Banking Law

1. Evolution of Banking

a) Definition and Origin of Banking:

Definition of Bank:

Different Authors and Economists have given some structural and functional definitions on Bank from different angles:

“ Bank is a financial intermediary institution which deals in loans and advances”--- Cairn Cross.

“ Bank is an institution which collects idle money temporarily from the public and lends to other people as per need.”

R.P. Kent.

“ Bank provides service to its clients and in turn receives perquisites in different forms.”--- P.A. Samuelson.

“ Bank is such an institution which creates money by money only.”-----W. Hock.

“ Bank is such a financial institution which collects money in current, savings or fixed deposit account; collects cheques

as deposits and pays money from the depositors‟ account through cheques.”-----Sir John Pagette.

Indian Company Law 1936 defines Bank as “ a banking company which receives deposits through current account or

any other forms and allows withdrawal through cheques or promissory notes.”

Objectives of Bank:

1. To establish as an institution for maximizing profits and to conduct overall economic activities.

2. To collect savings or idle money from the public at a lower rate of interests and lend these public money at a higher

rate of interests.

3. To create propensity of savings amongst the people.

4. To motivate people for investing money with a view to bringing solvency in them .

5. To create money against money as an alternative for enhancing supply of money.

6. To build up capital through savings.

7. To expedite investments.

8. To extend services to the customers.

9. To maintain economic stability by means of controlling money market.

10. To extend co-operation and advices to the Govt. on economic issues.

11. To assist the Govt. for trade& business and socio-economic development.

12. To issue and control notes and currency as a central bank.

13. To maintain and control exchange rates as a central bank.

Definition of Banking:

According to the law of India “The Banking Regulations Act 1949, Sec.5 (b) defines the term banking as “Banking means
accepting, for lending or investment, of deposits of money from the public repayable on demand or otherwise and
withdraw by cheque, draft, and order or otherwise.”
The term "banking" refers to the business activity of providing financial services, managing money, and facilitating various
financial transactions. Banks, as financial institutions, play a central role in the economy by offering a range of services to
individuals, businesses, and governments. Banking plays a crucial role in the economy by facilitating the flow of money and
enabling economic activities.

Banking refers to the system of financial institutions, such as banks and credit unions, that provide various financial services
to individuals, businesses, and governments. Banking services mainly include accepting deposits, lending money, facilitating
transactions, and offering various financial products like savings accounts, loans, and credit cards.

Functions of banking include:

1. Accepting Deposits: Banks provide a safe and secure place for individuals and businesses to deposit their money.
Customers can open accounts, such as savings or checking accounts, to store their funds.

2. Providing Loans: Banks lend money to individuals, businesses, and other entities for various purposes, such as buying a
home, starting a business, or funding capital projects. This lending function is crucial for economic growth and
development.

3. Facilitating Payments: Banks enable the transfer of money between individuals and businesses. This includes processing
checks, electronic funds transfers, and facilitating online or mobile payments.

4. Currency Exchange: Banks offer services for buying and selling foreign currencies, facilitating international trade and
travel.

5. Investment Services: Many banks provide investment products and services, including savings accounts, certificates of
deposit (CDs), mutual funds, and retirement accounts. Some banks also engage in investment banking activities.

6. Credit Services: Banks extend lines of credit and issue credit cards, allowing individuals and businesses to borrow money
for short-term needs or make purchases on credit.

7. Safekeeping of Valuables: Some banks offer safe deposit boxes for customers to store valuable items, documents, and
important papers in a secure environment.

8. Electronic Banking: In the modern era, banks offer electronic banking services, including online banking, mobile banking
apps, and ATMs, allowing customers to access their accounts, make transactions, and manage finances remotely.

9. Risk Management: Banks engage in risk management activities, assessing and mitigating various financial risks to
maintain stability and protect the interests of depositors.

Banks play a vital role in the overall financial system, providing the infrastructure for economic activities and contributing to
the efficient functioning of markets. Banking activities are subject to regulatory oversight to ensure the stability and
integrity of the financial system and to protect the interests of depositors and consumers.

The origin of banking can be traced back to ancient times when various civilizations developed rudimentary financial
systems to facilitate trade and commerce. Here are some key points on the origin of banking:

1. Ancient Mesopotamia (circa 2000 BCE): One of the earliest known forms of banking activities can be found in
Mesopotamia, where temples served as safe places for people to store valuables. Temples also engaged in lending money,
effectively acting as early financial institutions.

2. Ancient Egypt (circa 2000 BCE): In ancient Egypt, goldsmiths played a role in early banking. People would deposit their
precious metals with goldsmiths for safekeeping. Over time, these goldsmiths started issuing receipts for the deposits,
which eventually evolved into an early form of paper money.

3. Ancient Greece and Rome (circa 5th century BCE): Banking practices continued to evolve in ancient Greece, where
moneylenders and early banking transactions existed. In Rome, during the Republic and Empire periods, banking activities
expanded with the establishment of institutions known as argentarii, who conducted financial transactions and provided
basic banking services.
4. Medieval Europe (circa 12th century): The medieval period saw the emergence of banking activities in European cities.
Moneychangers and early bankers conducted business in urban centers, providing services such as currency exchange and
money lending. Italian city-states, such as Florence and Venice, became notable financial centers during this time.

5. The Renaissance (14th–17th centuries): The Renaissance marked a period of significant development in banking. Italian
bankers, including the Medici family, played a crucial role in advancing financial practices. The use of double-entry
bookkeeping, which enhances financial record-keeping, became more widespread during this era.

6. The Rise of Central Banking (17th century): The establishment of central banks began in the 17th century. The Bank of
England, founded in 1694, is often considered one of the first modern central banks. Central banks played a key role in
issuing currency, managing national reserves, and stabilizing the financial system.

7. 18th–19th Centuries: The banking system continued to evolve during the Industrial Revolution. Commercial banks
proliferated, providing financial services to support industrialization, trade, and economic growth.

8. 20th Century Onward: The 20th century witnessed further advancements in banking, including the widespread adoption
of electronic banking, the development of credit cards, and the establishment of international financial institutions. Banking
became increasingly globalized, with financial markets interconnected on a global scale.

Throughout history, the evolution of banking has been closely tied to economic development, trade, and the need for
secure and efficient financial intermediaries. Today, banking is a complex and integral part of the global financial system,
offering a broad range of services to individuals, businesses, and governments.

b) Evolution and Development of Banking in Nepal:

Nepal had proven history of money but no banking history were developed in the past. But indirect non formal banking
service practice is evident from Vedic period time 200 BC to 1400 BC. In the gi century, it was evident for the development
of traditional banking system in Nepal. Around 723 AD King Gunakam Dev had borrowed money to rebuild the Kathmandu
valley. At the end of go century the new era known as Nepal Sambat was introduced by Sankhadhar, a Sudra merchant of
Kantipur in 879/880 AD after having paid all outstanding debts taken by citizen of the country. In 1 1d century. Malla
regime evident of professional moneylender and bankers for financing the foreign trade in Tibet. Therefore Nepal banking
system had been studied on two categories.

A. Traditional Banking System

B. Modern Banking System

A. Traditional Banking System

There were four types of bankers involved in traditional banking system. They were:

1. Tankadhari: At the mid of 14% century, during regime of King laysichite Malla recognized Tankadhari as one of the caste
out of 64 caste who were recognized as per their profession. They issued four types of loans (9) Business Loan (i) Family
Loan (lI) International Loan & (v) Wartime Loan. But there was no unanimous rate of interest charged as well as cruelty in
collecting the loan. This lead to development of other type of banker in Nepal.

2. Tejaratha: The Rana Prime Minister Ranodeep Singh developed Tejaratha as Governmental Financial Institution at 1933
B.S. The main objective of this institution was to rescue Nepali people from the exploitation of Tankadhari. This institution
was very important which helped for development of banking system in the country for distribution of loan at the rate of
5% to the people in security against gold or other valuables. Despite of this fact of low interest on loan, this institution did
not able to meet the requirement of cash & capital as per the increment in trade. Ultimately this institute turns to failure.

3. Mahajan: With failure of Tejaratha, Unorganized institutions like Sahukar and Mahajan were come into exist. Mahajan
used to provide business and personal loans in local arena. These Mahajan also charged no usury rate of interest like
Tankadhari. There were two types of Mahajan existed: i) Mahajan involved in retail shop business along with lending
money i) Mahajan completely involved in pure money lending business and carn interest on it.
4. Indigenous Banker; Indigenous bank were also developed along with Mahajan. The difference between Mahajan and
indigenous banker were Mahajan simply lend money and earn interest but IB provide other services along with lending loan
ie. collection of deposit, involved in retail business, provide agency service, bill of exchange and sale and purchase deed of
mortgage etc. These IB also exploited the people by charging usury interest like Mahajan. Despite of this fact, this
traditional banking system helped a lot in development of modern banking system in Nepal.

B. Modern Banking System:

The modern banking system was started with the establishment of Nepal Bank Limited (NBL) in 1994 B.S (1937

AD) and the foundation for development of modern banking lies on development of trade and commerce in Nepal. With
the advent of trade and industrial development, business world demand huge amount of money had to be investment
which IB and Mahajan could not fulfill the gap and their usury rate of interest also not acceptable in growing trade and
industry. There were long history of Small cottage industry exercised in Nepal and the Rana Prime minister Chandra
Shamsher had signed treaty with British Indian government for transporting Nepalese product to foreign land using
Calcutta port. Due to this treaty. Nepal had big scope for trading their goods without taking any support from India thereof
Nepal realized their own independent banking institution. As a result, than Trade Council passed Act "Nepal Bank Kanoon
1994".

Nepal Bank Limited (NBL)

- On the basis of this Act, NBL was established on 304 Kartik 1994 as first commercial bank in Nepal, having Authorized
Capital was one crore, Paid-up Capital 8.42 Lakhs. This NBL was not only started banking system in the country but also
introduced public private partnership in financial sector having 52% share of Government & 48% share of general public.
This was first joint stock Company in Nepal.

- This bank is authorized for conducting commercial banking as well as to work as a bank of the government initially.

- NBL has expanded their branches in the major cides which helped to introduce banking services outside the Kathmandu
valley.

Rastriya Banijya Bank (RBB)

- The monopoly of NBL in commercial banking system exists until establishment of Rastriya Baniya Bank (RBB) on 10th
Magh, 2022 B.S under the provision of Rastriya Banijya Bank Act (RBB Act) 2021.

- Due to political interference & lack of professionalism this bank was declared technically insolvent by the report of
multinational auditing firm KPMG. Then government had lunched the "Financial sector Reform Programme" to reform this
bank.

Nepal Rastra Bank (NRB)

- Another milestone for the development of banking system was establishment of NRB on 14th Baishakh, 2013 as a central
bank of the country under the provision of the NRB Act 2012. And it played an important role in development of banking
system.

- This bank gets success in substituting Indian Currency by effectively circulating Nepalese currency through different
mechanisms, issuing the Nepalese currency, promoting different bank and financial institutions in the country. Perfect
example: Establishment of Banking Promotion committee in 2025

- NRB Act 2012 & Currency Act 2020 is repealed by NRB Act 2058. This Act not only changed the objective of

NRB but also made it more autonomous & responsible regulator as well as supervisor of financial sector. This act widens
the scope of NRB in operation of monetary 9 foreign exchange policies.

Nepal Industrial Development Corporation (NIDC)

• NIDC was established in 2016 B.S under the provision of NIDC Act 2016. This Act introduced the concept of development
banking system in Nepal
•This bank is established to help the industrial development of the nation by providing the technical and financial
assistance to the industries.

- Some internal problem, NIDC is not involved in banking transaction. Government had also decided to liquidate but
decision is not executed

- later on NIDC has changed into public limited by changing name NIDC Development Bank Limited.

Corporative Banks and Agricultural Development Bank (ADB)

• Another Specified bank established under provision of Cooperative Act 2017 is Co-operative Bank. This bank started to
focus on compulsory saving scheme for the farmers.

• Later Cooperative Bank merged into newly established Agricultural Development Bank under the provision of Agricultural
Development Act 2024 B.S

• This bank involved in both commercial and development banking system having wider network in both urban and rural
sector.

• A saving institution was established in 2022 B.S to help land development and reform in the country. Major objective was
to provide loan to the landless peasants for the payment of the due which they had to pay to the government for the land
which they had received during the implementation of land reform program. But this notion was failed and was merged
into ADB in 2030 B.5

Foreign Investment in banking sector

• The monopoly of government continued in Nepalese financial sector before liberalization of economy in the 80's. After
liberalization, joint venture banks started to establish with new business idea and technology.

• First Foreign Joint Venture Bank "Arab Bank Limited" (Presently known as NABIL Bank) was established in 214 Ashadh
2041 B.S. (1984 A.D) with the venture of Dubai Bank Limited and Nepalese investors.

• 16th Chaitra 2042, Nepal Indosuez Bank Limited was established in joint venture of Banque Indosuez & Nepalese
investors.

• Likewise Nepal Grindlays Bank Limited (now Standard Charter Bank Limited) was established in 2043.

• After Liberalization: i) Himalayan Bank Limited (JV with Habib Bank Limited-Pakistan).

ii) Nepal SBI Bank Limited (IV with State Bank of India-India).

ii) Nepal Bangladesh Bank Limited (V with IFIC Bank Limited-Bangladesh),

iv) Everest Bank Limited (IV with Punjab National Bank-India).

v) Bank of Kathmandu were established.

• Not only IV but different banks were established by Nepalese investor in national and regional level. For examples:

i) Nepal Credit and Commerce Bank

ii) Nepal Industrial & Commerce Bank
iii) Machapuchhre Bank Limited
iv) Kumari Bank Limited
v) Global IME Bank Limited are established.

After re-establishment of democracy in 1990, government reared up the speed of liberalization in banking & economy.
During the decade of democracy Nepalese financial sector achieved unprecedented development in quantity and quality of
banking institution & services.

Present development
• Nepalese banking system development at present comprises of one central bank and different financial institution whose
nominee culture was changed by the BFI Act 2063. Before this Act, institutions were known as development banks, rural
development bank etc. This BFI Act is also in process of repeal as new bill has submicted.in cabinet for discussion.

• Other institution; meaning contractual saving institution like: Employee Provident Fund. Citizen Investment Trust & postal
saving equally contributing for the development of banking system in Nepal

Types of Banks

a) Commercial Banks

b) Agricultural Development Banks

c) Development Banks

d) Cooperative Banks

e) Financial Institution

a) Commercial Banks:

• These are the most common types of banks that offer a wide range of financial services to individuals, businesses, and
governments.

• Services include accepting deposits, providing loans, facilitating international trade, and offering various investment
products.

b) Agricultural Development Banks:

• Specifically focused on providing financial services and support to the agricultural sector.

Offer loans, credit, and other financial products tailored to the needs of farmers and agricultural businesses.

c) Development Banks:

• These banks play a crucial role in funding economic development projects.

Often involved in long-term financing for infrastructure, industrial, and other developmental projects to promote economic
growth.

d) Cooperative Banks:

• Owned and operated by their members, who are often customers or employees.

Cooperative banks follow the cooperative principles and provide banking services to their members with a focus on
meeting local community needs.

e) Financial Institution:

• This is a broad term that encompasses a variety of entities engaged in financial services.

• It can include banks, credit unions, insurance companies, investment firms, and other entities that deal with financial
transactions.

Each type of bank serves specific purposes and caters to different segments of the population or economic sectors. The
diversity in the types of banks allows for a more specialized approach to meet the varied financial needs of individuals,
businesses, and communities.
Functions of Banks:

a) Account operation: Account operation is a fundamental function of banks that involves the management and
administration of various types of accounts held by customers. Here are some key aspects of account operation:

1. Account Opening:

• Banks allow individuals, businesses, and other entities to open different types of accounts, such as savings accounts,
checking accounts, fixed deposit accounts, and more.

• The account opening process typically involves providing necessary identification documents and completing required
forms.

Deposits:

• Customers can deposit money into their accounts through various channels, including in-branch transactions, ATMs,
mobile banking, and online banking.

• Deposits may include cash, checks, or electronic transfers from other accounts.

Withdrawals:

• Account holders can withdraw funds from their accounts, either through over-the-counter transactions at bank branches,
ATMs, or electronic fund transfers.

• Withdrawals can be made in the form of cash, checks, or electronic transfers.

Account Maintenance:

• Banks help customers manage and maintain their accounts by providing statements, online access, and other tools to
monitor transactions and account balances.

• Account maintenance also includes updating customer information, issuing new checkbooks or debit cards, and
addressing account-related queries.

Account Closure:

• Customers can close their accounts when needed, and banks facilitate the closure process, ensuring that all outstanding
transactions are cleared and the account is properly closed.

Account Security:

• Banks implement security measures to protect customer accounts, including authentication processes, encryption of
online transactions, and monitoring for unusual activities.

Overdraft Facilities:

Some accounts may have overdraft facilities, allowing customers to withdraw more than their actual account balance, up to
a predetermined limit. Overdrafts may incur fees and interest.

Overall, account operation is a core banking function that involves the day-to-day management of customer accounts,
providing essential financial services to individuals and businesses.

b) Lending and Investment Functions:

Lending and investment functions are key activities undertaken by banks to allocate capital and contribute to economic
development. Here's an overview of these functions:

1. Lending Functions:

• Consumer Loans: Banks provide loans to individuals for various purposes, such as purchasing homes (mortgages), buying
cars, financing education, or covering personal expenses. These loans may be secured or unsecured.
• Commercial Loans: Banks extend credit to businesses for expansion, working capital, equipment purchases, or other
operational needs. These loans may be short-term or long-term, and they can be secured by assets or unsecured.

• Real Estate Loans: Banks offer loans for real estate development, construction, and investment. This includes financing for
residential, commercial, and industrial properties.

2. Investment Functions:

• Securities Investment: Banks invest in a variety of financial instruments, including government and corporate bonds,
stocks, and other securities. This allows them to earn returns on the funds they hold.

• Treasury and Central Bank Securities: Banks often invest in government and central bank securities, which are considered
low-risk and provide a source of liquidity.

• Derivative Investments: Banks may engage in derivative transactions for hedging purposes or to speculate on market
movements. Derivatives include options, futures, and swaps.

• Venture Capital and Private Equity: Some banks have divisions or subsidiaries dedicated to venture capital and private
equity investments, supporting startups and businesses in various stages of development.

Overall, the lending and investment functions of banks play a crucial role in the functioning of the financial system,
supporting economic growth by facilitating the flow of capital to individuals, businesses, and various sectors of the
economy.

c) Agency Function:

The agency function of banks refers to the role they play as intermediaries or agents on behalf of their customers in various
financial transactions and services. Banks act as representatives or agencies to facilitate certain activities for their
customers. Here are key aspects of the agency function:

1. Bill Payments:

• Banks often serve as agents for their customers in the payment of bills. This includes utility bills, credit card payments,
insurance premiums, and other recurring payments. Customers can authorize banks to make these payments on their
behalf.

2. Collection of Checks:

• Banks act as agents for customers by collecting checks on their behalf. When customers receive checks, they can deposit
them into their bank accounts, and the bank handles the clearing and settlement process.

3. Purchase and Sale of Securities:

• Many banks provide brokerage services, acting as agents for customers in the purchase and sale of securities such as
stocks, bonds, and mutual funds. Customers can instruct their banks to execute these transactions on the stock market.

4. Safe Deposit Boxes:

• Banks offer safe deposit boxes as a secure place for customers to store valuable items such as documents, jewelry, or
other possessions. The bank acts as an agent providing a secure storage facility.

5. Foreign Exchange Transactions:

• Banks act as agents for customers in foreign exchange transactions. They facilitate the buying and selling of foreign
currencies, wire transfers, and other international financial transactions on behalf of their customers

The agency function is an important aspect of banking services, as it allows customers to delegate certain financial tasks to
their banks, streamlining processes and providing convenience. It involves a trusted relationship where the bank acts in the
best interest of its customers in executing specific financial transactions and services.
d) Remittance:

The function of bank remittance refers to the services provided by banks to facilitate the transfer of funds from one
location to another, often across borders. This financial service is crucial for individuals, businesses, and families who need
to send or receive money internationally. Here are the key functions of bank remittance:

1. International Money Transfers:

• Banks enable individuals and businesses to transfer money across borders, allowing for international trade, investment,
and personal financial support.

2. Currency Exchange:

• Bank remittance involves the conversion of one currency into another to facilitate cross-border transactions. Banks
provide foreign exchange services to ensure that the recipient receives funds in their local currency.

3. Secure Fund Transfer:

• Bank remittance services prioritize the security and reliability of fund transfers. Utilizing established banking systems and
networks, these services ensure that money is transferred securely between sender and recipient accounts.

Multiple Transfer Channels:

• Banks offer various channels for remittance, including in-person transactions at bank branches, online banking platforms,
mobile banking apps, and automated teller machines (ATMs). This flexibility allows customers to choose the most
convenient method for their needs.

Transaction Tracking and Confirmation:

• Remittance services by banks often include features that allow customers to track the status of their transactions.
Customers receive confirmation when the funds are sent and, in some cases, when the funds are received by the recipient.

Remittance Fees:

• Banks may charge fees for their remittance services. These fees can vary depending on the amount being transferred, the
destination country, and the chosen transfer method. Some banks may also offer fee discounts or promotions.

Compliance with Regulations:

• Banks adhere to regulatory requirements when providing remittance services. This includes compliance with anti-money
laundering (AML) and know your customer (KYC) regulations to ensure the legitimacy of transactions.

Financial Inclusion:

• Bank remittance services contribute to financial inclusion by providing individuals access to formal financial channels for
transferring money. This helps in bringing unbanked or underbanked populations into the formal financial system.

Integration with Other Banking Services:

• Bank remittance services are often integrated with other banking services, such as online banking platforms and mobile
apps, allowing customers to manage their international transactions alongside their other financial activities.

The function of banks in remittance is essential for fostering global financial connectivity, supporting families across
borders, and facilitating international trade and economic activities. Banks ensure that the transfer of funds is secure,
reliable, and compliant with regulations.

4) Central Bank and Commercial Banks:

Commercial Bank:

Historically, commercial bank came into being for its commercial purpose. The inception of modern banking is the outcome
of commercial bank. In the words of Professor Roger, “ the bank which deals with money and money‟s worth with a view
to earning profit is known as ``Commercial bank.”
Professor Hart says, “ A banker is one who, in the ordinary course of business, honours cheques drawn upon him by
persons for and for whom he receives money on current account.”

The objectives of a commercial bank:

1. To establish as an institution for maximizing profits and to conduct overall economic activities.

2. To collect savings or idle money from the public at a lower rate of interests and lend these public money at a higher rate
of interests.

3. To create propensity of savings amongst the people.

4. To motivate people for investing money with a view to bringing solvency in them .

5. To create money against money as an alternative for enhancing supply of money.

6. To build up capital through savings.

7. To expedite investments.

8. To extend services to the customers.

9. To maintain economic stability by means of controlling money market.

10. To extend co-operation and advices to the Govt. on economic issues.

11. To assist the Govt. for trade& business and socio-economic development

The functions of commercial bank are given below:

A: General Functions:

1. Receiving Deposits:

The first and foremost function of commercial bank is to receive or collect deposits from the public in different forms of
accounts e.g. current, savings, term deposits. No interest is charged in the current account, lower rate of interest is
charged in the savings account and comparatively higher interest rates charged in fixed deposits. Thus, commercial bank
builds up customer network.

2. Accommodation of loans and advances: Commercial Bank attaches much importance to providing loans and advances at
a higher rates than the deposit rates and thus earns profits on it. Working capital is accommodated to the borrower for
expansion and smooth running of business. In the similar manner, commercial bank extends financial accommodation for
the development of agriculture and industry. Credit accommodation is provided to the entrepreneurs for reviving sick and
old industries as per Govt. directives. Thus, commercial bank also extends welfare services to the people at large.

3. Creation of Loan Deposits: Commercial Bank not only receives deposits from public and accommodates loans to public
but also creates loan deposits. For example: while disbursing loans as per sanction stipulation, the amount of loan is
credited to the borrower’s account. The borrower may not withdraw the full amount at a time. The residual amount i.e.
balance left in the account creates loan deposits.

4. Creation of medium of exchange:

Central Bank has got exclusive right to issue notes. On the other hand, Commercial Bank creates medium of exchange by
issuing cheques. Like notes, cheque is transferrable being popularly used in the banking transactions.

5. Contribution in foreign trade:

Commercial Bank plays a vital role in expediting foreign exchange and foreign trade business e.g. import, export etc. It
contributes greatly in the economy through import finance and export finance and thus, earn foreign exchange for the
country.

6. Formation of capital:
Commercial Bank extends financial assistance for the formation of capital in the trade, commerce and industry in the
country which expedites its economic development.

7. Creation of Investment Environment:

Commercial Bank plays a significant role in creating investment environments in the country.

B. Public Utility Functions:

In modern banking, commercial bank executes public utility services:

1. Remittance of Money:

Remittance of money to the public from one place to another is one of the functions of commercial bank. Remittance is
effected in the form of demand draft, telegraphic transfer etc. through different branches and correspondents home and
abroad.

2. Help in trade and commerce:

Commercial Bank helps expand trade and commerce. In inland and foreign trade customers are allowed credit
accommodation in the form of letter of credit, bill purchased and discounted etc.

3. Safe custody of valuables:

Commercial Bank introduces„ locker‟ services to the customers for safe custody of valuables e.g. documents, shares,
securities etc.

4. Help in Foreign Exchange business:

While opening letter of credit, commercial bank obtains credit report of the suppliers and thus help expedite import and
export business.

5. Act as a Referee:

Commercial Bank acts as a referee for and on behalf of the customers.

6. Act as an Adviser:

Commercial Bank provides valuable advice to the customers on different products, business growth and development,
feasibility of business and industry.

7. Collect utility service bills: As a social commitment, Commercial Bank collects utility service bills e.g. water, electricity,
gas, telephone etc. from the public.

8. Purchase and sale of prize bonds, sanchaya patra, shares etc.

Commercial Bank undertakes to purchase and sale of prize bonds, sanchaya patra, shares etc. as a part of social
commitment.

9. Help people travel abroad:

Commercial Bank helps customers in traveling abroad through issuance of travelers cheques, drafts, cash etc. In favor of
the customers.

C. Agency Functions:

Besides above stated functions, commercial bank acts as a representative of the customers.

1. Collection and payment:

Commercial Bank is engaged in collection and payment of cheque, bill of exchange, promissory notes, pension, dividends,
subscription, insurance premium, interest etc. on behalf of the clients.

2. Purchase and sale of shares and securities:

Commercial Bank is entrusted with the responsibility of purchase and sale of shares and securities on behalf of the
customers.

3. Maintenance of secrecy:

Maintenance of secrecy is one of the most important functions of commercial bank.

4. Act as a trustee:

Commercial Bank acts as a trustee on behalf of the customer.

5. Economic Development and Welfare activities:

Commercial Bank contributes much for the welfare and economic development of the country.

Central Bank:

The bank which governs banking system and money market is Central Bank. The primary function of a central bank is to
assist Government in formulating economic policy, in controlling and conducting money-market and also controlling bank‟
credit. Some specialized Bankers, Economists and thinkers have given different definitions: “ A central bank is a bank whose
essential duty is to maintain stability of the monetary standard.”

In the words of Decock “The central bank is a banking system in which a single bank has either a complete or a residuary
monopoly of note issue.”

Professor Hatley says, “Central Bank is the lender of the last resort.”

Functions of Central Bank:

The functions of central bank are different from other banks. The following functions of central bank are stated below:

A. Traditional or general functions:

1. Issue of notes and coins: The first and foremost function of central bank is to issue notes and coins as per needs of the
public and requirement of business and commerce. As per rules, notes are issued against gold, silver and foreign currency.
Bangladesh Bank (Central Bank) keeps foreign currency reserves as security against issuance of notes. Bangladesh Bank
unilatarilly reserves the right to issue notes.

The arguments in its favor are as follows:

(a) To maintain equilibrium in quality between notes and currency issue

(b) To maintain equilibrium in size, types and values of notes and currency

© To maintain stability in rates of exchange both inland and foreign

(d) To create confidence on the people

(d) To control money market.

2. Government Bank:

Central Bank acts as banker and economic adviser of the Government. The central bank conducts and maintains
Government accounts for all Government receipts and payments.

3. Banker’s Bank:

Central Bank acts as banker‟s bank. As a rule, all scheduled and commercial banks have to maintain Statutory Liquidity
Reserve(SLR) 18% with Bangladesh Bank(CRR: 5% and Bonds & Securities 13%).

4. Lender of the last Resort:

In case of financial crisis of the commercial banks, central bank acts as a lender of the last resort through lending against
first class securities, bill of exchange etc.
5. Reservoir of foreign currency:

Central Bank maintains Foreign Currency Reserve. For the purpose of control of foreign currency, the following factors are
responsible:

(a) For issuance of notes

(b) For payments of liabilities

(c) For payments of debts.

6. Clearing House:

Central Bank acts as a Clearing House for settlement of inter bank transactions.

7. Credit Control:

Credit Control is one of the major functions of central bank. The following are the ways of controlling credit:

(a) Change in bank rates

(b) Open market operation

© Change (increase or decrease) in reserve- ratio

(d) Selective credit

(e) Direct influence

(f) Moral suasion

(g) propaganda.

B. Purposeful functions:

(a) Control Currency Market:

Central Bank acts as a controller and guardian of the currency market. For the purpose of formation, control and
maintenance of currency market and for its overall development, central bank is the pioneer.

(b) Stabilize Exchange Rate:

Central Bank maintains stability of the foreign currency exchange rates by means of controlling credit. Stable exchange
rates position helps create favourable balance of trade and acceptability of stable currency gets momentum in the
international market.

(c) Maintain Gold Standard:

Central Bank is responsible for maintenance and control of gold reserve.

(d) Stabilize Price-Level:

Fluctuations and frequent changes of price-level affect economic growth. With a view to making good of the economic
imbalances and crisis situations, central bank takes necessary measures for stabilizing price-level.

(e) Stabilize business activities:

Central Bank formulates credit policy and with this spirit, central bank takes necessary steps to protect economic
depression for stabilizing business activities.

(f) Employment opportunities:

Central Bank takes initiatives for creating employment opportunities by means of credit-control mechanism.

C. Expansion and Development Functions:

(a) Development of Agriculture Sector:

Central Bank formulates policy for expansion of Agri-sector for the purpose of economic upliftments in the country.

(b) Development of Industry Sector:

(c) Development of natural resources:

Central Bank plays vital role for tapping natural resources which may lead to economic growth.

D. Other Functions:

(a) Adviser and Representative of Government:

10

Central Bank advises Government on economic issues and sometimes acts as a representative of the Government.

(b) Economic Research:

Central Bank conducts various economic research works and formulates policies for economic development. Central Bank
conducts survey on different economic issues for the knowledge of the general public of the country.

Sl. Points of Central Bank Commercial Bank

distinction
01. Formation Central Bank is the sole banking Institution which is Commercial Bank is formed on the basis of Banking Company
established through ordinance or special law of the Laws.
Government.
02. Ownership Central Bank is established under Commercial Bank is established under both govt. and private
Government ownership. Ownership.
03. Purpose To earn profit is not the main purpose of central The main purpose of commercial bank is to earn profit.
bank. Its main purpose is to control credit system and Recovery of loan is the main stay for generation of profit.
money market.
04. Number In a country there is only one Central Bank. In a country there may be more number of commercial banks.

05. Control Central bank is conducted exclusively under Commercial Bank is conducted under central bank‟s control.
Government control.
06. Government Government has direct influence on Central Bank. Government has indirect influence On Commercial Bank
Influence through Central Bank.
07. Currency Central Bank organizes, controls and administers Commercial Banks are the members of the currency market.
Market currency market.
08. Competition Central Bank does not compete with other banks. Commercial Bank has to face to face lot of competition.

09. Representative Central Bank represents the country or state. Commercial Bank represents the
Customers.
Foreign Central Bank has no branch abroad. Commercial Bank may have many
Branch Branches abroad.
Note issue Note issue is the primary function of central bank. Commercial Bank cannot issue notes.

Credit control Central Bank controls credit. Commercial Bank assists central bank In controlling credit.

Clearing Central Bank acts as a clearing house for settlement Commercial banks are the members of the clearing house. They
House of inter-bank transactions. settle transactions through clearing house.

Lender of In case of any crisis, central bank Last resort lends Commercial Bank gets assistance from central bank in case of
commercial bank as a last resort. need.
Nature Of work Central bank is not engaged in general Commercial bank is engaged in receiving deposits, paying
banking activities i.e. to receive deposits, to lend, to money, creating loan etc.
create loan etc.
Foreign Central Bank controls foreign exchange. Commercial bank helps central bank in controlling foreign
Exchange exchange.
 Investments Central bank does not Make any investment for Commercial bank makes investments in
profitability purpose. Various sectors for the purpose of profitability.

Refinance Central bank refinances commercial bank against first class Commercial bank takes refinance facility from the central bank.
Facility securities, bill of exchange.
Development Central Bank formulates policy on development
Commercial bank participates in the development
work Work. program Initiated by the central bank.

Relationship between Central Bank and Commercial Bank

The relationship between central banks and commercial banks is multifaceted and crucial for the overall stability and
functioning of the financial system. Let’s delve into the key aspects of this relationship:

1. Central Banks:

• A central bank (also known as a reserve bank or monetary authority) manages a country’s currency, money supply, and
interest rates.

Key functions of central banks include:

• Currency Management: Central banks have the authority to issue and manage the country’s currency.

• Monetary Policy Implementation: They actively implement monetary policies set by the government.

•Lender of Last Resort: During financial crises, central banks act as a lender of last resort to the banking sector.

• Supervision and Regulation: Most central banks oversee and regulate commercial banks to ensure their solvency and
prevent reckless behavior.

• Central banks play a critical role in maintaining overall economic stability.

Commercial Banks:

• Commercial banks are private financial institutions that provide various services, including accepting deposits, granting
loans, and offering basic investment products.

Their primary functions include:

• Deposits and Loans: Commercial banks accept deposits from the public and provide loans to individuals, businesses, and
corporations.

• Currency Distribution: They distribute currency to the public and maintain cash reserves.

• Customer Services: Commercial banks offer services such as customer advice, lending, and corporate financing.

• Unlike central banks, commercial banks are not owned by the government.

3. Cooperation and Reciprocity:

• The relationship between central banks and commercial banks should be based on reciprocity.

• Central banks set directives, and commercial banks should adhere to the spirit of these directives.

• In times of stress, central banks should meet the genuine needs of commercial banks.

• A moral code of conduct between the two is essential for harmonious cooperation.

4. Balancing Roles:

• Central banks manage macroeconomic aspects (e.g., money supply, currency stability).

• Commercial banks focus on customer services, lending, and corporate financing.

• Together, they contribute to a well-functioning financial system.

b) Credit Control Mechanism of Central Bank and Commercial Bank:

Both central banks and commercial banks play vital roles in credit control within an economy, but they operate with
different tools and mechanisms. Here's an overview of the credit control mechanisms employed by central banks and
commercial banks:

Central Bank Credit Control Mechanisms:

1. Open Market Operations (OMO): The central bank conducts OMO by buying or selling government securities in the open
market. These transactions influence the money supply, affecting interest rates and credit conditions in the economy.

2. Discount Rate (Policy Rate): The central bank sets the discount rate, which is the interest rate at which commercial
banks can borrow from the central bank. Changes in the discount rate influence the cost of borrowing for commercial
banks and can impact their lending rates to consumers and businesses.

3. Reserve Requirements: Central banks mandate reserve requirements, specifying the proportion of deposits that
commercial banks must hold as reserves. Adjustments to reserve requirements affect the amount of funds available for
lending by commercial banks.

4. Selective Credit Controls: Central banks can implement selective credit controls to target specific sectors of the
economy. This may involve setting limits on the amount of credit that can be extended for particular purposes, such as real
estate or consumer loans.

5. Interest Rate Policy: Central banks use their policy interest rates (e.g., the federal funds rate in the United States or the
repo rate in other countries) to influence overall interest rates in the economy. Changes in policy rates impact borrowing
costs for commercial banks and, subsequently, influence credit creation.

Commercial Bank Credit Control Mechanisms:

1. Credit Policies: Commercial banks formulate internal credit policies to manage their lending activities. These policies
include guidelines on loan approval criteria, risk assessment, and the types of loans offered.

2. Credit Scoring and Risk Management: Commercial banks use credit scoring models and risk management techniques to
assess the creditworthiness of borrowers. This helps in determining the interest rates, loan amounts, and terms of credit
offered.

3. Loan-to-Value Ratios (LTV): Commercial banks often set maximum loan-to-value ratios for certain types of loans, such as
mortgages. LTV ratios restrict the amount of money borrowers can obtain relative to the appraised value of the collateral.

4. Interest Rate Adjustments: Commercial banks have the flexibility to adjust interest rates on loans based on market
conditions, risk profiles of borrowers, and changes in the cost of funds. This allows them to respond to changes in the
overall interest rate environment.

5. Collateral Requirements: Commercial banks may require borrowers to provide collateral for loans. The type and value of
collateral influence the risk perception of the loan, impacting the terms and conditions set by the bank.

6. Loan Maturity: Commercial banks can control credit by setting the maturity terms of loans. Short-term loans may have
different risk characteristics compared to long-term loans, and banks adjust their lending practices accordingly.

7. Loan Review and Monitoring: Regular review and monitoring of the loan portfolio help commercial banks identify and
manage credit risks. Banks may adjust their lending practices based on the performance of existing loans and changes in
economic conditions.

Both central banks and commercial banks work in tandem to maintain a stable and well-functioning financial system.
Central banks use broad policy tools to influence the overall money supply and credit conditions, while commercial banks
implement specific credit control measures to manage their lending portfolios and mitigate risks. The coordination of these
efforts helps achieve macroeconomic stability and sustainable economic growth.

5. Bankers Customer Relations:

The relationship between a banker and a customer comes into existence when the banker agrees to open an account in the
name of the customer. The relationship between a banker and a customer depends on the activities, products, or services
provided by the bank to its customers or availed by the customer. Thus the relationship between a banker and customer is
the transaction relationship. Bank’s business depends much on the strong bondage with the customer. Trust plays an
important role in building a healthy relationship between a banker and a customer.

It means that to become a customer account relationship is a must. Account relationship is a contractual relationship.
Banking is a trust-based relationship. There are numerous kinds of relationships between the bank and the customer. The
relationship between a banker and a customer depends on the type of transaction. Thus the relationship is based on
contract, and certain terms and conditions.

These relationships confer certain rights and obligations both on the part of the banker and on the customer. However, the
personal relationship between the bank and its customers is long-lasting. Some banks even say that they have a generation-
to-generation banking relationship with their customers.

The main relationship between bank and a customer is that of debtor -creditor in the case of deposit account and creditor-
debtor in the case of overdraft or loan account. The bank acts trustee in case of valuables entrusted with the bank branch
and as agent or bailee in other kinds of transactions. These kinds of relationships enjoin different rights and duties on the
bank, involving different degrees of care and diligence as below:

The Relationship between banker and customer can be in the form of

1. Debtor - Creditor

2. Trustee - Beneficiary

3. Agent - Principal

4. Bailor - Bailee

5. Assignor - Assignee

Definition of Customer:

The term Customer has not been defined by any act. In simple words, a customer is such a person to whom you extend
your services in return for consideration. A customer is a person who maintains an account with the bank without taking
into consideration the duration and frequency of operation of his account. To be a customer for any bank the individual
should have an account with the bank. The individual should deal with the bank in its nature of regular banking business.

Those who do not maintain any account relationship with the bank but frequently visit a branch of a bank to availing
banking facilities such as for purchasing a draft, en-cashing a cheque, etc. Technically they are not customers, as they do
not maintain an account with the bank branch. The term ‘customer’ is used only concerning the branch, where the account
is maintained.

The legal relationship between a customer and the bank is based on contract and is generally classified as a debtor-
creditor relationship.

a) Debtor and Creditor

When a ‘customer’ opens an account with a bank, he fills in and signs the account opening form. By signing the form he
agrees/contracts with the bank. When a customer deposits money in his account the bank becomes a debtor of the
customer and the customer a creditor. The money so deposited by the customer becomes the bank’s property and the
bank has a right to use the money as it likes. The bank is not bound to inform the depositor of the manner of utilization of
funds deposited by him. Bank does not give any security to the depositor i.e. debtor. The bank has borrowed money and it
is only when the depositor demands, the banker pays. Bank’s position is quite different from normal debtors.

Lending money is the most important activity of a bank. The resources mobilized by banks are utilized for lending
operations. Customer who borrows money from the bank own money to the bank. In the case of any loan/advances
account, the banker is the creditor and the customer is the debtor. The relationship is the first case when a person deposits
money with the bank reverses when he borrows money from the bank. Borrower executes documents and offers security
to the bank before utilizing the credit facility.

In the context of Banking, when a customer deposits money in a bank, the bank becomes the customer’s debtor (Foley v
Hill (1848) 2 HLC 28) and has to return the money according to the terms of the deposit.

b) Trusteeship Relation:

A trusteeship relationship refers to a legal arrangement where one party, known as the trustee, holds and manages assets
or property on behalf of another party, known as the beneficiary. This relationship is established through a legal document
or agreement, often called a trust deed or trust agreement.

1. Trustee:

The trustee is the individual or entity responsible for managing and administering the assets held in the trust.

The trustee has a fiduciary duty to act in the best interests of the beneficiary and must adhere to the terms and conditions
outlined in the trust agreement.

2. Beneficiary:

The beneficiary is the party for whom the trustee holds and manages the assets. The beneficiary is entitled to receive the
benefits and proceeds from the trust as specified in the trust agreement.

This relation works out when the,

• Customer deposits money for a specific purpose, the banker is a trustee and the customer beneficiary. As such, the
banker has to employ the funds for a specific purpose for which it is meant.

• Banker becomes a trustee whenever he undertakes to collect cheques on behalf of customers. After realizing, banker has
to credit the proceeds to the account of the customer. When the amount is credited to the account of the customer, the
relationship changes wherein the banker becomes a debtor and the customer creditor.

• Customer deposits securities and valuables for safe custody with the banker. The banker in such a case is a trustee and so,
whenever the customer demands the securities, the banker has to return them to the customer who is a beneficiary.

• In the case of companies, when they receive debenture amount from the public, the banker acts as one of the trustees of
the company and so has a responsibility to review the value of the assets against which the debentures are issued. Hence,
the banker has a responsibility to supervise the property of the company for which he is a trustee.

c. Agency Relations:

Agency relationships involve one party (the agent) acting on behalf of another (the principal) with the authority to make
decisions and perform actions on the principal's behalf.

Agents owe fiduciary duties to act in the best interests of the principal, avoiding conflicts of interest.

Agent – Principal

An agent is a person who acts for or represents another.

The principal is the person who gives authority to another, called an agent, to act on his or her behalf.
Banker acts as an agent of a customer, when

• Purchasing and selling securities on behalf of the customers

• Collecting dividend warrants and interest warrants

• Paying club subscription, insurance premium, rent and other bills, as per instruction of the customer

Here again, the relationship cannot be called in the true sense as agent - principal. In the case of a normal agent-principal
relationship, the agent has to render accounts to the principal and should also inform the principal how the amount given
to him by the principal has been spent or invested. In other words, the agent has to render accounts to the principal while
dealing with the funds of the principal.

However in the case of a banker- customer relationship, though the banker is dealing with the money belonging to the
customer, he need not render accounts to the customer or inform the customer as to how the money is lent or invested.
Though the money invested or lent, belong to the customers the banker need not tell them the extent of profit or return he
made from such investment or loan. But in the case of normal agent- principal relationship, it is the duty of the agent to
render accounts to the principal and also inform the return earned on the investment.

Thus, though a banker may act as an agent of customer, in the true legal sense, he is not an agent and so he need not
render account for the money deposited with him.

d) Bailor and Bailee Relation:

The relationship between a bank and its customer is typically not described as a bailor and bailee relationship. However,
some aspects of the banking relationship may have similarities to bailment, particularly when customers deposit items such
as valuables or documents in safe deposit boxes or when customers entrust the bank with specific tasks.

Bailment is a legal relationship in which one party temporarily hands over possession of goods or property to another party
for a specific purpose. In banking, instances of bailment may include safe deposit boxes or storage of valuable items.

Bailor:

• The bailor is the party who delivers goods or property to another party (bailee) for a specific purpose. In the context of
banking, a bailor could be someone who deposits items in a safe deposit box.

Bailee:

• The bailee is the party to whom goods or property are delivered by the bailor. The bailee has possession of the items but
does not own them. In banking, this could relate to the bank safeguarding valuables in a safe deposit box.

Let's explore how the bailor and bailee relationship may have relevance to certain aspects of banking:

1. Safe Deposit Boxes:

Bailment may be applicable when a customer rents a safe deposit box from the bank. In this scenario, the customer (bailor)
places valuable items in the box, and the bank (bailee) safeguards and maintains the security of the items.

2. Document Storage:

If a customer entrusts important documents to the bank for safekeeping or storage, a bailment relationship may exist. The
customer retains ownership of the documents, while the bank holds them as a bailee.

3. Special Collections:

In cases where customers deposit items like artwork or collectibles with the bank for safekeeping, the bank may act as a
bailee for those specific items.

4. Electronic Documents:

In the context of electronic banking, customers may entrust the bank with electronic documents, passwords, or digital
assets, creating a bailment relationship regarding the custody and safekeeping of these items.
It's important to note that the primary relationship between a bank and its customer is that of a contractual and fiduciary
nature rather than a strict bailment relationship. The bank is typically considered a debtor in terms of the funds deposited
by the customer, and the bank owes certain duties to the customer, including the duty of care and confidentiality.

e) Opening of an account:

Opening a bank account is a crucial step in establishing a relationship between a customer and a financial institution. The
process may vary slightly depending on the bank and the type of account being opened.

6. Merchant Banking and Mutual Funds

Merchant Banking

The term ‘Merchant Banking’ was originated in the 18th and early 19th centuries in the United Kingdom when trade
between countries was financed by bills of exchange drawn on the principle merchant houses.

In the context of Nepal though Merchant banking exists from the establishment of Nepal Bank Limited in 1990 B.S., its
existence was in crude form. After the restoration of democracy in 2046 B.S., and an announcement of government’s
economic liberalization policy, private sector investors are attracted to invest in different organized commercial ventures.
As a result numerous new private and public limited companies were established in a very short span of time to reap the
benefit of economic liberalization policy of the nation.

The growing demand for funds from capital market has enthused many organizations to enter into the field of merchant
banking for managing the public issues. The Finance Company Act 2042 gave birth to a new dimension to the merchant
Banking Services as the act permits finance companies to sell and purchase the bonds issued by His Majesty’s Government
or securities issued by other companies or institutions, to underwrite them and to form syndicate for such purpose or to
participate in such syndicates and to act as broker under the Securities Exchange Act, 1983. Similarly section3 (g) of the
same act permits them to perform functions of merchant banking with prior approval of NRB.

Merchant banking refers to a range of financial services provided by financial institutions to corporations and governments.
These services typically go beyond traditional banking functions.

Merchant banks work as a bridge, which provides every kind of financial assistance to industries and commerce. They play a
highly significant role in mobilizing funds of savers to investible channels assuring of promising return on investments and
thus can help in meeting the widening demand for investible funds for economic activity. Merchant bankers help the
economic development of the country through its wide range of services.

The basic services provided by merchant banks are corporate counseling, project counseling, issue management,
underwriting of public issue, portfolio management, bankers to the issue, loan or credit syndication, merger and takeover,
arranging offshore finance venture capital, factoring, etc.

Features of Merchant Banking

• Merchant banking is a specialized form of banking that focuses on providing customized financial services and advice to
corporations, governments, and high net-worth individuals.

• Merchant bankers act as intermediaries between their clients and financial markets, helping clients to raise capital,
manage risks, and invest wisely.

• Merchant banking services include underwriting, syndication, mergers and acquisitions, portfolio management, corporate
restructuring, and project financing.

• Merchant bankers are skilled in analyzing financial data, assessing market trends, and identifying investment
opportunities for their clients.

• Merchant banking requires a high level of expertise and experience in financial markets, as well as strong relationships
with other financial institutions, regulators, and key stakeholders.

Merchant banks, also known as investment banks, engage in activities such as:
1. Corporate Finance:

• Assisting companies in raising capital through various means, including issuing stocks or bonds.

• Providing advice on mergers and acquisitions.

2. Underwriting:

• Underwriting securities, which involves assuming the risk of buying securities from an issuer and then selling them to
investors.

3. Advisory Services:

• Offering financial and strategic advice to clients.

• Providing guidance on investment decisions, risk management, and financial structuring.

4. Project Finance:

• Assisting in financing large-scale projects, such as infrastructure or development projects.

5. Syndication:

• Forming a syndicate to collectively finance a project or underwrite a security.

6. Asset Management:

• Managing assets on behalf of clients.

• Offering portfolio management and investment advisory services.

7. Issue Management:

• Managing the issuance of new securities, such as initial public offerings (IPOs).

8. Risk Management:

Merchant banks often provide risk management services, helping clients identify and mitigate financial risks associated with
their business operations.

Functions of Merchant Banking

• Portfolio Management Merchant banking provides investment advice to the investors to make the investment decisions.
The merchant bank provides portfolio managing assistance to the investors by trading securities on their behalf.

• Raising funds for clients Merchant banks assist clients in raising funds from the domestic and international market by
buying securities.

• Promotional activities The merchant bank also helps in the promotion of the business institute in its initial stages. It helps
the organisation to work on their business idea and to get the approval from the government.

• Loan Syndication This is the service provided by merchant banks to its clients for raising credit from banks and financial
institutions.

•Leasing Services Merchant banks also provide leasing services to their customers.

Merchant banking provides a lot of support and opportunities for new businesses. This in turn also has a positive effect on
the country’s economic growth.

Benefits of Merchant Banking

• Risk Management: Merchant banks can provide risk management services such as hedging, derivatives, and insurance
solutions to protect clients from market fluctuations.
• Expertise: Merchant banks have extensive knowledge of financial markets and industries, providing clients with strategic
advice and guidance.

• Networking: Merchant banks have vast networks of contacts, including investors, corporations, and financial institutions,
which can help clients identify opportunities and connect with potential partners.

• International Presence: Merchant banks often have a global presence, which can help clients expand their business
internationally and access foreign markets.

• Customized Solutions: Merchant banks provide tailored solutions to meet the specific needs of clients, rather than
offering off-the-shelf products and services.

• Long-term Relationships: Merchant banks typically work closely with clients over the long term, building strong
relationships and providing ongoing support and advice.

Mutual Funds:

Mutual funds fall under the purview of securities regulation rather than banking law. Mutual fund pools money from
investors and use it to buy other securities such as stocks and bonds. The value of the mutual fund company depends on
the performance of the securities it buys. Investing in a mutual fund is different from investing in shares or stocks. Unlike
shares, investors do not get any voting rights when they invest in mutual funds. When you are buying a unit of a mutual
fund, you are actually purchasing its portfolio or a part of the portfolios value. That's why the price of a mutual fund unit is
referred to as the net asset value (NAV).

Many mutual funds are distributed through banks. Banks may offer mutual funds to their customers as part of their
financial services. In such cases, banks may need to comply with both securities regulations and banking laws.

A mutual fund is a pure intermediary

which performs a basic function of
buying and selling securities on behalf of
its unit-holders, which latter also can
perform but not easily, conveniently,
economically, and profitably
A mutual fund is a pure intermediary
which performs a basic function of
buying and selling securities on behalf of
its unit-holders, which latter also can
perform but not easily, conveniently,
economically, and profitably
If a bank is acting as a fiduciary or investment adviser to clients, it may be subject to fiduciary duty standards, which require
the bank to act in the best interests of its clients when recommending or managing mutual fund investments.

Anti-Money Laundering (AML) Compliance: Banks, as financial institutions, are often subject to AML regulations. If a bank is
involved in the distribution or management of mutual funds, it may need to implement AML compliance measures to
prevent money laundering and illicit financial activities.

Banks involved in mutual fund activities should be familiar with both securities laws and banking laws applicable in their
region and ensure compliance with all relevant regulations.

One should invest in mutual funds because of the following reasons:

1. Diversification:

• Mutual funds invest in a variety of securities, such as stocks, bonds, and other instruments. This diversification helps
spread risk, as the performance of different securities may not move in the same direction under various market
conditions.

2. Lowest Lock-in Period:

• The term "lock-in period" usually refers to the minimum period for which an investor needs to stay invested in a fund. If a
mutual fund has the "lowest lock-in period," it means investors have the flexibility to redeem or sell their units with a
relatively short notice.

3. Expert Management:

• Mutual funds are managed by professional fund managers who have expertise in financial markets. These experts analyze
market conditions, conduct research, and make investment decisions on behalf of investors to achieve the fund's
objectives.

4. SIP Option Available:

• Systematic Investment Plan (SIP) allows investors to invest a fixed amount regularly (monthly or quarterly) in a mutual
fund. This approach promotes disciplined and regular investing, regardless of market fluctuations.

5. Flexibility to Switch Funds:

• Mutual funds often offer the flexibility to switch between different funds managed by the same fund house. This allows
investors to adjust their investment strategy based on changing market conditions or their financial goals.

6. Affordable Investment:

• Mutual funds provide an affordable investment option, allowing investors to participate in diversified portfolios with a
relatively small amount of money. This accessibility makes mutual funds suitable for a wide range of investors with varying
financial capacities.

7. Financial Institution

a. Banking and non- banking function of Financial Institution

Financial institutions perform various functions, encompassing both banking and non-banking activities. Here's an overview
of the key functions associated with financial institutions:
Banking Functions of Financial Institutions:

1. Accepting Deposits:

• Commercial Banks: Accept deposits from individuals and businesses.

• Savings Banks: Focus on savings deposits and provide loans.

2. Providing Loans:

• Commercial Banks: Offer various types of loans, including personal loans, home loans, and business loans.

• Development Banks: Specialize in providing long-term loans for industrial development.

3. Credit Intermediation:

• Financial institutions act as intermediaries between depositors and borrowers, facilitating the flow of funds in the
economy.

4. Payment Services:

• Financial institutions, especially commercial banks, offer payment services such as checks, electronic funds transfers, and
credit/debit card transactions.

5. Foreign Exchange Services:

• Banks often facilitate currency exchange, international money transfers, and provide services related to foreign exchange.
6. Investment Banking:

• Some financial institutions engage in investment banking activities, including underwriting, mergers and acquisitions, and
securities issuance.

Non-Banking Functions of Financial Institutions:

1. Insurance Services:

• Insurance companies, a type of financial institution, provide coverage against various risks, including life, health, and
property insurance.

2. Asset Management:

• Financial institutions manage investment portfolios on behalf of clients through mutual funds, pension funds, and other
investment vehicles.

3. Brokerage Services:

• Brokerage firms facilitate the buying and selling of financial securities on behalf of clients in financial markets.

4. Financial Advisory:

• Some financial institutions offer advisory services, providing guidance on financial planning, investment strategies, and
wealth management.

5. Real Estate Services:

• Financial institutions may be involved in real estate financing, investment, and development.

6. Payment Processing:

• Non-banking financial institutions, such as payment processors and fintech companies, play a role in electronic payment
processing and innovations in financial technology.

7. Venture Capital and Private Equity:

• Financial institutions may invest in and provide funding to startups and businesses through venture capital and private
equity.

8. Trust and Estate Planning:

• Financial institutions may offer trust services, helping individuals manage and distribute their wealth as part of estate
planning.

It's important to note that the distinction between banking and non-banking functions can sometimes blur, especially with
the diversification of financial services. Financial institutions often operate across multiple sectors to meet the evolving
needs of clients and the financial markets.

b. Operation:

The term "financial institution operation" generally refers to the various activities and functions that financial institutions
undertake to provide financial services and manage financial transactions. Here are key aspects of financial institution
operations:

1. Accepting Deposits:

• Financial institutions, particularly banks, operate by accepting deposits from individuals, businesses, and other entities.
These deposits form the basis for providing loans and other financial services.

2. Providing Loans and Credit:

• Financial institutions extend credit and loans to individuals and businesses. This involves evaluating creditworthiness,
setting interest rates, and managing the repayment of loans.

3. Payment Services:

• Financial institutions facilitate payment services, including the processing of checks, electronic fund transfers, wire
transfers, and credit/debit card transactions. This involves managing payment networks and ensuring the smooth flow of
funds.

4. Investment and Asset Management:

• Financial institutions, such as investment banks and asset management firms, engage in investment activities on behalf of
clients. This includes managing investment portfolios, mutual funds, and other financial assets.

5. Risk Management:

• Financial institutions are involved in identifying, assessing, and managing various types of risks, including credit risk,
market risk, and operational risk. Risk management is crucial for maintaining financial stability.

6. Foreign Exchange Services:

• Many financial institutions provide services related to foreign exchange, helping clients with currency exchange,
international trade transactions, and managing exposure to exchange rate fluctuations.

7. Financial Advisory:

• Financial institutions offer advisory services to clients, providing guidance on financial planning, investment strategies,
and wealth management.

8. Securities Trading and Brokerage:

• Investment banks and brokerage firms engage in securities trading, buying and selling financial instruments such as
stocks, bonds, and derivatives on behalf of clients.

9. Regulatory Compliance:
Financial institutions must adhere to various regulatory requirements and compliance standards set by regulatory
authorities. Compliance involves implementing measures to ensure that the institution operates within legal and regulatory
frameworks.

10. Customer Service:

• Financial institutions provide customer service to address inquiries, resolve issues, and assist clients with their financial
needs. This includes services through branches, online platforms, and customer support centers.

11. Technology and Innovation:

• Many financial institutions focus on leveraging technology and innovation to improve efficiency, enhance security, and
offer new financial products and services.

12. Anti-Money Laundering (AML) and Know Your Customer (KYC):

• Financial institutions implement AML and KYC measures to prevent money laundering and ensure that they have a clear
understanding of their customers' identities and activities.

The operations of financial institutions are diverse and multifaceted, covering a broad range of activities aimed at providing
financial services, managing risks, and contributing to economic stability. The specific operations may vary based on the
type of financial institution, such as banks, investment firms, credit unions, and insurance companies.

8. Negotiable Instruments: (Negotiable Instrument act 2034)

• A negotiable instrument is a document that guarantees the payment of a specific amount of money to a specified person
(the payee) and requires payment either on-demand or at a set date.

• Negotiable instruments are distinct from non-negotiable instruments in that they can be transferred to different people,
and, in that case, the new holder obtains full legal title to them.

• Negotiable instruments contain key information such as principal amount, interest rate, date, and, most importantly, the
signature of the payor.

a. Features of Negotiable instruments:

Negotiable instruments have certain features that make them easy to transfer from one party to another and that establish
the legal rights and obligations of the parties involved.

These features include:

Writing:

• Negotiable instruments must be in writing, signed by the issuer (also known as the maker or drawer), and contain an
unconditional promise or order to pay a specific sum of money.

Certainty of Sum:

• The amount of money to be paid must be certain and fixed.

Order or Promise to Pay:

• The instrument must contain an unconditional order or promise to pay a specific sum of money.

Signature of the Issuer:

• The instrument must be signed by the issuer (also known as the maker or drawer).

Negotiability:
• The instrument must be transferable by endorsement (signing the back of the instrument) and delivery, and it must
contain a statement that it is payable to the bearer (i.e., the person who holds it) or to the order of a designated person.

Fixed Maturity:

• The instrument must have a fixed maturity date, meaning that the payment is due on a specific date.

Interest:

• Negotiable instruments often carry interest until they are paid.

These features are designed to make the different types of negotiable instruments easy to transfer and to establish the
legal rights and obligations of the parties involved.

Negotiable instruments serve several important functions in financial transactions.

Some of the main functions of negotiable instruments include:

1. Transfer of Value Negotiable instruments are used as a means of transferring value from one party to another.

For example, a cheque is a written order to a bank to pay a specified sum of money to a designated person or entity, and a
promissory note is a written promise to pay a specific sum of money at a specific time or on demand.

2. Credit Instrument Negotiable instruments can be used as credit instruments, meaning that they can be used to borrow
or lend money.

For example, a promissory note can be used to borrow money from a lender, and a draft can be used to pay for goods or
services before the payment is due.

3. Payment Instrument Negotiable instruments can be used as payment instruments, allowing parties to pay for goods and
services without having to exchange physical currency.

For example, a cheque can be used to pay for goods or services, and a bill of exchange can be used in international trade
transactions.

4. Investment Instrument Negotiable instruments can also be bought and sold in financial markets, making them a popular
investment option.

For example, commercial paper, which is a short-term unsecured promissory note issued by corporations, is often bought
and sold in financial markets.

Overall, negotiable instruments serve as a convenient and secure means of transferring value, borrowing and lending
money, paying for goods and services, and investing.

Negotiable instruments offer several advantages for both businesses and consumers. Some of the main advantages of
negotiable instruments include:

1. Convenience

Negotiable instruments are a convenient way to transfer value from one party to another. For example, a cheque or draft
can be used to pay for goods or services without the need to exchange physical currency.

2. Security

Negotiable instruments are generally considered a secure form of payment because they are backed by a written promise
or commitment to pay.

In addition, negotiable instruments can be traced and tracked through the endorsement and delivery process, which helps
to prevent fraud and unauthorized use.

3. Credit

Negotiable instruments can be used as credit instruments, allowing businesses and individuals to borrow or lend money.
For example, a promissory note can be used to borrow money from a lender, and a draft can be used to pay for goods or
services before the payment is due.

4. Investment

Negotiable instruments can also be bought and sold in financial markets, making them a popular investment option.

b. Types of Negotiable instrument:

There are many types of negotiable instruments. The common ones include personal checks, traveler’s checks, promissory
notes, certificates of deposit, and money orders.

1. Personal checks

Personal checks are signed and authorized by someone who deposited money with the bank and specify the amount
required to be paid, as well as the name of the bearer of the check (the recipient).

While technology has led to an increase in the popularity of online banking, checks are still used to pay a variety of bills.
However, a limitation of using personal checks is that it is a relatively slow form of payment, and it takes a long time for
checks to be processed compared to other methods.

2. Traveler’s checks

Traveler’s checks are another type of negotiable instrument intended to be used as a form of payment by people on
vacation in foreign countries as an alternative to the foreign currency.

Traveler’s checks are issued by financial institutions with serial numbers and in prepaid fixed amounts. They operate using a
dual signature system, which requires the purchaser of the check to sign once before using the check and a second time
during the transaction. As long as the two signatures match up, the financial institution issuing the check will guarantee
payment to the payee unconditionally.

With traveler’s checks, purchasers do not have to worry about carrying large amounts of foreign currency while on
vacation, and banks provide security for lost or stolen checks.

With technological advancement in the last few decades, the use of traveler’s checks has gone into decline as more
convenient ways of making payments abroad have been introduced. There are also security concerns associated with
traveler’s checks, as signatures can be forged, and the checks themselves can also be counterfeit.

Today, many retailers and banks do not accept traveler’s checks due to the inconvenience of the transactions and fees
charged by banks to cash them. Instead, traveler’s checks have been mostly replaced with debit and credit cards as
methods of payment.

3. Money order

Money orders are like checks in that they promise to pay an amount to the holder of the order. Issued by financial
institutions and governments, money orders are widely available, but differ from checks in that there is usually a limit to
the amount of the order – typically $1,000.

Entities who need more than $1,000 need to purchase multiple orders. Once the money orders are bought, the purchaser
fills in the details of the recipient and the amount and sends the order to that person.

Money orders contain relatively little personal information compared to checks with just the names and addresses of the
sender and recipients and not any personal account information.

International money orders are also a popular way of sending money abroad nowadays since money orders do not need to
be cashed in the country of issuance. As such, they enable a simple and quick method of transferring money.

4. Promissory notes
Promissory notes are documents containing a written promise between parties – one party (the payor) is promising to pay
the other party (the payee) a specified amount of money at a certain date in the future. Like other negotiable instruments,

promissory notes contain all the relevant information for the promise, such as the specified principal amount, interest rate,
term length, date of issuance, and signature of the payor.

The promissory note primarily enables individuals or corporations to obtain financing from a source other than a bank or
financial institution. Those who issue a promissory note become lenders.

While promissory notes are not as informal as an IOU, which merely indicates that there is a debt, it is not as formal and
rigid as a loan contract, which is more detailed and lists out the consequences if the note is not paid and other effects.

5. Certificate of Deposit (CD)

A certificate of deposit (CD) is a product offered by financial institutions and banks that allows customers to deposit and
leave untouched a certain amount for a fixed period and, in return, benefit from a significantly high interest rate.

Usually, the interest rate increases steadily with the length of the period. The certificate of deposit is expected to be held
until maturity when the principal, along with the interest, can be withdrawn. As such, fees are often charged as a penalty
for early withdrawal.

Most financial institutions, including banks and credit unions, offer CDs, but the interest rates, term limits, and penalty fees
vary greatly. Interest rates charged on CDs are significantly higher (around three to five times) than those for savings
accounts, so most people shop around for the best rates before committing to a CD.

CDs are attractive to customers not only because of the high interest rate but also of their safe and conservative nature, as
the interest rate is fixed throughout the course of the term.

c. Promissory notes, Cheques, Bill of exchange:

Promissory notes

A promissory note refers to a written promise to its holder by an entity or an individual to pay a certain sum of money by a
pre-decided date. In other words, Promissory notes show the amount which someone owes to you or you owe to someone
together with the interest rate and also the date of payment.

For example, A purchases from B INR 10,000 worth of goods. In case A is not able to pay for the purchases in cash, or
doesn’t want to do so, he could give B a promissory note. It is A’s promise to pay B either on a specified date or on demand.

In another possibility, A might have a promissory note which is issued by C. He could endorse this note and give it to B and
clear of his dues this way. However, the seller isn’t bound to accept the promissory note. The reputation of a buyer is of
great importance to a seller in deciding whether to accept the promissory note or not

Bill of exchange

Bills of exchange refer to a legally binding, written document which instructs a party to pay a predetermined sum of money
to the second(another) party. Some of the bills might state that money is due on a specified date in the future, or they
might state that the payment is due on demand.

A bill of exchange is used in transactions pertaining to goods as well as services. It is signed by a party who owes money
(called the payer) and given to a party entitled to receive money (called the payee or seller), and thus, this could be used
for fulfilling the contract for payment. However, a seller could also endorse a bill of exchange and give it to someone else,
thus passing such payment to some other party.

It is to be noted that when the bill of exchange is issued by the financial institutions, it’s usually referred to as a bank draft.
And if it is issued by an individual, it is usually referred to as a trade draft.
A bill of exchange primarily acts as a promissory note in the international trade; the exporter or seller, in the transaction
addresses a bill of exchange to an importer or buyer. A third party, usually the banks, is a party to several bills of exchange
acting as a guarantee for these payments. It helps in reducing any risk which is part and parcel of any transaction.

Cheques

A cheque refers to an instrument in writing which contains an unconditional order, addressed to a banker and is signed by a
person who has deposited his money with the banker. This order, requires the banker to pay a certain sum of money on
demand only to to the bearer of cheque (person holding the cheque) or to any other person who is specifically to be paid as
per instructions given.

Cheques could be a good way of paying different kinds of bills. Although the usage of cheques is declining over the years
due to online banking.

Individuals still use cheques for paying for loans, college fees, car EMIs, etc.

Cheques are also a good way of keeping track of all the transactions on paper.

On the other side, cheques are comparatively a slow method of payment and might take some time to be processed.

d. Endorsement, Presentation and Dishonour of Negotiable Instruments:

Endorsement

The act of a person who is a holder of a negotiable instrument in signing his or her name on the back of that instrument,
thereby transferring title or ownership is an endorsement. An endorsement may be in favour of another individual or legal
entity. An endorsement provides a transfer of the property to that other individual or legal entity. The person to whom the
instrument is endorsed is called the endorsee. The person making the endorsement is the endorser.

Endorsement is the act of signing, usually on the back of a negotiable instrument, to legally transfer its ownership to
another party. It certifies certain aspects regarding the instrument, such as validity, enforceability to the transferee, and
any subsequent holder.

The person making an endorsement is the endorser, and the individual to whom the endorser transfers the instrument is
the endorsee. If there is no space to sign on the back of an instrument, the holder may sign on a piece of paper attached to
it.

Types of Endorsement

• Blank Endorsement – Where the endorser signs his name only, and it becomes payable to bearer.

• Special Endorsement – Where the endorser puts his sign and writes the name of the person who will receive the
payment.

• Restrictive Endorsement – Which restricts further negotiation.

• Partial Endorsement – Which allows transferring to the endorsee a part only of the amount payable on the instrument.

• Conditional Endorsement – Where the fulfilment of some conditions is required.

Presentation:

• Definition: Presentation refers to the act of presenting a negotiable instrument, typically a cheque or a bill of exchange, to
the party obligated to make payment (the drawee or the acceptor).

• Timely Presentation: Negotiable instruments often have specific timeframes within which they must be presented for
payment.

• Requirements: Proper presentation includes submitting the instrument to the right party at the right place and time.
Dishonour of Negotiable Instruments:

Dishonour of a negotiable instrument means the loss of honour for the instrument on the part of the maker, drawee or
acceptor, which renders the instrument unsuitable for the realization of the payment.

Dishonor of Negotiable Instrument refers to the state when the party who has to pay the sum in an instrument fails to
honor it. In other words, it implies the loss of honor for the instrument indicating the unsuitability of the instrument to
realize funds.

Note that the dishonour of a negotiable instrument can be done by the maker, drawee or the acceptor depending on the
case.

Types of Dishonour

On the dishonor of the negotiable instrument, the holder of the instrument must issue a notice of the same to all the
parties concerned. This is done to make them liable. It is of two types:

• Dishonor by Non-Acceptance

• Dishonor by Non-Payment

Dishonor by Non-Acceptance: When a bill is duly presented for acceptance, however, it is not accepted by the party
concerned, it is called Dishonour by non-acceptance. It can take place in the following ways:

1. When a bill of exchange is presented before the drawee for acceptance, but it is not accepted within 48 hours from the
presentment for acceptance.

2. In case there is more than one drawee, acceptance by all is a must. So, even if one of them defaults in acceptance, the
bill of exchange is regarded as dishonored. However, if the drawees are partners, then one partner can accept the same on
behalf of all.

3. In case the drawee is a fictitious person

4. When the drawee is untraceable after a normal search.

5. If the drawee to the instrument is not competent to contract, the bill is considered dishonored.

6. Qualified or Conditional acceptance of the bill, the holder may deem it as dishonored.

7. Insolvency or death of the drawee also results in dishonor by non-acceptance.

8. When presentment is excused and the instrument is not accepted.

Dishonor by Non-Payment: Dishonor by non-payment arises when the maker of the promissory note, acceptor of the bill of
exchange, and the drawee of the cheque defaults in the payment or refuses to pay the sum due on the instrument when it
is being presented for payment. Dishonor of bill and note can also take place in case the instrument is expressly excused by
its acceptor or maker or when it remains unpaid at or after maturity.

e. Letter of Credit : Definition , use importance and international practicrs: