored for specific
trade needs.
3. Function Ensures payment to the beneficiary
for goods or services upon presenting
compliant documents.
4. Parties Involves the applicant (buyer),
beneficiary (seller), issuing bank,
advising bank, and possibly
confirming bank.
5. Payment Payment is made to the beneficiary
upon document compliance and
presentation to the bank (usually in
trade transactions).
6. Risk The primary risk is credit risk, where
the issuing bank's ability to pay is a
concern (especially in international
trade).
7. Flexibility LCs can be structured to meet various
trade requirements and can be
tailored for specific transactions.
8. Usage Commonly used in international trade
to facilitate payment and reduce risk
for both buyers and sellers.
134
Bank Guarantee
Provides a guarantee to the beneficiary
(often the seller or a party in the
contract) that the obligations of the
applicant (buyer or contractor) will be
fulfilled.
Typically, two primary types: Financial
BG (securing financial obligations) and
Performance BG (ensuring contractual
performance).
Acts as a promise or assurance from the
issuing bank to the beneficiary that the
applicant will meet its contractual or
financial obligations.
Involves the applicant (party requesting
the BG), beneficiary (party receiving the
guarantee), and the issuing bank.
Payment is made only if the beneficiary
invokes the BG due to the applicant's
default, and it complies with the BG
terms.
The primary risk is the applicant's
default or failure to meet contractual
obligations, leading to a demand for
payment under the BG.
BGs are generally standard instruments
with fewer variations, often following
standard industry practices.
Widely used in construction, project
finance, government contracts, and
other situations where contractual or
financial obligations need assurance.
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5.12 Recovery of Bank loans and Position under the

SARFAESI Act, 2002
Introduction
If the borrowers make default in the payment of loans lent by the banks, their loans after
certain periof of time (usually 90 days) are declared as Non-performing Assets by the Banks
following the RBI guidelines. Loans in the balance sheets of banks are the financial assets. They
are classified by RBI as Standard, Sub-standard, Doubtful and Loss assets. Except the Standard
assets, all assets are Non-performing assets (NPAs) where the risk varies with each type of NPA.
The risk involved with sub-standard assets is lesser than doubtful assets and the risk involved
with the doubtful assets is lesser than the loss assets. Banks usually provide for these NPAs as
per RBI guidelines from the profits. If they are capable of recovering from borrower, those
amounts, therefore go into profits, as they have already made some provision for these NPAs.

Prior to 1993, the recovery process was very slow involving huge losses for banks because all
the cases relating to the bank loans were filed by banks in civil courts and civil courts used to
hear these cases (irrespective of huge amounts involved) by clubbing with other civil court
cases. This resulted in huge losses for banks. Therefore, to provide quicker remedy for banks
suffering from the NPAs, the government following the recommendation of Narasimham
Committee, passed “The Recovery of Debts due to Banks and Financial Institutions Act, 1993”.
With the passing of this Act, the Debt Recovery Tribunals in India came into existence to
provide quicker resolution of bank loan related disputes on a fast track. However, the loan
outstanding amounts lesser than 10 lakhs were still kept under the purview of the Civil Courts.
It means that the DRTs have jurisdiction over the loan outstanding amounts involving Rs.10 lacs
and above. Now after amendment to the said Act in 2018, this amount is further increased to
Rs.20 lacs, which means DRTs will only deal with cases involving Rs.20 lacs or above.

The creation of DRTs have speedened the recovery process for the banks after 1993 however,
the banking practices were still far away in India from International Standards. Therefore to
match the international standards, the government passed SARFESI Act, 2002 (Securitization
and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002).

Usually to sell the mortgaged or pledged assets the banks were obliged to follow the tedious
process of filing the Original applications in DRTs or Original suits in Civil Courts. The courts
after declaring through a decree that the borrower is liable would permit the bank to
appropriate the sale proceeds of the mortgaged/pledged assets/hypothecated assets towards
loan amounts. However, merely obtaining a decree did not enable them to recover dues
because the Civil court/DRT must appoint a receiver/debt recovery officer to sell the secured
assets and give the sale proceeds to banks. This is a cumbersome process sometimes involving
several years even after decree was issued by courts in favour of banks.
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Securitization Act, 2002 (SARFAESI Act, 2002) is passed to by-pass the filing of cases in courts to
enable Banks to sell the secured assets without the intervention of courts with codified
process/procedure under Security Interest (Enforcement) Rules, 2002, made under the
provisions of the Securitization Act, 2002.

Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002 (SARFAESI Act):

1. Objective: The SARFAESI Act empowers banks and financial institutions to take possession of
the secured assets of borrowers without the intervention of a court or tribunal to facilitate the
recovery of dues.

2. Applicability: This Act is applicable when the loan agreement includes a security interest over
immovable property or movable property. It is not subject to any minimum threshold amount.

3. Steps involved in the sale of secured assets

I. Notice: Before taking possession of assets, the bank or financial institution must issue a
notice to the borrower, providing an opportunity to rectify the default. This notice is
called Demand notice, it is issued under Sec.13(2) of the SARFAESI Act, 2002.

II. Asset Possession: If the borrower fails to comply with the notice, the bank can take
possession and sell the secured assets. Notice for possession must be served under
Section 13(4) of the SARFAESI Act.

III. Sale notice: Even after taking possession, the borrower does not come forward to repay
the amounts of Demand Notice, the borrower will be served with a Sale Notice, which
notifies that the Creditor Bank intends to sell the Secured asset. This notice is intended
to alert the borrower that, bank is giving final opportunity to the borrower to make
repayment in terms of Demand notice. Some time is provided to make repayment
under sale notice. After the lapse of the time, if borrower has not responded, the final
step is issuing Auction notice in newspapers and bank’s website etc.

IV. Auction Notice: Auction notice, calls for bids to be presented by the parties intending to
purchase the secured asset (movable or immovable property). Earnest money deposit
(EMD) must be paid by the borrowers to participate in the bid. Bidding happens
through the process of sealed covers, which will be opened at the site of Auction by the
bank in front of the bidders. There only the successful bidder is declared. The bidder
quoting highest price for the secured asset will be declared successful bidder. EMD will
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be forfeited if the bidder after being declared as the successful bidder fails to puchase
the secured asset. EMD is usually 10 % of the value of the Secured asset.

V. Debt Recovery Tribunals: Borrowers can approach Debt Recovery Tribunals (DRTs) for
any grievances related to the SARFAESI proceedings. Under Section 17 of the Act, the
borrower is entitled to approach the DRT if there is any grievance. The remedy provided
under Section 17 is limited because the borrower can only approach the DRT for
violation of Security Interest (Enforcement) Rules, 2002 or for not properly following the
procedure prescribed under these rules. He can only challenge deviations, violations of
these rules. If the Bank properly follows the procedure the borrower can not get any
relief from the DRT.

The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act) and the
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 (SARFAESI Act) are two significant legislative frameworks in India that address the
recovery of Non-Performing Assets (NPAs) by banks and financial institutions. Here's an
overview of how these two acts affect the recovery of NPAs:

Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act):

1. Objective: The primary objective of the DRT Act is to establish Debt Recovery Tribunals
(DRTs) and Appellate Tribunals to facilitate the expeditious recovery of debts due to banks and
financial institutions.

2. Applicability: The DRT Act is applicable when a bank or financial institution seeks to recover
outstanding dues of Rs. 20 lakhs or more from a borrower.

3. Debt Recovery Tribunals (DRTs): Under this Act, DRTs are established to hear and adjudicate
cases related to debt recovery. Banks and financial institutions can file cases before DRTs to
recover their dues.

4. Role of DRTs: DRTs have the authority to issue recovery orders against borrowers, directing
them to repay the outstanding debts. They can also attach and sell the borrowers' assets to
recover the dues.

Comparison:

1. Speed of Recovery: SARFAESI provides a quicker and more streamlined process for asset
possession and sale, while DRT proceedings may take longer.
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2. Asset Possession: SARFAESI allows banks to take possession of assets without the need for
court intervention, while DRTs issue recovery orders but do not handle asset possession
directly.

3. Scope: SARFAESI is applicable to a broader range of cases involving secured assets, while the
DRT Act applies to specific cases involving larger outstanding dues.

4. Legal Recourse: Borrowers have the option to approach DRTs for grievances related to
SARFAESI proceedings, providing a legal avenue for recourse.

In summary, the DRT Act and the SARFAESI Act both play significant roles in the recovery of
NPAs by banks and financial institutions in India. SARFAESI provides banks with more direct
control over asset possession and sale, while the DRT Act involves a tribunal-based process for
debt recovery. The choice between these mechanisms depends on the specific circumstances of
each case and the type of assets involved.
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5.13 Jurisdiction and Powers of Debt Recovery Tribunal

Pecuniary Jurisdiction

The pecuniary jurisdiction of the Debts Recovery Tribunal (DRT) was Rs. 10 lakhs (1 million) until
the Debts Recovery Tribunal (Amendment) Act, 2018 came into force on 13th May 2018. The
amendment increased the pecuniary jurisdiction of the DRT to Rs. 20 lakhs (2 million).

The amendment was made in order to provide a more effective mechanism for the recovery of
debts due to banks and financial institutions. The increase in the pecuniary jurisdiction of the
DRT will allow it to entertain cases of larger debts, which will help to reduce the backlog of
cases pending before the DRTs.

The amendment also made some other changes to the DRT Act, such as:

* Increasing the number of members of the DRT from three to five.

* Providing for the appointment of retired judges as members of the DRT.
* Empowering the DRT to appoint a receiver to manage the assets of a defaulting borrower.

The amendment to the DRT Act is a welcome move that will help to improve the efficiency of
the debt recovery process in India.

Cases dealt by the DRTs

DRTs deal with two kinds of cases viz., one under Section 19 of the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993, which facilitates the Banks and Financial Institutions
to file Original Applications to recover dues involving amounts of Rs.20 lacs or more. Second is
under the Section 17 of the Securitization Act, 2002, which facilitates the borrowers who are
facing action by Banks under Security Interest (Enforcement) Rules, 2002, to challenge lapses,
violations or deviations in procedure followed by Banks under these rules. The borrowers file
Securitization Applications under Section 17 pleading that the Bank has no right to proceed
under Securitization Act or it has not properly followed the procedure laid down in the Security
Interest (Enforcement) Rules, 2002.

In a nutshell DRTs entertain two types of cases:

1. Filing of Original Applications (OA) by Banks

2. Filing of Securitization Applications by Borrowers
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1. Filing of Original Applications (OA) by Banks

Banks and financial institutions file the Original Application (OA) under the Recovery of Debts
Due to Banks and Financial Institutions Act, 1993 (DRT Act) under Section 19 of the Act.

Section 19 of the DRT Act empowers banks and financial institutions to file an Original
Application before the Debt Recovery Tribunal (DRT) to recover debts due to them from
borrowers. The OA is a formal legal document that initiates the proceedings before the DRT.

Here are some key points regarding Section 19 and the filing of the OA:

1. Filing of OA: When a bank or financial institution seeks to recover outstanding dues from a
borrower, it files an OA with the relevant DRT.

2. Jurisdiction: The OA is filed in the DRT having jurisdiction over the area where the defendant
(borrower) or the defendant's registered office or residence is situated.

3. Content: The OA typically contains details of the outstanding debt, the parties involved, the
grounds for recovery, and the relief sought by the bank or financial institution.

4. Adjudication: Once the OA is filed, the DRT proceeds to adjudicate the matter and issue
orders for debt recovery, including orders for attachment and sale of the borrower's assets if
necessary.

It's important to note that the DRT Act is primarily focused on expeditious debt recovery, and
the procedures and timelines for resolving cases are designed to facilitate this objective.

2. Filing of Securitization Application by the borrowers facing action under

Securitization Act

Borrowers are entitled to file securitization applications with the Debt Recovery Tribunal (DRT)
under Section 17 of the Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2002 (SARFAESI Act).

Section 17 of the SARFAESI Act grants borrowers the right to approach the DRT by filing an
application if they have grievances or objections related to the actions taken by the secured
creditor (usually a bank or financial institution) under the SARFAESI Act. This section provides
borrowers with a legal recourse to challenge the enforcement of security interest by the
secured creditor.
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Key points regarding Section 17 of the SARFAESI Act:

1. Filing of Application: Borrowers who wish to contest or raise objections to the actions taken
by the secured creditor can file an application before the DRT.

2. Grounds for Application: The application can be filed on various grounds, including
challenging the possession of secured assets, disputing the amount claimed by the secured
creditor, or questioning the validity of the enforcement process.

3. Jurisdiction: The application is filed with the DRT having jurisdiction over the area where the
secured asset is located.

4. Adjudication: The DRT adjudicates the matter and may issue orders or directions as it deems
fit after considering the arguments and evidence presented by both the borrower and the
secured creditor.

5. Timelines: The SARFAESI Act emphasizes the expeditious resolution of cases, and the DRT is
expected to prioritize and resolve these matters promptly.

It's important for borrowers to be aware of their rights under Section 17 of the SARFAESI Act
and to seek legal counsel if they believe they have valid objections or grievances related to the
actions taken by the secured creditor.

Jurisdiction of DRT under Securitization Act and the RDDBF Act - Comparison

Jurisdiction of the DRT under Securitization Act is limited to the resolution of disputes relating
to the Secured Assets between banks and borrowers. However, there may be instances when
the banks have to rely on personal assets of the borrowers beyond the secured assets to
recover outstanding dues. DRT cannot attach the personal assets of the borrowers under the
Securitization Act because under this Act, it merely deals with Secured Assets (Secured assets,
means the assets (movable/immovable) mortgaged, pledged or hypothecated by the borrower.

However, under the RDDBF Act, 1993, the DRT has wider jurisdiction to even attach the
personal assets (apart from his secured assets) of the borrower to meet borrower’s liability
towards the bank.
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Renaming of the RDDBF Act

The "Recovery of Debts Due to Banks and Financial Institutions Act, 1993" (DRT Act, 1993) was
renamed and amended by the "Recovery of Debts and Bankruptcy (Amendment) Act, 2016."
This amendment act came into effect on August 1, 2016, and it introduced significant changes
to the debt recovery framework in India.

The key renaming and changes introduced by the Recovery of Debts and Bankruptcy
(Amendment) Act, 2016, include:

1. Renaming: The DRT Act, 1993, was renamed as the "Recovery of Debts and Bankruptcy Act,
1993" (RDB Act, 1993).

2. Expanded Scope: The amended act expanded its scope to include individuals, partnerships,
and other legal entities, in addition to banks and financial institutions, as creditors eligible to
file applications for debt recovery. The "Recovery of Debts and Bankruptcy (Amendment) Act,
2016" introduced several significant changes in the functioning of Debt Recovery Tribunals
(DRTs) in India. These changes expanded the jurisdiction and powers of DRTs and aimed to
streamline the debt recovery process. Here are some key changes:

a. Expanded Jurisdiction: The 2016 amendment expanded the jurisdiction of DRTs

to include cases where the amount of debt due to banks and financial
institutions exceeds Rs. 20 lakh. Previously, the threshold was Rs. 10 lakh.

b. Jurisdiction Over Individuals and Other Entities: DRTs were given jurisdiction over
cases involving individuals, partnerships, or any other person or entity, in
addition to banks and financial institutions. This expanded the scope of cases
that could be adjudicated by DRTs.

c. Transfer of Pending Cases: The amendment allowed for the transfer of pending
cases from various forums, such as civil courts and other tribunals, to DRTs if
they fell within the DRTs' expanded jurisdiction.

d. Enhanced Powers of Recovery Officers: Debt Recovery Officers (DROs), who assist
DRTs in the enforcement of recovery orders, were granted enhanced powers.
They were empowered to take possession of secured assets and manage and sell
them for the purpose of debt recovery.
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e. Provision for Compounding of Offenses: The amendment introduced a provision

for compounding offenses under the Act, allowing parties involved to reach
settlements and resolve disputes, thereby reducing the burden on DRTs.

f. Provision for Individual Insolvency: While not directly related to DRTs, the 2016
amendment introduced provisions for individual insolvency resolution, providing
individuals with a framework for dealing with financial distress.

g. Introduction of Debts Recovery Appellate Tribunals (DRATs): While DRATs existed

prior to the amendment, the 2016 Act clarified their role and appellate
jurisdiction in hearing appeals against DRT orders.

These changes were aimed at improving the efficiency and effectiveness of the debt recovery
process and providing a more comprehensive framework for addressing non-performing assets
(NPAs) in the banking and financial sector.

3. Empowerment of Debt Recovery Officers: The amended act empowers Debt Recovery
Officers (DROs) with enhanced enforcement authority to take possession of, manage, and sell
secured assets.

4. Provisions for Individual Insolvency: The act introduced provisions for individual insolvency
resolution, providing individuals with a framework for dealing with financial distress.

The renaming and amendments were aimed at streamlining the debt recovery process,
addressing the rising issue of non-performing assets (NPAs), and bringing more entities under
the purview of the act. The RDB Act, 1993, now serves as a key legislative framework for debt
recovery and insolvency resolution in India.
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