Professional Documents
Culture Documents
S Page No.
Unit/ Topic(s)
No From To
UNIT – I:
1 History of the Banking Regulation Act – Salient features - 01 04
Banking Business and its importance in modern times
UNIT – II:
2 Relationship between Banker and Customer – Debtor & Creditor 05 10
relationship – Fiduciary relationship – Trustee and Beneficiary –
Principal and agent – Bail and bailee – Guarantor etc.
UNIT – III:
Cheques – Crossed cheques – Account payee – Banker’s Drafts –
3 Dividend Warrants – Postal order and money orders – Travelers 11 18
cheques and circular notes – Negotiable instruments and deemed
negotiable instruments – Salient features of Negotiable
Instruments Act
UNIT – IV:
4 The Paying Banker – Statutory protection to Bankers – Forgeries 19 23
– Collecting Banker – Statutory protection
UNIT – V:
5 Banker’s lien and set off – Advances – Pledge – Land – Stocks – 24 42
Shares – Life Policies – Document of title to Goods – Bank
Guarantees – Letters of Credit
UNIT – I
History of the Banking Regulation Act – Salient features - Banking Business
and its importance in modern times
Banking is as old as the civilization itself. Ass early as 2,000 B.C., the Babylonians had developed
a system of banks. They used the temples for lending at higher rates of interest against gold and
silver which had been left with them for safe custody.
In England, the development of business of banking can mainly be attributed to the London
goldsmiths, during the reign of Queen Elizabeth. It led to the growth of private banking and later
on establishment of Bank of England in 1964. Banking was in existence in India during Vedic
times (from 2000 BC to 1400 BC) Loans and usury were well understood in those days. During
Mahabharata and Ramayana banking has become a full-fledged business in India.
1. The Negotiable instrument Act., 1881 is intended “to define and amend the law relating to
promissory notes, bills of exchange and ‘cheque’, whether negotiable or not”. The Indian
Act, even now is not as comprehensive as it should be, although it has been amended
several times.
3. The Banking Regulation Act., 1949 (Previously The Banking Companies Act., 1949):
With effect from 1st March, 1966, the name of the Act has been changed to the Banking
Regulation Act., 1949, deals with the banking companies and does not purport to codify the
law of banking. Banking Regulation Act, 1949 are “In addition to, and not, save an
expressly provided in derogation of the Companies Act, 1956 and any other law for the
time being in force”
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 no-banking companies from accepting deposits repayable on demand
3) Prohibition of trading with a view to eliminating no-banking risks;
4) Prescription of minimum capital standards;
5) Limiting the payment of dividends;
6) Inclusion in the scope of the legislation of banks incorporated or registered outside the
provinces of India;
7) Induction of a 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) Inspection of the books and accounts of a bank by the Reserve Bank
10) Empowering the Central Government to take action against banks conducting their affairs in a
manner detrimental to the interests of the depositors;
11) Provisions to bring the Reserve Bank of India into closer touch with banking companies
Definition of Banking: Section 5(b) of the Banking Regulation Act, 1949 states that “banking”
means accepting the deposits of money from the public, for the purpose of lending or investment,
repayable on demand or otherwise, and withdrawable by cheque, order or otherwise.
Range or Forms of Banking Business allowed under the Banking Regulation Act, 1949:
(a) The borrowing, raising, or taking up of money; the lending or advancing of money either upon
or without security; and drawing making, accepting, discounting, buying, selling, collecting
and dealing in bills of exchange, bundies, promissory notes, coupons, drafts, bills of lading,
railway receipts, warrants, debentures, certificates, scripts and other instruments and securities
whether transferable or negotiable or not; the granting and issuing of letters of credit, traveler’s
cheque and circular notes; the buying, selling and dealing in bullion and specie; the buying and
selling of foreign exchange on commission, underwriting and dealing in stock, funds, shares,
debentures, debenture stock, bonds, obligations, securities and investments of all kinds; the
purchasing and selling of bonds, others; the negotiating of loans and advances; the receiving or
all kinds of bonds, scripts or valuables on deposit or for safe custody or otherwise; the
providing of safe deposit vaults; the collecting and transmitting of money and securities;
(b) Acting as agents for any Government or local authority or any other person or persons; the
carrying on of agency business of any description including the clearing and forwarding of
goods, giving of receipts and discharges and otherwise acting as an attorney on behalf of
customers, but excluding the business of a Managing or Secretary and Treasurer of a
company;
(c) Contracting for public and private loans and negotiating and issuing the same
(d) The effecting, insuring, guaranteeing, under writing, participating in managing and
carrying out of any issue, public or private, or State, municipal or other loans or of shares,
stock, debentures or debenture stock of any company, corporation or association and the
lending of money for the purpose of any such issue;
(e) Carrying on and transacting every kind of guarantee and indemnity business;
(f) Managing, selling and realizing any property which may come into the possession of the
company in satisfaction or part satisfaction or any of its claims;
(j) Establishing and supporting or aiding, in the establishment and support of associations,
institutions, funds, trusts and conveniences calculate to benefit employees or ex-employees
of the company or the dependents or connections of such persons; granting pensions an
allowances and making payments towards insurance; Subscribing to or guaranteeing
moneys for charitable or benevolent objects or for any exhibition or for any public, general
or useful object;
(k) The acquisition, construction, maintenance and alteration of any building or words
necessary or convenient for the purposes of the company;
(m) Acquiring and undertaking the whole or any part of the business of any person or company,
when such business is of a nature enumerated or described in this sub – section;
(n) Doing all such other things as are incidental or conducive to the promotion or advancement
of the business of the company;
(o) Any other form of business which the Central Government may, by notification in the
official Gazette, Specify as a form of business in which it is lawful for a banking company
to engage.
Section 8 of the Banking Regulation Act, 1949 prohibits a banking company from engaging
directly or indirectly dealing in the buying or selling or bartering of goods, except in
connection with the realization of security given to or held by it, or engage in any trade, or buy,
or sell or barter goods for others otherwise than in connection with bills of exchange received
for collection or negotiation or with such of its business as is referred to in Section 6(1)(i) i.e.
undertaking the administration of estate as executor, trustee etc.,.
Role of Reserve Bank of India (RBI) under the Banking Regulation Act, 1949.
Definition of Banker:
“Halsbury’s Laws of England states, “A banker is an individual, partnership or corporation,
whose sole or predominating business is banking, that is the receipt of money on current or
deposit account and the payment of cheques drawn by and the collection of cheques paid in by
a customer”
Money lender is not considered as banker as mere money – lending does not constitute banking
business. Banker is an institution which borrows money by accepting deposits from the public
for the purpose of lending to those who are in need of money.
Customer: According to Dr. Herbert L.Har, “A customer is one who has an account with a
baker or for whom a banker habitualioty undertakes to act as such [See Chapter 4 of Unit-1 for
detailed discussion on ‘customer’]
In view of judicial pronouncement, a customer is a person who has “some sort of an account,
either deposit or current account or some similar relation” with a banker.
Banker’s relationship with the customer is reversed as soon as the customer’s account is
overdrawn. Banker becomes creditor of the customer who has taken a loan from the banker and
continues in that capacity till the loan is repaid. As the loans and advances granted by a banker
are usually secured by the tangible assets of the borrower, the banker becomes a secured
creditor of his customer.
Though the relationship between a banker and his customer is mainly that of a debtor and
creditor, this relationship differs from similar relationship arising out of ordinary commercial
debts as the banker is a ‘privileged debtor’ in the following respects;
(1) In the case of ordinary commercial debtor, he approaches the creditor while the banker
does not approach the creditor as the creditor himself voluntarily approaches the bank and
pay his money, cheque, etc., without force, frand and obligation.
(2) In case of ordinary commercial debt, the debtor pays the amount on the specified date or
earlier or whenever creditor demands. But in case of deposit in the bank, the debtor-bank is
not bound to pay on his own account. It is necessary that the depositor must demand the
money from the bank. An express demand by a customer in writing is essential to get back
the deposit money.
(3) In the case of an ordinary commercial debt, the debtor can repay the money to the creditor
at any place, But, in case of a banking debts, the demand by the creditor must be made
only at bank. With the arrangement of ATM system in banking, now there is a facility to
draw the amount at any place.
(4) Time is not an essential element in the case of any ordinary commercial debt, whereas the
demand for repayment of a banking debt should be made only during the specified hours of
business which are statutorily laid down. A banker is liable to honour a cheque provided it
is presented during the baking hours.
(5) In the case of an ordinary commercial debt, the depositor can withdraw the amount orally
asking or by giving an acknowledgement, but in case of banking, deposits are
withdrawable by cheques, drafts, order or otherwise.
(6) The banker is able to get the deposit money without giving any security to the customer,
while it is not possible in the case of an ordinary debtor. Thus, the customer is acting only
as an unsecured creditor. It is really an enviable privilege given to the banker.
(8) Generally, the customer claims money from a bank only a part of his deposit which
depends on his necessity. But creditor generally claims entire amount from the debtor.
(9) An ordinary commercial debtor, sometimes may fail to pay back the loan to his creditor on
request, but the banker-debtor pays the amount to his creditor immediately.
(10) An ordinary debtor can close the account of his creditor at any time. But, a banker cannot
close the account of creditor at any time without getting his prior approval.
(11) The banker has the right to combine the accounts whereas the debtor has no such choice.
(12) The rate of bank interest is lessor and depends upon the policy of Government, where as
the rate of interest is higher than the bank-rate depending on the law of demand and supply
and of the risk involved.
Section 182 the Indian contract Act, 1872 defines that “An ‘agent’ is a person employed to do
any act for another, r to represent another in dealings with third person. The person for whom
such act is done, or who is so represented, is called the ‘principal’.
A person can authorize another person to do an carry on whatever acts he himself can do.
In such circumstances, the banker acts as an agent for his principal i.e customer. The Law of
Agency applies to them. The banker its an agent is bound to conduct the business of the agency
with as much skills as is generally possessed by persons engaged in similar business. The agent
is always bound to act with reasonable diligence, and to use such skills, as he possess.
The banker has to deal with an agent of his client, while dealing with agents a banker must bear
in m8ind the fowling points
3) The power delegated must be expressly stated. A general power to transact the donor’s
business does not include authority to draw, accept, endorse bills of exchange, or to borrow
money or the authority to draw does not impact an authority to endorse one.
4) If the agent has no authority to borrow, the banker allowing the account to be overdrawn
will be in difficulty as the principal would not be bound to make good the amount so
overdrawn.
5) If the agent is authorized to borrow and he pledged securities belonging to the principal
against the borrowings made, the bank acting in good faith would be entitled to hold the
securities against the entire amount advanced even if the principal’s instructions to the
agent was for lessor some.
When the agent acts if any loss results, he must make it good to his principal and if any profit
accrues, he must account for it.
In Bharat Bank Ltd., v Kashyap industries (AIR 1958 J&K 25), the plaintiff sold certain goods
to third party and sent the documents to collect amount to the defendant bank, within 10 days
after presentation of the invoice. The defendant Bank took too must time but did not explain
the reason for the delay. As a result the plaintiff was put in loss, and filed, the case. The
Supreme Court held that the defendant bank was liable to pay compensation to the plaintiff for
the loss caused due to the negligence in presenting the invoice to the third party. And also
opined the at the bank being the agent should have acted with reasonable diligence and to use
such skills as the possesses and to make compensation to his principal in respect of the direct
consequences of his own neglect.
FIDUCIARY RELATIONSHIP
Fiduciary relations are several kinds. Indeed every relationship of trust and confidence is a
fiduciary relation. And confidence is at the base of innumerable transitions of mankind.
Spiritual adviser and his devotee, doctor and patient, a woman and her confidential managing
agent, parent or guardian and child and creditor and debtor. The relationship of trust and
confidence presents a very good opportunity to the person in whom confidence is held to
exploit it to his own use. A contract between persons related is, therefore, voidable if the
consent was obtained by abusing the confidence.
If the money is paid to the bank by a customer for the purpose of effecting specific transaction
and be credit in suspense account awaiting the instructions of the customer as regards their
disposal, the amount is received by the bank in a fiduciary relation.
In Bank of India v. The Official Liquidator (AIR 1915 Bom. 375), it was held that where a bank
collects a cheque as an agent of the holder for the purpose of collecti9on, the proceeds of the
cheque are held by the bank as a trustee for the holder of the cheque. This is because where on
branch of a bank which is liable to honour a negotiable instrument, validity debits the accounts
of its own customer and transfers the money to another branch or to its head office, the
The ‘bailee’ is the party of whom personal property is delivered under a contract of bailment.
The ‘bailor is the party who bails or delivers goods to another under a contract of bailment.
Section 148 of the Indian Contract Act, 1872 states, “A bailment is the delivery of goods by
one person to another for some purpose, upon a contract that they shall, when the purpose is
accomplished, be returned or otherwise disposed of according to the directors of the person
delivering them. The person delivering the goods is called the bailor. The person to whom they
are delivered is called the bailee.
During certain occasions, a banker becomes a bailee. It happens when he receives gold
ornaments and important documents for safe custody. The banker takes charge of goods,
articles etc., as bailee and not as trustee or agent. In that case, he cannot make use of them to
his best advantage because he is bound to return the identical articles on demand. A banker
does not allow any interest on these articles. It is only the customer who has to pay rent for the
lockers. So, a banker acts as a bailee only when he receive articles for safe custody and not,
when he received money on deposit account.
Duties of the Banker as a Bailee:
1) Duty to take reasonable care of goods bailed:
2) Agreement exempting bailee bank from liability
3) Duty not to make unauthorized use of goods bailed
4) Duty not to mix bailor’s goods with his own goods
5) Duty to return the goods on the fulfillment of the purpose
6) Duty to deliver to the bailor increase or profit on goods beiled
Guarantor is one who gives a promise to answer for the payment of some debt or performance
of some duty in the case of the failure of another person, who, in the first instance, is liable to
such payment or performance. The guarantor by executing the Guarantee assures the Bank or
the holder of guarantor by executing the Guarantee assures the Bank or the holder of guarantee
that on any break of the Contract or promise or to discharge any liability by the Borrower the
guarantor would make good the same. The extent of the liability of the guarantor will be
determined by the terms of the agreement or contract of guarantee. In a contract of guarantee,
or party promise to save the other from loss caused to him by the conduct of the promisor
himself or by the conduct of any other person. Contract of guarantee may be oral or in writing.
Almost all agreements of guarantee are entered into in writing.
In a number of circumstances, a bank gives bank guarantees to its customers, through letter of
credit to provide facilities for international trade. A letter of credit is an instrument or letter
issued by a foreign exchange department of a bank indicating that the bank will honour for the
account of a buyer of merchandise drafts drawn by a seller under certain conditions laid down
in the letter. The drafts may be drawn either on the issued bank or another bank designated in
the instrument. While the ultimate liability to pay is always that of the buyer, a more
responsible third party, a bank, assumes the liability to provide the seller an assurance that the
payment will be made. The bank is willing to give such an assurance or guarantee because of
its knowledge or the confidence in the credit standing of the buyer. Similary, the bank issues
bank guarantee to facilitate inland trade also.
A bank which gives a performance guarantee must honour guarantee according to its terms. A
bank guarantee is not an indemnity. It is a peculiar type of guarantee. Under a bank guarantee
that a bank must pay regardless of the merits of the disputes between the supplier and the buyer
and the only exception to the rule has been made in cases of fraud.
In Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court Ernakulam
(AIR 1982 SC 1947 = 1982 (3) SCC 358), the Canara Bank gave a bank guarantee of
Rs.50,000 to the Maharashtra Electricity Board, Bombay on behalf of M/s.Cochin Malleables
(Pvt.) Ltd., Later, the company was liquidated after a dispute arose between them. It was
argued that the dispute arose between the Board and the company, and further it was
liquidated, therefore, the bank was not liable to pay the bank guarantee on behalf of the
company. Ht Supreme Court held that the bank was not concerned with the dispute between
the company and the Board, and it had to remit the amount of Rs.50,000 with interest to the
Board.
Negotiable Instruments:
Negotiable instruments have occupied a prominent place not only in trade and commerce but
also in public life. The term ’negotiable instrument’ literally means a written document which
creates a right in favour of some person and which is freely transferable. These instruments
have gained prominence as the principal instruments for making payments and discharging
business obligations. These instruments pass on freely from hand to hand and thus form an
integral part of the modern financial transactions.
Justice K.C.Willis states, “A negotiable instrument is one, the property in which is acquired by
any one who takes in bona fide and for value notwithstanding any defect of title in the person
from whom he tool it.”
A ‘negotiable instrument’ means a promissory note, bill of exchange or cheque payable either
to order or to bearer.
1) A negotiable instrument must be easily transferable and it may be payable either to bearer
or to order of the named payee
2) A bona fide transferee for value, subject to his complyi9ng with some other conditions,
acquires absolute and good title to the instrument even if the transferor had no title or a
defective title.
3) A holder in due course can sue on the instrument in his own name, he need not depend
upon another’s title. Nor is he under any duety to justfy his title in the first instance.
6) There must be clear and specific period of time for its payment
9) A negotiable instrument can be transferred infinitum i.e can be transferred any number of
times till its maturity
10) It must call for payment in money and money only and it should contain the sum of money
to be paid through it.
13) Sections 143 to 147 has been inserted in 2002 through an Amendment Act providing the
procedure of Courts in connection with dishonour of a chque.
The transferor cannot transfer to the transferee title better then what he himself possesses. ‘Nemo
dat quid non habet’
This privilege of the holder of a negotiable instrument in due course constitutes the main
difference between a transferable instrument or article and negotiable instrument.
According to Section 118 of the Negotiable Instruments Act, 1981, the following are the
presumptions as to Negotiable instruments unless the contrary o\is proved:
b) Every negotiable instrument bearing a date was made or drawn on such date
d) Order of Indorsements
a. Promissory Note: a promissory note contains a promise by the debtor to the creditor to
pay a certain sum of money after a certain date. Hence, it is always drawn by the
debtor. He is called the ‘maker’ of the instrument.
c. Cheque: It includes the electronic image of a truncated cheque and a cheque in the
electronic form.
CHEQUES
Definitions of Cheques:
A cheque is an order on a bank purporting to be drawn upon a deposit of funds for the
payment of a specified sum of money, on presentation, to the person named in the document,
or to him on his order or to the bearer. It is made payable instantly on demand.
A cheque is bill of exchange drawn on a specified banker and not expressed to be payable
otherwise than on demand and it includes the electronic image of a truncated cheque and a
cheque in the electronic form.
In India, all banks follow more or less a common form. They supply standard printed forms to
their customers. The customer should invariably make use of those cheque leaves and this is
one of the conditions laid down in the Pass Book supplied to the customer.
CROSSED CHEQUES
When a cheque bears across its face two parallel transverse lines on the left hand top corner, the
cheque is said to be crossed and such a cheque is called a crossed cheque. Act of 1858, laid down
that crossing was a material part of a cheque and its obligation or alteration amounted to forgery
and that, the person committing this fraud was liable to transportation for life.
Crossing of a cheque does not affect its negotiability. Holder of a crossed cheque, who has no
account in any bank, can obtain payment by endorsing it in favour of some person who has got an
account in a bank.
1) The payment does not amount to payment in due crouse. So, the paying banker will lose his
statutory protection
2) He has no right to debit his customer’s account, since, it will constitute a breach of his
customer’s mandate
3) He will be liable to the drawer for any loss, which he may suffer
4) He will be liable to the true owner of the cheque who may be a third party, irrespective of
the fact, that, there is no contract between the banker and the third party
The safest form of crossing will be a combination of “Not Negotiable” and A/c Payee” Crossings,
which give the fullest protection to a cheque.
S
Promissory Note Bill of exchange
No
There are only two parties the
There are three parties the drawer, drawee and
1) marker (Debtor) and the payee
payee
(Creditor)
It cannot be made payable to The drawer and the paye or drawee and payee
2)
the maker himself may be same person
It contains an unconditional
There is an unconditional order to the drawee
3) promise by the maker to pay to
to pay according to the drawer’s attention
the payee or his order
It does not require any It must be accepted by the drawee before
4)
acceptance presentation for payment
There is no question of
5) It can be accepted conditionally
conditional acceptance
The maker stands in The marker or drawer of an accepted bill
6) immediate relationship with stands in immediate relationship with the
the payee acceptor and the payee
The liability of the maker is The liability of the drawer is secondary and
7)
primary and absolute conditional
If it is dishonoured, no notice If it is dishonooured, due notice of dishonour
8) of dishonour is to be given to tis to be given by the holder to the drawee and
any person the intermediate indorses
If it is dishonorued, it is not
9) Foreign bills must be protested for dishonour
required to be protested
10) It cannot be drawn in sets It can be drawn in sets
There is no question of
11) It can be accepted conditionally
conditional acceptance
The maker is the debtor and he The drawer of the bill is the creditor who
12)
himself undertakes to pay directs the drawee to pay
S
Cheque Bill of Exchange
No
It may be drawn on any one, including a
1) It is always drawn on a bank
banker
It may be payable after a certain period
2) It is always payable on demand
or on demand or on sight
It is always drawn on a printed
3) It need not be drawn on a printed form
form
The drawee (banker) need not
4) Acceptance by the drawee is essential
accept a cheque
Accordingly there is no pri-vity of
5) There is no such supposition
contract between and the banker
It is always supposed to be drawn
Unreasonable delay in the presentation
6) against the funds in the hands of
will discharge the bill
the banker.
7) It is free from stamp duty. It is subject to ad valorem duty
The issue of a draft is regarded in banking practice as a purchase, the person at whose instance the
draft issued being called the purchase. A draft is issued in consideration of money received in
advance by the bank. The purchaser is required to fill up a draft application-cum-voucher, stating
the amount of the draft required, name of the payee and place of payment. He must also deposit
cash for the amount of the draft plus commission or provide a cheque in favour of the bank or an
authority to debit his account with that amount. After receipt of money, the draft is issued to the
purchased who in turn may send it to the payee.
Legal status of a Draft:
1) Banker’s Draft
It resembles to a bill of exchange or cheque. Section 85 A to the Act, which makes a specific
reference to drafts and brings them on par with bills of exchange.
For all practical purposes, the banker’s draft is considered to be a negotiable instrument, as it
resembles to a bill of exchange. The payment of a draft cannot be refused by the drawee branch
except on technical discrepancies as its consideration is already received in advance. Generally, a
banker’s draft is valid for a period of six months from the date of issue. It can be reviewed after six
months for further period of six months.
5) Purchaser can inform the bank to withhold the payement, when the draft is lost
In Thairlwall v. Great Northern Railway [(1940) 2 KB 509] the plaintiff was a share holder of the
defendant company, who sent dividend warrant to the plaintiff by post. It was missed. The
company requested the plaintiff to send indemnity bond. The plaintiff refused to do and sued the
company. The question arose before the Court that whether a dividend warrant would be a
Postal orders and money orders are not negotiable instruments. Generally banks do not entertain
the post orders and do not collect such instruments for their customers. The reason is that if the
order proves to have been stolen, the banker would be liable in an action for conversion. The
statutory protection which is available to bills of exchange, cheques, drafts, etc., could not be
available to him in case of postal orders.
TRAVELER’S CHEQUES
“Traveler’s cheques bear a striking resemblance to circular notes, with the exception that they do
not require any letter of indication. Like the circular notes, they are generally drawn for certain
round sums and are cashed at the current exchange rate. At the time of the issue of a traveler’s
cheque, its holder signs it at the place appoi9nted for the purpose and he has only to sign it again in
the presence of the banker to whom he presents it for payment. This signature must correspond
with the signature already on the cheque, which serves to identify the holder.”
When a person wants to travel without taking the risk of carrying cash with him. He may avail of
the facility of traveler’s chaeque. Traveller’s cheques are issued in different denominations mainly
for the convenience of travellors. A person may purchase any number of traveller’s cheques
irrespective of the fact that he has a bank account or not.
A traveler’s cheque can be enchased at any office of the issuing bank and at any other place with
arrangements viz. hotels, petrol pumps, showrooms, departmental store, etc.,
There is no time limitation to utilize the traveller’s cheques. As long as it is not countersigned, the
cheque can be kept with the purchaser for a long time. He may keep left over cheques for future
trips and unexpected expenses.
In the modern age, with the computerisation of banks, the facility of traveller’s cheque has become
unattractive due to ATM facility provided by the commercial banks. Some banks have since
discontinued traveller’s cheque scheme. Traveller’s cheque is one of the negotiable instruments.
CIRCULAR NOTES
‘Circular notes’ are instruments which are somewhat similar to letters of credit. They are issued by
banks to persons about to travel abroad to obviate carrying large sums with the person. A circular
note is a request in writing by a bank to its correspondents abroad to pay up a specified sum to a
specified person.
PAYING BANKER
The banker upon whom duty to pay the amount of the Cheque is imposied, is called the paying
banker. The paying banker to whom the order to pay, where the order takes the form of a cheque,
is addressed when a person opens an account with a particular branch of bank, the contractual
relationship of banker and the customer starts. The relationship is mutual and contractual nature,
and is effected by legal obligation from both sides. The customer deposits amount, deposits
cheques with his banker. Whenever he needs, draws such amount or issue cheques to other
persons. It is the obligations of the bank to honour such cheque. If it is presented in the proper
form, in working hours, at a proper place. The drawee of a cheque is always paying banker.
The obligation of paying bank money to his customer or his indorsee is not absolute but
conditional.
Circumstances under which duty of paying Banker to honour cheque can be enforced:
1. A banker is bound to honour his customer’s cheques, to the extent of the funds available
and the existence of no legal bar to payment
The paying banker should use reasonable care and diligence in paying a cheque, so as to abstain
from any action likely to damage his customer’s credit. If the paying banker wrongfully dishonours
a cheque, he will be asked to pay heavy damages. At the same times, if he makes payments in a
hurry, even when there is no sufficient balance, the banker will not be allowed to debit the
customer’s account. If he does so, it will amount to sanctioning of overdraft without prior
arrangement. Later on, the customer can claim it as a precedent and compel the banker to pay
cheques even in the absence of sufficient balance. His position is very precarious and he is in
between the devil and deep sea.
Precautions to be taken by the banks:
1. He must see whether there is any order of the customer not be pay a cheque.
2. He must see whether there is any evidence of misappropriation of money. If so, the cheque
should be returned e.g breach of trust.
Supposing, a paying banker pas a cheque which bears a forged signature of the payee or
endorsee, he is liable to the true owner of the cheque. But, it is quite unjustifiable to make the
banker responsible for such errors. It is so because, he is not expected to know the signature of
the payee or endorsee.
Therefore, law relives the paying banker from his liability to the true owern in such cases. This,
relief given by the legislature is know as ‘statutory protection’.
Protection to the paying banker in case of order cheque (i.e when cheque drawn payable to
order and bearing endorsement)
Statutory protection has been extended to an order cheque. Example of an order cheque is “pay to
X or order”. Even if makes payment of an order cheque with forged endorsement becaue the
bankers is not expected to verify the signatures of each and every endorser.
Two conditions must be fulfilled by the paying banker. They are: (a) Payment must made in due
course and (b) the endorsement must be regular
“Payment in due course means payment in accordance with the apparent tenor of the instrument in
good faith and without negligence to any person in possession thereof under circumstances which
do not afford a reasonable ground for relieving that he is not entitled to receive payment of the
amount therein mentioned”
C) Protection for drafts drawn by one office of a bank on another office of same bank:
Protection has been extended to drafts drawn by one office of bank on another office of the same
bank by inserting Section 85-A through the Negotiable Instrument (Amendment) Act, 1930 which
provides that: “ Where any draft, that is an order to pay money, drawn by one office of a bank
upon another office of the same bank for a sum of money payable to order on demand, purports to
be indorsed by or on behalf of the payee, the bank is discharged by payment in due course”
When the paying banker also acts as the collecting banker he cannot claim the protection which
would be denied to the collecting banker on the ground of negligence
Though drafts drawn by one office of a bank on another office of the same bank are not negotiable
instruments at all, in view of the wordings of Section 85-A an 131-A the Negotiable Instruments
Act, 1881, they are to be treated for the purpose of protection of the bank as a cheque.
D) Protection in case of Forgery: If the cheque is forged with the signature of customer, the
paying banker should refuse to honour.
E) Statutory Protection to the paying banker when payment is made by mistake (one man’s
cheque into another man’s account and for double payment). Money paid by mistake is
recoverable in the following circumstances
FORGERY
Forgery is the false making or materially altering with intent to defraud, of any writing which if
genuine, might apparently be of legal efficacy, or the foundation of a legal liability.
Forgery is the fraudulent making or alteration of any record, deed, writing, instrument, register,
stamp, etc., to the prejudice of another mans’ right.
Section 463 of the Indian Penal Code, 1860 defines forgery as under: “ Whoever makes any false
documents or false electronic record or part of a document or electronic record, with intent to
cause damage or injury, to the public or to any person, or to support any claim or title, or to cause
any person to part with property or to tender into any express or implied contract, or with intent to
commit fraud or that fraud may be committed, commits forgery.
(a) Forgery of Drawer’s signature: The paying banker must see that the cheque is really an order
of his customer, since he is only bound to pay his customer’s money with his authority.
If the drawer’s signature on a cheque differs from the specimen signature supplies to him, he
should no honour it. There are various instances of forgeries of signatures in India. In some
Government departments, cheques were issued to fictitious contractors by forgiving the
signatures of various cheques issusing authorities of the department. In another case, the
banker stolen a passbook of a client and withdrawn the money by using withdrawal slips over a
period and exhausted the bank balance.
(b) Detecting of forged cheques: There are always natural variations in the hand writing of an
individual and there are fundamental variouans in the hand writing of two persons. The banker
should check the cheque under the instruments with the strong light and a magnifier if he gets
doubt about the genuineness of the signature of the drawer.
(c) Protection against forgery: Section 85(2) of the Negotiable Instruments Act, 1881, gives
protection only when the payee or endorsee’s signature is forged and the banker makes
payment in due course. Every banker is expected to know the signature of his own customers.
Hence, he cannot even think of claiming protection in the case of forged endorsement of the
drawer.
A forgery is nullity. A forged cheque as a nullity and the banker must bear the loss. However,
if the customer by his conduct enables the forgery of his signature, then, the paying banker is
relieved from his liability. Whether the customer has enabled the forgery or not depends upon
the circumstances of the case.
However, the banker has a remedy against the forger. He can recover the whole of the amount
from the forger as money paid under a mistake of fact. It is, therefore, the duty of the customer,
when he learns of his forgery of his signature, to inform the banker so that the banker may take
action against the forger.
STATUTORY PROTECTION TO COLLECTING BANKER
Collecting banker – Meaning:- A banker who collects cheques, bills of exchange and other
instruments on behalf of a customer is know as a collecting banker. A banker is under no legal
obligation to collect cheques drawn upon other banks for a customer. But every banker acts
both as paying as well as a collecting banker. A large part of collecting cheques is carried on
through the bankers’ clearing houses. While collecting his customer’s cheques, a banker acts
either (i) as a holder for value, or (ii) as an agent of the customer.
(a) Collecting banker as holder for value: When a collecting banker pays to the customer the
amount of the cheque or credit such amount to his account and allows him to draw it, before
the amount of the cheques in fact realized from the drawee banker, the collecting banker will
be known as holder for value of the cheque. The customer in such case is obliged to reimburse
the banker if the cheque is dishonoured.
(b) Banker as an agent: A collecting banker acts as an agent to a principal, who is his customer.
The agent is always bound to act with reasonable diligence, and to use such skill as he
possesses.
The banker thus acts as on agent of the customer and charges from him a commission for
collecting the amount from outstation banks. As an agent of the customer. He does not possess
title to the cheque better than that of the customer. If the customer’s title is defective, the
collecting banker cannot have good title to the cheque.
The onus of proof that he was not negligent in collecting the cheque lies on the banker himself.
Payment of interest for delay in collection of outstation cheques. If the collecting banker
presents a cheque before the drawee bank with undue delay on his part and the cheque is
dishonoured, the collecting banker will be liable to reimburse the loss suffered by his
customer. If the drawer of the cheque himself becomes insolvent during the period the
cheque remains with the collecting banker, the latter is liable to reimburse his customer. If
the banker does not employ the normal and usual channel of collection of cheque and
thereby payment is received with dlay and the meanwhile a cheque drawn by the customer
is dishonoured, the customer will be entitled to recdover damages from the collecting
banker.
Meaning of Lien: According to Halsburry, ‘lien’ may be defined as “a right in one man to retian
that which is in his possession belonging to another, until certain demands of the person in
possession are satisfied.
A lien may be defined as a charge on property for the payment of a debt or duty, and for which it
may be sold in discharge of the lien. A lien, in a limited and technical sense, signifies the right by
which a person in possession of personal property holds and retains it against the owner in
satisfaction of a demand due to the party retaining it; but in its more extensive meaning and
common acceptation it is understood and used to denote a legal claim or charge on property, either
real or personal, as security for the payment of some debt or obligation; it is not strictly a right in
or right to the thing itself but more properly constitutes a charge or security thereon. Lien gives to
a person only a right to retain the possession of the goods and not the power to sell unless such a
right expressly conferr3ed by statute or by custom or usage. It is only a personal right to hold the
goods of another until a debt is paid and continues so long as the possessor of the right holds the
goods.
Kinds of Lien: There are two types of lien rights, namely (i) special lien or particular lien; and
(ii) general lien. A general lien is the right to retain the property for a general balance of accounts.
A particular lien is a right to retain property for a charge on account of labour employed or express
bestowed upon the identical property detained.
Particular lien or specific lien: It is attached to some specific goods. It is a right to retain
possession over those particular goods in connection with which the debt arose.
For example, a tailor has the right to retain the clothes made by him for his customer until his
tailoring charges are paid by the customer.
Other particular liens are: (i) lien of finder of goods (Section 168 of the Contract Act), Pawnees’s
or pledger’s lien (Section 173 & 174 of the Contract Act), (ii) Agents lien (Section 221 of the
Contract Act), (iii) Unpaid seller’s lien (Section 47 of the Sale of goods Act, 1930) and (iv)
Partner’s lien (Section 52 of Partnership Act, 1932).
General lien (Banker’s General Lien): A general lien entitles a person to retain possession of
goods belonging to another for a general balance of account. It will entitle a person in possession
of the goods to retain them until all claims or accounts of the person in possession against the
owern of the goods are satisfied. A banker is entitled to a general lien. A banker can retain all
securities etc., it his possession till all its claims against the concerned person are satisfied. It is
said that a Banker’s lien is paramount.
Section 171 of the Contract Act, 1872 states, “Bankers, factors, wharfingers, attorneys of a High
Court and policy-brokers may, in the absence of a contract to the contrary, retain, as a security for
a general balance of accounts nay goods bailed to them; but no other person have a right to retain,
as a security for such balance, goods bailed to them, unless there is an express contract to that
effect”.
If a customer has different accounts with a bank, the bank has a right to combine the two accounts
for the purpose of general lines. For instance, if money is due from the customer on loan account
The money once deposited belongs to the bank and the bank is its owner. The bank is the debtor of
the money deposited, which has to be repaid. The bank cannot exercise lien over money under
Section 171, Section 171 is confined to lien on papers, securities and other goods deposited with
the bank.
As the general lien of the bank is recognized statutorily, no separate contract or agreement is
required for this purpose. As a precautionary measure, however, banks obtain ‘letter of lien’ from
the customer, stating that goods and securities are entrusted to the banker as security for the
existing and future advances and authorizing the bank to sell them in case of default on the part of
the customer. The letter spells out the object of the entrustment of the goods and securities to the
banker so that the same may not be denied by the customer later on.
A banker’s lien is more than general line. A general lien does not, as a rule, carry with it a right to
dispose of the property. The general lien of a banker has been described as an implied pledge and
for this reason he is generally regarded as having power to sell securities over which he has a lien.
The power to sell can only be exercised by the banker when a customer has reasonable notice of
the banker’s intentions.
The banker’s right of lien is not barred by the Law of the effect of the Limitation Act is only to bar
the remedy and not to discharge the debt. Consequently, it does not affect the property over which
the banker has a lien.
1) The banker is empowered to retain the securities of a customer regarding his balance of
amount due on the customer.
2) The ownership of the securities is not transferred from the customer to the banker
3) The banker gets the right to retain the securities handed over to him in his capacity as a
banker.
4) The banker’s lien tantamount to an implies pledge and the banker becomes entiled in
certain circumstances to sell the securities
5) The right of the lien can be exercised on goods or other securities standing in the name
of the borrower only and not jointly with others
6) The banker can exercise his right of lien on the securities remaining in his possession
after the loan, for which they were lodged, is paid by the customer, if not contract to the
contract exists.
7) The right of lien is conferred upon the banker by the Contract Act. No separate
agreement or contract is, therefore, necessary for this purpose.
8) The banker’s right to lien can not be exercised if the goods and securities have been
entrusted to the banker as a trustee or an agent of the customer; and a contract – express
or implies – exists between the customer and the banker which is inconsistent with the
Exception to the Right of Banker’s General Lien: The right of lien cannot be exercised in
the following circumstances.
1. The banker cannot exercise his right of general lien on safe custody deposits.
2. If a customer sends a bill of exchange or any other document with the specified instruction
to utilize its proceeds for any specific purpose, a contract inconsistent with the right of lien
is presumed to exist.
3. The banker does not possess the right of lien on the document or valuables left in his
possession by the customer by mistake or by negligence. A banker can exercise lien on
property or valuable which have come into his hands, in the ordinary course of day to day
business.
4. The banker cannot exercise his right of lien over the securities, lodged with him for
securing a loan, before such loan is actually granted to him
5. The banker cannot exercise his right of general lien over the securities deposited by the
customer as a trustee in respect of his person loan.
6. Banker does not possess the right of license on money deposited as money deposited in the
bank and the credit balance in the account do not fall in the category of goods and
securities.
Negative Lien: In order to protect their interests, banks usually obtain an undertaking from the
borrower declaring that assets (eg. Land, building, machinery, stocks, outstandings etc.,) are free
from encumbrances and the he will not create any charge or encumbrances on any of these assets
in favour of third parties without obtaining the bank’s prior consent in writing so long as the loan/
advance continues. This undertaking is called negative lien.
Set off: The contract between the banker and his customer is a contract between a debtor and a
creditor. The contract implies a promise by the banker to repay the money lend to him by the
customer. Where, however, a customer has an account which is in credit but owes money to the
banker in respect of another account, the banker has a right to reduce the amount which the
customer owes to him, by the credit balance in the customer’s account. This is known as the
banker’s right of set-off or of combining accounts. There banker may exercise the right of set-off
only when the money owed to him is a sum certain, which is due, and where there is not
agreement, express or implied, to the contrary.
A banker, like other debtors, possesses this right of set-off which enables him to combine two
accounts in the name of the same customer and to adjust the debit balance in one account with the
credit balance in the other. To be on the safe side, the banker takes a letter of set-off from the
customer authorizing the banker to exercise the right of set-off without giving him any notice.
A claim by a person in a representative capacity cannot be set off against a personal claim. Thus,
as a trustee of B, A owes to banker Rs.3000, no set off can be claimed by the banker. The right of
set0-off can be exercised subject to the fulfillment of the following conditions;
Subject-matter of set-off:
1) The right of set-off can be exercised only in respect of debts i.e the credit balances held in
the accounts of the customers
2) In the case of time deposit receipts, a balance may apply them towards the debts due to him
by the customer, when they become due.
3) The overdraft on the private account of a customer cannot be set off against credit balance
in such accounts as, “Clients’ Account” because the title of the account indicates that the
money is held in trust for the clients and as such is not in the same right
5) A creditor cannot set off a debt owed by him to or more debtors jointly against a debt
owned to him by one of the joint debtors because in such a situation the debts are not due in
the same right. The credit balance held in the joint account cannot be set off against the
overdraft allowed to one of them singly.
6) The credit balance held in a partnership account cannot be set off against personal overdraft
of a partner. However, the balance held in a partner’s private account can be set off by the
banks against the overdraft in the firm’s account
7) The right of set off can be exercised only in respect of debts due and determined and not
for the customer’s contingent liability, such as that under a guarantee to a banker. Bust
once the guarantor’s liability crystallizes and a notice of demand is served on him, the
banker can exercise the right of set-off
8) The right of set-off is not available to the bank in case where the customer has earmarked
the funds for a specific purpose. Where the customer pays in money to meet a particular
cheque and the bank accepts it, the latter cannot apply the money in reduction of the
overdraft and dishonour the cheque when presented.
9) The right of set-off can be exercised even though the remedy to recover the debt by filing a
suit may have been time-barred by the Law of Limitation
10) A banker’s right of set-of cannot be exercised after the money in his hands has been validly
assigned or in any case after he has been notified of the fact of an assignment.
11) The right to set-off can be invoked where there have been mutual dealings between an
insolvent customer and the banker
Classification of Loans and Advances (/Secured and Unsecured Loans): The loans and advances
granted by banks are broadly classified into (i) secured; and (ii) unsecured advances
Principles that guide the banks in granting loans and advances to a customer: The main
business of a banking company is to receive deposits and lend money. Receiving deposit involves
no risk, since it is the banker who owes a duty to repay the deposit, whenever it is demanded. On
the other hand, lending always involves much risk because there is no certainty of repayment. A
banker shall be very cautious in lending, because he is not lending money out of his own capital. A
major portion of the money lent comes from the deposits received from the public. These deposits
are mostly repayable on demand. Hence, while lending money, a banker should follow a very
cautious policy.
(a) Main principles of sound lending: Banks lend money to their customers and non-customers
also. They have to look at and examine the trustworthiness of the borrowers to return the
money with interest. In order that the money of the bank which is being advanced may not be
lost, the banker has to take into his consideration the fundamental principles of sound lending.
These are mainly the following:
i. Safety: The term ‘safety’ means that the borrower is in a position to repay the loan, along
with interest, according to the terms of the loan contract. The repayment of borrowers in
turn depends upon the borrower’s (i) capacity to pay, (ii) willingness to repay; (iii) the
collateral security offered. The capacity to pay the borrower depends upon his tangible
assts and the success of his business; If he is successful in his efforts, he earns profits and
can repay the loan promptly. Otherwise, the loan is recovered from out of the sale
proceeds of his other tangible assets. The willingness to pay depends upon the honesty
and character of the borrower. The banker should see that the business for which the loan
is being granted is a sound one and the borrower is capable of carrying out it
successfully. The borrower should be a person of integrity, good character and reputation.
The security given of tangible assets of the borrower must be worthwhile for recovery of
the loan amount.
ii. Liquidity: The nature of assets owned by the borrower and pledged with the banker is to
be carefully examined. Goods and commodities which are easily marketable are to be
preferred to the landed properties which take time to be sold or auctionable and even that
may bring loss of worthwhile proceeds.
iii. Profitability: Banks advances loans to earn profits by way of interest thereon. But the bank can
charge interest according to the directions of the Reserve Bank of India, issued from time to
time.
iv. Loan purpose: Nationalisation of Banks in 1969 has diverted the funds of the banks for loans to
be given to small entrepreneurs, small each industries, agriculture, and small scale industries
allied to agriculture. The banks have begun to give loans to start such small trades in order to
lessen the unemployment problem.
vi. Technical competence: The proprietor/ partner should be technically qualified person or they
should have practical experience in the concerned line of activity. This is necessary so as to
ensure that the entrepreneur would be able to manufacture the item of good quality to withstand
competition in the market.
vii. Managerial ability: The entrepreneur should have business acumen to manage the affairs of the
unit in a coordinated manner. He should be able to maintain an uninterrupted production
schedule and handle labour, financial and other matters effectively.
viii. Security: No banker sees the horoscope of a customer and lends. He calculates his lending risk
and led. To minimize the chances of risk, security should be insisted. The security must be
adequate, easily realizable and free from encumbrances. Where principal security is deemed as
highly fluctuating or not conveniently controllable, a supporting security may be asked by the
bank e.g., equitable mortgage, of the property owned by the proprietors, if any, or a third party
guarantee.
ix. Assured repayment (Economic Viability): A banker should come forward to lend only when
the repayment is assured. The project should be an economically viable one. The unit must
generate surplus cash sufficient to repay the loan installments in time.
x. Marketability: The market demand of the product is an important factor. Unless the product is
profitably sold, the unit will not be in a position to function smoothly.
xi. Social objectives: While making advances the banker should give the highest priority to the
national interest. Today banks have a strong social objective and social conscience. It is the
responsibility of each and every bank to ensure that the bank credit flows smoothly to the
neglected sectors of the economy and to the under privileged sectors of the society. Towards this
end in view, banks have given up their ‘security-oriented lending’ and have taken up ‘need-based
loans’ or ‘productivity-oriented lending’ and have taken up short term loans to primary sector
and small scale sector.
xii. Quantum of finance: The banker should give a loan/ advances which is an approximate
requirement of the unit after taking into consideration the following points;
It is essential that an object assessment of the borrower’s requirement is made and financial
assistance provided accordingly
xiii. Law of Limitation and Advances: Limitation means the period of time allowed by the statute
within which a legal remedy for the infringement of a right must be taken in a Court of Law.
The period of limitation, for filing a suit on a promissory note payable on demand, is three years
from the date of the execution of promissory note and not from the date of demand irrespective
of the fact whether the promissory note is accompanied by an agreement of hypothecation/
pledge or not. In the case of a usance promissory note, it is three years from the due date. If the
customer is in debit in respect of an overdraft current account (i.e. where a temporary overdraft is
created), the period of limitation is three years from the date of overdraft
Where the bank on the basis of a personal covenant intends to enforce the personal liability of
the mortgage, the period is three years from the date of execution of the mortgage deed or the
date of default as the case may be. A mortgagee may institute a suit for foreclosure within thirty
years from the date of the money secured by the mortgage becomes due.
xiv. Limitation bars remedy, but does not destroy right: The Limitation Act bars the remedy, but
does not destroy the right which the remedy relates to the right to the debt continues to exist,
notwithstanding the remedy is barred by limitation. When the principal debtor did not repay the
bank loan, the bank as creditor can adjust it at maturity of the Fixed Deposit Receipt deposited
by the guarantor with the bank as security, through the debt becomes barred by limitation at the
time of maturity of the said Fixed Deposit Receipt.
Characteristics of Tangible Security: The word “MAST” signified the basic qualities which a
good tangible security should possess from the view point of a lending bank. The word ‘MAST’
denotes;
a) Marketability: to realize the debt by its disposal if the borrower commits a default
b) Ascertainability: to ascertain the value easily
c) Stability: Not to prone to wide fluctuations
d) Transferability: to give the possession to others easily
A pledge consists of a delivery of goods by a debtor to his creditor to be held until debtor’s
obligation is discharged, and then to be delivered to the pledgor, the title not being changed during
the continuance of the pledge.
This method of charging is suitable to movable properties such as goods, documents of title to
goods, stock exchange securities, etc.,
Essential features of a Pledge: To constitute a valid pledge, the following conditions must have
been fulfilled:
Delivery of documents of title which would enable the pledge to obtain possession, is
equally effective to create a pledge. The documents which generally fall into this category
are bills of lading, dock warrant, railway receipts, warehouse-keeper’s transferable receipts
etc.,
2) Transfer of possession of goods: Under pledge, the pledger transfers only the possession
of goods subject to a charge, and not the legal owenership to the goods
3) Existing goods only: A pledge can be created only in respect of existing goods, which are
in the possession of the pledge. There cannot be any bailment of future goods
4) Right of sale: The most important feature of pledge is that the pledge has a right to sell the
security, in case, the pledger fails to repay the loan within the specified period. The pledge
can exercise this right, only after giving a reasonable period of notice.
5) Agreement: An agreement in writing between the pledge and the pledge for creating a
charge is essential, though not necessary. An agreement of pledge may also be implied, in
some cases, depending upon the circumstances of the case. However, it is advisable to have
to have the agreement in writing.
6) Right of lien: so long as the loan together with the accrued interest thereon is not paid, the
pledgee has a right to restrain the possession of the goods pledged. No other creditor of the
pledger has any right to take away the goods from the pledge, before the loan due to him is
paid In case, the pledge incurs any extraordinary expenses to preserve the pledged property,
he cannot exercise lien on the property for the amount due as extraordinary expense. He
can only sue the pleger recover the amount.
Pledge and bailment: A pledge is only a special kind of bailment and (he chief basis of distinction
is the object of the contract. Where the object of the delivery of goods is not provide a security for
a loan or for the fulfillment of an obligation, that kind of bailment is called ‘pledge’
i. The banker should ensure that the pledger is the real owner of the pledged goods. A valid
pledge can be created only by the owner of goods or merchantile agents in possession of
goods or any other pledge
ii. The peldgee banker must take a reasonable care of the pledged goods, in such a way that,
an ordinary prudent man would take of his own goods
iii. The banker should exercise full control over the pledged property. For this purpose, he
must make periodical inspections and check the goods. It would prevent the creation of
any subsequent pledge in respect of the same goods
iv. The banker shall not make any unauthorized use of the pledged property. If he does so,
the pledger has every right to terminate the contract and to claim changes for the
unauthorized use.
v. The banker should put up a signboard at the place, where the goods are kept, prominently
showing that the goods are pledged to the banker. It goods
vi. The banker must carefully draft the agreement, while creating a charge by way of pledge.
The contract of pledge must be complete in all respects and it must incorporate all safety
clauses from the banker’s point of view. He must also check whether the parties are
competent to enter into the contract of pledge.
Advances against mortgage of property (land) are not self-liquidating in nature and rather expose a
lending banker to a number of difficulties and problems on its disposal in case of default. Banks
usually do not prefer to advance money on the security of immovable properties or real estates e.g.
land, building etc. on account of the following reasons;
1) A banker has to spend sufficient time and money to verify the title of the borrower to the
property he is offering as security. This is due to possibility of multiplicity of mortgages,
absence of proper records particular in case of agricultural loans etc.,
2) It is very difficult to value land and buildings, since, there is not standard basis for its
valuation. In valuing a real estate, one has to take into account many factors like its
location, size, materials used in the construction, amenities provided. The banker has to
depend upon the valuation reports of valuers and architects which may differ from person
to person.
3) The laws governing immovable properties are very complicated and not easily understood
by bankers. Varity of soils, tenures of land existing in our country and various laws and
customs relating to succession and transfer of property are impediments in allowing loans
and advances against them.
4) In the case of agricultural lands, up-to-date and proper lands records are not available.
According to the Royatwari system, the land becomes the property of the tiller after a
certain period. Similarly, the Land Ceiling Act permits a person to own lands upto a certain
limit only. All these factors have made the agricultural lands as a worthless security
5) Properties are not readily realizable. First of all, searching out a buyer is a problem,
Secondly, the banker has to undergo several formalities before the sale of the mortgaged
property actually takes place and it also involves a considerable time which may be several
months and sometimes even several years.
6) Creation of legal mortgage of land involves heavy expenses
2) Tenures of Land: The tenures of land may be freehold, leasehold or state-owned. The
freehold tenure vests absolute ownership rights in the owner/ purchaser who is, of course,
liable to pay rates, takes and assessment of Government and local authorities. While
accepting leasehold land as security, it is essential to examine the terms and conditions
contained in the original lease deed in favour of borrower. There should be no onerous
condition in the lease-deed which might affect the bank’s rights as mortgagee. The latest
ground rent receipt should be obtained from the borrower so as to ensure that the rent is not
in arrears and that the lease continues to subsist. The unexpired period of lease should be
sufficient to cover the repayment period of loan.
The holder of the State-owned land is entitled to merely occupancy rights because the
ownership of such a land exclusively vests either in the Central or State Government.
Certain occupancy rights may be heritable and assignable while other may not be. Such
land may be mortgaged by the occupants in favour of the bank if permitted under the
relevant State laws.
3) Tax and Rent payments: While accepting an urban property as security, the receipts for
the payment of house tax and other taxes should be obtained and kept along with title
deeds. It should be ensured that the payment of land revenue and other Government dues,
taxes, ground rents, etc., due on the property, is regularly made.
4) Payment of Income Tax: In case the value of the mortgaged property exceeds Rs.50,000/-,
a certificate from the Income Tax Officer should have been obtained stating that there are
5) Financial soundness of the borrower: A prudent banker always scrutinises the financial
soundness of the borrower and the viability of his business enterprise for which a loan is to
be advanced.
6) Valuation of the property: The value of the property is generally estimated by the bank’s
qualified valuers by personally inspecting the property and making enquiries through
brokers and neighbours etc. The value depends upon several factors such as:
7) First mortgage: In all cases, the banker must secure the first mortgage on the property. It
is so because, a second and subsequent mortgages rank only next to the first one.
Moreover, title deeds to property will not be available to the second and subsequent
mortgagee. However, if he were compelled immediately, so that, he may not extend further
loans and the documents can be handed over to the banker as soon his loan is repaid.
9) Registration of charge: Loans and advances made to joint stock companies against
immovable properties require registration of charge under Section 125 of the Companies
Act, 1956 within a period of thirty days from the date of its creation.
10) Adequate Insurance: The bank should also see that the property is inured against fire and
other natural calamities. The property should be insured to its total value. Again, the policy
must be endorsed in favour of the bank. The policy must be renewed regardless at the
borrower’s expenses, till the loan is repaid.
The word ‘share’ ordinarily means a part or definite portion of a thing owned by a number of
persons in common. A ‘share’ in relation to a company is not a sum of money, but represents an
interest measured by a sum of money and made up of diverse rights contained in the contract
evidenced by the articles of company along some obligations”
1. Government securities issued by the Central and State Governments like loan bonds,
Treasury Bills etc.,
2. Securities like debentures and bonds issued by the semi-Government organization such as
port trust, electricity boards, municipalities etc.,
3. Shares and debentures issued by joint stock companies
Stock: The Government securities may be in the form of stock. A stock is a certificate to the effect
that the person named therein (i.e the holder) has been registered in the books of the Public Debt
Office as the also specified the rate of interest and the date from which the interest is payable. It is
not transferable by endorsement. The holder of a stock certificate can transfer the ownership by
executing a regular transfer deed which is printed on the reverse of it. The title to the stock
certificate passes upon completion of the transfer deed and registration of the transferee’s name in
the Public Debt Office. After completing these formalities the Public Debt Office issued a fresh
certificate in the name of the transferee.
Advances against stock certificate are allowed only after they are transferred in the bank’s name in
the books of the Public Debt Office. Since no endorsement are allowed on the certificate itself, a
stock certificate affords complete protection against loss by theft etc. The transfer of a stock
certificate does not involve any cost as it is exempt from stamp duty. Alternatively, the borrower
should be asked to have the certificates converted into Government Promissory Notes which
should be endorsed in favour of the bank. Such conversion is permissible under the rules.
Shares of Joint-Stock Companies: The capital of companies is raised by issue of shares of fixed
denominations. The Companies Act permits only two kinds of shares to be issued viz., equity
shares and preference shares.
a) The preference shares are those shares which fulfill the following two conditions:
a. During the continuance of the company theyi must be assured of preferential
dividend. In other words, they carry a preferential right of dividend at a fixed rate;
and
b. On the winding-i[ of the company, they carry a preferential right to be paid back
b) Equity shares are those which are not preference shares. Banks grant advance against those
shares which have ready market. If the shares of a company are dealt with at a stock
exchange, obviously they have got ready market and such shares are known as “quoted
shares”. Thus, banks allow advance against quoted shares only. Generally speaking, banks
do not grant advances against shares of private limited companies because:
Debentures: When a company takes a loan and issues a loan certificate, that certificate is called a
debenture. Debenture is a document issued by a company which creates or acknowledges a debt
owed by the company. A fixed rate of interest is payable on debentures either at stipulated periods
or on maturity thereof. Debentures may be redeemable debentures i.e the company has a right to
pay back the debenture-holders at a fixed future date or irredeemable debentures or perpetual
debentures without fixing a date of payment or convertible debentures which can be converted into
Precautions should be taken into account while taking the life insurance policies as
securities due to the following drawbacks of the policies:
2. All insurance contracts are contracts of uberimae fidel i.e maintenance of utmost
good faith. It means, that the assured should have disclosed all material facts
affecting his life, at the time of taking out a policy. Otherwise, the policy would
become void. A banker cannot find whether the insured has disclosed all material
facts or not.
3. One of the essential conditions of a life insurance contract is that, there must be
insurable interest at the time of taking out a policy. Otherwise, the contract would
become void. It is a kind of pecuniary interest that must exist. It is difficult to find
out its existence especially when a policy is taken on the life of another individual.
4. Sometimes, a policy may contain some onerous clauses like ‘suicide clause’. This
clause provides that, if the assured commits suicide within a certain period after
taking out the policy, the policy would become void.
5. There is a clause for the borrower to obtain a duplicate policy from the company
stating that he has lost his original policy. This duplicate can be given as a security
and loan can be obtained from another bank. Thus, there is a possibility for double
financing.
6. The insurance company may repudiate the claim, particularly during the first two
years of the policy, under the provision contained in Section 45 of the Insurance
Act.
The document of title of goods are those documents which are drawn against goods. Hence, these
documents actually represent goods. The delivery of these documents actually amounts to a
symbolic delivery of goods represented by them.
Bankers find it more easy to deal with these documents than physically dealing with goods. Hence,
these documents are very popular among banks.
Documents which in the ordinary course of trade, are regarded as proof of the possession or
control of the goods, are called documents of title. They authorize the holder, therefore, to transfer
or receive goods which are mentioned therein. It is presumed that the holder of document of title
shall have the right to claim possession of goods from every other person. If a banker has received
a document of title of goods duly endorsed in his favour, he will have legal title to the goods
represented by such document and such goods ill be taken out of the order and deposition of the
insolvent.
The transferee of a document of title to goods does not get a better title than what the transferor
himself possesses. In other words, the transferee of such a document derives his title to the goods
subject to defects, if any, that existing in the title of the transferor (i.e. the borrower)
Advantage of Document of Title to goods: Since the documents of title of goods are drawn
against goods, they simply represent goods. Hence, all the advantages of goods are automatically
applicable. Besides, the following additional advantages are available.
It can be handled very conveniently. The person, who is in possession of this document,
can transfer the goods to any person by mere endorsement and delivery without the
necessity of any physical transfer of goods
Granting of advances against documents of title involve the following risks in addition to the risks
involved in case of advances against goods.
1) The borrower, on one hand, may pledge the documents of title with the bank and on the
other hand, manage to obtain the delivery of goods on the basis of indemnity bond or
some other device. Thus, the banker’s risk increases
2) On account of the non-negotiability nature of the documents of title, the title of the
transferee will not be better than that of the transferor
3) The transporter issuing a railway receipt or bill of lading certificates that the goods have
been received by him but he does not certify the contents or quality of the packages
delivered to him. This increases the chances of fraud being played
4) In case of the endorsement on the document happens to be a forged one, the bankers
cannot get any right of ownership to the goods covered by that document, since, the rule
is “forgery conveys not title”
5) Under the Sale of Goods Act, the unpaid vendor has a right to stop goods in transit,
provided, the buyer has become insolvent and the goods have not yet been delivered to
him. In such a case, the banker cannot take delivery of the goods by producing the
document and his security is lost.
6) Dishonest persons can easily alter the number of packages given on the document and
their values. Thus they may try to get more credit limits by manipulating the documents
BANK GUARANTEE
Guarantee – Meaning: A Guarantee is the most common form of security taken by bankers to
ensure safety of funds lent. A guarantee is the personal security of the third person, who should be
a man of worth and enjoy the confidence of the banker. The guarantor should possess assets,
preferably land and buildings which should be sufficient enough to cover the amount of loan.
Specific guarantee: A guarantee may be given for a single debt. Such a debt is called a ‘specific
guarantee’ and is discharged on repayment of the particular debt/ advance it was given to
secure.
Joint and several guarantee: Where two or more person joint in executing a guarantee, their
liability may be joint, or several, or joint and several depending upon the agreement between
them. In the absence of any express provision in the guarantee, their liability will be presumed
to be joint and several and the banker can enforce against any one or more of the guarantors.
Limited guarantee: A guarantor may prefer to guarantee on a particular account of the borrower,
or he may guarantee only a limited amount, or may restrict the period of guarantee, say a year,
and so on.
Liability of a guarantor or surety: According to Section 128 of the Contract Act, “the liability of
the surety is co-extensive with that of the principal debtor, unless otherwise provided by the
contract”
Bank Guarantee: Apart from accepting deposits and lending money, bankers also undertake the
business of issuing bank guarantee on behalf of their customer. Such guarantees are contingent
liabilities to the Bank i.e. There is not immediate outlay of funds but the Bank undertakes the risk
of meeting the obligation in the event of default by the customer.
Since, bankers usually have a through knowledge of a customer’s financial position and his
capacity to discharge business obligations, they do take a calculated risk by standing as his surety
to third parties for financial commitments or performance of contract. For rendering this service,
banks charge commission at varying rates depending upon the security available there against.
A bank guarantee is a guarantee whereby a bank undertakes to pay the guaranteed amount to the
person in whose favour the guarantee is issued, called the beneficiary. In commercial contracts, a
bank guarantee may be called for to be given by a bank on behalf of a party to a contract who is
under certain contractual obligations (say, the seller of goods etc.) and the guarantee is a cover
against default and breach of such obligations. When the bank issues a bank guarantee, it accepts
an obligation to make payment to the beneficiary (say, the buyer of goods, etc.,) in terms of bank
Counter-guarantee of the customer is the main security for a guarantee. It forms the legal basis on
which a suit can be filed against the customer, in case the guarantee is involved by the beneficiary.
The limitation for counter-guarantee starts from the date of payment by the bank under the
guarantee. The limitation period for the beneficiary for proceeding against the Bank is 3 years
from the date of invocation of the guarantee or as provided for in the guarantee. The limitation
period for Government suiting the Bank as a beneficiary of a guarantee is 30 years.
LETTERS OF CREDIT
Meaning: Apart from providing appropriate mechanism for making payments arising out of trade
transactions, modern banks are rendering many more subsidiary services. To issue letter of credit
is an important subsidiary service to facilitate the dealings between merchants domiciled in
different countries by ensuring payment to the seller on the one hand and delivery to the buyer of
the contract goods on the other.
In other words, a letter of credit is a written undertaking given by the buyer’s bank (the issuing
bank) to pay the exporters of goods (the beneficiary) through the negotiating or confirming bank in
the seller’s country, provided the terms and conditions of the credit are complied with the
documents called for by the letter of credit are presented within the time limit specified. As the
letter of credit is a conditional undertaking, it cannot be treated as a negotiable instrument.
The law governing the commercial letters of credit is largely the Lay of Contract and
Agency: A letter of credit is a documentary credit, which facilitates commercial relation between
an importer and exporter, or in financing a shipment of merchandise from one country to another.
The importer gets his banker to issue a documentary credit which incorporates and undertaking to
accept or pay bills of exchange upto a certain amount by the merchant abroad, provided that they
are accompanied by specified documents. The law governing the commercial letters of credit is
largely the law of contract of agency. The provisions of the law of contract apply to every step in
the letter of credit from its commencement to the ending.
The letter of credit is a written agreement i.e. undertaking given by the buyer’s bank (i.e. the
issuing bank) to pay the exporters of goods (i.e. the beneficiary through the negotiating bank in the
seller’s country)
The importer is an officer and the exporter is an acceptor and the banks act as agents. “The law
guiding the letter of credit, hence, resembles the law of contract and the agency”
Letter of credit play a crucial role in completing international business transactions. This can be
illustrated as following:
Suppose a buyer in India wishes to buy machinery from a seller in Germany at a cost of U.S $
20,000. The contract for the sale of the machinery, which is a c.i.f (cost, insurance and freight)
terms, provides that payment shall be by confirmed irrevocable letter of credit against delivery of
the shipping documents covering machinery i.e. bills of lading, invoice and policy or certificate of
insurance. The contract further provides that the letter of credit must be opened by the buyer at
least one month before the intended shipment date. The buyer therefore goes to his bank and asks
the letter to open the required letter of credit by the required date. The bank will require the Buyer
to complete and sign a request from the other forms for his purpose. The request form sets out
The bank, which is called “the Issuing Bank” then opens the letter of credit and sends it to its
correspondent bank in Germany, by letter. If the matter is very urgent, the letter of communication
may be sent by telex or cable. The issuing bank also notifies the seller (i.e. the beneficiary under
the letter of credit). By adding its conformation, the confirming bank itself accepts liability to
make payment under the letter of credit and in that way, the seller has a bank resident in his own
country to look to for payment.
1. Circular Notes:
2. Circular cheques
3. Traveller’s Cheques
Letters of Commercial Credit: These are otherwise simply called ‘letters of credit’. When any
letter of credit is issued for the purpose of business then it is called commercial letter of credit.
Commercial letter of credit is a letter issued by the banker of foreign buyer at the request of the
buyer in favour of the exporter of another country informing that the issuing banker accept the bills
drawn in respect of the exports made to the foreign buyer. These are of a great use for foreign
trade.