5th Sem BR&O

2015
Banking Regulations and Operations
Syllabus
Unit 1: COMMERCIAL BANKS 08 Hours

Introduction Role of Commercial Banks Functions of Commercial Banks Primary Functions
and Secondary Functions Credit Creation of Commercial Banks Investment Policy of
Commercial Banks Profitability of Commercial Banks. Regulation and Control of Commercial
Banks by RBI
Unit 2: BANKER AND CUSTOMER RELATIONSHIP 12 Hours

Introduction Meaning of Banker Customer Banking Company General & Special
Relationships of Banker and Customer
Unit 3: NEGOTIABLE INSTRUMENTS 10 Hours

Introduction Meaning & Definition Features Kinds of Negotiable Instruments Promissory
Notes Bills of Exchange Cheques Meaning & Definition Features - Parties Crossing of
cheques types of crossing. Endorsements Meaning Essentials Kinds of Endorsement.
Unit 4: PAYING BANKER AND COLLECTING BANKER 10 Hours

Paying Banker Meaning Precautions Statutory Protection to the Paying Banker Dishonor
of Cheques Grounds of Dishonor Consequences of wrongful dishonor of Cheque.
Collecting Banker Meaning Duties & Responsibilities of Collecting Banker Holder for
Value Holder in Due Course. Statutory Protection to Collecting Banker
Unit 5: TYPES OF CUSTOMERS AND ACCOUNT HOLDERS 10 Hours

Types of Customers and Account Holders - Procedure and Practice is opening and conducting
the accounts of customers particularly individuals including minors - Joint Account Holders.
Partnership Firms - Joint Stock companies with limited liability-executors and trustees-clubs and
associations-joint Hindu family
Unit 6: PRINCIPLES OF BANK LENDING 10 Hours

Sound principles of Bank Lending Different kinds of borrowing facilities granted by banks
such as Loans, Cash Credit, Overdraft, Bills Purchased, Bills Discounted, Letters of Credit,
Types of Securities, NPA.
International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 1

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CHAPTER-1
COMMERCIAL BANK
Introduction Role of Commercial Banks Functions of Commercial Banks Primary Functions
and Secondary Functions Credit Creation of Commercial Banks Investment Policy of
Commercial Banks Profitability of Commercial Banks. Regulation and Control of
Commercial Banks by RBI
Introduction
A commercial bank is a type of bank that provides services such as accepting deposits, making
business loans, and offering basic investment products.
Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits
and loans from corporations or large businesses, as opposed to individual members of the
public (retail banking).
In the US the term commercial bank was often used to distinguish it from an investment bank
due to differences in bank regulation. After the great depression, through the GlassSteagall
Act, the U.S. Congress required that commercial banks only engage in banking activities,
whereas investment banks were limited to capital markets activities. This separation was
mostly repealed in the 1990s.
The role of commercial banks
Commercial banks engage in the following activities:
processing of payments by way of telegraphic transfer, EFTPOS, internet banking, or

other means
issuing bank drafts and bank cheques
accepting money on term deposit
lending money by overdraft, installment loan, or other means

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providing documentary and standby letter of credit, guarantees, performance bonds,

securities underwriting commitments and other forms of off balance sheet exposures
safekeeping of documents & other items in safe deposit boxes
sales, distribution or brokerage, with or without advice, of: insurance, unit trusts and
similar financial products as a financial supermarket
cash management and treasury
merchant banking and private equity financing
traditionally, large commercial banks also underwrite bonds, and make markets in
currency, interest rates, and credit-related securities, but today large commercial banks
usually have an investment bank arm that is involved in the aforementioned activities
Functions
Commercial banks perform many functions. They satisfy the financial needs of the sectors such
as agriculture, industry, trade, communication, so they play very significant role in a process of
economic social needs. The functions performed by banks, since recently, are becoming
customer-centred and are widening their functions. Generally, the functions of commercial
banks are divided into two categories: primary functions and the secondary functions. The
following chart simplifies the functions of commercial banks.
Commercial banks perform various primary functions; some of them are given below:
Commercial banks accept various types of deposits from public especially from its
clients, including saving account deposits, recurring account deposits, and fixed
deposits. These deposits are payable after a certain time period
Commercial banks provide loans and advances of various forms, including an overdraft
facility, cash credit, bill discounting, money at call etc. They also give demand and
demand and term loans to all types of clients against proper security.

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Credit creation is most significant function of commercial banks. While sanctioning a

loan to a customer, they do not provide cash to the borrower. Instead, they open a
deposit account from which the borrower can withdraw. In other words, while
sanctioning a loan, they automatically create deposits, known as a credit creation from
commercial banks.
Along with primary functions, commercial banks perform several secondary functions, including
many agency functions or general utility functions. The secondary functions of commercial
banks can be divided into agency functions and utility functions.
The agency functions are the following:
To collect and clear cheque, dividends and interest warrant.

To make payments of rent, insurance premium, etc.
To deal in foreign exchange transactions.
To purchase and sell securities.
To act as trustee, attorney, correspondent and executor.
To accept tax proceeds and tax returns.
The utility functions are the following:
To provide safety locker facility to customers.

To provide money transfer facility.
To issue travelers cheque.
To act as referees.
To accept various bills for payment: phone bills, gas bills, water bills, etc.
To provide merchant banking facility.
To provide various cards: credit cards, debit cards, smart cards, etc

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Credit Creation of Commercial Bank-
One of the important functions of commercial bank is the creation of credit. Credit creation is
the multiple expansions of banks demand deposits. It is an open secret now that banks advance
a major portion of their deposits to the borrowers and keep smaller parts of deposits to the
customers on demand. Even then the customers of the banks have full confidence that the
depositors lying in the banks are quite safe and can be withdrawn on demand. The banks
exploit this trust of their clients and expand loans by much more time than the amount of
demand deposits possessed by them. This tendency on the part of the commercial banks to
expand their demand deposits as a multiple of their excess cash reserve is called creation of
credit.
The single bank cannot create credit. It is the banking system as a whole which can expand
loans by many times of its excess cash reserves. Further, when a loan is advanced to an
individuals or a business concern, it is not given in cash. The bank opens a deposit account in
the name of the borrower and allows him to draw upon the bank as and when required. The
loan advanced becomes the gain of deposit by some other bank. Loans thus make deposits and
deposits make loans.
The most common mechanism used to measure this increase in the money supply is typically
called the money multiplier. It calculates the maximum amount of money that an initial deposit
can be expanded to with a given reserve ratio.
Formula
The money multiplier, m, is the inverse of the reserve requirement, R
m=1/R
Example
For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as
a fraction:
R=1/5
so then the money multiplier, m, will be calculated as:

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m=1/(1/5)=5
This number is multiplied by the initial deposit to show the maximum amount of money it can
be expanded to.
Investment Policy of Commercial Bank
The banker while making advances/investments has to observe certain important principles.
They are known as principles of good lending. The bankers have to follow these principles when
appraising the proposal for advancing loans.
They may be classified as follows:
General principles
(i) Principle of diversification
(ii) Principle of purpose
(iii) Principle of Security
(iv) Principle of National interest and suitability
Let us discuss these principles one by one.
A. Basic Principles
These are considered as prime because the success of the bank depends upon these principles.
They include the following:
(i) Safety:
A bank is a dealer in other people's money. So, it cannot indulge in reckless risk. It should
ensure the safety of funds while taking decision regarding landings and investments. One of the

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important risks involved in lending money is the credit risk i.e., the possibility of borrowers not
repaying the money on due dates.
It is therefore necessary for the banks to maintain expert staff to appraise every credit proposal
received by it. Borrowers may default in payment, due to circumstances beyond his control.
For example, due to recessionary conditions in the economy, due to destruction of

manufacturing activity by natural calamity. Hence banks have to appraise every credit proposal
by taking into consideration market risk, individual borrower risk etc.
To avoid credit risk, the bank may call for acceptable securities, which will give full values on
default. Likewise, the market risk can be avoided by preferring high-grade securities of shorter
terms. While lending, a bank should grant advances only for short periods to creditworthy
borrower and avoid granting advances for unproductive purposes.
The lending and investment policies of a bank are generally decided by the Board of Directors.
In India the RBI also used to prescribe certain sound lending/investment policies to avoid credit
or market risk.
For example, as per RBI guidelines a bank should not lend more than 25 per cent of its owned
funds i.e., in simple term paid up capital, free reserves and accumulated profits] to a single
borrower. This prescription is known as Single Exposure Norm or Limit. International banks
have such limit restricted to 15% of owned fund.
For Indian banks, this single exposure limit is being reduced to 20% from April, 2000 as per RBI
policy guidelines. Safety of an advance or loan is determined on the basis of regular payment of
interest and principal repayment as and when due.

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(ii) Liquidity:
Liquidity means the ability of a bank to meet the demand of customers for his money. Simply to
put it, the ability of bank to produce cash on demand. It is very importantly to be observed by
every bank.
Banks are able to obtain deposits from public on the basis of the confidence created by it to pay
back the money when needed by depositors. It can do so only when it has invested certain
portion of the deposit in such investments (like Government Securities) which can be sold
quickly to convert them into cash.
This is the reason for which Statutory Liquidity Ratio (SLR) has been prescribed by RBI. A bank
must have sufficient liquid assets to meet the demands of the depositors. The liquid assets
should have the following characteristics.
(a) It should be convertible into cash quickly and easily.
(b) It should be convertible into cash without any risk of loss of value.
The need of liquidity arises on account of the following reasons:
Banks accept deposits from the public. The public can demand their deposits back at any time.
Inability to pay back deposits leads to failure of the banking system itself. Hence, a bank must
maintain adequate liquidity.
Factors Determining Liquidity of Banks
The liquidity of banks depend upon the banking habits of the people, the volume and number
of monetary transactions, nature of business conditions, the liquid reserve considerations, the
structure of banking system and money market etc. In India banks have to keep reserves as
legal requirements.

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(i) Under Sec. 42 of the RBI Act, 1934 - the commercial banks have to keep a certain minimum
reserve with RBI called CRR which is not less than 3 per cent and not exceeding 15 per cent of
total Net Demand and Time Liabilities (NDTL).
(ii) Under Sec. 24 of the Banking Regulation Act, 1949 every commercial bank have to maintain
liquid assets in the form of cash, gold, and gilt edged securities - SLR which is not less than 25
per cent and not more than 40 per cent of NDTL.
(iii) Profitability
SLR Calculation
For the basic understanding of students, the concept of Net Demand and Time Liabilities (NDTL)
may be explained roughly as follows:
Bank XYZ Ltd. (As on a Reporting Friday) Demand Deposits: 100 crore
Time Deposits: 500 crore
Other outside Liability: 40 crore
Total outside liabilities: 640 crore
Plus:
Net position of payables (liabilities) over receivables (Assets) : 10 crore (only Excess of liabilities
included) Total NDTL : 650 crore
If the bank is required to maintain SLR at 25 per cent, then 25 per cent of NDTL of Rs. 650 crore
i.e., 162.50 crore is maintained in the form of investment in approved (mainly Govt) securities,
cash and/or gold.
The basic objective of commercial banks is aiming at profit. That is, the bank carries on its entire
functions to earn profit. Sound banking demands the use of bank funds in such a way so as to

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get the highest return/profit. It must earn sufficient profit to meet out its expenses and to pay
adequate return to its shareholders.
But there is a trade-off between liquidity and profitability. For example the most liquid asset is
not most profitable and vice versa. From the liquidity point of view, banks are expected to
invest in high-grade securities of short-term. But they are not profitable as income from such
investment is very low. Banks prefer long-term securities which yield higher returns. The
objective of liquidity and profitability are contradictory.
The success of the bank depends upon its ability to balance between liquidity and profitability.
Crothers has stressed the same by remarking as "the secret of successful banking is to
distribute resources between the various forms of assets in such a way so as to get a sound
balance between liquidity and profitability".
Each depends on the others. No one or two can stand alone. If one leg of a stool is weaker or
shorter, the stool of banking will be unstable. In effective banking, all the three elements are
equal, interrelated and interdependent. They are all equally important.
General Principles
Besides the above basic principles, the banks have to follow certain other general principles in
order to make a safe lending. They are:
(i) Principle of Diversity:
Another important principle of good lending is the diversification of advances. An element of

risk is always present in every advance, however secure it might appear to be. In fact, the entire
banking business is one of taking calculated risks and a successful banker is an expert in
assessing such risks and avoiding or minimizing it in its operation.
The bank is keen on spreading the risks involved in lending, over a large number of borrowers,
over a large number of industries and areas, and over different types of securities. For example,

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if it has advanced too large a proportion of its funds against only one type of security, it will run
a big risk if that class of security steeply depreciates.
The bank has numerous branches spread over the country; it gets a wide assortment of
securities against the advances. Slump does not normally affect all industries and business
centers simultaneously. Unless there is a general recession in the economy the principle of
diversity is simply do not put all your eggs in a single baskets to avoid total loss.
(ii) Principle of Purpose or End use:
A banker must closely scrutinize the purpose for which the money is required, and ensure as far
as he can, that the money borrowed for a particular purpose is applied by the borrower
accordingly. The purpose should be productive so that the money not only remains safe but
also provides a definite source of repayment.
The purpose should also be short-termed so that it ensures liquidity. Banks discourage
advances for hoarding stocks or for speculative activities. There are obvious risks involved
therein apart from the anti-social nature of such transactions.
Purpose has assumed a special significance in the present day concept of banking. This principle
ensures end use of funds. In fact as per RBI guidelines, banks should ensure end use of funds in
respect of large advances.
(iii) Principle of Security:
It has been a practice of banks not to lend as far as possible except against security. Security is
considered as insurance or a cushion to fall back upon in case of an emergency. The bankers
carefully scrutinize all the different aspects of an advance before granting it. Thus the security
serves as a safety valve for an unexpected emergency. This is commonly accepted prudent
lending policy.

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(iv) Principle of National Interest and Suitability:
The consideration of national interest serves as a good principle of lending and investment. The
Reserve Bank of India has issued directives prohibiting banks to allow certain particular type of
advances.
For example, banks are not permitted to lend money to speculation in share or for real estate
business. It is because that these activities are considered socially not desirable.
The law and order situation at the place where the borrower carries on his business may not be
satisfactory. The advance may be on the security of manufactured goods of which proper
valuation is not possible. There may be other reasons of a like nature for which it may not be
suitable for the bank to grant the advance.
In the changing concept of banking, factors such as purpose of advance and national interest
are assuming a greater importance than security, especially in advances to agriculture, small
borrowers, and export oriented industries.
(v) Fee Based Services of Banks:
Banks are financial intermediaries. Apart from mobilizing deposits from savers and lending
them to needy borrowers, banks help the savers and borrowers to transfer funds from one
place to another in a secured way without physically moving the funds. Usually the following
methods are adopted by banks for transfer of funds:
(i) Mail Transfer
(ii) Telegraphic Transfer
(iii) Demand Drafts
(iv) Pay orders
(v) Electronic Funds Transfer

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Mail Transfer
Under Mail Transfer system, the remitter of funds is required to deposit the amount required to
be remitted together with a challan detailing the particulars of remittance. This information will
relate to the value of funds to be transferred, the bank account number and address of the
receiver of funds, particulars of remitter and purpose of remittance etc.
Under this system it is necessary that both the parties to the remittance maintain bank
accounts with the same bank, albeit with different branches / places.
This method of transfer of funds is called Mail Transfer since the advice of remittance is sent by
mail / post by the remitting bank to the branch where the beneficiary has his account. On
receipt of remittance information, the receiving branch will credit the account of the
beneficiary. Thus it is an intra bank fund transfer.
The banks do not accept large cash (usually restricted to Rs. 20,000/-) for remittances. If the
required remittance is large, bank will ask the remitter to draw a cheque on his account for the
purpose of remitting funds. Banks also charge fees for this type of service.
This facility of fund transfer is provided usually to their own customers. Funds can be
transferred only between branches of the same bank and not between one bank to another. It
is also necessary that both the parties to the transfer maintain account with the same bank.
It is however a slow method for transfer of funds as advice regarding remittance is forwarded
only through post. The paying branch will credit the account of the beneficiary only on receipt
of the advice received from the remitting bank.
Telegraphic Transfer / Telex Transfer
The method followed for transfer of funds under Telegraphic Transfer / Telex Transfer (TT) is
the same as in the case with Mail Transfer. However, the advice regarding remittance of funds
will be sent by a telegram / telex by the remitting bank to the receiving bank.

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As such the fund transfer will be quick and fast. Since the advice is sent by telegraphic/ telex
message this mode of transfer of funds will be costlier than that of Mail Transfer. However,, the
additional cost will be insignificant if we take into consideration the immediate availability of
funds to the beneficiary. This method will be costly mainly for those who remit small amounts
of money.
Demand Drafts
Drafts are basically Bills of Exchange. As in the case of bill of exchange, a draft is driven by one
party on another party and made payable to the drawer himself or someone else. Demand
Drafts are drafts drawn by a bank on its own branches at different places and made payable to
third parties or purchaser of the draft.
Supposing you as a student desire to remit certain fees for taking up a competitive examination
conducted by the Service Board, usually the Board asks all the candidates to remit the
examination fees by demand drafts issued by banks.
In such a case, you may pay the requisite sum to a bank along with the prescribed challan
detailing the name of the payee, purchaser or remitter, amount, place where it should be
remitted, etc. The bank on receipt of the amount will issue a draft which has to be sent by the
candidates to the Board along with the application.
For obtaining money or credit to the account, the payee (in the present case the Board) has to
present the draft to the paying bank. Since these drafts are payable immediately on
presentation by the payee, they are called demand drafts.
The drafts can be crossed "Account Payee "to restrict its transfer. Demand Drafts can be
defined as cheques issued by a bank on its own branches or on other banks under
corresponding arrangement.

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Pay Order
Pay Orders are drafts issued by an office / branch of a bank on itself. In other words the issuing
branch / office and paying branch / office are one and the same. Pay orders are issued by banks
only against receipt of funds first. Suppose, a candidate desires to remit certain examination /
admission fees to a particular educational authority.
In case both the candidate and the educational authority happen to maintain accounts with the
same branch, then the candidate may remit the fees by obtaining a Pay Order instead of a
demand draft. If the fees can be paid to any branches of the bank, then a demand draft can be
obtained.
Thus, the main difference between pay order and a demand draft is that whereas a demand
draft is issued by a bank on any of its branches, a pay order is issued on itself. In both the cases
the bank will issue the instruments only after receipt of funds first.
Electronic Funds Transfer
Normally remittance or transfer of funds between banks gets originated by a paper instrument.
For example, under Mail Transfer, the remitter has to fill up necessary challan and give it to the
bank along with a cheque or cash for transfer of funds. Under Electronic Funds Transfer the
transaction of funds transfer is initiated through an electronic equipment and systems or
telephone or computer devices, etc.
In India, the Reserve Bank of India has introduced Electronic Funds Transfer ( EFT ) Scheme to
assist banks in providing their customers fund transfer facility from one account to another
either with the same bank or with different banks.
Under this system a customer desiring to remit certain amount to another place fills in the
prescribed EFT application form together with the details like, beneficiary's name, bank account
number, name of the bank & branch, location of the branch, etc., and hands over the form and
a cheque drawn on his account.

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The remitting bank through one of its designated branches for this purpose transmits the
details of transfer to the Reserve Bank of India.
The Reserve Bank at the transaction originating centres consolidates all such transfer advice
and transmits information of transfer to its various centres for advising the concerned banks for
providing the requisite credit to the beneficiaries.
Thus, it acts as an intermediary between the remitting bank and receiving bank and affects the
transfer. The Reserve Bank allows up to Rs. 2.00 crore per transaction to be transferred in this
way. Further it charges only Rs. 5.00 per transaction to banks.
The banks will charge separately fees on their customers for availing of this facility. However,
fees charged by banks for transfer of funds under EFT system will be smaller as compared to
remittance facilities under MT, TT and Demand Drafts.
This system of funds transfer is available with all the public sector banks and many of the
private sector and State Cooperative banks. Fund transfer under EFT is possible from any
branch to branch with the same bank or with other banks.
Other Fee Based Services
These services can be identified as:
Issue of Guarantees
Issue of guarantees on behalf of customers is one of the important revenue earning services
provided by banks. In the course of commercial business the customers may be required to
provide with a bank guarantee under different circumstances.
Guarantees basically serve the purpose of assuring that the work awarded to a person will be
performed / executed in terms of a contract. If not, the guarantor will step in to pay any
compensation stipulated under the contract. This service brings in sizeable income to the

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banks. The guarantee fees usually depend upon the value and period of guarantees as well as
the customer-banker relationship.
Locker Facilities
Bankers make available Safety Locker Facilities to customers for keeping their valuables. In
return, the bank levies half-yearly or annual charges which may depend upon the size of the
lockers. The Lockers may be used to hold valuables like ornaments, jewellery, Share / Bond
Certificates and other important documents. These items are held only at the risk of the
customers. Banks will not be held liable if the customers misuse the locker facility.
Issue of Credit Cards
Banks issue their own as well as Cards of other reputed agencies under arrangement to
customers. Banks collect charges for this facility from card holders depending upon the type of
card, value limit, etc. The fees may be charged on annual basis with certain specified onetime
entry fees also.
Under Portfolio Management Services, the banks accept large sums of money from wealthy
customers for investment purposes with the permission of Reserve Bank of India. The guide-
lines governing PMS services are issued by Reserve Bank.
Banks are expected to maintain separate accounts for this purpose and they are not permitted
to mix up these funds with their own funds. They cannot guarantee fixed income to customers
under this scheme. Banks are basically expected to utilize the funds for investments and income
generated out ot such activity will be credited to customers account.
Banks are, however, permitted to levy fees / charges for such services. Funds accepted under
the Scheme should normally be for one year or more. Risk related to such investments will be
that of the customers and not that of the bank.

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Tax Advice
Most of the banks have their own Legal Departments. Although these Departments normally
engage themselves to protect the interest of the institution from legal disputes, the
Departments also have experts to provide legal counseling to customers. Such advice may
pertain to personal taxation, capital gain tax and other tax issues.
Investment Guidance
These days a number of financial saving products are available for investors. Some of them are
money market instruments like, Treasury Bills, Commercial Paper, Certificate of Deposits, etc.
Some of them are Capital Market instruments like Shares, Bonds, and Government Securities
with long term horizon.
Banks offer their expertise to customers in choosing the right type of investment depending
upon the amount, duration, risk appetite, expected return, etc., of customers. Banks charge
fees for providing such services. This type of service is different from that of PMS services
mentioned above.
Under PMS, the banks accept large sum of money from a customer and utilize the funds for
various investment in consultation with the customer and at his own risk. However, banks will
provide investment advice and guidance for any customers and actual investment decision and
employment of funds and maintenance of accounts there to will be done by the customers.
Agents for selling Financial Products
Under arrangement with other agencies engaged in Financial Services, banks sell their products
like Credit / Debit Cards, ATM Services, etc., to customers. Although the banks may obtain a
share of fees from other agencies, banks may also levy certain charges for these additional
facilities.

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Sale of Insurance Products
Recently, banks in India are permitted to sell insurance products to their customers under
arrangement with Insurance Companies. These products may be life insurance policies,
accident insurance policies, Pension Policies and other general insurance policies. Banks which
have wide network of branches are expected to earn sizeable income / fees from these
services.
Project Consultancy Services
Many first-time entrepreneurs need expert advice for crystallizing their investment ideas into
workable projects. Unplanned schemes may run into cost escalation and delayed execution.
Persons intending to put up small scale industries normally overlook many aspects of the
project requirements like environment clearance, legal issues, etc. Banks will be in a better
position to provide all round advice in such cases for certain fees.
Demat Accounts
Under SEBI guidelines, the issue and transfer of securities of many corporate are now required
to be transacted in demat forms. The word "Demat" is an abbreviation for De materialized
account. Under Demat form, physical securities are converted into electronic form and held in
accounts with banks and other institutions permitted to maintain this type of accounts.
This helps to avoid loss of securities, facilitate easy method of transfer and avoidance of large
quantity of paper work and storage problem. Banks may usually levy a charge for maintaining
such accounts although in many cases such service may be provided free of charge.
Letters of Credit
Banks issue Letters of Credits on behalf of their customers particularly in international trade.
The issue of Letter of Credit may be a non-fund based service if banks are not providing their
own funds to honour the bills drawn under letter of credit. Banks charge fees for issue of letters
of credit which may depend upon the value of credit, tenor of credit and customer relationship.

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Custodial Services
Apart from offering Safety Locker Facility, banks also provide custodial services for holding
valuable financial instruments, important legal deeds and documents of customers against
payment of periodic fees.
It should be remembered that under Locker Facility the banks make available Lockers on rental
basis for safe keeping of valuables at customer risk.
However, under custodial services, the banks accept valuable documents, etc., of customers for
safe custody, transfer, maintaining proper accounts relating to it and bank is liable for any
wrong doing.
Presently Indian Corporate is permitted to raise equity funds from overseas market through
issue of Global Depository Receipts (GDRs). The equity share issued against GDR entitlements
are held with a bank in India under Custodial Accounts.
In this case the bank acting as a Custodian will maintain all records relating to the shares held
and transferred under GDR mechanism and the bank will be earning certain fees from the
company for this purpose.
Arranging Foreign Currency Loans from Overseas Market
Presently Government permits Indian Corporate to raise foreign currency loans from overseas
market under certain conditions. Since they may not be well conversant with overseas market
and the risk associated with it, the corporate take the assistance of banks for raising the loans
at minimum cost.
Here the banks will not be providing their own funds but only help the corporate to raise cheap
and reliable funds. The banks collect fees like management fees, etc., for such services. They
may also arrange loan syndication against specific fees.
Charges in such cases will relate to the total fund raised, the duration of loan, management of
loan accounts and other services expected of the bank under arrangement with the customers.

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Other Fee Based Services
Innovation is one of the catch words in banking services today. Banks tend to innovate new
types of services to suit the personal requirements of various customers as well as that of
corporate-clients. As such these services will be different from banks to banks. In the estab-
lished overseas markets, banks may also provide the following specialized services to corporate
clients:
Factoring Services;
Forfeiting Services;
Bankers Acceptances, etc.
In India Factoring and Forfeiting services are provided by specialized agencies and not by banks.
Similarly Bankers Acceptances are not popular in the Indian industry. Few years back banks
were trying to popularize "Gift Cheque "scheme. However, it did not turn out to be a successful
scheme.
Under Gift Cheque facility, a person intending to make a present to another person on
occasions like wedding, birthday, etc., can buy a gift cheque from a bank of the required value
and present it instead of making the present in cash or in kind.
Factors are basically institutions financing the receivables of corporate on recourse or non-
recourse basis. In other words, the accounts receivables are sold outright to factors who
arrange to collect the receivables directly from debtors.
It is beneficial to the corporate since they are able to realize funds on the bills immediately
from the factor. The factor deducts commission or other charges plus interest component from
the value of bills before making payment to customers.

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Forfeiting is another method of purchasing the receivables of customers on non-recourse basis.

However, Forfeiting is more common in international trade while Factoring is a common
practice adopted in domestic trade.
Under Forfeiting the financing institution purchases long-term bills/ instruments on revolving
basis up to certain maximum value and period unlike in the case of Factoring where financing is
done for a short term. Since Forfeiting is always done under non-recourse basis, the discounted
value is higher as compared to the discount under Factoring.
Bankers' Acceptances refer to bills which have been accepted by banks. This acceptance
enhances the safety aspect of the bill and becomes a good instrument for value to discount
houses. Further bankers acceptances strike a better realization with lower discount.
Many of the services mentioned above like EFT Scheme, PMS Service, Investment Guidance,
Issue of Letters of Credit, Demat Accounts, Custodial Services, Bankers Acceptances, Factoring
and Forfeiting Services, Sale of Insurance Products, Issue of Credit / Debit Cards, ATM Services,
Arrangement of Funds from Overseas Markets are being offered by banks recently in India.
The financial statements of a Banking company consists of 16 schedules of which the schedules
1 to 12 are for 'Balance sheet' items and the schedules 13 to 16 are for "Profit and Loss
Account", i.e., for Revenue items.
Among the schedules of Balance sheet, schedules 1 to 5 gives liabilities and the schedules 6 to
11 reveal about Assets. The schedule 12 gives contingent liabilities. Let us see the contents of
these schedules one by one.
Bills for Collection:
Bills and other items in the course of collection and not adjusted will be shown against this item
in the summary version only. No separate schedule is proposed.

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The liabilities side of the balance sheet of a bank explains how the bank has mobilized its
resources. It shows the bank's indebtedness to its shareholders and to the public. It also shows
the Reserves and provisions created out of past profits and the current year's profit, if any.
The assets side reveals how the bank has invested its resources. From the balance sheet it can
be seen that the asset side of the balance sheet is arranged in the order of liquidity, starting
with cash the most liquid ones and ending with fixed assets and other assets which are least
liquid.
On the liabilities side items are arranged in the order of descending urgency. The most urgent
liability is shown in the last and capital which is paid back only in the event of winding up is
shown first.
Profitability of Commercial Bank
Commercial banks form a significant part of the countrys Financial Institution System.
Commercial Banks are those profit seeking institutions which accept deposits from general
public and advance money to individuals like household, entrepreneurs, businessmen etc. with
the prime objective of earning profit in the form of interest, commission etc. The operations of
all these banks are regulated by the Reserve Bank of India, which is the central bank and
supreme financial authority in India. The main source of income of a commercial bank is the
difference between these two rates which they charge to borrowers and pay to depositors.
Examples of commercial banks ICICI Bank, State Bank of India, Axis Bank, and HDFC Bank.
Classification of commercial banks
1. Scheduled banks: - Banks which have been included in the Second Schedule of RBI Act
1934. They are categorized as follows:
o Public Sector Banks: - are those banks in which majority of stake are held by the
government. Eg. SBI, PNB, Syndicate Bank, Union Bank of India etc.

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o Private Sector Banks :- are those banks in which majority of stake is held by
private individuals. Eg. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank etc.
o Foreign Banks: - are the banks with Head office outside the country in which
they are located. Eg. Citi Bank, Standard Chartered Bank, Bank of Tokyo Ltd. etc.
Regulation and Control of Commercial Bank
The Banking Regulation Act, 1949 empowers the Reserve Bank of India to inspect and
supervise commercial banks. These powers are exercised through on-site inspection and off
site surveillance.
Till 1993, regulatory as well as supervisory functions over commercial banks were performed
by the Department of Banking Operations and Development (DBOD). Subsequently, a new
Department of Banking Supervision (DBS) was set up to take over the supervisory functions
relating to the commercial banks from DBOD. For dedicated and integrated supervision over
all credit institutions, i.e., banks, development financial institutions and non-banking financial
companies, the Board for Financial Supervision (BFS) was set up in November 1994 under the
aegis of the Reserve Bank of India. For focused attention in the area of supervision over non-
banking finance companies, Department of Supervision was further bifurcated in August 1997
into Department of Banking Supervision (DBS) and Department of Non-Banking Supervision
(DNBS). These Departments now look after supervision over commercial banks &
development financial institutions and non-banking financial companies, respectively. Both
these departments now function under the direction of the Board for Financial Supervision
(BFS).
The Board for Financial Supervision constituted an audit sub-committee in January 1995 with
the Vice-Chairman of the Board as its Chairman and two non-official members of BFS as
members. The sub-committees main focus is up gradation of the quality of the statutory
audit and concurrent / internal audit functions in banks and development financial
institutions.

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On site Inspection
On site inspection of banks is carried out on an annual basis. Besides the head office and
controlling offices, certain specified branches are covered under inspection so as to ensure a
minimum coverage of advances.
The Annual Financial Inspection (AFI) focuses on statutorily mandated areas of solvency,
liquidity and operational health of the bank. It is based on internationally adopted CAMEL
model modified as CAMELS, i.e., capital adequacy, asset quality, management, earning,
liquidity and system and control. While the compliance to the inspection findings is followed
up in the usual course, the top management of the Reserve Bank addresses supervisory
letters to the top management of the banks highlighting the major areas of supervisory
concern that need immediate rectification, holds supervisory discussions and draws up an
action plan, that can be monitored. All these are followed up vigorously. Indian commercial
banks are rated as per supervisory rating model approved by the BFS which is based on
CAMELS concept.
Off-site Monitoring
As part of the new supervisory strategy, a focused off-site surveillance function was initiated
in 1995 for domestic operations of banks. The primary objective of the offsite surveillance is
to monitor the financial health of banks between two on-site inspections, identifying banks
which show financial deterioration and would be a source for supervisory concerns. This acts
as a trigger for timely remedial action.
During December 1995 first tranche of off-site returns was introduced with five quarterly
returns for all commercial banks operating in India and two half yearly returns one each on
connected and related lending and profile of ownership, control and management for
domestic banks. The second tranche of four quarterly returns for monitoring asset-liability
management covering liquidity and interest rate risk for domestic currency and foreign
currencies were introduced since June, 1999. The Reserve Bank intends to reduce this
periodicity with effect from April 1, 2000.

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Corporate Governance
With a view to strengthening the corporate governance and internal control function in the
banks, several steps have been initiated. Introduction of concurrent audit system,
constitution of independent audit committee of board, appointment of RBI nominees on
boards of banks, creation of a post of compliance officer, such are some steps. Besides, the
Reserve Bank monitors the implementation of recommendations of Jilani Committee relating
to internal control systems in banks on an on-going basis during the annual financial
inspection of banks.
Initiatives and Directions
The Reserve Bank has taken several other supervisory policy initiatives. These include
quarterly monitoring visits to banks displaying financial and systemic weaknesses,
appointment of monitoring officers and direct monitoring of certain problem areas in house-
keeping, etc. In addition the department provides secretarial support to the Board for
Financial Supervision and acts as its executive arm. It is the BFS which evolves policies relating
to supervision. It also attends to appointment of statutory central auditors / branch auditors
for all banks and selected all India financial institutions and to complaints against banks. The
department monitors cases of frauds perpetrated in banks and reported to it. The
department as a onetime measure, issued several guidelines to banks and all india financial
institutions to enable them to become Y2K compliant.
Core Principles
Against the backdrop of banking sector reforms in India and the global focus on internal
control and supervisory mechanism, the need for building a strong and efficient banking
system comparable to the international standards cannot be gainsaid. A detailed study was
carried out so as to ascertain gaps, if any, in implementing the 25 core principles of effective
banking supervision enunciated by the Bank for International Settlements (BIS). Necessary
steps have already been initiated to fill in the gaps, so as to make the regulatory as well
supervisory system more sound and comparable to international standards.

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Supervision over FIs
On the basis of the recommendations made by an in-house group, the monitoring of the
financial institutions first started after 1990. This was done through prescribed quarterly
returns on liabilities / assets, source and deployment of funds, etc. The objective of this
monitoring was to obtain a macro level perspective for evolving monetary and credit policy,
to assess the quality of assets of the financial system and to improve co-ordination between
banks and FIs. In 1994, these institutions were brought under the prudential regulation of the
Reserve Bank.
The Reserve Bank has adopted more or less, the CAMELS approach for regulation of Fis. Since
FIs are vested with developmental role as welland with responsibility of supervision of other
institutions, evaluation of their developmental, co-ordinating and supervisory role is also
undertaken.
The newly created division in the department at present supervises and regulates ten select
all-India financial institutions viz., IDBI, ICICI, IFCI, IIBI, Exim Bank, NABARD, NHB, SIDBI, IDFC
and TFCI. With a view to having a continuous monitoring and supervision of these FIs, an off-
site surveillance system has also been put in place.
Further, the division collects from LIC, GIC and UTI information relating to assets and liabilities
and flow of funds for the purpose of overall assessment of the impact of the operations of FIs
on the total flow of resources in the economy and for compiling new liquidity and monetary
aggregates.

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CHAPTER -2
BANKER AND CUSTOMER RELATIONSHIP
INTRODUCTION TO BANKING
Banks and financial institutions (FIs) are in the process of great change in the context of the
ongoing financial sector reforms and the emerging competitive financial system within and
outside the country.
With the widening and deepening of markets for long-term funds, the justification for further
prolonging the role of subsidized credit from banks and FIs has weakened; more so because
prolonged concessional
Finance by the Government has been deemed to be neither sustainable nor desirable. This is
consistent with the process of financial sector reforms, with its focus to allocate efficiency and
stability. With the
withdrawal of concessional sources of finance of banks and FIs and blurring of distinction
between FIs and banks, FIs not only have to raise resources at market-related rates but also
have to face a competitive environment on both asset and liability sides. Moreover, structural
changes in the financial system coupled with the industrial slowdown in recent years have
adversely affected the volume of business and profitability of FIs.
Banks are becoming increasingly complex organizations. Investors are finding it harder to
understand the quality of financial performance and risk exposures of banks. The traditional set
of information as
contained in banks balance sheet often fails to convey information to readers of financial
statements that can enable them to ascertain the quality of earnings. Accordingly, supervisors
world-wide are making conscious efforts towards increasing the quality and quantity of
disclosures in banks balance sheets. Transparency challenges are met where market
participants not only provide information, but also place the information in a context that
makes it meaningful to accurately reflect risks. The quest for transparency has, therefore, to be
continuous and persistent.

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Increasing competition among banks, emanating not only from peers, but also from new
entrants and other intermediaries, has been exerting pressure on bank spreads. The
technology-intensive new private
and foreign banks are positioning themselves as one-stop-shop financial services and
providing customers greater convenience and high quality services backed by appropriate
investments in technology and other infrastructure. Therefore, the future profitability of public
sector banks would depend on their ability to generate greater non-interest income and control
operating expenses.
Approaches are expected to provide a more standardized but tighter framework for the
banking sector. Simultaneously, the banking industry is undergoing a change driven by
technological advancements. Since retail customers is fast becoming more demanding, in the
competitive environment, banks have to offer the value-added services. Harnessing technology
to improve productivity so as to produce highly competitive types of banking and generating
greater non-interest income by diversifying into non-fund based activities will be important
features of the Indian banking of tomorrow.
In view of this changed environment, banks FIs are in the process of adjusting business
relationship with their customer. The bank customer relationship is an emerging area that has
attracted the attention of many stakeholders in this regard. Before we take up the relationship
that exists between a banker and his customer, let us understand the definitions of the terms
banker and customer.

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DEFINITION OF BANKER
There has been much controversy regarding the definition of the term banker. The essential
function of a banker is the acceptance of deposits of funds with drawable on demand.
Section 5(a) of the Banking Regulation Act defines banking company as a company, which
transacts the business the business of banking. In order to understand the nature of a banking
company, one will have to look into the definition of the term banking. In simple words it can
be defined as trading in money and instruments of credit.
According to section 5(b) Banking means the accepting for the purpose of lending or
investment of deposit of money from the public, repayable on demand or otherwise and
withdrawal by cheque, draft, order or otherwise. Sir John Paget another well-known authority
on banking considers that no person or body, corporate or otherwise, can be a banker who
does not (1) Take deposits accounts (2) Take current accounts (3) Issue and pay cheques and (4)
Collect cheques crossed and uncrossed for his customers. Besides Sir Paget maintains that a
banker should progress himself to be a banker and the public should accept him as such.
Banking should be his main source of income.
According to section 7of the Banking Regulation Act, 1949, No company other than a banking
company shall use as part of its name any of the words bank, banker or banking and no
company shall carry on the business of banking in India unless it uses as part of its name at least
one such.
The functions of a banker are: -

Accepting of deposits
Lending of money
Undertaking to honor cheques drawn upon it by customers and
To work in the capacity of an agent etc.

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These additional functions can be grouped under two broad heads
(a) Agency service.

The agency services comprise of payment and collection of cheques, bills, promissory
notes, salary and pension bills, purchase and sale of stock and share, etc.
(b) General utility services.
The general utility services of the banker include the issue of credit instruments,
letters of credit, traveler cheques, transactions of foreign exchange, acceptance of valuable and
documents for safe custody, provision of facilities for safe deposit lockers, administration of
estates as trustees, executors etc. Now a bank can be distinguished from any other commercial
institutions of the basis of the following features: -
A. Deposit Accounts: The bank receives deposits from the public in the form of saving
accounts, fixed deposit accounts, recurring deposit accounts pigmy deposit accounts etc.
B. Current Accounts: The bank receives deposits on current accounts from the
businessperson. A current account is a running account. There is no limit on the number of
times the account holder can withdraw his money.
C. Cheque Facility: The saving and current account holders enjoy the cheque facility. They
can withdraw money by drawing cheques on their bank. The saving account holders who dont
enjoy cheque facility can withdraw money with the help of withdrawal slips. It may be noted
that the account holder may issue a cheque in favour of any person. The bank will honor it if
there is sufficient balance in the account.

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Meaning of a customer:
Law does not define the term customer of a bank. Ordinarily a person who has an account in
a bank is considered its customer. In chambers dictionary, it is written, A customer is one who
is accomplished to frequent a certain place of business.
According to Dr. Hart, A customer is one who has an account with a banker or for whom a
banker habitually undertakes to act as such.
Therefore, neither the number of transactions nor the period during which business has been
conducted between the parties is material in determining whether a person is a customer. The
accepted position at present recognizes a customer as one who satisfies the following
conditions: -
1. Duration not of essence: The duration of dealing is no of essence. Even a single transaction
can constitute a customer.
2. Frequency anticipated: Although frequency of transactions is not essential to constitute a
person as customer, still his position must be such that transactions are likely to become
frequent.
3. Dealings to be of banking nature: He should have dealing with the bank, which should be in
the nature of regular banking business. That is, the person should have some type of account
with the bank-either deposit, current or loan account. A person having dealings with the bank
only in respect of its utility service viz. Safe deposit lockers, safe custody, remittances etc. does
not constitute a customer.
4. Introduction necessary: The banker must have taken due care to satisfy him about the
bonfires and repeatability of the customers. This is necessary to institute the persons as 98
customers for the purpose of protection of the banker under Negotiable Instruments Act.
5. Commencement of relation of from first transaction: As soon as the banker accepts money
from any person on the footing that he will honor his cheques up to the amount standing to his
credit, the person becomes his customer. The money accepted can even be by way of cheque.
The relation of banker and customer begins as soon as the first cheque is paid in and accepted
for collection.

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GENERAL RELATIONSHIP BETWEEN BANKER AND CUSTOMER
The relationship between a banker and his customer is basically contractual. It is regulated by:
The general rules of contract
The rules of agency where applicable
Banking practice.
Of the several possible relationships between a banker and his customer, the primary one is
that of debtor and creditor. But who is what at a particular moment depends on the state of
customers accounts. If the account shows a credit balance, obviously the banker is a debtor
and the customer a creditor. Reverse shall be the position when the customers account shows
an overdrawing.
There are three are tree possible other relationships depending upon the receptive state of
circumstances.
Bailer and bailee

Principal and agent and
Trustee and beneficiary.
Debtor and creditor relationship: The general relationship between a banker and his customer
is basically that of debtor and creditor. If the account shows a credit balance, the banker will be
a debtor and the customer a creditor. But in case of debit balance or overdraft, the banker will
be the creditor and the customer the debtor. When the customer deposits money in the bank
by opening an account,
it amounts to lending money to the banker. The bank can make use of this money as it is
absolutely at the disposal of the bank. The bank undertakes to repay the amount on demand. It
has been rightly said that a banker is normally a debtor of his customer and is bound to
discharge his indebtedness by honoring his customers cheque.
The banker only undertakes to ray a sum equivalent to the amount deposited with his and the
customer has no right whatsoever to claim the identical coins or notes deposited with him.

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The usual debtor-creditor relationship between a banker and a customer is governed by the
following conditions, which are not applicable to similar commercial debts:
1. Demand for Payment: A bank is not an ordinary debtor in the sense that it is under no
obligation to refund the customers deposits unless demand is made. Even in case of fixed
deposit the bank is not required to return the money on its own accord. The customer must
make a demand for repayment of funds deposited except when the bank is being wound up.
2. Proper place and time: The obligation to repay the amount deposited is limited to the
branches where the account is kept. The customer can issue cheques only on the branch of the
bank where the account is kept. The demand for payment must be made during the working
hours and on working days of the branch concerned.
3. Demand in proper manner: The demand for payment should be made in proper manner as
allowed by the law or custom. The demand should not be made verbally or through a
telephonic message. The proper manner may be cheque; draft or anything, which may prove
the geniuses of demand buy the customer whose identity, must be disclosed and authenticated
to the satisfaction of the bank.
4. No time bar: The depositor with a bank does not become time barred on the expiry of three
years as in the case of other commercial debts. This is because of the reason that the amount
does not be come due unless it is demanded.
Banker as a trustee:
The banker assumes the position of trustee when they accepts securities or valuables
from the customer for safe custody. The articles deposited with the bank for safe custody
continue to be owned by the customer. The banker is to deal with the articles as per the
instructions of the customer. The banker is a trustee of the customer in respect of cheques and
bills deposited buy the customer for collection till they are collected. He becomes the debtor
once it is collected and credited to the account of the customer. If the bank is liquidated before
the cheques is realized the bank remains a trustee of the customer. Therefore, the customer
can claim back the cheque or the proceeds of the cheque in full.

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Banker as agent:
A banker acts as an agent of his customer and performs a number agency function for the
convenience of his customer.
For example: some banks have established tax service departments to take up the tax problems
of their customers.
Bailee and bailer:

Another relation between the banker and the customer is that of bailee and bailor. The bank
functions as bailee when it keeps valuable articles, diamond, gold, securities and other
documents of its customers. The bank works, as the custodian of these things and it is implied
responsibility of the bank to return these things safely. Thus the bank is a bailee and the
customer is a bailor or beneficiary.
SPECIAL RELATIONSHIP BETWEEN BANKER AND CUSTOMER
The relationship between the banker and the customer creates certain obligations on the part
of the banker. These obligations along with the rights of the banker create special relationship.
The various special features of the relationship are detailed below:
1. Banker has an obligation to honor the cheques of the customer up to the amount standing
to the credit of the customers account
2. The banker has to maintain the secrecy of his customers account.
3. The banker can charge interest all compound rates for defaults in payments of loan by the
customer or for overdrawn amounts.
4. Banker is allowed to produce certified copies of the entries made in the original books of
account as proof of transaction in legal proceedings under certain circumstances and cases
in accordance with the provisions of bankers book evidence act, 1891.
5. A banker is under the obligation of law to suspend the operation of accounts by the
customer in case of receipt of garnishee order from the court.

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Obligations of a banker:
Though the primary relationship between a banker and his customer is that of a debtor and
creditor or vice-versa the special features of this relationship as noted above impose the
Following additional obligations on the banker:
1. Obligation to honor the cheques: Section 31 of Negotiable Instrument act, 1881 imposes
upon bank the obligation to honor the cheques. The text of the act is as follows:
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 so to do and in
default of such payment must compensate the drawer for any less or damage caused buy such
default.
2. Time and Place of Payment: The demand of payment by the creditor must be made to the
debtor at the proper palace and in proper time. Transactions in the banks are carried out upto 2
p.m. on working days and up to 12 noon on every Saturday. A commercial bank, having a
number of branches is considered to be one entity but the depositor enter into relationship
with only that branch where an account is opened in his name.
3. Demand made in proper order: The statutory definition of banking system explains that
deposits are withdrawal by cheque, drafts, order or otherwise. This is to be done as per the
common usage amongst the bankers.
Cases in which the Banker Refuses Customers Cheques
(A) When may a banker refuse to honour a customers cheque:-

When the balance to the credit of the customer not sufficient to meet the cheque.
When money deposited by the customer cannot be withdrawn on demand e.g., fixed
deposits.
When the cheque is state i.e. it has become older than six months and has not been
presented for Payment within reasonable time of the date of the issue.
When the account is in joint names and all the persons have not signed the cheque.

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(B) When the banker must reuse to honour customers cheque:-

When the customer has stopped the payment of the cheque.
When the banker is served with garnishee order or a prohibitory order by any court.
When the bank comes to know of the defect in the title of the person presenting the
cheque before the bank.
When the holder of the cheque gives a notice of its loss to the bank.
When the cheque is post-dated and is presented for payment before its ostensible date.
Garnishee Order:
A garnishee order INS an order issued by the court under order 21 rules 46 of the code
of civil Procedure, 1908, generally served on banks. Such order prohibits a banker from making
payments from a particular account named therein. When a debtor does not repay the debt
owed by him to his creditor, the latter may apply to the court for the issue of a Garnishee Order
on the banker of his debtor. Such order attaches the debts not secured by a negotiable
instrument.
It attaches only the balance in the account at the time the order is received. Cheques
etc. are sent for collection and the amounts deposited by the customer after the order is
received are not attached. However, uncleared effects already placed to customers credit are
attached.
A Garnishee order is issued in two parts. In the first instance the court issue an order, called
order nisi directing the banker to stop payments from the accounts of the judgment-debtor.
The banker is also required to submit explanation, if any, as to why the funds in the said
account should not be utilized for meeting the claim or the judgment. After the receipt of order
nisi, the banker stops all payments from the said accounts and informs his customer
accordingly.

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RIGHTS OF BANKER
1. Right of Set off or the right to combine accounts: A banker can combine two or more
accounts of a
Customer and shoe the net balance as the amount due to from him.
2. Bankers General Lien: The banker has a right of general lien against the customer; the right
to retain
as security for a general balances of accounts any goods and securities bailee to him.
3. Right of Application: Where customer has not directed the bank to appropriate a deposit
against a
Particular debt, it is the banks right to appropriate the Payment to any debt.
4. Law of Limitation: Under article 22 of part 2 of the schedule to the limitation act 1963 the
period of Limitation for the refund of bank deposits is there years from the date the customer
demand repayment.
TERMINATION OF RELATIONSHIP
The relationship of a banker and customer may be terminated in any of the following ways:
1. Mutual Agreement: This is clear enough. The balance at the credit of the customer will have to
be paid off and the overdraft, if any cleared.
2. Notice to Terminate: In case of a current account, no such notice appears necessary. But if
its a deposit account, the banker could insist on the notice period specified on the fixed
deposit.
3. Death of Customer: This is an obvious method of terminating the relationship. But it is the
notice of death, which revokes the bankers authority to pay Cheques.
4. Lunacy of Customer: The lunacy of a customer automatically terminates relationships though
here again the bankers authority to pay cheques is revoked by notice of insanity.
5. Bankruptcy: Bankruptcy or winding up is a sufficient ground for terminating the relationship.
The customer will be entitled to a dividend in respect of any balance standing to the credit of his
account calculated in the ordinary ways and will be entitled to the return of any articles bartered.

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QUESTIONS
2 Marks
1. What is particular lien?

2. What is right of set off?
3. Who is customer?
4. State the ruling in Claytons case?
5. Define the term banker
6. What is lien?
7. Who is Bailee and who is Bailor?
8. What is Garnishee order?
8 Marks
1. Banker is called dignified debtor. Discuss

2. Distinguish between general lien and particular lien.
3. Explain how the termination of relationship can be terminated?
16 Marks
1. Explain briefly special relationship between banker and customer?

2. Explain the function of modern commercial banks?
3. Explain the various subsidiary services of a modern banker?
4. Explain the relationship between banker and customer?
5. Explain the obligation to maintain secrecy. What are the consequences of wrongful
disclosure?

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CHAPTER-3
NEGOTIABLE INSTRUMENTS
INTRODUCTION
The Negotiable Instruments Act was enacted, in India, in 1881. Prior to its enactment, the
provision of the English Negotiable Instrument Act were applicable in India, and the present Act
is also based on the English Act with certain modifications. It extends to the whole of India
except the State of Jammu and Kashmir. The Act operates subject to the provisions of Sections
31 and 32 of the Reserve Bank of India Act, 1934.
Section 31 of the Reserve Bank of India Act provides that no person in India other than the
Bank or as expressly authorised by this Act, the Central Government shall draw, accept, make or
issue any bill of exchange, hundi, promissory note or engagement for the payment of money
payable to bearer on demand. This Section further provides that no one except the RBI or the
Central Government can make or issue a promissory note expressed to be payable or demand
or after a certain time.
Section 32 of the Reserve Bank of India Act makes issue of such bills or notes punishable with
fine which may extend to the amount of the instrument.
The effect or the consequences of these provisions are:
1. A promissory note cannot be made payable to the bearer, no matter whether it is payable
on demand or after a certain time.
2. A bill of exchange cannot be made payable to the bearer on demand though it can be made
payable to the bearer after a certain time.
3. But a cheque {though a bill of exchange} payable to bearer or demand can be drawn on a
persons account with a banker.

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MEANING OF NEGOTIABLE INSTRUMENTS
According to Section 13 (a) of the Act, Negotiable instrument means a promissory note, bill of
exchange or cheque payable either to order or to bearer, whether the word order or
bearer appear on the Instrument or not.
In the words of Justice, Willis, A negotiable instrument is one, the property in which is
acquired by anyone who takes it bonafide and for value notwithstanding any defects of the title
in the person from whom he took it.
CHARACTERISTICS OF A NEGOTIABLE INSTRUMENT
1. Property: The possessor of the negotiable instrument is presumed to be the owner of the
property Contained therein. A negotiable instrument does not merely give possession of the
instrument but right to property also. The property in a negotiable instrument can be
transferred without any formality. In the case of bearer instrument, the property passes by
mere delivery to the transferee. In the case of an order instrument, endorsement and deli very
are required for the transfer of property.
2. Title: The transferee of a negotiable le instrument is known as holder in due course. A bona
fide transferee for value is not affected by any defect of title on the part of the transferor or of
any of the previous holders of the instrument.
3. Rights: The transferee of the negotiable instrument can sue in his own name, in case of
dishonour. A negotiable instrument can be transferred any number of times till it is at maturity.
The holder of the instrument need not give notice of transfer to the party liable on the
instrument to pay.
4. Presumptions: Certain presumptions apply to all negotiable instruments e.g., a presumption

that consideration has been paid under it. It is not necessary to write in a promissory note
the words for value received or similar expressions because the payment of consideration
is presumed. The words are usually included to create additional evidence of consideration.

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5. Prompt payment: A negotiable instrument enables the holder to expect prompt

payment because dishonour means the ruin of the credit of all persons who are parties
to the instrument.
PRESUMPTIONS TO NEGOTIABLE INSTRUMENT
1. Consideration: It shall be presumed that every negotiable instrument was made drawn,
accepted or endorsed for consideration. Its presumed that, consideration is present in every
negotiable instrument until the contrary is presumed. The presumption of consideration,
however may be rebutted by proof that the instrument had been obtained from, its lawful
owner by means of fraud or undue influence.
2. Date: Where a negotiable instrument is dated, the presumption is that it has been made or
drawn on such date, unless the contrary is proved.
3. Time of acceptance: Unless the contrary is proved, every accepted bill of exchange is
presumed to have been accepted within a reasonable time after its issue and before its
maturity. This presumption only applies when the acceptance is not dated; if the acceptance
bears a date, it will prima facie be taken as evidence of the date on which it was made.
4. Time of transfer: Unless the contrary is presumed it shall be presumed that every transfer of
a negotiable instrument was made before its maturity.
5. Order of endorsement: Until the contrary is proved it shall be presumed that the
endorsements appearing upon a negotiable instrument were made in the order in which
they appear thereon.
6. Stamp: Unless the contrary is proved, it shall be presumed that a lost promissory note, bill of
exchange or cheque was duly stamped.
7. Holder in due course: Until the contrary is proved, it shall be presumed that the holder of a
negotiable instrument is the holder in due course. Every holder of a negotiable instrument is
presumed to have paid consideration for it and to have taken it in good faith. But if the

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instrument was obtained from its lawful owner by means of an offence or fraud, the holder
has to prove that he is a holder in due course.
8. Proof of protest: Section 119 lays down that in a suit upon an instrument which has been
dishonored, the court shall on proof of the protest, presume the fact of dishonour, unless and
until such fact is disproved.
TYPES OF NEGOTIABLE INSTRUMENT

1. Negotiable instruments recognized by statute or by law are:
(i) Promissory notes
(ii) Bills of exchange
(iii) Cheques.
2. Negotiable instruments recognised by usage or custom are:
(i) Hundis
(ii) Share warrants
(iii) Dividend warrants
(iv) Bankers draft
(v) Circular notes
(vi) Bearer debentures
(vii) Debentures of Bombay Port Trust
(viii)Railway receipts
(ix) Delivery orders.
Promissory notes
Section 4 of the Act defines, A promissory note is an instrument in writing (note being a
bank-note or a currency note) containing an unconditional undertaking, signed by the maker, to
pay a certain sum of money to or to the order of a certain person, or to the bearer of the
instruments.

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Essential elements of Promissory note
1. It must be in writing:
A mere verbal promise to pay is not a promissory note. The method of writing (either
in ink or pencil or printing, etc.) is unimportant, but it must be in any form that cannot be
altered easily.
2. It must certainly an express promise or clear understanding to pay:

There must be an express undertaking to pay. A mere acknowledgment is not enough.
(3) Promise to pay must be unconditional:

A conditional undertaking destroys the negotiable character of another wise
negotiable instrument. Therefore, the promise to pay must not depend upon the happening of
some outside contingency or event. It must be payable absolutely.
(4) It should be signed by the maker:

The people who promise to pay must sign the instrument even though it might have
been written by the promisor himself. There are no restrictions regarding the form or place of
signatures in the instrument. It may be in any part of the instrument. It may be in pencil or ink,
a thumb mark or initials. The pro note can be signed by the authorised agent of the maker, but
the agent must expressly state as to on whose behalf he is signing, otherwise he himself may be
held liable as a maker .The only legal requirement is that it should indicate with certainty the
identity of the person and his intention to be bound by the terms of the agreement.
(5) The maker must be certain:

The note self must show clearly who the person is agreeing to undertake the
liability to pay the amount. In case a person signs in an assumed name, he is liable as a maker
because a maker is taken ascertain if from his description sufficient indication follows about his
identity. In case two or more persons promise to pay, they may bind themselves jointly or
jointly and severally, but their liability cannot be in the alternative.

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(6) The payee must be certain:

The instrument must point out with certainty the person to whom the promise has
been made. The payee may be ascertained by name or by designation. A note payable to the
maker himself is not pronating unless it is indorsed by him. In case, there is a mistake in the
name of the payee or his designation; the note is valid, if the payee can be ascertained by
evidence. Even where the name of a dead person is entered as payee in ignorance of his death,
his legal representative can enforce payment.
(7) The promise should be to pay money and money only:

Money means legal tender money and not old and rare coins .A promise to deliver
paddy either in the alternative or in addition to money does not constitute a promissory note.
(8) The amount should be certain:

One of the important characteristics of a promissory note is certaintynot only
regarding the person to whom or by whom payment is to be made but also regarding the
amount.
However, paragraph 3 of Section 5 provides that the sum does not become indefinite merely
because
(a) There is a promise to pay amount with interest at a specified rate.
(b) The amount is to be paid at an indicated rate of exchange.
(c) The amount is payable by installments with a condition that the whole balance shall fall due
for payment on a default being committed in the payment of anyone installment.
(9) Other formalities:

The other formalities regarding number, place, date, consideration etc. though usually
found given in the promissory notes but are not essential in law. The date of instrument is not
material unless the amount is made payable at a certain time after date. Even in such a case,
omission of date does not invalidate the instrument and the date of execution can be
independently ascertained and proved.

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Bill of exchange
Section 5 of the Act defines, A bill of exchange is an instrument in writing containing an

unconditional order, signed by the maker, directing a certain person to pay a certain sum of
money only to, or to the order of a certain person or to the bearer of the instrument.
A bill of exchange, therefore, is a written acknowledgement of the debt, written by the

creditor and accepted by the debtor. There are usually three parties to a bill of exchange
drawer, acceptor or drawee and payee. Drawer himself may be the payee.
Essential conditions of a bill of exchange
(1) It must be in writing.

(2) It must be signed by the drawer.
(3) The drawer, drawee and payee must be certain.
(4) The sum payable must also be certain.
(5) It should be properly stamped.
(6) The order must be unconditional.
Distinction between bill of exchange and Promissory Note
1. Number of parties:
In a promissory note there are only two parties the maker (debtor) and the payee
(creditor). In a bill of exchange, there are three parties; drawer, drawee and payee;
although any two out of the three may be filled by one and the same person,
2. Payment to the maker:
A promissory note cannot be made payable the maker himself, while in a bill of
exchange to the drawer and payee or drawee and payee may be same person.
3. Unconditional promise:
A promissory note contains an unconditional promise by the maker to pay to the
payee or his order, whereas in a bill of exchange, there is an unconditional order to the
drawee to pay according to the direction of the drawer.

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4. Prior acceptance:
A note is presented for payment without any prior acceptance by the maker. A bill
of exchange is payable after sight must be accepted by the drawee or someone else on
his behalf, before it can be presented for payment.
5. Primary or absolute liability:

The liability of the maker of a promissory note is primary and absolute, but the
liability of the drawer of a bill of exchange is secondary and conditional.
6. Relation:
The maker of the promissory note stands in immediate relation with the payee, while
the maker or drawer of an accepted bill stands in immediate relations with the acceptor
and not the payee.
7. Protest for dishonour:

Foreign bill of exchange must be protested for dishonour when such protest is
required to be made by the law of the country where they are drawn, but no such
protest is needed in the case of a promissory note.
8. Notice of dishonour:
When a bill is dishonoured, due notice of dishonour is to be given by the holder to
the drawer and the intermediate indorsers, but no such notice need be given in the case
of a note.
Classification of Bills
Bills can be classified as:
(1) Inland and foreign bills.
(2) Time and demand bills.
(3) Trade and accommodation bills.

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(1) Inland and Foreign Bills
Inland bill:
A bill is, named as an inland bill if:
(a) It is drawn in India on a person residing in India, whether payable in or outside India, or
(b) It is drawn in India on a person residing outside India but payable in India.
The following are the Inland bills
i. A bill is drawn by a merchant in Delhi on a merchant in Madras. It is payable in Bombay.

The bill is
an inland bill.
ii. A bill is drawn by a Delhi merchant on a person in London, but is made payable in India.
This is an
inland bill.
iii. A bill is drawn by a merchant in Delhi on a merchant in Madras. It is accepted for payment
in Japan.
The bill is an inland bill.
Foreign Bill: A bill which is not an inland bill is a foreign bill. The following are the foreign bills:
1. A bill drawn outside India and made payable in India.
2. A bill drawn outside India on any person residing outside India.
3. A bill drawn in India on a person residing outside India and made payable outside India.
4. A bill drawn outside India on a person residing in India.
5. A bill drawn outside India and made payable outside India.

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Rules: Sections 132 and 133 provide for the rules of the foreign bills:
(i) A bill of exchange may be drawn in parts, each part being numbered and containing a
provision that it shall continue payable only so long as the others remain unpaid. All parts
make one bill and the entire bill is extinguished, i.e. when payment is made on one part-
the other parts will become inoperative (Section 132).
(ii) The drawer should sign and deliver all the parts but the acceptance is to be conveyed only
on one of the parts. In case a person accepts or endorses different parts of the bill in
favour of different persons, he and the subsequent endorsers of each part are liable on
such part as if it were a separate bill (Sec. 132).
(iii) As between holders in due course of the different parts of the same bill, he who first
acquired title to anyone part is entitled to the other parts and is also entitled to claim the
money represented by bill (Sec. 133).
(2) Time and Demand Bill
Time bill: A bill payable after a fixed time is termed as a time bill. In other words, bill
payable after date is a time bill.
Demand bill: A bill payable at sight or on demand is termed as a demand bill.
(3) Trade and Accommodation Bill
Trade bill: A bill drawn and accepted for a genuine trade transaction is termed as a
trade bill.
Accommodation bill: A bill drawn and accepted not for a genuine trade transaction but
only to provide financial help to some party is termed as an accommodation bill.
Rules regarding accommodation bills are:

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(i) In case the patty accommodated continues to hold the bill till maturity, the accommodating
party shall not be liable to him for payment of, the bill since the contract between them is not
based on any consideration (Section 43).
(ii) But the accommodating party shall be liable to any subsequent holder for value who may
know the exact position that the bill is an accommodation bill and that the full consideration
has not been received by the acceptor. The accommodating party can, in turn, claim
compensation from the accommodated party for the amount it has been asked to pay the
holder for value.
(iii) An accommodation bill may be negotiated after maturity. The holder or such a bill after
maturity is in the same position as a holder before maturity, provided he takes it in good
faith and for value (Sec. 59)
Parties to bill of exchange
1. Drawer: The maker of a bill of exchange is called the drawer.
2. Drawee: The person directed to pay the money by the drawer is called the drawee,
3. Acceptor: After a drawee of a bill has signed his assent upon the bill, or if there are more
parts than one, upon one of such pares and delivered the same, or given notice of such signing
to the holder or to some person on his behalf, he is called the acceptor.
4. Payee: The person named in the instrument, to whom or to whose order the money is
directed to be paid by the instrument is called the payee. He is the real beneficiary under the
instrument. Where he signs his name and makes the instrument payable to some other person,
that other person does not become the payee.
5. Indorser: When the holder transfers or indorses the instrument to anyone else, the holder
becomes the indorser.
6. Indorsee: The person to whom the bill is indorsed is called an indorsee.

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7. Holder: A person who is legally entitled to the possession of the negotiable instrument in his
own name and to receive the amount thereof, is called a holder. He is either the original
payee, or the indorsee. In case the bill is payable to the bearer, the person in possession of the
negotiable instrument is called the holder.
Parties to a Promissory Note
1. Maker. He is the person who promises to pay the amount stated in the note. He is the
debtor.
2. Payee. He is the person to whom the amount is payable i.e. the creditor.
3. Holder. He is the payee or the person to whom the note might have been indorsed.
4. The indorser and indorsee (the same as in the case of a bill).
Cheques
Section 6 of the Act defines A cheque is a bill of exchange drawn on a specified banker, and
not expressed to be payable otherwise than on demand.
A cheque is bill of exchange with two more qualifications, namely,
(i) it is always drawn on a specified banker, and

(ii) It is always payable on demand. Consequently, all cheque are bill of exchange, but
all bills are not cheque. A cheque must satisfy all the requirements of a bill of
exchange; that is, it must be signed by the drawer, and must contain an
unconditional order on a specified banker to pay a certain sum of money to or to the
order of a certain person or to the bearer of the cheque. It does not require
acceptance.

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Distinction between Bills of Exchange and Cheque
1. A bill of exchange is usually drawn on some person or firm, while a cheque is always drawn
on a bank.
2. It is essential that a bill of exchange must be accepted before its payment can be claimed A
cheque does not require any such acceptance.
3. A cheque can only be drawn payable on demand; a bill may be also drawn payable on
demand, or on the expiry of a certain period after date or sight.
4. A grace of three days is allowed in the case of time bills while no grace is given in the case of
cheque.
5. The drawer of the bill is discharged from his liability, if it is not presented for payment, but
the drawer of a cheque is discharged only if he suffers any damage by delay in presenting the
cheque for payment.
6. Notice of dishonour of a bill is necessary, but no such notice is necessary in the case of
cheque.
7. A cheque may be crossed, but not needed in the case of bill.
8. A bill of exchange must be properly stamped, while a cheque does not require any stamp.
9. A cheque drawn to bearer payable on demand shall be valid but a bill payable on demand
can never be drawn to bearer.
10. Unlike cheques, the payment of a bill cannot be countermanded by the drawer.

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Different Kinds / Types of Cheques
1. Bearer Cheque
When the words "or bearer" appearing on the face of the cheque are not cancelled, the
cheque is called a bearer cheque. The bearer cheque is payable to the person specified
therein or to any other else who presents it to the bank for payment. However, such
cheques are risky, this is because if such cheques are lost, the finder of the cheque can
collect payment from the bank.
2. Order Cheque
When the word "bearer" appearing on the face of a cheque is cancelled and when in its
place the word "or order" is written on the face of the cheque, the cheque is called an
order cheque. Such a cheque is payable to the person specified therein as the payee, or
to any one else to whom it is endorsed (transferred).
3. Uncrossed / Open Cheque

When a cheque is not crossed, it is known as an "Open Cheque" or an "Uncrossed
Cheque". The payment of such a cheque can be obtained at the counter of the bank. An
open cheque may be a bearer cheque or an order one.
4. Crossed Cheque
Crossing of cheque means drawing two parallel lines on the face of the cheque with or
without additional words like "& CO." or "Account Payee" or "Not Negotiable". A
crossed cheque cannot be cashed at the cash counter of a bank but it can only be
credited to the payee's account.
5. Anti-Dated Cheque
If a cheque bears a date earlier than the date on which it is presented to the bank, it is
called as "anti-dated cheque". Such a cheque is valid up to three months from the date
of the cheque.

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6. Post-Dated Cheque
If a cheque bears a date which is yet to come (future date) then it is known as post-
dated cheque. A postdated cheque cannot be honoured earlier than the date on the
cheque.
7. Stale Cheque
If a cheque is presented for payment after three months from the date of the cheque it
is called stale cheque. A stale cheque is not honoured by the bank.
Parties to a Cheque
1. Drawer. He is the person who draws the cheque, i.e., the depositor of money in the bank.
2. Drawee. It is the drawers banker on whom the cheque has been drawn.
3. Payee. He is the person who is entitled to receive the payment of the cheque.
4. The holder, indorser and indorsee (the same as in the case of a bill or note).
(Example of cheque)
CROSSING
Crossing of a cheque means "Drawing Two Parallel Lines" across the face of the cheque.
Thus, crossing is necessary in order to have safety. Crossed cheques must be presented through
the bank only because they are not paid at the counter.

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Different Types of Crossing
1. General Crossing:-
Generally, cheques are crossed when
1. There are two transverse parallel lines, marked across its face or
2. The cheque bears an abbreviation "& Co. "between the two parallel lines or
3. The cheque bears the words "Not Negotiable" between the two parallel lines or
4. The cheque bears the words "A/c. Payee" between the two parallel lines.
A crossed cheque can be made bearer cheque by cancelling the crossing and writing that the
crossing is cancelled and affixing the full signature of drawer.
Specimen of General Crossing
2. Special or Restrictive Crossing:-
When a particular bank's name is written in between the two parallel lines the cheque is said to
be specially crossed.

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Specimen of Special or Restrictive Crossing
In addition to the word bank, the words "A/c. Payee Only", "Not Negotiable" may also be
written. The payment of such cheque is not made unless the bank named in crossing is
presenting the cheque. The effect of special crossing is that the bank makes payment only to
the banker whose name is written in the crossing. Specially crossed cheques are safer than a
generally crossed cheque.
ENDORSEMENT
The word endorsement in its literal sense means, writing on the back of an instrument.
But under the Negotiable Instruments Act it means, the writing of ones name on the back of
the instrument or any
Paper attached to it with the intention of transferring the rights therein. Thus, endorsement is
signing a negotiable instrument for the purpose of negotiation. The person who effects an
endorsement is called an endorser, and the person to whom negotiable instrument is
transferred by endorsement is called the endorsee.

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Essentials of a valid endorsement
The following are the essentials of a valid endorsement:

1. It must be on the instrument. The endorsement may be on the back or face of the instrument
and if no space is left on the instrument, it may be made on a separate paper attached to it
called allonage. It should usually be in ink.
2. It must be made by the maker or holder of the instrument. A stranger cannot endorse it.
3. It must be signed by the endorser. Full name is not essential. Initials may suffice. Thumb
impression should be attested. Signature may be made on any part of the instrument. A rubber
stamp is not accepted but the designation of the holder can be done by a rubber stamp.
4. It may be made either by the endorser merely signing his name on the instrument (it is a
blank endorsement) or by any words showing an intention to endorse or transfer the
instrument to a specified person (it is an endorsement in full). No specific form of words is
prescribed for an endorsement. But intention to transfer must be present. When in a bill or
note payable to order the endorsees name is wrongly spelt, he should when he endorses it,
sign the name as spelt in the instrument and write the correct spelling within brackets after his
endorsement.
5. It must be completed by delivery of the instrument. The delivery must be made by the
endorser himself or by somebody on his behalf with the intention of passing property therein.
Thus, where a person endorses an instrument to another and keeps it in his papers where it is
found after his death and then delivered to the endorsee, the latter gets no right on the
instrument.
6. It must be an endorsement of the entire bill. A partial endorsement i.e. which purports to
transfer to the endorse a part only of the amount payable does not operate as a valid
endorsement. If delivery is conditional, endorsement is not complete until the condition is
fulfilled.

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Who may endorse?
The payee of an instrument is the rightful person to make the first endorsement.
Thereafter the instrument may be endorsed by any person who has become the holder of the
instrument. The maker or the drawer cannot endorse the instrument but if any of them has
become the holder thereof he may endorse the instrument (Sec.51).
The maker or drawer cannot endorse or negotiate an instrument unless he is in lawful

possession of instrument or is the holder there of. A payee or indorsee cannot endorse or
negotiate unless he is the holder there of.
Classes of endorsement
An endorsement may be:

(1) Blank or general.
(2) Special or full.
(3) Partial.
(4) Restrictive.
(5) Conditional.
(a) Blank or general endorsement (Sections 16 and 54).
It is an endorsement when the endorser merely signs on the instrument without

mentioning the name of the person in whose favour the endorsement is made. Endorsement in
blank specifies no endorsee. It simply consists of the signature of the endorser on the
endorsement. A negotiable instrument even though payable to order becomes a bearer
instrument if endorsed in blank. Then it is transferable by mere delivery. An endorsement in
blank may be followed by an endorsement in full.

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Example: A bill is payable to X. X endorses the bill by simply affixing his signature. This is an
endorsement in blank by X. In this case the bill becomes payable to bearer. There is no
difference between a bill or note indorsed in blank and one payable to bearer. They can both be
negotiated by delivery.
(b) Special or full endorsement (Section 16)
When the endorsement contains not only the signature of the endorser but also the
name of the person in whose favour the endorsement is made, then it is an endorsement in
full. Thus, when endorsement is made by writing the words Pay to A or As order, Followed by
the signature of the endorser, it is an endorsement in full. In such an endorsement, it is only the
endorsee who can transfer the instrument.
Conversion of endorsement in blank into endorsement in full:

When a person receives a negotiable instrument in blank, he may without signing his own
name, convert the blank endorsement into an endorsement in full by writing above the
endorsers signature a direction to pay to or to the order of himself or some other person. In
such a case the person is not liable as the endorser on the bill. In other words, the person
transferring such an instrument does not incur all the liabilities of an endorser (Section 49).
Example: A is the holder of a bill endorsed by B in blank. A writes over Bs signature the
words Pay to C or order. A is not liable as endorser but the writing operates as an
endorsement in full from B to C. Where a bill is endorsed in blank, or is payable to bearer and is
afterwards endorsed by another in full, the bill remains transferable by delivery with regard to
all parties prior to such endorser in full. But such endorser in full cannot be sued by anyone
except the person in whose favour the endorsement in full is made (Section 55).
Example: C the payee of a bill endorses it in blank and delivers it to D, who specially
endorses it to E or order. E without endorsement transfers the bill to F. F as the bearer is
entitled to receive payment or to sue the drawer, the acceptor, or C who endorsed the bill in
blank but he cannot sue D or E.

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(c) Partial endorsement (Section 56)
A partial endorsement is one which purports to transfer to the endorsee a part only of the
amount payable on the instrument. Such an endorsement does not operate as a negotiation of
the instrument.
Example: A is the holder of a bill for Rs.1000. He endorses it pay to B or order Rs.500.
This is a partial endorsement and invalid for the purpose of negotiation.
(d) Restrictive endorsement (Section 50)
The endorsement of an instrument may contain terms making it restrictive. Restrictive

endorsement is one which either by express words restricts or prohibits the further negotiation
of a bill or which expresses that it is not a complete and unconditional transfer of the
instrument but is a mere authority to the endorsee to deal with bill as directed by such
endorsement.
Pay C, Pay C for my use, Pay C for the account of B are instances of restrictive
endorsement. The endorsee under a restrictive endorsement acquires all the rights of the
endorser except the right of negotiation.
Conditional or qualified endorsement
It is open to the endorser to annex some condition to his owner liability on the
endorsement. An endorsement where the endorsee limits or negatives his liability by putting
some condition in the instrument is called a conditional endorsement. A condition imposed by
the endorser may be a condition precedent or a condition subsequent. An endorsement which
says that the amount will become payable if the endorsee attains majority embodies a
condition precedent. A conditional endorsement unlike the restrictive endorsement does not
affect the negotiability of the instrument. It is also sometimes called qualified endorsement. An
endorsement may be made conditional or qualified in any of the following forms:

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(i) Sans recourse endorsement: An endorser may be express word exclude his own liability
thereon to the endorser or any subsequent holder in case of dishonour of the instrument. Such
an endorsement is called an endorsement sans recourse (without recourse). Here if the
instrument is dishonoured, the subsequent holder or the indorsee cannot look to the indorser
for payment of the same. An agent signing a negotiable instrument may exclude his personal
liability by using words to indicate that he is signing as agent only. The same rule applies to
directors of a company signing instruments on behalf of a company. The intention to exclude
personal liability must be clear. Where an endorser so excludes his liability and afterwards
becomes the holder of the instrument, all intermediate endorsers are liable to him.
Example: A is the holder of a negotiable instrument. Excluding personal liability by an
endorsement without recourse, he transfers the instrument to B, and B endorses it to C, who
endorses it to A. A can recover the amount of the bill from B and C.
(ii) Facultative endorsement: An endorsement where the endorser extends his liability or
abandons some right under a negotiable instrument, is called a facultative endorsement. Pay A
or order, Notice of dishonour waived is an example of facultative endorsement.
(iii) Sans frais endorsement: Where the endorser does not want the endorsee or any
subsequent holder, to incur any expense on his account on the instrument, the endorsement is
sans frais.
(iv) Liability dependent upon a contingency: Where an endorser makes his liability depend
upon the happening of a contingent event, or makes the rights of the endorsee to receive the
amount depend upon any contingent event, in such a case the liability of the endorser will arise
only on the happening of that contingent event. Thus, an endorser may write Pay A or order on
his marriage with B. In such a case, the endorser will not be liable until the marriage takes
place and if the marriage becomes impossible, the liability of the endorser comes to an end.

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Effects of endorsement
The legal effect of negotiation by endorsement and delivery is:

(i) To transfer property in the instrument from the endorser to the endorsee.
(ii) To vest in the latter the right of further negotiation, and
(iii) A right to sue on the instrument in his own name against all the other parties (Section 50).
Cancellation of endorsement
When the holder of a negotiable instrument, without the consent of the endorser destroys
or impairs the endorsers remedy against prior party, the endorser is discharged from liability to
the holder to the same extent as if the instrument had been paid at maturity (Section 40).

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Important questions
1. Define endorsement?
2. What are the negotiable instruments?
3. What is payment in due course?
4. What is general crossing?
5. What is stale cheque?
6. Define promissory note?
7. Define cheque?
8. What is blank endorsement?
Section B
1. What are the legal provisions regarding endorsement?

2. Who is a holder for value? Explain.
3. Define cheque. Explain the characteristics of a cheque?
4. Write a short note on marking or a cheque?
5. Explain the features of negotiable instruments.
6. Distinguish between promissory note and bill of exchange?
7. Explain the differences between discounting of bills and purchase of bills?
8. Briefly explain different types of cheque?
9. Distinguish between general crossing and special crossing?
10. Can a cheque be crossed twice? State the consequences?
Section C
1. What are the essential of a valid endorsement? Mention the types.

2. What is negotiable instrument? Briefly explain the different types of negotiable
instruments?

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CHAPTER-4
PAYING BANKER AND COLLECTING BANKER
Paying Banker Meaning Precautions Statutory Protection to the Paying Banker Dishonor
of Cheques Grounds of Dishonor Consequences of wrongful dishonor of Cheque.
Collecting Banker Meaning Duties & Responsibilities of Collecting Banker Holder for Value
Holder in Due Course, Statutory Protection to Collecting Banker.
PAYING BANKER
The bank on which a cheque is drawn (the bank whose name is printed on the cheque) and
which pays the amount for which the cheque is written and deducts that sum from the
customer's account.
MEANING OF BANKER
A banker on whom the cheque is drawn should pay the cheque, when it is presented for
payment. It is his obligation by section 31 of the NI Act. A banker is bound to honour his
customers cheque to the extent of the fund available & the existence of no legal bar for
payment. The paying banker should use reasonable care and diligence in paying a cheque so as
to abstain from any action likely to damage his customers credit.
PRECAUTIONS-
The relation between a banker and his customer is that of a debtor and creditor. Money
deposited with a banker is always belongs to the customer and the bank obliged to return its
equivalent to the customer or to any person to his order on demand. This obligation has been
imposed on the bank by sec. 31 of the N.I. Act. 1881. Wherein it is stated that The drawee of a
cheque having sufficient funds of drawer in his hands, properly applicable to the payment of
such, 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.

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Precautions to honor Cheque
Analysis of sec.31 of the N.I.Act.1881 reveals that a banker should be very cautious both at the
time of honoring as well as dishonoring his customers cheque. Thus, in order to safeguard its
as well as the customers interests, the paying banker has to observe the following precautions
before honoring a cheque:
1. Precaution regarding Form of the Cheque
The cheque should be in proper form. According to banking practice the cheque must be drawn
in the printed forms supplied by the banks and the bank reserve the right of dishonoring a
cheque in case it is not in the prescribed form. Beside this, the cheque should not contain any
condition, as a cheque is an unconditional order to pay on a specified banker.
2. Precaution regarding Branch
The paying banker should see whether the cheque is drawn on the branch where the account is
maintained. If it is drawn on another branch, without any prior arrangement, the banker can
safely return the cheque.
3. Precautions regarding Account
Even in the same branch, a customer might have opened two or more accounts. For each
account, a separate checkbook would have been issued. Hence, the paying banker should see
that the cheque of one account is not used for withdrawing money from another account.
4. Precaution regarding Date
Before honoring a cheque, the paying banker must see whether there is a date on the
instrument. If it is undated it cannot be regarded as a valid instrument. If a cheque is ante
dated, it may be paid if it has not become stale by that time. A cheque becomes stale after six
months of its issue and requires drawers revalidation/confirmation. The paying banker should

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also not honor a cheque containing future date. A future dated cheque is known as post-dated
cheque and it should not be honored before its ostensible date.
5. Precaution regarding Amount
The banker should see whether the amount stated in the cheque, both in words and figures,
agree with each other. If the amount is stated only in figures the banker should not honor it.
However, if the amount is stated only in words, the banker may honor it. If there is any
difference between the amount in figures and words, the banker can return the cheque, since,
the amount is not certain. On the other hand, sec. 18 of the N.I. Act, 1881 permits the banker to
honor the cheque to the extent of the amount stated in words. However, in practice, if the
difference is insignificant, payment of the smaller amount sometimes made. But, usually the
paying banker returns the cheque under such circumstance with a return memo containing the
remarks words and figures differ since, there is an audit objection to the practice of honoring
such cheque.
6. Precaution regarding Funds of the Customer
There should be sufficient balance/funds in the account of the customer to meet the cheque.
Cheque has to be paid in full and not in part and therefore, if the funds are not sufficient to
honor the cheque in full, the paying banker is justified in returning it. The paying banker,
however, honor the cheque if he has an O/D arrangement with the customer to that extent or
more than the amount of deficit.
The cheque should be paid in chronological order of their receipt by the bank. The date of their
issue or serial number is not significant in this respect. Therefore, in case of inadequacy of
funds, the cheque will be paid in the order in which they are received by the bank to the extent
of the funds permit and the rest will be dishonored. When several cheque are received at the
same time (for example, cheque received by post) the usual practice is to honor the cheque of
bigger amount unless it is for tax liability etc. where the cheque is honored first though it must

2015
be of a smaller amount. In case of two or more cheque of equal amount, the bank has the
discretion to honor any of them to the extent the funds of the drawer permit.
7. Precaution regarding Drawers Signature
Before honoring any cheque, a paying banker is required to compare the drawers signature on
the cheque with that of his specimen signature. If the banker fail to do so and pays a cheque
containing forged signature of the drawer, then, the payment will not be a payment in due
course. When there is a joint account, both or all the signatures on the cheque should be
genuine. If any one of the signatures is forged the bank should not make payment. If the
signature has been too, skillfully forged for the banker to find it out, even then the banker is
liable. However, if the customer facilitates the forgery of his signature by his conduct, then the
banker will be relieved from his liability.
8. Precaution regarding Material Alteration
A paying banker should be very cautious in finding out the alterations that may appear on a
cheque. A banker will be held liable for paying any materially altered cheque. If there is any
material alteration, the banker should return it with a memorandum Alteration requires
drawers confirmation. A materially altered cheque can only be honored if the alteration is
confirmed by the drawer by means of his full signature. However, in case a cheque is materially
altered and the banker makes payment, he shall be discharged from liability only when he
proves the following:
(i) The alteration could not be detected with reasonable care, prudence & scrutiny, and
(ii) The payment had been made in due course.
9. Precaution regarding Crossing
Before honoring any cheque the paying banker must find out whether the cheque is open or
crossed. If it is an open one, the payment may be made at the counter. If the cheque is a

2015
crossed one, the payment should be through a collecting banker. If it is specially crossed, the
payment must be specifically made to that banker in whose favor it has been crossed. If there
are A/C payee and Not Negotiable crossing, the paying banker need not worry, as they are
directions to the holder and to the collecting banker.
10. Precaution regarding Endorsement
Before honoring a cheque, the banker must verify the regularity of endorsement, if any, that
appears on the instrument. An order cheque requires endorsement for delivery as well as
payment. If there is per pro endorsement, the banker must find out the existence of authority.
Failure to do so constitutes negligence on the part of the paying banker.
11. Precaution regarding Mutilated Cheques
A cheque is said to be mutilated when it is torn into two or more pieces. Such a cheque should
not be paid unless the banker is satisfied that mutilation was unintentional and it also requires
confirmations of the drawer.
12. Precaution regarding Legal Bar
The existence of legal bar like garnishee order limits the duty of the banker to pay a cheque. So,
the paying banker should be cautious while paying cheque against any account on which any
legal bar is imposed.
13. Precaution regarding banking hours
The paying banker should make payment of only such cheques which have been presented (to
it for payment) during the banking hours on a business/working day. Payment outside the
banking hours does not amount to payment in due course. However, a banker is justified in
extending the time during peak days, for those, who are still waiting for enchasing a cheque.

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14. Minor Precautions-
A paying banker should look into the following minor details also, before honoring a cheque:
a) He must see whether there is any order of the customer not to pay a cheque.
b) He must see whether there is any evidence of misappropriation of money. If so, the cheque
should be returned.
c) He must see whether he has got any information about the death or bankruptcy or insanity
of his customer. Failure to note those instructions will land him on trouble.
Statutory Protection to the Paying Banker-
1. Protection in case of order cheque:
In case of an order cheque, Section -85(1) provides statutory protection to the paying banker as
follows: "Where a cheque payable to order purports to be endorsed by or on behalf of the
payee, the drawee is discharged by payment in due course". However, two conditions must be
fulfilled to avail of such protection.
(a) Endorsement must be regular: To avail of the statutory protection, the banker must confirm
that the endorsement is regular.
(b) Payment must be made in Due Course: The paying banker must make payment in due
course. If not, the paying banker will be deprived of statutory protection.
2. Protection in case of Bearer Cheque:
Section -85(2) provides protection to the paying banker in respect of bearer cheques as follows:
"Where a cheque is originally expressed to be payable to bearer, the drawee is discharged by
payment in due course to the bearer thereof, notwithstanding any endorsement whether in
full or blank appearing thereon and notwithstanding that any such endorsement purports to
restrict or exclude further negotiation". This section implies that a cheque originally issued as a
bearer cheque remains always bearer. In other words it retains its bearer character irrespective
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of whether it bears endorsement in full or in blank or whether any endorsement restricts

further negotiation or not. So the banks are not required to verify the regularity of the
endorsement on bearer cheque, even if the instruments bears endorsement in full. The banker
shall free from any liability (discharged) if he makes payment of an uncrossed bearer cheque to
the bearer in due course. If such cheque is a stolen one and the banker makes its payment
without the knowledge of such theft, he will be discharged of his obligation and will be
protected under Section -85(2).
3. Protection in case of Crossed cheque:
The paying banker has to make payment of the crossed cheques as per the instruction of the
drawer reflected through the crossing. If it is done, he is protected by Section -128. This section
states "Where the banker on whom a crossed cheque is drawn has paid the same in due
course, the banker paying the cheque and (in case such cheque has come to the hands of the
payee) the drawer thereof shall respectively be entitled to the same rights, and be placed in if
the amount of the cheque had been paid to and received by the true owner thereof".
It is clear that the banker who makes payment of a crossed cheque is by the Section -128 given
protection if he fulfills two requirements-
(a) That he has made payment in deuce course under Section -10 i.e. in good faith and without
negligence and according to the apparent tenor of the cheque, and
(b) That the payment has been made in accordance with the requirement of crossing (Section -
126), i.e. through any banker in case of general crossing and through the specified banker in
case of special crossing.
Thus, the paying banker is free from any liability on a crossed cheque even if the payment was
received by the collecting banker on behalf of a person who was not a true owner. For example,
a cheque in favour of X is stolen by Y. He endorses it in his own favour by forging the signature
of X and deposits it in his bank for collection . In this case, the paying banker shall be
discharged if he makes payment as mentioned above and shall not be liable to pay the same to
X, the true owner of the cheque.

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The drawer of the cheque is also discharged since protection is also granted to him under this
Section. There is, however, one limitation to the protection granted under this Section. If the
banker cannot avail of the protection granted by other Section of the Act, the protection under
Section -128 shall not be available to him.
For example, if the paying banker makes payment of a cheque crossed with
(a) Irregular endorsement or
(b) A material alteration or
(c) Forged signature of the drawer, he loses statutory protection granted to him under the Act
for these lapses on his part.
Hence he cannot avail of the statutory protection under Section -1289, even if he pays the
cheque in accordance with the crossing.
DISHONOUR OF CHEQUE
Meaning-
The bank should pay the amount mentioned on the cheque as soon as it is presented. If the
amount of cheque is paid by the bank to the payee, the cheque is said to be honored. If the
bank refuses to pay the amount of cheque, then the cheque is said to be dishonored. Thus the
dishonored of the cheque means the refusal by the bank to pay the amount of cheque to the
payee. It is a condition in which the bank does not pay the amount of the cheque to the payee.
In fact, when the drawer draws the cheque without following all the rules of issuing cheque or
when he/she draws the cheque exceeding the bank balance then the bank dishonors the
cheque.

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Following are the some important reasons for dishonoring a cheque
* If the date is not written or written incorrectly or the date given is of three months before or
if the advance date is given.
* If the name of the payee is not written or not written clearly.
* If the ordered or crossed cheques are transferred without proper endorsement and delivery.
* If the amount is not written in words and figures or written incorrectly or if the amount
written in words and figures does not match with each other.
* If the alteration made on the cheque is not proved by the drawer giving signature.
* If the account number is not mentioned or if it is not clear or if it is not mentioned clearly.
* If the signature is not given or if the signature given in the cheque does not match with the
signature given on the signature specification card kept by the bank.
* If the amount mentioned on the cheque is more than the amount that the drawer has in his
bank account or if as per bank's rule the minimum balance in the account of the drawer cannot
remain.
* If the cheque is overwritten.
* If the cheque is not found in proper condition or it is found wet, torn or spotted.
* If the drawer has given order to the bank to stop payment of the cheque.

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* If the bank has got the information regarding the death or insolvency or lunacy of the drawer
of depositor.
* If the court of law orders the bank to stop payment of the cheque.
* If the bank balance remains shortage on account of not collecting the cheque deposited.
* If the drawer has closed his/her account before presenting the cheque.
GROUNDS FOR DISHONOUR OF CHEQUE-
Funds Insufficient
Section 138 describes the above ground of insufficient funds in the account of the drawer of the
cheque in the following words:
The amount of money standing to the credit of the account of the drawer on which the cheque
is drawn is insufficient to honour the cheque, or
1. The cheque amount exceeds the amount that can be paid by the bank under an arrangement
entered into between the bank and the drawer of the cheque.
However, besides the above, the Courts have also accepted some other heads which though
expressly do not say insufficient funds but are implied to mean the same and a cheque
dishonoured on any of these grounds can be used for the purpose of prosecution under section
138 Negotiable Instruments Act. Some of these grounds are:
1. Account Closed: It is an offence under section 138 of the Act Closure of account would
be an eventuality after the entire amount in the account is withdrawn It means that there
was no amount in the credit of that account on the relevant date when the cheque was
presented for honouring the same
This has been held by the Honble Supreme Court of India in-
NEPS MICON LTD. AND OTHERS VS. MAGMA LEASING LTD.

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1999 ISJ (BANKING) 0433; 1999 (1) APEX C.J. 0624; 1999 AIR (SCW) 1637
2. Stop Payment instructions:
Once the cheque has been drawn and issued to the payee and the payee has presented the
cheque, stop payment instructions will amount to dishonour of cheque.
MAHENDR S. DADIA VS. STATE OF MAHARASHTRA
I (1999) BANKING CASES (BC) 133 (17/03/1998)
3. Refer to drawer:
. makes out a case under section 138 of the Negotiable Instruments Act, 1881 which
expression means that there were not sufficient funds with the bank in the account of the
respondent
LILY HIRE PURCHASE LTD. VS. DARSHAN LAL,
(1997) 89 COMPANY CASES 663 (10/01/1997)
4. Not a clearing member:
Cheque returned with endorsement not a clearing member. To attract the provisions of
section 138 NI Act, the cheque should be presented with the bank on which it I drawn- If the
cheque is not presented to the bank on which it is drawn, then provisions of sec 138 would not
be attracted. If bank on which the cheque is drawn is not a clearing member of the Reserve
Bank of India unpaid return of the cheque would not attract section 138.
CHAIRMAN, JAWAHAR COOPERATIVE URBAN BANK LTD. ANDOTHERS VS. RAMANJANEYA

ENTERPRISES, HYD. AND ANOTHER
2005 (5) CRIMINAL REPORTED JUDGEMENTS (CRJ) 0591

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2005 (2) DISHONOUR OF CHEQUE REPORTER (DCR) 0169
5. Effect of other endorsements:
It has been repeatedly held by courts that manifest dishonest intention of the drawer resulting
in dishonour of the cheque would lead to prosecution under section 138 Negotiable
Instruments Act regardless of the actual ground of dishonour.
Consequences for wrongful Dishonour of Cheques-
Incase a bank fails to honour a customers cheque, it can be held liable

b y t h e customer to pay him the damage. The damages wil l not only be the
pecuniary loss that the customer might have suffered but also to his reputation.
The amount of damages claimed by the customer need not depend on the amount of the
cheque. As a matter of fact reverse is true. It means the smaller is the amount of the cheque
dishonoured, the greater will be the amount of damages. This is because it is presumed that
the dishonour of a cheque of a smaller amount will result in greater loss to the credit
of the customer.
Collecting Banker-
A Collecting Banker is one who undertakes to collect various types of instruments representing
money in favour of his customer or his own behalf from the drawers of these instruments;
some are negotiable instruments as provided for in the negotiable instruments Act. 1881 and
some are quasi negotiable instruments.
Duties & Responsibilities of Collecting Bankers:
Acting as agent: While collecting an instrument, whether for credit to customers

account or for himself, the Bankers works as agent of his customer. As an agent he has
generally to take such steps & precautions to protect the interest or his customer as a
man of ordinary prudence would take to safe-guard his own interest.

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Scrutinizing the instruments: Name of the holder, Branch name, date, amount in world
and figure, any cutting without signature, material alteration of any to be checked
carefully.
Checking the endorsement: Bankers has to check the instrument whether it has been
endorsed properly.
Presenting the instrument in due time: It is the responsibility of the collecting bank to
present the instrument in due time to the paying bank.
Collecting the proceeds in the payees account: It is the duty of collecting banks to
collect and credit the proceed of the instruments to the proper/correct account.
Notice of dishonor and returning the instruments: If any instrument is dishonored by

the paying bank it should be informed to the customer on the business day following
the receipt of the unpaid instruments.
Collecting Bankers Protection:
Under section 131 of negotiable instrument Act the collecting banker is not liable to the true
owner of a cheque or a bankers draft if his title to the instrument proves defective provided
the cheque or draft was one crossed generally or specially to himself and collected for a
customer is good faith and without negligence.
The above statutory protection is available to the collecting banker only if he fulfills the
following conditions:
i. The cheque he collected is a crossed cheque.
ii. He collected such crossed cheque only for his customer as an agent & not as a holder for
value.
iii. He collected such crossed cheque in good faith and without negligence.

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No Protection:
Opening of A/c without satisfactory references/ introduction.

Crediting the proceeds of cheque to an endorsee with irregular endorsement.
Crediting the proceed of a cheque to the personal A/c of director, partners or any
employee when it is payable to the company.
Crediting the proceeds of charge to personal name of the official when it is payable to a
govt. agency, autonomous body, or corporation.
Crediting the amount of a cheque in the personal A/c which is drawn by an agent on
behalf of its principal.
When the customer depositing the cheque is of little means and the cheque deposited
suddenly is of sizable amount and the banker credited the proceeds there to without
making proper enquiry.
Cheque drawn by customer is dishonored very often and crediting such account with
the proceeds of collecting cheque without making proper enquiry.
If the crossed cheque is collected and credited the proceed to the other account.
Holder for Value-
Meaning-
One who has given a legal consideration for a negotiable instrument is a holder for value. The
holder of a negotiable note taken as collateral security for a preexisting debt is a holder for
value in due course of business. Similarly, an endorsee of a negotiable note taken as collateral
security for a preexisting debt, there being no extension of time of payment or other new
consideration except such as may be deemed to arise from the acceptance of the paper, is a
holder for value. [Birket v. Elward, 68 Kan. 295 (Kan. 1904)].

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Course in Due course-
Meaning-
Legal term for an original or any subsequent holder of a negotiable instrument (check, draft,
note, etc.) who has accepted it in good-faith and has exchanged something valuable for it. For
example, anyone who accepts a third-party check is a holder in due course. He or she has
certain legal rights, and is presumed to be unaware that (if such were the case) the instrument
was at any time overdue, dishonored when presented for payment, had any claims against it, or
the party required to pay it has valid reason for not doing so. It can be also called protected
holder, or bonafide holder for value.
Statutory Protection to Collecting Banker.
1. Crossed cheque only:
The statutory protection is available to the banker only in case of cheque crossed generally or
specially to himself. He can not avail this protection in case of uncrossed cheque.
2. Collection as an Agent: The statutory protection is available to the banker if he collects the
cheque as an agent of the customer and not as its holder for value.
3. Good faith and without negligence:
The most essential prerequisite for availing of the statutory protection is that the banker must
receive payment in good faith and without negligence. A thing is deemed to be done in good
faith when it is in fact done honestly irrespective of whether negligently or not . He should not
be negligent in receiving the payment. The onus of proving that he was not negligent in
collecting the cheque lies, however, on the banker himself.

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CHAPTER-5
TYPES OF CUSTOMERS AND ACCOUNT HOLDERS
Types of Customers and Account Holders - Procedure and Practice is opening and conducting
the accounts of customers particularly individuals including minors - Joint Account Holders.
Partnership Firms - Joint Stock companies with limited liability-executors and trustees-clubs
and associations- joint Hindu family
Types of Customers and Account Holders
Opening of an account binds the banker and customer into a contractual relationship. Every
person who is competent to contract can open an account with a bank. The capacity of certain
classes of person, to make valid agreement is subject to certain legal restrictions, as is the case
with minors, lunatics, drunkards, married women, un discharged insolvents, trustees,
executors, administrators etc. Extra care is also needed for the banker while he deals with
customers like public authorities, societies, joint stock companies, partnership firms etc.
1. Minors
A minor is a person who has not completed 18 years of age. In case a guardian of his person or
property is appointed by a court of law before he completes his 18 years, the period of minority
is extended to the completion of 21 years. As per section 11 of the contract act a minor is
incompetent to contract but section 26 of the Negotiable Instrument Act allows a minor to
draw, endorse, deliver and negotiate a negotiable instrument. So, a banker can open an
account in a minors name and the banker will be safe if the account runs with credit balance.
So, it is suggested to open a savings bank account in the minors name and not to open a
current account as because an overdraft may be created at any time in a 2 current account and
money lent to a minor cannot be recovered from him as he is free from personal liability. The
minors savings bank account may be opened in any of the following ways:
(i) In the name of minor himself:- This account will be operated by the minor alone. In his
personal presence (in the bank) he can withdraw the money from his account.

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(ii) In the joint names of the minor and his/her guardian:- This account will be operated
jointly by minor and his/her guardian.
(iii) In the name of guardian:- This account will be operated by the guardian on behalf of the
minor. In case of (i) and (ii) stated above the minor must have at least attained the age of 10
years or above and able to sign his name uniformly. Like savings bank account, a fixed deposit
account or a recurring deposit account in the name of a minor (along a with guardian) may also
be opened. It should be noted that in the event of death of a minor the money will be payable
to his guardian. In case the guardian dies before the minor attains majority and the account is a
joint account or operated by the guardian only, the money should be paid by the banker to the
minor on attaining majority or to someone else who has appointed as guardian of the minor by
the court. While opening a minors account the banker should record the date of birth of the
minor as disclosed by his/her guardian. The account in the name of minor can be continued on
minors attaining the age of majority and at that time the banker will have to obtain a
confirmation regarding the balance standing in his account.
2. Lunatics
A person of unsound mind cannot make a valid contract. So, the bankers should not open an
account in the name of a person of unsound mind. But a customer may become lunatic after
opening an account with the bank. However, a banker will not be liable if it honour the cheque
or bill of an account holder unless it comes to know of his lunacy at the time of honouring
cheque/bill. Where a customer becomes insane and the banker comes to know of it, he must
stop all the operations on the account immediately. However, the banker should carefully verify
the information about customers lunacy. Sometimes, the court may issue a lunacy order and
the banker must follow this order. Before resuming operations on the account, the banker must
obtain a certificate from two medical officers certifying his mental soundness or get an order of
the court to that effect.

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3. Illiterate persons
An illiterate person means a person who cant sign his name. While opening of an account of
such a person is unavoidable, the banker should obtain ( 1) Left thumb impression on the
account opening form and specimen signature card in the presence of an authorized bank
official (2) Details of identification marks should be noted on the account opening form and
specimen signature card (3) At least two copies of photograph duly attested by any account
holder/authorized bank official.
Except his physical presence (in the bank) any withdrawals from the account of an illiterate
person will not be allowed.
4. Married women
A married woman can enter into contract and bind her personal (separate) estate. A banker
may, therefore, open an account in the name of a married woman. The bank should observe
extra precautions regarding sanction of overdraft/loan to a married woman because it will have
no remedy against her if she does not have any personal estate. It should be noted that the
husband will not be liable for any debt of his wife except the following cases:
(1) Where the loan is taken with his consent or where she acts as the agent of her husband.
(2) Where the loan has taken for the purchase of necessities which the husband has failed to
provide.
5. Executors and administrators:
Executors and Administrators are allowed to open bank account. Following formalities are to be
observed while opening the account in the name of executor/administrator:
(I) An executor should submit a probate, and an administrator should submit the letter of
administrator to the bank as a proof of their authority to operate the account of a deceased
person.

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(2) The banker should thoroughly examine the probate/letter of administration to acquaint
himself with the power and functions of executors/ administrators.
(3) An account may be opened in the name of executor/administrator in the following style:
ABC executors (or Administrators) of the estate of X, the deceased.
(4) In case of joint executor/administrator a mandate signed by all of them should be

obtained regarding the operation of the account.
(5) The insolvency of the executor/administrator will terminate his authority to operate the
account (unless it has been overdrawn) but the lunacy of the executor/administrator will not
terminate his authority to) operate the account.
7. Trustees
A banker must be cautions in opening/operating a trust account as the trustees are responsible
for public money.
(1) While opening the trust account a banker should thoroughly study the trust deed as it
contains the name of trustees, their powers, details of the trust properties and other terms.
(2) If there are several trustees and account is opened for two or more trustees the banker
should obtain a mandate signed by all the trustees as to how cheques and bills are to be signed
and endorsed. In the absence of such instructions all trustees must sign the instrument(s) on
each occasion.
(3) The bank must not knowingly permit the misuse of trust fund (e.g. fraudulent transfer of
trust fund by the trustees to his personal account).
8. Joint accounts
Joint account means account of two or more persons who are not partners. A banker should
keep in view the following provisions while opening and operating joint accounts:

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The account should be opened only on receiving application signed by all persons
interested in that account.
A mandate signed by all the parties containing clear instructions as to how the account
is to be operated should be obtained. The mandate should mention the name(s) of the
person (s) authorized to operate the account and clear instructions as to whom the
balance in the account shall be payable must be obtained. In absence of such
instructions banker will honour only those cheques signed by all the parties.
Instructions regarding the operation of account must be clearly written in the account
opening form/specimen signature card.
In absence of either or survivor instruction the balance will be payable to all the joint
account holders including legal representative/heirs of the deceased but in case of
either or survivor instruction the balance will be payable to the survivor (s).
It is wise to stop the operation of a joint account after the death of anyone of the joint
account holders and a new account be opened in the name of surviving account
holder(s).
Joint Account in the name of Husband and Wife:
In case of joint account of husband and wife their position differs from those of other joint
account holders. Where the account is opened by the husband for his convenience the balance
can not be claimed by the widow but has to be brought to the estate of the deceased. But
where the intention of the husband (by opening a joint account) was to make a provision for his
wife in case of his untimely death, the widow would receive the money.
9. Partnership firm:
A firms account should always be opened in the name of the firm and not in the name(s) of the
individual partner (s) because a partner does not have (implied) authority to open a bank
account on behalf of the firm in his own name. Before opening the account, a banker must
obtain the partnership agreement/deed and thoroughly acquaint itself with the clauses.

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While opening an account of a partnership firm the banker should take a letter signed by all the
partners containing the following particulars:
(a) The name and address of all the partners
(b) The nature of the firms business
(c) The name of the partners authorized to operate the account.
It should be noted that any partner may by notice in writing to the banker, revoke the authority
given to any other partner regarding operation of the firms account. Similarly any partner can
stop the payment of a cheque already issued and the banker will be bound to honour such
instructions. The banker should not credit a cheque in the firms name to the personal account
of a partner without the consent of other partners. It fails to do so; the banker will be liable to
other persons for wrongful conversion of funds.
10. Joint stock companies
A joint stock company is an artificial person and it has a separate legal entity. So, a bank
account may be opened on its own name. A joint stock company may either be a Private
Limited Company or a Public Limited Company. Following documents are required while
opening an account of a joint stock company:
(i) Certificate of incorporation
(i) Certificate of commencement of business (in case of Public Ltd. Co. only).
(iii) Memorandum of association
(iv) Articles of Association
(v) Copies of annual accounts
(vi) Certified copy of the Boards resolution regarding appointing the bank concerned as the
bank of the company. This also specifies the persons authorized to operate the account on
behalf of the company. The resolution should be signed by the chairman of the meeting and

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countersigned by the secretary of the company. As Memorandum of Association is the main

document of the company the Banker must go through it very carefully because if a company
done anything beyond its object is ultra vires and does not bind the company. The banker
should also examine the Articles of Association as it contains the procedure and authority to
draw and endorse cheques, bills etc. on behalf of the company. It is necessary to obtain printed
copies of companys Memorandum and the Articles with a confirmation from the company that
they are up-to-date.
11. Societies and other non- trading institutions
The society, be it a club, school, hospital or any institution must be registered as a corporate
body. Societies, unless registered are not recognized by the law and have no contracting
powers. While opening and operating an account of any society the following procedures be
followed by a banker:
(a) Copies of Memorandum, Articles of Association of the society must be obtained to

acquaint with its broad objectives, its rules & by-laws.
(b) The banker should call for a duly certified copy of resolution passed by the managing
committee of the society authorizing the bank for opening the societys account. The resolution
should also state the name (s) of persons authorized to operate the account. In case of death or
resignation of the person (s) entitled to operate the account, the banker should stop operations
on the account till the nomination/appointment of other person(s).
(c) If the office bearer (i.e. the person authorized to operate the account) of the society has a
personal account in the bank the banker should exercise precautionary measure so that the
society money does not find its way into the personal account of the office bearer.

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12. Customers attorneys
A person may by a written and stamped document appoint a person as his attorney to deal on
his behalf with third parties. This power may be general (to act in more than one transaction) or
special (to act in a single transaction). The power of attorney can authorize a person to sign
cheques (i.e. operate the account) on behalf of the customer. The banker, while dealing with
customers attorney should carefully examine the document regarding power of attorney. It
should be properly stamped and still in force. The banker should keep a copy of the document
with it for reference. It should keep in view that power to operate an account does not
automatically imply the power to overdraw. Such power should be specifically given. The
customer may revoke the authority of the attorney and the authority of the attorney shall stand
terminate in the event of death, insolvency and insanity of the principal.
Procedure and Practice is opening and conducting the accounts of customers particularly
individuals including minors-
One of the important functions of the Bank is to accept deposits from the public for the
purpose of lending. In fact, depositors are the major stakeholders of the Banking System. The
depositors and their interests form the key area of the regulatory framework for banking in
India and this has been enshrined in the Banking Regulation Act, 1949. The Reserve Bank of
India is empowered to issue directives / advices on interest rates on deposits and other aspects
regarding conduct of deposit accounts from time to time. With liberalization in the financial
system and deregulation of interest rates, banks are now free to formulate deposit products
within the broad guidelines issued by RBI.
This policy document on deposits outlines the guiding principles in respect of

formulation of various deposit products offered by the Bank and terms and conditions
governing the conduct of the account. The document recognizes the rights of depositors and
aims at dissemination of information with regard to various aspects of acceptance of deposits
from the members of the public, conduct and operations of various deposits accounts, payment
of interest on various deposit accounts, closure of deposit accounts, method of disposal of
deposits of deceased depositors, etc., for the benefit of customers. It is expected that this

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document will impart greater transparency in dealing with the individual customers and create
awareness among customers of their rights. The ultimate objective is that the customer will get
services they are rightfully entitled to receive without demand.
While adopting this policy, the bank reiterates its commitments to individual customers
outlined in Bankers Fair Practice Code of Indian Banks Association. This document is a broad
framework under which the rights of common depositors are recognized.
KNOW YOUR CUSTOMER (KYC) GUIDELINES:
Know Your Customer (KYC) is the platform on which banking system operates to avoid the
pitfalls of operational, legal and reputation risks and consequential losses by scrupulously
adhering to the various procedures laid down for opening and conduct of accounts. The Bank
shall follow appropriate Know Your Customer Policies, procedures and internal control
mechanism designed to :
1. Establish and document the true identity and address of the customers who
maintain/establish relationships, open accounts or conduct business transactions.
2. Obtain background information on existing and/or new customers;
3. Safeguard the Bank from the risks of doing business with any individual or entity whose
identity cannot be determined.
4. Protect the Bank from the risks of having business relationships with any individual or
entity who refuses to provide information, or who has provided information that
contains significant inconsistencies which cannot be resolved after due investigation.

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IDENTIFICATION THROUGH DOCUMENTS PROVIDED BY THE CUSTOMER:

The bank shall establish customers identity (true name, residential and mailing address)
with the help of certain official documents as may be provided by the customer concern
in original. The indicative lists of identity and address proof documents to be submitted
in case of individuals are as under :
Proof of Identity
1. Passport
2. PAN card
3. Voters Identity Card
4. Driving license
5. Job card issued by NREGA duly signed by an officer of the State Government
6. The letter issued by UIDAI containing details of name, address and Aadhaar
number
7. Identity card (subject to the banks satisfaction)
8. Letter from a recognized public authority or public servant verifying the identity
and residence of the customer to the satisfaction of bank
9. Letter issued by UIDAI containing details of name, address and Aadhaar number
(Aadhaar Card)
The Bank shall not rely upon Ration Card as a document to establish ones identity

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Address Proof
o Telephone bill
o Bank account statement
o Letter from any recognized public authority
o Electricity bill
o Ration card
o Letter from employer (subject to satisfaction of the bank)
o Any proof of identity providing the address as declared in account opening form.
o Letter issued by UIDAI containing details of name, address and Aadhaar number
(Aadhaar Card)
MINORS ACCOUNTS -
i. In terms of Indian Majority Act, a minor is a person below the age of 18 years, but in
case of minor whose guardian is appointed by the Court, he/she attains the majority at
the age of 21 years.
ii. The minor can open Savings Bank Account and the same can be operated by the natural
guardian/guardian. It is permissible to open any type of deposit account in the name of
a minor within the framework for minor account but no current account should be
opened, in the name of the minor.
iii. On attaining majority, the erstwhile minor should confirm the balance in his/her
account and if the account is operated by the natural guardian /guardian, fresh
specimen signature of erstwhile minor duly verified by the natural guardian would be
obtained and kept on record for all operational purposes.
iv. The Bank shall normally allow a literate minor over the age of 10 years to operate a
Savings Bank account and also Recurring Deposit account. The Bank shall take adequate
care to see that the minor is receiving payment himself/herself when such account is
opened. No cheque book will be issued in these accounts.

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Joint Account Holders-
Joint account is a bank account shared by two or more individuals. Any individual who is a
member of the joint account can withdraw from the account and deposit to it. Usually, joint
accounts are shared between close relatives or business partners.
Joint accounts are often created in order to avoid probate. If two individuals open a joint
account and one of them dies, the other person is entitled to the remaining balance and liable
for the debt of that account.
Sometimes a temporary joint account is opened by two parties entering into a transaction
where one party needs a security for the fulfillment of the transaction and the other party has
to pay the sum (deposit), being the security for the other party. Any payment from the joint
account, or return of the deposit from the joint account, will only be possible if both parties
sign a joint written instruction to the bank. It is not possible that only one of the parties gives
instruction for payments of the joint account.
Because (European) banks are not very interested in opening temporary joint accounts, as they
are normally used for one transaction only, there are specialized parties or companies taking
care of such accounts as trustees. A temporary joint account is normally closed after the
transaction for which it was opened has been concluded. Temporary joint accounts are used in
transactions in which large sums of money are involved as an alternative to letters of credit or
escrow accounts.

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Partnership Firms-
Partnership is defined as a relation between two or more persons who have agreed to share
the profits of a business carried on by all of them or any of them acting for all. The owners of a
partnership business are individually known as the "partners" and collectively as a "firm". Its
main features are:-
A partnership is easy to form as no cumbersome legal formalities are involved. Its

registration is also not essential. However, if the firm is not registered, it will be
deprived of certain legal benefits. The Registrar of Firms is responsible for registering
partnership firms.
The minimum number of partners must be two, while the maximum number can be 10
in case of banking business and 20 in all other types of business.
The firm has no separate legal existence of its own i.e., the firm and the partners are
one and the same in the eyes of law.
In the absence of any agreement to the contrary, all partners have a right to participate
in the activities of the business.
Ownership of property usually carries with it the right of management. Every partner,
therefore, has a right to share in the management of the business firm.
Liability of the partners is unlimited. Legally, the partners are said to be jointly and
severally liable for the liabilities of the firm. This means that if the assets and property of
the firm is insufficient to meet the debts of the firm, the creditors can recover their
loans from the personal property of the individual partners.
Restrictions are there on the transfer of interest i.e. none of the partners can transfer
his interest in the firm to any person (except to the existing partners) without the
unanimous consent of all other partners.

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The firm has a limited span of life i.e. legally; the firm must be dissolved on the
retirement, lunacy, bankruptcy, or death of any partner.
A partnership is formed by an agreement, which may be either written or oral. When the
written agreement is duly stamped and registered, it is known as "Partnership Deed".
Ordinarily, the rights, duties and liabilities of partners are laid down in the deed. But in the case
where the deed does not specify the rights and obligations, the provisions of THE INDIAN
PARTNERSHIP ACT, 1932 will apply. The deed generally contains the following particulars:-
Name of the firm.
Nature of the business to be carried out.
Names of the partners.
The town and the place where business will be carried on.
The amount of capital to be contributed by each partner.
Loans and advances by partners and the interest payable on them.
The amount of drawings by each partner and the rate of interest allowed thereon.
Duties and powers of each partner.
Any other terms and conditions to run the business.
Advantages
Ease of formation
Greater capital and credit resources
Better judgment and more managerial abilities
Disadvantages
Absence of ultimate authority
Liability for the actions of other partners
Limited life

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Unlimited liability
Partnership is an appropriate form of ownership for medium sized business involving limited
capital. This may include small scale industries, wholesale and retail trade; small service
concerns like transport agencies, real estate brokers; professional firms like charted
accountants, doctors' clinic, attorney or law firms etc.
Stock companies with limited liability-
Many states allow a business form called the limited liability company (LLC). The LLC arose from
business owners' desire to adopt a business structure permitting them to operate like a
traditional partnership. Their goal was to distribute income to the partners (who reported it on
their individual income tax returns) but also to protect themselves from personal liability for
the business's debts, as with the corporate business form. In general, unless the business owner
establishes a separate corporation, the owner and partners (if any) assume complete liability
for all debts of the business. Under the LLC rules, however, an individual isn't responsible for
the firm's debt, provided he or she didn't secure them personally, as with a second mortgage, a
personal credit card or by putting personal assets on the line.
The LLC offers a number of advantages over subchapter S corporations. For example, while S
corporations can issue only one class of the company stock, LLCs can offer several different
classes with different rights. In addition, S corporations are limited to a maximum of 75
individual shareholders (who must be U.S. residents), whereas an unlimited number of
individuals, corporations, and partnerships may participate in an LLC.
The LLC also carries significant tax advantages over the limited partnership. For instance, unless
the partner in a limited partnership assumes an active role, his or her losses are considered
passive losses and cannot be used as tax deductions to offset active income. But if the partner
takes an active role in the firm's management, he or she becomes liable for the firm's debt. It's
a catch-22 situation. The owners of an LLC, on the other hand, do not assume liability for the
business' debt, and any losses the LLC incurs can be used as tax deductions against active
income.

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However, in exchange for these two considerable benefits, the owners of LLCs must meet the
"transferability restriction test," which means the ownership interests in the LLC are not
transferable without restriction. This restriction makes the LLC structure unworkable for major
corporations. For corporations to attract large sums of capital, their corporate stock must be
easily transferable in the stock exchanges. However, this restriction isn't as problematic for
smaller companies, where stock ownership transfers take place relatively infrequently.
Since the LLC is a relatively new legal form for businesses, federal and state governments are
still looking at ways to tighten regulations concerning them. Unfortunately, some investment
promoters use LLCs to evade securities laws. That's why it's imperative to consult with your
attorney and CPA before deciding which corporate structure makes sense for your business.
Executors and Trustee-
1. Executor Role
o As required by law, the executor guides your will through probate, gathers the estate's
assets, safeguards estate property, fulfills all valid claims against the estate and
distributes the estate property to beneficiaries. The executor can employ professional
help to assist with these tasks, especially those that require financial expertise. Keep in
mind that since the executor can use the estate's assets to pay the professional for
their services, the distributions available for beneficiaries may be reduced.
2. Trustee Role
o Leaving your estate to a trust limits the executor's role to passing on the assets to the
trustee. The trustee manages and distributes funds and assets of the trust. In addition
to duties such as collecting assets and paying claims against the estate, trustees must
consult regularly with the beneficiaries on various issues such as investments and
withdrawals. The trustee is responsible for "reasonable and prudent" management of
the trust funds, and the beneficiaries have the power to sue the trustee for any
mismanagement.

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3. Executors vs. Trustees
o Although the functions of an executor and trustee are similar, there are slight
differences in their roles. For example, while an executor's role may last for a couple of
years, a trustee's duties can go on for generations which are why a bank or trust
company should be appointed the successor trustee. Many estates do not require the
executor to possess legal or financial expertise; trustees, however, are the official
managers of the estate and must possess the expertise to this end.
Whom to Appoint
o There are certain factors you should consider when appointing an executor or trustee
for your will. The candidate should have sufficient time and capability to fulfill your
wishes. Family members may not be appropriate for the executor role because they
may have conflicts of interest. Also, family members may lack the necessary expertise
to execute your will. Executors who are older than you are also not the best choice as
the older individual may predecease you. Appointing trustees and executors who live
overseas is also not advisable; this can cause delays and complications in the execution
process.
Joint Hindu Family-
A Hindu Joint Family or Joint Family is an extended family arrangement prevalent among Hindus
of the Indian subcontinent, consisting of many generations living under the same roof. All the
male members are blood relatives and all the women are either mothers, wives, unmarried
daughters, or widowed relatives, all bound by the common [sapinda] relationship. The joint
family status being the result of birth, possession of joint cord that knits the members of the
family together is not property but the relationship. The family is headed by a patriarch, usually
the oldest male called "[Karta]", who makes decisions on economic and social matters on behalf
of the entire family. The patriarch's wife generally exerts control over the kitchen, child rearing
and minor religious practices. All money goes to the common pool and all property is held
jointly.

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There are several schools of Hindu Law, such as Mitakshra, the Dayabhaga, the
Marumakkathayam, the Santayana etc. Broadly, Mitakshra and Dayabhaga systems of laws are
very common. Family ties are given more importance than marital ties. The arrangement
provides a kind of social security in a familial atmosphere.
Key aspects of a joint family are:
Head of the family (Karatha) takes all decision regarding financial and economic aspects
of family.
All members live under one roof.
Share the same kitchen.
Three generations living together (though often two or more brothers live together, or
father and son live together or all the descendants of male live together).
A common place of worship.
All decisions are made by the male head of the family- patrilineal, patriarchal.
No division of property until the death of the Karta (head of family or older male
person).
Income earned by the HUF and expenses incurred by the HUF are of the whole family
and not of any specific individual. All Incomes are also taxed in the hands of the HUF and
not any specific individual.

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CHAPTER-6
PRINCIPLES OF BANK LENDING
Sound principles of Bank Lending Different kinds of borrowing facilities granted by banks
such as Loans, Cash Credit, Overdraft, Bills Purchased, Bills Discounted, Letters of Credit,
Types of Securities, NPA.
LENDING BANKER
One of the primary functions of a bank is to grant loans. Whatever money the bank
receives by way of deposits, it lends a major part of it to its customers by way of loans,
advances, cash credit and overdraft. Interest received on such loans and advances is the major
source of its income. The banks make a major contribution to the economic development of the
country by granting loans to the industrial and agricultural sectors.
The banks make loans and advances out of deposits, received from their customers. Most of
these deposits are payable on demand. As such the bank owes a greater responsibility to the
depositors. Hence he should be extremely careful while granting loans.
General Rules of Sound Lending
A banker should use his third eye and third ear (although the God has given him only
two eyes and two ears) while granting loans. In other words, he must be extra careful while
granting loans. A banker should take the following precautions:
Principles of Sound Lending
1. Safety
2. Liquidity
3. Profitability
4. Diversification
5. Object of loan
6. Security

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7. Margin Money
8. National Interest
9. Character of the borrower money interest
These are discussed below.

1. Safety: The most important golden rule for granting loans is the safety of funds. The main
reason for this is that the very existence of the bank is dependent upon the loans granted by him.
In case the bank does not get back the loans granted by it, it might fail. A bank cannot and must
not sacrifice the safety of its funds to get higher rate of interest. For example, if a reputed credit-
worthy businessman offers to pay 10% interest per annum and on the other hand a pauper offers
15% rate of interest per annum. Obviously as per safety rule, the banker should not grant loan to
the pauper although paying 5% higher rate of interest.
2. Liquidity: The second important golden rule of granting loan is liquidity. Liquidity means
possibility of converting loans into cash without loss of time and money. Needless to say, that
the funds with the bank out of which he lends money are payable on demand or short notice.
As such a bank cannot afford to block its funds for a long time. Hence the bank should lend only
for short-term requirements like working capital. The bank cannot and should not lend for long-
term requirements, like fixed capital.
3. Return or Profitability: Return or profitability is another important principle. The funds of the
bank should be invested to earn highest return, so that it may pay a reasonable rate of interest
to its customers on their deposits, reasonably good salaries to its employees and a good return
to its shareholders. However, a bank should not sacrifice either safety or liquidity to earn a high
rate of interest. Of course, if safety and liquidity in a particular case are equal, the banker
should lend its funds to a person who offers higher rate of interest.
4. Diversification: One should not put all his eggs in one basket is an old proverb which very
clearly explains this principle. A bank should not invest all its funds in one industry. In case that
industry fails, the banker will not be able to recover his loans. Hence, the bank may also fail.
According to the principle of diversification, the bank should diversify its investments in
different industries and should give

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loans to different borrowers in one industry. It is less probable that all the borrowers and
industries will fail at one and the same time.
5. Object of Loan: A banker should thoroughly examine the object for which his client is taking
loans. This will enable the bank to assess the safety and liquidity of its investment. A banker
should not grant loan for unproductive purposes or to buy fixed asset. The bank may grant loan
to meet working capital requirements. However, after nationalization of banks, the banks have
started granting loans to meet loan-term requirements. As per prudent banking policy, it is not
desirable because of term lending by banks a large number of banks had failed in Germany.
6. Security: A banker should grant secured loans only. In case the borrower fails to return the
loan, the banker may recover his loan after realising the security. In case of unsecured loans,
the chances of bad debts will be very high. However, the bank may have to relax the condition
of security in order to comply with the economic. Banking policy of the government. For
example, loans to weaker sections of society may be given without security if so directed by the
government.
7. Margin Money: In case of secured loans, the bank should carefully examine and value the
security. There should be sufficient margin between the amount of loan and the value of the
security. If adequate margin is not maintained, the loan might become unsecured in case the
borrower fails to pay the interest and return the loan. The amount of loan, should not exceed
60 to 70% of the value of the security. If the
value of the security is falling, the bank should demand further security without delay. In case
he fails to do so, the loan might become unsecured and the bank may have to suffer loss on
account of bad debt.
8. National Interest: Banks were nationalised in India to have social control over them. As such,
they are required to invest a certain percentage of loans and advances in priority sectors viz.,
agriculture, small scale and tiny sector, and export-oriented industries etc. Again, the Reserve
Bank also gives directives in this respect to the scheduled banks from time to time. The banks
are under obligations to comply with
those directives.

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9. Character of the Borrower: Last but not the least, the bank should carefully examine the
character of the borrower. Character implies honesty, integrity, creditworthiness and capacity
of the borrower to return the loan. In case he fails to verify the character of the borrower, the
loans and advances might become bad debts for the bank.
Kinds /Forms of Lending (Advances)
Banks lend for working capital requirements in the form of:

1. Loans
2. Cash credit
3. Overdraft
4. Purchase and discounting of bills of exchange.
1. Loans: This is the oldest and very popular form of lending by the banks. In case of loans,
financial assistance is given for a specific purpose and for a fixed period. The customer can
withdraw the entire amount of loan in a single installment. As such, interest is payable on the
entire amount. In case he needs the funds again, he has to make a fresh application for a new
loan or renewal of the existing one. Ordinarily, the loan is repayable in one installment.
However, a customer may return the loan
in more than one installment also.
Merits of Granting Loans
A. Simplicity
The method is very simple. Interest is payable on the entire amount of the loan.
B. Better Recovery of Interest and Loan
The customer knows in advance the time of return of the loan. Therefore, he makes
arrangement for its return. In case he does not return the loan in time, the bank will not grant
loans and advances to him in future. It acts as an automatic regulator to discipline the
borrower.
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C. Profitability
From the point of view of the bank, the method is economical. The customer has to pay interest
on the entire amount of the loan even if he has not withdrawn the entire loan. To that extent
funds can be used by the bank.
Demerits
A. Inflexibility
The method is simple but inflexible. Borrower has to make a fresh request for the loan every
time he requires the loan.
B. Over borrowing
Since the loan method is inflexible a customer takes a loan in excess of his needs to meet any
contingency. This results in over borrowing.
C. More Formalities
As compared to cash credit and overdraft methods, loan documentation is more complicated.
2. Cash Credit: Cash credit is the most popular method of lending by the banks in India. It
accounts for more than two third of total bank credit. Under cash credit system, a limit, called
the credit limit is specified by the bank. A borrower is entitled to borrow upto that limit. It is
granted against the security of tangible assets or guarantee. The borrower can withdraw
money, any number of times upto that limit. He can also deposit any amount of surplus funds
with him from time to time. He is charged interest on the actual amount withdrawn and for the
period such amount is drawn.
Commitment Charges: To discourage the borrower from keeping large funds idle within the
sanctioned limit bank levies commitment charges. This also helps the bank in two ways. Firstly,
it compensates him for the loss on idle funds kept by him within the credit limit sanctioned.
Secondly, it facilitates better credit funds management. It will be applicable to borrower having
a working capital limit of Rs. one crore or more. The rate of commitment charges is 1% per
annum on the un utilised portion of cash credit limit sanctioned. However, no such charges will
belevied, if the unutilised quarterly operating limit is upto 15%.Again, it will not be applicable to
sick units, export credit or export incentives, inland bills and credit limits granted to commercial
banks, cooperative banks and financial institutions.
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Merits of Cash Credit
A. Flexibility
The greatest advantage of cash credit method is that it is flexible. A customer can withdraw and
deposit money any number of times.
B. Economical
The scheme is economical. A borrower has to pay interest only on the amount borrowed and
that too for the period the amount is actually withdrawn. Unlike a loan he is not required to pay
interest on the entire amounts of the loan.
C. Less Formalities
As compared to the loan method, there are less formalities, and frequent documentation is
avoided. Moreover, documentation in this method is less complicated.
Demerits
A. Over Borrowing
Credit limits are fixed one in a year. It gives rise to the tendency of fixing higher limits to cover
contingencies. Thus it encourages over-borrowing.
B. Division of Funds
The bank has control over the amount of credit sanctioned. It does not have any control over
the use of such funds. Consequently the borrower diverts the funds, without the knowledge of
the bank, for unapproved purposes.
C. Non-utilisation of Funds
In practice a large amount of sanctioned cash credit limit remains unutilised. Levy of
commitment charges has failed to put an end to this weakness because it is levied on cash
credit limit of Rs. one crore or more.
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Distinction between Loan and Cash Credit
(a) Amount: In case of loan a fixed amount is sanctioned, whereas in case of cash credit a limit
is fixed.
(b) Period: Loan can be granted for a short, medium and long-term but cash credit is granted
only for a short period upto one year only.
(c) Withdrawal: The entire amount of loan is credited to the customers account. In case of cash
credit the customer can withdraw the amount upto the limit when he needs.
(d) Interest: In case of loan, interest is payable on the entire loan, whereas in case of cash
credit, interest is payable only on the amount actually withdrawn and for the period the
amount is withdrawn.
(e) Repayment: Ordinarily a loan is repayable in one lump sum. However, it may be paid in
installments also. On the other hand in case of cash credit, the borrower may repay any surplus
amount from time to time.
3. Overdraft: One of the main advantages of a current account is that, its holder can avail of the
facility of overdraft. An overdraft facility is granted to a customer on a written request.
Sometimes, it may be implied where a customer overdraws his account and the bank honour
his cheque. [Bank of Maharashtra Vs. M/s United Construction Co. and Others (1985) Boom.
432 A.I.R.] The bank should obtain a written request from the customer. He should also settle
the terms and conditions and the rate of interest chargeable. It is usual to obtain a promissory
note from the customer to cover the overdraft
Distinction between Cash Credit and Overdraft

Ordinarily, in practice no distinction is made between cash credit and overdraft. The reason is
that their purpose and nature is almost the same. Inspite of this there are the following points
of distinction between them:
(a) Period: The main difference between cash credit and overdraft is that the former is granted
comparatively, for a longer period, whereas overdraft is a temporary facility.
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(b) Opening Separate Account: For granting cash credit it is necessary to open a new account.
No new account is necessary for overdraft.
(c) Current Account: Overdraft facility is granted to a current account holder only. It is not
necessary to be a current account holder, to avail of the facility of cash credit.
(d) Control of Central Government: The Central Government exercises strict control over cash
credit. There is no such control on overdraft.
(e) Commitment Charges: In case of under-utilisation of cash credit a customer has to pay
commitment charges. No commitment charges are payable in case of overdraft.
(f) Form of Security: Cash credit is ordinarily granted on the security of goods by way of pledge
or hypothecation. Overdraft is granted on the personal security of the borrower or financial
securities viz., shares, bonds etc.
4. Purchase and Discounting of Bills of Exchange: The bank provides the customers with the
facility of purchasing and discounting their bills receivable. This is a method of financial
accommodation offered by the banker to the customer. The bank permits the customer to
discount his bills receivable and have the value of the bills credited to his account. The bank
charges discounting charges on the face value of the bills. It waits till the maturity of the bill and
presents it on the due date to the drawee for payment. After collection, the proceeds of the bill
are appropriated towards the loan and interest due by the customer. If the bill is discounted,
the amount will be recovered from the customer.
LETTER OF CREDIT
A Letter of Credit has been defined by the International Chamber of Commerce as an

arrangement, however, named or described whereby a bank (the issuing bank) acting at the
request and in accordance with the instructions of a customer (the applicant of the credit), is to
make payment or to the order of a third party (the beneficiary) or is to pay, accept or negotiate
Bills of Exchange (Drafts) drawn by the beneficiary or authorised such payments to be made or
such drafts to be paid, accepted or negotiated by another bank, against stipulated documents
and compliance with stipulated terms and conditions.
2015
These are following parties to a Letter of Credit.
(1) The buyer.

(2) The beneficiary.
(3) The issuing bank.
(4) The notifying bank.
(5) The negotiating bank.
(6) The confirming bank.
(7) The paying bank.
1. The Buyer: The buyer who is the importer, applies to the bank for the opening of a Letter of
Credit.
2. The Beneficiary: The seller, who is the exporter, is the beneficiary of the Letter of Credit.
3. The Issuing Bank: The bank which issues the Letter of Credit at the request of the buyer is
the issuing bank.
4. The Notifying Bank: The notifying bank is the correspondent bank situated in the same place
as that of the seller which advises the credit to the beneficiary.
5. The Negotiating Bank: It is the bank which negotiates the Bills or Drafts under the Letter of
Credit.
6. The Confirming Bank: It is the bank the seller insists that the credit must be confirmed by it.
7. The Paying Bank: The paying bank is the bank on which the bill or draft is drawn. It can be
the confirming bank, the issuing bank or the notifying bank.
Types of Letters of Credit
The Letter of Credit can be divided into two broad categories:

1. Travellers Letter of Credit.
2. Commercial Letter of Credit.
T
rs of Credit
2015
I. Travellers Letter of Credit

Such types of Letters of Credit are issued by the banks for the convenience of the travellers. The
travellers are saved from the risk of travelling with heavy cash with them. The facility of such
Letters of Credit can be available both for travelling in and outside the country. The
characteristics of such Letters of Credit are as under:
(a) A Travellers Letter of Credit is issued by a bank on its own branch/ branches or
correspondent bank/banks situated anywhere in the world.
(b) It contains a request by the issuing bank to make payment up to the amount to the person
named therein.
(c) The issuing banker may issue a Letter of Identification to the holder of the Letter of Credit.
The signature of the holder must be attested therein.
Types of Travellers Letter of Credit: The Travellers Letter of Credit can be divided into the
following forms:
1. Travellers Cheque: It is issued and drawn by a bank upon its own branch or another bank. It
is a request by the issuing bank to the paying bank to pay a specified amount to the holder. It
also contains the specimen signature of the holder for the purpose of identification.
2. Circular Letter of Credit: It is addressed to more than one banker. Details of the amount paid
by the various bankers are entered in the proforma, printed on the back of the letter of credit.
The holder is to deposit the required amount for which he wants a letter of credit with the
issuing bank. The issuing bank charges its commission for the service.
In case of a letter of credit, the banker issues an identification slip which bears the signature of
the holder attested by the issuing banker. In a travellers cheque these signatures are on the
travellers cheque itself.
3. Circular Note: It is like a travellers cheque. Unlike a letter of credit it is of specified

denomination. In a letter of credit the banker has to make and entry at the time of the making
payment. However, in a circular note, payment is made by the bank on surrender of the circular
note.
2015
4. Circular Cheques: These are like travellers cheques. However, these are not of specified
denominations. The maximum amount payable is indicated on the circular cheque. No separate
identification slip or letter is issued along with it. The holders signatures are on the circular
cheques like those on the travellers cheques.
5. Guarantee Letter of Credit: In case of other letters of credit the holder has to pay in advance
the required amount of the credit to the banker who issues letter of credit. In case of guarantee
letter of credit, the holder is not required to deposit any amount in advance; he is only required
to give guarantee of the amount required.
6. Bank Draft or Demand Draft: A bank draft or a demand draft is a bill of exchange drawn by
one bank on its own branch or any other bank. The essential features of a bank draft are:
(a) It is always drawn by a bank upon its own branch or another bank.
(b) It is always payable on demand and it cannot be made payable to bearer.
(c) Ordinarily, payment of a demand draft cannot be stopped or countermanded. It is because
of this reason payment is demanded through a bank draft.
II. Commercial Letter of Credit
Such letters of credit are issued to facilitate trade and commerce particularly the international
trade. An exporter is reluctant to send goods to the importer because he wants to minimize the
risk for the payment. Similarly, the importer is also reluctant to send the payment in advance to
the exporter. He is afraid that the exporter may not send the goods even after receiving
payment in advance. The bank comes to the rescue (help) of both the parties. The documents
of goods are sent through the bank with the instructions that the bank should deliver the
documents viz., Bill of Lading or Freight Bill to the importer against payment or acceptance of
the bill. The importer can get the delivery of the goods by surrendering the bill of lading to the
shipping company and the exporter will get the payment from the bank.
2015
However, in the above case a risk is involved. The importer may not pay or accept the bill. The
exporter will have to spend unnecessary money in getting the goods back. Such risks can be
avoided if a letter of credit is opened by the importer.
A letter of credit issued by the importers bank guarantees the exporter that the bank will pay
or accept the bill accompanying the documents sent through the bank.
The letter of credit specifies what goods have to be despatcher and also the date by which the
goods must be dispatched. The exporter should strictly comply with the terms and conditions of
the letter of credit. In case he fails to do so, the bank issuing the letter of credit will not liable to
pay or accept the bill drawn by the exporter.
Types of Letters of Commercial Credit
1. Documentary Letter of Credit: When a clause is inserted in the letter of credit that the
document of title to goods viz., bill of lading, insurance policy, invoice etc. Must be attached to
the bill of exchange drawn under the letter of credit. It is called a documentary letter of credit.
2. Clean Letter of Credit: If no such clause (as in documentary letter of credit) is inserted in the
letter of credit, it is called a clean letter of credit. The documents of title in that case are sent
directly to the importer. In a clean letter of credit there is greater risk for the banker. As such a
banker issues clean letter of credit only to those customers, who have good reputation and
credit in the market.
3. Fixed Letter of Credit: If the banker specifies in the letter of credit the amount of the bill to
be drawn within the time fixed, it is called a fixed letter of credit. Such a letter remains valid
until the specified amount is utilized within the specified time.
4. Revolving Letter of Credit: In case of revolving letter of credit, the banker specifies the total
amount upto which the bills drawn may remain outstanding at a time. For example, X opens a
letter of credit with City Bank for a total sum of Rs. one lakh valid for a period of 3 months. The
beneficiary (exporter) can draw bills under the letter of credit with the condition that the value
of such outstanding bills should not exceed Rs. one lakh at any given time.
2015
The main advantage of revolving credit is that the beneficiary may draw a bill for an amount
higher, than the one specified in the letter of credit. Again there is no need of renewal again
and again. However, it is complicated. It is difficult to ascertain how much amount is
outstanding at a particular time.
5. Revocable Letter of Credit: Unless specified otherwise, a letter of credit will be deemed
revocable (Art. 1 Uniform Custom and Practice). In case of revocable letter of credit, the issuing
banker resumes the right to cancel or modify the credit at any time without notice. Therefore,
such a letter of credit is hardly of any use. However, as per Article 2 of Uniform Custom and
Practice, in the above case modification or cancellation will become effective only on receipt of
the notice by the negotiating banker.
6. Irrevocable Letter of Credit: Such a letter cannot be modified or cancelled without the
consent of the applicant and the beneficiary. As per Article 3 of Uniform Custom and Practice
the issuing banker will be liable in case of irrevocable letter of credit if the exporter strictly
complies with the terms and conditions of the letter of credit.
7. Confirmed Letter of Credit: When the banker issuing the letter of credit requests the
advising bank in the exporters country to signify his confirmation to an irrevocable credit and
the advising bank accepts the request, it is called irrevocable and confirmed letter of credit. The
advising banker is called confirming banker. He cannot cancel or modify his undertaking
without the consent of the parties concerned.
8. Unconfirmed Letter of Credit: In case the issuing banker does not ask the advising banker to
confirm the letter of credit, it remains unconfirmed letter of credit.
9. With Recourse Letter of Credit: You might recall that a bill of exchange may be drawn with
recourse to the drawer. If such a bill is drawn under a letter of credit, it is called with recourse
letter of credit. In case of such a bill, if the drawee does not honour the bill, the banker as a
holder can recover the payment of the bill from the drawer.
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10. Without Recourse Letter of Credit: If an exporter wants to avoid his liability (as in the case
of with recourse letter of credit) he can ask the importer to open a letter of credit without
recourse to the drawer. If the importer fails to honour the bill, the issuing banker cannot hold
the drawer liable. He can hold only the drawee liable in such a case. The banker may realize the
amount by selling the goods if the documents of title have not been given to the importer.
11. Transferable Letter of Credit: Where the goods are exported through middle men, the
exporter may ask the importer to open a transferable letter of credit. Under a transferable
letter of credit, the beneficiary will be able to transfer his right to draw a bill to a third party.
12. Non-transferable Letter of Credit: Every letter of credit unless stated otherwise is non-
transferable. Hence the beneficiary cannot transfer such a letter of credit to a third party.
13. Back to Back Letter of Credit: A beneficiary of a non-transferable letter of credit may
request the bank to open a new letter of credit in favour of some third party on the security of
letter of credit issued in his favour, it is called a back to back letter of credit.
14. Red Clause Letter of Credit: If the exporter wants financial assistance in advance against his
export for purchase of materials, packing etc., he can ask the importer to arrange a Packing
Credit. This packing credit is made available through the letter of credit by inserting a clause in
red ink. Such a clause is called Red Clause. The negotiating banker can advance specified money
to the exporter. Such accommodation is of temporary nature and is adjusted at the time of final
payment.
2015
NON- PERFORMING ASSETS
In the normal course, borrowers repay their dues to the bank by their respective due dates.
Some debts, however, turn sticky. The borrower is unable or unwilling to pay. If such debt is
shown as a regular debt, and interest is accrued on such debt as a regular income, then the
financial statements would give an incorrect picture of the financial status of the bank.
Therefore, RBI has laid down strict requirements regarding recognition of Non-Performing
Assets (NPA).
An NPA is a loan or advance where:
Term Loan interest and / or installment of principal remains overdue for more than 90days.
Overdraft / Cash credit - account is out of order i.e. Outstanding balance remains
continuously in excess of the sanctioned limit / drawing power; or Outstanding balance is
within the sanctioned limit / drawing power, but there are no credits continuously for 90 days
as on the date of balance sheet, or the credits are not enough to cover the interest debited
during the same period.
Bills purchased and discounted bill remains overdue for more than 90 days.
Short duration crops (crop season is up to a year) installment of principal or the interest
there on remains overdue for two crop seasons.
Long duration crops - installment of principal or the interest thereon remains overdue for one
crop season.
A few more relevant points
Banks are supposed to classify an account as NPA only if the interest charged during any
quarter is not serviced fully within 90 days from the end of the quarter.
If an advance is covered by term deposits, National Savings Certificates eligible for surrender,
Indira Vikas Pastras, Kisan Vikas Patras and Life policies, then it need not be treated as NPA.
This exemption however does not extend to government securities and gold ornaments.
Drawing power should be determined based on stocks statements that are not older than 3
months. Else, it would be treated as irregular.
If irregular drawings are permitted in the working capital account for a continuous period.

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2015

Banking Regulations and Operations

Unit 1: COMMERCIAL BANKS 08 Hours

Unit 2: BANKER AND CUSTOMER RELATIONSHIP 12 Hours

Unit 3: NEGOTIABLE INSTRUMENTS 10 Hours

Unit 4: PAYING BANKER AND COLLECTING BANKER 10 Hours

Unit 5: TYPES OF CUSTOMERS AND ACCOUNT HOLDERS 10 Hours

Unit 6: PRINCIPLES OF BANK LENDING 10 Hours

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 1

The role of commercial banks

Commercial banks engage in the following activities:

processing of payments by way of telegraphic transfer, EFTPOS, internet banking, or

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 2

providing documentary and standby letter of credit, guarantees, performance bonds,

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 3

Credit creation is most significant function of commercial banks. While sanctioning a

The agency functions are the following:

To collect and clear cheque, dividends and interest warrant.

The utility functions are the following:

To provide safety locker facility to customers.

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 4

Credit Creation of Commercial Bank-

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 5

Investment Policy of Commercial Bank

They may be classified as follows:

(i) Principle of diversification

(ii) Principle of purpose

(iii) Principle of Security

(iv) Principle of National interest and suitability

Let us discuss these principles one by one.

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 6

For example, due to recessionary conditions in the economy, due to destruction of

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 7

(a) It should be convertible into cash quickly and easily.

The need of liquidity arises on account of the following reasons:

Factors Determining Liquidity of Banks

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 8

Time Deposits: 500 crore

Other outside Liability: 40 crore

Total outside liabilities: 640 crore

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 9

(i) Principle of Diversity:

Another important principle of good lending is the diversification of advances. An element of

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 10

(ii) Principle of Purpose or End use:

(iii) Principle of Security:

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 11

(iv) Principle of National Interest and Suitability:

(v) Fee Based Services of Banks:

(i) Mail Transfer

(ii) Telegraphic Transfer

(iii) Demand Drafts

(iv) Pay orders

(v) Electronic Funds Transfer

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 12

Telegraphic Transfer / Telex Transfer

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 13

International Academy of Management and Entrepreneurship Mr. Shree Harsha C , Faculty 14

Electronic Funds Transfer