II- B.

COM BANKING LAW AND PRACTICE CM409A

SEMESTER -IV (For the Students Admitted from the year 2019 HRS/WK –6
CORE-10 onwards) CREDIT - 4

Objectives:

1. To make the students understand the law and practice of banking.

2. To enable the students to understand the latest banking technologies.

UNIT –I Introduction to Bank (25 Hrs.)

Bank –Meaning, Definition, Classification, types of banks and their functions and Services.
Commercial Banks – meaning, definition and functions. Central Bank - meaning, definition
and functions - Universal Banking - Banking Regulations Act 1949 – features, objectives and
recent amendments.

UNIT –II Negotiable Instruments (15 Hrs.)

Negotiable instruments- meaning and definition, features and types of Cheque-Essentials of a
Cheque-Crossing of a Cheque-General Crossing a n d Special Crossing-Payment of
ChequeCollection of Cheque -Endorsement. Promissory note- meaning and features. Bill of
Exchange – Meaning, features, difference between cheque and bill of exchange, difference
between bill of exchange and promissory note.

UNIT –III Banker and Customer Relationship and Types of Customers (15 Hrs.)
Banker - Customer - General and Special relationship between Banker and Customer -
Opening of Current - Saving - Recurring - Fixed deposit Accounts - Special types of Accounts
- Minor - Lunatic - Partnership Firm - Joint Stock Company -: Non - Trading Institutions.

UNIT –IV Credit Rating, Lending and Recovery Management (15 Hrs.)
Credit Rating – Meaning, Basis, symbols and Benefits. Lending – Meaning, Lending and
Investment Policies of Commercial Banks. Types of loans – Secured and Unsecured Loans.
Recovery Management – Meaning, Advantages and Disadvantages – Elements of Debt
Recovery – Procedure of Debt Recovery – Non-Performing Assets – Meaning.

UNIT–V Innovation of Banking Technologies (20 Hrs.)

E-Banking - Internet Banking - Telephone Banking - Mobile Banking- ATMs - CashMachine -
Electronic Money - Electronic Fund Transfer System (EFT) – RTGS -– ElectronicClearing
Services (ECS) ElectronicFundTransfer: Interbank Fund Transfer Processor (IFTP),
Immediate Payment Service (IMPS)– National Electronic Fund Transfer (NEFT) and Real
Time Gross Settlement (RTGS)– Difference Between IMPS, RTGS, NEFT, UPI and Mobile
Wallets- Indian Financial Network - Customer Grievances Redressal andOmbudsman.
TEXT BOOKS

1. Sundaram, .K.P.M. & Varshney, Banking Theory Law & Practice - Sultan Chand & Sons,
New Delhi, Reprint 2015.
2) Banking Law and Practice - M. L.Tannan, - India Book House, and New Delhi.

REFERENCEBOOKS

1. Banking Theory Law & Practice - Gordon, E. Natarajan, Himalaya Publishing House,
Mumbai.
2. Banking Theory Law and Practice - Gurusamy.S, Tata McGraw Hill, New Delhi.
3. Banking Theory Law and Practice - Rajesh, Tata McGraw Hill, New Delhi.

UNIT 1

INTRODUCTION TO BANK

MEANING:

An Organization where people and businesses can invest or borrow money, change it
to foreign money, etc., or a building where these services are offered.

A bank is a financial institution that accepts deposits from the public and creates a demand
deposit while simultaneously making loans. Lending activities can be directly performed by the
bank or indirectly through capital markets.
Banks as institutions which channel people's savings into productive loans and investments.
Thus banking mainly refers to deposits and loans. A broader definition of banking is any
financial institution that receives, collects, transfers, pays, exchanges, lends, invests, or
safeguards money for its customers.

DEFINITION:

According to Sec 5(b) of the Banking Companies Act, 1949 defines banking as “Accepting
for the purpose of lending or investment of deposits of money received from the public
repayable on demand and withdrawal by cheque, draft, and order or otherwise”.

“A bank is an organization whose principal operations are concerned with the accumulation of
the temporarily idle money of the general public for the purpose of advancing to others for
expenditure.”-R.P. Kent
ORIGIN OF BANK:

 In ancient Babylon, Egypt and Greece, banking was carried on.

 In fact, the temples usually served as the place to deposit money.
 In Rome in the year 210 B.C., an ordinance was issues that set aside a place for money
changers.
 The work ‘Bank’ comes to us from Italian. Italian word for bench is ‘Banco’ from
which we derive the word ‘Bank’. which mean a bench upon which the mediaeval European Money-
lenders and Money –Changers used to display their coins
 In Venice in 1587, Banco di Rialto was first set up.
 The present-day bank has three predecessors, namely: The Goldsmith, The Merchant,
and The Money lender.
 Bank of England was setup in 1694 which was later on followed by other Central banks
of different countries.
 In India, first ever bank was establishing in 1786 called General Bank of India which
was followed by Bank if Hindustan and Bengal bank.
 The Reserve Bank of India Act was passed in the year 1934 and after independence;
Reserve Bank of India was taken over by Government by the passing of the Transfer of
Ownership Act. The shareholders of Reserve Bank of India were paid compensation.

BANKING SYSTEM:

Banking system refers to the various aspects of banking industry prevailing in a country. It
deals about the ownership of banks, the structure of banks, functions undertaken by banks and
also the nature of the business. we can exhibit banking system as follows:

A. Ownership
B. Types
C. Kinds
D. Business

A. OWNERSHIP OF BANKS:
Based on ownership, banks can be classified as Public sector banks, private sector banks,
cooperative banks and foreign banks.

a) Public sector banks: banks in a country, if fully owned by the government are public
sector bank. The word ‘the and limited’ will not feature in their names. This is because
their ownership rests with the government and the liability is unlimited.

b) Private sector banks: Private sector banks are those which are owned by group of
shareholders who elect their directors for managing the bank.

c) Co-operative banks: These banks are run under the co-operative principles of service
motive, rather than profit motive which are mainly to help the weaker sections of the
society.
 d) Foreign banks: Banks belonging to foreign countries, having their branches in India are
foreign banks; foreigners contribute the entire share capital.

B. TYPES OF BANK:

1. Unit Bank: Unit banking means a system of banking under which a single banking
organization provides banking services. Such a bank has a single office or place of work. It has
its own governing body or board of directors.

In Unit banking, the banking operations are carried on through a single office rather than
through a network of branches under the control of a single bank. The single office is both the
controlling and the operating unit. Each banking unit is a separate company with a separate
entity, with its capital, shareholders, and board of directors.

The area of operations and the bank size is small under the unit banking system compared to
the branch banking system. However, a few unit banks may have branches operating in a
limited area, and thus, it is a localized banking system.

Merits / Advantages of Unit Banking:

1) Local funds for local people: The unit banking of a particular locality utilizes its resources
to develop its locality only and does not transfer them to other localities like branch
banking.
2) Intimate Knowledge of Customer: The Managers of the local unit bank can easily acquire
the personal knowledge of customers and the specialized knowledge of the local industries
and occupations. Therefore, he is better positioned to serve the local borrowers’ needs; lie
has greater chances of cultivating a friendly and personal relationship with the individual
entrepreneurs of his locality.
3) Efficient Management supervision and control: One of the most important advantages of
the unit banking system is that it can be managed efficiently because of its size and work.
Coordination and control become effective.
4) Discontinuance of inefficient branches.
5) Better Service: Unit banks can render efficient service to their customers. Their area of
operation is limited. They can concentrate well on that limited area and provide the best
possible service.
6) Close Customer-banker Relations: Since the area of operation is limited, the customers
can have direct contact. Their grievances can be redressed then and there.
7) No Effects Due to Strikes or Closure: If there is a strike or closure of a unit, it does not
impact the trade and industry because of its small size.
8) No Monopolistic Practices: Since the size of the bank and the area of its operation are
limited, it is difficult for the bank to adopt monopolistic practices.
9) No Risks of Fraud: Due to the small size of the bank, there is stricter and closer control of
management.
10) Closure of Inefficient Banks: Inefficient banks will be automatically closed as they would
not satisfy their customers by providing efficient service.
11) Local Development: Unit banking is localized banking. The unit bank has the specialized
knowledge of the local problems and serves the requirement of the local people in a better
manner than branch banking.
12) Promotes Regional Balance: Under the unit banking system, there is no transfer of
resources from rural and backward areas to the big industrial and commercial centers.

Demerits / Disadvantages of Unit Banking:

1) No Economies of Large Scale: Since the size of a unit bank is small, it cannot reap the
advantages of a large scale.
2) Lack of Uniformity in Interest Rates: In a unit banking system, there will be a large
number of banks in operation. Transfer of funds will be difficult and costly.
3) Lack of Control: Since the number of unit banks is huge, their coordination and control
would become very difficult.
4) Risks of Bank’s Failure: Unit banks are more exposed to closure risks.
5) Limited Resources: Under the unit banking system, the size of banks is small, so they
cannot meet the requirements of large-scale industries.
6) Unhealthy Competition: Some unit banks come into existence at an important business
center.
7) Wastage of National Resources: Unit banks concentrate in big metropolitan cities,
whereas they do not have their workplaces in rural areas.
8) No Banking Development in Backward Areas: Unit banks cannot open branches.
9) Local Pressure: Since unit banks are highly localized in their business, local pressures
and interferences generally disrupt their normal functioning.

2. Branch Bank: Banking Branch Banking System means a system of banking in which a
banking organization works at more than one. This is the world’s most practices banking
system. Branch bank is a system with the group shareholders and board of directors
constituting the head office. The business operations of the bank are carried by these branches
spread throughout the town, state or country or even throughout the world.

Merits / Advantages of Branch Banking: The rapid growth and wide popularity of branch
banking systems are due to various advantages.

a) Economics of Large Scale: Operations under the branch banking system, the bank with
some branches possesses huge financial resources and enjoys the benefits of large-scale
operations. Highly trained and experienced staff is appointed which increases the efficiency
of management. Division of labor is introduced in the banking operations, ensuring a
greater economy in the bank’s working. Right persons are appointed at the right place, and
specialization increases; large financial resources and wider geographical coverage increase
public confidence in the banking system.
b) Spreading of Risk: Another advantage of the branch banking system is the lesser risk and
greater capacity to meet risks. Since there are geographical spreading and diversification of
risks, the bank’s failure is remote. The profits earned by other branches may offset the
losses incurred by some branches. Large resources of branch banks increase their ability to
face any crisis.
c) The economy in Cash Reserves: Under the branch banking system, a particular branch
can operate without keeping large amounts of idle reserves. In a time of need, resources can
be transferred from one branch to another.
d) Diversification of Deposits and Assets: There is greater diversification of both deposits
and assets under a branch banking system because of wider geographical coverage.
Deposits are received from the areas where savings are in plenty, and Loans are extended
 in those areas where funds are scarce, and interest rates are high. The choice of securities
and investments is wider in this system, increasing the safety and liquidity of funds.
e) Decentralization of Risks: In the blanch banking system, branches are not concentrated in
one place or one industry.
f) Easy and Economical Transfer of Funds: Under branch banking, it is easier and
economical to transfer funds from one branch to the other.
g) Cheap Remittance Facilities: Since bank branches are spread over the whole country, it is
easier and cheaper to transfer funds from one place to another. Inter-branch indebtedness is
more easily adjusted than inter-bank indebtedness.
h) Uniform Interest Rates: Under the branch banking system, the mobility of capital
increases, which in turn, brings about equality in interest rates. Funds are transferred from
areas with excessive demand for money to areas with deficit demand for money. As a
result, the uniform rate of interest prevails in the whole area; it is prevented from rising in
the excessive demand area and falling in the deficit demand area.
i) Proper Use of Capital: There is a proper use of capital under the branch banking system.
If a branch has excess reserves but no opportunities for investment, it can transfer the
resources to other branches, which can make the most profitable use of these resources.
j) Better Facilities to Customers: The customers get better and greater facilities under the
branch banking system. The small number of customers per branch and the increased
efficiency achieved through large-scale operations result from the small number of
customers per branch.
k) Contacts with the Whole Country: Under branch banking, the bank maintains continual
contacts with all parts of the country. This helps it to acquire correct and reliable
knowledge about economic conditions in various parts of the country.
l) Uniform Rates of Interest: In branch banking, there is better control and coordination of
the central bank.
m) Better Training Facilities for Employees: Banks’ can hire and train the employees better.
This is possible because the branch banking system has a vast network.

Demerits / Disadvantages of branch banking system: The Branch banking system has many
disadvantages that can affect the grassroots customers and the entire economy.

a) Difficulties of Management, Supervision, and Control: Since hundreds of bank

branches under this system, management, supervision, and control became more
inconvenient and difficult.
b) Lack of Initiative: Under this system, the bank branches suffer from a complete lack of
initiative on important banking problems confronting them.
c) Monopolistic Tendencies: Branch banking encourages monopolistic tendencies,
dominating and controlling the country’s whole banking system through their branches.
d) Regional Imbalances: Under the branch banking system encourages regional imbalances
in the country.
e) Continuance of Non-profitable Branches: In this system, unprofitable branches
continue to operate under the protection cover of the stronger and profitable branches.
f) Unnecessary Competition: Under branch banking the branches the competing banks try
to tempt customers by offering extra inducements and facilities.
g) Expensiveness: The Branch Banking system is much more expensive than the unit
banking system.
h) Losses by Some Branches affect Others: When some branches suffer losses due to
certain reasons, this has repercussions on other bank branches.
3. Group Bank: Group banking is type of banking in which there is a holding company,
controlling the subsidiary companies which are doing banking business. The banking business
is controlled by the holding company.

 Group Banking is a plan offered by banks designed to be used by groups rather than
individuals. In Group Banking, the bank will offer incentives such as discounts, lower
fees, interest rates, and other benefits not available to individual customers.
 Group banking can also provide a more personalized banking relationship for the
members if the bank designates one representative, who is generally more knowledgeable
about the group’s needs, as the point of contact for all the group members.
 A plan offered by banks designed to be used by groups rather than individuals. A
common example is a company plan offered to employees.
 Usually, the bank will offer incentives such as discounts, lower fees, interest rates, and
other benefits not available to individual customers.
 Group banking members may have access to lower interest rates, lower fees, discounts,
and other perks not available to regular account holders.
 Group banking can also provide a more personalized banking relationship for the
members if the bank designates one representative, who is generally more knowledgeable
about the group’s needs, as the point of contact for all the group members.

4. Chain Bank: When different banks are coming under a common control through common
shareholders or by the inter-locking of directors, such banking are called chain banks. Chain
Banking is a form of banking when a small group of individuals controls three or more
independently chartered banks. The underlying principles of chain banking are:

a) A small group of persons owns and controls some independent banks.

b)Each bank carries its operations independently without any external interference by any
holding company.
c) Every member of the chain retains its independent identity.

 Conceptually, chain banking refers to a form of bank governance that occurs when a small
group of people controls at least three independently chartered banks.
 Usually, the controlling parties are majority shareholders or the heads of interlocking
directorates. Chain banking as an entity has declined with the surge in interstate banking.
 Chain banking is when a small group of people controls three or more banks that are
independently chartered.
 The concept of chain banking is different from group banking. The entities involved in the
chain bank arrangement remain autonomous and are not owned by a single holding
company.
 By contrast, the group banking model requires a holding company to own all the banks
involved, effectively creating an umbrella under which all the banks operate.
 Chain banking is also different from branch banking, where a single banking institution
owns all local branches of a bank.
 A bank holding company is a company that controls one or more banks but does not
necessarily engage in banking itself.

5. Correspondent bank: When two banks of different statue or size are linked by another
bank, the bank which is linking them is called a correspondent bank. In India, for many of the
foreign banks certain Indian banks act as correspondent banks.
C. KINDS OF BANKS:

1. Commercial Banks: It is a kind of bank which promotes commercial activities by lending

for various commercial activities. The bank cannot afford to give long-term loan and can
provide only working capital for business purposes. The commercial activities in the country
such as trade, warehousing, transport, etc., are financed by the commercial banks.

2. Industrial or Investment Bank: When banks provides long-term loan to industries, they
are called industrial bank or investment bank. As investments banks, they take part in the
shares capital of companies. They even promote companies by underwriting shares which
enables the public to purchase the shares of these companies.

3. Co-operative Bank: Co-operative banks are registered under the Cooperative Societies Act.
They generally give credit facilities to small farmers, salaried employees, small-scale
industries, etc. Co-operative Banks are available in rural as well as in urban areas. The
functions of these banks are just similar to commercial.

4. Agricultural Development Bank: As the bank is promoting the growth of agriculture, it is

called Agricultural Development Bank. Similar to the Co-operative banks, these banks help by
providing loans to the weaker section. In Tamilnadu, it is called Tamilnadu Co-operative Land
Development Bank. These banks raise funds by the issue of long-dated debentures. They
specialize in granting long-term loans against agriculture and urban properties for their
development. These banks are also known as Land Development Banks.

5. Savings Bank: The purpose of this kind of bank is to encourage people to save more. The
bank accepts even small amount for the purpose of savings. At the same time, it discourages
people from withdrawing. For this purpose, it was restricted the number of withdrawals in a
year.

6. Foreign Banks or Exchange Banks: Banks which are incorporated outside the country but
doing banking business in India are called Exchange Banks. They provide foreign exchange,
subject to the rules and regulations of the country in which they are located. They help in
exports and imports. The exchange banks are banking institutions that finance foreign trade.
They are primarily engaged in transactions involving foreign exchange. In this way, they
facilitate import and export. Besides dealing in foreign exchange, these banks also undertake
ordinary banking business. Most of these banks are of foreign origins, such as Standard
Chartered Bank. Bank of America. City Bank, etc.

7. Central Banks: The Central Bank of a country is an institution that acts as the leader of the
banking system and the money market. It regulates money and credit in close cooperation with
the government. It also controls the other banks of the country. It occupies a central position in
the banking structure of a country. It not only controls the banks but also protects by helping
them whenever they are in difficulty. The central bank is also responsible for controlling the
price level. It has authority to issue the money. Though this, it controls the exchange rate.

8. Consumers Banks: Consumers bank is a new addition to the existing type of banks. Such
banks are usually found only in advanced countries like the USA and Germany. The main
objective of this bank is to give consumers loans to purchase durables like Motor cars,
television set washing machines, furniture, etc. The consumers have to repay the loans in easy
installments.
EXIM Bank: EXIM bank means export and import banks, it only includes the transaction of
export and import function. In India, export and import bank setup to provide export and
import finance. This bank was setup in January 1982, as a public sector bank. It was started
with a limited paid-up capital of RS.500 crores, contributed as initial by Government of India.

Functions of EXIM Bank

1. Export to finance.
2. Credit to the foreign imported in Indian goods.
3. Foreign exchange.
4. Assistance in export of finance management.
5. Assistance required by exports.
6. Discount and rediscount export.
7. Export marketing is provided to exports.
8. Not only to help Indian exporters.

D. BANKING BUSINESS: The banks concentrating only on deposits come under deposit
banking. They may lend only for a short period, such as less than a year.

a) Investment banking pertains to promoting long-term investment and it helps business to

acquire fixed assets by lending for a longer period.

b) Mixed banking combines both deposit and investment banking. Mixed banking is a
system of banking where a bank combines both deposit banking and investment banking.
In other words, the bank will provide short-term loans for commerce and trade and long-
term finance for industrial units. While this type of banking promotes rapid
industrialization, the mixed banking system reduces commercial banks’ liquidity. Stated
differently, it is difficult to pay back the borrowed funds of customers whenever they
demand their money. This is because funds get blocked when the bank gives long-term
loans to industries.

c) Wholesale banking is a kind of banking business in which the banker concentrates on

corporate customers, consisting of different types of companies. Here, the bank will have
less number of customers but more business and turnover, which result in more profits.

d) Retail banking is quite opposite to wholesale banking. The bank concentrates on

individual customers and has its business operations in residential areas and gives more
consumer loans to improve their standard of living. Compared to whole sale banking, the
volume of business of retail banking will be less, but they concentrate more on the
requirements of individual customers.

Meaning of Commercial Banks:

A commercial bank is a financial institution which performs the functions of accepting deposits
from the general public and giving loans for investment with the aim of earning profit. In fact,
commercial banks, as their name suggests, axe profit-seeking institutions, i.e., they do banking
business to earn profit.
They generally finance trade and commerce with short-term loans. They charge high rate of
interest from the borrowers but pay much less rate of Interest to their depositors with the result
that the difference between the two rates of interest becomes the main source of profit of the
banks. Most of the Indian joint stock Banks are Commercial Banks such as Punjab National
Bank, Allahabad Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc.

Functions of Commercial Banks:

The two most distinctive features of a commercial bank are borrowing and lending, i.e.,
acceptance of deposits and lending of money to projects to earn Interest (profit). In short, banks
borrow to lend. The rate of interest offered by the banks to depositors is called the borrowing
rate while the rate at which banks lend out is called lending rate.

The difference between the rates is called ‘spread’ which is appropriated by the banks. Mind,
all financial institutions are not commercial banks because only those which perform dual
functions of (i) accepting deposits and (ii) giving loans are termed as commercial banks. For
example post offices are not bank because they do not give loans. Functions of commercial
banks are classified in to two main categories—(A) Primary functions and (B) Secondary
functions.

(A) Primary Function: The primary function consists of traditional functions of the bank.

1. It accepts deposits: A commercial bank accepts deposits in the form of current, savings and
fixed deposits. It collects the surplus balances of the Individuals, firms and finances the
temporary needs of commercial transactions. The first task is, therefore, the collection of the
savings of the public. The bank does this by accepting deposits from its customers. Deposits
are the lifeline of banks. Deposits are of four types as under:
a. Savings Account:

Saving account can be opened by any person above the age of 18 and he/she has to be
introduced by another customer of the same branch. In the modern days, banks insist on two
copies of photographs of persons intending to open account. This is to prevent benami account
holders which are opened in joint accounts. In savings account, the credit balance of the
customer must be sufficient enough so that cheques issued by the customers could be honored.
If a customer issues a cheque without sufficient credit balance in his/her account, the cheque
will bounce or will be dishonored. The customer who has issued such a cheque will be liable
for legal action. A saving account can also be opened without a cheque book facility. In such
case, the customer will use the withdrawal slip provided by the bank. The bank will be
provided to the savings account holder interest on the minimum credit balance remaining
between the 10th and last working day of each month. This interest is payable half yearly and
is credited to the account of the customer. If deposits are kept beyond the limit, no interest
will be payable for that excess amount. A minor can also open a saving account.
 As per the new instruction by RBI, all banks have been asked to calculate interest rate on
savings account on daily basis @ 3.5% and so the previous method of calculating interest rate
has been given up. This will benefit bankers, as cash withdrawals will come down and there
will be more arrival of deposits.

b. Current Account:

Unlike savings account current account cannot be opened by every individual. For opening
a current account, a letter of introduction is required which testifies the character and conduct
of the person who intend to open the current account. This letter of introduction can be given
either by another current account holder of the same branch or by a well reputed person known
to the banker or by an employee not below the rank of an officer of the same bank. If a current
account is opened without the letter of introduction, it will be an offence and the banker will
lose statutory protection. The advantage of current account is that the customer can draw more
than his credit balance, provided he is given overdraft facility. Normally, this type of account
is held by business people who may require money for various activities. Banker will not pay
interest for credit balance of the customer. But any debit balance in the current account will be
charged interest rate on day to day basis, and this will work out to be cheaper for the customer.
The cheque book facility is given to all current account holders. A minor can open a current
account with a bank, but he cannot be given overdraft. The law does not prevent a minor from
having a current account.

c. Recurring Account:

A stipulated amount of money is deposited every month for a fixed period, say one or
two years, which is payable at the expiry of the fixed period along with interest is called
recurring Deposits.

This can be opened either in a bank or even in s post office savings account. The
interest rate on recurring deposits will be higher as they are calculated on a cumulative basis.
In order to attract people to open more deposit account with the bank, the government has
provided income tax allowances up to Rs.12,000 i.e., any interest income earned up to
Rs.12,000 during financial year is exempted from income tax (Sec 80L of the Income Tax
Act). This facility is not available to depositors with any other institution.

d. Fixed Deposit Account:

When a customer deposits certain sum of money to be kept with the banker for a fixed
period, it is called a fixed deposit account. The banker will issue a receipt which is called as
fixed deposit receipt.

This receipt is nontransferable. This mean that the amount is payable on maturity only
to that deposit holder in whose name the deposit receipt stands. Thus, a fixed deposit account
can be opened even in the name if a minor. The deposit amount is payable along with the
interest at the rate as agreed upon. But a customer has the opinion to foreclose the deposit even
before the date of maturity. In such a case, the customer will not be entitled to the agreed rate
of interest.
 Fixed deposit is non-transferable. In case of death of the owner, it can be given only to
the legal heir. However, the owner of the fixed deposit receipt when he/she is in the deathbed,
can write a will by which he can transfer the fixed deposit receipt to anyone. Such an Act is
called donation-mortis-causa- death bed gift.

2. It gives loans and advances: The second major function of a commercial bank is to give
loans and advances particularly to businessmen and entrepreneurs and thereby earn interest.
This is, in fact, the main source of income of the bank. A bank keeps a certain portion of the
deposits with itself as reserve and gives (lends) the balance to the borrowers as loans and
advances in the form of cash credit, demand loans, short-run loans, overdraft as explained
under.

a). Clean loan:

Clean loan is a loan granted by the banker without any security but the banker safeguards
himself by granting clean loan to salaried person will deduct from the salary and pay to the
banker the installment amounts due on the loan. Thus, a clean loan enables the banker to
grant loan to salaried people. Only condition that the employment of the borrower be
permanent in future.

b). Secured loan:

 Pledge: when loans are granted against the security of the borrower it is a secured loan.
The borrower will hand over the security to the banker under pledge.

 Mortgage: In mortgage, the loan is granted against fixed immovable property. If the
borrower fails to repay the loan, the mortgaged property will be sold and the loan amount
realized.

 Hypothecation: It is a kind of loan where in the borrower is enabled to purchase a vehicle

or machinery with the help of bank loan. The document of title will have the mention of
hypothecation.
 Assignment: This is transfer of an actionable claim. If the borrower of a bank has an
insurance policy, he can transfer the policy in favor of the bank before its maturity and
obtain a loan. The bank will adjust the loan from the policy amount when it matures.

3. Discounting bills of exchange or

bundles:
A bill of exchange represents a promise to pay a fixed amount of money at a specific point of
time in future. It can also be encashed earlier through discounting process of a commercial
bank. Alternatively, a bill of exchange is a document acknowledging an amount of money
owed in consideration of goods received. It is a paper asset signed by the debtor and the
creditor for a fixed amount payable on a fixed date. It works like this.

Suppose, A buys goods from B, he may not pay B immediately but instead give B a bill of
exchange stating the amount of money owed and the time when A will settle the debt. Suppose,
B wants the money immediately, he will present the bill of exchange (Hundi) to the bank for
discounting. The bank will deduct the commission and pay to B the present value of the bill.
When the bill matures after specified period, the bank will get payment from A.

4. Overdraft facility:
An overdraft is an advance given by allowing a customer keeping current account to overdraw
his current account up to an agreed limit. It is a facility to a depositor for overdrawing the
amount than the balance amount in his account.

In other words, depositors of current account make arrangement with the banks that in case a
cheque has been drawn by them which are not covered by the deposit, then the bank should
grant overdraft and honour the cheque. The security for overdraft is generally financial assets
like shares, debentures, life insurance policies of the account holder, etc.

5. Cash credit:

For the benefit of businessmen who are in need of working capital, cash credit system
is arranged. The bank will charge interest according to the period of the loan. Thus, this
system not only leaves certain amount of money at the disposal of the customer but also
carries lesser rate of interest.

6. Investments of Funds:

While making an investment a bank is required to observe three principles, namely

liquidity, profitability and safety. A bank invests its funds in government securities issued
by central government as well as state government. It also invests in other approved
securities like the units of UTI, shares of GIC and LIC, securities of State Electricity
Board etc.

(B) Secondary Functions:

Apart from the above-mentioned two primary (major) functions, commercial banks perform
the following secondary functions also.

7. Agency functions of the bank: The bank acts as an agent of its customers and gets
commission for performing agency functions as under:

 Transfer of funds: It provides facility for cheap and easy remittance of funds from
place-to-place through demand drafts, mail transfers, telegraphic transfers, etc.
 Collection of funds: It collects funds through cheques, bills, bundles and demand drafts
on behalf of its customers.
 Payments of various items: It makes payment of taxes. Insurance premium, bills, etc. as
per the directions of its customers.
  Purchase and sale of shares and securities: It buys sells and keeps in safe custody
securities and shares on behalf of its customers.
 Collection of dividends, interest on shares and debentures is made on behalf of its
customers.
 Acts as Trustee and Executor of property of its customers on advice of its customers.
 Letters of References: It gives information about economic position of its customers to
traders and provides similar information about other traders to its customers.
 Disperses salary to employees on instruction from employer.
 Issue of credit cards, both in rural and urban areas.

8. Performing general utility

services:
 On permission from RBI, the bank purchase or sells foreign exchange.
 On behalf of importer, the banker issues letter of credit to the exporter.
 The banker act as “drawee in case of need” by accepting bills on behalf of customers.
 The bank undertakes merchant bank activity such as underwriting of shares and
debentures of companies.
 It provides safe deposit vault in which customers can keep their valuables.
 It accepts income tax on behalf of RBI.
 On behalf of certain customers, it acts as referee by which the credit worthiness of the
customer improves.
 The bank also supplies data and trade information required by businessman.
 On behalf of the government the bank is able to mobilize huge amount of foreign
exchange for investing in infrastructure.
 Global Deposit Receipt of companies is promoted by banks.
 Underwriting securities issued by government, public or private bodies.

MODERN FUNCTION OF COMMERCIAL BANKS:

1. Teller system: Under this system, when a customer presents a cheque, a counter clerk will
make payments immediately. In big metropolitan cities, the bank provides this facility to the
customers, so that they need not wait for a longtime for withdrawal of money.

2. ATM: Automatic Teller Machine, under this system a customer can withdraw money by
using his credit card. The customer who wants to avail ATM facility will be given a code
number which will be kept secret by the customer. The ATM facility is available in all
metropolitan cities.

3. Home Banking: Instead of going to the bank for withdrawal of money or for depositing of
cheques, a customer can do his banking business by sitting at home. For this purpose, personal
computers of customers will be connected with banker’s computer through network.

4. Green Card: In India, credit card facility is given to the farmers by issue of Green card to
them. This will enable them to buy all their inputs by using the Green Card.
5. Factoring: Commercial banks in India are undertaking factoring business. Under this, the
bills drawn by customers on the buyer will be handed over to the bank fir collection.

6. Mutual funds: To enable the customer to avail the benefit of investments, banks in India
have started mutual funds. The saving of the customers are invested in mutual funds by
purchase of units.

7. Electronic Clearing System (ECS): The telephone charges are being paid through this
system. The banks are connected to the telephone department through a network by which, the
telephone charges of the customers are paid.

8. Gold or Platinum Card: Generally, customers are given credit card facility through the
banks according to their credit worthiness. The purchase of the customers are restricted upto
the available credit and once this limit is exhausted, the purchase through credit card will not
be ratified.

9. Gold Banking: It is a scheme introduced in 2000-01 budget year by the union finance
minister and State Bank of India is the first bank in India to introduce Gold Deposit Scheme.

10. E-Banking: E-Banking refers to electronic banking; where in the entire operations are
done by the customer through his computer system by using a code, which maintain secrecy of
transaction. Banking operations are done throughout the day and global transactions are made
much more easy.

11. Innovative Banking: When banks deviate from their traditional functioning of accepting
deposits and lending for various activities, such functions comes under innovative banking.

12. Disounting of Foreign Bills/ Forfeiting: This is an arrangement under which the exporter
is provider finance against his bills by the forfeiting bank. In domestic trade, it is discounting
of foreign bills whereas in foreign trade, it is discounting of foreign bill in favour of the
exporter.

13. Core Banking: It is a device whereby a bank will link all its branches through a network
system. By this method, a customer will able to operate his account in any of the branches of a
particular bank.

Significance of Commercial Banks:

Commercial banks play such an important role in the economic development of a country that
modern industrial economy cannot exist without them. They constitute nerve centre of
production, trade and industry of a country. In the words of Wick-sell, “Bank is the heart and
central point of modern exchange economy.”

The following points highlight the significance of commercial banks:

1) They promote savings and accelerate the rate of capital formation.
2) They are source of finance and credit for trade and industry.
3) They promote balanced regional development by opening branches in backward areas.
4) Bank credit enables entrepreneurs to innovate and invest which accelerates the process of
economic development.
 5) They help in promoting large-scale production and growth of priority sectors such as
agriculture, small-scale industry, retail trade and export.
6) They create credit in the sense that they are able to give more loans and advances than the
cash position of the depositor’s permits.
7) They help commerce and industry to expand their field of operation.
8) Thus, they make optimum utilization of resources possible.

DIFFERENCE BETWEEN CENTRAL BANK AND COMMERCIAL BANK:

S.No Basis Central Bank Commercial Bank
Its main objective is to earn the
1. Objectives It is non-profit organization
profit
It is owned by government or
2. Procedures It is owned by government
private sector
Central bank alone is empowered to Commercial bank has no power no
3. Functions
issue currency issue currency
Deals of Central bank deals only Commercial banks deal mainly the
4.
Accounts government accounts account of people
Central bank control commercial Commercial bank only request for
5. Control
bank assistance from central bank
Statutory control can be
Rules and exercised on commercial banks, Commercial bank have no such
6.
Regulations filing which their business can power
be suspended
Commercial bank can have only a
The entire foreign exchange
small part time of the foreign
7. Reserve reserved of the country is handled
exchange that too with the consent
by the central bank
of central bank

FUNCTIONS OF CENTRAL BANK:

1. Issue of currency

The central bank is entrusted with the responsibility of issuing currency. For issuing
currency, the central bank has to maintain certain amount of reserves in the form of god and
foreign exchange. This is to support the issue of currency and to maintain its value. The banks
maintain certain amount of asset in the form of gold and foreign currency.

2. Acts as banker to the Government

The central bank act as a banker to the government by maintaining the accounts of the
government. All the government revenues are received by the central bank and similarly, the
payments are also made through the central bank. The revenue of the government will be
irregular while the expenditure is recurring and periodical.

3. Acts as banker’s bank

 The central bank is responsible for the development of banking industry in the country.
For this purpose it must encourage sound banking principle. Only genuine banks should be
encouraged to do banking activity while others should not be allowed. The central bank should
also act as a custodian of the commercial banks.

4. Lender of last resort

A central bank is said to be the lender of last resort when the commercial banks
approach it during a financial crisis. Normally, a commercial bank will have various options to
meet its requirements. It may discount its bills and sell its securities for raising additional
funds.

E. Controller of Credit

When commercial banks undertake lending activity, it creates the economy an increase
in the money supply. When there is too much of credit extended, it will result in an
inflationary trend.

When the central bank, exercise control on commercial banks with the view to increase
or decrease the money supply, it is called credit control. Through credit control, the central
bank would like to expand bank credit or contract bank credit. An exercise Bank credit leads to
more money supply in the hands of customer.

F. Arranges Clearing house facilities

With more number of banks in operation, cheques of different banks are received.
These cheques have to be collected, realized and credit to the amount of the customers. A
clearing house is one which arranges the clearance of cheque drawn on different banks.
G. Custodian of Foreign Exchange Reserve

Every central bank has responsibility to maintain not only the domestic value of the
currency but also its foreign value. For this purpose, the banks have to maintain adequate
foreign exchange reserve. The central bank receives foreign currency not only from the
government but also from other commercial banks.

QUANTITATIVE AND QUALITATIVE METHODS OF CREDIT CONTROL:

A central bank can adopt various quantitative and qualitative methods for credit control
(quantitative methods) such as bank rate, open market operation, changes in reserve ratio;
selective controls (qualitative methods) such as margin requirements, regulation of consumer
credit, direct action and moral suasion etc.

Quantitative control regulates the volume of total credit. Whereas the qualitative or selective
controls regulates the flow of credit for various uses and purposes.

The central bank with its methods usually controls the volume of credit in the country. The use
of these methods is guided by the following objectives:
a) Stability of Internal Price-level: The commercial bank can create credit because their
main task is borrowing and lending. They create credit without any increase in cash with them.
This leads to increase in the purchasing power of many people which may lead to an increase
in the prices. The central bank applies its credit control to bring about a proper adjustment
between the supply of credit and measures requirements of credit in the country. This will help
in keeping the prices stable.
b) Checking Booms and Depressions: The operation of trade cycles causes instability in the
country. So the objective of the credit control should be to reduce the uncertainties caused by
these cycles. The central bank adjusts the operation of the trade cycles by increasing and
decreasing the volume of credit.
c) Promotion of Economic Development: The objective of credit control should be to
promote economic development and employment in the country. When there is lack of money,
its supply should be increased so that there are more and more economic activities and more
and more people may get employment. While resorting to credit squeeze, the central bank
should see that these objectives are not affected adversely.
d) Stability of the Money Market: The central bank should operate its weapons of
credit control so as to neutralize the seasonal variations in the demand for funds in the country.
It should liberalize credit (supply of funds) in terms of financial stringencies to bring
about stability in the money market.
e) Stability in Exchange Rates: This is also an important objective of credit control. Credit
control measures certainly influence the price level in the country. The internal price level
affects the volume of exports and imports of the country which may bring fluctuations in the
foreign exchange rates. While using any measure of credit control, it should be ensured that
there will be no violent fluctuation in the exchange rates.

Types of credit control

1. Quantitative Control

 Aims at increasing or decreasing the quantity of money supply.

 The increase or decrease in the quantum of credit influences the economic activity.
 It is a traditional weapon and an indirect weapon.
 The effect of this control can be felt in the long run,
2. Qualitative Control

 It does not affect the quantum of money supply but affects the ultimate use of the
money supply, hence it is discriminatory.
 This control does not influence the entire economy but affects only a particular section
of the economy.
 It is a modern weapon and a direct weapon.
 It has human effect.
Objectives of Credit Control

i. It tries to bring stability in the economy by removing those factors responsible for price
increase or unemployment or trade fluctuation.
ii. Through control of credit, the central bank will achieve this object of economic growth
or price stability or correcting adverse balance of payment.
iii. The Central bank exercises effective control over commercial banks.
 iv. It helps the government to achieve economic development with the higher.

Quantitative Credit Control

1. Bank Rate: It is the rate at which the Central bank rediscounts the bills presented by the
commercial banks for giving loans. Whenever the commercial banks are in need of funds, they
approach the Central bank by presenting to the central bank eligible securities, mainly
government securities. By discounting these securities, the central bank grants loan to the
commercial banks. It is based on this rate that the commercial banks in turn grants loans to its
customers. Thus, if the bank rate is increased, the commercial banks will have to pay a higher
rate of interest for their borrowings from central bank. In turn, the commercial banks will
charge higher interest rate when they grant loans to their customer. Thus, the bank rate
indirectly influences the borrowers of the bank. The bank rate operation is based on certain
assumptions. These are:

i. The commercial banks are doing business with minimum cash reserve.
ii. The commercial banks have eligible securities which the central bank discounts for
granting loan.
iii. The commercial banks have no other option except to borrow from central banks.
iv. Based on the bank rate only, the interest rates on borrowings are decided and so when the
bank rate is raised, interest rate will also be increased.
2. Open market operation: When the Central bank resorts to direct buying and selling of
securities in the money market, it is called open market operation. By selling in the money
market, the central bank tries to absorb the excess money supply with the commercial banks,
insurance companies and other financial institutions. Thus, during a period of inflation, the
sale of security by Central bank will encourage commercial banks to buy. In this process, the
surplus cash will the commercial banks disappear and in its place the securities will appear.
When the commercial banks are left with less amount of funds, they cannot lend more and so
borrowers will find it difficult to obtain loan. This will bring down the economic activities and
thereby the income. Thus, price or inflation is bought down. Similarly, during a period of
depression, central bank will buy the securities from the commercial banks and thereby infuse
money supply in the economy which will result in more demand and the economic activities
will revive. Price level will also pick-up showing revival in the economy.

3. Variable Cash Reserve Ratio: Under this weapon of credit control, the central bank
prescribes the minimum percentage of cash the commercial banks are to maintain against their
funds time and demand deposits. If the cash reserve ratio is reduced, the bank will be
maintaining a low cash in hand and this will enable them to give more loans. Increased
lending by commercial banks will lead to more economic activities. At the same time, if there
is inflation, the central bank will hike the percentage of cash reserve ratio. This will leave a
lesser amount of cash at the disposal of commercial banks for lending. We have explained
under credit creation mechanism how there will be an increased expansion of deposit with
reduction in cash reserve ratio and how the contraction of deposits takes place when there is an
increase in the cash reserve ratio.

Qualitative Credit Control:

 This is a weapon used by the Central bank when it wants to specifically take action
against a particular industry or a particular segment of borrowers. For example, if the price of
sugar is increasing, it may be due to artificial scarcity created by the traders. Suppose a trader
is given Rs.1,000 loan by the bank and he purchase sugar bags out of that money, to that
extend the supply of sugar is affected. If the borrows on the security of sugar stock and again
buys fresh sugar bags, the price of sugar will further go up. It is at this juncture the Central
bank enters the Market and gives specific instruction to commercial bank not to lend against
the security of sugar stock. This will lead to discouragement of trading in sugar and the price
of sugar is bought down. This kind of credit is known as discriminating credit. The bank will
also be told to extend credit against such securities whose prices are low so that demand will
pick up against those stocks. The qualitative credit control measures are:

a. Margin requirements: Under this method, the Central bank will prescribe the percentage
of margin a bank should maintain while granting loan. During inflation the central bank
will increase the margin leaving a lesser amount of cash at the disposal of the borrower.
This will affect their borrowing capacity and thereby the demand for other goods. The same
margin will be lowered during depression so that more money is given as loan enabling the
borrower to demand more goods. Thus, a higher margin on loans will reduce borrowing
cash flows, demands for goods and their inflation. A lower margin will increase borrowing,
cash flow, demand for goods and there revive depression. This method has many
advantages:
 It controls credit in the speculative areas without affecting the availability of credit in
the productive sectors,
 It controls inflation by curtailing speculative activities on the one hand and by diverting
credit to the productive activities on the other,
 It reduces fluctuations in the market prices of securities,
 It is a simple method of credit control and can be easily administered. However, the
effectiveness of this method requires that there are no leakages of credit from
productive areas to the unproductive or speculative areas.
b. Regulation of consumer credit: When banks are lending to consumers for the purchase
of consumer goods or installment basis or hire purchase basis, there will be two aspect
taken into account:

i. The margin money to be brought by the consumer.

ii. The number of installments the consumer has to pay towards the price.

i. Control bank advances: The central bank may instruct the commercial bank not to lend
for undesirable and unproductive purposes and direct credit only for productive purposes.
For this purpose, the central bank will specifically inform the commercial banks that they
will discount only certain specific bills and will refuse to discount other bills. In this
manner, control on bank advances is brought about.

ii. Rationing of credit: Credit rationing is a selective method of controlling and regulating
the purpose for which credit is granted by the commercial banks. Credit rationing is a
method by which the distribution of credit is done according to the condition of the
 national economy. If there is more demand for agricultural credit, then the central bank
may say that certain percentage of loanable funds should go to agriculture. The central
bank fixes a ratio regarding the capital of a commercial bank to its total asset. By credit
rationing, a limit is also fixed for each portfolio of loans advances by the commercial
banks. In other words, credit rationing aims at- (a) limiting the maximum loans and
advances to the commercial banks, and (b) fixing ceiling for specific categories of loans
and advances.

iii. Moral suasion: It is nothing but a request made by a Central bank to commercial banks to
co-operate with the policies of central bank. The appeal of the central bank will be
acceded by the commercial bank only when a cordial relationship exists among them.
This weapon is considered as a lever without the desired teeth. So, the effectiveness of
this control depends on the strength of the central bank and its influences on the
commercial banks. For instance, the central bank may request the commercial banks not to
grant loans for speculative purposes. Similarly, the central bank may persuade the
commercial banks not to, approach it for financial accommodation. This method is a
psychological method and its effectiveness depends upon the immediate and favourable
response from the commercial banks.

iv. Direct action: It is a method used to supplement other methods, i.e., the central bank will
inform commercial banks that they must strictly adhere to the regulations imposed by its
on the commercial banks. Direct action may take different forms:

(a) The central bank may refuse to rediscount the bills of exchange of the commercial
banks, whose credit policy is not in line with the general monetary policy of the
central bank,
(b) The central bank may charge a penal rate of interest, over and above the bank rate, on
the money demanded by the bank beyond the prescribed limit,
(c) The central bank may refuse to grant more credit to the banks whose borrowings are
found to be in excess of their capital and reserves.
In practice, direct action as a method of controlling credit has certain limitations:
(a) The method of direct action involves the use of force and creates an atmosphere of
fear. In such conditions, the central bank cannot expect whole-hearted and active
cooperation from the commercial banks.
(b) It may be difficult for the commercial banks to make clear-cut distinction between
essential and non-essential industries, productive and unproductive activities,
investment and speculation,
(c) It is difficult for the commercial banks to control the ultimate use of credit by the
borrowers,
(d) Direct action, which involves refusal of rediscount facilities to the commercial banks,
is in conflict with the function of the central bank as the lender of the last resort
according to which the central bank cannot refuse such facilities.
v. Publicity : The conditions prevailing in the economy if informed to the public through the
press or other media by which a condition is created to make the people to realize the
necessary action the central bank is likely to take to achieve the required object. But this
method is possible only in countries where the percentage of literacy is high among the
population.

Importance of Selective Credit Controls:

In modem times, the selective credit controls have become very popular, particularly in the
developing countries. They serve to achieve the following objectives:
(i) The selective credit control measures divert credit from nonessential and less urgent uses to
essential and more urgent uses.
(ii) The measures influence only the particular areas of the economy (e.g., speculative
activities) without affecting the economy as a whole.
(iii) The selective credit controls discourage excessive consumer spending on durable goods
financed through the hire-purchase schemes.
(iv)The selective credit controls are particularly useful in the developing countries where
quantitative methods are not so much effective because of underdeveloped money market.
(v) Through selective measures, the central bank can give preferential treatment to the
backward and priority sectors, such as agricultural sector, small scale sector, export sector,
of the developing economies by providing special credit facilities to these sectors.
(vi)The selective credit controls are helpful in ensuring balanced economic growth. They play
an important role in removing various types of imbalances which tend to emerge in an
economy during the process of economic development.
(vii) Selective credit controls may also be used in curbing inflationary tendencies in the
developing economies. This may be done by encouraging productive investments and
restricting unproductive investments.
Limitations of Selective Credit Controls:
The selective controls suffer from the following limitations:
(i) The selective credit controls are effective only in influencing the credit policies of the
commercial banks and not of the other non-bank financial institutions. These non-bank
financial institutions also create a large proportion of total volume of credit and are not
under the control of the central bank.
(ii) Through selective credit controls, the monetary authority seeks to divert bank credit from
unproductive to productive activities. But, it is not easy for the commercial banks to
distinguish between productive and unproductive activities.
(iii) Even if the commercial banks are able to provide loans for productive purposes, it is
not possible for them to control the ultimate use of these loans. The borrowers may use
these loans for unproductive purposes.
 (iv)Under the selective credit control policy, there is no restriction on clean credit. Thus, the
selective measures, like higher marginal requirements, may be violated by the borrower
who can obtain clean loans from the banks.
(v) The commercial banks, motivated by higher profits, may manipulate their accounts and
advance loans for prohibited uses.
(vi)The selective credit controls are not so effective under unit banking system as they are
under branch banking system.
(vii) The selective credit controls are also not effective in the indigenous and unorganised
banking sector of the developing economies.
Despite these limitations, the selective credit controls are an important tool with the
central bank and are extensively used as a method of credit control. However, for effective and
successful monetary management, both the quantitative and qualitative credit control methods
are to be combined judiciously. The two types of credit control are not competitive; they are
supplementary to each other.

DIFFERENCE BETWEEN REGIONAL RURAL BANK AND COMMERCIAL BANK:

S. No Basis Regional Rural Bank Commercial Bank

1. Location Located in backward areas Located throughout the country
2. Marginal and landless laborer
Customer No restriction for customers
are the main customers
3. Loans and advances Loans will be given at a Loans given at commercial rate
(Rate of interest) concessional rate of interest of interest
4. The main objectives is service The main objectives is
Objectives
motive commercial motive
5. Owned by central, state
government and the Owned by central government or
Sources
sponsored private sector.
bank

UNIVERSAL BANKING:

Bank that engaged in diverse kind of banking business, which are generally handled by
different types of banking entities, are known as universal banks. Banking that includes
investment service in addition to service related to saving and loan is known as Universal
banking.

A universal bank participates in many kinds of banking activities and is both a

commercial bank and an investment bank as well as providing other financial services such as
insurance. These are also called full-service financial firms, although there can also be full-
service investment banks which provide wealth and asset management, trading, underwriting,
researching as well as financial advisory.
 Universal Banking is a multi-purpose and multi-functional financial supermarket (a
company offering a wide range of financial services e.g. stock, insurance and real-estate
brokerage) providing both banking and financial services through a single window.
Definition of Universal Banking: As per the World Bank, "In Universal Banking, large banks
operate extensive network of branches, provide many different services, hold several claims on
firms(including equity and debt) and participate directly in the Corporate Governance of firms
that rely on the banks for funding or as insurance underwriters".
In a nutshell, a Universal Banking is a superstore for financial products under one roof.
Corporate can get loans and avail of other handy services, while can deposit and borrow. It
includes not only services related to savings and loans but also investments.
However in practice the term 'universal banking' refers to those banks that offer a wide
range of financial services, beyond the commercial banking functions like Mutual Funds,
Merchant Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans,
Investment banking, Insurance etc. This is most common in European countries.
For example, in Germany commercial banks accept time deposits, lend money,
underwrite corporate stocks, and act as investment advisors to large corporations. In Germany,
there has never been any separation between commercial banks and investment banks, as there
is in the United States.
Advantages of Universal Banking
a) Economies of Scale. The main advantage of Universal Banking is that it results in greater
economic efficiency in the form of lower cost, higher output and better products. It enables
banks to be accounted for economies of scale and scope.
b) Profitable Diversions. By diversifying the activities, the bank can use its existing expertise
in one type of financial service in providing other types. So, it entails less cost in
performing all the functions by one entity instead of separate bodies.
c) Resource Utilization. A bank possesses the information on the risk characteristics of the
clients, which can be used to pursue other activities with the same clients. A data collection
about the market trends, risk and returns associated with portfolios of Mutual Funds,
diversifiable and non diversifiable risk analysis, etc, is useful for other clients and
information seekers. Automatically, a bank will get the benefit of being involved in the
researching
d) Easy Marketing on the Foundation of a Brand Name. A bank's existing branches can
act as shops of selling for selling financial products like Insurance, Mutual Funds without
spending much efforts on marketing, as the branch will act here as a parent company or
source. In this way, a bank can reach the client even in the remotest area without having to
take resource to an agent.
e) One-stop shopping. The idea of 'one-stop shopping' saves a lot of transaction costs and
increases the speed of economic activities. It is beneficial for the bank as well as its
customers.
f) Investor Friendly Activities. Another manifestation of Universal Banking is bank holding
stakes in a form: a bank's equity holding in a borrower firm, acts as a signal for other
investor on to the health of the firm since the lending bank is in a better position to monitor
the firm's activities.
Disadvantages of Universal Banking
a) Grey Area of Universal Bank. The path of universal banking for Development financial
institutions (DFIs) is covered with obstacles. The biggest one is overcoming the differences
in regulatory requirement for a bank and DFI. Unlike banks, DFIs are not required to keep
a portion of their deposits as cash reserves.
b) No Expertise in Long term lending. In the case of traditional project finance, an area
where DFIs tread carefully, becoming a bank may not make a big difference to a DFI.
Project finance and Infrastructure finance are generally long- gestation projects and would
require DFIs to borrow long- term. Therefore, the transformation into a bank may not be of
great assistance in lending long-term.
c) NPA Problem Remained Intact. The most serious problem that the DFIs have had to
encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Universal
Banking or installation of cutting-edge-technology in operations are unlikely to improve
the situation concerning NPAs.
UNIVERSAL BANKING IN INDIA
In India Development financial institutions (DFIs) and refinancing institutions (RFIs) were
meeting specific sectoral needs and also providing long-term resources at concessional terms,
while the commercial banks in general, by and large, confined themselves to the core banking
functions of accepting deposits and providing working capital finance to industry, trade and
agriculture. Consequent to the liberalization and deregulation of financial sector, there has
been blurring of distinction between the commercial banking and investment banking.
Reserve Bank of India constituted on December 8, 1997, a Working Group under the
Chairmanship of Shri S.H. Khan to bring about greater clarity in the respective roles of banks
and financial institutions for greater harmonization of facilities and obligations . Also report of
the Committee on Banking Sector Reforms or Narasimham Committee (NC) has major
bearing on the issues considered by the Khan Working Group.
The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to
RBI to discuss the time frame and possible options for transforming itself into an universal
bank. Reserve Bank of India also spelt out to Parliamentary Standing Committee on Finance,
its proposed policy for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.
Now RBI has asked FIs, which are interested to convert itself into a universal bank, to submit
their plans for transition to a universal bank for consideration and further discussions. FIs need
to formulate a road map for the transition path and strategy for smooth conversion into a
universal bank over a specified time frame. The plan should specifically provide for full
compliance with prudential norms as applicable to banks over the proposed period.

UNIT-2 NEGOTIABLE INSTRUMENTS

NEGOTIABLE INSTRUMENTS:

It is used in all business transaction as a medium of payment. It is transferable

instrument from one person to another. A negotiable instrument may be bearer instrument
or an order instrument. A bearer instrument is one which can be transferred by mere
delivery while an order instrument can be transferred by endorsement and delivery.

DEFINITION OF NEGOTIABLE INSTRUMENTS:

 According to section 13 of the negotiable instruments act, 1881 “Negotiable
instruments mean promissory notes, bills of exchange or cheque, payable either to order or to
bearer”. When a negotiable instrument is transferred by the owner is called transferor to
another person is called transferee.

FEATURES OF NEGOTIABLE INSTRUMENTS:

1. Negotiability: A negotiable instrument is one which can be transferred from one person
to another. The person who transfers the negotiable instrument is the transferor and the
person to whom it is transferred is the transferee. Normally, if there is a defective title
with the transferor, the same defect will be passed on to the transferee. But in a
negotiable instrument, even if the transferor has a defective title, the transferee will
receive an absolute title free from defects and so the transferee becomes an absolute
owner, provided he is a holder in due course. A holder in due course is one who has a
negotiable instrument by fulfilling three conditions 1) good faith 2) without negligence 3)
valid consideration.
2. Transferability: Transfer of a negotiable instrument is the transfer of ownership from
transferor to transferee. The transfer of a negotiable instrument can be done in two ways:
1) A bearer instrument can be transferred by mere delivery. i.e., a cheque may contain the
words to X or bearer. Here, when the cheque is given to X he can transfer to Y or Z by
mere delivery.
2) At the same time, when the cheque is written as pay to X or order, X can transfer the
cheque to Y or Z by writing on the reverse side of the cheque as to pay Y or Z followed
by his signature and it has to be handed over to Y or Z. This is called by endorsement and
delivery.
3. Chose in action and chose in position: A negotiable instrument provides both the rights
against the whole world and rights against specific person under a contract. Right against
the whole world is right in rem i.e., chosen in action. Right against particular person is
right in personam or chose in possession.
4. Payment of cash only: The negotiable instrument can be issued only for payment of
cash. It cannot represent any other thing. A cheque, bill of exchange or promissory note
is issued only for payment of cash and not for any other.

TYPES OF NEGOTIABLE INSTRUMENTS:

Negotiable Instruments are broadly of three types. They are:

1. Cheque.
2. Promissory note.
3. Bill of exchange.

CHEQUE MEANING:

A Cheque is a negotiable instrument which is supplied by a banker to the customer

who opens a savings or current account in a bank. A savings account holder may have an
account with cheque or without cheque facility. The customer who draws the cheque on the
bank is called capital drawer. The bank on whom the cheque is drawn is called the drawee.
The person who receives payment on the cheque is called the payee.

CHEQUE DEFINITION:

According to Section 6 of the Negotiable Instruments Act, a cheque is “a Bill of

exchange drawn on a specified banker and not expressed to be payable otherwise than on
demand”. Therefore, a cheque is also a bill of exchange as far as it is always drawn on a
specified banker and is always payable on demand. Thus, all cheques are bills of exchange but
all bills are not cheques.

ESSENTIALS OF A CHEQUE:

All the cheques are in a proper format and they are stipulated by Negotiable Instruments
Act. Following are the features:

1. It is an instrument in writing.
2. A cheque is to be drawn only on the branch in which the customer is maintaining an
account.
3. Before drawing a cheque, the customer must have sufficient funds in his account or
else, the cheque will get dishonoured.
4. A cheque is an order by the customer on the bank and so the cheque should be very
clear in the instructions given to the banker.
5. As the cheque is meant for payment of money, the amount mentioned in the cheque
should be specific and it should be written both in words and figures.
6. A cheque is payable either to order or bearer. An order cheque is one which is payable
only to a specific person or to whom so ever he orders.
7. Signature is an important aspect in a cheque. A cheque should be signed by the
customer and the signature in the cheque should be as per the specimen signature given
by the account holder at the time of opening the account. In case, the customer adopts a
different style of signature, he must furnish to the bank, a set of fresh specimen
signatures and cancel the old specimen signature.
8. Date appearing on the cheque is a date on which the cheque is said to have been issued.
A banker will make payment on a cheque either on the date of the cheque or
subsequently but not before the date. A post-dated cheque will never be honoured by the
bank. Date also decides the valid period of the cheque, which is normally six months.
9. The number appearing on the cheque at the bottom represents the cheque number and
the code number of the bank. When the cheque is presented in the clearing house the
computer decodes the cheque and by this the name of the bank the branch and the
cheque number with the amount is available which will be prepared in a statement, when
banks take the cheque to the clearing house for realisation.
10. Endorsements are done when an order cheque is transferred and the endorsements
appearing on the cheque mention clearly the manner in which the cheque is transferred
from one person to another. According to sections 118 and 119 of the Negotiable
instruments act, endorsement should appear in the same sequence in which the cheque is
 transferred from one person to another. This enables the banker to find out as to who is
liable in case of dishonour.

TYPES OF CHEQUES:

1. Order Cheque: Where a cheque is drawn to or to the order of a specified person,

using such words as “pay Mr A or order” it is known as the order cheque. An order
cheque may be paid either to the payee or to a person authorised by him.
2. Bearer Cheque: Where a cheque is drawn in favour of the person for the time being
in possession of the cheque using such words as “pay Mr A or bearer” is known as a
bearer cheque. A bearer cheque may be paid either to the payee or to any person who
presents it to the bank.
3. Stale Cheque: Where a cheque is not presented for payment within a reasonable
period from the date of its issue, it is called a stale cheque. In India a cheque is treated
as stale cheque, after the expiry of six months from the date of the cheque and the
banker returns such cheque requiring drawer’s confirmation thereon.
4. Post Dated Cheque: Where a cheque bears a date subsequent to the one on which it
is actually drawn, it is called a post-dated cheque. Any banker making payment on the
post-dated cheque loses the statutory protection and any loss accruing from such a
payment will have to be borne by the banker itself.
5. Marked Cheque: According to the Dictionary of Banking “A marked cheque is one
which is marked by a banker that it is good for the amount for which it is drawn”.
Marking consists of a mere initial on the back of the cheque by the drawee bank. It
implies that the cheque will be paid if presented through the clearing.
6. Bank draft or demand draft: Demand draft is a financial instrument drawn by one
branch of a bank or another branch of the same bank instructing the latter to pay a
specified sum of money to a named payee or to his order. The essential features of a
bank draft are as follows: (a) It is drawn by a bank’s branch on another branch. (b) it
cannot be made payable to bearer. (c) Its payment cannot be stopped or
countermanded. (d) It is always payable on demand.
7. MICR Cheques: MICR stands for Magnetic Ink Character Recognition. It is the
technology introduced by the RBI for speeding up the cheque clearing process. The
scheme was initially introduced in four metropolitan cities Mumbai, Chennai, Kolkata
and New Delhi.

CROSSING OF A CHEQUE:

The drawing of two transverse parallel lines with or without any words across the face of a
negotiable instrument, usually a cheque is known as crossing. Crossing carries a direction by a
customer to the paying banker instructing to pay the money generally to a banker or a
particular banker as the case may be. The crossed negotiable instrument is not payable to the
holder at the counter. Crossing may be written, stamped, printed.

Sections 123 to 131(A) of the Negotiable Instruments Act deal about crossing of a cheque.
There are two types of crossing. They are (1) General crossing and (2) Special crossing.
Section 123 defines general crossing of a cheque while Section 124 defines special crossing.
General crossing:

A cheque is said to contain a general crossing when two parallel lines are drawn cheque
bears across its face an addition of the words and company or any abbreviation thereof,
between two parallel transverse lines, or of two parallel traverse lines simply, either with or
without the words not negotiable that addition shall be deemed a crossing, and the cheque shall
be deemed to be crossed generally. A cheque is said to be crossed when two parallel transverse
lines, with or without any words, are drawn on the left-hand top corner of the cheque. It is
relevant to state that such lines are essential for general crossing and may not be drawn in case
of special crossing.

Special crossing:

Sec 124 of the Negotiable instruments act, 1881 defines special crossing as “where
cheque bears across its face an addition of the name of a banker, either with or without the
words not negotiable that addition shall be deemed a crossing, and cheque shall be deemed to
be crossed specially and to be crossed to that banker”. Further, Sec 126 Para 2 states, “where a
cheque is crossed specially the banker on whom it is drawn shall not pay it otherwise than to
the banker to whom it is crossed, or his agent, for collection”.

Types of crossing:

In general crossing, the cheque will bear across the two parallel transverse lines, 2 types
of words. These are: (1) Not negotiable, (2) Account payee

a) Not negotiable crossing: when a cheque bears across its face two transverse parallel lines
with the words not negotiable, it is a clear indication to the banker that the bank as to be
very careful while making payment on the cheque. Not negotiable takes away the character
of negotiability on a cheque. It means that if there is any defect in the cheque, it will affect
the transferee, even if the transferee is a holder in due course. Thus, not negotiable crossing
is a forewarning given to all the transferees of the cheque that they should be careful while
receiving the cheque even if they happened to be a holder in due course.
b) Account payee crossing: Though not negotiable crossing is mentioned nowhere in the
section 130 of the Negotiable Instruments Act, account payee crossing is mentioned. This
means that account payee crossing is not legally permitted under the Negotiable
Instruments Act. The reason is that when a cheque is crossed account payee only, payment
should be credited by the bank only to the account of the payee.
Special crossing: Section 124 defines special crossing wherein the cheque will contain the
name of another bank in the crossing. Special crossing does not require two parallel transverse
lines. It may or may not exist.

Double special crossing or double crossing: normally in a special crossing, the paying
banker will pay only to that bank whose name is appearing in the crossing. But sometimes, the
bank whose name is appearing in the crossing may not find a branch in the place where the
payee is to present the cheque. For example, a cheque belonging to Indian bank with a
 crossing of bank of Tamil Nadu is sent to a person in Punjab. Since, the bank of Tamil Nadu
does not have a branch in
Punjab, Indian bank at Punjab will find it difficult to pay on the cheque. Hence, bank of Tamil
Nadu will appoint Punjab National Bank as its agent for collection. If in tis crossing, the word
as agent for collection is not there, Indian bank which is a paying banker will refuse to pay on
the cheque according to section 127 of the Negotiable Instruments Act. Thus, a paying banker
will have to be careful and the collecting banker also must write the words as agent for
collection, failing which cannot receive payment on the cheque.

PAYMENT OF CHEQUE:

Meaning of a paying banker:

A paying banker is one who is a drawee of a cheque. He takes the responsibility of making
payment on a cheque to the true owner. Any wrong payment will make the paying bank liable
to the true owner of the cheque and also to the drawer of the cheque. The true owner of the
cheque when denied payment will not only sue for the amount of the cheque but also for the
damages or losses he has suffered. So, the paying banker has to be very careful in making
payment on the cheques drawn upon him. The Negotiable Instruments Act as laid down
conditions for the paying banker. He has to strictly adhere to the conditions for obtaining
statutory protection.

Payment in due course: (Section 10)

Section 10 of the Negotiable Instruments Act 1881 clearly mentions the manner in which
the paying banker should make payment on a cheque when presented to him and demanded
payment.
Section 10 defines “payment in accordance with the apparent tenor of the instrument in good
faith and without negligence to any person in possession thereof under circumstances which
do not afford a reasonable ground therein mentioned”. This definition clearly states the
conditions the paying banker has to fulfill before making payment on any cheque. If these
conditions are fulfilled, the paying banker will get statutory protection and will not be liable to
any party. Under section 85 of the Negotiable Instruments act 1881, the banker is given
statutory protection.

Conditions given under payment in due course:

(1) Payment in accordance with apparent tenor: when a paying banker receives
cheques, he has to carefully go through the instructions given by the drawer. For example, if
the drawer has issued a cheque dated 10th June 2000, payment cannot be made before the date.
If the cheque is crossed, then the banker cannot make payment across the counter. If the
crossing contains words such as account payee, the paying banker cannot make payment to any
other person other than the payee whose name is appearing on the cheque and even then, only
his account can be credited. If a paying banker overlooking all these factors, makes payment, it
is a clear violation of payment in due course.
(2) In good faith: The paying banker will make payment to a person where ownership is
certain. In other words, the person presenting the cheque creates absolute good faith in the
minds of the banker regarding the ownership.
(3) Without negligence: The paying banker has to go through the contents of cheque
before making payment. If the cheque contains any alteration, overwriting or cancellation,
payment cannot be made. Sometimes, the cheque may also contain material alteration. A
material alteration is one which is done deliberately on a cheque without the knowledge of the
drawer or drawee with an intention to defraud them and thereby alter their liabilities. This may
be done either by increasing the amount or altering the date or including the name of another
payee, etc. When a cheque is given by a person to his daughter, which is drawn as pay to Mrs.
A, the husband Mr. A, may alter the cheque by adding his name in the payee’s column as Mrs.
A and Mr. A, the paying banker becomes liable to the joint account of Mrs. A and Mr. A. But
the cheque was originally drawn only in the name of Mrs. A. When the paying banker without
knowing this alteration, makes payment on this altered cheque, it is a negligence. That is, the
paying banker has overlooked the material alteration which has been done by the husband. The
signature of the cheque should also be verified. A cheque with the forged signature is paid by
overlooking the verification of the signature, it amounts to negligence.
(4) To the person in possession: Paying banker can make payment to a holder in due
course only when he is in possession of the instrument. Possession is a must for a holder in due
course. For a holder it is not a must. Thus, a paying banker should make payment only to that
person who is in possession and presents the cheque for payment.
(5) Circumstances: Even though the person presenting the cheque may fulfill all the
conditions, but still creates a doubt in the minds of the paying banker at the time of making
payment, the paying banker must get it clarified before making payment. There are instances
where the amount of the cheque and the status of the person presenting the cheque are
inconsistent. For example, a peon in office may have an amount more than Rs.25 lakhs, the
banker must clarify with the employer of the peon. Failure to do so is a negligence on the part
of the paying banker and such payment made without proper clarification is deemed to be
against payment in due course.

Duties and responsibilities of a paying banker:

Section 31 of the Negotiable Instruments Act 1881 provides that “the drawee of a cheque
having sufficient funds of the drawer in his hands, properly applicable to the payment of such
cheque must pay the cheque when duly required to do so, and in default of such payment must
compensate the drawer for any loss or damage caused by such default”. Thus, a bank has an
obligation to honour the cheques of the customer subject to the condition that there are
sufficient funds and the cheque is in order. Moreover, it becomes necessary for a banker to
take certain precautions at the time of honouring/dishonouring customer’s cheque.

Obligation of paying banker to honour cheques:

The paying banker is under an obligation to honour cheques subject to the fact that certain
conditions are satisfied.
 a) There must be sufficient funds in the customer’s account and only in the account on
which the cheque is drawn. The accounts in the credit of the customer’s account in other
branches will not be considered.
b) The funds should be properly applicable to the payment of such cheques.
c) The cheque should be properly drawn and should not be irregular or ambiguous.
d) Cheques should be presented during the banking hours of the bank.
e) Cheques should be presented for payment within a reasonable time. They should be
presented within six months of their issue. Usually, cheques presented after six months of
their issue are considered to be stale.

Conditions for dishonour of a cheque by a paying banker:

The banker before honouring the cheques presented to him/her for payment should look
into the following points in order to safeguard himself/herself against the risk of losing the
customer’s money. They are:

(1) Open or crossed cheque: When a cheque is presented for payment, the banker should
verify as to whether it is an open cheque or a crossed one and whether the cheque is in
printed form. There is no provision in the Banking Regulation act preventing a customer
from drawing his own cheque. But the banks prefer the printed form as it is easy for
verification and filing. An open cheque, if it is otherwise valid, can be paid across the
counter. If it is crossed, the holder is required to present it only through another banker. The
specific instruction in case of a crossed cheque is that, it should be paid through an account
and not across the counter.
(2) Drawn on the specific branch: Cheque should be drawn on the particular branch at
which they are presented. If they are presented at a different branch where an account is not
maintained by a customer, the banker should refuse payment because he/she has no means
of knowing the state of the customer’s account and cannot verify the genuineness of the
customer’s signature.
(3) Mutilated cheque: The banker should also verify whether a cheque is mutilated, torn
or cancelled. If it is torn in such a way as to give an impression that the customer had
desired its cancellation, the banker should return the cheque with the remark, mutilated
cheque. When a cheque is torn accidentally, the banker can pass it for payment after
obtaining the drawer’s confirmation on the cheque.
(4) Date of the cheque: A cheque must always bear a date because the mandate of the
customers to the banker given in the form of cheque becomes legally valid on the date
mentioned therein. If no date is written and still presented for payment, the banker must
refuse payment. The date should not be incomplete. It should contain the day, month and
year in a proper form. It should not be ambiguous in any manner. The drawer of the cheque
fills in the date before the cheque is issued, but if it is not done, the instrument does not
become invalid, the payee or the subsequent holder thereto may fill in the date. The banker
should verify whether a cheque is post-dated, if it is so, he should not honour it. A cheque
bearing a future date is called a postdated cheque. A customer may countermand payment
or may become insolvent or insane or may die before the due date. A banker who has
honoured a post-dated cheque cannot debit the customer’s account under such
circumstances. He will lose his statutory protection also. A cheque will be valid for six
 months under statute and a cheque not presented within six months from the date of issue
becomes stale and is not accepted by the banker.
(5) Words and figures differ: When the amount stated in words and figures differ in a
cheque, the banker follows the practice of returning the cheque with a remark to that effect.
But the banker has no risk in paying the amount stated in words. If the amount is written in
figures only, then the banker should return cheque.
(6) Material alteration: Changing the date, amount, name of the payee, removal of
crossing, etc., affect the credibility of the instrument. The banker should refuse payment of
a materially altered cheque unless it is confirmed by the drawer.
(7) Specimen signature: The signature of the customer should be verified by the banker.
The cheque should bear the genuine signature of the drawer. If it differs from the specimen
signatures furnished to him, the banker should return the cheque. Of course, he should not
make payment if the drawer’s signature appears to be a forged one. If the drawer adopts a
different style of signature other than that of specimen signature, the banker can inform the
drawer to adopt the new style of signature after accepting a new set of specimen signature
with a new style of signature. The signature should not be followed by date. If any customer
by mistake writes the date below the signature, the banker has every right to dishonour the
same. The reason being that the specimen signature of the customer does not carry a date. In
the case of persons serving in the Defense services, holding a rank, they should give along
with their signature the rank they are holding at present. As per the service code of conduct
of the defense personnel, any cheque issued by them should never be dishonoured for want
of funds or else they will be taken for breach of code of conduct.
(8) Proper endorsement: It should be ensured whether the cheque presented for payment
requires endorsement or not and if so, whether the endorsement made thereon is regular or
not.
(9) Insufficient funds: The banker is under an obligation to pay his customers’ cheques if
the latter’s account shows sufficient credit balance. If there are no sufficient funds, the
banker is not bound to honour the cheques. But if the banker has already agreed to grant a
loan or overdraft to a customer up to a certain amount, cheques in excess of the credit
balance in the account but within the limit of the loan or the overdraft must be honoured by
the banker in the usual course. The minimum balance required to be maintained in a current
account or savings account is deemed as available for honouring the cheques. It should not
be regarded as frozen by the banker. If the actual balance gets reduced below the prescribed
minimum amount, the banker should honour the cheque and may charge an incidental
expense from the customer.
(10) Chronological order of payment: The banker generally follows the rule of making
payment of the cheques in the chronological order of their receipt. It means that the cheque
received first on an account will be paid first and the rule for making payment is not based on
the serial number of the cheque or the date of its issue.
(11) Garnishee order: The banker should not honour a cheque received by him after the
issue of the garnishee order by the court authorities. Section31 of the Negotiable Instrument
Act 1881 provides that the drawee of a cheque having sufficient funds of the drawer in his
hands, properly applicable to the payment of such cheques must pay the cheque when duly
required to do so, and, in default of such payment, must compensate the drawer for any loss or
damage caused by such default. The obligation to honour cheques may be extended by an
agreement to the amount of overdraft sanctioned.
 (12) Inchoate cheque: At the time of presenting the negotiable instrument to drawee for
payment, the negotiable instrument should be complete in all respects. If the negotiable
instrument is incomplete with regard to date, amount, payee or signature, then such an
instrument is called inchoate instrument or inchoate cheque. Such an incomplete cheque will
be dishonoured.
Grounds for refusing payment of a customer’s cheque:

Dishonouring a cheque is different from refusing payment on a cheque. Dishonour takes place
when there is a defect in the instrument or when there are insufficient funds in the accounts.
Refusing payment of a cheque takes place on the happening of certain events. We can see the
grounds under which a bank refuses payment.

(1) Countermanding payment: When a customer after having issued the cheque to third
party, instructs the banker to stop payment on the cheque before the instrument is presented,
it is called countermanding of payment. It is the responsibility of the customer to inform the
banker before the payment is effected. If the order is received after the disbursal of payment
on the cheque, the banker cannot recover from the party, even though he may be within the
banking premises.
(2) Death of the customer: Notice of death of customer has to be given by the close
relative of the deceased. On receipt of the notice, banker will close the account and any
cheque received thereafter, payment will be refused.
(3) Insolvency of the customer: When the court adjudged the customer of a bank as
insolvent, the account of that customer will be taken over by an official assignee by the
court. Hence, any cheque received thereafter will be refused payment.
(4) Lunacy: When a customer is of unsound mind, his account cannot be operated. But the
lunacy of the customer has to be certified by a doctor and the nature of the lunacy must also
be stated. If it is of a temporary nature, the account may be suspended till such time of
lunacy is cured. But when the lunacy is of a permanent nature, on the advice of a doctor, the
account will be closed and cheques received thereafter will be refused payment.
(5) Garnishee order: Here, the court gives order to the bank to close the account of the
customer partially or completely and according to that order cheques will be refused
payment.
(6) Closing of account voluntarily: When the customer on his own accord, closes the
account by giving a written declaration, the bank will close the account. But the customer
has to surrender all the unused cheques and the passbook. The banker will close the account
after arriving at the balance. The amount will be paid to the customer.
(7) Assigning the entire balance to a third party: When a customer gives in writing to
the bank to assign his entire credit balance to a third parties’ account, the bank will close the
account automatically.
(8) Undesirable customer: When a customer issues cheque frequently with insufficient
funds, these are dishonoured causing embarrassment, both to the banker and customer. Such
a customer will be intimated by the banker to close the account, failing which the banker on
his own will close the account and will send the balance, if any, to the customer.
(9) Partnership firms, companies and institutions: Their account will be operated
according to the bye-laws. In the case of death of a partner, winding up of companies or
dissolution of institutions, the account will be closed.
 (10) In public interest: When a banker comes to know that the account holder is building
an account by cheating the public, he may close the account by giving the notice to the
party. The bank does this in the interest of the public and prevents the public from incurring
any monetary loss.

COLLECTION OF CHEQUE:

Meaning of a collection banker:

A collecting banker is one who undertakes to collect cheques, drafts, bills, pay order,
traveller cheque, letter of credit, documents such as lottery chits, dividend warrants, debenture
interest, etc., on behalf of the customer. For undertaking this collection, the collecting banker
will be charging commission. The collection of these documents may be done by presenting
these instruments in the local clearing house or in case of outstation cheques or drafts in those
clearing houses in the respective centres. A collecting banker has a moral responsibility of not
merely collecting these documents and realising the amount but should credit the amount to
the account of the true owner of the instrument. Thus, the collecting banker is not only acting
as an agent of the customer but also acts as a bailee and trustee. He is a bailee when he is in
possession of the document and a trustee when he collects the amount for benefit of the
customer.

Capacity of collecting banker:

While collecting the instrument on behalf of the customer, the collecting banker acts

a) As holder for value or b) As agent for collection

(a) As holder for value: The collecting banker is said to be acting as holder for value
1. When the collecting banker advances money to the customer before the realisation of the
cheques given for collection.
2. When the collecting banker settles the loan amount due from the customer with the
cheque amount given for collection, even before its realisation.
3. Where a collecting banker reduces an overdraft with the amount for collection before its
realisation.
4. Where a part of the cheque amount is given by the collecting banker to the customer even
before the realisation of the cheque.
5. By allowing the customer to draw the full amount of the cheque before its realization.
(b) As agent for collection: When the banker undertakes to collect the cheques, and
credits the account of the customer only on realisation. Thus, in acting as agent for collection,
there is no risk for the collecting banker whereas in the case of holder for value, the
collecting banker has enormous risks, especially when the cheque is dishonoured or payment
has been made to the wrongful owner of the cheque.

CONDITIONS UNDER SECTION 131:

The following conditions are to be followed to make the statutory protection available for the
collecting banker.

(1) Collecting for a customer: A collecting banker must collect the cheque or draft or any
other instrument only for a customer. A customer is one wo as an account opened with the
bank which may be a savings or a current account. A savings account can be opened by
any person, only when that person is introduced by another savings account holders of the
same branch of the bank. But in the case of current account, the account can be opened
only when a letter of introduction is presented by the person intending to open the current
account. Letter of introduction is a fidelity guarantee given to the banker vouchsafing the
character and conduct of the person. This can be given by another current account holder
or by an employee of the bank not less than that of an officer or by persons well reputed
and who are well known to the banker. Without letter of introduction if current account is
opened, then it is the violation of section 131.
(2) The cheque presented to the bank for collection should be crossed generally or
specially: That is, the banker is collecting the cheque only on behalf of a customer. If a
customer gives an open cheque which is uncrossed, the banker will cross the cheque
before it is sent for collection.
(3) In Good faith: A collecting banker should accept the cheque for collection from the
customer on good faith. i.e., there should not be any ambiguity with regard to the
ownership of the cheque. If any doubt arises, the banker should clarify the same before the
collection of the cheque.
(4) Without negligence: Negligence pertains not only with regard to the instrument but
also the manner and the circumstance under which the cheque is given for collection.
However, the fact of negligence will be seen under the duties of collecting banker. There
are number of instances for revealing the negligence of the collecting banker.
(5) Agent for collection: Section 131 gives statutory protection to the collecting banker
acts as agent for collection and not as holder for value. i.e., the account of the customer
should be credited only after the realisation of the cheque and not before it. If, in case the
banker credits the account of the customer before the realisation, the statutory protection
under Section 131 will not be available.

DUTIES OF A COLLECTING BANKER:

A collecting banker as three major duties to perform towards the customer:

1) Quick clearance of cheques or other instruments given for collection: Whenever

the customer gives any instrument for collection, the collecting banker should immediately
send the same for collection. Any delay on the part of the collecting banker may lead to
either the drawer declaring insolvent or the winding up of the paying banker. Hence, a
collecting banker while receiving a cheque for collection affixes seal on the pay-in-slip wen
the cheque is sent for collection on the same date. But when it is not possible to send the
cheque for collection on the same day, the collecting banker will affix seal on the pay-on-
slip which contain the words too late for today’s collection. By doing so, the collecting
banker escapes the liability for any delay in the collection.
2) Acting as bailee: When a cheque is given for collection, the collecting banker is bailee
until the cheque is realized and the proceeds are credited to the account of the customer.
Sometimes, the cheque given for collection may bounce and gets dishonoured due to
insufficient funds. In such a case, the collecting banker as a duty to return the cheque which
has been dishonoured to the customer and by doing so e discharges his duty as a bailee. The
collecting banker should either credit the account to the customer or return the cheque that
has been dishonoured. Normally, banks after returning the dishonoured cheque to the
customer will obtain their signature in separate register
3) To collect cheques without negligence: Negligence of a collecting banker is of
different nature. We can state the following negligence of collecting banker:
a) Negligence wile opening account for a customer wherein the banker as failed to obtain
letter of introduction and as opened the current account.
b) A cheque crossed but payment made across the counter by oversight.
c) A cheque crossed account payee and payment credited to the account of a person other
than the payee. For example, a cheque is drawn in the name of pay to Mr. X and crossed
account payee. The bank should credit the account of only Mr. X. but if the bank credits
the account of Mr. Y or Z it is negligence.
d) A cheque crossed not negotiable. Here, the collecting banker should take due
precaution before making any payment. But if a collecting banker makes payment without
any precautions, it amounts to negligence.
e) Were the amount of the cheque and the status of the person being inconsistent, failure
to make proper enquiry is a round for negligence. For example, a cheque is drawn in the
name of principal for Rs.2 lakhs. The peon of the college takes advantage of blank
endorsement, deposits it in is personal account and the banker without proper enquiry,
credits the account of the peon. This is gross negligence of the collecting, banker as he as
failed to enquire the peon, regarding the circumstances under which the cheque was
endorsed.
f) Opening of accounts without proper enquiry. i.e., where banker as not made proper
enquiries with the employer of the intending customer.
g) A cheque belonging to a partnership firm endorsed to the personal account of the
customer and if the banker, without proper enquiries, credited the personal account of the
partner it is round for negligence.
h) An official misusing his position credits the cheque received in is official capacity to
his personal account by endorsing the same. For example, a cheque received in the name
of a principal of a college. The cheque is endorsed by the principal to is personal account,
failure to enquire the same by the bank will be negligence on the part of the collecting
banker.
i) When a customer as opened accounts in two different branches of the same bank, the
branch managers have to concur on the status of the account holder. Failure to do so will
be negligence of the collecting banker.

DIFFERENCE BETWEEN CHEQUE AND PROMISSORY NOTE:

CHEQUE PROMISSORY NOTE

1. It is an unconditional order. 1. It is an unconditional promise or undertaking.

2. A cheque is drawn by the drawer who is a 2. A promissory note is made by the promisor who is
creditor. a debtor.

3. The bank is primarily liable on a cheque. 3. The promisor is primarily liable.

4. There can be more than one drawer but not 4. There can be more than one promisor and also
more than one drawee as the drawee is the bank. more than one promise.

5. A cheque can be crossed generally or

5. There is no crossing for a promissory note.
specially.

6. No need for a stamp for a cheque. 6. Stamp is a must for a promissory note.

7. The valid period for a cheque is six months. 7. The valid period for a promissory note is three
years.

8. No interest is mentioned on a cheque. 8. Promissory note will contain the interest rate
payable.

9. A cheque is settled by full payment on 9. Part payment is allowed and the debtor of a
demand and there is no part payment. promissory note can make any number of payments.

10. A cheque is payable either to bearer or 10. A promissory note is payable to order and in India
order. bearer promissory note can be issued only by RBI.
PROMISSORY NOTE:
Definition: According to Section 4 of the Indian Negotiable Instruments Act, 1881, a
promissory note is defined as an instrument in writing containing an unconditional
undertaking, signed by the maker, to pay a certain sum of money only to or to the order of a
certain person or to the bearer of the instrument.

A promissory note is drawn and signed by the debtor who promises to pay the certain sum
of money. A promissory note may be drawn by more than one person also, who may undertake
to pay the amount both in their individual capacities as well as jointly.

FEATURES: Following are the essential features of a promissory note:

a) Instruments in writing: A fundamental feature of a promissory note is that it has to be in

writing. This implies that oral promise does not constitute a promissory note. The promise
must be in writing. The writing may be in any form.
b) Promise to pay: A promissory note contains an express promise to pay and a mere
acknowledgement of debt cannot constitute a promise to pay. The promise to pay is
applicable to securities for money. Accordingly, money instruments such as bank notes and
currency notes are excluded from the purview of promissory note.
c) Unconditional undertaking: A promissory note contains an unconditional undertaking to
pay the sum contained in it. The payment on the instrument is not dependent on the
contingencies and events of business and commerce. However, a document is considered a
promissory note where it is written payable on the happening of the event, which is bound
to happen.
d) Maker’s signature: the maker, the person who promises to pay, signs a promissory note.
Signing of a pro-note indicates with certainty the identity of the maker who is bound to
make payment on the promissory note.
e) Certain maker: a promissory note expresses clearly the name of the maker who is bound
to make payment of the instrument. The maker’s identity is described by the maker’s
designation too.
f) Certain Payee: A promissory note contains clearly the name or designation of the person
to whom the promise as been made. A promissory note made payable by the maker himself
is not valid unless it is endorsed by him. Similarly, a promissory note that contains the
name of the payee, which is miss-spelt is still considered a certain and a valid document if
the payee’s identity can be established by evidence.
g) Promise to pay money only: A promissory note contains clearly a promise to pay money
and money only. Money means legal tender currencies and coins. Accordingly, promise to
pay non-money items does not constitute a promissory note.
h) Certain amount: a promissory note contains a promise by the maker to pay a certain and a
specified sum of money only. Definiteness of the sum of money includes amount payable
with interest, amount payable at an indicated rate of exchange, and amount payable by
installment.
i) Proper stamping: An essential feature of a promissory note is that it should be adequately
and properly stamped as per the requirements of the Indian Stamp Act. Further, it is also
important to note that the stamp is cancelled properly. An unstamped promissory note is
not valid.
j) Other features: In addition to the above, a promissory note also contains certain other
desirable features such as date, place, consideration, etc. These are not essential in that
their absence does not make the promissory note invalid

DIFFERENCE BETWEEN CHEQUE AND A BILL OF EXCHANGE

CHEQUE BILL OF EXCHANGE

1. Drawn on a specified banker only. 1. Can be drawn on any party.

2. Payable on demand only. 2. Payable either on demand or after a fixed period.

3. No need for acceptance. 3. Acceptance is a must.

4. When a cheque is not paid, it is said to be 4. A bill can be dishonoured even for non
dishonoured. acceptance.

5. A cheque can be crossed generally or specially. 5. No crossing is allowed.

6. There are no grace days for a cheque as it is 6. Time bill has three days of grace.
payable on demand.

7. A cheque is presented only once for payment. 7. A bill is presented for acceptance and later, on
the due date for payment.

8. No stamp is required for cheque. 8. Stamp duty has to be paid for a bill according to
 its value.

9. Payment on a cheque can be stopped by 9. No countermanding of payment is allowed.

countermanding by the drawer.

10. No documents will accompany a cheque 10. Trade bills will be accompanied by trade
documents.

11. A cheque is valid only for six months after 11. The valid period of a time bill depends on the
which it is a stale cheque. duration of the bill.

12. Payment on a cheque can be suspended due to 12. Payment of a bill is not affected by any of
the death, insolvency or insanity of the drawer. these reasons.

13. Noting and protesting is not necessary for a 13. A dishonoured bill requires noting and
cheque protesting

14. Cheques are issued as a mode of payment. 14. Accommodation bills are issued for raising
funds in the money market.

15. Generally, cheques are not discounted. 15. Bills are discounted.

16. A banker will not pay before the due date on a 16. The drawee of a bill can make an advance
cheque. payment.

17. A bank is primarily liable on a cheque. 17. The drawee is primarily liable

BILL OF EXCHANGE:
Definition: Section 5 of the Indian Negotiable Instruments Act, 1881 defines a bill of
exchange as “an instrument in writing containing an unconditional order, signed by the maker,
directing a certain person to pay a certain sum of money only to or to order of a certain person
or to the bearer of the instrument”.
A bill of exchange contains an order from the creditor to the debtor to pay a specified
amount to a person mentioned therein. The maker of a bill is called the drawer. Person who is
directed to pay is called the drawee. The person who is entitled to receive payment is called
the payee. Sometimes the drawer himself is the payee.

Features: A bill of exchange possesses many of characteristics similar to the promissory note.
Following are the essential features of bill of exchange.

• It contains an express order to pay money only.

• The order is unconditional
• It is in writing.
• It is signed by the drawer.
• Drawer, drawee and the payee are certain.
• Amount payable is certain.
• It is properly and adequately stamped.
 • Clean bills: Bills that are not accompanied by any document and reflect the
genuineness of trade transactions between parties concerned are called clean bills. Due to
the clean nature of these bills, the interest rate charged is higher than that on documentary
bills.
• Inland bills: Bills that are drawn on Indian residents are called inland bills. Such bills
may be endorsed in a foreign country, or may remain in circulation in foreign countries. A
bill drawn in a foreign country is considered an inland bill if it is drawn on a resident of
India.
• Foreign bills: Bills that are payable outside India are called foreign bills. Such bills are
either
(a) Drawn outside India and payable in India by a party outside India.
(b) Drawn outside India and payable outside India by a person resident in India.
(c) Drawn outside India and payable outside India by a person non-resident in India.
(d) Drawn in India but made payable outside India.
Another classification of foreign bills is export bills and imports bills. Bills that are drawn by
exporters on a party outside India are called export bills, and when exporters outside India
draw bills on importers in India, it is called an import bill.
• Accommodation bills: Accommodation bills, also called kite bills or wind bills, are
those bills that are created by borrowers and lenders simply to each other, without the
backing of any trading transaction. It works essential as a mutual financing arrangement,
whereby parties draw bills on each other for creating instruments, which are subsequently
accepted and discounted with their respective bankers. This way, the financial
requirements of both the parties are easily met.
• Supply bills: Bills that are drawn by a supplier or contractor on a government or semi-
government department for supplies made are supply bills. These bills are not accepted by
government departments and therefore, do not enjoy the status of a negotiable instrument.
However, it is possible for the supplier to obtain an advance from commercial banks
against such bills in order to meet the financial needs, pending payment from the
government department. Due to the non-negotiability character, these bills are eligible for
clean advances by banks.
• Hundis: Indigenous bills of exchange and promissory notes are known as hundis.
These are used for financing agriculture and inland trade. They are handled by various
types of indigenous banks.

DIFFERENCE BETWEEN A BILL OF EXCHANGE AND A PROMISSORY NOTE:

BILL OF EXCHANGE PROMISSORY NOTE

1. It is an unconditional order. 1. It is an unconditional undertaking or promise.

2. There are three parties in a bill of exchange- 2. There are two parties, the promisor and
drawer, drawee and payee. promise.

3. It is drawn by the drawer who is a creditor. 3. It is drawn by the promisor who is a debtor.

4. A bill requires acceptance by the drawee. 4. As a promissory note is drawn by the promisor,
there is no need for acceptance.
5. The drawee is primarily liable on a bill. 5. The promisor is primarily liable.

6. A bill can be payable either to bearer or order. 6. A promissory note is payable to order as in
India, bearer promissory note is the exclusive
right or RBI.

7. Foreign bills are drawn in sets of three. 7. Promissory note is a single document.

8. Acceptor may impose conditions while accepting 8. A promisor cannot impose conditions while
a bill. making a promissory note.

9. Notice of dishonour has to be given by the holder 9. No need for such notice.
to the drawer.

10. In the case of a dishonour of a foreign bill 10. Protest is not compulsory.
noting and protesting is compulsory.

11. The liability of a drawee can be shifted to an 11. The liability of the promisor cannot be shifted
acceptor for honour. to any other person.

12. In the absence of the original drawee. There can 12. There is no such change of promisor or
be a substitute drawee called drawee in case of promisor cannot be substituted.
need.

ENDORSEMENT:
Endorsement of a negotiable instrument refers to the act of writing a person’s name on the
back of instrument for the purpose of negotiation an order. Endorsement is applicable only to
an order instrument and is accepted only in current account. In savings account only, cheques
drawn in the name of the account holder are accepted and no third-party cheques will be
accepted by the bank. Whereas in a current account, third party cheques are accepted and so an
order cheque drawn in the name of the third party can be deposited when the third party
endorses the cheque in favour of the account holder and delivers the same.

Definition:

Section 15 of the Negotiable instruments act, 1881 defines endorsement as “when the
maker or holder of a negotiable instrument signs the same, otherwise than as such maker, for
the purpose of negotiation, on the back or face thereof or on a slip of paper annexed thereto, or
so signs for the same purpose a stamped paper intended to be completed as a negotiable
instrument, he is said to endorse the same and is called the endorser”.

TYPES OF ENDORSEMENT: The different types of endorsement are as follows:

1. General or blank endorsement

2. Special or in-full endorsement
3. Converted full endorsement
4. Partial endorsement
5. Restrictive endorsement
 6. Conditional endorsement
1. General or Blank endorsement: General or blank endorsement refers to signing on the
back of the negotiable instrument only the name of the person making it. The maker
makes no mention of the endorsee’s name. the effect of blank endorsement is that it
makes an order instrument payable to the bearer and thereby makes possible the transfer
of the property of the negotiable instrument by mere delivery.

2. In-full or special endorsement: In full or special endorsement refers to writing on the

back of the negotiable instrument direction to pay the amount to or to the order of a
specified person by the person making it. Under Section 16, any holder of the negotiable
instrument can easily convert a blank endorsement. This is possible by the holder of a
negotiable instrument endorsed in a blank signing his own name, by writing above the
endorser’s signature, a direction to pay to any other person as endorsee

3. Converted full endorsement: Under Section 49, an endorsement in blank may be

converted into an endorsement in full with the holder of a negotiable instrument
endorsing in blank without signing his own name and by writing above the endorser’s
signature a direction to pay to any other person. By converting a blank endorsement into a
full endorsement, the holder does not incur the responsibility of an endorser. Further, the
amount cannot be claimed from the endorser in full, except by the person to whom it has
been endorsed or by one who derives title through such person.

4. Partial endorsement: It refers to writing on the back of the negotiable instrument

direction to pay only a partial amount to or to the order of a specified person by the
person making it. Legally a negotiable instrument cannot be endorsed for a part of its
value. In fact, a partial endorsement is invalid. It is considered bad, as it would result in
causing inconvenience to prior parties, besides subjecting them to plurality of action and
thereby interfering with the free circulation of these instruments. Partial endorsement is
allowed where fact of the part payment may be endorsed on the instrument, which may
lead them be negotiated for the residue.

5. Restrictive endorsement: Restrictive endorsement is a type of endorsement that

prohibits the endorsee from further negotiating the instrument or restricts the endorsee to
deal with the instrument as directed by the endorser. Restrictive endorsement simply
restricts the negotiability of the instrument. Here the rules of agency are not applicable.

6. Conditional endorsement: Conditional endorsement is a type of endorsement that limits

or negatives the liability of endorser. Under section 52, a conditional endorsement refers
to the negotiation by the endorser by expressing certain words that make his liability, or
the right of the endorsee to receive the amount due thereon, dependent on the happening
of a specified event, although such event may never happen. Conditional endorsements do
not make the instruments non-transferable although such endorsements are generally not
used.

a) Sans recourse endorsement

b) Facultative endorsement
c) Sans frais endorsement
 d) Contingency conditional endorsement.

UNIT 3 BANKS AND CUSTOMER RELATIONSHIP AND TYPES OF

CUSTOMER

BANKER:
According to Dr.Herbert L. Heart “A banker is one who in the ordinary course of his
business honors cheques drawn upon him by persons from and for whom he receives money
on current accounts”.
According to Sir John Paget “No persons or body corporate or otherwise can be a banker who
does not
i. Accept deposit account;
ii. Accept current accounts;
iii. Issue and pay cheques; and
iv. Collect cheques crossed or uncrossed for his customers.

CUSTOMER:
According to Sir. John Paget “to constitute a customer, there must be some recognizable
course or habit of dealing in the nature of regular banking business”.
In the above definition of Sir. John Paget, two conditions are given 1) A customer is
one who deals with the bank.
2) The dealing of the customer must be in the nature of regular banking business.

RELATIONSHIP BETWEEN BANKER AND CUSTOMER:

1. Debtor - Customer
2. Trustee - Beneficiary
3. Agent - Principle
4. Bailor - Bailee
5. Assignor - Assignee
1. Debtor - Creditor
According to Sir John Paget, “the relationship between banker and customer is
primarily that of a debtor-creditor and respective position is determined by the state of the
account”. This means when a banker receives deposits from a customer, if the deposits is to
the credit of the customer, the banker becomes a debtor and the customer creditor. Thus, in all
savings account where the customer’s account is in credit balance, the banker is the debtor and
the customer are a creditor.

2. Trustee – beneficiary

The second type of relationship, i.e., as trustee-beneficiary arises when

 i. Customer deposits securities and valuable for safe custody with the banker. The
banker in such a case us a trustee and so, whenever the customer demands the
securities, the banker has to return them to customer who is a beneficiary.
ii. When the customer deposits money with the bank 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.

3. Agent – Principle

A banker act as an agent of a customer when he performs certain functions as per the
instruction of the customer. We can state some of the functions performed by the banker as
an agent of the customer.

i. Purchasing and selling securities on behalf of the customers.

ii. Collecting dividend warrants and interest warrants. iii. Paying club subscription,
insurance premium, rent, etc., as per the instructions of the customer.

4. Bailor – Bailee

When a customer borrows from a bank against the security under pledge, the bank is
regarded not only a pledge but also a bailee and so the bank has to take care of the security
until it is returned to the customer. But the goods kept in the safe deposit vault will not come
under bailment. Any expenses incurred towards maintenance of the security or goods have to
be borne by the customer.

5. Assignor – Assignee

Whenever a bank gives loan against life insurance policy or book debts is supply bills,
the banker is the assignee and the customer the assignor. Under assignment, the actionable
claim of the customer is transferred to the bank as security for loan. Thus, assignment is done
by customer whenever they take loan against insurance policy or book debts.

RIGHTS AND DUTIES OF BANKER:

Rights of a Banker:

1. Right of set off

2. Right of Lien
3. Right of appropriation
4. Rights to charge interest, commission and brokerage
5. Right to close the account of undesirable customer

1. Right of set off

When a debtor who owes a debt to the creditor recovers any debt due from the creditor
before the settlement of debt with the creditor is called the right of set off. In other words,
when a bank accepts deposits from the customer, the bank is a debtor and the customer is a
creditor.
2. Right of lien

Lien is a right of banker by which he can retain any security coming to his possession
for the purpose of any loan due by the customer. Lien is a right to certain any security
belonging to the customer.

3. Right of appropriation

Right of appropriation is right exercised by a creditor upon his debtor for the purpose of
setting loan account. Sections 59 to 61 of the Indian Contract Act deal with the provisions
of the right of appropriation of payments.

4. Right to charge interest, commission and brokerage

A banker grants loan and advances to customers and charges interest on the same.
Bankers usually debit the customer’s account when a customer fails to pay the interest amount
every month. The rate on this will differ between a customer and non-customer.

5. Right to close the account of undesirable customer

A banker has a right to close the account of the customer who is found undesirable as
he has been frequently issuing cheques which are bouncing which are getting dishonored.

Duties of Banker:

1. Duty to honor customer cheque

2. Duty to maintain secrecy of customer’s account
3. Duty to render proper account of deposits made and withdrawn by customers.
1. Duty to honor customer cheque

Every bank has a prime duty to honor customer’s cheques which are drawn properly
and presented during the working hours of the bank. The banker has a right to dishonor
cheques under the following grounds:
a) Date: Postdated cheques are those which carry a date is yet to come. If a banker
honors a postdated cheque, he will not only lose statutory protection but will sued by the
customer. Stale Cheque is a cheque which is more than 6 months old, it is no more a
cheque.
b) Payee: When the payee is not clear or when he payee is a wrong person the banker will
not pay and has every right to dishonor.
c) Amount in words and figure differ: When the amount given in words and stated in
figure differs, the banker will dishonor.
d) Signature: If the signature is not clear or when the payee is a wrong person, the
banker will not pay and has every right to dishonor.
e) Endorsement: The endorsement appearing on the cheque should be proper and if there
is any defect in endorsement,
f) Insufficient funds: If there are insufficient funds in the account and the cheque
presented is for a higher amount, the bank will dishonor the cheque and mention as
insufficient funds.
g) Mutilated cheques: Where the cheques are torn and are beyond recognition.
h) Smudged cheque: Where the writing on the cheque is unclear or smudged because of
sweat or water the banker will dishonor such cheques.
i) Material alteration: When a cheque contains alteration, which are made without the
knowledge of the drawer or the banker and with an intention to defraud both the parties, the
cheque will be dishonored.
j) Overwriting or Cancellation: Those which are approved by the drawer by his full
signature on the cheques at the place of such overwriting. The cheques will be dishonored.

2. Duty to maintain secrecy of customer’s account

The banker has an obligation towards the customer to maintain secrecy about the status
of the account. Under any circumstances, the banker should not reveal the secrecy of
customer’ account. In the following conditions the secrecy of the customer’s account will be
disclosed:

a) Express or Implied Condition: When a customer has given in writing to the banker to
reveal the secrecy of the customer’s account, the banker may do so. This is expressed
condition. At the same time, when a customer acts as a guarantor for a principal debtor, the
banker has to reveal the secrecy of the customer’s account to the guarantor or else the
guarantor will revoke the contract. Thus, the introduction of a guarantor by a customer,
implies him to reveal the secrecy of the customer’s account to the guarantor.
b) Under compulsion of law: A banker, under compulsion of law will have to reveal the
secrecy of customer’s account:
1. Under the income tax act 1961, when the income tax authorities demand for the
details of the customer’s account, the banker has to reveal.
2. Under foreign exchange regulation act.
3. Under Indian penal code when any police official makes an enquiry.
4. Under gift tax act.
5. Under reserve bank of India act.
6. Enquiries by government, both state and central
7. Under the banking companies act the central government and reserve bank of India
can ask the banker about the status of any account.
8. Under Indian companies act sections235,237 and 251.
9. Under section 4 of banker’s book evidence act.
10. A banker can produce for any investigation, books and documents belonging to the
customer.
c) In the course of banking business: A bank in order to protect its own interest may
have to reveal the secrecy of customer’s account. In the case of Sunderland vs. Barclays
bank, when the banker was explaining to the wife the grounds under which her cheque was
explaining to the wife the grounds under which her cheque was dishonored the husband
barged in and asked for the reason for dishonor and banker had to explain to the husband
the account position of his wife. When the wife sued the banker, the bank had to defend
itself, as its own interest. The bank had to reveal the account of the customer.
d) Disclosure in the public interest: When a customer is amassing wealth by cheating
the public and increasing the deposit account with the bank, it is the duty of the banker to
 reveal the same to the public. Otherwise, the banker will be held liable for abetting the
crime.
e) Bankers among themselves: Between the bankers as per trade custom, information
can be shared in their own business interests. This is as per the custom of the trade.

3. Duty to render proper account of deposits made and withdrawn by customers

OPENING OF BANK ACCOUNT:

Opening savings bank account: Normally, a banker will not open an account in favor of a
stranger. Any person who wishes to open a savings account has to be introduced by another
savings account holder of the same branch. Even a minor is allowed to open a savings account.

Opening current account: In the case of current account, it cannot be opened by any person
unless he is introduced by another current account holder of the branch. The current account
holder has to give a letter of introduction in favor of the person intending to open the current
account. Current account can also be opened when the employee of the bank given a letter of
introduction about the person intending to open the current account. A third type of letter of
introduction can be given by a well reputed person known to the banker. The contents of letter
of introduction must spell out the conduct and character of the person intending to open the
current account. It is more of a fidelity guarantee vouchsafing the character of the person,
willing to open the current account. The banker requires such a letter as the current account
holder is not only provided with overdraft and cash credit facility but also acceptance of third-
party cheques through endorsement. At present the bank insists not only the introduction but
also the photographs in duplicate of persons intending to open an account. One photograph is
affixed in the pass book and the other in the ledger.

Opening fixed deposit account and recurring deposit account: For opening a fixed deposit
account, the banker does not impose any condition. But he normally accepts fixed deposits
from known persons and the fixed deposit account is opened only by deposit of cash or in case
of cheques only after realization of the cheques. The same rule applies for recurring deposit
also.

SAVING ACCOUNT:

Saving account can be opened by any person above the age of 18 and he/she has to be
introduced by another customer of the same branch. In the modern days, banks insist on two
copies of photographs of persons intending to open account. This is to prevent benami account
holders which are opened in joint accounts. In savings account, the credit balance of the
customer must be sufficient enough so that cheques issued by the customers could be honored.
If a customer issues a cheque without sufficient credit balance in his/her account, the cheque
will bounce or will be dishonored. The customer who has issued such a cheque will be liable
for legal action. A saving account can also be opened without a cheque book facility. In such
case, the customer will use the withdrawal slip provided by the bank. The bank will be
provided to the savings account holder interest on the minimum credit balance remaining
between the 10th and last working day of each month. This interest is payable half yearly and
is credited to the account of the customer. If deposits are kept beyond the limit, no interest
will be payable for that excess amount. A minor can also open a saving account.
 As per the new instruction by RBI, all banks have been asked to calculate interest rate on
savings account on daily basis @ 3.5% and so the previous method of calculating interest rate
has been given up. This will benefit bankers, as cash withdrawals will come down and there
will be more arrival of deposits.

RECURRING ACCOUNT:

A stipulated amount of money is deposited every month for a fixed period, say one or
two years, which is payable at the expiry of the fixed period along with interest is called
recurring Deposits.

This can be opened either in a bank or even in s post office savings account. The
interest rate on recurring deposits will be higher as they are calculated on a cumulative basis.
In order to attract people to open more deposit account with the bank, the government has
provided income tax allowances up to Rs.12,000 i.e., any interest income earned up to
Rs.12,000 during financial year is exempted from income tax (Sec 80L of the Income Tax
Act). This facility is not available to depositors with any other institution.

FIXED DEPOSIT ACCOUNT:

When a customer deposits certain sum of money to be kept with the banker for a fixed
period, it is called a fixed deposit account. The banker will issue a receipt which is called as
fixed deposit receipt.

This receipt is nontransferable. This mean that the amount is payable on maturity only
to that deposit holder in whose name the deposit receipt stands. Thus, a fixed deposit account
can be opened even in the name if a minor. The deposit amount is payable along with the
interest at the rate as agreed upon. But a customer has the opinion to foreclose the deposit even
before the date of maturity. In such a case, the customer will not be entitled to the agreed rate
of interest.

Fixed deposit is non-transferable. In case of death of the owner, it can be given only to
the legal heir. However, the owner of the fixed deposit receipt when he/she is in the deathbed,
can write a will by which he can transfer the fixed deposit receipt to anyone. Such an Act is
called donation-mortis-causa- death bed gift.

SPECIAL TYPES OF ACCOUNTS:

Minor

In India as per section 3 of the Indian Majority Act, a minor is one who has not completed
18 years of age and in case where a guardian is appointed, a minor in one who has not
completed 21 years of age.

A bank can open account for any person who has completed 12 years of age. When accounts
are opened for a minor, the banker can allow the account as long as it is in credit balance. If a
loan is granted to a minor, the banker cannot recover the same as contract with a minor is
“void ab initio”, but when a banker grants loan for necessaries of the minor the loan can be
recovered.

Lunatics

Contract with person of unsound mind is invalid according to Sec 11 of the Indian
Contract Act. When a customer of a bank has become of unsound mind, the banker cannot
allow him to continue as the customer of the bank. In order to confirm the lunacy of the
customer, the banker can seek medical advices. If the doctor on examination of the customer,
find that his lunacy is temporary, the account of the customer can be suspended till such time
the customer becomes normal.

Illiterate Person

A person who cannot read or write is considered as an illiterate person. The banker
while opening an account in favor of an illiterate person, should adopt the following
procedure:

i. The illiterate person will have to be introduced by an existing literate account holder of
the branch.
ii. The left-hand thumb impression has to be attested by a judicial officer or by any
witness who is also the account holder of the bank.
iii. The illiterate person should not be given cheque book.
iv. Three passport size photographs should be obtained. One will be affixed in the
passbook, the order in the ledger and the third in the account opening form.
v. While withdrawing money from the account, the withdrawal slip should be
accompanied by the pass book.
vi. The left-hand thumb impression affixed in the withdrawal slip should carry the sign of
a witness. vii. While endorsing any cheque, the thumb impression should carry
the signature or witness.
viii. No bank employee should fill up the withdrawal slip for the illiterate customer and he
can be assisted by any other customer of the bank.
ix. In the account opening from the banker should obtain two identification marks from the
illiterate person.
x. If the illiterate person is unable to come to the bank in person for withdrawal of cash,
he can send a messenger with an authorization letter which should contain the
signature of two witnesses authorizing his left-hand thumb impression.

Partnership firm

When a bank is opening an account in the name of a partnership firm, it must take the
following precautions:

i. Details of the firm: The bank should know clearly the names and addresses of
partners. The name of the partnership firm and its registered office.
ii. Registration: The firm should be registered, and if it is unregistered, the bank should
insist on the registration of firm.
 iii. Liability & Duty: The partners should know that they act both as agent and principle
of the firm and so their act will bind the firm.
iv. Contingency: On the death or insolvency of any partner, the bank must close the
account of the firm and open a fresh account in the name of surviving partners.
v. Loans: While granting loan to the partnership firm, the bank should insist that all the
partners to sign the promissory note.
vi. Appropriation: In the case of firm having debit balance and the individual partners
having credit balance, the bank can exercise the right of sell off so that the loan due by
the firm can be recovered from the individual account of the partner.
vii. Negligence of Banker: Any cheque endorsed by any partner belonging to the firm, to
his personal account, should be supported by proper resolution. Banker must enquire
as to how the firm’s cheque can be endorsed to the personal account of the partner.
viii. Borrowing Powers: The borrowings powers of the firm should be clearly mentioned
in the agreement and the bank should be grant loan in excess of this limit.
ix. Dissolution: In the case of voluntary dissolution of the firm by the partners, the bank
must get the consent of all the partners before closing the account. The balance
amount can be paid jointly to the partners by which the banker will discharge his
liabilities.
x. Power of Court: The account of the partnership firm can also be closed on the order
of the court, when a creditor sues the firm.
xi. Power to countermand: Any cheque issued by a firm can be countermand by any
partner in the capacity of agent of the firm.
xii. Retirement: In case of retirement of a partner, he will not be liable for loans aster his
retirement from the firm.
Joint Stock Company:

An account can be opened in the name of the joint stock company only after its
registration. The banker must obtain the following documents,

i. Copy of the certificate of incorporation.

ii. Memorandum of Association.
iii. Articles of Association.
iv. A copy of the company seal.
v. Resolution of the board authorizing a particular director to operate the bank account.
vi. Borrowing powers of the company. vii. Persons who are authorized to endorse cheques
on behalf of the company.
viii. Powers of the board borrowing during emergency.
ix. Details of the properties of the company.
x. Net worth of the company.

NON – TRADING INSTITUTIONS:

Joint Hindu Family

When a Hindu family inheriting ancestral property, conduct a firm or business from out
of the property for the common benefit of all the family members, it is called Joint Hindu
Family. Every adult member, both male and female has equal right in the property and are
called “COPARCENERS”. The eldest members of the family are called the “KARTA” and he
represents the family in entering intro contract with third parties. The death of any member in
the family will increase the share of the coparceners: while the birth of any new member will
decrease the share of the coparceners.

Trust Account

A trust is an agreement created between two parties of which one is called the trustee and the
other is called beneficiary. The trust deed will clearly mention the purpose of the trust and the
rights and duties of the trustees.

While opening an account for the trust, the bank should observe the following precaution:

i. The bank should have a copy of trust deed.

ii. The rights and duties of the trustees should be noted down.
iii. The beneficiary and the extend of benefits due.
iv. Borrowing powers of the trustees.
v. Duration of the trustees and the trust.
vi. Identification of the trust property.
vii. The value of the trust property.
viii. The loan granted to the trust should be signed by all the trustees.
ix. Insolvency of the trustee will not affect his position as a trustee.
x. The banker should not allow the endorsement of a cheque belonging to the trust to be
transferred to the personal account of the trustee.

Clubs (or) Associations

Whenever accounts are opened in the bank in favor of clubs or association the banker must
insist on the registration of the club or association. When they are registered, they get a legal
identity.

Resolution with regard to the elections of office bearers must be handed over to the
bank. The persons who are authorized to operate the bank account will provide their specimen
signature along with the seal of the club or association. All the cheques issued by the club or
associations will be signed by the authorized persons along with the seal and designation.