BLP Module3 Paper 9 1

Study Material
PROFESSIONAL PROGRAMME
BANKING – LAW & PRACTICE
module 3
ELECTIVE paper 9.1

© THE INSTITUTE OF COMPANY SECRETARIES OF INDIA
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In the contemporary perspective, Indian economy is considered as the one of the fastest growing and emerging economies
in the world. Contributing to its high growth are many critical sectors including Agriculture, Banking Industry, Capital
Market, Money Market, Financial Services and many more. Among all, ‘Banking Sector’ has unarguably been one of the
most distinguished sectors of Indian economy.
Indeed, the development of any country depends on the economic growth, the country achieves over a period of time.
This confirms the very fact that the role of financial sector in shaping fortunes for Indian economy has been even more
critical, as India since independence has been equally focussed on other channels of growth too along with resilient
industrial sector and the domestic savings in the government instruments. This prompted India to majorly depend on
sectors for its dynamic progression.
Considering the fact that banking sector plays a significant role in the economic empowerment and global growth of the
country, a balanced and vigil regulation on Banking Sector has been always mandated to ensure the transparent run of
this sector while avoiding any tantamount of fraud and malpractices injurious to the interest of investors, stakeholders
and country as a whole.
Therefore a robust regulatory regime has been established in India along with the presence of Reserve Bank of
India to regulate the conduct and day to day affairs of banking sector.
In the phase, where plethora of Laws, Regulations and Rules are the guiding the conduct of Banking Industry towards
good governance, the role of Company Secretaries become much vivacious to meet the challenges of a more dynamic
business and regulatory environment on one side and to ensure timely compliance on other side.
Considering the role of Company Secretaries in the Banking Sector as well as supporting the idea of all-rounded
development of our professional brigade, this subject under the title of Banking Laws and Practice serve a one spot
resource of understanding basic features of Banking and Banking Industry along with providing a detailed account of
laws and regulation governing the banking industry in the country.
The amendments notified up to July, 2021 have been incorporated in this study material. However, it may happen that
some developments might have taken place during the printing of the study material and its supply to the students. The
students are therefore advised to refer to the supplement uploaded on ICSI website from time to time and ICSI Journal
Chartered Secretary and other publications for updation of study material. In the event of any doubt, students may
contact the Directorate of Academics at [email protected].
Although due care has been taken in publishing this study material, yet the possibility of errors, omissions and/ or
discrepancies cannot be ruled out. This publication is released with an understanding that the institute shall not be
responsible for any errors, omissions and/or discrepancies or any action taken in that behalf.
Should there be any discrepancy, error or omission noted in the study material, the Institute shall be obliged, if the same
are brought to its notice for issue of corrigendum.
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PROFESSIONAL PROGRAMME – BANKING – LAW & PRACTICE

Banking sector plays a vital role in the development of the economy of a country and day by day the importance of bank
is increasing in everybody’s daily life. There are various risks like Credit Risk, Market Risk, Operational Risk, Business
Risk etc. faced by the Banks. A banking professional working in a bank or providing any service related to the banking
sector can reduce the risks associated with bank by gaining appropriate knowledge of banking. A career in banking and
finance is one of the most lucrative career options one can choose these days. Changes in the banking environment make
it necessary for banking staff to equip themselves with the banking skills and knowledge in the financial sector.
Banks are a subset of the financial services industry. It is a financial institution that provides banking and other financial
services to their customers. A bank is generally understood as an institution which provides fundamental banking
services such as accepting deposits and providing loans. The banks safeguards the money and valuables and provide
loans, credit, and payment services, such as checking accounts, money orders, and cashier’s cheques and some banks
also offer investment and insurance products. Due to their critical status within the financial system and the economy,
banks are subject to stringent regulations.
Reserve Bank of India Act, 1934

The RBI Act was enacted with an objective of constituting Reserve Bank of India to regulate issue of bank notes, to keep
reserves to ensure monetary stability, to operate currency and credit system.
This Act is the basis for constitution, powers, and functions of RBI. This act does not regulate banking directly though
section 18 and 42 of RBI Act are used in regulating credit. In broad sense, RBI Act deals with Incorporation, Capital,
Management, Business of RBI itself, Central Banking Functions, Collection and furnishing of information, Regulating
Non-Banking Institution receiving deposits and financial institutions, Prohibition of Acceptance of deposits by
unincorporated bodies, Regulation of transactions in derivatives, money market instruments, securities etc., Joint
mechanism, Monetary Policy, General Provisions, Penalties along with Schedule I and II.
The RBI Act was amended several times in the past to expand the powers of RBI. The task of the Monetary Policy
Committee (‘MPC’) would be fixing the benchmark policy rate (repo rate) to control and contain inflation within the
specified target level. The Committee-based structure is expected to bring in value addition and transparency in this
area of policy decisions. MPC will hold meetings at least four times a year and publish the decisions after each such
meeting.
Credit Controls
Statutory
Cash Reserve Ratio Financial
Liquidity Ratio Directives Moral Suasion
(Sec 42 of RBI Act) Accommodation
(Sec 24 of BR Act)
Selective Credit
General Credit Rate Policy (Bank Re Discounting/
Control (BR Act Sec
Control Rate & Repo) Refinancing
21 and Sec 35 A)
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Diverse Role of A Company Secretary : The role of Company Secretary in the banking company derives from the nature
of assignments performed by him/her in that organization. While it is a statutory requirement to engage / employ on
whole-time basis a Company Secretary for the banking company set up under the Companies Act, 2013 and having a
Banking Licence to carry on banking business under the Banking Regulation Act, 1949, the other banking companies
irrespective of their nature of corporate entities such as commercial banks, Regional Rural Banks, Non Banking Finance
Companies (NBFC), Development Finance Institutions will be better placed where professionally qualified Company
Secretaries are employed in view of their diversified knowledge in legal and related fields.
It is indeed an arduous task for the Board of Directors to see that not only the shareholders, but also the other
stakeholders, viz. the customers, suppliers, investors, employees and the society at large, are benefited by the result of
excellent management practices, so as to justify the survival and sustenance of the organization. The role of a Company
Secretary, being a Principal Officer of the organization, in the banking sector, is crucial, since he acts as a facilitator in
the entire corporate management process, to ensure that the corporate entity is run on sound management principles
and practices.
The role of the Company Secretary in different management hierarchy, varies from the positions held in the organization
and the functions looked after by him/her. Company Secretary’s functions encompass a wide spectrum of duties and
responsibilities, which, if laid down, would be a never ending list. However, for the sake of brevity and to be precise,
some of the important tasks, generally entrusted to a Company Secretary and satisfactorily discharged by him/her in the
banking organizations, are enumerated below.
Adherence to Regulatory Guidelines

Company Secretaries in the Banking Companies formed either under the Companies Act, 1956, Companies Act, 2013 or
any other legislation(s) and having Banking Licence from RBI under the Banking Regulation Act 1949, have to discharge
onerous responsibility not only to ensure compliance with the various statutory provisions as a Principal Officer, but also
to ensure fulfilment of the requirements of various allied Statutes, Rules, Regulations issued by statutory authorities/
Govt. agencies including RBI, SEBI, Ministry of Finance/Ministry of Company Affairs, Govt. of India on issues related to
the banking sector.
Company Secretaries are in a better position to discharge this responsibility with greater confidence. Company
Secretaries also play an important role in the process of conforming to the different statutory/regulatory requirements
as prescribed by RBI such as maintaining Statutory Liquidity Ratio, Cash Reserve Ratio, Capital Adequacy etc. Banks are
also required to ensure compliance with the lending norms in different sectors/ categories as specified by RBI from time
to time. In view of strict banking governance norms, especially to achieve Basel I/II/III compliance targets, professional
services rendered by Company Secretaries, in this regard, deserve due recognition.
Formulation of Corporate Management Policies

Company Secretaries generally take part in the formulation of various corporate policies for approval by the Board
of Directors. Threadbare discussions are held by the Corporate Management Team including the Company Secretary,
before any policy is firmed up. His/her views on any corporate matters are held in high esteem in the banking sector, in
view of diverse knowledge/expertise acquired as a qualified Company Secretary.
Conducting Corporate Meetings

Smooth and systematic conduct of Board/Directors’ Committees/shareholders’ meetings in conformity with the
provisions of the Companies Act, Banking Regulations Act etc. and to comply with all related statutory functions are the
inherent functions performed by the Company Secretary. His administrative acumen is reflected in the manner in which
all such Corporate Meetings are conducted right from convening such Meetings till their completion.
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Active Contributory to Corporate Governance
Practices Company Secretary generally involves himself/herself in the establishment of various corporate governance
practices in the organization. In the banking sector also, such role is played by the Company Secretary, who acts
as Secretary to the different Directors’ Committees constituted to look after various matters, either under the
Listing Agreement (Clause 49), or for better management practices. Some of the Committees of Directors in banking
organization, where he/she acts as Secretary, are –
 Audit Committee of the Board;
 Shareholders’/Investors’/Customers’ Grievance Redressal Committee;
 Remuneration Committee;
 Shares/Securities Transfer Committee;
 Management Committee;
 Risk Management Committee;
 Fraud Monitoring Committee.
Liaison in the Audit Process

Company Secretary also keeps a close liaison with the different departments in the organization to enable the
Statutory Auditors to complete the audit process in time, till the Accounts are considered/recommended/approved
by the Audit Committee/Board and finally adopted by the shareholders at the Annual General Meeting. He/she also
ensures compliance with statutory/regulatory requirements including reporting to the Stock Exchanges (in case of
listed banking organization), finalization and submission of quarterly/half-yearly accounts, which are subjected to
review by Statutory Auditors.
During the course of such Supplementary Audit by CAG, close co-ordination is required amongst the Corporate
Accounts Department, In-charge of Internal Audit Department, Statutory Auditors and the CAG audit team, till the
Supplementary Audit Report is received. Reply to any observation (adverse or otherwise) is to be prepared/ finalized,
recommended by the Audit Committee and approved by the Board of Directors and finally adopted by the shareholders
at the Annual General Meeting.
Advice to the Board of Directors

To render proper and timely advice to the Board of Directors and other top executives in adhering to the various
prudent Corporate Governance practices, not only as a pre-requisite for the Listing Agreement but also as a
systematic development of core ethical standards is within the domain of the Company Secretary’s functions. Being
assigned with the task of Secretary to the various Directors’ Committees in the banking organization, he/she ensures
compliance with the various statutory obligations/requirements, which include formulation of Code of Conduct for
the Directors and Senior Management Personnel, adherence to the proper internal control systems, etc. In the matter
of servicing shareholders’ for payment of dividend (including interim dividend), redemption of preference shares,
wherever applicable, further issue of shares etc. Company Secretary’s advice is generally sought by the Board of
Directors/top management to ensure that the relevant laws, rules, regulations, guidelines, if any, are complied with.
Risk Management Functions

In view of the complex nature of the guidelines issued by RBI from time to time in the matter of assessment of various
risks involved such as credit risk, interest risk, market risk etc., the professional knowledge of the Company Secretary
facilitates evolving appropriate strategy in such matters without jeopardizing the interest of the Banks. Different
criteria/systems are developed by the individual banks to assess the nature of risks involved in the bank’s dealings on
credit management, investment/disinvestment strategy, determining bank’s prime lending rates etc. Now-a-days the
professional knowledge of the Company Secretaries is also utilized by the Banks in various decision making process.
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Formulation of Recovery Policy another important area where Company Secretary generally renders effective and
fruitful services, is to participate in the formulation of appropriate recovery policy for approval by the Board. The
functions of Banks including Non-Banking Finance Companies (NBFC) and Development Finance Institutions include
lending activities to various sectors/industries and categories of customers, such as individuals, firms, corporate
bodies etc. Hence, their recovery policy varies depending upon the category of loan/investment portfolio and
quantum of assistance at stake. As is common in banking parlance, Standard/ Performing Assets and Stressed/Non-
performing Assets (NPAs) are to be dealt with based on separate strategies/principles and degree of importance.
Such strategy differs from Standard to NPAs. Attention/ focus on recovery from Standard Assets is generally drawn/
thrust not only to ensure maintenance of quality of assets, but also to arrest slippage of Standard Assets to NPA
category. On the other hand, intensive endeavor is made by bank management to initiate appropriate timely recovery
steps depending upon the nature of NPA such as substandard, doubtful and loss assets, classified as per the guidelines
issued by Reserve Bank of India from time to time.
Recovery policy of the banks also envisages, inter-alia, One Time Settlement for recovery of dues from NPAs through
protracted negotiations in the recovery settlements by applying prudent negotiating skills to realize best possible
deal for the organization. Company Secretary, when assigned with such tasks of recovery process, along with other
assignments, offers suggestions in consultation with the legal executives in the banks for timely action for recovery
under the Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act, 2002, which
has proved to be an effective tool for the bank management to realize dues from Non-Performing Assets with greater
promptness.
Merger/Acquisition Process
Company Secretary also plays an important role in the process of merger and amalgamation in the Banking sector
and/or for any takeover, acquisition of any target/weak bank either as a strategic decision to bail out any weak bank,
as may be advised/permitted by Reserve Bank of India, or as a policy decision to expand the bank’s business domain.
Armed with adequate professional knowledge/expertise in this field, the role played by the Company Secretary in such
tasks, to ensure compliance with the various statutory requirements under the Companies Act, Banking Regulations
Act and other allied legislations/Regulations, is quite significant.
In the prevailing global economic scenario, the issues arising out of overseas acquisition/take over etc. in the banking
sector, can be effectively dealt with by the Company Secretary. His/her professional skills with legal background and
far sightedness in dealing with such matters, helps the top management not only to ensure compliance with different
regulatory requirements in the countries involved, but also to strike a better deal for the organization for takeover/
merger of any banking company.
Resource Mobilization
Strategy For mobilization of resources by way of shares/Bonds etc., the role played by Company Secretary is of
paramount importance. Right from deciding on the nature of resources such as Share Capital, Subordinate Capital/
Bonds etc. as per Reserve Bank of India norms upto the actual raising of such capital and during the course of servicing
thereof, professional services rendered by the Company Secretary is crucial and widely appreciated/relied upon by
the top management.
Compliance Officer
The Company Secretary in the Banking organization, also acts as a Compliance Officer under the Listing Agreement,
where the shares / securities of the Banking organization are listed with any Stock Exchange. He/ she also advises on
various compliance requirements, applicable to the concerned Banking organization and periodically certifies to the
appropriate authority(ies).
In the present era of globalization, “survival of the fittest” is the rule of the game and there is an impending danger of
weeding out the weak entities unless the organization is run by the management based on sound principles. In this
respect, Company Secretary’s role in the Banking organization, need not be over emphasized.
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He/she is the person who generally participates in the key decision making process at various stages besides attending
Meetings of the Board of Directors/various Directors’ Committees, Corporate Management Team and other various
crucial Committees in the top management hierarchy, so as to ensure highest standard of excellence in various
activities/functions. Enforcement of corporate governance practices by rules or legislative measures only may not
yield a desired result unless there is a key man behind the scene in achieving this task, which is best performed
by the Company Secretary. The expertise of the Company Secretary in the banking industry can be best utilized
by the top management with a view to ensure enhancement of the value of the company to the stakeholders viz.
customers, borrowers, lenders, suppliers, Government and public at large, which is ultimately reflected in the Annual
Report, generally drafted by the Company Secretary, in association with other key executives in the organization
and ultimately approved by the Board of Directors and adopted by the shareholders. It is expected that a time will
come when there may be legal necessity to have a professional Company Secretary in place for all such banking
organizations, with a view to ensure satisfying standard of governance.
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PROFESSIONAL PROGRAMME MODULE 3
ELECTIVE PAPER 9.1
BANKING – LAW & PRACTICE (MAX MARKS 100)
Objective
To develop a robust knowledge base pertaining to significant facets of Banking Sector among those students who
wish to pursue a career in Banking Sector.
1. Overview of Indian Banking System : Indian Banking System – Evolution; RBI and its Role; Structure of Banks
in India; Commercial Banks; Co-operative Banking System; Development Banks; NBFCs.
2. Regulatory Framework of Banks : Constitution, Objectives, Functions & Powers of RBI; Tools of Monetary
Control; Regulatory Restrictions on Lending; Business of Banking; Constitution of Banks; RBI Act, 1934; Banking
Regulation Act, 1949; Role of RBI; Govt. as a Regulator of Banks; Control over Co-operative Banks; Regulation by
other Authorities.
3. Control over Organization of Banks : Licensing of Banking Companies; Branch Licensing; Paid up Capital
and Reserves; Shareholding in Banking Companies; Subsidiaries of Banking Companies; Board of Directors;
Chairman of Banking Company; Appointment of Additional Directors; Restrictions on Employment; Control over
Management; Directors and Corporate Governance.
4. Regulation of Banking Business : Power of RBI to Issue Directions; Acceptance of Deposits; Nomination;
Loans and Advances; Regulation of Interest Rate; Regulation of Payment Systems; Internet Banking Guidelines;
Regulation of Money Market Instruments; Reserve Funds; Maintenance of CRR, SLR; Assets in India.
5. Banking operations : Preparation of Vouchers, Cash Receipt and Payment Entries, Clearing Inward and Outward
Entries, Transfer Debit and Credit Entries; What is KYC and What are the Different to satisfy KYC; Verify KYC and
authenticity of documents, Operational Aspects in Regard to Opening of All Types of accounts; Scrutiny of Loan
Applications / Documents, Allowing Drawals and Accounting Entries involved at various stages, operational
Aspects of CBS environment etc.; Back Office Operations in Banks, Handling of Unreconciled Entries in Banks.
6. IT in Banking : Overview of Banking services and IT related Risk and Controls, Components and Architecture of
CBS, Core Business Processes Flow and Relevant Risks and Controls Reporting System and MIS; Data Analytics
and Business Intelligence.
7. Payment and Collection of Cheques and Other Negotiable Instruments : NI Act; Role & Duties of Paying &
Collecting Banks; Endorsements; Forged Instruments; Bouncing of Cheques; Its Implications; Return of Cheques;
Cheque Truncation System.
8. Case Laws on Responsibility of Paying Bank : Negotiable Instruments Act and Paying Banks;
Liability of Paying Banker; Payment in Due Course; Payment in Good Faith; Whether Payment under Mistake
Recoverable.
9. Case Laws on Responsibility of Collecting Bank : Statutory Protection to Collecting Bank; Duties of Collecting
Bank.
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10. Various Government Schemes : Pradhan Mantri Jan DhanYojana (PMJDY); SukhanyaSamridi Account; MUDRA
Bank Yojana; Pradhan Mantri Jeevan Jyoti BeemaYojana (PMJJBY); Pradhan Mantri Suraksha BimaYojana
(PMSBY); Atal Pension Scheme, etc.
11. Consumer Protection : Operational Aspects of Consumer Protection Act & Banking Ombudsman Scheme.
12. Loans and Advances : Different Types of Borrowers; Types of Credit Facilities- Cash Credit, Overdraft, Demand
Loans, Term Loans, Bill Finance.
13. Securities for Banker’s Loans : Types of Securities; Assignment; Lien; Set-off; Hypothecation; Pledge; Mortgage;
Indemnities and Guarantees; Factoring; Bill discounting; Letter of Credit; Commercial Papers; Bank Guarantees;
Book debts; Corporate Securities; Charges.
14. Documentation : Types of Documents; Procedure; Stamping; Securitisation.
15. Calculation of Interest and Annuities : Calculation of Simple Interest & Compound Interest; Calculation of
Equated Monthly Instalments; Fixed and Floating Interest Rates; Calculation of Annuities; Interest Calculation
using Products / Balances; Amortisation of a Debt; Sinking Funds.
16. Calculation of YTM : Debt- Definition, Meaning & Salient Features; Loans; Introduction to Bonds; Terms
associated with Bonds; Cost of Debt Capital; Bond value with semi-annual Interest; Current Yield on Bond;
Calculation of Yield-to- Maturity of Bond; Theorems for Bond Value; Duration of Bond; Properties of Duration;
Bond Price Volatility.
17. Foreign Exchange Arithmetic : Fundamentals of Foreign Exchange; Forex Markets; Direct and Indirect Quote;
Some Basic Exchange Rate Arithmetic – Cross Rate, Chain Rule, Value date, etc.; Forward Exchange Rates –
Forward Points; Arbitrage; Calculating Forward Points; Premium / discount; etc.
18. Non Performing Assets : Definition; Income Recognition; Asset Classification; Provisioning Norms; CDR
Financial Inclusion BC; BF; Role of ICT in Financial Inclusion, Mobile based transactions, R SETI.
19. Final Accounts of Banking Companies : Definition and Functions of a Bank; Requirements of Banking
Companies as to Accounts and Audit; Significant Features of Accounting Systems of Banks; Principal Books of
Accounts; Preparation and Presentation of Financial Statements of Banks; CMA Format; Accounting Treatment
of Specific Items; Preparation of Profit and Loss Account; Comments on Profit and Loss Account; Important Items
of Balance Sheet; Disclosure Requirements of Banks; Additional Disclosures prescribed by RBI; Disclosures
required under BASEL norms.
20. Risk Management in Banks and Basel Accords : Introduction to Risk Management; Credit Risk Management;
Liquidity and Market Risk Management; Operational Risk Management; Risk Management Organisation;
Reporting of Banking Risk; Risk Adjusted Performance Evaluation; Basel- I, II & III Accords.
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LESSON WISE SUMMARY
1. Overview of Indian Banking System

Banks are one of the important pillars that support the edifice of economy of every country and so too in India.
Banking system in its modernized form in India has evolved over the last two hundred and it continues to do so even
to the present day. India has a complex banking structure with Reserve Bank of India (‘RBI’) playing the pivotal role of
Central bank of this country. Apart from its statutory functions (as enshrined in The RBI Act, 1934) the RBI regulates
Commercial Banks, Cooperative Banks, Payment Banks and Small Finance Banks, Regional Rural Banks, Local
Area Banks, Development Banks/All-India Financial Institutions. In view of emerging global and local regulatory
compulsions such as capital adequacy and other related developments, the Government of India has effected a major
consolidation of PSU Banks recently. Also to encourage and expand the reach of financial inclusion among the public
at large, setting up of Small Finance Banks and Payment Banks are being actively encouraged. Apart from banks,
RBI is also given powers to regulate NBFCs. To have a better regulation based on activity over NBFCs, the RBI has
harmonized the classification of NBFCs
2. Regulatory Framework of Banks

RBI regulates banks in terms of powers it derives from The RBI Act, 1934 and The Banking Regulation Act, 1949
(‘BR Act’). The RBI Act confers power to RBI in the matter of managing itself as well as discharging its supervisory
duties vis-à-vis other banks as well as powers to function as Monetary Policy/Control Authority. The BR Act confers
vast powers to RBI vis-à-vis banks such as issuing directions to banks in the area of Deposit Accounts, interest rates,
advances, foreign exchange, CRR/SLR etc. To increase the effectiveness of regulation over NBFCs, the RBI Act has also
been amended recently, to confer more powers than ever before, in tune with emerging economic/financial scenario.
It also regulates credit in India as per the clauses of the BR Act. RBI has also been empowered to direct banks to initiate
insolvency resolution process of borrowers under Insolvency and Bankruptcy Code 2016. Apart from RBI, banks
are also regulated by other regulators in a limited way such as Securities and Exchange Board of India, Insurance
Regulatory and Development Authority of India, Registrar of Companies, Central / State Registrar of Co-operatives
etc. wherever applicable.
3. Control over Organization of Banks

RBI exercises control over banks through the power conferred on it by the Banking Regulation Act, 1949. The control
measures include Licensing of various categories of banks including branches/banking outlets of banks including
RRBs, Small Finance Banks and Payment Banks, prescribing Capital & Reserves, Shareholding, Setting up of banking
subsidiaries, composition of Board of Directors, Duties and functions of Chairman, Directors, fit and proper criteria
for election of a person as a Director, other officials as well as various Corporate Governance aspects of Banks in India.
4. Regulation of Banking Business

The extensive regulatory powers conferred on RBI enables it to regulate the following aspects of banking viz. Advances,
Guarantees, Rate of Interest, Deposit Portfolio, Affairs of Board of Directors/Directors/Other officials, Electronic/
Internet Banking, Payment and Settlement systems of banks. In order to make Payment & Settlement system more
customer friendly, RBI has announced harmonisation of Turn Around Time (TAT) and customer compensation for
failed transactions using authorised Payment Systems. RBI also issues directions in the interest of banking policy
to banks and guidelines, on resolving stressed assets. It also maintains Depositor Education and Awareness Fund in
respect of specified inoperative deposit accounts and other sundry liability items of banks, provide guidance to banks
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on Nomination in deposit accounts, safe deposit lockers and safe custody accounts. As a part of its monetary control
measures RBI controls issue of various money market instruments. It also guides and monitors the maintenance of
reserve fund, Cash Reserve Ratio and Statutory Liquidity Ratios of banks.
5. Banking Operations
As Public Financial Entities, banks offer various products and services. Doing so, involves accounting, passing of
vouchers, opening accounts for different types of customers across different asset and liability products through
cash, clearing and transfer modes. As all routine operations are done practically through computerized packages
involving sophisticated software and hardware, it requires proper follow- up, monitoring and reconciliation in the
light of directions and guidelines of RBI. In the light of national and global developments in the state of economy,
prevention of Money Laundering and other regulatory developments, RBI periodically revises it’s directions to banks
which need careful implementation and follow-up.. Also banks use extensive centralized back office operations
for several services such as opening accounts, KYC verification, cheque book issue, servicing third party products,
dematerialized accounts, other investments as well reconciliation of entries.
6. IT in Banking
Banking has been transformed in to an Information Technology (‘IT’) intensive operation which has introduced
efficient customer service, better housekeeping and improved internal controls, productivity and decision making. On
the flip side, IT based products and services have their inherent risks which need to be managed through preventive,
detective and corrective controls. Also banks implement various other control measures to protect interests of
customers and themselves. Majority of commercial banks offer CORE banking based services to customers across
various geographical locations with the help of Central Data Centers. CORE banking operations also carry risks which
are being managed through various controls. CORE banking has enabled banks to generate various Management
Information System reports for decision making, as well as for analysis with a view to improve various products and
services offered to customers.
7. Payment and Collection of Cheques and Other Negotiable Instruments

As a part of banking operations banks handle many types of Negotiable Instruments such as Cheques, Bills of Exchange,
Demand Drafts etc. on behalf of their customers. Negotiable Instruments Act, 1881 (NI Act) which governs various
aspects of Negotiable Instruments, deals with duties and responsibilities of a paying bank as well as a collecting bank
of such Negotiable Instruments. To get legal protection under NI Act banks have to adhere to various provisions as
enumerated in the said Act. For making payment and collection of NIs such as cheques and DDs, Banks use the process
of clearing. Cheque Truncation System (CTS) has been adopted in India in clearing of cheques to speed up customer
service, reduce reconciliation problems, eliminate logistic problems and minimize frauds. CTS is subject to detailed
rules and procedures prescribed by RBI in this regard.
8. Case Laws on Responsibility of Paying Bank

Negotiable Instruments Act, 1881 offers protection to a paying bank in terms of Section 85 & 85A in respect of Cheques
and Demand Drafts provided these instruments are paid in due course. When banks act with negligence while paying
a NI, disregarding the provisions of the NI Act, they stand to lose the protection of the Act and are liable to the parties
concerned thereof as borne out in various judgments of courts. A paying banker is also affected by the provisions of
Consumer Protection Act in addition to that of NI Act.
9. Case Laws on Responsibility of Collecting Bank

Banks when they act as Collecting Banks are governed by Section 131& 131A of NI Act which also governs the
framework of their role and responsibilities. There have been numerous judgments pertaining to legal cases which
have been handed down by various courts in India when banks have acted negligently while acting as collecting
banks.
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10. Various Government Schemes
To address some of the major issues that affect our economic growth such as unemployment, poor agricultural and
industrial growth, non-availability of credit at reasonable interest, social inequities etc., Government of India has
been coming up with various bank linked credit delivery schemes from time to time for promoting - agriculture,
micro, small and medium industries, employment opportunities (including self-employment) as well making ,
available credit at affordable rates of interest, nil/marginal security etc. Additionally the Government has introduced
socio- welfare schemes for the citizens of the country through banks. Some of the schemes have been state specific
and in some cases a collaborative effort between the Centre and the states. The government has started the ‘Make In
India’ initiative to encourage more SMEs to become a part of India’s growth journey.
11. Consumer Protection

Banking being a service industry dealing with a variety of customers who need to be protected against deficiencies in
services extended to them. Bank customers are also covered under the definition of “Consumer” and can take recourse
through Consumer Protection Act, 1986. A customer can file a case within a period of 2 years from the date cause
of action has arisen with Consumer redressal councils according to the monetary jurisdiction applicable. Supreme
Court has the ultimate appellate jurisdiction in the matter. Similarly customers’ complaints against banks can also be
resolved through Banking Ombudsman Scheme in an inexpensive way. Under this scheme, a bank customer has one
year time to complain to Banking Ombudsman after he/she has complained to the bank concerned. Decisions of the
Banking Ombudsman can be appealed against with the Appellate authority by either the complainant or the bank,
subject to rules in this regard.
12. Loans and Advances

Lending is one of the generic functions of banks. When banks extend loans and advances, they follow certain basic
principles such as safety, liquidity, profitability, security, purpose and spread to minimize risks involved. As banks
lend to different types of customers they adopt appropriate legal procedures in consonance with the constitution of
such customers. While lending, banks are required to adhere to various directives of RBI issued from time to time.
While lending, banks obtain security to safe guard themselves against the risk of default by borrowers. Based on
type of advance and the nature of security, banks create appropriate charges against such securities so as to legally
enforce their rights in the event of default by borrowers. As a part of lending, banks also provide certain non-fund
based facilities such as Letters of Credit and Guarantees. Banks also finance, receivables of a borrower through the
facility of ‘factoring’. Banks extend sales finance in the form of Purchase/ Discounting of bills to eligible borrowers.
Also banks extend finance against Corporate Securities such as Shares/Debentures/Bonds.
13. Securities for Banker’s Loans

Security is something of value given to a lender by a borrower to support his or her intention to repay. Securities
given by a borrower comes to the rescue of banks in cases where borrower defaults. To legally enforce their rights,
Banks create different types of ‘charge’ over securities offered by borrowers such as Assignment, Lien, Pledge,
Hypothecation, and Mortgage. Apart from securities, banks also obtain Guarantees (both personal and corporate)
and Indemnities from borrowers to safe guard themselves against defaults in certain cases.
14. Documentation
Documentation is an integral part of bank credit portfolio that enables a bank to identify the borrower, his capacity,
security, type of charge created, and also serves as evidence in a court of law in recovery proceedings. Properly
executed documents (including registration and stamping wherever necessary) by different types of borrowers
are essential to determine limitation period. Further properly executed documents enable banks to enforce their
rights without the intervention of courts as provided under SARFAESI Act, 2002 as well as commence recovery action
through Debt Recovery Tribunals.
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15. Calculation of Interest and Annuities
For deposits held by customers banks pay interest on simple and compounded basis. They also charge interest on
loans and advances, which forms their main source of income, as per their credit policy. Where loans are repayable
over a term, banks provide an option of Equated Monthly Instalment (EMI). As a part of financial innovation banks
offer fixed or floating interest rates on certain products based on specific terms and conditions. The concept of
annuities is used by banks while calculating interest. Banks also collect interest upfront in certain credit facilities
like Discounting of bills and also charge interest on daily product basis on facilities like Cash credit etc. Estimation of
annuity values are derived by banks based on the Sinking fund concept.
16. Calculation of YTM

As a part of one of their core functions, banks make investments and trade in various securities such as Bonds,
Debentures and Money Market instruments. Through this process banks meet their statutory obligation of SLR
investment and also earn revenue from such instruments. Banks are also involved in extending wealth management
services for their clients which involves investment in various securities. Therefore to maximize revenue, banks take
in to account the calculations of various aspects of bonds such as Yield, current yield, Yield to maturity, duration as
well as bond volatility, carrying amount, underlying value etc.
17. Introduction to Foreign Exchange

Banks offer a variety of Foreign Exchange products and services, (as RBI licensed ‘Authorised Dealers’) to customers
as a part of their routine business. These products and services can be classified as Current/Capital Account
transactions and are subject to rules and regulations of Foreign Exchange Management Act, RBI’s directions, Trade
control regulations, FEDAI Rules, International Commercial Rules, Uniform Customs and Practices for Documentary
Credits, Uniform Rules for Collection, International Standard Banking Practices etc. As a part of the foreign exchange
business, banks buy from customers as well as sell to customers, foreign currencies by following exchange arithmetic
rules such as chain rule, cross rate, forward points etc., for arriving at the correct exchange rate by following applicable
FEDAI/Internal guidelines. Banks also make profits by doing arbitrage transactions in various forex markets across
the globe.
18. Non Performing Assets

As a part of prudential guidelines, Banks follow the RBI norms of Asset Classification, Income Recognition, Provisioning
for bad advances and maintain stipulated risk weighted Capital. While making asset classification, banks segregate
their assets in to performing and Non-performing, based on the record of repayment of principal and interest by
borrowers. Banks also undertake debt restructuring exercise for corporates for the benefit of all stake holders.
What is restructuring and the prudential norms? When and how the one-time settlement (OTS) is done? What is BIFR
and Asset Reconstruction Companies (ARCs)? What are the functioning of Debt Recovery Tribunals (DRTs)? What is
SARFEASI Act and its conditions for sale of assets?
19. Final Accounts of Banking Companies

What are major financial statements and the objective of financial statement analysis? Who are the users of the
financial statements and the tools used for the analysis of financial statements? Important ratios for evaluation of
performance of the banks. The accounting system followed by banks in India, differs from the general accounting
system followed by companies and other business entities. Nevertheless, they are required to prepare and present
their Annual Financial Statements as per specified formats in compliance with provisions of B R Act, The Companies
Act, RBI directions and ICAI Accounting Standards. While doing so, Banking companies are required provide a
summary of Accounting policies followed by them in preparing these financial statements as well as comply with
Disclosure/Additional disclosure requirements as advised by RBI, from time to time. Some terms used in Analysis of
Bank performance.
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20. Risk Management in Banks and Basel Accords
Every business organization is exposed to many risks while doing business. Banks too face several financial and
non- financial risks such as Credit risk, Market risk, Operational risk, Strategic risk, Funding risk, Political and Legal
risks. Based guidelines issued by RBI, banks assess the magnitude of risks faced by them and adopt proper strategies
to manage the same. In the light of banks adopting BASEL I, II and III norms, RBI has sensitized them in sound risk
management practices, as under the present norms a Bank’s capital is linked to various risks faced by it. RBI also
monitors compliance of risk management practices of banks through its onsite and off-site surveillance so as to
prevent crisis in the banking sector. Prompt Corrective Action -2017, the existing framework was revised by RBI and
made effective from March 2017.
21. Audits in Banks

Banks play a significant role in any financial system by virtue of the important role they play in spurring economic
growth by undertaking maturity revolution and supporting the critical payment systems. An audit is a systematic
and independent examination of books, accounts, statutory records, documents and vouchers of an organization to
ascertain how far the financial statements as well as non-financial disclosures present a true and fair view of the
concern.
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LIST OF RECOMMENDED BOOKS
MODULE 3 - Elective PAPER 9.1

Readings
1. M.L. Tannan : Banking Law and Practice, Wadhwa & Company, Nagpur C.R. Datta & revised by
S.K. Kataria
2. A.B. Srivastava and : Seth’s Banking Law, Law Publisher’s India (P) Limited K. Elumalai
3. R.K. Gupta : Banking Law and Practice, Modern Law Publications.
4. Prof. Clifford Gomez : Banking and Finance - Theory, Law and Practice, PHI Learning Private Limited
5. J.M. Holden : The Law and Practice of Banking, Universal Law Publishing.
xvi
ARRANGEMENT OF STUDY LESSONS
Module-3 Elective Paper-9.1

S. No. Lesson Tittle

1. Overview of Indian Banking System
2. Regulatory Framework of Banks
3. Control over Organization of Banks
4. Regulation of Banking Business
5. Banking operations
6. IT in Banking
7. Payment and Collection of Cheques and Other Negotiable Instruments
8. Case Laws on Responsibility of Paying Bank
9. Case Laws on Responsibility of Collecting Bank
10. Various Government Schemes
11. Consumer Protection
12. Loans and Advances
13. Securities for Banker’s Loans
14. Documentation
15. Calculation of Interest and Annuities
16. Calculation of YTM
17. Introduction to Foreign Exchange
18. Non Performing Assets
19. Final Accounts of Banking Companies
20. Risk Management in Banks and Basel Accords
21. Audits in Banks
Test Paper
xvii
Professional PROGRAMME
CONTENTS
LESSON 1
Indian Banking System
Introduction 2
Indian Banking System - an Evolution 2
Brief Overview of Reserve Bank of India (Rbi) 3
Non-Banking Financial Companies (Nbfc) 17
LESSON ROUND UP 24
GLOSSARY 24
TEST YOURSELF 26
LIST OF FURTHER READINGS 26
LESSON 2
Regulatory Framework of Banks
Introduction 28
The Banking Regulation Act, 1949 (an Overview) 29
The Banking Regulation (Amendment) Act, 2020 29
Constitution of Reserve Bank of India 29
Objectives of Rbi 31
Functions of Rbi 32
Powers of Rbi (Overview) 40
Tools of Monetary Control 45
Regulatory Restrictions on Lending 48
Selective Credit Control (Under Section 21 and Section 35A Of Banking Regulation Act) 49
LESSON ROUND UP 53
GLOSSARY 53
TEST YOURSELF 54
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LESSON 3
Control Over Organization of Banks
Introduction 58
Issuing of Licence 58
Licensing of Foreign Banks in India 59
Licensing of Differentiated Banks – Small Finance Bank and Payments Bank 62
Branch Licensing 64
Paid Up Capital and Reserves of Banking Companies 74
Subsidiaries of Banking Companies 76
Board of Directors in Banking Companies 76
Chairman/Managing Director of a Banking Company 78
Appointment of Additional Directors 80
Restrictions on Employment 83
Control Over Management/ Directors/Other Persons 83
Corporate Governance 86
LESSON ROUND UP 90
GLOSSARY 91
TEST YOURSELF 92
LESSON 4
Regulation Of Banking Business
Introduction 96
Powers of Rbi to Issue Directions 96
Acceptance of Deposits 97
Nomination 99
Loans and Advances 100
Regulation of Payment Systems 102
Overview of Evolution and Status of Payment System in India 103
Internet Banking Guidelines 109
Regulation of Money Market Instruments 112
Reserve Funds 116
Maintenance of Crr, Slr 117
LESSON ROUND UP 120
GLOSSARY 121
TEST YOURSELF 123
LIST OF FURTHER READING 124
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LESSON 5
Banking Operations
Introduction 126
Preparation of Vouchers 126
Accounting Entries of Transactions 127
Kyc in Banks 131
Risk Assessment 141
Reporting Requirements to Financial Intelligence Unit - India (FIU-IND) 142
Broad Classification of Types of Deposit Accounts 145
Certain Operational aspects of Deposit Accounts 157
Scrutiny of Loan Applications/Documents 160
Accounting Entries Involved In Various Stages of a Loan 162
Operational Aspects of CBS Environment 163
Operational aspects of Controls in CBS 166
Responsibilities of Banks under CBS 168
Back Office Operations in Banks 171
Handling of Un-Reconciled Entries in Banks 171
Nomination Facility 173
LESSON ROUND UP 178
GLOSSARY 178
LESSON ROUND UP 179
LESSON 6
It In Banking
Introduction 182
Trends in Information Technology 183
Overview of Banking Services and it Related Risks and Controls 185
Various IT Driven Products in Banking Industry 186
IT Related Risks and Controls 190
Components and Architecture of CBS 193
Challenges in CORE Banking Solution 195
Cyber Crime 196
Core Business Process Flow and Relevant Risk Controls 207
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Reporting System and MIS 208
Business Intelligence and Data Analytics 209
Data Analytics 210
LESSON ROUND UP 211
TEST YOURSELF 212
LIST OF FURTHER READING 212
LESSON 7
Payment And Collection Of Cheques And Other Negotiable Instruments
Introduction 214
Types of Negotiable Instruments 215
Parties to a Negotiable Instrument 216
Inland and foreign instrument 217
Endorsements 218
Characteristics of Negotiable Instruments under various sections 218
Crossing of a cheque 222
Penalties for dishonour of a cheque 224
Role and Duties of Paying Bank 228
Forged Instruments 230
Role and Duties of a Collecting Bank 230
Cheque Truncation System 231
LESSON ROUND UP 235
TEST YOURSELF 236
LESSON 8
Case Laws On Responsibilities Of Paying Bank
Introduction 240
Specimen of Cheque 240
Liability of a Paying banker under a forged cheque 243
Section 138 to 142 of the NI Act: Cheque bouncing 246
LESSON ROUND UP 247
GLOSSARY 247
TEST YOURSELF 248
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LESSON 9
Case Laws On Responsibility Of Collecting Bank
Introduction 250
Court Cases and Judgments under Section 131 & 131A of NI Act. 250
Due Diligence and Close Monitoring required by the Bankers 242
LESSON ROUND UP 260
TEST YOURSELF 260
LESSON 10
Various Government Schemes
Introduction 262
Pradhan Mantri Mudra Yojana (Pmmy) 263
Sukanya Samriddhi Account Yojana 266
Pradhan Mantri Jeevan Jyoti Bima Yojana (Pmjjby) 268
Pradhan Mantri Suraksha Bima Yojana (Pmsby) 269
Atal Pension Yojana (Apy) 271
Pradhan Mantri Vaya Vandana Yojana (Pmvvy) 272
Pradhan Mantri Fasal Bima Yojana (Pmfby) 274
Deendayal Antyodaya Yojana (Day) 279
National Rural Livelihood Mission (NRLM) 279
National Urban Livelihood Mission (NULM) 283
The Self Employment Scheme for Rehabilitation of Manual Scavengers (Srms) 290
Pradhan Mantri Awas Yojana 293
Pradhan Mantri Awas Yojana (Urban) 293
Prime Minister Awas Yojana – Gramin 296
Stand-Up India Scheme (For Financing SC / St and / Or Women Entrepreneurs) 298
Rural Self Employment Training Institutes (RSETI) 301
Financial Inclusion 303
Business Correspondents / Business Facilitators (BCBF Model) 305
LESSON ROUND UP 308
TEST YOURSELF 310
LESSON 11
Consumer Protection
Introduction 314
Constitution of Consumer Protection Councils / Authority/ Redressal Forum 315
xxii
Central Consumer Protection Authority 316
District Consumer Disputes Redressal Commission 321
State Consumer Disputes Redressal Commission 325
National Consumer Disputes Redressal Commission 327
Mediation 329
The Consumer Protection (e-Commerce) Rules, 2019 333
The Banking Ombudsman Scheme, 2006 336
Internal Ombudsman Scheme, 2018 for Scheduled Commercial Banks 344
Ombudsman Scheme for Digital Transactions, 2019 344
LESSON ROUND UP 351
GLOSSARY 352
TEST YOURSELF 352
LESSON 12
Loans And Advances
Introduction 354
Basic Principles of Lending 354
Different Types of Borrowers 355
Fund Based Credit Facilities 360
Demand Loan 360
Term Loan 361
Overdraft (O/D Account) 363
Cash Credit Account 363
Maximum Permissible Bank Finance (MPBF) 364
Non Fund Based Limits 367
Bank Guarantees 367
Letter Of Credit (LC) 369
Factoring 373
Commercial Papers (CP) 374
Bills Purchase and Discount 375
Restriction on Lending 376
LESSON ROUND UP 379
TEST YOURSELF 379
xxiii
LESSON 13
Securities For Banker’s Loan
Introduction 382
Securities for Banker’s Loan 382
Attributes of Good Security (MAST Principle) 383
Assignment 384
Lien 384
Set-Off 385
Appropriation 385
Pledge 386
Hypothecation 386
Mortgage 386
Indemnities and Guarantees 389
Book Debts 391
Corporate Securities (Shares / Debentures / Bonds) 392
CERSAI 393
Charge Creation 394
LESSON ROUND UP 396
GLOSSARY 396
TEST YOURSELF 399
LESSON 14
Documentation
Document and Purposes Of Documents 400
Procedure of Documentation 401
Selection of Documents 401
Stamping Of Documents 401
Filling of Documents 402
Execution of Documents 402
Registration of Loan Documents 404
Limitation Act, 1963 405
Securitization 406
LESSON ROUND UP 410
TEST YOURSELF 410
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LESSON 15
Calculation Of Interest And Annuities
Introduction 412
Interest Rate 412
Calculation of Simple Interest 414
Calculation of Compound Interest 415
Equated Monthly Instalments (EMI) 416
Fixed Interest Rate 418
Floating Interest Rate 418
Annuities 419
Calculation of Annuities 420
Interest Calculation Using Products / Balances 422
Concept of Sinking Funds 424
LESSON ROUND UP 426
TEST YOURSELF 426
LESSON 16
Calculation Of Ytm
Introduction 430
Structure of Indian Financial System 430
Classification of Financial Markets 431
Debt 432
Risks involved in holding Government Securities 434
Terms Associated with Bonds 436
Valuation of Bonds 437
Cost of Debt Capital 437
Bond Value with Semi-Annual Interest 438
Current Yield on Bond 439
Calculation of Yield-To- Maturity Of Bond 439
Theorems for Bond Value 440
Duration of Bond 444
Volatility 445
Properties of Duration 445
Bond Price Volatility 445
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LESSON ROUND UP 446
TEST YOURSELF 447
LESSON 17
Introduction To Foreign Exchange
Introduction 452
Functions of the Foreign Exchange Market 452
Participants in Foreign Exchange Market 453
Fundamentals of Foreign Exchange 455
Balance of Payments 455
Foreign Exchange Management Act, 1999 (Fema 1999) 457
Method of Settlement of International Trade 458
Foreign Exchange Market 458
Foreign Exchange Rate Management 464
Exchange Rate Mechanism 465
Exchange Rates 467
Exchange Arithmetic 469
Forward Exchange Rates 472
Forward Margin Premium and Discount 473
Calculation of Forward Premium / Discount 474
Relevant Concepts /Areas in Foreign Exchange 484
LESSON ROUND UP 489
TEST YOURSELF 490
LESSON 18
Non-Performing Assets
Introduction 494
Classification of Bank Advances 494
Performing Assets 495
Non-Performing Asset (NPA) 495
Income Recognition Norm 496
Asset Classification 496
Change in Ownership 498
xxvi
Provisioning Norms 499
Corporate Debt Restructuring (CDR) 500
Prudential Norms 504
Restructuring of Advances of MSME 506
BIFR (Board for Industrial and Financial Reconstruction) 507
Asset Reconstruction Companies (ARCs) 507
Debt Recovery Tribunals (DRTs) 508
Enforcement of security under SARFEASI 509
LESSON ROUND UP 510
GLOSSARY 510
TEST YOURSELF 510
LESSON 19
Final Accounts Of Banking Companies
Introduction 514
Objective of Financial Statement Analysis 514
Requirements of Banking Companies as to Accounts and Audit 515
Significant Features of Accounting Systems of Banks 516
Principal Books of Account Maintained by Banks 516
Preparation and Presentation of Financial Statements of Banks 519
Balance Sheet items: Notes, Detailed comments and instructions for compilation 524
Accounting Treatment of Specific Items 530
Preparation of Profit And Loss Account 531
Important Ratios for evaluation of performance of banks 531
Comments on Profit And Loss Account 534
Important Items of Balance Sheet 535
Disclosure Requirements of Banks 542
Additional Disclosures Prescribed by RBI 542
Disclosures Required Under Basel Norms 550
LESSON ROUND UP 552
GLOSSARY 552
TEST YOURSELF 553
LESSON 20
Risk Management In Banks And Basel Accords
Introduction 556
Stages of Risk Management 557
Types of Risks 558
Credit Risk Management 559
Credit Risk Models 564
Role of RBI in Risk Management in Banks 572
Risk-Adjusted Performance Measurement 574
Basel I, II And III Accords 574
LESSON ROUND UP 583
GLOSSARY 583
TEST YOURSELF 584
LESSON 21
Audits In Banks
Introduction 588
Auditing 588
Features of Audit 589
Standards on Auditing 589
Internal Audit 589
Principles of Internal Audit 590
Scope of Internal Auditor in Bank: 591
Basel Guidance on Internal Audit 591
Credit Audit 593
Information System Audit or Information Technology Audit 594
Concurrent Audit 597
Audit of Financial Statements of Bank 599
Special Audit 601
Stock & Receivables Audit 601
Forensic Audit 601
Revenue Audit 601
Test Paper 604
Lesson 1 • Overview of Indian Banking System 1
Overview of
Lesson 1
Indian Banking System
Key Concepts One Learning Objectives Regulatory Framework
Should Know
• Old Generation This Lesson will enable a • Reserve Bank of India Act, 1934.
Private Bank reader to understand : • State Bank of India Act, 1955.
• New Generation • The Indian Banking system • State Bank of India (Subsidiary
Private Bank and its evolution over the Banks) Act, 1959.
last two centuries. • Banking Companies (Acquisition and
• Co-operative Banks Transfer of Undertakings) Act, 1970.
• Regional Rural Bank • The role and functions of
• Banking Regulation Act, 1949.
(RRBs) Reserve Bank of India.
• Banking Regulation (Co-Operative
• Small Finance Banks • The structure of Banks in Societies) Rules, 1966.
India including • Regional Rural Banks Act, 1976.
• Payments Bank
• Commercial banks • Industrial Finance Corporation of
• Development India Act, 1948.
Finance Institutions • Co-operative banks
• Industrial Credit and Investment
(DFIs) • Development banks Corporation of India Act, 1955.
• Non Banking Finance • All-India Financial • Industrial Development Bank of
Corporations(NBFCs) Institutions India Act 1964.
• Industrial Reconstruction Bank of
• National Bank for • NBFCs. India Act, 1984.
Agriculture and
• State Financial Corporations Act,
Rural Development 1951.
(NABARD)
• Export-Import Bank of India Act,
• Small Industries 1981.
Development Bank of • National Bank for Agriculture and
India (SIDBI) Rural Development Act, 1981.
• National Housing • Small Industries Development Bank
Bank (NHB) of India Act, 1989.
• National Housing Bank Act, 1987.
• Co-Operative Societies Act. (State &
Central)
Lesson Outline
• Introduction • Payment Banks
• Indian Banking System – • Small Finance Banks
Evolution • Financial Institutions
• Nationalised Banks • Development Banks
• Private Banks • NBFCs
• Foreign banks • LESSON ROUND UP
• Co-operative Banks • TEST YOURSELF
• Regional Rural Banks
1
2 Lesson 1 • PP-BL&P
INTRODUCTION
Banks form the back bone of a country’s financial system. Modern Banking system in India is more than two
centuries old. The Indian banking system consists of various constituent banks which mobilize savings from
several sources for lending to productive activities. These banks are regulated by Reserve Bank of India (RBI)
which came in to existence in 1935. RBI controls credit, issues currencies and regulates banks and other non-
banking financial companies. Besides these, the services offered by banks also have expanded over the years in the
light of various national and international developments. Keeping in mind all these, the Lesson covers evolution
of banking system in India, role of RBI and structure of banks which are a must for any student of Banking.
INDIAN BANKING SYSTEM - AN EVOLUTION

The Evolution of Indian Banking System encompasses Agency House Banks, Presidency Banks, Imperial Bank
of India, Reserve Bank of India, Private/Joint Stock Banks (Old generation private sector banks), State Bank of
India, Associate Banks, Nationalized Banks, Old and New Generation Private Sector Banks, Foreign Banks, Co-
operative Banks, Regional Rural Banks, Small Banks and Payments Banks and Financial Institutions known as
Development Banks and Non-Banking Financial Companies.
From the beginning till early 20th century
Agency House Banks/Presidency Banks/Imperial Bank of India

Though money lending and trade credits were known in India since Vedic period and subsequent times, seeds
of modern banking system was sown in India in the year 1776. Wwhen Bank of Hindustan at Kolkata (the then
capital of British in India) was established by the British agency house of Alexander and Company for catering
to the needs of British merchants operating in India. This bank can easily said to be the first commercial bank
in India. This was followed by General Bank of India in 1786. However, liquidation proceedings were started in
the year 1829 for winding up Bank of Hindustan and finally it was liquidated in 1832. The General Bank of India
survived only for five years and in the year 1791 it failed.
Thereafter, Bengal Presidency (equal to present day State Government) established a bank called Bank of
Calcutta in the year 1806 which was later rechristened as Bank of Bengal in 1809. The Bank was funded by the
Presidency of Bengal. This was later followed by two more Presidency Banks namely Bank of Bombay in the
year 1840 and Bank of Madras in 1843. All three Presidency banks were incorporated as joint stock companies.
Under Royal charter “these three banks received the exclusive right to issue paper currency till 1861 when, with
the Paper Currency Act, the right was taken over by the Government of India”.
Later these three Presidency banks were merged to form Imperial Bank of India in 1921, which in 1955 was
renamed as State Bank of India. Until the birth of Reserve Bank of India in 1935, the Presidency Banks and later
Imperial Bank of India were acting as a sort of bankers to the government, by holding Government of India’s
balances”, a function which was later taken over by RBI upon its commencement.
During the period, British merchants established the Union Bank of Calcutta in 1829, first as a private joint
stock association, then converting it in to a partnership. Union Bank was incorporated in 1845 but failed in
1848, as it became insolvent. Bank of Upper India, which was established in 1863 and survived until 1913.
BRIEF OVERVIEW OF THE START OF RESERVE BANK OF INDIA (RBI)

In1927, the British government appointed a commission under Hilton-
Young (known as the Royal Commission on Indian Currency and Finance)
with the main objective to separate the control of currency and credit
from the government, as well as spread the banking network across the
country. The commission recommended setting up a central bank in
India known as Reserve Bank. However, initially the proposal was not
accepted. Later, with a few modifications it was reintroduced and finally
it was accepted in 1934. As a consequence, Reserve Bank of India (‘RBI’)
was established on 1935 as a banker to the central government. It was
initially head quartered in Kolkata and commenced its operations from
April 01, 1935. Later in the year 1937 it was shifted to Mumbai.
At the beginning of its operation, RBI was started as a privately owned entity with a share capital of Rs. 5
crores; almost fully subscribed by private shareholders excepting a token shareholding (2.2 per cent) of the
Central Government. In 1948, the Central Government took over the institution through an Act named Reserve
Bank (Transfer to Public Ownership) Act. All private shareholders were paid compensation. The complete
government take over took place in 1949 as RBI started in statutory role from January 01, 1949.
Private / Joint Stock Banks

There were many commercial banks that were started as Private/Joint stock banks in India. The Allahabad
Bank in 1865 was one of the earliest joint stock banks started in India. Subsequently it was nationalized in 1969
and continues its existence.
On 30 August, 2019, the Ministry of Finance announced that Allahabad Bank would be merged with Indian
Bank, another nationalized Bank. The proposed merger would create the seventh largest public sector bank in
the country with assets of Rs.8 lakh crore.
Oudh Commercial Bank was the first joint stock bank conducting its operations from 1881 to till it failed in
1958. In 1894, the Punjab National Bank was established at Lahore, is now one of the largest public sector
banks in India.
The period between 1906 and 1920 saw the establishment of banks inspired by the ‘Swadeshi’ movement.
Inspired by the movement, native Indians founded banks to serve the Indian community at large. A number of
banks established as joint stock banks then, have survived to the present day such as Bank of Baroda, Central
Bank of India, Catholic Syrian Bank, South Indian Bank, Bank of India, Corporation Bank, Indian Bank, Indian
Overseas Bank. The Swadeshi movement also had its impact in South Kanara district of present day Karnataka
State in which Syndicate Bank, Corporation Bank, Canara Bank, Vijaya Bank and Vysya Bank were founded.
Consequent upon nationalization of banks in 1969 and 1980, as well as economic liberalization ushered in
1991-92, there was a profound impact of expansion of bank/branch network of banks in India.
Establishment of State Bank of India / Associate Banks

As indicated in the beginning, State Bank of India as we know today originated from the three Presidency banks
namely Bank of Bengal, Bank of Bombay and Bank of Madras and the successor to these Presidency banks viz.
Imperial Bank of India.
These banks were basically created by European masters
and served mostly to the common needs of local European
commerce in India. Though Imperial Bank of India was
recognized for its services and integrity, its contribution
was mainly confined to urban populace of India. And it
was “not equipped to respond to the emergent needs of
economic regeneration of rural areas. As this was an area
of concern for the Government of India, the All-India Rural
Credit Survey Committee recommended creation of a
Government partnered and sponsored bank by taking over
the Imperial Bank of India along with those princely states
owned banks. Through State Bank of India Act, in 1955 the
Government of India constituted State Bank of India that
had a 25% share of Indian banking resources at that time.
Subsequently through another enactment viz. State Bank
of India (Subsidiary Banks) Act in 1959, all the princely
state banks were taken over by State Bank of India. Thus
the focus of State Bank of India was concentrated towards
social purpose. It had a network of 480 offices, sub-offices,
Local Head Offices to service the planned economic development of the country to start with. Thus State Bank
of India was destined to be the prime mover of national development in the banking sphere.
The eight princely State Banks that became associate banks of State Bank of India were State Bank of Patiala,
State Bank of Bikaner, State Bank of Jaipur, State Bank of Hyderabad, State Bank of Saurashtra, State Bank of
Indore, State Bank of Mysore and State Bank of Travancore. In 1963 State Bank of Bikaner and State Bank of
Jaipur were merged to form State Bank of Bikaner and Jaipur. Subsequently on 13th August, 2008 State Bank of
Indore and State Bank of Saurashtra were merged with State Bank of India as a part of Government of India’s
plan for creating a “mega bank” by merging all associate banks with State Bank of India. On 15th February,
2017, the Union Cabinet approved the merger of five associate banks with SBI. Pursuant to this, from 1st April
2017 the remaining associate banks were merged with State Bank of India. Also along with its former Associate
Banks, the erstwhile Bharatiya Mahila Bank, an all-women bank established by the Government of India in
2013 for “empowering women and instilling confidence among them to avail bank financing” was also merged.
Bharatiya Mahila Bank was set up to provide credit exclusively to women. Apart from India only two countries
viz, Pakisthan and Tanzania have a bank especially for women. Immediately before the merger, Bharatiya Mahila
Bank had 103 branches and business volume was Rs. 1600 crores. The merger of Bharatiya Mahila Bank was
made considering the large outreach of SBI and its record of establishing all women branches and providing
loan to women borrowers.
Over the years due to various regulatory developments and relaxations made available in permitted activities by
the banking regulator and the Government of India, State Bank of India has created the following non-banking
subsidiaries:
• SBI Capital Markets Limited.
• SBI Funds Management Pvt. Limited.
• SBI Factors & Commercial Services Pvt. Limited.
• SBI Cards & Payments Services Pvt. Limited. (SBICPSL)
• SBI DFHI Limited.
• SBI Life Insurance Company Limited.
• SBI General Insurance Company Limited.
Apart from the above, SBI has 190 overseas offices spread over 32 countries having the largest presence in
foreign markets among Indian banks.
Nationalization of Banks
Until 1968 excepting State Bank of India, all other joint stock banks were under private ownership. As these
banks were catering to the banking needs of urban India, a large number of them did not involve themselves
in the economic upliftment of rural areas, though they mobilized deposits from public at large. Looking at this
state of affairs, the Government of India brought in Social Control of Banks in 1967 with a view to make these
banks contribute to the economic regeneration of rural and semi-urban areas of the country.
The Banks which were operating under private ownership then were also given targets to be achieved in
extending loans to the rural segment. However, dissatisfied with the performance of private banks, the
Government nationalized 14 banks in July 1969 through Banking Companies (Acquisition and Transfer of
Undertakings) Ordinance which was later made into a law in 1970.
Major reasons for nationalization can be summarized as under:

1. To curtail monopoly practices by the industrialists who were having close connections with owners of
these banks such that new entrants would not pose a threat by way of competition to established units.
Therefore, through nationalization this monopoly practice was sought to be curtailed.
2. Private banks did not participate effectively in social welfare measures of the Government. Some of the
banks were lukewarm in their approach and did not follow regulations given under social control. This
failure of social welfare front forced the Government to nationalize banks.
3. To prevent the misuse of resources mobilized from public: Banks collected deposits in the form of savings
deposits, term deposits etc. from the public at large. Since the controls over these funds were with private
hands, they neglected to apply these for specified sectors like agriculture, small-industries which were
treated as ‘Priority’ by the Government. Thus, through nationalisation of banks, the Government could
access to these funds so that they could be channeled for national development.
4. Greater spread of branch network: Privately owned banks confined their operations in select geographical
areas that were convenient to them thus neglecting rural areas which also had business potential.
Nationalization was resorted to mobilize resources in the form of deposits through expansion of branch
network.
5. Financing of Agriculture was grossly neglected by privately owned banks. India’s economy primarily
depends upon agriculture in many ways. Private banks were reluctant to extend finance to agriculture
sector in which 70% of the population was involved. Thus, for providing increased finance to agriculture,
banks were nationalized.
6. For balanced development all regions: In our country due to various reasons, many areas remained
backward for lack of financial resources and credit. Private banks neglected these areas due to lack of
business potential and profitability. With a view to provide bank finance and resources for achieving
balanced growth and to remove regional disparities, nationalization was ushered in.
7. For implementing greater credit control and discipline: As credit was scarce in India, bank credit need to
be monitored and strict control has to be exercised by the regulator and government. If the ownership
of banks is under the control of the Government it would be smooth to exercise such control. Hence,
nationalization was brought in.
8. To provide greater Stability of banking structure. Due to historical reasons, the fear of failure of banks
under private ownership was perceived greater in comparison to banks under Government control. India
cannot afford such failures when it was in a crucial take off stage of economic revival. Therefore to provide
confidence to customers about the safety of their savings and funds, nationalization was resorted to.
Taking into account all the factors listed above,14 banks (as listed below), which had a demand and time
liabilities base of Rs. 50 crores and above were nationalized in the first phase of nationalization in 1969.
A similar exercise was also carried out in1980 and the Government took over the control of the following six
banks which had demand and time liabilities base of Rs. 200 Crores and above.
First Phase of Nationalization
Second Phase of Nationalization
Till the start of liberalization period Government of India held 100% of the equity capital of banks. Post-
liberalization the Government had diluted its stake in several of these PSU Banks in such a way that it has just
majority stake in these institutions.
Consolidation of PSU Banks +

In view of stringent capital adequacy norms as well as mounting NPAs, especially among the Public Sector Banks
and also to arrest sliding performance in their contribution to the economic development of the country, the
Government of India took a decision in late 2018 to consolidate the PSU Banks. In pursuance of this objective
in April of 2019, Vijaya Bank and Dena Bank were amalgamated with Bank of Baroda. In effect, the operations
of Vijaya Bank and Dena Bank have been combined with Bank of Baroda. Ultimately the merged banks are now
working under the umbrella of Bank of Baroda brand. Their consolidated operations had commenced from
1st April 2019. As a consequence of these mergers RBI has excluded “Vijaya Bank” and “Dena Bank” from the
Second Schedule of the Reserve Bank of India Act, 1934 vide it’s circular dated November 28, 2019.
In addition to the above, in August 2019, the Union Finance Minister announced a second dose of consolidation
of PSU Banks which came intoeffect from 1st April,2020 to strengthen the banking system for a robust
performance. The details are as follows:
Details of merging PSU Banks

Accordingly the merged banks have started functioning
as a part of Anchor banks with effect from 1st April,
2020.
After merger of PSU banks the names of Syndicate
Bank, Oriental Bank of Commerce, United Bank of India,
Andhra Bank, Corporation Bank and Allahabad Bank
have been excluded from the Second Schedule to the
Reserve Bank of India Act, 1934 with effect from April
01, 2020 since these banks have ceased to carry on
banking business with effect from April 01, 2020.
With this process of consolidation, the total number of PSU Banks will stand reduced to 12 as indicated below:
They are as follows:
1. Bank of Baroda 7. State Bank of India
2. Bank of India 8. United Commercial Bank
3. Bank of Maharashtra 9. Canara Bank
4. Central Bank of India 10. Indian Bank
5. Indian Overseas Bank 11. Punjab National Bank
6. Punjab & Sind Bank 12. Union Bank of India.
New Generation Private Sector Banks

The private sector banks which were operating in India prior to the liberalization year of 1991 are known
as Old generation private Sector banks. The banks that came into existence subsequent to Narasimham
Committee Report I and revised RBI guidelines in 1993 are known as new generation private sector banks.
The Narasimham Committee-I, recommended to allow private and foreign banks into the industry as a part of
economic liberalization policy of Government of India. In deference to the recommendations of the committee,
the RBI formulated guidelines for the establishment of the private sector banks on January 1993. These
guidelines prescribed that the private banks should be established as public limited companies under the then
Indian Companies Act,1956 (which amended in year 2013 and now it is Companies Act, 2013). The paid-up
capital shall not be less than Rs. 100 Crore. The new guidelines issued in 2001 raised the minimum paid-up
capital to Rs. 200 Crore, which should be enhanced to Rs. 300 Crore within three years after the commencement
of business. The promoters’ share shall not be less than 40 per cent and the voting right of a shareholder shall
not exceed 10 per cent.
Housing Development Finance Corporation Limited (“HDFC”) was the first private bank in India to receive
license from RBI, to set up a bank in the private sector in India.
Accordingly, nine banks were set-up in private sector including some by development financial institutions.
Prominent among them are ICICI Bank, Global Trust Bank, HDFC and IDBI bank. Another interesting development
was the merger of some banks. Bareily Corporation Ltd. merged with Bank of Baroda in 1999, Times Bank
merged with HDFC Bank in 1996, Bank of Madura Ltd. merged with ICICI Bank in 2001 and Nedungadi Bank
Ltd. merged with Punjab National Bank in 2003.
Presently the following new generation private Banks operate in India:
S. No. Name of the Bank Year of establishment
1 Axis Bank 1993
2 Development Credit Bank 1995 (See note 2 below)
3 HDFC Bank 1994
4 ICICI Bank 1990
5 Indus-Ind Bank 1994
6 Yes Bank 2004
7 Kotak Mahindra Bank 2001
8 IDFC First Bank** 2015
9 Bandhan Bank 2015
Note: 1. The new generation banks namely Times Bank, Centurion Bank, Global Trust Bank, Bank of Punjab
have merged with other banks and hence cease to exist.
2. Erstwhile Development Co-Operative Bank renamed into Development Credit Bank in 1995 after it got
Schedule Bank License. Again it is changed its name into DCB in 2014.
** Consequent upon merging a NBFC named Capital First with itself in December 2018, IDFC Bank has changed
its name to IDFC First Bank.
As the name itself implies the majority of the equity is held by private promoters including permitted foreign
entities and other investing public in these institutions.
Foreign Banks
Foreign banks too started setting up their branches in India during late 19th century. The Chartered Bank of
India which later became Standard Chartered Bank, opened an office in Calcutta in 1858 after getting a Royal
Charter from the Queen of England. In Kolkata, Grindlays Bank commenced its operations by opening its first
branch in 1864.The arrival of the Hong Kong and Shanghai Banking Corporation (HSBC) was in 1859 after it
acquired a bank known as Mercantile Bank in India. The Comptoird’ Escompte de Paris, started operations in
Kolkata in 1860 which later was one of the constituent of BNP Paris which represented the French. American
banking companies entered India in 1902 through Citibank’s predecessor, The National City Bank of New York
and JP Morgan, a noted name in American banking entered India in 1922 through its affiliation with Andrew
Yule and Co. Ltd of Kolkata. The post-liberalization era saw several foreign banks enter India for business
opportunities. According to RBI, as of 31st May 2020 there were forty six licensed foreign banks operated in
India.
Co-Operative Banks
The beginnings of Indian Co-operative credit institutions can be traced back to the great Bengal famine of 1840s.
Problems of rural poverty and indebtedness and matters associated with such conditions of rural farmers forced
the then British government to set up a commission to suggest a holistic remedial measures. The Woodhead
Commission which enquired in to the famine, suggested many remedial measures to the British Government.
One such remedial measure suggested was to make available credit at low rate of interest to the needy people
(more so to farmers). The farmers found this proposition very attractive as their experience with private
money lenders not to their liking in view of exorbitant interest rates. Subsequently, the Rayat Commission
which was set up to look in to the matters including credit availability, suggested creation of Co-operatives as an
organizational means to extend credit to farmers in the year 1872. As a sequel to these developments, the first
Co-operative Land Mortgage Bank was started.
In order to strengthen the credit availability to agriculturists, in the year 1904 the Co-operative credit societies
Act was passed enabling establishment of co-operative credit societies for making available agricultural credit
through such societies. Further in 1912 a comprehensive Cooperative Societies Act was passed to facilitate
starting of non-credit related societies too, since the 1904 Act was oriented only towards “Credit” to the
exclusion of other activities.
With the passing of 1904 and 1912 Acts “a large number of Cooperative Credit societies, Central banks.
Provincial Cooperative Banks came into existence.” The reforms Act of 1919 made ‘Co-operation’ a provincial
(a State) subject. The Bombay Co-operative Societies Act, 1925 brought in the concept of one-man- one-vote. In
the year 1929 Land Mortgage Banks were also started for providing long term loans to agriculturists.
Since the subject of ‘Co-operation’ came under the purview of provinces, several thousand co-operative banks
had been set up in various provinces. In 1942, the British Government enacted the Multi-Unit Cooperative
Societies Act, 1942 with an object to cover societies whose operations extended to more than one state. After
independence in 1966 Co-operative Banks were brought under the supervision of RBI through The Banking
Regulation (Co-operative Societies) Rules, 1966. The co-operative banks were also brought under the provision
of Banking Regulation Act, 1949. From the year 2012 (through a Banking Law Amendment Act, 2012) a primary
Cooperative Society can carry on the business of banking only after obtaining a license from RBI. These banks
thus face dual control from State Governments / Central Government (in the case of multi-state co-operative
societies) and RBI which exercises control over their banking operations. Co-operative banks are owned by
members who subscribe to their shares.
Regional Rural Banks

Close on the heels after Nationalization of private banks, Regional Rural Banks (RRBs) were established in 1975
under the provisions of an ordinance promulgated on September 26, 1975 which was followed by Regional
Rural Banks Act, 1976. This was done due to a perceived feeling “that even after nationalization, there were
cultural issues which made it difficult for commercial banks, even under government ownership, to lend to
farmers.”
The main objective for establishing these banks were “to develop the rural economy and to create a
supplementary channel to the ‘Cooperative Credit Structure’” so as to expand the scope of institutional credit
for rural and agriculture sector. The share capital of these banks was contributed in the proportion of 50%,15%
and 35% respectively by Government of India, the concerned State Government and the Sponsoring bank, of a
RRB. RRBs were permitted to engage in all permitted Banking activities with their area of operation restricted
to a few notified districts in a State. RRBs came in to existence in 1975 and as on March 31, 2020 only 43 exist
out of 196 established at different points in time from 1975.
For providing RRBs additional options for augmenting regulatory capital funds, so as to maintain the minimum
prescribed Capital to Risk weighted Assets Ratio, besides meeting the increasing business requirements, it RBI
has in November 2019 allowed RRBs to issue Perpetual Debt Instruments (PDIs) eligible for inclusion as Tier 1
capital under specified terms and conditions including the following:
They are not permitted to
• issue Perpetual Debt Instruments to retail investors / FPIs / NRIs.
• invest in the Perpetual Debt Instruments of other banks including RRBs.
RRBs shall issue the Perpetual Debt Instruments in Indian currency only.
Small Finance Banks and Payments Banks

To deepen and to develop a comprehensive monitoring frame work to track the financial inclusion, a Committee
on Comprehensive Financial Services for Small Businesses and Low Income Households (commonly known
as the Nachiket Mor Committee) was appointed in September, 2013 by RBI. The committee submitted its
final report on 7 January, 2014. One of the recommendations made by the committee was to establish Small
Banks and Payments banks - a new class of banks with an exclusive focus on small businesses and low income
households.
Note: The licensing conditions of Small Finance Bank and Payments Bank is elaborated in Lesson-3.
Payments Banks
In July 2014, the RBI released the draft guidelines for payments banks, seeking comments from interested
entities and public at large. After taking in to account suggestions from respondents in November 2014,
RBI released the final guidelines for payments banks and invited applications for opening such banks from
interested parties, subject to the guidelines enunciated.
There were 41 applications from various applicants including some corporate houses. After a due process of
vetting these applications through an External Advisory Committee headed by Mr. Nachiket Mor, in August
2015, the RBI accorded ‘in-principle’ licences to the following eleven entities to launch payments banks.
1. Aditya Birla Nuvo Limited
2. Airtel M Commerce Services Limited
3. Cholamandalam Distribution Services Limited
4. India Post Limited.
5. FinoPayTech Limited.
6. National Securities Depository Limited.
7. Reliance Industries Limited.
8. Vodafone M-Pesa Limited.
9. Paytm Limited.
10. Tech Mahindra Limited.
11. Sun Pharmaceuticals Limited.
The “in-principle” license was valid for 18 months within which the entities must fulfill the requirements and
they were not allowed to engage in banking activities within that period. The RBI granted full licenses under
Section 22 of the Banking Regulation Act, 1949 after satisfactory compliances of requirements/conditions by
the banks.
The other terms and conditions are as follows:
• To be registered as a public limited company under the Companies Act, 2013.
• Payments Banks cannot form subsidiaries.
• For the first five years, the promoters stake to remain at 40% at minimum.
• Foreign shareholding will be allowed in these banks as per extant FDI norms.
• The voting rights will be regulated as per provisions of the Banking Regulation Act,1949. [Voting rights are
restricted at 10% for any one share holder. RBI has the discretion to raise this to 26% on merits.].
• If there is any acquisition of more than 5% shares this will require prior RBI approval.
• The majority of the bank’s board of directors should consist of independent directors, appointed according
to RBI guidelines.
• The bank should be fully networked from the beginning.
• Initially, the deposits will be capped at Rs. 1,00,000 per customer, but later it may be raised on the basis of
performance of the bank.
• No lending activity is permitted. Bank can accept utility bills.
• A quarter of its branches should be in unbanked rural areas. -
*Note: As of November 2019, Aditya Birla Idea Payments Bank Limited is put under liquidation.
Small Finance Banks

These banks also have been established with an aim of financial inclusion “to sections of the economy not being
served by other banks, such as small business units, small and marginal farmers, micro and small industries and
unorganied sector entities.” These banks were expected to provide an institutional mechanism for promoting
rural and semi urban savings and extending credit for viable economic activities in the local areas.
In July 2014, draft guidelines for small finance banks, seeking comments from interested entities and the
general public was released by RBI. After receiving comments and submissions from public, the final guidelines
were released in November 2014 with the instructions that interested parties were to submit applications
before 16 January, 2015.
Thereafter, in February 2015, RBI released the list of 72 entities which had applied for a small finance bank
license. After a due screening of these applications by an External Advisory Committee headed by Mrs. Usha
Thorat, in September 2015, RBI had issued 10 provisional licences to entities, which were required to convert
themselves in Small Finance Banks within one year.
Small Finance Banks are -
1. Ujjivan Small Finance Bank Limited.
2. Jana Small Finance Bank Limited.
3. Equitas Small Finance Bank Limited.
4. AU Small Finance Bank Limited.
5. Capital Small Finance Bank Limited.
6. Fincare Small Finance Bank Limited.
7. ESAF Small Finance Bank Limited.
8. North East Small Finance Bank Limited.
9. Suryoday Small Finance Bank Limited.
10 Utkarsh Small Finance Bank Limited.
Salient Regulatory features of Small Finance Banks

• These banks can be promoted by individuals, corporate houses, trusts or societies.
• Promoters should have 10 years’ experience in banking and finance and they should have a capital stake
of 40% of equity which must be brought down to 26% over a period of 12 years.
• Joint ventures are not permitted. Foreign shareholding will be allowed in these banks as per the Foreign
Direct Investment rules in private banks in India.
• Existing Non-Banking Financial Companies (NBFCs), Micro Finance Institutions (MFI) and Local Area
Banks (LAB) may convert themselves to become small finance banks by making applications to RBI.
• These Small Finance Banks need to be registered as Public Limited Companies under The Companies Act,
2013 and Reserve Bank of India Act, 1934, Banking Regulation Act, 1949 and other relevant statutes, are
applicable to them.
• The banks will not be restricted to any region. 75% of its Net Credit should be lent to Priority Sector and
50% of its loans should be in the range of up to Rs. 25 lakhs.
• The Small Payments Banks should have capital of at least Rs. 100 crore.
• At net worth of Rs. 500 crore, listing will be mandatory within three years.
• Those small finance banks having net worth of below Rs.500 crore could also get their shares listed
voluntarily.
The scope of business of a small finance bank, include “basic banking activities of acceptance of deposits and
lending to unserved and underserved sections including small business units, small and marginal farmers,
micro and small industries and unorganised sector entities”.
With prior approval of RBI, it can undertake risk less activities such as distribution of mutual fund units,
insurance products, pension products, etc. after complying with the requirements of the sectoral regulator for
such products. The small finance bank can also become a Category II Authorised Dealer in foreign exchange
business for its clients’ requirements. It cannot set up subsidiaries to undertake non-banking financial services
activities.
Initially the RBI had issued detailed guidelines for licensing of “Small Finance Banks” in the Private Sector
on November 27, 2014. The process resulted in licensing and granting in-principle approval to ten applicants
and they have since then successfully established the banks. It was also notified by RBI that result of gaining
experience in dealing with these banks, RBI will consider ‘on tap’ licensing of these banks. After a review of the
performance of the existing small finance banks and to encourage competition, it was announced in the Second
Bi-monthly Monetary Policy Statement, 2019-20 dated June 06, 2019 that the Reserve Bank would put out
draft guidelines for ‘on tap’ licensing of such banks. Accordingly, the RBI has circulated guidelines for licensing
of small finance banks in the private sector have been formulated for continuous authorization (i.e., “On Tap
licensing”).
These guidelines consist of the following:
1. Registration, licensing and regulations
2. Objectives
3. Eligible promoters
4. Scope of activities
5. Capital requirement
6. Promoters’ contribution
7. Foreign shareholding
8. Voting rights and transfer / acquisition of shares
9. Prudential norms
10. Additional conditions for NBFCs/MFIs/LABs converting into a bank
11. Business plan
12. Corporate governance
13. Other conditions
14. Transition path
15. Procedure for application
16. Procedure for RBI decisions.
Note: Please refer Lesson 3 for major aspects of detailed guidelines on licensing of Small Finance Banks.
Development Banks
The emerging economies of post-colonial era, assumed responsibilities of national economic development
activities such as industrial, financial, infrastructure, agricultural, exports etc. themselves. Financial institutions
which were created to address these issues of economic importance are called Developmental Financial
Institutions (‘DFI’). The basic emphasis of a DFI is to offer cheaper long-term financial assistance “for activities or
sectors of the economy where the risks may be higher than that the ordinary financial system is willing to bear.”
In India soon after independence RBI was entrusted with the responsibility of establishing appropriate
institutions in the preferred sectors as per plans of the Government. The need of the hour was to establish
institutions to cater to the demand for long-term finance by the industrial sector. This was followed by the
formation of Industrial Finance Corporation of India (IFCI) in the year 1948.
The following represents a list in chronological order Development Banks set up in India over the years.
1. Industrial Finance Corporation of India (IFCI) 1948: IFCI was established for catering to the long term
finance needs of the industrial sector. It was provided access to low-cost funds through the RBI’s Statutory
Liquidity Ratio (SLR) which in turn enabled it to provide loans and advances to corporate borrowers at
concessional rates. This arrangement lasted till 1990s. Later it was decided to access capital markets for
its funds needs. For this purpose its constitution was changed to a company under The Companies Act
1956. IFCI’s main focus was project finance, financial services and corporate advisory service. It continued
to play its pioneering role. IFCI has been revamped over the years.
IFCI is also a Systemically Important Non-Deposit taking Non-Banking Finance Company (NBFC-ND-SI),
registered with the Reserve Bank of India. The primary business of IFCI is to provide medium to long term
financial assistance to the manufacturing, services and infrastructure sectors. Through its subsidiaries and
associate organizations, IFCI has diversified into a range of other businesses including broking, venture
capital, financial advisory, depository services, factoring etc. As part of its development mandate, IFCI was
one of the promoters of National Stock Exchange (NSE), Stock Holding Corporation of India Ltd (SHCIL),
Technical Consultancy Organizations (TCOs) and social sector institutions like Rashtriya Gramin Vikas
Nidhi (RGVN), Management Development Institute (MDI) and Institute of Leadership Development (ILD).
Industrial Credit and Investment Corporation of India (ICICI) 1956: For providing foreign currency
financing over medium term and long term for importing of capital goods for industries, ICICI was formed
at the initiative of the World Bank, the Government of India and Indian industry. From 1990s onwards,
ICICI focused on Project Finance. However due to liberalization of economic policies of the Government
of India, during the period1991- 2000, ICICI transformed itself as a diversified financial services group,
including commercial banking services through its subsidiary ICICI Bank. Later in the year 2002 through
the merger route, ICICI Ltd. along with two of its subsidiaries merged with ICICI Bank Ltd. to form a
single entity. Today, ICICI along with its subsidiaries, has moved close to being an Universal Bank and is
functioning under umbrella brand of ICICI Bank.
2. Industrial Development Bank of India (IDBI) 1964: Government of India through an Act of parliament
established IDBI in the year 1964. IDBI has played a pioneering role in promoting industrial growth
through financing of medium and long-term projects from various sectors for the development of Indian
economy. IDBI has played a significant role, particularly in the pre-reform era period of 1964-1991. Right
from the beginning IDBI focused its objectives on long term financing of industries. Unlike IFCI which
focused on a few industries, IDBI had a broad based approach of a gamut of industries including core
sector. The basket of services provided included financial assistance in rupee and foreign currencies, for
green-field projects as also for expansion, modernization and diversification purposes.
In the wake of financial sector reforms unveiled by the Government since 1992, IDBI evolved an array of
fund and fee-based services for providing an integrated solution to meet the entire demand of financial
and corporate advisory requirements of its clients. IDBI also provided indirect financial assistance by
refinancing loans extended by State-level financial institutions and banks, and by rediscounting bills of
exchange arising out of sale of indigenous machinery on deferred payment terms.
In response to the felt need and on commercial prudence, IDBI was advised to transform itself in to a
Bank. Since IDBI was constituted through an Act of Government of India in 1964 as a Development bank,
to facilitate it’s conversion in to a bank, the Industrial Development Bank (transfer of undertaking and
Repeal) Act, 2003 [Repeal Act] was passed repealing the Industrial Development Bank of India Act, 1964.
“In terms of the provisions of the Repeal Act, a new company under the name of Industrial Development
Bank of India Limited (IDBI Ltd.) was incorporated as a Govt. Company under the Companies Act, 1956
on September 27, 2004. Thereafter, the undertaking of IDBI was transferred to and vested in IDBI Ltd.
From the effective date of October 01, 2004. In terms of the provisions of the Repeal Act, IDBI Ltd. has
been functioning as a Bank in addition to its earlier role of a Financial Institution. In view of changes
in the economic and corporate environment due to reforms, Government of India later decided to
transform IDBI into a commercial bank without sacrificing its development finance role and obligations.
The new structural change enables IDBI to have access to low-cost current, savings bank deposits, would
support the development finance obligations as also simultaneously enable it to expand its client/ asset
base.” Subsequently United Western Bank Ltd. a private sector bank which was under moratorium was
amalgamated with IDBI on October 3, 2006.
To truly reflect the multifarious functions it performed, the name of the Bank was changed to IDBI Bank
Limited effective from May 07, 2008. In 2011 two of IDBI’s wholly owned subsidiaries viz. IDBI Home
Finance Ltd. and IDBI Gilts Ltd. were amalgamated with IDBI Bank. After merger IDBI Bank has been able
to offer a comprehensive service to various clientele right from an individual to a giant corporate.
On account of NPAs from the year 2016-17 onwards, there was mounting losses recorded by IDBI Bank.
Due to this, the RBI placed IDBI Bank under Prompt Corrective Action (‘PCA’) restricting its credit disbursal.
Taking cognizance of the developments, in August 2018, the Union Cabinet “approved the acquisition of
controlling stake by Life Insurance Corporation (LIC) as a promoter” in IDBI Bank through “a combination
of preferential allotment and open offer of equity”.
Accordingly, LIC applied to Insurance and Regulatory and Development Authority (IRDA), for permission
as LIC’s primary business was that of Insurance. IRDA gave a technical go ahead for acquisition of 51% of
the stake of the IDBI Bank by LIC. The acquisition of 51% stake in IDBI Bank was completed on January
2019 making it a majority stake holder of the bank.
Later in March 21, 2019 by way of Press Notification, the RBI has informed the public as under:
“IDBI Bank Limited has been categorized as a ‘Private Sector Bank’ for regulatory purposes by Reserve
Bank of India with effect from January 21, 2019 consequent upon Life Insurance Corporation of India
acquiring 51% of the total paid-up equity share capital of the bank.”
3. Industrial Investment Bank of India Ltd.: The Industrial Investment Bank of India, earlier known as
Industrial Reconstruction Bank of India is one of the oldest banks in India. It was earlier known as The
Industrial Reconstruction Corporation of India Ltd., (IRBI) which was set up in 1971 for rehabilitation of
sick industrial companies. It was reconstituted in 1985 under the IRBI Act, 1984. With a view to convert
the institution into a full-fledged development financial institution, IRBI was incorporated under the
Companies Act, 1956, as Industrial Investment Bank of India Ltd. (IIBI) in 1997. IIBI offered a wide range
of products and services, including term loan assistance for project finance, short duration non-project
asset-backed financing, working capital/ other short-term loans to companies, equity subscription, asset
credit, equipment finance as also investments in capital market and money market instruments However,
due to plethora of problems faced by this institution on account of impaired assets, IIBI was ordered to be
wound up in the year 2012.
4. Infrastructure Development Finance Company (1997): IDFC was founded in 1997 in terms of
recommendations of an expert group on commercialization of Infrastructure projects under the
Chairmanship of Dr. Rakesh Mohan. Later in the year 1998 it applied for a Non-Banking Finance Company
registration with RBI. In the year 1999 it was declared as a Public Financial Institution. In 2000 it registers
as a Merchant Banker and also as a debenture trustee in 2001. In subsequent years IDFC has forayed in
to overseas fund raising for private equity and through infrastructure bonds, investment banking, asset
management etc. In 2013 IDFC had applied for a Banking licence to RBI under new licencing policy. In April
2014 RBI had granted an in-principle approval to IDFC for setting up a bank. After 18 months IDFC got
a banking licence to commence Banking operations. It started operating Banking services from October
2015. Now, IDFC operates its banking operation through a separate entity called IDFC Bank.
Over the years IDFC had been building up its competence in various areas of financial services like providing
assistance by way of debt and equity support, mezzanine financing and advisory services. It encouraged
banks to participate in financing of infrastructure projects through ‘takeout’ financing for a specific term
and at a preferred risk profile, with IDFC taking out the obligation after a specific period. Also through its
guarantee structure, had helped to promote raising of resources from international markets. IDFC was s
actively involved in the process of policy formulation of Government of India, relating to infrastructure
sector development. However due to changes in Macro environmental factors globally as well as locally.
With a range of expertise under its belt IDFC can be said to be well settled to play a role of an Universal
Bank.
IDFC Bank and a NBFC called Capital First had announced completion of their merger on December 2018,
creating a combined loan asset book of Rs 1.03 lakh crore for the merged entity and renamed itself as IDFC
First Bank Limited. Their aim was stated to become a “Universal Bank” in providing banking services to
the public.
5. State Financial Corporations: The State Financial Corporation Bill passed by both houses of parliament,
received the concurrence of the Hon’ble President on 31st October,1951. It came on the statute book
as “The State Financial Corporation Act, 1951.” This Act empowered each state and union territory to
establish a state financial corporation with a view to provide financial assistance to house hold, small
and medium scale industries. The area of operation of each State Financial Corporation (SFC) falls within
the state, in which it has been established, but in some exceptional cases the activities may be extended
to neighbouring states or union territory, if there are no state financial corporations in the concerned
states. For example, Maharashtra State Financial Corporation’s activities extended to Goa, Daman & Diu.
Similarly, Delhi Financial Corporation, on reorganization of erstwhile Punjab Financial Corporation (PFC)
which was divided into four SFCs in 1967 was established and since then the DFC has been catering the
financial needs of the industries in UT of Delhi and Chandigarh. In terms of Section 13(1)(1) of SIDBI
Act,1989 SIDBI provides refinance to State Financial Corporations and other banks. Under the scheme,
SIDBI sanctions refinance against term loans sanctioned by the SFCs to industrial concerns in Micro, Small
and Medium Enterprises (MSMEs) sector for setting up of industrial projects and also for their expansion,
modernization and diversification. Based on the annual Business Plan and Resources Forecast (BPRF),
refinance limits are sanctioned to SFCs annually.
The services of State Financial Corporations (SFCs), mainly aims at lending money for creation, technology
up-gradation, modernization, expansion and overall development of Micro, Small and Medium Enterprises
(MSME), including commercial vehicles. SFCs are also providing financial assistance to manufacturing and
service industries of their respective states. To diversify its activities, the SFCs are also contemplating to
offer their services through Non-Banking Financial Companies (NBFC). By the year 1955-56, only 12 SFCs
were set up and 1967-68, all the 18 SFCs came into existence and now are fully in operation. SFCs set up in
various states as regional institutions represent an attempt to diversify structure of development banking
in India so as to be able to cope up with requirements of wider sections of industrial enterprises.
NON-BANKING FINANCIAL COMPANIES (NBFC)

Financing of business by unorganized sector had been a long time practice in India. It dates back from 1930s
till 1965. In 1965 need was felt to bring in separate regulatory mechanism. As a consequence Chapter III-B
was inserted in the RBI Act. This was basically brought in to regulate the fiercely competitive car segment.
Thus began the regulation of the unorganized players in the financial market. In 1975 the RBI accepted the
recommendations of James Raj committee which went in to the working and regulation of finance companies in
the market. Certain recommendations made relating to the quantum of accepting deposits from public and also
regarding net-owned funds. In spite of this, there was quantum jump in the establishment of NBFCs in India.
The number of NBFCs went up from 7000 in 1980 to 30,000 in 1992. The sudden growth brought in its own set
of problems as well as certain unhealthy practices in these finance companies.
To address these issues RBI set up a committee under the Chairmanship of Mr. A.C. Shah, which recommended
compulsory registration and prudential norms. Subsequently, regulatory norms were put in place in
1997 incorporating the above norms. In the light of continuous changes in operating environment, further
amendments to NBFC regulations were made in subsequent years too on an ongoing basis.
According to RBI, the current definition of NBFC is “a company registered under the Companies Act, 1956
engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities
issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase,
insurance business, chit business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any
services and sale/purchase/construction of immovable property. A non-banking institution which is a company
and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in
installments by way of contributions or in any other manner, is also a non-banking financial company called
Residuary non-banking company.”
Technically a NBFC has also been defined by RBI as “ when a company’s financial assets constitute more than
50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross
income. A company which fulfills both these criteria will be registered as NBFC by RBI”.
NBFCs differ from Banks on following grounds:
i. NBFC cannot accept demand deposits; whereas banks can accept the same.
ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself,
whereas banks can do so;
iii. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to
depositors of NBFCs, unlike in case of banks.
iv. An NBFC is not required to maintain Reserve Ratios (CRR, SLR etc.).
v. An NBFC cannot indulge Primarily in Agricultural, Industrial Activity, Sale-Purchase and Construction of
Immovable Property.
NBFCs play an important role in the Indian financial system by complementing and competing with banks and
by bringing in efficiency and diversity into financial intermediation. The Reserve Bank’s regulatory perimeter
is applicable to companies conducting non-banking financial activity, such as lending, investment or deposit
acceptance as their principal business.
The regulatory and supervisory architecture is, however, focused more on systemically important non-deposit
taking NBFCs (with asset size Rs. 5 billion and above) and deposit accepting NBFCs with light touch regulation
for other non-deposit taking NBFCs.
Harmonisation of different categories of NBFCs: With effect from February 22, 2019, the RBI has decided to
harmonise three different categories of NBFCs into one, based on the principle of regulation by activity rather
than regulation by entity. Accordingly, three categories of NBFCs, that is, asset finance companies (AFCs), loan
companies (LCs) and investment companies (ICs) are to be combined into a single category NBFC Investment
and Credit Company (NBFC-ICC). Accordingly the categorization of NBFC will stand reduced from 12 to 10.
Classification of NBFCs based on Activity

Type of NBFC Activity
1. Investment and Credit Financing of physical assets supporting productive / economic
Company (NBFC- ICC) activities, including automobiles, tractors and generators.
(merged entity of Asset Providing of finance whether by making loans or advances or otherwise
Finance Company (AFC) /. for any activity other than its own but does not include an asset finance
Loan Company, Investment company.
Company)
Acquiring securities for purpose of selling.
2. NBFC- Infrastructure Finance Providing infrastructure loans.
Company (NBFC- IFC)
3. NBFC-Systemically Important Acquiring shares and securities for investment mainly in equity market.
Core Investment Company The Reserve Bank of India (RBI) on August 13, 2020 announced stricter
(CIC-ND-SI) guidelines for Core Investment Companies (CICs), mandating more
disclosures, better risk management and a simpler group structure.
While computing Adjusted Net Worth (ANW), the amount representing
any direct or indirect capital contribution made by one CIC in another
CIC, to the extent such amount exceeds 10% of Owned Funds of the
investing CIC, shall be deducted.
All other terms and conditions for computation of ANW remain the
same. The deduction requirement shall take immediate effect for any
investment made by a CIC in another CIC after date of issue of this
circular. In cases where the investment by a CIC in another CIC is already
in excess of 10 percent as on the date of this circular, the CIC need not
deduct the excess investment as on the date of this circular from owned
funds for computation of its ANW till March 31, 2023.
4. Infrastructure Debt Fund- For facilitating flow of long-term debt into infrastructure projects.
NBFC (IDF-NBFC)
5. NBFC-Micro Finance Extending credit to economically disadvantaged groups.
Institution (NBFC-MFI)
6. NBFC-Factor Undertaking the business of acquiring receivables of an assignor or
extending loans against the security interest of the receivables at a
discount.
7. NBFC- Non-Operative For permitting promoters / promoter groups to set up a new bank.
Financial Holding Company
(NOFHC)
8. Mortgage Guarantee Undertaking mortgage guarantee business.
Company (MGC)
Type of NBFC Activity

9. NBFC-Account Aggregator Collecting and providing information about a customer’s financial
(NBFC-AA) assets in a consolidated, organized and retrievable manner to the
customer or others as specified by the customer.
10. NBFC-Peer to Peer Lending Providing an online platform to bring lenders and borrowers together
Platform (NBFC- P2P) to help mobilize funds.
Special liquidity scheme for NBFCs/HFCs

The Government of India has approved a scheme to improve the liquidity position of NBFCs/HFCs through a
Special Purpose Vehicle (SPV) to avoid any potential systemic risks to the financial sector. To be eligible under
the Scheme, the following conditions should be met:
a. NBFCs including Microfinance Institutions that are registered with the RBI under the Reserve Bank of
India Act, 1934, excluding those registered as Core Investment Companies;
b. Housing Finance Companies that are registered under the National Housing Bank Act, 1987;
c. CRAR/CAR of NBFCs/HFCs should not be below the regulatory minimum, i.e., 15% and 12% respectively
as on March 31, 2019;
d. The net non-performing assets should not be more than 6% as on March 31, 2019;
e. They should have made net profit in at least one of the last two preceding financial years (i.e. 2017-18 and
2018-19);
f. They should not have been reported under SMA-1 or SMA-2 category by any bank for their borrowings
during last one year prior to August 01, 2018;
g. They should be rated investment grade by a SEBI registered rating agency;
h. They should comply with the requirement of the SPV for an appropriate level of collateral from the entity,
which, however, would be optional and to be decided by the SPV.
As per the Government decision, SBICAP which is a subsidiary of the State Bank of India has set up a SPV
(SLS Trust) to manage this operation. The SPV will purchase the short-term papers from eligible NBFCs/HFCs,
who shall utilise the proceeds under this scheme solely for the purpose of extinguishing existing liabilities.
The instruments will be CPs and NCDs with a residual maturity of not more than three months and rated as
investment grade. The facility will not be available for any paper issued after September 30, 2020 and the SPV
would cease to make fresh purchases after September 30, 2020 and would recover all dues by December 31,
2020; or as may be modified subsequently under the scheme.
Financial Institutions in India

According to the Economic Survey of 2012-13 the Reserve Bank of India had declared the following institutions
as All-India Financial Institutions. They are-
Export- Import Bank of India

Established in 1982 through an Act of Government of India viz. Export -Import Bank of India Act, 1981. It
was established to make available financial facilities for exporters and importers. Export-Import Bank of India
is the premier export finance institution of the country. Also EXIM Bank was intended to serve as principal
financial institution coordinating the functioning of those institutions engaged in financing export and import
of goods and services with a view to promote International Trade of our country . Commencing its role as a
purveyor of export credit, similar to some of its foreign counterparts, EXIM Bank over the period had evolved in
to a dependable institution for the global operations of various industries including that of Small and Medium
enterprises.
EXIM Bank offers a wide range of products for partner industries such as import of technology and export
product development, export production, export marketing, pre-shipment and post-shipment and overseas
investments.
The flagship schemes of EXIM Bank are as follows:
In addition to the above, EXIM Bank offers

• Marketing Advisory: To help Indian exporting firms in their globalisation efforts by proactively assisting in
locating overseas distributors/buyers/partners for their products/services as well as to identify overseas
opportunities for setting up plants or projects or for acquisition of overseas companies. In this EXIM Bank
plays a promotional role to create and enhance export capabilities and international competitiveness of
Indian companies. For this efforts, the Group leverages the Bank’s high international standing, in-depth
knowledge and understanding of the international markets and well established institutional linkages. Its
physical presence supports Indian companies in their overseas marketing initiatives on a success based
fee.
• Research & Analysis: A team of experienced economists and strategists with in-depth insights on
international economics, trade and investment monitors trends in global and domestic economies to
analyse their impact on Indian and other developing economies. Besides catering to the constituents
within the Bank, the Group also connects with the Government, RBI, exporters/importers, trade & industry
associations, external credit agencies, academic institutions and researchers. It also searches avenues to
enhance India’s international engagement and implements the research under a broad classification of
regional, sectoral and policy related studies etc. With an objective to provide up-to- date information to
Indian traders and investors, the Group publishes various bulletins regularly with information on export
opportunities and highlights developments that have a bearing on Indian exports.
• Export Advisory: Under this, EXIM Bank offers a diverse range of information, advisory and support
services, which enable exporters to evaluate international risks, exploit export opportunities and improve
competitiveness. Value added information and support services are provided to Indian projects exporters
on the projects funded by multilateral agencies.
EXIM Bank undertakes customised research on behalf of interested companies in the areas such as establishing
market potential, defining marketing arrangements, and specifying market distribution channels. Developing
export market entry plans, facilitating accomplishment of international quality certification and display of
products in trade fairs and exhibitions are other services provided.
EXIM Bank provides a wide range of information, advisory and support services, which complement its financing
programmes. These services are provided on a fee basis to Indian companies and overseas entities. The scope of
services includes market-related information, sector and feasibility studies, technology supplier identification,
partner search, investment facilitation and development of joint ventures both in India and abroad.
Thus EXIM Bank has evolved itself as a single window service provider to international trading entities from India.
National Bank for Agriculture and Rural Development (NABARD)

Till late 1970s there was no institutional credit arrangement for Agriculture and Rural credit in India. The needs
were looked after by Reserve Bank of India and Agricultural Refinance and Development Corporation (‘ARDC’).
However, the importance of institutional credit in boosting rural economy has been clear to the Government
of India right from its early stages of planning. Therefore, the Reserve Bank of India (RBI) at the insistence
of the Government of India, constituted a Committee to Review the Arrangements For Institutional Credit
for Agriculture and Rural Development (CRAFICARD) to look into these very critical aspects. The Committee
was formed in 30 March 1979, under the Chairmanship of Shri B. Sivaraman, a former member of Planning
Commission, Government of India.
The Committee’s interim report, submitted in November 1979, outlined the need for a new institutional
arrangement for providing attention, direction and focus to credit related issues linked with rural development.
It recommended for formation of a unique development financial institution which would address these
aspirations and this lead to the formation of National Bank for Agriculture and Rural Development (NABARD)
as approved by the Parliament through Act 61 of 1981.
NABARD came into existence in July 1982 by transferring the agricultural credit functions of RBI and
refinance functions of the then ARDC. It was dedicated to the service of the nation by the then Prime
Minister in November 1982.
Set up with an initial capital of Rs.100 crore. Consequent to the revision in the composition of share capital
between Government of India and RBI, NABARD today is fully owned by Government of India. As on March 2019
the entire capital of NABARD which stands at Rs. 12,580 crores is fully held by Government of India. NABARD
is involved directly and indirectly in an extensive manner in financing of agriculture, rural development apart
from extension activities and supervisory roles. A brief on the same is as follows:
• Direct Finance in the form of Loans for Food Parks and Food Processing Units in Designated Food Parks,
• Loans to Warehouses, Cold Storage and Cold Chain Infrastructure,
• Credit Facilities to Marketing Federations, Rural Infrastructure Development Fund,
• Direct Refinance Assistance to Co-operative Banks,
• Financing and supporting Producer Organisations,
• More Direct Finance in the form of Infrastructure Development Assistance,
• Financing and developing Primary Agricultural Co-operative Societies and Umbrella Programme for
Natural Resource Management.
• Short term and long term refinancing of agriculture loans to various banks and other agencies apart from
refinancing under off-farm sector.
NABARD in its developmental role, is involved in efficient credit delivery system to service the needs of
agriculture and rural development. Since more than 50% of the rural credit is disbursed by the Co-operative
Banks and Regional Rural Banks (RRBs) NABARD is responsible for regulating and supervising Co-operative
banks and RRBs. In this direction NABARD has been taking various initiatives in association with Government of
India and RBI to improve the health of Co-operative banks and Regional Rural Banks. Apart from this, NABARD
is also involved in Financial inclusion, Micro credit and Micro credit innovation, Core Banking Solution to Co-
operative Banks, Climate change, to name a few.
In its supervisory role as empowered by Section 35(6) of the Banking Regulation Act, 1949, NABARD conducts
inspection of State Cooperative Banks, Central Cooperative Banks and RRBs. On its own, on a voluntary basis
NABARD conducts periodic inspections of state level cooperative institutions such as State Cooperative
Agriculture and Rural Development Banks (SCARDB), Apex Weavers Societies, Marketing Federations etc.
Small Industries Development Bank of India (SIDBI) (1990)

The Small Industries Development Bank of India (SIDBI) came in to existence in 1990 through an Act of
Parliament (SIDBI Act, 1989) as a wholly owned subsidiary of IDBI. It was envisaged to be the principal financial
institution for promoting, financing the development of industries in the small-scale sector and also carries out
coordinating the functions of institutions engaged in similar activities.
SIDBI commenced its operations in April 1990 by taking over the outstanding portfolio and activities of IDBI
pertaining to the small-scale sector. By an amendment to the SIDBI Act in 2000, IDBI the majority stake holder,
diluted its holdings in SIDBI in favour of a few Public Sector Banks and other Central Government undertakings.
SIDBI’s operational domain consist of the entire domain of SSI sector, including the tiny, village and cottage
industries as defined under MSME Act, 2008. With appropriate tailor made schemes to meet setting up of new
projects, expansion, diversification, modernization and rehabilitation of existing units therein. SIDBI caters
the need of SSI sector. SIDBI also offers refinance, bills rediscounting, lines of credit and resource support
mechanisms to route assistance to SSI sector through a network of banks and State level financial institutions.
SIDBI also offers direct finance for meeting specific requirements of SSI sector. The Government also extends
line of credit to SIDBI to enable it to extend loans at more affordable rates to its traditional clientele. Over the
years SIDBI has carved for itself a ‘niche’ in financing of SSI and associated sectors.
National Housing Bank (NHB)

In India there was no institutional arrangement for long term financing of individuals’ housing, for a long time.
This short coming was identified by the Sub-Group on Housing Finance for the Seventh Five Year Plan (1985-
90) as a stumbling block, hindering the progress of the housing sector and recommended setting up of a nodal,
national level institution.
The Government of India, accepted the recommendation of the sub-group of the planning commission and a
High Level Group under the Chairmanship of Dr. C. Rangarajan, the then Deputy Governor of RBI, was set-up to
examine the proposal. The high level group recommended the setting up of National Housing Bank (‘NHB’) as
an autonomous housing finance institution which as accepted by the Government .
While presenting the union budget in 1987-88 the Hon’ble Prime Minister of India, on February 28, 1987
announced the decision to establish the NHB as an apex level institution for housing finance.
Following that, the legislative process for passing an Act was in progress and NHB bill was passed in the winter
session of 1987 and in December, 1987, became an Act of Parliament. The National Housing Policy, formulated
in 1988 envisaged the setting up of NHB as the Apex level institution for housing. All these steps resulted in
setting up of NHB on July 9, 1988 under the NHB Act, 1987.NHB is wholly owned by Reserve Bank of India,
which contributed the entire paid-up capital. However the RBI has divested its entire stake in NHB amounting
to Rs. 1450 crore on March 19, 2019 in favour of Government of India. With this, the Government of India now
holds 100% stake in NHB. This was done on the basis of the recommendation of Narasimham Committee II
Report and the Discussion Paper prepared by RBI on Harmonizing the Role and Operations of Development
Financials Institutions and Banks. Based on the recommendation, RBI announced the proposal to transfer
ownership of its shares in SBI, NHB and NABARD to the Central Government in the Monetary and Credit Policy
for the year 2001-02.
The Preamble of the National Housing Bank Act, 1987 describes the basic functions of the NHB as -”… to operate
as a principal agency to promote housing finance institutions both at local and regional levels and to provide
financial and other support to such institutions and for matters connected therewith or incidental thereto.”
According to Section 14 of NHB Act, some of the important businesses which NHB is permitted to transact, are
the following:
“(a) promoting, establishing, supporting or aiding in the promotion, establishment and support of housing
finance institutions.
(b) making of loans and advances or rendering any other form of financial assistance whatsoever to housing
finance institutions and scheduled banks, [or to any authority established by or under any Central, State
or Provincial Act and engaged in slum clearance].
(d) guaranteeing the financial obligations of housing finance institutions and underwriting the issue of stocks,
shares, bonds debentures and securities of every other description of housing finance institutions.
(h) formulating one or more schemes, for the purpose of mobilisation of resources and extension of credit for
housing.
(i) formulating one or more schemes for the economically weaker sections of society which may be subsidised
by the Central Government or any State Government or any other source etc.”
The operations of NHB include the following :
• Raising resources from various sources including from general public.
• Refinancing various Primary Lending Institutions.
• Extending Project Finance in terms of Section 14 (ba) of the NHB Act, 1987 to various public agencies like
State Housing Boards, State Slum Clearance Development Municipal Corporations, Urban Local Bodies,
etc.
• The power to Register, Regulate and Supervise Housing Finance Companies (HFC) of NHB has been now
taken over by RBI on account of the following:
On August 19, 2019 RBI had issued the following notification - “The Finance (No.2) Act, 2019 (23 of 2019) has
amended the National Housing Bank Act, 1987 conferring certain powers for regulation of Housing Finance
Companies (HFCs) with Reserve Bank of India. HFCs will henceforth be treated as one of the categories of Non-
Banking Financial Companies (NBFCs) for regulatory purposes. Reserve Bank will carry out a review of the
extant regulatory framework applicable to the HFCs and come out with revised regulations in due course. In the
meantime, HFCs shall continue to comply with the directions and instructions issued by the National Housing
Bank (NHB) till the Reserve Bank issues a revised framework. NHB will continue to carry out supervision of
HFCs and HFCs will continue to submit various returns to NHB as hitherto. The grievance redressal mechanism
with regard to HFCs will also continue to be with the NHB.” This effectively implies that RBI will exercise its
authority for registering, regulating and supervising HFCs from a date to be notified in future.
• Provides Equity Participation to various HFC.
• Participation in Government Schemes as a Nodal agency for the following schemes. o NHB introduce 1%
interest subvention scheme on 1.10.2009
NHB is one of the two nodal agencies for the Urban Poor (ISHUP) and heating and solar lighting systems in
renamed it as Rajiv Rinn Yojana (RRY)
NHB has been designated as an agency for administering and monitoring Capital Subsidy Scheme for Installation
of Solar Water Heating and Solar Lighting Systems in Homes
LESSON ROUND UP
• Under the British government, Agency banks gave rise to Presidency banks. Presidency Banks later
lead to the formation of Imperial Bank of India, which was succeeded by State Bank of India after
independence.
• Reserve Bank of India which was formed in 1935 started playing the roles of central bank and monetary
authority which until then were performed by Imperial Bank of India. Post-independence Reserve Bank
was nationalized and also is armed with Regulatory powers.
• According to the felt needs of the government, State Bank of India was established for taking over the
functions of Imperial Bank of India. Later banks of all princely States were amalgamated with State
Bank of India as its Associates.
• These Associates were again amalgamated in to State Bank of India and presently State Bank of India is
a single entity and its Associates having merged in SBI.
• Private Joint stock banks were being established from 1894 onwards in India; some of them continue to
function even today. Out of these 20 of them were nationalized in 1969 and 1980 respectively and they
became a formidable force in Indian banking, which is highly regulated by Government / RBI.
• In view of the stringent capital adequacy norms as well as to ensure a robust performance consolidation
of nationalised banks were initiated during 2018 / 19 resulting in the total number of PSU banks stand
at 12 as on date.
• Post-independence era saw the establishment of Development Banks at national level and at States
levels spanning across Industrial Development including Small Industries, Agriculture, Housing,
Export-Import etc., and some of them have converted themselves as commercial banks.
• Economic liberalization coupled with banking reforms saw the birth of New generation private sector
banks which have become a force to reckon with in Indian banking.
• Cooperative Institutions have emerged from a simple setup to one of the largest segments that finance
agriculture over the period of time.
• Private financing companies which were in existence from 1930s have been brought under a regulatory
frame work and today they function as NBFCs.
• To deepen Financial inclusion as well as financing of small businesses and also to track the same,
new categories of banks viz. Small Finance Banks and Payments banks were established from
2015/2016 onwards.
GLOSSARY
Indian banking System Indian Banking System encompasses Agency House Banks, Presidency Banks,
Imperial Bank of India, Reserve Bank of India, Private/Joint Stock Banks (Old
generation private sector banks), State Bank of India, Associate Banks, Old
Nationalized Banks, New Generation Private Sector Banks, Foreign Banks, Co-
operative Banks, Regional Rural Banks, Local Area Banks, Small Finance Banks
and Payments Banks and Financial Institutions known as Development Banks
and Non-Banking Financial Companies.
Reserve Bank of India It was established on 1935 as a banker to the central government.
Scheduled Bank A scheduled bank is one which is included in the Second Schedule of RBI Act
and enjoins it to have a minimum capital of Rs. 5 lacs and maintain reserves as
per the directions of RBI.
Non-Scheduled Bank Non-scheduled banks are those which are not listed in the Second schedule of
the RBI Act, 1934 having a reserve capital of less than 5 lakh rupees.
Private Sector Banks As the name implies the ownership of these banks rests with private individuals
and corporates including foreign entities.
State Bank of India State Bank of India originated from the three Presidency banks namely Bank
of Bengal, Bank of Bombay and Bank of Madras and the successor to these
Presidency banks viz. Imperial Bank of India.
Old Generation Private The private sector banks which were operating in India prior to the liberalization
Bank year of 1991 are known as Old generation private Sector banks.
New Generation The banks that came into existence subsequent to Narasimham Committee
Private Bank Report I and revised RBI guidelines in 1993 are known as new generation
private sector banks.
Co-operative Banks Cooperative Banks are registered under the Cooperative Societies Act, 1912.
And regulated by the Reserve Bank of India under the Banking Regulation Act,
1949 and Banking Laws (Application to Cooperative Societies) Act, 1965.
Regional Rural Bank RRBs are scheduled banks (Government banks) operating at regional level in
(RRBs) different States of India. Regional Rural Banks (RRBs) were established in 1975
under the provisions of the Ordinance promulgated on September 26, 1975 and
followed by Regional Rural Banks Act, 1976.
Small Finance Banks These banks promote financial inclusion to sections of the economy not being
served by other banks, such as small business units, small and marginal farmers,
micro and small industries and unorganised sector entities.
Payments Bank A payments bank aims to further financial inclusion, especially through savings
accounts and payments services. Accordingly, a payments bank is not allowed
to give any form of loan or issue a credit card.
Development Finance Financial institutions which were created to is offer cheaper long-term financial
Institutions (DFIs) assistance “for activities or sectors of the economy where the risks may be
higher than that the ordinary financial system is willing to bear.” are called
Developmental Financial Institutions (‘DFIs’).
State Financial The services of State Financial Corporations (SFCs), mainly aims at lending
Corporations money for creation, technology up-gradation, modernization, expansion
and overall development of Micro, Small and Medium Enterprises (MSME),
including commercial vehicles. SFCs are also providing financial assistance to
manufacturing and service industries of their respective states.
Non Banking Finance NBFC is “a company registered under the Companies Act, 1956 engaged in
Corporations(NBFCs) the business of loans and advances, acquisition of shares/stocks/bonds/
debentures/securities issued by Government or local authority or other
marketable securities of a like nature, leasing, hire-purchase, insurance
business, chit business but does not include any institution whose principal
business is that of agriculture activity, industrial activity, purchase or sale of
any goods (other than securities) or providing any services and sale/purchase/
construction of immovable property.
Export Import Bank of Export-Import Bank of India is the premier export finance institution of the
India country. Established in 1982 through an Act of Government of India viz. Export
-Import Bank of India Act, 1981.
National Bank for NABARD came into existence in July 1982 by transferring the agricultural credit
Agriculture and functions of RBI and refinance functions of the then ARDC
Rural Development
(NABARD)
Small Industries Small Industries Development Bank of India (SIDBI) was established in April
Development Bank of 1990 and it acts as the Principal Financial Institution for Promotion, Financing
India (SIDBI) and Development of the Micro, Small and Medium Enterprise (MSME) sector
as well as for co-ordination of functions of institutions engaged in similar
activities.
National Housing Bank NHB is an apex financial institution for housing. NHB has been established
(NHB) with an objective to operate as a principal agency to promote housing finance
institutions both at local and regional levels and to provide financial and other
support incidental to such institutions and for matters connected therewith.
TEST YOURSELF
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. Fill up the blanks.
a. RBI was established in the year _________________________.
b. As on date the total number of nationalized banks are _________________________.
c. The objectives of Payments Banks and Small Finance Banks are _________________________.
2. State whether the following is True of False.
a. Presidency Banks were amalgamated to form State Bank of India.
b. RBI plays the role of only Monetary Authority.
c. NBFCs come under the jurisdiction of Government of India.
d. Cooperative banks come under the regulatory jurisdiction of RBI only.
e. Payments Banks are allowed to issue credit card.
f. Small Finance Banks finance only entities in the unorganized sector.
3. Write Short note on -
i. State Bank of India iii. AIFI
ii. Reserve Bank of India iv. NHB
4. Explain the reasons for Nationalization of private banks.
5. Explain the reasons for establishing Small Banks and Payments banks.
For further reading

• RBI functions & Other materials - available in www.rbi.org,in
• Banking Law and Practice - P.N. Varshney , 25th Edition, Sultan Chand & Sons
• Law and Practice of Banking - M.L. Tannan
• Commercial Banking - Volume I, II &III - IBA Publication
• Various articles on History of Banking in India from internet.
• Evolution of SBI - www.sbi.co.in.
Lesson 2 • Regulatory Framework of Banks 27
Regulatory Framework
Lesson 2
of Banks
Should Know
• Monetary Policy Banking companies are regulated • The Reserve Bank of India Act
Committee in India through various laws. The 1934 (RBI Act).
• Liquidity principal ones among them are • Banking Regulation Act 1949
Adjustment Facility Reserve Bank of India Act, 1934 and (‘BR Act’).
Banking Regulations Act, 1949.
• Marginal Standing • Payment and Settlement
Facility This lesson will enable a reader to Systems Act 2007 (PSS Act).
learn about -
• Open Market
Operations • RBI Act, 1934 and its salient
features.
• Repo rate
• Powers of the RBI.
• Reverse Repo rate
• Tools of Monetary policy used by
• Statutory Liquidity the RBI.
Ratio
• The Banking Regulation Act,
• Cash Reserve Ratio 1949 and its salient features.
(CRR)
• How Co-operative banks are
regulated?
• How the Government regulates
banks?
• How other Authorities regulate
banks?
Lesson Outline
• Reserve Bank of India Act, 1934 (An overview)
• Banking Regulation Act, 1949 (An overview)
• Constitution of RBI
• Objectives of RBI
• Functions of RBI
• Powers of RBI (An overview)
• Tools of Monetary Control
• Regulatory Restrictions on Lending Business of Banking
• Government as a Regulator of Banks
• Control over Co-operative Banks
• Regulation by other Authorities
• LESSON ROUND UP
• TEST YOURSELF
27
INTRODUCTION
Banks in India are highly regulated and have to ensure compliance and reporting to RBI and other authorities.
The principal regulations applicable to banks originate from the Banking Regulation Act, 1949 and RBI Act,
1934. A detailed knowledge of these are necessary for any student of banking in India. Keeping this in mind,
contents this lesson covers constitution and powers of RBI, monetary control measures adopted by banks,
constitution & control of banks and other regulatory authorities of banks. These form the broad regulatory
frame work of banks in India, the knowledge of which is essential for a any student on banking. The contents
are of Level 1 orientation and will be useful for equipping oneself with deeper knowledge about how banks are
regulated.
RESERVE BANK OF INDIA ACT, 1934 (AN OVERVIEW)

The RBI Act, 1934 was enacted with an objective of constituting Reserve Bank of India (as mentioned in Lesson
1) to regulate issue of bank notes, to keep reserves to ensure monetary stability, to operate currency and credit
system.
This Act is the basis for constitution, powers, and functions of RBI. This act does not regulate banking directly
though section 18 and 42 of RBI Act, 1934 are used in regulating credit. In broad sense, RBI Act deals with
Incorporation, Capital, Management, Business of RBI itself, Central Banking Functions, Collection and furnishing
of information, Regulating Non-Banking Institutions receiving deposits and financial institutions, Prohibition
of Acceptance of deposits by unincorporated bodies, Regulation of transactions in derivatives, money market
instruments, securities etc., Joint mechanism, Monetary Policy, General Provisions, Penalties along with
Schedule I and II.
The RBI Act, 1934 was amended several times in the past to expand the powers of RBI. The last amendment to
RBI Act, 1934 was done in February, 2016 to provide for a Monetary Policy Committee (‘MPC’), to maintain price
stability under an overall objective of growth. The task of the MPC would be fixing the benchmark policy rate
(repo rate) to control and contain inflation within the specified target level. The Committee-based structure is
expected to bring in value addition and transparency in this area of policy decisions. MPC will hold meetings at
least four times a year and publish the decisions after each such meeting.
Amendments to RBI Act

While presenting the Finance Bill in August 2019, the Finance Minister proposed the following amendments/
Insertions of Sections to RBI Act 1934 vv:-
45 IA – Amendment. Increasing the quantum of Net owned funds of a NBFC, 45-ID – (Insertion) Power of RBI
to remove directors of an NBFC from office, 45 IE – (Insertion) Supersession of Board of directors of NBFC
(other than Government Company), ‘45MAA - Power to take action against auditors, ‘45MBA - Resolution of
non-banking financial company, 45NAA – Power in respect of group companies, 58B – (Amendment) Increase
in Penalties for Non-compliance and 58G – (Amendment) Increase in Penalties for Non-compliance by NBFCs.
Implications of these amendments are as under:-
• RBI has been given more Powers to regulate NBFCs than before including seeking additional financial and
business information including activities of group/group companies.
• Empowering RBI to remove directors and superseding board of directors of delinquent NBFCs.
• Empowering RBI for a Resolution of problematic NBFCs by way of framing of schemes of amalgamation,
reconstruction or spilitting in to separate companies, of NBFCs.
• Empowering RBI to forcefully interefere in legitimate business of NBFCs in case of emergencies.
• Arming RBI with power of removal/ debaring of Auditors for a period of three years, at a time from
auditing any RBI regulated entities.
THE BANKING REGULATION ACT, 1949 (AN OVERVIEW)

The Banking Regulation Act, 1949 applies to the whole of India including Jammu and Kashmir. The Act was
initially brought in to force as the Banking Companies Act, 1949, and later renamed as Banking Regulations
Act, 1949 w.e.f. 01.03.1966. The Banking Regulation Act does not apply to primary agricultural credit societies,
non-agricultural primary credit societies and cooperative land mortgage banks as per section 3. Till 1965 the
coverage of this Act was limited to Banking Companies and later in 1966 Co-operative banks were also brought
under its jurisdiction. The Banking Regulation Act, 1949 is applicable alongwith other statutory laws, unless
specifically exempted. Therefore provisions of Companies Act, 2013 are also applicable unless there is an
express special provision in the Banking Regulation Act, 1949.
Broadly speaking, the Act regulates the entire activities of banking right from licensing, restrictions on share
holding, directors, voting rights etc. In addition to these, by an amendment in August 2017, RBI has also been
empowered to issue directions to banks to initiate insolvency resolution to recover bad loan.
The Banking Regulation Act, 1949 further specifies restrictions on loans and advances, interest rates to be
charged, maintenance of SLR reserves, Audit, inspection, submission of balance sheet and accounts. There are
also provisions regarding control over management, apart from liquidation and winding up as well as penalties.
The Banking Regulation (Amendment) Act, 2020

The Banking Regulation (Amendment) Act, 2020 has replaced the Banking Regulation (Amendment) Ordinance,
2020.
Features of Banking Regulation (Amendment) Act, 2020

1. substitution of Section 3 to provide that the Act shall not apply to—
(a) a primary agricultural credit society; or
(b) a co-operative society whose primary object and principal business is providing of long term finance
for agricultural development, if such society does not use as part of its name, or in connection with
its business, the words “bank”, “banker” or “banking” and does not act as drawee of cheques;
2. amendment of Section 45 to address the potential disruptions in the financial system by providing for
the Reserve Bank of India to prepare a scheme for the reconstruction or amalgamation of the banking
company without the necessity of first making an order of moratorium;
3. amendment of Section 56 to provide that notwithstanding anything contained in any other law for the time
being in force, the provisions of the Act shall apply to co-operative societies, subject to the modifications
specified therein.
CONSTITUTION OF RESERVE BANK OF INDIA
The Genesis
Till the establishment of Reserve Bank of India (RBI), there was dual control of currency issuance and credit
control by the then Central Government (under British rule) and the Imperial Bank of India respectively. Due
to certain developments in the economy, there was a strong view that currency issuance should be delinked
from the Government. The Hilton-Young Commission, which was appointed to go in to this issue among others,
recommended constituting a central bank to be named as – Reserve Bank of India — which would regulate note
issuance and to operate credit system throughout the country. This is evident in the Preamble to the RBI Act,
1934 which reads as “ to constitute a Reserve Bank for India to regulate the issue of Bank notes and the keeping
of reserves with a view to securing monetary stability in India and generally to operate the currency any credit
system of the country to its advantage”. Hence, the Reserve Bank of India was constituted with these primary
objects.
Constitution of RBI & Management

The main purpose for which RBI was constituted has been stated in Chapter II Section 3 (1) and (2) of the RBI
Act as under -
Central
Board of
Directos
Governer
Deputy Governors
Executive Directors
Principal Chief General Manager
Chief General Managers
General Managers
Deputy General Mangers
Assistant General Managers
Managers
Assistant Managers
Support Staff
“(1) A bank to be called the Reserve Bank of India shall be constituted for the purposes of taking over the
management of the currency from the Central Government and of carrying on the business of banking in
accordance with the provisions of this Act.
(2) The Bank shall be a body corporate by the name of the Reserve Bank of India, having perpetual succession
and a common seal, and shall by the said name sue and be sued.”
RBI has been constituted as a body corporate (under the then prevailing Companies Act) in 1935 and continues
in the same manner as it was envisaged, with a capital of Rs. 5 crores, which is wholly owned by the Government
of India from January 1, 1949. Prior to 1949 RBI was Private entity owned by public shareholders.
In terms of sections 7(2) and section 8 of the RBI Act, the general superintendence and direction of the affairs
and business of RBI is vested in Central Board of Directors, consisting of a Governor, 4 Deputy Governors, and
16 Directors (4 from each local boards, 10 nominated directly by Central Government, 2 Government officials)
appointed in terms of the Provisions of RBI Act, 1934.
Section 7(1) of RBI Act empowers the Central Government to give directions to the Governor in the public
interest after due consultations. The Governor and Deputy Governors hold office for a period of five years,
the independent director’s tenure is for four years and that of government officials is at the pleasure of
the government. All the board officials are eligible for re-appointment. However, independent directors’
appointment is restricted to two terms of 4 years each (continuously or intermittently spread over 8 years). A
Deputy Governor and Government officials nominated as Director may attend any meeting of the Central Board
and take part in its deliberations but shall not be entitled to vote.
However, in the absence of the Governor, and if permitted by Governor in writing, a Deputy Governor may vote
in the meetings of Central Board.
In terms of section 9 of the RBI Act, 1934, four local boards have been constituted for each of four areas namely
Delhi, Mumbai, Kolkata and Chennai. Local board consists of 5 members each appointed by Central Government
to represent, “as far as possible, territorial and economic interests and the interests of co-operative and
indigenous banks.”
RBI Act, 1934 confers powers to disqualify directors and members of Local Boards, remove and vacate them
from their office under section 10 & section 11. The Governor has to convene meeting of Central Board at least
six times in a year and at least once in a quarter. If any four directors request the Governor to convene the
meeting of Central Board, the Governor has to convene a meeting forthwith.
For the day-to-day conduct of the bank’s business the Central Board, in terms of the powers vested in it under
section 58 of the RBI Act, 1934 can make such regulations as it may consider necessary. The regulations so
made will be effective only with the prior sanction of the Central Government. The powers of the Board to make
regulations .are fairly wide in that the Board can make regulations to cover all matters for which provision is
necessary or convenient for the purpose of giving effect to the provisions of the Act including that of internal
functioning of RBI.
In particular, the Board is authorised to make regulations in regard to the following matters:
• Conduct of the business of the Central Board/Local Boards and the procedure that may be followed at
meetings;
• Delegation of powers and functions to Central Board to Deputy Governors, Directors, or Officers of the
Bank, Local Boards;
• Formation of committees of the Central Board and delegation of functions and powers to such committees;
• Constitution and management of staff and superannuation funds
• Execution of contracts binding on RBI, Use of the common seal of the Bank;
• Maintenance of accounts and preparation of balance sheets of RBI;
• Remuneration of Directors;
• The relationship of the scheduled banks with the RBI;
• The returns submitted by the scheduled banks to the RBI;
• Conduct and management of clearing houses for scheduled banks;
• Refund of currency notes of the Government of India or bank notes which are lost, stolen, mutilated or
imperfect;
• Any other matter for the efficient conduct of the business of the RBI.
OBJECTIVES OF RBI
The original objectives for which RBI was established were:
Objectives of RBI
Maintain value of Preserve the External Ensure Price of Promote Economic Promote Financial
Currency Value of Rupee Stability Growth Institutions
• To regulate the issue of Bank notes.

• To keep reserves with a view to securing monetary stability in India.
• To operate the currency and credit system of the country to its advantage.
• To operate the monetary policy for maintaining price stability while keeping in mind objective of growth.
FUNCTIONS OF RBI
The functions of the RBI have been enumerated in Chapter III of the RBI Act, 1934. The following are the broad
functions:
Note issuing
Agency
Manages Price
Stability Banker's Bank
Functions
Manages
Exchange
Controller of
Rate/Currency.
Credit
Lender of Last Banker of the

Resort Government
(i) Issue and Management of Currency and distribution of coins

The currency of our country consists of One-rupee notes and coins (including lower denominations
thereof) as well as Bank notes issued by RBI. Issuance of bank notes (currency) is one of the original central
banking functions for which the RBI was established. In terms of section 22, of the RBI Act, 1934, RBI has
the sole right to issue bank notes in India. Such bank notes are issued by a department of RBI known
as Issue Department, which is a separate and wholly distinct department from the Banking Department
which is responsible for banking business of the RBI.
However the design, form and material of bank notes are to be approved by the Central Government on
the basis of recommendations of Central Board of the RBI. Every bank note shall be a legal tender at any
place in India. On recommendation of the Central Board, the Central Government may declare any series
of bank notes of any denomination to be not a legal tender.

For example on November 8, 2016, the Government of India announced the demonetization of all
Rs.500 and Rs.1,000 banknotes of the Mahatma Gandhi Series. It also announced the issuance of new
Rs.500 and Rs.2,000 banknotes in exchange for the demonetised banknotes. Also RBI has introduced
new Rs. 200 denomination notes.
Under Section 24 of RBI Act, 1934, the RBI has the power to recommend to Central Government various
denominations of bank notes, which shall be two rupees, five rupees, ten rupees, twenty rupees, fifty
rupees, one hundred rupees, five hundred rupees, one thousand rupees, five thousand rupees and ten
thousand rupees or other denominations not exceeding ten thousand rupees. The issue department keeps
its assets, which forms the backing for note issuance, distinctly separate from that of the assets of the
banking department.
The assets of the Issue Department against which notes are issued to public consist of gold coin, gold
bullion, foreign securities, rupee coin and rupee securities to such aggregate amount as is not less than Rs.
200 Crores of rupees out of which the value of Gold coins and bullion are to be not less than Rs. 115 Crores.
Within RBI, the Department of Currency Management (‘DCM’) has the responsibility of administering the
functions of currency management. Currency management basically relates to the issue of notes and coins
and retrieval of unfit notes from circulation. As on March 2020, the currency management infrastructure
consists of a network of 19 issue offices, 3367 currency chests and 2782 small coin depots of commercial,
cooperative and regional rural banks (‘RRB’s) spread across the country. In order to improve the currency
distribution system by leveraging technology, the RBI adopted a hub-and-spoke model for the distribution
of banknotes across the country. Fresh note remittances are sent to larger currency chests, which meet the
currency needs of a designated area (such as a district). These chests are identified as hub chests and, in
turn, supply notes to smaller currency chests in their vicinity which act like spokes in the distribution
model. Fresh notes are distributed to every issue office of the RBI as per an allocation plan.
RBI has established a chain of currency chests with several banks in the
A currency chest is a
country. Currency chests are designated branches of commercial banks
place where the RBI
authorised by the RBI to hold stock of bank notes, rupee notes and coins.
keeps all the excess
These currency chests have the responsibility for distribution of these notes
money in the form of
and coins on behalf of RBI. The currency chests get their supply of printed
cash under the custody
notes from RBI, which are later delivered to the respective banks. Currency
of different banks.
chests can be stated to be a depository frame work of the RBI.
The banks which host the currency chests are required to maintain accounts of the chests independently
which is subject to monitoring and scrutiny of RBI. Also through a separate set of policy and rules RBI
exchanges mutilated or torn notes surrendered by customers through bank branches and currency chests.
The bank notes which are issued and circulated by RBI are bearer promissory notes and they are exempt
from payment of stamp duty.
Facility for Exchange of Notes and Coins
All branches of banks in all parts of the country are mandated to provide the customer services related to Issuing
fresh/good quality notes and coins of all denominations on demand, Exchanging soiled/ mutilated/ defective
notes and Accepting coins and notes either for transactions or exchange more actively and vigorously to the
members of public so that there is no need for them to approach the RBI Regional Offices for these purposes.
(i) Issuing fresh / good quality notes and coins of all denominations on demand,
(ii) Exchanging soiled / mutilated / defective notes,*
* Small Finance Banks and Payment Banks may exchange mutilated and defective notes at their
option. and
(iii) Accepting coins and notes either for transactions or exchange.
(a) It will be preferable to accept coins, particularly, in the denominations of ₹ 1 and 2, by weighment.
However, accepting coins packed in sachets of 100 each would perhaps be more convenient for the
cashiers as well as the customers. Such sachets may be kept at the counters and made available to the
customers.
(b) All branches should provide the above facilities to members of public without any discrimination on
all working days. The scheme of providing exchange facility by a few select currency chest branches
on one of the Sundays in a month will remain unchanged. The names and addresses of such bank
branches should be available with the respective banks.
(c) The availability of the above-mentioned facilities at the bank branches should be given wide publicity
for information of the public at large.
(d) None of the bank branches should refuse to accept small denomination notes and / or coins
tendered at their counters. All coins in the denomination of 50 paise, ₹ 1/-, 2/-, 5/-, 10/- and 20/-
of various sizes, theme and design issued from time to time by the Government of India continue
to be legal tender.
(ii) Banker to the Government
In terms of section 20 of RBI Act, 1934, RBI has an obligation to Act as a banker to the central government.
Under this obligation RBI has to accept monies for account of the Central Government, to make payments
up to the amount standing to the credit of Central Government, to carry out its exchange, remittance and
other banking operations, including the management of the public debt of the Union of India.
Also under section 21 of RBI Act, RBI has a right to transact Government business in India which include
money, remittance, exchange and banking transactions in India; and, the Central Government to deposit free
of interest all its cash balances with the RBI under mutually agreed terms. The Reserve Bank is also saddled
with the responsibility of receiving and paying money on behalf of the various Government departments.
For carrying out its duties as banker to the Government of India, it is not paid any remuneration. RBI is
entitled for a commission for managing public debt functions. The Government transaction work also
includes maintaining currency chests at places specified by the Central Government. Similarly section 21A
of the RBI Act enables RBI to enter in to agreements with State Governments to transact their businesses.
Under sections 20 and 21(A)(b) of the RBI Act, RBI manages public debt of both Central and State
governments. Float new loans on behalf of Central/State governments, conduct periodical auctions of
Treasury Bills, issue of dated Government securities as well buying and selling the same are some of the
additional work done by RBI in its capacity as a Banker to the Government.
Under the mandate signed with Central Government and State governments RBI extends Ways and
Means Advances up to 90 days at an interest rate 2% over the Repo rate. This is basically to manage the
temporary mismatches in their short term receipts and payments. RBI also provides investment services
by deploying temporary surplus cash balances in Government accounts. RBI also advises the Government
on monetary and banking issues when requested to do so. Also manages Consolidated Fund of India,
contingency fund and public accounts as these accounts are maintained by RBI.
(iii) Banker to the Banks
This is a special relationship that is created due to statutory requirements under the RBI Act. Once the
name of a bank is included in the Second Schedule, that Bank is eligible to be called as a Scheduled Bank.
Among other conditions, it is bound to maintain the stipulated Cash reserves under section 42 in an
account with RBI. The Scheduled Bank status to any bank also confers privileges such as availing financial
accommodation from RBI under specified conditions.
Reserve Bank also provides means of transfer and settlement of funds between banks on account of
clearing, remittances, lending and borrowing through such accounts. Thus RBI provides a platform for
inter-bank financial transactions. Such accounts of banks are maintained by Deposit Accounts Department
of RBI. Intra-bank funds transfers also takes place through an RBI portal known as e-Kuber.
(iv) Lender of last resort
When banks exhaust all other means for raising funds for their operations, they fall back on RBI as a
source for finance as provided under the RBI Act. Hence RBI is known as Lender of last resort. RBI grants
financial accommodation to banks in terms of section 17(2), (3) and 3 (A) “sale, purchase and rediscount
of eligible bills” as well as loans and to advances banks under section 17(4) of RBI Act.
Rediscount of bills with RBI by banks are confined to the following categories :
(a) Bonafide Commercial bills forming part of commercial or trade transactions drawn on and payable in
India and maturing within 90 days from the date of discount by banks. In case of export bills relating
to export from India the maturity may be 180 days. The other pre-requisite is that such bills should
have two signatures with one among them that of a scheduled bank.
(b) Bills related to financing agriculture operations or marketing of crops: Such bills which are to mature
within 15 months from the date of purchase or discount by banks.
(c) Bills that are associated with Cottage and Small Scale Industries: Such bills that are associated with
production or marketing aspects of these industries maturing within 12 months of its discount or
purchase by banks, drawn and payable within India and having two signatures one of which that
of a State Co-operative Bank or a State Financial Corporation supported by a guarantee from State
Government concerned on repayment of Principal and interest on these bills.
(d) Bills representing holding or trading in Government Securities: Such bills drawn and payable within
India, bearing the signature of a Scheduled Bank and maturing within 90 days from the date of
purchase or re-discount.
(e) A foreign bill: Bills arising out of bonafide export transactions maturing with 180 days drawn in or on
any country outside India, such country being a member of International Monetary Fund. For other
than export bill, the maturity is not to exceed 90 days.
(v) Loans and Advances
Section 17(4) of the RBI Act empowers Reserve Bank to grant loans among others to, Scheduled Banks,
State Co-operative Banks, and State Financial Corporations loans and advances, repayable on demand or
on the expiry of fixed periods not exceeding ninety days.
Such loans and advances are granted against the securities of
• stocks, funds and other (than immovable property) securities, in which there is an authorization to
a trustee to invest monies
• Gold or silver or documents of title to these
• Promissory Notes or Bills of Exchange eligible for purchase or rediscount by RBI or guaranteed by
State Government regarding repayment of principal and interest due on them
• Promissory notes of any scheduled bank or State Co-operative Bank which are supported by
documents of title to goods (which have been already transferred, assigned or pledged to any other
bank as a security for any advance or loan made of bonafide commercial or trade transactions or
those in respect of financing agricultural operations or marketing of crops).
Further by means of Section 17(3-A) of the RBI Act, RBI grants financial accommodation at concessional
rates on export oriented bills, repayable on demand or a fixed period which mature in not exceeding 180
days based on declarations from banks. For financing under these schemes RBI had introduced Bill Market
Schemes in 1951 and subsequently modified the same in 1970 as New Bill Market Scheme.
(vi) Emergency Advances
Also RBI, grants emergency advances to specified banks on special occasions as envisaged in Section 18 of
the said Act in the interest of regulating credit to trade, commerce, agriculture and industries. This special
provision is available despite any restrictions stated under Section 17 and Section 18 to RBI and extend
such financial accommodation to banks on such bills which are not financeable by RBI, otherwise. Further
under Section 18 RBI can make an advance to a State Cooperative Bank or to a cooperative society based
on the recommendations of a State Cooperative Bank. Such advance is repayable on demand, or on the
expiry of fixed period generally not exceeding 90 days under the terms and conditions specified by RBI.
(vii) Controller of Credit

As Bank credit extended by various banks has its own impact on the economy, one of the key functions for
which RBI was constituted was to manage the credit for the advantage of the country. RBI exercises control
over the credit extended by banks through specific instruments on account of wide powers granted to it by
RBI Act as well as Banking Regulation Act, 1949.
The frame work of credit control are implemented through the following instruments at the command of
RBI. They are–
a. Cash Reserve Ratio
b. Statutory Liquidity Ratio
c. Directives under BR Act
d. Refinancing of loans
e. Moral suasion
a. Cash Reserve Ratio (CR )

In terms of Section 42 of the RBI
Act every scheduled bank in India is
required to maintain an average daily
balance the amount of Cash Reserves
with RBI as a percentage of Total
Net Demand and Time Liabilities
in India. Reserve Bank notifies the
percentage of CRR to be maintained
by banks at regular intervals through
gazette notifications.
The main purpose of maintaining CRR by the banks is to secure the monetary stability of the country.
By increasing the CRR or decreasing the CRR the lendable resources of a bank can be reduced or
increased. This would lead to scarcity of availability of funds or increase in availability of funds in the
economy resulting in a deflationary or inflationary effect.
When the RBI Act was introduced, the minimum and maximum floor rates of this ratio to be maintained
by banks was specified between 3% to 20% .This was amended 2006 and floor rates were abolished,
to give RBI the flexibility to decide and announce the percentage of CRR to be maintained by banks
from time to time keeping in view the monetary situation prevailing in the country. By varying CRR,
RBI can expand or contract the credit extended by a bank, thus affecting the quantum of credit a bank
can extend.
All scheduled banks and Non-scheduled banks have to maintain CRR as per section 18 of the RBI
Act. Banks have to calculate the CRR on the basis of their respective demand and time liabilities as
on the Friday of second preceding fortnight. Reserve Bank of India has prescribed statutory returns
i.e. Form A Return (for CRR) under section 42(2) of the RBI Act, and Form VIII Return (for SLR)
under section 24 of the Banking Regulation Act, 1949. In addition to the above an incremental CRR
in terms of section 42(1A) also need to be maintained as advised by RBI from time to time. At present
no incremental CRR need to be maintained. Provisional return of Form A to be submitted by banks
within 7 days and final Form A to be submitted within 20 days from expiry of the relevant fortnight.
Maintenance of CRR
(a) Every scheduled bank shall maintain in India with the Reserve Bank, an average daily balance,
the amount of which shall not be less than four per cent of the bank’s total NDTL in India as
on the last Friday of the second preceding fortnight. The extent of provisions in this regard as
applicable to scheduled banks shall, mutatis mutandis, be applicable to Small Finance Banks
(SFBs) and Payments Banks (PBs).
(b) Every co-operative bank, (not being a scheduled co-operative bank), shall maintain in India
on daily basis by way of cash reserve with itself; or by way of balance in current account with
the Reserve Bank or the state co-operative bank of the State concerned; or by way of net
balance in current accounts; or in case of a primary (Urban) co-operative bank, balances with
District Central Co-operative bank of the district concerned; or in one or more the aforesaid
ways, a sum equivalent to four per cent of its NDTL in India, as on the last Friday of the second
preceding fortnight.
(c) Local Area Banks shall maintain in India by way of cash reserve with itself or by way of balance
in a current account with Reserve Bank, or by way of net balance in current accounts or in one
or more of the aforesaid ways, a sum equivalent to four percent of the total of its NDTL in India
as on the last Friday of the second preceding fortnight.
b. Statutory Liquidity Ratio
In terms of section 24 (2A) of Banking Regulation Act, another tool for controlling credit in the
country is available to RBI in the form of Statutory Liquidity Ratio under which, Liquid assets (in the
form of prescribed securities by RBI) have to be maintained by all scheduled banks in India.
Statutory Liquidity Ratio (SLR ) is the Indian government term for the reserve
requirement that the commercial banks in India are required to maintain in the form
of cash, gold reserves, government approved securities before providing credit to the
customers.
The value of such assets will be specified by RBI from time to time and “such assets shall be
maintained, in such form and manner, as may be specified in such notification.”
SLR has to be maintained by both Scheduled and Non-Scheduled banks in India. Scheduled banks
have to maintain SLR in addition to the CRR to be maintained by them under Section 42 of the RBI
Act and as far as Non-Scheduled banks are concerned SLR would be in addition to balances to be
maintained under section 18 of the Banking Regulation Act.
Liquid assets are those assets which can be converted into cash within a shortest time. The main aim
of this statutory obligation for a bank to maintain SLR is to safeguard the interests of the depositors
but it has also been used as an effective credit control instrument in the hands of RBI. The category
of assets to be maintained by banks need to be specified by RBI, though it was earlier formed part of
Banking Regulation Act itself.
The Securities that banks can invest under SLR are as follows:
a) Cash
b) Gold Valued at the current market price
c) Unencumbered securities as under:
i. Dated Securities of Government of India under market borrowing programme or Market
Stabilization Scheme; or
ii. Treasury Bill of Government of India; or
iii. State Development Loan securities under their market borrowing programme.
d) Deposit and unencumbered approved securities under Section 11 of the Banking Regulation
Act, 1949 to be made with the Reserve Bank by a banking company incorporated outside India.
e) Balances maintained by a scheduled bank with the Reserve Bank in excess of the balance
required to be maintained under CRR.
f) Any other securities notified by RBI from time to time.
The procedure for computation of net demand and time liabilities for the purpose of SLR under
section 24 of the Banking Regulation Act 1949 is broadly similar to the procedure followed for CRR
purpose. On the recommendations of Narasimham Committee, RBI has reduced the SLR from its
peak level of 38.5% in 1991 to 27%in 1997 and to 25% in October 1997. By amending Section 24 of
the BR Act, RBI has done away with the minimum level of SLR to be maintained by banks that is 25%
but has retained the upper cap level of 40%. And in subsequent years the SLR level to be maintained
by banks has been gradually scaled down. RBI in its fifth bi-monthly monetary policy review, took a
decision that it will reduce the SLR by 25 basis points (0.25 per cent) every calender quarter until the
SLR reaches 18 per cent of the Net Demand and Time Liabilities (NDTL) as part of aligning it with the
Liquidity Coverage Ratio (LCR).
(Note: Please refer to Lesson 4 for a detailed schedule of reduction in SLR by RBI.)
If a bank defaults in maintaining SLR,RBI will levy a penalty for that day at the rate of three per cent
per annum above the Bank Rate on the shortfall and if the default continues on the next succeeding
working day, the penal interest may be increased to a rate of five per cent per annum above the Bank
Rate for the concerned days of default on the shortfall.
The effect of increasing SLR would result in leaving lesser amount of lendable funds at the hands
of a Bank. Therefore this automatically reduces the supply of funds in the economy resulting in
deflationary effect. The same effect can also be created by increasing the interest rates of lendable
funds. On the other hand reducing the SLR would have the opposite effect of increasing the availability
of lendable funds which may lead to inflationary effect.
As part of post Global Financial Crisis (GFC) reforms, Basel Committee of Reserve Bank of India
(RBI) on Banking Supervision (BCBS) had introduced Liquidity Coverage Ratio (LCR), which
requires banks to maintain High Quality Liquid Assets (HQLAs) to meet 30 days net outgo under
stressed conditions.
Further, as per Banking Regulation Act, 1949, the banks in India are required to hold liquid assets to
maintain Statutory Liquidity Ratio (SLR). In view of the fact that liquid assets under SLR and HQLAs
under LCR are largely the same, RBI has been allowing banks to use a progressively increasing
proportion of the SLR securities for being considered as HQLAs for LCR so that the need to maintain
liquid assets for both the requirements is optimised).
c. Directives
Though one of the core businesses of banking is lending, it has to done by the banking system in a
judicial manner so that all sectors of the economy are benefitted. One of the key objectives of RBI
is to control the credit through which RBI ensures that credit distribution is in line with national
priorities. This casts responsibility on it to ensure adequate credit to industry, priority sector (that
includes agriculture and others), housing, infrastructure and other consumers. Therefore RBI has
put in special mechanisms for credit controls which are carried out through General Credit Control
and Selective Credit Control.
Under General Credit Control RBI uses monetary policy instruments such as Repo rate, Bank rate,
Open market operations, and moral suasion and under Selective credit control RBI restricts quantum
of credit, margins, maximum amount, etc. relating to sensitive commodities and sectors.
d. Rediscounting/Refinance
Reserve Bank as a lender of last resort provides liquidity support though on a temporary basis
through rediscounting/refinance of various schemes, the details of which has already been covered
under “Lender of last resort”. By increasing or reducing the quantum, rates of interest and period up
to which refinance can be availed RBI can curtail or expand the credit availability in the market.
e. Moral Suasion
Moral suasion is a persuasion of banks by Reserve Bank to adhere to the directives and guidelines
issued by it. Through advisories the RBI tries influence the banks to follow a desired practice. This is
used a soft tool in controlling credit in the economy.
To ensure that the payment systems are safe and secure and the various stakeholders conform to
regulatory requirements, on review it has been decided to revise the process of levy of penalty on
payment system operators by the Reserve Bank of India.
The revised framework continues to centre around objectivity and transparency in the decision-
making process. It may be noted that action taken under this framework would be without prejudice
to any other laws of the country.
(viii) Managing the external value of Rupee (i.e. Managing Foreign Exchange)
Under section 40 of the RBI Act, there is an obligation on the part of RBI to buy or sell foreign exchange
from or to an Authorised Person based on the exchange rate as well as other conditions as the Central
Government may determine. The Authorised Persons are those who are licensed to buy or sell foreign
exchange under Foreign Exchange Management Act, 1999 (FEMA).
In addition, RBI is charged with maintaining the foreign exchange reserves of the country and plays a
significant role as controller/regulator of foreign exchange transactions in terms of wide powers it derives
from FEMA.
Under the Foreign Exchange Regulation Act regime from 1973, RBI had a very highly centralized role
in the area of foreign exchange and it had delegated only limited powers to the Authorised Dealers. All
foreign currency inflows were to be surrendered by banks to RBI and it was the only agency which can
supply foreign currency at the rates it had determined. Therefore it had a pivotal role in determining
and administering rupee exchange rate. However gradually over a period from August 1993, due to
liberalization and banking reforms RBI started relaxing many controls over foreign exchange transactions.
Due to this, surrendering of foreign exchange to RBI is no more obligatory on banks. RBI also had shifted
to market determined rates based on demand and supply for exchanging foreign currency.
With the introduction of FEMA in 2000, the RBI’s directions are more obligatory on banks. Authorised
persons have been delegated considerable powers relating to various foreign exchange transactions
including remittances, overseas. Due to India’s significant reliance on capital flows, which are often large,
bulk demand for oil imports and bunching up of government payments, along with international political
and economic developments, the forex market becomes susceptible to bouts of volatility. Under these
circumstances, as a matter of policy RBI intervenes in the market along with monetary and administrative
measures to stabilize the exchange rate of Rupee.
The main objective of exchange rate management by RBI is to ensure that exchange rate of Indian rupee
reflects the strong economic fundamentals of the country. Additionally, maintenance of external value of
Indian Rupee is guided by three major objectives: “first, to reduce excess volatility in exchange rates, while
ensuring that the market functions in an orderly fashion; second, to help maintain an adequate level of
foreign exchange reserves, and; third, to facilitate the development of a healthy foreign exchange market.”
(ix) Collection and furnishing of Credit Information
Section 45(B) of the RBI Act, empowers the RBI to collect credit information regarding borrowers from
banks and under Section 45(D) to furnish the same to other banks against request in writing and payment
of a nominal fee. The term Credit information includes:
i. the amounts and the nature of loans or advances and other credit facilities granted,
ii. the nature of security taken from any borrower for credit facilities granted,
iii. the guarantee furnished by a bank for any of its customers,
iv. the means, antecedents, history of financial transactions and the credit worthiness of any borrower,
v. any other information which the Bank may consider to be relevant for the more orderly regulation of
credit or credit policy.
POWERS OF RBI (OVERVIEW)

Reserve Bank derives extensive powers under RBI Act as well as Banking Regulation Act, to regulate and
supervise various banks in India. An over view of important powers of RBI are given as under (also refer to
Lesson 4).
Under Banking Regulation Act the RBI enjoys the following powers:
Section 10 BB - Power of Reserve Bank to appoint Chairman of the Board of Directors appointed on a
whole-time basis or a Managing Director of a banking company.
Where the office of the Chairman of the Board of Directors appointed on a whole-time basis or a Managing
Director of a banking company is vacant, the Reserve Bank may, if in its opinion that the continuation of such
vacancy is likely to adversely affect the interests of the banking company, appoint a person as Chairman of the
Board of Directors or a Managing Director of the banking company.
Section 21 - Power of Reserve Bank to control advances by banking companies: Reserve Bank has the
powers to determine policies and direct banking companies to follow the same.
Section 22 - Licensing of banking companies: All Banking companies need to get a licence from RBI and it
issues licence only after ‘tests of entry’ are fulfilled.
Section 24A- Power to exempt a Co-operative bank: Without prejudice to the provisions of section 53, the
RBI by notification in the Official Gazette, declare that, the whole or any part of the provisions of section 18 or
section 24, as may be specified therein, shall not apply to any co-operative bank.
Section 27 - Monthly returns and power to call for other returns and information: At any time, the RBI
may direct a banking company to furnish it with such statements and information relating to the business
or affairs of the banking company (including any business or affairs with which such banking company is
concerned) as RBI may consider necessary or expedient to obtain for the purposes of this Act, apart from calling
for information every half-year regarding the investments of a banking company and the classification of its
advances in respect of industry, commerce and agriculture.
Section 29A - Power in respect of associate enterprises: The RBI may direct a banking company to annex
to its financial statements or furnish to it separately, within such time or intervals, necessary statements and
information relating to the business or affairs of any associate enterprise of the banking company. It can also
conduct an inspection of any associate enterprise of a banking company and its books of account jointly by
one or more of its officers or employees or other persons along with the Board or authority regulating such
associate enterprise.
Section 30 – Power to order Special audit: In the public interest or in the interest of the banking company or
its depositors, the RBI may at any time by order direct that a special audit of the banking company’s accounts.
Section 35 - Inspection of Banking Companies: Reserve Bank on its own or being directed so to do by the
Central Government, inspect any banking company and its books and accounts and supply to the banking
company a copy of its report on such inspection.
Section 35A - Power of the Reserve Bank to give directions: In the public interest or in the interest of
Banking policy RBI has powers to issue, modify or cancel as it deems fit, and the banking companies or the
banking company, are bound to comply with such directions.
Section 35AA: Power to Central Government: To, authorise RBI to issue directions to any banking company
or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of
the Insolvency and Bankruptcy Code, 2016
Section 35AB. (1) Power to RBI: To issue directions to any banking company or banking companies for
resolution of stressed assets. (2) Power to RBI to specify one or more authorities or committees with such
members as the Reserve Bank may appoint or approve for appointment to advise any banking company or
banking companies on resolution of stressed assets.’
Section 36 - Further powers and functions of Reserve Bank: RBI may caution or prohibit banking companies
or any banking company in particular against entering into any particular transaction or class of transactions.
• On a request by the companies concerned and subject to the provision of section 44A, assist, in the
amalgamation of such banking companies.
• Give assistance to any banking company by means of a loan or advance in terms of section 18 of the RBI Act.
• Direct the banking company to
– call for a meeting of Directors
– discuss such matters with Officers of RBI
– depute an officer to such meeting, appoint observers to such meetings
– furnish information of such meetings
– make changes in management.
In addition to the above the RBI has also been vested with powers to remove managerial and other persons from
office(section 36AA), to appoint additional Directors (section 36AB), to issue directions in respect of stressed
assets (Section 35AB), Supersede Board of Directors in certain cases (Section 36ACA), Supersede Board of
Directors of a multi-State Co-operative bank (Section 36AAA) and also to impose penalty (Section 47).
In addition to the above, RBI also enjoys certain powers vis-a-vis banks under RBI Act as per the following table-
S.No. Power Section

1 Power of direct discount. 18
2 Power to require returns from co-operative banks. 44
S.No. Power Section

3 Power to collect credit information. 45B
4 Power to call for returns containing credit information 45C
5 Power to determine policy and issue directions 45JA
6 Power to call for information from financial institutions and to give directions. 45L
7 Power to regulate transactions in derivatives (excluding capital market derivatives), 45W
money market instruments
8 Power of Bank to depute its employees to other institutions 54AA
9 Power of the (RBI’s) Central Board to make regulations. 58
Note : The following amendments were inserted in the RBI Act in August 2019: 45 IA – Amendment. Increasing
the quantum of Net owned funds of a NBFC, 45-ID – (Insertion) Power of RBI to remove directors of an NBFC
from office, 45 IE – (Insertion) Supersession of Board of directors of NBFC (other than Government Company),
45MAA - Power to take action against auditors, ‘45MBA - Resolution of non-banking financial company, 45NAA
– Power in respect of group companies, 58B – (Amendment) Increase in Penalties for Noncompliance and 58G
– (Amendment) Increase in Penalties for Non-compliance by NBFCs.
Provisions with Respect to Deposit Accounts

Acceptance of deposits
This is a fundamental function of banks. However this is regulated by RBI under the provisions of Section 35
A including the types of deposits that can be accepted, period up to which deposits can be accepted, rates of
interest in case of specific deposits such as non-resident deposits, FCNR accounts etc.
RBI has given freedom to banks to decide the interest rates to be offered on deposits based on their Asset
Liability Management policies. It has also issued deposit policy to be followed by banks for providing uniform
customer service across all banks.
Unclaimed Deposits
Under section 26A of RBI Act (as per announcement made on May 2014), with effect from June 2014, any
unclaimed deposits or unclaimed balances remaining with the banks for 10 years and above should be
transferred to Depositor Education and Awareness Fund (DEAF) and such accounts becoming due in each
calendar month (i.e. proceeds of the inoperative accounts and balances remaining unclaimed for ten years or
more) on the last working day of the subsequent month. Subsequently when a claim is made by depositors
or legal heirs it should be re-credited with interest applicable for Savings Bank accounts and a claim to be
lodged with RBI for retransferring such balances. Prescribed returns are to be submitted by banks at different
periodicities to RBI.
Nomination facility
Under Section 45 ZA the facility of nomination is provided to depositors of banks including Cooperative banks.
The nominee is entitled to claim the deposits in the event of death of depositor/s. In case of a minor too this
facility is available in favour of a person who is legally entitled to be a guardian. Payment made by banks in
terms of the nomination rules, discharges a bank. The rules framed outline the procedure to be followed and
forms to be submitted for nomination, cancellation and variation of nomination.
Similar facility of nomination is available to customers who hire Safe deposit lockers, avail Safe custody service
from banks as per Section 45 ZC and Section 45 ZE.
Note: For detailed information on Nomination please refer to Annexure to Lesson 5.
Regulation of Payment Systems and Internet Banking

Till the year 2007, payments system in India was unregulated. Since the introduction of Payment and
Settlement Systems Act, 2007 (‘PSS Act’) as well as the Payment and Settlement System Regulations, 2008
framed thereunder, came into effect from August 12, 2008. In terms of Section 4 of the PSS Act, only the Reserve
Bank of India (RBI) can commence or operate a payment system in India unless authorised by RBI. Coupled
with powers conferred under Section 58 and PSS Act provisions, RBI has the power to make clearing houses
rules for banks as well as post office savings bank. Also to bring in electronic payment within the ambit of RBI
regulation, The Information Technology Act, 2000 was amended to provide powers for RBI through insertion
Section 58(2) that enables RBI to frame regulations in respect of electronic payment systems of banks and
financial institutions.
Reserve Bank has since authorised payment system operators of pre-paid payment instruments, card schemes,
cross-border in-bound money transfers, Automated Teller Machine (ATM) networks and centralised clearing
arrangements.
In addition to these, RBI has issued detailed internet banking guidelines to all banks in respect of internet
banking in the year 2001. All banks are expected to follow these guidelines which concern the (i) security and
technology issues (ii) legal issues (iii) regulatory and supervisory issues.
Additionally RBI has issued detailed guidelines regarding issuance of Card products such as Credit Card, Debit
Card and Rupee Denominated Co-branded Pre-paid Card operations of Banks and Credit Card issuing NBFCs.
Banks can undertake Credit card business either departmentally or through a subsidiary company set up for
the purpose. They can also undertake domestic credit card business by entering into tie-up arrangement with
one of the banks already having arrangements for issue of credit cards. No prior approval of the RBI is necessary
for banks to issue credit cards independently or in tie-up with other banks. They need their Board of Directors
approval. Banks with networth of Rs. 100 crore and above should undertake credit card business, other Banks
would require prior approval of the Reserve Bank. Each bank must have a well documented policy and a Fair
Practices Code for credit card operations. RBI guidelines inter alia provide detailed rules regarding issuance of
cards, interest rate or other charges, wrongful billing, issue of unsolicited card, fair practices in debt collection,
redressal of grievances etc.
Debit cards were issued by banks since 1999. In the light of Payment and Settlement Systems Act, 2007 RBI
also issued instructions on some aspects of debit cards such as security and risk mitigation, transfer of funds
between domestic debit, prepaid and credit cards, and merchant discount rates. Debit card issuing banks have
to adhere to RBI guidelines on Board approved policy, Compliance with Prevention of Money Laundering Act,
2000, Payment of interest on balances, Terms and conditions for issue of cards to customers, Security and other
aspects, compliance with RBI directives, etc. Similar set of guidelines have also been issued covering Rupee
Denominated Co-branded Pre-paid Cards.
Reserve Bank of India has the right to impose any penalty on a bank/NBFC under the provisions of the BR Act,
1949/the RBI Act, 1934, respectively for violation of any of these guidelines.
Chief Compliance Officer (CCO)

As part of robust compliance system, banks are required, inter-alia, to have an effective compliance culture,
independent corporate compliance function and a strong compliance risk management programme at bank
and group level. Such an independent compliance function is required to be headed by a designated Chief
Compliance Officer (CCO) selected through a suitable process with an appropriate ‘fit and proper’ evaluation/
selection criteria to manage compliance risk effectively.
A bank shall lay down a Board-approved compliance policy clearly spelling out its compliance philosophy,
expectations on compliance culture covering Tone from the Top, Accountability, Incentive Structure and
Effective Communication & Challenges thereof, structure and role of the compliance function, role of CCO,
processes for identifying, assessing, monitoring, managing and reporting on compliance risk throughout the
bank. This shall, inter-alia, adequately reflect the size, complexity and compliance risk profile of the bank,
expectations on ensuring compliance to all applicable statutory provisions, rules and regulations, various codes
of conducts (including the voluntary ones) and the bank’s own internal rules, policies and procedures, and
creating a disincentive structure for compliance breaches. The bank shall also develop and maintain a quality
assurance and improvement program covering all aspects of the compliance function. The quality assurance
and improvement program shall be subject to independent external review periodically (at least once in
three years). The policy should lay special thrust on building up compliance culture; vetting of the quality of
supervisory / regulatory compliance reports to RBI by the top executives, non-executive Chairman / Chairman
and ACB of the bank, as the case may be. The policy shall be reviewed at least once a year;
The duties and responsibilities of the compliance function.
These shall include at least the following activities:
i. To apprise the Board and senior management on regulations, rules and standards and any further
developments.
ii. To provide clarification on any compliance related issues.
iii. To conduct assessment of the compliance risk (at least once a year) and to develop a risk-oriented activity
plan for compliance assessment. The activity plan should be submitted to the ACB for approval and be
made available to the internal audit.
iv. To report promptly to the Board / ACB / MD & CEO about any major changes / observations relating to the
compliance risk.
v. To periodically report on compliance failures/breaches to the Board/ACB and circulating to the concerned
functional heads.
vi. To monitor and periodically test compliance by performing sufficient and representative compliance
testing. The results of the compliance testing should be placed to Board/ACB/MD & CEO.
vii. To examine sustenance of compliance as an integral part of compliance testing and annual compliance
assessment exercise.
viii. To ensure compliance of Supervisory observations made by RBI and/or any other directions in both letter
and spirit in a time bound and sussustainable manner.
Framework for imposing Monetary Penalty on authorised payment system operators / banks)
In terms of its Circular No: DPSS.CO.OD.No.1328/06.08.005/2019-20 dated January 10, 2020 RBI has announced
a detailed and revised frame work for imposing penalties on authorised payment system operators/banks for
violation of Payment and Settlement Systems Act, 2007 provisions and guidelines issued by RBI in this regard.
The same is summarised as under: -
S.No. Subject Revised Framework
1 Powers of RBI to RBI has powers to impose monetary penalty in respect of certain contraventions
impose fine and as well as compound certain contraventions. The type / nature of contravention
compound for which penalty can be imposed and compounded are different and vary. This
has been detailed including the procedure to be followed.
2 Procedure for Considering that the powers of RBI to impose monetary penalty and compound
imposing monetary contraventions are different, and further that the nature of identification of
penalty / fine contraventions is also different, separate procedures have been proposed.
3 Delegation of The powers to impose monetary penalty on account of RBI identified

powers to impose contraventions and compounding of contraventions have been separated.
fine and compound
contraventions
4 Issuance of Show The decision to issue SCN will be based on certain parameters dovetailed in a
Cause Notice (SCN) Scoring Matrix.
5 Action based Will depend on whether the contraventions are quantifiable or non-quantifiable.
on nature of
contravention
6 Amount of Objective methodology dovetailed into a scoring matrix to determine the
monetary penalty amount of penalty to be imposed, including action for non-compliance
7 Type of All offences mentioned in Section 26 of PSS Act, 2007 except those relating to
contraventions that sub-section 2 of Section 26, can be compounded. All eligible contraventions,
can be compounded irrespective of its nature of being quantifiable or non-quantifiable, shall be
compounded.
Detailed procedural framework has also been advised by RBI through the aforesaid circular.
Scheme of Banking Ombudsman

In exercise of powers vested with RBI under Section 35A of the Banking Regulation Act, RBI had established
an Authority of Banking Ombudsman in 1995 for resolving customer complaints on various grounds against
commercial banks excluding RRBs. The scheme was expanded in 2002 covering RRBs too. Additionally the
scope, authority and functions of Banking Ombudsman were expanded with a provision of empowering Banking
Ombudsman as an Arbitrator. All scheduled banks, RRBs and Co-operative banks are now covered under the
revised scheme. The Scheme was further amended in 2006/2007/2009/2017 to encompass deficiencies
arising out of sale of insurance/ mutual fund/ other third party investment products by banks misselling of
Mobile Banking/ Electronic Banking services in India.
Under the latest amendment in the Banking Ombudsman Scheme the pecuniary jurisdiction of the Banking
Ombudsman to pass an Award has been increased from existing rupees one million to rupees two million.
Compensation not exceeding Rs.1 lakh also be awarded by the Banking Ombudsman to a complainant for loss
of time, expenses incurred as also, harassment and mental anguish suffered by the complainant.
On January 31, 2019 RBI has launched the Ombudsman Scheme for Digital Transactions (OSDT) for redressal
of complaints against System Participants as defined in the said Scheme. The scheme also includes an appellate
mechanism for appeal against decisions of OSDT. Please see Lesson 11 for a detailed coverage on this topic.
Note: Please see Lesson 11 for a detailed coverage on this topic.
TOOLS OF MONETARY CONTROL

There RBI uses various direct and indirect tools (instruments) for implementation of monetary policy.
These are:
• Repo Rate,
• Reverse Repo Rate,
• Liquidity Adjustment Facility (‘LAF’),
• Marginal Standing Facility (‘MSF’),
• Corridor,
• Bank Rate,
• Cash Reserve Ratio (‘CRR’), Section 45 W of RBI Act 1934

• Statutory Liquidity Ratio (‘SLR’) , Updation of Re-purchase option (Repo) Directions,
Updated in 2019
• Open Market Operations, (‘OMO’s) and Salient features:
• Market Stabilization Scheme (MSS). • Applicable to Repo deals undertaken on
recognized stock exchanges, electronic trading
Repo Rate: With the introduction of Liquidity Adjustment platforms (ETP) and Over-the- Counter (OTC)
Facility (‘LAF’) from the year 2000 onwards RBI has
• In case of exchange trades Repo transactions this
started to provide funds against collateral of government will be as per SEBI/Stock exchange guidelines.
and approved securities for short duration periods to • These directions will not apply to repo/
banks against Repurchase option of such securities by reverse repo transactions under the Liquidity
borrowing banks. The interest rate at which the Reserve Adjustment Facility and the Marginal Standing
Bank provides this short duration liquidity to banks is Facility,
known as ‘Repo’ rate. Under inflationary conditions RBI • Eligible Securities for Repo : Central/State
Government Securities, Listed corporate
increases the Repo rate and this discourages the banks
bonds and debentures (other than own
to borrow thereby reducing the money circulation in the securities),Commercial Papers, Certificate of
economy. This helps to reduce inflation. Repo rate has Deposits, Units of Debt Exchange Traded Funds,
become a reference rate for interest rate movements in the Any other security of Local Authority specified
banking system as of now, a place which was occupied by by Central Government.
Bank rate in earlier times. • Eligible Participants: Any regulated entity,
any listed company, any unlisted company
Reverse Repo Rate: The (fixed) interest rate at which which has been issued special securities by
the Reserve Bank absorbs liquidity, on an overnight basis, Govt. of India (repo will be available only on
from banks against the collateral of eligible government such securities),Any of the All-India Financial
securities under the LAF. The effect of increasing Reverse Institutions, any other approved entity by RBI
from time to time.
Repo rate, will lead to decrease in the money supply as
• Tenor: Minimum period of one day and a
commercial banks will get better interest rates to keep
maximum of one year.
their funds with the RBI. Therefore Reverse Repo rate also
• Trading venue: RBI approval is required for
is used as an instrument of monetary control by RBI. any trading venue including recognised stock
Liquidity Adjustment Facility: The monetary policy exchanges.
environment in India has been greatly influenced with the • Specific directions regarding Tri-Party Agent,
Trading process, Reporting of trades, Settlement,
launch of Liquidity Adjustment Facility (LAF) by the RBI
Sale and Substitution of Repoed security,
in June 2000. With the introduction of LAF, the important Pricing-Haircut and Margining, Accounting,
tool of monetary policy- ‘the repo rate’ became the prime presentation, valuation and disclosure,
instrument at the hands of RBI for controlling the monetary Computation of CRR /SLR and borrowing limit,
policy. LAF is a mechanism for adjusting liquidity in the Documentation have also been given by RBI.
banking system. It has twin aims of withdrawing funds or
increasing the same in the banking system when there are excess or shortages of liquidity in the system. LAF is
operated daily by RBI thro Repo / Reverse Repo mechanisms.
Normally the Reverse repo rate is charged at a lower rate than the repo rate. This means whenever the repo rate
changes, the reverse repo rate also changes.
For example, an increase in repo rate by 50 basis points, the reverse repo rate may also increase by 50 basis
points or on any other basis by as decided by RBI from time to time. Therefore LAF forms a component tool for
controlling monetary system.
Marginal Standing Facility (‘MSF’): From May 9, 2011 RBI had introduced an additional facility for the
scheduled commercial banks to borrow funds, up to 1% of their Net Demand and Time Liabilities (NDTL)
against their SLR securities. Subsequently it was raised to 2% and from 27th March, 2020 it has been raised
for Scheduled Banks (excluding Regional Rural Banks) under the MSF to 3 per cent up to 30th June, 2020
of their NDTL outstanding at the end of the second preceding fortnight with immediate effect. In terms of
RBI notification RBI/2019-20/259 DOR.No.Ret.BC.77/12.02.001/ 2019-20 the same raised borrowing limit is
allowed to continue till September 30, 2020. The rate of interest applicable on such advances is fixed at a higher
rate than Repo rate. Presently i.e., as at July 2020 the applicable rate is 4.25% p.a., the same as Bank rate as per
the table given below.
In the event, the banks’ SLR holdings fall below the statutory requirement up to one per cent of their NDTL,
banks will not have the obligation to seek a specific waiver for default in SLR compliance arising out of use
of this facility from RBI in terms of notification issued under sub section (2A) of section 24 of the Banking
Regulation Act, 1949. The MSF facility acts as a safety valve against sudden short fall in liquidity for a bank.
The recent changes in Repo and Reverse Repo rates under LAF and MSF Rate are as follows :
Date/Month /Year Repo rate Reverse Repo Rate MSF Rate

27 March /2020 4.40% 4.00% 4.65%
17 April /2020 4.40% 3.75% 4.65%
22 May /2020 4% 3.35% 4.25%
Corridor: Also known as interest rate corridor. It is a term that denotes arrange with in
which a short term interest rate moves around. In the context of monetary policy of RBI,
Repo rate can be said to be the policy rate as of now. The interest rates of MSF and Reverse
repo determine the corridor for the daily movement in the weighted average call money rate.
Bank Rate, Cash Reserve Ratio (‘CRR’), and Statutory Liquidity Ratio (‘SLR’) are also used by RBI as effective
monetary tools by RBI. These have already been discussed in the earlier paragraphs.
The differences between Repo rate and Bank rate can be summarized as under:
Repo Rate Bank Rate

Interest rate fixed for repurchase of securities sold by Interest rate charged by RBI for discounting or
banks to RBI. extending loans to eligible banks.
Lower than the Bank Rate. Higher than repo rate.
Repo Rate increases do not directly affect Customers Increase in Bank rate can hike lending rates.
of banks directly.
Securities as a collateral are involved under Repo rate Collaterals are not directly involved in the transactions.
transactions. Mostly based on declarations and statements.
Repo Rate is for short term financial needs. Bank Rate is for a longer rate duration, some times as
long as 180 days for banks.
Open Market Operations (‘OMO’): Open market operations are conducted by the RBI either to increase or
decrease the liquidity in the market in order to adjust the money supply. This is done by way of sale or purchase
of Government Securities popularly known as G-Secs. The RBI sells G-Secs and reduces the liquidity from the
financial system or buys back G-Secs to increase liquidity into the system. OMOs are conducted on a daily basis
to balance inflationary forces at the same time ensuring banks continue to lend. OMO includes both, outright
purchase and sale of government securities, for increasing or decreasing liquidity, respectively.
Market Stabilization Scheme (‘MSS’): MSS is an instrument to reduce money supply in the economy. This was
used to by RBI to purchase foreign currencies in the foreign exchange market which flowed in to our economic
system due huge capital inflows on account of foreign investments. This resulted in appreciation of the value
of rupee. As this was not in the interest of exports, RBI started buying dollars in exchange for Rupees. This
led to an excess liquidity and gave rise to potential for inflation. To avoid this situation, RBI started selling
Government bonds to reduce excess Rupees in circulation. This process is called sterilisation. MSS is used as
one of the instruments of monetary control since 2004.
The money mobilized under MSS is kept in a separate account at RBI and is not transferred to Government,
as per agreement with RBI. Government of India pays interest on these bonds through a special budgetary
allocation.
REGULATORY RESTRICTIONS ON LENDING

There are some key regulatory restrictions on granting advances by commercial banks so also to regulate credit.
These can be summarized as under:
i. As per section 20(1) of the Banking Regulation Act, 1949 no bank can grant any loan or advance against
security of its own shares.
ii. Under section 20(1), Banks cannot sanction loans and advances to Directors and firms in which they hold
substantial interest with exception of following loans granted to Chief Executive Officers, Whole Time
Directors. These are - Loan for a car, personal computer, furniture, construction/acquisition of a house for
personal use, festival advance and limits granted under credit card facility.
iii. In all other cases Banks have to approach RBI for prior permission except in case of loans granted to a
Director who was an employee before his appointment as a Director.
iv. However with effect from September 16, 2015 RBI has permitted banks to extend loans and advances
to Chief Executive Officer/ Wholetime Director without seeking prior approval under the following
circumstances–
a. if granting of such loans forms part of remuneration/compensation policy approved by the Board of
Directors of the bank concerned.
b. these loans do not attract guidelines of RBI on Base rate on loans; interest rates on these loans cannot
be lower than rate of interest applicable for staff members.
v. While extending non-fund based facilities such as guarantees, L/Cs, acceptance on behalf of directors
and the companies/firms in which the directors are interested; it should be ensured that: (a) adequate
and effective arrangements have been made to the satisfaction of the bank that the commitments would
be met by the openers of L/Cs, or acceptors, or guarantors out of their own resources, (b) the bank will
not be called upon to grant any loan or advance to meet the liability consequent upon the invocation of
guarantee, and (c) no liability would devolve on the bank on account of L/Cs/ acceptances.
vi. A banking company cannot start a subsidiary company except under circumstances provided under
section 19 (1) (a),(b) and (c).
vii. A banking company cannot hold shares in any company, whether as pledgee, mortgagee or absolute owner,
of an amount exceeding thirty per cent of the paid-up share capital of that company or thirty per cent of its
own paid-up share capital and reserves, whichever is less.
viii. Banks are not to provide loans to companies for buy-back of shares/securities.
ix. Banks to follow regulatory restrictions while granting loans and advances to directors and their relatives
and also to senior officers of banks and their relatives.
x. Banks are not to extend finance for setting up of new units consuming/producing the Ozone Depleting
Substances (ODS). Similarly no financial assistance should be extended to small/medium scale units
engaged in the manufacture of the aerosol units using chlorofluorocarbons (CFC) and no refinance would
be extended to any project assisted in this sector.
xi. Banks are to follow the directions given by RBI while extending loans and advances - against Shares,
Debentures and Bonds to individuals, to Share and Stock Brokers/ Commodity Brokers, to Market Makers,
to Individuals against shares to Joint holders or third party beneficiaries, for subscribing to IPOs by
individuals, against Mutual Fund units, financing Promoters Contribution, for Margin Trading to brokers,
for Housing, for financing Infrastructure, Certificate of Deposits, Discounting/Rediscounting of Bills by
Banks, for purchase of Gold and lending against Gold Bullion/Coins/Primary gold etc.
RBI also contains flow of lending to certain sectors through selective credit control (discussed in next section)
and through tweaking prudential norms relating to risk weights. Increasing risk weight of an exposure to a
particular sector act as disincentive to lenders as such lending reduces CRAR. For example, loans extended
against shares carries a risk weight of 125%.
SELECTIVE CREDIT CONTROL (UNDER SECTION 21 AND SECTION 35A OF BANKING

REGULATION ACT)
To control speculative holding of essential commodities by traders who hoard the same with the help of
advances from banks and thereby stem the price rise, RBI under section 21 and section 35A issues directives
to banks containing restrictions in financing against selective commodities. This is known as Selective Credit
Control measure. The directives of RBI to banks contain the following:
i. Purpose for which advances can be made.
ii. The margins to be maintained on secured advances.
iii. The maximum amount of advances that can be extended to any constituent.
iv. The interest rate to be charged, as well as other terms and conditions for extending advances.
In the past advances against price sensitive commodities such as food grains, cotton, kappas, oils seeds (grown
indigenously such as ground nut, rapeseed, mustard, cottonseed, linseed and castor seed) and their respective
oils, all imported oils, vanaspati, sugar, kandasari and jaggery (gur) and cotton textiles including man-made
fibres, yarn and fabric made out of man-made and Cotton fibres were subject to strict guidelines under Selective
Credit Control.
Over a period due to Economic liberalization and improvements in economic environment, several of the
aforesaid commodities have been taken out of Selective Credit Control mechanism of RBI. Presently the
following are under Selective Credit Control coverage:
i. Buffer stock of Sugar with Sugar Mills.
ii. Unreleased stocks of sugar with Sugar Mills representing levy sugar as well as free sale sugar.
RBI has specified 0% margin on buffer stocks of sugar and 10% on unreleased sugar with sugar mills
representing levy sugar.
Business of Banking
The business of banking is broadly defined by section 5 & 6 section of Banking Regulation Act.
They can be classified as Primary and Secondary functions. These are as follows:
Primary
• Accepting of deposits.
• Lending and investment.
Secondary
The following forms of business in which banking companies may engage are as follows:
i. the borrowing, lending or advancing of money either upon or without security;
ii. the drawing, making, accepting, discounting, buying, selling, collecting and dealing in negotiable
instruments and quasi negotiable instruments;
iii. issuing of letters of credit, traveller’s cheques and circular notes;
iv. the buying, selling and dealing in bullion and specie;
v. the buying and selling of foreign exchange including foreign bank notes;
vi. the acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures,
debenture stock, bonds, obligations, securities and investments of all kinds;
vii. purchasing and selling of securities and bonds or other forms of securities on behalf of constituents or
others, the negotiating of loans and advances;
viii. the receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise the
providing of safe deposit vaults;
ix. the collecting and transmitting of money and securities.
Agency business
i. acting as agents for any Government or local authority or any other person or persons; the carrying on of
agency business of any description excluding the business of a Managing Agent or Secretary and Treasurer
of a company;
ii. contracting for public and private loans and negotiating and issuing the same;
iii. indulging in Merchant banking activities and the lending of money for the purpose of any such issue;
iv. carrying on and transacting every kind of guarantee and indemnity business;
v. Managing, selling and realising any property which may come into the possession of the banking company
in satisfaction or part satisfaction of any of its claims;
vi. acquiring, holding and generally dealing with any property or any right, title or interest in any such
property which may form the security or part of the security for any loans or advances or which may be
connected with any such security;
vii. undertaking and executing trusts;
viii. undertaking the administration of estates as executor, trustee or otherwise;
ix. establishing and supporting or aiding in the establishment and support of associations, institutions,
funds, trusts and conveniences calculated to benefit employees or ex-employees of the company or the
dependents or connections of such persons;
x. granting pensions and allowances and making payments towards insurance; subscribing to or guaranteeing
moneys for charitable or benevolent objects or for any exhibition or for any public, general or useful
object;
xi. the acquisition, construction, maintenance and alteration of any building or works necessary or convenient
for the purposes of the company;
xii. selling, improving, managing, developing, exchanging, leasing, mortgaging, disposing of or turning into
account or otherwise dealing with all or any part of the property and rights of the company;
xiii. acquiring and undertaking the whole or any part of the business of any person or company, when such
business is of a nature enumerated or described in this sub- section;

xiv. doing all such other things as are incidental or conducive to the promotion or advancement of the business
of the company;
xv. any other form of business which the Central Government may, specify for a banking company.
a. In pursuance of the powers available, the Central Government has permitted banking companies to
engage either departmentally or through subsidiaries in Mutual Funds, Locker services,
b. Housing finance, Life and General Insurance (Bancassurance), Credit Card Services, Wealth
management, Factoring, Forfaiting, Demat Services etc.
c. A banking company cannot engage in any form of business other than those referred to in subsection
(1) of Section 6 of the Banking Regulation Act.
d. In addition to the above, a Banking company cannot appoint managing agents or employ a person
who is an adjudicated insolvent or a person convicted by a court of moral turpitude.
Government as a Regulator of Banks

Directly or indirectly under the RBI Act, 1934 as well as The Banking Regulation Act, 1949, the Government of
India, enjoys extensive powers in the banking domain in India. This is primarily due to the following:
i. The Government of India is the owner of RBI as it holds the entire share capital of RBI.
ii. Power to appoint Governor and the Board members of the Central Board, as also removing them is vested
in the Government.
iii. Wherever necessary Government has powers to issue special directions to banks in consultation with RBI.
iv. The Government also enjoys the status of appellate jurisdiction vis-à-vis RBI in the matters of removal of
managerial persons, cancellation of banking licence, refusal of issuance of certificate regarding floating
charge on assets.
v. Besides these, the Government has powers to suspend the operation of the BR Act, 1949 or grant exemption
from the applicability of the provisions of the same on the basis of recommendations of RBI.
vi. The Government has power to determine the forms of business a banking company can do under Sec. 6(1)
of the BR Act.
vii. Powers to make rules under Section 52 and 45 Y reside with the Government
viii. The Government also enjoys numerous powers for permitting formation of subsidiary for some business
activities, notifying banks for maintenance of assets under Section 24, with reference to accounts and
balance sheet, direction for inspection of banks, acquire undertakings, appointment of court liquidator,
suspension of business, amalgamation of banks etc.
The Government being the majority share holder in case of SBI, Public Sector Banks etc. also enjoys statutory
powers granted under such statues.
Control over Co-operative Banks

A Cooperative Bank by basic constitution is a cooperative society governed by Cooperative Act of either Central
Government or State Government. Due to an amendment in 1965, cooperative banks come under the jurisdiction
of RBI in the matters of licensing and regulation of banking business. Therefore cooperative banks face dual
control from Central Government (in case of Multi State Cooperative Banks)/State governments and RBI.
Cooperative banks operating in more than one state are known as multi-state cooperative banks. These are
regulated by Multi-State Cooperative Societies Act, 2002 as far as their cooperative aspects are concerned. The
Registrar of Multi-state Cooperative Societies appointed by the central government oversees their functions
other than licensing and regulation of banking business are concerned. Their licensing and banking functions
come under the jurisdiction of RBI.
On the contrary, banks which operate within a state come under the State Cooperative Societies Act and are
monitored by Registrar of Cooperative societies of the respective states. Registrar of Cooperatives enjoys vast
powers under the Cooperative Societies Act. However their banking functions come under the jurisdiction of
RBI as in the case of Multi-State Cooperative Banks.
The Government of India on 24th June, 2020 has approved an ordinance to bring all cooperative banks i.e. 1,482
urban cooperative banks and 58 multi-state cooperative banks, under the supervisory powers of the RBI.
This will become effective from the date of President of India’s assent to the ordinance.
Regulation by other Authorities

Apart from RBI, the banking companies come under regulatory jurisdiction of the following Authorities, during
the course of business conducted by themselves or through subsidiaries. Major regulators are listed and list is
not exhaustive.
S. No. Function/Reasons Regulatory Authorities

1 Incorporation as a corporate body/cooperative Registrar of Companies/Registrar of Cooperatives
body/ entity with Registered office. (State & Central)
2 Profit earning entities through services provided Income Tax authorities/ GST Authorities
to customers
3 Employing large number of personnel Labour law authorities/Employment Exchanges.
4 Having a place of business/branch Local bodies such as Municipal Authorities/
Nagar ‘panchayats’ etc.
5 Offering Equity participation to public/ providing Securities Exchange Board of India
Demat accounts to customers /Merchant banking
6 Offering bancassurance products Insurance Regulation and Development Authority
7 Housing Finance subsidiaries NHB
8 Overseas subsidiaries Host country Regulators/ supervisors
9 ADR/GDR issued by Indian banks. Respective country’s capital market authorities
like Security Exchange Commission.
LESSON ROUND UP
• The Reserve Bank of India Act, 1934 was enacted with a view to constitute RBI to regulate issue of bank
notes and to control monetary and banking system.
• Banking Regulation Act, 1949 came into the picture which played a very important role in controlling
the banking sector & the activities related to it.
• Through the RBI Act, 1934 the role of issuance of notes was allotted to RBI in order to bring in a stability
in the economy of India.
• The constitution of RBI started with an initial capital of Rs. 5 crores which is wholly owned by
Government of India from 1st Jan 1949, prior to which it was owned by public shareholders.
• Through different quantitative & qualitative measures, the RBI manages monetary stability and plays a
critical role to monitor Indian banking system.
• The objectives of RBI are: i) to regulate the issue of Bank notes. ii) To keep reserves with a view to
securing monetary stability in India iii) to operate the currency and credit system of the country to
its advantage iv) To operate the monetary policy for maintaining price stability while keeping in mind
objective of growth.
• Banking Regulation Act, 1949 provides detailed provisions on acceptance of deposits and nomination
facilities.
• RBI has come up with different rules regarding issuance of card products.
• In order to settle down customer complaints against different commercial banks, RBI has come up with
the Banking Ombudsman Scheme.
• In order to make effective control of the monetary system, RBI uses different tools like Bank rate, SLR,
CRR etc.
• RBI uses selective credit controls to channelize the flow of credit to desired sectors and to restrict the
flow of credit to sensitive sectors.
• The Government of India through various Acts, Regulations etc. (including Regulations of Self-
Regulatory Bodies, e.g. SEBI) regulates different aspects of Banking Business.
GLOSSARY
Monetary Policy a committee of the Reserve Bank of India that is responsible for fixing the
Committee (‘MPC’) benchmark interest rate in India.
Liquidity Adjustment is a monetary policy tool which allows banks to borrow money through
Facility (‘LAF’) repurchase agreements
Marginal Standing is the rate at which the banks are able to borrow overnight funds from RBI
Facility (‘MSF’) against the approved government securities.
Open Market refer to the buying and selling of government securities in the open market in
Operations (‘OMO’s) order to expand or contract the amount of money in the banking system.
Market Stabilization a monetary policy intervention by RBI to withdraw excess liquidity or money
Scheme (MSS) supply by selling government securities in the economy.
Automated Teller a machine that dispenses cash or performs other banking services when an
Machine (ATM) account holder inserts a bank card
Payment and provides for the regulation and supervision of payment systems in India and
Settlement Systems Act, designates the Reserve Bank of India (Reserve Bank) as the authority for that
2007 (‘PSS Act’) purpose and all related matters.
Foreign Exchange This is an Act of the Parliament of India “to consolidate and amend the law
Management Act, 1999 relating to foreign exchange with the objective of facilitating external trade
(FEMA) and payments and for promoting the orderly development and maintenance
of foreign exchange market in India
Repo Providing funds by RBI against collateral of government and approved
securities for short duration periods to banks against Re-purchase option of
such securities by borrowing banks.
Reverse Repo Borrowing by Reserve Bank of India, on an overnight basis, from banks against
the collateral of eligible government securities.
Repo rate is the rate at which the central bank of a country (Reserve Bank of India in
case of India) lends money to commercial banks in the event of any shortfall
of funds.
Reverse Repo rate The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an
overnight basis, from banks against the collateral of eligible government
securities.
Statutory Liquidity is the Indian government term for the reserve requirement that the commercial
Ratio banks in India are required to maintain in the form of cash, gold reserves,
government approved securities before providing credit to the customers.
Cash Reserve Ratio is a specified minimum fraction of the total deposits of customers, which
(CRR) commercial banks have to hold as reserves either in cash or as deposits with
the central bank.
Department of has the responsibility of administering the functions of currency management,
Currency Management
(‘DCM’)
Regional Rural banks are scheduled banks(Government banks) operating at regional level in
(‘RRB’s) different States of India.
TEST YOURSELF
1. Fill in the blanks
a. A scheduled bank is one which is included in the ____________ Schedule of ____________ Act.
b. Cooperative banks are regulated by ____________ and ____________ Acts.
c. Repo rate is a ____________ of RBI.
d. CRR is to be maintained under the provisions of ____________ Act and SLR is to be maintained under
the provisions of ____________ Act.
e. When a Bank sells an insurance policy it comes under the regulatory jurisdiction of _______________
_________________________________________________________.
f. The current SLR and CRR ratios are ____________ & ____________.
g. Any of the All-India Financial Institutions can be a party to Repo deals on a _______________________
______________________________________.
2. Answer the following questions.
a. Discuss the constitution of RBI.
b. How does RBI manage Issue of currency and distribution of coins.
c. What are the various credit control measures of RBI?
d. Discuss various tools of monetary controls used by RBI.
e. What are the various powers of RBI under Banking Regulation Act?
f. How does RBI control Cooperative banks in India?
LIST OF FURTHER READINGS

• The RBI Act - www.rbidocs.org
• The Banking Regulation Act - www.rbidocs .org
• Commentaries by various authors available in internet
• Banking Law and Practice - P.N. Varshney, 25th Edition.
• Law and Practice of Banking in India - M L Tannan
Lesson 3 • Control Over Organization of Banks 57
Control Over
Lesson 3
Organization of Banks
Should Know
• Organization RBI exercises control over Banking Banking Regulation Act, 1949
for Economic companies in different ways. This
Cooperation and lesson will enable a reader to learn
Development in detail about:
• Licensing policy of
• World Trade
Organisation - various banks
• Point of Sale (PoS) - branches of various banks

• Paid Capital and Reserves
• Cash Deposit stipulated for different banks.
Machines
• Shareholding in Banking
• Foreign Direct Companies and its restrictions.
Investment • Setting up of Subsidiaries of
Banking Companies.
• Board of Directors in Banking
Companies.
• Constitution and set-up.
• Chairman of Banking Company.
• Appointment of Additional
Directors.
• Restrictions on Employment by
banks.
• Control over Management,
Directors and other officials of
banks.
• Corporate Governance aspects
of banks in India.
Lesson Outline
• Introcution • Chairman of Banking Company
• Licensing of Banking Companies • Appointment of Additional
• Branch Licensing Directors
• Paid up Capital and Reserves of • Restrictions on Employment
Banking Companies • Control over Management
• Shareholding in Banking Directors
Companies • Corporate Governance
• Subsidiaries of Banking • LESSON ROUND UP
Companies • GLOSSARY
• Board of Directors in Banking • TEST YOURSELF
Companies
57
INTRODUCTION
RBI exercises control over banks through the power conferred on it by the Banking Regulation Act, 1949 (B
R Act). The contents of this chapter therefore cover in detail, regulations concerning licensing to corporate
governance of banks. The contents will expose a student to a deeper level of understanding of applicability of B
R Act provisions on banks. The contents are of Level 1 & 2 mix.
Statutory Background
Before the Banking Regulation Act, 1949 was enacted, the provisions of Part XA of the Indian Companies Act,
1913 (as amended in 1936) were made applicable, as a law relating to banking companies. While company law
provisions were enacted to safeguard the interests of shareholders, the protection of interest of depositors was
found to be inadequate in that legislation. Therefore a separate legislation as known as Banking Companies Act
was introduced through a bill in 1944. This bill was passed in 1949 and was named as the Banking Companies
Act, 1949. With the introduction of Banking Laws (Application to Cooperative Societies) Act, 1965, the Banking
Companies Act was renamed as The Banking Regulation Act 1949 (B R Act).
Licensing of Banking companies forms part of the Banking Regulation Act, 1949. To commence and operate
banking business in India, every banking company needs a licence in terms of Section 22 of the Banking
Regulation Act, 1949. Before issuing a licence, the applicant company needs to satisfy RBI about the fulfillment
of following conditions:
(i) The company has adequate financial strength or will have strength to pay its present or future depositors
in full as and when their claims arise;
(ii) That the company has adequate capital structure and earning prospects;
(iii) The potential scope for expansion of banks is there in the area;
(iv) That the affairs of the company are not and will not be detrimental to the interests of its present or future
depositors;
(v) That the character of the management of the applicant bank will not be prejudicial to the public interest
or the interest of its depositors.
At the time of commencement of Banking Regulation Act, 1949 existing banks at that juncture were required
to apply for a licence within six months. They were allowed to continue till their application was rejected. One
of the objectives behind licensing was to discourage banks which were operating not on sound lines and also
indiscriminate formation of banks.
ISSUING OF LICENCE
Issuing Licenses to an applicant bank is at the discretion of RBI. Before a licence is issued RBI satisfies itself
regarding the ‘Tests of entry’ namely :
RBI may also scrutinize the books of accounts of the applicant company and also gather market information to
satisfy itself about the advisability of granting a licence.
Section 11(2) & Section 11(3) of Banking Regulation Act,1949 specifies a minimum capital and reserves for a
foreign bank, local banks operating in more than one state and in one state. RBI has powers to specify a higher
amount of paid up capital for the purpose of licensing.
Refusal of license by RBI

The granting of licence or refusal of RBI, if based on relevant material and germane consideration, cannot be
challenged in a court of law. In the matter of Shivabhai Zaverbhai Patel vs. RBI AIR 1986 Guj. 19; (1985) 1 GLR
257, Hon’ble High Court of Gujarat upheld the RBI’s decision of rejection of application for a banking licence
which was based on diligent study and material facts.
LICENSING OF FOREIGN BANKS IN INDIA

Foreign banks wishing to open a branch in India require a licence under the Banking Regulation Act, 1949. India
issues a single class of banking licence unlike some other countries. No undue restrictions are placed on them
on their operations. In some countries there is a requirement of multiple licences for dealing in local currency
and foreign currencies with different categories of clientele. Like domestic banks foreign banks enjoy similar
facilities to the payments and settlement systems and they are admitted as full members of clearing houses and
payments system.
Procedurally, foreign banks are required to apply to RBI for opening their branches in India. Foreign banks’
application for opening their maiden branch is considered under the provisions of Section 22 of the Banking
Regulation Act,1949. Before granting any licence under this section, RBI may require to be satisfied that the
Government or the law of the country in which it is incorporated does not discriminate in any way against
banks from India. Other conditions as enumerated in section 2(5) of the Banking Regulation Act, 1949 are also
required to be fulfilled.
Unlike the restrictive practices of certain foreign countries, India is liberal in respect of the licensing and
operation of the foreign bank branches as illustrated by the following:
• India issues a single class of banking licence to foreign banks and does not place any limitations on their
operations. All banks can carry on both retail and wholesale banking.
• Deposit insurance cover is uniformly available to all foreign banks operating in India at a non- discriminatory
rate of premium.
• The norms for capital adequacy, income recognition and asset classification are by and large the same.
Other prudential norms such as exposure limits are the same as those applicable to Indian banks.
Licencing of private sector banks in India

Prior to 1993 licensing of Private Sector banks were done in a routine way under Section 22 of the Banking
Regulation Act, 1949. In the year 1993 the RBI has announced a new set of guidelines as a part of economic
liberalization in that year and a few in the subsequent years. In 2001 the RBI had revised the guidelines for
licensing Private Sector banks in India and two more banks namely Kotak Bank and Yes Bank were issued
licences. The policy was known as ‘Stop and Go’. In February 2013, a need was felt for reviewing of the licensing
of banks under ‘Stop and Go’ in view of emerging scenarios in International banking and Indian banking, and
also in the light of recommendations of Raghuram G. Rajan Committee and other points of view, RBI decided to
have an explicit policy on banking structure. After due deliberations, existing ‘Stop and Go’ licensing policy was
reviwed and in its place a ‘continuous authorization [or on tap]’ policy was announced with effect from August
1, 2016, with a view to increase the level of competition and bring new ideas into the system.
The salient features of continuous authorization policy

(a) Individuals/professionals who are ‘residents’ or (‘residents’ as per FEMA definition) with 10 years of
experience in banking and finance at a senior level would be eligible to promote banks, singly or jointly.
(b) Entities/groups in the private sector which are ‘owned and controlled by ‘residents’ [as per FEMA
definition], having a successful track record for at least 10 years, with total assets of Rs. 50 billion or more,
where in non-financial business of the group does not exceed 40% or more in terms of total assets / in
terms of gross income are also eligible to promote banks.
(c) Existing Non-Banking Financial Companies (NBFCs), that are ‘controlled by residents’ [as per FEMA
definition], with a successful track record for at least 10 years will be eligible to convert into a bank or
promote a new bank.
[Note: Any NBFC, which is a part of the group that has total assets of Rs. 50 billion or more and that the
non-financial business of the group accounts for 40 per cent or more in terms of total assets / in terms of
gross income, is not eligible.]
(d) ‘Fit and Proper’ criteria: The RBI assess the promoters under the following parameters to ‘decide
whether such promoters are ‘fit and proper’ for promoting banks.
(i) Where promoters are individuals: Each of the Promoters should have a minimum 10 years of
experience in banking and finance at a senior level. The Promoters should have a past record of sound
credentials and integrity. The Promoters should be financially sound and should have a successful
track record for at least 10 years.
(ii) Where promoters are entities / NBFCs: The promoting entity / promoter group should have a
minimum 10 years of experience in running its / their businesses. The promoting entity and the
promoter group should have a past record of sound credentials and integrity. The promoting entity
and the promoter group should be financially sound and should have a successful track record for at
least 10 years. Preference will be given to promoting entities having diversified shareholding.
As an extension of licensing condition the RBI enumerated detailed guidelines in respect of corporate structure
for the applicant that seeks licence as below:
With Non-Operative Financial Holding Company (NOFHC)
(a) In the case of promoters being individuals or standalone promoting / converting entities who / which do
not have other group entities, the requirement of Non-Operative Financial Holding Company (NOFHC)
is not mandatory and such promoters would have the option of setting up / converting into a banking
company under the Companies Act, 2013. However, in case other group entities are proposed to be
established after the bank is incorporated, the bank should move to the NOFHC structure.
(b) In case the proposal is for setting up / conversion into a bank, any change in shareholding of 5% or more,
within the promoting / converting entity from the date of application to the RBI, of the voting equity
capital of the promoting / converting entity, shall be reported to the RBI.
Structure with Non-Operative Financial Holding Company (NOFHC)

In case the individual promoters / promoting entities / converting entities have other group entities, the bank
shall be set up only through a NOFHC. In such cases, the following conditions will be applicable:
(a) The NOFHC shall be registered with RBI as a Non-Banking Financial Company (NBFC).
(b) Not less than 51 per cent of the total paid-up equity capital of the NOFHC shall be owned by the Promoter
/ Promoter Group.
(c) The NOFHC shall hold the bank as well as all the other financial services entities of the Group regulated by
RBI or other financial sector regulators. The objective is that the Holding Company should ring fence the
regulated financial services entities of the Group, including the bank, from other activities of the Group
i.e. commercial, and financial activities not regulated by financial sector regulators and also that the bank
should be ring fenced from other regulated financial activities of the Group.
(d) Only those regulated financial sector entities in which the individual Promoter(s) group have significant
influence or control will be held under the NOFHC.
(e) The financial services entities whose shares are held by the NOFHC cannot be shareholders of the NOFHC.
(f) Apart from setting up the bank, the NOFHC shall not be permitted to set up any new financial services
entity for at least three years from the date of commencement of business of the NOFHC. However, this
would not preclude the bank from having a subsidiary or joint venture or associate, where it is legally
required or specifically permitted by RBI.
RBI has clarified that:
(i) Specialised activities, such as, insurance, mutual funds, stock broking, infrastructure debt funds, etc. to be
conducted through a separate Subsidiary / Joint Venture / Associate structure.
(ii) A bank can conduct activities such as Credit cards, Primary dealers, Leasing, Hire purchase, Factoring,
etc., either from within the bank or through a separate outside structure (Subsidiary / Joint Venture /
Associate).
Accordingly, the activities at (i) above and activities at (ii) above which are to be / proposed to be carried out
outside the bank may be carried out through separate financial entities under the NOFHC.
If Promoters desire to continue existing specialized activities from a separate entity proposed to be held under
the NOFHC, prior approval from RBI would be required and it should be ensured that similar activities are not
conducted through the bank.
Activities which are not permitted for a bank would also not be permitted to the group i.e. entities under the
NOFHC would not be permitted to engage in activities that the bank is not permitted to engage in.
Licensing of Local Area Banks

In the year 1996 the RBI decided to allow LocaI Area Bank (LABs) to be set up in the private sector for bridging
gaps as well enhance credit availability in the rural and semi-urban areas in the country to provide competitive
financial intermediation.
Minimum start-up capital of a LocaI Area Bank was stipulated at Rs.5 crore which should be brought upfront.
A family among the promoter group was permitted to hold not more than 40% of the capital. Non-Resident
Indians were also allowed to contribute a maximum equity of 40% of the paid-up capital. A lock-in-period of 3
years was fixed for capital contributed by promoters (including their friends and relatives/associates) from the
date of licensing of the bank. Promoter’s capital is to be locked up for further period of 2 years beyond the initial
period of 3 years subject to a review before expiry of five years from the date of licensing of the bank.
LABs can be promoted by individuals, corporate entities and societies. NRI promoters cannot exceed 20%
of the total number of promoters. Individual shareholder voting rights are restricted a ceiling of 10% of total
voting rights as stipulated under Section 12 (2) of the Banking Regulation Act, 1949. The LAB’s area operation
is restricted up to 3 contiguous districts, geographically. LAB has to focus on local customers in rural and semi-
urban areas to reduce credit gaps.
Permitted activities of a LAB include financing agriculture and allied activities, SSI, agro-industrial activities,
trading activities and non-farm sector. Forty per cent of their net bank credit should go to priority sector and
their lending to weaker section was to be at least 25% of their priority sector lending.
A LAB has to be registered as a public limited company under the Companies Act, 2013 To get licensed under
the Banking Regulation Act, 1949 and would be eligible for inclusion in the Second Schedule of the RBI Act,
1934. As far as liquidity requirements and interest rates are concerned, such banks would be governed by
the provisions applicable to the Regional Rural Banks under the Regional Rural Banks Act, 1976. These banks
would be subject to prudential norms, capital adequacy, accounting policies and other policies as laid down by
RBI from time to time. As per the procedure followed, RBI initially grants an in-principle approval along with
terms and conditions for setting up an LAB. Once these terms and conditions are fulfilled a licence is granted.
LICENSING OF DIFFERENTIATED BANKS – SMALL FINANCE BANK AND PAYMENTS BANK
Small Finance Bank (SFB)

SFBs can be promoted by resident individuals/professionals with 10 years of experience in banking and finance
as well as companies and societies owned and controlled by residents. Existing Non-Banking Finance Companies
(NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) that are owned and controlled by
residents are also permitted to convert themselves in to SFBs. Promoter/promoter groups should have a five
year successful record of professional experience or of running their businesses are eligible to promote small
finance banks.
The minimum paid-up equity capital for SFB should be Rs. 100 crore with a leverage ratio not less than 3 per
cent, i.e., its outside liabilities should not exceed 33.33 times its net worth (paid-up capital and reserves). The
promoter’s minimum initial contribution has to be at least 40% of paid-up equity capital for the first five years
from the commencement of its business and gradually brought down to 26 per cent within 12 years from the
date of commencement of business of the bank. On 5th December 2019 Reserve Bank of India released on its
website, “Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector”.
Major changes from the earlier Guidelines on Small Finance Banks dated November 27, 2014, are
(i) The licensing window will be open on-tap;
(ii) minimum paid-up voting equity capital / net worth requirement shall be Rs. 200 crore;
(iii) for Primary (Urban) Co-operative Banks (UCBs), desirous of voluntarily transiting into Small Finance
Banks (SFBs) initial requirement of net worth shall be at Rs. 100 crore, which will have to be increased to
Rs. 200 crore within five years from the date of commencement of business. Incidentally, the net-worth of
all SFBs currently in operation is in excess of Rs, 200 crore;
(iv) SFBs will be given scheduled bank status immediately upon commencement of operations;
(v) SFBs will have general permission to open banking outlets from the date of commencement of operations;
(vi) Payments Banks can apply for conversion into SFB after five years of operations, if they are otherwise
eligible as per these guidelines.
According to the clarification issued by RBI, in March 2020, the term ‘paid-up equity capital’ means ‘paid-up
voting equity capital’. Further it has also been clarified by RBI, regarding cessation or exit of a promoter after
completion of a period of five years, would depend on the RBI’s regulatory and supervisory comfort / discomfort
and SEBI regulations in this regard at that time. The foreign shareholding is allowed and would be as per the
Foreign Direct Investment (FDI) policy for private sector banks as amended from time to time. SFBs are subject
to all prudential norms applicable to existing Commercial banks including CRR, SLR.
The small finance banks will be required to extend 75 per cent of its Adjusted Net Bank Credit (ANBC) to the
sectors eligible for classification as priority sector lending (PSL) by the Reserve Bank. At least 50 per cent of
its loan portfolio should constitute loans and advances of upto Rs. 25 lakh. If a SFB wants to convert in to a
universal bank, it would be subject to fulfilling minimum paid-up capital / net worth requirement as applicable
to universal banks, its track record of performance as a SFB and the RBI’s due diligence exercise.
For granting of licenses an External Advisory Committee (EAC) comprising eminent professionals will evaluate
the applications. On the basis of evaluation, RBI will issue an in-principle approval for setting up of a SFB or
otherwise. RBI decision will be final. The in-principle approval issued by the Reserve Bank will be valid for
eighteen months.
Note: Further to the matters covered in Lesson 1, the above forms part of the licensing aspects of SFBs.
Payment Banks (‘PB’)

Banks can be promoted by:
(i) Existing non-bank Pre-paid Payment Instrument (PPI) issuers;
(ii) Individuals/professionals;
(iii) NBFCs, Corporate Business Correspondents(BCs);
(iv) Mobile telephone companies;
(v) Super-market chain;
(vi) Companies;
(vii) Real sector cooperatives; that are owned and controlled by residents; and
(viii) Public sector entities.
A promoter/promoter group can have a joint venture with an existing scheduled commercial bank to set up a
payments bank. Scheduled commercial banks can take equity stake as permitted under Section 19 (2) of the
Banking Regulation Act,1949. Promoter/promoter groups should be ‘fit and proper’ with a sound track record
of professional experience or running their businesses for at least a period of five years in order to be eligible
to promote payments banks.
PBs can accept demand deposits and they will initially be restricted to hold a maximum balance of Rs. 100,000
per individual customer which later in April, 2021 increased up to Rs. 2,00,000 per individual customer.
PBs are also permitted to :
• issue ATM/debit cards (but cannot issue credit cards);
• offer Payments and remittance services through various channels;
• function as Business Correspondent of another bank as per RBI guidelines;
• distribute non-risk sharing products like mutual fund units and insurance products, etc.
PBs cannot undertake lending activities. Apart from maintaining CRR with the RBI, a PB is required to invest
minimum 75% of its “demand deposit balances” in SLR securities with maturity up to one year and hold
maximum 25% in current and time/fixed deposits with other Scheduled Commercial banks for operational and
liquidity management.
Right from the beginning a PB should be “fully networked and technology driven” as per the standards generally
accepted and norms. Should also have a high powered Customer Grievances Cell to handle customer complaints.
Procedure for granting license and its validity is similar to that of SFBs.
Following table depicts salient differences between Payment Banks and Small Finance Banks.
Payment Banks Small Finance Banks
Payment Banks (PBs) can receive deposits and Small Finance Banks( SFBs) will lend to unserved and
remittances but can not lend. underserved sections including small business unit,
micro and small industries and small and marginal
farmers.
Deposits from a customer should not exceed Rs. 2 It can provide basic services of excepting deposits
Lakh. and lending.
Cannot give loans and cannot issue credit cards but No restriction of area of operation.
can issue ATM/Debit Card.
Can distribute non-risk financial products such as, Loan portfolio to the extent of 50% or more should
Mutual Funds and Insurance Products. constitute loans and advances of upto Rs. 25 Lakhs.
BRANCH LICENSING
Every company or entity wishing to commence or for carrying on an activity of banking, should obtain a licence
under Section 22 of the Banking Regulation Act, 1949. In addition to this, in terms of Section 23 (1) (a), (b)
of the Banking Regulation Act, 1949, RBI’s permission is also needed for opening a new ‘place of business’ or
changing of location of existing place of business. However if the change of location is within the same city,
town or village such prior permission is not needed. Similarly a banking company incorporated in India, needs
prior RBI permission to open a new place of business or change a place business (except when the change of
place is within the same city, town or village) outside India. Place of business has been defined as “includes any
sub-office, pay office, sub pay office and any place of business at which deposits are received, cheques cashed
or moneys lent.”
Where an existing place of business is there, a Bank may open a temporary place for business up to one month in
an exhibition, mela, conference and similar occassion, no prior permission from RBI is required. The temporary
facility has to be within limits of the city or town or village of the existing place of business.
Before granting any permission under this section, the RBI needs to be satisfied through inspection under
Section 35 of the Banking Regulation Act, 1949 or otherwise, regarding financial condition, history of the
company, the general character of its management, the adequacy of its capital structure and earning prospects
and that public interest will be served by the opening or, change of location of the place of business.
If a banking company had failed to comply with any of the conditions imposed on it under this Section 23, the
Reserve Bank of India Act, 1934 after giving a reasonable opportunity to the bank concerned, may revoke its
permission in writing, granted earlier for opening a place of business.
Regional Rural Banks(‘RRB’s) need to route their application for opening a place of business through NABARD,
which will put its recommendation on the same and forward to RBI. RRBs also need to send an advance copy
to RBI.
Revised Branch Licensing Policy of RBI

In tune with liberalization and banking reforms, RBI has over a period of time relaxed its norms for branch
licensing. RBI has issued revised branch licensing policy covering branches and permissible methods of
outreach bearing in mind attributes of various banks and the types of services that are dispensed.
General Permission
Domestic scheduled commercial banks (other than RRBs) are permitted to open, by RBI, ‘Banking Outlets’ in
Tier 1 to Tier 6 centres (on the basis of population as per Census 2011), without prior permission in each case
otherwise specifically restricted.
‘Banking outlet’ for a domestic scheduled commercial bank (‘DSCB’), a Small Finance
Bank (‘SFB’) and a Payment Bank (‘PB’) is” a fixed point service delivery unit, manned by
either bank’s staff or its Business Correspondent where services of acceptance of deposits,
encashment of cheques/ cash withdrawal or lending of money are provided for a minimum
of 4 hours per day for atleast five days a week.”
Such an outlet should carry the usual attributes of a place of business such as signage with name of the bank
and authorisation from Head office, contact details of the controlling authorities and complaint escalation
mechanism. It should be regularly monitored to ensure proper supervision, ‘uninterrupted service’ (except
temporary interruptions due to telecom connectivity, etc.) and timely addressing of customer grievances. The
working hours/days need to be displayed prominently.
Any fixed point service delivery unit of the bank which does not comply
with the prescription regarding minimum working hours/days will be ATMs, E-lobbies, Bunch Note
considered as a ‘Part-time Banking Outlet’. Acceptor Machines (BNAM), Cash
Extension Counters, Satellite Offices, Part-shifted Branches, Ultra Small Deposit Machines (CDM), E- Kiosks
Branches and Specialised Branches, subject to their satisfying the and Mobile Branches will not be
definition mentioned above, are eligible to be treated as independent treated as ‘Banking Outlets’.
‘Banking Outlets’ or ‘Part-time Banking Outlets’, as the case may be.
Point of Sale (PoS) terminals where limited cash withdrawal facility is allowed by banks in terms of existing norms
without having an arrangement with the concerned entities as ‘business correspondents’ will not be considered as
‘Banking Outlets’.
An Unbanked Rural Centre (URC) is defined as a rural (Tier 5 and 6) centre that does not have a CBS-enabled
‘Banking Outlet’ of a Scheduled Commercial Bank, a Payment Bank or a SFB or a Regional Rural Bank nor a branch
of a Local Area Bank or licensed Co-operative Bank for carrying out customer based banking transactions.
This is however subject to following conditions given below:
At least 25 percent of the total number of ‘Banking Outlets’ opened during a financial year must be opened in
an unbanked rural centres (Tier 5 and Tier 6).
Pro-rata benefit for part-time banking outlet will be given.
• A ‘Banking Outlet’/‘Part-time Banking Outlet’ opened in any Tier 3 to Tier 6 centre of North-Eastern States
and Sikkim as well as in any Tier 3 to 6 centre of Left-Wing Extremism (LWE) affected districts as notified
by the Government of India from time to time, will be considered as equivalent to opening a ‘Banking
Outlet’/ ‘Part-time Banking Outlet’, as the case may be, in a URC.
• A full-fledged ‘brick and mortar’ branch opened in a rural (Tier 5 and 6) centre which is already being
served by a fixed point BC outlet by any bank will also be eligible to be treated as equivalent to opening a
‘Banking Outlet’ in a URC.
• A ‘banking outlet’ opened in a rural (Tier 5 and 6) centre which is served by only a banking outlet of a
Payment Bank will also be eligible to be treated as equivalent to opening a ‘banking outlet’ in a URC for
computing compliance with the 25% norm.
• The time given to a bank for opening an outlet in a URC is one year. If a bank fails to adhere to the
requirement of opening 25% banking outlets in a year, RBI will impose penalties including restricting
opening of Tier 1 branches.
• To encourage the banks to open more outlets in URCs, they will be allowed to carry forward the benefit
of the ‘Banking Outlets’, opened in excess of the requirement in one year, for a period of next 2 years. No
extension to avail the benefit will be allowed.
• State Level Banker Committees (SLBCs) will facilitate banks to choose/indicate the place where they wish
to open a ‘banking outlet.’
• If a bank fails to open the banking outlet in the prescribed period of 1 year, SLBC convenor bank may
indicate the Centre as available for other banks to open a banking outlet. The non-member banks of the
SLBC, may also refer to the website and keep the SLBC Convenor banks informed of the centres identified
by them.
• If a bank proposes to undertake government business at any of the banking outlets/part-time banking
outlets, prior approval of the Government authority concerned as also of RBI’s Central Office, DAD should
be obtained.
Merger/Closure/ Shifting/Conversion of ‘Banking Outlets’

a. Banks having general permission are allowed to shift, merge or close all ‘Banking Outlets’ (except rural
outlets and sole semi-urban outlets) at their discretion.
b. Merger, Closure and shifting of any rural ‘Banking Outlet’ as well as a sole semi urban ‘Banking Outlet’
would require approval of the DCC (District Consultative Committee)/DLRC (District Level Review
Committee).
c. Conversion of any rural or sole semi-urban banking outlet into a full-fledged brick and mortar branch
and vice versa would not require such approval. While merging/closing/shifting/converting a rural or a
sole semi urban ‘Banking Outlet’, banks and DCC/DLRC shall ensure that the banking needs of the centre
continue to be met.
d. Banks should ensure that customers of the Banking Outlet, which is being merged/closed/shifted are
informed well in time and also continue to fulfill the role entrusted to these ‘Banking Outlets’ under the
Government sponsored programmes and Direct Benefit Transfer Schemes.
e. It may further be ensured that ‘Banking Outlets’ are shifted within the same or to a lesser population
category, i.e., semi urban ‘Banking Outlets’ to semi urban or rural centres and rural ‘Banking Outlets’ to
other rural centres.
Guidelines for Banks which do not have General Permission

Domestic Scheduled Commercial Banks from whom general permission has been withdrawn, require prior
approval of Department of Banking Regulation (DBR), Central Office, RBI for opening all their branches.
Further, in respect of their fixed point BC outlets, they shall also approach RBI for permission except for outlets
opened in Tier 5 and 6 Centres.
Small Finance Banks, Payment Banks as well as Local Area Banks (LABs) need to have prior approval of DBR,
Central Office, RBI for all categories of banking outlets.
These banks are to submit their Annual Banking Outlet Expansion Plan (ABOEP) with the consolidated details
of proposals for opening, closing, shifting, merger and conversion of these banking outlets.
The guidelines are as applicable to banks having general permission. On approval of the consolidated proposal,
individual proposals for opening branches at specific centres, for which prior permission is required from RBI,
must be submitted in the prescribed form to RBI.
4Proposals required to be submitted to RBI in this regard should have the approval of the Board of Directors
of the bank or such other authority to which powers have been delegated by the Board of the bank. Banks
shall ensure that an authenticated / certified copy of such approval is invariably submitted along with these
proposals.
Support to MFI Structure of the Small Finance Banks

In order to provide an enabling environment to preserve the advantages of the Micro Finance Institutions(‘MFI’)/
Non-Banking Financial Company (‘NBFC’) structure of SFBs they are allowed a time of 3 years from the date of
commencement of business, to comply with branch licensing guideline of RBI. Till such time, they are allowed
to continue the existing structure and would be treated as ‘Banking Outlets’ though not immediately reckoning
for the 25 per cent norm.
At the end of three years from the date of their commencement of business, all SFBs should have opened in
URCs, at least 25 per cent of their total Banking Outlets failing which penal measures including restrictions on
further expansion by such banks will be considered and imposed. This is for ensuring a level playing field for
all such entities.
Manning of ATMs/E-kiosks/CDMs/BNAMs/Mobile Branches

Banks are allowed to set up onsite/offsite Automated Teller Machines (ATMs) at centres/places identified by
them, including SEZs. Banks are permitted to post suitable staff member(s) to provide guidance to the customers
using the services of these outlets. Such ATMs shall not be reckoned as ‘banking outlets’. Banks are allowed to
open/operate mobile branches in all Centres. These mobile branches will not be considered as Banking Outlets.
Setting up of Administrative Offices, Back Offices (Central Processing Centres/Service

Branches) and Call Centres etc.
Banks having general permission can set up Administrative Offices (Head/Regional/Zonal Offices etc.),
Training Centres, Back Offices (Central Processing Centres (CPCs)/Service Branches), Treasury Branches and
Call Centres, etc. without prior permission from Reserve Bank of India.
The banks should ensure that back offices i.e. CPCs/Service Branches which are set up exclusively to attend
to back office functions such as data processing, verification and processing of documents, issuance of cheque
books, etc. should not have any direct interface with customers for them to be not considered as banking outlets.
Information as per specified formats regarding opening, merger, conversion, closure etc. of Business outlets
are to be communicated to Department of Statistics and Information Management (DSIM) of RBI on a quarterly
basis (instead of Annual basis) with effect from April 2017.
Opening of branches in India by Foreign banks

The policy for approving foreign banks applications to open maiden branch and further expand their branch
presence has been incorporated in the ‘Roadmap for presence of Foreign banks in India’ indicated in the Press
Release dated February 28, 2005 as well as in the liberalized branch authorisation policy issued on September
8, 2005. The branch authorisation policy for Indian banks has been made applicable to foreign banks subject
to the following:
• Foreign banks are required to bring an assigned capital of US $25 million up front at the time of opening
the first branch in India.
• Existing foreign banks having only one branch would have to comply with the above requirement before
their request for opening of second branch is considered.
• Foreign banks may submit their branch expansion plan on an annual basis.
• In addition to the parameters laid down for Indian banks, the following parameters would also be
considered for foreign banks :
¡ Foreign bank and its group’s track record of compliance and functioning in the global markets would
be considered. Reports from home country supervisors will be sought, wherever necessary.
¡ Weightage would be given to even distribution of home countries of foreign banks having presence
in India.
¡ The treatment extended to Indian banks in the home country of the applicant foreign bank would be
considered.
¡
Due consideration would be given to the bilateral and diplomatic relations between India and the
home country.
¡ The branch expansion of foreign banks would be Financially Sound and Well Managed
considered keeping in view India’s commitments (FSWM) UCBs are those which satisfy following
at World Trade Organisation (WTO). Licences criteria:
issued for off-site ATMs installed by foreign (a) Capital to Risk Assets Ratio not less than
banks are not included in the ceiling of 12 10 per cent;
(explained below). (b) Gross NPA of less than 7% and Net NPAs
not more than 3%;
In terms of India’s commitment to WTO, as a part of market
(c) Net profit for at least three out of
access, India is committed to permit opening of 12 branches
the preceding four years subject to it
of foreign banks every year. Reserve Bank of India has
not having incurred a net loss in the
permitted more number of branches in the past. The Bank immediate preceding year;
follows a liberal policy where the branches are sought to be
(d) No default in the maintenance of CRR /
opened in unbanked/under-banked areas. Off-site ATMs
SLR during the preceding financial year;
are not counted for the purpose of calculation of limit.
(e) Sound internal control system with at
Branch licensing policy for Regional Rural least two professional directors on the
Banks (RRBs) Board;
(f) Core Banking Solution (CBS) fully
• RRBs are required to obtain prior approval of implemented; and
RBI for opening new branches in Tier 1 centres.
(g) the bank should have track record of
The applications will be considered on a very regulatory compliance and no monetary
selective basis on merits of each case including the penalty should have been imposed on
overall financial position of the RRB, quality of its violation of any RBI directives / guidelines
management, efficacy of the internal control system, during the last two financial years.
CBS compliance and other relevant factors.
• RRBs are permitted to open branches in Tier 2 to Tier 6 centers (with population of up to 99,999 as
per Census 2001) without having the need to take prior permission from RBI in each case, subject to
reporting, provided they fulfill the conditions laid down in this regard. RRBs which do not satisfy the said
conditions should obtain prior approval from the Regional Office of RBI.
• RRBs which require prior approval for opening branches should submit applications to the concerned
Regional Office of the Reserve Bank, through respective Regional Office of NABARD in the prescribed Forms
under Banking Companies Rules, 1949 which will give its comments on the merits of the application.
• The RRBs need to submit an advance copy of the application to the concerned Regional Office of the RBI.
• RRBs should open at least 25 percent of the total number of branches proposed to be opened during a year
in unbanked rural (Tier 5 and Tier 6) centres.
Recently RBI has issued a separate Branch licensing policy for RRBs. It is as follows:
Opening of Banking Outlets by Regional Rural Banks

Regional Rural Banks are permitted to open banking outlets in Tier 1 to Tier 6 centres subject to the following:
Prior RBI approval is required for opening of banking outlets (excluding BC outlets) in Tier 1 to 4 centres, RRBs
have to fulfill the following conditions:
(a) Minimum CRAR of 9% .

(b) Net NPA ratio does not exceed five percent.
(c) No default in maintenance of CRR and SLR during last two years.
(d) Should have registered net profit in the previous financial year.
(e) All branches and Head offices of the RRB should be CBS compliant and have in place system generated NPA
recognition.
No specific approval is needed from RBI for opening banking outlets in rural centres (i.e. Tier 5 and 6 centres)
in each case, subject to post facto reporting (within seven days of opening a banking outlet) to Regional Office
RBI. Only after the RRB has achieved the target of opening 25 percent of the total banking outlets in unbanked
rural centres, during the previous financial year, permission for opening new branches in tier 1 to 4 centres will
be granted in the current year. If they fail to achieve no permission will be granted for opening branches in tier
1 to 4 in the current year. RRBs opening branches in Tier 5 and 6 centres, may approach the Regional Office
concerned of RBI for post-facto automatic issue of the licence/s. Such licences should be displayed in branches
for the information of customers. Regional Office concerned of RBI, through the Empowered Committee on
Regional Rural Banks, will be monitoring opening/ closing/shifting /merger of banking outlets of the RRBs
under their jurisdiction.
Directions for opening of ‘Banking Outlets’ during a financial year will be subject to the following conditions:
• At least 25% of the total number of banking outlets opened during a financial year must be opened in
unbanked rural centres. A part-time banking outlet, opened in any Centre, will be counted and added to
the denominator as well as numerator on pro rata basis for computing the requirement as well as the
compliance with the norm of opening 25% banking outlets in unbanked rural centres.
• A banking outlet/part-time banking outlet opened in any Tier 3 to Tier 6 centre of North-Eastern States
as well as in any Tier 3 to 6 centre of Left-Wing Extremism (LWE) affected districts as notified by the
Government of India periodically, will be considered as equivalent to opening a banking outlet/ part-time
banking outlet, as the case may be, in a URC. As the overall objective is enabling expansion of banking
facilities, each banking outlet opened, irrespective of the banked/unbanked status of the centre, will be
reckoned as having been opened in an URC.
• The first fixed point BC outlet of a bank as well as the first ‘brick and mortar’ branch of any bank opened
in a URC will be reckoned for computing compliance with the 25% norm.
• The time given to a RRB for opening a banking outlet is one year. If a bank fails to adhere to the requirement
of opening 25% banking outlets in URC in a year, appropriate penal measures, including restrictions on
opening of banking outlets in Tier 1 to 4 centres (except tier 5 and 6) shall be imposed. To encourage the
RRBs to open more number of banking outlets in unbanked rural centres, they will be allowed to carry
forward the benefit of the banking outlets, if any, opened in excess of the requirement specified in these
rules for a period of next 2 years. No further extension to avail the benefit will be allowed.
• For identifying an unbanked rural centre, State Level Bankers Committees (SLBCs) will compile and
provide an updated list of all unbanked rural centres in the state on their website. This list will help RRBs
to choose/indicate the place where they wish to open a banking outlet and coordinate with the SLBC to
earmark the centre identified by them. If a bank fails to open the banking outlet in the prescribed period
of 1 year as provided above, the SLBC convenor bank may indicate the centre as available for other banks
to open a banking outlet. Prior approval of Government Authority as well as RBI are needed if a RRB
proposes to undertake government business at any of the banking outlets/part-time banking outlets.
Merger/Closure/ Shifting/Conversion of ‘Banking Outlets’ by RRBs

RRBs can shift, merge or close all banking outlets (except rural outlets and sole semi-urban outlets) at their
discretion. Merger, closure and shifting of any rural banking outlet as well as a sole semi urban banking outlet
would require approval of the DCC/DLRC and Regional Office concerned of RBI. However, conversion of any
rural or sole semi-urban banking outlet into a full-fledged brick and mortar branch and vice versa would not
require such approval. While merging/closing/shifting/converting a rural or a sole semi urban banking outlet,
banks and DCC/DLRC shall ensure that the banking service needs at that centre continue to be met, without
disruptions.
RRBs are to ensure that customers of the banking outlet, are kept informed of merger/closure /shifting two
months in advance so as to avoid inconvenience. However RRBs to ensure that they continue to fulfil their
obligations and role entrusted to these banking outlets under the Government sponsored programmes and
Direct Benefit Transfer schemes. Also RRBs to ensure that while shifting banking outlets they are shifted within
the same or to a lesser population category , i.e., semi urban banking outlets to semi urban or rural centres and
rural banking outlets to other rural centres.
Annual Plans
RRBs are required to submit their Annual Banking Outlet Expansion Plan (ABOEP), which is approved by Board
of Directors, together with the consolidated details of proposals for opening, closing, shifting, merger and
conversion of these banking outlets as per Proforma given in these guidelines to Regional Office concerned of
RBI, and to NABARD for monitoring.
Manning of ATMs/E-kiosks/CDMs/BNAMs
RRBs are allowed to set up onsite/offsite Automated Teller Machines (ATMs) at centres/places identified by
them. Banks at their discretion may post suitable staff member(s) to provide guidance to the customers using
the services of these outlets. Such ATMs shall not be reckoned as banking outlets as defined in the circular.
Mobile Branches–Extension to all Tiers

The scheme of mobile branch envisages extension of banking facilities through a well-protected van with
arrangements for two or three officials of the bank sitting in it with books, safe containing cash, etc. The mobile
unit would visit the places proposed to be served by it on specific days/hours. The mobile offices would be
attached to a branch of an RRB.
Regional Rural Banks are allowed to open/operate mobile branches in all Centres. These mobile branches will
not be considered as ‘Banking Outlets’.
Setting up of Regional Offices, Administrative Offices, Back Offices (Central Processing

Centres/Service Branches) and Call Centres, etc.
RRBs shall be allowed to open one Regional Office (RO) for every 50 banking outlets for which they are required
to obtain licence from the concerned Regional Office of RBI prior to functioning / opening of these offices. RRBs
having up to 50 banking outlets will be under the direct control of the Head Office, without any intermediate
tier. for any relaxations in these norms due to geographical / other conditions, it has to be referred to the
Empowered Committee (EC) and referred to Central Office, Department of Banking Regulation (DBR) for
consideration.
The ROs are not permitted to transact any banking business. RRBs can either shift or close / merge these offices
at their discretion without prior approval of RBI, and report the same post-facto to the concerned Regional
Office of RBI at the earliest, but not later than one month from the date of shifting. As regards closure / merger of
such offices, the same to be communicated to the concerned Regional Office of RBI for cancellation immediately
after the closure / merger of the office under advice to the DSIM of RBI.
RRBs may set up Training Centres, Back Offices (Central Processing Centres (CPCs)/Service Branches), Treasury
Branches and Call Centres, etc. exclusively to attend to back office functions and other functions incidental to
their banking business after obtaining necessary permission from the concerned Regional Office of RBI. They
should not have any interface with customers and will not be allowed to be converted into general banking
branches.
RRBs to ensure that administrative offices, training centres, back offices do not have any direct interface with
customers for them to be not considered as banking outlets. Banks currently having specific permission to
allow customer interface at these back offices (service branches and/or CPCs), have to align with the above
instructions within one year from the date of this circular and report compliance to Regional offices concerned
of RBI.
Business Facilitator/ Business Correspondent Model

RRBs to follow instructions on Business Facilitators/Business Correspondents as notified in July 2015. They
are also required to follow instructions on Customer Education as advised in Master Circular dated July 1, 2015.
The instructions on Business Facilitator/Business Correspondent Model as contained in our Master Circular
DBR.CO.RRB.BL.BC.No.17/31.01.002/2015-16 dated July 01, 2015 remain unchanged.
Reporting Requirements
RRBs shall furnish the information on opening of new place of business i.e. branch/office/NAIOs (Non-
Administratively Independent Office) as per Proforma I and any change on change in status – merger, conversion,
closure, etc. Proforma II given in these instructions to Banking Statistics Division, Reserve Bank of India, Central
Office, C-8/9, Bandra-Kurla Complex, Mumbai-400051.
RRBs are also required to report regarding fixed point BC outlets classified as banking outlets, as per Annex VIII
on quarterly basis starting from April 01, 2018. In order to furnish the initial statistics, banks have to furnish
the first such report to DSIM, Reserve Bank of India (position as on March 31, 2017), not later than one month
from the date of issue of this Circular. From the year 2018-19, the reporting on opening of branches to the
Department of Banking Regulation, Central Office has been dispensed with.
Scheme for setting up of IFSC Banking Units (IBU) by Indian Banks

The RBI had issued a notification under FEMA vide Notification No. FEMA.339/2015-RB dated March 02, 2015
setting out RBI regulations relating to financial institutions set up in International Financial Services Centres
(IFSC). In line with the above Notification, RBI has formulated a detailed scheme applicable for Indian banks and
foreign banks already having presence in India for setting up of IFSC Banking Units (IBUs) by banks in IFSCs.
The scheme covers Eligibility criteria, Licensing, Capital, Reserve requirements, Resources and deployment,
Permissible activities, Prudential regulations, Anti-Money Laundering Measures, Regulation, Supervision,
Reporting, Ring fencing of activities, Priority sector Lending, deposit Insurance, Lender of last resort etc. Since
these are highly specialised units, elaborate details can be accessed through circulars dated January 21, 2020,
December 23, 2019 and April 15, 2015 of RBI.
Licensing of Urban Co-operative Bank (UCB) branches

Introduction
On July 1, 2015 RBI liberalised and rationalised the branch authorisation norms for Financially Sound and Well
Managed (FSWM) UCBs in the States that have signed Memorandum of Understanding (MoU) with it, as well as
those registered under Multi-State Co-operative Societies Act, 2002. The present policy is given in the following
paragraphs.
Eligibility Criteria
• FSWM UCBs will be eligible to open branches/Extension Counters (ECs) in their approved area of operation
beyond the current annual ceiling of 10 per cent and upgrade ECs which are in operation for more than
three years, provided they have the required headroom capital in terms of assessed net worth (ANW) per
branch, including existing branches and subject to fulfillment of the six FSWM criteria.
Classification of UCBs
Tier I Banks
(i) Banks having deposits below Rs.100 crore operating in a single district;
(ii) Banks with deposits below Rs.100 crore operating in more than one district will be treated as Tier I
provided the branches are in contiguous districts and deposits and advances of branches in one district
separately constitute at least 95 per cent of the total deposits and advances respectively of the bank; and
(iii) Banks with deposits below Rs.100 crore, whose branches were originally in a single district but
subsequently, became multi-district due to reorganisation of the district may also be treated as Tier I
UCBs.
Tier II Banks: All other Banks
(Deposit and advances are reckoned as on 31st March of the immediate by preceding financial year).
FSWM UCBs should maintain a minimum CRAR of 10 per cent on a continuous basis with minimum Assessed
Net Worth (ANW) commensurate with the prevalent entry point capital norms for the centre where branch is
proposed / where it is registered. Entry point norms for various categories of UCBs are given as below.
In the tables below A, B, C and D denote centres with the following population:
Category of centre Population
A Over 10 lakh
B 5 lakh and above but less than 10 lakh
C 1 lakh and above but less than 5 lakh
D Less than 1 lakh
I. Entry Point Norms for General Category
Particulars A B C D
Assessed Net Worth (Rs. lakh) 400 200 100 25
Membership 3000 2000 1500 500
II. Entry Point Capital Norms for Unit Banks /Banks organised by Mahilas/SCs/STs and those
organised in less developed States
Particulars A B C D
Assessed Net Worth (Rs. lakh)( 50% of EPN) 200 100 50 12.50
Membership 3000 2000 1500 500
III. Entry Point Norms for Banks organised in least developed States/North-Eastern States/
Tribal Regions
Particulars A B C D
Assessed Net Worth (Rs. lakh)(33.33% of 133.33 66.67 33.33 8.33
EPN)
Membership (66.67% of normal membership) 2000 1334 1000 334
• UCB which are categorized as Unit banks and have been extended relaxation in the entry point capital
as indicated, would be eligible to open branches only after augmenting their Assessed Net Worth (ANW)
to be computed as per RBI’s norms, to the level required for opening a new general category bank at the
place where the bank was organised or where the branch is desired to be opened, whichever is higher.
• For example, if a unit bank was organised at a category ‘D’ centre and it intends to open a branch at a
‘B’ category centre, such bank’s ANW should necessarily be raised to entry point capital prescribed for
organising a general category bank at a ‘B’ category centre.
• Similarly if a bank, other than a unit bank, desires to open a branch at a higher category centre, other than
the centre at which it was established, within the district of its registration, the ANW of the bank should at
least be equivalent to the entry point capital prescribed for that centre.
• A bank which desires to open a branch at a centre, other than its district of registration but within the state
of registration, must have ANW not less than the entry point capital required for organisation of a new
general category bank at the highest category centre in that state.
Process of application
UCBs, satisfying applicable norms, to prepare an Annual Business Plan (ABP) for opening of branches (including
extension counters and up-gradation of extension counters into full-fledged branches, in their existing area
of UCB which are categorized as Unit banks and have been extended relaxation in the entry point capital as
indicated, would be eligible to open branches only after augmenting their Assessed Net Worth (ANW) to be
computed as per RBI’s norms, to the level required for opening a new general category bank at the place where
the bank was organised or where the branch is desired to be opened, whichever is higher.
• For example, if a unit bank was organised at a category ‘D’ centre and it intends to open a branch at a
‘B’ category centre, such bank’s ANW should necessarily be raised to entry point capital prescribed for
organising a general category bank at a ‘B’ category centre.
• Similarly if a bank, other than a unit bank, desires to open a branch at a higher category centre, other than
the centre at which it was established, within the district of its registration, the ANW of the bank should at
least be equivalent to the entry point capital prescribed for that centre.
• A bank which desires to open a branch at a centre, other than its district of registration but within the state
of registration, must have ANW not less than the entry point capital required for organisation of a new
general category bank at the highest category centre in that state.
Process of application
UCBs, satisfying applicable norms, are to prepare an Annual Business Plan (ABP) for opening of branches
(including extension counters and up-gradation of extension counters into full-fledged branches, in their
existing area of operation), for the next 12 months, with the approval of their Board of Directors and submit the
ABP, in duplicate, along with specified annexures to the respective Regional Offices of Reserve Bank of India.
Normally RBI expects submission of ABPs by end of December of the previous financial year.
Approval for Centres

Eligible banks will be allotted centres strictly in the order of preference given by them. Once a centre is allotted,
no request for change in the allotted centre would be entertained.
Authorisation and its Validity Period

After making arrangements for opening of branches, the bank should approach the Regional Offices of Urban
Banks Department under whose jurisdiction they operate, in the prescribed form, indicating the exact postal
address of the place where the branch is to be opened, for issuance of authorisation within a period of six
months from the date of allotment of the centre.
Authorisation will be valid for one year from the date of issue, or one and a half year from the date of allotment
of the centre, whichever is earlier.
Extension of period
No extension of time will be granted after the expiry of validity period of licence. In exceptional cases, an
extension of time not exceeding six months may be granted by the Regional Offices, under advice to Central
Office.
Non-compliance and penalties

Opening of branches without a valid authorisation from the Reserve Bank is an act of violation of Section 23
of the BR Act, 1949, and liable to attract penalties. Where the banks have opened extension counters without
complying with the prescribed norms and subsequently approach Reserve Bank of India for up-gradation of
the same into full-fledged branches, such banks would not be allotted centres unless they close unauthorised
extension counters. Further, a centre where a bank has opened an unauthorised extension counter, such a
centre would not be considered for opening a branch in future.
In case, the information/particulars furnished by any bank are found to be incorrect, the Reserve Bank of India
will take a serious view in the matter and the bank will be liable for penal action, including debarring it from
allotment of centres for a period of three years.
RBI has also given its policy guidelines in respect of Opening of Specialised branches – Central Processing
Centres (CPCs)/Retail Asset Processing Centres, Opening of Extension Counters, Up-gradation of Extension
Counters into Full-Fledged Branches etc. under the said policy.
PAID UP CAPITAL AND RESERVES OF BANKING COMPANIES

Section 11 of the Banking Regulation Act, 1949 specifies the minimum paid up capital and reserves of banking
companies. Before commencing the banking business every bank has to fulfill the conditions under this Section
or as directed by RBI in this regard. As on date no bank can start its activities without complying with this
provision. The minimum capital are linked to place of business or places of business. A place of business has
been defined as “any office, sub-office, sub-pay office and any place of business at which deposits are received,
cheques cashed, or moneys lent”. If there is a dispute arises in computing the aggregate value of the paid-up
capital and reserves of any banking company, the decision of RBI would be final in terms of Section11(6) of the
Banking Regulation Act, 1949.
Section 11 (2) and 11(3) of the Banking Regulation Act, 1949 deal with the capital and reserves of Foreign
banks that operate in India as well as that of banks in India.
The following summarises the requirement of capital and reserves under the Banking Regulation Act, 1949:
Foreign Banks
1. Keep a deposit of Rs. 15 lacs and if it has place of business in Mumbai or Kolkata or both Rs. 20 lacs with
RBI.
2. Additionally to keep 20% of the yearly profit in respect of business transacted through branches in India,
as per P & L account, with RBI.
3. Central Government can exempt a bank from this requirement on RBI’s recommendations for a specified
period if the amounts already deposited is adequate.
4. The capital funds will form the assets of the company to which creditors will have first charge on cessation
of business.
5. Mode of funds can be Cash, unencumbered securities or partly both. Securities can be replaced by other
unencumbered securities or cash or cash equivalents.
Indian Banks
1. If it has a place of business in more than one state Rs. 5 lacs; if such place of business include Mumbai or
Kolkata or both, Rs. 10 lacs.
2. If the place of business is only in one state and not including Mumbai or Kolkata, Rs. 1 lac for principal
place of business, plus Rs. 10,000 for other places of business in the same district in which principal place
of business is situated, plus Rs. 25,000 in respect of each place of business situated elsewhere in the State
other than in the same district, total being not in excess of Rs. 5 lacs.
3. If such a bank has only one place of business the amount is restricted to Rs. 50,000.
4. For the banks commencing business after the commencement of the Banking Regulation Act, paid up
capital is stipulated at Rs. 5 lacs.
5. If the places of business are in one state only but one or more of them is in Mumbai or Kolkata Rs. 5 lacs
plus Rs. 25,000 for each place of business outside these cities and in total not exceeding Rs. 10 lacs.
REGUL ATION OF PAID-UP CAPITAL, SUBSCRIBED CAPITAL AND AUTHORISED CAPITAL

AND VOTING RIGHTS OF SHAREHOLDERS
Section 12(1) of the Banking Regulation Act, 1949 requires that the subscribed capital of the company is not
less than half of the authorised capital, and the paid-up capital is not less than half of the subscribed capital.
Further, when the capital is increased, the concerned bank will comply with conditions within a period of two
years as RBI may allow.
As amended in 2012, under Section 12 (1) (ii) of the Banking Regulation Act, 1949 a banking company’s equity
capital should consist of only equity shares or equity& preference shares. Such issuance of preference share
would be in accordance with RBI’s guidelines.
Voting Rights
Under Section 12(2) of the Banking Regulation Act, 1949 a person holding any share/s in a banking company
may exercise voting rights on poll, not exceeding10 % of the total voting rights of all the shareholders of the
banking company. With effect from 18th January 2013, RBI has powers to increase the same gradually from
10% to 26%. Further under Section 12(1) (ii)(b) preference holders cannot exercise voting rights in respect of
shares held by them in a banking company as specified under Companies Act. Under Section 12 (3) no suit can
be filed against a registered share holder except by genuine transferee of such shares or on behalf of minors or
lunatic for whom such shares held by a registered share holder.
Limits on brokerage/commission /Discount

Section13 of the Banking Regulation Act, 1949 places a ceiling of 2½% of the price (including the premium) at
which shares are issued as commission, brokerage, discount or remuneration on the sale of shares of banking
companies.
Dividend
In terms of Section 15 of the Banking Regulation Act, 1949 a company can pay dividend only after capitalized
expenses, such as preliminary expenses, organizational expenses, commission on shares sold, brokerage, loss
incurred etc. are written off.
RBI has in the light of COVID-19 pandemic, has directed banks not to make any further dividend payouts from
the profits pertaining to the financial year ended March 31, 2020 until further instructions. This restriction will
be reassessed by the RBI on September 30, 2020.
Returns to be submitted
The Chairman or CEO of the banking company is obligated to furnish to RBI, particulars of extent and value of
his holding of shares, either directly or indirectly, in the banking company, as well as any change in the extent of
such holding or any variation in the rights thereof or any other information.
SUBSIDIARIES OF BANKING COMPANIES

Section 19 of the Banking Regulation Act, 1949 governs the formation of subsidiaries of banking companies.
According this section, banks are allowed to form subsidiary companies for the activities which are permitted
under Section 6 (1), including formation of Credit Information subsidiaries under Section 6 of Banking
Regulation Act either in India or abroad with prior permission of RBI. The main objective is to prevent trading
as well as securing control of Non-banking companies.
Activities which subsidiary companies engage in will not be deemed as a direct or indirect activity of the
banking company.
Holding of shares in other companies

Under Section 19(2) of the Banking Regulation Act, 1949 banking company shall hold shares in any company,
whether as pledgee, mortgagee or absolute owner, not exceeding thirty per cent of the paid-up share capital of
that company or thirty per cent of its own paid-up share capital and reserves, whichever is less. Also Section
19 (3) , a banking company cannot hold shares, whether as pledgee, mortagagee or absolute owner, in any
company in the management of which any Managing Director or Manager of the banking company is in any
manner concerned or interested.
BOARD OF DIRECTORS IN BANKING COMPANIES

In terms of Section 10A of the Banking Regulation Act, 1949 not less than 51% of Board of Directors of a banking
company, should have special knowledge or practical experience in any one or more of the following fields : -
(i) accountancy (ii) agriculture and rural economy, (iii) banking, (iv) co-operation, (v) economics, (vi) finance,
(vii) law, (viii) small-scale industry, (ix) any other matter which according to RBI to be useful to the banking
company. Among them at least two persons having special knowledge or practical experience in respect of
agriculture and rural economy, co-operation or small scale industry.
Under Section 10(2), a director of banking company cannot
• have substantial interest in or any way connected with, as employee, manager or Managing agent, any
company, other than a Section 8 Company under Companies Act, 2013 ( earlier Section 25 company under
Companies Act, 1956) or
• be connected with any trading or commercial or industrial concerns (excluding small scale industrial
concern)
• be a proprietor of any trading, commercial or industrial concern, (excluding a small scale industrial
concern).
On August 2, 2019 Reserve Bank of India has announced through a direction the procedure and criteria for
determining the ‘fit and proper’ status of a person to be eligible to be elected as a director on the Board of Public
Sector Banks, vide its circular RBI/DBR/2019-20/71 Master Direction DBR. Appt. No: 9/29.67.001/ 2019-20
August 2, 2019.
A summary of the same is as under:
1. These Directions applies to Public Sector Banks.
2. All PSU banks are to constitute a Nomination and Remuneration Committee consisting of a minimum of
three non-executive directors from amongst the Board of Directors (‘Board’). Out of which not less than
one-half shall be independent directors and should include at least one member from Risk Management
Committee of the Board, for undertaking a process of due diligence to determine the ‘fit and proper’ status
of the persons to be elected as directors as per Section 19 (C) of the SBI Act/clause and as per Section 9 (3)
(i) of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/ 1980.
3. The nominee director from Government of India and the director appointed under Section 19(f) of SBI
Act/ Section 19 (c) (3) of Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/ 1980.
can’t be a part of the committee mentioned in point 2 above.
4. The Non-executive Chairman of the bank can be a member of the committee but can’t chair the meetings.
Any other directors nominated to the committee can Chair the meetings.
5. The quorum is three, including the Chairman of the Committee. For want of quorum, In case of absence
of any nominated directors, the Board may nominate any other non-executive director to attend the
committee meeting.
6. The Board can decide the tenure of the committee while constituting the same.
7. A brief procedure has been spelt out by RBI regarding nomination for election, acceptance of application
etc. from applicants for Director’s post.
8. Brief criteria:
a. Candidates should be between 35 to 67 years of age as on the cut-off date. Should be at least a
graduate.
b. Candidates should have special knowledge/experience as per Section 19A(a) of the SBI Act / section
9(3A)(A) of the Banking Companies (Acquisition and Transfer of Undertaking ) Act, 1970/ 1980.
c. Tenure for such elected director will be for three years and is eligible for re-election: subject to no
such director to hold office for a period exceeding six years, whether continuously or intermittently.
d. Apart from the disqualifications stated in SBI Act/Banking Companies Act 1970/1980 the following
also apply:
i. The candidate should not be a member of the Board of any bank or the RBI or a Financial
Institution (FI) or an Insurance Company or a NOFHC holding any other bank.
Explanation: The expression “bank” includes a banking company, a corresponding new bank,
State Bank of India, a co-operative bank and a regional rural bank.
ii. A person connected with hire purchase, financing, money lending, investment, leasing and
other para banking activities shall not be considered for appointment as elected director on the
board of a Public Sector Bank.
However, investors of such entities will not be disqualified for appointment as directors, if they do
not have any managerial control in them.
iii. No person may be elected/ re-elected on the Board if he/she has served as director in the
past on the board of any bank/FI/RBI/Insurance Company under any category for six years,
whether continuously or intermittently.
iv. The candidate should not be engaged in the business of stock broking.
v. The candidate should not be a Member of Parliament or State Legislature or Municipal
Corporation or Municipality or other local bodies.
vi. The candidate should not be acting as a partner of a Chartered Accountant firm which is
currently engaged as a Statutory Central Auditor of any nationalised bank or State Bank of
India or as Statutory Branch Auditor or Concurrent Auditor of the bank in which nomination
for election is filed.
9. Professional Restrictions: The candidate should not have any business connection (including legal services,
advisory services etc.) with the concerned bank and also should not be engaged in activities which might
result in a conflict of business interests with that bank.
10. The candidate should not be having any professional relationship with a bank or any NOFHC holding any
other bank.
11. In the event of elected as a Director, the candidate should severe his relationship with such bank or as the
case may be.
12. The candidate should not be under adverse notice of any regulatory or supervisory authority/agency, or
law enforcement agency and should not be a defaulter of any lending institution.
13. Once a candidate is elected as a director he has to submit the prescribed declarations as enumerated in the
circular. Also to submit yearly declaration as required under the directions. Failure to do so or suppression
of any information or any non compliance of any of the requirement, will be liable for legal consequences.
Limitation on period of office

As per Section 10(2A) of the Banking Regulation Act, 1949 other than a Chairman or whole-time Director,
no director can hold office continuously for a period beyond eight years. Also a Chairman or other whole-
time Director who has been removed from such posts will cease to be a Director and will not be eligible to be
appointed as a Director by any process, for a period of four years from the date of his cessation as Chairman or
whole-time Director as applicable.
Reconstitution of Board
In the opinion of RBI, if the composition of the Board of Directors requires reconstitution, RBI shall direct
the banking company for such reconstitution through a written communication after giving a reasonable
opportunity of being heard. Within two months of such communication, direction of the RBI shall be complied
with.
In order to reconstitute the Board of Directors, if it is necessary to retire any Director or Directors, it has to be
done through drawing of lots, to decide which Director or Directors shall cease to hold office. Such decision will
be binding on every Director of the Board.
If the banking company fails to comply with directions, that Bank through lots drawn as prescribed remove the
person who ought to be removed from the membership of the Board of Directors, remove such person from the
office of the Director of banking company for compliance of provisions, appoint a suitable person as a member
of the Board of Directors in the place of the person so removed. The person thus appointed will be considered
as deemed to have been duly elected as a Director who will continue in office till his predecessor would have
continued. Any reconstitution or removal in terms of these provisions cannot be challenged in any court. No
proceedings of the Board of Directors will become invalid, merely because of any defect in the composition of
the Board.
CHAIRMAN/MANAGING DIRECTOR OF A BANKING COMPANY

Appointment of a Chairman of a banking company is subject to the provisions of Section 10 (A), (B), (C),(D)
of the Banking Regulation Act, 1949. Accordingly one of the Directors a banking company has to be appointed
as a whole-time or a part-time Chairman. If the Chairman is appointed on a whole-time basis, he will exercise
his powers under the superintendence, direction and control of the Board of Directors. If a Chairman is to
be appointed on part-time basis, it requires the prior approval of RBI which may specify conditions thereof.
The affairs of the banking company have to be managed by a Managing Director who will exercise his powers
subject to the superintendence, control and direction of the Board of Directors.
Appointment of MD & CE O / CE O / part-time Chairperson (PTC) in Banks – ‘Declaration and

Undertaking’ and allied matters
In the case of Private Sector Banks including Local Area Banks, Small Finance Banks, Payments Banks and
Foreign Banks operating in India / RBI vide its Notification dated March 31, 2020 has directed that for the
re-appointment of an MD & CEO/ CEO in banks, as above the complete applications in the prescribed format’
along with ‘Declaration and Undertaking’ from candidate(s), along with the remarks of Nomination and
Remuneration Committee should be submitted to the Department of Regulation, Central Office, RBI, Mumbai, at
least six months before the expiry of the term of office of the incumbent.
For appointment of a new MD & CEO/ CEO, the proposal should contain a panel of at least two names in the
order of preference. The proposals should be submitted to the Reserve Bank at least four months before the
expiry of the term of office of the present incumbent.
Period of appointment
The period of appointment of a Chairman/ Managing Director on a whole-time basis will be for a period not
exceeding five years, as the board of Directors may fix, and also be eligible for re-election/reappointment as
specified in the Banking Regulation Act. A Chairman is allowed to be a Director of a subsidiary of the banking
company or a company registered under Section 8 Company under The Companies Act, 2013 (earlier Section
25 company under Companies Act 1956).
Qualifications: Whole-time Chairman/Managing Director

Every whole- time Chairman and every Managing Director of a banking company should have special knowledge
and practical experience of the working of a banking company, or of the State Bank of India or any subsidiary
bank or a financial institution, or financial, economic or business administration.
A Chairman, appointed on a whole time basis or a Managing Director of a banking company -
• Will be disqualified if he is a Director of any company [other than a subsidiary company or a Section 8
company as provided under Section 10 (2)],is a partner of any firm which carries on any trade, business
or industry, or has substantial interest in any other company or firm, or is a Director, manager, Managing
agent, partner or proprietor of any trading, commercial or industrial concern, or is engaged in any other
business or vocation.
May resign his office through a letter in writing addressed to the company.
Subject to the approval of RBI, a whole-time Chairman or a Managing Director whose term of office has ended
or has resigned is allowed to continue till his successor assumes office.
Removal of Chairman/Managing Director

If in the opinion of RBI any person who, is, or has been elected as whole-time Chairman/ Managing Director
is not a fit and proper person, RBI may require the banking company to elect or appoint any other person as
Chairman or the Managing Director. If within a period of two months from the date of receipt of such order, the
banking company fails to elect or appoint a suitable person, the RBI may remove the first-mentioned person
and appoint a suitable person in his place who will be deemed to have been duly elected or appointed, as
Chairman or the Managing Director and will hold office for the residual period of office of the person in whose
place he has been so elected or appointed.
In the public interest, RBI may permit Whole-time Chairman or the Managing Director undertake part-time
honorary work which is not likely to interfere with his duties as Chairman or Managing Director.
Such persons who have been removed by RBI, can appeal to Central Government against the removal The
Central Government’s decision in the matter will be final and cannot be questioned by any court. In all other
cases, RBI’s decision will be final.
Powers of RBI to appoint Chairman/ Managing Director

If Chairman or the Managing Director dies or resigns or becomes infirm or incapable of carrying out his duties
or is absent on leave or any other circumstances which does not involve vacation of his office, the banking
company can make alternate arrangement with the approval of the RBI up to a total period of four months.
Under Section 10 BB, if the position of whole-time Chairman or Managing Director of a banking company lies
vacant, and in the opinion of RBI that this may prejudicial to the interests of the bank, it may appoint an eligible
person as Chairman on a whole-time basis or a Managing Director. Such a person though may not be a director
of that bank, will be deemed as a Director, so long as he holds the post of whole-time Chairman or Managing
Director, and will hold office for a period not exceeding three years, as RBI specifies. Such person may also be
eligible for reappointment as per the Banking Regulation Act provisions.
Salary and Holding of qualification shares

The whole-time Chairman or a Managing Director appointed by the RBI will draw from the banking company
pay and allowances as determined by the RBI and can be removed from office only by the Reserve Bank.
The whole-time Chairman or a Managing Director of by whomsoever appointed and a Director who is appointed
by the RBI under Section 10A will not be required to hold qualification shares of the banking company.
Overriding Provisions
Appointment or removal of a whole-time Chairman, Managing Director, Director under the provisions of Section
10 (A), (B), (BB) will over ride all other laws or contracts. A person who is affected by any action taken in terms
of these provisions including termination, is not entitled to claim any compensation for any loss.
APPOINTMENT OF ADDITIONAL DIRECTORS

The power to appoint additional directors is vested in RBI under Section 36 AB of Banking Regulation Act.
• In the interest of a banking company and its depositors, through a written order the RBI can appoint, one
or more persons to hold office as additional Directors.
• Such a person appointed as additional Director/s
– will hold office during the pleasure of the RBI, subject to a period not exceeding three years or such
further periods not exceeding three years at a time;
– will not incur any obligation or liability by reason only of his being a Director or for anything done or
omitted to be done in good faith in the execution of the duties of his office; or
– is not required to hold qualification-shares in the banking company.
Any additional Director so appointed, will not be taken in to account for the purpose of reckoning any proportion
of the total number of Directors of the banking company.
The powers conferred under Section 36AB have overriding effect on any other law contract or instrument
which is in force.
Chief Compliance Officer (CCO)

As part of robust compliance system, banks are required, inter-alia, to have an effective compliance culture,
independent corporate compliance function and a strong compliance risk management programme at bank
and group level. Such an independent compliance function is required to be headed by a designated Chief
Compliance Officer (CCO) selected through a suitable process with an appropriate ‘fit and proper’ evaluation/
selection criteria to manage compliance risk effectively.
The Reserve Bank of India has place following guidelines to bring uniformity in approach followed by banks, as
also to align the supervisory expectations on CCOs with best practices.
1. Policy : A bank shall lay down a Board-approved compliance policy clearly spelling out its compliance
philosophy, expectations on compliance culture covering Tone from the Top, Accountability, Incentive
Structure and Effective Communication & Challenges thereof, structure and role of the compliance function,
role of CCO, processes for identifying, assessing, monitoring, managing and reporting on compliance risk
throughout the bank. This shall, inter-alia, adequately reflect the size, complexity and compliance risk
profile of the bank, expectations on ensuring compliance to all applicable statutory provisions, rules and
regulations, various codes of conducts (including the voluntary ones) and the bank’s own internal rules,
policies and procedures, and creating a disincentive structure for compliance breaches. The bank shall
also develop and maintain a quality assurance and improvement program covering all aspects of the
compliance function. The quality assurance and improvement program shall be subject to independent
external review periodically (at least once in three years). The policy should lay special thrust on building
up compliance culture; vetting of the quality of supervisory / regulatory compliance reports to RBI by the
top executives, non-executive Chairman / Chairman and ACB of the bank, as the case may be. The policy
shall be reviewed at least once a year;
2. Tenor for appointment of CCO - The CCO shall be appointed for a minimum fixed tenure of not less than
3 years. The Audit Committee of the Board (ACB) / Managing Director (MD) & CEO should factor this
requirement while appointing CCO.
3. Transfer / Removal of CCO - The CCO may be transferred / removed before completion of the tenure only
in exceptional circumstances with the explicit prior approval of the Board after following a well-defined
and transparent internal administrative procedure.
Eligibility Criteria for appointment as CCO
Rank - The CCO shall be a senior executive of the bank, preferably in the rank of a General Manager or an
equivalent position (not below two levels from the CEO). The CCO could also be recruited from market;
Age - Not more than 55 years;
Experience - The CCO shall have an overall experience of at least 15 years in the banking or financial services,
out of which minimum 5 years shall be in the Audit / Finance / Compliance / Legal / Risk Management functions;
Skills - The CCO shall have good understanding of industry and risk management, knowledge of regulations,
legal framework and sensitivity to supervisors’ expectations;
Stature - The CCO shall have the ability to independently exercise judgement. He should have the freedom and
sufficient authority to interact with regulators/supervisors directly and ensure compliance;
Others - No vigilance case or adverse observation from RBI, shall be pending against the candidate identified
for appointment as the CCO.
The duties and responsibilities of the compliance function
These shall include at least the following activities:
i. To apprise the Board and senior management on regulations, rules and standards and any further
developments.
ii. To provide clarification on any compliance related issues.
iii. To conduct assessment of the compliance risk (at least once a year) and to develop a risk-oriented activity
plan for compliance assessment. The activity plan should be submitted to the ACB for approval and be
made available to the internal audit.
iv. To report promptly to the Board / ACB / MD & CEO about any major changes / observations relating to the
compliance risk.
v. To periodically report on compliance failures/breaches to the Board/ACB and circulating to the concerned
functional heads.
vi. To monitor and periodically test compliance by performing sufficient and representative compliance
testing. The results of the compliance testing should be placed to Board/ACB/MD & CEO.
vii. To examine sustenance of compliance as an integral part of compliance testing and annual compliance
assessment exercise.
viii. To ensure compliance of Supervisory observations made by RBI and/or any other directions in both letter
and spirit in a time bound and sustainable manner.
Note: The bank’s Board of Directors shall be overall responsible for overseeing the effective management of
the bank’s compliance function and compliance risk. The MD & CEO shall ensure the presence of independent
compliance function and adherence to the compliance policy of the bank.
GUIDELINES ON COMPENSATION OF WHOLETIME DIRECTORS/CHIEF EXECUTIVE

OFFICERS/MATERIAL RISK TAKERS AND CONTROL FUNCTION STAFF
A review of these guidelines issued in 2012-13 was carried out to comply with Guidelines with Financial
Stability Board’s (FSB) Principles and Implementation Standards for Sound Compensation Practices and the
Supplementary Guidance issued by FSB in March 2018. After extensive consideration of views of all stake
holders, the RBI has amended and superseded the 2012-13 guidelines vide its Circular dated November 4,
2019.
These Guidelines became applicable for pay cycles beginning from April 01, 2020. All applications for
approval of appointment/re-appointment or approval of remuneration/revision in remuneration of Whole
Time Directors (WTDs)/ Chief Executive Officers (CEOs) shall be submitted with full details as prescribed in a
amended guidelines.
Private sector banks, foreign banks operating under the Wholly Owned Subsidiary mode (WOS), and foreign
banks operating in India under the branch mode are required to obtain regulatory approval for grant of
remuneration (i.e. compensation) to WTDs/ CEOs in terms of Section 35B of the Banking Regulation Act, 1949
(B.R. Act, 1949).The approval process will involve, an assessment of whether the bank’s compensation policies
and practices are in accordance with the Guidelines.
Salient features:
a. The Guidelines are applicable to private sector banks, including Local Area Banks, Small Finance Banks
and Payments Banks.
b. Foreign banks operating in India under branch mode would be required to continue to submit a declaration
to RBI annually from their Head Offices to the effect that their compensation structure in India, including
that of CEO’s, is in conformity with the FSB Principles and Standards. RBI would take this into account
while approving CEOs’ compensation.
c. The compensation proposals for CEOs and other staff of foreign banks operating in India that have not
adopted the FSB principles in their home country are required to implement the compensation Guidelines
as prescribed for private sector banks in India, to the extent applicable to them.
d. For the foreign banks operating in India by way of Wholly Owned Subsidiary (WOS) structure, the
compensation Guidelines as prescribed for private sector banks in India will be applicable.
These guidelines cover in detail :
• Compensation policy including bonuses, ESOPs, pension plan, gratuity etc.
• Constitution of Nomination and Remuneration Committee (NRC).
• Effective alignment of compensation with prudent risk taking for Whole Time Directors / Chief Executive
Officers / Material Risk Takers (MRTs) covering a) Fixed Pay and Perquisites b) Variable Pay c) Malus/
Clawback d) Guaranteed Bonus e) Hedging.
• Guidelines for risk control and compliance staff.
• Guideline for other categories of staff.

• Identification of Material Risk Takers of the bank.
• Disclosure.
• Regulatory and Supervisory Approval / Oversight.
RESTRICTIONS ON EMPLOYMENT
There are certain restrictions imposed on a banking company under Section 10 of the Banking Regulation Act,
1949. They are as under:
A banking company cannot

a. employ or allow a Managing agent to manage its affairs.
b. employ any person who is or at any time in the past has been an adjudicated insolvent, or has suspended
payment or has compounded with his creditors, or who is, or has been, convicted by a criminal court of an
offence involving moral turpitude or whose remuneration or part of whose remuneration takes the form
of commission or of a share in the profits of the company.
c. employ a person whose remuneration according to RBI, is excessive.
d. allow a person to manage its affairs, who is a Director of any other company. (excepting a subsidiary of the
banking company, or a company registered under section 8 of the Companies Act, 2013. [The prohibition
mentioned in this sub-clause will not apply in respect of any such Director for a temporary period not
exceeding three months or such further period not exceeding nine months as the RBI may allow].
e. employ a person who is engaged in any other business or vocation; or whose term of office as a person
Managing the company is for period exceeding five years at any one time (excepting renewal of term of
office as specified under the Banking Regulation Act, 1949].
CONTROL OVER MANAGEMENT/ DIRECTORS/OTHER PERSONS

As a measure of control over management and other persons of a banking company, Section 36AA of the
Banking Regulation Act confers powers to RBI, to remove managerial and other persons from office, under
certain circumstances.
If the RBI is satisfied that in the public interest or in the overall interest of the banking company as well as to
protect the interests of depositors it is necessary to remove a managerial person, it can remove by a written
order with effect from any specified date any Chairman, Director, Chief Executive Officer (by whatever name
called) or other officer or employee of the banking company. Before removal, such persons who are being
removed would be given a reasonable opportunity to make a presentation to RBI, against the said order.
Pending the consideration of the representation from persons facing removal, in the opinion of RBI any delay
in the interim would harm the interests of the bank or its depositors, order such persons not to take part either
directly or indirectly in the management of, the banking company. Persons who are facing an order of removal
from RBI, within thirty days from the date of communication of the order, can appeal to the Central Government
against the order. After considering the appeal, the Central government may take a decision and communicate
the same to the concerned persons who have made the appeal and it’s decision would be final in the matter. The
decision of the Central Government cannot be questioned in any court.
Such persons who are facing removal order from RBI, cease to be Whole-time Chairman, Managing Director or
Director or any other employees as the case may be of the banking company and cannot directly or indirectly,
be concerned with, or take part in the management of, any banking company for period not exceeding five years
or as stated in the order. Any one violating or contravenes the terms such order shall face punishment of fine up
to two hundred and fifty rupees for each day during which such contravention continues. The person who has
been removed is entitled to claim any compensation for the loss or termination of office.
Through a written order, RBI may appoint a suitable person in place of Chairman or Director or chief executive
officer or other officer or employee who has been removed from his office with effect from such date as it may
specify. The person who is thus appointed in the position of the removed employee will hold office for a period
not exceeding three years and such further period not over three years at a time and such person will not incur
any obligation or liability by reason only of his being a Chairman, Director or Chief Executive Officer or other
officer or employee for anything done or omitted to be done in good faith in the execution of the duties of his
office.
Supersession of Board of Directors

Under Section 36 ACA, RBI has the powers to supersede the Board of Directors of a Banking Company in certain
cases.
If RBI is of the opinion that it is necessary in the interests of a banking company or its depositors and in
consultation with Central Government, through a written order, supersede the Board of Directors of such
banking company for a period of not exceeding six months (subject to a maximum period of 12 months) or as
specified in the order.
Appointment of Administrator
Upon superseding the Board of Directors, the RBI (after due consultation with the Central Government) will
appoint, an Administrator (not an officer of the Central Government or a State Government) who has experience
in law, finance, banking, economics or accountancy for such period as it determines. The Administrator so
appointed, is bound to follow directions issued by the RBI in this regard. Consequent to the supersession of the
Board of Directors, the Chairman, Managing Director and other Directors have to vacate their offices.
Powers/Duties/Role of Administrator
The Administrator will exercise all powers, discharge functions and perform duties that are applicable under
the provisions of the Companies Act or the Banking Regulation Act or any other applicable law in force, until the
Board of Directors is reconstituted.
Committee to assist the Administrator

The RBI in consultation with Central government may also appoint a committee of three or more persons who
holding meetings. The RBI will specify salary and allowances payable to the Administrator and the members of
the committee constituted and the same to be borne by the concerned banking company.
Time limit for reconstitution of the Board of Directors

Two months before the expiry of the period of supersession as specified in the RBI order issued earlier, the
Administrator will call the general meeting of the company to elect new Directors and reconstitute its Board of
Directors.
No compensation is payable to any person for the loss or termination of his office in the process. The
Administrator will vacate the office immediately after the reconstitution of Board of Directors.
Highlights of guidelines on Appointment of Managing Director (MD) / Whole-Time Director

(WTD) in Primary (Urban) Co-operative Banks vide circular dated June 25, 2021
• These directions are applicable to all Primary (Urban) Co-operative Banks (UCBs).
• UCBs with a deposit size of less than ₹100 crore as per preceding year’s audited balance sheet and all Salary
Earners’ Banks, inter-alia, are exempt from the requirement of seeking prior approval of the Reserve Bank
of India.
• UCBs which have appointed CEO with the prior approval of the Reserve Bank in terms of the RBI’s
guidelines related to Constitution of Board of Management in Primary (Urban) Co-operative Banks, may
continue with the CEO so appointed till completion of his / her tenure or for a period of three years
from the date of initial appointment, whichever is earlier. After the aforesaid period, UCBs shall follow the
directions issued herein for appointment / re-appointment of MD.
• UCBs, other than those stated above shall review the ‘Fit and Proper’ status of the existing MD in terms
of these directions and confirm the same, with the approval of BoD, to the concerned Regional Office
(Department of Supervision, Central Office, in case of UCBs under jurisdiction of Mumbai office) of Reserve
Bank within a period of two months from the date of issue of this circular. In case, the present MD does not
satisfy the prescribed ‘Fit and Proper’ criteria, the UCB shall initiate the process for appointment of new
MD immediately. If a UCB had appointed WTD, the bank shall follow the same procedure to comply with
these directions.
• All UCBs shall obtain a deed of covenants in the specified format from the present MD/ WTD who is found
to be complying with these directions.
• Managing Director, who may also be designated as Chief Executive Officer or by any other name, is a
person who is entrusted with the management of the whole, or substantially the whole of the affairs of
a UCB, subject to the regulations or directions issued by the Reserve Bank from time to time. MD shall
function under the overall general superintendence, direction and control of the Board of Directors (BoD).
• If a UCB decides to appoint Whole-Time Director (WTD), who may also be designated as Executive Director
or by any other name, the need for such an appointment may be decided by the bank keeping in view the
growth in business, expansion of activities, geographical footprints and organisational vision for growth
in the medium and long term. The creation of the post of WTD and the functions that can be performed
may be decided by the BoD and approved by the General Body of the bank. The WTD shall report to the
Managing Director.
• The UCBs shall ensure that the ‘fit and proper’ criteria is fulfilled by the person being appointed as
MD/ WTD.
Supervisory Action Frame Work for Urban Cooperative Banks

On January 6, 2020 by it’s circular the RBI has announced the rationalization of Supervisory Action Framework
(SAF) for UCBs. The announcement contains the action triggers in bringing about the desired improvement
in the UCBs as also expeditious resolution of financial stress of the concerned UCBs. The summary of SAF
measures are as per the following table.
Following abbreviations are used : AP – Action Plan; BoD- Board of Directors of the UCB.
Situations A B C
Financial Parameter Asset quality Profitability Capital to Risk-
weighted Assets
ratio (CRAR)
SAF Trigger Point When UCB’s Net When UCB incurs losses for two When UCB’s CRAR
NPAs exceed 6% of consecutive financial years or has falls below 9%
its net advances accumulated losses on its balance sheet
Action Points 1. Advising the 1. Advising the UCB to submit a BoD- 1. Advising the
UCB to submit approved Action Plan for restoring UCB to submit
a BoD approved the profitability and/or wiping out a BoD approved
Action Plan for the accumulated losses Action Plan for
reducing its Net increasing the
NPAs below 6% CRAR to 9% or
above within 12
months
Situations A B C
Action Points 2. Advising the BoD to review the progress under the Action Plan on quarterly/
monthly basis
3. Advising the UCB to submit the post- 3. Restriction on incurring capital
review progress report to RBI. expenditure beyond a specified limit,
without prior approval of RBI.
4. Restriction on declaration/ payment 4. Prohibition on declaration / payment
of dividend/donation without prior of dividend/donation
approval of RBI
5. Curtailment of sanction/renewal of 5. Measures for reduction in interest and
credit facilities to sectors/ segments operating/administrative expenses
having high NPAs/defaults
6. Reducing exposure limits for fresh loans and advances.(Applies to A & C situations)
Further in the case of CRAR falling below 9% (situation C) the action triggers would also include the following:
• Seeking a BoD approved proposal for merging the UCB with another bank or converting itself into a credit
society
• Restrictions on
¡ fresh loans and advances carrying risk-weights beyond the specified limit
¡ expansion on the size of the balance sheet
¡ fresh borrowings, except for meeting temporary liquidity mismatches
• Prohibition on
¡ sanction/disbursal of fresh loans and advances other than loans against collateral security of term
deposits / NSCs / KVPs / insurance policies
¡ expansion of size of the deposits.
The RBI has powers to impose SAF in case stress is noticed in other important indicators/parameters or in case
of serious governance issues of the UCB.
CORPORATE GOVERNANCE
Corporate Governance and its importance

Banks are the backbone of an economy and play a crucial role in the distribution of capital. Hence, the proper
governance of banks is essential for economic growth and development of the nation as a whole. According
to Cadbury Committee report, corporate governance means the system by which companies are directed and
controlled. ‘Corporate Governance’ in the context of banking denotes, managing the affairs of a banking company
by adopting the global best practices so as to protect the interests of all stake holders such as depositors, other
customers, investors, employees, regulatory authorities and society at large. Therefore the gamut of corporate
governance involves several governance aspects namely regulatory, market, stake holder and internal
governance aspects. For a balanced performance of an economy the country’s economic and financial systems
have to be stable. If any of these factors is found wanting there could be destabilization of the economy.
Banks are which are highly regulated in India form the back bone of the economy. Any failure of the governance
factors will have its chain reaction on other sectors of the economy as banking industry is linked to nearly 80
industries. Therefore banks must follow and act in many ways so as to inspire confidence among all its stake
holders. Hence good governance practices are a pre-requisite for a robust banking system in the interest of
all. Poor governance in the banking system can lead to bank failures and consequently erode the confidence of
depositors and other customers leading to run on banks and will have significant national and international
negative fallouts.
Why Corporate governance is important for banking institutions?

The reasons are as follows:
• Financial institutions play a pivotal role in an economy. Any mishap therein will be detrimental to the
economy and to get back to normalcy, it would take a long time which may impede growth plans.
• Financial institutions, especially banks are highly leveraged and this make them vulnerable to any adverse
developments in the economy. Therefore in order to ensure economic stability, governance of these
institutions is a must.
• Among financial institutions, banks are highly trusted organizations that deal with funds of the public at
large. Anything amiss in its functions will result in loss of trust, leading eventually to the collapse of such
institutions and also will have its contagion effect on the economy. Therefore good corporate governance
is essential for building of trust among all stake holders in these institutions.
• Banks act as agents for transmission of monetary policies to the public. They also play a vital role in
payment and settlement system in an economy. Any weaknesses arising out of poor or inadequate
monitoring can be set right with robust internal controls which is an essential part of governance.
Therefore Corporate governance plays a beneficial role in an economy.
Evolution of Corporate Governance in Indian Banking

Though banks in India were highly regulated by RBI, guidelines for corporate governance were very limited
before the reforms took place in the banking sector in India. Dominance of Public sector banks with a few private
sector banks along with cooperative sector banks formed the space of banking in India previously. However the
economic reforms of 1991-92 and subsequent banking reforms changed the scenario, More number of private
banks and foreign banks entered the Indian banking scenario and began to function in a competitive manner
with Public sector banks and old generation private sector banks in India. Banks were given more freedom in
their functions as well as autonomy. Over a period, the share holding of Government of India also came down in
Public sector banks, giving way to public shareholding. This has compelled banks to improve their governance
standards.
International developments in corporate governance also contributed its share in the development of the same
in India during late 1990s and early 2000. Guidelines of the Basel Committee, the Organization for Economic
Cooperation and Development (OECD) principles on Corporate governance, developments in US during this
period etc. had its impact on corporate governance aspects of banks in India. The South East Asian crisis of 1997
also made its impact about the need for proper corporate governance aspects of banks.
The seeds of corporate governance for banks in India began with the announcement of by Dr. Bimal Jalan, the
then RBI Governor who in 2001 constituted an advisory group under Dr. R.H. Patil. This group looked in to
the state of corporate governance prevailing in banks made a set of recommendations regarding governance
standards in Indian banks in line with international best practices. Subsequently, a group under Dr. A.S. Ganguly
was appointed, to study the role of Board of Directors of banks and suggest ways to strengthen the same. This
report was shared with all banks and submitted to Central Government also for its consideration in mid 2002.
Along with these another study group headed by Mr. M.S. Verma (former Chairman of SBI) was set up to make
recommendations on Banking Supervision. This study group submitted its recommendations in early 2003.
The Reserve Bank then took measures to strengthen the corporate governance in the Indian banking sector and
try to bring it at par with international standards. On 21 August 2002, the then Department of Company Affairs
instituted a committee to look into various corporate governance issues in the country.
The economic reforms and banking reforms brought in several changes in banking environment in India
including Corporate governance. Increased entry of private and foreign banks, enhanced level of competition
between various banks, conferring greater independence to Public Sector bank boards, granting more
functional autonomy, appointment of independent directors on boards etc. called for a more enhanced level
of corporate governance in banks in India. Though banks are highly regulated, the primary responsibility to
develop governance practices rests on themselves. The Banking scams that took place in 1990s pointed to the
gaps in disclosure and governance aspects of banks. All these developments resulted in bringing in a need for
adoption and enforcement of best corporate governance standards among banks in India.
The April 2001 regulatory compulsion of SEBI on companies including banking companies in India, to follow
strict corporate governance practices and disclosures under Clause 49 of the Listing Agreement ushered in
a milestone in corporate governance among banks in India. However, in spite of various initiatives taken to
entrench best Corporate governance practices among banks, certain impediments such as vast powers enjoyed
by Government in appointment of members of board of banks, directive powers of RBI, disclosure practices etc.
still exist.
Effect of lack of Corporate Governance

There are glaring national and international examples of involving banks that showed what an ineffective
corporate governance can do to financial institutions and national economies. Enron crisis in early 2000, sub-
prime crisis leading to collapse of Lehman Brothers and near collapse of the global financial system in 2008, the
recent LIBOR crisis involving several leading American and European banks are all some of the international
examples. Harshad Mehta Scam in 1992, Ketan Parekh scandal in 1997, Software giant Satyam Computer’s
crisis, folding up of Global Trust Bank (which later merged with a PSU Bank) etc. are some of the national
examples in this regard. Even the latest Nirav Modi’s case, points to the failure of governance aspects on the
part of the concerned bank. The Punjab Maharashtra Co-operative Bank crisis which has erupted on September
23, 2019 also reveals the lack of proper corporate governance practices including failure of oversight functions
leading to erosion of public confidence in banking institutions.
Good Corporate Governance standards include the following:
1. Establishing code of conduct and ethical behaviour right from the Board of Directors level to all other
employees including accountability aspects thereof.
2. Constant review of role, responsibilities as well as accountability aspects of the Board of Directors.
3. Evaluating the effectiveness managing the operations of the bank by senior management.
4. Supervising strategic management and oversee risk management by establishing appropriate procedures
for managing risks.
The Basel Committee in1999, had pronounced some important oversight aspects within the organizational
structure to maintain proper checks and balances. They are“(i) oversight by the board of directors or
supervisory board;(ii) oversight by individuals not involved in the day-to-day running of the various business
areas;(iii) direct line supervision of different business areas;(iv)Independent risk management and audit
functions”. Additionally there was an emphasis on key personnel being ‘fit and proper’ for their roles. These
recommendations convey an undercurrent of governance standards in banks.
Regulatory Bodies involved in Corporate Governance of Banks

Among the financial regulators, RBI and SEBI play complementary roles in corporate governance of banks in
India. Prudential norms and associated principles of Basel norms, form the basis of corporate governance in
banks. Within RBI, the Board of Financial Supervision is concerned with corporate governance functions which
has supervisory oversight of Department of Banking Supervision and Department of Non-banking Supervision
and Financial Institutions Division. On the other hand SEBI which regulates securities markets, oversees the
mandatory compliance of corporate governance norms in listed banks.
Qualitative Standards in Corporate Governance of Banks

Qualitative standards of corporate governance of a bank is reflected, in the following areas of working of a bank.
• Standard of Ethics in the organization
• Standards of internal control
• Role of Board of Directors
• Disclosure standards
• Accounting system
• Risk management systems
Governance and day to day management

It is the basic responsibility of operating management consisting of CEO, top management functionaries and
line managers. It is the responsibility of operating management to ensure day to day management functions are
carried out within the governing standards and plug loopholes by constant review.
Bench marks for evaluating Corporate Governance Standards

The bench marks for evaluation of corporate governance standards of a banking company include the following
- model codes for best practices, role of the board of directors and various committees, recommended disclosure
requirements, level of transparency, reporting system to various levels including to the board of directors,
policies framed by the board, monitoring performances at periodical intervals.
Indian scenario – RBI’s initiatives

Due to economic liberalization, banking reforms as well as introduction of prudential regulations in 1990s, the
emphasis of regulator shifted from control to governance. Banks were given more freedom as well as autonomy
in their functional areas. This called for greater governance standards from the Board of Directors of banks.
Keeping in mind the changed scenario several guidelines were issued by RBI to strengthen corporate governance
in banks. These guidelines were in line with Basel Committee recommendations such as Role of the Board of
Directors, fit and proper criteria of Board members, separation of the post of Chairman and Managing Director,
remuneration aspects, role of independent directors, ownership and extent of shareholding in private sector
banks and governance thereof. Further recently, guidelines on Non-Operative Financial Holding Companies, Fit
and proper status of groups, Prompt Corrective Action etc. were also issued to strengthen Corporate governance
of banks in India.
Judicial Pronouncement
In the matter of Assistant General Manager and Ors. vs. Radhey Shyam Pandey (02.03 . 2020 - SC) the Honorable
Supreme Court was of the opinion that the employees who completed 15 years of service or more as on cutoff
date were entitled to proportionate pension under SBI VRS to be computed as per SBI Pension Fund Rules. Let
the benefits be extended to all such similar employees retired under VRS on completion of 15 years of service
without requiring them to rush to the court. However, considering the facts and circumstances, it would not
be appropriate to burden the bank with interest. Let order be complied with and arrears be paid within three
months, failing which amount to carry interest at the rate of 6 per cent per annum from the date of this order.
The appeals are accordingly disposed of. No costs were issued.
LESSON ROUND UP
• The Banking Regulation Act, 1949 was enacted with the view to provide a law for the banking companies.
• Licensing which includes the permission provided to banking companies for operating forms a major
part of the BR Act, 1949.
• Certain eligibility criteria like Background of the banking companies, their sources of funds, their
geographical locations are required to be fulfilled before to get licence to run banking business.
• In case of any non-fulfilment of the required conditions on continuous basis the license may be cancelled
by RBI.
• When foreign banks want to operate in India, they have to seek permission of RBI for license. The
prescribed procedures are almost same as applicable to other banks in the country.
• For private sectors banks continuous authorization policy is prescribed in place of Stop and Go policy.
• Other than licensing, RBI has provided separate guidelines for carrying out the activities of insurance,
mutual funds etc.
• For Small Finance Banks & Payment Banks, RBI provides separate licensing norms and a handful
number of banks are now operating in India. Directions for On-tap licensing has been made available
now with for starting Payment Banks by private sector players. .
• RBI provides detailed guidelines for branch licensing and no bank can operate unless it is licensed
under Section 22 of Banking Regulation Act, 1949.
• Banks having general permission are allowed to shift, merge or close all ‘Banking Outlets’ (except rural
outlets and sole semi-urban outlets) at their discretion.
• Merger, Closure and shifting of any rural ‘Banking Outlet’ as well as a sole semi urban ‘Banking Outlet’
would require approval of the DCC/DLRC.
• However where general permission has been withdrawn banks have to take the approval of Department
of Banking Regulation in order to open the branches.
• A minimum amount of paid up capital has to be maintained both for domestic & foreign banks to start
up their operations.
• Under Banking Regulation Act not less than 51% of the directors of the Board of Directors of the banking
companies should have practical & special knowledge in subjects like Accountancy, economics, Taxation
etc. Recently RBI has issued directions on– Not only that, the RBI holds special power to appoint and/
or remove Managing Director/Chairman in specified circumstances.
• Recently RBI has issued directions concerning procedure and criteria for determining the ‘fit and
proper’ status of a person to be eligible to be elected as a director on the Board of Public Sector Banks.
• RBI has further announced conditions for appointments of MD&CEO/CEO/Part-time Chairman of
Private Sector Banks in India.
• RBI has announced detailed guidelines on compensation of whole time directors/ chief executive
officers/ material risk takers and control function staff in the light of compliance with Financial
Stability Board’s (FSB) Principles and Implementation Standards for Sound Compensation Practices
and the, covering the specified Private Sector Banks and foreign banks operating in India.
• RBI has released guidelines for formation of Board of Management (BoM) for Primary (Urban) Co-
operative Banks (UCBs) with deposits of Rs. 100 crores and above including criteria for selection and
appointment of members of BoM.
• To tighten the control on UCBs, RBI has also announced detailed guidelines on rationalization of
Supervisory Action Framework incorporating Financial Action Parameters and Action trigger points.
• In line with Basel Committee recommendations, RBI has issued Guidelines on corporate governance
covering areas such as Role of the Board of Directors, fit and proper criteria of Board members,
separation of the post of Chairman and Managing Director, remuneration aspects, role of independent
directors etc.
GLOSSARY
Organization for is an intergovernmental economic organisation with 36 member countries,
Economic Cooperation founded in 1961 to stimulate economic progress and world trade.
and Development
(OECD)
Assessed net worth book value or shareholders’ equity.
(ANW)
Financially Sound and a business, economy, etc. that is controlled in a way that produces good results.
Well Managed (FSWM)
World Trade an intergovernmental organization that regulates international trade.
Organisation (WTO)
State Level Banker an inter-institutional forum at State level ensuring co- ordination between
Committees (SLBCs) Government and Banks on matters pertaining to banking development.
Unbanked Rural Centre’ is defined as a rural (Tier 5 and 6) centre that does not have a CBS-enabled
(URC) ‘Banking Outlet’ of a Scheduled Commercial Bank, a Payment Bank or a SFB
or a Regional Rural Bank nor a branch of a Local Area Bank or licensed Co-
operative Bank for carrying out customer based banking transactions.
Point of Sale (PoS) the place at which a retail transaction is carried out.
E-lobbies a facility which is now provided by banks so that their customers can do their
banking transactions as per their convenience 24×7 i.e. without any time
restriction. E-Lobby provides the facility on bank holidays also.
Bunch Note Acceptor These machines can be used for both deposits as well as withdrawal of cash.
Machines (BNAM)
Cash Deposit Machines an ATM like machine that allows you to deposit cash directly into your account
(CDM) using the ATM cum debit card.
E-Kiosks a computer terminal featuring specialized hardware and software that provides
access to information and applications for communication, commerce,
entertainment, or education.
Domestic scheduled are those banks which are included in the second schedule of RBI Act 1934 and
commercial bank which carry out the normal business of banking such as accepting deposits,
(‘DSCB’) giving out loans and other banking services.
Corporate Business are retail agents engaged by banks for providing banking services at locations
Correspondents (BCs) other than a bank branch/ATM.
Pre-paid Payment are methods that facilitate purchase of goods and services against the value
Instrument (PPI) stored on such instruments.
Payment Banks (‘PB’) a niche bank that can accept demand deposits (up to Rs 1 lakh), offer remittance
services, mobile payments/transfers/purchases and their banking services
like ATM/debit cards, net banking and third party fund transfers.
Foreign Direct is an investment in the form of a controlling ownership in a business in one
Investment (FDI) country by an entity based in another country.
Adjusted Net Bank It is the net bank credit plus investments made by banks in non-SLR bonds
Credit (ANBC) held in the held-to-maturity category or credit equivalent amount of off-
balance-sheet exposure, whichever is higher.
Priority sector lending is an important role given by the Reserve Bank of India (RBI) to the banks
(PSL) for providing a specified portion of the bank lending to few specific sectors
like agriculture and allied activities, micro and small enterprises, poor people
for housing, students for education and other low income groups and weaker
sections.
External Advisory a committee appointed by RBI for evaluating Applications of Small Finance
Committee (EAC) Banks and Payments Banks.
Non-Banking Finance is a company registered under the Companies Act, 1956/2013 engaged in
Companies (NBFCs) the business of loans and advances, acquisition of shares/stocks/bonds/
debentures/securities issued by Government or local authority or other
marketable securities of a like nature, leasing, hire-purchase, insurance
Micro Finance is an organization that offers financial services to low income populations.
Institutions (MFIs)
Non-Operative means a non-deposit taking NBFC referred to in the “Guidelines for Licensing of
Financial Holding New Banks in the Private Sector”1 issued by Reserve Bank, which holds shares
Company (NOFHC) of a banking company and shares of all other financial services companies in its
group, whether regulated by Reserve Bank or by any other financial regulator,
to the extent permissible under the applicable regulatory prescriptions.
Local Area Banks small private banks, conceived as low cost structures which would provide
(LABs) efficient and competitive financial intermediation services in a limited area
of operation, i.e., primarily in rural and semi-urban areas, comprising three
contiguous districts.
Board of Management – A body of persons with special knowledge and practical experience in banking
(BoM) and other specified fields to facilitate professional management and focused
attention to the banking related activities and advising Board of Directors of
the UCBs.
Supervisory Action A set of corrective action points to be adopted by RBI, for improvement and for
Framework (SAF) expediting resolution of financially stressed UCBs.
TEST YOURSELF
1. Fill in the blanks.
a. Where there is already a place of business, Banks are allowed to open a temporary place of
business for a period of in an exhibition, mela, conference and similar occasions.
b. NOFHC shall be registered with RBI as a _____________________.
c. Minimum capital for a Small Finance bank is _____________________.
d. Payment banks are allowed to hold a maximum deposit of __________ per depositor.
e. RBI has powers to increase Voting rights of a person holding shares of a bank from _____ % to _____ %.
f. In case of a banking company _____ % of Directors should have special knowledge or practical
experience in accountancy, agriculture and rural economy, banking, co-operation etc.
g. A director of a banking company cannot continuously hold his office for a period beyond
_____________________.
h. The period of appointment of a Chairman/ Managing Director on a whole-time basis will be for a
period of _____________________.
i. RRBs shall be allowed to open one Regional Office (RO) for every _____ banking outlets for which
they are required to obtain licence.
j. The age limit for a person to be eligible to be elected as a director on the Board of Public Sector
Banks is between _____ and _____ years.
2. Say True or False.
a. Foreign banks are required to bring an assigned capital of US $ 100 million up front at the time of
opening the first branch in India.
b. Tier II banks have deposits below Rs. 100 crores.
c. A banking company’s equity capital should consist of only equity shares.
d. A banking company can hold shares in any company, whether as pledgee, mortgagee or absolute
owner, not exceeding thirty per cent of the paid-up share capital of that company or thirty per
cent of its own paid-up share capital and reserves, whichever is less.
e. If a Chairman is to be appointed on part-time basis, no prior approval of RBI is required.
f. A banking company cannot employ or allow a Managing agent to manage its affairs.
g. RBI in consultation with Central government can appoint a committee of three or more
persons who have experience in law, finance, banking, economics or accountancy to assist the
Administrator.
i. If a person has served as a Director of any bank /FI/ Insurance co./ RBI for a period of six years
he cannot be elected/ re-elected as a Director on the Board of a PSU Bank.
j. Normally, back offices of banks can have direct interface with customers.
k. The purpose of constitution of BoM is in a UCB is ___________________________.
l. The main objective of rationalization of Supervisory Action Framework (SAF) for UCBs is
___________________________.
3. Attempt the following:
a. Discuss briefly the licensing of Private sector banks and RRBs in India.
b. Write a brief note on branch licensing aspects of banks in India.
c. What are the powers of RBI with reference to appointment Chairman, Managing Director and
other directors of banks?
d. What are the various powers of RBI regarding control over Directors and other employees of
banks?
e. Write a note on Importance and Evolution of Corporate governance in Banks in India.
f. Summarize the fit and proper criteria for a person to be elected as a Director in a PSU Bank.
Lesson 4 • Regulation of Banking Business 95
Lesson 4 Regulation of Banking Business

Should Know
• SLR This lesson will enable a reader to • Reserve Bank of India Act,
understand : 1934.
• CRR
• Various powers of RBI to • Banking Regulation Act, 1949.
• FCNR
issue directions under powers • Payment and Settlement
• DEAF conferred by various acts cited. Systems Act, 2007.
• CRILC • Regulation concerning • Nomination Rules 1985.
acceptance of deposits.
• ALCO
• Rules and practices on
Nomination facility provided by
banks to customers.
• Various provisions involved
in regulation of Loans and
advances.
• Interest rate regulations on
Deposits and Advances.
• Payment systems in India and it’s
regulation.
• Regulatory mechanism of money
market and money market
instruments.
• Reserve funds to be maintained
by Banks in India with RBI.
• Mechanism of maintenance of
CRR and SLR.
Lesson Outline
• Introduction • Regulation of Money Market
• Power of RBI to Issue Directions Instruments
• Acceptance of Deposits • Reserve Funds
• Nomination • Maintenance of CRR, SLR
• Loans and Advances • LESSON ROUND UP
• Regulation of Interest Rate • GLOSSARY
• Regulation of Payment Systems • TEST YOURSELF
• Internet Banking Guidelines • LIST OF FURTHER READINGS
95
INTRODUCTION
The topic presented in this lesson deals with certain regulatory aspects of banks in India by RBI. The objective
of the lesson is to give a reader a deeper insight and understanding of operational regulations concerning
business of banks like interest rates, deposits, advances, payment system, service delivery channel like internet,
apart from giving an exposure to money market instruments which are used by banks for compliance as well
as investments for maintaining statutory reserves. Keeping in mind the Regulatory frame work contents have
been elaborated with regard to the usefulness of the same from basic knowledge, compliance as well as advisory
roles that would be performed by students in future. In that sense the contents are a mix of Level 1 and 2
orientations. The topic and contents will expose students equip themselves with the required knowledge base
if and when an opportunity arises in future.
POWERS OF RBI TO ISSUE DIRECTIONS

The RBI derives its powers to issue directions to banks from Sections 21, 35A, 35 AA, 35 AB, 36, 36AA, 36AB,
36ACA of the Banking Regulation Act, 1949.
Under Section 21(2) of the Banking Regulation Act, the RBI has powers to give directions to banking companies,
regarding their advances as under :
(a) the purposes for which advances may or may not be made,
(b) the margins to be maintained in respect of secured advances,
(c) the maximum amount of advances/ other financial accommodation that can be made by banking company
to any one company, firm, association of persons or individual,
(d) the maximum amount up to which, guarantees may be given by a banking company on behalf of any one
company, firm, association of persons or individual, and
(e) the rate of interest and other terms and conditions on which such advances or other financial
accommodation or guarantees can be given.
It is expected that every banking company complies with all directions given in this regard. Sections 35 A, 35
AA, 35 AB, 36, 36 AA, 36 AB, 36 ACA confers much more broader powers to RBI in respect of regulation of
banking companies and also in respect of Board of Directors etc.
Under Section 35 A, the RBI has powers to issue directions in the interest of Banking policy or public interest
or safeguarding the interests of a bank/depositors or for securing the proper management of any bank. RBI
may issue directions in general as well as to a particular bank or banks or group of banks as the case may
be. All banks are bound to follow/comply with such directions issued. The RBI, either on its own or based on
representation made to it, can modify or cancel any such direction issued. While doing so, RBI can impose
conditions as it may consider necessary.
Under Section 35 AA, the Central Government can authorize the RBI to issue directions to any bank/banks
in the matter of initiating insolvency resolution process in respect of loan default, under the Insolvency and
Bankruptcy Code, 2016.
Section 35 AB, confers powers on the RBI, to issue directions in respect of resolution of stressed assets i.e. NPAs.
For resolution of stressed assets, RBI may advise the bank to form an authority or committee, with members
either appointed by RBI or approved by RBI.
Under Section 36, the RBI derives following powers in respect of a bank or banks as the case may be –
i. caution or prohibit a bank/ banks from entering into any particular transaction or class of transactions
and advise any bank;
ii. order a bank to call a meeting of its Directors for the purpose of considering any matter relating to the
bank or require an officer of the bank to discuss any such matter with an officer of the RBI;
iii. depute one or more of its officers to the proceedings/meeting of the Board of Directors/any committee/
any other body of the bank.;
iv. instruct the concerned bank to give an opportunity to its officers deputed, be heard at such meetings and
also order such officers to send a report of proceedings thereof;
v. require the Board of Directors/committee/any other body of the bank to submit in writing a report
regarding any meeting held by such bodies;
vi. depute an any of its officers as an observer observe the manner in which the bank/branches/offices are
being conducted and submit a report thereon.
The RBI has powers to appoint any staff at such places as deemed necessary to scrutinize returns, statements
and information furnished by a bank/banks for ensuring their efficient performance of functions.
Under Section 36 AA, 36 AB, 36 ACA RBI has extensive powers relating to removal of managerial and other
persons from office, to appoint additional Directors, Supersession of Board of Directors respectively as deemed
necessary in the interests of the bank/depositors etc.
Note: For details refer Lesson 3 of the study material.
ACCEPTANCE OF DEPOSITS
Accepting deposits is one of the basic functions of banks as per Section 5(b) of the Banking Regulation Act,
1949. Though the Banking Regulation Act, 1949 does not contain any specific provisions for regulating deposits
of banks,
RBI derives its powers for regulating deposits of banks Section
A deposit is a financial term that means
35A of the said Act. Therefore in the interests of depositors as
money held at a bank. A deposit is a
well as banks, RBI regulates the acceptance of deposits through
transaction involving a transfer of money
it’s directions issued periodically regarding rates of interest
by one party i.e. customer to another
applicable on Savings accounts, Non-Resident Indians deposits,
party i.e. bank for safekeeping.
minimum and maximum period, rules for premature closure,
bulk deposits etc.
Banks accept different types of deposits which can be broadly classified in to Demand Deposits and Time
Deposits. Savings Bank account, Current Accounts which are repayable on demand are known as Demand
deposits. Fixed deposits, Recurring deposits which are repayable after a certain fixed period are known as Time
Deposits. Most of the interest rate structures have been left to the discretion of banks, RBI specifies the rates
of interest on Savings bank deposits and NRI deposits. However RBI impresses upon banks to have a Board
approved policy on various operational aspects, on the lines of RBI’s directions. Banks have to ensure there
is no discrimination between depositors in the same class. RBI’s master directions on deposits relate to the
following areas for commercial banks:
i. Interest Rate framework;
ii. Interest rate on domestic Current Account;
iii. Interest Rate on domestic Saving Deposits;
iv. Interest Rates on domestic Term Deposits;
v. Payment of Additional Interest on domestic deposits;
vi. Interest on overdue domestic deposits;
vii. Floating rate domestic term deposits;
viii. Periodicity of payment of Interest on domestic savings deposits;
ix. Interest payable on the domestic deposit account of deceased depositor;
x. Discretion to pay interest on the minimum credit balance in the composite cash credit account of a farmer;
xi. Penalty on premature withdrawal of domestic term deposit;

xii. Interest rates on Rupee Deposits of Non-Residents;
xiii. Prohibition on marking lien on Rupee Deposits of Non-Residents;
xiv. Penalty on premature withdrawal of NRE deposits;
xv. Foreign Currency (Non-resident) Accounts (Banks) ‘FCNR- B’ Scheme;
xvi. Manner of calculation of interest on FCNR (B) deposits;
xvii. Calculation of interest on renewal of FCNR (B) deposits;
xviii. Interest payable on the deposit of a deceased FCNR (B) depositor;
xix. Payment of interest on FCNR (B) deposits of NRIs on return to India;
xx. Conversion of FCNR (B) Accounts of Returning Indians into Resident Foreign Currency Accounts/ Resident
Rupee Accounts- Payment of interest;
xxi. Resident Foreign Currency Accounts Scheme;
xxii. Prohibitions;
xxiii. Exemptions.
The RBI also issues similar directions in respect of Co-operative banks too.
Depositor Education and Awareness Fund Scheme (DEAF)

As per Section 26 of the Banking Regulation Act, banks have to file an annual report in respect of unclaimed
deposits as well as inoperative accounts that are not operated for 10 years. However, in a fresh development
relating to unclaimed deposits, effective from May 23, 2014 all unclaimed deposits lying with a bank for a
period of ten years or more are to be transferred to Reserve Bank of India towards Depositor Education and
Awareness Fund Scheme (‘DEAF’).
According to the scheme all banks should transfer to the DEAF, “the amounts becoming due in each calendar
month (i.e. proceeds of the inoperative accounts and balances remaining unclaimed for ten years or more)”
along with the interest accrued thereon, on the last working day of the subsequent month. The amounts to be
credited to the DEAF should consist of the credit balance in any deposit account maintained with banks which
have not been operated upon for ten years or more, or any amount remaining unclaimed for ten years or more,
which include :
(a) savings bank deposit accounts;
(b) fixed or term deposit accounts;
(c) cumulative/recurring deposit accounts;
(d) current deposit accounts;
(e) other deposit accounts in any form or with any name;
(f) cash credit accounts;
(g) loan accounts after due appropriation by the banks;
(h) margin money against issue of Letter of Credit/Guarantee etc., or any security deposit;
(i) outstanding telegraphic transfers, mail transfers, demand drafts, pay orders, bankers cheques, sundry
deposit accounts, vostro accounts, inter-bank clearing adjustments, unadjusted National Electronic Funds
Transfer (NEFT) credit balances and other such transitory accounts, un-reconciled credit balances on
account of Automated Teller Machine (ATM) transactions, etc.;
(j) undrawn balance amounts remaining in any prepaid card issued by banks but not amounts outstanding
against travellers cheques or other similar instruments, which have no maturity period;
(k) rupee proceeds of foreign currency deposits held by banks after conversion of foreign currency to rupees
in accordance with extant foreign exchange regulations; and
(l) any other amount as RBI may specify.
From the effective date, every month, banks are required to transfer to the DEAF the amounts becoming due
in each calendar month balances remaining unclaimed for ten years or more along with the interest accrued
thereon, on the last working day of the subsequent month.
If a customer demands repayment whose deposits/unclaimed amount had been transferred to DEAF, banks
shall repay the customer/depositor, along with interest if applicable, and lodge a claim for refund from DEAF
for an equivalent amount paid to the customer/depositor.
DEAF will pay the interest on a claim only from the date on which the balance in an account was transferred
to the DEAF to the date of payment to the customer/depositor. No interest will be paid in respect of amounts
refunded if no interest was payable by the bank as per the terms of the deposits to its customer/depositor.
RBI will specify the rate of interest payable on the amount transferred to the fund from time to time. If foreign
currency deposits are involved banks can claim refund of the eligible amount from the DEAF only in Indian
rupees. Banks should claim refunds made by them in each calendar month from the DEAF, on the last working
day of the subsequent month. Banks are required to submit returns as specified by the RBI.
DEAF is administered by RBI through a committee constituted for this purpose and has been given specific
powers to call for information for any information relating to unclaimed amounts and the inoperative accounts,
in general or a bank in particular, as deemed necessary. The income on the funds lying in the DEAF will be
utilized by RBI for promoting depositors’ interests and for any such purposes as RBI may decide.
NOMINATION
Nomination facility for Deposits, Safe Deposit Locker holders,
as well as for articles kept in Safe Custody in a bank including Nomination is a facility that enables
a Cooperative bank, was made available in India from March a deposit account holder, investor in
1985 by introducing Sections 45 ZA to 45 ZF under the Banking mutual fund/other financial instruments
or safe deposit locker holder to nominate
Regulation Act. The procedures to be followed by a Bank are
an individual, who can claim the proceeds
enumerated in Banking Companies Nomination Rules 1985.
of the deposit account, investment or
Under the nomination facility a customer holding a deposit contents of the safe deposit locker, post
or a customer jointly holding a deposit with others in a bank the demise of the original depositor,
may nominate, an eligible person as nominee, to whom such or investor or locker holder.
deposits may repaid, in the unfortunate event of death of the
deposit holder/joint holders.
Nomination made in respect of a person can be varied or cancelled by submitting suitable forms specified in
this regard. These are as under :
Account Registration Cancellation Variation
Deposit DA-1 DA-2 DA-3
Safe Deposit Lockers SL -1 SL-2 SL-3
Safe Custody SC-1 SC-2 SC-3
Nomination facility is available only in respect of living individual/joint individuals holding deposits with
banks. It is not available to business entities except Proprietorship concerns. If nominee is a minor, there is
a provision to appoint a person (guardian) who can lawfully represent the minor for receiving deposit on his
behalf, if a claim has to be made.
In case of a joint deposit, all joint holders should together nominate / cancel a nominee. According to
RBI’s directions Nomination is compulsory in respect of account held by an individual (single name).
If the accountholder in such cases refuses to nominate, he has to give the refusal in writing. If the customer
declines to give his refusal in writing the concerned bank officer should record the same in the account opening
form itself.
Banks are required to give an acknowledgement in respect of nomination/cancellation/ variation filed by
customers. Banks are required to record on the face of pass books/FDRs the legend “Nomination Registered” in
all cases where account holder/s opt for nomination. If agreed by customers, the name of nominee can also be
indicated on the face of pass books/FDRs.
Settlement in favour of a nominee in respect of deposit accounts, delivery of contents in respect of a safe deposit
locker, delivery of article left for safe custody constitute a full discharge to the banking company of its liability
in the respective cases.
Note: Further details on the topic can be found in Lesson 5.
LOANS AND ADVANCES

Lending has been core of banking business in terms of the definition of banking under Section 5 (b) of the
Banking Regulation Act, 1949. Loans and advances of banking companies can be for short term, medium or
long term. In terms of securities, loans given for different purposes can also be fully secured or partly secured
or unsecured.
The RBI regulates loans and advances through powers The Reserve Bank has created a Central
conferred by Section 21 of the Banking Regulation Act. It Repository of Information on Large Credits
has powers to issue directions in general or in respect of (CRILC) of scheduled commercial banks, all
a particular bank. It has also policy making powers in the India financial institutions and certain non-
public interest or in the interest of depositors or in the banking financial companies with multiple
objectives, which, among others, include
interest of banking policy. From the point of regulation,
strengthening offsite supervision and early
RBI may issue directions in respect of purposes for which
recognition of financial distress. With a view
loan or advance can be made, margins in respect of to building a similar database of large credits
secured advances, maximum amount of advance that can extended by primary (urban) co-operative
be extended in respect of a borrower or a group (exposure banks (UCBs), it has been decided to bring UCBs
norm) in relation to, capital, reserves and deposits of with assets of Rs.500 crores and above under
banks concerned, maximum amount of non-fund based the CRILC reporting framework vide. Detailed
limits that can be granted i.e. guarantees, letter of credit Guidelines have been vide RBI notification
etc., rate of interest and other terms under which credit/ dated December 27, 2019 and January 16, 2020.
guarantees can be extended.
Depending upon the macro economic scenario the RBI also issues appropriate directions from time to time.
Some of the tools of credit control which RBI exercises include Selective credit control which also involves
indirectly price control, restrictions on loans and advances under Section 20 of the Banking Regulation Act,
1949 such as:
• Advances against its own shares,
• Commitment for granting loans on behalf of its directors,
• Granting loans to companies in which any director is interested or has substantial interest,
• Where a director is a partner or a guarantor.
Limits on exposure to single and group borrowers/parties and large exposures and Revision
in the target for priority sector lending – UCBs (Notification dated March 13, 2020)
RBI has revised the limits on exposure to single and group of borrowers to 15% and 25% of their Tier I capital
from the present 15% and 40% (which was fixed in April 2005). Revised exposure limits shall apply to all types
of fresh exposures taken by UCBs. Exposures which are in excess of the revised limits are to be brought to within
the aforesaid revised limits by March 31, 2023.
For existing term loans and non-fund based limits no further exposures to be taken; they are allowed to continue
as per their repayment schedule/maturity. Definitions of “Tier – I capital’ and ‘group of connected borrowers/
parties’ will be the same as defined in July 1, 2015 Master Circular on the topic. Loans include funded and non-
funded exposures of credit. UCB should see to it that at least 50 per cent of their aggregate loans and advances
comprising loans of not more than Rs. 25 lakh or 0.2% of their tier I capital, whichever is higher, subject to
a maximum of Rs.1 crore, per borrower/party. UCBs which do not, at present, comply with the prescribed
threshold should comply with the above requirements by March 31, 2024.
Revised Priority Sector Lending targets for UCBs

RBI has stepped up the priority sector lending target for UCBs from the present level of 40% of Adjusted Net
Bank Credit (ANBC) or Credit Equivalent of Off-balance Sheet Exposure (CEOBSE) to higher levels as per the
table below: The revised lending targets to be achieved by March 31, 2024.
PSL targets to be achieved by
March 31, 2021 March 31, 2022 March 31, 2023 March 31, 2024
45% of ANBC or CEOBSE, 50% of ANBC or CEOBSE, 60% of ANBC or CEOBSE, 75% of ANBC or CEOBSE,
whichever is higher whichever is higher whichever is higher whichever is higher
REGULATION OF INTEREST RATE

RBI regulates interest rates of deposits and advances in terms of powers given to it under Section 21(2) and
and 35(A). RBI started regulating interest rates on deposits from the year 1964, prior to which it was left to
individual banks themselves to decide the same. Till1990s RBI administered interest rates of Deposits as well
as Advances. As a part of economic reforms, banking sector reforms took place too.
One of the important reforms carried out in the banking sector was in respect of interest rates on deposits and
advances. In order to strengthen the competitiveness the RBI started a process of deregulating interest rates
and was able stabilize the same by October 1997.
Deregulation of Deposit Interest Rates in India – A History

The process of deregulation of deposit interest rates had begun in the 1980s. In April 1985, banks were
allowed to set interest rates for maturities between 15 days and up to 1 year, subject to a ceiling of 8 per cent.
It was expected that with reasonable rates of interest on maturities, banks would be able to achieve a better
distribution of term deposits rather than highly skewed distribution around longer maturities at relatively
higher costs. However, when a few banks started offering the ceiling rate of 8 per cent even for maturities
of 15 days, other banks followed suit without regard to consideration of profitability and set a single rate of
8 per cent for maturities starting from 15 days and up to one year. The consequence was a shift of deposits
from current accounts and, to a lesser extent, from savings accounts to 15-day deposits. As a result of price
war among banks, the freedom to set interest rates subject to a ceiling was withdrawn in May 1985. The
process of deregulation resumed in April 1992 when the existing maturity wise prescriptions were replaced
by a single ceiling rate of 13 per cent for all deposits above 46 days. The ceiling rate was brought down
to 10 per cent in November 1994, but was raised to 12 per cent in April 1995. Banks were allowed to fix
the interest rates on deposits with maturity of over 2 years in October 1995, which was further relaxed
to maturity of over 1 year in July 1996. The ceiling rate for deposits of 30 days up to 1 year’ was linked to
the Bank Rate less 200 basis points in April 1997. In October 1997, deposit rates were fully deregulated by
removing the linkage to the Bank Rate. Consequently, the Reserve Bank gave the freedom to commercial
banks to fix their own interest rates on domestic term deposits of various maturities with the prior approval
of their respective Board of Directors/Asset Liability Management Committee (ALCO). Banks were
permitted to determine their own penal interest rates for premature withdrawal of domestic term deposits
and the restriction on banks that they must offer the same rate on deposits of the same maturity irrespective
of the size of deposits was removed in respect of deposits of Rs. 15 lakh and above in April 1998. Now banks
have complete freedom in fixing their domestic deposit rates, except interest rate on savings deposits, which
continues to be regulated.
The RBI also regulates interest rates on loans and advances through powers conferred under Section 21(2)
and 35 (A). For example, RBI regulates the interest rates chargeable on Priority Sector Advances and other
advances through linking it to the Marginal Cost of Lending Rate (MCLR) of banks. The RBI has also given
freedom to banks to determine their own rates for lending depending on individual banks performance, market
and economic conditions.
Recognising the high cost of borrowing in India, RBI has been urging banks to pass on the benefits of bench mark
Repo rate reductions to borrowers of the banking system (known as “Monetary Transmission”) particularly to
borrowers belonging to MSME sector and others who opt for floating rate loans.
However such Monetary Transmission was found to be slow by the banking system in India. In order to speed
up the process of Monetary Transmission, the RBI had announced vide its circular dated September 4, 2019 that
from October 1, 2019 it is mandatory for banks to link all new floating rate personal or retail loans (housing,
auto, etc.) and floating rate loans to Micro
and Small Enterprises extended to an external bench mark such as Repo rate or Six-month Treasury Bill yield
or any other bench mark market interest rate published by Financial Benchmarks India Pvt. Ltd. from October
1, 2019.
As a consequence of this several banks have already launched Repo-linked lending rate or Repo-based lending
rate products. Under this repo-rate linked interest rates on loans it is expected that banks would revise their
lending rates at least once in three months instead of earlier practice of yearly changes. This is expected help in
monetary transmission faster to eligible borrowers.
It is also worth noting that the interest rates charged by banks cannot be a matter of scrutiny in court of law, as
decided in Corporation Bank vs. D.S. Gowda [(1994) 5 SCC 213] case.
As per notification dated July 02, 2021, the Reserve Bank of India has decided that if a Term Deposit (TD)
matures and proceeds are unpaid, the amount left unclaimed with the bank shall attract rate of interest as
applicable to savings account or the contracted rate of interest on the matured TD, whichever is lower.
REGULATION OF PAYMENT SYSTEMS

As on date payment system in India consist of pre-paid payment instruments, card schemes, cross-border in-
bound money transfers, Automated Teller Machine (ATM) networks and centralised clearing arrangements.
Till the Payment and Settlement Systems Act, 2007 (PSS Act) was legislated, RBI was managing the same with
powers available under the Section 58 of RBI Act, 1949 that as well as Section 35A of BR Act, 1949. Section 58
itself was introduced after the Information Technology Act, 2000 was enacted. As per the PSS Act only RBI has
the power to commence or operate a payment system in India unless any other entity authorised by RBI.
The Reserve Bank of India had constituted a Committee in June 2019 under the Chairmanship of the Chief
Executive, Indian Banks’ Association to review the entire gamut of Automated Teller Machine (ATM) charges
and fees with particular focus on interchange structure for ATM transactions. The recommendations of the
Committee have been comprehensively examined. It is also observed that the last change in interchange fee
structure for ATM transactions was in August 2012, while the charges payable by customers were last revised
in August 2014. A substantial time has thus elapsed since these fees were last changed. Accordingly, given
the increasing cost of ATM deployment and expenses towards ATM maintenance incurred by banks / white
label ATM operators, as also considering the need to balance expectations of stakeholder entities and customer
convenience, RBI has decided to revise the charges.
The revised charges are as under:
a. Allow increase in interchange fee per transaction from ₹15 to ₹17 for financial transactions and from ₹5
to ₹6 for non-financial transactions in all centres. This shall be effective from August 1, 2021.
b. Customers are eligible for five free transactions (inclusive of financial and non-financial transactions)
every month from their own bank ATMs. They are also eligible for free transactions (inclusive of financial
and non-financial transactions) from other bank ATMs viz. three transactions in metro centres and five
transactions in non-metro centres. Beyond the free transactions, the ceiling / cap on customer charges
is ₹20 per transaction. To compensate the banks for the higher interchange fee and given the general
escalation in costs, they are allowed to increase the customer charges to ₹21 per transaction. This increase
shall be effective from January 1, 2022.
OVERVIEW OF EVOLUTION AND STATUS OF PAYMENT SYSTEM IN INDIA

The beginning – coins and written mode India has a long history of payment and settlement systems from
ancient times. Initially through barter, later through the form of metal coins and subsequently through stamped
metal bar was first made use of. Subsequently loan deeds (known as rnapatra or rnalekhya) were in use. This
was followed by ‘Adesha’ i.e. order on banks were also known to have been used. Demand bills and usance bills
were also known to be used during Mughal period, part from Pay orders between Royal Treasury and provincial
governments. Hundies were in vogue since 12th century in India. Paper money made its entry in India with the
advent of Bank of Hindustan during the British regime. Inland promissory notes were introduced by British in
1827.
Paper Instruments
The enactment of Negotiable Instruments Act, 1881 paved the way of formalizing Promissory notes, cheques
and bill of exchange as payment instruments. With the increase in transactions through these instruments –
especially of cheques – clearing houses were started for payment and settlements in Presidency towns. With
establishment of RBI in 1935 clearing houses were brought under it’s purview.
Automation
Computerization of clearing house operations in 1980s for settlement is the beginning of modernization of
payment system. Subsequently, to speed up clearing, Magnetic Ink Character Recognition (MICR) technology
was brought in 1986 ushering in a dramatic change in processing of cheques that speeded up settlement.
Cheques were also redesigned to conform to the standards of MICR. As a further step to modernize clearing
of cheques, the Cheque Truncation System (CTS) was introduced first in New Delhi in 2008 and now all the
erstwhile 66 MICR centres have been made as a part of three grid-CTS systems. Thus a large part of the cheque
clearing in the country has been brought under faster clearing process making available funds to customers
speedily. Simultaneously cheques were also standardized for fraud proof CTS clearing.
Electronic Payment Systems

Subsequent to computerization of banks electronic
Electronic Clearing Service (ECS) is an
payment modes have also been introduced in banks from electronic mode of payment / receipt for
early 1990s. Electronic Clearing Service (ECS) was the transactions that are repetitive and periodic in
first one to be introduced for crediting large payments nature. ECS is used by institutions for making
such as dividend, salary, interest payments, etc. as well bulk payment of amounts towards distribution
as ECS Debit to handle “many-to-one payments” such of dividend, interest, salary, pension, etc., or for
as payment of electricity/telephone/gas and similar bulk collection of amounts towards telephone /
payments. Several developments in ECS, culminated in electricity / water dues, cess / tax collections, loan
National Automated Clearing House (NACH) by National instalment repayments, periodic investments in
Payments Corporation of India Limited. mutual funds, insurance premium etc.
NACH is a funds clearing platform set up by NPCI similar to the existing ECS of RBI. NACH has both Debit
and Credit variants and it aims at managing large volume interbank bulk debit/credit transactions, which
are repetitive in nature. The main focus of NACH is to handle low value, high-volume transactions based on
electronic files. Ideally implementing this mandate will allow transactions to be cleared in real-time mode
rather than batch mode. NACH network covers more than 80000 bank branches. The new centralized ACH
solution known as NACH is aimed at consolidating the current multiple ECS systems and which will be free of
local barriers /inhibitors bringing in harmonization of standards and practices. If any new customer wants to
give a fresh ECS mandate to his/her bank, it will be done through NACH henceforth. However all existing ECS
mandates whether debit/credit will continue as they are till they are cancelled by customers.
To facilitate larger payments of more than Rs. 2 lakhs in a faster mode between customers to customers and
institutions Real Time Gross Settlement (RTGS) was introduced in 2004. This was upgraded in 2013 with
straight through credit arrangement. In the year 2004, the first RTGS was introduced in the country which has
been upgraded into a new system dedicated to the nation in 2013.
Prior to the introduction of RTGS there was a payment system known as Electronic Funds Transfer system
between banks which was limited to only centres where RBI had its office. This was subsequently upgraded to
National Electronic Funds Transfer (NEFT) system. As per RBI’s announcement vide its circular dated December
6, 2019, NEFT has been made a 24 hour facility with 48 half hourly settlements from December 16, 2019. NEFT
system will be available on all days of the year, including holidays. NEFT transactions after usual banking hours
of banks are expected to be automated transactions initiated using ‘Straight Through Processing (STP)’ modes
by the banks. The existing discipline for crediting beneficiary’s account or returning the transaction (within
2 hours of settlement of the respective batch) to originating bank will continue. Banks are required to send
positive confirmations for all NEFT credits.
With changes in the NEFT settlement frequency, RBI vide it’s announcement dated 13th December 2019, has
decided to provide an additional collateralised intra-day liquidity facility, called Liquidity Support (LS), to
facilitate smooth settlement of NEFT transactions in the accounts of member banks held by it, on a round-the-
clock-basis. LS facility will operate on the same terms and conditions as the Intra-Day Liquidity (IDL) facility.
Member banks eligible for IDL will also be able to draw LS which will be counted as a part of their borrowings
under IDL. LS limits would be set by RBI. Margin requirement is similar to that of IDL. Any outstanding LS
drawings at the end of the day will be automatically be counted as a part of RBI’s Marginal Standing Facility
(MSF).MSF borrowing reversal will take place along with other Liquidity Adjustment Facility operations as per
existing practice.
By a separate notification on December 16,2019, RBI has directed member banks of the NEFT system, not to
levy any charges from their savings bank account holders for funds transfers done through online (viz. internet
banking and/or mobile apps of the member banks). This is done further to encourage digital retail payments.
Now NEFT & RTGS facility is available 24 hours on all days.
Payments and Settlements Act & National Payments Corporation of India (NPCI)
With the introduction of Payment and Settlements Act,
2007 (PSSA), the RBI is the designated nodal agency for National Payments Corporation of India (NPCI),
regulation and supervision of payment systems in India. an umbrella organisation for operating retail
In the year 2008, an apex organization for operating the payments and settlement systems in India,
retail payment systems in India in the name of National is an initiative of Reserve Bank of India (RBI)
Payments Corporation of India (NPCI), was established and Indian Banks’ Association (IBA) under
on a joint initiative of RBI and Indian Banks Association the provisions of the Payment and Settlement
(IBA) as per provisions of the PSSA for managing Payment Systems Act, 2007, for creating a robust
& Settlement Infrastructure in India. The objective of Payment & Settlement Infrastructure in India.
NPCI is “to provide infrastructure to India.
The entire Banking system in India for physical as well as electronic payment and settlement systems.” NPCI
is innovatively engaged in widening the retail payment systems by adopting state-of-the-art technology for
bringing in efficiency and safety in the payment systems. Notable contribution of NPCI include RuPay Card
products as well as Bharat Interface Money (‘BHIM’)& Immediate Payment System (“IMPS”) money transfer
applications, the BHIM being introduced post-demonetization in 2017. Among the retail electronic payment
systems, the National Electronic Funds Transfer (NEFT) system of RBI plays a key role. In addition to the NEFT,
the IMPS operated by NPCI is convenient for remitting small remittances round the clock through interbank
electronic fund transfer service that could be accessed on multiple channels like Mobile, Internet, ATM, SMS,
Branch and USSD(*99#). IMPS is an instant money transfer facility instantly within banks across India.
Card products
Banks in India issue a variety of cards such as, Credit, Debit and Pre-paid cards of international card networks
such as Master Card, VISA and American Express. Credit cards are of three types, simple credit cards, co- branded
credit cards and corporate credit cards issue to employees. Add-on cards are subsidiary to the principal card
and liability devolves to the principal cardholder.
After its formation, NPCI, it has launched, an indigenous card network called ‘RuPay’. All these cards can be used
in online transactions and in over 2,20,000 ATMs and 28,00,000 Point of Sale (POS) terminals.
Note: Regulatory aspect of issuance of card and related issues are already discussed in Lesson 2.
Processing of e-mandate in Unified Payments Interface (UPI) for recurring transactions

In 2019 RBI had permitted processing of e-mandate on cards /
Due to Pandemic the Additional
Prepaid Payment Instruments (PPIs) for recurring transactions
Factor of Authentication (AFA)
(merchant payments), with Additional Factor of Authentication
requirement was relaxed for values
(AFA) during e-mandate registration, modification and revocation,
up to Rs. 2,000/- per transaction for
as also for the first transaction, and simple / automatic subsequent
card transactions in contactless mode
successive transactions, subject to certain conditions. The same has
at Points of Sale (PoS) terminals.
been extended to cover Unified Payment Interface (UPI) transactions
as well vide its Notification dated January 10, 2020.
Enhancing Security of Card Transactions

Over the years in India the volume and value of transactions made through cards have increased manifold. To
improve user convenience and increase the security of card transactions, RBI through it’s notification dated
January 15, 2020 has issued the following directives :
1. (a) At the time of issue / re-issue, all cards (physical and Now due to COVID-19 pandemic
virtual) be enabled for use only at contact based points of the RBI vide its notification dated
usage [viz. ATMs and Point of Sale (PoS) devices] within December 04, 2020 enhanced the
India. Issuers to provide cardholders a facility for enabling limit for contact less transaction
card not present (domestic and international) transactions, from to Rs. 2,000/- to Rs. 5,000/- per
card present (international) transactions. transaction for card transactions.
(b) For existing cards, issuers to take a decision, based on their risk perception, whether to disable the
card not present (domestic and international) transactions, card present (international) transactions
and contactless transaction rights. Existing cards which have never been used for online (card not
present) / international / contactless transactions are to be mandatorily disabled for this purpose.
(c) Additionally, the issuers to provide to all cardholders:
i. facility to switch on / off and set / modify transaction limits (within the overall card limit, if
any, set by the issuer) for all types of transactions – domestic and international, at PoS / ATMs
/ online transactions / contactless transactions, etc.;
ii. the above facility on a 24x7 basis through multiple channels - mobile application / internet
banking / ATMs / Interactive Voice Response (IVR); this may also be offered at branches /
offices;
iii. alerts / information / status, etc., through SMS / e-mail, as and when there is any change in
status of the card.
2. The provisions of this circular are not mandatory for prepaid gift cards and those used at mass transit
systems.
Guidelines on Merchant Acquiring Business – Regional Rural Banks

RBI has permitted RRBs to act as merchant acquiring banks using Aadhaar Pay – BHIM app and POS terminals
by deploying their own devices subject to fulfilling following conditions –
• Should have the permission for mobile banking from the RBI;
• Bank’s IT systems & CBS should have been subjected to an Information System Audit not earlier than six
months from the date of application to confirm that the system is adequately secure;
• Bank must ensure necessary infrastructure for application development, safety and security of the
transactions and handling of customer grievance;
• Customer grievance redressal mechanism duly approved by the bank’s board should be in place;
• Bank should have a board approved policy on merchant acquisition for card transactions;
• Should not be any restrictions imposed on the bank for accepting deposits/ withdrawals by RBI.
• No penalty should have been imposed in last two financial years;
• In the preceding financial year Net worth should be of Rs. 100 crore or more as on March 31, Minimum
CRAR of 9% and Net NPA below 5%.
Concerned RRB to inform the respective Regional Offices of Reserve Bank, within a period of 15 days from the
date of operationalising the merchant acquisition business.
Regulation of Payment Aggregators (PAs) and Payment Gateways (PGs)

Taking into account the important functions of these intermediaries in the online payments space as also
keeping in view their role vis-à-vis handling funds, Vide its circular dated March 17, 2020 RBI has announced
detailed guidelines on the regulation of PAs and PGs.
PAs are entities that facilitate e-commerce sites and merchants to accept various payment instruments from
the customers for completion of their payment obligations without the need for merchants to create a separate
payment integration system of their own. They facilitate merchants to connect with acquirers. In the process,
they receive payments from customers, pool and transfer them on to the merchants after a time period. Example:
PayTM, Bill Desk, Pay Pal etc.
PGs are entities that provide technology infrastructure to route and facilitate processing of an online payment
transaction without any involvement in handling of funds. In India mostly PGs are banks such as HDFC, AXIS,
UBI etc.
Pre-Paid Instruments (PPIs)

In addition to the above, Pre-paid instruments (PPIs) are also used as payment products due to introduction
of mobile wallets. Banks and non-banking entities can issue PPIs after getting a licence from RBI in this regard.
PPI can be categorized as open, semi-closed and closed. Open category allows cash withdrawal and is restricted
to only banks. The PPI guidelines allow for two kinds of PPI, limit up to Rs. 200,000.NPCI has also launched
National Common Mobility Card (NCMC) and National Electronic Toll Collection (NETC) to enable cash-less
transactions. It has also launched the National Unified USSD Platform (NUUP). By dialing ‘*99#’ on their mobile
phone and transact, Sending and Receiving funds from one account to another bank account, balance enquiry,
setting / changing UPI PIN etc. Forty one banks offer *99# service through GSM service providers in 13 different
languages including Hindi & English. The Bharat Bill Payments (BBPS) system is floated by RBI and managed by
NPCI to enable citizens of India to pay their bills from anywhere in India. RBI vide it’s circular dated October 16,
2018 has issued detailed operational guidelines on “Inter operability” of Pre-paid Instruments.
Bharat Bill Payment System (BBPS) started as an interoperable platform for repetitive bill payments, which
covered bills of five categories viz. Direct to Home (DTH), Electricity, Gas, Telecom and Water. The system
provided standardised bill payment experience, centralised customer grievance redressal mechanism,
prescribed customer convenience fee and ensured availability of a bouquet of anytime, anywhere digital
payment options. Now due to consistent growth in different biller categories and to facilitate mobile prepaid
customers with more options to recharge, it has been decided to permit ‘mobile prepaid recharges’ as a biller
category in BBPS, on a voluntary basis.
Introduction of semi-closed Pre-paid Instruments

To give impetus to small value digital payments and for enhanced user experience, by its Notification dated
December 24, 2019, RBI has allowed introduction of a new type of semi-closed PPI with the following features:
• Such PPIs can be issued by bank and non-bank PPI Issuers after obtaining minimum details of the PPI
holder such as a mobile number verified with One Time Pin (OTP) and a self-declaration of name and
unique identity / identification number of any ‘mandatory document’ or ‘Officially Valid Document’ (OVD)
as per KYC norms.
• Such PPIs should be
¡ loadable in nature and issued in card or electronic form.
¡ used only for purchase of goods and services and not for funds transfer.
• Loading / Reloading can be only from a bank account; loading during any month not to exceed Rs.10,000
and the total amount loaded during the financial year not to exceed Rs. 1,20,000.
• Amount outstanding at any point of time in such PPIs not to exceed Rs.10,000.
• PPI issuers to provide an option to close the PPI at any time and also allow to transfer the funds ‘back to
source’ (payment source from where the PPI was loaded) at the time of closure.
• PPI issuers to communicate features of such PPIs to the purchasers/holder at the time of issue by SMS /
e-mail / post or by any other means.
• Other Master Directions instructions issued is applicable to this PPI also.
Cash withdrawal using Point of Sale (PoS) terminals

RBI vide it’s Notification dated January 31, 2020 has dispensed with requirement of obtaining permission from
it for allowing Cash withdrawal using PoS terminals and that henceforth, banks based on the approval of their
Board, provide cash withdrawal facility at PoS terminals. The designated merchant establishments are to be
advised to clearly indicate / display the availability of this facility along with the charges, if any, payable by the
customer.
Harmonization of Turn Around Time in respect of failed transactions

In view of increasing customer complaints and dissatisfaction expressed by various user groups of banking
services, on 20th September 2019, the RBI has issued a detailed circular concerning harmonization of
turnaround time for failed transactions in respect of ATMs, Card Transactions as well as compensation payable
in respect of such transactions as per the following table.
Harmonisation of Turn Around Time (TAT) and customer compensation for failed
transactions using authorised Payment Systems
Sl. No. Description of the incident Framework for auto-reversal and compensation
Timeline for auto- Compensation payable
reversal
I II III IV
1 Automated Teller Machines (ATMs) including Micro-ATMs
a Customer’s account debited but cash not Pro-active reversal (R) of Rs. 100/- per day of delay
dispensed. failed transaction within a beyond T + 5 days, to
maximum of T + 5 days. the credit of the account
holder.
2 Card Transaction
a Card to card transfer Card account Transaction to be reversed Rs. 100/- per day of delay
debited but the beneficiary card account (R) latest within T + 1 day, beyond T + 1 day.
not credited. if credit is not effected to
the beneficiary account.
b Point of Sale (PoS) (Card Present) Auto-reversal within T + 5 Rs. 100/- per day of delay
including Cash at PoS Account debited but days. beyond T + 5 days.
confirmation not received at merchant
location i.e., charge-slip not generated.
c Card Not Present (CNP) (e-commerce)
Account debited but confirmation not
received at merchant’s system.
3 Immediate Payment System (IMPS)
a Account debited but the beneficiary If unable to credit to Rs.100/- per day if delay is
account is not credited. beneficiary account, beyond T + 1 day.
auto reversal (R) by the
Beneficiary bank latest on
T + 1 day.
4 Unified Payments Interface (UPI)
a Account debited but the beneficiary If unable to credit the Rs. 100/- per day if delay is
account is not credited (transfer of beneficiary account, beyond T + 1 day.
funds). auto reversal (R) by the
Beneficiary bank latest on
T + 1 day.
b Account debited but transaction Auto-reversal within T + 5 Rs. 100/- per day if delay is
confirmation not received at merchant days. beyond T + 5 days.
location (payment to merchant).
5 Aadhaar Enabled Payment System (including Aadhaar Pay)

a Account debited but transaction Acquirer to initiate “Credit Rs. 100/- per day if delay is
confirmation not received at merchant Adjustment” within T + 5 beyond T + 5 days.
location. days.
b Account debited but beneficiary account
not credited.
6 Aadhaar Payment Bridge System (APBS)
a Delay in crediting beneficiary’s account. Beneficiary bank to reverse Rs. 100/- per day if delay is
the transaction within T + beyond T + 1 day.
1 day.
7 National Automated Clearing House (NACH)
a Delay in crediting beneficiary’s account Beneficiary bank to reverse Rs. 100/- per day if delay is
or reversal of amount. the uncredited transaction beyond T + 1 day.
within T + 1 day.
b Account debited despite revocation of Customer’s bank will be
debit mandate with the bank by the responsible for such debit.
customer. Resolution to be completed
within T + 1 day.
8 Prepaid Payment Instruments (PPIs) – Cards / Wallets
a Off-Us transaction The transaction will ride on UPI, card network, IMPS, etc., as the case may be. The
TAT and compensation rule of respective system shall apply.
b On-Us transaction Beneficiary’s PPI not Reversal effected in
credited. PPI debited but transaction Remitter’s account within
confirmation not received at merchant T + 1 day.
location.
RBI has vide its Notification dated June 4, 2020 has announced extension of time lines with various payment
system requirements as per the table below:
In the light of increasing instances of Payment frauds RBI vide its notification dated 26th June 2020 has directed
all authorised payment systems operators and participants to undertake targeted multi-lingual campaigns by
way of SMSs, advertisements in print and visual media, etc., to educate their users on safe and secure use of
digital payments.
INTERNET BANKING GUIDELINES

In the year 2001 the RBI had issued guidelines in respect of internet banking based on recommendations of
a Working Group on Internet Banking. The recommendations of the group were accepted by RBI and it had
issued guidelines to banks based on the same. The guidelines cover broad areas of the following Information
Technology and Security Standards, Legal issues and Regulatory and Supervisory issues. A brief of over view of
the same is given under:
Technology & security issues

Banks should :
a. Designate a network and database administrator with clearly defined roles.
b. Have a Board of Directors approved security policy. Segregate duties of Security Officer / Information
system security and information Technology division. Information Systems Auditor will audit the
information systems.
c. Introduce logical access controls to data, systems, application software, utilities, telecommunication lines,
libraries, system software, etc. These may include user-ids, passwords, smart cards or other biometric
technologies.
d. Use the proxy server type of firewall so that there is no direct connection between the Internet and the
banks system. Install inspection firewall that include security alert.
e. Ensure all the systems supporting dial up services through modem on the same LAN as the application
server should be isolated.
f. Use the following alternatives system during the transition, until the Public Key Infrastructure is put in
place:
• Make use of SSL (Secured Socket Layer),
• Use of at least 128-bit SSL for securing browser to web server communications and, in addition,
encryption of sensitive data like passwords in transit within the enterprise.
g. Disable all unnecessary services on the application server such as FTP (File Transfer Protocol), telnet etc.
isolate application server from the e-mail server.
h. Maintain proper log of computer accesses, including messages received; reports of security violations
(suspected or attempted) and follow up action taken; acquire tools for monitoring systems and the
networks against intrusions and attacks; educate their security personnel and also the end-users on an
ongoing basis.
i. Undertake periodic penetration tests of the system, which should include:
• Attempting to guess passwords using password-cracking tools.
• Search for back door traps in the programs.
• Attempt to overload the system using DDoS (Distributed Denial of Service) & DoS (Denial of Service)
attacks.
ii. Check if commonly known holes in the software, the browser and the e-mail software exist.
j. Carry out penetration testing by engaging outside experts.
k. Enforce access controls against internal and external threats. Have proper infrastructure and schedules
for backing up data and test the same periodically. Business continuity should be ensured by setting up
disaster recovery sites. These facilities should also be tested periodically.
l. Have proper record keeping of all applications for legal purposes. It is necessary to keep all received and
sent messages both in encrypted and decrypted form.
m. Test security infrastructure properly before using the systems and applications for normal operations;
upgrade the systems by installing patches released by developers to remove bugs and loopholes, and
upgrade to newer versions which give better security and control.
Legal Issues
From a legal point of view following issues need to be taken care of:
a. Accounts should be opened only after physical verification of the identity of the customer, though request
for opening account can be accepted over Internet. (introduction has been waived by banks).
b. Information Technology Act, 2000, in Section 3(2) provides for a particular technology (viz., the asymmetric
crypto system and hash function) as a means of authenticating electronic record, security procedure adopted
by banks for authenticating users needs to be recognized by law as a substitute for signature. Any other
method used by banks for authentication should be recognized as a source of legal risk.
c. Institute adequate risk control measures to manage secrecy and confidentiality of customers accounts as
banks may be exposed to enhanced risk of liability to customers because of hacking/ other technological
failures.
d. Banks should clearly notify customers the timeframe and the circumstances in which any stop payment
instruction could be accepted as there is very little scope for banks to act on stop-payment instructions
from the customers.
e. Banks’ liability to the customers on account of unauthorized transfer through hacking, denial of service
on account of technological failure etc. needs to be assessed and banks providing Internet banking should
insure themselves against such risks in the light of The Consumer Protection Act, 1986. In 2017 RBI issued
directions regarding limiting liability of customers.
Regulatory and Supervisory Issues

1. Only banks which are licensed, supervised and have a physical presence in India can offer Internet banking
services. Both banks and virtual banks incorporated outside India and having no physical presence in
India, will not be permitted to do so.
2. Products offered is restricted to account holders only and not be offered in other jurisdictions.
3. Services is restricted to only local currency products.
4. The services offered to customers residing abroad by Indian banks (or branches of foreign banks in India)
and Indian residents offered banking services by banks operating from abroad are generally not permitted
in Internet banking also. The existing exceptions for limited purposes under FEMA i.e. where resident
Indians have been permitted to continue to maintain their accounts with overseas banks etc.
5. Overseas branches of Indian banks will be permitted to offer Internet banking services to their overseas
customers subject to conforming to regulations of the host country supervisor and the home supervisor
(RBI).
Given the regulatory approach as above, banks are advised to follow the following instructions:
a. All banks, need prior approval from RBI to offer internet banking services .
b. Applications should be supported by business plan, cost benefit analysis, operational aspects and
arrangements like technology adopted, business partners, service providers and systems and control
procedures the bank proposes to adopt for managing risks along with their security policy duly certified
by an independent Auditor certifying the compliance of meeting minimum requirements need to be
submitted.
c. After the initial approval, if there are any material changes the banks will be obliged to inform RBI. Also
the need to inform every breach or failure of security systems and procedure. If necessary RBI would
conduct a special audit/inspection.
d. RBI guidelines on Risks and Controls in Computers and Telecommunications will equally apply to Internet
banking.
e. Wherever services are outsourced, banks would develop guidelines to manage risks arising out of such
service providers, such as, disruption/defective services, personnel of service providers gaining intimate
knowledge of banks systems and misutilizing the same etc. effectively.
f. In case of e-commerce transactions, they should follow guidelines regarding protocol for transactions
between the customer, the bank and the portal and the framework for setting up of payment gateways.
Further guidelines regarding Inter-bank payment gateways, connectivity security, contractual aspects between
payee ad payee’s banks, mandatory disclosures, hyperlink – security and other aspects are also covered as a
part of internet guidelines of banks.
Apart from the above the RBI has also announced detailed guidelines in respect of Certain UCBs offering internet
bank services to their customers in 2011 and revised the same for other UCBs (View only). Subsequently in
2015 RBI had announced uniform guidelines for cooperative banks on internet banking. RBI has prescribed
specific norms in this regard. RBI has also issued guidelines on Customer Protection - Limiting Liability of
Customers of Co-operative Banks in unauthorised Electronic Banking Transactions in December 2017. RBI had
also announced guidelines on internet banking to RRBs in November 2015.
REGULATION OF MONEY MARKET INSTRUMENTS

RBI regulates money market in India vide powers vested in it by virtue of Sections 45K, 45L and 45W of the RBI
Act 1934. The money market is a part of overall financial markets in India. The other components of financial
markets include Capital market, Debt Markets and Foreign exchange markets. The money market is a market
where instruments of short term duration (up to one year) are dealt in. The instruments which are traded in the
money market consist of the following:
• Call/Notice Money
• Commercial Paper
• Certificates of Deposit and
• Non-Convertible Debentures (original maturity up to one year)
One of the significant features of money market is, these instruments offer better liquidity i.e. they can be
converted into cash in a very short time and the cost of transactions is low as compared to capital/foreign
exchange/debt markets.
RBI regulates the money market through the following ways:
i. Specifying market players and their eligibility for different products
ii. Setting prudential limits for overall transactions
iii. Setting up of Self-regulatory bodies
iv. Setting up of support systems for dealings and settlements
(i) Call / Notice money market

This is an important market for banks as they are predominant participants. Therefore it is also known as
inter-bank call money market as majority of the transactions take place only between banks. Under call money
market, funds are lent overnight basis.
In the notice money market, funds are lent for a period between 2 to 14 days. The permitted participants in this
market are - Scheduled commercial banks (excluding RRBs), Co-operative banks (other than Land Development
Banks) and Primary Dealers (PDs) both as borrowers and lenders. Primary Dealers are legal entities (NBFCs)
who are registered and licensed by RBI to deal in government securities. They purchase government securities
from RBI whenever there is an issue and resell the same to eligible buyers. Thus they create a market for
government securities.
The prudential limits for lending and borrowing in call/notice money markets by various players are as follows:
Sr. No. Participant Category Prudential Limit
1 Scheduled Commercial Call and Notice Money:
Banks (including Small (i) 100% of capital funds, on a daily average basis in a reporting fortnight,
Finance Banks) and
(ii) 125% of capital funds on any given day.
Term Money:
(i) Internal board approved limit within the prudential limits for inter-
bank liabilities.
2 Payment Banks and Call, Notice and Term Money:
Regional Rural Banks (i) 100% of capital funds, on a daily average basis in a reporting fortnight,
and
(ii) 125% of capital funds on any given day.
3 Co-operative Banks Call, Notice and Term Money:
(i) 2.0% of aggregate deposits as at the end of the previous financial year.
4 Primary Dealers Call and Notice Money:
(i) 225% of Net Owned Fund (NOF) as at the end of the previous financial
year on a daily average basis in a reporting fortnight.
Term Money:
(i) 225% of Net Owned Fund (NOF) as at the end of the previous financial
year.
Banks/PDs/ Co-operative banks have to inform their Board approved prudential limits (as above) to Clearing
Corporation of India Ltd. (CCIL) for setting of limits in Negotiated Dealing Settlement -CALL System, under
advice to Financial Markets Regulation Department (FMRD), Reserve Bank of India. No non-banking institution
other than PDs is allowed to participate in call/notice money market.
Interest rates are left to individual participants to decide. However they have to follow procedures prescribed
by the Fixed Income Money Market Dealers Association (FIMMDA) in calculation of interest and documentation.
RBI’s guidelines on timings, settlement method and reporting of transaction are also to be followed.
RBI vide its circular dated October 29, 2018 has permitted Payments Bank and Small Finance Banks– access
to Call/Notice/Term Money Market as under – It is clarified that Payments Banks and Small Finance Banks are
eligible to participate in the Call/Notice/Term money market (hereafter referred to as Call money market) both
as borrowers and lenders. Such eligibility is valid even prior to the completion of the process to get themselves
included in the Second Schedule of Reserve Bank of India Act, 1934.
The prudential limits and other guidelines on Call money market for Payments Banks and Small Finance Banks
will be the same as those applicable to Scheduled Commercial Banks in terms of the Master Direction referred
above.
These Directions have been issued by RBI in exercise of the powers conferred under section 45W of the Reserve
Bank of India Act, 1934 and of all the powers enabling it in this behalf.
(ii) Commercial Paper (CP)

It is an unsecured money market instrument issued in the form of a promissory note introduced in the year
1990 to enable highly rated corporates to borrow on short-term basis. It also serves as a additional money
market instrument for investment. Later Primary Dealers (PDs) and All-India Financial Institutions (AIFIs)
were also permitted to issue CP to borrow funds for meeting their short-term commitments. Companies, PDs,
AIFIs are permitted to issue CPs.
A company can issue CP subject to satisfying following conditions:
i. the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs.4 crore;
ii. the company has been sanctioned working capital limit by bank/s or FIs; and
iii. the borrowal account of the company is classified as a Standard Asset by the financing bank/institution.
Other terms and conditions of CP Issue

• CP issuer should be credit rated by any one of the approved SEBI registered Credit rating agencies (CRA)
with minimum credit rating of ‘A3’ as per rating symbol and definition prescribed by SEBI.
• At the time of issuance of the CP that the rating should be current and has not fallen due for review.
• Normally CPs would be issued on a stand-alone basis and normally no back-up finance would be provided
by banks and AIFIs for its prepayment.
• However banks can provide back-up finance facility subject to their commercial judgement, prudence and
Board of Directors approval.
• Corporate may provide guarantees for CP issuance subject to :-
¡ issuer satisfying CP guidelines.
¡ the guaranteeing company has a one grade better Credit rating than the CP issuing company.
¡ offer document for CP should disclose about of the guarantor company, its net worth, other companies
to which such guarantees have been given, the extent and conditions under which such guarantees
offered and the conditions under which the guarantee will be invoked.
¡ The quantum of CP issued will be as per the decision of the Board of Directors of the company or as
indicated by the credit rating company, whichever is lower.
¡ Financing banks can take into account the CP issue while fixing the working capital limits of such CP
issuing company.
¡ Total amount of CP issue, has to be raised within a period of two weeks from the date of opening of
CP issue. Though CPs are to be issued on common date, if issued in parts in different dates the CPs
should have a common date of maturity. Renewal of every CP will be treated as fresh issue.
¡ CPs issue can be subscribed by individuals, banks, other corporate bodies (registered or incorporated
in India), unincorporated bodies, Non-Resident Indians and Foreign Institutional Investors (FIIs).
While investing, FIIs have to comply with regulations of Securities and Exchange Board of India as
well as provisions of Foreign Exchange Management Act.
¡ Form and issuance
¡ CPs are issued as Promissory note at a discount to face value as determined by issuer.
¡ It can be issued in physical or dematerialized form. Dematerialized form should be issued through
any other depositories approved by SEBI.
¡ All RBI regulated entities should hold CPs in demat form.
¡ CP should be issued in denominations of Rs. 5 lakh and its multiples.
¡ Minimum investment by a single investor should be Rs. 5 lacs (face value).
¡ CP shall be issued at a discount to face value as may be determined by the issuer.
¡ No underwriting or co-acceptance of CP issue is permitted. Options (Put/call) are not permitted on
CP.
¡ CP should be issued for a minimum tenor of 7 days and a maximum of up to one year from the date of
issue. However, the maturity date of the CP shall not go beyond the date up to which the credit rating
of the issuer is valid.
¡ Issue of CP to be done through Issuing and Paying Agent (‘IPA’).
¡ The latest financial position of the issuer has to be disclosed to the potential investors.
¡ After due formalities the issuer has to issue a hard copy of CP or credit the Demat version of CP to
the Demat account of the investor. Issuer has also to issue a certificate that the issuer has a valid
agreement with the IPA and documents are in order.
¡ Issuer/IPA should follow FIMMDA guidelines with reference to documentation procedures.

¡ In addition to the above, issuers should follow RBI directions on Trading and settlement, buy back of
CP, duties and obligations.
¡ RBI has also issued guidelines in respect of IPAs as well as Credit Rating agencies in this regard.
(iii) Certificate of Deposits (CDs)

Certificate of Deposit (CD) is one of the money market instruments in the form of a negotiable usance promissory
note. It is issued at a discount to face value either in dematerialised form or as a Usance Promissory Note, against
funds deposited by an investor with a bank or other eligible financial institution for a specified time period.
CDs are issued by scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks} and
select AIFIs as per RBI directions. The quantum of CD issue by a bank will depend on its funds requirements as
well as the umbrella limit fixed by RBI’s Department of Banking Regulation.
Minimum amount of CD issue will be for a face value of Rs. 1 lac to an investor and it will be issued in multiples
of Rs. 1 lac. CDs can be issued to individuals, corporations, companies (including banks and PDs), trusts, funds,
associations, etc. Non-Resident Indians (NRIs), can subscribe to CDs on non-repatriable basis only.
Such CDs cannot be transferred to another NRI in the secondary market. CDs can be issued between 7 days
and not exceeding one year, from the date of issue. AIFIs can issue CDs for a minimum period of 1 year and a
maximum of 3 years, from the date of issue.
Banks / FIs are also allowed to issue CDs on floating rate of interest basis, subject to their disclosing the method
of compiling floating rate in a transparent manner. Banks are allowed freedom to determine the rate of interest
on CDs issued by them. The floating rate would have to be reset periodically as per changes in pre-decided
bench mark rate and the same need be disclosed in a transparent manner.
CRR and SLR are to be maintained on CDs too by banks. CDs are transferable between different holders and there
is no lock-in-period applicable in their case. Trading and settlement are to be executed as per RBI’s directions in
this regard. No loans can be granted against CDs and banks cannot buy back these CDs before maturity.
Normally CDs are to be issued in Demat form. If any investor insists the same in physical form, the same can be
issued with permission of RBI. Physical form will attract stamp duty.
If the maturity date of CD happens to be a holiday then it falls due on the immediate preceding working day.
There is no grace period in the repayment CDs. Banks are required to follow the procedure outlined by RBI
in respect of redemption of CDs both in physical and demat forms. Issuing banks are required to follow RBI
guidelines in respect of issuing of duplicate certificate, accounting, documentation as well as reporting in this
regard.
Reporting Investment in Certificates of Deposit (CDs)

RBI has directed banks to adhere to the following practice vide it’s notification dated February 26th, 2020 with
the reference to reporting their transactions in CDs in Form ’A’ Return as below: .
A) Based on the statement issued by depositories, if the CDs issued are held by banks on reporting Friday,
the issuer bank should report such CDs under item I of the Form ‘A’ Return i.e., “Liabilities to the Banking
System in India”. The CDs held by non-bank entities should be reported as “Liabilities to Others in India”, as
hitherto. If the bank is not in a position to segregate the holders of CDs issued between bank and non-bank
entities, then the total CDs issued should be reported under item II of the Form ‘A’ Return i.e., “Liabilities
to Others in India”. The reporting of CDs should be done as per the issue price of the CDs.
B) Investments in CDs issued by other banks should be reported under item III of the Form ‘A’ Return i.e.,
“Assets with the Banking System in India” and these assets could be netted off against “Liabilities to the
Banking System in India”.
(iv) Non-convertible debentures of original or initial maturity up to one year

These are debt instruments of original maturity period of one year, issued by companies incorporated under
Companies Act (including NBFCs) by way of private placement.
The eligibility for issuance of NCDs is the same as applicable in respect of CP issue (except in case of NBFCs
including PDs, in respect of net worth). Companies desirous issuing NCDs should get themselves rated by a
credit rating agency approved by SEBI. They should have secured a minimum rating of A2 as defined by SEBI in
this respect. The credit rating should be current at the time of issuance of NCD and should not have fallen due
for review. NCDs should have a minimum maturity period of 90 days from the date of issuance. Its maximum
tenor cannot exceed the validity period of its credit rating. If there is a put/call option, it shall not fall due within
90 days from the date of issue of NCDs. NCDs can be issued with a minimum denomination of Rs. 5 lacs (face
value) and in multiples of Rs. 1 lac thereof.
The quantum of NCD to be issued will be as decided by the Board of Directors of the company or as indicated by
the credit rating agency for the rating given whichever is less. The total issue amount of NCD will have to be raised
within a period of two weeks from the date of opening of the NCD issue. All provisions as applicable under the
Companies Act, SEBI guidelines on issue and listing should be followed. A certificate from Auditors regarding
compliance of eligibility conditions, proper disclosures regarding financial position of the company should be
obtained. NCD can be issued at face value carrying an interest rate or at a discount to the face value as decided
by the company and it should be issued within the time limit as permitted under the Companies Act. For every
issue of NCD, the company should appoint a SEBI registered Debenture Trustee (DT) who will submit periodical
information to RBI as per its directions. NCDs may be subscribed by individuals, banks, Primary Dealers (PDs),
other corporate bodies including insurance companies and mutual funds registered or incorporated in India
and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). Banks and
PDs will invest in NCDs up to the limit as per legal provisions applicable from time to time. Investment by FII
will be subject to FEMA rules and regulations including limits up to which they can invest.
Issuer companies, DTs and Credit Rating Agencies should follow applicable guidelines issued by the respective
regulatory authorities. Companies should use the disclosure document format issued by FIMMDA for NCD
issued. Any non- compliance with RBI directions will be penalized including debarring such companies from
NCD market.
RESERVE FUNDS
In terms of Section 17(1) of the Banking Regulation Act, 1949, every bank has to create a Reserve fund out of
profits for each year before declaration of any dividend and transfer twenty percent of the same to the reserve
fund.
Exemptions from transferring to reserves

Based on the recommendation of RBI, the Central Government may exempt a bank from the application of
Section 17(1) of the Banking Regulation Act, 1949 for a specified period, if the banking company has adequate
paid-up capital and reserves in relation to its deposit liabilities (such that the amount in the reserve fund
together with the amount in the share premium account, is not less than the paid-up capital of the banking
company.)
Foreign banks operating in India

Foreign banks operating in India have to maintain capital and reserves in terms of Section 11 of the Banking
Regulation Act, 1949. Apart from the capital to be brought in for starting business in India, they have to keep
depositing twenty percent of their profits for each year, in respect of their business conducted through their
branches in India. The amount to be deposited can be in the form of cash or unencumbered approved categories
of securities or a mix of both. If the foreign bank operating in India has already deposited adequate amounts
with RBI in relation to its deposit liabilities, the Central government may exempt such a foreign bank on the
recommendation of RBI from depositing amounts with RBI for a further period as it may determine.
MAINTENANCE OF CRR, SLR

Note: As already seen in Lesson 2 every scheduled bank in India have to maintain in India Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR).
Cash Reserve Ratio (CRR )

As on date, every scheduled bank has to maintain with RBI cash reserves under Section 42 (1) of the RBI Act,
1934 an average daily balance of 4% their Net Demand and Time Liabilities (‘NDTL’) in India. Non-scheduled
banks also have to maintain CRR under the Banking Regulation Act Section 18 at 3% of NDTL.
Computation of NDTL
For the purpose of computation NDTL the following liabilities are not to be taken in to account.
a) Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount of any loan
taken from the RBI and the amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI;
b) Net income tax provision;
c) Amount received from Deposit Insurance and Credit Guarantee Corporation towards claims and held by
banks pending adjustments thereof;
d) Amount received from Export Credit Guarantee Corporation by invoking the guarantee;
e) Amount received from insurance company on ad-hoc settlement of claims pending judgement of the
Court;
f) Amount received from the Court Receiver;
g) The liabilities arising on account of utilization of limits under Bankers’ Acceptance Facility (BAF);
h) District Rural Development Agency (DRDA) subsidy of Rs.10,000/- kept in Subsidy Reserve Fund account
in the name of Self Help Groups;
i) Subsidy released by NABARD under Investment Subsidy Scheme for Construction/Renovation/ Expansion
of Rural Godowns;
j) Net unrealized gain/loss arising from derivatives transaction under trading portfolio;
k) Income flows received in advance such as annual fees and other charges which are not refundable;
l) Bill rediscounted by a bank with eligible financial institutions as approved by RBI;
RBI has vide its Notification dated 10th February 2020 allowed banks to deduct the equivalent amount of
incremental credit disbursed by them as retail loans to automobiles, residential housing, and loans to micro,
small and medium enterprises (MSMEs), over and above the outstanding level of credit to these segments
as at the end of the fortnight ended January 31, 2020 from their net demand and time liabilities (NDTL) for
maintenance of the cash reserve ratio (CRR).
They can claim the first such deduction from the NDTL of February 14, 2020 for the amount equivalent to the
incremental credit extended to the sectors over the outstanding level of credit as at the end of the fortnight
ended January 31, 2020. The amount equivalent to the incremental credit outstanding from the fortnight
beginning January 31, 2020 and up to the fortnight ending July 31, 2020 will be eligible for deduction from
NDTL for the purpose of computing the CRR for a period of five years from the date of origination of the loan
or the tenure of the loan, whichever is earlier. Proper records needs to be maintained by banks in this regard.
RBI vide its notification dated February 05, 2021 Scheduled Commercial Banks are allowed to deduct the amount
equivalent to credit disbursed to ‘New MSME borrowers’ from their Net Demand and Time Liabilities (NDTL)
for calculation of the Cash Reserve Ratio (CRR). For the purpose of this exemption, ‘New MSME borrowers’ shall
be defined as those MSME borrowers who have not availed any credit facilities from the banking system as on
January 1, 2021.
This exemption will be available only up to Rs.25 lakh per borrower disbursed up to the fortnight ending
October 1, 2021, for a period of one year from the date of origination of the loan or the tenure of the loan,
whichever is earlier.
Banks are required to report the exemption availed at the end of a fortnight under the item “Any other liabilities
coming under the purview of zero prescription” at VIII.1. Proper fortnightly records of credit disbursed to new
MSME borrowers/CRR exemption claimed, duly certified by the Chief Financial Officer (CFO) or an equivalent
level officer, must be maintained by banks for supervisory review in prescribed format.
Scheduled commercial banks are exempted from including the following for the computation of NDTL–
i. Liabilities to the banking system in India as computed under clause (d) of the explanation to Section 42(1)
of the RBI Act, 1934;
ii. Credit balances in ACU (US$) Accounts; and
iii. Demand and Time Liabilities in respect of their Offshore Banking Units (OBU).
iv. The eligible amount of incremental FCNR (B) and NRE deposits of maturities of three years and above
from the base date of July 26, 2013, and outstanding as on March 7, 2014, till their maturities/premature
withdrawals, and
v. Minimum of Eligible Credit (EC) and outstanding Long term Bonds (LB) to finance Infrastructure Loans
and affordable housing loans, as per the circular dated July 15, 2014 of RBI.
Incremental Cash Reserve Ratio

Apart from the above RBI has powers to impose incremental CRR on banks. However as on date there is no
incremental CRR prescribed for banks. All SCBs are to maintain a minimum CRR balances up to 95 percent of
the average daily required reserves for a reporting fortnight on all days of the fortnight with effect from the
fortnight beginning September 21, 2013. No interest on CRR balances is paid by RBI with effect from March 31,
2007.
Returns to be filed
For the purposes of CRR computation, all Scheduled Commercial Banks are required to submit provisional
Return in Form ‘A’ to RBI, within 7 days from the expiry of the relevant fortnight. The final Form ‘A’ Return is
required to be submitted to RBI within 20 days from expiry of the relevant fortnight.
Penalties for non-maintenance of Cash Reserve Ratio

From June 2006, RBI has started levying penal interest in all cases of default in maintenance of CRR by
Scheduled Commercial Banks. If CRR reserves are maintained below the required 95% level on a daily basis -
penal interest will be charged at Bank rate + 3% for the shortfall on the day of default, If the shortfall continues
next succeeding days penal interest will be Bank rate + 5%, the same rate will be charged for every day of
subsequent delay.
All scheduled banks are required to furnish to RBI, the particulars of date, amount, percentage, reason for
default in maintenance of requisite CRR and also action taken to avoid recurrence of such default.
Statutory Liquidity Ratio (SLR)

Every bank in India has to maintain liquid assets as per Section 24(2) of the BR Act, 1949 a specified percentage
of its NDTL in the form of cash, gold or unencumbered ‘approved’ securities. Through an amendment in January
2007 to the Banking Regulation Act, it is provided that RBI can specify SLR for specific assets. Value of such
assets should not be less than such a percentage as specified by RBI, subject to a maximum of 40% of a bank’s
Demand & Time liabilities as on the last Friday of the second preceding fortnight. RBI will specify the percentage
of assets to be maintained by banks from time to time.
RBI vide its notification RBI/2018-19/86 DBR.No.Ret.BC.10/ 12.02.001/ 2018-19 dated December 05, 2018
has announced a progressive reduction in maintenance of SLR as under such that by April 11, 2020 it will be
18% of NDTL from the current 19.5% The circular is as under -
“All Scheduled Commercial Banks (including Regional Rural Banks)
Local Area Banks, Small Finance Banks, Payments Banks
Primary (Urban) Co-operative Banks (UCBs)
State and Central Co-operative Banks (StCBs / CCBs)
Section 24 and Section 56 of the Banking Regulation Act, 1949
Maintenance of Statutory Liquidity Ratio (SLR)
The following assets qualify for SLR securities :
(a) Cash or
(b) In Gold valued at a price not exceeding the current market price, or
(c) Investment in:
(i) Dated securities issued up to May 06, 2011 as listed in the Annex to RBI Notification dated May 9,
2011;
(ii) Treasury Bills of the Government of India;
(iii) Dated securities of the Government of India issued from time to time under the market borrowing
programme and the Market Stabilization Scheme;
(iv) State Development Loans (SDLs) of the State Governments issued from time to time under the
market borrowing programme; and
(v) Any other instrument that may be notified by the RBI.
Provided that the securities (including margin) referred to above, if acquired under the Reserve Bank-
Liquidity Adjustment Facility (LAF), shall not be treated as an eligible asset for this purpose.
Procedure for Computation of SLR

The procedure to compute total NDTL for the purpose of SLR is very similar to that of CRR as enumerated under
the head Computation of NDTL under CRR in the previous paragraphs.
However, Scheduled Commercial Banks are required to include inter-bank term deposits / term borrowing
liabilities of all maturities in ‘Liabilities to the Banking System’. Similarly, banks should include their inter-bank
assets of term deposits and term lending of all maturities in ‘Assets with the Banking System’ for computation
of NDTL for SLR purpose.
Penalty for non-maintenance of SLR

RBI will levy a penalty for non-maintenance of SLR, similar to that of CRR.
Returns to be filed with RBI

Banks are to submit to RBI before the 20th of every month, a Return in Form VIII showing the amounts of SLR
held on alternate Fridays during immediate preceding month with particulars of their DTL in India held on such
Fridays. If such Friday is a public holiday under the Negotiable Instruments Act, the return should be submitted
as on the close of preceding working day.
Certification of computation of DTL

Statutory Auditors of the bank are required to verify and certify that all items of outside liabilities, as per the
bank’s books had been duly compiled and correctly reflected under DTL/NDTL in the periodical statutory
returns submitted to the RBI for the financial year.
Case Laws
10.01.2020 Anuradha Bhasin and Ors. (Petitioner) vs. Union of India (UOI) Supreme Court of India
and Ors. (Respondent)
Journalists are to be accommodated in reporting and there is no justification for allowing a sword of
Damocles to hang over the press indefinitely
Facts of the Case :
The issue starts with the security advisory issued by the Civil Secretariat, Home Department, Government of
Jammu and Kashmir stating to cut short their stay and make their safe arrangements to go back. Subsequently,
educational institutions and offices were also shut down until further orders. On August 4, 2019 internet services,
mobile connectivity and landline were shut down until further orders. On August 5, 2019, the Constitutional
Order No. 272 was passed by the President of India applying all provisions of the Constitution of India to
Jammu and Kashmir and stripped it from special status enjoyed since 1954. On the same day, due to prevailing
circumstances, the District Magistrate passed the order restricting the movement and public gathering,
apprehending breach of peace and tranquility under Section 144 of CrPC. Due to this, journalist movements
were restricted and this was challenged under Article 19 of the Constitution which guarantees freedom of
speech and expression and freedom to carry any trade or occupation. In this context, in the Supreme Court,
legality of internet shutdown and movement restrictions are challenged under Article 32 of the Constitution.
Judgement :
In it was observed that widening of the ‘Chilling Effect Doctrine’ has always been viewed with judicial scepticism.
In this context, one possible test of chilling effect is comparative harm. In this framework, the Court is required
to see whether the impugned restrictions, due to their broad-based nature, have had a restrictive effect on
similarly placed individuals during the period. It is the contention of the Petitioner that she was not able to
publish her newspaper from 06-08-2019 to 11-10-2019. However, no evidence was put forth to establish that
such other individuals were also restricted in publishing newspapers in the area. Without such evidence having
been placed on record, it would be impossible to distinguish a legitimate claim of chilling effect from a mere
emotive argument for a self-serving purpose. Journalists are to be accommodated in reporting and there is no
justification for allowing a sword of Damocles to hang over the press indefinitely.
LESSON ROUND UP
• The Banking Regulation Act,1949 plays a very important role in framing systems & policies of the
banking sector.
• The RBI issues different directions to different banks by taking into account various sections included
under the Banking Regulation Act, 1949.
• Banks accept demand deposits & time deposits from the depositors based on instructions & guidelines
provided by RBI.
• Apart from guiding the commercial banks, RBI also provides guidelines to the cooperative banks.
• A per the guidelines under Banking Regulation Act 1949, the accounts of customers of different banks
which lie inoperative for more than 10 years are to be transferred to Depositor Education & Awareness
Fund Scheme under RBI.
• Nomination facilities are provided to different depositors/customers are based on Banking Companies
Nomination Rules 1985.
• Lending under Section 5 (b) of the Banking Regulation Act, 1949 of banking companies can be for short
term, medium or long term.
• Till the Payment and Settlement Systems Act, 2007 (PSS Act) was legislated, RBI was managing the
same with powers available under the Section 58 of RBI Act, 1934 as well as Section 35A of Banking
Regulation Act, 1949.
• RBI has issued guidelines for Payment Aggregators and Payment Gateways involving Authorization,
Capital requirements, Governance, Safeguards against Money Laundering Provisions, Merchant on-
boarding, Settlement and Escrow Account Management, Customer Grievance Redressal and Dispute
Management Frame work, Reports, General Instructions.
• Apart from different monetary policy matters & issues, RBI has framed regulations for money market
instruments too.
• As per Banking Regulation Act, 1949, every bank has to create a Reserve fund before they declare
dividends out of the profit.
• In exceptional cases where the banks have sufficient paid up capital or deposits for liabilities, such
reserve funds need not be created.
• As per Banking Regulation Act, 1949, foreign banks operating in India have to maintain specified capital
& reserves.
• Last but not the least, every scheduled bank in India has to maintain Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio (SLR) under The RBI Act, 1934 and Banking Regulation Act,1949.
GLOSSARY
Indian banking System Indian Banking System encompasses Agency House Banks, Presidency Banks,
Imperial Bank of India, Reserve Bank of India, Private/Joint Stock Banks (Old
generation private sector banks), State Bank of India, Associate Banks, Old
Nationalized Banks, New Generation Private Sector Banks, Foreign Banks,
Co-operative Banks, Regional Rural Banks, Small Finance Banks and Payment
Banks and Financial Institutions known as Development Banks and Non-
Banking Financial Companies.
Reserve Bank of India It was established on 1935 as a banker to the central government.
State Bank of India State Bank of India originated from the three Presidency banks namely Bank
of Bengal, Bank of Bombay and Bank of Madras and the successor to these
Presidency banks viz Imperial Bank of India.
Old Generation Private Private sector banks which were operating in India prior to the liberalization
Bank year of 1991 are known as Old generation private Sector banks.
New Generation Banks that came into existence subsequent to Narasimham Committee Report I
Private Bank and revised RBI guidelines in 1993 are known as new generation private sector
banks.
Co-operative Bank Cooperative Banks are registered under the Cooperative Societies Act, 1912
and regulated by the Reserve Bank of India under the Banking Regulation Act,
1949 and Banking Laws (Application to Cooperative Societies) Act, 1965.
Regional Rural Bank RRBs are scheduled banks(Government banks) operating at regional level in
(RRBs) different States of India. They were established in 1975 under the provisions of
the Ordinance promulgated on September 26, 1975 and followed by Regional
Rural Banks Act, 1976.
Small Finance Banks These banks promote financial inclusion to sections of the economy not being
served by other banks, such as small business units, small and marginal farmers,
micro and small industries and unorganised sector entities.
Payment Bank A payment bank aims to further financial inclusion, especially through savings
accounts and payments services. Accordingly, a payments bank is not allowed
to give any form of loan or issue a credit card.
Development Finance Financial institutions which were created to offer cheaper long-term financial
Institutions (DFIs) assistance “for activities or sectors of the economy where the risks may be
higher than that the ordinary financial system is willing to bear.”
State Financial The services of State Financial Corporations(SFCs),mainly aims at lending
Corporations money for creation, technology up-gradation, modernization, expansion
and overall development of Micro, Small and Medium Enterprises (MSME),
including commercial vehicles. SFCs are also providing financial assistance to
manufacturing and service industries of their respective states.
Non Banking Finance NBFC is “a company registered under the Companies Act, 2013 (earlier act of
Corporations (NBFCs) 1956) engaged in the business of loans and advances, acquisition of shares/
stocks/ bonds/debentures/securities issued by Government or local authority
or other marketable securities of a like nature, leasing, hire-purchase, insurance
Export Import Bank of Export-Import Bank of India is the premier export finance institution of the
India country. Established in 1982 through an Act of Government of India viz. Export
–Import Bank of India Act, 1981.
National Bank for NABARD came into existence in July 1982 by transferring the agricultural credit
Agriculture and functions of RBI and refinance functions of the then ARDC.
Rural Development
(NABARD)
Small Industries Small Industries Development Bank of India (SIDBI) was established in April
Development Bank of 1990 and it acts as the Principal Financial Institution for Promotion, Financing
India (SIDBI) and Development of the Micro, Small and Medium Enterprise (MSME) sector
as well as for co-ordination of functions of institutions engaged in similar
activities.
National Housing Bank NHB is an apex financial institution for housing. NHB has been established
(NHB) with an objective to operate as a principal agency to promote housing finance
institutions both at local and regional levels and to provide financial and other
support incidental to such institutions and for matters connected therewith.
Scheduled Bank A scheduled bank is one which is included in the Second Schedule of RBI Act
which enjoins it to have a minimum capital of Rs. 5 lacs and maintain reserves
as per the directions of RBI.
Non-Scheduled Bank Non-scheduled banks are those which are not listed in the Second schedule of
the RBI Act, 1934 having a reserve capital of less than 5 lakh rupees.
Private Sector Banks As the name implies the ownership of these banks rests with private individuals
and corporates including foreign entities.
Payment Aggregators Entities that facilitate e-Commerce sites and merchants to accept various
payment instruments from the customers for completion of their payment
obligations without need for merchants to create separate payment integration
system on their own.
Payment Gateways entities that provide technology infrastructure to route and facilitate processing
of an online payment transaction without any involvement in handling of funds.
In India mostly PGs are banks such as HDFC,AXIS, UBI etc.
TEST YOURSELF
1. Fill in the blanks:
a. Under Sec 35 AA Central Government can authorize the RBI to issue directions to any bank/ banks
in the matter of _____________________________.
b. Under _____________________________, _____________________________& RBI has extensive powers
relating to removal of managerial and other persons from office, to appoint additional Directors,
Supersession of Board of Directors.
c. RBI specifies the rates of interest on _____________________________ & _____________________________
deposits.
d. DEAF is administered by RBI through _____________________________.
e. Nomination is not available to business entities except _____________________________.
f.
After its formation of NPCI, it has launched, an indigenous card network called
_____________________________.
g.
PPIs can be categorized as _____________________________, _____________________________, and
_____________________________.
h. The instruments which are traded in the money market consist of _____________________________, ,
_____________________________, _____________________________ and _____________________________.
i.
CPs can be issued only by _____________________________, _____________________________, and
_____________________________.
j. The minimum maturity period of a NCD should be _____________________________.
k. The Monetary Transmission is predominantly linked to _____________________________ rate of interest
loans.
l. The maximum loading in a year in a semi-closed PPI is Rs. _____________________________.
m. At the time of issue / re-issue, all cards (physical and virtual) be enabled for use only at
_____________________________of usage [viz. ATMs and Point of Sale (PoS) devices] within India.
2. Write True or False:
a. Section 35AB confers powers on the RBI, to issue directions in respect of resolution of stressed
assets i.e. NPAs.
b. Most of the interest rate structures have been left to the discretion of banks.
c. Floating rate domestic term deposits are not covered by RBI’s Master directions.
d. All unclaimed deposits lying with a bank for a period of ten years or more are to be transferred to
Reserve Bank of India towards Depositor Education and Awareness Fund Scheme.
e. Nomination made in respect of a person can be varied or cancelled by submitting suitable forms
specified in this regard.
f. The RBI regulates loans and advances through powers conferred by Section 21 of the Banking
Regulation Act.
g. In the year 2008, an apex organization for operating the retail payment systems in India in the
name of National Payments Corporation of India (NPCI), was established.
h. Open category PPI allows cash withdrawal and is restricted to only banks.
i. Only banks which are licensed, supervised and have a physical presence in India can offer Internet
banking services.
j. In the notice money market, funds are lent for a period between 2 to 14 days.
k. Semi-closed PPI issuers should be only banks.
l. Domestic leg of import and export related payments facilitated by PAs.
a. What are the powers enjoyed by RBI under Sections 35 A, 35 AA, 35 AB, 36, 36AA, 36AB, 36ACA?
Discuss briefly.
b. What is the responsibility of a bank with regard to deposits that are lying with a bank for 10 years
and above? What is the procedure to be followed by a bank under DEAF?
c. Discuss briefly about the facility of nomination provided by RBI.
d. How does RBI regulate interest rates on Deposits and Advances?
e. What is the role of RBI in Payment and Settlements Systems Act? Discuss briefly.
f. How does RBI controls Money Market instruments? What is the role of banks on the same?
g. What are the guidelines of RBI regarding internet banking?
h. What are the securities included under CRR and SLR?
i. Write a short note on Merchant Acquiring business of RRBs?
List of further reading

• Master circular/Master Directions of RBI at www.rbi.org.in :
• The Reserve Bank of India Act, 1934
• The Banking Regulation Act, 1949
• www.npci.org.in
• Speeches of The Governor/Deputy Governors/Executive Directors of RBI
• www.shodganga.com
Lesson 5 • Banking Operations 125
Lesson 5 Banking Operations

Should Know
Banking operations require • Prevention of Money
• Officially Valid
proper follow-up, monitoring and Laundering Act, 2002 (PMLA).
Documents
reconciliation while observing • The Income-tax Act, 1961.
• Central KYC Records directions and guidelines of RBI.
Registry • Banking Regulation Act, 1949.
In the light of this, the Lesson will
• Central Registry of enable a reader to understand : • The Limited Liability
Securitisation Asset Partnership Act, 2008.
• Accounting system and
Reconstruction and vouchers passed by banks • The Companies Act, 2013.
Security Interest of under cash, clearing and
India transfer mode of transactions
• Central • KYC and associated
Identification documentation formalities
Registry • Different types of accounts for
• Financial different types of persons
Intelligence Unit • Operational formalities of
• Video based loans including scrutiny of
Customer applications and documentation
Identification requirements including drawls
Process and accounting thereof
• Foreign Accounts • An over view of back office
Tax Compliance Act operations
(USA) • Handling reconciliations
Lesson Outline
• Introduction • Accounting entries involved at
• Preparation of Vouchers, cash various stages.
receipt and payment entries, • Operational aspects of CBS
clearing inward and outward environment.
entries, transfer debit and credit • Back office operations in banks.
entries.
• Handling of un-reconciled entries
• What is KYC? in banks.
• What are the different documents • LESSON ROUND UP
to satisfy KYC?
• GLOSSARY
• How to verify KYC and
• TEST YOURSELF
authenticity of documents?
• LIST OF FURTHER READINGS
• Operational aspects regarding
opening of all types of accounts.
• Scrutiny of loan applications/
documents.
125
INTRODUCTION
The topic presented in this chapter deals with many aspects of operational banking areas such as preparation
of vouchers; accounting entries; cash accounting; clearing; KYC; opening of accounts for different types of
customers and formalities thereof; loan applications and related formalities, CBS environment, back office and
reconciling of accounting entries. The objective of the contents is to give a reader an in-depth understanding of
major operational domains in which a banker functions. The coverage of topics is interspersed with practical
examples as found in day to day working of a bank for easy understanding. The contents will reinforce the basic
knowledge of banking and add value in thorough understanding of certain nitty- gritties involved in operations.
The contents are based on RBI directions and will be useful in practical understanding of certain operational
domains of deposits and advances, apart from the technology systems involved. The contents have been elab-
orated to offer rationale for various procedures adopted by banks. The contents are of Level 1 and 2 orientation
enabling students to reinforce themselves with deeper operational knowledge.
PREPARATION OF VOUCHERS
A voucher is essentially the backup documents / proof for a transaction. The Banks when debit or credit the
customer’s or other accounts, the customers or their details of the transaction is noted on a piece of paper
(approved format by the bank) which is called as voucher. Example - paying-in-slip, cheques, office debit and
credit vouchers used for their internal transactions (These do not have counterfoils). They serve as documentary
evidence for a transaction. Office debit /credit vouchers are to be authenticated by sanctioning authority before
the transaction is entered the system.
Pay-in-slip
Whenever banks do any transaction for a customer, it results in accounting entries which are to be properly
done as per the internal accounting procedures of the bank. To facilitate accounting entries vouchers are passed.
Banks being commercial organizations follow double entry system of accounting. Double entry system consists
of a debit and an equivalent credit to the respective heads of accounts.
For certain transactions customers themselves prepare the vouchers as given in the following example.
A & B are having an account in the same branch.
Vouchers are prepared by banks themselves for transactions like debiting of charges towards interest due on
loan accounts, locker rent, service charges, insurance charges, standing instructions etc. For this purpose, they
would use a debit voucher of the bank, fill up all the required details, get it authorized and debit to the concerned
account head and pass on the credit voucher which would have also been filled up by the same department,
duly signed by the department-in-charge where debit entry originates.
ACCOUNTING ENTRIES OF TRANSACTIONS
Depositing a cheque for opening a term deposit of Rs. 1,00,000 from own Savings bank account, the resultant
entries under the double entry system of accounting will be -
• Debit: Customer’s Saving Bank Account Rs. 1,00,000.
• Credit: Term Deposit Account of the customer Rs. 1,00,000.
As it is evident from the above example, credit and debit entries are self- balancing in nature. Thus, in a bank
branch there would be a series of transactions of debit and credit during a given day, due to large number
of transactions of customers. However, due to age old accounting practice in banks, for normal day to day
transac tions of customers, vouchers are first posted in ledgers (basically these are equivalent ‘subsidiaries’
in accounting parlance) and later they are entered in journals. This is a diametrically opposite practice of
conventional accountancy. Later at the end of the day the credit vouchers and debit vouchers of transactions
pertaining to Savings Bank, Current Account, Term deposits, different loans accounts, bills etc. are entered
in separate summary voucher sheets/books under cash, clearing, transfer types and thereafter the totals are
posted in General ledger. Subsequently trial balance is prepared from the General ledger balances every day.
Before the introduction of computers, banks traditionally were doing all accounting entries manually by-passing
physical vouchers for every transaction involving double entry system of accounting as described above. With
computerized system of accounting, preparation of manual vouchers has reduced to a great extent.
It should be remembered however that computerized accounting is based on Double Entry System of
accounting only. Hence staff members of banks should have a clear understanding of the basic concepts of
preparation of vouchers using double entry system so that there is clarity about accounting entries made
through computers.
Double Entry System, in accounting, is a system of book keeping where every entry to an account requires
a corresponding and opposite entry to a different account. The double-entry system has two equal and
corresponding sides known as debit and credit.
Transaction types in a bank

In a bank, transactions can be classified in to cash and non-cash categories. The non-cash mode is made up of
two components namely clearing and transfer. Thus, it can be represented as below:
The transactions may involve Customer to Customer, Customer to Bank, Bank to Customer and Bank to another
Bank. For all practical purposes therefore, transaction vouchers may belong to any one of the three modes viz.,
cash or clearing or transfer.
Instruments / Vouchers used in Banking transactions

The following types of instruments/vouchers are generally being used as Debit vouchers in banks:
i. Cheques of customers.
ii. Banker’s cheques (also known as Pay orders). Banker’s cheques / Pay orders are issued by the bank of a
branch on itself.
[Note: Banks have stopped issuing Pay order in favor of customers as per RBI directions. They issue these only for
settling payments with other banks].
iii. Withdrawal forms at the counter issued to Savings Bank customers.
iv. Letter of Authority (for debits) issued by customers duly signed by Authorized Signatories for standing
instructions/ transfer in respect of specific transactions.
v. Drafts issued by the branches of the same bank on one another / Payable at par drawn on service branches.
vi. Drafts issued by correspondent banks on one another for payment. (Similar to DD issued branches on one
another).
vii. Deposit receipts/Recurring deposit pass books, on maturity of the respective deposits.
viii. Interest warrants/Dividend warrants/Refund orders issued by the banks/corporates and payable by the
bank/branch as per arrangement with Corporates. [Issuing and paying banks in Merchant Banking].
ix. Bank’s Debit vouchers duly authorized by customers/officials of the bank towards transactions where
debit to customers’ accounts are involved.
x. Travelers cheques/Gift cheques of the bank or other banks as per arrangement.
xi. Debit advices of other branches/banks in respect of certain collection charges etc. (Inter-bank and intra-
bank).
It is also a practice in banks to prepare a common/single debit voucher for many payments originating from a
single account such as Salary payment, Bonus payment, interest payments on term deposits etc.
The following are being used as Credit Vouchers in banking transactions
i. Pay-in-slips of banks.
ii. Applications for NEFT / RTGS / Pay orders / Gift cheques / Travelers cheques etc. made by customers /
bankers for the respective transactions.
iii. Challans for State/Central Government transactions such as Income Tax, GST, Professional Tax, Estate
Duty Tax, Wealth tax, Public Provident Fund, Municipal Taxes, Stamp duty payments etc.
iv. Credit Vouchers prepared by the bank on its stationery for various transactions either on behalf of
customer or on its own account.
v. Credit Memo/Advice from other banks in respect of collection items sent to other banks.
It is also a practice in banks to prepare a single/common credit voucher for many debits involving multiple ac-
counts at the same branch and the credit is afforded to a single beneficiary’s account e.g., electricity bill, school
fees etc.
Cash receipt and payment entries

Following are some examples:
A. Cash Receipt transaction / entry
Mr. R deposits Rs. 10,000 in his Savings Bank account. The accounting Voucher / Debit entries will be
• Debit- (Cash) A/c - Rs. 10,000. (For cash transaction no separate voucher is passed as per prevailing
practice; but it gets reflected in the total of the cash scroll taken in the cash book).
• Credit - Saving Bank account of Mr. R - Rs. 10,000 [through a Pay-in-slip (Credit voucher for Cash
entry)].
The transaction set will be reflected as cash transactions in subsidiary books of account as well as in
journals.
B. Cash Payment (Withdrawal) transaction/entry
Mr. B & Co., a proprietorship company has issued a bearer cheque to Mr. J for Rs. 3000 and the bearer has
come to the branch with the cheque for encashment. The accounting Voucher / Debit entries will be
• Debit - B & Co. account - Rs.3000. The cheque itself will form the debit voucher which will be first
entered in the ledger account and after due verification will be delivered to the cash department for
payment.
• Credit - Cash Account - Rs. 3000 (For cash transaction no separate voucher is passed as per prevailing
practice; but it gets reflected in the total of the cash payments scroll taken in the cash book).
Clearing outward and inward entries, transfer debit and credit entries.
Clearing Transactions
C. Clearing Outward: The term represents cheques received by the collecting banker from their customers
through the clearing house at the respective centres. (If A deposits a cheque in his account with SBI which
is given to him by B who has his account with Bank of Baroda. Then this cheque is clearing outward for SBI
which acts as Collecting bank and is clearing inward for bank of Baroda which acts as a Paying Bank)
An example to illustrate the clearing outward transaction is given below:
A Limited has deposited a clearing cheque for amount of Rs. 1,00,000 drawn on SBI, with its bank for the
credit of its account.
• Debit - Clearing Adjustment Account of Service branch Rs. 1,00,000. (This will ultimately be reflected
in the debit raised on the drawee bank, i.e., SBI, through the clearing house. The cheque deposited
by A Limited will serve as debit voucher. However, as cheques belonging to different banks would be
sent to them, a gross debit voucher for the entire clearing of the branch would be passed, in which
the amount of Rs. 1,00,000 would also be included).
• Credit - Current Account of ‘A’ Limited through a Credit Voucher (Pay-in-slip prepared by A Limited
at the time of deposit of cheque). However as per clearing house practices the amount so deposited
will be available to the customer only after the return time zone as per local clearing house practice.
D. Clearing inward: Clearing inward term represents cheques received by a bank for debiting its customer’s
accounts with it. In other words, the bank which received the cheques for payment will be the drawer’s
bank (paying bank) which has to pay the amount of the cheques to the collecting bank) through the
clearing house at the respective centres.
An example to illustrate the clearing inward transaction is given below:
Info Limited holder of s a Current Account with Canara Bank has issued a salary cheque to Mrs. P for Rs.
8000. Mrs. P maintains a Savings Bank account with Bank of India.
The entries during inward clearing:
• Debit - Info Limited account for Rs. 8000 maintained with Canara Bank and the amount would be
passed on as a Credit to Bank of India through the clearing house for crediting to the account of
Mrs. P. The cheque would have been presented to Canara Bank in their inward clearing by Bank of
India through the local clearing house. The cheque itself would serve as the debit voucher in the
transaction. The amount of Rs. 8000 would also have been included as a part of total debit raised by
Bank of India through clearing house on Canara Bank.
• Credit- Bank of India Savings Bank account of Mrs. P, Pay-in-slip prepared by Mrs. P at the time of
deposit of her salary cheque with Bank of India would serve as the credit voucher. However as per
clearing house practices the amount so deposited will be available to the customer only after the
return time as per local practice. Canara Bank would have included the amount of Rs.8000 as a part
of the total credit passed on to Bank of India through the clearing house.
E. Transfer Transaction
Mrs. N has given a cheque for Rs. 2,00,000 from her bank account towards a term deposit to be opened in
her name along with a pay-in-slip for crediting her deposit account. Since the transaction is a transaction
in the same branch the entries are as follows-
• Debit - SB Account of Mrs. N for Rs. 2,00,000 by way of transfer. The cheque itself will serve as the
debit transfer voucher.
• Credit - New Term deposit account of Mrs. N. The pay-in-slip itself will serve as the credit transfer
voucher.
The transaction set will be reflected as transfer transaction in subsidiary books of account as well as in
journals.
KYC IN BANKS
What is KYC?
KYC stands for Know Your Customer. KYC forms part of Anti-Money Laundering measures taken by the
Government of India and RBI, as a part of international agreements. Money laundering activities are those
activities in which money earned by illegal means [as defined in the Prevention of Money Laundering Activities
Act, 2002 (PMLA)] are made to appear as proceeds from legal means. In this process unscrupulous persons/
criminals use banks as conduits for depositing and transferring illegal money. To prevent such attempts of
banks being used as conduits in the money laundering process, RBI has issued specific directions/guidelines.
In terms of such directions every banking entity must frame policies, procedures and controls duly approved by
respective Board of Directors, for managing the risk of money laundering.
From time to time, RBI issues updated KYC directions/ guidelines for all financial institutions covering deposits,
loans as well as money remittances. This is required to be complied with banks, failing which stiff penalties are
levied.
These guidelines cover the following:
(1) Customer Acceptance Policy: This policy must be followed by every bank/financial institution so that accounts
are opened for genuine customers based on stipulated documentary proof. This is also to ensure that:
(a) No account is opened in anonymous or fictitious/benami name.
(b) No account is opened where the Reporting Entity (RE) is unable to apply appropriate Customer Due
Diligence (‘CDD’) measures, either due to non- cooperation of the customer or non- reliability of the
documents/information furnished by the customer.
(c) No transaction or account-based relationship is undertaken without following the CDD procedure.
(d) The mandatory information to be sought for KYC purpose while opening an account and during the
periodic up-dation, is specified.
(e) Optional/additional information is obtained with the explicit consent of the customer after the
account is opened.
(f) REs shall apply the CDD procedure at the UCIC level. Thus, if an existing KYC compliant customer of a
RE desires to open another account with the same RE, there shall be no need for a fresh CDD exercise.
(g) CDD Procedure is followed for all the joint account holders, while opening a joint account.
(h) Circumstances in which, a customer is permitted to act on behalf of another person/entity, is clearly
spelt out.
(i) Suitable system is put in place to ensure that the identity of the customer does not match with any
person or entity, whose name appears in the sanctions lists circulated by Reserve Bank of India.
(j) As per RBI circular dated January 9, 2020 where PAN is obtained, the same shall be verified from
the verification facility of the issuing authority. And where an equivalent e-document is obtained
from the customer, RE shall verify the digital signature as per the provisions of the Information
Technology Act, 2000.
Customer Acceptance Policy shall not result in denial of banking/financial facility to members of the
general public, especially those, who are financially or socially disadvantaged.
2. Risk Management
For Risk Management, Banks shall have a risk based approach which includes the following.
(a) Customers shall be categorised as low, medium and high risk category, based on the assessment and
risk perception of the banks.
(b) Risk categorisation shall be undertaken based on parameters such as customer’s identity, social/
financial status, nature of business activity, and information about the clients’ business and their
location etc. While considering customer’s identity, the ability to confirm identity documents through
online or other services offered by issuing authorities may also be factored in.
Provided that various other information collected from different categories of customers relating to the
perceived risk, is non-intrusive and the same is specified in the KYC policy.
“Officially Valid Document” (OVD) means -

o The passport,
o The driving license,
o Proof of possession of Aadhaar number,
o The Voter’s Identity Card issued by the Election Commission of India,
o Job card issued by NREGA duly signed by an officer of the State Government, and Letter issued by the National
Population Register containing details of name and address.
For this clause, a document shall be deemed to be an OVD even if there is a change in the name subsequent to its
issuance provided it is supported by a marriage certificate issued by the State Government or Gazette notification,
indicating such a change of name.
Provided that,
a. where the customer submits his proof of possession of Aadhaar number as an OVD, he may submit it in such form
as are issued by the Unique Identification Authority of India.
b. where the OVD furnished by the customer does not have updated address, the following documents shall be
deemed to be OVDs for the limited purpose of proof of Address.
i. utility bill which is not more than two months old of any service provider (electricity, telephone, post-paid
mobile phone, piped gas, water bill);
ii. property or Municipal tax receipt;
iii. pension or family pension payment orders (PPOs) issued to retired employees by Government Departments
or Public Sector Undertakings, if they contain the address;
iv. letter of allotment of accommodation from employer issued by State Government or Central Government
Departments, statutory or regulatory bodies, public sector undertakings, scheduled commercial banks,
financial institutions and listed companies and leave and licence agreements with such employers allotting
official accommodation.
c. the customer shall submit OVD with current address within a period of three months of submitting the documents
specified at ‘b’ above.
d. where the OVD presented by a foreign national does not contain the details of address, in such case the documents
issued by the Government departments of foreign jurisdictions and letter issued by the Foreign Embassy or
Mission in India shall be accepted as proof of address. For undertaking CDD, REs shall obtain the following from
an individual while establishing an account-based relationship or while dealing with the individual who is a
beneficial owner, authorised signatory or the power of attorney holder related to any legal entity:(a) a certified
copy of any OVD containing details of his identity and address (b) one recent photograph (c) the Permanent
Account Number or Form No. 60 as defined in Income-tax Rules, 1962, and (d) such other documents pertaining
to the nature of business or financial status specified by the REs in their KYC policy.
3. Customer Identification Procedure (CIP)

REs shall undertake identification of customers in the following cases:
a. Commencement of an account-based relationship with the customer.
b. Carrying out any international money transfer operations for a person who is not an account holder
of the bank.
c. When there is a doubt about the authenticity or adequacy of the customer identification data it has
obtained.
d. Selling third party products as agents, selling their own products, payment of dues of credit cards/
sale and reloading of prepaid/travel cards and any other product for more than rupees fifty thousand.
e. Carrying out transactions for a non-account-based customer, that is a walk-in customer, where
the amount involved is equal to or exceeds rupees fifty thousand, whether conducted as a single
transaction or several transactions that appear to be connected.
f. When a RE has reason to believe that a customer (account- based or walk-in) is intentionally
structuring a transaction into a series of transactions below the threshold of rupees fifty thousand.
g. REs shall ensure that introduction is not to be sought while opening accounts.
For the purpose of verifying the identity of customers at the time of commencement of an account- based
relationship, REs, shall at their option, rely on customer due diligence done by a third party, subject to the
following conditions:
a. Records or the information of the customer due diligence carried out by the third party is obtained
within two days from the third party or from the Central KYC Records Registry.
b. Adequate steps are taken by REs to satisfy themselves that copies of identification data and other
relevant documentation relating to the customer due diligence requirements shall be made available
from the third party upon request without delay.
c. The third party is regulated, supervised or monitored for, and has measures in place for, compliance
with customer due diligence and record-keeping requirements in line with the requirements and
obligations under the PML Act.
d. The third party shall not be based in a country or jurisdiction assessed as high risk.
e. The ultimate responsibility for customer due diligence and undertaking enhanced due diligence
measures, as applicable, will be with the RE.
On May 10, 2021 RBI amended the Master Direction on KYC and it has been decided to amend the MD
on KYC to further leverage the Video based Customer Identification Process (V-CIP) and to simplify and
rationalise the process of periodic updation of KYC.
Few important amended provisions are as under:
Amended definition of V-CIP- Video based Customer Identification Process (V-CIP) is an alternate method
of customer identification with facial recognition and customer due diligence by an authorised official of
the RE by undertaking seamless, secure, live, informed-consent based audio-visual interaction with the
customer to obtain identification information required for CDD purpose, and to ascertain the veracity of
the information furnished by the customer through independent verification and maintaining audit trail
of the process. Such processes complying with prescribed standards and procedures shall be treated on
par with face-to-face CIP for the purpose of this Master Direction.
Accounts, both deposit and borrowal, opened using OTP based e-KYC shall not be allowed for more than
one year unless identification as per Section 16 or as per Section 18 (V-CIP) is carried out, If Aadhaar
details are used under Section 18, the process shall be followed in its entirety including fresh Aadhaar OTP
authentication.
Amended Section 18 on V-CIP:
REs may undertake V-CIP to carry out:
i. CDD in case of new customer on-boarding for individual customers, proprietor in case of
proprietorship firm, authorised signatories and Beneficial Owners (BOs) in case of Legal Entity (LE)
customers.
Provided that in case of CDD of a proprietorship firm, REs shall also obtain the equivalent e-document
of the activity proofs with respect to the proprietorship firm, as mentioned in Section 28, apart from
undertaking CDD of the proprietor.
ii. Conversion of existing accounts opened in non-face to face mode using Aadhaar OTP based e-KYC
authentication as per Section 17.
iii. Updation/Periodic updation of KYC for eligible customers.
Monitoring Transactions
Banks have to undertake on-going due diligence to ensure that their customers transactions match with their
knowledge of customers, their business and risk profile and also importantly the source of funds.
The following types of transactions need proper monitoring:
a. Large and complex transactions including RTGS transactions and those with unusual patterns, inconsistent
with the normal and expected activity of the customer.
b. Transactions which exceed the thresholds prescribed for specific categories of accounts. [Depending upon
the profile of customers, banks can fix threshold levels of transactions for every individual customer.]
c. High account turnover inconsistent with the size of the balance maintained.
d. Deposit of third party cheques, drafts, etc. in the existing and newly opened accounts followed by cash
withdrawals for large amounts.
e. Monitoring should match the risk category of customer. That is to say high risk customer would receive a
close and intense monitoring. In short, higher the risk category higher will be the level of monitoring.
f. Banks must institute a system of periodic review of risk categorization of accounts, with such periodicity
being at least once in six months, and the need for applying enhanced due diligence measures shall be put
in place.
g. In the case of accounts of Multi-level Marketing (MLM) Companies, close monitoring must be done.
Accounts in which many cheque books are sought by a company and/or multiple small deposits (generally in
cash) are made across the country in one bank account and/or where a large number of cheques are issued
bearing similar amounts / dates, are to be immediately reported to RBI and other appropriate authorities such
as Financial Intelligence Unit (India).
What are the different documents to satisfy KYC?

The following table gives different documents required under KYC norms, depending upon the legal status of
different customers such as Individuals, Proprietorship, Partnership, Trust, Companies, Trust etc.
Type of Account holder/ Documents for Identity Proof & Proof of Address
Legal entity
Accounts of Individual For undertaking Customer Due Diligence, Banks shall obtain the following
from an individual while establishing an account-based relationship or while
dealing with the individual who is a beneficial owner, authorised signatory or
the power of attorney holder related to any legal entity:
(a) a certified copy of any officially valid document (OVD) containing details
of his identity and address
(b) one recent photograph
(c) the Permanent Account Number or Form No. 60 as defined in Income-
tax Rules, 1962, and
(d) such other documents pertaining to the nature of business or financial
status specified by the REs in their KYC policy.
Provided that,
i) Banks shall obtain the Aadhaar number from an individual who is
desirous of receiving any benefit or subsidy under any scheme notified
under section 7 of the Aadhaar (Targeted Delivery of Financial and Other
subsidies, Benefits and Services) Act, 2016 (18 of 2016). or he decides
to submit his Aadhaar number voluntarily to a bank or the proof of
possession of Aadhaar number where offline verification can be carried
out or where offline verification cannot be carried out or any OVD or
the equivalent e-document thereof containing the details of his identity
and address and the Permanent Account Number or the equivalent
e-document thereof or Form No. 60 as defined in Income- tax Rules, 1962;
and such other documents including in respect of the nature of business
and financial status of the customer, or the equivalent e-documents
thereof as may be required by the RE ( RBI circular dated January 9, 2020):
Banks, at receipt of the Aadhaar number from the customer may carry
out authentication of the customer’s Aadhaar number using e-KYC
authentication facility provided by the Unique Identification Authority
of India. According to RBI Circular dated January 9, 2020, further, in such
a case, if customer wants to provide a current address, different from the
address as per the identity information available in the Central Identities
Data Repository, he may give a self-declaration to that effect to the RE.
i) Where proof of possession of Aadhaar under clause mentioned above
where offline verification can be carried out, the RE shall carry out
offline verification.
iii) an equivalent e-document of any OVD, the RE shall verify the digital
signature as per the provisions of the Information Technology Act, 2000
(21 of 2000) and any rules/issues thereunder and take a live photo as
specified.
iv) any OVD or proof of possession of Aadhaar number under the above
clause where offline verification cannot be carried out, the RE shall carry
out verification through digital KYC as specified under. Provided that for
a period not beyond such date as may be notified by the Government
for a class of REs, instead of carrying out digital KYC, the RE pertaining
to such class may obtain a certified copy of the proof of possession
of Aadhaar number or the OVD and a recent photograph where an
equivalent e-document is not submitted.
v) Banks may carry out Aadhaar authentication/ offline-verification of an
individual who voluntarily uses his Aadhaar number for identification
purpose. (Note: “Offline” verification as defined in Section 2 of The
Aadhar Act, 2016)
In cases where successful authentication has been carried out, other OVD and
photograph need not be submitted by the customer.
Provided further that in case biometric e-KYC authentication cannot be
performed for an individual desirous of receiving any benefit or subsidy under
any scheme notified under section 7 of the Aadhaar (Targeted Delivery of
Financial and Other subsidies, Benefits and Services) Act, 2016 owing to injury,
illness or infirmity on account of old age or otherwise, and similar causes,
Regulated Entities shall, apart from obtaining the Aadhaar number, perform
identification preferably by carrying out offline verification or alternatively
by obtaining the certified copy of any other OVD from the customer. Customer
Due Diligence done in this manner shall invariably be carried out by an official
of the, Regulated Entities and such exception handling shall also be a part of
the concurrent audit as mandated in Section 8 of the Aadhar Act, 2016. REs
shall ensure to duly record the cases of exception handling in a centralised
exception database. The database shall contain the details of grounds
of granting exception, customer details, name of the designated official
authorising the exception and additional details, if any. The database shall be
subjected to periodic internal audit/inspection by the, Regulated Entities and
shall be available for supervisory review.
Explanation 1: Regulated Entities shall, where its customer submits his
Aadhaar number or proof of possession of Aadhar containing Aadhar number,
ensure such customer to redact1 or blackout his Aadhaar number through
appropriate means where the authentication of Aadhaar number is not
required under clauses mentioned above.
Explanation 2: Biometric based e-KYC authentication can be done by bank

official/business correspondents/business facilitators.
Explanation 3: The use of Aadhaar, proof of possession of Aadhaar etc., shall
be in accordance with the Aadhaar (Targeted Delivery of Financial and Other
Subsidies Benefits and Services) Act, the Aadhaar and Other Law (Amendment)
Ordinance, 2016 and the regulations made thereunder. Accounts opened
using OTP based e-KYC, in non-face-to-face mode are subject to the following
conditions:
i. There must be a specific consent from the customer for authentication
through OTP.
ii. the aggregate balance of all the deposit accounts of the customer shall
not exceed rupees one lakh. In case, the balance exceeds the threshold,
the account shall cease to be operational, till CDD as mentioned at (v)
below is complete.
iii. the aggregate of all credits in a financial year, in all the deposit accounts
taken together, shall not exceed rupees two lakh.
iv. As regards borrowal accounts, only term loans shall be sanctioned. The
aggregate amount of term loans sanctioned shall not exceed rupees sixty
thousand in a year.
v. Accounts, both deposit and borrowal, opened using OTP based e-KYC
shall not be allowed for more than one year within which identification
as per Section 16 is to be carried out.
vi. If the CDD procedure as mentioned above is not completed within a year,
in respect of deposit accounts, the same shall be closed immediately. In
respect of borrowal accounts no further debits shall be allowed.
vii. 12A declaration shall be obtained from the customer to the effect that
no other account has been opened nor will be opened using OTP based
KYC in non-face-to-face mode with any other Regulated Entities. Further,
while uploading KYC information to CKYCR, Regulated Entities shall
clearly indicate that such accounts are opened using OTP based e-KYC
and other, Regulated Entities shall not open accounts based on the KYC
information of accounts opened with OTP based e-KYC procedure in
non-face-to-face mode.
viii. Regulated Entities shall have strict monitoring procedures including
systems to generate alerts in case of any non-compliance/violation, to
ensure compliance with the above mentioned conditions.
In case an individual A Bank may open a ‘Small Account’, subject to:
customer who does not a. the aggregate of all credits in a financial year does not exceed rupees one
possess Section 16 of KYC lakh;
Master Directions
b. the aggregate of all withdrawals and transfers in a month does not
exceed rupees ten thousand; and the balance at any point of time does
not exceed rupees fifty thousand.
c. Provided, that this limit on balance shall not be considered while making
deposits through Government grants, welfare benefits and payment
against procurements.
Further, small accounts are subject to the following conditions:
a. The bank shall obtain a self-attested photograph from the customer.
1
censor or obscure (part of a text) for legal or security purposes
b. The designated officer of the bank certifies under his signature that
the person opening the account has affixed his signature or thumb
impression in his presence.
Provided that where the individual is a prisoner in a jail, the signature
or thumb print shall be affixed in presence of the officer in-charge of the
jail and the said officer shall certify the same under his signature and the
account shall remain operational on annual submission of certificate of
proof of address issued by the officer in-charge of the jail.
c. Such accounts are opened only at Core Banking Solution (CBS) linked
branches or in a branch where it is possible to manually monitor and
ensure that foreign remittances are not credited to the account.
d. Banks to ensure that the stipulated monthly and annual limits on
aggregate of transactions and balance requirements in such accounts are
not breached, before a transaction is allowed to take place.
e. The account shall remain operational initially for a period of twelve
months which can be extended for a further period of twelve months,
provided the account holder applies and furnishes evidence of having
applied for any of the OVDs during the first twelve months of the opening
of the said account.
f. The entire relaxation provisions shall be reviewed after twenty four
months.
g. Notwithstanding anything contained in clauses (e) and (f) above, the
small account shall remain operational between April 1, 2020 and
June 30, 2020 and such other periods as may be notified by the Central
Government. (RBI circular dated April 1, 2020)
h. The account shall be monitored and when there is suspicion of money
laundering or financing of terrorism activities or other high risk
scenarios, the identity of the customer shall be established as per Section
16 of the Master Directions on KYC.
i. Foreign remittance shall not be allowed to be credited into the account
unless the identity of the customer is fully established as per Section 16
of the Master Directions on KYC.
Sole proprietary firm 1. For opening an account in the name of a sole proprietary firm, CDD of the
individual (proprietor) shall be carried out.
2. Any two of the following documents or the equivalent e-documents
there of as proof of business/ activity in the name of the proprietary firm
a. Registration certificate
b. Certificate / licences issued by the municipal authorities under
Shop and Establishment Act
c. Sales Tax and income tax returns
d. CST/VAT/GST certificate(provisional/final)
e. Certificate/registration document issued by Sales Tax / Service Tax
/ Professional Tax authorities
f. IEC (Importer Exporter Code) issued to the proprietary concern
by the office of DGFT Or Licence / certificate of practice issued
in the name of the proprietary concern by any professional body
incorporated under a statute
g.
Complete Income Tax Return (not just the acknowledgement) in
the name of the sole proprietor where the firm’s income is reflected,
duly authenticated/acknowledged by the Income Tax authorities.
i. Utility bills such as electricity, water, and landline telephone
bills.
ii. If the bank is satisfied that it is not possible to furnish two
such documents, at its discretion, accept only one of those
documents as proof of business/activity subject to field
verification of the authenticity of address and business
activity.
Provided REs undertake contact point verification and collect such
other information and clarification as would be required to establish
the existence of such firm, and shall confirm and satisfy itself that the
business activity has been verified from the address of the proprietary
concern.
Account of a company Certified copies or the equivalent e-documents thereof each of the following -
a. Certificate of incorporation;
b. Memorandum and Articles of Association;
c. Permanent Account Number of the company;
d. A resolution from the Board of Directors and authority granted to its
managers, officers or employees to transact on its behalf; and
e. In addition, documents for CDD of individuals in respect of managers,
officers or employees holding an attorney to transact on its behalf are to
be obtained.
f. Documents, as specified in Section 16 of the Master Directions, relating
to beneficial owner, the managers, officers or employees, as the case may
be, holding an attorney to transact on the company’s behalf.
Account of a Partnership firm Certified copies or the equivalent e-documents thereof of
a. Registration certificate:
b. Partnership deed;
c. Permanent Account Number of the partnership firm;
d. Documents, as specified in Section 16 of the Master Directions, relating
to beneficial owner, managers, officers or employees, as the case may be,
holding an attorney to transact on its behalf.
Account of a Trust Certified copies or the equivalent e-documents thereof of each of the following
documents to be obtained:
a. Registration certificate;
b. Trust deed; and
c. Permanent Account Number or Form No.60 of the trust.
Documents as specified in Section 16 of the Master Directions, relating to
beneficial owner, managers, officers or employees, as the case may be, holding
an attorney to transact on its behalf.
Account of an unincorporated Certified copies or the equivalent e-documents thereof of each of the following
association or a body of documents to be obtained;
individuals. a. Resolution of the managing body of such association or body of
(Note: Unregistered trusts/ individuals;
partnership firms shall be b. Authority granted to transact on its behalf (Resolution);
included under the term
c. Permanent Account Number or Form No. 60 of the unincorporated
‘unincorporated association’.
association or a body of individuals;
The term ‘body of individuals’
includes societies.) d. Power of attorney granted to transact on its behalf;
e. Documents as specified in Section 16, relating to beneficial owner,
managers, officers or employees, as the case may be holding an attorney
to transact on its behalf; and
Such information as may be required by the RE to collectively establish the
legal existence of such an association or body of individuals.
Accounts of juridical persons Certified copies or the equivalent e-documents thereof the following
not specifically covered in documents to be obtained:
the earlier part, societies, a. Document showing name of the person authorized to act on behalf of the
universities and local bodies entity;
like village panchayats.
b. Documents, for CDD, of the person holding an attorney to transact on its
behalf; and
c. Any other document bank may require establishing the legal existence
of such an entity / juridical person such as orders of the concerned
Government Department.
Self Help Groups (SHGs) Under the simplified norms:
a. CDD of all the members of SHG shall not be required while opening
the savings bank account of the SHG. CDD of all the office bearers shall
suffice.
b. CDD of all the office bearers shall suffice.
c. No separate CDD as per the CDD procedure mentioned in Section 16 of
the Master Directions of the members or office bearers shall be necessary
at the time of credit linking of SHGs.
d. On April 01, 2021, the RBI after review of Master Direction on KYC norms
of Self Help Groups decided to amend clause (c) of Section 43 to read as
under: “Customer Due Diligence (CDD) of all the members of SHG may
be undertaken at the time of credit linking of SHGs.” and shall come into
force with immediate effect.
Foreign Students Banks can open a Non-Resident Ordinary (NRO) bank account of a foreign
student based on the following documents:
(a) His/her passport (with visa & immigration endorsement) bearing the
proof of identity and address in the home country; with a photograph
and a letter offering admission from the educational institution in India.
Provided declaration about the local address shall be obtained within
a period of 30 days of opening the account and the said local address is
verified.
Provided further pending the verification of address, the account
shall be operated with a condition of allowing foreign remittances not
exceeding USD 1,000 or equivalent into the account and a cap of rupees
fifty thousand on aggregate in the same, during the 30-day period.
(b) The account to be treated as a normal NRO account, and to be operated

in terms of RBI’s instructions on Non-Resident Ordinary Rupee (NRO)
Account, and the provisions of FEMA,1999.
(c) Students with Pakistani nationality require prior approval of the RBI for
opening the account.
Risk Assessment
A new section (5A) has been added to chapter II of the Master Directions on KYC (vide RBI Circular dated April
20, 2020) requiring REs to carry out ‘Money Laundering (ML) and Terrorist Financing (TF) Risk Assessment’
exercise periodically to identify, assess and take effective measures to mitigate its money laundering and
terrorist financing risk for clients, countries or geographic areas, products, services, transactions or delivery
channels, etc. While assessing the ML / TF risk, REs are required to take cognizance of the overall sector-
specific vulnerabilities, if any, that the regulator/supervisor may share with REs from time to time. Further,
the internal risk assessment carried out by the RE should be commensurate to its size, geographical presence,
complexity of activities / structure, etc. Also, the REs shall apply a Risk Based Approach (RBA) for mitigation
and management of the identified risk and should have Board approved policies, controls and procedures in
this regard. As per recent amendment done by the RBI through amendments in Master Direction on May 10,
2021 REs may undertake V-Customer Identification Procedure (CIP) to carry out:
i) CDD in case of new customer on-boarding for individual customers, proprietor in case of proprietorship
firm, authorised signatories and Beneficial Owners (BOs) in case of Legal Entity (LE) customers.
Provided that in case of CDD of a proprietorship firm, REs shall also obtain the equivalent e-document
of the activity proofs with respect to the proprietorship firm, as mentioned in Section 28, apart from
undertaking CDD of the proprietor.
ii) Conversion of existing accounts opened in non-face to face mode using Aadhaar OTP based e-KYC
authentication as per Section 17.
iii) Updation/Periodic updation of KYC for eligible customers.
V-CIP Records and Data Management
i) The entire data and recordings of V-CIP shall be stored in a system / systems located in India. REs shall
ensure that the video recording is stored in a safe and secure manner and bears the date and time stamp
that affords easy historical data search. The extant instructions on record management, as stipulated in
this MD, shall also be applicable for V-CIP.
ii) The activity log along with the credentials of the official performing the V-CIP shall be preserved.
Periodic Updation
Amended Section 38:
According to RBI guidelines, periodic updation of KYC data shall be carried out at least once in every two years
for high risk customers, once in every eight years for medium risk customers and once in every ten years for low
risk customers as per the following procedure by RBI.
Individual Customers:
a. No change in KYC information: In case of no change in the KYC information, a self-declaration from the
customer in this regard shall be obtained through customer’s email-id registered with the RE, customer’s
mobile number registered with the RE, ATMs, digital channels (such as online banking / internet banking,
mobile application of RE), letter etc.
b. Change in address: In case of a change only in the address details of the customer, a self-declaration of
the new address shall be obtained from the customer through customer’s email-id registered with the
RE, customer’s mobile number registered with the RE, ATMs, digital channels (such as online banking /
internet banking, mobile application of RE), letter etc., and the declared address shall be verified through
positive confirmation within two months, by means such as address verification letter, contact point
verification, deliverables etc.
Further, REs, at their option, may obtain a copy of OVD or deemed OVD or the equivalent e-documents
thereof, as defined in Section 3(a)(xiii), for the purpose of proof of address, declared by the customer at
the time of periodic updation. Such requirement, however, shall be clearly specified by the REs in their
internal KYC policy duly approved by the Board of Directors of REs or any Committee of the Board to
which power has been delegated.
c. Accounts of customers who were minor at the time of opening account on their becoming major:
In case of customers for whom account was opened when they were minor, fresh photographs shall be
obtained on their becoming a major and at that time it shall be ensured that CDD documents as per the
current CDD standards are available with the REs. Wherever required, REs may carry out fresh KYC of
such customers, i.e., customers for whom account was opened when they were minor, on their becoming
a major.
Customers other than individuals:
a. No change in KYC information: In case of no change in the KYC information of the LE customer, a self-
declaration in this regard shall be obtained from the LE customer through its email id registered with the
RE, ATMs, digital channels (such as online banking / internet banking, mobile application of RE), letter
from an official authorized by the LE in this regard, board resolution etc. Further, REs shall ensure during
this process that Beneficial Ownership (BO) information available with them is accurate and shall update
the same, if required, to keep it as up-to-date as possible.
b. Change in KYC information: In case of change in KYC information, RE shall undertake the KYC process
equivalent to that applicable for on-boarding a new LE customer.
Sharing KYC information with Central KYC Records Registry (CKYCR)

Effective from July 2015 Banks are required to share KYC information with the CKYCR in the manner mentioned
in the Rules, as required by the revised KYC guidelines in formats prepared for ‘individuals’ and ‘Legal
Entities’ as the case may be. Government of India has authorized the Central Registry of Securitization Asset
Reconstruction and Security Interest of India (CERSAI), to act as, and to perform the functions of the CKYCR
vide Gazette Notification No. S.O. 3183(E) dated November 26, 2015.
i. Banks must upload the KYC data pertaining to all new individual accounts opened on or after January
1, 2017 with CERSAI in terms of the provisions of the Prevention of Money Laundering (Maintenance of
Records) Rules, 2005.
ii. Banks other than Scheduled Commercial Banks are to upload KYC data pertaining to all new individual
accounts opened on or after from April 1, 2017 with CERSAI in terms of PMLA Rules, 2005.
iii. As the CKYCR is now fully operational for individual customers, it has been decided by the RBI to extend
the CKYCR to Legal Entities (LEs). Accordingly, REs shall upload the KYC data pertaining to accounts of
Legal Entities opened on or after April 1, 2021, on to CKYCR in terms of Rule 9 (1A) of the PML Rules.
iv. In order to ensure that all existing KYC records of individual customers are incrementally uploaded on to
CKYCR, REs shall upload the KYC data pertaining to accounts of individuals opened prior to January 01,
2017, at the time of periodic updation as specified in Section 38 of the Master Direction, or earlier when
the updated KYC information is obtained/received from the customer in certain cases. REs shall ensure
that during periodic updation, the customers’ KYC details are migrated to current CDD standard.
Reporting Requirements to Financial Intelligence Unit - India (FIU-IND)

REs shall furnish to the Director, Financial Intelligence Unit-India (FIU-IND) the following information as per
Rule 3 of the PML (Maintenance of Records) Rules, 2005 in terms of Rule 7 thereof. Director, FIU-IND shall have
powers to issue guidelines to the REs for detecting transactions referred to in various clauses of sub-rule (1) of
rule 3, to direct them about the form of furnishing information and to specify the procedure and the manner of
furnishing information.
The reporting formats and comprehensive reporting format guide, prescribed/ released by FIU-IND and Report
Generation Utility and Report Validation Utility developed to assist reporting entities in the preparation of
prescribed reports shall be taken note of. The editable electronic utilities to file electronic Cash Transaction
Reports (CTR) / Suspicious Transaction Reports (STR) which FIU-IND has placed on its website shall be made
use of by REs which are yet to install/adopt suitable technological tools for extracting CTR / STR from their live
transaction data.
The Principal Officers of those REs, whose all branches are not fully computerized, shall have suitable
arrangement to cull out the transaction details from branches which are not yet computerized and to feed
the data into an electronic file with the help of the editable electronic utilities of CTR/STR as have been made
available by FIU-IND on its website.
While furnishing information to the Director, FIU-IND, delay of each day in not reporting a transaction or delay
of each day in rectifying a mis-represented transaction beyond the time limit as specified in the Rule shall be
constituted as a separate violation. REs shall not put any restriction on operations in the accounts where an STR
has been filed. REs shall keep the fact of furnishing of STR strictly confidential. It shall be ensured that there is
no tipping off to the customer at any level.
Reporting requirement under Foreign Account Tax Compliance Act (FATCA) and Common
Reporting Standards (CRS)
Under FATCA and CRS, REs shall adhere to the provisions of Income Tax Rules 114F, 114G and 114H and
determine whether they are a Reporting Financial Institution as defined in Income Tax Rule 114F and if so,
shall take following steps for complying with the reporting requirements:
(a) Register on the related e-filling portal of Income Tax Department as Reporting Financial Institutions
follow below procedure:
(b) Submit online reports by using the digital signature of the ‘Designated Director’ by either uploading the
Form 61B or ‘NIL’ report, for which, the schema prepared by Central Board of Direct Taxes (CBDT) shall be
referred to.
Explanation: REs shall refer to the spot reference rates published by Foreign Exchange Dealers’ Association
of India (FEDAI) on their website at http://www.fedai.org.in/RevaluationRates.aspx for carrying out the
due diligence procedure for the purposes of identifying reportable accounts in terms of Rule 114H.
(c) Develop Information Technology (IT) framework for carrying out due diligence procedure and for
recording and maintaining the same, as provided in Rule 114H.
(d) Develop a system of audit for the IT framework and compliance with Rules 114F, 114G and 114H of Income
Tax Rules.
(e) Constitute a “High Level Monitoring Committee” under the Designated Director or any other equivalent
functionary to ensure compliance.
(f) Ensure compliance with updated instructions/ rules/ guidance notes/ Press releases/ issued on the
subject by Central Board of Direct Taxes (CBDT) from time to time and available on the web site.
How to verify KYC and authenticity of documents?

The verification of authenticity of a document submitted by a prospective customer/existing customer at a
branch level, must be based on the original documents submitted by such customers; however, there are few
additional verification methods available, such as given here:
i. Income Tax Department has made available PAN verification facility to a few reputed agencies in India.
Therefore, if a customer submits a PAN Card it can be verified from the verification facility through
the accredited agencies. All banks have a link with such agencies and through such arrangements PAN
verification can be done.
ii. Authentication, of Aadhar Number already available with the Bank can also be done with explicit consent
of the customer in applicable cases through the Aadhar data base and biometric data available with Central
Identification Registry (CIDR).
iii. In the case of Electricity bills/Telephone bills these can also be verified through the service providers by
mentioning the consumer number/telephone number as well as through verification software available
online.
iv. In case of Companies and Directors, the data submitted by such customers can be verified through the
website data of Ministry of Corporate Affairs.
v. In case of certain banks, they employ field personnel who make a visit to the address provided by the
prospective customer and physically verify the details provided by such customers.
vi. Also, at the time opening a new account/establishing a new relationship, the customer will be checked
against watch lists provided by International/National/Local authorities including Central Banks and
Anti-terrorist Organizations. If the names of such customers match with any of such names in the list, a
thorough screening will take place to ensure such accounts are not opened. If such names are detected it
must be reported to concerned agencies including RBI.
Additional points on verification of KYC documents

Verification of customers’ KYC data will also be carried out in case of borrowers too. If third party agencies
are involved in verification of KYC data such agencies will also be evaluated keeping in mind the norms
prescribed by RBI. In case identification information available with Aadhar does not contain current address
an OVD containing current address may be obtained. Certified copy of OVD containing identity and address
shall be obtained at the time of periodic up-dation from individuals not eligible to obtain Aadhar, except from
individuals who are categorized as ‘low risk’. In case of low risk customers when there is no change in status
with respect to their identities and addresses, a self-certification to that effect shall be obtained. In case of Legal
entities, banks shall review the documents sought at the time of opening of account and obtain fresh certified
copies wherever it is required.
Operational aspects regarding opening of all types of accounts
One of the basic functions of a bank is accepting deposits. Deposits constitute the working capital of a bank
for doing its business by way of lending and investment. Acceptance of deposits involves paying of interest,
which is a cost and therefore from the profitability aspect, most banks try to have an optimum mix of low cost
and high cost deposits. Thus, for accepting deposits, banks offer a range of deposit accounts. Basic features of
deposits are the same across banks. However due to discretionary powers conferred on banks by RBI, banks
incorporate attractive and unique features in such accounts to attract customers. For example, Kotak Mahindra
bank offers a higher rate of interest on certain Savings Bank Deposit accounts, using the discretionary option
when compared to other banks.
Following are the salient features of different deposit accounts offered by banks in brief.
Deposit accounts offered by banks can be classified under
a. Demand deposit accounts; and
b. Term deposit accounts.
Broad Classification of Types of Deposit Accounts
According to Indian Banks’ Association, deposits are classified under different types as below:
1) Demand deposits: It means a deposit received by a Bank which is withdrawable on demand.
2) Savings deposits: It means a form of demand deposit which is subject to restrictions as to the number of
withdrawals as also the amounts of withdrawals permitted by a Bank during any specified period.
3) Term deposit: means a deposit received by a Bank for a fixed period withdrawable only after the expiry of
the fixed period and include deposits such as Recurring / Double benefit Deposits / Short Deposits / Fixed
Deposits where Monthly /Quarterly Interest are paid etc.
4) Notice Deposit: It means term deposit for specific period but withdrawable on giving atleast one complete
banking days’ notice.
5) Current Account: It means a form of demand deposit wherefrom withdrawals are allowed any number
of times depending upon the balance in the account or up to an agreed amount and will also include other
deposit accounts which are neither Savings Deposit nor Term Deposit.
Features of Savings Bank Accounts (SB)

a. Savings Bank accounts are meant for promoting Savings habit among people.
b. These accounts can be opened by Individuals singly, two or more individuals jointly, certain organizations
as permitted by RBI (See box item). Minors’ accounts can be opened by their guardians.
c. Business organizations engaged in profit generating activities are generally not permitted to open SB
accounts.
d. Minors above the age of 10 are also allowed to open
Self-operated SB accounts under certain conditions as per RBI directions. This is basically to inculcate
Savings habit in them.
e. Government Departments, Municipal authorities, political parties, trade/professional/business entities,
or associations are not allowed to open these accounts.
f. Cheque book facility is offered in these

accounts. Due to electronic banking Organizations which are permitted to open SB accounts are
as under:
ATM/Debit Card are also offered.
• Primary Co-operative Credit Society financed by a bank,
Internet banking facility is also offered
to customers subject to conditions • Self Help Groups (Registered or Unregistered) /Farmers
Club
stipulated by banks in this regard. Upon
• Agriculture Produce Marketing Committees
request, Credit card facility is also offered.
• Khadi & Village Industries Board
g.
Cheques can be used for withdrawals • Societies registered under Societies Act 1860 or any
or for making any payments. Since the other corresponding law in States or Union territories
advent of electronic banking there are • Companies registered under Section 8 of Companies
several online payment options available Act 2013 (Corresponding to Section 25 erstwhile of the
for transfer of money which can be made Companies Act of 1956 or corresponding Act of 1913)
use of. • Government Departments/bodies/agencies receiving
grants/subsidies for implementation of various
h.
The number of withdrawals in these Government sponsored Schemes/Programmes
accounts is restricted as per RBI by the Central/State Governments on production
directions as these accounts are not of authorization of the concerned Government
meant for business or trading. However Ministries/Departments.
there is no restriction on the number of
deposit transactions.
Other features of SB Accounts

Before opening an account, every bank would complete the KYC verification process of prospective customers.
In case of joint accounts KYC for all joint holders would be done. Every bank will stipulate minimum balance to
be maintained in the account. Failure to do so will result in levy of charges as per Banks’ schedule of charges.
Similarly, there can be charges for issue of cheques books, additional statement of accounts, duplicate pass
book, folio charges, SMS charges etc. All such details, regarding terms and conditions for operation of accounts
and schedule of charges for various services provided will be communicated to the prospective depositor while
opening the account.
Nomination as applicable under Nomination Rules, 1985 may also be obtained wherever applicable in these
accounts.
Interest rates on Saving Bank Account

Interest is generally paid at 4% p.a. on the daily closing balances. Such interests will be credited once in a
quarter as per latest RBI directions. Banks also have discretion to pay higher rate of interest (called preferential
rate of interest) on deposits held by staff members, senior citizens, retired employees, widows/widower of
retired employees; also, on deposits of association of employees in which employees are members etc.
Pass Books
Right from the opening of the account, Pass books are to be issued to customers. If a customer who is not issued
cheque book will have to present the pass book to get a withdrawal form from the bank. Pass books are needed
to be updated whenever they are presented by customers.
Due to spread of electronic banking instead of pass books customers are issued statements either in hard copies
or email versions as per agreement with the bank. Also, now-a-days banks are providing separate pass book
printing machines to enable customers to update their pass book on their own.
Operations in Joint Accounts

Joint Accounts opened by individuals can be operated either by only one person among the joint holders, or
more than one according to the arrangements agreed to by the joint holders. Such mandates for operating the
account can be modified with the consent of all account holders at any time by them with due intimation to the
bank. The Savings Bank Account opened by minor jointly with natural guardian / guardian can be operated by
guardian only.
Mandates in case of joint account

The joint account holders can give any of the following mandates for operation as well as the disposal of balance
in the above accounts:
(i) Former or Survivor: If the account is held by two individuals say D & E, under this mandate D only will
have the authority to operate the account. After, the death of D the balance in the account will be paid to E.
(ii) Either or Survivor: If the account is held by two individuals say, A & B, it can be operated by any one.
Also, it implies that the final balance along with interest, if applicable, will be paid to survivor on death of
anyone of the account holders.
(iii) Anyone or Survivor/s: If the account is held by more than two individuals say, A, B and C, the final balance
along with interest, if applicable, will be paid to the survivor on death of any two account holders.
This mandate can be modified by the express consent of all the account holders.
Transfer of accounts
On an application by a customer an account can be transferred from one branch to another free of cost. In such
cases all unused cheque leaves must be surrendered to the branch where the account is held. The transferor
branch will forward the original account opening form and specimen signature cards after due cancellation of
the same to the transferee branch after retaining a Xerox copy of the same.
However, with the introduction of CBS and issuance of multi-city cheques transfer of accounts has become a
thing of past.
Conversion of accounts
Savings Bank account rules permit the conversion of individual accounts in to joint accounts. In this case a fresh
joint account opening form duly signed by all account holders is to be submitted along with a request letter to
convert the existing account in to a joint account. KYC formalities need to be completed in respect of all joint
account holders. They need to mention the mandate of operation in such cases.
Closure of accounts
Savings Bank accounts can be closed at the request of the account holder. Account holder must submit a letter
in writing requesting for closure and along with all unused cheque leaves to the bank.
In case of joint accounts, all joint account holders should sign the request letter for closure and submit the same
along with unused cheque leaves to the bank.
The balance in the account to be paid after adding up to date interest in the account and ensuring that all
applicable charges are debited to the account as per schedule of charges of the bank.
Inoperative / Dormant Account

A Savings Bank account or a Current account will be treated as an inoperative/dormant account if there are
no customer induced transactions for a period of two years and above. Normally in practice if there are no
operations in the account for of one year the customer is contacted with a request to operate the account. If
the customer does not operate the account even after reminders the account will be classified as inoperative
account. Subsequently if there are operations, the same needs to be scrutinized by a higher official and if found
genuine, after a proper due diligence, operations may be allowed.
If the customer wants to revive the account a letter needs to be obtained from the account holder regarding the
same and the accounts would be transferred from inoperative account to operative accounts.
Inoperative accounts need to be segregated and a strict control should be exercised as it is a fraud prone area.
Inoperative SB accounts continue to earn interest on their balances till they are transferred to DEAF of RBI as
described below.
If any of such accounts remain inoperative beyond a period of ten years and above the balances are to be
transferred to Depositors Education and Awareness Fund (DEAF) of RBI. Subsequently when a claim arises
later the same should be claimed from RBI as per directions of RBI in this regard. RBI will pay interest on these
accounts from the date of their transfer to RBI. A detailed procedure has been enumerated by RBI in respect of
DEAF which needs to be followed by banks.
On May 11, 2021 the RBI has issued a notification wherein it has been decided that the rate of interest payable
by banks to the depositors / claimants on the unclaimed interest-bearing deposit amount transferred to the
Fund shall be 3 per cent simple interest per annum with effect from the date of this circular. Accordingly, all the
banks are advised to calculate the interest payable on interest bearing deposits transferred to RBI at the rate
of 4 per cent p.a. up to June 30, 2018, 3.5 per cent w.e.f. July 1, 2018 up to May 10, 2021 and at 3 per cent with
effect from May 11, 2021 till the time of payment to the depositor / claimant.
Note: Please refer to Lesson 4 for a detailed coverage on DEAF.
Information to Depositors on Inoperative accounts / Unclaimed deposits

RBI has directed banks to display on their websites details of inoperative accounts in their branches by adopting
the following method:
i. Such lists should contain only the name/s of the account holder/s and address.
ii. If such accounts are not held by individuals, names of authorized signatories who are authorized to
operate the accounts should be displayed.
iii. Account number, type/s of accounts and name of the branch are not to be displayed.
iv. Banks should also provide ‘Find’ option to enable the members of the public to search the list by name.
v. Banks should also display the process of claiming the same (including forms/documents) from the
concerned bank.
vi. Banks should also put in place proper procedures of due diligence for verification of genuineness of the
claim.
Salient Features of Current Accounts

1) These accounts are meant for customers who have large number of transactions of credit and debit on
everyday basis.
2) Current accounts can be opened by individuals, proprietary concerns, partnership concerns, public and
private limited companies, trusts, associations, societies and other institutions.
3) Unlike Savings bank accounts, no interest is paid on current account balances (Exception: Accounts of
Regional Rural Banks maintained by sponsoring banks or as per RBI directions from time to time).
4) While opening a new account it is usually done with a cash deposit of the stipulated minimum amount.
5) Customers are expected to maintain the minimum balances in their accounts as per the rules of business
of the bank concerned.
6) There are no restrictions on the number of withdrawals or deposit transactions that can be routed through
a current account.
7) Withdrawals from these accounts normally are to be done through cheque leaves issued to the customers.
8) If a cheque book is issued through a bearer, a separate confirmation is to be obtained from the account
holder regarding the receipt of the cheque book by him.
9) Whenever requests for cheque books are received from clients, a banker has to satisfy himself about the
genuineness of each request by verifying the signature etc.
10) Even the cheque requisition slip should be signed as per mandate given to the bank and if a cheque book
is to be delivered to a bearer then the bearer should carry an authorization from the account holder to
obtain a cheque book from the bank.
11) As soon as cheque books are issued to the account holder, the serial number particulars should be noted
in the account folio.
12) Based on the mandate of a customer, banks can debit the account of the customer through debit vouchers.
13) ATM Cards/Debit cards, internet banking facility are also provided to the account holders.
14) Normally current accounts cannot be allowed to be opened by pardanashin1 women, illiterates and blind
persons. However, guardians can operate current accounts of minors.
15) If any overdraft arrangements are made this will be as per rules stipulated by the bank including period,
interest rate, quantum and validity of such facility.
16) Nomination facility is available only in the account of proprietary concerns among current accounts.
Opening of Current Accounts by Banks - Need for Discipline

• No bank shall open current accounts for customers who have availed credit facilities in the form of cash
credit (CC) / overdraft (OD) from the banking system and all transactions shall be routed through the CC/
OD account.
• In case of customers who have not availed CC / OD facility from any bank, banks may open current accounts
as under:
¡ Banks shall monitor all current accounts and CC/ODs regularly, at least on a quarterly basis,
specifically with respect to the exposure of the banking system to the borrower, to ensure compliance
with these instructions.
¡ Banks should not route drawal from term loans through current accounts. Since term loans are
meant for specific purposes, the funds should be remitted directly to the supplier of goods and
services. Expenses incurred by the borrower for day-to-day operations should be routed through
CC/OD account, if the borrower has a CC / OD account, else through a current account.
¡ As regards existing current and CC / OD accounts, banks shall ensure compliance with the above
instructions within a period of three months from the date of this circular.
Term Deposit Accounts/Fixed Deposit accounts

1) Fixed deposits or Term deposits are those deposits that are parked with a bank for specified period at an
interest rate offered by a bank. These are generally availed by risk aversion minded depositors for income.
Though these deposits carry a fixed interest, banks also offer floating rate of interest-based term deposits.
2) Floating rate of interest term deposits are those whose deposit rates are linked to a bench mark rate and
whenever there is change in the bench mark interest rate there will be a revision in the interest rate. For
example, Bench mark rate could be ‘Repo’ rate or Bank rate of RBI.
1
Pardanashin women are women, who have almost zero contact with the outside world. A pardanashin lady is one who remain in complete
seclusion and does not transact with people other than members of her family. Though Pardanashin lady is legally competent to enter
into a contract, she may be able to able to avoid it on the pretext of undue influence and the onus of proving of influence is on the bank.
Therefore, bank should take extra care in this regards. Signature of pardanashin lady should be attested by her guardian if she is unmarried
and by her husband if she is married. The signature may be attested by any other member of the family also. If she is illiterate she will not
be issued cheque book and for every payment she will have to give the discharge in the presence of an independent witness. However, in
case of literate Woman, cheque book will be issued and payment will be made on the basis of recorded signatures.
3) Banks also offer compound interest-based term deposits apart from Recurring/Cumulative deposits.
4) As per RBI directives interest is paid on Fixed Deposits on a quarterly basis or half yearly basis on yearly
basis. However monthly interest can be paid at a discounted rate as per RBI directives.
5) Fixed deposits period can vary from a minimum of 7 days to a maximum of 10 years. Accordingly, banks
offer interest rate for different periods. These rates can change periodically in tune with RBI’s Monetary
Policy.
6) It is important to note that fixed deposits up to Rs.1 lakh per person per capacity per bank are mandatorily
insured under the scheme of deposit insurance provided by Deposit Insurance and Credit Guarantee
Corporation, a wholly owned subsidiary of RBI.
7) Fixed deposits can be withdrawn pre-maturely subject to some penalty as per RBI directives to banks in
this regard.
8) Deposit holders can avail loan against pledge of Fixed Deposits receipts; banks offer up to 90% of the
principal as loan amount at 1 or 2% higher interest rate than the rate of interest offered on the deposit.
9) Senior citizens are generally paid higher interest rates compared to interest rate offered to public.
10) TDS is applicable on the interest paid by banks as per prevailing Income Tax rules. Exemption from TDS is
also granted to General public/Senior citizens against submission of Form 15G or 15H.
Recurring Deposit
A Recurring Deposit or RD (in some banks it is also known by the name Cumulative Deposit) is also a form
of term deposit in which depositors can make deposits at regular intervals for a term and earn interest on a
compounded basis at the end of the term.
As FDs are rigid in certain respects, a Recurring Deposit is an ideal investment cum savings option.
All banks in India offer a Recurring Deposit Account, for a minimum period of 6/12 months and a maximum
period of 10 years, suiting to the needs of depositors. The interest rate remains fixed throughout the term and
upon maturity, the depositors will be paid proceeds of the deposit that includes compounded interest earned
on the principal amount deposited every month. Interest calculations will be based on monthly balances held
in the account.
Recurring deposits can also be closed before maturity if a customer so desires because of emergency situations.
Interest would be paid as per the rules of the bank which is like that of the term deposits. No recurring deposits
are accepted under Foreign Currency Non-Resident Deposit scheme.
Certificate of Deposit (CD)

This is a variant of term deposit and issued at a discount to face value. These are short-term negotiable money
market instrument which attracts stamp duty. A detailed coverage of CDs has been dealt in the earlier chapter.
Note: For detailed coverage of CDs please refer Lesson 4.
Cash certificates
These are term deposits which offer interest payments on a cumulative or compounded basis. They are governed
by the same rules as applicable to term deposits.
Some operational features of Fixed deposits are covered in the later part of this chapter.
Different types of Accounts that can be opened for different entities.

Following are the operational aspects of deposit accounts:
Accounts of an individual
(a) Account opening form must be completed, including all mandatory details.
(b) Documents required as per KYC norms are to be obtained.
(c) Should be advised to nominate a nominee to the account. Nomination must be registered and an
acknowledgement must be given to the customer.
Account of a Minor
(a) A minor is a person who has not completed 18 years of age, under Indian Majority Act, 1875. A person who
is under the custody of a court, remains a minor till he completes 21 years.
(b) As a contract with a minor is void, a minor’s account can be opened in the name of a minor, to be operated
by his/her guardian. A Guardian could be a Natural guardian or a Legal Guardian or a Testamentary
Guardian.
(c) Parents are the Natural Guardians. Legal Guardian is appointed by the Court in the absence of parents.
Guardian appointed by Will is known as Testamentary guardian. Whenever a guardian operates the
account his fiduciary capacity should be clearly brought out in cheques and other instruments.
(d) A guardian’s power to operate the account ceases once the minor attains majority. The moment a minor
attains majority, new account opening forms and specimen signature cards etc. should be got signed by
him. A letter confirming the balance in the account on the date when the minor became a major should
also be obtained.
(e) In the case of Hindus and Christians, Father and Mother constitute Natural guardians in that order. In
case of Muslims, Father constitutes the first natural guardian and the person named in his Will becomes
a guardian of the minor, after his demise. If the father has not named any one in his Will, the father’s
father becomes the natural guardian after the demise of father. While opening accounts we also accept a
guardian appointed under Mental Disabilities Act, 1999.
Joint Accounts
(a) When two or more persons jointly open an account, it is called a joint account. As far as possible a joint
account should be opened only among close relatives. Account opening form should be signed jointly by
all.
(b) A clear operational mandate from the account holders should be obtained, as to who would operate the
account.
(c) Photographs, id and address proof of all individuals as a part of KYC process are to be obtained.
(d) All joint account holders should jointly nominate a nominee.
Sole Proprietorship Accounts

(a) Business carried out in a firm’s name solely by an individual is known as “Sole Proprietorship”. Only
Current accounts can be opened.
(b) Formalities while opening the account will include compliance with KYC norms.
(c) While opening this account, if it is a new proprietorship account, a declaration in the letter head of the
firm should be obtained. If it is an existing proprietorship, any proof regarding its existence such as tax
returns, Municipal licence under Shop & Establishment Act should be obtained.
Partnership Accounts
(a) A partnership is a relation between persons who have agreed to share the profits of a business carried
on by all or any one of them acting for all. The relationship is spelt out in a document called, “Deed of
Partnership”.
(b) The minimum number of partners in a partnership should be 2. The maximum number of partners allowed
is 100. These restrictions/revisions are in accordance with The Companies Act, 2013.
(c) A partnership can be either registered or un-registered. Where partnerships require compulsory
registration with Registrar of Firms, while opening partnership accounts, the registration certificate
should be obtained.
(d) A minor cannot be admitted to a partnership, but he can be admitted to the benefits of a partnership, with
consent from other partners. Hence minor is represented by a guardian in partnerships.
(e) When a minor attains majority, he within 6 months of attaining majority, has the option to exit the
partnership. If he fails to do so, he is deemed as a partner from the date of his admission to the partnership
and will be responsible for any liabilities and loss too.
(f) Every single partner can bind a partnership by his action. Hence, while opening a partnership account,
signatures from all the partners in their individual capacity as well as the fiduciary capacity of a partner,
should be obtained.
(g) If the partnership has applied for registration at the time of opening the account obtain the provisional
receipt from the partners as proof.
(h) Clear instructions regarding as to who will operate the account, should be obtained from the partners at
the time of opening the account.
(i) If a new partner is admitted, operations in the account can be allowed subject to making changes in the
account opening forms and bank’s data base. If a partner retires from a partnership, all other remaining
partners have to authenticate the transactions. Partnership suffers dissolution on account of death/
retirement/insolvency of any one of the partners unless the Deed provides otherwise.
(j) When a partnership is dissolved, the operations in the account are to be stopped if the account is in debit
balance.
(k) In a partnership account any one partner can stop the operations. The bank needs to inform all the other
partners about the stopping of operations in the account through a specific letter.
(l) The bank will allow any further transactions, only after all partners jointly authorize the bank to do so,
through a letter.
(m) A Hindu Undivided Family (HUF) is not allowed as a partner in a partnership. But individual members of
HUF can become members of the Partnership subject to the legal limit of partnership.
(n) Cheques drawn in favour of the firm should not be allowed to be collected in the individual account of a
partner. Cheques drawn by a partner in his own favour if sought to be credited to his individual account,
should be counter signed by any other partner, so that, the bank is not held liable for conversion.
(o) Documentation to be obtained while opening an account will include -
• Bank’s account opening form duly completed and signed by all partners.
• Id and address proof of the firm.
• Photographs and address proof of all the partners; Partnership deed copy.
• Rubber stamp of the firm should be impressed on the application form and partner’s signature
should be affixed under it.
• Mandate regarding operation of the account.
Limited Liability Partnerships

(a) Limited Liability Partnerships (LLP) were introduced in India in 2009. This legal entity is a combination
of traditional partnership and a limited liability aspect of a company. To overcome the limitation placed
by Indian Partnership Act regarding total number of partners as well as unlimited liability aspect, The
Limited Liability Partnership Act, 2008 (LLP Act) was introduced.
(b) LLP can be incorporated for only business purposes; not for charity or philanthropy purposes.
(c) There is no limit on the number of partners in this entity. It is a separate legal entity from Partners.
Partners of an LLP enter in to an agreement on mutually agreed terms. The registering Authority of LLP in
some states is Registrar of Companies and in some states, it is Registrar of LLPs.
(d) Liability of a partner is limited to the extent of his contribution in the LLP. Personal assets of a partner are
not liable except in case of fraud committed by any individual partner.
(e) Every LLP should have at least 2 designated partners, out of which, one of them should be resident in
India. Designated partners will look after the affairs of the LLP.
(f) One partner is not liable for the acts of misconduct of other partners except in certain circumstances. LLP
is having perpetual succession.
(g) An individual/ a company or other LLP can be partners. HUF,NBFC cannot be partners in LLP.
(h) LLP can borrow on its own name on the security of assets; it can create charges on its assets in favour of a
lender. LLPs must submit their annual financial statements to ROC/RoLLPs.
For opening an account of LLP, the following documents are needed:
(i) Certificate of Registration of LLP. (Registration of LLP is mandatory)
(ii) LLP Agreement (In the absence of LLP agreement, provisions of Schedule I of the Act become applicable).
(iii) Designated Partner identification numbers of all the partners, (minimum no. of designated partners is
2, out of which one must be resident of India, in case where all the partners are Body Corporate, the
nominees of such bodies act as Designated Partners).
(iv) Resolution signed by all the partners indicating the authorized signatories.
(v) KYC documents of all the authorized signatories.
Accounts of Companies
(a) Companies are artificial persons which have legal existence. Companies which are incorporated under
the Companies Act, 2013 can open accounts with banks. Companies can be broadly divided in to Private
Limited and Public Limited companies.
(b) Private Limited companies cannot issue shares to public and the minimum number of shareholders are 2
and the maximum number of shareholders are restricted to 200.
(c) Public Limited company can issue shares to public. The minimum number of shareholders are 7 and there
is no ceiling of maximum number of shareholders.
(d) Formalities relating to opening accounts of companies will include obtaining the following documents
namely
(i) Memorandum of Association and Articles of Association [Memorandum of association usually
contains various details such as name of the company, place of registered office, objects, statement of
liability and details of capital (division of the share capital). Articles of Association usually contains
operational rules for day to day functioning as well as other internal matters.]
(ii) Certificate of Incorporation issued by the Registrar of Companies in whose jurisdiction the company
is registered.
(iii) Certificate of Commencement of Business. As per revised Companies Act, 2013 provisions, a company
with a share capital can commence business or exercise borrowing powers after a declaration is filed
with Registrar of Companies that the paid-up capital is not less than Rs. 5 lacs (public company)
or Rs. 1 lac (private company) or as applicable. Such declarations should be obtained and kept on
record.
(iv) Copy of Board resolution certified by the Chairman to open an account with the bank. Operating
instructions regarding execution of documents, the name/s of director/s other executives authorized
to sign etc.
(v) Copy of latest Audited Balance sheet and Profit and Loss account, List of present directors duly
certified by the Chairman, Address of the registered office along with the KYC documents pertaining
to the Company should also be obtained along with KYC documents in respect of authorized
signatories.
(vi) All account opening forms should be signed by authorized signatories. Photographs of authorized
signatories as per KYC norms should be obtained.
(vii) All documents should contain the company’s seal (Embossing Stamp).
(viii) In case of change of constitution, the company has to inform to the bank. In case of death of a director,
as a company is a legal entity having perpetual existence, its account should not be stopped.
(ix) A fresh resolution by the board of directors, authorizing the new directors and their specimen
signatures should be submitted to the bank.
Accounts of Trusts
A trust is a body created by a person/s (called “Author/s”) for the benefit of another person/s (called
“Beneficiary”) or for a cause and managed by a person or a group of persons (known as “Trustee/s”).
(a) There is a document through which a trust is created known as “Trust Deed”. Trusts can be created for
private purposes or for public purposes. A trust can be a registered body or an unregistered body. The
property belonging to a trust is normally handled by trustees as per the terms and conditions contained
in the trust deed. While opening such accounts the original trust deed should be called for.
(b) This deed should be scrutinized to identify the rights and duties of trustees and to ensure that no undue
onus is placed on the bank. A certified true copy along with rules, bye-laws should be studied to know the
rights, powers, duties and restrictions of the trustees while operating the account.
(c) If it is a public trust, trust registration certificate should be obtained. If the trust is a private trust concerned
registration certificate issued by competent authorities should be obtained.
(d) Specific resolution for operation in the account should be obtained from the trustees as to who among
them will operate the account. Account opening form should be signed by all trustees. KYC documents of
the Trust should also be obtained.
(e) A trustee can’t appoint any other person as a proxy unless the trust deed provides. Balance confirmation
letter should be obtained from the trustees on a half yearly basis and the same must be kept on record.
(f) If there are changes in the board of trustees, a resolution in this regard signed by all trustees, should be
obtained and kept on record. Any of the trustees can stop payment of a cheque. In case if a trustee dies, the
operations in the account should be stopped unless the trust deed states otherwise. In case of lunacy of a
trustee, operations in the account should be stopped, unless the trust deed allows the trust to continue.
(g) Bankruptcy/insolvency of a trustee does not affect the trust. Normally no over drawings to be allowed
in the trust account. Cheques collected on behalf of trust should not be credited to a trustee’s account as
otherwise the bank maybe held for “conversion”.
Accounts of Clubs and Associations

(a) Clubs, Societies and Associations are bodies of members, who come together for a common cause.
Generally, non-trading clubs, societies and associations approach banks to open accounts. Such bodies do
not share profits with members.
(b) Clubs can be registered or unregistered. Accounts of unregistered clubs, societies and associations cannot
be opened as individual members are not liable for debts of the body, hence suits can’t be enforced.
(c) While opening of accounts of Clubs and Associations obtain the account opening form along with photos
of the office bearers, address proof of all the office bearers, certified true copy of the original certificate of
registration, certified true copy of memorandum of association, certified true copy of the rules, regulations,
bye-laws, resolution of managing committee appointing the authorized persons to operate the account.
(To be certified true by The Chairman/Secretary). KYC documents of the Club/ Association should also be
obtained.
(d) The type of account to be opened should be specified in the resolution. Resolution should be in terms of
rules, regulations, bye-laws of the body.
(e) Upon the death of the Chairman/Secretary/ Treasurer, cheques signed by any one of them before their
death, can be passed after due enquiry.
(f) Cheques in the name of clubs/associations/societies should not be collected and credited to the accounts
of office bearers. Otherwise the bank may be liable for conversion.
Accounts of Co-operative Societies

Co-operative societies are bodies formed by individuals under Central Co-operative Societies Act or State Co-
operatives Act. They require registration from designated authorities such as Central Registrar of Co-operatives
or State Registrar of Co-operatives. Co-operative societies receive their capital from members and can indulge
in legally permitted activities.
(a) For opening an account, first obtain true copy of the letter from Registrar of co-op societies permitting
the opening of the account with a bank. Obtain Copy of latest balance sheet, Certified list of office bearers,
Certified true copy of resolution of general body or managing committee appointing persons authorized
to operate the bank accounts, Specimen signatures and photographs of persons authorized to operate the
account. Latest KYC documents of the society should also be obtained apart from the KYC documents for
all office bearers authorized to operate the account.
(b) If there is any change in office bearers/ managing committee, a certified true copy of resolution of managing
committee incorporating the change to be obtained and kept on record with the existing account opening
forms.
Accounts of Special Types

(1) Lunatics
(a) A banker does not knowingly open the account of a lunatic, as he is incompetent to contract. If after
opening an account when a banker comes to know the lunacy of the account holder, operations in
the account should be stopped until a Court of competent jurisdiction gives an order, or a banker
has a solid proof the account holder’s sanity. A solid proof includes written report from a competent
specialist like a psychiatrist/psychologist.
(b) Drunkards in their drunken state are of unsound mind and are incompetent to contract. Contracts
entered in the drunken state are void. Therefore, a banker stands to lose if he knowingly opens a
drunkard’s account.
(2) Illiterate persons

(a) They can enter in to contractual relationships. Hence a banker opens accounts of illiterates with
some precautions.
(b) Since illiterate persons do not know to read/write, their thump impressions are obtained in lieu
of signatures. For males, their left-hand thumb (LHT) impression is obtained and for females, their
right- hand thumb (RHT) impression is obtained. These thumb impressions are got witnessed/
attested by known witnesses.
(c) Other forms of identification such as Photographs, Address proof etc. are obtained as per KYC norms.
Photographs are properly to be affixed along with seals to prevent substitution. Due to the presence
of photographs, the need for witness stands reduced at every withdrawal transaction.
(3) Blind person
(a) A blind person, if mentally sound can enter in to contract. If a blind person can sign he should be
asked to sign account opening forms. Also, a blind person should be properly informed of the care he
should take regarding the pass book, deposit receipts which will be issued to him.
(b) He/she should come in person to open the account.
(c) If the blind person wants to open an individual or joint account, he/she may be allowed to do so.
(d) While opening the account itself, the branch official should read out the rules of business and other
terms and conditions in presence of a witness and accordingly obtain the signature of the witness.
(e) If the blind person is literate, in addition to thumb impressions, signature should also be obtained in
the account opening forms. This should be countersigned by the Manager.
[Note: While opening an account for illiterate and blind persons, mark the account as “illiterate” or “blind”
across the Account Opening Form.]
(4) Executors and Administrators
• An Executor is one who is appointed in terms of a Will of a person (known as ‘Testator’). An
Administrator is a person appointed by a Court to manage some one’s estate or property, when an
owner of a property dies without leaving a Will or leaves a Will without naming an Executor or
an Executor dies before the maker of the Will or the appointed Executor refuses to undertake the
responsibilities.
(i) Before opening the account, a banker should obtain certified copies of “Probate” or “Letters of
Administration” and keep the same on record. The operations in these accounts will be in terms
of these documents. If there are more than one Executor or Administrator, the account will bear
all their name under the style.
(ii) Account opening forms should be signed by all Executors/Administrators as mentioned in the
document. KYC documents of the individual Executor or Administrators are to be obtained.
(iii) In case of accounts having more than one Executor or Administrator, clear mandate should be
obtained regarding the operations in the account. Any one of the Executors/Administrators can
stop the payment of a cheque pertaining to the account. In case of revocation all of them should
jointly sign a letter and authorize the bank to do so.
(iv) Executors/administrators cannot delegate their authority to any one and a banker should
not honour cheques signed by such delegatee. In case an Executor or Administrator becomes
lunatic his authority stands terminated.
Under this circumstance, a banker should not honour cheques drawn by such Executor/
Administrator but seek instructions from fellow Executors/Administrators or the Court as the
case may be.
(v) Bankruptcy of an Executor/Administrator will not affect the bank account. A banker should
always be on guard to prevent any misappropriation of funds held in the account by Executors/
Administrators. Otherwise the bank will be held liable for Conversion.
• Liquidators: Are appointed by a Court to dispose off properties and assets of institutions as well as
collect the amount from debtors and settle the claims of creditors while winding up of a company.
While opening an account of a Liquidator, first the terms of court order appointing the Liquidator
should be studied and understood.
(i) In case of voluntary liquidation of a company wherein a Liquidator has been appointed, terms
in resolution of the company to open account should be studied. Such a resolution must be
certified by Chairman of the meeting (winding up).
(ii) If an account is to be opened it should be titled as Liquidator a/c of (name of the company).
We must obtain account opening form duly signed by the Liquidator. Also obtain all other KYC
documents pertaining to the individual/s appointed as Liquidator/s.
Certain Operational aspects of Deposit Accounts

(1) Operation in Minor’s Account
When a deposit account of a minor is opened, the proof of birth should be verified with reference to the
school / birth certificate and a certified copy of it should be kept on record.
The birth date of the minor must be properly noted in the Customer/ Account Master. Constant watch
has to be kept on accounts of minors and their attaining majority, particularly where the accounts are
operated by the guardians of the minor, because the erstwhile minor may question withdrawals from
his account by the guardian after he attains majority. To eliminate this risk and to safeguard the Bank’s
interest, it is necessary to keep a watch on such accounts. At present in the Core banking system this
information is generated and made available to branches at the beginning of every month.
If withdrawal/cheque signed by the guardian, is presented for payment, after the date on which the
minor became major, the erstwhile minor must be contacted, and his instructions sought. If he cannot be
contacted, the withdrawal form/ cheque should be returned with reason. “Mr./Miss/Mrs. _________________
___________________________ has since attained majority.”
(2) Tax Deducted at Source (TDS)
As per the prevailing regulations, Income Tax must be deducted at source (TDS) if the annual interest paid
to the customer/s exceeds Rs. 40,000 (For senior citizens it is Rs. 50,000) during the financial year . The
rate at which income tax is to be deducted is as notified from time to time by Income Tax authorities.
Exemption from deduction of tax is applicable for Shareholders (members) and Nominal Members of
Co-operative banks as per Income Tax regulations applicable from time to time. Therefore, at the time of
accepting or renewing any deposit, this aspect must be confirmed and accordingly dealt with.
If any depositor such as Senior Citizen (one who has completed 60 years of age as defined by Income
Tax department) claims exemption from deduction of TDS, they should be asked to submit duly filled in
Form No. 15H to the Bank within the time limit specified under the Income Tax Act. Three copies of Form
No15H are taken and one form is returned to the customer after acknowledging the same. One such form
is forwarded for onward submission to Income Tax Department. If an eligible Depositor fails to submit
Form 15G or 15H, then TDS must be deducted at the appropriate rate as advised by Head office of the
respective banks.
(3) Premature closure of Term Deposits
If a deposit account is closed before its maturity a letter signed by the depositor/s as per operating
instructions on the account opening form should be obtained.
The interest rate payable will be 1% less than the actual rate of interest applicable for the period for which
the deposit has remained with the bank, prevailing as on the date when the deposit account was opened,
as given in the examples below:-
Example 1: Where the interest is payable on simple interest basis on the deposit at the time of opening
and if such a deposit is sought to be prematurely closed, then the interest payable on the deposit will also
be the applicable rate for the period for which the deposit remained with us less 1% on simple interest
basis. Any excess interest will have to be recovered from the customer as given in the following example.
• Customer X has kept a Fixed Deposit of Rs. 10,000 for 36 months at a simple interest rate of say 10%.
After two years he approaches the bank for closing the deposit prematurely. The rate of interest
applicable for two-year period at that point of time when the customer opened the FD was, say 6%.
• The customer will be paid simple interest on Rs. 10,000 at the rate of 6-1= 5%.
• The bank will have to recover the excess interest paid, i.e., 10-5=5% on Rs. 10,000 for two years from
the customer.
Example 2: Where the interest is payable on a compounded basis on the deposit at the time of opening
and if such a deposit is sought to be prematurely closed, then the interest payable on the deposit will be
applicable rate for the period for which the deposit remained with us less 1%. Any excess interest will have
to be recovered from the customer as given in the following example.
• Customer A has kept a compounding interest deposit of Rs. 20,000 for a period of 36 months at an
interest rate of say 9% p.a. (paid on a compounded basis).
• After 18 months the customer approaches us for a premature repayment. If the deposit rate applicable
for 18 months at the time of opening the deposit, is say 7.5% p.a.
• Therefore, the customer will be paid compounded interest at the rate of 7.5 - 1 = 6.5% for 18 months.
• Excess interest paid in this case will be recovered from the customer.
Note: Under Core banking environment calculations as mentioned above are done by computers.
(4) Auto renewal of Deposits

Many banks have introduced auto renewal of deposits to overcome the problem of late renewal of deposits
and its attendant problems like interest for intervening period etc.
Under the scheme of auto renewal, a depositor will be given two options.
i. At the time of accepting the deposit itself option for automatic renewal of the term deposit receipts
at the rate of interest prevailing on the date of maturity Or
Option to await the customer’s instruction for disposal of Maturity proceeds. Such instructions to be
given one week before the date of maturity.
ii. Separate form is printed for accepting the Auto renewal instructions from the depositor.
iii. The bank branches can get the forms filled up for the existing depositors one week before the date of
maturity and enter the details in the core banking system.
iv. In case getting the instructions from the depositor is not possible even then the receipts from the
cut-off date would be Auto renewed.
v. While sending the maturity notices to existing depositors, they should be made aware of the process.
vi. Term Deposit products like NRE, NRO, FCNR, Tax Saver Term deposits etc. do not come under the
purview of the Auto renewal process.
vii. Generally, all the Term Deposit receipts on which lien are marked would also be excluded from the
Auto renewal process.
(5) Addition/Deletion of in the name of the Depositors

Addition/Deletion of a depositor is allowed in the deposit accounts provided all the existing account
holder/s express their consent in writing to the Bank.
(6) Mode of Payment of Term deposit of Rs. 20,000 and over
Under the prevailing Income Tax laws, the limit for repaying the maturity proceeds of a term deposit in
cash is up to Rs.20,000.
If the maturity proceeds together with interest is Rs. 20,000 and over, it must be paid either by credit to
the account the depositor/depositors concerned or by way of crossed pay order.
When the depositor/s has more than one term deposit maturing on the same or on different dates even
though the amount of individual deposits is less than Rs. 20,000, whether maturing on the same date or
on different dates the aggregate of all such deposits should be taken into consideration for this purpose.
(7) Death of a depositor
In case of a death of a depositor the same must be dealt with as per the survivorship instructions. In
case of death of a sole depositor the balance in the account will be paid to the Nominee as per the claim
settlement procedure spelt out by the Bank concerned.
(8) Dealing with “Stop payment of cheques”
Whenever Savings Bank, Current Account and Cash Credit account holders give “Stop payment Instructions”
of the cheque/s issued by them the following precautions need to be observed by a bank:
• Before accepting the instruction, it is to be verified whether the authorised signatory has signed the
instruction. If this is not, then it should be insisted for an authorized signatory’s signed instruction.
• Banker must ensure that before they accept the instruction whether the cheque has already been
passed. If the cheque has already been passed bank cannot accept the instruction.
• If the concerned cheque has not been passed already, it is to be verified whether the instruction
contains the cheque number, the payee’s name, date of the cheque, and the amount of the cheque. It
is also needed to be ascertain the reason for stopping the payment of the cheque.
• If the instruction is otherwise satisfactory, an acknowledgement is given to the customer and then
the stop payment instruction is entered in the proper field in the Core banking system pertaining to
the account and must be authorized.
• If a cheque for which a “Stop payment” instruction has been received from a customer, is presented
in clearing or across the counter, the same should be returned to the presenter.
• Before returning, the concerned cheque should be defaced with the words “Payment Stopped by
the drawer” and then it should be returned with cheque returning/objection memo indicating the
appropriate reason for return.
• Immediately the cheque returning charges should be debited to the customer’s account.
• In case of joint accounts and Partnership firms any one of the joint account holders/partners can
give the “Stop payment of Cheque” instruction.
• If the same must be revoked all the account holders/partners should jointly sign the revocation
instruction.
(9) Deposits Maturing on a Holiday
As per the Master Circular of RBI RBI/2010-11/92 UBD.PCB. MC. No. 11 /13.01.000/ 2010-11 dated July
01, 2010 on Interest rates on Rupee Deposits, in respect of a term deposit maturing on a Sunday or Holiday
the bank shall pay interest at the contracted rate till the next working day at the contracted rate -
• On the maturity value in case of reinvestment deposits and recurring deposits.
• On the original principal amount in case of ordinary term deposit (based on 365 days in a year).
(10) Coverage under Deposit Insurance and Credit Guarantee Corporation (DICGC)
Through a Press Note No: 2019-2020/1878 dated 4th February 2020 Reserve Bank of India, has raised the
limit of insurance cover for Deposits held by customers such as savings, fixed, current, recurring, etc. from
the present level of Rs.1 lakh to Rs.5 lakh per depositor for deposits held by them in the same capacity and
in the same right at all the branches of the Bank taken together with effect from February 4, 2020 with the
approval of Government of India. The following deposits are not covered by DICGC:
(i) deposits of foreign governments
(ii) deposits of Central/ State Governments
(iii) deposits of State Land Development Banks with the State cooperative banks
(iv) inter-bank deposits
(v) deposits received outside India, and
(vi) deposit specifically exempted by the DICGC with the previous approval of the Reserve Bank. The
premium for the insurance cover is borne by the Bank.
(11) Interest Rates on Deposits
Interest rates on Term Deposits are subject to periodical changes. The latest rates of interest as well as
the maturity values based on the same are to be provided to customers. There should not be any mistake
in quoting rates to the customers. Quoting wrong rates sometimes results in monetary loss to the Bank
which should be avoided.
Scrutiny of loan applications/documents Types of borrowers & loan applications
Different customers of banks may approach a bank for loans for various needs. The borrowers can be
(a) Individuals/Self-Help groups/Joint Liability groups
(b) Sole proprietary firms
(c) Partnership firms
(d) Hindu Undivided Families
(e) LLPs
(f) Companies
(g) Statutory Corporations
(h) Trusts
(i) Co-operative Societies
As different laws are applicable to these types of borrowers, procedures evolved by banks in respect of these
borrowers are also different.
Note: A detailed coverage regarding different types of credit facilities and types of borrowers are
provided in Lesson 12.
SCRUTINY OF LOAN APPLICATIONS/DOCUMENTS

This is known as pre-sanction procedure which is followed in all banks. There are various stages in the same
and they are as follows:
Receipt of Loan applications & other formalities

In terms of BCSBI guidelines standardized loan applications are collected in respect of different borrowers.
Most of the banks also provide check lists to help borrowers regarding documents to be submitted along with
application in support of their loan proposals. The staff members of the bank also brief customers regarding
requirements. Now-a-days these details are also provided in the website of respective banks alongwith details
of various schemes and downloadable application forms.
It has to be ensured that application forms submitted by borrowers are properly filled with the required details
such as Name, age, father’s/husband’s name, present address, telephone/mobile contact numbers, email id,
employer’s name and id, salary details/business income/ annual profit, details of existing bank borrowings etc.,
details of security offered, guarantors details, etc. These details are to be obtained at the initial stage itself, so
that these will be useful later, at the time of recovery. Signatures of the applicant along with those of guarantors
are also to be obtained. These are to be verified with reference to documents submitted by the applicant. As KYC
norms are also applicable to loan applications, required checks in that regard are also to be done. In the case
industrial/business borrowers their business address, factory address / godown address/Administrative office
address/Head office etc. are to be obtained.
Thirdly, it must be ensured that the borrower submits all applicable information such as Salary particulars
of borrower and Guarantors, Income Tax returns/Assessment order, quotation for assets to be purchased in
case of consumer loans/car/estimates for house/demand letter for fees to be paid in case of education etc. In
case of industrial/ business borrowers financial statements/cash flow/projected balance sheet/ quotations
for machinery purchase/ stock purchase etc. are required to be submitted. In short it should be ensured that
documents as specified by internal guidelines are required to be obtained.
Fourthly, it must be ensured that the particulars entered in the loan application match with the data contained
in the enclosures which are submitted along with the application form.
Verification/Scrutiny of application helps a bank to advise a customer to rectify any omission or commission.
Also, it can help a bank to reject if it doesn’t conform to the norms. Proper scrutiny of a loan application will
reveal the eligibility of a borrower to avail the loan in terms of internal guidelines.
Also, a proper scrutiny will lead to proper evaluation of the proposal in terms of various directions of RBI
including prudential exposure and risk management aspects. The required degree of scrutiny may vary
depending upon the amount of loan applied for.
The following aspects will be considered for evaluating a proposal in terms of technical feasibility, economic
viability as well as commercial prudence.
1. Whether the activity proposed included under banned list or negative list as per policies of Government /
RBI /banks (e.g. Financing Commercial real estate/oil extraction unit/Steel units etc.)
2. Will the quantum of finance exceed the exposure norms as prescribed by RBI?
3. Whether the borrower has relevant experience in managing similar activity? If not what other arrangements
are made by him?
4. Back ground of promoters.
5. Performance of existing units/ Projected performance of the unit in comparison to peer units.
6. Technical feasibility aspects.
7. Inputs availability for sustained viability of the unit.
8. Financial analysis of the unit including promoters’ stake in the unit.
9. Capacity of the unit to break even and generate profitability.
10. Guarantees, main and collateral securities offered.
11. Borrowers status in terms of credit report from credit rating agencies/other banks
12. History of conduct of the accounts with other banks.
Thus, a detailed scrutiny of a proposal will help a bank to arrive at a prudent credit decision. It will also enable
the processing/sanctioning of proposal less time consuming.
Allowing drawals and accounting entries involved at various stages.
While sanctioning loans/advances for working capital to trading, manufacturing and other activities against
stocks, book debts/receivables etc. banks fix the quantum of finance based on drawing powers fixed for the
borrowers in cash credit accounts. Banks also fix up drawing powers in respect of certain securities like shares,
selective credit control items. The drawing power fixed for a borrower indicates the maximum quantum of
finance a borrower can avail during a stipulated period. In respect of trading concerns and manufacturing
concerns the drawing power fixed for a customer may vary on a month to month basis due to the value of stocks
held by the borrower. Also, in the case of shares too due to fluctuating market prices, the drawing power will
undergo changes.
Let us understand the concept of drawal limit through the following examples:
Drawls in respect of Term Loans
In respect of term loan, the drawal limit is limited to the extent of finance sanctioned and availed indicates
the drawing power. Subsequent payments made by the borrower will gradually reduce the finance availed.
For example, if a trader is sanctioned Rs. 20 lacs loan on the security of properties worth Rs. 50 lacs and the
loan is repayable in 5 years, at the end of the 1st year the outstanding will be Rs.16 lacs, at the end of 2nd year
outstanding will be Rs. 12 lacs and so on. The outstanding indicates the drawing power utilized by the borrower.
Drawls in respect of Cash Credit accounts
In practice drawls in respect of Cash Credit accounts are fixed based on the value of Securities, less the margin
prescribed in respect of each security. However, the drawl in the cash credit account will be limited to the limit
sanctioned or drawl fixed based on securities whichever is lower. The following example will illustrate the
concept of drawls or Drawing Power as it is commonly known in banking.
Details Example 1 (Against stocks only) Example 2 (Against Example 3 (Against
Stocks with Sundry Stocks, Book Debts
Creditors) with Sundry Creditors)
Sanctioned Limit (A) 50 50 50
Value of Stocks (B) 80 80 80
Less Sundry creditors (C) 0 30 30
Paid Stocks (D) =(B-C) 80 50 50
Less Margin for stocks -
25% of D (E) 20 12.5 12.5
DP for stocks (F) 60 37.5 37.5
Book Debts (G) Nil Nil 25
Margin for book debts -
40% of G (H) Nil Nil 10
D P for book debts (I) Nil Nil 15
Total D P (F+I) 50** 37.5 50**
** Though total DP comes to 60, it cannot Exceed 50 which is the ** Though total DP comes
sanctioned limit. to 52.5, it cannot Exceed
50 which is the sanctioned
limit.
ACCOUNTING ENTRIES INVOLVED IN VARIOUS STAGES OF A LOAN

Term loans are usually disbursed in one or more instalments depending upon the sanction terms or need of a
borrower. For example, in case if a term loan for house construction loan may be released in instalments as and
when various stages of construction is completed. In respect of education loans loan may be released in one or
two or three installments as per demand from an educational institution on the student.
i. At the time of release of loan generally the following entries are passed: (Example of a housing loan where
the house is under construction)
Debit: Loan Account of the borrower
Credit: DD issued in favour of the builder (for direct payment to the builder)
ii. At the time of debiting interest amount to the loan

Debit: Loan account of the customer
Credit: P& L Account -Interest on Loans
iii. At the time of repayment of interest & installment amount by the borrower
Debit: Borrower’s Savings Bank account (Amount of installment+ interest)
Credit: Loan account of the borrower (Amount of installment+ interest)
iv. At the time of debiting service charges to the customer account
Debit: Customer’s loan account
Credit: P&L account - Income head: Service charges
The service charge debited to the borrower’s account, should be recovered by the following debit to
the borrower’s account:
Debit: Borrower’s Savings Bank account
Credit: Customer’s loan account.
v. At the time of paying/renewing insurance policy on the house
Debit: Customer’s loan account
Credit: DD Issued account or NEFT account in favour of Insurance Company
Simultaneously Debit: Borrower’s Savings Bank account
Credit: Customer’s loan account
[Sometimes in respect of examples iv and v to reduce the accounting entries the accounting is done by Debit:
Borrower’s SB account and Credit: Income head & Debit: SB account of the borrower and DD issued or NEFT
account respectively.]
Note: Now-a-days under the core banking in the case of Equated Monthly Instalment paid by a customer from
every instalment some portion of the repayment will be adjusted towards interest and the balance towards
principal amount. In initial stages the proportion of credit towards the interest will be higher and towards the end
of repayment period, the credit towards the principal will be higher. Interest calculations are done through the
software used by the respective banks. The example given above illustrates the manual system of passing entries,
for proper understanding.
OPERATIONAL ASPECTS OF CBS ENVIRONMENT
Introduction
CBS stands for Core Banking Solutions. It signifies, a banking process where a customer’s transactions are done
in a centralized manner through the data stored in a central computer server in a bank. The centralized data
is made use by branches which are net worked together for handling customer’s transactions across various
geographical locations. CBS is one of the shining examples of Technology and Communication coming together
in one platform.
CBS is the advanced stage of computerization of banks, which commenced during late 1980s in India. The
Narasimham Committee also recommended computerization of banks in its report for efficient customer service
and proper housekeeping of banks. CBS operations are carried out though tailor made software provided by
specialized software companies. Depending upon the size and uses by banks, the software varies.
Need for CBS

The need for CBS arose in view of several adverse factors noticed in customer service provided by banks due
to manual processing of transactions. Inordinate delays in processing transactions, pass book updation, poor
housekeeping, revenue leaks, delays in MIS generation etc. were responsible for introduction of CBS.
Essential Requirements for CBS

The following are the essential frame work needed for CBS namely Central Data Centre, Disaster recovery sites,
Business process re-engineering, Software, Networking and trained personnel.
1. Central Data Centre (‘CDC’): This houses the Central server for the entire bank that facilitates online
transactions. All delivery channels are linked to this centre which provides 24x7availability of data for
processing. It should be operational throughout the year for a smooth functioning of the bank. Powerful
equipment of enough storage capacity forms the main hardware in these sites.
2. Disaster Recovery Sites: Every computer site is prone to failure due to technical reasons. To avoid any
such disruptions in centralized data centre, as a risk management measure, most of the banks maintain a
back-up system of servers which will ensure non-stop availability of data for processing transactions as
well as managing various delivery channels.
3. Business process re-engineering: This is to realign the existing business process in an organization
in the light of introduction of new technologies. In the banking sector most of the banking transactions
were done manually/partly through computers before the introduction of CBS. Therefore, to reap the full
benefit of the introduction of CBS, existing business practices were modified through business process re-
engineering. Several leading companies specialized in business process re-engineering were involved in
bringing about the desired changes in banks in this regard.
4. Software: CBS software consists of branch modules in respect of various functions, modules for various
associated delivery channels such as ATM, tele-banking, internet banking and other inter-face software for
connecting to RTGS, NEFT, CTS and other payment gateways.
5. Networking: Networking of branches to the central server as per standard specifications through Wider
Area Network is required with backup network such as Integrated Services Digital Network (ISDN). “ISDN
is an internationally accepted communications standard for simultaneous digital transmission of voice,
video, data, and other network services over the traditional circuits of the public switched telephone
network.”
6. Trained personnel: Skilled and trained manpower is a pre-requisite for implementation and maintenance
of uninterrupted CBS.
Reserve Bank of India has been encouraging all banks to switch over to CBS in the interests of Customer service,
proper housekeeping, timely reconciliation and balancing and tallying of books of account, preparation of MIS,
submission of returns etc. Due to variety of benefits accruing to the banks, large number of banks in India have
successfully implemented CBS.
Uses of CBS to Banks

CBS is useful to banks in the following functional activities:
i. Opening of accounts
ii. Recording/handling of routine Transactions even from remote branches
iii. Interest calculations on all products
iv. Pass book updation/Statements of Accounts generation
v. Cash deposits and withdrawals
vi. Clearing and Money transfers
vii. Managing accounts of various types
viii. Generation of Statements for Reporting and Management Information System

ix. Customer Relationship Management
CBS is seamlessly linked to both onsite and offsite ATMs facilitating cash withdrawals, Fund transfers, Cheque
book requisitions, mobile banking/internet banking. This feature enables customer convenience of doing
transactions at their will. As CBS is also linked to CTS, clearing of cheques is also speeded up. CBS helps better
housekeeping and plugs income leaks. Similarly, execution of standing instructions is done promptly. Intra-
bank operations on behalf of customers also become easy. Payments like Utility bill payments, tax payments
etc. can be conveniently done by customers. Thus, there are several advantages flowing to customers and banks.
Transactions flow in CBS

Transactions flow in CBS begins with login to the system by staff members of banks. For this purpose, each staff
member is allotted a user id and the concerned staff member must create his own password. While logging in
to the system every staff member must use his/her login id and password. Always staff members must maintain
confidentiality of their passwords.
Once a transaction is entered by a staff member it is filtered through maker-checker protocol in the system.
When a transaction is initiated at a lower level (clerical/teller) the same needs to be authorized by a senior
supervisory level official, if the transaction exceeds the authority level fixed for such lower level staff. Once
the transaction passes through the system, the transaction will be validated by the system. The user (i.e., the
staff) will receive an indication whether the transaction is complete or not. While validating the transaction
the system will analyse the account number, authority level of staff who puts through the transaction, authority
level of supervisory official who authorizes the transaction and other points of validation as per set parameters
as applicable to the respective transaction.
The process of accounting through the CBS

There are different levels of software in the CBS that are involved while accounting a transaction. One level of
software takes care of transactions and another level takes care of posting of entries in the general ledger. There
is a connecting inter-face between these two levels.
While accounting a transaction in the CBS entries are passed through an intermediary stage known as balancing
account (also known as ‘temporary parking account’). The following example illustrates the same:
Let us assume that Mr. K has given a cheque for Rs. 1,00,000 towards a term Deposit account in his name. The
entries through the system will be:
Debit: Mr. K’s Saving Bank Account Rs. 1,00,000
Credit: Balancing Account Rs. 1,00,000
Simultaneously the following entries will also be done in the system
Debit: Balancing Account: Rs. 1,00,000
Credit: Term deposit Account of Mr. K: Rs.1,00,000.
Similarly, in respect of transactions where a single debit results in, multiple credit and vice versa known as
Batch transactions the following accounting entries will be generated.
Let us say a company gives a single cheque of Rs. 2,00,000 with a request to credit a sum of Rs. 20,000 being a
lumpsum payment to 10 different staff members’ SB accounts maintained with the branch.
Debit: Current Account of the Company: Rs. 2,00,000
Credit: Balancing account: Rs. 2,00,000
Debit: Balancing Account: Rs. 2,00,000
Credit: Individual SB Account of 10 staff members (each Rs. 20,000): Rs. 2,00,000
Other routine operational aspects under CBS

Startup activities: A day start up activity should be done by the Data Base Administrator (DBA). Usually in
every branch, a senior officer is designated as a DBA. In small branches the branch head himself may perform
this function. Every day after the startup an entry should be made in the log book or register should be signed to
indicate as to who has initiated the day start up. Startup activities should be performed at the commencement
of business hours. Before doing so, security checks (including check sum verification) as per internal guidelines
should be carried out. Along with these verifications of banking date is also to be done.
Begin of Day operations: Every day a branch commences its work with ‘Begin of the Day’ (BOD) first. Only
after this is performed will the staff members be able to login with their individual id and passwords to put
through other transactions.
End of the Day operations at branches: Like BOD transaction every branch will have to do the End of Day
(EOD) process to complete the day end routines. Back up of the day’s transactions is taken during the EOD
and statements are also generated. Once EOD is done staff members will not be able to access the transactions
modules, but they may be able to access enquiry modules.
Operational aspects of Day end activities at branches

Every branch must carry out the following day end activities through their designated DBA or branch head as
the case may be:
i. Checking of supplementary activities and deletion of special users.
ii. Minimum balance calculated.
iii. Products calculated for debit balances in current account.
iv. Generation of mandatory reports as per internal guidelines.
v. Taking up of Day end back-up and recording the same in the register meant for that purpose. These are to
be stored securely as per procedure recommended in internal guidelines.
vi. Activation of fall back procedures.
vii. Log book updation. (Recordings).
viii. Filing reports in their respective files.
ix. Shut down of the system and locking of server room.
During the day end the following reports namely Access log, Supplementary, Audit trail, Transaction number
report for each transaction entered are also be generated.
EOD at CDC
Also, at the CDC there will also be EOD operation usually late in the night, say around 10 or 11 p.m. By doing
EOD at CDC, branches will be cut-off from the main host server at the CDC so that branches do not do any
transaction after the EOD commences. Back up is also taken at CDC in which the entire data of the bank is stored
at CDC level. During back up process all data gets updated and posted. Reports are also generated during the
EOD process. After the EOD process a separate Start of the Day process is also done at CDC so that branches
will be able to have access the CDC server. ATM transactions and other such transactions that have taken place
during the EOD run get recorded once the Start of the Day process commences. EOD and SOD at CDC covers the
entire branch network across the bank.
Operational aspects of Controls in CBS

1. Password controls: As access to computerized banking is only through passwords, staff members should
ensure the following:
(a) Maintain the secrecy of their individual passwords. This applies to all levels of staff members. Several
frauds have taken place due to the disclosure of passwords or not changing of passwords.
Username ***************
Password ****************
(b) Passwords for certain critical and sensitive operations
such as access to Master Data, access to operating
system, taking of back-up, disk space creation etc.
should be confined only to the Head of the branch or
DBA.
(c) The operating system passwords should be held
under joint control of the Head of the branch and
other designated official. It should be held in sealed
cover and to be opened only in the presence of two
officials. Immediately it should be changed, and the
new password should be held in joint custody. Biometric Device to login
(d) Password register is to be maintained for recording and updation.

2. Transaction controls: Transaction controls are maintained at the data base level and every branch must
ensure the following:
(a) Date must be authorized by the Head of the branch or the DBA.
(b) Software control accepts only the current date and rejects any
back date or future dated transactions.
(c) In case of unused work stations, they are to be logged off. Work stations which are manned, only to
be connected to the network.
(d) Every software problem is entered in the register meant for that purpose and follow-up action is
taken.
(e) Printing of special batch reports, their checking and filing of the same appropriately.
3. Personnel control: Branch must maintain the following controls in respect of staff who are involved in
the operations under CBS.
(a) Clear allotment of work and proper segregation of duties.
(b) Rotation of duties at regular intervals.
(c) Ensuring authorization limits are defined for various levels of staff and documented.
(d) Ensuring deletion of passwords of transferred/retired employees. Also ensure that no access is given
to employees who are facing suspension/disciplinary action.
4. Logical access control: Logical access control deals with safety of CBS assets, maintaining of data
integrity etc. To ensure logical access control the following need to be ensured:
(a) Staff should be given access levels on need basis only, that too to specific menus/files that relate to
their work, and servers.
(b) File maintenance access should be restricted to limited number of staff with proper approval and
periodical review.
(c) Encryption of Password files in the system for restricting the access.
(d) Security violation alerts should be given immediate attention.
(e) Access to work stations are restricted after working hours.

(f) Access to sever/modem is to be restricted and controlled.
5. Security control: The following need to be ensured for a proper security control aspect under CBS
environment.
(a) In case of power failure or mechanical failures the system restarts with proper completion of entries
and records.
(b) Anti-virus of latest version is in place in branches/servers.
(c) Periodical release of security patches by software vendors are applied to the systems.
(d) Back-ups are properly taken and stored including that of off-site stored back-ups.
(e) Unauthorized amendments are not accepted by the system.
(f) Authenticate changes made in parameters and user levels are authorised.
(g) Ensure all modules are implemented.
(h) Exceptional transaction reports are generated and verified on a day to day basis.
(i) All GL codes authorised by controlling office/HO exist in the system.
(j) Important Passwords are kept in a sealed cover with the Manager /Branch Head so that in case of
need/absence of staff it can be used.
Responsibilities of Banks under CBS

In these days of information technology, banks are increasingly becoming vulnerable to cyber-attacks and
electronic frauds such as hacking, ransomware attacks and other malicious activities. Therefore, there is an
imperative need for banks to have proper counter threat mechanisms to thwart, arrest and minimize such
attacks. RBI has issued specific guidelines in this behalf in the year 2011 after the acceptance of the report
by G. Goplakrishna Committee. Also, in the year 2013 RBI has additionally issued guidelines on the topic.
Subsequently, in the year 2016 through its circular bearing Ref. No: DBS.CO/CSITE/BC.11/33.01.001/2015-16
dated June 2, 2016 the RBI advised banks about Cyber Security framework to be put in place.
A gist of the above is as follows:
1. All banks should have their Board of Directors approved Information Technology Policy including the
structure, environment of the concerned bank’s IT system. The policy should be updated in the light of
developments that take place from time to time.
2. Banks also should have a separate Information Security Policy through which they can identify and
implement appropriate information security management measures/practices keeping in view their
business needs. The policies need to be supported with relevant standards, guidelines and procedures.
3. Senior management should ensure the implementation of a safe IT Operation environment. Policies and
procedures defined as a part of IT Operations should support bank’s goals and objectives, as well as
statutory requirements.
4. Board and senior management have the responsibility for an effective governance mechanism and risk
management process for all outsourced operations.
5. All banks to have an effective Information System Audit that include:
a. Determining effectiveness of planning and oversight of IT activities.
b. Evaluating adequacy of operating processes and internal controls.
c. Determining adequacy of enterprise-wide compliance efforts, related to IT policies and internal
control procedures.
d. Identifying areas with deficient internal controls, recommend corrective action to address deficiencies
and follow-up, to ensure that the management effectively implements the required actions.
6. Various IT related frauds need to be included in the fraud reporting system and banks should take adequate
steps to mitigate such risks.
7. Banks should also frame policies, standards and procedures to ensure continuity, resumption and recovery
of critical business processes, at an agreed level and limit the impact of the disaster on people, processes
and infrastructure (includes IT); or to minimise the operational, financial, legal, reputational and other
material consequences arising from such a disaster. There should also be clearly spelt out plans of Disaster
recovery and business continuity.
8. There needs to be commitment from the Board of Directors/Senior Management towards the process
of consumer education initiatives by providing adequate resources, evaluating the effectiveness of the
process and fine-tuning and improving customer education measures on an ongoing process.
9. The Risk Management Committee at the Board-level needs to put in place, the processes to ensure that
legal risks arising from cyber laws are identified and addressed. It also needs to ensure that the concerned
functions are adequately staffed and that the human resources are trained to carry out the relevant tasks
in this regard.
10. Banks to have operational Risk Group and this group needs to incorporate legal risks as part of operational
risk framework and take steps to mitigate the risks involved in consultation with its legal functions within
the bank. Also, the legal department /functionaries within the bank needs to advise the business groups
on the legal issues arising out of use of Information Technology with respect to the legal risk identified and
referred to it by the Operational Risk Group.
11. To address the need for the entire bank to contribute to a cyber-safe environment, the Cyber Security Policy
should be framed by banks. It should be distinct and separate from the broader IT policy / Information
Security policy so that it can highlight risks from cyber threats and measures to address / mitigate these
risks.
12. While identifying and assessing the inherent risks, banks are required to reckon the technologies adopted,
alignment with business and regulatory requirements, connections established, delivery channels, online
/ mobile products, technology services, organisational culture, internal & external threats.
13. Depending on the level of inherent risks, banks are required to identify their riskiness as low, moderate,
high and very high or adopt any other similar categorisation.
14. Riskiness of the business component also may be factored into while assessing inherent risks.
15. While evaluating the controls, Board oversight, policies, processes, cyber risk management architecture
including experienced and qualified resources, training and culture, threat intelligence gathering
arrangements, monitoring and analysing the threat intelligence received vis-à-vis the situation in banks,
information sharing arrangements (among peer banks, with IDRBT/RBI/CERT-In), preventive, detective
and corrective cyber security controls, vendor management and incident management & response are to
be outlined.
16. Testing for vulnerabilities at reasonable intervals of time is very important. The nature of cyber-attacks is
such that they can occur at any time and in a manner that may not have been anticipated.
17. Hence, it is mandated that every bank to set up a Security Operations Centre to ensure continuous
surveillance and keep itself regularly updated on the latest nature of emerging cyber threats.
18. Banks depend on technology in providing cutting-edge digital products to their customers and in the
process collect various personal and sensitive information. They as owners of such data, should take
appropriate steps in preserving the confidentiality, integrity and availability of the same, irrespective of
whether the data is stored/in transit within themselves or with customers or with third party vendors; the
confidentiality of such custodial information should not be compromised in any situation and therefore
suitable systems and processes across the data/information lifecycle need to be put in place by banks.
19. Every bank should have a Cyber Crisis Management Plan (CCMP) and it should be a part of the overall
Board approved strategy.
20. As cyber-risk is different from many other risks, the traditional Business Continuity Plan /Disaster
Recovery arrangements may not be adequate and hence needs special attention keeping in view the
nuances of the cyber-risk.
21. In India, CERT-IN (Computer Emergency Response Team - India, a Government entity) provides proactive
and reactive services as well as guidelines, threat intelligence and assessment of preparedness of various
agencies across the sectors, including the financial sector.
22. CERT-IN also has come out with National Cyber Crisis Management Plan and Cyber Security Assessment
Framework. CERT-In/NCIIPC/RBI/IDRBT guidance may be referred to by banks while formulating the
CCMP which should address the following four aspects:
(i) Detection (iii) Recovery and
(ii) Response (iv) Containment.
23. Banks are expected to be well prepared to face emerging cyber-threats such as ‘zero-day’ attacks, remote
access threats, and targeted attacks. Also, banks should take necessary preventive and corrective measures
in addressing various types of cyber threats including, but not limited to, denial of service, distributed
denial of services (DDoS), ransom-ware / crypto ware, destructive malware, business email frauds
including spam, email phishing, spear phishing, whaling, vishing frauds, drive- by downloads, browser
gateway fraud, ghost administrator exploits, identity frauds, memory update frauds, password related
frauds, etc.
Scheme of Penalties for bank branches based on performance in rendering customer

service to the members of public
In the year 2020, the RBI issued master circular on Scheme of Penalties for bank branches including currency
chests order to ensure that all bank branches provide better customer service to members of public with regard
to exchange of notes and coins, in keeping with the objectives of Clean Note Policy.
The Competent Authority to decide the nature of irregularity will be the Officer-in-Charge of the Issue Department
of the Regional Office under whose jurisdiction the defaulting currency chest/bank branch is located. Appeal
against the decision of the Competent Authority may be made by the Controlling Office of the currency chest/
branch to the Regional Director/Chief General Manager/Officer-in-Charge of the Regional Office concerned,
within one month from the date of debit, who may decide whether the same can be accepted / rejected.
Sharing of information on cyber-security incidents with RBI

(i) RBI has observed that banks are hesitant to share cyber-incidents faced by them. However, the experience
indicates that collaboration among entities in sharing the cyber-incidents and the best practices would
facilitate timely measures in containing cyber-risks.
(ii) Banks need to report all unusual cyber-security incidents (whether they were successful or were attempts
which did not fructify) to the RBI. Banks are also encouraged to actively participate in the activities of
their Chief Information Security Officers’ Forum coordinated by Institute for Development and Research
in Banking Technology (IDRBT) and promptly report incidents to Indian Banks - Center for Analysis of
Risks and Threats (IB-CART) set up by IDRBT.
Mandatory Leave for Employees Posted in Sensitive Positions or Areas of Operation

As per notification issued by RBI in July, 2021 as a prudent operational risk management measure, the banks
shall put in place a ‘mandatory leave’ policy wherein the employees posted in sensitive positions or areas of
operation shall be compulsorily sent on leave for a few days (not less than 10 working days) in a single spell
every year, without giving any prior intimation to these employees, thereby maintaining an element of surprise.
BACK OFFICE OPERATIONS IN BANKS

In financial services institutions such as Banks, depending on functionalities, an office can be divided in to
Front office, mid office and back office. Front offices are those offices consist of client-facing staff members
on a day-to-day basis. In this case, typically, an operating branch. Mid offices consist of staff who look after
risk management, research, compliance and follow-up departments, as well as technology centres. Back offices
consist of Centralised Processing Centres such as Clearing, KYC Verification and account opening, Cheque book
issue, Demat transaction processing, Processing of Retail and other Loans such as MSME, Data processing,
Reconciliation, Treasury and forex operations, etc.
The following broadly cover specific functions of some of the back offices in a bank:
i. Deposit related: Reminder generation in respect of maturing deposits, posting of service charges, interest
calculation, obtaining confirmations etc. KYC scrutiny and centralised opening of accounts, handling of
customer complaints etc.
ii. Loans related: Loan origination management, servicing of loans, follow-up, recoveries (collections),
Calculation of interest and EMIs, posting various entries relating to various charges, interest, penal interest
etc.
iii. Compliance: Various reports generation for internal and external users, Implementation of customer
grievance decisions.
iv. Accounting: Maintenance of GL and other books of accounts, preparation of financial statements,
reconciliation of various accounts and follow-up of pending items.
v. Demat: Settling transactions.
vi. Digital banking: Handling/Trouble shooting/Resolving issues relating to internet banking, mobile banking,
ATMs, Other smart card related operations including PINs, Passwords etc.
HANDLING OF UN-RECONCILED ENTRIES IN BANKS

Banks while doing their business have to carry out reconciliation of the following:
i. Reconciliation of inter branch entries in respect of various transactions.
In every bank, daily, a lot of inter-branch transactions are done in which one leg of a transaction is done in
one branch and other leg of the transaction is done in another branch which is involved in the transaction.
Usually such transactions are done through a routing account known as Inter-branch account (Also known
as HO account in some banks.)
Let us see an example in this regard. A Demand Draft is issued by a branch in Mumbai on behalf its
customer ‘A’ in favour of another customer ‘B’ at Delhi. The Mumbai branch will issue the DD on its own
service branch at Delhi. For this transaction, Mumbai branch will debit its customer’s account for DD and
crediting the amount of DD to Inter-branch Account. At the time of payment at Delhi Service branch, (after
due verification of DD) it will debit Inter-branch account with the amount of DD and crediting the amount
of DD to ‘B’s account. From the point of reconciliation, after the payment of the said DD, there won’t be any
pending item relating to this transaction in the inter-branch account. This is how reconciliation is done
in respect of such transactions. Since there could be many transactions, reconciliation would be done at a
centralized back office.
However as per RBI’s study the major problem before computerization was noticed in reconciliation of
pending entries in intra-branch entries pertaining to Other assets/Sundry Assets and Suspense accounts.
Suspense account is a parking account for a temporary period in respect of those transactions where
particulars of transaction are incomplete or absent. After the full information is available the relevant
credit entry to this account is reversed and credited to the proper account. Similarly, when interest/
dividend etc. are paid by debit to suspense account on behalf of a company pending adjustments with the
branch where the main account of the company is held. Upon payment by the company of the total of such
amounts, the amount is credited to suspense account. The suspense account would be nullified by proper
credit from the company concerned towards such interest/dividend payments. If reconciliation is done
it will be known as to how many such items in suspense are outstanding and remedial action could be
taken to resolve them. Otherwise large number of pending entries (especially credit entries) in Suspense
account may give rise to frauds through siphoning of funds. Similarly pending debit entries also need to
be reconciled to avoid any fraudulent debits with intent to siphon-off funds. Hence reconciliation must be
done in these accounts. Similar is the case of Sundry Deposits account.
ii. Reconciliation of accounts maintained with other banks including RBI.
Every bank maintains a Current Account with RBI through which reserve maintenance, clearing
adjustments, payment adjustments such as RTGS/NEFT/ECS etc. repo/reverse repo transactions and other
adjustments are done. Banks must always keep this account properly funded to meet any contingencies.
For this purpose, banks reconcile the balances in this account against payables with the help of statement
of account obtained from RBI daily and accordingly fund this account. Due to computerization of banks
and RBI, the account statement is downloaded electronically and reconciled. Similar type of reconciliation
is done when securities are sold or bought with Subsidiary General Ledger account maintained by RBI.
Also, banks are mandated to reconcile their investment account balances with Public Debt Office of RBI
every quarter/month depending upon the volume of transactions.
In addition to the above banks in different locations (other than metros/State Capitals) maintain their
bank account with other banks for the purposes of receivable/payable in respect of clearing adjustments/
collections/cash management etc. These accounts are operated by the respective branch officials at these
locations. As a standard procedure these accounts are to be reconciled keeping in mind no items of P& L
nature, collections, clearing remain pending. Due to computerization of banks status of accounts can be
ascertained online and reconciliation is done so that proper balance is maintained in these accounts to
meet any commitment or deploy any excess funds in these accounts for revenue generation.
iii. Reconciliation of accounts with Correspondent banks in India/abroad.
When a bank conducts a foreign exchange transaction, Nostro accounts are involved. Nostro accounts
are those accounts maintained by banks from India in an overseas country in the local currency. When
transactions pertaining to credit/ receivable to India result in the credit to this account and similarly
when payments are to be made to overseas entities debits are made to this account. When banks receive
intimation of credit in their Nostro account they trace out the relevant transaction and pass on the credit to
the concerned beneficiary in India. Similarly, when payments are to be made they will pass on instructions
to the correspondent bank which maintains the account to effect payments by debiting this account. Hence
these accounts are reconciled on a day to day basis for credits and pending items and accordingly action
is taken.
iv. Reconciliation of transactions with third party service providers and sub-contractors. (For example, ATM
management services).
With proliferation of ATMs across India (It is more than 2,00,000 ATMs across India as on date) banks
employ third parties/vendors for loading cash as well as collecting cash deposited by account holders in
ATMs. To avoid any fraud in this respect banks monitor activities centrally in respect of ATMs. Monitoring
also involves reconciling of cash loading and collection transactions and balances held at ATMs.
v. Reconciliation of transactions with other intermediaries:
The rapid spread of electronic payment mechanisms through Point of Sale, Internet, e-Commerce portals,
mobile commerce portals etc. involve Merchants. Such payments made by users are done through certain
intermediary agencies such as Payment gateways, Aggregators etc. In the case of e-Commerce and Mobile
commerce transactions, these are supported by platforms provided by third party intermediaries. For
example - Paytm.
In the cycle of transactions when payments are made by users of these services, first it is credited to the
account of the intermediary. Thereafter it is forwarded to the credit of concerned merchants. Any delay
in the transmission of payments made by users to the merchants will make the users lose the confidence
in the payment system as well as bring in suspicion on traders and intermediaries. Hence banks have to
ensure that payments made by users are properly reconciled by intermediaries receiving these payments
and also ensure such payments are also passed on to Merchants.
Nomination Facility
The nomination facility is intended to facilitate expeditious settlement of claims in the accounts of deceased
depositors and to minimise hardship caused to the family members on the death of the depositors.
Provisions in the Banking Regulation Act, 1949

The Banking Regulation Act, 1949 was amended by Banking Laws (Amendment) Act, 1983 by introducing new
Sections 45ZA to 45ZF, to enable a banking company to:
a. make payment to the nominee of a deceased depositor, the amount standing to the credit of the depositor.
b. return articles left by a deceased person in its safe custody to his nominee, after making an inventory of
the articles in the manner directed by RBI.
c. release contents of a safety locker to the nominee of the hirer of such locker, in the event of the death of
the hirer, after making an inventory of the contents of the safety locker in the manner directed by RBI.
The Banking Companies (Nomination) Rules, 1985

For making nomination in a prescribed manner the Government of India in consultation with the RBI framed,
The Banking Companies (Nomination) Rules, 1985. These Rules, along with new Sections 45ZA to 45ZF of the
Banking Regulation Act, 1949 regarding nomination facilities were brought into force with effect from 1985.
Nomination Rules, 1985 were framed for providing:
i. Nomination Forms for deposit accounts, articles kept in safe custody and contents of safety lockers.
ii. Forms for cancellation and variation of the nominations.
iii. Registration of Nominations and cancellation and variation of nominations, and
iv. matters related to the above.
Forms to be used under Nomination Rules
The nomination can be made, cancelled or varied in the prescribed form as follows:
Facility Deposit Account Safe Custody Safety Locker (Sole

Hirer)
Nomination DA1 SC 1 SL 1
Cancellation DA2 SC 2 SL 2
Variation DA3 SC 3 SL 3
Nomination facilities in respect of safe deposit locker / safe custody articles

Sections 45ZC to 45ZF of the Banking Regulation Act, 1949 provide for nomination and release of contents of
safety lockers / safe custody article to the nominee and protection against notice of claims of other persons.
Banks are guided by the provisions of Sections 45 ZC to 45 ZF of the Banking Regulation Act, 1949 and the
Banking Companies (Nomination) Rules, 1985 and the relevant provisions of Indian Contract Act and Indian
Succession Act.
In the matter of returning articles left in safe custody by the deceased depositor to the nominee or allowing
the nominee/s to have access to the locker and permitting him/them to remove the contents of the locker, the
Reserve Bank of India, in pursuance of Sections 45ZC (3) and 45ZE (4) of the Banking Regulation Act, 1949 has
specified the formats for the purpose.
In order to ensure that the amount of deposits, articles left in safe custody and contents of lockers are returned
to the genuine nominee, as also to verify the proof of death, banks have devised their own claim formats and
follow the procedure, as suggested by the Indian Banks’ Association for the purpose.
Nomination Facility - Sole Proprietary Concern
Banks extend the nomination facility also in respect of deposits held in the name of a sole proprietary concern.
Nomination Facility in Single Deposit Accounts
As per Allahabad High Court direction “the Reserve Bank of India has issued guidelines to the effect that no
Savings Account or Fixed Deposit in single name be accepted unless name of the nominee is given by the
depositors. It will go a long way to serve the purpose of the innocent widows and children, who are dragged on
long drawn proceedings in the Court for claiming the amount, which lawfully belongs to them”.
Therefore, banks generally insist that the person opening a deposit account make a nomination. In case the
person opening an account declines to fill in nomination, the bank explains advantages of nomination and asks
him to give a specific letter to the effect that he does not want to make a nomination. In case the person opening
the account declines to give such a letter, the bank records the fact on the account opening form and proceed
with opening of the account if otherwise found eligible. Banks cannot refuse to open an account merely because
the person opening the account refused to nominate.
Acknowledgement of Nomination & Registering the nomination
In terms of Nomination Rules 2 (9), 3 (8) and 4 (9) applicable to Banking Companies they acknowledge in
writing to the depositor(s) / locker hirers (s) the filing of the relevant duly completed Form of nomination,
cancellation and / or variation of the nomination. Such acknowledgement is given to all the customers
irrespective of whether the same is demanded by the customers or not.
In terms of Nomination Rules 2 (10), 3 (9) and 4 (10) banks are required to register in their books the nomination,
cancellation and / or variation of the nomination. The banks should accordingly act to register nominations or
changes therein, if any, made by their depositor(s) / hirers.
Incorporation of the legend “Nomination Registered” in pass book, deposit receipt etc. and
indicating the Name of the Nominee in Pass Books / Fixed Deposit Receipts
When an account holder has opted for the nomination facility, it has to be indicated on the passbook so that, in
case of death of the account holder, his relatives can take suitable action with the bank. This practice holds good
for term deposit receipts too. Also, if a customer agrees, banks can indicate the name of the Nominee in the Pass
Books / Statement of Accounts / FDRs.
Separate nomination for savings bank account and pension account
As Banking Companies (Nomination) Rules, 1985 are distinct from the Arrears of Pension (Nomination) Rules,
1983 a separate nomination is necessary in terms of the Banking Companies (Nomination) Rules, 1985 in case
a pensioner desires to avail of nomination facility.
Nomination facility in respect of deposits
i. Nomination facility can be availed by individuals including a sole proprietary concern.
ii. Nomination can be made only in favour of individuals. As such, a nominee cannot be an association,
trust, society or any other organisation or any office-bearer thereof in his official capacity. Due to this any
nomination other than in favour of an individual will not be valid.
iii. There cannot be more than one nominee in respect of a joint deposit account at any time.
iv. Banks allow variation/cancellation of an existing nomination by all the surviving depositor(s) acting
together. This is also applicable to deposits having operating instructions “either or survivor”.
v. In the case of a joint deposit account the nominee’s right arises only after the death of all the depositors.
vi. Witness in Nomination Forms: Under Nomination Rules, in various Forms prescribed, only the thumb-
impression(s) of illiterate customers are to be attested by two witnesses. Signatures of the account holders
need not be attested by witnesses.
vii. Nomination in case of Joint Deposit Accounts: Nomination facility is available for joint deposit accounts
also. Banks are, to ensure that their branches offer nomination facility to all deposit accounts including
joint accounts opened by the customers.
Nomination in Safe Deposit Lockers / Safe Custody Articles
(i) Nomination facilities are available only in the case of individual depositors and not in respect of persons
jointly depositing articles for safe custody.
(ii) In terms of Section 45ZE of the Banking Regulation Act, 1949 a minor can be a nominee for obtaining
delivery of the contents of a locker. However, banks must ensure that when the contents of a locker were
sought to be removed on behalf of the minor nominee, articles are handed over to a person who, in law
(i.e., a guardian), is competent to receive the articles on behalf of the minor.
(iii) In respect of lockers hired jointly, on the death of any one of the joint hirers, the contents of the locker
are only allowed to be removed jointly by the nominees and the survivor(s) after an inventory was taken
in the prescribed manner. In such a case, after such removal preceded by an inventory, the nominee and
surviving hirer(s) may keep the entire contents with the same bank, if they so desire, by entering into a
fresh contract of hiring a locker.
Settlement of claims in respect of deceased depositors - Simplification of Accounts with
survivor/nominee clause
If a depositor/s had made a valid nomination or where the account was opened with the survivorship clause
(“either or survivor”, or “anyone or survivor”, or “former or survivor” or “latter or survivor”), the payment of the
balance in the deposit account to the survivor(s)/nominee of a deceased deposit account holder represents a
valid discharge of the bank’s liability provided:
a. the bank has established with proper care and diligence, the identity of the survivor(s) / nominee and the
fact of death of the account holder, through applicable documentary evidence;
b. there is no injunction or restraining order from any competent court on the bank from making the payment
from the account of the deceased; and
c. it has been made clear to the survivor(s) / nominee that he would be receiving the payment from the bank
as a trustee of the legal heirs of the deceased depositor, i.e., such payment to him shall not affect the right
or claim which any person may have against the survivor(s) / nominee to whom the payment is made;
d. If payment is made to the survivor(s) / nominee, based on the foregoing conditions, it would be deemed
as a full discharge of the bank’s liability;
e. Any further demand on production of legal representation is superfluous and will be viewed as
inconvenience to the survivor(s) / nominee. This would be viewed seriously by RBI. Therefore, banks
should not demand production of succession certificate, letter of administration or probate, etc., or obtain
any bond of indemnity or surety from the survivor(s)/nominee, irrespective of the amount standing to the
credit of the deceased account holder.
Accounts without the survivor / nominee clause

If a deceased depositor had not made any nomination or for the accounts other than those styled as “either
or survivor” (such as single or jointly operated accounts), banks are required to adopt a simplified procedure
for repayment to legal heir(s) of the depositor and within their risk management framework fix a minimum
threshold limit, for the balance in the account of the deceased depositors, up to which claims in respect of the
deceased depositors could be settled without insisting on production of any other documentation except a
letter of indemnity.
Premature Termination of term deposit accounts
In the case of term deposits, banks are required to include a clause in the account opening form itself to the
effect that in the event of the death of the depositor, premature termination of term deposits would be allowed.
Terms and conditions in such cases should also be specified in the account opening form. No penalty will be
applicable on such premature withdrawals.
Treatment of flows in the name of the deceased depositor
If banks receive credits in the name of the deceased depositors after their death, banks should adopt any one of
the following methods to avoid hardship to the survivor(s) / nominee of a deposit account:
i. The bank can obtain an authorization from the survivor(s) / nominee of a deceased account holder to
open an account styled as ‘Estate of Shri/Smt. ______________, the Deceased’ where all the pipeline flows in
the name of the deceased account holder could be allowed to be credited. However, no withdrawals will
be permitted till final settlement.
OR
ii. The bank can obtain an authorization to return the pipeline flows to the remitter with the remark “Account
holder deceased”. The survivor(s) / nominee / legal heir(s) could then approach the remitter to settle such
payments in the name of the appropriate beneficiary.
Interest payable on the deposit account of deceased depositor
In the case of a term deposit standing in the name/s of
i. a deceased individual depositor, or
ii. two or more joint depositors, where one of the depositors has died, for payment of interest on matured
deposits in such cases should be based on the Board of Directors approved policy of the respective banks
which should be disclosed to depositors.
In case of a deceased individual depositor/sole proprietorship concern, interest should be paid only from
1st May 1983, or from the date of death of the depositor, whichever is later, till the date of repayment to the
claimant/s at the rate of interest applicable to savings deposit as on the date of payment.
Time limit for settlement of claims
Banks should settle the claims in favour of survivors/nominees in respect of deceased depositors and release
payments within a period not exceeding 15 days from the date of receipt of the claim. This is however subject
to the production of proof of death of the depositor and suitable identification of the claimants to the bank’s
satisfaction.
At periodical intervals banks should report to the Customer Service.
Committee of the Board of Directors, the details of the number of claims received pertaining to deceased
depositors / locker-hirers / depositors of safe custody article accounts and those pending beyond the stipulated
period, giving reasons thereof.
Claim Forms to be made available

For facilitating timely settlement of claims on the death of a depositor/s, banks are to provide claim forms for
settlement of claims. Formats of claim forms are to be put on the bank’s website.
Access to the safe deposit lockers / Return of safe custody articles to Survivor(s) /
Nominee(s)/ Legal heir(s)
The generality of nomination rules which are applicable to deposit accounts also apply to safe deposit lockers/
safe custody articles.
However, the following specific guidelines in this regard are applicable.
Access to the safe deposit lockers / return of safe custody articles (with survivor/nominee clause)
On the death of a sole locker hirer, the nominee should be given access of the locker and liberty to remove the
contents.
If a locker was hired jointly with the instructions to operate it under joint signatures, and the locker
hirer(s) have nominated a nominee, upon the death of any of the locker hirers, the bank should give access of
the locker and the liberty to remove the contents jointly to the survivor(s) and the nominee(s).
If a locker was hired jointly with survivorship clause and the hirers instructed that the access of the locker
should be given over to “either or survivor”, “anyone or survivor” or “former or survivor” or according to any
other survivorship clause, banks should follow the mandate in the event of the death of one or more of the
locker- hirers.
Precautions to be taken before handing over the contents of locker:
(a) Banks to take proper care and caution in identifying the survivor(s) / nominee(s) and should have proper
documentary evidence in respect of the death of the locker hirer.
(b) Banks should ensure that there are no order/s from a competent court restraining the bank from giving
access to the locker of the deceased; and
(c) Banks should make the survivor(s) / nominee(s) understand that access to locker / safe custody articles
is given to them only as a trustee of the legal heirs of the deceased locker hirer, i.e., such access given to
him shall not affect the right or claim which any person may have against the survivor(s) / nominee(s) to
whom the access is given.
Banks are required to follow a similar procedure in respect of return of articles placed in the safe custody of
the bank. Banks should be aware that the facility of nomination is not available in case of deposit of safe
custody articles by two or more persons.
Access to the safe deposit lockers / return of safe custody articles (without survivor/nominee clause)
In case where the deceased locker hirer had not made any nomination or where the joint hirers had not given
any mandate regarding the access to one or more of the survivors by a clear survivorship clause, banks are
required to adopt procedure drawn up in consultation with their legal department/advisers for giving access
to legal heir(s) / legal representative of the deceased locker hirer. Similar procedure should be followed for the
articles under safe custody of the bank.
Preparing Inventory
Banks should prepare an inventory before returning articles left in safe custody / before permitting removal of
the contents of a safe deposit locker as per RBI’s Notification DBOD.NO.Leg.BC.38/ C.233A-85 dated March 29,
1985. Banks are not required to open sealed/closed packets left with them for safe custody or found in locker
while releasing them to the nominee(s) and surviving locker hirers / depositor of safe custody article.
Further, if the nominee(s) / survivor(s) / legal heir(s) wish to continue with the locker, banks may enter
into a fresh contract with nominee(s) / survivor(s) / legal heir(s) and adhere to KYC norms in respect of the
nominee(s)/ legal heir(s).
LESSON ROUND UP
• Banks open different types of deposit accounts such as demand deposits which include savings bank
deposits, current accounts, notice deposits and term deposits that include fixed deposits, recurring
deposits etc. for their customers under the broad guidelines provided by RBI. Customers for whom banks
open accounts include individual, joint individuals, minors, sole proprietary concerns, partnership
firms, LLPs, Companies, trusts, clubs and associations, cooperative societies, special customers like
illiterate persons, blind, executors and administrators, liquidators etc.
• Banks also are statutorily required to comply with TDS norms of Income-Tax Department while
paying interest, except in cases where customers submit specific exemption forms. They also follow
operational rules regarding paying interest on premature closure of term deposit accounts; pay interest
on deposits if they mature on a holiday; auto renew deposits in the absence of disposal instructions,
provide insurance cover for deposits under DICGC.
• Banks deal with different types of borrowers. They follow relevant documentation procedures at pre-
sanction and post-sanction stages. They scrutinize, process and sanction loans/advances as per set
procedures.
• Banks have adopted core banking solution (CBS) environment in operational banking to improve
customer service as a part of computerization of banking operations. CBS has been adopted by banks
to bring in efficiency and improve productivity and profitability in banking operations. Essential
requirement for CBS include central data centre, disaster recovery sites, business process re-
engineering, software, networking and trained personnel. In view of the risks involved in CBS, banks
have various controls such as password controls, transaction controls, personnel control, logical access
control, security control. Banks shoulder specific responsibilities in terms of RBI’s directives on CBS.
They are also responsible for reporting any cyber frauds that are attempted or took place in their banks.
Banks also have established back offices for deposit related, loan related, compliance, accounting,
Demat and digital banking functions for increasing efficiency and better customer service. Banks carry
out voluminous transactions across inter-branch, inter-bank, correspondent banks, third party service
providers and intermediaries which necessitates reconciling their transactions to eliminate/ minimize
risk of frauds, settle and square-up transactions, and improve confidence among parties involved in the
transactions.
GLOSSARY
OVD-Officially Valid OVDs that can be accepted for establishing the legal name and current address
Documents of Individuals. E.g. Copy of Aadhaar/Voter ID Card, Passport, the validity of
which has not expired (Also for NRI/PIO/OCI/Foreign National), NREGA Job
Card etc.
Central KYC Records The Central Know Your Customer Registry (CKYC) is a centralised depository
Registry (CKYCR) of KYC documents of customers availing various services of the financial sector.
Central Registry of CERSAI has been established as a company under section 8 of the Companies
Securitisation Asset Act, 2013 by the Government of India. CERSAI was formed to identify and
Reconstruction and check fraudulent activity in lending transactions against equitable mortgages.
Security Interest of
India (CERSAI)
Financial Intelligence Financial Intelligence Unit - India (FIU-IND) was set by the Government
Unit (FIU) of India in 2004 as the central national agency responsible for receiving,
processing, analyzing and disseminating information relating to suspect
financial transactions.
Foreign Account Tax The Foreign Account Tax Compliance Act (FATCA) is a tax law that compels
Compliance Act (USA) U.S. citizens at home and abroad to file annual reports on any foreign account
(FATCA) holdings.
LESSON ROUND UP
a. Banks being commercial organizations follow _____________ system of accounting.
b. Non-cash mode of transactions consists of _____________ and _____________.
c. Withdrawal forms at the counter issued to Savings Bank customers is a form of
_____________ voucher.
d. Applications for NEFT/RTGS/Pay orders/Gift cheques/Travelers cheques etc. are examples of
_____________ vouchers.
e. Clearing inward term represents cheques received by a bank for _____________ its customers’
accounts with it.
f. KYC forms part of _____________ measures taken by the Government of India and RBI.
g. Letter issued by the National Population Register containing details of name and address is one of
the _____________.
h. Monitoring should _____________ of customer.
i. Periodic updation of KYC data shall be carried out at least once in _____________ for high risk
customers.
j. Saving Bank account or a Current account will be treated as an inoperative/dormant account if
there are no customer induced transactions for a period of _____________.
k. Recurring Deposit is also a form of _____________.
l. Guardian appointed by Will is known as _____________ guardian.
m. LLP can be incorporated for only _____________ purposes.
n. _____________ are appointed by a Court to dispose off properties and assets of institutions.
o. In case an individual customer who does not possess any of the OVDs and desires to open a bank
account, a bank can open _____________ account.
p. FATCA stands for _____________.
q. For variation in nomination in case of deposit account _____________ for needs to be obtained.
2. State whether True or False:
a. When a deposit account of a minor is opened, the proof of birth should be verified with guardian’s
filled up particulars in the account opening forms.
b. Exemption from deduction of tax is applicable for Shareholders (members) and Nominal Members
of Co-operative banks.
c. Many banks have introduced auto renewal of deposits to overcome the problem of late renewal of
deposits and its attendant problems.
d. In case of joint accounts and Partnership firms any one of the joint account holders/partners can
give the “Stop payment of Cheque” instruction.
e. In respect of a reinvestment term deposit maturing on a Sunday or Holiday, interest is payable on
the maturity value in respect of such holidays.
f. Deposits held by customers such as savings, fixed, current, recurring, etc. are insured up to Rs.
10,00,000 per depositor.
g. A proper scrutiny of loan application will lead to proper evaluation of the proposal in terms of
various directions of RBI.
h. The drawl in the cash credit account will be limited to the limit sanctioned or drawal fixed based
on securities whichever is lower
i. Central Data Centre, Disaster recovery sites, Business process re-engineering, Software,
Networking and trained personnel form part of essential frame work for CBS.
j. Mid offices consist of Centralised Processing Centres such as Clearing, KYC Verification and account
opening, Cheque book issue, Demat transaction processing, Processing of Retail and other Loans
such as MSME, Data processing, Reconciliation, Treasury and forex operations.
k. If a minor is appointed as a nominee he needs to be represented by a guardian.
l. Account opened by a PEP requires enhanced due diligence.
m. Under Transaction control, date must be authorised only by DBA.
n. Recurring deposit is a form of Term Deposits.
o. Banks should settle the claims in favour of survivors/nominees in respect of deceased depositors
within a month.
p. Inter-bank deposits are covered under DICGC deposit insurance.
q. A guardian can be natural guardian or a legal guardian or a testamentary guardian.
a. Discuss briefly the salient features of Savings bank accounts.
b. Discuss operational aspects of Partnership accounts.
c. Write a note on Scrutiny of loan applications.
d. How the drawls in a Cash credit account are fixed? Illustrate with an example.
e. What are the essential requirements of CBS?
f. What are the operational controls under CBS? Discuss each of these controls.
g. Write a note on reconciliation functions in a bank.
h. What are the precautions that a bank needs to exercise in case the holder of a Savings Bank
Account is a - (i) Pardanashin; (ii) Minor; (iii) Blind man; (iv) Illiterate.

• Banking Law and Practice - P.N. Varshney
• Practice and Law of Banking - M.L. Tannan
• Master Circulars/Directions of RBI
• Recommendations of various committees of RBI on Information Technology/ Cyber Security
• Circulars of Indian Banks Association
• Credit Appraisal - Dr. T.C.G, Namboodiri
Lesson 6 • IT in Banking 181
Lesson 6 IT in Banking

Should Know
• NEFT Since the early nineties, every bank • Reserve Bank of India Act,
• RTGS in India has adopted Information 1934.
Technology based banking. This • Banking Regulation Act, 1949.
• UPI lesson will enable a reader to
• PoS understand: • Information Technology Act,
2000.
• the importance of Information
technology in Banking and • Negotiable Instruments Act,
risks associated with as well 1881
controlling the same. • Payment And Settlement
• the Components and Systems Act, 2007
Architecture of CBS, Process
flow, Risks and controls.
• the concept and importance
of MIS.
• how to gain an overview about
Data Analytics and Business
Intelligence.
Lesson Outline
• Introduction
• Overview of Banking Services and IT related Risk and controls
• Components and Architecture of CBS
• Core Business Processes Flow and Relevant Risks and controls
• Reporting System and MIS
• Data Analytics and Business Intelligence
• LESSON ROUND UP
• TEST YOURSELF
181
INTRODUCTION
Information technology has played a revolutionary role in the working of banks since 1990s in India. Multiple
product and services offered by banks based on information technology have resulted into faster, accurate and
efficient payment systems in banking industry. However, changes in banking processes happen on an ongoing
basis due to changes in Information Technology for the benefit of customers as well as for the banks. Therefore
for a student of banking there is an imperative need to know about Information Technology based services
offered by banks. However, in any business there are risks. So with banking as well as with services provided by
banks using Information Technology. A student of banking also needs to be aware of such risks as well as how
to manage the same so that banking business can be safe.
Therefore the contents of this lesson cover relevant topic and are of Level 1 orientation so that students become
familiar with IT based banking and recent emerging trends in digital banking and fintech.
Technology plays a vital role by ushering in a fundamental shift in the functioning of banks, when compared to
manual system of operations earlier. It helps banks in bring improvements not only in their internal functioning
but also enable them to provide better customer service. Technology has broken all boundaries in bringing
seamless banking and encouraged speedier cross border banking business.
In India, till 1980 there was a slow progress in electronic automation of banks due to lack of Information
Technology (IT) development in India as well as resistance from trade unions in the banking industry for
its implementation. However, in the aftermath of a report by Dr. Rangarajan Committee in 1983, initiatives
were taken to introduce in Information Technology based banking in a phased manner to address several key
problems such as customer service, housekeeping, productivity and decision making that were plaguing the
banking industry. However, from early 1990s the pace was accelerated in banks due to implementation of
computerization resulting in total branch automation and core banking in banks, which continues till today.
In providing IT based banking, banks would have to undertake extensive Business Process Re-engineering
(BPR) and tackle issues like:
a. How best to deliver innovative products and services to customers?
b. Designing an appropriate organizational model to fully capture the benefits of technology and business
process changes brought about.
c. How to exploit technology for deriving economies of scale?
d. How to create cost efficiencies?
e. How to create a customer- centric operational model?
To understand the role of technology in banking services, first we have to analyze services that the banking
sector offers and understand the customer`s requirements.
The Indian Banking industry, which is governed by the Banking Regulation Act, 1949 and Reserve Bank of India
Act, 1934 can be broadly classified into two major categories as non-scheduled banks and scheduled banks.
Scheduled banks comprise commercial banks and the co-operative banks. In terms of ownership, commercial
banks can be further grouped into nationalized banks, the State Bank of India and it’s associate banks (since
merged), Regional Rural banks and Private Sector banks including foreign banks operating in India.
IT Considerations
Since the early nineties, each Indian bank has taken initiatives in IT improvement and implementation. The
first and foremost compulsion is the fierce competition. While deciding on the required architecture for the IT
consideration is given to following realities.
(1) Meeting Internal Requirement: The requirements of the banks are different individually depending
upon their nature and volume of business; focus on a particular segment, spread of branches and a like.
Many a time’s banks do have the required information but it is scattered. The operating units seldom
know the purpose of gathering the information by their higher authorities.
(2) Effective in Data Handling: As stated earlier the banks have most of the required data but are distributed.
Further the cost of collection of data and putting the same to use is prohibitively high. The accuracy
and timeliness of data generation becomes the causalities in the process. Best of the intentions on
computerization are wished away because there is non-visible reduction in cost /efforts/ time required
for the required data gathering.
(3) Extending Customer Services: Addressing to rising customers’ expectations is significant particularly
in the background of increased competition. In case bank A is unable to provide the required service at a
competitive price and in an accurate manner with speed. There is always a bank IT at its next-door waiting
to hire the customer. Awareness of customers about the availability of services and their pricing as also
available options have brought into sharp focus the issue of customer satisfaction.
(4) Creative Support for New Product Development: It has become necessary for the banks to vitalize the
process of product development. Marketing functionaries needs a lot of information not only from the
outside sources but also from within the banks. Banks are looking to retail segment as the future market
places for sales efforts. Having full-fledged information of existing customer is the key for this purpose.
The emergences of data requirement and an appropriate architecture to support the same are significant
issues to be handled in this regard.
(5) End-user Development of the Non-Technical Staff: Banking being a service industry, it is the staffs
at counters that deliver the products. In Indian scenario, virtual banking is likely to have a few more
years to establish. The dependence on counter staff is unavoidable. The staffs are large in number and the
majority is non-technical. The customer satisfaction levels at the counter determine the ultimate benefit
of IT offensive. Giving due consideration to this aspect in choosing architecture in necessary.
Trends in Information Technology

Certain trends have been visualized of information technology in banking sector all over the world.
(1) Outsourcing: Outsourcing is one of the most talked about
Outsourcing is the business practice
as also a controversial issue. The drivers for getting in to
of hiring a party outside a company to
outsourcing are many to include gaps in IT expectations perform services and create goods that
and the reality, demystification of computerization in traditionally were performed in-house by
general and IT in particulars, trend towards focusing on the company’s own employees and staff.
core competencies, increased legitimacy of outsourcing
and intention of getting out of worries and sort of up gradation of hardware and software versions. Not
that the practice is new as earlier it was refused to as ‘buying time’ or ‘service bureau’. What is needed is
the clear of outsourcing, beside a definite plan to be more competitive after outsourcing. It is necessary
to have checks and balances to monitor vendor performance. Cost aspects merit consideration, as also a
decision on the part of the process to be outsourced shall be significance. Exit route and resource on the
amount of failure after outsourcing are the other issue to be looked onto. Notwithstanding these risks,
outsourcing has come to say.
(2) Integration: One of the IT trend is moving from hierarchy to team approach. The purpose is to see an
alternative to retooling, to react speedily and to develop capabilities rather than exploiting them. Such
integration is necessary so as to address to prevalent situations:
(a) Functions needing data and not getting from others.
(b) Sending data to those who do not want to require them.
(c) Global data exist but do not travel to required business functions.
Indian banks seem to follow this trend through the sincere redesign as described earlier. Instead of
vertically divided pyramid type organizational set-ups, banks are now being to have separate group like
finance, international consumer banking, industrial/commercial credit etc.
(3) From Solo to Partnership: With the development of IT, two things are taking place simultaneously. The
work force as a percentage of total staff is going down and spending on IT as percentage of total spending
is going up. The forms of partnership can include binding by superior service, accommodation in service
sharing network, equal partnership and situations, where survival is threatened. At times, the partnership
becomes necessary to get out of areas where there is no competitive advantage. Low development cost
or wider geographical coverage is the aspects that create such partnership. Instances are not frequent,
where joint ventures have been found with the IT vendors. E Collaborations between the banks and fintech
companies are increasing to provide the best of electronic banking services.
(4) Distinctive Edge: It is always said that many use but a few make use of IT. Historically, the emphasis is
on using IT for large volumes like payrolls, balancing the books, the consolidation etc. That realization on
having IT as matter of competitive edge has come about very lately. It is recognized that customer service
is not an easy thing to provide, but IT is used as a mean. It does give value additions and erases barriers
for competitors to enter. Banks understand that the cost of cultivating the new customer is 5 to 6 times of
retaining the old one. Customer normally switches banks due to poor service. The appreciation of these
facts has compelled the banks world over to look upon IT as an instrument to create distinctive edge over
competitors. The private sector banks that were established in 1990’s as a part of finance sector reforms
did make good of IT to have an edge over the others. The foreign banks operating in India have also been
able to market IT superiority as a distinctive edge. The public sector banks are still to make use of IT in
this regard, although they are blessed with huge information base all across the country. While steps are
mooted in this direction by leading public sector banks, more offensive postures are necessary.
(5) IT as Profit Centre: In the embryonic phases, IT was looked upon a means to get rid of high processing
cost and time and to convert the manual operation with high volume/low complexity in two mechanical
ones. With the evolutionary the process, it was seen as the best means of generating, MIS. The same
approach gave the status of DSS to IT. All along, IT has been recognized as the service function in Indian
Banks. However, the new trend that is emerging is considering IT as a profit centre. The cost benefit
analysis of having IT or otherwise in one part. But having IT set up to generate income for the organization
is the new beginning. Getting jobs from outside the bank for processing data and the like are the current
trends. The outsourcing done by others is the business,
A profit center is a business unit or
cater to by these organizations the trend of this kind is not
department within an organization that
deserved in Indian situation particularly banks. The Banks
generates revenues and profits or losses.
have been able to just manage what is to consider as their
responsibility as IT, within the individual banks.
(6) Prospering in Down Market: The trend suggests that when there is a down turn in the market place, Pro-
active corporations take the benefit of available unutilized resources to upgrade and revisit technology
issues. This is seen as the right time to establish the R & D centre for IT. There are false notions about
technology and its capability. Some misconceptions include:
a) Best-fit possible technology is implemented.
b) System solution is good enough and there is need to look into user expectations.
c) Innovations are generally successful.
d) Success is related only to novel ideas.
e) Technology is the sole determinant of business success.
f) Measures and standards i.e. audit and inspection issues stand in the way of innovation.
The time available to debate on similar issues is ample and these false notions get clarified during the down
market. Eventually, the decision makers reach a consensus that IT is not a panacea but it is an enabler that
too when well supported by BRP (Business Process Reengineering), human resources initiatives, physical
infrastructure and responsive organization set up.
(7) Leading to Downsizing: The IT initiative is making the organization lean and flat. For IT functionaries
downsizing means transferring computing power from mainframe to the personal computer and
workstations. Downsizing is a typical issue faced with associated problems. Absence of top management
commitment, lack of understanding of the prevalent IT infrastructure, doing too much and too fast and
undertaking the exercise without a framework for controlling the downsizing operations are primarily the
situations that create adversities in downsizing. In any case the trend of downsizing is very much existent
in the IT environment.
(8) Getting Competitive Intelligence: IT is now seen as a resource for gathering and dissemination of
Executive Information System (EIS). The purpose is to minimize that the bombarding and focusing on the
relevance, accuracy and timeliness of the information particularly about the competitors such information
enhances follow up and tracks early warning on competitor move and also customer expectations.
OVERVIEW OF BANKING SERVICES AND IT RELATED RISKS AND CONTROLS

Services Offered by Banks
The services offered by banks can be broadly classified into four categories:
1. Payment services: The Payment service is vital aspect
of the entire money flow of the economy. Earlier cheques,
demand drafts, mail transfers, telegraphic transfers etc. used
to be the main modes in the payment system, which have now
been replaced with direct online money transfer with the
evolution of technology.
2. Financial intermediary: This is one of the oldest
functions of banks which enables the banks to accept
the funds from depositors and then lend this money to
deserving borrowers after completion and compliance
of certain norms. This is the main core business of the
banking system and will continue as long as the banking
system exists.
3. Financial Services: Financial services include new services which were launched by different financial
institutions with time. These services include investment banking, foreign exchange business, line of credit
services, wealth management and broking services. These services generate income for the commercial
bank in the form of fee based income and commissions etc., which is also termed as non- fund income for
banks.
4. Ancillary Services: Other services that the banks offer to the common man along with the essential
banking services. These ancillary services form a very minuscule of the services offered by the banks.
Typical ancillary services include safe deposits lockers for valuables; collections, Demat accounts, On line
Trading, selling gold/bullion, cheque pick up facility, door step banking, cash management etc.
With years, banks also introduce new services to their customers. The Indian banking industry is passing
through technology transition phase. Customers have more and better choices in choosing their banks, as all
the banks are using the technology as a tool and trying to improve their customer acquisition. A competition
has sprung up within the banks operating in India. With stiff competition and advancement of technology, the
services provided by banks have become more easy and convenient.
In a technically advanced environment, a bank’s operations are highly dependent on the integrity of its
technology systems. Its success depends to a great extent, on its ability to use increasingly rich databases and
make timely decisions connected to banking industry changes. The performance of a financial organization
performance is negatively impacted if it experiences system interruptions, errors, or even if it falls behind its
competitors concerning the information technology, which it uses, and the way it is using it. So, every bank has
to be committed to an ongoing process of upgrading, enhancing and testing its technology, so it can effectively
meet sophisticated client requirements, market and regulatory changes and internal needs for information
management.
Information technology risk includes the failure to respond to these requirements, as well as many other issues
such as: human error, internal fraud through software manipulation, external fraud by intruders, obsolesce in
applications and machines, reliability issues, mismanagement, and of course the effect of natural disasters. This
risk is definitely manageable, but it takes a significant amount of skill to do it, and maybe the most important
thing is that a strong team is needed, constituted both of economic, banking and engineering experts.
Various IT Driven Products in Banking Industry
Real Time Gross Settlement (RTGS)

Introduced in 2004, Real-Time Gross Settlement (RTGS) systems are specialist high speed funds transfer
systems where the transfer of money takes place from one bank to another for settlement of transactions.
“Gross settlement” means the transaction is settled on one-to-one basis through RBI.
RTGS systems are typically used for high-value transactions that require and
“Settlement” means that
receive immediate money transfers. RBI works as an intermediary between
once processed, payments
banks working on specified hourly batch basis. Increasing adoption and
are final and irrevocable.
usage trends of RTGS by corporates and individuals were observed in higher
volumes and values.
24x7 Availability of Real Time Gross Settlement (RTGS) System – The Reserve Bank of India (RBI) on
December 04, 2020 had announced making available the Real Time Gross Settlement (RTGS) system round
the clock on all days. Accordingly, it has been decided to make RTGS available round the clock on all days of
the year with effect from 00:30 hours on December 14, 2020.
Note: For detail please refer lesson 4.

National Electronic Funds Transfer (NEFT)

National Electronic Funds Transfer (NEFT) is an electronic fund transfer system maintained by the Reserve
Bank of India (RBI), started in November 2005. NEFT is a facility which enables bank customers in India to
transfer funds between any two NEFT-enabled bank accounts on one-to-one basis. It is done via electronic
messages. Unlike RTGS, fund transfers through the NEFT system do not occur in real-time basis. NEFT has been
made 24 hour facility with 48 half hourly settlements from December 16, 2019.
Considering the progress made by Payment Banks (PBs) in furthering financial inclusion and with the objective
of giving more flexibility to the PBs, RBI has enhanced the limit of maximum balance at the end of the day from
Rs.1 lakh to Rs.2 lakh per individual customer of PBs w.e.f. April 08, 2021.
Note: For details please refer Lesson 4.
Credit Card
A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for
goods and services based on the cardholder’s promise to the card issuer to pay them for the amounts so paid
plus the other agreed charges. The card issuer (usually a bank) creates a revolving account and grants a line of
credit to the cardholder, from which the cardholder can borrow money for payment to a merchant or as a cash
advance. In other words, credit cards combine payment services with extensions of credit.
Debit Card
A debit card (also known as a bank card, plastic card or check card) is a plastic payment card that can be used
instead of cash when making purchases or any online payments, It is similar to a credit card, but unlike a credit
card, the money comes directly from the user’s bank account when performing a transaction.
Due to COVID-19 pandemic the RBI vide its notification dated December 04, 2020 enhanced the limit for
contact less transaction from to Rs.2,000/- to Rs.5,000/- per transaction for card transactions.
Unified Payments Interface (UPI)

Unified Payments Interface (UPI) is an instant real-time payment system developed by National Payments
Corporation of India (NPCI) facilitating inter-bank transactions. The interface is regulated by the Reserve Bank
of India and works by instantly transferring funds between two bank accounts on a mobile platform. In this,
instead of using beneficiary’s IFSC code and account number, it uses the virtual ID.
Immediate Payment Service (IMPS)

Immediate Payment Service (IMPS) is an instant real-time inter-bank electronic funds transfer system in India.
IMPS offers an inter-bank electronic fund transfer service through mobile phones. Unlike NEFT and RTGS, the
service is available 24/7 throughout the year including bank holidays. It is managed by the National Payments
Corporation of India (NPCI) and is built upon the existing National Financial Switch network.
Mobile Banking
Mobile banking is a service provided by a bank or other financial institution that allows its customers to conduct
financial transactions remotely using a mobile device such as a smart phone or tablet. Unlike internet banking,
it uses software usually called an Application (commonly known as ‘App’), provided by the financial institution
for the purpose. Mobile banking is usually available on a 24-hour basis.
Internet Banking
It is an electronic payment system that enables customers of a bank or other financial institution to conduct
a range of financial transactions through the financial institution’s website. The online banking system will
typically connect to or be part of the core banking

system operated by a bank and is in contrast to
branch banking which was the traditional way
customers accessed banking services. Today, “virtual
banks” (or “direct banks”) have only an internet
presence, which enables them to lower costs than
traditional brick-and-mortar banks.
Pre-paid Payment Instruments/System

Pre-paid instruments are payment instruments that facilitate purchase of goods and services against the value
stored on these instruments. The pre-paid payment instruments can be issued in the form of smart cards,
magnetic stripe cards, internet accounts, internet wallets, mobile accounts, mobile wallets and paper vouchers
etc.
Point of Sale (PoS) Terminals / Online Transactions

There are more than 10 lacs PoS terminals in the country, which enable customers to make payments for
purchases of goods and services by means of credit/debit cards. To facilitate customer convenience banks have
also permitted cash withdrawal using debit cards issued by the banks at PoS terminals.
Automatic Teller Machine (ATM)

Automatic Teller Machine is the most popular device in India, which enables customers to withdraw their money
24 hours a day, 7 days a week. It is a device that allows customers who have an ATM card to perform routine
banking transactions without interacting with a human teller. In addition to cash withdrawal, Automatic Teller
Machines (ATMs) can be used for payment of utility bills, funds transfer between accounts, deposit of cheques
and cash into accounts, balance enquiry, statement of account generation etc.
Cyber Security controls for Third party ATM Switch Application Service Providers
RBI has vide it’s Circular No: RBI/2019-20/130 DoS.CO/CSITE/BC.4084/31.01.015/2019-20 dated December
31, 2019 has advised all Scheduled Commercial Banks (excluding Regional Rural Banks), Small Finance Banks
and Payments Banks, Primary (Urban) Co-operative Banks, Local Area Banks and White-Label ATM Operators to
implement Cyber Security controls for Third party ATM Switch Application Service Providers. All RBI Regulated
Entities (RREs) manage their ATM Switches through shared services of third party ATM Switch Application
Service Providers (ASPs). Since these service providers also have exposure to the payment system network, it
is felt that some cyber security controls are required to be put in place by them. In view of this, the RREs it is
advised that the contract agreement signed between them and the third party ATM Switch ASP shall necessarily
mandate the third party ATM Switch ASP to comply with the detailed cyber security controls given in the
Annexure to the circular on an ongoing basis and to provide access to the RBI for on-site/off-site supervision.
The list of prescribed controls is indicative but and that these controls are applicable to the ASPs limited to the
IT ecosystem (such as physical infrastructure, hardware, software, reconciliation system, network interfaces,
security solutions, hardware security module, middleware, associated people, processes, systems, data,
information, etc.) providing ATM switch services as well as any other type of payment system related services
to the RREs.
The annexure to the circular covers:
1. Preventing access of unauthorised software
2. Environmental Controls
3. Network Management and Security

4. Secure Configuration
5. Application Security Life Cycle (ASLC)
6. Patch/Vulnerability and Change Management
7. User Access Control / Management
8. Data Leak prevention strategy
9. Audit Logs
10. Incident Response and Management
11. Advanced Real-time Threat Defence and Management
12. Vulnerability assessment and Penetration Test
13. Forensics
14. Arrangement for continuous surveillance - Setting up of Cyber Security Operation Center (C-SOC)
15. Compliance with various standards.
E-cheques
E-cheques (Electronic Cheques) are form of electronic tokens designed to make payments through the internet
and performs the same functions as a conventional paper cheque.
As the cheque is in an electronic form, it can be processed in fewer steps and has more security checks than a
standard paper cheque, like authentication, public key cryptography, digital signature, encryption, etc.
With the amendments in Negotiable Instruments Act, 1881, an e-cheque has become legalized since 2002. E-
Cheques make the transfer process faster, due to the use of conventional encryption.
Society for Worldwide Inter-bank Financial Telecommunications (SWIFT):
SWIFT, as a co-operative society was formed in May 1973 with 239 participating banks from 15 countries with
its headquarters at Brussels. It started functioning in May 1977. RBI and 27 other public sector banks as well
as 8 foreign banks in India have obtained the membership of the SWIFT. SWIFT provides rapid, secure, reliable
and cost effective mode of transmitting the financial messages worldwide. At present more than 3000 banks are
members of the network. To cater to the growth in messages, SWIFT was upgrade in the 80s and this version is
called SWIFT-II. Banks in India are hooked to SWIFT-II system.
SWIFT is a method of the sophisticated message transmission of international repute. This is highly cost
effective, reliable and safe means of fund transfer.
a) This network also facilitates the transfer of messages relating to fixed deposit, interest payment, debit-
credit statements, foreign exchange etc.
b) This service is available throughout the year, 24 hours a day.

c) This system ensures against any loss of mutilation against transmission.
d) It serves almost all financial institution and selected range of other users.
It is clear from the above benefit of SWIFT that it is very beneficial in effective customer service. SWIFT has
extended its range to users like brokers, trust and other agents.
Cash Dispensers
Cash withdrawal is the basic service rendered by the bank branches. The cash payment is made by the cashier
or teller of the cash dispenses is an alternate to time saving. The operations by this machine are cheaper than
manual operations and this machine is cheaper and faster than ATM. The customer is provided with a plastic
card, which is magnetically coated. After completing the formalities, the machine allows the transactions for
required amount.
IT RELATED RISKS AND CONTROLS

Classifying IT risk
Identification, analysis, measurement and management of IT risk, requires specialized knowledge and skill. IT
risk management has to be done in every organization, and each has its own unique IT risk profile. Technology
risks have a deep impact on financial, operations, regulatory and reputation of the banks. IT risks can be
classified according to their impact on the organization, as listed below:
1. Security risk 3. Performance risk
2. Availability risk 4. Compliance risk
Security risk – The risk that information will be altered, accessed, or used by unauthorized parties. Sources of
security risk could be external attacks, malicious code, physical destruction, inappropriate access, unsatisfied
employees, variety of platform and messaging types.
Potential impacts associated with them are corruption of information, external fraud, identity theft, theft of
financial assets, damage to reputation and damage to assets.
Availability risk – The risk that information or applications will be inaccessible due to system failure or natural
disaster, including recovery period. Sources of availability risk are hardware failures, network outages, data
centre failures, force majeure etc.. Potential impacts associated with them are abandoned transactions and
lost sales, reduced level of customer, partner, or employee confidence, interruption or delay of business critical
processes, reduced IT staff productivity.
Performance risk – The risk that under performance of systems, applications, or personnel, or IT as a whole can
diminish business productivity or value. Sources of performance risk are poor system architectures, network
congestion, inefficient code, inadequate capacity etc. Potential impacts associated with them are reduced
customer satisfaction and loyalty, interruption or delay of business critical process, lost IT productivity.
Compliance risk – It is a risk of information handling or processing which fail to meet regulatory, IT or
business policy requirements. Usually, it involves penalties, fines, or loss of reputation from failure to comply
with laws or regulations, or consequences of non-compliance with IT policies. Sources of compliance risk are
regulations unique to each jurisdiction, legal actions, internal IT safeguards supporting compliance, inadequate
third-party compliance standards etc. Potential impacts associated with them are damage to reputation, breach
of client confidentiality, litigation.
These four areas of IT risk are shown in below mentioned figure, each with its own set of drivers and potential
impacts.
Controls required for managing IT risks

An effective control mechanism is required managing risks in IT areas. These controls are:
i. Preventive controls: This is a control mechanism that stops and reduce errors and mistakes from
occurring. Good layout of forms or screen to a large extent reduces the likelihood of mistakes happening
while inputting the data.
ii. Detective controls: They identify the errors after they are committed. This is done through what is known
as validation protocols or programmes.
iii. Corrective controls: These controls eliminate or reduce errors after identification of such data with
errors or irregularities.
The basic purpose of these controls is to prevent the occurrence of errors or irregularities in the system. Secondly
in spite of such prevention if such errors or irregularities occur they need to be detected and eliminated or
corrected.
In addition to generic controls mentioned above, depending upon the nature of controls that can be exercised
in managing risks are as follows:
Physical controls: These are the controls that restricts physical access to IT assets such as computers, servers,
computer room, media, documentation, data storage places, other hardwares / components etc.
• The first restriction to be put, is to ensure that only authorized persons are allowed access for repairs,
maintenance servicing etc. through a prior log in entry in a register, validated by a proper authentication.
• Care should also be taken to see such persons are not allowed access to data stored.
• Access to system and software is to be restricted through PINs, Passwords or biometric verification.
Similarly, access register/log should be maintained to record access to the system by various users.
• Clear segregation of machines should be done such that machines which are meant for operations are not
used for developing or testing software and vice-versa. Similarly hard copies of various transactional reports
should be kept under proper security and access should be given to these to only authorized persons/staff.
• Preventive checks of disaster prevention equipments such as Fire alarm, fire extinguishers, smoke
detectors, CCTV cameras, physical locking arrangements etc. should be done on outline basis. Similarly
hardware servicing at periodical intervals should also be done to prevent failures through AMCs.
Internal controls: These controls are in-built computers, for checking accuracy and reliability of data. Indirectly
they ensure operational efficiency and safeguard assets too. there are two types of Internal controls: They are
(i) Accounting controls
(ii) Administrative controls.
These controls also ensure that adherence to procedures and policies formulated by a bank.
Accounting controls form part of the Software and can be seen in the form of –
Administrative control flows through spelt out policies of responsibility and procedures. One may also see
existence of controls in the following activities such as:
• Validation / authorization of:
¡ transactions relating to limits, authorizations on bank`s software, passing of cheques and vouchers,
¡ drawing powers, defective / incorrect drawn cheques, stop payment orders, reactivation of dormant
and inoperative accounts, standing instructions, money transfer transactions etc.
• pre-transaction verification of due dates, rates of interest etc.
Operational controls: These are embedded in software itself to ensure data integrity, consistency apart
from processing. Check sum verification is another example of operational control exercised during day
begin operations. Double checking concept of inputter and authorizer of every system transaction should be
introduced by banks to control operations risk.
Additionally the following controls are also available for banks to monitor system and its operations by
authorized personnel.
Audit trail: Recording of all events that occur in a system on a chronological order.
There are two types of Audit trails - Accounting Audit trail and Operations Audit trail.
• Accounting Audit trail maintains chronological order based record of processes that had taken place
within the system involving data and information.
• Operations Audit trail gives a chronological record of access to a terminal, user id, data, time of access,
authorization record etc. which are generated by the system itself. This will provide evidence in case of
any violations or unauthorized use.
Data encryption: This is control measure involved while transmitting data from one place to another using
encoding process. It is a fixed algorithm based and uses a key word. At the receiving end the encryption is
decoded. At both ends if the codes match, it indicates that message has not been altered and thus integrity of
the transmitted message is confirmed. If there is no matching, then it triggers an investigation. This process is
also used for electronic funds transfers.
COMPONENTS AND ARCHITECTURE OF CBS
Introduction to CORE Banking

Core banking is a banking service
The world is changing rapidly and technology is
provided by a group of networked bank
considered to be the key driver for these changes around
branches where customers may access
us. Many activities are handled electronically due to the
their bank account and perform basic
acceptance of information technology at home as well as
transactions from any of the member
at workplaces. The Indian customers are moving towards
branch offices.
the internet banking. The ATM and the Net transactions are
conventionally adopted. But the customer is clear on one thing that he wants net-banking to be simple and
secure. CORE is a generic term for the delivery of banking services and products through the electronic
channels such as the telephone, the internet, the mobile phone etc. The concept and scope of CORE banking is
still evolving. It facilitates an effective payment and accounting system thereby enhancing the speed of delivery
of banking services significantly.
Several initiatives have been taken by the Government of India as well as the Reserve Bank of India (RBI) to
facilitate the development of CORE banking in India. The government of India enacted the IT Act, 2000, which
provides legal recognition to electronic transactions and other means of electronic commerce. The RBI has
been preparing to upgrade itself as regulator and supervisor of the technologically dominated financial system.
It issued guidelines on the risks and controls in computer and telecommunication systems to all the banks of
India, advising them to evaluate the risks inherent in the systems and put in place adequate control mechanisms
to address these risks. It is also advising banks from time to time on the same in the light of new developments.
Core Banking System replaced the manual banking operations to process the transactions faster and accurate.
CBS replaced the branch banking concept to One Bank as the customer can do anywhere banking transactions
from any branch of the bank.
Banking business has evolved over a period and grown exponentially encompassing an entire range of products
and transactions under a wide umbrella. All such activities undertaken by banks are called CORE banking
viz. “Centralized Online Real-time Environment”. This basically means that the entire bank’s branches access
applications from centralized data centres. It also means that the deposits made are reflected immediately
on the bank’s servers and the customer can withdraw the deposited money from any of the bank’s branches
throughout the world. These applications now also have the capability to address the needs of corporate
customers, providing a comprehensive banking solution. The CORE banking policy has to be approved by the
Board of Directors. The policy fits into the banks overall Information Technology and Information security
policy and ensures confidentiality, integrity and accountability of information and information processing
security system within a bank, and ensures confidentiality, integrity and accountability of information and
information processing security system.
What is CORE Banking?

CORE (Centralized Online Real-time Environment) banking
enables anytime anywhere banking. The bank customers
can operate their accounts from anywhere on a 24X7 basis.
The customers are no more the customer of a branch, they
become the bank’s customers. Thus CBS is a step towards
enhancing customer convenience through anywhere and
anytime banking. This is achieved through the centralized
processing of transactions. All transactions are processed at
central site called as Data Centre where all the data relating to
core branches reside.
Thus the core banking in simple terms is a highly efficient “customer accounting” and transaction processing
engine for high volumes of back office transactions. The main purpose of a core banking system is thus to give
banks the ability to process large transaction volumes in a fast and efficient way. Core banking also handles
transactions such as interest and fee calculation, pre-processing for statement printing, end-of-day processing,
and consolidation of daily individual transactions as “accounting entries” which are posted into the bank’s
general ledger system according to its chart of accounts structure for the daily trial balance sheet preparation.
The CBS process is convenient for both - customers and banks.
Need for CORE Banking

In order to meet requirements and needs of the IT modernization as per direction given by Reserve Bank of
India, Core Banking Solution (CBS) is being implemented across India covering all the urban cooperative banks
also. Core Banking Solution (CBS) is networking of all the bank’s branches which enables customers to operate
their accounts and avail account related services from anywhere at any time on CBS network, regardless of
where a customer maintains his account, as the customer is no more the customer of a branch, he becomes
the customer of the bank. Thus CBS is a step towards enhancing customer convenience through “Anywhere and
Anytime Banking”.
Technological requirement for Core Banking Solution (CBS)

In core banking solution all servers are centrally located at a place called “The Central Data Centre”. All branches
are connected to this data centre through a leased line or any other network connectivity with security and
redundancy built in. Most of the servers like Application server and Database server are placed behind the
firewall and protected from unauthorized access. In order to manage load and also to build redundancy, multiple
servers performing the same function are clustered. All servers are not in same local area network (LAN). They
are segregated using the concept of virtual local area network (VLAN) which has its own built in security.
Technology Requirements
• CORE banking environment consist of –
• Central Database Server that stores the data of the bank.
• Application architecture /Central Application Server that run the CORE banking solution (CBS) centrally
accessed by branches.
• Necessary infrastructure to provide for internet banking and Automated Teller Machine (ATMs).
• Authentication techniques.
• Information Security system.
Application Architecture Requirements

A computer-based application may
be built as a huge software, or may be
structured to run on a client–server
environment, or even have three or
multi-tiered architecture. A computer
application typically separates its three
main tasks-
(i) interactions with the user,;
(ii) processing of transactions as per
the business rules; and
(iii) the storage of business data.
These three tasks can be viewed as three layers, which may run on the same system (possibly a large, proprietary
computer system), or may be separated on to multiple computers (across the Internet), leading to three-tier or
multi-tier architecture.
These layers can be briefly described as follows.

• Presentation Layer: This layer is responsible for managing front-end devices, which include browsers on
personal computers, Personal Digital Assistants (PDAs), Mobile phones, Internet kiosks, Web TV etc. The
presentation layer takes care of user interface related issues like display details, color, layout, image etc. It
also has important responsibilities in user authentication and session management activity.
• Application layer: It contains the business logic (for processing of data and transactions) and necessary
interfaces to the data layer. It processes requests from the presentation layer, connects to the data layer,
receives and processes the information and passes results back to the presentation layer. It is responsible
for ensuring that all business rules are incorporated in the software. The issues of scalability, reliability
and performance of the services to a great extent depend upon the application layer architecture.
• Data Layer: The data layer uses a database package to store, retrieve and update application data. The
database may be maintained on one or multiple servers. A database package also supports back- up and
recovery of data, as well as logging of all transactions.
• System & Network logging: “Logging” basically means recording of activities. All computers are
automatically programmed to create a record of activities. Operating systems, database packages and
even business applications produce a ‘log’ of various tasks performed by them. Most operating systems
keep a log of all user actions. Log files are the primary record of suspicious behavior. Log files alert the
administrator of data base system, to carry out further investigation in case of suspicious activity and help
in determining the extent of intrusion. Log files can also provide evidence in case of legal proceedings.
The administrator has to select types of information to be logged, the mechanisms for logging, locations for
logging, and locations where the log files are stored. The information required to be logged should include
login/logout information, location and time of failed attempts, changes in status, status of any resource, changes
in system status such as shutdowns, initializations and restart, file accesses, change to file access control lists,
mail logs, modem logs, network access logs, web server logs, etc. The log files must be protected and archived
regularly and securely.
Challenges in CORE Banking Solution

The security and availability of IT systems, networks and data is critical importance in terms of ensuring
business continuity. Any security breach can lead to problems. Security breaches can be classified into three
categories. They are –
1. Serious criminal intent (fraud, theft of commercially sensitive or financial information).
2. Hackers attack, Phishing attacks (defacement of web sites or ”denial of service” causing web sites to
crash).
3. Flaws in systems design and/or set up.
All of these threats have potentially serious financial, legal and reputational implications. Many banks are
finding that their systems are being probed for weaknesses hundreds of times a day but damage/losses arising
from security breaches have so far tended to be minor.
However, some banks could develop more sensitive burglar alarms, so that they are better aware of the nature
and frequency of unsuccessful attempts to break into their system. The most sensitive computer systems, such
as those used for high value payments or those storing highly confidential information, be likely to be the most
carefully secured. Complex encryption software is used to protect account information. However, there are no
perfect systems. Accounts are prone to hacking attacks, phishing, malware and illegal activities.
Cyber Crime
What is Cyber Crime?

As the use of internet is increasing, a new face of crime is spreading rapidly from in-person crime to nameless
and faceless crimes involving computers. Cyber Crime includes all unauthorized access of information and break
of security like privacy, password, etc. with the use of internet. Cyber Crimes also include criminal activities
performed by the use of computers like virus attacks, financial crimes, sale of illegal articles, online gambling,
e-mail spamming, cyber phishing, cyber stalking, unauthorized access to computer system, theft of information
contained in the electronic form, e-mail bombing, physically damaging the computer system, etc.
Cyber stalking
Online harassment and online abuse all comes under stalking. The term “stalking” generally involves harassing
or threatening behavior that an individual engages in repeatedly, such as following a person, appearing at a
person’s home or place of business, making harassing phone calls, leaving written messages or objects, or
vandalizing a person’s property. Cyber stalking shares important characteristics with offline stalking. Many
stalkers (online or off line) are motivated by a desire to control their victims. A major damaging effect of online
abuse is a victim avoiding his/her friends, family and social activities.
Intellectual Property Crimes

Intellectual property consists of a person’s creations such as articles, books, paintings, photos or any such
intellectual content. Any unlawful act by which an owner of such intellectual property is deprived completely
or partially of his rights is an offence and this is known as intellectual property crime. The common form of IPR
violation/crime may be said to be software piracy, infringement of copyright, trademark, patents, designs and
service mark violation, theft of computer source code, etc.
Bot Networks
The word botnet is made from two words - robot and network. A cyber crime is called ‘Bot Networks’, when
hackers remotely take control upon computers by using malware software. Computers can be co-opted into
a botnet when they execute malicious software. A botnet’s originator can control a group of computers too
remotely.
Hacking
In general, the word ‘hacking’ means seeking and exploiting weakness and security of a computer system or a
computer network for unauthorized access. The person who does hacking is known as hacker. A Hacker uses
his/her computer expertise and some tool or scripts to hack any computer system.
Internet Time Thefts
Basically, Internet time theft comes under hacking. It is the use by an unauthorized person, of the Internet hours
paid for by another person. The person who gets access to someone else’s Internet Service Provider given user
ID and password, either by hacking or by gaining access to it by illegal means, uses it to access the Internet
without the person’s knowledge.
Cracking
It is a dreadful feeling to know that a stranger has broken into user computer systems without user’s knowledge
and consent and has tampered with precious confidential data and information. A Cracker differs from the
hacker because hacker is hired by companies to audit network security or test software but cracker do the same
work for their own profit or to harm others.
Phishing
Phishing means acquiring information such as usernames, passwords, credit card details, personal detail etc. by
electronic communication. Phishing commonly uses fake emails or fake messages which contain link of virus/
malware infected fake websites. These websites request user to enter their personal details. Then get hold of
these and commit a fraud.
Voice Phishing
The term is a combination of “voice” and “phishing”. Voice phishing is used to gain access of private, personal
and financial information from the public. Voice phishing uses a landline telephone call to get information.
Carding
It means false ATM cards i.e. Debit and Credit cards used by criminals for their monetary benefits through
withdrawing money from the victim’s bank account.
E-Mail/SMS Spoofing
A spoofed E-mail/ SMS may be said to be one, which misrepresents its origin. It shows its origin to be different
from which actually it originates. Here an offender steals identity of another in the form of email address,
mobile phone number etc. and send the message via internet.
Cross-site Scripting
Cross-Site Scripting (XSS) is a type of computer security vulnerability. By cross-site scripting attacker can
bypass the predefined access permissions of website. Reflected XSS is the most frequent type of XSS attack.
Reflected XSS attack is also known as non-persistent XSS. Scripting languages like java script, VB script etc. are
used for Reflected XSS attack.
Cyber Squatting
Squatting is the act of occupying an abandoned or unoccupied space. Cyber-squatting is the act of registering a
famous domain name and then selling it to needy for a high cost. It means where two persons claim for the same
Domain Name either by claiming that they had registered the name first or by right of using it before the other
or using something similar to that previously.
Cyber Vandalism
Vandalism means destroying or damaging property of another. Thus cyber vandalism means destroying or
damaging the data when a network service is stopped or disrupted. It may include within its purview any kind
of physical harm done to the computer of any person.
Cyber Trespass
It means to access someone’s computer without the proper authorization of the owner without disturbing,
altering, misusing, or damaging data or system by using wireless internet connection.
Cyber Trafficking
It may be trafficking in drugs, human beings, arms weapons etc. which affects large number of persons through
internet. Trafficking in the cyberspace is also a gravest crime.
Cyber Crime & Social Networking

Cyber criminals use social media for not only to commit crime online, but also for carrying out real world crime
owing to “over-sharing” across these social platforms. This risk is associated with our identities. Identity theft
can happen to anyone who exposes too much personal information online on various social networking sites.
To protect one self, get to know the security and privacy settings, and configure them to protect from identity
theft. One in five online adults (21 percent) have reported of becoming a victim of either social or mobile cyber
crime and 39 percent of social network users have been victims of profile hacking, scam or fake link.
Comprehensive Cyber Security Framework for Primary (Urban) Cooperative Banks (UCBs) –
A Graded Approach
Apart from Cyber Security points discussed in Lesson 5, RBI has formulated a comprehensive Cyber Security
Framework for UCBs vide its notification dated December 31, 2019 based on a graded approach. The Salient
features are as follows:
Level Criteria Regulatory Prescription Remarks

Level I All UCBs Level I controls In addition to the controls
prescribed in Annex I to prescribed bank specific email
this circular. domain with DMARC controls,
two factor authentication for
CBS etc., are salient controls
prescribed.
Level II All UCBs, which are sub- members Level II controls given in Additional controls include
of Centralised Payment Systems1 Annex II of this circular, Data Loss Prevention Strategy,
(CPS) and satisfying at least one of in addition to Level I Anti-Phishing, VA/PT of critical
the criteria given below: controls. applications.
• offers internet banking
facility to its customers
(either view or transaction
based)
• provides Mobile Banking
facility through application
(Smart phone usage)
• is a direct Member of CTS/
IMPS/UPI.
Level III UCBs having at least one of the Level III controls given in Additional controls include
criteria given below: Annex III of this circular, Advanced Real-time Threat
• Direct members of CPS in addition to Level I and Defence and Management, Risk
II controls. based transaction monitoring.
• having their own ATM Switch
• having SWIFT interface
Level IV UCBs which are members/ sub- Level IV controls given in Additional controls include
members of CPS and satisfy at Annex IV of this circular, setting up of a Cyber Security
least one of the criteria given in addition to Level I, II Operation Center (C-SOC)
below: and III controls. (either on their own or through
• having their own ATM Switch service providers), IT and IS
and having SWIFT interface Governance Framework.
• hosting data centre or
providing software support
to other banks on their own
or through their wholly
owned subsidiaries
The Board of Directors of the UCB is ultimately responsible for the information security and should play a
proactive role in ensuring an effective IT (Information Technology) and IS (Information Security) governance.
The major role of top management involves implementing the Board approved cyber security policy, establishing
necessary organisational processes for cyber security and providing necessary resources for ensuring adequate
cyber security.
UCBs to undertake a self-assessment of the level in which they fit into, based on the criteria given in the table
above and report the same to their respective RBI Regional Office, Department of Supervision within 45 days
from the date of issuance of this circular.
All UCBs to comply with the control requirements prescribed in Annex I within 3 months from the date of
issuance of this circular. Similarly, Level II, III and IV UCBs are required to implement additional controls
prescribed in Annex –II, III and IV to this circular.
UCBs may adopt higher level of security measures based on their own assessment of risk and capabilities.
Further, if a UCB, irrespective of its asset size already has a dedicated CISO and/or governance framework
as discussed in Annex IV, then as a matter of best practice, it is desirable that it continues with the existing
governance structure.
Annexure – I
Following controls to be implemented:
I. Implement bank specific email domains (example, XYZ bank with mail domain xyz.in) with anti-phishing
and anti-malware, DMARC controls enforced at the email solution.
II. UCBs shall put in place two factor authentication for accessing their CBS and applications connecting to
the CBS with the 2nd factor being dynamic in nature. (E.g. 2nd factor should not be a static password and
must not be associated with the PC/terminal used for putting through payment transactions).
III. Conduct security review of PCs/terminals used for accessing corporate Internet Banking applications of
Scheduled Commercial Banks (SCBs), CBS servers and network perimeter through a qualified information
security auditor.
IV. There should be a robust password management policy in place, with specific emphasis for sensitive
activities like accessing critical systems, putting through financial transactions. Usage of trivial passwords
shall be avoided. [An illustrative but not exhaustive list of practices that should be strictly avoided are:
For example, XYZ bank having password as xyz@123; network/server/security solution devices with
passwords as device/solution_name123/device_name/solution@123; hard coding of passwords in plain
text in thick clients or storage of passwords in plain text in the databases]
V. Educate employees to strictly avoid clicking any links received via email (to prevent phishing attacks).
VI. Put in place an effective mechanism to report the cyber security incidents in a timely manner and take
appropriate action to mitigate the incident. UCBs shall also report all unusual cyber security incidents to
CERT-In and IB-CART.
Vendor/Outsourcing Risk Management

Apart from the general guidelines issued in October, 2013 the following guidelines need to be implemented by
UCBs:
I. Accountable for ensuring appropriate management and assurance on security risks in outsourced vendor
arrangements. UCBs should be
a. carefully evaluate the need for outsourcing critical processes and selection of vendor/partner based
on comprehensive risk assessment.
b. shall regularly conduct effective due diligence, oversight and management of third party vendors/
service providers and partners.
II. Required to necessarily enter into agreement with the service provider that, among other things, provides
for right to audit by the UCB. The outsourcing agreements should include clauses to recognise
a. the right of the RBI to cause an inspection to be made of a service provider of the UCB; and
b. allow the RBI or persons authorised by it to access the bank’s documents, records of transactions,
logs and other necessary information given to, stored or processed by the service provider within a
reasonable time.
Required to thoroughly satisfy about the credentials of vendor/third-party personnel accessing and managing
the UCB’s critical assets. Background checks, non-disclosure and security policy compliance agreements shall
be mandated for all third party service providers.
Annexure II
Annexure II Baseline Cyber Security and Resilience Requirements (in addition to the requirements given in
Annex I) (for level II).
Following controls shall be implemented:
UCBs shall identify an official responsible for a) articulating and enforcing the policies that UCBs use to protect
their information assets, apart from coordinating the cyber security related issues / implementation within the
organisation as well as relevant external agencies. b) ensuring compliance to various instructions issued on
information/cyber security by RBI.
1.1 Maintain an up-to-date/centralised inventory of authorised devices connected to UCB’s network
(within/ outside UCB’s premises) and related network devices in the UCB’s network.
1.2 Boundary defences should be multi-layered with properly configured firewalls, proxies, De-Militarized
Zone (DMZ) perimeter networks, and network-based Intrusion Prevention System (IPS)/Intrusion
Detection System (IDS). Mechanism to filter both inbound and outbound traffic shall be put in place.
1.3 LAN segments for in-house/onsite ATM and CBS/branch network should be different.
2.1 Document and apply baseline security requirements/configurations to all categories of devices (end-
points/workstations, mobile devices, operating systems, databases, applications, network devices,
security devices, security systems, etc.), throughout the lifecycle (from conception to deployment)
and carry out reviews periodically.
3.1 The development/test and production environments need to be properly segregated. The data used
for development and testing should be appropriately masked.
3.2 Software/Application development approach should incorporate secure coding principles, security
testing (based on global standards) and secure rollout.
4. Change Management
4.1. UCBs should have a robust change management process in place to record/ monitor all the changes
that are moved/ pushed into production environment. Changes to business applications, supporting
technology, service components and facilities should be managed using robust configuration
management processes that ensure integrity of any changes thereto.
5. Periodic Testing
5.1 Periodically conduct Vulnerability Assessment/ Penetration Testing (VA/PT) of internet facing
web/ mobile applications, servers and network components throughout their lifecycle (pre-
implementation, post implementation, after changes etc.). VA of critical applications and those on
DMZ shall be conducted atleast once in every 6 months. PT shall be conducted atleast once in a year.
5.2 UCBs having their CBS on a shared infrastructure of an Application Service Provider (CBS-ASP) shall
get their CBS application including the infrastructure hosting it subjected to VA/PT through the CBS-
ASP.
5.3 Application security testing of web/mobile applications should be conducted before going live and
after every major changes in the applications.
5.4 The vulnerabilities detected are to be remedied promptly in terms of the UCB’s risk management/
treatment framework so as to avoid exploitation of such vulnerabilities.
5.5 Penetration testing of public facing systems as well as other critical applications are to be carried out
by professionally qualified teams. Findings of VA/PT and the follow up actions necessitated are to
be monitored closely by the Information Security/Information Technology Audit team as well as Top
Management.
6. User Access Control / Management

6.1 Provide secure access to the UCB’s assets/services from within/outside UCB’s network by protecting
data/information at rest (e.g. using encryption, if supported by the device) and in-transit (e.g. using
technologies such as VPN or other standard secure protocols, etc.)
7. Authentication Framework for Customers
7.1 UCBs should have adequate checks and balance to ensure (including security of customer access
credentials held with them) that transactions are put only through the genuine/authorised
applications and that authentication methodology is robust, secure and centralised.
7.2 Implement authentication framework /mechanism to securely verify and identify the applications of
UCB to customers (Example, with digital certificate).
8. Anti-Phishing
8.1 Subscribe to Anti-phishing/anti-rogue application services from external service providers for
identifying and taking down phishing websites/rogue applications.
9. Data Leak Prevention Strategy
9.1 Develop and implement a comprehensive data loss/leakage prevention strategy to safeguard
sensitive (including confidential) business and customer data/information.
9.2 Similar arrangements need to be ensured at vendor managed facilities as well.
10. Audit Logs
10.1 Capture the audit logs pertaining to user actions in a system. Such arrangements should facilitate
forensic auditing, if need be.
10.2 An alert mechanism should be set to monitor any change in the log settings.
11.1 Put in place an effective Incident Response programme. UCBs must have a mechanism/ resources
to take appropriate action in case of any cyber security incident. They must have written incident
response procedures including the roles of staff / outsourced staff handling such incidents.
11.2 UCBs are responsible for meeting the requirements prescribed for incident management and BCP/
DR even if their IT infrastructure, systems, applications, etc., are managed by third party vendors/
service providers.
Annexure III (in addition to the requirements given in Annex I & II) (For level III)
1.1 Put in place mechanism to detect and remedy any unusual activities in systems, servers, network
devices and endpoints.
1.2 Firewall rules shall be defined to block unidentified outbound connections, reverse TCP shells and
other potential backdoor connections
2.1 Disable remote connections from outside machines to the network hosting critical payment
infrastructure (Ex: RTGS/NEFT, ATM Switch, SWIFT Interface). Disable Remote Desktop Protocol
(RDP) on all critical systems.
2.2 Enable IP table to restrict access to the clients and servers in SWIFT and ATM Switch environment
only to authorised systems.
2.3 Ensure the software integrity of the ATM Switch/SWIFT related applications.
2.4 Disable Power Shell in servers where not required and disable PowerShell in Desktop systems.
2.5 Restrict default shares including IPC$ share (inter-process communication share)

3.1 In respect of critical business applications, UCBs may conduct source code audits by professionally
competent personnel/service providers or have assurance from application providers/OEMs that
the application is free from embedded malicious / fraudulent code.
3.2 Besides business functionalities, security requirements relating to system access control,
authentication, transaction authorization, data integrity, system activity logging, audit trail, session
management, security event tracking and exception handling are required to be clearly specified at
the initial and ongoing stages of system development/acquisition/implementation.
3.3 Ensure that software/application development practices adopt principle of defence-in-depth to
provide layered security mechanism.
3.4 Ensure that adoption of new technologies is adequately evaluated for existing/evolving security
threats and that the IT/security team of the UCB achieve reasonable level of comfort and maturity
with such technologies before introducing them for critical systems of the UCB.
4. User Access Control : Implement
4.1 A centralised authentication and authorisation system through an Identity and Access Management
solution for accessing and administering critical applications, operating systems, databases, network
and security devices/systems, point of connectivity (local/remote, etc.) including enforcement
of strong password policy, two-factor/multi-factor authentication, securing privileged accesses
following the principle of least privileges and separation of duties. This shall be implemented by the
bank either with the in-house team managing the infrastructure or through the service provider if
their infrastructure is hosted at a shared location at the service provider’s end.
4.2 Centralised policies through Active Directory or Endpoint management systems to whitelist/
blacklist/ restrict removable media use.
5. Advanced Real-time Threat Defence and Management
5.1 Build a robust defence against the installation, spread, and execution of malicious code at multiple
points in the enterprise.
5.2 Implement whitelisting of internet websites/systems.
6. Maintenance, Monitoring, and Analysis of Audit Logs
6.1 Consult all the stakeholders before finalising the scope, frequency and storage of log collection.
6.2 Manage and analyse audit logs in a systematic manner so as to detect, respond, understand or recover
from an attack.
6.3 Implement and periodically validate settings for capturing of appropriate logs/audit trails of each
device, system software and application software, ensuring that logs include minimum information
to uniquely identify the log for example by including a date, timestamp, source addresses, destination
addresses.
7.1 UCB’s BCP/DR capabilities shall adequately and effectively support the UCB’s cyber resilience
objectives and should be so designed to enable the UCB to recover rapidly from cyber-attacks/other
incidents and safely resume critical operations aligned with recovery time objectives while ensuring
security of processes and data is protected.
7.2 UCBs shall have necessary arrangements, including a documented procedure, with such third party
vendors/service providers for such purpose. This shall include, among other things, to get informed
about any cyber security incident occurring in respect of the bank on timely basis to early mitigate
the risk as well as to meet extant regulatory requirements.
7.3 Have a mechanism to dynamically incorporate lessons learnt to continually improve the response
strategies. Response strategies shall consider readiness to meet various incident scenarios based on
situational awareness and potential/post impact, consistent communication and co-ordination with
stakeholders during response.
8. User / Employee/ Management Awareness
8.1 Encourage them to report suspicious behaviour incidents to the incident management team.
8.2 Make cyber security awareness programs mandatory for new recruits and web-based quiz and
training for lower, middle and upper management every year.
8.3 Board members may be sensitised on various technological developments and cyber security related
developments periodically.
9. Risk based transaction monitoring (This control shall be applicable to those banks who are direct
members of CPS as well as having their own ATM Switch interface or SWIFT interface)
9.1 Risk based transaction monitoring or surveillance process shall be implemented as part of fraud risk
management system across all -delivery channels.
Baseline Cyber Security and Resilience Requirements (in addition to the requirements
given in Annex I, II & II ) - Level IV
1. Arrangement for continuous surveillance - Setting up of Cyber Security Operation Centre (C-SOC)
UCBs are mandated that a C-SOC (Cyber Security Operations Centre) be set up at the earliest, if not yet
done. It is also essential that this Centre ensures continuous surveillance and keeps itself regularly updated
on the latest nature of emerging cyber threats.
1.1 Expectations from C-SOC : Ability to
i. protect critical business and customer data/information, demonstrate compliance with
relevant internal
ii. provide real-time/near-real time information on and insight into the security posture of the
UCB
iii. effectively and efficiently manage security operations by preparing for and responding to cyber
risks/threats, facilitate continuity and recovery
iv. know who did what, when, how and preservation of evidence
v. Integration of various log types and logging options into a Security Information and Event
Management (SIEM) system, ticketing/workflow/case management, unstructured data/big
data, reporting/dashboard, use cases/rule design (customised based on risk and compliance
requirements/drivers, etc.), etc.
vi. C-SOC should be able to monitor the logs of various network activities and should have the
capability to escalate any abnormal / undesirable activities
vii. Key Responsibilities of C-SOC could include: Monitor, analyse and escalate security incidents;
Develop Response - protect, detect, respond, recover; Conduct Incident Management and
Forensic Analysis; Co-ordination with relevant stakeholders within the UCB/external agencies
1.2 Steps for setting up C-SOC – Technological Aspects
i. First step is to arrive at a suitable and cost effective technology framework designed and
implemented to ensure proactive monitoring capabilities aligned with the banking technology
risk profile and business and regulatory requirements. Clear understanding of the service
delivery architecture deployed by the UCB will enable identification of the location for the
sensors to collect the logs that are required to carry out the analysis and investigation. SIEM is
able to meet this requirement to some extent but a holistic approach to problem identification
and solution is required.
ii. Second step is to have a security analytics engine which can process the logs within reasonable
time frame and come out with possible recommendations with options for further deep dive
investigations
iii. Third step is to look at deep packet inspection approaches
iv. Fourth step is to have tools and technologies for malware detection and analysis as well as
imaging solutions for data to address the forensics requirements
v. It is to be noted that the solution architecture deployed for the above has to address performance
and scalability requirements in addition to high availability requirements. Some of the aspects
to be considered are :
• Staffing of C-SOC - is it required to be 24x7x365, in shifts, business hours only, etc.
• Model used - Finding staff with required skills /managed security service provider with
required skill set
• Metrics to measure performance of C-SOC
• Ensuring scalability and continuity of staff through appropriate capacity planning
initiatives.
2. Participation in Cyber Drills : 2.1. UCBs shall participate in cyber drills conducted under the aegis
of Cert-IN, IDRBT etc.
3.1 UCBs shall ensure incident response capabilities in all interconnected systems and networks
including those of vendors and partners and readiness demonstrated through collaborative and co-
ordinated resilience testing that meet the UCB’s recovery time objectives. 3.2. Implement a policy &
framework for aligning Security Operation Centre, Incident Response and Digital forensics to reduce
the business downtime/ to bounce back to normalcy.
4. Forensics and Metrics
4.1 Develop a comprehensive set of metrics that provides for prospective and retrospective measures, like
key performance indicators and key risk indicators. Some illustrative metrics include coverage of anti-
malware software and their updation percentage, patch latency, extent of user awareness training,
vulnerability related metrics, number of open vulnerabilities, IS/security audit observations, etc.
4.2 Have support/ arrangement for network forensics/forensic investigation/distributed denial-of-
service (DDOS) mitigation services on stand-by.
5. IT Strategy and Policy
5.1 The UCB shall have a Board approved IT-related strategy and policies covering areas such as: Existing
and proposed hardware and networking architecture for the UCB and its rationale; Standards for
hardware or software prescribed by the proposed architecture; Strategy for outsourcing, in-sourcing,
procuring off-the-shelf software, and in-house development; IT Department’s Organisational
Structure; Desired number and level of IT expertise or; Strategy for independent assessment,
evaluation and monitoring of IT risks, findings of IT/IS/Cyber security related audits.
6. IT and IS Governance Framework
6.1 Cyber Security Team/Function : UCBs shall form a separate cyber security function/group to
focus exclusively on cyber security management. The organisation of the cyber security function
should be commensurate with the nature and size of activities of the UCB including factors such
as technologies adopted, delivery channels, digital products being offered, internal and external
threats, etc. The cyber security function should be adequately resourced in terms of the number of
staff, level of skills and tools or techniques like risk assessment, security architecture, vulnerability
assessment, forensic assessment, etc.
6.2 IT Strategy Committee : UCBs may consider setting up a Board level IT Strategy Committee
with a minimum of two directors as members, one of whom should be a professional director. At
least two members of the IT Strategy Committee would need to be technically competent4 while
at least one member would need to have substantial expertise5 in managing/guiding technology
initiatives. Some of the roles and responsibilities that the IT Strategy Committee/Board should have
are: (i) Approving IT strategy and policy documents (iii) ensuring that the management has put
an effective strategic planning process in place (iii) ensuring that the IT organizational structure
complements the business model and its direction (iv) ensuring IT investments represent a balance
of risks and benefits and that budgets are acceptable (v) Reviewing IT performance measurement
and contribution of IT to businesses
6.3 IT Steering Committee: An IT Steering Committee shall be formed with representatives from the
IT, HR, legal and business sectors. Its role is to assist the Executive Management in implementing IT
strategy that has been approved by the Board. It includes prioritization of IT-enabled investment,
reviewing the status of projects (including, resource conflict), monitoring service levels and
improvements, IT service delivery and projects. The IT Steering committee/Board should appraise/
report to the IT strategy Committee periodically. The committee should focus on implementation. Its
functions, inter-alia, include:
(i) Defining project priorities and assessing strategic fit for IT proposals2
(ii) Reviewing, approving and funding initiatives, after assessing value-addition to business process.
(iii) Ensuring that all critical projects have a component for “project risk management”.
(iv) ponsoring or assisting in governance, risk and control framework, and also directing and
monitoring key IT Governance processes.
(v) Defining project success measures and following up progress on IT projects.
(vi) Provide direction relating to technology standards and practices.
(vii) Ensure that vulnerability assessments of new technology is performed.
(viii) Verify compliance with technology standards and guidelines.
(ix) Ensure compliance to regulatory and statutory requirements.
(x) Provide direction to IT architecture design and ensure that the IT architecture reflects the need
for legal and regulatory compliance, the ethical use of information and business continuity.
6.4 Chief Information Security Officer (CISO) : A sufficiently
senior level official should be designated as Chief Information
Security Officer (CISO), responsible for articulating and
enforcing the policies that the UCB uses to protect its
information assets apart from coordinating the cyber security
related issues / implementation within the organisation as
well as relevant external agencies. The CISO shall be primarily
responsible for ensuring compliance to various instructions
issued on information/cyber security by RBI.
The following may be noted in this regard:
The CISO should:
(i) Report directly to the top executive overseeing the risk
management function or in his absence to the CEO
directly.
(ii) Have the requisite technical background and expertise.
(iii) Have a reasonable minimum term.

(iv) Place a separate review of cyber security arrangements/ preparedness of the UCB before the
Board on a quarterly basis.
(v) The UCB’s Board should be able to objectively measure steps to assess the effectiveness of the
CISO’s office.
(vi) The CISO will be responsible for bringing to the notice of the Board about the vulnerabilities
and cyber security risks that the UCB is exposed to the CISO.
(vii) By virtue of his role as member secretary of information security and/or related committees(s),
if any, may ensure, inter alia, current/ emerging cyber threats to banking (including payment
systems) sector and the UCB’s preparedness in these aspects are invariably discussed in such
committee(s).
(viii) Office shall manage and monitor the C-SOC and drive cyber security related projects. It can
have a dotted relation with Chief Information Officer (CIO)/ Chief Technology Officer (CTO) for
driving such projects.
(ix) Shall be an invitee to the IT Strategy committee and IT Steering Committee. The CISO may
also be a member of (or invited to) committees on operational risk where IT/ IS risk is also
discussed.
(x) Office shall be adequately staffed with technically competent people, if necessary, through
recruitment of specialist officers, commensurate with the business volume, extent of technology
adoption and complexity.
(xi) Shall not have any direct reporting relationship with the CIO/CTO and shall not be given any
business targets.
(xii) The budget for IT security/ CISO’s office may be determined keeping in view the current/
emerging cyber threat landscape.
6.5 Information Security Committee : Since IT/ cyber security affects all aspects of an organisation, in
order to consider IT/ cyber security from a UCB-wide perspective a steering committee of executives
should be formed with formal terms of reference. The CISO would be the member secretary of the
Committee. The Information Security Committee may include, among others, the Chief Executive
Officer (CEO) or designee and two senior management officials well versed in the subject. The
Committee shall meet atleast on a quarterly basis. Major responsibilities of the Information Security
Committee, inter-alia, include:
(i) Developing and facilitating the implementation of information security policies, standards and
procedures to ensure that all identified risks are managed within a UCB’s risk appetite.
(ii) Approving and monitoring major cyber security projects and the status of cyber security plans
and budgets, establishing priorities, approving standards and procedures.
(iii) Supporting the development and implementation of a UCB-wide information security
management programme.
(iv) Reviewing the position of security incidents and various information security assessments and
monitoring activities across the UCB.
(v) Reviewing the status of security awareness programmes.
(vi) Assessing new developments or issues relating to information/ cyber security.
(vii) Reporting to the Board of Directors on cyber security activities.
(viii) Minutes of the Information Security Committee meetings should be maintained to document
the committee’s activities and decisions and a review on information/cyber security needs to
be escalated to the Board on a quarterly basis.
6.6 Audit Committee of Board (ACB): Vide DCBR.CO.BPD.(PCB).MC.No.3/12.05.001/2015-16 Master

circular dated July 1, 2015 all UCBs have been advised to set up an Audit Committee (ACB) at the
Board level. In addition to its prescribed role as per extant instructions, the ACB shall also be
responsible for the following:
(i) Performance of IS Audit and Evaluation of significant IS Audit issues – The ACB should devote
appropriate and sufficient time to IS Audit findings identified and members of ACB need to
review critical issues highlighted and provide appropriate guidance to the UCB’s management.
(ii) Monitor the compliance in respect of the information security reviews/VA-PT audits under
various scope conducted by internal as well as external auditors/consultants to ensure that
open issues are closed on a timely basis and sustenance of the compliance is adhered to.
CORE BUSINESS PROCESS FLOW AND RELEVANT RISK CONTROLS

The transaction flow in CBS is described as under:
First the user log in after the day begin is activated at the branch. Once log in is successful the user is allowed
to access different product modules. Let us take an example to understand the process flow in the CBS system.
Assume that Mr. X has come to the branch to withdraw Rs. 1,00,000/- from his SB account through a cheque.
The cheque is given to the user who after verifying the cheque for its validity, enters all particulars of the cheque
in the system. According to the branch procedures the user has only powers up to pass cheques only up to Rs.
5,000/- Therefore his transaction has to be verified and authorized by a senior official of the branch who has
been given powers to pass cheques up to Rs. 5,00,000/-.
Since the powers of the user is restricted up to Rs. 5000/- as soon as the user enters the cheque data it is
transmitted to what is known as maker checker functionality in the system through which the senior official
(who has more power to pass the cheque) will authorize the transaction after due verification. Once this
transaction is registered by the host server flashes back a message to the user whether the transaction is
successful and complete. During the entire process the CBS system validates account number, cheque number,
date, balance in the account, authority level of teller and senior official etc. as per the parameters for validation
already set and stored in the system.
This is how the flow of the transactions normally takes place in the core banking for all transactions.
Controls in the flow of transactions under CBS

The following controls forms part of transactions flow in CBS:
1. Password control: Every authorized user/operator is given
a User id and Password for login in to the system. These are
required to be kept confidential by the respective user. The
preventive aspect in this is to change passwords at suitable
intervals. In the case visiting officials who come to the branch
for inspection, investigation or temporary postings etc. they are
given guest login arrangement with a user Id and password. This
should be deleted as soon as their work is over. Also if an existing
authorized user is no more associated with the branch/bank
due to long leave, outside deputations, transfers, retirement,
sickness, suspensions or death etc. they should be deactivated.
2. Transaction control: Inactive work stations or desktops or terminals are to be logged off. Only those who
are present their workstation or terminals should be enabled for transactions. Authorization of date in
the system should be done by designated officials only. Reports such as special batch reports should be
checked and authenticated by designated officials. Software problems encountered in operations should
be recorded and rectification work should be carried out with the help of authorized officials/ vendors.
3. Personnel control: Job rotation at periodical intervals as per bank’s policy should be done and a written
record is maintained in this regard. it should be ensured proper clear distribution duties is affected.
Similarly, authorization limits for various levels of staff is fixed and documented.
4. Logical Access control: To ensure logical access control give access to menus to Staff on “need” only
basis. Restrict file maintenance access to a few staff documented approval. This needs review at regular
intervals. Encrypt Pass word files for restricted access. Give top priority to Security violations and ensure
that they are investigated and remedial action is taken. Restrict access to work stations during and after,
office hours. Completely restrict access to sever room and modem installations.
5. Security control: To maintain security control under CBS, Ensure proper remedial action, in case of
power failure or mechanical failures. Also ensure system restarts with proper completion of entries and
records which were in midway when the power was disrupted. Install latest Anti-virus version in servers.
Updating patches whenever or wherever made available by software vendors should also applied on an ongoing
basis. Take proper back-ups at appropriate times and ensure its proper storage either on-site or off-site. Ensure
only authorized amendments are accepted by the system. Authenticate/ authorize parametric changes and
user levels. Unauthorized amendments are not accepted by the system. Ensure all authorized modules are
installed and activated. Generate exception transaction reports on a daily basis and they are scrutinized. Ensure
all authorized GL codes from Head office / controlling departments are in existence. Keep important Passwords
in a sealed cover with Branch Head /Manager for easy access in case of need /absence of staff.
REPORTING SYSTEM AND MIS

Banking business environment is characterized by battle for the customer, as need to grow in volume has given
way to selective growth strategies (rather than messages about a slowing of new business). an undeniable
competitive advantage is provided by robust, reliable and useful systems for measuring customer profitability
or value, both current and potential, in connection with budgeting and pricing methodologies. This is due both
to their capacity to identify where to generate value and to the capacity to direct the actions of branches and
sales staff, identifying the real profitability of each customer in order to focus on those making the greatest
contribution to the margin while at the same time that working on the profitability of those who at present
contribute less. This is achieved by a proper Management Information System.
Management Information System (MIS)

MIS Means Management Information System. Business organizations, use and manage information systems to
revitalize business process, improve business decision making with information technologies, gain competitive
advantage on the market. As described by World Bank, Management Information System (MIS) is a system that
helps management in making, carrying out and controlling decisions. In effect, a project/ program monitoring
system is a Management Information System that provides information for making decision by the management.
In the design of the MIS, the following six basic stages of a MIS, in their sequential order, are followed:
Key elements of MIS are –

1. Internet technologies - as platform for business and commerce;
2. Collaboration processes among all business stakeholders – in networked enterprises;
3. Global markets and the international dimension, Foundation Concepts, Decision support - in Business; and
4. Banking - Information technologies and Banking applications, an approach to computing, Systems and
information channels and Developing business.
Objectives of MIS
Objective of MIS is to make available timely and meaningful data for decision making by managements. The
main focus therefore of MIS is that of converting raw and massive date in to meaningful pieces of information
that would be useful. As timing is the essence of any decision, MIS should provide timely information.
Characteristics and uses of MIS

• The MIS of a Bank whose branches are so well-spread becomes a pivotal point of study as it caters to many
segments of the society (urban and rural) and offering a diversified portfolio of services like credit cards,
loans, bank accounts, etc. Thus, it becomes absolutely essential for a bank to maintain an accurate mass
record of all transactions of every individual or corporate. One cannot ignore the fact that every record /
data should have a reliable back-up in case of any uncertainty like System Crashing’, ‘Virus Attack’, etc.
• MIS helps to validate our theoretical understanding.
• Leads a better understanding of an organization by top management, without which the efficient
management of that organization would become difficult.
• While computers cannot create business strategies by themselves they can assist management in
understanding the effects of their strategies, and help enable effective decision-making. MIS systems can
be used to transform data into information for useful for decision making. Computers can provide financial
statements and performance reports to assist in the planning, monitoring and implementation of strategy.
• MIS provides a valuable function in that they can collate into coherent reports of unmanageable volumes
of data that would otherwise be broadly useless to decision makers.
• Not only do MIS allow for the collation of vast amounts of business data, but they also provide a valuable
time saving benefit to the workforce. Where in the past business information had to be manually
processed/compiled for filing and analysis, data can now be entered quickly and easily onto a computer
by a data processor, allowing for faster decision making and quicker reflexes for the enterprise as a whole.
Business Intelligence and Data Analytics

The term intelligence has been used by researchers in artificial intelligence since the 1950s. Business intelligence
(‘BI’) became a popular term in the business and IT communities only in the 1990s. In the late 2000s, business
analytics was introduced to represent the key analytical component in BI. More recently big data and big data
analytics have been used to describe the data sets and analytical techniques in applications that are so large
(from terabytes to Hexabytes) and complex (from sensor to social media data) that they require advanced
and unique data storage, management, analysis, and visualization technologies. Business intelligence and data
analytics (BI&DA) is a unified term and deals with big data analytics. BI&DA is a collection of decision support
technologies for gathering, providing access to, and analyzing data for the purpose of helping enterprise users
(executives, managers and analysts) make better and faster business decisions. The term implies having a
comprehensive knowledge of all of the factors that affect the business. It is imperative that companies have an in
depth knowledge about factors such as the customers, competitors, business partners, economic environment,
and internal operations to make effective and good quality business decisions. Business intelligence enables
firms to make these kinds of decisions. Enterprises aim at enabling knowledge to executives, managers and
analysts to make better and faster decisions.
Business Intelligence (BI) and Customer Relationship Management (CRM)

CRM and BI form an integral part of a bank‘s strategy. BI allows banks to pull together usable information
from disparate systems. CRM and BI tools provide a bank with the ability to look at customer data and use it
to drive business. Integrating BI capabilities into applications is important. Banks are choosing to implement
data warehousing solutions to consolidate data from diverse sources into one easy-to-use database to facilitate
time critical decision support. Banks can track and respond to business trends and analyze data in the light of
business perspectives. Banks can utilize BI to focus on:-
• Customer acquisitions/profitable accounts
• Track customer needs
• Identify cross-selling opportunities
• Provide customer satisfaction at levels hitherto not even dreamt of.
CRM can be an effective method by which banks can attract new customers and retain existing customers. It
involves reorienting bank operations around the needs of the most profitable customers. CRM enables banks
to segment customer bases. Tailor make appropriate products for different segments and add personalized
services.
CRM is a key component of the bank‘s growth strategy. Many banks are now participating in strategic
partnerships with IT companies. These are not just limited to outsourcing initiatives. Banks are looking at
partnerships to obtain timely and predictable returns on their IT investments. The benefits accruing to banks
from strategic alliances include one-stop-shopping experience and procurement of best product/s, carefully
integrated and fine-tuned.
DATA ANALYTICS
Data Analytics plays a significant role in virtually every field, where
data could be collected and stored. Data Analytics is vastly different
from data analysis. While data analysis, by convention, connotes
statistics, data analytics goes beyond statistics, into the fields of
computer science (via machine learning subsuming new wave of
artificial intelligence) and operations research. In fact, Dr. Jim Gray
of Microsoft, refers to it as the fourth paradigm of science with
theoretical, experimental and computational paradigms being the
others that preceded it in the evolution of science. Interestingly, all
the four complement one another and all are required in sufficient
proportion to conduct meaningful research/practice in numerous
fields nowadays.
Service industries including banking derive immense advantage from data analytics. Analytics is of three types:
(i) Descriptive;
(ii) Predictive; and
(iii) Prescriptive.
Descriptive analytics concerns various ways of depicting the past and present data using Statistics and Online
Analytical Processing, whereas predictive analytics answers questions like what is going to happen based on
the past data using data mining, text mining and web mining. However, prescriptive analytics provides insights
from the data that is not necessarily predictive in nature using operations research and optimization techniques.
LESSON ROUND UP
• Information Technology based banking was introduced in India since late 1980s for bringing in efficient
customer service, better housekeeping and internal controls, improving productivity as well as faster
decision making.
• As products and services offered are IT based, they are also subject to risks such as Security, Availability
Performance and Compliance risks. However, these risks can be managed with the help of controls such
as Preventive, Detective and Corrective controls.
• Additionally, Physical control, internal control and operational controls can also be exercised to safe
guard the interest of banks and customers. RBI has issued specific directions for banks including UCBs
in the area of comprehensive cyber security controls as well pertaining to Third party ATM Switch
Application Service Providers.
• Large number of banks today are on the platform of CORE banking for facilitation bank wide transactions
simultaneously across several geographical locations with the help of Central Data Centres. Core
banking also has certain inherent risks which can be managed through appropriate controls such as
Password control, Logical access controls, Personnel controls and Security controls.
• With the introduction of IT based system banks are able to generate MIS for faster decision making.
Also banks nowadays use analytical methodologies such as Business intelligence and data analytics to
study customer requirements for offering tailor made products and services.
TEST YOURSELF
a. ___________ is the most popular devise in India, which enables the customers to withdraw their
money 24 hours a day
b. ___________ means acquire information such as usernames, passwords, credit card details, personal
detail etc. by electronic communication.
c. ___________ is a risk of information handling or processing will fail to meet regulatory, IT or business
policy requirements.
d. ___________ is a collection of decision support technologies for gathering, providing access to, and
analyzing data for the purpose of helping enterprise users (executives, managers and analysts)
make better and faster business decisions.
e. Analytics is of ___________ types. They are ___________, ___________ and ___________.
f. Cyber Security controls are applicable to ______________________ in India.
g. Performance of IS Audit and Evaluation of significant IS Audit issues are the responsibilities of
______________________ at the apex level of the banks.
a. Fund transfers through the NEFT system do not occur in real-time basis.
b. CORE banking enables anytime anywhere banking.
c. ATMs can only be used for withdrawals of money.
d. Application layer contains the business logic (for processing of data and transactions) and
necessary interfaces to the data layer.
e. Cyber crime includes all unauthorized access of information and break of security like privacy,
password, etc. with the use of internet
1. What are IT related risks and controls? Mention briefly about them.
2. Write a short note on cyber crime
3. What is the importance of the MIS for a bank
4. What is core banking? What are the controls in Core Banking process flow?
List of Further Reading

• Article by Ana Savic Managing IT-Related Operational Risks.
• http://shodhganga.inflibnet.ac.in/bitstream/10603/84085/16/16_chapter4.
• A Study of Information Security Systems for core Banking in urban co-operative Banks of Pune &
Mumbai”.
• Latest Face of Cybercrime and Its Prevention In India, Vineet Kandpal HMI Technology Pvt. Ltd. Almora.
• Management Information System (MIS) in Banking Sector, Khaja Mohammad Fathe Ali.
• Data Analytics: A Phenomenal, Pervasive, Productive and Profitable Paradigm - Dr. V. Ravi, Professor,
IDRBT.
Lesson 7 • Payment and Collection of Cheques and other Negotiable Instruments 213
Payment and Collection

Lesson 7 of Cheques and other
Negotiable Instruments
Should Know
• Promissory Note To provide an insight of various • Banking Regulation Act, 1949
• Bill Of Exchange negotiable instruments and the role • Banking Negotiable
of a bank in collecting and paying Instruments Act, 1881
• Payment in due these instruments. The lesson will
Course enable a reader to understand:
• Crossing of a cheque • What are negotiable instruments?
• Important Provisions of
Negotiable Instruments Act, 1881.
• Collection and Payment of
Negotiable Instruments.
• Working of clearing house
Lesson Outline
• Introduction
• Negotiable Instruments Act, 1881
• Endorsements
• Role and Duties of a Paying Bank
• Forged Instruments
• Bouncing/Return of Cheques and its Implications
• Role and Duties of a Collecting Bank
• Cheque Truncation System
• LESSON ROUND UP
• TEST YOURSELF
213
INTRODUCTION
The topics covered in this chapter deals with payment and collection of cheques and other negotiable
instruments like of Bill of Exchange, Promissory Notes and Cheques, etc. The objective of the chapter is to
familiarize a reader to the various types of negotiable instruments, the statutory role and responsibilities of a
banker, related aspects like crossings, endorsements, forgeries, implications of dealing with forged instruments,
liabilities thereof, duties of a collecting and paying banker as set out in the Negotiable Instruments Act, 1881. In
addition, an overview of the modern Image based cheque collection process under Cheque Truncation System
(CTS) is also given to make the reader familiar with the current process that is in vogue in banking.
For an easy understanding of a student, materially important sections from a professional banker’s point of
view from the Act are discussed.
The contents are presented in such a way that it would help a student to equip himself with basic knowledge,
operational practicalities as well as for advisory role in future should he chooses to take. The contents are a mix
of level 1 and 2 orientations.
Negotiable Instruments Act, 1881

Section Deals with
Section 4 Promissory Note
Section 5 Bill of Exchange
Section 6 Cheque
Section 7, 8 & 9 Parties to a Negotiable Instrument
Section 10 Payment in due Course
Section 11 & 12 Inland and Foreign Instrument
Section 14 Negotiation - Better Title to Transferee
Section 15 And 16 Of Endorsements
Negotiable
Section 18 to 38, 43, Characteristics of Negotiable Instruments under various sections
46, 79, 80, 85 to 89
Section 99 Noting
Section 100 & 101 Protest
Section 117 Compensation
Section 118 Presumptions
Section 123 to 131A Crossing of a cheque
Section 138 Dishonour of Cheque for Insufficiency, etc., of Funds in the Account
Section 139 Presumption in Favour of Holder
Section 140 Defence which may not be allowed in any Prosecution under Section 138
Section 141(1) Offences by Companies
Section 142A Validation for Transfer of Pending Cases
Section 143 Power of Court to try Cases Summarily
Section 144 Mode of Service of Summons
Section 145 Evidence on Affidavits
Section 146 Bank’s Slip Prima Facie Evidence of Certain Facts
Section 147 Offences to be Compoundable
Section 148 Power of Appellate Court to Order Payment Pending Appeal against Conviction
Types of Negotiable Instruments

The Negotiable Instruments Act was passed in 1881 and was subsequently amended in 1988 and the again in
2002. The act as on date has 147 sections. The Act is applicable to whole of India. Negotiable instrument is as
such specifically not defined in the Act. Section 13 states “A Negotiable Instrument” (NI) means a promissory
note, bill of exchange or cheque payable either to order or to bearer. A negotiable instrument may be made
payable to two or more payees jointly, or in the alternative to one of the two, or one or some of several payees.
All negotiable instruments are in written form and contains an unconditional undertaking (promise) or
unconditional order.
Following are some of the important sections of Negotiable Instrument Act, 1881 (NI Act) with some
explanations.
Section 4 of Negotiable Instruments Act:

Defines the features of Promissory Note. A “Promissory note” is an
instrument in writing containing
Note the following terms, where A signs instruments as -
an unconditional undertaking,
(a) “I promise to pay B or order Rs.1000.00”. signed by the maker, to pay a
(b) “I acknowledge myself to be indebted to B in Rs.1000.00, to be paid certain sum of money only to, or
on demand, for value received.” to the order of, a certain person
or to the bearer of the instrument.
(c) “Mr. B, I Owe You Rs.1000.00”.
(d) “I promise to pay B Rs.1000.00 and all other sums which shall be
due to him.”
(e) “I promise to pay B, Rs.1000.00, first deducting from it any money which he may owe me.”
(f) “I promise to pay B, Rs.1000.00, seven days after his marriage with C”
(g) “I promise to pay B, Rs.1000.00, after the death of D, provided he leaves me enough money to pay.”
(h) “I promise to pay B, Rs.1000.00 and deliver my blue shirt on 1 January of next year”
In above illustrations only a and b are promissory notes and the rest (c to h) are not.
Section 5 of Negotiable Instruments Act:

A “bill of exchange” is an
For section 4 and 5 of the Act note that a promise or order to pay is
instrument in writing containing
not “conditional”, by reason of the time for payment of the amount or
an unconditional order, signed
any installment thereof being expressed to be on the lapse of a certain
by the maker, directing a certain
period after the occurrence of a specified event which, according to the
person to pay a certain sum of
ordinary expectation of a common man, is certain to happen, although
money only to, or to the order of a
the time of its happening may not be certain. For example, while signing
certain person or to the bearer of
bill of exchange, if the drawer adds certain conditions, it will be treated
the instrument.
as incorrect drawn negotiable instrument.
Sum payable is “certain”, although it includes future interest or is payable at an indicated rate of exchange.
Person is “certain”, although he is mis-named or designated by description only.
Section 6 of Negotiable Instruments Act: A “cheque” is a bill of exchange

A cheque is an example of Bill of exchange which is drawn on a banker drawn on a specified banker
in the form of physical paper (Cheque Book issued by the bank.) In and not expressed to be payable
modern banking system, the cheque in the “electronic form” means a otherwise than on demand and it
cheque drawn by using any computer resource and signed in a secure includes the electronic image of a
system with digital signature (with or without biometrics signature) truncated cheque and a cheque in
and asymmetric crypto system or with electronic signature, as the case the electronic form.
may be (meanings as assigned in Information Technology Act) “A truncated cheque” means a cheque which is
truncated during the course of a clearing cycle, either by the clearing house or by the bank whether paying or
receiving the payment, immediately on
generation of an electronic image for transmission, substituting the further physical movement of the cheque in
writing. Cheque Truncation System replaced the manual processing of clearance of cheques with Image based
solutions with various benefits like faster clearance, cost savings and accurate processing.
Sample Cheque
Parties to a Negotiable Instrument
Section 7 of Negotiable Instruments Act

Defines the role of three parties of negotiable instruments - Drawer, Drawee and Payee.
Example: Mr. Dinesh Sawant, issues a cheque of Rs. 12,000.00 from his savings account with State Bank of India,
Fort Branch to Kalpataru Housings Society as monthly rent, then in this case - Mr. Dinesh Sawant is Drawer,
State Bank of India, Fort Branch is drawee (Under CBS environment the cheques drawn on one branch of a
particular bank can be paid at any other branch of the said bank as the data is centralized and accessible to all
branches of the said bank, the drawee of the cheque may be considered as the bank and not the branch. In the
example cited above thus the drawee is State Bank of India) and Kalpataru Housing Society is payee.

The maker of a bill of exchange or cheque
The “holder” of NI means any person entitled in his own name is called the “drawer”; the person thereby
to the possession thereof and to receive or recover the amount directed to pay is called the “drawee”.
due thereon from the parties thereto. When in the bill or in any indorsement
thereon the name of any person is given
Section 9 of Negotiable Instruments Act in addition to the drawee to be resorted
The “holder in due course” means any person who for to in case of need, such a person is called
consideration became the possessor of NI, if payable to bearer “drawee in case of need”. After the drawee
of a bill has signed his assent upon the bill,
or the payee or indorsee thereof if payable to order, before the
or if there are more parts thereof than
amount mentioned in it became payable and without having
one, on one of such parts, and delivered
sufficient cause to believe that any defect in the title of the the same, or given notice of such signing
person from whom he derived his title. to the holder or to some person on his
The difference between the “holder” and the “holder in due behalf, he is called the “acceptor.” The
course” can be understood from following: person named in the instrument, to
whom or to whose order the money is to
be paid is called “payee”.
1. Consideration - it is a must to become “holder in due course” but not essential to be a “holder.” For
example, if A issues a cheque to a C - a charitable institution, C cannot become holder in due course.
However, If A issues cheque to G - an owner of grocery shop, from where purchases are done, G becomes
holder in due course.
2. Possession - to be a holder in due course, the possession of the instrument, before it becomes due, is a
must. For example, if a bill of exchange is payable on June 25, 2018, the possessor (payee or endorsee)
must possess the said bill before this date (even if consideration exits).
3. Defect in the title of Negotiable Instrument - in order to become holder in due course the instrument
must be received after taking care that it is free from any defect and the title is good. If P, a partner of a
firm, endorses a cheque in favour of a Partnership firm, in the name of X, to pay off his personal debts. Here
X cannot be holder in due course as apparently the validity of partner’s title over the cheque is doubtful.

Payment in due Course: Any person liable to make payment under a negotiable instrument, must make the
payment of the amount due thereunder in due course in order to obtain a valid discharge against the holder.
A payment in due course means a payment in accordance with the apparent tenor of the instrument, in good
faith and without negligence to any person in possession thereof.
A payment will be a payment in due course if:
(a) it is in accordance with the apparent tenor of the instrument, i.e., according to what appears on the face of
the instrument to be the intention of the parties;
(b) it is made in good faith and without negligence, and under circumstances which do not afford a ground for
believing that the person to whom it is made is not entitled to receive the amount;
(c) it is made to the person in possession of the instrument who is entitled as holder to receive payment;
(d) payment is made under circumstances which do not afford a reasonable ground believing that he is not
entitled to receive payment of the amount mentioned in the instrument; and
(e) payment is made in money and money only.
Under Sections 10 and 128, a paying banker making payment in due course is protected.
Some examples, where the payment of cheque, is not a payment in due course -
1. Payment of a postdated cheque (Cheque bearing a date 20 July, 2018 is paid on 15 July, 2018)
2. A cheque bearing crossing in the name of “State Bank of India”, is paid to when presented by “Bank of
India”
3. A cheque, the payment of which was already countermanded (stopped) by the drawer, is paid when
presented.
Inland and foreign instrument

Section 11 & 12 of Negotiable Instruments Act: Inland and Foreign instrument - A NI drawn or made in India,
and made payable in, or drawn upon any person resident in India shall be deemed to be an inland bill and any
such instrument not so drawn, made or made payable shall be deemed to be a foreign instrument.
Some examples of inland and foreign instruments -
1. A, a seller from Mumbai, draws a bill on B, a buyer from Baroda, payable at Kolkata - Inland
2. A, a seller from Nasik, draws a bill on B, a buyer from London, payable at Mumbai - Inland
3. A, a seller from Baroda, draws a bill on B, a buyer from London, payable at New York - Foreign
4. A, a seller from Mumbai, draws a bill on B, a buyer from Baroda, payable at London - Inland
Negotiation - Better Title to Transferee

Section 14 of Negotiable Instruments, Act: Negotiation - when a NI is transferred to any person, so as to
constitute that person the holder thereof, the instrument is said to be negotiated.
The difference between transferability and negotiability - In case of a commodity the transferor cannot pass on
a better title than what he has, to the transferee, as a general rule. It is not so in case of NIs, where the transferee
can get better title than the transferor.
For example, If A sells a TV set (commodity) to B which is actually stolen by A and B purchases it after paying
price (consideration) and without the knowledge that it is stolen one, later on if it is revealed and proved that
it is a stolen set, B will have to return the TV set to true owner (in spite of paying consideration and not being
aware of the fact that it was a stolen one.) However, had it been a cheque (NI) where B was not aware that A
from whom he had taken it for consideration and in good faith, without having knowledge of the defect in the
title, can have better title than A.
ENDORSEMENTS
Section 15 and 16 of Negotiable Instruments Act: Indorsement (endorsement) - when the maker or holder
of a NI signs the same, otherwise than as maker, for the purpose of negotiation, on the back or face thereof or on
a slip of paper annexed thereto for purpose of receiving an additional endorsements as sufficient space may not
be there on the back 44 of the page (Allonge), he is said to indorse (endorse) the same and is called as indorser
(endorser).
In present days scenario the cheques with endorsements are not seen as it is expected that every person who
holds a cheque in his favour must open an account with the bank and get the proceeds of the cheque collected
in his account only.
If the endorser signs his name only, the endorsement is said to be “in blank”, and if he adds a direction to pay the
amount mentioned in the instrument to or to the order of a specified person, the endorsement is said to be “in
full”. For example A issues cheque to B for Rs. 5000 /- and B endorse cheques to C and write on the back of the
cheque as “Pay C “and signs with the name, will be considered as endorsement in full. The person so specified
is “indorsee (endorsee)” of the instrument.
• The cheque can not be endorsed when - Account Payee crossing, Restrictive endorsement, and Negotiation
back to drawer,
Other types of endorsements in addition to “in blank” and “in full” endorsements -
1. “Conditional” where the endorser excludes his own liability or makes it conditional (the right of endorsee
to receive the amount due on the instrument depends on happening of a specified event, which may or
may not happen) (Section 52)
2. “Restrictive” where the right to negotiate or receive the amount is restricted or excluded. e.g. “Pay A only”
(Section 50)
3. Sans Recourse (without liability) where the endorser excludes his liability. e.g. “Pay to A without recourse
to me.” (Section 52)
4. Facultative where the right of a endorsee to give a notice of dishonour to the endorser is waived, in writing.
Characteristics of Negotiable Instruments under various sections

Section18 of Negotiable Instruments Act: Where the amount undertaken or ordered to be paid is stated
differently in figures and in words, the amount stated in words shall be the amount undertaken or ordered to
be paid. For example, The amount in words in cheque is mentioned as Rs. Six thousand only and in the figures
it is mentioned as Rs.60000/-, cheque should be paid with Rs. 6000/-.
Section 19 of Negotiable Instruments Act: A promissory note and a bill of exchange, in which no time is for
payment is specified, and a cheque are payable on demand.
Section 21 of Negotiable Instruments Act: In a promissory note or bill of exchange the expressions “at
sight” and “on presentation” mean “on demand”. The expression “after sight” means, in a promissory note,
after presentation and in bill of exchange, after acceptance, or noting for non-acceptance or protest for non-
acceptance.
Section 22 of Negotiable Instruments Act: “Maturity” of a promissory note or bill of exchange is the date at
which it falls due.
Every promissory note or bill of exchange which is not expressed to be payable on demand, at sight or on
presentation is at maturity on the third day after the day on which it is expressed to be payable. (“Days of
Grace”)
Section 23, 24 & 25 of Negotiable Instruments Act: In calculating the maturity date of promissory note or
bill of exchange, made payable at stated number of months after date or after sight, the period stated shall be
held to terminate on the day of the month which corresponds with the day on which the instrument is dated, or
presented for acceptance or sight. If the month in which the period would terminate has no corresponding day,
the period shall terminate on the last day of such month.
In calculating the date at which promissory note or bill of exchange made payable a certain number of days after
date or sight, the day of the date, or presentation, sight shall be excluded.
When the day on which a promissory note or bill of exchange is at maturity is a public holiday (or Sunday or any
other day declared as public holiday by notification), the instrument will be due on next preceding business day.
Examples:
1. A bill dated 31st August, 2018 payable 3 months after date will be due on 3rd November, 2018. (since
November has 30 days, the 3 months period will complete on November 30. Adding 3 days of grace, the
3rd day of grace will be the due date which is 3rd November)
2. A bill dated 1st January 2018, payable 30 days after date will be due on 3rd February, 2018. (31 days of
January, day of the bill to be exclude so 30 days completed on 31st January. Adding 3 days of grace, the 3rd
day of grace being the due date, it will be 3rd February 2018.)
3. If the above bill in example 2, is payable 30 days after sight and is accepted on 5th of January 2018, the due
date of the bill would be 7th February 2018. (excluding date of acceptance 26 days of January plus 4 day of
February will make 30 days. Thereafter adding 3 days of grace, the third day of grace will be 7th February
2018, which will be the due date.)
4. If the same bill in example 2, is payable one month after date, the due date would 4th February 2018.
(excluding date of bill that is 1st January, from 2nd of January one month will be completed on 1st of
February. Adding 3 days of grace the third day of grace would be 4th February 2018.)
5. if the same bill in example 2, is payable one month after sight and is accepted on 5th January, the due
date would be 8th February 2018. (excluding date of acceptance that is 5th January, from 6th of January
one month will be completed on 5th February. Adding 3 days of grace, the third day of grace that is 8th
February 2018 will be the due date.)
Section 26 of Negotiable Instruments Act: Every person capable of contracting, according to the law to which
he is a subject, may bind himself and be bound by the making, drawing, acceptance, endorsement, delivery and
negotiation of a NI.
Minor may draw, endorse, deliver and negotiate such instrument so as to bind all parties except himself.
Section 27 & 28 of Negotiable Instruments Act: Every person capable of binding himself or of being bound,
may so bind himself or be bound by a duly authorized agent acting in his name.
An agent who signs his name to a NI without indicating thereon that he signs as agent, or that he does not intend
thereby to incur personal responsibility, is liable personally on the instrument.
Section 30 of Negotiable Instruments Act: The drawer of a bill or cheque is bound, in case of dishonour by
the drawee or accepter thereof, to compensate the holder, provided due notice of dishonour has been given to
or received by the drawer.
Section 31 of Negotiable Instruments Act: The drawee of a cheque having sufficient funds of the drawer in
his hands properly applicable to the payment of such cheque must pay the cheque when duly required so to do,
and, in default of such payment, must compensate the drawer for any loss or damage caused by such default.
Section 36 of Negotiable Instruments Act: Every prior party to a negotiable instrument is liable thereon to a
holder in due course until the instrument is duly satisfied.
Section 38 of Negotiable Instruments Act: Example: A (drawer) draws a bill to his own order on B (drawee)
who accepts it (acceptor). A afterwards endorses the bill to C, C to D, and D to E. As between E and B, B is
principal debtor and A, C and D are sureties. As between E and A, A is the principal debtor and C and D are
sureties. As between E and C, C is the principal debtor and D is surety.
Section 43 of Negotiable Instruments Act: A negotiable instrument made, drawn, accepted, endorsed or
transferred without consideration, or for a consideration which fails, creates no obligation of payment between
the parties to the transaction. But if any such party has transferred the instrument with or without endorsement
to a holder for consideration, such holder, and every subsequent holder deriving title from him, may recover the
amount due on such instrument from the transferor for consideration or any prior party thereto.
Section 46 of Negotiable Instruments Act: The making, acceptance or endorsement of a promissory note, bill
of exchange or cheque is completed by delivery, actual or constructive.
NI payable to bearer is negotiable by the delivery thereof.
NI payable to order is negotiable by the holder by endorsement and delivery thereof.
Section 79 & 80 of Negotiable Instruments Act: When interest at a specified rate is expressly made payable
on a promissory note or bill of exchange, interest shall be calculated at the rate specified, on the amount of the
principal money due thereon, from the date of the instrument, until tender or realization of such amount, or
until such date after the institution of a suit to recover such amount as the court directs.
When no rate is specified in the instrument, interest will be calculated at the rate of 18% p.a.
Section 85 & 85A of Negotiable Instruments Act: 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. Order cheques can be transferred
by endorsement and delivery from one person to another.
When 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 in blank appearing, thereon,
and notwithstanding that any such endorsement purports to restrict or excludes further negotiation. Bearer
cheques can be transferred by mere delivery from one person to another.
Where any draft (DD - Demand Draft) payable to order on demand, purports to be endorsed by or on behalf of
the payee, the bank is discharged by payment in due course.
Section 87 & 88 of Negotiable Instruments Act: Any material alteration of a NI renders the same void against
anyone who is a party thereto at the time of making such alteration and does not consent thereto, unless it was
made in order to carry out the common intention of the original parties. Any alteration in the cheques need
to be authenticate by the drawer with full signature. Signature of the drawer on the negotiable instrument
is a mandate of the drawer therefore any material alteration in the cheques change the customer`s mandate.
Example alteration in payee`s name, date, amount in words or figures. Opening of crossing etc. requires drawer`s
full signature.
Any such alteration, if made by endorsee, discharges its endorser from all liability to him in respect of the
consideration thereof.
Section 89 of Negotiable Instruments Act: Where a NI has been materially altered but does not appear to
have been so altered, or where a cheque is presented for payment which does not at the time of presentation
appear to be crossed or to have had crossing which has been obliterated, -
Payment thereof in due course, shall discharge such a person or bank from all liability thereon.
Where the cheque is an electronic image of a truncated cheque, any difference in apparent tenor of such
electronic image and the truncated cheque shall be a material alteration and it shall be the duty of the bank or
the clearing house, as the case may be, to ensure the exactness of the apparent tenor of electronic image of the
truncated cheque while truncating and transmitting the image.
Any bank or a clearing house which receives a transmitted image of a truncated cheque, shall verify from the
party who transmitted the image to it, that the image so transmitted to it and received by it, is exactly the same.
Noting
Section 99 of Negotiable Instruments Act: When a promissory note or bill of exchange has been dishonoured
by non-acceptance, or non-payment, the holder may cause such dishonour to be noted by a notary public upon
the instrument, or upon a paper attached thereto.
Such note must be made within a reasonable time after dishonour, and must specify the date of dishonour, the
reason if any for dishonour, or if the instrument has not been expressly dishonoured, the reason why the holder
treats it as dishonoured, and the notary charges.
Protest
Section 100 & 101 of Negotiable Instruments Act: When a promissory note or bill of exchange has been
dishonoured by non-acceptance or non-payment, the holder may, within a reasonable time, cause such
dishonour to be noted and certified by a notary public. Such certificate is called a protest. The protest must
contain -
(a) Either the instrument itself or a literal transcript of the instrument.
(b) The name of the person for whom and against whom the instrument protested.
(c) A statement (payment, acceptance, better security) that has been demanded of such person by the notary
public.
(d) Date, place and time of dishonour.
(e) The subscription of notary public making the protest.
(f) The name of the person by whom, of the person for whom, and the manner in which, such acceptance or
payment was offered and effected.
Compensation
Section 117 of Negotiable Instruments Act: The compensation payable in case of dishonour of a promissory
note, bill of exchange or cheque, by any party liable to the holder or any endorser shall be determined by the
following rules -
(a) The holder is entitled to the amount together with the expenses incurred in presenting, noting and
protesting.
(b) When the person charged resides at a place different from that at which the instrument was payable, the
holder is entitled to receive such sum at the current rate of exchange between two places.
(c) The endorser is entitled to the amount paid with interest from the date of payment until tender or
realization thereof, together with all expenses caused by the dishonour and payment.
(d) When the person charged and such endorser reside at different places, the endorser is entitled to receive
such sum at the current rate of exchange between two places.
(e) The party entitled to compensation may draw a bill upon the party liable to compensate him, payable
at sight or on demand, for the amount due to him. Such bill must be accompanied by the instrument
dishonoured and the protest, if any. If such bill is dishonoured, the party dishonouring is liable to make
compensation thereof in the same manner as in the case of original bill.
Presumptions
Section 118 of Negotiable Instruments Act: Until the contrary is proved, the following presumptions shall be
made to negotiable instrument.
(a) Consideration - that every negotiable instrument was made or drawn for consideration, and that such
instrument, when it was accepted, endorsed, negotiated or transferred, was accepted, endorsed, negotiated
or transferred for consideration.
(b) Date - that every negotiable instrument bearing a date was made or drawn on such date.
(c) Time of acceptance - that every accepted bill of exchange was accepted within the reasonable time after
its date and before its maturity.
(d) Time of transfer - that every transfer of negotiable instrument was made before its maturity.
(e) Order of endorsements - that the endorsements appearing upon a negotiable instrument were made in
the order in which they appear thereon.
(f) Stamp - that a lost instrument was duly stamped.
(g) Holder is a holder in due course.
Crossing of a cheque
Section 123 of Negotiable Instruments Act: Where a cheque bears across its face an addition of the words
“and company” or any abbreviation thereof, between two parallel transverse lines, or of two parallel transverse
lines simply, either with or without the words “not negotiable”, that addition shall be deemed a crossing, and
the cheque shall be deemed to be crossed generally. Crossed cheque cannot be paid on the bank branch counter
for cash payment and has to be paid through clearing process.
Section 124 of Negotiable Instruments Act: Where a cheque bears across its face an addition of the name
of a banker, either with or without the words “Not Negotiable”, that addition shall be deemed a crossing and
the cheque shall be deemed to be crossed specially, and to be crossed to that banker. (in special crossing, two
parallel transverse line are not necessary) . (e.g. a cheque is drawn as “Pay State Bank of India Account No.111
Mr. XYZ., is also a cheque specially crossed to SBI even if it does not bear two parallel transverse lines on the face
of it. Special crossed cheques need to be mandatory collected by the bank whose name is mentioned between
the two parallel lines and where the payee`s account is maintained. Special crossing make the cheque more safe
and reduces the risk of wrong credit.
Section 125 of Negotiable Instruments Act: Where a cheque is uncrossed, the holder may cross it generally
or specially.
– Where a cheque is crossed generally, the holder
may cross it specially.
– Where a cheque is crossed generally or
specially, the holder may add the words “Not
Negotiable”
– Where a cheque is crossed specially, the
banker to whom it is crossed may again cross
it specially to another banker, his agent for
collection.
Section 126 of Negotiable Instruments, Act: Where a cheque is crossed generally, the banker on whom it is
drawn shall not pay it otherwise than to a banker.
– Where a cheque is crossed specially, the banker on whom it is drawn shall not pay it otherwise than to the
banker to whom it is crossed, or his agent for collection.
Section 127 of Negotiable Instruments Act: Where a cheque is crossed specially to more than one banker, except
when crossed to an agent for the purpose of collection, the banker on whom it is drawn shall refuse payment
thereof.
Section 128 of Negotiable Instruments Act: 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 right, and be placed in the same position in
all respects, as they would respectively be entitled to and placed in if the amount of the cheque had been paid
to and received by the true owner thereof.
Section 129 of Negotiable Instruments Act: Any banker paying a cheque crossed generally otherwise than
to a banker, or a cheque crossed specially otherwise than to a banker to whom it is crossed, or his agent for
collection, being a banker, shall be liable to the true owner of the cheque for any loss he may sustain owing to
the cheque having been so paid.
Section 130 of Negotiable Instruments Act: A person taking a cheque crossed generally or specially, bearing
in either case the words “not negotiable”, shall not have, and shall not be capable of giving, a better title to the
cheque than that which the person from whom he took it had.
Section 131 of Negotiable Instruments Act: A banker who has in good faith and without negligence received
payment for a customer of a cheque crossed generally or specially to himself shall not, in case the title of the
cheque proves defective, incur any liability to the true owner of the cheque by reason only of having received
such payment.
A banker receives payment of a crossed cheque for a customer within the meaning of this section notwithstanding
that he credits his customers’ account with the amount of the cheque before receiving payment thereof.
It shall be the duty of the banker who receives payment based on an electronic image of a truncated cheque
held with him, to verify the prima facie genuineness of the cheque to be truncated and any fraud, forgery or
tampering apparent on the face of the instrument that can be verified with due diligence and ordinary care.
Section 131A of Negotiable Instruments Act: These provisions shall apply to any draft, as defined in section
85A, as if the draft were a cheque.
Penalties for dishonour of a cheque

Chapter XVII of the Negotiable Instruments Act, 1881 provides for penalties in case of dishonour of certain
cheques for insufficiencies of funds in the accounts. Sections 138 to 147 deal with these aspects.
Chapter XVII has been amended by the Negotiable Instruments (Amendment and Miscellaneous Provisions)
Act, 2002. The amendments have provided the drawer with more time to send notice, made the punishment
for the offence more stringent, given power to court for condonation of delay in filing of complaint, excluded
liability of government nominated directors, made provision for summary trial of cases under the Chapter
and time bound disposal of cases, have relaxed the rules of evidence, and made the offences under the Act
compoundable.
The working of the provisions of Chapter XVII for a period of more than a decade had brought to the fore
front various lacunae and shortcomings from which it suffered. It was seen that there were enormous delays
in the disposal of the cases filed under Section 138 and the drawer of the cheques, by taking shield of various
technicalities and procedures were frustrating the very object of the Chapter.
Further Chapter XVII amended by the Negotiable Instruments (Amendment) Act, 2015. The amendment
focused on clarifying the jurisdiction related issues for filing cases for offence committed under section 138 of
the Negotiable Instruments Act, 1881. The Negotiable Instruments (Amendment) Act, 2015, facilitates filing
of cases only in a court within whose local jurisdiction the bank branch of the payee, where the payee delivers
the cheque for payment through his account, is situated, except in case of bearer cheques, which are presented
to the branch of the drawee bank and in that case the local court of that branch would get jurisdiction. The
Negotiable Instruments (Amendment) Act, 2015 provides for retrospective validation for the new scheme of
determining the jurisdiction of a court to try a case under Section 138 of the Negotiable Instruments Act, 1881.
The Negotiable Instruments (Amendment) Act, 2015 also mandates centralisation of cases against the same
drawer.
With a view to address the issue of undue delay in final resolution of cheque dishonour cases so as to provide
relief to payees of dishonoured cheques and to discourage frivolous and unnecessary litigation, Parliament
enacted the Negotiable Instruments (Amendment) Act, 2018 and notified by the Central Government on 1st
September, 2018.The Amendments Act strengthen the credibility of cheques and help trade and commerce
in general by allowing lending institutions, including banks, to continue to extend financing to the productive
sectors of the economy. The Negotiable Instruments (Amendment) Act, 2018 inserted two new sections i.e.
Section 143A dealing with Power to direct interim compensation and Section 148 dealing with Power of
Appellate Court to order payment pending appeal against conviction.
Dishonour of Cheque for Insufficiency, etc., of Funds in the Account

Section 138 of the Act provides that where any cheque drawn by a person on an account maintained by him with
a banker for payment of any amount of money to another person from out of that account for the discharge, in
whole or in part, of any debt or other liability, is returned by the bank unpaid, either because of the amount of
money standing to the credit of that account is insufficient to honour the cheque or that it exceeds the amount
arranged to be paid from that account by an agreement made with that bank, such person shall be deemed to
have committed an offence and shall, without prejudice to any other provision of this Act, be punished with
imprisonment for a term which may be extended to two years’, or with fine which may extend to twice the
amount of the cheque, or with both.
Provided that nothing contained in this section shall apply unless -
(a) the cheque has been presented to the bank within a period of six months from the date on which it is
drawn or within the period of its validity, whichever is earlier;
(b) the payee or the holder in due course of the cheque, as the case may be, makes a demand for the payment
of the said amount of money by giving a notice; in writing, to the drawer of the cheque, within thirty days]
of the receipt of information by him from the bank regarding the return of the cheque as unpaid; and
(c) the drawer of such cheque fails to make the payment of the said amount of money to the payee or, as the
case may be, to the holder in due course of the cheque, within fifteen days of the receipt of the said notice.
Presumption in Favour of Holder

As per Section 139 of the Act, it shall be presumed, unless the contrary is proved, that the holder of a cheque
received the cheque of the nature referred to in section 138 for the discharge, in whole or in part, of any debt
or other liability.
Defence which may not be allowed in any Prosecution under Section 138
Section 140 states that it shall not be a defence in a prosecution for an offence under section 138 that the drawer
had no reason to believe when he issued the cheque that the cheque may be dishonoured on presentment for
the reasons stated in section 138.
Offences by Companies
According to Section 141(1) of the Act, if the person committing an offence under section 138 is a company,
every person who, at the time the offence was committed, was in charge of, and was responsible to, the company
for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the
offence and shall be liable to be proceeded against and punished accordingly.
Provided that nothing contained in this sub-section shall render any person liable to punishment if he proves
that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the
commission of such offence.
Provided further that where a person is nominated as a Director of a company by virtue of his holding any office
or employment in the Central Government or State Government or a financial corporation owned or controlled
by the Central Government or the State Government, as the case may be, he shall not be liable for prosecution
under Chapter XVII.
Further Section 141 (2) states that notwithstanding anything contained in sub-section (1), where any offence
under this Act has been committed by a company and it is proved that the offence has been committed with the
consent or connivance of, or is attributable to, any neglect on the part of, any director, manager, secretary or
other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty
of that offence and shall be liable to be proceeded against and punished accordingly.
Explanation: For the purposes of section 141 (a) “company” means anybody corporate and includes a firm or
other association of individuals; and (b) “director”, in relation to a firm, means a partner in the firm.
Cognizance of Offences
As per Section 142(1) of the Act, notwithstanding anything contained in the Code of Criminal Procedure, 1973 -
(a) no court shall take cognizance of any offence punishable under Section 138 except upon a complaint, in
writing, made by the payee or, as the case may be, the holder in due course of the cheque;
(b) such complaint is made within one month of the date on which the cause of action arises under clause (c)
of the proviso to Section 138.
Clause (c) of the proviso to Section 138 provides that the drawer of such cheque fails to make the payment of
the said amount of money to the payee or, as the case may be, to the holder in due course of the cheque, within
fifteen days of the receipt of the said notice.
Provided that the cognizance of a complaint may be taken by the Court after the prescribed period, if
the complainant satisfies the Court that he had sufficient cause for not making a complaint within such
period;
(c) no court inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the first class shall try any
offence punishable under Section 138.
Further, Section 142(2) provides that the offence under Section 138 shall be inquired into and tried only by a
court within whose local local jurisdiction -
(a) if the cheque is delivered for collection through an account, the branch of the bank where the payee or
holder in due course, as the case may be, maintains the account, is situated; or
(b) if the cheque is presented for payment by the payee or holder in due course, otherwise through an account,
the branch of the drawee bank where the drawer maintains the account, is situated.
Explanation: For the purposes of clause (a), where a cheque is delivered for collection at any branch of the
bank of the payee or holder in due course, then, the cheque shall be deemed to have been delivered to the
branch of the bank in which the payee or holder in due course, as the case may be, maintains the account.
Validation for Transfer of Pending Cases

Section 142A (1) of the Negotiable Instrument Act states that notwithstanding anything contained in the Code
of Criminal Procedure, 1973 or any judgment, decree, order or direction of any court, all cases transferred to
the court having jurisdiction under section 142(2), as amended by the Negotiable Instruments (Amendment)
Ordinance, 2015, shall be deemed to have been transferred under this Act, as if that sub-section had been in
force at all material times.
As per Section 142A(2), notwithstanding anything contained in Section 142(2) or Section 142(1), where the
payee or the holder in due course, as the case may be, has filed a complaint against the drawer of a cheque in
the court having jurisdiction under section 142(2) or the case has been transferred to that court under Section
142(1) and such complaint is pending in that court, all subsequent complaints arising out of section 138 against
the same drawer shall be filed before the same court irrespective of whether those cheques were delivered for
collection or presented for payment within the territorial jurisdiction of that court.
Section 142A(3) states that if, on the date of the commencement of the Negotiable Instruments (Amendment)
Act, 2015, more than one prosecution filed by the same payee or holder in due course, as the case may be, against
the same drawer of cheques is pending before different courts, upon the said fact having been brought to the
notice of the court, such court shall transfer the case to the court having jurisdiction under Section 142(2), as
amended by the Negotiable Instruments (Amendment) Ordinance, 2015, before which the first case was filed
and is pending, as if that sub-section had been in force at all material times.
Power of Court to try Cases Summarily

Section143 (1) of the Act provides that notwithstanding anything contained in the Code of Criminal Procedure,
1973 all offences under Chapter XVII of the Act shall be tried by a Judicial Magistrate of the first class or by
a Metropolitan Magistrate and the provisions of sections 262 to 265 (both inclusive) of the Code of Criminal
Procedure, 1973 shall, as far as may be, apply to such trials.
Provided that in the case of any conviction in a summary trial under this section, it shall be lawful for the
Magistrate to pass a sentence of imprisonment for a term not exceeding one year and an amount of fine
exceeding five thousand rupees.
Provided further that when at the commencement of, or in the course of, a summary trial under this section,
it appears to the Magistrate that the nature of the case is such that a sentence of imprisonment for a term
exceeding one year may have to be passed or that it is, for any other reason, undesirable to try the case
summarily, the Magistrate shall after hearing the parties, record an order to that effect and thereafter recall any
witness who may have been examined and proceed to hear or rehear the case in the manner provided by the
Code of Criminal Procedure, 1973.
As per Section143(2), the trial of a case under this section shall, so far as practicable, consistently with the
interests of justice, be continued from day to day until its conclusion, unless the Court finds the adjournment of
the trial beyond the following day to be necessary for reasons to be recorded in writing.
Section1433) states that every trial under this section shall be conducted as expeditiously as possible and an
endeavour shall be made to conclude the trial within six months from the date of filing of the complaint.
Power to Direct Interim Compensation

Section 143A(1)Negotiable Instruments Act provides that notwithstanding anything contained in the Code
of Criminal Procedure, 1973, the Court trying an offence under section 138 of the Negotiable Instrument
Act,1881(Dishonour of cheque for insufficiency, etc., of funds in the account) may order the drawer of the
cheque to pay interim compensation to the complainant-
(a) in a summary trial or a summons case, where he pleads not guilty to the accusation made in the complaint;
and
(b) in any other case, upon framing of charge.
Section 143A (2) states that the interim compensation under sub-section (1) shall not exceed twenty per cent.
of the amount of the cheque.
Section 143A (3), the interim compensation shall be paid within sixty days from the date of the order under
sub- section (1), or within such further period not exceeding thirty days as may be directed by the Court on
sufficient cause being shown by the drawer of the cheque.
As per Section 143A (4), if the drawer of the cheque is acquitted, the Court shall direct the complainant to repay
to the drawer the amount of interim compensation, with interest at the bank rate as published by the Reserve
Bank of India, prevalent at the beginning of the relevant financial year, within sixty days from the date of the
order, or within such further period not exceeding thirty days as may be directed by the Court on sufficient
cause being shown by the complainant.
Section 143A (5) provides that the interim compensation payable section 143A may be recovered as if it were
a fine under section 421 of the Code of Criminal Procedure, 1973.
As per Section 143A(6), the amount of fine imposed under section 138 or the amount of compensation awarded
under section 357 of the Code of Criminal Procedure, 1973, shall be reduced by the amount paid or recovered
as interim compensation under this section.
Mode of Service of Summons

According to Section 144 of the Act, a Magistrate issuing a summons to an accused or a witness may direct
a copy of summons to be served at the place where such accused or witness ordinarily resides or carries on
business or personally works for gain, by speed post or by such courier services as are approved by a Court of
Session.
Where an acknowledgment purporting to be signed by the accused or the witness or an endorsement purported
to be made by any person authorised by the postal department or the courier services that the accused or the
witness refused to take delivery of summons has been received, the Court issuing the summons may declare
that the summons has been duly served.
Evidence on Affidavit
Section 145 of the Act provides that notwithstanding anything contained in the Code of Criminal Procedure,
1973, the evidence of the complainant may be given by him on affidavit and may, subject to all just exceptions
be read in evidence in any enquiry, trial or other proceeding under the Code of Criminal Procedure, 1973.
The Court may, if it thinks fit, and shall, on the application of the prosecution or the accused, summon and
examine any person giving evidence on affidavit as to the facts contained therein.
Bank’s Slip Prima Facie Evidence of Certain Facts

According to Section 146, the Court shall, in respect of every proceeding under this Chapter, on production of
Bank’s slip or memo having thereon the official mark denoting that the cheque has been dishonoured, presume
the fact of dishonour of such cheque, unless and until such fact is disproved.
Offences to be Compoundable
Section 147 of the Act provides that notwithstanding anything contained in the Code of Criminal Procedure,
1973, every offence punishable under the Negotiable Instrument Act Act shall be compoundable.
Power of Appellate Court to Order Payment Pending Appeal against Conviction
Section 148(1) provides that notwithstanding anything contained in the Code of Criminal Procedure, 1973, in an
appeal by the drawer against conviction under section 138 of the Negotiable Instrument Act, 1881(Dishonour
of cheque for insufficiency, etc., of funds in the account), the Appellate Court may order the appellant to deposit
such sum which shall be a minimum of twenty per cent. of the fine or compensation awarded by the trial Court.
The amount payable shall be in addition to any interim compensation paid by the appellant under section 143A.
Section 148(2) states that the amount referred to in sub-section (1) shall be deposited within sixty days from
the date of the order, or within such further period not exceeding thirty days as may be directed by the Court on
sufficient cause being shown by the appellant.
As per Section 148(3) the Appellate Court may direct the release of the amount deposited by the appellant to
the complainant at any time during the pendency of the appeal:
It may be noted that if the appellant is acquitted, the Court shall direct the complainant to repay to the appellant
the amount so released, with interest at the bank rate as published by the Reserve Bank of India, prevalent
at the beginning of the relevant financial year, within sixty days from the date of the order, or within such
further period not exceeding thirty days as may be directed by the Court on sufficient cause being shown by the
complainant.
Role and Duties of Paying Bank

Under section 31 of NI Act, it is the duty of a bank to honour the cheque of a customer subject to fulfillment
of certain conditions (Customer as a creditor has right to ask his money back from his banker who is debtor).
Otherwise the bank has to compensate the drawer (customer) for any loss or damage caused due to non-
payment. The conditions to be fulfilled include -
1. The drawer should have sufficient and properly applicable funds in the account from which the cheque is
issued.
Drawer may have more than one account in the same branch of the bank or different branches of the same
bank; he cannot expect bank to combine the balances in his different accounts to honour the cheque.
Similarly the drawer’s balance includes the funds, which are not yet realized, the balance may be sufficient
but not applicable. If a competent court has issued order to the bank, restraining from making payment,
the balance in the drawer’s account may be sufficient but not applicable.
If more than one cheque are received for payment simultaneously, and the balance in the account is not
sufficient to honour all the cheques; it is the decision of the bank to decide which cheque(s) is(are) to
be honoured. This is because it is the duty of a customer to ensure, at the time of issuing cheque, that
adequate balance is available in the account. However, bank’s decision under such situation depends on -
(a) who is the payee? A government department, statutory payments will have priority over individuals.
(b) May be maximum number of cheques and maximum amount of liability is paid. (c) The dates of the
cheques issued earlier are paid first. (d) Amount of the cheques (if cheque(s) of very small amount is/
(are) dishonoured, the reputation in the market is damaged to a large extent).
2. Demand made must be in order. This means-
(a) cheque used is from the cheque book issued by the bank.
(b) cheque is signed by authorized person whose signature is on bank’s record.
(c) cheque is presented within business hours on a working day. (due to technology available, any
branch banking and payment through ATMs are also possible)
(d) cheque is not outdated / postdated.
Under following circumstances, even if sufficient balance is available in the drawer’s account and the
presentation is also proper, the paying bank should not honour the cheque -
(a) Death of a drawer, in case of accounts in the name of individuals (single or joint), proprietor, HUF and
partnership. Even if the cheque bears the date before the death of a drawer, such cheque should be returned.
The status at the time of payment (when the drawer is deceased), matters. In case of joint savings account
with either or survivor operative instructions, a fresh cheque with the signature of the survivor should be
issued. In case of HUF account, the next senior most male coparcener will become Karta, after the death
of Karta. In case of partnership accounts, the cheque can be honoured with the consent of other partners.
In case of death of a director of company the cheque can be passed, since the company is a separate legal
entity, different from the director and has perpetual existence.
(b) Insanity and Insolvency of the drawer - insanity and insolvency bring an end to the operative instructions.
Insanity should be certified by a competent medical practitioner (not MBBS doctor). Competent court
serves notice of insolvency and the balance in the account is vested thereafter with official receiver.
(c) Liquidation of company - here the liquidator is appointed by the court to look after the operations in the
account.
(d) Payment countermanded by the drawer - the drawer who has right to issue cheque, has equal right to stop
(countermand) the payment of cheque. Only drawer can effectively stop the payment of the cheque. The
stop payment instructions must be given in writing and the bank, after noting the date and time of receipt
of the instructions, and making entry in the system, must issue proper acknowledgement for the same.
(e) Cheques issued or endorsed in favour of company, government department, corporate bodies etc, even if
they are open (uncrossed) and bearer should not be paid in cash. These entities must clear the cheques by
depositing them in their account with their bankers.
Paying bank gets protection in following circumstances.
(a) If payment is made in due course. (section 10)
(b) In case the cheque bears endorsements, the endorsements are in order (chain is not broken, even if they
may not be genuine). (section 85)
(c) Material alteration on the cheque which is not apparent at the time of payment. (section 89)
DISHONOUR/RETURN OF CHEQUES AND IT’S IMPLICATIONS

When a banker dishonours a cheque of a customer, appropriate reason in writing, duly signed by its official
must be given. Such cheque may either be returned across the counter or through the clearing. Following are
common reasons for which the cheques are returned.
(a) Refer to drawer - In the past, banks used to return cheques with this reason when there was no sufficient
balance in the drawer’s account to honour the cheque. However, after addition of section 138 in NI Act, it
is now expected that no such reason for insufficiency of funds be given. Some authors are of the opinion
that when the drawer of the cheque becomes insane, the cheque signed by him should be returned with
the reason “refer to drawer”. Except this situation, the reason should not be used.
(b) Not arranged for - basically it means, the drawer has not arranged funds in the account to honour the
cheque.
(c) Effects not clear, present again - where drawer has deposited cheque/(s) which is(are) sent for the clearing
but not yet realized.
(d) Funds expected, present again - where the drawer has submitted some bills for collection, the payment of
which is expected to be received.
(e) Exceeds arrangements - when the over draft / cash credit facility sanctioned to the drawer will exceed the
limit, if the cheque is honoured.
(f) Payment countermanded (stopped) by the drawer.

(g) Drawer’s signature differs / required.
(h) Cheque is outdated (stale) / post dated.
(i) Amount in words and figures differs. - although in such cases NI Act says that amount stated in words
should be honoured, the general practice followed amongst bankers is to return such cheques.
(j) Cheque crossed to two banks (unless the presenting bank is acting as an agent for another bank, whose
crossing appears on the cheque)
FORGED INSTRUMENTS
Forged instrument means signature of a person fraudulently put by somebody else. A negotiable instrument
containing the forged signature of its drawer, maker or acceptor is totally ineffective and the holder cannot
enforce payment on them. If A forges B’s signature on a cheque and gives to C, who accepts it for consideration;
acquires no title. In case such a holder obtains payment, the true owner can sue for recovery. In the absence of
genuine signature of the drawer, maker or acceptor, the instrument is totally worthless and not even the holder
in due course acquires any title thereto. The forged signature cannot be ratified because the forger does not
have authority to act on behalf of the person whose signature is forged.
A negotiable instrument with forged signature of endorser does not pass on valid title to the endorsee even if he
is bonafide holder for value. The true owner will remain entitled to it and payment made to wrong person will
not discharge the drawee, acceptor or the maker of the instrument. The paying banker however gets statutory
protection against payment of cheques with forged endorsement but not with forged signature of the drawer.
ROLE AND DUTIES OF A COLLECTING BANK

When a person receives cheque in his favour, if it is open (uncrossed) and bearer, he can go the bank on which it
is drawn and en-cash the same (receive cash across the counter). However if it is a crossed and order cheque, he
has to deposit it in the bank where he has account. Thereby he appoints his bank as his agent, who collects the
payment for its customer from the bank on which the cheque is drawn. The bank thus acts as a Collecting Bank
and performs the function of agency for its customer. While doing so, the collecting bank acts either as an agent
of customer where the customer is allowed to withdraw money, after the bank receives it from the drawee bank
or as holder for value where the customer is allowed to withdraw money before the cheque is realized (this is
called as cheque purchased).
The most important aspect of collection of cheque for a collecting bank is to avoid conversion. Conversion
means wrongful or unlawful interference (using, selling, occupying or holding) with another person’s property.
Negotiable instruments are included in the term “property” and hence banker may be charged for conversion
if it collects cheques for a customer who has no title or defective title to the instrument. The basic principle is
that rightful owner of the goods can recover the same from anyone who takes it without his authority and in
whose hands it can be traced. When the banker acts as an agent of its customer for the collection of his cheques,
he cannot escape this liability.
Section 131 and 131A provides statutory protection to the collecting banker, when it collects cheques and
demand drafts for its customer. However to avail the protection, collecting banker must fulfill the following
conditions.
1. Cheque must be a crossed cheque - since the protection is not available to un-crossed (open) cheques,
but only for crossed cheques, the collecting bank should ensure that before the cheques are sent to paying
bank, each cheque is affixed with a special crossing stamp, bearing the name of collecting bank. Customers
should also be advised to cross the cheques before they are deposited.
2. The payment must be received for the customer - bankers should ensure that person depositing cheque
for collection has an account with the bank (savings, current or other). The general practice followed by
the bankers is, they first open the account of customer and then extend this cheque collection facility to
them.
3. Collecting bank should have acted in good faith and without negligence - ‘good faith’ means the bank
should have acted bonafide and honestly (whether negligently or not). ‘Without negligence’ means with
reasonable care and without doubt about the genuineness of the validity of title of the customer. Some
examples of negligence are as under:
(a) The account of customer is not properly KYC complied.
(b) The endorsement(s) is(are) not genuine. To ascertain genuineness of endorsement is the duty of
collecting banker.
(c) No enquires are made in case of doubtful cases e.g. - a customer of ordinary means deposits a cheque
of large amount, cheques payable to corporate bodies are endorsed by the authorized signatories for
the credit of their personal accounts or for the credit of accounts of their relatives.
(d) Cheque bearing “Not Negotiable” crossing is negotiated further.
(e) Cheque bearing “Account Payee only” crossing is collected for the account, other than the payee. The
words “Account Payee”, though not mentioned in NI Act, they are still considered to be a part of the
law due to highly extensive practice and usage of this custom. The RBI vide its circular issued to banks,
have advised that an account payee cheque is required to be collected for the payee constituent only.
Duties of Collecting Bank

• To present the cheque for collection in reasonable time, else will be liable for damages if customer incurs,
due to delayed presentation.
• RBI vide its circular has advised banks as under:
(a) Banks are required to give immediate credit up to Rs. 15,000.00 of outstation / local cheques
deposited by all savings, current and cash credit customers - after satisfying about proper conduct of
the account by the customer. In the event of the cheque being returned unpaid, the bank can recover
interest in conformity with applicable interest rate directive of RBI. No interest to be charge for the
period from the date of credit of outstation cheque to date of its return. Where cheque is credited
to a savings account no interest will be charged if the cheque is returned. A notice regarding the
availability of facility should be displayed prominently at each branch.
• If the delay in collection of outstation cheques / instruments is beyond 10days in the case of cheques
lodged at and drawn on state head quarters and beyond 14 days in all other cases, banks should pay
interest at the rate as applicable for appropriate tenure of fixed deposit for the period of delay. Further,
banks should also pay penal interest at the rate of 2 percent above fixed deposit rate for abnormal delay
caused by the branch in collection of outstation instruments.
• While the cheque drop facility may be made available to the customers, the facility of acknowledgement
of cheques at the regular collection counter should not be denied to them. No branch should refuse to give
an acknowledgement on cheques being tendered by the customers at their counters. Customers should be
made aware of both options available to them.
CHEQUE TRUNCATION SYSTEM

The salient features of the Cheque Truncation System (CTS) are as under:
• Truncation is the process of stopping the flow of the physical cheque issued by a drawer to the drawee
branch. The physical instrument will be truncated at some point en-route to the drawee branch and an
electronic image of the cheque would be sent to the drawee branch along with relevant information like
the MICR fields, date of presentation, presenting banks etc. thus the physical movement of cheques across
branches would not be required, except in exceptional circumstances. This would effectively reduce the
time required for payment of cheques, the associated cost of transit and delay in processing, etc., thus
speeding up the process of collection.
• The system thus enhances customer service, reduces reconciliation problems, eliminates logistic problems
etc. Cheque truncation is also a more secure system than the current exchange of physical documents in
which the cheques move from one point to another, thus not only creating delays but inconvenience to the
customer in case the instrument is lost in transit or manipulated during the clearing cycle. It is thus an
important efficiency enhancement initiative in the payment system area, undertaken by RBI.
• The images captured at the presenting bank level would be transmitted to the Clearing House and then
to the drawee branches with digital signatures of the presenting bank. Thus each image would carry the
digital signature, apart from the physical endorsement of the presenting bank, in a prescribed manner.
In order to ensure only images of requisite quality reach the drawee branches, there will be a quality
check process at the level of the Capture Systems and Clearing House Interface. In addition, drawers could
consider using holograms, bar-coding, or such other features, which would add to the uniqueness of
images.
• To ensure security, safety and non-repudiation the PKI (Public Key Infrastructure) is being implemented
across the system. The banks will send the captured images and data to the central clearing house for
onward transmission to the payee/drawee banks. For the purpose RBI will be providing the banks
software called the Clearing House Interface (CH I). The clearing house will process the data and arrive at
the settlement figure for the banks and send the required data to payee/drawee banks for processing at
their end. It will be the responsibility of the drawee bank Capture System to process the inward data and
images and generate the return file for unpaid instruments.
• The criteria for banks participating in the cheque truncation system are - (i) Membership of the clearing
house in the NCR and (ii) Membership of the Indian Financial Network (INFINET). In respect of banks who
are not members of INFINET, they may become the sub-members of the direct members or may use the
infrastructure of the other banks having INFINET membership.
• Imaging of cheques can be based on various technology options. The cheque images can be black and
white, Grey Scale or coloured. Black and White images do not reveal all the subtle features that are there
in the cheques. Coloured images increase storage and network bandwidth requirements, so it was decided
that the electronic images of truncated cheques will be in grey scale technology.
• As all the payments will be made on the basis of images, it is essential to ensure the quality of the images.
RBI will be specifying the image standards to the member banks. The presenting bank is required to
perform the quality audit during the capture itself. Further quality audit will be done at the gateway
before onward transmission to clearing house. The drawee bank can ask for the physical instrument if it is
not satisfied about the image quality for payment processing.
• All the local cheques can be presented in the CTS. Cheques on banks situated outside the NCR, provided
such banks have branches in the NCR region can also be presented. CTS also supports intercity clearing
and high value clearing. The on-us instruments (where the presenting and drawee branches are of the
same bank) are not allowed.
• Customers should use dark coloured ink while writing cheques. The use of rubber stamps should not
overshadow the clear appearance of basic features of the cheques (date, payee’s name, amount and
drawer’s signature).
• Under CTS, after the capture of image, the physical cheque will be warehoused with the presenting bank.
In case the beneficiary or any other connected persons require the instrument, the payee bank could issue
a copy of image, under its authentication, which is called Image Replacement Document (IRD). NI Act
section 81(3) permits the usage of such IRDs.
• It would be obligatory for presenting bank to warehouse the physical instruments for the prescribed
statutory period. In case a customer desires to get a paper instrument back, the instrument can be sourced
from the presenting bank through the drawee bank.
Positive Pay System for Cheque Truncation System

1. The concept of Positive Pay involves a process of reconfirming key details of large value cheques. Under
this process, the issuer of the cheque (drawer) submits electronically, through channels like SMS, mobile
app, internet banking, ATM, etc., certain minimum details of that cheque (like date, name of the beneficiary
/ payee, amount, etc.) to the drawee bank, details of which are cross checked with the presented cheque by
CTS. Any discrepancy is flagged by CTS to the drawee bank and presenting bank, who would take redressal
measures.
2. National Payments Corporation of India (NPCI) shall develop the facility of Positive Pay in CTS and make
it available to participant banks. Banks, in turn, shall enable it for all account holders issuing cheques for
amounts of Rs.50,000 and above. While availing of this facility is at the discretion of the account holder,
banks may consider making it mandatory in case of cheques for amounts of Rs.5,00,000 and above.
3. Only those cheques which are compliant with above instructions will be accepted under dispute resolution
mechanism at the CTS grids. Member banks may implement similar arrangements for cheques cleared /
collected outside CTS as well.
4. Banks are advised to create adequate awareness among their customers on features of Positive Pay System
through SMS alerts, display in branches, ATMs as well as through their web-site and internet banking.
5. Positive Pay System implemented from January 01, 2021.
Extension of Cheque Truncation System (CTS) across all bank branches in the country
RBI on December 04, 2020 has announced the extension of Cheque Truncation System (CTS) across all bank
branches in the country:
1. The CTS is in use since 2010 and presently covers around 1,50,000 branches. All the erstwhile 1219 non-
CTS clearing houses (ECCS centres) have been migrated to CTS effective September 2020. It is, however,
seen that there are branches of banks that are outside any formal clearing arrangement and their customers
face hardships due to longer time taken and cost involved in collection of cheques presented by them.
2. To leverage the availability of CTS and provide uniform customer experience irrespective of location
of her/his bank branch, it has been decided to extend CTS across all bank branches in the country. To
facilitate this, banks shall have to ensure that all their branches participate in image-based CTS under
respective grids by September 30, 2021.
Introduction of Legal Entity Identifier for Large Value Transactions in Centralised Payment
Systems
The Legal Entity Identifier (LEI) is a 20-digit number used to uniquely identify parties to financial transactions
worldwide. It was conceived as a key measure to improve the quality and accuracy of financial data systems for
better risk management post the Global Financial Crisis.
1. It has now been decided to introduce the LEI system for all payment transactions of value 50 crore and
above undertaken by entities (non-individuals) using Reserve Bank-run Centralised Payment Systems viz.
Real Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT).
2. In preparation for the wider introduction of LEI across all payment transactions, member banks should:
i. advise entities who undertake large value transactions ( 50 crore and above) to obtain LEI in time,
if they do not already have one;
ii. include remitter and beneficiary LEI information in RTGS and NEFT payment messages (details of
the identified fields in the messaging structures of RTGS and NEFT for inclusion of LEI information
are at Annex);
iii. maintain records of all transactions of 50 crore and above through RTGS and / or NEFT.
3. Entities can obtain LEI from any of the Local Operating Units (LOUs) accredited by the Global Legal Entity
Identifier Foundation (GLEIF), the body tasked to support the implementation and use of LEI. In India, LEI
can be obtained from Legal Entity Identifier India Ltd. which is also recognised as an issuer of LEI by the
Reserve Bank under the Payment and Settlement Systems Act, 2007.
Case Laws
1. Rajeshbhai Muljibhai Patel and Ors vs. State of Gujarat and Ors (dated 10.02.2020)
Court had the power to quash the criminal complaint filed under Section 138 of the N.I. Act on the legal
issues like limitation, etc.
The Validity of - Sections 114, 406, 420, 465, 467, 468 and 471 of Indian Penal Code, 1860 and Sections
138 and 139 of Negotiable Instruments Act, 1881 was in question.
Hence, present appeal - Whether High Court erred in quash criminal case against Accused under Section
138 of Act and declining to quash FIR against Appellants under Sections 114, 406, 420, 465, 467, 468
and 471 of Code.
Supreme Court held, while allowing the appeals that though, the Court had the power to quash the
criminal complaint filed under Section 138 of the N.I. Act, 1881 on the legal issues like limitation, etc.
Criminal complaint filed under Section 138 of the N.I. Act, 1881 against accused ought not to have been
quashed merely on the ground that there are inter se dispute between Appellant No. 3 and Respondent
No. 2. Without keeping in view the statutory presumption raised under Section 139 of the N.I. Act,1881
the High Court, committed a serious error in quashing the criminal complaint filed under Section 138
of N.I. Act, 1881.
2. Pareshbhai Amrutlal Patel and Ors. vs. The State of Gujarat and Ors.(dated 28.02.2020)
Since the issue in both the cases revolves around the same cheque, therefore, instead of quashing
the FIR, the ends of justice would meet if proceedings arising out of FIR were transferred to the
Court of Judicial Magistrate
Quashing of proceedings - Denial of - Sections 114, 120-B, 379, 406, 419, 420, 465, 467, 468 and 475 of
Indian Penal Code, 1860 and Section 138 of the Negotiable Instrument Act, 1881 was in question.
Hence, in present appeal - Whether impugned proceedings initiated against Appellants liable to be
quashed. It is held, while disposing off the appeal:
(i) The issue in both the complaints pertains to cheque which was said to be from the cheque book of
the Company of which Respondent No. 2 was the officer.
(ii) Since the issue in both the cases revolves around the same cheque, therefore, instead of quashing
the FIR, the ends of justice would meet if proceedings arising out of FIR were transferred to the
Court of Judicial Magistrate, where the proceedings of other complaint under Section 138 of the
NI Act were pending so that the complaint filed by the Appellants and the proceedings arising out
of FIR alleged by Respondent No. 2 were decided together to avoid contradictory judgments and
to facilitate the issues which were common in both.
LESSON ROUND UP
• Negotiable Instruments Act governs the Negotiable Instruments. A negotiable Instrument”(NI) means a
promissory note, bill of exchange or cheque payable either to order or to bearer. The Act further defines
a Promissory note” as an instrument in writing containing an unconditional undertaking, signed by the
maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the
instrument.” In the same way Bill of Exchange and Promissory Note have also been defined.
• Due to an amendment to NI Act, now the definition of cheque includes the electronic image of a truncated
cheque and a cheque in the electronic form. Parties to a cheque include drawer, drawee, Payee, drawee
in case of need as well as ‘Acceptor’; it also includes Holder, Holder in due course. The payment made
a bank in accordance with the apparent tenor of the instrument, in good faith and without negligence
to any person in possession thereof under circumstances which do not afford a reasonable ground for
believing that he is not entitled to receive payment of amount mentioned therein is known as Payment
in due course. Negotiation said to take place when a NI is transferred to any person, so as to constitute
that person the holder of that NI. When the maker or holder of a NI signs the same, other than as a
maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed to
the NI, he is called as an Endorser. Types of endorsements include Blank, conditional, restrictive, sans
recourse, and facultative. The NI Act also covers the characteristics of the NIs and acts of various parties
involved.
• The act deals with duties and responsibilities of a paying bank through Section 85 and 85A. It also
defines the duties and responsibilities of a collecting bank through Section 131 and 131A. To get
legal protection under section 131, generally banks collect cheques only after the establishment of a
contractual relationship through opening of an account.
• When a NI is materially altered without the consent of parties involved, it makes the instrument void.
When a promissory note or bill of exchange is dishonoured by non-acceptance, or non-payment, the
holder may take remedial action through ‘Noting’ and ‘Protest’ as per Sections 99,100 & 101. In case of
dishonour of a promissory note or a bill of exchange the holder is entitled for compensation in terms of
section 117.
• When a cheque bears across its face, two parallel transverse lines, an addition of the words “and
company” or any abbreviation thereof, between or of two parallel transverse lines simply, either with
or without the words “not negotiable”, the cheque is said to be crossed. The banker on whom crossed
cheque is drawn will pay the same only to a banker. When a cheque is dishonored for financial reasons
penalties for dishonour are applicable on a drawer in terms of sections 138 to 147.
• Cheque Truncation System CTS) has been adopted in India in clearing of cheques to enhance customer
service, reduce reconciliation problems, eliminate logistic problems and minimize frauds. CTS is subject
to detailed rules procedures prescribed by RBI in this regard.
GLOSSARY
Promissory Note A “Promissory note” is an instrument in writing containing an unconditional
undertaking, signed by the maker, to pay a certain sum of money only to, or to
the order of, a certain person or to the bearer of the instrument.
Bill of Exchange 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.
Cheque A “cheque” is a bill of exchange drawn on a specified banker and not expressed
to be payable otherwise than on demand and it includes the electronic image of
a truncated cheque and a cheque in the electronic form.
Payment in due Course A payment in due course means a payment in accordance with the apparent
tenor of the instrument, in good faith and without negligence to any person in
possession thereof.
Endorsement Indorsement (endorsement) - when the maker or holder of a NI signs the
same, otherwise than as maker, for the purpose of negotiation, on the back or
face thereof or on a slip of paper annexed thereto for purpose of receiving an
additional endorsements as sufficient space may not be there on the back of
the page (Allonge), he is said to indorse (endorse) the same and is called as
indorser (endorser).
Crossings of Cheque Where a cheque bears across its face an addition of the words “and company”
or any abbreviation thereof, between two parallel transverse lines, or of
two parallel transverse lines simply, either with or without the words “not
negotiable”, that addition shall be deemed a crossing, and the cheque shall be
deemed to be crossed generally.
TEST YOURSELF
a. Negotiation of an order cheque is completed by ___________ and ____________.
b. A bill dated December 31, 2018 payable 2 months after date, falls due for payment on _________________.
c.. A cheque dated July 17, 2018 presented for payment on July 15, 2018 will be returned with the
reason_________________.
d. Is Mr. Vasant, issues a cheque to his friend Mr. Prashant, from his account with Bank of India,
Andheri branch - then Payee is ____________, Drawee is _______________ and Drawer is _____________ .
e. IRD stands for ________________________.
a. For Holder in due course, the consideration is must but for holder it is not essential.
b. A Bill of Exchange, drawn by Mr. John, a foreigner, in Delhi, payable at Mumbai is a foreign bill.
c. “Account Payee” crossing is a special crossing.
d. A minor cannot draw a cheque.
e.. A paying is protected if drawer’s signature is cleverly forged.
3. Attempt the followin:
a. What is Payment in due Course? Give some examples of payments which are not considered as
payment in due course.
b. What are the duties of a Collecting Banker?
c. Explain provisions of Section 138 to 142 of N.I. Act.
d. Which are various types of Bills of Exchange?
e. Explain Cheque Truncation System, in brief.
List of Further Readings

• Negotiable Instruments Act, 1881
• Banking Law And Practice by P.N. Varshney, Published by: Sultan Chand & Sons, Reprint 2017.
• RBI’s Master Circulars/Master Directions
• Banking Law & Practice by M.L. Tannan
• Negotiable Instruments by M.S. Parthasarathi
• Negotiable Instruments Act, J.C. Verma, Bharat Law House Private Ltd., New Delhi
Lesson 8 • Case Laws on Responsibilities of Paying Bank 239
Case Laws on Responsibilities

Lesson 8
of Paying Bank
Should Know
• NI Act This lesson will enable a reader to • Negotiable Instruments Act, 1881
• Cheque understand :
• Demand Draft • To explain the role and

responsibilities of a paying bank.
• Pay Order
• What are the protections
paying bank can get in terms
of case laws as decided by
various courts.
• Various provisions and case
laws applicable for paying
banker under Negotiable
Instruments Act, 1881.
Lesson Outline
• Introduction
• Section 10
• Section 31
• Section 85
• Section 89
• Section 128
• Section 138
• LESSON ROUND UP
• TEST YOURSELF
239
INTRODUCTION
The contractual relationship between a banker and a customer is a complex one and manifold mostly based on
principles and practice and usage of bankers for years. Many of those practices and usages have been recognized
by the courts and to such an extent that they have been accepted as implied terms of contract between the bank
and the customer.
A cheque drawn by a customer is a mandate to the banker to pay the amount according to the apparent tenor of
the cheque. At the same time, it’s a responsibility of the customer reciprocally that he will draw the cheques in
such form as to enable the banker to fulfill its obligations, and therefore customer need to give clear instructions
and free from ambiguity.
For example, the payee`s name on the cheque should be certain. Customer A issues cheque to the payee B or C is
not a clear mandate to the bank to whom to make the payment of the cheque. Another example where customer
issues a cheque with date as 29th March but the year is not mentioned. In such case bank will dishonor the
cheque with reason incomplete date or year not mentioned.
Specimen of Cheque
The Negotiable Instruments Act, 1881 (the “NI Act”) offers protection to a paying bank in terms of Section 85 &
85 A in respect of Cheques and DDs provided these instruments are paid in due course. While NI Act provides
certain protection to the banks, it also casts certain duties and obligations on the banks, in its capacity as paying
banker. These responsibilities are provided under Sections 10, 31, 85, 89 and 128 of the NI Act.
Section 10 of the NI Act: Payment in due course is one made in accordance with the apparent tenor of the
instrument in accordance with the instructions appearing on the face of the instrument according to the
intention of the parties (Section 10 of the NI Act).
To qualify as payment in due course, the payment will have to comply with the following:
(a) payment should be made to the person entitled to the payment;
(b) it should not be made before the due date;
(c) it should not be made with the knowledge that it may impair the rights of the holder to receive money or
under reasonable grounds for believing that the holder in due course is not entitled to receive payment;
and
(d) the payment must be made in good faith and without negligence under circumstances which do not afford
a reasonable ground for believing that he is not entitled to receive payment.
If the payment complies with the above requirements, then it will get the protection as a payment in due course.
Actually, it is difficult to list down good faith and / or negligence, it will depend on the facts and circumstance
of each and every case. Payment in Due Course provides a protection to the banker in case he has acted with
due diligence and take necessary actions while making the payment to the customer according to the mandate
of the cheque.
1. Whether the Paying Bank was bound to keep ultraviolet lamp and scrutinize cheques
even if alteration is not noticed on visual examination?
Facts of the Case:
A partnership firm opened a current account with a branch of Bank of Maharashtra at Wagle Industrial Estate,
Thane. As cases of forgery of cheques were frequently occurring in that locality, all branches were provided
with ultraviolet lamp for examining the cheques, except this branch at Thane.
On 26th May 1967 one Mr. Shah, opened an account in the name of Imperial Tube and Hardware Mart as a
proprietary concern with another nationalized Bank viz. Union Bank of India.
On 29th May 1967 a cheque was presented for Rs. 6,500 in clearing in favour of Imperial Tube and Hardware Mart
on Bank of Maharashtra by Union Bank on behalf of Mr. Shah. The cheque was passed by Bank of Maharashtra
and debited to the account of the drawer namely Automotive Engineering Company (AEC). Later, AEC raised an
objection towards the debit of the cheque on account of forgery. The cheque which was originally issued for an
amount of Rs. 95.98 in favour of one Mr. G. R. Pardawala seemed to have been chemically altered with reference to
date, payee’s name as well as the amount of the cheque. AEC wanted Bank of Maharashtra to compensate the loss.
Bank of Maharashtra did not compensate AEC but filed a suit in a court. The trial court held that bank was
negligent by not providing ultraviolet lamp at the branch though it agreed that no infirmity is noticed on visual
examination of the cheque in question. The Bank had appealed to the district court in the matter and they too
passed a judgement similar to that of trial court. Bombay High Court too held the Bank for negligence by not
providing the ultraviolet lamp. The matter was taken to Supreme Court on further appeal by the Bank.
Decision of the Supreme Court

The Supreme Court held that that there is nothing in the NI Act, which makes it obligatory for the bank to
subject every cheque to examination under ultraviolet ray lamp, though it could be prudent to examine under
the said light. The bank will not be deemed as failed to take reasonable care in passing the cheque for payment
without subjecting it for further scrutiny under ultraviolet ray lamp, as material alteration was not visible on the
cheque. The Supreme court ruled in favour of the bank. (Bank of Maharashtra Vs. M/s. Automotive Engineering
Co., 1993, 2SCC-97).
What the law requires is to ensure that the alteration is not apparent and visible to the naked eye. In this case
the original amount and the name of the payee was chemically altered. To prevent such frauds, normally a
transparent cell tape should be pasted over the payee’s name and amount.
Section 31 of the NI Act reads as ‘The drawee of a cheque, having sufficient funds of the drawer in hands,
properly applicable to the payment of such cheque must pay the cheque when duly required to do so and, in
default of such payment must compensate the drawer for any loss or damage caused for such default.
A banker is entitled to refuse payment of a cheque drawn in a form whose identity is doubtful or when it is
irregular or when it is undated or incomplete. The relationship between the customer and the banker also
creates certain obligations on the customer. The customer must take due and proper care not to mis-lead the
bank. For any negligence on the part of the customer, the customer shall be responsible. If the customer draws a
cheque which facilitates fraud, he is guilty of breach and will be responsible to the banker for any loss sustained
by the banker as a direct consequence of breach of duty. The negligence should be directly connected to the
transaction itself. This will depend on the facts and circumstances of each case.
Under the provisions of Section 31, the bank is liable only to the drawer of the cheque. The holder of the cheque
has no right to enforce payment from the bank, except under Section 128.
When a cheque bearing forged signature or joint signatures of the customer, is presented, there is no mandate
to the bank to pay and if any payments are made under such circumstances a bank stands to lose the legal
protection. Banker need to be careful in tallying the flow of signature on the cheque with specimen signature
held as per the bank record at the time of account opening or any amendments subsequently. In a promissory
note if insertions are made without the consent of the promisor it makes the instrument invalid under the
eyes of law. If alterations are made in a promissory note, the burden of proof, falls on the person who seeks to
enforce the negotiable instrument, failing which he cannot enforce his rights. If any alteration is made in an
instrument, which is not apparent to the naked eye, the banker will not be held liable for payment, provided he
had taken other precautions in terms of payment in due course. Though a customer (drawer) may be negligent,
if a bank makes payment of a forged cheque, the bank will be held liable. If the material alteration on cheques
were visible and if they were not authenticated by the drawer’s initials, the payment made by a bank was not
according to the apparent tenor of the instrument and as such the bank cannot get protection under Section 89
of NI Act. A paying banker also is also affected by the provisions of Consumer Protection Act in addition to that
of NI Act.
2. A banker is not absolved of his liability on forged cheque if it has acted negligently,
even if the customer was negligent.
Facts of the Case:

Lala Pirbhu Dayal (LPD) was a customer of Jwala Bank. On 16th March 1936 cheque No. 23958 for Rs. 57-8-0
was presented at the bank alleged to have been signed by the plaintiff LPD in favour of one Bhai Kashi Nathji.
The Bank honoured the cheque and paid the amount to the person who presented the cheque. LPD complained
to the Bank that he had not drawn cheque of Rs. 57-8-0 debited to his account. The bank did not accept LPD’s
contention and refused to make good the amount and maintained that the cheque was passed in the usual
course and his signature was fully tallied with his specimen signatures. Unable to recover any money from the
bank, LPD filed a suit to recover his money.
The trial court judge found that though the signature on the forged cheque did not tally with LPD’s signatures
and held that bank was not legally liable to return the amount of the cheque to LPD as it has not been shown that
the payment of the same was made by it dishonestly and knowing that it was a forged cheque. The court also
took cognizance of the matter that other persons had also access to the box containing the cheques remained
unlocked during day time at LPD’s home and held him negligent for leaving his cheques in an unlocked box and
dismissed the case. LPD filed an appeal against the trial court judgement before the Allahabad High Court.
Decision of the Allahabad High Court

A banker is not absolved of his liability on forged cheque, even if the customer was negligent in keeping the
cheque book under lock and key as required by the rules of the bank. The Court held that it is the duty of the
employees of the bank to be able to identify the signature of the customers and if they fail to discharge their
duty and thereby suffer loss, there is no reason why the customer should make good that loss. (Lala Pirbhu
Dayal vs. Jwala Bank Ltd., AIR 1938 All. 374)
Section 85 of the NI Act: (a) Where the cheque is payable to order is indorsed by or on behalf of the payee, the
drawee is discharged by payment in due course.(b) where a cheque is drawn in favour of a bearer, the drawee
is discharged by payment in due course to the bearer thereof, notwithstanding any indorsement in full or blank
and notwithstanding any such indorsement purports to restrict or exclude further negotiation.
This section ensures that a bearer cheque does not lose its character by any indorsement on the same, but the
protection is available only if the payment is in due course. It must appear that the holder is the person entitled
to payment of the cheque though the bank need not bother itself about the genuineness of indorsement.
Cheque honoured without reference to the crossing is negligent. However, in case of any irregularity, if the
bank make enquiries and is satisfied and makes payment thereafter, the bank will be considered as not being
negligent.
This section does not extend protection to the banker if the payment is made on a forged cheque. Mandate of
the customer to the bank to pay the cheque signed by him, which is recognized by Section 85 is not available to
the bank in a case of forged cheque. If a customer is aware of forgery whereby his banker debits his account, but
fails to inform the bank till the chances of recovery from the forger is materially prejudiced, it was decided that
the customer was precluded from claiming the amount.
3. Liability of a Paying banker under a forged cheque
Facts of the Case:

M/s Canara Sales Corporation (CSC) was maintaining a current account with Canara Bank. The bank account
was operated by the authorized signatory of CSC namely the Managing Director. Cheque books of CSC were in
the custody of the Accountant of CSC, who cleverly forged the signature of the Managing Director in 42 cheques
involving an amount of Rs. 3.26 lakhs over a period of time. The forgery came to light when another accountant
of the company scrutinized the accounts of the company. As soon as the fraud came to light, CSC filed a claim
with the bank for recovery. When CSC did not get any response they filed a case in the local court which delivered
the judgement against the bank. The matter finally went to the Supreme Court.

Supreme Court stated that one of the banker-customer relationship being that of a debtor and creditor; bank
being debtor of a customer in case of savings, current or fixed deposit account, will have no authority to debit
the customer’s account with a cheque bearing forged signature of the customer. When customer’s signature is
forged, there is no mandate to the bank to pay.
(Canara Bank vs Canara Sales Corporation and Others, 1987)
In this matter, the Supreme Court relied on its own earlier decision in the matter of Bihta Cooperative and Cane
Marketing Union Ltd. vs. Bank of Bihar (AIR 1967 Supreme Court 389) which is cited below.
4. If one of the signatures in a joint account is forged, it is not a mandate for the banker to pay
Facts of the Case:

Bihta Co-operative Development and Cane Marketing Union Ltd. (‘BCDCM’) was maintaining an account with
Bank of Bihar. The account of (‘BCDCM’ was jointly operated by the Authorized signatories of BCDCM namely
The Joint Secretary and Treasurer. In the month of April 1948 the bank made a payment amounting to Rs.
11,000 on the strength of a loose cheque leaf. This loose cheque leaf did not belong to the cheque book issued
to BCDCM by the bank. This was bearing two signatures that of Joint Secretary and the Treasurer. It appears
that the signature of the Joint Secretary was forged. After the bank made the payment, the forgery came to light
and accordingly BCDCM lodged a claim on the bank for recovering the amount of the forged cheque paid by the
bank. As they did not succeed, they filed a case against the bank for recovering the money.
The bank took a stand that though there is some negligence on their part, they were taking shelter on the
grounds of dishonest employees of BCDCM. The bank subsequently went in appeal to Supreme Court against
the judgement of lower court.

The Hon’ble Supreme Court’s decision in the matter is summarized as below.
A cheque was drawn on a cheque form issued by the banker to somebody other than the drawer, the banker
would not be justified in refusing its payment, if the cheque was otherwise in order. The drawer’s order to the
banker does not become invalid because the form of the cheque was not issued to the drawer. The cheque in
question was a loose cheque-form surrendered by some other customer of the bank. It is invalid not because
it was drawn on a form not issued to the customer but because the signature of one of the joint account holder
(drawer) was forged. In a jointly operated account, if one of the signatures is forged there is no mandate to the
bank. (Bihta Co-operative Development and Cane Marketing Union Ltd vs. Bank of Bihar and others. 1967)
5. What is a proper way of payment in due course?
Facts of the Case:

The bank, instead of making payment to the partner of the firm or its authorized person, handed over cash to
one of its own employee, who accompanied the partner who was to pay the cash to the wholesalers. However,
before they could reach the wholesalers, the bank employee absconded.

Supreme Court held that this was not “payment in due course” as it was not made to the holder (partner, his
agent or servant) instead made was made to their own employee by the bank. (Bank of Bihar vs. Mahabir Lal,
AIR 1964, 397)
6. Payment made under mistaken belief
Facts of the Case:

M/s. A received a cheque from their customer, who purchased goods from them. The cheque was sent to A’s
banker, Union Bank for collection. On receiving advice from Union Bank, having realized the cheque, M/s. A
delivered the goods to the customer. The paying bank, United Bank of India, later on found that the drawer’s
signature on the cheque was forged and filed suit for recovery of amount from Union Bank and M/s A. .
The Court found that the forgery was so cleverly done that even the drawer found it difficult to deny his signature
on the forged cheque. The High Court therefore held that the paying bank was neither negligent nor careless in
paying the cheque. The payment was made under mistaken belief.
Decision of the Court

According to section 72 of Indian Contract Act, a person to whom money has been paid by mistake must repay
it. But the rule is qualified by the doctrine of equity. Payee must repay money to the payer if the position of
former is not altered to his detriment. In this case the position of payee was changed before the mistake was
detected. He therefore cannot be held liable. The Court held that Union Bank and M/s A were therefore not
liable to the United Bank of India. (AIR 1978, Calcutta, 169)
Section 89 of the NI Act: If the alternation of a cheque is not apparent and the bank has made payment in due
course, in good faith and not acting negligent, then such payment shall not be questioned by the reason of that
the instrument was altered or the cheque crossed.
Now since truncated cheques are transmitted, it shall be the duty of the collecting bank or the clearing
house, as the case may be, to ensure exactness of the electronic image while truncating and transmitting the
same. Collecting bank need to take necessary precautions while scanning the cheques on the scanner before
submitting the truncated images of the cheques to the drawee bank for payment through clearing house. The
receiving party of such truncated cheque shall also ensure from the other party transmitting the image, that the
image transmitted is exactly the same.
Protection under this section is available to the Bank only if the (a) alteration is not apparent; and (b) the
instrument is paid in due course and in good faith and without negligence.
7. Liability of a Bank in respect of a cleverly forged cheque
Facts of the Case:

On 1-7-1946 One Mr. Brahma issued cheque for Rs. 256/- payable to Mr. J. M. Das Gupta from his account in
which the bank used to allow overdrafts against securities given for such overdrafts from time to time in the
form of marketable shares. The cheque was sent by post, but the it did not reach the said payee. Mr. Brahma use
to allow his clerks to prepare the cheques and he used to sign. Mr. Brahma was informed by his bank by a letter
dated 24-7-1946, that after paying a sum of Rs. 2,34,081/-, against the said cheque the drawer’s account had
been overdrawn to the extent of Rs. 2,19,460/-.
It was later found that Mr. Brahma did not draw any cheque or authorize any payment of Rs. 2,34,081/-. He had
issued the said cheque for Rs. 256/=. During the transit of the cheque was intercepted and stolen. The amount
and the name of the payee had been cleverly altered to Rs. 2,34,081/- with the name of the payee as S. Dass &
Co. in place of J.M. Das Gupta, the original payee. These alterations and forgeries were not visible to the naked
eyes. The cheque was collected on behalf of S. Dass & Co by Hindustan Industrial Bank Ltd. Mr. Brahma sued his
bank, S. Dass & Co. and Hindusthan Industrial Bank Ltd., through whom the collection of the cheque was made
for negligence and wrongful conversion or unlawful appropriation of the proceeds of the cheque.
After lengthy deliberations over a period of time the Calcutta High Court gave a judgement in the matter, the
summary of which is below:
Decision of the High Court

The Calcutta High Court held that since no alteration or obliteration was visible at the time of payment, the
payment was made according to the apparent tenor of the cheque. Further since drawer had on other occasions
also issued cheque signed by him and written by others, the bank suspicion could not have aroused. The court
also held that the words “liable to pay” appearing in section 89 included a liability to pay under an overdraft
agreement as much as it applied to an ordinary deposit account. As regards exceeding the overdraft limit, the
court held that no definite limit was fixed at the time and it fluctuated according to the securities deposited.
Hence the paying bank was absolved of negligence. However, the court held S. Dass & Co. as well the collecting
bank for negligence and conversion. (Brahma Shum Shere Jung Bahadur and Other vs. Chartered Bank of India
and Others, AIR 1956, 399)
Section 128 of the NI Act: Section 126 and 127 of the NI Act, specifies how crossedcheques should be paid.
When a cheque is crossed generally it should not be paid otherwise than to a banker. When a cheque is specially
crossed, it shall not be paid to a banker otherwise than to whom it is crossed. If a cheque is specially crossed
more than once, then the bank can refuse payment, except when it is crossed in favour of an agent of the first
crossed bank. Under these sections, responsibility of the paying bank is very clearly spelt.
Due to changes in technology and with a view to provide efficient and quick service to the customers, the
banking system has undergone tremendous change and one such important change was that the physical
movement of cheques from one branch / bank to another branch/bank for payment has been stopped. Magnetic
Ink Character Recognition (MICR) Clearing has been replaced by Image based cheque truncation system (CTS ).
In CTS, a mirror image of the cheque is sent by the branch/bank where the cheque is deposited by its customer
to the drawee bank where the cheque is to be paid.
Truncated Cheques:
The collection and payment of the cheques in India is governed by the various provisions of NI Act, 1881. Since
the manual processing of cheques and through MICR Clearing was time taking process and require physical
instrument to be presented to the bank for payment in due course. The process of truncation requires the
banker to convert the cheque data to electronic form for the purposes of safe keeping or to forward the images
of cheques at the request of the banker to provide information on cheques as and when requested. Cheque in
the electronic form means a cheque which contains the exact mirror image of a paper cheque and id generated,
written and signed in a secure system ensuring minimum safety standards with the use of digital signatures
(with or without biometric signature) and asymmetric crypto system.
Under the cheque truncation system all cheques are transmitted electronically. The original cheques are
retained by the collecting banker at the branch or place where the cheques are scanned.
Provision and Process:

Truncation of cheques can be done by the clearing house or the bank which collects the truncated version of
the cheque.
Section 6 (b) of the NI Act, defines a truncated cheque as a cheque which is truncated during the course of a
clearing cycle, either by the clearing house or by the bank whether paying or receiving payment, immediately on
generation of an electronic image for transmission, substituting the further physical movement of the cheque
in writing.
As per Section 81 of the NI Act, the banker who receives the payment is also supposed to retain a copy of
the cheque even after payment has be done. Section 89 of the NI Act provides that any difference between
the original cheque and the truncated image should be construed as material alteration. In such cases, it is
obligatory on the part of the clearing house or the bank to ensure correctness of the truncated image while
transmitting the image.
An explanation has been added to Section 131 of the NI Act, which states that ‘it shall be the duty of the banker
who received payment based on an electronic image of a truncated cheque to ensure that there is no fraud,
forgery or tampering apparent on the face of the instrument’.
According to Section 64 (2) of the NI Act, where an electronic image of a truncated cheque is presented for
payment, the drawee bank is entitled to demand any further information regarding the truncated cheque from
the bank holding the truncated cheque in case of any reasonable suspicion.
Section 138 to 142 of the NI Act: Cheque bouncing

Under Section 138 of the NI Act, dishonour of a cheque is a criminal offence liable to be punished with 2 years
imprisonment.
The following are required to be satisfied to make the dishonour an offence under the provisions of the NI Act.
1. Existence of a legally enforceable debt or other liability by the drawer of the cheque towards another
person (will be payee or holder of the cheque, as the case may be) and a cheque is drawn to discharge the
debt or liability.
2. Cheque is returned due to insufficient funds or exceeds the amount agreed upon to be paid by the bank.
3. Cheque should be presented within its validity(i.e.) 3 months from the date of issue.
4. Notice in writing is sent within 30 days to the drawer along with the receipt of information from bank
about failure of payment of cheque
5. The payee or holder doesn’t receive the payment within 15 days of the receipt of the notice to the drawer
Cheques issued towards payment of debt will only attract the provisions of Section 138. Cheques given for
donation or post dated cheques issued for security purposes or undated cheques will not be covered under this
section.
8. Sec 138 – Dishnour of Post Dated Cheques offered as a Security in case of Loan Accounts
Facts of the Case:

Sampelly Satyanarayan Rao (appellant) is the director of the company which is engaged in power generation
activities. Indian Renewable Energy Development Agency Limited (respondent), a Government of India
enterprise, is engaged in the field of renewable energy development. On 15th March ,2011 both the parties
entered into a loan agreement by means of which the respondent consented to grant a loan of Rs. 11.50 Crore
for the purpose of establishing 4.00 MW Biomass Power project. Clause 3.1 (iii) of the said loan agreement
provided that post dated cheques should be issued by the appellant as a security for discharge of loan instalments
(principal and interest). The post dated cheques carried different dates based on the due loan instalments .The
said post dated cheques were dishonoured and complaint was filed by the respondent. Issues involved in the
case was whether the dishonor of post dated cheques issued as a security by the appellant will attract Section
138 of the Negotiable Instruments Act, 1881.

Supreme Court held that whether a post dated cheque has been issued for the discharge of an outstanding
liability shall depend on the nature of transaction and Section 138 of the NI Act, 1881 shall be attracted only
on the date of the cheque there is a legally recoverable outstanding debt or liability. Further the court held
that although according to clause 3.1 (1) of the loan agreement provided that postdated cheques are given as
security, however, the expression “security” must be understood to refer to cheques that have been issued by
the appellant for payment of the loan instalments to discharge the existing outstanding debt or liability. The
relevant extract of the judgement is provided below:
“Once the loan was disbursed and instalments have fallen due on the date of the cheque as per the agreement,
dishonour of such cheques would fall under Section 138 of the Act. The Cheque undoubtedly represent the
outstanding liability.” Further the post dated cheques were described as a security in the loan agreement but
in essence the issuance of the same was for the purpose to repay the loan instalments for satisfaction of the
outstanding liability thus in the judgement the court held that is this case loan transaction in which the loan
has been granted to the borrower and the repayment of the loan instalments is due on the date of the cheque.
LESSON ROUND UP
The N I Act governs the framework of role and responsibilities of a paying banker. It also offers legal protection
to banks which are involved in paying various negotiable instruments such as cheques and drafts. The paying
bank is duty bound to pay customers’ cheques in accordance with Sections 10, 31, 85, 89 and 128 to get the
protection of the NI Act. In a promissory note if insertions are made without the consent of the promisor it
makes the instrument invalid under the eyes of law. If alterations are made in a promissory note, the burden
of proof, falls on the person who seeks to enforce the negotiable instrument failing which he cannot enforce
his rights. If any alteration is made in a NI which is not apparent to the naked eye, a banker will not be held
liable for payment, provided he had taken other precautions in terms of payment in due course. Though a
customer (drawer) may be negligent, if a bank makes payment of a forged cheque, the bank will be held
liable.
GLOSSARY
NI Act Negotiable Instruments Act
BCDCM Bihta Co-operative Development and Cane Marketing Union Ltd.
COPRA 1986 Consumer Protection Act.
NC National Commission
TEST YOURSELF
Write true or false:
a. A banker gets protection if he makes payment in due course.
b. A forged cheque is a mandate to pay.
c. Inspite of negligence of a customer, if a bank pays a forged cheque it is liable to the customer.
d. If a forgery is not evident to the naked eye in a cheque, on payment of such cheques in due course, a
bank is not liable.
e. Banks are legally bound to examine a cheque under Ultra violet lamp before paying the same.
Lesson 9 • Case Laws on Responsibilities of Collecting Bank 249
Case Laws on Responsibility

Lesson 9
of Collecting Bank
Should Know
• Negotiable This lesson will enable a reader to • Banking Regulations Act, 1949
Instruments understand: • Negotiable Instruments Act, 1881
• Collecting Banks • Provisions and case laws
• Payee Banks applicable for collecting Bank
• Demand Drafts • Responsibility of collecting Bank
• Crossed Cheques
Lesson Outline
• Introduction
• Section 131
• Section 131A of the Negotiable Instruments Act, 1881
• LESSON ROUND UP
• TEST YOURSELF
249
INTRODUCTION
Bank’s rights and responsibilities as a collecting bank are governed by Section 131 of the Negotiable Instruments
Act, 1881 (the” NI Act”) needless to say this section also offers legal protection to banks when they collect various
negotiable instruments like cheques, pay order, demand drafts etc. in good faith and without negligence. Section
131 imposes duty of due diligence, care and good faith on the banker and banker will not incur any liability to
the true owner of the negotiable instrument, for collecting a negotiable instrument on behalf of a customer, in
case the title to the negotiable instrument is proved defective. It may be noted that Demand Drafts (DD) were
not included in instruments originally covered by NI Act. Subsequently when frauds started to increase in the
collection of DDs, they were also covered by inserting Demand Drafts under section 131A.
In manual clearing and Magnetic Ink Character Recognition (MICR) clearing the physical copy of the negotiable
instrument deposited with a bank is sent to the drawer branch of the bank where it was drawn/ or where
the account is maintained and the cheque book issued. As a result the clearing / settlement of cheques takes
collection time of 3 to 4 business days. With new emerging payment systems and advancement in technology,
the Reserve Bank of India and National Payment Corporation of India (NPCI) introduced Image Based Cheque
Truncation System which allowed banks to transmit truncated negotiable instruments for collection purposes,
instead of sending the original instruments, which lead to reduction in cost and time.
In 2003, the NI Act was amended to include the responsibilities of the collecting bank, based on a truncated
image of the instrument. The collecting bank shall verify the prima facie genuineness of the instrument and any
fraud or forgery or tampering apparent on the face of the instrument that can be verified with due diligence
and ordinary care.
It’s a duty of the collecting bank to collect instruments deposited by customers after taking due precautions
in the matter as normal prudence would require. Unless this is done, the bank may not get legal protection, as
borne out by various case laws discussed in the chapter.
All the case laws are based on the section 131 and 131A of NI Act and a reference to the concerned case citations
have also been given for easy reference.
It is also to be noted that important case laws pertaining to England have also been included to draw a parallel,
as our NI Act is based on English law.
The topic and contents will impart a practical knowledge in understanding the role and responsibilities of a
collecting bank. Facts of each case as a background, as well decisions of courts, to the extent required is also
explained in the case laws. After a study of this chapter, students should be able to understand and explain the
role and responsibilities of a collecting bank as well as protection it can get in terms of case laws as decided in
various courts.
Section 131
Section 131 reads as under: “A banker who has in good faith and without negligence received payment for a
customer of a cheque crossed generally or specially to himself shall not, in case the title to the cheque proves
defective, incur any liability to the true owner of the cheque by reason only of having received such payment.
Explanation I: A banker receives payment of a crossed cheque for a customer within the meaning of this section
notwithstanding that he credits his customer’s account with the amount of the cheque before receiving payment
thereof. Crossed cheques means that payment of the cheque cannot be made in cash on the bank`s branch
counter. Crossing can be general or special crossing.
Explanation II: It shall be the duty of the banker who receives payment based on an electronic image of a
truncated cheque held with him, to verify the prima facie genuineness of the cheque to be truncated and any
fraud, forgery or tampering apparent on the face of the instrument that can be verified with due diligence and
ordinary care.”
Section 131A
Application of Chapter to drafts. - The provisions of this Chapter shall apply to any draft, as defined in section
85A, as if the draft were a cheque.”
Conditions applicable for protection under Section 131 and 131A: The NI Act does not provide an absolute
immunity or protection to the bank. Protection to a collecting bank is subject to compliance by the bank
provided the following conditions are fulfilled:
a. banker acting in good faith and without negligence in receiving payment;
b. should have received the payment for and on behalf of its customer; and
c. the cheque should have been crossed generally or specially to himself.
It follows from the above that to fulfill these conditions, a banker should have performed some duties in this
regard. To prove that the banker has acted in good faith and without negligence, he should have taken the
following precautions:
a. Opening of accounts: The bank should have complied with proper KYC procedures while opening the
new account by obtaining proof of Identity and current address. Also it should have made proper enquiries
and background checks as per bank’s policy of opening of new accounts. KYC documents submitted
by the customer should have been independently verified through verification policy of the bank. The
banker needs to classify its customers according to their risk profile and monitor account operations
and transactions right from the opening of the account. Any suspicious activity or profile mismatch in
the account should be investigated and monitored. If the banker fails to do observe regular monitoring
of transactions and investigation, it may be considered negligent. In the recent times RBI has been very
active on stipulation of KYC norms, to ensure that due and proper care is taken by banks while opening
and maintenance of accounts.
b. Crossing cheques: At the time of acceptance of the cheque / DD for collection the bank should ensure
that the cheque is crossed either generally or specially in favour of its customers, on behalf of whom the
bank is acting as a collecting bank. If the cheque is not crossed the customer should be requested to cross
the cheque or if the cheque is specially crossed to some other banker, the banker should refuse to collect
the same. If a cheque is crossed to particular account holder and if it is sought to be credited to another
account, then such requests are required to be rejected, failing which a bank may be considered negligent.
c. Verification of instruments: Before accepting the instrument, a banker should verify the payee name,
valid date, amount in words and figures and signature on the cheque in order to ensure any material
defect apparent on the instrument. Collecting Bank is responsible for the correctness of the cheque before
presenting the cheque for collection.
d. Status of accounts: The general nature of credits and debits in an account should be ordinarily correspond
to employment, profession, business etc. of the account holder. Any large value credits which does not
seem appropriate in relation to the employment or profession of the account holder should receive due
attention of the banker. Banker need to investigate the legal source of funds to rule out misappropriation,
fraud or money laundering activities. Any account over a specific value of credit are required to be
monitored at regular intervals by the bank.
e. Collection cheques payable to third parties: The collecting bankers are required to make necessary
enquires before collection of cheques tendered by customers on behalf of third parties.
Due diligence and close monitoring required by the bankers for :

(a) large value transactions , patterns, inconsistent with the normal and expected activity of the customer,
which have no apparent economic rationale or legitimate purpose
(b) Transactions which exceed the thresholds prescribed for specific categories of accounts.
(c) High account turnover inconsistent with the size of the balance maintained.
(d) Deposit of third party cheques, drafts, etc. in the existing and newly opened accounts followed by cash
withdrawals for large amounts.”
Failure to adhere to these will amount to negligence on the part of collecting bankers within the meaning of
Section 131 of NI Act.
The following case laws will give the reader a clear understanding of the roles and responsibilities of the banker,
as enumerated by various courts.
1. Test of negligence in respect of a collecting banker

Mr. Gopinathan (Mr. G) was a trader from Allepy in Kerala who used to purchase goods from M/s. Hurry Dass
Auddy of Kolkata from 1953 onwards and make payments thereof through Demand Drafts (DD) purchased from
Alleppey branch of Central Bank of India (CBI) drawn in favor of their New Market branch at Kolkata. These
DDs were made payable to Hurry Dass Auddy or order. These DDs were delivered to M/s. Hurry Dass Auddy
through a friend of Mr. G at Calcutta. In October 1953 Mr. G purchased a DD for Rs. 4000 and sent the same to
M/s. Hurry Dass Auddy in the usual manner. It was intercepted during transit, and was presented before the
Kolkata- Shambazar branch of CBI by someone with a forged endorsement in his favour purporting to be that
of the payee. The payment was obtained from the New Market branch by Shambazar branch by the fraudster
through local clearing. (in those days there was no centralized payment mechanisms like Service branches
for payment of DDs) However there appeared to be some irregularities in the endorsement on the backside
of the DD. Later when G came to know the facts approached CBI for compensation. CBI refused to pay on the
ground that the payment of DD was in the usual course. G filed a case against the bank at the local court, which
ruled that the bank is liable to pay. The Bank appealed in the District court which also delivered the judgement
directing the bank to pay. The Bank further contested the matter before the Kerala High Court.
Decision of Kerala High Court

The Kerala High Court, in this case, observed - “The test of negligence under sec.131 of N. I. Act, is whether the
payment considered in the light of the circumstances, antecedent and present, was so much out of ordinary
course that it ought to have aroused doubt in the banker’s mind and caused him to make enquires” e.g.
if circumstances create doubt or suspicion about the right of the customer to the cheque, the banker must
make proper enquiries and take adequate provision. Failure to this will be considered negligence on its part.
Ordinarily a banker owes duty towards his customer, but law make him responsible to the true owner of the
cheque. In case of negligence, the collecting banker will not get statutory protection. Hence CBI was ordered to
compensate the payee.(Central Bank of India Vs. Gopinathan Nair and others AIR 1970 Ker 74).
2. Duty of a collecting bank to check endorsements
Facts of the case:

On 10th November 1960 Reliable Hire Purchase Co. Pvt. Ltd. (RHC) issued cheque drawn on Indian Overseas
Bank in favour of SM Ltd. and handed over to Mr. R to enable him purchase a vehicle. Mr. R forged the endorsement
on the cheque in favour of M & Co. of which he himself was a director. On the very next day he deposited the
cheque in United Commercial Bank for collection and to be credited to the account of M & Co. The United
Commercial Bank guaranteed the endorsement and the cheque was duly collected and credited to the account
of M & Co. When subsequently true facts came to light, the drawer of the cheque (RHP), claimed the amount of
the cheque and damages from both - the collecting bank and the paying bank.
Decision of courts
The trial judge held that the paying bank did not make the payment in due course and was liable for suit amount.
The collecting bank acted negligently and hence was liable to the paying bank.
The Division Bench of the High Court, on the appeal of both the banks, held that paying bank was justified in
accepting as to the reliability of the endorsement which was guaranteed by the collecting bank. Hence the
paying bank was not liable but the collecting bank was liable for conversion as it should have made enquires
about the genuineness of the endorsement for the following reasons:
(i) A company endorsing a cheque drawn in its favour to another company is not a usual feature.
(ii) The endorsement was by the sales manager of SM Ltd., which again should have aroused suspicion as to
where sales manager has authority to endorse on behalf of company.
(iii) The cheque was of unusually high amount and the endorsement was undated.
(iv) SM Ltd. was in the business of selling vehicles, while M & Co. in transport business. So why should SM Ltd.
pay to M & Co.?
The collecting bank was held liable to pay the amount of the cheque to the drawer of the cheque who was
deemed to be true owner of the cheque. The United Commercial Bank Ltd vs. Reliable Hire Purchase Co. Pvt. Ltd.
And others (1976, IIMLJ p.286).
3. Fictitious and fraudulent endorsements - responsibility of collecting bank
Facts of the Case:

Bank draft, for Rs. 10,000 was purchased at Bareilly in favour of M/s. Mithanlal Mangal Sain. It was en-
cashed through Canara Bank by fictitious endorsement and credited to the account of Universal Traders. The
endorsement was purported to be done by Mangal Sain in Urdu. Mangal Sain signed on behalf of the firm but had
not revealed the capacity in which he signed. The person in the collecting bank who examined the endorsement
did not know Urdu and merely relied on the confirmation by the second payee and confirmed it.
Decision of Delhi High Court

It was held that once the endorsement was found to be suspicious, it was the duty of the collecting bank to
verify it from independent source.
Hence Canara Bank was held for negligence as a collecting bank fails to take utmost care in verifying the
genuineness of endorsement and was ordered to pay compensation. Canara Bank vs. Govind Ram Rajinder
Kumar and others (1981, 51, Company Cases 476).
4. Collecting bank’s responsibility in respect of newly opened account
Facts of the Case:

A current account was opened in Indian Bank, Salem branch by Mr. S. M. Desai. Another person purchased a
demand draft from Catholic Syrian Bank, Singanallur (a nearby town to Salem) for Rs.20.00 in favour of M/s.
Desai and Co. payable at it its Cochin branch.
The said draft was forged by altering- (i) the amount to Rs. 29,000.00, (ii) payee’s name to Mr. S.M. Desai and (iii)
draft payable at Cochin to, Salem branch. The demand draft was collected through the newly opened current
account of Mr. S. M. Desai, in Indian bank and the amount was withdrawn.
Subsequently when the forgery was detected, the drawee (paying) bank filed a suit for Rs. 29,000.00 against the
collecting bank, on the ground of conversion. The collecting bank contended that there was no negligence as the
draft was collected for properly opened account.
The evidence before the High Court showed that the person who had taken Mr. Desai to the Indian bank to
open a new account, had told the Manager that Mr. Desai was a man from Indore and wanted to open a bank
account to be able to purchase carpets from Salem. He had never mentioned that he knew Mr. Desai or they had
any business relationships or even as Mr. Desai being a bona fide customer and account could be opened in his
name. Mr. Desai had not even given his permanent address and had admitted that he was opening account for
the first time.
Decision of the High court

The Court held that, “where a bank allowed a customer to open an account on the recommendation of a customer
who could not be said to be respectable and without testing the credentials of the person desirous of opening
the accounts, cannot be considered to have acted without negligence even if it has acted in good faith” Hence
the collecting bank was negligent in both - opening the account and collecting the draft shortly after opening
the account. The collecting bank may have acted in good faith but have not acted without negligence and hence
could not get statutory protection of Section 131. (Indian Bank vs. Catholic Syrian Bank Ltd. AIR 1981 Mad 129).
5. Axis Bank Vs Punjab National Bank & another
Facts of the Case:

One Mr. A, approached the branch of Axis Bank at Pithampura at Delhi, submitting necessary forms and
documents. Axis Bank sends a letter of thanks to the customer as address verification and the customer collected
a cheque book from the bank on production of the thanks letter. Two months later, Mr. A, deposited certain
demand drafts purported to be issued by PNB from Kurukshetra. The drafts were presented for payment by
Axis Bank and was also cleared by PNB. Later PNB informed Axis Bank that the drafts were not issued by them
and the demand drafts were actually issued in favour of Registrar, Delhi University for an amount of Rs.100/-.
Upon receiving the information, Axis Bank immediately froze the account and initiated the same to PNB.
PNB filed a claim against Axis Bank in Debt Recovery Tribunal , which was ordered in favour of PNB. Axis filed
an appeal before the Appellate Tribunal, which was also decided in favour of PNB. Axis then appealed to the
High Court at Delhi.
Decision of the High Court:

The court observed that” The standard of care expected from a banker in collecting the cheque does not require
him to subject the cheque to a minute and microscopic examination. To fasten the responsibility for cheating on
account of fabrication, the forgery or tampering must be such as can be detected from the face of the instrument
by applying ordinary care and diligence.”
Further, in this case, the High Court found that there was no proximate connection between the opening of the
account or the deposits of the forged instruments so as to treat the said events as intimately associated with
each other. There was no undue hurry shown by the fraudster in making the withdrawals. It is not the case of
PNB that the forgery could have been detected by the collecting bank from the face of the instruments. The
fact that the forgery could not be detected by the centralized draft payable centre of PNB itself shows that the
collecting bank could not have entertained any doubts as to the genuineness at the time of receiving the drafts
from the customer or for making them over to the drawee bank for collection. The DRAT has found PNB also to
negligent in these transactions as PNB, service branch should have detected the fraud at the time of making the
payment of the drafts.
The Court decided that Axis Bank was wrongly denied the immunity of a collecting banker under Section 131.
Therefore, it is very important for the banks to observe due care and diligence in the ordinary course of business
of opening accounts and processing payments.
6. Liability on account of negligence of third parties
Facts of the Case:

A trader RKB of Delhi, under a contract, supplied goods to Government department and received its full payment.
The contract bills submitted by suppliers were usually audited by Government Auditor before payment of the
bill amount. The Government Auditor while auditing some bills of the trader, fraudulently omitted to make
cancellation on the inspection notes and handed over uncancelled inspection notes to another person by name
MCJ. MCJ opened account in the name of RKB with a bank and presented bill purporting to be drawn by RKB
accompanied by one of the stolen inspection notes. The bank sent the bill for collection and credited the account
of RKB on collection. MCJ withdrew the amount subsequently. Similarly, another bill was also collected in the
same manner and MCJ withdrew the amount. When the fraud came to light, the Government (i.e., Union of
India) filed a suit against the bank to recover money on the ground of conversion.
Observation and decisions of the Court

The trial court at Delhi observed that bank which collected the bills on behalf of MCJ was merely acting as
collecting agent and there was no evidence that the officials of the Government were deceived into issuing the
cheques. The bank further failed to produce any evidence to show that it acted without negligence by opening
the account on the recommendation of any reliable introducer of the account. The court, therefore, held that
the manner in which the account was opened by the Bank and allowed operations does not show the absence
of negligence and is entitled to avail of protection under Section 131.
The High Court of Delhi held that the Banker had no means, machinery or material to scrutinize whether the
bills and the inspection notes on which the bills were based was forged and the two uncancelled inspection
notes were obtained by RKB by means of fraud. It was the Govt. Department who had the means of knowledge
to ascertain whether the inspection notes accompanying the two bills were fraudulently kept uncancelled and
whether or not any payment was due under the particular acceptance of tender.
The Court held that negligent conduct of the Government Dept was the real cause of the loss and the Government
Dept. was therefore stopped from claiming the amount from the bank. (Union of India vs. National Overseas and
Grindlays Bank Ltd., 1978, 48 Company cases 277 Del.)
7. Collecting Bank’s Role and responsibility
Facts of the Case:

(Keshrichand Jaisukhlal vs. Shillong Banking Corporation Ltd. (1965, company case 514 (S.C.))
On December 09, 1946, one Mr. K J a customer of Shillong Banking Corporation (SBC) presented for collection
two cheques for Rs. 8,200 and Rs. 600 respectively drawn on the Bharati Central Bank, Shillong. On receipt of
the cheques, SBC credited the account of KJ a sum of Rs. 8,800. SBC then sent the cheques to the Bharati Central
Bank, Shillong (BCB) for collection. Instead of paying cash, BCB sent a cheque dated December 9, 1946 for Rs.
8,800 drawn by it on the Nath Bank, Shillong in favour SBC.
SBC accepted this cheque on its own responsibility without consulting KJ. On December 10, 1946, SBC presented
the cheque to the Nath Bank for payment. The Nath Bank returned the cheque with the remark “full cover not
received”. SBC orally informed KJ of the non-payment of the cheque on the Nath Bank, and on December II,
1946 under oral instructions from KJ, represented the cheque to Nath Bank for payment. The Nath Bank again
returned the cheque with the remark “full cover not received”, and the SBC thereupon debited KJ’s account
with the sum of Rs. 8,800. On the same day, SBC wrote to the BCB demanding cash payment of the two cheques
drawn on them and dated December 09, 1946. KJ also contacted SBC.
Under instructions from KJ, SBC accepted from BCB a demand draft for Rs. 8,800 dated December 13, 1946
draw on its Calcutta Head Office towards payment of the two cheques. SBC presented the draft to the BCB
Calcutta for payment, but instead of making payment, BCB Calcutta wrote on December 16, 1946 requesting
SBC to obtain payment from its Shillong Branch. The SBC communicated this advice to KJ. After several days SBC
presented the draft to the BCB Shillong for payment, but the draft was not paid. On January 2, 1947, the BCB
closed its business and was placed under moratorium.
On January 11, 1947, SBC wrote to the KJ stating that it was holding the demand draft as also the cheque on the
Nath Bank and would be glad to receive further instructions in the matter for necessary action. As KJ refused
to give any instructions, SBC continued to hold the securities on account of KJ. In respect of the draft, SBC duly
preferred a claim in the liquidation of the BCB and was admitted as a preferential creditor for the amount of
the draft. On January 28, 1947, KJ wrote to SBC alleging that it had accepted the demand draft at its own risk
and responsibility and was bound to give credit to the appellant for the sum of Rs. 8,800. The dealings between
KJ and SBC continued, and the last entry in his account as done on December 29, 1950. On February 26, 1953,
a petition was presented in the Assam High Court for the winding up of SBC. By an order dated May 24. 1953,
SBC was ordered to be wound up. On June 28, 1954 the liquidator of SBC presented an application to the Assam
High Court under s. 45(D) of the Banking Companies Act, 1949 for settlement of the list of debtors and interest
against KJ who did not agree with the claim. Subsequently KJ filed a suit against SBC. The lower courts at Assam
upheld the liquidator’s settlement but KJ went in appeal to Supreme Court in the matter.\

It was observed that the bank had acted in good faith and in the interest of the customer, when it accepted
cheque instead of cash. The customer had also approved all the steps taken by the collecting bank in the matter
of collecting draft.
The Supreme Court summarized the duties of collecting bank as - “a banker entrusted by his customer with the
collection of a cheque is bound to act according to the directions given by the customer, and in the absence of
such direction, according to usage prevailing at the place. The banker is also bound to use reasonable skill and
diligence in presenting and securing payment of the cheque and placing the proceeds to his customer’s account
and in taking such other steps as may be proper to secure the customer’s interest.” In this case, by a majority
decision, the Supreme Court dismissed the claim of KJ.
8. Collecting Bank’s negligence

Indian Overseas Bank v. Industrial Claim Concern 1989 (2) LW 437 (SC)
Facts of the Case:

Suit was filed by the defendant for recovery of loss it claimed to have sustained on account of the alleged
negligence and conversion on the part of the bank. The matter reached Supreme Court on appeal by the bank.
Though the trial court decided that the bank was negligent in allowing the firm to open a ‘fictitious account’ and
permitting the customer to withdraw proceeds and also close the account.

The Supreme Court held that the facts and materials available on record did not show that the bank has acted
negligently. Though the Supreme Court made certain observations on banking practice, it concluded that the
bank was not negligent and protection under Section 131 of the NI Act was available to the bank.
9. Responsibilities of collecting bank in the case of substituted agent
Facts of the Case:

The firm Ishwarbhai Lalbhai Patel and Co. deposited a cheque in their favour drawn on Lakshmi bank, Bandara
for collection with Punjab National Bank, Gondia. PNB had no branch at Bandara, hence they sent the cheque to
Lakshmi bank, Gondia for collection. The cheque was passed and a pay order was issued to PNB for receiving
payment at its Gondia branch. In spite of presenting the pay order twice the payment was not received and the
third time when the cheque was presented to Lakshmi bank it had suspended the payment. Shortly thereafter
Laxmi Bank went into liquidation. A suit was filed by the firm for realization of cheque on PNB.
Decision of the High court

The court held that the acts of Lakshmi Bank, Gondia, as substituted agent would be binding on the customer
and PNB would not be responsible to the customer unless it had received the payment in its hand and credited
the same to the account of customer. The collecting banker collects the amount of the cheque from the paying
banker through its own branch at the place of the paying banker. If there is no branch of the collecting banker at
that place, it appoints another banker, having branch at that place, as its agent for collection. The status of such
agent banker is a sub agent or a substitute agent.
After weighing all aspects of the case the court did not find any negligence on the part of Punjab National Bank
as it could not collect the money from the paying bank in spite of its reasonable efforts.
(Punjab National Bank, Gondia vs. Iswarbhai Lalbhai Patel and Co. (AIR 1971, Bombay 348)
The following are the English Case laws with the reference to negligence of a Collecting
Banker.
10. Negligence in case of a Stolen cheque
Facts of the Case:

A cheque in transit was stolen, collected through a bank and money was withdrawn by a thief by forging
signature of the payee and posing himself as payee.
Decision of the court

The collecting bank was held liable to make good the amount to the true owner, since it acted negligently while
opening the account by not making proper enquiries or asking suitable references. [English Court Decision
Ladbroke vs. Todd (1914,30 TLR 433).]
11. Negligence while opening accounts
Facts of the Case:

An account was opened for a new customer after completing the necessary formalities. The account was
opened by accepting a third party cheque for collection instead of depositing cash. On making enquires with
the customer he produced a forged letter issued by his employer giving him power to deal with cheque. When
it was later on found that the cheque was stolen.
Decision of the court

The bank was held negligent for failure to make necessary enquiries from the employer as to whether the
customer who was employee had power to deal with cheque. (Harding vs. London Joint Stock Bank, 1914, 3).
12. Negligence of Conversion

It was held that a non-negotiable crossing is only one of the factors amongst others to be considered to decide
about the banker’s negligence and that the mere taking of a non-negotiable cheque cannot be held to be evidence
of negligence on the part of banker. It is the duty of banker to ensure that the cheque is crossed specially to
himself and if the cheque is crossed to some other banker they should refuse to accept it. Similarly, where the
cheque is crossed to a specific account then crediting the same to another account without necessary enquiries
would make him liable on the grounds of negligence. (Crumpling vs. London Joint Stock Bank Ltd., 1911-13).
13. Negligence of conversion
Facts of the Case:

The MD of a company paid into his personal account large number of cheques which were issued in favour of
the company.

The bank was held negligent on account of conversion. (The Underwood Ltd. vs. Bank of Liverpool Martin Ltd.,
1924 1KB 775.)
14. Negligence while opening accounts
Facts of the Case:

Two clerks of stock broker stole bearer cheques belonging to their employer and collected through accounts;
one opened in the name of one such clerk and other opened in the name of his wife.

The bank was held negligent in opening the accounts as it did not ask the employers name while opening
account of that clerk and in his wife’s case the name of the employer of her husband and his occupation. (Savory
Company vs. Lloyds Bank, 1932 2KB, 122)
15. When there is no negligence of conversion bank is not liable
Facts of the Case:

An agent deposited in his personal account, a few cheques, favouring his principal. The bank was charged for
conversion. The bank, however, defended that there was implied authority from principal to his agent to use his
private account for such purpose.

The bank was not held liable since it was found that the principal had in fact authorized his agent to use his
personal account. (Australia and New Zealand Bank vs. Ateliers de Constructions Eletriques de Cherleroi, 1967, 1
AC 86 PC).
16. Negligence of conversion
Facts of the Case:

The Manager of a company, was permitted to draw cheques per pro his employer and he drew some cheques
payable to himself and collected in his personal account.

The bank was held negligent for collecting these cheques because it did not make proper enquiries. (Morrison
vs. London county and Westminster Bank, 1914-15, all ER Rep 853)
17. Failure to take precautions
Facts of the Case:

The Nu-Stilo Footwear Limited (NFL) were manufacturers of ladies footwear. Their Secretary and Works
Accountant fraudulently deposited a total of 9 cheques payable to NFL in to his newly opened personal account
with Lloyds Bank, in false name by giving reference of his real name. During the preliminary enquiry before the
account was opened the bank was informed that the account opener had recently come to the town with the
intention to start his own business. The nine cheques were then deposited in the account. When the fraud came
to light, NFL sued Lloyds Bank for collecting these cheques and sought compensation.

The Court held that the collecting bank was negligent for not taking necessary precaution because the amounts
of cheques collected were inconsistent with the business of account holder. (Nu-Stilo Footwear Ltd. vs. Lloyds
Bank, 1956, 7 P 121)
18. Negligence of the bank in making payment with forged signatures
Facts of the Case:

Mrs. Rosali opened a Saving Bank Account with Syndicate Bank in the year 1983 under Account No.5623/14.
Every month, she used to deposit her rental income Rs.750 to Rs.800/- in the said account. On 01.07.1985, she
withdrew a sum of Rs.1500/- under a cheque bearing No.332771 and on 03.11.1986, she withdrew a sum of
Rs.10,000/- under a cheque bearing No.332772. Except these two withdrawals, she has not withdrawn any
money during that period. Her balance as on May 1987 ought to have been a sum of Rs.52,900.55. But, to her
shock and surprise, when she verified with the bank, she found that she had only balance of Rs.127.55 and one
Mr.Thomas, who is her messenger and relative used to transact with the Bank on her behalf, has forged her
signatures in the cheque slips and withdrawn a total sum of Rs.52,900.55, without her knowledge.
The Bank Officials, who should have shown proper care, while passing cheques containing forged signatures,
has failed to do so, resulting in withdrawal of Rs.52,900.55 by the said Thomas fraudulently. The defendant
Bank Officials had passed the cheques without due care and by gross negligence, which amounts to dereliction
of duty and misconduct in the course of employment. Had due diligence shown by the Bank Officials by proper
comparison of the specimen signatures of the plaintiff kept in the custody of the Bank with, the cheques
presented by the said Thomas ought not have passed the forged cheques.
Based on her complaint to the Mylapore Police Station against the said Thomas, the Police has registered a
case and the Trial ended in conviction for two years of Rigorous Imprisonment. Since the defendant Bank has
negligently passed the cheques containing four signatures, they are liable to pay a sum of Rs.52,900.55 with
interest at the rate of 18%.

Court, on going through the materials placed, holds that the respondent bank was never negligent in honouring
the cheques. Hence, they are protected under Section 131 of the Negotiable Instrument Act, 1881. In the absence
of justification on the part of the plaintiff for allowing the said Thomas to handle her passbook and cheque book
and representing to the bank implicitly and explicitly that Thomas is her representative, she is estopped from
alleging negligence on the part of the respondent bank. Therefore, the conduct of the respondent Bank estops
her from questioning the bank for honoring the cheques of the plaintiff. Even if it is not signed by her, but due
to lookalike signatures, the bank cannot be held responsible. The evidence of DW1 to DW6 narrate the care
and caution exercised by the bank officials while passing the cheques. Therefore, their evidence cannot be just
ignored, in the absence of contra evidence. As pointed out by the lower appellate Court, the reasoning of the
trial Court is bad and bereft of details for his conclusion that the signatures found in the cheques are forged.
Therefore, even though there is no legal impediment to exercise the power under Section 73 of the Indian
Evidence Act, 1872, without resorting to expert opinion under Section 45 of the Indian Evidence Act, 1872, the
manner in which the power under Section 73 of the Indian Evidence Act, 1872 exercised is always subject to
judicial scrutiny. First and foremost, the plaintiff/appellant ought to have proved the case of forgery by letting
in plausible evidence, which is well within her limitation, but miserably failed to do. Next, in the absence of
reasoning and the process undertaken by the trial Court to arrive at the conclusion that signatures found in
the disputed signatures are forged, since finding deserves to be reversed. The lower appellate Court has rightly
reversed the trial Court finding by allowing the first appeal.
(In the High Court of judicatures at Madras - Mrs Rosali Versus Syndicate Bank , Myloapore , Madras , pronounced
on 23.08.2017 )
LESSON ROUND UP
• Protection is available to a collection bank under Section 131 of the NI Act, only when the following
conditions are satisfied:
• The bank should collect the instrument only for its customers;
• The cheque should be crossed generally or specially;
• The collected proceeds are deposited only into the account of the customer or to the account of the
endorsee;
• The collecting bank should have acted in ‘good faith’, mans the banker had no reasonable ground to
believe that the customer is not entitled to receive payment of the amount mentioned therein;
• The collecting bank should have acted without negligence (i.e.) all account opening KYC and monitoring
should be done in accordance with the policy and normal practice. Opening of account and deposit of
the cheque, if forms part of the same scheme, where the account itself was opened for enchasing the
instrument fraudulently, then it could lead to an inference that the bank is negligent;
• Collection based on truncated instruments should be verified for apparent fraud, forgery or tampering
on the face of the instrument by ordinary care and due diligence.
TEST YOURSELF
Write True or False:
a. Section 131 A extends protection to banks when they collect DDs.
b. Under Section 131 collecting bankers also get protection for collecting uncrossed cheques.
c. If documents are lost against which the bank has advanced money, the bank can debit the customer’s
account.
d. If circumstances create doubt or suspicion about the right of the customer to the cheque, the banker
must make proper enquiries and take adequate precaution.
e. If an endorsement was found to be suspicious, it is the duty of the collecting bank to verify it from
independent source.
Lesson 10 • Various Government Schemes 261
Lesson 10 Various Government Schemes

Should Know
• PMJDY This lesson will enable a reader to • Banking Regulation Act, 1934
• PMMY understand: • Insurance Act, 1938
• APY • Background.
• MUDRA • Objectives of the schemes.
• PMJJBY • Formalities relating to account

opening formalities (where
• PMFBY applicable).
• PMEGP • The salient features of the
• NRLM scheme.
• NULM • Documents required.
• RSETI • Eligibility.
• Benefits.
• Details of the scheme.
• Conditions to be fulfilled.
Lesson Outline
• Introduction • Deendayal Antodya Yojana –
• Pradhan Mantri Jan Dhan Yojana NULM
(PMJDY) • Differential Rate of Interest
• MUDRA Bank Yojana Scheme
• National Equity Fund • Self Employment Scheme

for Rehabilitation of Manual
• Sukhanya Samridi Account Scavengers
• Pradhan Mantri Jeevan Jyoti • Prime Minister’s Awas Yojana –
Beema Yojana (PMJJBY) Urban
• Pradhan Mantri Suraksha Bima • Prime Minister’s Awas Yojana –
Yojana (PMSBY) Gramin
• Atal Pension Scheme • Standup India Scheme for
• Pradhan Mantri Vaya Vandana financing SC/ST
Yojana. • Women Entrepreneurs
• Pradhan Mantri Fasal Bima Yojana • Rural Self Employment Training
(PMFBY) Institutes (RSETI)
• Pradhan Mantri Employment • LESSON ROUND UP
Generation Programme (PMEGP)
• TEST YOURSELF
• Deendayal Antodya Yojana – NRLM
261
INTRODUCTION FOR STARTING GOVERNMENT SCHEME

Indian Government, at all levels, announces Welfare Schemes for a cross section of
the society from time to time. These schemes could be either Central, State specific
or a collaboration between the Centre and the States. In this section, we have
attempted to provide an easy and single point access to information about several
welfare schemes of the Government and their various aspects including eligible
beneficiaries, types of benefits, scheme details etc.
PRADHAN MANTRI JAN-DHAN YOJNA (PMJDY)

Hon’ble Prime Minister, Sh. Narendra Modi on 15th August 2014 announced “Pradhan Mantri Jan-Dhan Yojana
(PMJDY)” which is a National Mission for Financial Inclusion. Financial Inclusion is the provision of banking
services at an affordable cost, to the disadvantaged sections of the society, who are hitherto excluded and
deprived of the Financial Services, to enable them to improve their standard of living. The task is gigantic and
is a National Priority.
Purpose of the Scheme

With the slogan “Mera Khata - Bhagya Vidhaata”, Pradhan Mantri Jan-Dhan Yojana (PMJDY) aims to ensure
access to financial services, namely, Banking/ Savings & Deposit Accounts, Remittance, Credit, Insurance,
Pension in an affordable manner.
Account can be opened in any bank branch or Business Correspondent (Bank Mitr) outlet. Accounts opened
under PMJDY are being opened with Zero balance. However, if the account-holder wishes to get cheque book,
he/she will have to fulfill minimum balance criteria.
Documents required for opening account

An account can be opened by presenting any one of the following officially valid document:
i. the passport,
ii. the driving licence,
iii. the Permanent Account Number (PAN) Card,
iv. the Voter’s Identity Card issued by Election Commission of India,
v. job card issued by NREGA duly signed by an officer of the State Government,
vi. the letter issued by the Unique Identification Authority of India containing details of name, address and
Aadhaar number, or
vii. any other document as notified by the Central Government in consultation with the Regulator.
Provided that where simplified measures are applied for verifying the identity of the clients the following
documents shall be deemed to be officially valid documents : -
a. identity card with applicant’s Photograph issued by Central/State Government Departments, Statutory/
Regulatory Authorities, Public Sector Undertakings, Scheduled Commercial Banks, and Public Financial
Institutions;
b. letter issued by a Gazetted officer, with a duly attested photograph of the person.
Reserve Bank of India (RBI), vide its Press Release dated 26.08.2014, has further clarified that those persons who
do not have any of the ‘officially valid documents’ can open “Small Accounts” with banks. A “Small Account” can
be opened based on a self-attested photograph and putting his/her signatures or thumb print in the presence
of officials of the bank. Such accounts have limitations regarding the aggregate credits (not more than Rupees
one lakh in a year), aggregate withdrawals (nor more than Rupees ten thousand in a month) and balance in the
accounts (not more than Rupees fifty thousand at any point of time). These accounts would be valid normally
for a period of twelve months. Thereafter, such accounts would be allowed to continue for a further period of
twelve more months, if the account-holder provides a document showing that he/she has applied for any of the
Officially Valid Document, within 12 months of opening the small account.
Benefits
Special benefits under the scheme include:
1. Interest on deposit as applicable.
2. Accidental insurance cover of Rs. 2 lac.
3. No minimum balance required to be maintained in the account.
4. Life cover of Rs. 30,000 payable on death of the beneficiary, subject to fulfillment of eligibility condition.
5. Easy transfer of money across India.
6. An overdraft facility of Rs. 10,000 after satisfactory operation of the account for 6 months. There will be
no conditions attached for over-draft of up to Rs. 2,000.
7. Access to pension and insurance products.
Conditions to be fulfilled to avail overdraft facility are:
1. Satisfactory operation for 6 months.
2. Facility to only earning member of the family, preferably a woman.
3. Age of the applicant should be between 18 years to 65 years.
4. Period of sanction will be 36 months subject to annual review.
5. Loan amount will be - 4 times of average monthly balance, or 50% of credit summations in the account for
preceding 6 months or Rs. 10,000/- whichever is less.
6. Interest rate not exceeding 2% above base rate of the bank.
7. No processing fee is applicable.
PRADHAN MANTRI MUDRA YOJANA (PMMY)

Micro Units Development and Refinance Agency Ltd. [MUDRA] is an NBFC supporting development of micro
enterprise sector in the country. MUDRA is a public sector institution for providing loans to small entrepreneurs
launched on 08/04/2015. MUDRA provides refinance support to Banks / Micro Finance Institutions (MFIs) for
lending to micro units having loan requirement up to 10 lakh. MUDRA provides refinance to micro business
under the Scheme of Pradhan Mantri MUDRA Yojana. The other products are for development support to the
sector. It targets mainstream young, educated or skilled workers and entrepreneurs who cannot have access to
credit from regular banking system.
The bouquet of offerings of MUDRA is depicted below. The offerings are being targeted across the spectrum of
beneficiary segments.
Purpose of MUDRA Loan

Mudra loan is extended for a variety of purposes which provide income generation and employment creation.
The loans are extended mainly for:
i. Business loan for Vendors, Traders, Shopkeepers and other Service Sector activities.
ii. Working capital loan through MUDRA Cards.
iii. Equipment Finance for Micro Units.
iv. Transport Vehicle loans.
MUDRA Scheme
MUDRA has launched following three loan instruments, as given below:
1. Shishu (the starters) upto Rs. 50,000.
2. Kishor (the mid stage finance seekers) above Rs. 50,000and upto Rs. 5 lakh.
3. Tarun (growth seekers) Above Rs. 5 lakh and upto Rs. 10 lakh.
Under Credit Guarantee Fund for Micro Units (CGFMU) for loans under MUDRA scheme, guarantee is offered by
National Credit Guarantee Trust Company for which following loans are eligible:
• All loans sanctioned under PM MUDRA Yojana by Commercial banks,
• MFIs and Non-Banking Finance Companies [these are called Member Lending Institutions (MLI)] - in the
categories of Shishu, Kishor and Tarun and overdraft up to Rs. 5,000.00 under PM Jan DhanYojana.
In these loans, the Member Lending Institutions should not obtain any collateral security or 3rd party guarantee
from the borrower.
Types of funding support from MUDRA

1. Micro Credit Scheme: It is offered mainly through
Micro Finance Institutions (MFIs), which deliver the
credit up to Rs.1 lakh, for various micro enterprise
activities. Although, the mode of delivery may be
through groups like SHGs/JLGs, the loans are given to
the individuals for specific income generating micro
enterprise activity. The MFIs for availing financial
support need to enroll with MUDRA by complying
to some of the requirements as notified by MUDRA,
from time to time.
2. Refinance scheme for Banks: Different banks like Commercial Banks, Regional Rural Banks and Scheduled
Cooperative Banks are eligible to avail of refinance support from MUDRA for financing micro enterprise
activities. The refinance is available for term loan and working capital loans, up to an amount of Rs. 10 lakh
per unit. The eligible banks, who have enrolled with MUDRA by complying to the requirements as notified,
can avail of refinance from MUDRA for the loan issued under Shishu, Kishor and Tarun categories.
3. Women Enterprise programme: To encourage women entrepreneurs, the financing banks / MFIs may
consider extending additional facilities, including interest reduction on their loan. At present, MUDRA
extends a reduction of 25bps in its interest rates to MFIs / NBFCs, who are providing loans to women
entrepreneurs.
4. Securitization of loan portfolio: MUDRA also supports Banks / NBFCs / MFIs for raising funds for
financing micro enterprises by participating in securitization of their loan assets against micro enterprise
portfolio, by providing second loss default guarantee, for credit enhancement and participating in
investment of Pass Through Certificate (PTCs) either as Senior or Junior investor. PTC is a certificate that
is given to an investor against certain mortgaged backed securities that lie with the issuer.
MUDRA Card
MUDRA Card is an innovative product which provides working
capital facility as a cash credit arrangement. MUDRA Card is a
debit card issued against the MUDRA loan account, for working
capital portion of the loan. The borrower can make use of MUDRA
Card in multiple withdrawal and credit, to manage the working
capital limit in a most efficient manner and keep the interest
burden minimum. MUDRA Card will also help in digitalization
of MUDRA transactions and creating credit history for the
borrower. National Payment Corporationof India (NPCI) has
given RuPay branding to MUDRA
Card and separate BIN / IIN for the same, by which credit history can be tracked. MUDRA Card can be operated
across the country for withdrawal of cash from any ATM / micro ATM and make payment through any ‘Point of
Sale’ machines.
The design of the MUDRA card as approved by Department of Financial Services (DFS), GoI and NPCI is given
below. Banks can customize the same by incorporating their logo and name.
National Equity Fund (NEF)

Objective
The objective of the Scheme is to provide equity type support The SIDBI of India has set up the national
to Micro and Small Enterprises (MSE) as defined under MSME equity fund scheme which provides the
Act, 2008 and thereby improving their acceptability for team equity type assistance to entrepreneurs
financing by Primary Lending Institutes (PLIs). The fund is for setting up new projects which can be
administered by SIDBI in participation with Government of India. classified as SSI units.
Secondly, the objective is to afford equity type support to entrepreneurs for setting up projects in small scale
sectors for undertaking expansion, modernization, technology up-gradation and diversification by existing
small scale sector and for rehabilitation of viable sick units in the SSI sector.
Eligibility
i. New as well as existing entrepreneurs in the MSE sector.
ii. Sanction of refinance in respect of term loan for the projects by SIDBI is a prerequisite.
iii. The complete requirements of the projects in the form of equity assistance, the term loan and working
capital will be provided by one agency viz. a nationalized bank or State Finance Corporation.
Features
1. Lending institutions to provide equity type of soft loan scheme under this scheme.
2. Project cost can be upto Rs. 50 lakh (including margin for working capital) for MSE sector.
3. Amount of Assistance - 25% of the project cost subject to a maximum Rs. 10 lakh per project.
4. Debt Equity Ratio - 1.875 : 1 (excluding state subsidy for working capital).
5. Minimum promoters’ contribution should be 10% of the project cost.
6. The rate of interest imposed by banks/SFCs for the various project will be as per RBI guidelines.
7. Repayment period - 7 years including moratorium up to 3 years.
8. Security - No security or collateral nor coverage under DICGC guarantee scheme is needed, as the credit
risk is borne by SIDBI.
Procedure for Availing Assistance

• A separate application is to be furnished for availing assistance under the NEF Scheme. Entrepreneurs
while requesting for term loan assistance from financial institutions can specify the amount of NEF
assistance in their financing proposal.
• Eligible applicants will submit five copies of the application, duly completed to Zila Sainik Board (ZSBs),
along with the project report.
• ZSB will maintain four copies of the application form and return one copy to the applicant duly endorsed.
• ZSB will transfer one copy to Rajya Sainik Board (RSB) and other three copies of the form along with the
project plan to the concerned branch of the banks for the sanction of loan.
• Also, the copy of the letter should be transferred by ZSBs to SIDBI and the District Lead Bank Officer, for
necessary information. One copy of the application form receipted will be reimbursed by the bank to the
ZSB for their record. The borrowers will be intimated by the Secretary, ZSB about the sanction of loans.
SUKANYA SAMRIDDHI ACCOUNT YOJANA
Objective
Sukanya Samriddhi Account is Government of India backed savings
scheme targeted at the parents of girl child. It is a Girl Child Prosperity
Account. The Sukanya Samriddhi Yojana was launched as a part of
the Beti Bachao, Beti Padhao campaign by the Modi government on
22 January 2015 after seeking the subjugating conditions of the girl
children in the country. The scheme encourages parents to build a
fund for the future education and marriage of a girl child.
Features of the scheme:
1. Who will open this account: A Sukanya Samriddhi Account can only be opened by the parent/legal
guardian for a maximum of two female children. An exemption is provided by presenting a medical
certificate from an authorized medical institution for twins and triplets.
2. Age Criteria: A Sukanya Samriddhi account can only be opened for a girl child anywhere between her
birth and 10 years of age.
3. Residential status: This account can only be opened for a girl child who is a resident of India. This scheme
is unavailable for a girl child having non-resident status. Even if the parents or the legal guardians are non-
residents, then also this scheme will not be available to them. If the girl child becomes a non resident after
opening this account, then this change should be intimated to the concerned post office/ bank within 1
month of such change after which the account gets closed.
4. Account in the name of the girl child: Sukanya Samriddhi account must always be opened in the name
of a girl child and not in the name of her parents or legal guardians. They will only deposit an amount in
the account on behalf of the minor girl child.
5. Number of accounts: A single parent/legal guardian can open only one account for every girl child in the
family. A maximum of two accounts for two girl children can be opened in one family.
6. Where to open this account: This account is opened in the authorized branches of Post Offices or
commercial banks like State Bank of India, Bank of Baroda, Punjab National Bank, Bank of India, Canara
Bank, and UCO Bank, to name a few.
7. Documents required: There are certain documents required to open this account-
– Birth certificate of the girl child
– Address and identity proof of the depositor (parents or the legal guardians)- Aadhaar card, PAN card,
passport, ration card, driving license.
– In case of twins or triplets, a medical certificate proving the order of birth of children.
– Certificate stating the nature of a relationship with the girl child. In cases where this account is
opened by the biological parents of the girl child, the birth certificate will serve the requirement of
this certificate. But in the case of the adopted girl child, this certificate becomes necessary.
8. Threshold of deposits: Sukanya Samriddhi account can be opened with a minimum deposit of Rs.250
per account. A maximum limit on the amount of deposit to this account has been set at Rs.1.50 lakhs per
account per financial year. There is no limit in the number of deposits in a month or a fiscal year.
9. Mode of payment of deposits: The cheque or the demand draft should be in the name of the-
– For Banks/Financial institutions- Concerned Bank Manager
– For Post Office- Concerned Postmaster
The parent or the guardian is required to write the girl child’s name and the account number on the back
of the cheque or draft while making the payment of deposit.
10. Account Transferability: The option to transfer the Sukanya Samriddhi Account from the post office to
post office, bank to bank, post office to the bank, and bank to post office on furnishing certain documents
is available.
11. Penalty: A penalty of Rs.50 will be imposed if there is a failure in meeting the minimum deposit
requirements.
12. Rate of Interest: The interest rate change chart is as under:
Financial year Assessment year Interest rate
Q1 of 2020-2021 Q1 of 2021 - 2022 7.60
Q1 of 2019 - 2020 Q 1 of 2021 -2022 8.50
Q4 of 2018-19 Q4 of 2019 - 2020 8.50
This interest is compounded on yearly basis.
13. Maximum duration of deposit: The maximum duration for which a parent/guardian is required to
deposit an amount in this account is 14 years. After the end of this duration, no more money is required to
be deposited to this account and it will continue to accumulate interest until it matures/closed.
14. Closure of Account: This account gets closed after it attains maturity after completing the tenure of 21
years. The money lying in this account including the interest is paid to girl child after attaining 18 years of
age and on submission of an account closure application along with address and identity proof, proof of
residence and citizenship.
15. Taxation aspects: Tax exemption under Section 80C of Income-tax Act, 1961.
16. Tenure of account: This savings account remains active for a maximum period of 21 years from the date
of opening of this account, after which the account stops to accrue any interest.
17. Premature closure of account -
(1) In the event of death of the account holder, the account shall be closed immediately on production of
death certificate issued by the competent authority, and the balance at the credit of the account shall
be paid along with interest till the month preceding the month of premature closure of the account
to the guardian of the account holder.
(2) Where the Central Government is satisfied that operation or continuation of the account is causing
undue hardship to the account holder, it may, by order, for reasons to be recorded in writing, allow
pre-mature closure of the account only in cases of extreme compassionate grounds such as medical
support in life threatening diseases, death, etc.
PRADHAN MANTRI JEEVAN JYOTI BIMA YOJANA (PMJJBY)
Background
Government of India backed Life Insurance
Scheme for the benefit of weaker sections of
the society. PMJJBY is an Insurance Scheme
offering life insurance cover for death due
to any reason. It would be a one year cover,
renewable from year to year Hon’ble Prime
Minister launched PMJJBY schemes nationally in Kolkata on 9th May, 2015.
Scope: All individual account holders of participating banks in the age group of 18 to 50 years will be entitled
to join. In case of multiple bank accounts held by an individual in one or different banks, the person would
be eligible to join the scheme through one bank account only. Aadhar would be the primary KYC for the bank
account.
Enrolment period: The cover period is from 1st June to 31st May, subscribers are required to enroll and
give their auto-debit consent by 31st May every year. Those joining subsequently would be able to do so with
payment of full annual premium for prospective coverage.
For subscribers enrolling for the first time on or after 1st June 2016, insurance cover shall not be available
for death (other than due to accident) occurring during the first 45 days from the date of enrolment into the
scheme (lien period) and in case of death (other than due to accident) during lien period, no claim would be
admissible.
Individuals is free to exit the scheme at any point and may re-join the scheme in future. The exclusion of
insurance benefits during the lien period shall also apply to subscribers who exit the scheme during or after the
first year and rejoin on any date on or after 1st June 2016.
In future years, new entrants into the eligible category or currently eligible individuals who did not join earlier
or discontinued their subscription shall be able to join while the scheme is continuing subject to the 45 days
lien period described above.
Benefits: Rs.2 lakh is payable on member’s death due to any cause.
Premium: Rs.330/- per annum per member. The premium will be deducted from the account holder’s bank
account through ‘auto debit’ facility in one instalment, as per the option given, on or before 31st May of each
annual coverage period under the scheme. Delayed enrolment for prospective cover after 31st May will be
possible with full payment of annual premium.
Eligibility Conditions:
Individual bank account holders of the participating banks aged between 18 years (completed) and 50 years
(age nearer birthday) who give their consent to join / enable auto-debit, as per the above modality, will be
enrolled into the scheme.
Termination of assurance: The assurance on the life of the member shall terminate on any of the following
events and no benefit will become payable there under:
1) On attaining age 55 years subject to annual renewal up to that date (entry, however, will not be possible
beyond the age of 50 years).
2) Closure of account with the Bank or insufficiency of balance to keep the insurance in force.
3) In case a member is covered under PMJJBY with LIC of India / other company through more than one
account and premium is received by LIC / other company inadvertently, insurance cover will be restricted
to Rs. 2 Lakh and the premium paid for duplicate insurance(s) shall be liable to be forfeited.
4) If the insurance cover is ceased due to any technical reasons such as insufficient balance on due date or
due to any administrative issues, the same can be reinstated on receipt of full annual premium, subject
however to the cover being treated as fresh and the 45 days lien clause being applicable.
5) Participating Banks shall remit the premium to insurance companies in case of regular enrolment on or
before 30th of June every year and in other cases in the same month when received.
Administration: The scheme, subject to the above, will be administered by the LIC P&GS Units / other insurance
company setups. The data flow process and data proforma will be informed separately.
It will be the responsibility of the participating bank to recover the appropriate annual premium in one
instalment, as per the option, from the account holders on or before the due date through ‘auto-debit’ process.
Members may also give one-time mandate for auto-debit every year till the scheme is in force.
The acknowledgement slip may be made into an acknowledgement slip-cum-certificate of insurance.
PRADHAN MANTRI SURAKSHA BIMA YOJANA (PMSBY)
Background
PMSBY provides personal accident cover
as a part of providing Social Security
cover to the weaker section population
through Public Sector General Insurance
Companies (PSGICs) and other General
Insurance companies willing to offer the
product on similar terms with necessary
approvals and tie up with Banks for this
purpose.
The scheme will be a one-year cover,
renewable from year to year, Accident
Insurance Scheme offering accidental
death and disability cover for death or disability on account of an accident.
Scope: All savings bank account holders in the age 18 to 70 years in participating banks will be entitled to join.
In case of multiple saving bank accounts held by an individual in one or different banks, the person would be
eligible to join the scheme through one savings bank account only. Aadhar would be the primary KYC for the
bank account.
Enrollment Period: The cover shall be for the one-year period stretching from 1st June to 31st May for which
option to join / pay by auto-debit from the designated savings bank account on the prescribed forms will be
required to be given by 31st May of every year.
Individuals is free to exit the scheme at any point and may re-join the scheme in future years through the above
modality.
Benefits
Sum Insured
A Death Rs. 2 Lakh
B Total and irrecoverable loss of both eyes or loss of use of both hands or feet or loss Rs. 2 Lakh
of sight of one eye and loss of use of hand or foot
C Total and irrecoverable loss of sight of one eye or loss of use of one hand or foot Rs. 1 Lakh
Premium: Rs.12/- per annum per member. The premium will be deducted from the account holder’s savings
bank account through ‘auto debit’ facility in one installment on or before 1stJune of each annual coverage
period under the scheme.
Eligibility Conditions: The savings bank account holders of the participating banks aged between 18 years
(completed) and 70 years (age nearer birthday) who give their consent to join / enable auto-debit, as per the
above modality, will be enrolled into the scheme.
Termination of cover: The accident cover for the member shall terminate on any of the following events and
no benefit will be payable there under:
1) On attaining age 70 years (age nearest birth day).
2) Closure of account with the Bank or insufficiency of balance to keep the insurance in force.
3) In case a member is covered through more than one account and premium is received by the Insurance
Company inadvertently, insurance cover will be restricted to one only and the premium shall be liable to
be forfeited.
4) If the insurance cover is ceased due to any technical reasons such as insufficient balance on due date or
due to any administrative issues, the same can be reinstated on receipt of full annual premium, subject to
conditions that may be laid down. During this period, the risk cover will be suspended, and reinstatement
of risk cover will be at the sole discretion of Insurance Company.
5) Participating banks will deduct the premium amount in the same month when the auto debit option is
given, preferably in May of every year, and remit the amount due to the Insurance Company in that month
itself.
Administration
The scheme, subject to the above, will be administered as per the standard procedure stipulated by the Insurance
Company. The data flow process and data proforma will be provided separately. It will be the responsibility
of the participating bank to recover the appropriate annual premium from the account holders within the
prescribed period through ‘auto-debit’ process. Enrollment form / Auto-debit authorization in the prescribed
proforma shall be obtained and retained by the participating bank. In case of claim, the insurance company may
seek submission of the same. Insurance Company reserves the right to call for these documents at any point of
time.
The acknowledgement slip may be made into an acknowledgement slip-cum-certificate of insurance.
ATAL PENSION YOJANA (APY)
Background
The scheme is for Indian citizen workers in unorganized sector. It was launched
in 2015. The scheme is administered by the Pension Fund Regulatory and
Development Authority (PFRDA) under the National Pension Scheme (NPS).
Subscribers would receive a fixed minimum of Rs. 1000 or Rs. 2,000 or Rs. 3,000
or Rs. 5000 per month at the age of 60 years depending on their contribution.
Benefit: Fixed pension for the subscribers between Rs. 1000 to Rs. 5000, if he
joins and contributes between the age of 18 years and 40 years.
Eligibility
Atal Pension Yojana (APY) is open to all bank account holders. The Central Government would also co- contribute
50% of the total contribution or Rs. 1000 per annum, whichever is lower, to each eligible subscriber account,
for a period of 5 years.
The Government co-contribution is payable to eligible PRANs by PFRDA after receiving the confirmation from
Central Record Keeping Agency at such periodicity as may be decided by PFRDA.
Age of joining and contribution period

The minimum age of joining APY is 18 years and maximum age is 40 years. The age of exit and start of pension
would be 60 years. Therefore, minimum period of contribution by the subscriber under APY would be 20 years
or more.
Focus of APY: Mainly targeted at unorganised sector workers.
Enrolment and Subscriber Payment

All bank account holders under the eligible category may join APY with auto debit facility to accounts, leading to
reduction in contribution collection charges. The subscribers should keep the required balance in their savings
bank accounts on the stipulated due dates to avoid any late payment penalty.
Enrolment agencies
All Points of Presence (Service Providers) and Aggregators under Swavalamban Scheme would enroll subscribers
through architecture of National Pension System. The banks, as POP or aggregators, may employ BCs/Existing
non - banking aggregators, micro insurance agents, and mutual fund agents as enablers for operational activities.
The banks may share the incentives received by them from PFRDA/Government, as deemed appropriate.
Operational Framework
It is Government of India Scheme, which is administered by the Pension Fund Regulatory and Development
Authority. The Institutional Architecture of NPS would be utilised to enroll subscribers under APY. The offer
document of APY including the account opening form would be formulated by PFRDA.
Funding of APY
Government would provide
(i) fixed pension guarantee for the subscribers;
(ii) would co-contribute 50% of the total contribution or Rs. 1000 per annum, whichever is lower, to eligible
subscribers; and
(iii) would also reimburse the promotional and development activities including incentive to the contribution
collection agencies to encourage people to join the APY.
Penalty for default

Under APY, the individual subscribers shall have an option to make the contribution monthly. Banks are required
to collect additional amount for delayed payments, such amount will vary from minimum Rs. 1 per month to Rs.
10/- per month as shown below:
• Rs. 1 per month for contribution up to Rs. 100 per month.
• Rs. 2 per month for contribution up to Rs. 101 to Rs. 500 per month.
• Rs. 5 per month for contribution between Rs 501 to Rs.1000 per month.
• Rs. 10 per month for contribution beyond Rs 1001 per month.
The fixed amount of interest/penalty will remain as part of the pension corpus of the subscriber.
Discontinuation of payments of contribution amount shall lead to following:
• After 6 months account will be frozen.
• After 12 months account will be deactivated.
• After 24 months account will be closed.
Exit and pension payment

Upon completion of 60 years, the subscribers will submit the request to the associated bank for drawing the
guaranteed monthly pension.
Exit before 60 years of age is not permitted, however, it is permitted only in exceptional circumstances, i.e., in
the event of the death of beneficiary or terminal disease.
PRADHAN MANTRI VAYA VANDANA YOJANA (PMVVY)
Introduction
PMVVY is a pension scheme announced by Government of India,
exclusively for the senior citizens aged 60 years and above which is
available from 4th May 2017 to 31st March 2020. Offline / Online
purchase can be through LIC of India.
The Union Cabinet chaired by Prime Minister Narendra Modi
implemented some major changes under Pradhan Mantri Vaya
Vandanan Yojana (PMVVY). They are as follows:
1. The investment limit has been increased to Rs.15 lakhs under the Pradhan Mantri Vaya Vandana Yojana
(PMVVY). The earlier limit was Rs. 7.5 lakhs.
2. The last date to apply for Pradhan Mantri Vaya Vandana Yojana (PMVVY) has been extended to 31st March
2020.
3. The limit on maximum investment has now revised to per senior citizen (and not per family). So now in
a family if both husband and wife are senior citizen. Both can invest Rs.15 lakhs each as purchase price
(total Rs. 30 lakhs) and can enjoy bonus facility.
Benefits
1) Pension Payment: On survival of the Pensioner during the policy term of 10 years, pension in arrears (at
the end of each period as per mode chosen) shall be payable.
2) Death Benefit: On death of the Pensioner during the policy term of 10 years, the Purchase Price shall be
refunded to the beneficiary.
3) Maturity Benefit: On survival of the pensioner to the end of the policy term of 10 years, Purchase price
along with final pension installment shall be payable.
Eligibility Conditions and Other Restrictions

a) Minimum Entry Age : 60 years (completed)
b) Maximum Entry Age : No limit
c) Policy Term : 10 years
d) Minimum Pension : Rs. 1,000 per month Rs. 3,000 per quarter Rs.6, 000 per half-year Rs.12,000 per
year
e) Maximum Pension : Rs. 10,000 per month Rs. 30,000 per quarter Rs. 60,000 per half-year Rs. 1,
20,000 per year
The maximum pension amount criteria in this plan is for per senior citizen.
Payment of Purchase Price:
The scheme can be purchased by payment of a lump sum Purchase Price. The pensioner has an option to choose
either the amount of pension or the Purchase Price. The minimum and maximum Purchase Price under different
modes of pension will be as under:
Mode of Pension Minimum Purchase Price Maximum Purchase Price
Yearly Rs. 1,44,578 Rs. 14,45,783
Half-yearly Rs. 1,47,601 Rs. 14,76,015
Quarterly Rs. 1,49,068 Rs. 14,90,683
Monthly Rs. 1,50,000 Rs. 15,00,000
The Purchase Price to be charged shall be rounded to nearest rupee.
Mode of pension payment

The modes of pension payment are monthly, quarterly, half-yearly & yearly. The pension payment shall be
through NEFT or Aadhaar Enabled Payment System. The first instalment of pension shall be paid after 1 year,
6 months, 3 months or 1 month from the date of purchase of the same depending on the mode of pension
payment i.e. yearly, half-yearly, quarterly or monthly respectively.
Sample Pension rates per Rs.1000 Purchase Price:
The pension rates for Rs.1000 Purchase Price for different modes of pension payments are as below:
Yearly : Rs. 83.00 p.a.
Half-yearly : Rs. 81.30 p.a.
Quarterly : Rs. 80.50 p.a.
Monthly : Rs. 80.00 p.a.
The pension instalment shall be rounded off to the nearest rupee. These rates are age independent.
Surrender Value
The scheme allows premature exit during the policy term under exceptional circumstances like the Pensioner
requiring money for the treatment of any critical/terminal illness of self or spouse. The Surrender Value payable
in such cases shall be 98% of Purchase Price.
Loan
Loan facility is available after completion of 3 policy years. The maximum loan that can be granted shall be 75%
of the Purchase Price. The rate of interest to be charged for loan amount shall be determined at periodic intervals.
For the loan sanctioned till 30th April 2018, the applicable interest rate is 10% p.a. payable half-yearly for the
entire term of the loan. Loan interest will be recovered from pension amount payable under the policy. The
Loan interest will accrue as per the frequency of pension payment under the policy and it will be due on the due
date of pension. However, the loan outstanding shall be recovered from the claim proceeds at the time of exit.
Free Look period:
If a policyholder is not satisfied with the “Terms and Conditions” of the policy, he/she may return the policy to
the Corporation within 15 days (30 days if this policy is purchased online) from the date of receipt of the policy
stating the reason of objections. The amount to be refunded within free look period shall be the Purchase Price
deposited by the policyholder after deducting the charges for Stamp duty and pension paid, if any.
Exclusion:
There shall be no exclusion on count of suicide and full Purchase Price shall be payable.
PRADHAN MANTRI FASAL BIMA YOJANA (PMFBY)
Introduction
The Government of India, in April 2016 had launched PMFBY after rolling back the
earlier insurance schemes - National Agriculture Insurance Scheme (NAIS), Weather
based Crop Insurance scheme and Modified National Agricultural Insurance Scheme
(MNAIS). The scheme is implemented by Agriculture Insurance Company of India
(AIC) and other empanelled private general insurance companies which are selected
by the State Governments through bidding.
Objectives
i. Providing financial support to farmers suffering crop loss / damage arising out of unforeseen events.
ii. Stabilizing the income of farmers to ensure their continuance in farming.
iii. Encouraging farmers to adopt innovative and modern agricultural practices.
iv. Ensuring flow of credit to the agriculture sector which contributes to food security, crop diversification and
enhancing growth and competitiveness of agriculture sector besides protecting farmers from production
risks.
Coverage of Farmers:
1. All farmers including sharecroppers and tenant farmers growing the notified crops in the notified areas
are eligible for coverage.
2. Compulsory Component
All farmers availing Seasonal Agricultural Operations (SAO) loans from Financial Institutions (i.e. loanee
farmers) for the notified crop(s) would be covered compulsorily.
3. Voluntary Component
The Scheme would be optional for the non-loanee farmers.
4. Special efforts shall be made to ensure maximum coverage of SC / ST/ Women farmers under the scheme.
Crops covered by PMFBY

a) Food crops (Cereals, Millets and Pulses);
b) Oil seeds;
c) Annual Commercial / Annual Horticultural crops.
Main conditions of sum insured / coverage limit in PMFBY

i. Sum insured per hectare for both loanee and non loanee farmers is same and equal to the Scale of Finance
as decided by the District Level Technical Committee
ii. Sum insured for individual farmer is equal to the Scale of Finance per hectare multiplied by area of the
notified crop proposed by the farmer for insurance. Area under cultivation shall always be expressed in
hectare.
iii. Sum insured for irrigated and un-irrigated areas may be separate.
Risk covered
1) Yield Losses (standing crops, on notified area basis). Comprehensive risk insurance is provided to cover
yield losses due to non-preventable risks, such as Natural Fire and Lightning, Storm, Hailstorm, Cyclone,
Typhoon, Tempest, Hurricane, Tornado. Risks due to Flood, Inundation and Landslide, Drought, Dry spells,
Pests/ Diseases also will be covered.
2) In cases where majority of the insured farmers of a notified area, having intent to sow/plant and incurred
expenditure for the purpose, are prevented from sowing/planting the insured crop due to adverse weather
conditions, shall be eligible for indemnity claims up to a maximum of 25 per cent of the sum insured
3) In post-harvest losses, coverage will be available up to a maximum period of 14 days from harvesting for
those crops which are kept in “cut & spread” condition to dry in the field.
4) For certain localized problems, Loss / damage resulting from occurrence of identified localized risks like
hailstorm, landslide, and Inundation affecting isolated farms in the notified area would also be covered.
Premium rates and premium subsidy on PMFBY

1) For Kharif crops, the farmer’s part of premium is 2% of sum assured.
2) For Rabi crops, the farmer’s part of premium is 1.5% of the sum assured.
3) For annual commercial and horticultural crops, the farmer’s part of premium is 5%
The remaining part of premium is paid equally by the central and respective state governments. All funds for
this scheme come from Krishi Kalyan Kosh.
The Government under this system has migrated from claim based insurance scheme to an upfront subsidy for
premium based system. It is a demand driven scheme, therefore no targets are fixed.
Farmers’ details are required to be entered by banks in the
unified portal for crop insurance which is available at www. Prime Minister’s Employment
agri-insurance.gov.in in order to facilitate assessment of
Generation Programme (PM EGP)
coverage of crops insured, premiums deducted, etc.
This scheme was launched by
While restructuring the loans in areas affected by a natural
Government of India to promote
calamity, banks shall also take into account the insurance
employment opportunities through
proceeds, if any, receivable from the Insurance Company. The
launching of new Micro enterprises in
insurance proceeds shall be adjusted to the ‘restructured
India. The programme does not cover
accounts’ in cases where fresh loan have been granted to
existing enterprises in the sector.
the borrower. However, banks shall act with empathy and
consider restructuring and granting fresh loans without
waiting for the receipt of insurance claim in cases where
there is reasonable certainty of receiving the claim.
Background & Other details

PMEGP is an outcome of merger of two earlier schemes of Government of India namely Prime Minister’s
Rojgar Yojana (PMRY) and Rural Employment Generation Programme (REGP) with an objective of generating
employment opportunities through establishment of new micro enterprises in rural as well as urban areas.
This is a credit linked subsidy programme.
PMEGP is a central sector scheme administered by the Ministry of Micro, Small and Medium Enterprises.
(MoMSME) and implemented by Khadi and Village Industries Commission (KVIC). Ministry of MSME is in
Administrative control of the programme as a single nodal agency.
Other objectives of the PMEGP include

• bringing together widely dispersed traditional artisans/ rural and urban unemployed youth and give
them self-employment opportunities to the extent possible, at their place.
• to help arrest migration of rural youth to urban areas by providing employment locally.
• to increase the wage earning capacity of artisans and contribute to increase in the growth rate of rural and
urban employment.
At the State level, the Scheme will be implemented through State KVIC Directorates, State Khadi and Village
Industries Boards (KVIBs) and District Industries Centres (DICs) and banks. The Government subsidy under
the Scheme will be routed by KVIC through the identified Banks (PSU Banks/RRBs/ SIDBI/Approved Private
Sector Bank/Co-operative Banks) for eventual distribution to the beneficiaries / entrepreneurs in their Bank
accounts.
Identification of beneficiaries, of area specific viable projects, and providing training in entrepreneurship
development will be taken care by KVIC, KVIBs and DICs in conjunction with reputed NGOs, Self Help Groups
(SHGs)/ National Small Industries Corporation (NSIC) / Udyami Mitras empanelled, Panchayati Raj institutions
and other relevant bodies including banks. Banks cannot directly sanction loan to an applicant as it has to be
identified by a Task force at District level consisting of District Magistrate/ District Collector/KVIC/DIC/Banks.
Defaulters of bank loans are not eligible to avail the loan.
• The Bank will sanction 90% of the project cost in case of General Category of beneficiary/ institution
and 95% in case of special category of the beneficiary/institution disburse suitably for setting up of the
project.
• Bank will finance Capital Expenditure in the form of Term Loan and Working Capital in the form of cash
credit. Bank can also finance in the form of Composite Loan consisting of Capital Expenditure and Working
Capital. Max The maximum cost of the project/unit admissible in manufacturing sector is Rs.25 lakhs and
in the business/service sector, it is Rs.10 lakhs.
• Bank Credit will be ranging between 60-75% of the total project cost after deducting 15-35% of margin
money (subsidy) and owner’s contribution of 10% from beneficiaries belonging to general category and
5% from beneficiaries belonging to special categories.
• Banks will claim Margin Money (subsidy) on the basis of projections of Capital Expenditure in the project
report and sanction thereof, Margin Money (subsidy) on the actual availment of Capital Expenditure
and excess, if any, will be refunded to KVIC, immediately after the project is ready for commencement of
production.
• Rate of interest and repayment schedule Normal rate of interest shall be charged. Repayment schedule
may range between 3 to 7 years after an initial moratorium as may be prescribed by the concerned bank/
financial institution.
Eligibility for Borrowers and other conditions

Individuals, should be above 18 years of age and have passed VIII Standard. in case of project above Rs.10.00
lakhs in manufacturing and above Rs. 5.00 lakhs for Service Sector. Apart from individuals, Charitable Trusts,
Institutions Registered under Societies Registration Act-1860, SHGs (including those belonging to BPL provided
that they have not availed benefits under any other Scheme) and Production based Co-operative Societies are
also eligible for applying under this scheme.
There is no income ceiling specified under the scheme. Only new projects including Village Industries projects
except activities indicated in the negative list of Village Industries, will receive assistance under the PMEGP.
Existing Units and the units that have already availed Government Subsidy under any other scheme of
Government of India or State Government are not eligible.
Other conditions
Only one person from one family is eligible for obtaining financial assistance for setting up of projects under
PMEGP. The definition of ‘family’ includes self and spouse.
Applicants, who have already undergone training of at least 2 weeks under Entrepreneurship Development
Programme (EDP) / Skill Development Programme (SDP) / Entrepreneurship cum Skill Development
Programme (ESDP) or Vocational Training (VT) will be allowed to submit applications directly to Banks.
Quantum of Bank Finance, Subsidy conditions

• The Maximum project cost for a manufacturing sector unit is pegged at Rs. 25 lacs and for service and
business oriented unit is pegged at Rs.10 lac. The Bank will sanction 90% of the project cost in case
of General Category of beneficiary/ institution and 95% in case of special category of the beneficiary/
institution and disburse suitably for setting up of the project.
• Bank will finance Capital Expenditure in the form of Term Negative List of Activities
Loan and Working Capital in the form of cash credit. Bank
The following list of activities will not be
can also finance in the form of Composite Loan consisting permitted under PMEGP for setting up
of Capital Expenditure and Working Capital. Max of micro enterprises/ projects /units.
• Bank Credit will be ranging between 60-75% of the Any industry/business connected with
total project cost after deducting 15-35% of margin Meat (slaughtered), i.e., processing,
money (subsidy) and owner’s contribution of 10% from canning and/or serving items made of
beneficiaries belonging to general category and 5% from it as food, production/manufacturing
beneficiaries belonging to special categories. or sale of intoxicant items like Beedi /
Pan/ Cigar/ Cigarette etc., any Hotel
• Banks will claim Margin Money (subsidy) on the basis of or Dhaba or sales outlet serving liquor,
projections of Capital Expenditure in the project report preparation/producing tobacco as raw
and sanction thereof, Margin Money (subsidy) on the actual materials, tapping of toddy for sale.
availment of Capital Expenditure and excess, if any, will be Any industry/business connected with
refunded to KVIC, immediately after the project is ready for cultivation of crops/ plantation like Tea,
commencement of production. Coffee, Rubber etc. sericulture (Cocoon
• Rate of interest and repayment schedule Normal rate of rearing), Horticulture, Floriculture,
interest shall be charged. Repayment schedule may range Animal Husbandry like Pisciculture,
Piggery, Poultry, Harvester machines etc.
between 3 to 7 years after an initial moratorium as may be
prescribed by the concerned bank/financial institution.
Eligibility for subsidy

The Institutions/Production Co-operative Societies/Trusts specifically registered as such and SC/ ST/ OBC/
Women/ Physically Handicapped / Ex-Servicemen and Minority Institutions with necessary provisions in
the bye-laws to that effect are eligible for Margin Money (subsidy) for the special categories. Institutions /
Production Cooperative Societies/ Trusts not registered as special categories, will be eligible for Margin Money
(Subsidy) for general category.
Institutions through which beneficiaries can avail the scheme

All Public Sector Banks. All Regional Rural Banks. Co- operative Banks, Private Sector Scheduled Commercial
Banks approved by State Level Task Force Committee, Small Industries Development Bank of India (SIDBI).
Coverage of Village Industry Manufacturing of Polythene carry bags

of less than 20 microns thickness and
Any Village Industry including Coir based projects (except those manufacture of carry bags or containers
mentioned in the negative list) located in the rural area which made of recycled plastic for storing,
produces any goods or renders any service with or without carrying, dispensing or packaging of
the use of power and in which the fixed capital investment per food stuff and any other item which
head of a full time artisan or worker i.e. Capital Expenditure on causes environmental problems.
workshop/ work-shed, machinery and furniture divided by full Industries such as processing of
time employment created by the project does not exceed Rs. 1 Pashmina Wool and such other products
lakh in plain areas and Rs.1.50 lakh in hilly areas. like hand spinning and hand weaving,
taking advantage of Khadi Programme
Rural Area under the purview of Certification
For the purpose of this scheme Rural Area has been defined as Rules and availing sales rebate.
(i) Any area classified as Village as per the revenue record of the Rural Transport (Except Auto Rickshaw
State/Union Territory, irrespective of population. (ii) Any area in Andaman & Nicobar Islands, House
Boat, Shikara & Tourist Boats in J&K
even if classified as town where its population does not exceed
and Cycle Rickshaw).
20,000 persons.
Operational modalities of the scheme
KVIC will place the margin money (subsidy) amount with the Banks involved in the implementation of the
scheme in accordance with the targets allocated to the implementing Banks in the State/ District. DICs, in close
coordination with Banks, will ensure that at least 50 % of the total margin money (subsidy) allocated to them
will be utilized in setting up of projects in rural areas.
The Task Force, under will hold quarterly meeting with the Banks at district level to review the status of the
project proposals.
If projects are rejected, shortcomings/reasons will be furnished by the concerned Banks to the implementing
agencies concerned and the applicants concerned will be requested by KVIC / KVIBs / DICs to provide
additional information/documents if required and concerned representatives of KVIC, KVIBs and DICs, will
provide assistance to the applicants in this process.
Basis of sanction, Release of Credit/Subsidy by banks

Banks will take their own credit decision on the basis of viability of each project. No collateral security will
be insisted upon by Banks in line with the guidelines of RBI for projects involving loan up to Rs. 5 lakh in
respect of the projects cleared by the Task Force. However, they have to appraise projects both technically and
economically after ensuring that each project fulfills inter alia the criteria of
(i) Industry
(ii) Per Capita Investment
(iii) Own Contribution
(iv) Rural Areas (projects sponsored by KVIC / KVIBs / DICs) and
(v) Negative List.
First installment of the loan will be released to the beneficiary only after completion of Entrepreneurship
Development Programme (EDP) training of at least 2 weeks specially designed for the purpose, to be organized
by KVIC / KVIBs / DICs or the institutions. After the successful completion of EDP training arranged by the
KVIC / KVIBs / State DICs, the beneficiary will deposit with the bank, the owner’s contribution. Thereafter, the
bank will release first installment of the Bank Finance to the beneficiary. If a beneficiary doesn’t complete EDP
training, projects sanctioned will be declared ineligible for Margin Money (subsidy) assistance.
Claim of subsidy by banks

After the release of Bank finance either partly or fully, Bank will submit Margin Money (subsidy) claim in the
prescribed format to the designated Nodal Branch of the State/Region where KVIC has placed lump sum deposit
of Margin Money (subsidy) in advance in the Savings Bank Account in the name of KVIC, for release of Margin
Money (subsidy). RRBs and SIDBI will follow respective guide lines issued to them in this regard. If a subsidy
claim is rejected. Detailed grounds for rejections shall be maintained by KVIC/KVIBs/DICs.
Treatment of subsidy (Margin Money)

Once the Margin Money (subsidy) is released in favour of the applicant borrower, it should be kept in the Term
Deposit Receipt of three years at branch level in the name of the beneficiary/Institution. No interest will be paid
on the TDR and no interest will be charged on loan to the corresponding amount of TDR. Since “Margin Money”
(subsidy) is to be provided in the form of subsidy (Grant), it will be credited to the Borrowers loan account after
three years from the date of first disbursement to the borrower/institution, by the Bank. In case the Bank’s
advance goes “bad” before the three year period, due to reasons, beyond the control of the beneficiary, the
Margin Money (subsidy) will be adjusted by the Bank to liquidate the loan liability of the borrower either in
part or full. If any recovery is effected subsequently by the Bank from any source whatsoever, such recovery will
be utilized by the Bank for liquidating their outstanding dues first. Any surplus will be remitted to KVIC. Banks
have to scrupulously follow the guidelines issued by KVIC and other concerned authorities while implementing
the scheme.
Monitoring Authority
Ministry of MSME. It will allocate target, sanction and release required funds to KVIC. Quarterly review meeting
will be held in the Ministry on the performance of PMEGP.
DEENDAYAL ANTYODAYA YOJANA (DAY)
A. National Rural Livelihood Mission (NRLM)
Background
The Ministry of Rural Development,
Government of India launched a
new programme known as National
Rural Livelihoods Mission (NRLM)
by restructuring and replacing the
Swarnjayanti Gram Swarozgar Yojana
(SGSY) scheme with effect from April 01, 2013. NRLM was renamed as DAY-NRLM (Deendayal Antyodaya
Yojana - National Rural Livelihoods Mission) w.e.f. March 29, 2016.
Objectives behind NRLM

The principal objective behind NRLM is poverty reduction through building strong institutions of the poor,
particularly women thereby enabling access to a range of financial services and livelihoods services. The
Scheme provides a continuous hand-holding support to the institutions of poor such as Self Help Groups (SHGs)
for a period of 5-7 years till they come out of poverty. The support from DAY-NRLM includes all round capacity
building of the SHGs ensuring that the group functions effectively on all issues concerning their members,
financial management, providing them with initial fund support to address vulnerabilities and high cost
indebtedness, formation and nurturing of SHG federations, making the federations evolve as strong support
organizations, making livelihoods of the poor sustainable, formation and nurturing of livelihoods organizations,
skill development of the rural youth to start their own enterprises or take up jobs in organized sector, enabling
these institutions to access their entitlements from the key line departments, etc.
Role of State Governments

The DAY-NRLM, enable States to formulate their own State specific poverty reduction action plans at State,
district and block level. The States will implement these programmes through identified blocks and districts
as intensive blocks and districts, whereas remaining will be non-intensive blocks and districts. The selections
of intensive districts are done by the states based on the demographic vulnerabilities and will be rolled out in
a phased manner over the next 7-8 years. Initially 250 such intensive blocks have been identified. Rest of all
blocks in the country will become intensive blocks over time. SHG is an informal group and registration under
any Societies Act, State cooperative Act or a partnership firm is not mandatory.
Beneficiaries
Women SHGs under DAY-NRLM consist of 10-20 persons (70% or more should be belonging to Below Poverty
Line or urban poor segment). In case of special SHGs i.e. groups in the difficult areas, groups with disabled
persons, and groups formed in remote tribal areas, this number may be a minimum of 5 persons. Only for
groups to be formed with Persons with disabilities, and other special categories like elders, transgenders, DAY-
NRLM will have both men and women in the self-help groups.
Financial Assistance to the SHGs & Conditions

DAY-NRLM would provide Revolving Fund (RF) support to SHGs in existence for a minimum period of 3 to 6
months and follow the norms of good SHGs, i.e. they follow ‘Panchasutra’ - regular meetings, regular savings,
regular internal lending, regular recoveries and maintenance of proper books of accounts.
Only such SHGs that have not received any RF earlier will be provided with RF, as corpus, with a minimum of
Rs.10,000 and up to a maximum of Rs.15,000 per SHG. The purpose of RF is to strengthen their institutional
and financial management capacity and build a good credit history within the group. No Capital Subsidy will be
sanctioned to any SHG from the date of implementation of DAY-NRLM.
Cluster Investment Fund (CIF) will be provided to the SHGs in the intensive blocks, routed through the Village
level/ Cluster level Federations, to be maintained in perpetuity by the Federations. The CIF will be used, by
the Federations, to advance loans to the SHGs and/or to undertake the common/collective socio-economic
activities.
Extension of Interest subvention

DAY-NRLM has a provision for interest subvention, to cover the difference between the Lending Rate of the
banks and 7%, on all credit from the banks/ financial institutions availed by women SHGs, for a maximum of Rs.
3,00,000 per SHG. This will be made in two ways:
(i) In 250 identified districts, banks will lend to the women SHGs @7% up to an aggregated loan amount of
Rs. 3,00,000/-. The SHGs will also get additional interest subvention of 3% on prompt payment, reducing
the effective rate of interest to 4%.
Prompt payment means:
For cash credit Limit - Outstanding balance not in excess of DP continuously for 30 days, regular operations
in account with at least one customer induced credit in a month which should cover interest debited in a
month.
For Term loans the instalment and interest should be paid within 30 days of the due date The scheme is
limited to women SHG in rural areas only.
(ii) In the remaining districts also, all women SHGs under DAY-NRLM are eligible for interest subvention to the
extent of difference between the lending rates and 7% for the loan up to Rs. 3,00,000, subject to maximum
of 5.5% for the year 2019-20 or as prescribed by the MoRD. This part of the scheme will be operationalized
by SRLM.
Women SHGs who have availed capital subsidy under SGSY in their existing loans, will not be eligible for
benefit of Interest Subvention for their subsisting loan under this scheme.
(Interest subvention scheme for women SHG - Year 2019-20 as per RBI circular RBI / 2019-20/105 FIDD.
GESSD.CO.BC.No.15/09/01/01/2019-20 dated November 26, 2019)
Services offered by banks under NRLM

Opening of Savings accounts: Banks would commence their services with opening of accounts for all the Women
SHGs including members with disability and the Federations of the SHGs as per KYC norms as applicable from
time to time.
The SHGs engaged in promoting of savings habits among their members would be eligible to open savings
bank accounts. Banks have to maintain separate Savings and loan account for Self Help Groups. Banks also help
to open savings account of Federations of SHGs at village, Gram Panchayat, Cluster or higher level, as savings
account for ‘Association of persons’ after following applicable KYC norms from time to time. SHGs and SHG
federations be guided to transact through their respective saving accounts on regular basis. To facilitate this,
banks are advised to enable transactions in jointly operated savings account of SHGs and their federations at
retail outlets managed by Business Correspondent Agents. RBI has issued detailed guideline in this regard.
Eligibility criteria for the SHGs to avail loans

• SHG should be
¡ In active existence at least since the last 6 months as per the books of account of SHGs and not from
the date of opening of S/B account.
¡ Practicing ‘Panchasutras’ i.e. Regular meetings; Regular savings; Regular inter-loaning; Timely
repayment; and Up-to-date books of accounts;
¡ Qualified as per grading norms fixed by NABARD. Grading can also be done by Federations of SHGs
come to existence.
• Even defunct SHGs are also eligible for credit if they are revived and continue to be active for a minimum
period of 3 months.
Loan amount
SHGs are eligible for multiple doses of assistance under DAY-NRLM over a period of time. They can avail either
Term Loan (TL) or a Cash Credit Limit (CCL) loan or both based on the need. In case of need, additional loan can
be sanctioned even though the previous loan is outstanding.
Cash Credit Limit (CCL): The quantum of CCL and Term Loan (TL) limits that can be sanctioned to a SHG
are as per table below. Under CCL, yearly drawing power can be enhanced annually based on the repayment
performance of the SHG. The drawing power (DP) in case of CC account as well as TL quantum, calculations are
as below
DP for CCL Quantum TL Dose
1st year 6 times of the existing corpus or minimum of Rs.1 lakh whichever is higher. I Dose
DP for CCL Quantum TL Dose

2nd year 8 times of the corpus at the time review/ enhancement or minimum of Rs. II Dose
2 lakh, whichever is higher.
3rd year Minimum of Rs. 3 lakhs, based on the Micro credit plan prepared by the III Dose
SHGs and appraised by the Federations /Support agency and the previous
credit History.
4th year onwards Minimum of Rs. 5 lakhs based on the Micro credit plan prepared by SHG IV Dose
and appraised by the Federations /Support agency and the previous credit
History.
Banks should take necessary measures to ensure that eligible SHG are provided with repeat loans. Banks are
advised to work with DAY-NRLM to institutionalize a mechanism for online submission of loan application of
SHGs for tracking and timely disposal of application.
Corpus = Revolving funds (if any, received by that SHG)+ Own savings+ Interest earned by SHG from on-
lending to its members + Income from other sources+ Funds from other sources in case of promotion by other
institutions/NGOs.
Purpose of loan and repayment

The loan amount will be distributed among members based on the Micro Credit Plan (MCP) prepared by the
SHGs. The loans may be used by members for meeting social needs, high cost debt swapping, construction or
repair of house, construction of toilets and taking up sustainable livelihoods by the individual members within
the SHGs or to finance any viable common activity started by the SHGs. In order to facilitate use of loans for
augmenting livelihoods of SHG members, it is advised that at least 50% of loans above ? 2 lakhs and 75% of
loans above ? 4 lakhs be used primarily for income generating productive purposes. MCP prepared by SHG
would form the basis for determining the purpose and usage of loans.
Repayment schedule
• The First year/ first dose of loan will be repaid in 12-18 months in monthly/ quarterly instalments.
• The Second year/ Second dose of loan will be repaid in 18-24 months in monthly/ quarterly instalments.
• The Third year/ Third dose of loan will be repaid in 24-36 months in monthly/ quarterly instalments.
• The loan from Fourth year/ Fourth dose onwards has to be repaid between 3-6 years based on the cash
flow in monthly/ quarterly installments.
Security and Margin

No collateral and no margin will be charged up to Rs. 10.00 lakhs limit to the SHGs. No lien should be marked
against savings bank account of SHGs and no deposits should be insisted upon while sanctioning loans.
Dealing with Defaulters: Willful defaulters should not be financed under DAY-NRLM. In case willful defaulters
are members of a group, they might be allowed to benefit from the thrift and credit activities of the group
including the corpus built up with the assistance of Revolving Fund. But for accessing bank loan by SHG for
financing economic activities by its members, the willful defaulters should not have the benefit of such bank
loan until the outstanding loans are repaid. SHG may be financed excluding such defaulters while documenting
the loan.
Banks are not to deny loan to entire SHG on the pretext that spouse or other family members of individual
members of SHG being a defaulter with the bank. Further, non-willful defaulters should not be debarred
from receiving the loan. In case default is due to genuine reasons, Banks may follow the norms suggested for
restructuring the account with revised repayment schedule.
Credit Target Planning

Based on the potential Linked Plan/ State Focus paper prepared by NABARD, State Level Bankers Committee
(SLBC) sub-committee on SHG Bank Linkage may arrive at District wise, block wise and branch wise credit
plans. The sub- committee should consider the existing SHGs, New SHGs proposed, and number of SHGs eligible
for fresh and repeat loans as suggested by the SRLMs to arrive at the credit targets for the states. The targets
so decided should be approved in the SBLC and should be reviewed and monitored periodically for effective
implementation. District Coordination Committee (DCCs) will communicate block-wise/cluster-wise targets to
the bank Branches through the Controllers.
Post sanction follow-up

Bank/branch staff to go and attend the meetings of the SHGs and Federations to observe the operations of the
SHGs and keep a track of the regularity in the SHGs meetings and performance.
Loan pass books or statement of accounts in regional languages to be issued to the SHGs which may contain
all the details of the loans disbursed to them and the terms and conditions applicable to the loan sanctioned.
The passbook should be updated with every transaction made by the SHGs. At the time of documentation and
disbursement of loan, it is advisable to clearly explain the terms and conditions as part of financial literacy.
For the purpose of proper recovery personal contact, organization of joint recovery camps with District
Authorities Mission Management Units (DPMUs) / DRDAs should be done. Banks should prepare a list of
defaulting SHGs under DAY-NRLM every month and furnish the list in the SLBC, DCC meetings. This would
ensure that DAY- NRLM staff at the district/ block level will assist the bankers in initiating the repayment.
Reporting
The bank branches are required to furnish the progress report and the delinquency report achieved under
various activities of DAY-NRLM in the specified formats to Lead District Managers every month for onward
submission to Special Steering Committee/sub-committee constituted by SLBC.
Banks have to forward a state-wise consolidated report on the progress made on DAY-NRLM to RBI/NABARD at
quarterly intervals. The data may be submitted within a month from the end of the concerned quarter. Existing
procedure of submitting Lead Bank Returns is also continued for these advances.
DEENDAYAL ANTYODAYA YOJANA (DAY)
B. National Urban Livelihood Mission (NULM)
Background
The Government of India, Ministry of
Housing and Urban Poverty Alleviation
(MoHUPA), restructured the existing Swarna
Jayanti Shahari Rozgar Yojana (SJSRY) and
launched the National Urban Livelihoods
Mission (NULM) in 2013. NULM has been
under implementation w.e.f. September 24,
2013 in all district headquarters (irrespective of population) and all the cities with population of 1 lakh or more.
With a view to improving the livelihood opportunities for the poor in urban areas including hawkers/street
vendors, Ministry of Housing and Urban Poverty Alleviation (UPA Division), Government of India decided to
enhance the scope of NULM in 2016. The Mission with enhanced scope was renamed as “Deendayal Antyodaya
Yojana - National Urban Livelihoods Mission (DAY-NULM)”.
Revision in the scope of NULM

The Self Employment Program (SEP) of DAY-NULM focuses on providing financial assistance through provision
of interest subsidy on loans to support establishment of Individual & Group Enterprises and Self-Help Groups
(SHGs) of urban poor. The erstwhile provision of capital subsidy for USEP (Urban Self Employment Program)
and UWSP (Urban Women Self-Help Program) under SJSRY has been replaced by interest subsidy for loans to
Individual enterprise (SEP-I), Group enterprise (SEP-G) and Self Help Groups (SEP-SHGs).
Introduction and Background - NULM

The Self Employment Programme (SEP) provides financial assistance to individuals / groups including street
venders / hawkers of urban poor for setting up gainful self-employment ventures / micro-enterprises, suited
to their skills, training, aptitude and local conditions. The programme also supports Self Help Groups (SHGs)
of urban poor to access easy credit from bank and avail interest subsidy on SHG loans. The programme will
also focus on technology, marketing and other support services to the above beneficiaries engaged in micro
enterprises for their livelihoods and will also facilitate issuance of credit cards for working capital requirement
of the entrepreneurs. The underemployed and unemployed urban poor will be encouraged to set up small
enterprises relating to manufacturing, service and small business for which there is considerable local demand.
Local skills and local crafts should be particularly encouraged. Each ULB should develop a compendium of such
activities/projects keeping in view skills available, marketability of products, costs, economic viability etc.
Special focus groups

The percentage of women beneficiaries under SEP shall not be less than 30%. SCs and STs must be benefited at
least to the extent of the proportion of their strength in the city / town population of poor. A special provision
of 5% reservation should be made for the differently-abled under this program. In view of the Prime Minister’s
15-Point Program for the Welfare of Minorities, at least 15% of the physical and financial targets be earmarked
for the minority communities.
Eligibility
Individuals of above 18 years, Groups of urban poor including Self-Help Groups. No minimum educational
qualification is required for prospective beneficiaries. However where the identified activity for micro-
enterprise development requires some special skills appropriate training must be provided to the beneficiaries
before extending financial support.
Identification of beneficiaries
The Community Organizers (COs) and professionals from Urban Local Body (ULB) will identify the prospective
beneficiaries from among the urban poor. Also they may identify eligible borrowers from references made by
SHGs, Area Level Federations, Banks (including cases identified by their Business Correspondents/ Business
Facilitators). The community structures formed under Social Mobilization & Institutional Development
(SM&ID) component of DAY- NULM viz. Self Help Groups (SHGs) and Area Level Federations (ALFs) may also
refer prospective individual and group entrepreneurs for purpose of financial assistance under SEP to ULB.
The beneficiaries may directly approach ULB or its representatives for assistance. Banks may also identify
prospective beneficiaries at their end and forward such cases directly to ULB. The Banks may also use their
empaneled Business Correspondents (BCs) and Business Facilitators (BFs) to increase the outreach. Due
diligence will be undertaken as per the Bank’s policy in this regard.
Application procedures
The application for individual and group enterprise loans will be sponsored by the Urban Local Body (ULB)
which will be the sponsoring agency for the individual and group enterprise. The applicants seeking loan can
submit an application to the concerned ULB officials on a plain paper with basic details viz: Name, Age, Contact
details, Address, Aadhaar details (if any), amount of loan required, bank account number (if available), type of
enterprise/ activity, category etc. The application can also be sent by mail /post to the ULB office. The ULB shall
accept such intents throughout the year.
On receipt of applications from beneficiaries respective ULBs will enter the details in a register/or MIS if
available and hence will generate a waiting list of beneficiaries. The ULB will issue an acknowledgement to the
beneficiary with a unique registration number, which may be used as a reference number for tracking the status
of application.
ULB will call the beneficiaries in order of the waiting list to complete requisite documentation including filling
of Loan Application Form (LAF), activity details, identity proof, address proof, bank account details etc. The LAF
will contain basic data in respect of economic status of the beneficiary and her / his family. The State Urban
Livelihoods Mission (SULM) may develop a Loan Application Form (LAF) in suitable format in consultation with
State Level Bankers Committee (SLBC) convenor bank. To verify the identity of the beneficiary, her/his Aadhar
number will also be brought on record. If beneficiary does not have Aadhar card, his/ her any other unique
identification document like voters’ card, driving license etc. will be taken and she/ he will be helped to obtain
Aadhar card as soon as possible. This data will be such that it can be used to analyse impact of the benefits on
her/his economic status at a later stage.
Task Force constituted at ULB level will scrutinize the applications based on experience, skills, viability of
Scheduled commercial banks (SCBs) which are on the Core Banking Solution (CBS) platform would be eligible
activity, scope of the activity etc. Thereafter, the Task Force will shortlist the applications and call for interview
of the applicants before recommending or rejecting the application or call for additional information from the
applicant, if required.
Procedure for Sanction of Loans by banks

The cases recommended by the task force will be forwarded by the ULB to the concerned banks for further
processing. Such cases have to be processed by concerned banks within a time frame of 15 days. Any rejection
of such cases by banks has to be only in exceptional circumstances. Banks will send a periodic report to the ULB
on the status of the applications received.
Banks can also directly accept the loan applications of urban poor beneficiaries on the basis of relevant
documents as per the guidelines of Prime Minister MUDRA Yojana (PMMY) or any other such scheme without
the need of having prior sponsoring from ULB.
The banks can send details of such loans sanctioned by them to ULBs for confirmation of their eligibility for
interest subsidy under DAY-NULM. The subsidy will be transferred directly to the loan account of DAY-NULM
beneficiaries. This procedure will also be direct benefit transfer compliant.
Financial Assistance
• The financial assistance will be in the form of Interest subsidy on the bank loans.
• Interest subsidy, over and above 7% rate of interest will be available on a bank loan for setting up of
individual or group enterprises. The difference between 7% p.a. and the rate of interest charged by the
bank will be provided to banks under DAY-NULM.
• Interest subsidy will be given only in case of timely repayment of loan. Suitable certification from banks
will be obtained in this regard.
• An additional 3% interest subvention will be provided to all Women Self Help Groups (WSHGs) who repay
their loan in time.
• The Interest subsidy will be subject to timely repayment of the loan (as per the loan repayment schedule)
and suitable certification obtained from banks by the ULB.
• The additional 3% interest subvention amount will be reimbursed to the eligible WSHGs. The banks
should credit the amount of 3% interest subvention to the eligible WHSGs accounts and thereafter seek
the reimbursement.
Training of beneficiaries
Employment through skills Training & Placement: Financial assistance should be extended only after the
prospective beneficiary has acquired required skills for running the proposed micro-enterprise. Such training
may not be necessary if the beneficiary has already undergone training from a known institution, registered
NGO/Voluntary organization or trained under any government scheme provided requisite certificate is
produced. In case the beneficiary has acquired requisite skills from family occupation such cases should be
certified by the ULB before extending financial assistance.
Entrepreneurship Development Program (EDP): In addition to skill training of the beneficiaries, the ULB
will also arrange to conduct Entrepreneurship Development Program for 3-7 days for individual and group
entrepreneurs. EDP will cover basics of entrepreneurship development such as management of an enterprise,
basic accounting, financial management, marketing, backward and forward linkages, legal procedures, costing
and revenue etc. In addition to above topics the module should also include group dynamics, allocation of work,
profit sharing mechanism etc. for group enterprises.
** Banks are required to cover the loan under Credit Guarantee Fund Trust for Micro and Small Enterprises
Follow-up entrepreneurial support to Individual and Group entrepreneurs: After financing to Individual
and Group beneficiaries, the ULB will also arrange to conduct follow-up Entrepreneurship Development
Programme (EDP) preferably once in six months for each beneficiary who has been given a loan. During the
follow-up EDP, problems and issues faced by beneficiaries should also be discussed and solutions should be
given. Procedure for interest subsidy to Banks and settlement
Procedure for interest subsidy to Banks and settlement

Scheduled commercial banks (SCBs) which are on the Core Banking Solution (CBS) platform would be eligible
for getting interest subvention under the scheme. After disbursement of loan to the beneficiaries, the concerned
branch of the bank will send details of disbursed loan cases to ULB along with details of interest subsidy amount.
Procedure for settlement claims from Banks
Procedure I
The settlement of claims made by banks would be done on quarterly basis by the ULBs in specified format,
however the submission of claims should be monthly. The ULB will check the data at their end and will release
the interest subsidy amount (difference between 7% p.a. and prevailing rate of interest) to the banks. The
claims should not be pending more than a quarter. In case the claims of the banks are not settled for a period of
6 months, SLBC is empowered to stop the scheme temporarily in selected cities subject to clearance of claims by
such ULBs. In such eventualities, the claims settlement should prospectively be given to the Lead District Bank.
Procedure II
Procedure for Settlement of Claims where Nodal Agency for releasing interest subsidy is designated:
All the Banks will consolidate data regarding interest subsidy from their branches and upload on the portal of
Nodal Bank designated for this purpose. The nodal bank, after verification, will transfer the interest subsidy to
the bank branches. The State/UT will deposit some funds in advance with the nodal bank, which will release
funds to the bank branches as per guidelines of the DAY-NULM. Nodal bank will regularly render account of
reimbursement to the SULM. This procedure will be followed in all three types of loans i.e. SEP (I), SEP (G) and
SHG-Bank Linkage.
Individual Enterprises (SEP -I)- Loan and Subsidy

An individual beneficiary desirous of setting up an individual micro-enterprise for self-employment can avail
benefit of subsidized loan under this component from any bank. The norms are as follows:
Particulars Norm
Age The beneficiary should have attained the age of 18 Years at the time of applying for loan.
Project Cost Maximum project cost for individual micro-enterprise is Rs. 2 lacs.
Collateral No collateral required. Banks are instructed not to accept collateral security in the case
Guarantee on of loans up to Rs. 10 lakhs extended to units in the MSE sector. Therefore, only the assets
Bank Loan created would be hypothecated/ mortgaged/ pledged to banks for advancing loans.**
Repayment Period Will be between 5 to 7 Years after initial moratorium of 6-18 months as per norms of
the banks.
Margin Money No margin for loan up to Rs. 50,000. For higher amount loans, preferably 5% as margin
money and in no case be more than 10% of the project cost.
Type of Loan Term loan for Capital Expenditure. Cash credit for working capital or a mix of both as per
Facility borrower’s requirements.
** Banks are required to cover the loan under Credit Guarantee Fund Trust for Micro and Small Enterprises
(CGTMSE) setup by Small Industries Development Bank (SIDBI) or any other appropriate guarantee fund for
the purpose of availing guarantee cover.
Group Enterprises (SEP-G) - Loan & Subsidy

A Self Help Group (SHG) or members of an SHG constituted under DAY-NULM or a group of urban poor for
self-employment can avail benefit of subsidized loans under this component from any bank. The norms/
specifications for group based micro-enterprise loans are as follows:
Particulars Norms
Eligibility Criteria Group enterprises should have minimum of 5 members with a minimum of 70% of the
members from urban poor families. More than one person from the same family should
not be included in the same group.
Age All members of the group enterprise should have attained an age of 18 years at the time
of applying for bank loan.
Project cost Maximum unit Project Cost for a group finance for enterprise is Rs. 10,00,000 (Ten
Lakhs).
Amount of loan Loan can be extended as a single loan to the group functioning as one borrowing unit
or each member of the group can be provided individual loans up to Rs.2 lakhs and
an overall cap of Rs. 10 lakhs based on mutual trust and collateral substitute among
the group. RBI guidelines/principals under ‘Bhoomi Heen Kisan’ dated 13th November,
2014” should be followed for group loans.
Type of loan In the form of Term Loan for Capital Expenditure. For Working Capital, through Cash
Credit Facility. Composite Loans for Capital Expenditure and Working Capital, as per
Group’s requirement.
Loan and Margin The Project Cost minus the beneficiary contribution (Margin Money) would be made
Money available as loan amount. No margin is applicable for loans up to Rs. 50,000/-.For loans
above Rs. 50,000, margin of 5% is to be taken. In any case margin cannot be more than
10%.
Particulars Norms
Collateral Guarantee No collateral/guarantee is required in the case of loans up to Rs. 10 lakhs. Only the
assets created would be hypothecated/ mortgaged/ pledged to banks for advancing
loans.**
Repayment Repayment schedule would range between 5 to 7 Years after initial moratorium of 6-18
months as per the norms of the banks.
**The banks may cover these loans under Credit Guarantee Fund Trust for Micro and Small Enterprises
(CGTMSE) or any other appropriate guarantee fund.
SHG-Bank Linkage - General Guidelines

Reserve Bank of India has issued detailed guidelines to banks on SHB- Bank linkage programme vide their
circular dated July 01, 2016. A brief over view of the same is as under:
a. Opening of Savings Bank Account of Self Help Groups (whether registered or unregistered), which are
engaged in promoting habit of savings among their members as a starting point.
b. Thereafter, the SHGs be sanctioned Savings Linked Loans (varying from a saving to loan ratio of 1:1 to 1:4)
after due assessment or grading by banks.
c. In case of matured SHGs, loans may be given beyond the limit of four times the savings as per the discretion
of the bank.
d. Under Social Mobilization & Institution Development (SM&ID) component of DAY-NULM, the ULB will do
necessary groundwork to open bank accounts for SHGs and facilitating access to Revolving Fund (RF).
e. The banks will send the details of disbursed loan cases to the ULB along with the calculation details of
the interest subsidy amount. The ULB will check the data at their end and will release the interest subsidy
amount on quarterly basis to the banks as per procedure.
f. ULB through its field staff or Resource Organization (ROs) will facilitate filling of loan applications for
eligible SHGs to access credit from the banks. The ULB will be responsible to forward the Loan application
of the SHGs to the concerned banks with requisite documentation.
g. ULB will forward the data on loan applications sent to various banks to State Urban Livelihood Mission
(SULM) authorities on monthly basis.
h. The SULM will monitor and review the progress with banks on regular basis and co-ordinate with SLBC
for interest subsidy/ subvention on SHG Loans in the state.
i. Identification, selection, formation and monitoring of SHGs who are to get interest subvention would be
the responsibility of State/ ULBs and banks would not be liable for wrong identification of SHGs who get
interest subvention.
j. SHGs can be sanctioned either Term loan or a Cash Credit Limit (CCL) loan or both based on their need. In
case of need, additional loan can be sanctioned even though the previous loan is outstanding.
RBI guidelines for prompt repayment are as under:
a. For Cash Credit Limit to SHGs
• Outstanding balance should not have remained in excess of the sanctioned limit/drawing power
continuously for more than 30 days.
• Regular credits and debits should be routed through the account.
• At least one customer induced credit during the month should be reflected in the account. Such
credit during a month should be sufficient to cover the interest debited during the month.
b. For Term Loan to SHGs

A term loan account where all of the interest payments and/or instalments of principal were paid within
30 days of the due date during the entire tenure of the loans would be considered as an account having
prompt payment.
The prompt payment guidelines will continue to be guided by RBI guidelines on the subject in future.
Issuance of credit card

At times micro enterprises do not enjoy uniform cash flows in all months. Seeking enhancement from banks
consume time. In such situations borrowers/beneficiaries approach private lenders for meeting their expenses
baring high interest costs. To mitigate this problem and support the micro-entrepreneurs to meet their working
capital and miscellaneous credit needs, DAY-NULM will facilitate access to Credit Cards or MUDRA Card through
banks.
Banks can issue to such borrowers General Credit Card or any suitable cards to help such enterprises. RBI had
advised details of General Credit Card Scheme through circular RPCD.MSME & NFS. BC.No.61/06.02.31/2013-14
dated December 02, 2013.
Support for Technology, Marketing and other services

Micro entrepreneurs often need support in order to grow and sustain their businesses. Support needed may
be for establishment, technology, marketing, and other services. Support services under this component are
envisaged with a view to provide an encouraging environment for development of micro enterprises. The City
Livelihoods Centers (CLCs) established under DAY-NULM will offer services to the micro-enterprises such as
in establishment (licenses, certificates registration, legal services etc.), production, procurement, technology,
processing, marketing, sales, packaging, accounting etc. for long term sustainability. CLCs will also provide
support in taking up feasibility/ assessment studies on market demand and market strategy for products and
services of micro-enterprises.
Reporting
To monitor progress of the targets vis-a-vis achievement under DAY-NULM, Banks are to furnish cumulative
progress reports on quarterly basis in specified formats to the Director, UPA at [email protected] as well as
to RBI within one month by the end of the quarter to which they relate.
Differential Rate of Interest Scheme
Background
Government of India had formulated in March, 1972 a scheme for extending financial assistance at concessional
rate of interest @ 4% to selected low income groups for productive endeavours initially by public sector banks
and then by private sector banks also . The scheme known as Differential Rate of Interest Scheme (DRI) is now
being implemented by all Scheduled Commercial Banks.
The salient features of the scheme are as given below:
Eligibility
The following persons are eligible to avail the loans -
a. Individuals whose family income does not exceed Rs. 18,000 p.a. in rural areas and Rs. 24,000 in Semi-
urban and Urban areas.
b. Individuals whose land holdings does not exceed 1 acre irrigated land and 2.5 acres of unirrigated land.
c. No ceiling for SC/ST engaged in agriculture and allied activities.
d. Those who are engaged in Cottage and Rural industries.
e. Physically handicapped person pursuing gainful occupation.

f. Orphanages and Women’s homes.
g. State Owned Corporations/cooperative societies including Corporation for SC’s/ST’s, Co-operative
Societies, Large Sized Adivasi Multi-purpose Cooperative Societies for Tribal areas.
Purpose of loans
For productive vocations/activities, pursuing higher education by indigent students, Purchase of artificial
limbs, hearing aids, wheel chair for physically handicapped etc.
Amount of loan
The maximum amount of loan is fixed at Rs. 15,000. For physically handicapped borrowers an additional amount
of Rs. 5000 for purchase of artificial limbs/Braille typewriter. Housing loan up to Rs. 20,000 per beneficiary for
SC/ST under Indira Awas Yojana.
Rate of interest
4% p.a.
Subsidy and Margin

No subsidy is granted, No margin requirement is specified.
Security
Hypothecation of Assets created out of bank loan. Banks are not to insist for any collateral security.
Repayment period
Maximum of 5 years with a grace period of 2 years depending upon activity and income generated.
Other conditions
a. Out of the loan disbursed 40% should be given to SC/St beneficiaries.
b. At least 2/3rd loans should be routed through Rural and Semi-urban branches.
c. The target for lending under the DRI scheme will continue to be 1 per cent of the previous years’ total
advances.
d. Loans given under the scheme are to be classified as Weaker Section Advances.
The Self Employment Scheme for Rehabilitation of Manual Scavengers (SRMS)
Background
The National Scheme for Liberation and Rehabilitation
of Scavengers (NSLRS) is being implemented by all
Public Sector banks since 1993 with an objective to
liberate all scavengers and their dependents from
their existing hereditary and obnoxious occupation of
manually removing night soil and filth and to provide
for and engage them in alternative and dignified occupations within a period of five years. Government of India
stopped funding the existing NSLRS since 2005-06 and approved the Self Employment Scheme for Rehabilitation
of Manual Scavengers (SRMS) with an objective to rehabilitate the remaining scavengers and their dependents
by March 2009. As the Government of India, Ministry of Social Justice & Empowerment has decided to continue
the scheme beyond September 30, 2009, banks have been advised to complete implementation of the scheme
up to December 31, 2009 and the spill over in inevitable cases up to March 31, 2010 with a provision for the
coverage of spill-over of beneficiaries even thereafter, if required. As per the updated number, reported by
States/UTs, after launch of the Scheme, 1.18 lakh manual scavengers and their dependents in 18 States/UTs
were identified for implementation of the Scheme.
The Central Sector Self Employment Scheme for Rehabilitation of Manual Scavengers (SRMS) has been revised
under the “Prohibition of Employment as Manual Scavengers and their Rehabilitation Act, 2013” effective from
Nov., 2013.
Objective
The objective of the scheme is to assist the manual scavengers, identified during various surveys, for their
rehabilitation in alternative occupations.
Eligibility
Manual Scavengers, as defined under the “Prohibition of Employment as Manual Scavengers and their
Rehabilitation Act, 2013” and their dependents, irrespective of their income, are eligible for assistance under
the Scheme.
Definition of Manual Scavenger and their dependents

“Manual Scavenger” means a person engaged or employed by an individual or a local authority or a public
or private agency, for manually cleaning, carrying, disposing of, or otherwise handling in any manner, human
excreta in an insanitary latrine or in an open drain or pit into which human excreta from insanitary latrines is
disposed of, or on a railway track, before the excreta fully decomposes and the expression “manual scavenger”
shall be interpreted accordingly. The dependent of manual scavengers is one who is a member of their family
or is dependent on them. Each individual manual scavenger and his/her spouse or children who are of 18 years
of age and above, who are not employed (other than manual scavengers) will be provided assistance. For the
purpose of training, the age of the dependent to be eligible would be reduced by the duration of the training so
that immediately after getting the training he/she can be provided other assistance immediately after attaining
the age of 18 years.
Cash assistance
The identified manual scavengers, one from each family, would be eligible for receiving cash assistance of
Rs. 40,000, immediately after identification. The beneficiary is allowed to withdraw the amount in monthly
instalments of maximum of Rs. 7000.
Quantum of loan
Loan up to a maximum of Rs. 10 lacs will be admissible under the scheme and Rs. 15 lacs in case of sanitation
related projects like Vaccum Loader, Suction Machine with Vehicle, Garbage Disposal Vehicle, Pay & Use Toilets
etc. which are extremely relevant for the target group, with high success rate and income.
Rate of interest
For projects upto Rs. 25000/- 5% p.a. (4% p.a. for women Beneficiaries)
For projects above Rs. 25000/- 6% p.a.
Moratorium period
Moratorium period will be two years.
Repayment period
Repayment period will be five years (including moratorium period of two years) for projects upto Rs. 5 lacs and
seven years (including moratorium period of two years) for projects above Rs. 5 lacs.
Subsequent loan
Beneficiaries will be allowed to avail second and subsequent loan from Banks, if required, without capital and
interest subsidy7 and other grants under the Scheme.
Penalty
In case of diversion of funds by beneficiaries for their other needs, the Banks can initiate action as per their
policy and rules in this regard. In case, it is found that the beneficiary has diverted the subsidy for any purpose,
other than for which the assistance was provided then -
(i) He/she will be liable to repay the entire amount of subsidy immediately with a penal interest of 9% p.a.,
and
(ii) He/she will become ineligible for any assistance under the scheme, in future.
• Other assistance
Manual Scavengers are also eligible for -
• Credit linked back-end capital Subsidy
Range of project cost Rate of subsidy
Upto Rs. 2 lacs 50% of the project cost
Rs. 2 lacs - Rs. 5 lacs Rs. 1 lac + 33.3% of the project cost between Rs. 2- 5 lacs
Rs. 5 lacs - Rs.10 lacs Rs. 2 lac + 25% of the project cost between Rs. 5 -10 lacs
Rs.10-15 lacs Rs. 3.25 lacs
• Interest subsidy
Where the rate of interest chargeable by the Banks on loans is higher than the rates prescribed in the
Scheme, interest subsidy to the extent of the difference will be given to the Banks by the respective
State Channelizing Agencies (SCAs). SCAs are required to pay this amount to Banks on monthly basis
so that there is no case of charging of compound interest by Banks on the interest subsidy portion.
Operation of Subsidy amount by the Bank

1. Subsidy will be back ended.
2. Banks/Lending agencies would disburse the full project cost including subsidy to the beneficiaries as
loan.
3. The subsidy admissible to the beneficiaries under SRMS should be kept in the Subsidy Reserve Fund
Account beneficiary-wise, instead of in term deposit in the name of the beneficiary. Banks should apply no
interest on the Subsidy Reserve Fund account. In view of this, for the purpose of charging interest on the
loan, the subsidy amount should be excluded.
4. The repayment schedule of the loan would be drawn in such a way that the subsidy kept under Subsidy
Reserve Fund Account would be sufficient for adjustment towards loan repayment equivalent to capital
subsidy amount.
5. Banks/Lending agencies would issue loan passbooks to beneficiaries.
Training
Training is provided to the beneficiaries for acquiring new skills and entrepreneurship capabilities. Training
can be provided by Govt. agencies/Institutes as well as by reputed specialized training agencies. Training
is provided in selected industries/business activities which facilitates gainful employment of the trainees.
Beneficiaries would be provided training for courses up to two years with stipend @ Rs. 3000 per month. The
training will be given as per the level of education and aptitude of the beneficiary.
PRADHAN MANTRI AWAS YOJANA
A. Pradhan Mantri Awas Yojana (Urban)
Introduction
“Housing for All” Mission for urban area is being implemented
during 2015-2022 and this Mission will provide central assistance
to implementing agencies through States and UTs for providing
houses to all eligible families/ beneficiaries by 2022. Pradhan
Mantri Awas Yojana (Urban) [PMAY(U)] is being implemented as
Centrally Sponsored Scheme (CSS) except for the component of
credit linked subsidy which will be implemented as a Central Sector Scheme. Mission with all its components
has become effective from the date 17.06.2015 and will be implemented up to 31.03.2022.
Eligibility condition for Beneficiaries

A beneficiary family will comprise husband, wife, unmarried sons and/or unmarried daughters. The beneficiary
family should not own a ‘pucca’ house either in his/her name or in the name of any member of his/her family in
any part of India to be eligible to receive central assistance under the Mission.
A beneficiary family will be eligible for availing only a single benefit under any of the existing options i.e.
slum redevelopment with private partner, credit linked subsidy, direct subsidy to individual beneficiary and
affordable housing in partnership, as detailed in PMAY (U) guidelines.
Coverage and Duration

All Statutory Towns as per Census 2011 and towns notified subsequently would be eligible for coverage under
the Mission.
Role of Urban Local bodies

Urban Local Bodies should ensure that individual houses under credit linked interest subsidy should have
provision for basic civic services like water, sanitation, sewerage, road, electricity etc.
The minimum size of houses constructed under the Mission under each component should conform to the
standards provided in National Building Code (NBC). All houses built or expanded under the Mission should
essentially have toilet facility.
The houses under the Mission should be designed and constructed to meet the requirements of structural
safety against earthquake, flood, cyclone, landslides etc. conforming to the National Building Code and other
relevant Bureau of Indian Standards (BIS) codes.
The houses constructed/acquired with central assistance under the Mission should be in the name of the
female head of the household or in the joint name of the male head of the household and his wife, and only in
cases when there is no adult female member in the family, the house can be in the name of male member of the
household.
Scheme Details
The Mission, in order to expand institutional credit flow to the housing needs of urban poor Credit linked subsidy
will be provided on home loans taken by eligible urban poor (EWS/LIG MIG I & II ) for acquisition, construction of
house. The extension of the scheme for Middle Income Group will be available up to March 2021 only.
Beneficiaries of Economically Weaker section (EWS) and Low Income Group (LIG), Middle Income Group I
(MIG - I) & Middle Income Group II (MIG II) seeking housing loans from Banks, Housing Finance Companies and
other such institutions would be eligible for an interest subsidy at the rate of 6.5 % (for EWS & LIG), 4% for MIG
(I) and 3% (for MIG - II) for a tenure of 20 years or during tenure of loan whichever is lower. The Net Present
Value (NPV) of the interest subsidy will be calculated at a discount rate of 9 %.
The credit linked subsidy will be available:
– only for loan amounts upto Rs 6 lakhs (EWS & LIG), up to Rs. 9 lakhs (for MIG I) & Rs. 12 lacs (for MIG II)
– additional loans beyond Rs. 6 lakhs, Rs.9 lakhs and Rs. 12 lakhs if any, will be at nonsubsidized rate;
– interest subsidy will be credited upfront to the loan account of beneficiaries through lending institutions
resulting in reduced effective housing loan and Equated Monthly Instalment (EMI).
Credit linked subsidy would be available for housing loans availed for acquiring, new construction and
enhancement (applicable to EWS & LIG).
The carpet area of houses being constructed or enhanced under this component of the mission should be up to
30 square metres and 60 square metres for EWS and LIG, 90 square meters and 110 square meters respectively
in order to avail of this credit linked subsidy.
The beneficiary, at his/her discretion, can build a house of larger area but interest subvention would be limited
to loan amounts as indicated above.
Nodal and Monitoring Agencies

Housing and Urban Development Corporation (HUDCO) and National Housing Bank (NHB), State Bank of
India (SBI) have been identified as Central Nodal Agencies (CNAs) to channelize this subsidy to the lending
institutions and for monitoring the progress of this component. Ministry may notify other institutions as CNA
in future.
CNAs will be responsible for ensuring proper implementation and monitoring of the scheme and will put in
place appropriate mechanisms for the purpose.
CNAs will provide periodic monitoring inputs to the Ministry of Housing and Urban Poverty Alleviation through
regular monthly and quarterly reports as per specified formats.
Primary Lending Institutions (PLIs) i.e. lenders can register only with one CNA by signing MOU.
Role of ULBs /Lenders

State/UTs/ULBs/PLIs shall link beneficiary identification to Aadhaar, Voter card, any other unique identification
or a certificate of house ownership from Revenue Authority of Beneficiary’s native district to avoid duplication
of benefits from other schemes.
Preference among beneficiaries

Preference under the Scheme, subject to beneficiaries being from EWS/LIG segments, should be given to
Manual Scavengers, Women (with overriding preference to widows), persons belonging to Scheduled Castes/
Scheduled Tribes/Other Backward Classes, Minorities, Persons with disabilities and Transgender.
Role of SLNA
State Level Nodal Agency (SLNA) identified by State/UT for implementing the Mission will facilitate the
identified eligible beneficiaries in getting approvals and documents, etc. to avail of credit linked subsidy. For
identification as an EWS or LIG beneficiary under the scheme, an individual loan applicant will submit self-
certificate/affidavit as proof of income.
In case a borrower who has taken a housing loan and availed of interest subvention under the scheme but
later on switches to another PLI for balance transfer, such beneficiary will not be eligible to claim the benefit of
interest subvention again.
Beneficiaries can take advantage under one component only.
In order that beneficiaries do not take advantage of more than one component, PLIs should take NOCs quarterly
from State/UT Governments or designated agency of State/UT Governments for the list of EWS beneficiaries
being given benefits under credit linked subsidy.
For enabling this process, the beneficiaries should be linked to his/her Aadhaar/ Voter ID Card/Any other
unique identification Number or a certificate of house ownership from Revenue Authority of Beneficiary’s
native district and State/UT Government or its designated agency should furnish the NOC within 15 days of
receipt of such request.
Till 30.06.2017, or as directed by the Ministry of Housing and Urban Poverty Alleviation, instead of taking NOC
from States/UTs, CNAs, on behalf of PLIs, would send list of beneficiaries under CLSS on fortnightly basis to
concerned States/UTs. Concerned States / UTs will consider this list, while deciding beneficiaries under other
three verticals of the Mission, so that no beneficiary is granted more than one benefit under the Mission.
Primary Lending Institutions, in the home loan applications, shall disclose transparently the Scheme eligibility
and ascertain willingness and eligibility of applicants under CLSS for EWS/LIG.
Release of Central Assistance and Subsidies

An advance subsidy will be released to each CNA at the start of the scheme. Subsequent amounts of credit
linked subsidy will be released to the CNAs after 70 % utilization of earlier amounts, on quarterly basis, and
based on claims raised by CNAs, as per prescribed format. Based on the loan disbursed by a PLI to EWS and
LIG beneficiaries, the CNA will release the subsidy amount to PLIs directly based on the claims submitted on
the total loans disbursed. Subsidy will be released to the PLI by the CNA in maximum of four instalments. 0.1%
of total fund disbursement by the CNAs to the PLIs will be paid to the CNAs for their administrative expenses.
Subsidy will be credited by the PLI to the borrower’s account upfront by deducting it from the principal loan
amount of the borrower. The borrower will pay EMI as per lending rates on the remainder of the principal loan
amount.
Processing Fee to Lenders

In lieu of the processing fee for housing loan for the borrower under the scheme, PLIs will be given a lump
sum amount of Rs. 3,000/- (Rupees Three Thousand only) per sanctioned application. PLIs will not take any
processing charge from the beneficiary for housing loans upto Rs. 6 lakh under the Scheme. For additional loan
amounts beyond Rs. 6 lakh, PLIs can charge the normal processing fee.
Beneficiary can apply for a housing loan directly or through the ULB or the local agencies identified by the
State/ ULBs for facilitating the applications from intended beneficiaries. In order to incentivize the designated
staff of ULBs or NGOs a sum of Rs.250/- only per sanctioned application would be paid out of CLS Scheme funds
payable through State Governments.
Administration and Implementation

The Programme will have a three-tier implementation structure. An inter-ministerial committee viz. Central
Sanctioning and Monitoring Committee (CSMC) is constituted under the Chairpersonship of Secretary (HUPA)
for implementation of the Mission, approvals there under and monitoring. A Committee of Secretary (HUPA) and
Secretary (DFS) in Government of India is also constituted for monitoring the credit linked subsidy component
of the Mission, giving targets to lenders etc. States/UTs are required to constitute an inter-departmental State
Level Sanctioning & Monitoring Committee (SLSMC), headed by Chief Secretary, for approval of Action Plans
and projects under various components of the Mission.
Each State/UT will identify a State Level Nodal Agency (SLNA) under the Mission wherein a State Level Mission
Directorate will be set up for coordination of the scheme and reform-related activities. State may nominate a
separate State Level Nodal Agency (SLNA) under the credit linked subsidy component of the Mission to identify,
motivate and organize beneficiaries to seek housing loans.
A city level Mission for selected cities should be set up under the chairpersonship of the Mayor or Chairman of
the ULB as the case may be.
Suitable grievance redressal system exits at State and City level to address the grievances in implementing the
PMAY (U) Mission including CLSS for EWS/LIG from various stakeholders.
PRIME MINISTER AWAS YOJANA
B. Prime Minister Awas Yojana - Gramin
Background
Public housing programme in the country started with the
rehabilitation of refugees immediately after independence and
since then, it has been a major focus area of the Government as an
instrument of poverty alleviation. Rural housing programme, as an
independent programme , started with Indira Awaas Yojana (IAY)
in January 1996. Although IAY addressed the housing needs in
the rural areas, certain gaps were identified during the concurrent evaluations and the performance Audit by
Comptroller and Auditor General (CAG) of India in 2014. These gaps, i.e. non-assessment of housing shortage,
lack of transparency in selection of beneficiaries, low quality of the house and lack of technical supervision,
lack of convergence, loans not availed by beneficiaries and weak the mechanism for monitoring was limiting
the impact and outcomes of the programme. To address these gaps in the rural housing program and in view of
Government’s commitment to providing “Housing for All’’ by 2022, the scheme of IAY has been re-structured
into Pradhan Mantri Awaas Yojana - Gramin (PMAY-G) w.e.f. 1st April 2016.
Aims and Objectives PMAY - G

PMAY-G aims at providing a ‘pucca’ house, with basic amenities, to all houseless householder and those
households living in kutcha and dilapidated house, by 2022. The immediate the objective is to cover 1.00 crore
household living in kutcha house/dilapidated house in three years from 2016-17 to 2018- 19.The minimum size
of the house has been increased to 25 sq.mt (from20sq.mt) with a hygienic cooking space. The unit assistance
has been increased from Rs. 70,000 to Rs. 1.20 lakh in plains and from Rs75,000 to Rs 1.30 lakh in hilly states,
difficult areas and IAP district. The assistance for construction of toilet shall be leveraged through convergence
with SBM-G, MGNREGS or any other dedicated source of funding.
Cost of assistance
The cost of unit assistance is to be shared between Central and State Government in the ratio 60:40 in plain
areas and 90:10 for North Eastern and the Himalayan States.
100% financing will be offered by the Central government for the construction of houses in Union Territories
including the newly-formed union territory of Ladakh.
Process of identification of beneficiaries

The selection of beneficiary under PMAY - G is done by using housing deprivation parameters in the Socio
Economic and Caste Census (SECC), 2011 which is to be verified by the Gram Sabhas. Using the data households
that are houseless and living in 0, 1 and 2 rooms, kutcha wall and kutcha roof houses can be segregated and
targeted. The Permanent Wait List so generated also ensures that the states have the ready list of the household
to be covered under the scheme in the coming years (through Annual Select Lists) leading to better planning of
implementation. To address grievances in beneficiary selection, an appellate process has also been put in place.
Eligible Borrowers under PMAY - G Scheduled Tribes / Scheduled Castes
• Freed bonded labourers
• Minorities and non - SC/ST rural households in the BPL category
• Widows and next-of-kin to defence personnel/paramilitary forces killed in action (irrespective of their
income criteria), ex-servicemen and retirement Scheme
Conditions for Loan

• The family applying for a loan under this scheme must include a husband, wife and child/children that are
unmarried. The family must not own a pucca house
• The applicant and his family must fulfil the income criteria mandated by this scheme and has to belong to
either the EWS (Economically Weaker Section), LIG (Lower Income Group), or BPL (Below Poverty Line)
category
• The income of the applicant’s family should be - EWS Rs 0 to 3 lakhs and LIG 3 to Rs. 6 lakhs
• Any loan amount above Rs.6 lakh, the interest rate on the additional amount will be as per market rate
Applying for PMAY - G

The beneficiary can apply by making an application along with the following documents as applicable in their
respective cases.
Ethnic group certificate/ other certificates indicating that the applicant belongs to such beneficiary group;
Income proof, ID proof such as Aadhar card, PAN, Driving licence, Voter ID, etc.; Address proof; Income certificate,
Salary certificate; 6 months bank account statement; IT returns (if applicable), An affidavit stating that neither
the applicant nor his family members own a pucca house.
The government will select the beneficiaries of PMAY-G and the final list will be published. Any interested
candidates can then approach the respective authorities and avail the benefits of PMAY-G. The beneficiaries can
login to PMAY site and on the ‘Stakeholder’ bar they can search for Beneficiary name.
Excluded category of persons

The following candidates who apply for a loan are excluded:
Candidates that
• have a motorised two wheeler / three wheeler/four wheeler/refrigerator
• have fishing boat

• have a mechanised three wheeler / four wheeler agricultural equipment
• have Kisan Credit Card (KCC) with a limit greater or equal to Rs.50,000 Any household that has at least
• one member that is employed with the government
• one member earning more than Rs.10,000 a month
• pays income tax/professional tax
• a landline phone connection.
Benefit under PMAY – G

Home loans obtained under PMAY - G are eligible for a 3% concession on interest rates on housing loans of up
to Rs.2 lakh.
STAND-UP INDIA SCHEME (FOR FINANCING SC / ST AND / OR WOMEN ENTREPRENEURS)
Background
Women in India had always faced problems in many
social, professional and entrepreneurial fronts. It is
more so in the case of women of SC/ST category. In
order to assist such women who have entrepreneurship
qualities in them, Government of India, introduced
“Stand Up India’. This scheme helps to promote
entrepreneurship spirit among women, especially SC &
ST category i.e., those sections of the population facing
significant hurdles due to lack of advice/mentorship as
well as inadequate and delayed credit.
The intention of the scheme to leverage the institutional credit structure to reach out to these SC/ST women in
starting greenfield enterprises to empower them economically. It caters to both experienced and new (trainee)
borrowers. The Stand-Up India scheme is based on recognition of the challenges faced by SC, ST and women
entrepreneurs in setting up enterprises, obtaining loans and other support needed from time to time for
succeeding in business. The scheme therefore hopes to create a climate of enabling system which facilitates and
continue to extend support measures for doing business activities by such SC/ST women .
Stand-up India scheme in addition to providing financial support also incorporates hand-holding support to the
potential borrowers. Thus it provides for convergence with Central/State Government schemes. The Stand Up
India scheme has been extended up to Financial year 2025.
Objective
To facilitate bank loans between 10 lakh and 1 Crore to at least one Scheduled Caste (SC) or Scheduled Tribe
(ST) borrower and at least one woman borrower per bank branch for setting up a greenfield (new activity)
enterprise. This enterprise may belong to manufacturing, services or the trading sector. In case of other than
individuals, i.e. enterprises, at least 51% of the shareholding and controlling stake of such enterprises should
be held by either an SC/ST or Woman entrepreneur.
Eligibility
1. SC/ST and/or woman entrepreneurs, above 18 years of age.
2. The loan is available for only green field project, that is, to say a first time venture of the beneficiary in the
manufacturing or services or trading sector.
3. In case of non-individuals such as other legal entities, 51% of the shareholding and controlling stake
should be held by either SC/ST and/or Women Entrepreneur.
4. Borrower should not be a defaulter with any bank/financial institution.
Coverage and access to loans

The scheme is available to all branches of Scheduled Commercial Banks. The scheme, will be accessed in any of
the three potential ways:
• Directly at the branch or
• Through SIDBI’s Stand-Up India portal
• The Lead District Manager (LDM) - under the Lead Bank Scheme.
A potential borrower can register on the portal directly which can be accessed at home, at Common Service
Centers (CSCs), through a bank branch (through the nodal officer for MUDRA at the branch) or through the
LDM. or through an internet access point facility.
Approach and assistance to women borrowers

The borrowers are assessed based on the response to following parameters, for guidance handholding right
from the initial stage.
1. Location of the borrower.
2. Category - SC/ ST/ Woman.
3. Nature of business planned.
4. Availability of place to operate the business.
5. Assistance needed for preparing a project plan.
6. Requirement of skills/training (technical and financial).
7. Details of present bank account.
8. Amount of own investment into the project.
9. Whether help is needed to raise margin money.
10. Any previous experience in business.
Based on the response, the portal provides relevant feedback and helps in categorizing the visitor to the portal
as a ready borrower or a trainee borrower.
Ready Borrower
1. In case the borrower who requires no guidance, then registration on the portal as itself starts the process
of application for the loan at the selected bank. While registering an application number will be generated
and information about the borrower shared with the bank concerned, the LDM (posted in each district)
and the relevant linked office of NABARD/ SIDBI. The offices of SIDBI and NABARD shall be designated
Stand-Up Connect Centres (SUCC). The loan application will now be generated and tracked through the
portal.
2. Trainee Borrower (New borrower)
Where the borrower requires need for handholding, then he borrower will be registered as a Trainee
Borrower on the portal which will link the borrower to the LDM of the concerned district and the relevant
office of SIDBI/ NABARD. This process can be done through internet at borrower’s home, or at a CSC or
through a bank branch by the officer dealing with MUDRA cases.
Support will be arranged by SIDBI (79 offices) and NABARD (503 offices) through Stand-Up India Connect
Centers. The trainee will be given support as per request in one or more of the following ways:
a. Financial training - at the Financial Literacy Centers (FLCs).
b. Skilling - at skilling centers ( Vocational Training Centers - VTPs/ Other Centers -OCs).
c. EDPs - at MSME DIs/ District Industries Centers (DICs)/ Rural Self Employment Training Institutes
(RSETIs).
d. Factory/ work shed - DICs.
e. Margin money - e.g., State SC Finance Corporation, Women’s Development Corporation, State Khadi &
Village Industries Board (KVIB), MSME-DIs etc.
f. For mentoring support - DICCI, Women Entrepreneur Associations, Trade bodies, Well established NGOs.
g. For utility connections - Offices of utility providers.
h. Detailed Project Reports - Project profiles available with SIDBI/ NABARD/ DICs
If an applicant requires any assistance even after the loan has been sanctioned, they may access the services of
the Stand-Up Connect Centers.
Nature of Loan
Composite loans (which includes term loan and working capital) between Rs.10 lakh and upto Rs.100 lakh as
per requirement.
Purpose of Loan
For setting up a new ventures/ enterprise in manufacturing, trading or services sector by SC/ST/Women
entrepreneur.
Size of Loan
Loan size will be 75% of the project cost including term loan and working capital. If the borrower’s margins
exceed 25% then loan size will be accordingly be lessened.
Interest Rate
The minimum applicable rate of the bank for that rated category of borrower. Interest not to exceed (MCLR +
3%+ tenor premium according to individual bank’s rate structure.
Security and Risk coverage

Besides primary security plus collateral security or guarantee of Credit Guarantee Fund Scheme for Stand-Up
India Loans (CGFSIL) as decided by the banks from time to time.
Repayment
The loan is repayable in 7 years with a maximum moratorium period of 18 months.
Working Capital
Working capital upto Rs.10 lakh will be by way of way of overdraft. Any working capital loan exceeding Rs.
10 lakh will be through Cash Credit limit. Banks can also issue RuPay debit card for the convenience of the
borrower.
Margin Money
As per scheme 25% margin money to be brought in by the borrower. This can be provided in convergence with
eligible Central / State schemes. While such schemes can be drawn upon for availing admissible subsidies or for
meeting margin money requirements, in all cases, the borrower shall be required to bring in minimum of 10%
of the project cost as own contribution.
A list of Central / State wise subsidy/incentive schemes is provided on the SIDBI Portal. This can be used by
borrowers to secure subsidies. New schemes will be added as they become available to this portal.
Monitoring/Review
Lead District Manager will monitor progress of various applicants through their quarterly meetings including
rejection cases.
Role of Bank branches:
• Wherever requested by borrowers help such borrowers in accessing the portal. Process loan applications
received online or in person as per bank’s policy as well as in the light of the BCSBI Code of Commitment
to SME borrower (i.e., for loan up to Rs.5 lakh within 2 weeks, between Rs.5 - Rs.25 lakh in 3 weeks, above
Rs.25 lakh in 6 weeks, from the date of receipt of application complete in all respects). In case of rejection,
reason to be made known to borrower in writing.
• If any compliant is received from borrower, grievance redressal at the bank level should be done in 15 days
as committed by bank under BCSBI code.
• Banks to have an independent monitoring arrangement for loan application, sanction etc.
Role of LDMs
• They will have the overall monitoring of Start-up India applications, progress of sanctions, easing of
bottlenecks, liaise with banks, follow-up with controlling offices of banks regarding processing, sanctioning
as per time frame specified under BCSBI code applicable to Micro and Small Enterprises.
• Take care to fulfill handholding support of borrowers, arrange DLCC meetings in the specified periodicity
and monitor progress.
• Participate in quarterly events with stakeholders organized by NABARD.
Role of DLCC
• Will review progress under the scheme under the supervision of Collector periodically. Look after the
grievance redressal aspects at district level.
• Help in resolving issues relating to public utility services and work space for potential borrowers.
RURAL SELF EMPLOYMENT TRAINING INSTITUTES (RSETI)

RSETIs - Rural Self Employment Training Institutes, are an initiative of
Ministry of Rural Development (MoRD) to have dedicated infrastructure
in each district of the country to impart training and skill up-gradation of
rural BPL (Below Poverty Line) youth geared towards entrepreneurship
development to mitigate the unemployment problem. RSETIs are
managed by banks with active co-operation from Government of India
and State Governments. The RSETI concept is based on RUDSETI
(Rural Development and Self Employment Training Institute, a society
established jointly by three agencies - Syndicate Bank, Canara Bank and Sri Manjunatheswara Trust, Karnataka).
One RSETI is established in every district in the country. Concerned bank is the lead bank in the district takes
responsibility for creating and managing it. Government of India will provide one-time grant assistance, up to
a maximum of Rs. 1 crore for meeting the expenditure on construction of building and other infrastructure.
After successful completion of the training, the candidates will be provided with credit linkage assistance by the
banks to start their own entrepreneurial ventures.
The common minimum infrastructure of each RSETI will be - 2 / 3 classrooms with toilet facilities (separate
for women and physically challenged friendly), two workshops, two dormitories with bath facilities, adequate
physical infrastructure for training, administration, hostel, staff quarters etc.
Programmes Structure and Contents

Each RSETI should offer 30 to 40 skill development programmes in a financial year in various avenues. The
programme duration can be from one week to six weeks and could be in following categories:
• Agricultural - Agriculture and allied activities like dairy, poultry, apiculture, horticulture, sericulture,
mushroom cultivation, floriculture, fisheries etc.
• Product - Dress designing, Rexene articles, incense sticks manufacturing, football making, bag,
bakery products, leaf cup making, recycled paper manufacturing etc.
• Process - Two wheeler repairs, radio / TV repairs, motor rewinding, electrical transformer
repairs, irrigation pump-set repairs, tractor and power tiller repairs, cell phone repairs,
beautification course, photography and videography, screen printing, domestic electrical
appliances repair, computer hardware and DTP (Desktop publishing).
• General - Skill development for women.
• Other - Related to sectors like leather, construction, hospitality and sectors depending on local
requirements.
Programmes will be decided by these institutes based on the local resource situation and potential demand
for products / services. A uniform standardized curriculum would be developed and circulated among the
institutes.
RSETIs have two sets of training curriculums - (i) Basic orientation programme courses for Swarnajayanti Gram
Swarojgar Yojana (SGSY) - (initiative launched by the Government of India to provide sustainable income to
poorest of poor people living in rural and urban areas of the country), Self Help Groups (‘SHG’s) and (ii) Skill
development programmes for micro enterprise and wage employment / placement. Soft skill programme shall
be an integral part in all the training programmes.
Selection of Trainees and Batch size

70% of the trainees should be from the rural Below Poverty Line (BPL) category certified by the District
Rural Development Agencies (DRDA) with proper weightage, as per SGSY guidelines will be given to SC/STs,
minorities, physically challenged and women. Ideal size of batch will be 25 -30 candidates. Shramdan / Yoga,
would become a common input in training module.
Certificates issued by an RSETI will be recognized by all banks for purposes of extending credit to the trainees.
Credit needs of trainees will appraised by RSETIs and will be conveyed to the bank branches. The trainees can
avail bank loans under SGSY or any government sponsored programmes.
RSETI performance -FY 2017 -18 (as on 31.03.2018) No. of States covered - 32
No. of Banks involved - 31 Functional RSETIs - 586
Target candidates to be trained - 3,97,688 Candidates trained - 4,23,343
Candidates settled - 3,49,918 (wage employed - 29,394 / self employed - 3,20,524)

With self finance - 1,57,386 With Bank finance - 1,63,138
FINANCIAL INCLUSION
“Financial inclusion may be defined as the process of ensuring access to financial services and timely and
adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an
affordable cost”. (The Committee on Financial inclusion, Chairman, Dr. C. Rangrajan). As per the definitions of
United Nations, financial inclusion, broadly defined, refers to a wide range of financial services at a reasonable
cost. These include not only banking products bur also other financial services such as insurance and equity
products. (The committee on Financial Sector Reforms, Chairman: Dr. Raghuram G. Rajan). The essence of
Financial inclusion is to ensure delivery of financial services which include - bank accounts for savings and
transactional purposes, low cost credit for productive, personal and other purposes, financial advisory services,
insurance facilities (life and non-life) etc.
Why Financial Inclusion?

It broadens the resource base of the financial system by developing a culture of savings among large segment
of rural population and plays its own role in the process of economic development. Further, by bringing low
income groups within the perimeter of formal banking sector, financial inclusion protects their financial wealth
and other resources in exigent circumstances. Financial inclusion also mitigates the exploitation of vulnerable
sections by the usurious money lenders by facilitating easy access to formal credit. In short, financial inclusion
provides an access to various services to rural population to improve their financial status.
RBI Policy initiatives

• Advised all banks to open Basic Saving Bank Deposit (BSBD) accounts with minimum common facilities
such as no minimum balance, deposit and withdrawal of cash at bank branch and ATMs, receipt / credit of
money through electronic payment channels, facility of providing ATM card.
• Relaxed and simplified KYC norms to facilitate easy opening of bank accounts, especially for small accounts
with balances not exceeding Rs. 50,000/- and aggregate credits in the accounts not exceeding Rs. 1,00,000
a year. Further, banks are advised not to insist on introduction for opening bank accounts of customers. In
addition, banks are allowed to use Aadhar Cards as a proof of both identity and address. (Supreme Court
rules that the Centre and States should not insist on Aadhar cards for providing essential services, as large
number of people are still not having Aadhar Cards. The matter is still being heard by Supreme Court.)
• Compulsory requirement of opening branches in un-banked villages, banks are directed to allocate at least
25% of the total number of branches to be opened during the year in un-banked (Tier 5 and Tier 6) rural
centers.
• Opening of intermediate brick and mortar structure, for effective cash management, documentation,
redressal of customer grievances and close supervision of Business Correspondents (‘BC’) operations.
Banks have been advised to open intermediate structures between the present base branch and BC
location. This branch could be in the form of a low cost simple brick and mortar structure consisting of
minimum infrastructure such as core banking solution terminal linked to a pass book printer and a safe
for cash retention for operating large customer transactions.
Financial Education, Financial Inclusion and Financial Stability are three elements of an integral strategy. While
financial inclusion works from supply side of providing access to various financial services, financial education
feeds the demand side by promoting awareness among the people regarding the needs and benefits of financial
services offered by banks and other institutions. Going forward, these two strategies promote greater financial
stability.
Important issues which need to be addressed:

• Business Correspondents (BC):
(i) BCs have to be adequately compensated so that they are sufficiently incentivized to promote financial
inclusion as a viable business opportunity.
(ii) The usefulness of BC model is dependent on the kind of support provided by the bank branches.
(iii) Banks should initiate suitable training and skill development programmes for effective functioning
of BCs.
• Tailor Made Services:
(i) Designing suitable innovative products to cater to the requirements of poor villagers at affordable
rates in an absolute imperative.
(ii) To wean away villagers from borrowing from money lenders, bank should develop simplified credit
disbursement procedures and also flexibility in their work processes.
• Technology Applications:
(i) Banks should enhance their ATM network in rural and un-banked areas to serve poor villagers.
While doing so, adequate care should be taken regarding safety / security issues.
(ii) To reduce the overall transaction costs associated with small ticket transactions in rural areas,
domestic RuPay cards may be utilized.
(iii) Banks may explore the possibility of issuing multipurpose cards which could function as debit cards,
KCC and GCC as per the requirements in rural areas.
(iv) There are a number of issues involving Technology Service Providers.
Other issues that need to be addressed for an effective financial inclusion are:
• For effective use of Basic Savings Bank Deposit accounts economic activity needs to be improved.
• Urban financial inclusion leaves vast scope for improvement. Migration from rural to urban centres is also
accentuating the problem.
• Providing of easy and cheap remittance facilities to migrant population is an absolute imperative as
migrants are not adequately covered.
• To deal with poor villagers, banks need to initiate training programmes to frontline staff and managers as
well as BCs on the human side of the banking.
• To achieve meaningful financial inclusion, banks should give priority for small farmers as compared to
large farmers while sanctioning credit.
• Banks should ensure scalability of their CBS platforms.
• Banks should promote Electronic Benefit Transfer (EBT) systems effectively for boosting their financial
inclusion plans.
• Banks should initiate steps to increase the credit absorption capacity in rural areas by promoting
employment and other opportunities.
• There is an imperative need to ramp up the number of rural branches by the private sector banks.
• For up-scaling financial inclusion, adequate infrastructure such as digital and physical connectivity,
uninterrupted power supply are prerequisites.
• Financial inclusion efforts should necessarily be done in vernacular languages.
• All round efforts should be made to ensure that Post Offices play a greater and more active role as they are
closest to the rural people compared to bank branches.
• SIDBI should go in to reasons for not getting access to formal sources of credit by majority of MSME units.
• Over 70% of total population resides in the rural areas of the country, however, insurance reaches less
than 3% of the total population.
• Research into the products, practices and procedures of unorganized sectors an absolute imperative to
identify and understand the same which the bottom of the pyramid populace finds so convenient and
comfortable to deal with.
BUSINESS CORRESPONDENTS / BUSINESS FACILITATORS (BCBF MODEL)

As penetration of banking services among masses has still not reached the desired level, RBI had issued
guidelines to Scheduled Commercial Banks including Regional Rural Banks (RRBs) and Local Area Banks
(LABs) to engage Business Correspondents (BCs)/ Business Facilitators subject to compliance with following:
• Banks to formulate a policy for engaging BCs with the approval of their Board of Directors. Due diligence
to be carried out on individuals / entities to be engaged as BCs prior to their engagement, covering aspects
such as:
(i) market standing
(ii) financial soundness
(iii) management and corporate governance
(iv) cash handling ability
(v) ability to implement technology solutions in rendering financial services.
• The banks are permitted to engage following individuals / entities as BCs:
(i) Retired- bank employees, teachers, government employees, ex-servicemen; individual owners of
kirana / medical / Fair Price shops, Individual public Call Office operators, agents of Small Savings
schemes of GoI / Insurance companies, individual owners of Petrol Pumps, authorized functionaries
of well run SHGs which are linked to banks, others.
(ii) NGOs / MFIs set up under Societies / Trust Act or Section25 Companies Act, 2013
(iii) Registered Co-operative societies
(iv) Post Offices
(v) Registered Companies with large and widespread retail outlets (excluding NBFCs)
• Appointing Non-deposit taking NBFCs (NBFCs-ND) as BCs, subject to the following conditions:
(i) There is no comingling of bank funds and those of the NBFC-ND appointed as BC.
(ii) There should be a specific contractual arrangement to ensure that all possible conflicts of interest
are adequately taken care of.
(iii) Ensure that the NBFC-ND does not adopt any restrictive practice such as offering savings or
remittance functions only to its own customers and forced bundling of services offered by the NBFC-
ND and the bank does not take place.
• A BC can be a BC for more than one bank. The banks will be fully responsible for the actions of the BCs and
their retail outlets / sub agents.
• The scope of activities of BC may include
(i) identification of borrowers
(ii) collection and preliminary processing of loan applications including verification of primary
information and submission of applications
(iii) creating awareness about products, educating and advising on managing money and debt counseling
(iv) promoting, nurturing and monitoring SHGs, Joint liability groups, credit groups
(v) disbursement of small value credit
(vi) post sanction monitoring and recovery
(vii) sale of third party products
(viii) small value remittances and other payment instruments.
• Banks to ensure
(i) compliance with KYC and AML norms under BC model.
(ii) the preservation and protection of the security and confidentiality of customer information in the
custody or possession of BC.
(iii) that the equipment and the technology used by the BC are of high standard.
• The banks are allowed pay reasonable commission / fee to the BC. The banks (not BCs) are permitted to
collect reasonable service charges from the customers in a transparent manner.
• Bank’s arrangement with BC should specify;
(i) Limits on cash holding by intermediaries and limits on individual customer payments and receipts
(ii) Cash collected from the customer should be acknowledged by issuing receipt on behalf of the bank
(iii) All off-line transactions to be accounted by the end of the day
(iv) All agreements / contracts with the customer shall clearly specify that the bank is responsible to the
customer for acts of omission and commission of BC.
• The distance between the place of business of a retail outlet/sub-agent of BC and the base branch should
ordinarily not exceed 30 kms. in rural, semi-urban and urban areas and 5 kms. in metropolitan centres.
• The banks should carry out a detailed review of the performance of various BCs engaged by them at least
once in a year and monitor their activities.
• Banks should take all measures to protect the interest of the customers.
The bank should constitute Grievance Redressal Machinery within the bank for redressing complaints
about services rendered by the BCs and give wide publicity about it through electronic and print media.
• Financial literacy and customer education should form an important part of the business strategy and
should form part of the commitment by banks adopting the BC model.
Financial Literacy is the ability to understand how money works; how someone makes, manages and invests
it, and expands it to help others. Financial Literacy creates demand for financial products and services, thereby
accelerating pace of financial inclusion as it enables the common man to understand the needs and benefits of
the products and services offered by the banks. All segments of the society need financial literacy in one form
or the other. However, considering that a large segment of our society is financially excluded, financial literacy
programmes, at present, should primarily focus on the individuals who are vulnerable to persistent downward
financial pressures due to lack of understanding in the matters relating to personal finance.
Financial Literacy Camps

• The objective of conduct of financial literacy camps is to facilitate financial inclusion through provision
of two essentials - literacy and easy access. It should aim at imparting knowledge to enable financial
planning, inculcate saving habits and improve the understanding of financial products leading to effective
use of financial services by the common man. Financial literacy should help them plan ahead of time for
their life cycle needs and deal with unexpected emergencies without resorting to debt. They should be
able to proactively manage money and avoid debt traps. In order to ensure that the knowledge imparted
through awareness results in inculcating banking habits, literacy inputs need to be synchronized with
access to financial services so as to enable the common man to use the information effectively to gain
control over financial matters. It should result in enhancement of their economic security aided by use of
banking services.
• The banks as providers of financial services, have an inherent gain in the spread of financial inclusion and
financial literacy, as it would help them capture the untapped business opportunities. Small customer is the
key and banks should harness the business opportunities available at the bottom of the pyramid. Hence,
banks must view the financial literacy efforts as their future investments. Banks must provide a bouquet of
banking services comprising of a small overdraft facility, variable recurring deposit accounts, remittance
facility to the account holders in order to make the accounts operative. People should be encouraged to
make transactions in these accounts so that the cost of maintaining the accounts is recovered to make it
a viable and profi table business of the banks. The provision of adequate credit is also important not only
in the interest of the customer, but also for the banks as the reviewed the extant policy on ATMs and has
decided to permit non-banks to set up, own and operate ATMs to accelerate the growth and penetration of
ATMs in the country. Such ATMs will be in the nature of White Label ATM (WLA) and would provide ATM
services to customers of all banks. Non-bank entities proposing to set WLAs have to seek authorization
from RBI.
Development of National Payment System: The payment system could be broadly divided into two segments
– Paper-based Payments and Electronic Payments.
Paper-based Payments - RBI introduced Magnetic Ink Character Recognition (MICR) technology for speeding
up and bringing in efficiency in processing of cheques. Recent developments include launch of Speed Clearing
(for local clearance of outstation cheques drawn on core-banking enabled branches of banks) and introduction
of Cheque Truncation System (‘CTS’ - to restrict physical movement of cheques and enable use of images for
payment processing).
Electronic Payments - the overall thrust is to reduce the use of paper for transactions and move towards
electronic mode. Following are various electronic payment services available in the country:
Electronic Clearing Service (ECS)/ National ECS (NECS): ECS is an electronic mode of payment / receipt for
transactions that are repetitive and periodic in nature. ECS is used by institutions for making bulk payment of
amounts towards distribution dividend, interest, salary, pension etc. or for bulk collection of amounts towards
telephone / electricity / water dues, cess / tax collections, loan installment repayments, periodic investments
in mutual funds, insurance premium etc.
National Electronic Funds Transfer (NEFT): NEFT is a payment system facilitating one-to-one funds transfer.
Under this, individuals, firms and corporate can electronically transfer funds from any bank branch to any
individual, firm or corporate having an account with any other bank branch in the country participating in the
Scheme. Thus, this is an interbank fund transfer system.
Real Time Gross Settlement (RTGS) System: This Real Time Gross Settlement is a continuous (real-time)
settlement of funds transfer individually on an order by order basis (without netting). ‘Real Time’ means the
processing of instructions at the time they are received rather than at some later time. ‘Gross Settlement’ means
the settlement of funds transfer instruction occurs individually (on an instruction by instruction basis).
Considering that the funds settlement takes place in the books of Reserve Bank of India, the payments are final
and irrevocable.
Pre-paid Payment System: Pre-paid instruments are payment instruments that facilitate purchase of goods
and services against the value stored on these instruments. The pre-paid instruments can be issued in the form
of smart cards, magnetic strip cards, internet accounts, internet wallets, mobile accounts, mobile wallets, paper
vouchers etc.
Point of Sale (POS) Terminals / Online Transactions: POS terminals enable customers to make payments for
purchases of goods and services by means of credit / debit cards. To facilitate customer convenience the Bank
has also permitted cash withdrawal using debit cards issued by the banks at POS terminals.
LESSON ROUND UP
• For the economic upliftment, poverty alleviation, creation of employment opportunities, elimination
of social inequities of people of India, Government of India has launched several credit linked and
social security based schemes such as Prime Ministers Employment Generation Programme (PMEGP),
Deendayal Antyodaya Yojana (DAY) - National Rural Livelihood Mission (NRLM) & National Urban
Livelihood Mission (MULM), Differential Rate of Interest Scheme, Scheme for Rehabilitation of Manual
Scavengers (SRMS) 2013, Pradhan Mantri Jana DhanYojna (PMJDY), Micro Units Development and
Refinance Agency (MUDRA) Bank Yojana, National Equity Fund, Pradhan Mantri Awas Yojana (Urban),
Pradhan Mantri Awas Yojana - Gramin, Start-up India Scheme, Sukanya Samriddhi Account, Pradhan
Mantri Jeevan Jyoti Bima Yojana. (PMJJBY), Pradhan Mantri Suraksha Bima Yojana (PMSBY), Atal
Pension Yojana (APY), Pradhan Mantri Vaya Vandana Yojana. (PMVVY), Pradhan Mantri Fasal Bima
Yojana. (PMFBY).
• PMJDY was launched on 28.08.2014, is a National Mission for Financial Inclusion to ensure access
to banking / savings and deposit accounts, Remittance, Credit, Pension, Insurance in an affordable
manner to those who were excluded from main stream banking. The scheme started off “Basic Banking
Accounts” with overdraft facility of Rs. 5000 after 6 months and RuPay Debit card with inbuilt accident
insurance cover of Rs. 1lakh and RuPay Kisan card.
• Under Prime Minister’s Mudra Yojana (PMMY) has been formulated in the year 2015 to provide financial
assistance to eligible entrepreneurs in the SME sector to obtain collateral free financial assistance
from banks from Rs. 50,000 to Rs. 10 lakhs by MUDRA loans are provided for income generating small
business activity in manufacturing, processing, and service sector or trading. The Project cost is decided
based on business plan and the investment proposed. MUDRA loan is not for consumption/personal
needs.
• Under National Equity Fund scheme, SIDBI provides equity assistance to Micro and Small Enterprises
(MSE) entrepreneurs. Sanction of refinance in respect of term loan for the projects by SIDBI is a
prerequisite The complete requirements of the projects in the form of equity assistance, the term
loan and working capital will be provided by one agency viz. a nationalized bank or State Finance
Corporation.
• Sukanya Samriddhi Account is Government of India backed savings scheme targeted at the parents of
girl children. It is a Girl Child Prosperity Account. The scheme encourages parents to build a fund for
the future education and marriage expenses for their female child. The scheme was launched in 2015.
• Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY) is a Government of India backed Life Insurance
Scheme for the benefit of weaker sections of the society. Life cover of Rs. 2.00 lac is available at a yearly
premium of Rs. 330 and is renewable every year. The scheme is available to people in the age group of
18 to 50 years, life cover up to age of 55.
• Pradhan Mantri Suraksha Bima Yojana (PMSBY) is another Government of India backed personal
accident insurance cover at a nominal premium of Rs. 12 per year providing an insurance cover of Rs.2
lac in the event of death. Bank account holders between age of 18 and 70 in participating banks are
eligible.
• Atal Pension Yojana covers people employed in the unorganized sectors in India who are denied of
social security benefits. To offer a social security and safety net Atal Pension Yojna was launched in the
year 2015 covering Indian citizen workers in unorganized sector. The scheme is administered by the
Pension Fund Regulatory and Development Authority (PFRDA) under the National Pension Scheme
(NPS). Subscribers would receive a fixed minimum of Rs. 1000 to Rs. 5000 per month at the age of 60
years depending on their contribution
• ‘Pradhan Mantri Vaya Vandana Yojana (PMVVY)’ provides social security during old age and to protect
elderly persons aged 60 and above against a future fall in their interest income due to uncertain market
conditions. The scheme enables old age income security for senior citizens through provision of assured
pension/return linked to the subscription amount based on government guarantee to Life Insurance
Corporation of India (LIC). PMVVY is available from 4th May 2017 to 31st March 2020 through LIC of
India.
• The Government of India, in April 2016 had launched Prime Minister’s Fasal Bima Yojana after rolling
back the earlier insurance schemes - National Agriculture Insurance Scheme (NAIS), weather based
crop insurance scheme and Modified National Agricultural Insurance Scheme (MNAIS). The main
objectives of the scheme are providing financial support to farmers suffering crop loss / damage arising
out of unforeseen events there by stabilizing the income of farmers to ensure their continuance in
farming and protecting farmers from production risks.
• PMEGP is a central sector scheme administered by the Ministry of Micro, Small and Medium Enterprises
the Scheme is being implemented by Khadi and Village Industries Commission (KVIC). At the State level,
the Scheme will be implemented through State KVIC Directorates, State Khadi and Village Industries
Boards (KVIBs) and District Industries Centres (DICs) and banks. The main objective is to generate
employment opportunities in rural as well as urban areas of the country through setting up of new self-
employment ventures/projects/micro enterprises by providing assistance in the form of subsidies to
individuals, Charitable Trusts, Institutions Registered under Societies Registration Act- 1860, Self Help
Groups (including those belonging to BPL provided that they have not availed benefits under any other
Scheme) and Production based Co-operative Societies.
• Under DAY NRLM the principal objective is poverty reduction through building strong institutions of
the poor, particularly women thereby enabling access to a range of financial services and livelihoods
services. The programme is a means to strengthen women’s self-help groups, the primary building block
of the DAY-NRLM community institutional design. The mission provides a continuous handholding
support to the institutions of poor for a period of 5-7 years till they come out of poverty. DAYNRLM has
a provision for interest subvention, to cover the difference between the Lending Rate of the banks and
7%, on all credit from the banks/ financial institutions availed by women SHGs, for a maximum of Rs.
3,00,000 per SHG.
• Under DAY NULM, Ministry of Housing and Urban Poverty Alleviation (MoHUPA) Government of
India, restructured the existing Swarna Jayanti Shahari Rozgar Yojana (SJSRY) and launched the
National Urban Livelihoods Mission (NULM) in 2013. It was renamed as DAY MULM in 2016. The Self
Employment Program (SEP) of NULM focuses on providing financial assistance through provision of
interest subsidy on loans to support establishment of Individual & Group Enterprises and Self- Help
Groups (SHGs) of urban poor.
• Under, Differential Rate of Interest Scheme, a limited financial assistance is extended at concessional
rate of interest @ 4% to selected low income groups for productive endeavours initially by public sector
banks and then by private sector banks also. DRI scheme is now being implemented by all Scheduled
Commercial Banks. A maximum amount of loan is given up to Rs. 15,000. For physically handicapped
borrowers an additional amount of Rs. 5000 for purchase of artificial limbs/Braille typewriter. Housing
loan up to Rs. 20,000 for SC/ST under Indira Awas Yojana for DRI scheme.
• SRMS started off as National Scheme for Liberation and Rehabilitation of Scavengers (NSLRS) is being
implemented by all Public Sector banks since 1993 with an objective to liberate all scavengers from
their age old profession and engage them in alternative and dignified occupations. Since 2005- 06 the
NSLRS was renamed as Self Employment Scheme for Rehabilitation of Manual Scavengers (SRMS)
with an objective to rehabilitate the remaining scavengers and their dependents. The Scheme was
further revised with the enactment of “Prohibition of Employment as Manual Scavengers and their
“Rehabilitation Act, 2013”under this scheme. The beneficiaries are provided cash assistance as well as
loans at concessional rates of interest.
• Under “Housing for all” vision of the Government of India Pradhan Mantri Awas Yojana (Urban)
• [PMAY(U)] is being implemented with effect from June 2015, as Centrally Sponsored Scheme (CSS) to
provide housing needs of identified urban poor, economically weaker section and low income group
etc., through Credit Linked Subsidy Scheme subject certain criteria specified in this regard.
• Under Pradhan Mantri Awas Yojana - Gramin scheme, housing needs of rural poor identified by local
bodies, is provided through home loans which are eligible for a 3% concession on interest rates on
housing loans of upto Rs.2 lakh.
• The Stand-up India Scheme was launched by the Government to promote entrepreneurship spirit
among women, especially SC & ST category i.e. those sections of the population facing significant
hurdles due to lack of advice/mentorship as well as inadequate and delayed credit. The scheme
encourages green-field ventures by women including those belonging to SC/ST category by providing
loans at concessional rates and various supports.
TEST YOURSELF
a. At the national level, the PMEGP Scheme is being implemented by _______________.
b. _______________ programme will be rolled out in a phased manner over the next 7-8 years.
c. NULM focuses on providing financial assistance through provision of interest subsidy on loans to
support establishment of _______________ and _______________ of urban poor.
d. Under DRI the maximum amount of loan fixed is _______________.
e. Identified manual scavengers, one from each family, would be eligible for receiving cash assistance
of _______________.
f. The slogan for PMJDY is _______________.
g. The 3 categories under MUDRA scheme are _______________, _______________, _______________.
h. Start-up India scheme provides loans for _______________ enterprises started by SC/ST/ women
entrepreneurs.
i. APY stands for _______________.
j. Under Beti Bachao, Beti Padhao scheme, the saving account opened is _______________.
k. Under PMVVY for monthly pension of Rs. 1000 the purchase price is Rs. _______________.
l. Minimum educational qualification for availing loan under NULM is _______________.
m. Maximum amount that can be deposited per year under Sukanya Samriddhi account is
_______________.

a. Under PMEGP Individuals, should be above 18 years of age and have passed VIII Std. in case of
project above Rs.10.00 lakhs in manufacturing and above Rs. 5lakh for Service Sector.
b. Under NRLM, Women SHGs will also get additional interest subvention of 3% on prompt payment,
reducing the effective rate of interest to 4%.
c. Under NULM, the percentage of women beneficiaries under SEP shall not be less than 30%.
d. Under DRI scheme, individuals whose family income does not exceed Rs. 24,000 p.a. in rural areas
and Rs. 18,000 in Semi-urban and Urban areas can be given a loan.
e. Under SRMS loan up to a maximum of Rs. 10 lakh will be admissible under the scheme and Rs. 15
lakhs in case of sanitation related projects.
f. If purchase price is Rs. 15 lakh under PMVVY, the medical exam is mandatory.
g. Under PMFBY, for the commercial horticulture crops, premium is 5%.
h. APY is available to all Indian Citizens between 18 to 60 years of age.
i. MUDRA bank works under SIDBI
j. Under PMJDY, overdraft facility of Rs.10,000 is available.
3. Attempt he following:
a. Explain the documents required in PMJDY scheme?
b. Explain MUDRA Yojana in detail.
c. What do you understand by MUDRA Card?
d. Explain features of National Equity Fund.
e. What do you understand by Sukanya Samriddhi Account Yojana?
f. Explain Pradhan Mantri Jeevan Jyoti Bima Yojana in detail.
g. Explain benefits and eligibility of Atal Pension Yojana.
h. Explain benefits and eligibility of Pradhan Mantri Vaya Vandana Yojana.
i. Which farmers are covered under PMFBY?
j. Explain : SEP – I, SEP – G, SEP - SHGs
Lesson 11 • Consumer Protection 313
Lesson 11 Consumer Protection

Should Know
• Consumer This lesson will enable the students • The Consumer Protection
Protection Act to understand: Act, 2019.
• Consumer • Consumer Protection. • The Consumer Protection
Protection Rules • Bodies established for Consumer (Consumer Disputes Redressal
• National Council Protection. Commissions) Rules, 2020.
• State Council • Procedures relating to filing • The Consumer Protection

complaints. (E - Commerce) Rules, 2020.
• District Council
• Provisions of the COPRA Act, • The Ombudsman Scheme, 2006.
• Central Protection
Authority 2019. • Ombusman Scheme for
• Decisions on cases. Digital Transactions, 2019
• Banking
Ombudsman • Banking Ombudsman.
• Operations of the Scheme.
• Grounds for complaint.
• Decision on cases.
Lesson Outline
• Introduction to Consumer Protection Act, 2019
• Establishment of Consumer Protection Council
• Operational Aspects of Consumer Protection Act
• The Consumer Protection E-Commerce Rules, 2020
• Banking Ombudsman
• LESSON ROUND UP
• GLOSSARY
• TEST YOURSELF
313
INTRODUCTION AND BACKGROUND

The Consumer Protection Act (COPRA) was enacted in India
Consumer rights
for the first time in the year 1986 to protect the interests
of consumers of goods and services. As it evolved over a The right to
period of time different sections of consumers as well as the • be protected against the marketing
providers of goods services were brought under it’s scope. of hazardous goods, products or
Post liberalization of economic reforms in the year 1991 and services;
its fall out over trade and commerce in India, necessitated • be informed about the quality,
amendments to COPRA 1986 which was done in the year quantity, potency, purity, standard
2002. However, past two decades has seen tremendous and price of goods, products or
developments in eCommerce and online based dispensation services, as a protection against
unfair trade practices;
of goods and services for which the COPRA was found to be
inadequate. To address the shortcomings noticed in this back • be assured, wherever possible, access
ground, the COPRA 1986 Act was repealed and replaced by to a variety of goods, products or
services at competitive prices;
The Consumer Protection Act 2019. The 2019 Act aims at
safeguarding and reinforcing the rights of the consumers • be heard and to be assured that
consumer’s interests will receive due
by establishing regulatory authorities, spelling out strict
consideration at appropriate fora;
liabilities and penalties on manufacturers, various service
providers including electronic service providers, misleading • seek redressal against unfair trade
practice or restrictive trade practices
advertisers, and by providing additional settlement consumer
or unscrupulous exploitation of
disputes through mechanisms such as mediation. The new
consumers;
Consumer Protection Act, 2019 (No. 35 of 2019) (COPRA
• consumer awareness.
2019) had received the assent of the President of India on
9.8.2019. However, while exercising the powers conferred by
sub-section (3) of section 1 of the COPRA 2019 (35 of 2019), the Central Government had fixed 20th day of July,
2020 as the ‘appointed date’, i.e., the date on which the provisions of the said Act came into force. The Act is
applicable to the whole of India.
Various Authorities created under COPRA 19: The following is a list of various authorities created
under COPRA 19:
Advisory Bodies
1. National Consumer Protection Council (National Council).
2. State Consumer Protection Council (State Council).
3. District Consumer Protection Council (District Council).
Consumer Rights Protection Authorities

1. The Central Consumer Protection Authority (Central Authority).
2. The Director-General of Investigation Wing appointed under sub-section (2) of section 15 under Central
Authority known as “Director-General”. (Note: District Collectors are also empowered under the Act to
play the role of consumer protection authority as and when necessary).
Consumer Disputes Resolution Forum

1. The National Consumer Disputes Redressal Commission established under sub-section (1) of section 53
known as “National Commission”.
2. State Consumer Disputes Redressal Commission under sub-section (1) of section 42 to be known as “State
Commission”.
3. District Consumer Disputes Redressal Commission under sub-section (1) of section 28 to be known as
“District Commission”.
4. Consumer Mediation Cell (at National/State/District Commissions).
CONSTITUTION OF CONSUMER PROTECTION COUNCILS / AUTHORITY/ REDRESSAL FORUM
Central Consumer Protection Council

(1) The Central Government shall, by notification, establish with effect from such date as it may specify in that
notification, the Central Consumer Protection Council to be known as the Central Council.
(2) The Central Council shall be an advisory council and consist of the following members, namely:-
(a) the Minister-in-charge of the Department of Consumer Affairs in the Central Government, who shall
be the Chairperson; and
(b) such number of other official or non-official members representing such interests as may be
prescribed.
(3) The Central Council shall meet as and when necessary, but at least one meeting of the Council shall be held
every year.
State Consumer Protection Council

(1) Every State Government shall, by notification, establish with effect from such date as it may specify in such
notification, a State Consumer Protection Council for such State to be known as the State Council.
(2) The State Council shall be an advisory council and consist of the following members, namely:-
(a) the Minister-in-charge of Consumer Affairs in the State Government who shall be the Chairperson;
(b) such number of other official or non-official members representing such interests as may be
prescribed;
(c) such number of other official or non-official members, not exceeding ten, as may be nominated by
the Central Government.
(3) The State Council shall meet as and when necessary but not less than two meetings shall be held every
year.
(4) The State Council shall meet at such time and place as the Chairperson may think fit and shall observe
such procedure in regard to the transaction of its business, as may be prescribed.
(5) The objects of every State Council shall be to render advice on promotion and protection of consumer
rights under this Act within the State.
District Consumer Protection Council

(1) The State Government shall, by notification, establish for every District with effect from such date as it may
specify in such notification, a District Consumer Protection Council to be known as the District Council.
(2) The District Council shall be an advisory council and consist of the following members, namely:
(a) The Collector of the district (by whatever name called), who shall be the Chairperson; and
(b) Such number of other official and non-official members representing such interests as may be
prescribed.
(3) The District Council shall meet as and when necessary but not less than two meetings shall be held every
year.
(4) The District Council shall meet at such time and place within the district as the Chairperson may think fit
and shall observe such procedure in regard to the transaction of its business as may be prescribed.
(5) The objects of every District Council shall be to render advice on promotion and protection of consumer
rights under this Act within the district.
CENTRAL CONSUMER PROTECTION AUTHORITY

Consumer Rights Protection Authorities under COPRA 19 - Reporting Hierarchy
(1) The Central Government shall, by notification, establish with effect from such date as it may specify
in that notification, a Central Consumer Protection Authority to be known as the Central Authority to
regulate matters relating to violation of rights of consumers, unfair trade practices and false or misleading
advertisements which are prejudicial to the interests of public and consumers and to promote, protect and
enforce the rights of consumers as a class.
(2) The Central Authority shall consist of a Chief Commissioner and such number of other Commissioners as
may be prescribed, to be appointed by the Central Government to exercise the powers and discharge the
functions under this Act.
(3) The headquarters of the Central Authority shall be at such place in the National Capital Region of Delhi,
and it shall have regional and other offices in any other place in India as the Central Government may
decide.
(4) The Central Government may, by notification, make rules to provide for the qualifications for appointment,
method of recruitment, procedure for appointment, term of office, salaries and allowances, resignation,
removal and other terms and conditions of the service of the Chief Commissioner and Commissioners of
the Central Authority.
(5) No act or proceeding of the Central Authority shall be invalid merely by reason of-
(a) any vacancy in, or any defect in the constitution of, the Central Authority; or
(b) any defect in the appointment of a person acting as the Chief Commissioner or as a Commissioner; or
(c) any irregularity in the procedure of the Central Authority not affecting the merits of the case.
(6) The Central Government shall provide the Central Authority such number of officers and other employees
as it considers necessary for the efficient performance of its functions under this Act.
(7) The salaries and allowances payable to, and the other terms and conditions of service of, the officers and
other employees of the Central Authority appointed under this Act shall be such as may be prescribed.
(8) The Central Authority may engage, in accordance with the procedure specified by regulations, such number
of experts and professionals of integrity and ability, who have special knowledge and experience in the
areas of consumer rights and welfare, consumer policy, law, medicine, food safety, health, engineering,
product safety, commerce, economics, public affairs or administration, as it deems necessary to assist it in
the discharge of its functions under this Act.
(9) The Central Authority shall regulate the procedure for transaction of its business and allocation of its
business amongst the Chief Commissioner and Commissioners as may be specified by regulations.
(10) The Chief Commissioner shall have the powers of general superintendence, direction and control in
respect of all administrative matters of the Central Authority:
(11) The Central Authority shall have an Investigation Wing headed by a Director- General for the purpose of
conducting inquiry or investigation under this Act as may be directed by the Central Authority.
(12) The Central Government may appoint a Director-General and such number of Additional Director-
General, Director, Joint Director, Deputy Director and Assistant Director, from amongst persons who have
experience in investigation and possess such qualifications, in such manner, as may be prescribed.
(13) Every Additional Director-General, Director, Joint Director, Deputy Director and Assistant Director shall
exercise his powers, and discharge his functions, subject to the general control, supervision and direction
of the Director-General.
(14) The Director-General may delegate all or any of his powers to the Additional Director-General or Director,
Joint Director or Deputy Director or Assistant Director, as the case may be, while conducting inquiries or
investigations under this Act.
(15) The inquiries or the investigations made by the Director- General shall be submitted to the Central
Authority in such form, in such manner and within such time, as may be specified by regulations.
(16) The District Collector (by whatever name called) may, on a complaint or on a reference made to him
by the Central Authority or the Commissioner of a regional office, inquire into or investigate complaints
regarding violation of rights of consumers as a class, on matters relating to violations of consumer rights,
unfair trade practices and false or misleading advertisements, within his jurisdiction and submit his
report to the Central Authority or to the Commissioner of a regional office, as the case may be.
(17) A complaint relating to violation of consumer rights or unfair trade practices or false or misleading
advertisements which are prejudicial to the interests of consumers as a class, may be forwarded either
in writing or in electronic mode, to any one of the authorities, namely, the District Collector or the
Commissioner of regional office or the Central Authority.
(18) The Central Authority shall-
(a) protect, promote and enforce the rights of consumers as a class, and prevent violation of consumers
rights under this Act;
(b) prevent unfair trade practices and ensure that no person engages himself in unfair trade practices;
(c) ensure that no false or misleading advertisement is made of any goods or services which contravenes
the provisions of this Act or the rules or regulations made there under;
(d) ensure that no person takes part in the publication of any advertisement which is false or misleading.
(e) inquire or cause an inquiry or investigation to be made into violations of consumer rights or unfair
trade practices, either suo motu or on a complaint received or on the directions from the Central
Government;
(f) file complaints before the District Commission, the State Commission or the National Commission, as
the case may be, under this Act;
(g) intervene in any proceedings before the District Commission or the State Commission or the National
Commission, as the case may be, in respect of any allegation of violation of consumer rights or unfair
trade practices;
(h) review the matters relating to, and the factors inhibiting enjoyment of, consumer rights, including
safeguards provided for the protection of consumers under any other law for the time being in force
and recommend appropriate remedial measures for their effective implementation;
(i) recommend adoption of international covenants and best international practices on consumer rights
to ensure effective enforcement of consumer rights;
(j) undertake and promote research in the field of consumer rights;
(k) spread and promote awareness on consumer rights;
(l) encourage non-Governmental organisations and other institutions working in the field of consumer
rights to co-operate and work with consumer protection agencies;
(m) mandate the use of unique and universal goods identifiers in such goods, as may be necessary, to
prevent unfair trade practices and to protect consumers’ interest;
(n) issue safety notices to alert consumers against dangerous or hazardous or unsafe goods or services;
(o) advise the Ministries and Departments of the Central and State Governments on consumer welfare
measures;
(p) issue necessary guidelines to prevent unfair trade practices and protect consumers’ interest.
The Central Authority may, after receiving any information or complaint or directions from the Central
Government or of its own motion, conduct or cause to be conducted a preliminary inquiry as to whether there
exists a prima facie case of violation of consumer rights or any unfair trade practice or any false or misleading
advertisement, by any person, which is prejudicial to the public interest or to the interests of consumers and if
it is satisfied that there exists a prima facie case, it shall cause investigation to be made by the Director-General
or by the District Collector.
Where, after preliminary inquiry, the Central Authority is of the opinion that the matter is to be dealt with by a
Regulator established under any other law for the time being in force, it may refer such matter to the concerned
Regulator along with its report. For the purposes of investigation, the Central Authority, the Director General or
District Collector may call to produce any document or record in his possession.
Where the Central Authority is satisfied on the basis of investigation that there is sufficient evidence to show
violation of consumer rights or unfair trade practice by a person, it may pass such order as may be necessary,
including -
(a) recalling of goods or withdrawal of services which are dangerous, hazardous or unsafe;
(b) reimbursement of the prices of goods or services so recalled to purchasers of such goods or services; and
(c) discontinuation of practices which are unfair and prejudicial to consumers’ interest.
Provided that the Central Authority shall give the person an opportunity of being heard before passing an order
under this section.
Where the Central Authority is satisfied after investigation that any advertisement is false or misleading and
is prejudicial to the interest of any consumer or is in contravention of consumer rights, it may, by order, issue
directions to the concerned trader or manufacturer or endorser or advertiser or publisher, as the case may
be, to discontinue such advertisement or to modify the same in such manner and within such time as may be
specified in that order.
If the Central Authority is of the opinion that it is necessary to impose a penalty in respect of such false or
misleading advertisement, by a manufacturer or an endorser, it may, by order, impose on manufacturer or
endorser a penalty which may extend to ten lakh rupees (Rs. 10,00,000).
Provided that the Central Authority may, for every subsequent contravention by a manufacturer or endorser,
impose a penalty, which may extend to fifty lakh rupees (Rs. 50,00,000).
Where the Central Authority deems it necessary, it may, by order, prohibit the endorser of a false or misleading
advertisement from making endorsement of any product or service for a period which may extend to one year.
Provided that the Central Authority may, for every subsequent contravention, prohibit such endorser from
making endorsement in respect of any product or service for a period which may extend to three years.
Where the Central Authority is satisfied after investigation that any person is found to publish, or is a party to
the publication of, a misleading advertisement, it may impose on such person a penalty which may extend to
ten lakh rupees (Rs. 10,00,000).
No endorser shall be liable to a penalty if he has exercised due diligence to verify the veracity of the claims made
in the advertisement regarding the product or service being endorsed by him. No person shall be liable to such
penalty if he proves that he had published or arranged for the publication of such advertisement in the ordinary
course of his business:
Provided that no such defence shall be available to such person if he had previous knowledge of the order
passed by the Central Authority for withdrawal or modification of such advertisement.
While determining the penalty under this section, regard shall be had to the following, namely:-
(a) the population and the area impacted or affected by such offence;
(b) the frequency and duration of such offence;
(c) the vulnerability of the class of persons likely to be adversely affected by such offence; and
(d) the gross revenue from the sales effected by virtue of such offence.
The Central Authority shall give the person an opportunity of being heard before an order under this section is
passed.
For the purpose of conducting an investigation under the Act, the Director-General or any other officer
authorised by him in this behalf, or the District Collector, as the case may be, may, if he has any reason to believe
that any person has violated any consumer rights or committed unfair trade practice or causes any false or
misleading advertisement to be made, shall,
(a) enter at any reasonable time into any such premises and search for any document or record or article or
any other form of evidence and seize such document, record, article or such evidence;
(b) make a note or an inventory of such record or article; or
(c) require any person to produce any record, register or other document or article.
The provisions of the Code of Criminal Procedure, 1973, relating to search and seizure shall apply, as far as may
be, for search and seizure under this Act.
Every document, record or article seized shall be returned to the person, from whom they were seized or who
produced the same, within a period of twenty days of the date of such seizure or production, as the case may
be, after copies thereof or extracts there from certified by that person, in such manner as may be prescribed,
have been taken.
Where any article seized are subject to speedy or natural decay, the Director-General or such other officer may
dispose of the article in such manner as may be prescribed.
Any person aggrieved by any order passed by the Central Authority under this Act may file an appeal to the
National Commission within a period of thirty days from the date of receipt of such order.
The Central Government may, after due appropriation made by Parliament by law in this behalf, make to the
Central Authority grants of such sums of money as that Government may think fit for being utilised for the
purposes of this Act.
The Central Authority shall maintain proper accounts and other relevant records and prepare an annual
statement of accounts in such form and manner as may be prescribed in consultation with the Comptroller and
Auditor-General of India.
The accounts of the Central Authority shall be audited by the Comptroller and Auditor-General of India at such
intervals as may be specified by him and any expenditure incurred in connection with such audit shall be payable
by the Central Authority to the Comptroller and Auditor-General of India. The Comptroller and Auditor- General
of India or any other person appointed by him in connection with the audit of the accounts of the Central
Authority shall have the same rights, privileges and authority in connection with such audit as the Comptroller
and Auditor-General of India generally has, in connection with the audit of the Government accounts and, in
particular, shall have the right to demand the production of books, accounts, connected vouchers and other
documents and papers and to inspect any of the offices of the Central Authority.
The accounts of the Central Authority as certified by the Comptroller and Auditor-General of India or any other
person appointed by him in this behalf together with the audit report thereon shall be forwarded annually to
the Central Government which shall cause the same to be laid before each House of Parliament.
The Central Authority shall prepare once in every year, in such form, manner and at such time as may be
prescribed, an annual report giving full account of its activities during the previous year and such other reports
and returns, as may be directed, and copies of such report and returns shall be forwarded to the Central
Government. A copy of such annual report shall be laid, as soon as may be after it is received, before each House
of Parliament.
Complaint filing/Disputes redressal jurisdictions available to a consumer under COPRA 19

Schedule of Fee payable while filing a case under COPRA 19 [Notification of the Ministry of Consumer
Affairs, Food and Public Distribution (Department of Consumer Affairs) New Delhi dated 15 July, 2020.]
S. No. Value of goods or services paid as consideration Amount of fee payable

District commission
01 Up to Rs. 5,00,000 Nil
02 Above Rs. 5,00,000 and up to Rs. 10,00,000 Rs. 200
05 Above Rs. 50,00,000 and up to Rs. 1 Crore Rs. 2000
State Commission
06 Above Rs. 1 Crore and up to Rs. 2 Crore Rs. 2500
National Commission
11 Above Rs. 10 crore Rs. 7500
District Consumer Disputes Redressal Commission

The State Government shall, by notification, establish a District Consumer Disputes Redressal Commission, to
be known as the District Commission, in each district of the State.
Provided that the State Government may, if it deems fit, establish more than one District Commission in a
district.
Each District Commission shall consist of-
(a) a President; and
(b) not less than two and not more than such number of members as may be prescribed, in consultation with
The Central Government may, by notification, make rules to provide for the qualifications, method of
recruitment, procedure for appointment, term of office, resignation and removal of the President and members
of the District Commission.
The State Government may, by notification, make rules to provide for salaries and allowances and other terms
and conditions of service of the President, and members of the District Commission.
If, at any time, there is a vacancy in the office of the President or member of a District Commission, the State
Government may, by notification, direct-
(a) any other District Commission specified in that notification to exercise the jurisdiction in respect of that
district also; or
(b) the President or a member of any other District Commission specified in that notification to exercise the
powers and discharge the functions of the President or member of that District Commission also.
The State Government shall provide the District Commission with such officers and other employees as may be
required to assist the District Commission in the discharge of its functions. The officers and other employees of
the District Commission shall discharge their functions under the general superintendence of the President of
the District Commission. The salaries and allowances payable to, and the other terms and conditions of service
of, the officers and other employees of the District Commission shall be such as may be prescribed.
The District Commission shall have jurisdiction to entertain complaints where the value of the goods or services
paid as consideration does not exceed one crore rupees.
Provided that where the Central Government deems it necessary so to do, it may prescribe such other value, as
it deems fit.
A complaint shall be instituted in a District Commission within the local limits of whose jurisdiction,
(a) the opposite party or each of the opposite parties, where there are more than one, at the time of the
institution of the complaint, ordinarily resides or carries on business or has a branch office or personally
works for gain; or any of the opposite parties, where there are more than one, at the time of the institution of
the complaint, actually and voluntarily resides, or carries on business or has a branch office, or personally
works for gain, provided that in such case the permission of the District Commission is given; or
(b) the cause of action, wholly or in part, arises; or
(c) the complainant resides or personally works for gain.
The District Commission shall ordinarily function in the district headquarters and may perform its functions at
such other place in the district, as the State government may, in consultation with the State Commission, notify
in the Official Gazette from time to time. A complaint, in relation to any goods sold or delivered or agreed to be
sold or delivered or any service provided or agreed to be provided, may be filed with a District Commission by-
(a) the consumer,
(i) to whom such goods are sold or delivered or agreed to be sold or delivered or such service is provided
or agreed to be provided; or
(ii) who alleges unfair trade practice in respect of such goods or service;
(b) any recognised consumer association, whether the consumer to whom such goods are sold or delivered or
agreed to be sold or delivered or such service is provided or agreed to be provided, or who alleges unfair
trade practice in respect of such goods or service, is a member of such association or not;
(c) one or more consumers, where there are numerous consumers having the same interest, with the
permission of the District Commission, on behalf of, or for the benefit of, all consumers so interested; or
(d) the Central Government, the Central Authority or the State Government, as the case may be.
Provided that the complaint under this sub-section may be filed electronically in such manner as may be
prescribed.
Explanation- For the purposes of this sub-section, “recognised consumer association” means any voluntary
consumer association registered under any law for the time being in force.
Every complaint filed shall be accompanied with such fee and payable in such manner, including electronic
form, as may be prescribed.
Every proceeding before the District Commission shall be conducted by the President of that Commission and
at least one member thereof, sitting together:
Provided that where a member, for any reason, is unable to conduct a proceeding till it is completed, the
President and the other member shall continue the proceeding from the stage at which it was last heard by the
previous member.
On receipt of a complaint the District Commission may, by order, admit the complaint for being proceeded with
or reject the same.
Provided that a complaint shall not be rejected unless an opportunity of being heard has been given to the
complainant.
Provided further that the admissibility of the complaint shall ordinarily be decided within twenty-one days
from the date on which the complaint was filed.
Where the District Commission does not decide the issue of admissibility of the complaint within the period so
specified, it shall be deemed to have been admitted.
Where the parties agree for settlement by mediation and give their consent in writing, the District Commission
shall, within five days of receipt of such consent, refer the matter for mediation. The District Commission shall,
on admission of a complaint, or in respect of cases referred for mediation on failure of settlement by mediation,
proceed with such complaint.
Where the complaint relates to any goods, the District Commission shall -
(a) refer a copy of the admitted complaint, within twenty-one days from the date of its admission to the
opposite party mentioned in the complaint directing him to give his version of the case within a period of
thirty days or such extended period not exceeding fifteen days as may be granted by it;
(b) if the opposite party on receipt of a complaint referred to him under clause (a) denies or disputes the
allegations contained in the complaint, or omits or fails to take any action to represent his case within the
time given by the District Commission, proceed to settle the consumer dispute;
(c) if the complaint alleges a defect in the goods which cannot be determined without proper analysis or test
of the goods, obtain a sample of the goods from the complainant, seal it and authenticate it in the manner
as may be prescribed and refer the sample so sealed to the appropriate laboratory along with a direction
that such laboratory to make an analysis or test, whichever may be necessary, with a view to finding out
whether such goods suffer from any defect alleged in the complaint or from any other defect and to report
its findings thereon to the District Commission within a period of forty-five days of the receipt of the
reference or within such extended period as may be granted by it;
(d) before any sample of the goods is referred to any appropriate laboratory under clause (c), require the
complainant to deposit to the credit of the Commission such fees as may be specified, for payment to the
appropriate laboratory for carrying out the necessary analysis or test in relation to the goods in question;
(e) remit the amount deposited to its credit under clause (d) to the appropriate laboratory to enable it to
carry out the analysis or test mentioned in clause (c) and on receipt of the report from the appropriate
laboratory, it shall forward a copy of the report along with such remarks as it may feel appropriate to the
opposite party;
(f) if any of the parties disputes the correctness of the findings of the appropriate laboratory, or disputes
the correctness of the methods of analysis or test adopted by the appropriate laboratory, require the
opposite party or the complainant to submit in writing his objections with regard to the report made by
the appropriate laboratory;
(g) give a reasonable opportunity to the complainant as well as the opposite party of being heard as to the
correctness or otherwise of the report made by the appropriate laboratory and also as to the objection
made in relation thereto.
If the foregoing procedures cannot the adopted by the District Commission in case of the complaint admitted by
it in relation to goods or if the complaint relates to any services, it shall -
(a) refer a copy of such complaint to the opposite party directing him to give his version of the case within a
period of thirty days or such extended period not exceeding fifteen days as may be granted by the District
Commission; and
(b) if the opposite party, on receipt of a copy of the complaint, referred to him under clause (a) denies or
disputes the allegations contained in the complaint, or omits or fails to take any action to represent his
case within the time given by the District Commission, it shall proceed to settle the consumer dispute
(i) on the basis of evidence brought to its notice by the complainant and the opposite party, if the
opposite party denies or disputes the allegations contained in the complaint; or
(ii) ex parte on the basis of evidence brought to its notice by the complainant, where the opposite party
omits or fails to take any action to represent his case within the time given by the Commission.
(c) decide the complaint on merits if the complainant fails to appear on the date of hearing.
The District Commission may, by order, require an electronic service provider to provide such information,
documents or records, as may be specified in that order.
Every complaint shall be heard by the District Commission on the basis of affidavit and documentary evidence
placed on record:
Provided that where an application is made for hearing or for examination of parties in person or through video
conferencing, the District Commission may, on sufficient cause being shown, and after recording its reasons in
writing, allow the same.
Every complaint shall be disposed of as expeditiously as possible and endeavor shall be made to decide the
complaint within a period of three months from the date of receipt of notice by opposite party where the
complaint does not require analysis or testing of commodities and within five months if it requires analysis or
testing of commodities:
No adjournment shall ordinarily be granted by the District Commission unless sufficient cause is shown and the
reasons for grant of adjournment have been recorded in writing by the Commission. The District Commission
shall make such orders as to the costs occasioned by the adjournment as may be specified by regulations. In
the event of a complaint being disposed of after the period so specified, the District Commission shall record in
writing, the reasons for the same at the time of disposing of the said complaint.
Where during the pendency of any proceeding before the District Commission, if it appears necessary, it
may pass such interim order as is just and proper in the facts and circumstances of the case and the District
Commission shall have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908
while trying a suit in respect of the following matters, namely:
(a) the summoning and enforcing the attendance of any defendant or witness and examining the witness on
oath;
(b) requiring the discovery and production of any document or other material object as evidence;
(c) receiving of evidence on affidavits;
(d) the requisitioning of the report of the concerned analysis or test from the appropriate laboratory or from
any other relevant source;
(e) issuing of commissions for the examination of any witness, or document; and
(f) any other matter which may be prescribed by the Central Government.
In the event of death of a complainant who is a consumer or of the opposite party against whom the complaint
has been filed, the provisions of Order XXII of the First Schedule to the Code of Civil Procedure, 1908 shall apply
subject to the modification that every reference therein to the plaintiff and the defendant shall be construed as
reference to a complainant or the opposite party, as the case may be.
Where the District Commission is satisfied that the goods complained against suffer from any of the defects
specified in the complaint or that any of the allegations contained in the complaint about the services or any
unfair trade practices, or claims for compensation under product liability are proved, it shall issue an order to
the opposite party directing him to do one or more of the following, namely:
(a) to remove the defect pointed out by the appropriate laboratory from the goods in question;
(b) to replace the goods with new goods of similar description which shall be free from any defect;
(c) to return to the complainant the price, or, as the case may be, the charges paid by the complainant along
with such interest on such price or charges as may be decided;
(d) to pay such amount as may be awarded by it as compensation to the consumer for any loss or injury
suffered by the consumer due to the negligence of the opposite party:
Provided that the District Commission shall have the power to grant punitive damages in such circumstances
as it deems fit;
(e) to pay such amount as may be awarded by it as compensation in a product liability action;
(f) to remove the defects in goods or deficiencies in the services in question;
(g) to discontinue the unfair trade practice or restrictive trade practice and not to repeat them;
(h) not to offer the hazardous or unsafe goods for sale;
(i) to withdraw the hazardous goods from being offered for sale;
(j) to cease manufacture of hazardous goods and to desist from offering services which are hazardous in
nature;
(k) to pay such sum as may be determined by it, if it is of the opinion that loss or injury has been suffered by
a large number of consumers who are not identifiable conveniently:
Provided that the minimum amount of sum so payable shall not be less than twenty-five per cent. of the
value of such defective goods sold or service provided, as the case may be, to such consumers;
(l) to issue corrective advertisement to neutralise the effect of misleading advertisement at the cost of the
opposite party responsible for issuing such misleading advertisement;
(m) to provide for adequate costs to parties; and
(n) to cease and desist from issuing any misleading advertisement.
In any proceeding conducted by the President and a member and if they differ on any point or points, they shall
state the point or points on which they differ and refer the same to another member for hearing on such point
or points and the opinion of the majority shall be the order of the District Commission:
Provided that the other member shall give his opinion on such point or points referred to him within a period
of one month from the date of such reference. Every order made by the District Commission shall be signed by
the President and the member who conducted the proceeding:
Provided that where the order is made as per majority opinion, such order shall also be signed by the other
member.
The District Commission shall have the power to review any of the order passed by it if there is an error apparent
on the face of the record, either of its own motion or on an application made by any of the parties within thirty
days of such order.
Any person aggrieved by an order made by the District Commission may prefer an appeal against such order to
the State Commission on the grounds of facts or law within a period of forty-five days from the date of the order,
in such form and manner, as may be prescribed:
Provided that the State Commission may entertain an appeal after the expiry of the said period of forty-five
days, if it is satisfied that there was sufficient cause for not filing it within that period:
Provided further that no appeal by a person, who is required to pay any amount in terms of an order of the
District Commission, shall be entertained by the State Commission unless the appellant has deposited fifty per
cent. of that amount in the manner as may be prescribed:
State Consumer Disputes Redressal Commission

The State Government shall, by notification, establish a State Consumer Disputes Redressal Commission, to be
known as the State Commission, in the State.
The State Commission shall ordinarily function at the State capital and perform its functions at such other
places as the State Government may in consultation with the State Commission notify in the Official Gazette.
Provided that the State Government may, by notification, establish regional benches of the State Commission,
at such places, as it deems fit.
Each State Commission shall consist of:
(b) not less than four or not more than such number of members as may be prescribed in consultation with
The Central Government may, by notification, make rules to provide for the qualification for appointment,
method of recruitment, procedure of appointment, term of office, resignation and removal of the President
and members of the State Commission. The State Government may, by notification, make rules to provide
for salaries and allowances and other terms and conditions of service of the President and members of the
State Commission. The State Government shall determine the nature and categories of the officers and other
employees required to assist the State Commission in the discharge of its functions and provide the Commission
with such officers and other employees as it may think fit.
The officers and other employees of the State Commission shall discharge their functions under the general
superintendence of the President. The salaries and allowances payable to and the other terms and conditions
of service of, the officers and other employees of the State Commission shall be such as may be prescribed.
The State Commission shall have jurisdiction-

(a) to entertain-
(i) complaints where the value of the goods or services paid as consideration, exceeds rupees one crore,
but does not exceed rupees ten crore:
Provided that where the Central Government deems it necessary so to do, it may prescribe such
other value, as it deems fit;
(ii) complaints against unfair contracts, where the value of goods or services paid as consideration does
not exceed ten crore rupees;
(iii) appeals against the orders of any District Commission within the State; and
(b) to call for the records and pass appropriate orders in any consumer dispute which is pending before or
has been decided by any District Commission within the State, where it appears to the State Commission
that such District Commission has exercised a jurisdiction not vested in it by law, or has failed to exercise
a jurisdiction so vested or has acted in exercise of its jurisdiction illegally or with material irregularity.
The jurisdiction, powers and authority of the State Commission may be exercised by Benches thereof, and a
Bench may be constituted by the President with one or more members as the President may deem fit:
Provided that the senior-most member shall preside over the Bench.
Where the members of a Bench differ in opinion on any point, the points shall be decided according to the
opinion of the majority, if there is a majority, but if the members are equally divided, they shall state the point
or points on which they differ, and make a reference to the President who shall either hear the point or points
himself or refer the case for hearing on such point or points by one or more of the other members and such
point or points shall be decided according to the opinion of the majority of the members who have heard the
case, including those who first heard it:
Provided that the President or the other members, as the case may be, shall give opinion on the point or points
so referred within a period of one month from the date of such reference.
A complaint shall be instituted in a State Commission within the limits of whose jurisdiction:
(a) the opposite party or each of the opposite parties, where there are more than one, at the time of the
institution of the complaint, ordinarily resides or carries on business or has a branch office or personally
works for gain; or
(b) any of the opposite parties, where there are more than one, at the time of the institution of the complaint,
actually and voluntarily resides, or carries on business or has a branch office or personally works for gain,
provided in such case, the permission of the State Commission is given; or
(c) the cause of action, wholly or in part, arises; or
(d) the complainant resides or personally works for gain.
On the application of the complainant or of its own motion, the State Commission may, at any stage of the
proceeding, transfer any complaint pending before a District Commission to another District Commission
within the State if the interest of justice so requires.
The State Commission shall have the power to review any of the order passed by it if there is an error apparent
on the face of the record, either of its own motion or on an application made by any of the parties within thirty
days of such order.
Any person aggrieved by an order made by the State Commission may prefer an appeal against such order to
the National Commission within a period of thirty days from the date of the order in such form and manner as
may be prescribed.
Provided that the National Commission shall not entertain the appeal after the expiry of the said period of thirty
days unless it is satisfied that there was sufficient cause for not filing it within that period.
Provided further that no appeal by a person, who is required to pay any amount in terms of an order of the State
Commission, shall be entertained by the National Commission unless the appellant has deposited fifty per cent.
of that amount in the manner as may be prescribed. An appeal shall lie to the National Commission from any
order passed in appeal by any State Commission, if the National Commission is satisfied that the case involves
a substantial question of law.
In an appeal involving a question of law, the memorandum of appeal shall precisely state the substantial
question of law involved in the appeal. Where the National Commission is satisfied that a substantial question
of law is involved in any case, it shall formulate that question and hear the appeal on that question:
Provided that nothing shall be deemed to take away or abridge the power of the National Commission to hear,
for reasons to be recorded in writing, the appeal on any other substantial question of law, if it is satisfied that
the case involves such question of law. An appeal may lie to the National Commission from an order passed ex
parte by the State Commission.
An appeal filed before the State Commission or the National Commission, as the case may be, shall be heard as
expeditiously as possible and every endeavor shall be made to dispose of the appeal within a period of ninety
days from the date of its admission:
Provided that no adjournment shall ordinarily be granted by the State Commission or the National Commission,
as the case may be, unless sufficient cause is shown and the reasons for grant of adjournment have been
recorded in writing by such Commission. The State Commission or the National Commission, as the case may
be, shall make such orders as to the costs occasioned by the adjournment, as may be specified by regulations.
In the event of an appeal being disposed of after the period so specified, the State Commission or the National
Commission, as the case may be, shall record in writing the reasons for the same at the time of disposing of the
said appeal.
National Consumer Disputes Redressal Commission

The Central Government shall, by notification, establish a National Consumer Disputes Redressal Commission,
to be known as the National Commission.
The National Commission shall ordinarily function at the National Capital Region and perform its functions at
such other places as the Central Government may in consultation with the National Commission notify in the
Official Gazette.
Provided that the Central Government may, by notification, establish regional Benches of the National
Commission, at such places, as it deems fit.
The National Commission shall consist of-
(b) not less than four and not more than such number of members as may be prescribed.
The Central Government may, by notification, make rules to provide for qualifications, appointment, term of
office, salaries and allowances, resignation, removal and other terms and conditions of service of the President
and members of the National Commission:
Provided that the President and members of the National Commission shall hold office for such term as specified
in the rules made by the Central government but not exceeding five years from the date on which he enters
upon his office and shall be eligible for re-appointment. No President or members shall hold office as such after
he has attained such age as specified in the rules made by the Central Government which shall not exceed:
(a) in the case of the President, the age of seventy years;
(b) in the case of any other member, the age of sixty-seven years.
Penalty for non- Imprisonment for a term not less than one month, but which may extend to
compliance of -the order three years, or with fine, which shall not be less than Rs. 25,000 but which may
passed by District/State/ extend to Rs. 1,00,000 or with both. Respective commissions will have powers of
National Commission a First Class Judicial Magistrate as provided under Code of Criminal Procedure
1973 which can be appealed in State/National Commission/ Supreme Court
respectively. [Section 72 (1), (2), (3) & 73]
Penalty for non- If any direction of the Central Authority under sections 20 and 21 are not
compliance of direction of complied with by any person, the punishment is imprisonment for a term which
Central Authority may extend to six months or with fine which may extend to Rs. 20 lakhs or with
both. (Section 88)
Punishment for misleading Imprisonment for a term which may extend to two years and with fine which
Advertisement may extend to Rs. 10 lakh, and for every subsequent offence, be punished with
imprisonment for a term which may extend to five years and with fine which
may extend to Rs. 50 lakhs. (Section 89)
Punishment for (a) If it does not result in any injury to the consumer, with imprisonment for
manufacturing for sale a term which may extend to six months and with fine which may extend to
or storing, selling or Rs. 1,00,000/-
distributing or importing (b) If injury is caused not amounting to grievous hurt to the consumer, with
products containing imprisonment for a term which may extend to one year and with fine
adulterant which may extend to Rs.3,00,000
(c) If injury is caused resulting in grievous hurt to the consumer, with
imprisonment for a term which may extend to seven years and with fine
which may extend to Rs. 5,00,000 and
(d) If results in the death of a consumer, with imprisonment for a term which
shall not be less than seven years, but which may extend to imprisonment
for life and with fine which shall not be less than Rs. 10 lakhs. Offences
under c & d are cognizable and non-bailable.
(e) In all offences mentioned above in case of first conviction, any licence
issued to the person referred to in that sub-section to be suspended for
a period up to two years, and in case of second or subsequent conviction,
cancellation of the licence. (Section 91)
Punishment for (a) If it does not result in any injury to the consumer, with imprisonment for a
manufacturing for sale or term which may extend to one year and with fine which may extend to Rs.
for storing or selling or 3.00,000/-
distributing or importing
spurious goods. (b) If injury is caused amounting to grievous hurt to the consumer, with
imprisonment for a term which may extend to seven years and with fine
which may extend to Rs.5,00,000
(c) If results in the death of a consumer, with imprisonment for a term which
shall not be less than seven years, but which may extend to imprisonment
for life and with fine which shall not be less than Rs. 10 lakhs. Offences
under b & c are cognizable and non-bailable.
(d) In all offences mentioned above in case of first conviction, any licence
issued to the person referred to in that sub-section to be suspended for
a period up to two years, and in case of second or subsequent conviction,
cancellation of the licence. (Section 92)
Cognizance of offences Offences under Sections 88 & 89 are cognizable only when when the Central
Authority or its authorized person files the same. (Section 92)
Mediation
The State Government shall establish, by notification, a consumer mediation cell to be attached to each of the
District Commissions and the State Commissions of that State. The Central Government shall establish, by
notification, a consumer mediation cell to be attached to the National Commission and each of the regional
Benches. A consumer mediation cell shall consist of such persons as may be prescribed.
Every consumer mediation cell shall maintain-
(a) a list of empanelled mediators;
(b) a list of cases handled by the cell;
(c) record of proceeding; and
(d) any other information as may be specified by regulations.
Every consumer mediation cell shall submit a quarterly report to the District Commission, State Commission or
the National Commission to which it is attached, in the manner specified by regulations.
For the purpose of mediation, the National Commission or the State Commission or the District Commission,
as the case may be, shall prepare a panel of mediators to be maintained by the consumer mediation cell
attached to it, on the recommendation of a selection committee consisting of the President and a member of
that Commission. The qualifications and experience required for empanelment as mediator, the procedure for
empanelment, the manner of training empanelled mediators, the fee payable to empanelled mediator, the terms
and conditions for empanelment, the code of conduct for empanelled mediators, the grounds on which, and
the manner in which, empanelled mediators shall be removed or empanelment shall be cancelled and other
matters relating thereto, shall be such as may be specified by regulations. The panel of mediators prepared
shall be valid for a period of five years, and the empanelled mediators shall be eligible to be considered for
re-empanelment for another term, subject to such conditions as may be specified by regulations. The District
Commission, the State Commission or the National Commission shall, while nominating any person from the
panel of mediators, consider his suitability for resolving the consumer dispute involved.
It shall be the duty of the mediator to disclose-
(a) any personal, professional or financial interest in the outcome of the consumer dispute;
(b) the circumstances which may give rise to a justifiable doubt as to his independence or impartiality; and
(c) such other facts as may be specified by regulations.
Where the District Commission or the State Commission or the National Commission, as the case may be, is
satisfied, on the information furnished by the mediator or on the information received from any other person
including parties to the complaint and after hearing the mediator, it shall replace such mediator by another
mediator. The mediation shall be held in the consumer mediation cell attached to the District Commission, the
State Commission or the National Commission, as the case may be. Where a consumer dispute is referred for
mediation by the District Commission or the State Commission or the National Commission, as the case may be,
the mediator nominated by such Commission shall have regard to the rights and obligations of the parties, the
usages of trade, if any, the circumstances giving rise to the consumer dispute and such other relevant factors, as
he may deem necessary and shall be guided by the principles of natural justice while carrying out mediation.
The mediator so nominated shall conduct mediation within such time and in such manner as may be specified
by regulations.
Pursuant to mediation, if an agreement is reached between the parties with respect to all of the issues involved
in the consumer dispute or with respect to only some of the issues, the terms of such agreement shall be reduced
to writing accordingly, and signed by the parties to such dispute or their authorised representatives.
The mediator shall prepare a settlement report of the settlement and forward the signed agreement along
with such report to the concerned Commission. Where no agreement is reached between the parties within
the specified time or the mediator is of the opinion that settlement is not possible, he shall prepare his report
accordingly, and submit the same to the concerned Commission.
The District Commission or the State Commission or the National Commission, as the case may be, shall, within
seven days (7 days) of the receipt of the settlement report, pass suitable order recording such settlement of
consumer dispute and dispose of the matter accordingly. Where the consumer dispute is settled only in part,
the District Commission or the State Commission or the National Commission, as the case may be, shall record
settlement of the issues which have been so settled and continue to hear other issues involved in such consumer
dispute. Where the consumer dispute could not be settled by mediation, the District Commission or the State
Commission or the National Commission, as the case may be, shall continue to hear all the issues involved in
such consumer dispute.
Product liability
Product liability shall apply to every claim for compensation under a product liability action by a complainant
for any harm caused by a defective product manufactured by a product manufacturer or serviced by a product
service provider or sold by a product seller. A product liability action may be brought by a complainant against a
product manufacturer or a product service provider or a product seller, as the case may be, for any harm caused
to him on account of a defective product.
A product manufacturer shall be liable in a product liability action, if-
(a) the product contains a manufacturing defect; or
(b) the product is defective in design; or
(c) there is a deviation from manufacturing specifications; or
(d) the product does not conform to the express warranty; or
(e) the product fails to contain adequate instructions of correct usage to prevent any harm or any warning
regarding improper or incorrect usage.
The major definitions are as under:
• A Consumer is a person who buys goods or hires services, for a price (consideration) for use and not for
resale. Any user of such goods and services, with the permission of the buyer is also a consumer.
But does not include a person who avails of such services for any commercial purposes. (for the
purpose of this clause, ‘commercial purpose’ does not include use by a person of goods bought and used
by him and services availed by him exclusively for the purpose of earning his livelihood by means of self-
employment).
• All goods and services including banking, insurance, transport, processing etc. in private, public and
cooperative sector are covered.
• A consumer individually or jointly, any voluntary consumer organization, central or state government can
file a complaint. A complainant also means one or more consumers, where there are numerous consumers
having the same interest. In case of death of a consumer, his legal heir or representative can file a complaint.
• “Complaint” means any allegation in writing made by a complainant that:
i) An unfair trade practice or a restrictive trade practices has been adopted by any trader or a service
provider.
ii) the goods bought by him or agreed to be bought by him suffer from one or more defects.
iii) services hired / availed / agreed to be hired / availed; suffer from deficiency in any respect.
iv) a trader or service provider, as the case may be, has charged for the goods / services mentioned in
the complaint a price in excess of the price - fixed by or under any law for the time being in force,
displayed on the goods or any package containing such goods, displayed on the price list exhibited
by him or under any law, agreed between the parties.
v) goods / services which are hazardous to life and safety when used or being offered for sale to the public.
• Limitation period is 2 years from the date of cause of action. A complaint may be entertained after the
period the period specified if the complainant satisfies the District Forum, The State Commission or the
National Commission, as the case may be, that he had sufficient cause for not filing the complaint with in
such period.
Provided that no such complaint shall be entertained unless the National Commission, the State
Commission or the District Forum, as the case may be, records its reasons for condoning such delay.
• A simple written complaint in duplicate with name and address of complainant and opposite party, facts of
the case, copies of supporting documents and relief sought should be covered. A consumer should obtain
proper receipt / cash memo for purchase made and guarantee / warranty card duly stamped and signed
by the seller where ever applicable.
• Relief includes removal of defect from goods, removal of deficiencies from services, replacement of new
goods free from defect, refund of fee / charges / price, award of compensation for loss or injury suffered,
discontinuation or non-repetition of unfair and restrictive trade practices, prohibition of sale of goods of
hazardous nature, providing for adequate cost to party.
• Penalty for non-compliance of orders include imprisonment for minimum one month and maximum three
years or fine of minimum Rs. 2,000 and maximum Rs. 10,000 or both imprisonment and fine.
• Cost awarded against complaint is maximum of Rs. 10,000.00.
• Period for appeal is 30 days from the date of order.
Some complaints and decisions:
1. The complaint: Not provided with the withdrawal slip for the reason that the customer did not bring the
pass-book.
Decision: It was held that it is not deficiency of service on the part of the bank when the rules required
that a pass-book is must for issue of withdrawal slip.
2. The complaint: Amount of Rs.1,85,000/- lying deposited in 3 FDs were claimed by the complainant in the
capacity of beneficiary under registered will executed by the depositor. The bank directed the beneficiary
to establish the authenticity of will before a competent court of law and to secure a succession certificate
in order to make payment.
Decision: No deficiency in service in asking the complainant to produce succession certificate for
disbursement of amount of depositor who died leaving a will.
3. The complaint: A complaint was filed for increase in service charges levied by banks for collection of
cheques, issue of demand drafts, processing of loans etc.
Decision: Complaint dismissed as it does not fall within the provisions of COPRA, 1986.
4. The complaint: The salary cheques were not cleared by the service branch of the bank due to riots /
disturbances in the city.
Decision: It was held not amounting to deficiency of service on the part of the bank.
5. The complaint: The cheque book facility was refused to the appellant – customer on the ground that
minimum balance in the account was not maintained at Rs. 250/- as required by the rules of the bank.
Decision: There was no deficiency in service on the part of the bank in such refusal.
6. The complaint: A customer en-cashing cheque insisted on the payment of the amount of cheque only in
the denomination of Rs. 100/- as a right and initially refused to accept payment in Rs. 50/- currency notes
as offered by the cashier. Filed case against the Bank.
Decision: No deficiency of service on the ground that the complainant had neither any legal right nor
justification to refuse the payment in Rs. 50/- denominations the same being legal tender. The complaint
was dismissed.
7. The complaint: The bank was alleged to have failed to issue bank guarantee despite sufficient security
and the complainant suffered financial loss.
Decision: Non-issuance of bank guarantee despite security deposit with the bank would amount to
deficiency in service.
The complainant would be entitled to interest on the security amount.
8. The complaint: A cheque drawn in favour of the bank itself without striking off the word bearer. Bank
paid the cheque to unknown outsider considering it as bearer.
Decision: Bank has clearly shown utter negligence in paying a huge amount Rs. 20,000/- to an unknown
outsider and thus caused loss to the account holder. The customer is entitled to the loss and costs of the
complaint.
9. It was held that dishonor of cheque of a customer on the ground of insufficiency of funds when the
customer had sufficient balance will obviously amount to “faulty” and “imperfect” manner of performance
of service.
Decision: On the quantum of damages, it was found that there was a clear nexus between the default of
the respondent bank and the denial of allotment of debentures to complainant and the bank is liable to
compensate the loss.
10. The complaint: A complaint was filed by one of the account holders of the bank alleging that an amount
of Rs. 95,000/- has been withdrawn from his account on the basis of a forged cheque. The said cheque was
not from the cheque book issued to the account holder.
Decision: The bank was guilty of deficiency of service in allowing withdrawal of amount on a forged
cheque, which was not issued by the bank to the complainant.
11. The complaint: Dividend warrants were issued by respondent No.1 and were sought to be encashed
by respondent No. 2, a Banker at Panjim. The appellant filed a complaint before the District Forum as
the warrants were returned unpaid with the remarks, “no advice” despite a letter dispatched to them by
Industrial Finance Branch of SBI, Chandigarh. Respondent no. 2 took the defense that they cannot honour
dividend warrants unless they received intimation from local Head Office at Mumbai.
Decision: The State Commission however held that refusal to clear the dividend warrants was deficiency
in service as question arise in view of the letter from Industrial Finance Branch of SBI, Chandigarh.
Respondent No. 2 and Respondent No. 1 were held to be jointly liable.
12. The complaint: In a case concerning the security at the banking premises, cash was snatched from the
hands of the complainant at the gate of the respondent bank. The appellant alleges that the absence of
security on the gate and the non-provision of steps like siren / alarm system etc. amounts to deficiency in
service on the part of the respondent bank.
Decision: The State Commission held that the non-provision of security on the gate of the bank on the
date of occurrence, i.e., snatching of cash in bank premises cannot be held to be amounting to deficiency
in service by the complainant.
13. The complaint: The bank charged, unilaterally without prior information or consent of the bank customer,
for providing their services by supply of MICR cheque.
Decision: Consumer Forum and State Commission held it as deficiency of service but National Commission
held that it was related to pricing and therefore, not in jurisdiction of the Consumer Fora to decide. The
Supreme Court held that the charges by the bank for issuance of MICR cheques, is not against the
directives of RBI. The question of it, being unilateral or with the consent of each customer does not arise.
14. The Complaint: Consumers were claiming the market value of the goods as compensation and not the
price paid by them.
Decision: A question arose before National Commission in an appeal as to what is the ground on which
the pecuniary jurisdiction of the Commission is to be decided. The Commission stated that in deciding the
pecuniary jurisdiction the aggregated price of the goods and the compensation claimed must be taken
into consideration and if its a class action suit then the aggregate prices of all the goods involved and the
total compensation claimed must be taken into consideration in deciding the pecuniary jurisdiction of the
Commission. Further clarifying, the Commission also cleared the question regarding whether the market
value of the goods is to be considered or the price at which the goods were purchased by the consumer.
The Commission stated that the price by the consumer must be the price that is considered. (The COPRA,
19 also prescribes the same.) The rationale of this Commission was affirmed by the Supreme Court bench
in 2019. [In the case of Rameshwar Prasad Shrivastava v. Dwarkadhin Project (P) Ltd. [(2019) 2 SCC 417].
The Consumer Protection (e-Commerce) Rules, 2019

In the exercise of powers conferred by sub-section (zg)(1) of section 101 of the Consumer Protection Act, 2019
(35 of 2019) the Central Government hereby makes the following rules, namely:-
1. Short Title & Commencement -
(1) These rules may be called the Consumer Protection (e-Commerce) Rules, 2019.
(2) They shall come into force on the date of their publication in the official Gazette.
2. Definitions. - (1) In these rules unless the context otherwise requires, -
a) “Act” means the Consumer Protection Act, 2019 (35 of 2019).
b) “Consumer” shall have the same meaning as provided under the Consumer Protection Act, 2019.
c) “E-Commerce entity” means a company incorporated under the Companies Act, 1956 or the
Companies Act, 2013 or a foreign company covered under section 2 (42) of the Companies Act,
2013 or an office, branch or agency in India as provided in Section 2 (v) (iii) of FEMA 1999, owned
or controlled by a person resident outside India and includes an electronic service provider or a
partnership or proprietary firm, whether inventory or market place model or both and conducting
the e-Commerce business.
Provided that “e-Commerce Entity” does not include any entity or business notified otherwise by the
Government for the said purpose from time to time.
d) “Electronic Record” means data, record or data generated, image or sound stored, received or
sent in an electronic form or micro film or computer generated micro fiche; (as per Information
Technology Act).
e) “Electronic Service Provider” means a person who provides technologies or processes to enable a
product seller to engage in advertising or selling of goods or services to a consumer and includes any
online market place or online auction sites.
f) “Goods” means goods as defined in the Sale of Goods Act, 1930.
g) “Inventory based model of e-Commerce” means an e-Commerce activity where inventory of goods
and services is owned by e-Commerce entity and is sold to the consumers directly.
h) “Information” includes data, message, text, images, sound, voice, codes, computer programmes,
software and databases or micro film or computer generated micro fiche; (as per Information
Technology Act).
i) “Market place model of e-Commerce” means providing of an information technology platform
by an e-Commerce entity on a digital & electronic network to act as a facilitator between buyer and
seller.
j) “Seller” means product seller as defined in the Sale of Goods Act, 1930 and includes a Service
Provider;
k) “Service” means Service as defined in the Consumer Protection Act, 1986.
Note: Words and expressions used in these guidelines and not defined but defined in the Consumer
Protection Act, 2019 shall have the meanings respectively assigned to them in the Act.
3. General Conditions for carrying out e-Commerce business.-
Every e-Commerce entity carrying out or intending to carry out e-Commerce business in India subsequent
to the publication of this notification in the Gazette, shall, within 90 days, comply with the following set of
conditions for the conduct of e-Commerce business:
i. It shall be a registered legal entity under the laws of India;
ii. It shall submit a self-declaration to this Department stating that it is in compliance with these
Guidelines;
iii. The promoter or key management personnel should not have been convicted of any criminal offence
punishable with imprisonment in last 5 years by any Court of competent jurisdiction;
iv. It shall comply with the provisions of Information Technology (Intermediaries Guidelines) Rules,
2011;
v. Payments for sale may be facilitated by the e-Commerce entity in conformity with the guidelines of
the Reserve Bank of India;
vi. Details about the sellers supplying the goods and services, including identity of their business, legal
name, principal geographic address, name of website, e-mail address, contact details, including
clarification of their business identity, the products they sell, and how they can be contacted by
customers shall be displayed in the web site.
4. Liabilities of E Commerce entity -
(1) An E-commerce Entity shall not -
i. directly or indirectly influence the price of the goods or services and shall maintain a level
playing field;
ii. adopt any trade practice which for the purpose of promoting the sale, use or supply of any
goods or for the provision of any service, or composite supply, adopts any unfair methods or
unfair or deceptive practice that may influence transactional decisions of consumers in relation
to products and services;
iii. falsely represent themselves as consumers or post reviews about goods and services in their
name; or misrepresent or exaggerate the quality or the features of goods and services.
(2) An e-Commerce Entity shall :
i. display terms of contract between e-Commerce entity and the seller relating to return, refund,
exchange, warranty / guarantee, delivery / shipment, mode of payments, grievance redressal
mechanism etc. to enable consumers to make informed decisions;
ii. ensure that the advertisements for marketing of goods or services are consistent with the
actual characteristics, access and usage conditions of such of goods or services;
iii) mention safety and health care information of the goods and service advertised for sale;
iv) provide information on available payment methods; the security of those payment methods,
how to use those methods; how to cancel regular payments under those methods; charge back
options and any costs applicable to those payment methods;
vi) ensure that personally identifiable information of customers are protected, and that such
data collection and storage and use comply with provisions of the Information Technology
(Amendment) Act, 2008;
vii) accept return of goods if delivered late from the stated delivery schedule or delivery of defective,
wrong or spurious products, and/or not of the characteristics/features as advertised;
viii) effect all payments towards accepted refund requests of the customers within a period of
maximum of 14 days;
ix) if the e-commerce entity is informed by the consumer or comes to know by itself or through
another source about any counterfeit product being sold on its platform, and is satisfied after
due diligence, it shall notify the seller and if the seller is unable to provide any evidence that the
product is genuine, it shall take down the said listing and notify the consumers of the same;
x) be held guilty of contributory or secondary liability if it makes an assurance vouching for the
authenticity of the goods sold on its market place - or if it guarantees that goods are authentic.
5. Liabilities of Sellers - Any seller selling or advertising his products or services through an e-Commerce
platform shall, -
a) have prior written contract with the respective e-Commerce entity in order to undertake or solicit
such sale or offer;
b) provide all information required to be provided either by law or by any other mandatory regime for
disclosing contractual information and compliance with that regime will be treated as sufficient;
c) display single-figure total and break up price for the goods or service, that includes all compulsory
charges such as delivery, postage, taxes and handling and conveyance charges;
d) comply with mandatory display requirements as per Legal Metrology (Amendment) Rules, 2017 for
pre- packaged commodities;
e) provide mandatory safety and health care warnings and shelf life that a consumer would get at any
physical point of sale;
f) provide fair and reasonable, delivery terms, or to directly reference the shipping policy;
g) be responsible for any warranty/guarantee obligation of goods and services sold;
h) be upfront about how exchange, returns and refund process work, and who bears the costs of return
shipping.
6. Consumer grievance redress procedure. - Every e-Commerce entity :
i) Shall Publish on its website the name of the Grievance Officer and his contact details as well as
mechanism by which users can notify their complaints about products and services availed through
their web site;
ii) The Grievance Officer shall redress the complaints within one month from the date of receipt of
Complaint;
iii) Provide facility to consumers to register their complaints over phone, email or website and shall
provide complaint number for tracking the complaint;
iv) Provide consumers with transparent and effective consumer protection that is not less than the level
of protection offered in other forms of commerce;
v) Provide mechanism/system to converge with NCH in grievance redressal process.
THE BANKING OMBUDSMAN SCHEME, 2006
Introduction and Background

The Banking Ombudsman, as a quasi-judicial authority, was introduced under section 35A of the Banking
Regulation Act, 1949 by RBI with effect from 1995. It was revised in 2002. The Banking Ombudsman is an
official authority to investigate the complaint from the customers and address the complaint and thereby bring
the solution among the aggrieved parties. So, the Banking Ombudsman plays the role of a mediator and serves
the purpose of reconciliation.
The Scheme is introduced with the object of enabling resolution of complaints relating to certain services
rendered by banks and to facilitate the satisfaction or settlement of such complaints.
1. Short Title, Commencement, Extent and Application
(1) This Scheme may be called the Banking Ombudsman Scheme, 2006.
(2) It shall come into force on such date as the Reserve Bank may specify.
(3) It shall extend to the whole of India.
(4) The Scheme shall apply to the business in India of a bank as defined under the Scheme.
2. Suspension of the Scheme
(1) The Reserve Bank, if it is satisfied that it is expedient so to do, may by order suspend for such period
as may be specified in the order, the operation of all or any of the provisions of the Scheme, either
generally or in relation to any specified bank.
(2) The Reserve Bank may, by order, extend from time to time, the period of any suspension ordered as
aforesaid by such period, as it thinks fit.
3. Definitions
(1) ‘award’ means an award passed by the Banking Ombudsman in accordance with the Scheme.
(2) ‘Appellate Authority’ means the Deputy Governor in charge of the Department of the Reserve Bank
implementing the Scheme.
(3) ‘authorised representative’ means a person duly appointed and authorised by a complainant to act
on his behalf and represent him in the proceedings under the Scheme before a Banking Ombudsman
for consideration of his complaint.
(4) ‘Banking Ombudsman’ means any person appointed under Clause 4 of the Scheme.
(5) ‘bank’ means a ‘banking company’, a ‘corresponding new bank’, a ‘Regional Rural Bank’, ‘State Bank
of India’ a ‘Subsidiary Bank’ as defined in Section 5 of the Banking Regulation Act, 1949 (Act 10 of
1949), or a ‘Primary Co-operative Bank’ as defined in clause (c) of Section 56 of that Act and included
in the Second Schedule of the Reserve Bank of India Act, 1934 (Act 2 of 1934), having a place of
business in India, whether such bank is incorporated in India or outside India.
(6) ‘complaint’ means a representation in writing or through electronic means containing a grievance
alleging deficiency in banking service as mentioned in clause 8 of the Scheme.
(7) ‘Reserve Bank’ means the Reserve Bank of India constituted by Section 3 of the Reserve Bank of India
Act, 1934 (Act 2 of 1934).
(8) ‘the scheme’ means the Banking Ombudsman Scheme, 2006.

(9) ‘secretariat’ means the office constituted as per Sub-Clause (1) of Clause 6 of the Scheme.
(10) ‘settlement’ means an agreement reached by the parties either by conciliation or mediation under
Clause 11 of the Scheme.
4. Appointment & Tenure
(1) The Reserve Bank may appoint one or more of its officers in the rank of Chief General Manager or
General Manager to be known as Banking Ombudsmen to carry out the functions entrusted to them
by or under the Scheme.
(2) The appointment of Banking Ombudsman under the above Clause may be made for a period not
exceeding three years at a time.
5. Location of Office and Temporary Headquarters
(1) The office of the Banking Ombudsman shall be located at such places as may be specified by the
Reserve Bank.
(2) In order to expedite disposal of complaints, the Banking Ombudsman may hold sittings at such
places within his area of jurisdiction as may be considered necessary and proper by him in respect
of a complaint or reference before him.
6. Secretariat
(1) The Reserve Bank shall depute such number of its officers or other staff to the office of the Banking
Ombudsman as is considered necessary to function as the Secretariat of the Banking Ombudsman.
(2) The cost of the Secretariat shall be borne by the Reserve Bank.
7. Powers and Jurisdiction
(1) The Reserve Bank shall specify the territorial limits to which the authority of each Banking
Ombudsman appointed under Clause 4 of the Scheme shall extend.
(2) The Banking Ombudsman shall receive and consider complaints relating to the deficiencies in banking
or other services filed on the grounds mentioned in clause 8 irrespective of the pecuniary value of
the deficiency in service complained and facilitate their satisfaction or settlement by agreement or
through conciliation and mediation between the bank concerned and the aggrieved parties or by
passing an Award as per the provisions of the Scheme.
(3) The Banking Ombudsman shall exercise general powers of superintendence and control over his
Office and shall be responsible for the conduct of business there at.
(4) The Office of the Banking Ombudsman shall draw up an annual budget for itself in consultation with
Reserve Bank and shall exercise the powers of expenditure within the approved budget on the lines
of Reserve Bank of India Expenditure Rules, 2005.
(5) The Banking Ombudsman shall send to the Governor, Reserve Bank, a report, as on 30th June every
year, containing a general review of the activities of his Office during the preceding financial year and
shall furnish such other information as the Reserve Bank may direct and the Reserve Bank may, if it
considers necessary in the public interest so to do, publish the report and the information received
from the Banking Ombudsman in such consolidated form or otherwise as it deems fit.
8. Grounds of Complaint
(1) Any person may file a complaint with the Banking Ombudsman having jurisdiction on any one of the
following grounds alleging deficiency in banking including internet banking or other services.
(a) non-payment or inordinate delay in the payment or collection of cheques, drafts, bills etc.;
(b) non-acceptance, without sufficient cause, of small denomination notes tendered for any
purpose, and for charging of commission in respect thereof;
(c) non-acceptance, without sufficient cause, of coins tendered and for charging of commission in
respect thereof;
(d) non-payment or delay in payment of inward remittances;
(e) failure to issue or delay in issue of drafts, pay orders or bankers’ cheques;
(f) non-adherence to prescribed working hours;
(g) failure to provide or delay in providing a banking facility (other than loans and advances)
promised in writing by a bank or its direct selling agents;
(h) delays, non-credit of proceeds to parties’ accounts, non-payment of deposit or non-observance
of the Reserve Bank directives, if any, applicable to rate of interest on deposits in any savings,
current or other account maintained with a bank;
(i) complaints from Non-Resident Indians having accounts in India in relation to their remittances
from abroad, deposits and other bank- related matters;
(j) refusal to open deposit accounts without any valid reason for refusal;
(k) levying of charges without adequate prior notice to the customer;
(l) non-adherence to the instructions of Reserve Bank on ATM /Debit Card and Prepaid Card
operations in India by the bank or its subsidiaries on any of the following:
i. Account debited but cash not dispensed by ATMs.
ii. Account debited more than once for one withdrawal in ATMs or for POS transaction.
iii. Less/Excess amount of cash dispensed by ATMs.
iv. Debit in account without use of the card or details of the card.
v. Use of stolen/cloned cards.
vi. Others.
(m) non-adherence by the bank or its subsidiaries to the instructions of Reserve Bank on credit
card operations on any of the following:
i. Unsolicited calls for Add-on Cards, insurance for cards etc.
ii. Charging of Annual Fees on Cards issued free for life
iii. Wrong Billing/Wrong Debits
iv. Threatening calls/ inappropriate approach of recovery by recovery agents including non-
observance of Reserve Bank guidelines on engagement of recovery agents
v. Wrong reporting of credit information to Credit Information Bureau
vi. Delay or failure to review and correct the credit status on account of wrongly reported
credit information to Credit Information Bureau;
(n) non-adherence to the instructions of Reserve Bank with regard to Mobile Banking / Electronic
Banking service in India by the bank on any of the following:
i. delay or failure to effect online payment / Fund Transfer,
ii. unauthorized electronic payment / Fund Transfer;
(o) non-disbursement or delay in disbursement of pension (to the extent the grievance can be
attributed to the action on the part of the bank concerned, but not with regard to its employees);
(p) refusal to accept or delay in accepting payment towards taxes, as required by Reserve Bank/
Government;
(q) refusal to issue or delay in issuing, or failure to service or delay in servicing or redemption of
Government securities;
(r) forced closure of deposit accounts without due notice or without sufficient reason;
(s) refusal to close or delay in closing the accounts;
(t) non-adherence to the fair practices code as adopted by the bank;
(u) non-adherence to the provisions of the Code of Bank’s Commitments to Customers issued by
Banking Codes and Standards Board of India and as adopted by the bank;
(v) non-observance of Reserve Bank guidelines on engagement of recovery agents by banks;
(w) non-adherence to Reserve Bank guidelines on para-banking activities like sale of insurance /
mutual fund /other third party investment products by banks with regard to following:
i. improper, unsuitable sale of third party financial products;
ii. non-transparency /lack of adequate transparency in sale;
iii. non-disclosure of grievance redressal mechanism available;
iv. delay or refusal to facilitate after sales service by banks; and
(x) any other matter relating to the violation of the directives issued by the Reserve Bank in relation
to banking or other services.
(2) A complaint on any one of the following grounds alleging deficiency in banking service in respect of
loans and advances may be filed with the Banking Ombudsman having jurisdiction:
(a) non-observance of Reserve Bank Directives on interest rates;
(b) delays in sanction, disbursement or non-observance of prescribed time schedule for disposal of
loan applications;
(c) non-acceptance of application for loans without furnishing valid reasons to the applicant; and
(d) non-adherence to the provisions of the fair practices code for lenders as adopted by the bank or
Code of Bank’s Commitment to Customers, as the case may be;
(e) non-observance of Reserve Bank guidelines on engagement of recovery agents by banks; and
(f) non-observance of any other direction or instruction of the Reserve Bank as may be specified
by the Reserve Bank for this purpose from time to time.
(3) The Banking Ombudsman may also deal with such other matter as may be specified by the Reserve
Bank from time to time in this behalf.
9. Procedure for Filing Complaint
(1) Any person who has a grievance against a bank on any one or more of the grounds mentioned in Clause
8 of the Scheme may, himself or through his authorised representative (other than an advocate),
make a complaint to the Banking Ombudsman within whose jurisdiction the branch or office of
the bank complained against is located. Provided that a complaint arising out of the operations of
credit cards and other types of services with centralized operations, shall be filed before the Banking
Ombudsman within whose territorial jurisdiction the billing address of the customer is located.
(2) (a) The complaint in writing shall be duly signed by the complainant or his authorized
representative and shall be, as far as possible, in the form specified in Annexure ‘A’ or as near
thereto as circumstances admit, stating clearly:

i. the name and the address of the complainant,
ii. the name and address of the branch or office of the bank against which the complaint is
made,
iii. the facts giving rise to the complaint,
iv. the nature and extent of the loss caused to the complainant, and
v. the relief sought for.
(b) The complainant shall file along with the complaint, copies of the documents, if any, which he
proposes to rely upon and a declaration that the complaint is maintainable under Sub-Clause
(3) of this Clause.
(c) A complaint made through electronic means shall also be accepted by the Banking Ombudsman
and a print out of such complaint shall be taken on the record of the Banking Ombudsman.
(d) The Banking Ombudsman shall also entertain complaints covered by this Scheme received by
Central Government or Reserve Bank and forwarded to the Banking Ombudsman for disposal.
(3) No complaint to the Banking Ombudsman shall lie unless:-
(a) the complainant had, before making a complaint to the Banking Ombudsman, made a written
representation to the bank and the bank had rejected the complaint or the complainant had not
received any reply within a period of one month after the bank received his representation or
the complainant is not satisfied with the reply given to him by the bank;
(b) the complaint is made not later than one year after the complainant has received the reply of
the bank to his representation or, where no reply is received, not later than one year and one
month after the date of the representation to the bank;
(c) the complaint is not in respect of the same cause of action which was settled or dealt with on
merits by the Banking Ombudsman in any previous proceedings whether or not received from
the same complainant or along with one or more complainants or one or more of the parties
concerned with the cause of action;
(d) the complaint does not pertain to the same cause of action, for which any proceedings before
any court, tribunal or arbitrator or any other forum is pending or a decree or Award or order
has been passed by any such court, tribunal, arbitrator or forum;
(e) the complaint is not frivolous or vexatious in nature; and
(f) the complaint is made before the expiry of the period of limitation prescribed under the Indian
Limitation Act, 1963 for such claims.
10. Power to Call for Information
(1) For the purpose of carrying out his duties under this Scheme, a Banking Ombudsman may require
the bank against whom the complaint is made or any other bank concerned with the complaint to
provide any information or furnish certified copies of any document relating to the complaint which
is or is alleged to be in its possession. Provided that in the event of the failure of a bank to comply
with the requisition without sufficient cause, the Banking Ombudsman may, if he deems fit, draw the
inference that the information if provided or copies if furnished would be unfavourable to the bank.
(2) The Banking Ombudsman shall maintain confidentiality of any information or document that may
come into his knowledge or possession in the course of discharging his duties and shall not disclose
such information or document to any person except with the consent of the person furnishing
such information or document. Provided that nothing in this Clause shall prevent the Banking
Ombudsman from disclosing information or document furnished by a party in a complaint to the
other party or parties to the extent considered by him to be reasonably required to comply with any
legal requirement or the principles of natural justice and fair play in the proceedings.
11. Settlement of Complaint by Agreement
(1) As soon as it may be practicable to do, the Banking Ombudsman shall send a copy of the complaint to
the branch or office of the bank named in the complaint, under advice to the nodal officer referred to
in Sub-Clause (3) of Clause 15, and endeavour to promote a settlement of the complaint by agreement
between the complainant and the bank through conciliation or mediation.
(2) For the purpose of promoting a settlement of the complaint, the Banking Ombudsman shall not be
bound by any rules of evidence and may follow such procedure as he may consider just and proper,
which shall, however, at the least, require the Banking Ombudsman to provide an opportunity to the
complainant to furnish his/her submissions in writing along with documentary evidence within a
time limit on the written submissions made by the bank. Provided, where the Banking Ombudsman
is of the opinion that the documentary evidence furnished and written submissions by both the
parties are not conclusive enough to arrive at a decision, he may call for a meeting of bank or the
concerned subsidiary and the complainant together to promote an amicable resolution. Provided
further that where such meeting is held and it results in a mutually acceptable resolution of the
grievance, the proceedings of the meeting shall be documented and signed by the parties specifically
stating that they are agreeable to the resolution and thereafter the Banking Ombudsman shall pass
an order recording the fact of settlement annexing thereto the terms of the settlement.
(3) The Banking Ombudsman may deem the complaint as resolved, in any of the following circumstances:
a. Where the grievance raised by the complainant has been resolved by the bank or the concerned
subsidiary of a bank with the intervention of the Banking Ombudsman; or
b. The complainant agrees, whether in writing or otherwise, to the manner and extent of resolution
of the grievance provided by the Banking Ombudsman based on the conciliation and mediation
efforts; or
c. In the opinion of the Banking Ombudsman, the bank has adhered to the banking norms and
practices in vogue and the complainant has been informed to this effect through appropriate
means and complainant’s objections if any to the same are not received by Banking Ombudsman
within the time frame provided.
(4) The proceedings before the Banking Ombudsman shall be summary in nature.
12. Award by the Banking Ombudsman
(1) If a complaint is not settled by agreement within a period of one month from the date of receipt of
the complaint or such further period as the Banking Ombudsman may allow the parties, he may,
after affording the parties a reasonable opportunity to present their case, pass an Award or reject the
complaint.
(2) The Banking Ombudsman shall take into account the evidence placed before him by the parties, the
principles of banking law and practice, directions, instructions and guidelines issued by the Reserve
Bank from time to time and such other factors which in his opinion are relevant to the complaint.
(3) The award shall state in brief the reasons for passing the award.
(4) The Award passed under Sub-Clause (1) shall contain the direction/s, if any, to the bank for specific
performance of its obligations and in addition to or otherwise, the amount, if any, to be paid by the
bank to the complainant by way of compensation for any loss suffered by the complainant, arising
directly out of the act or omission of the bank.
(5) Notwithstanding anything contained in Sub-Clause (4), the Banking Ombudsman shall not have
the power to pass an Award directing payment of an amount towards compensation which is more
than the actual loss suffered by the complainant as a direct consequence of the act of omission or
commission of the bank, or two million rupees whichever is lower. The compensation that can be
awarded by the Banking Ombudsman shall be exclusive of the amount involved in the dispute.
(6) The Banking Ombudsman may also award compensation in addition to the above but not exceeding
rupees 0.1 million to the complainant, taking into account the loss of the complainant’s time,
expenses incurred by the complainant, harassment and mental agony suffered by the complainant.
(7) A copy of the Award shall be sent to the complainant and the bank.
(8) An award shall lapse and be of no effect unless the complainant furnishes to the bank concerned
within a period of 30 days from the date of receipt of copy of the Award, a letter of acceptance of the
Award in full and final settlement of his claim. Provided that no such acceptance may be furnished by
the complainant if he has filed an Appeal under Sub-Clause (1) of clause 14.
(9) The bank shall, unless it has preferred an appeal under Sub-Clause (1) of Clause 14, within one
month from the date of receipt by it of the acceptance in writing of the Award by the complainant
under Sub- Clause (8), comply with the Award and intimate compliance to the Banking Ombudsman.
13. Rejection of the Complaint
(1) The Banking Ombudsman may reject a complaint at any stage if it appears to him that the complaint
made is:
(a) not on the grounds of complaint referred to in clause 8; or
(b) otherwise not in accordance with Sub-Clause (3) of clause 9; or
(c) beyond the pecuniary jurisdiction of Banking Ombudsman prescribed under clause 12(5) and
12 (6): or
(d) requiring consideration of elaborate documentary and oral evidence and the proceedings
before the Banking Ombudsman are not appropriate for adjudication of such complaint; or
(e) without any sufficient cause; or
(f) that it is not pursued by the complainant with reasonable diligence; or
(g) in the opinion of the Banking Ombudsman there is no loss or damage or inconvenience caused
to the complainant.
(2) The Banking Ombudsman, shall, if it appears at any stage of the proceedings that the complaint
pertains to the same cause of action, for which any proceedings before any court, tribunal or
arbitrator or any other forum is pending or a decree or Award or order has been passed by any such
court, tribunal, arbitrator or forum, pass an order rejecting the complaint giving reasons thereof.
14. Appeal before the Appellate Authority
(1) Party to the complaint aggrieved by an Award under Clause 12 or rejection of a complaint for the
reasons referred to in sub clauses (d) to (g) of Clause 13, may within 30 days of the date of receipt of
communication of Award or rejection of complaint, prefer an appeal before the Appellate Authority;
Provided that in case of appeal by a bank, the period of thirty days for filing an appeal shall commence
from the date on which the bank receives letter of acceptance of Award by complainant under Sub-
Clause (8) of Clause 12; Provided that the Appellate Authority may, if he is satisfied that the applicant
had sufficient cause for not making the appeal within time, allow a further period not exceeding 30
days;
Provided further that appeal may be filed by a bank only with the previous sanction of the Chairman
or, in his absence, the Managing Director or the Executive Director or the Chief Executive Officer or
any other officer of equal rank.”
(2) The Appellate Authority shall, after giving the parties a reasonable opportunity of being heard (a)
dismiss the appeal; or (b) allow the appeal and set aside the Award; or (c) remand the matter to
the Banking Ombudsman for fresh disposal in accordance with such directions as the Appellate
Authority may consider necessary or proper; or (d) modify the Award and pass such directions as
may be necessary to give effect to the Award so modified; or (e) pass any other order as it may deem
fit.
(3) The order of the Appellate Authority shall have the same effect as the Award passed by Banking
Ombudsman under Clause 12 or the order rejecting the complaint under Clause 13, as the case may
be.
15. Banks to Display Salient Features of the Scheme for Common Knowledge of Public
(1) The banks covered by the Scheme shall ensure that the purpose of the Scheme and the contact
details of the Banking Ombudsman to whom the complaints are to be made by the aggrieved party
are displayed prominently in all the offices and branches of the bank in such manner that a person
visiting the office or branch has adequate information of the Scheme.
(2) The banks covered by the Scheme shall ensure that a copy of the Scheme is available with the
designated officer of the bank for perusal in the office premises of the bank, if anyone, desires to do
so and notice about the availability of the Scheme with such designated officer shall be displayed
along with the notice under Sub-Clause (1) of this Clause and shall place a copy of the Scheme on
their websites.
(3) The banks covered by the Scheme shall appoint Nodal Officers at their Regional/Zonal Offices and
inform the respective Office of the Banking Ombudsman under whose jurisdiction the Regional/
Zonal Office falls. The Nodal Officer so appointed shall be responsible for representing the bank
and furnishing information to the Banking Ombudsman in respect of complaints filed against the
bank. Wherever more than one zone/region of a bank are falling within the jurisdiction of a Banking
Ombudsman, one of the Nodal Officers shall be designated as the ‘Principal Nodal Officer’ for such
zones or regions.
16. Removal of Difficulties
If any difficulty arises in giving effect to the provisions of this Scheme, the Reserve Bank may make such
provisions not inconsistent with the Banking Regulation Act, 1949 or the Scheme, as it appears to it to be
necessary or expedient for removing the difficulty.
17. Application of the Banking Ombudsman Schemes, 1995 and 2002
The adjudication of pending complaints and execution of the Awards already passed, before coming into
force of the Banking Ombudsman Scheme, 2006, shall continue to be governed by the provisions of the
respective Banking Ombudsman Schemes and instructions of the Reserve Bank issued there under.
Fee for filing complaints

Banking Ombudsman does not charge any fee for filing and resolving customer’s complaints. If any loss
is suffered by the complainant, then complainant is limited to the amount arising directly out of the act or
omission of the bank, with the ceiling of Rs. 20.00 lac.
Internal Ombudsman Scheme, 2018 for Scheduled Commercial Banks

Reserve Bank of India (RBI) had, in May 2015, advised all public-sector and select private and foreign banks
to appoint Internal Ombudsman (IO) as an independent authority to review complaints that were partially or
wholly rejected by the respective banks. The IO mechanism was set up with a view to strengthen the internal
grievance redressal system of banks and to ensure that the complaints of the customers are redressed at the
level of the bank itself by an authority placed at the highest level of bank’s grievance redressal mechanism so as
to minimize the need for the customers to approach other fora for redressal.
As a part of this customer-centric approach, to enhance the independence of the IO while simultaneously
strengthening the monitoring system over functioning of the IO mechanism, RBI has reviewed the arrangement
and issued revised directions under Section 35 A of the Banking Regulation Act, 1949 in the form of ‘Internal
Ombudsman Scheme, 2018’. The Scheme covers, inter-alia, appointment / tenure, roles and responsibilities,
procedural guidelines and oversight mechanism for the IO.
All Scheduled Commercial Banks in India having more than ten banking outlets (excluding Regional Rural
Banks), are required to appoint IO in their banks. The IO shall, inter alia, examine customer complaints which
are in the nature of deficiency in service on the part of the bank, (including those on the grounds of complaints
listed in Clause 8 of the Banking Ombudsman Scheme, 2006) that are partly or wholly rejected by the bank. As
the banks shall internally escalate all complaints, which are not fully redressed to their respective IOs before
conveying the final decision to the complainant, the customers of banks need not approach the IO directly.
The implementation of IO Scheme, 2018 will be monitored by the bank’s internal audit mechanism apart from
regulatory oversight by RBI.
Ombudsman Scheme for Digital Transactions, 2019

Digital transaction in the banking industry is increasing day by day. In order to deal specifically with complaints
relating to digital transaction, the RBI has introduced a separate Ombudsman Scheme for digital transactions in
January 2019. The salient features of the schemes are as under:
• The scheme may be called the Ombudsman Scheme for Digital Transaction, 2019.
Grounds of Complaint
(1) Prepaid Payment Instruments: Non-adherence to the instructions of RBI by system participants about
Prepaid Payment Instruments on any of the following:
a) Failure in crediting merchant’s account within reasonable time
b) Failure to load funds within reasonable time in wallets / cards
c) Unauthorised electronic fund transfer
d) Non-transfer / refusal to transfer / failure to transfer within reasonable time, the balance in the
Prepaid Payment Instruments to the holder’s ‘own’ bank account or back to source at the time of
closure, expiry of validity period etc. of the Prepaid Payment Instrument
e) Failure to refund within reasonable time / refusal to refund in case of unsuccessful / returned /
rejected / cancelled / transactions
f) Non-credit / delay in crediting the account of the Prepaid Payment Instrument holder as per the
terms and conditions of the promotion offer(s) from time to time, if any
g) Non-adherence to any other instruction of the RBI on Prepaid Payment Instruments.
(2) Mobile / Electronic Fund Transfers: Non-adherence to the instructions of the RBI on Mobile / Electronic
fund transfers by System Participants on any of the following:
a) Failure to effect online payment /Fund transfer within reasonable time
b) Unauthorized electronic fund transfer
c) Failure to act upon stop payment instructions within the time frame and under the circumstances
notified to the customers within prescribed timeline
d) Failure to reverse the amount debited from customer account in cases of failed payment transactions
within prescribed timeline
e) Non-adherence to any other instruction of the RBI on mobile / Electronic fund transfers.
(3) Non-adherence to instructions of RBI / respective System Provider to System Participants, on payment
instructions through Unified Payments Interface (UPI) / Bharat Bill Payment System (BBPS) / Bharat QR
code / UPI QR Code on the following grounds:
a) Failure in crediting funds to the beneficiaries’ account
b) Failure to return within reasonable time the payment to the originating member in case of failure to
credit the funds to the beneficiary’s account
c) Failure to / delay in refund of money back to account in case of transaction failure or decline
transactions (failed transactions)
d) Non-adherence to any other instruction of the RBI on Payment transactions / through UPI / BBPS/
Bharat QR code / UPI QR Code
(4) Non-reversal / failure to reverse within reasonable time, funds wrongly transferred to the beneficiary
account due to lapse at the end of System Participant.
(5) Any other matter relating to the violation of the directives including fees / charges, if any, issued by RBI in
relation to digital transactions.
The other formalities/procedures are similar to the Banking Ombudsman Scheme which is on operation and
hence a separate mention has not been made about the same.
The Reserve Bank of India (RBI) has observed that many digital platforms have emerged in the financial
sector claiming to offer hassle free loans to retail individuals, small traders, and other borrowers. The
banks and NBFCs lending their money either directly through their own digital platforms or through a
digital lending platform under an outsourcing arrangement. The Central bank said that digital delivery
in credit intermediation is a welcome development, but RBI has instructed all the banks and NBFCs and
said that irrespective of whether they lend through their own digital lending platform or through an
outsourced lending platform, must adhere to the Fair Practices Code guidelines in letter and spirit.
Some of the cases:

Case 1
A house in the name of B. Narayanama was given on lease to a bank in1982. Subsequently, the lady died. The
Bank did not pay rent from June 1992 to February 1997. Bella Ramarao, the appellant approached the bank and
the Bank immediately paid amount around Rs. 3 lac. Bella contended that the interest also should be paid for
the period. The bank refused to pay the interest. The appellant approached the Banking Ombudsman.
But the complaint was rejected, holding no merit in the case as it was outside the scope of scheme. Bella
approached the Andhra Pradesh High Court. The High Court rejected the appeal, finding that it was outside the
jurisdiction of the banking ombudsman.
Case 2
The appellant had the cash credit facility from 1994 with respondent bank and he had also issued two cheques
of which one was en-cashed and the other was dishonoured. Respondent bank averred that the appellant had
overdrawn account. It was held that when there was credit in favour of the complainant, dishonour of the
cheque issued by the complainant could not be said to be bona fide. Respondent bank was guilty of deficiency
of service and appellant was held entitled for compensation.
Case 3
The respondent was an exporter. Under discounting agreement, he entrusted documents relating to export and
bills of exchange with appellant bank to negotiate the same through a foreign bank. Respondent alleged that
the bank had failed to collect money in foreign currency indicated in documents but instead collected in local
currency, hence there was deficiency in service on the part of the appellant bank and hence a claim for damages
was made.
In appeal to the Ombudsman it was held that there was no deficiency of service on the part of the bank as
appellant bank, acting for and behalf of the respondent, had negotiated the documents as provided under
agreement. However the conversion of local currency in U.S. dollars became difficult on account of policy of
Sudan Government. It was observed that all that was required to be done under terms of the agreement and
under contract had been done by the two banks.
Case 4
The complainants had purchased a tractor after taking loan from the respondent bank. The respondent bank
did not remit the premium amount to the insurance company with which complainants have insured their
tractor as a result of which a loss suffered when the tractor met with an accident could not be recovered from
the insurance company.
The issue for consideration is whether non-payment of premium amount by the bank amounted to deficiency
in service. It was held that when hire purchase agreement between the bank and buyer of vehicle with the
help of bank loan did not contain a condition creating obligation on the part of the bank to remit premium for
insurance policy, complainant buyer of vehicle could not hold bank guilty of deficiency in service.
Case 5
The complainant withdrew overdraft facility sanctioned to him by the bank only after availing facility to the
extent of Rs. 1,20,000/- the facility was availed by the complainant for business purpose. It was held that where
complaint alleging banking service deficiency was found connected with commercial purpose, the consumer
complaint would not be maintainable.
Case 6
The complainant had deposited amount for issue of pay order in favour of a particular firm. However, the said
pay order was cancelled by the bank and was issued in favour of another party.
It was held that when the bank has acted in good faith in cancellation of bank pay order and issuance of fresh
pay order in favour of another party on the request made by manager of the complainant firm, there would be
no deficiency in service.
The Reserve Bank of India has introduced an Ombudsman Scheme for Digital Transactions, 2019 (the Scheme). It
is an expeditious and cost-free apex level mechanism for resolution of complaints regarding digital transactions
undertaken by customers of the System Participants as defined in the Scheme. The Scheme is being introduced
under Section 18 Payment and Settlement Systems Act, 2007, with effect from January 31, 2019.
Ombudsman for Digital Transactions
The Ombudsman for Digital Transactions is a senior official appointed by the Reserve Bank of India to redress
customer complaints against System Participants as defined in the Scheme for deficiency in certain services
covered under the grounds of complaint specified under Clause 8 of the Scheme.
As on date, 21 Ombudsman for Digital Transactions have been appointed with their offices located mostly in
state capitals.
The Scheme has been made applicable to System Participants as defined in Clause 3 (11) of the Scheme.
Grounds of complaints
As per Clause 8 of the Scheme, the Ombudsman for Digital Transactions shall receive and consider complaints
on deficiency in services against System Participants defined in the Scheme on any of the following grounds:
(1) Prepaid Payment Instruments: Non-adherence to the instructions of Reserve Bank by System
Participants about Prepaid Payment Instruments1 on any of the following:
a. Failure in crediting merchant’s account within reasonable time;
b. Failure to load funds within reasonable time in wallets / cards;
c. Unauthorized electronic fund transfer;

d. Non-Transfer / Refusal to transfer/ failure to transfer within reasonable time, the balance in the
Prepaid Payment Instruments to the holder’s ‘own’ bank account or back to source at the time of
closure, expiry of validity period etc., of the Prepaid Payment Instrument;
e. Failure to refund within reasonable time / refusal to refund in case of unsuccessful / returned /
rejected/ cancelled / transactions;
f. Non-credit / delay in crediting the account of the Prepaid Payment Instrument holder as per the
terms and conditions of the promotions offer(s) from time to time, if any;
g. Non-adherence to any other instruction of the Reserve Bank on Prepaid Payment Instruments.
(2) Mobile / Electronic Fund Transfers: Non-adherence to the instructions of the Reserve Bank on Mobile
/ Electronic fund transfers by System Participants on any of the following:
a. Failure to effect online payment / fund transfer within reasonable time;
b. Unauthorized electronic fund transfer;
c. Failure to act upon stop-payment instructions within the time frame and under the circumstances
notified to the customers within prescribed timeline;
d. Failure to reverse the amount debited from customer account in cases of failed payment transactions
within prescribed timeline;
e. Non-adherence to any other instruction of the Reserve Bank on Mobile/Electronic fund transfers.
(3) Non-adherence to instructions of Reserve Bank / respective System Provider to System Participants, on
payment transactions through Unified Payments Interface (UPI) / Bharat Bill Payment System (BBPS) /
Bharat QR Code / UPI QR Code on the following grounds:
a. Failure in crediting funds to the beneficiaries’ account;
b. Failure to return within reasonable time the payment to the originating member in case of failure to
credit the funds to the beneficiary’s account;
c. Failure to / delay in refund of money back to account in case of transaction failure or declined
transactions (i.e., failed transactions);
d. Non-adherence to any other instruction of the Reserve Bank on payment transactions / through
Unified Payments Interface (UPI) / Bharat Bill Payment System (BBPS)/ Bharat QR Code / UPI QR
Code.
(4) Non-reversal / failure to reverse within reasonable time, funds wrongly transferred to the beneficiary
account due to lapse at the end of System Participant.
(5) Any other matter relating to the violation of the directives including on fees / charges, if any, issued by the
Reserve Bank in relation to digital transactions.
NOTE: In respect of digital transactions done on third party platforms, it will be the responsibility of the
Payment Service Provider to resolve customer disputes arising out of such transactions.
When can one file a complaint?
For redressal of grievance, the complainant must first approach the System Participant (as defined in the
Scheme) concerned. If the System Participant does not reply within a period of one month after receipt of the
complaint, or rejects the complaint, or if the complainant is not satisfied with the reply given, the complainant
can file the complaint with the Ombudsman for Digital Transactions within whose jurisdiction the branch or
office of the System Participant complained against, is located. For complaints arising out of services with
centralized operations, the same shall be filed before the Ombudsman for Digital Transactions within whose
territorial jurisdiction the billing / declared address of the customer is located.
When will one’s complaint not be considered by the Ombudsman?

One’s complaint will not be considered under the following circumstances:
(i) If the System Participant against whom the complaint is registered, is not covered under the Scheme.
(ii) If one has not approached the System Participant concerned in the first instance for redressal of the
grievance.
(iii) If the subject matter of the complaint is not pertaining to the grounds of complaint specified under Clause
8 of the Scheme.
(iv) If one has not made the complaint within one year from the date of receipt of reply from the System
Participant; or if no reply is received, and the complaint to the Ombudsman is made after the lapse of
more than one year and one month from the date of complaint to the System Participant. In exceptional
circumstances as decided by the Ombudsman, a complaint made after the period mentioned above may be
accepted by the Ombudsman, provided the complaint is made before the expiry of the period of limitation
prescribed under the Indian Limitation Act, 1963 for such claims.
(v) If the subject matter of the complaint is pending for disposal / has already been dealt with at any other
forum like court of law, consumer court etc.
(vi) If the complaint is for the same subject matter that was settled through the office of the Ombudsman in
any previous proceedings.
(vii) If the complaint is frivolous or vexatious.
(viii) The complaint falls under the disputes covered under Section 24 of the Payment and Settlement Systems
Act, 2007.
(ix) The complaint pertains to dispute arising from a transaction between customers.
Procedure for filing the complaint before the Ombudsman
One can file a complaint with the Ombudsman by writing on a plain paper and sending it to the concerned
office of the Ombudsman by post/fax/hand delivery. One can also file it by email to the Ombudsman for Digital
Transactions. A complaint form along with the scheme is also available on RBI’s website, though, it is not
mandatory to use this format.
Where can one lodge his/her complaint?
One may lodge complaint with the Office of the Ombudsman for Digital Transactions within whose jurisdiction
the branch or office of the System Participant complained against, is located. For complaint arising out of services
with centralized operations, complaints can be filed with the office of the Ombudsman for Digital Transactions
within whose territorial jurisdiction the billing / declared address of the customer is located.
Filing of complaint through an authorized representative
The complaint can be filed through an authorized representative of the complainant (other than an advocate).
Cost involved in filing a complaint with the Office of the Ombudsman for Digital Transactions
There is no charge or any fee for filing / resolving customers’ complaints.
Limit on the amount of compensation that the Ombudsman can sanction
The compensation amount, if any, which can be awarded by the Ombudsman, for any loss suffered by the
complainant, is limited to the amount arising directly out of the act or omission or commission of the System
Participant, or two million rupees whichever is lower. The compensation shall be over and above the disputed
amount.
Compensation for mental agony and harassment
The Ombudsman may award compensation not exceeding rupees 0.1 million to the complainant for mental
agony and harassment. The Ombudsman, while giving the compensation, shall take into account the loss of
time, expenses incurred by the complainant, harassment and mental anguish suffered by the complainant.
Details required in a complaint to the Ombudsman
The complainant is required to give details such as,
a. The name and the address of the complainant;
b. The name and address of the branch or office of the System Participant against whom the complaint is
made;
c. The facts giving rise to the complaint, supported by documents, if any;
d. The nature and extent of the loss caused to the complainant;
e. The relief sought for; and
f. Declaration that the complaint is maintainable under Clause 9(3) of the Scheme.
What happens after a complaint is received by the Ombudsman?
The Ombudsman endeavours to promote settlement of the complaint through conciliation/ mediation by
agreement between the complainant and the System Participant. If the terms of settlement (offered by the
System Participant) are acceptable in full and final settlement of one’s complaint, the Ombudsman will pass an
order as per the terms of settlement which becomes binding on the System Participant and the complainant. If
the System Participant is found to have adhered to the extant norms and practices in vogue and the complainant
has been informed to this effect through appropriate means and complainant’s objections, if any, are not received
by the Ombudsman within the time frame provided, the Ombudsman may pass an order to close the complaint.
Can the Ombudsman reject a complaint at any stage?
As per Clause 13 of the Scheme, the Ombudsman may reject a complaint at any stage on the following grounds:
a. Complaint not on the grounds of complaint referred to in Clause 8; or
b. Not in accordance with Sub Clause (3) of Clause 9; or
c. The compensation claimed beyond the limit prescribed under Clause 12 (5) and 12 (6); or
d. Requiring consideration of elaborate documentary and oral evidence and the proceedings before the
Ombudsman are not appropriate for adjudication of such complaint; or
e. Without any sufficient cause; or
f. Complaint not pursued by the complainant with reasonable diligence; or
g. In the opinion of the Ombudsman there is no loss or damage or inconvenience caused to the complainant.
What happens if the complaint is not settled by agreement?
If the Ombudsman is satisfied that there is indeed a deficiency of service on the part of the System Participant
and the complaint is not settled by agreement within a specified period as allowed by the Ombudsman, he/she
proceeds to pass an Award. Before passing an Award, the Ombudsman will provide reasonable opportunity to
the complainant and the System Participant to present their case. It is upto the complainant to accept the Award
in full and final settlement or reject it.
Further recourse if one rejects the Ombudsman’s decision
The Scheme provides the appellate mechanism for the complainant as well as the System Participant. Any person
aggrieved by an Award issued under Clause 12 or by the decision of the Ombudsman rejecting the complaint for
the reasons specified in sub-clause (d) to (g) of Clause 13 of the Scheme, can approach the Appellate Authority.
The Appellate Authority is vested with a Deputy Governor-in-Charge of the department of the RBI implementing
the Scheme. The address of the Appellate Authority is:
The Appellate Authority

Ombudsman Scheme for Digital Transactions
Consumer Education and Protection Department
Reserve Bank of India
First Floor, Amar Building, Fort, Mumbai 400 001.
The complainant also has the option to explore other recourse and/or remedies available as per the law.
Time limit for filing an appeal
One can file appeal against the Award or the decision of the Ombudsman rejecting the complaint, within 30 days
of the date of receipt of communication of Award or rejection of the complaint. The Appellate Authority may, if
satisfied that the applicant had sufficient cause for not making an appeal within prescribed time, may allow a
further period not exceeding 30 days.
How does the Appellate Authority deal with the appeal?
The appellate authority may:
a. Dismiss the appeal; or,
b. Allow the appeal and set aside the Award; or,
c. Remand the matter to the Ombudsman for fresh disposal in accordance with such directions as the
Appellate Authority may consider necessary or proper; or,
d. Modify the Award and pass such directions as may be necessary to give effect to the Award so modified; or,
e. Pass any other order as it may deem fit.
Semi-closed System PPIs: These PPIs are issued by banks (approved by RBI) and non-banks (authorized by RBI)
for purchase of goods and services, including financial services, remittance facilities, etc., at a group of clearly
identified merchant locations / establishments which have a specific contract with the issuer (or contract through
a payment aggregator / payment gateway) to accept the PPIs as payment instruments. These instruments do not
permit cash withdrawal, irrespective of whether they are issued by banks or non-banks.
Case Laws
1. Punjab and Sind Bank and Ors. vs. Durgesh Kuwar (25.02.2020 -Supreme Court)
Considering the period which has elapsed, it would be necessary for the Court to issue a direction,
which, while sub-serving the interest of the bank, is also consistent with the need to preserve the
dignity of a woman employee who, we hold, has been unfairly treated.
The Honorable Court is of the view that the High Court cannot be faulted in coming to the conclusion
that the transfer of the respondent, who was holding the office of Chief Manager in the Scale IV in
Indore branch to the branch at Sarsawa in the district of Jabalpur was required to be interfered
with. At the same time, a period of nearly four years has since elapsed.
Despite the order of stay, the respondent was not assigned an office at Indore and had to suffer the
indignity of being asked to sit away from the place assigned to a Branch Manager. Considering the
period which has elapsed, it would be necessary for the Court to issue a direction, which, while sub-
serving the interest of the bank, is also consistent with the need to preserve the dignity of a woman
employee who, we hold, has been unfairly treated. We accordingly direct that Ms. Durgesh Kuwar, the
respondent officer, shall be reposted at the Indore branch as a Scale IV officer for a period of one year
from today.
While affirming the decision of the High Court, the appeal is disposed of in terms of the above
directions. The respondent would be entitled to costs quantified at Rs 50,000 which shall be paid
over within one month.
2. Canara Bank vs. United India Insurance Co. Ltd. (06.02.2020 Supreme Court)
Beneficiaries of the policies taken out by the insured are also ‘consumers’ under the Consumer
Protection Act.
In the above case, some farmers had stored their agricultural produce in the cold storage run by a
partnership firm and took loan from the Canara Bank against the agricultural produce stored in the
cold storage. The cold store was insured with United India Insurance Co. Ltd. A fire took place in
cold store, the entire building with agricultural produce was destroyed. The cold store owners had
taken out a comprehensive insurance policy and raised claim with the insurance company but the
claim was repudiated on the ground that the fire was not an accidental fire. The farmers also issued
notice to insurance company in respect of the plant, machinery and building but this claim was also
repudiated by the insurance company on additional ground that the farmers had no locus standi to
make the claim and there was no privity between the farmers and insurance company. The farmers
filed a claim against cold store, Canara Bank and the Insurance Company.
It was found that in the tripartite agreement among the farmers, Canara Bank and Cold store, it was
mandatory to insure the agricultural produce hypothecated with the Canara Bank.
The Honorable Supreme Court held that the beneficiaries of the policies taken out by the insured
are also ‘consumers’ under the Consumer Protection Act, even though they are not parties to the
contract of insurance.
LESSON ROUND UP
• The Consumer Protection Act, 2019 seeks to take care to protect the interests of consumers, in the light
of certain new developments which have taken place on account of emergence of e-Commerce trade
during the last two decades, which was not fully addressed in the earlier Act of 1986. Apart from making
provisions for establishing Consumer Councils as well as Consumer Disputes Redressal Commissions,
the newly created Act has established A Central Consumer Protection Authority to protect, promote
and enforce the rights of consumers as a class, and prevent violation of consumers rights including
preventing unfair trade practices, ensuring that no false or misleading advertisement is made of any
goods or services which contravenes the provisions of this Act. The 2019 Act also establishes a Director
General of Investigation Wing to conduct inquiry or investigation to assist Central Consumer Protection
Authority.
• The 2019 Act has brought in changes in the monetary jurisdictions of the District, State and National
Consumer Disputes Redressal Commissions to up to Rs. 1 Crore, above Rs. 1 Crore and up to Rs. 10
Crores as well as above Rs. 10 crores respectively. The 2019 Act has also provided a wider choice of
jurisdiction for filing complaints as compared to the earlier Act. The new Act facilitates electronic filing
of complaints too. The alternate dispute resolution mechanism of mediation has been included as a
part of the revised Act. The Act has made punishments/penalties much more stringent compared to the
1986 Act. As before, the 2019 Act retains the role of Supreme Court as appellate jurisdiction of the last
resort.
• The Consumer Protection (e-Commerce) Rules, 2020 aim to protect the interests of consumers vis-à-
vis various entities involved in that line of selling/marketing various products and services. This was
a newly emerged domain where the regulation for protecting consumers’ interests were lacking and
hence these rules have been incorporated. These Rules define duties/liabilities of e-Commerce entities,
market place e-Commerce entities, sellers on market place and liabilities of inventory e-commerce
entities. Contravention of any of these rules will invite penalties and punishments as applicable under
COPRA 2019 Act.
GLOSSARY
Consumer The Consumer Protection Act (COPRA) was enacted in India for the first time in the year
Protection Act 1986 to protect the interests of consumers of goods and services.
Consumer The definition of Consumer right is ‘the right to have information about the quality,
Rights potency, quantity, purity, price and standard of goods or services’.
Unfair Trade Unfair trade practices refer to the use of various deceptive, fraudulent, or unethical
Practices methods to obtain business.
E-Commerce The E-Commerce Rules defines “e-commerce entities” as any person who owns, operates,
entities or manages a digital or electronic facility or platform (i.e., an online interface in the form
of any software including a website or mobile applications) for electronic commerce.
TEST YOURSELF
a. The different Consumer redressal fora under COPRA are ___________, ___________, and ___________.
b. The State Consumer Disputes Redressal Commission (SCDRC) takes up compensation cases of
claims less than Rs. ___________ lac but above Rs. ___________ lac.
c. The Limitation period under COPRA is ___________ years from the date of cause of action.
d. Supreme Court has only ___________ jurisdiction under COPRA.
e. A Banking Ombudsman is an official appointed by ___________.
f. The Banking Ombudsman is required to send to the ___________ a report, as on 30th June every year
regarding his activities.
2. State True or False:
a. A customer of a bank is also a consumer.
b. No filing fee is required to be paid for filing a case under COPRA.
i. National Redressal Commission deals with compensation matters only up to Rs. 100 lacs.
ii. The limitation period for lodging a complaint with Banking Ombudsman is two years from
the time a complaint is made to the bank.
iii. For filing an appeal against a Banking Ombudsman’s decision no permission is required.
iv. The time period for resolving a matter by Banking Ombudsman is one month.
a. Describe the rationale for the introduction of COPRA.
b. Describe the procedure of filing complaints with various redressal fora under COPRA.
c. Who is a Banking Ombudsman? Mention the circumstances under which complaints can be made.
d. Write brief about Appellate Authority in the Scheme of Banking Ombudsman.

• The Consumer Protection Act, 2019 .
• The Banking Ombudsman Scheme - RBI Circular & Annual Reports.
• Various decisions of Consumer Courts
Lesson 12 • Loans and Advances 353
Lesson 12 Loans and Advances

Should Know
• Principles of lending This lesson will enable a reader to • Banking Regulation Act, 1949.
• Loans and Advances understand – • Reserve Bank of India Act, 1934.
• Retail borrowers • Basic Principles of lending • Indian Partnership Act,1932.
• Corporate • Classification of borrowers • Companies Act, 2013.
borrowers ○ Retail borrowers • Foreign Exchange Management
• MAST ○ Corporate borrowers Act, 1999.
• Fund based facilities • Different types of borrowers • Indian Contract Act, 1872.
• Non-fund based ○ Individuals
facilities ○ Firms
• Loan system of ○ Joint stock companies
delivery of credit
○ HUF
• Exposure norms
○ Societies/Associations/Clubs
• Cash credit
○ Trusts
• Overdraft
• Types of credit facilities granted
• Term Loans by Banks
• Bank Guarantees • Loan System for Delivery of Bank
• Letter of Credit Credit
• Bill Purchase and • Types of Non Fund Based Limits
Discount granted by banks
• Factoring • Restriction on Lending by Banks
• Commercial Paper
Lesson Outline
• Introduction • Non Fund Based Credit Facilities
• Difference between Loans and ○ Bank Guarantees
Advances ○ Letter of Credit (LC)
• Different Types of Borrowers ○ Factoring
• Fund Based Credit Facilities ○ Commercial Papers (CP)
○ Cash Credit ○ Bills Purchase and Discount
○ Overdraft • LESSON ROUND UP
○ Demand Loans • TEST YOURSELF
○ Term Loans • LIST OF FURTHER READINGS
○ Bill Finance etc.
353
INTRODUCTION
The business of banking involves accepting money from public and lending the same to various borrowers.
Banks lend in the form of ‘Loans’ and ‘Advances’ which are collectively called ‘Credit Portfolio’ of a Bank. Though
these two terms appear to denote lending and are interchangeably used there are some differences between
them as detailed below:
Loan Parameter Advances
Lending interest bearing funds, which Meaning Lending interest bearing funds for meeting
is repayable after a specified period/ day to day expenses, which is repayable
interval, usually more than a year. within a short duration, say a year
Considered as a debt. Nature Considered as a credit facility.
Repayable over a long term. Period of repayment Repayable within a short duration, say a
year.
May have underlying securities or it Securities Supported by primary security or a
may be unsecured. guarantee, including collateral securities
where necessary.
There could be complex legal Legal formalities In some cases legal formalities are less
formalities complex.
Auto loan, Educational loan, Home Examples Cash credit, Overdraft, Bills purchased,
loan etc. Ad-hoc facilities etc.
The business of lending carries some inherent risks such as default in repayment, delay in repayment etc. Since
the money lent to borrowers come from depositors, banks follow certain basic principles to safe guard their
interests
BASIC PRINCIPLES OF LENDING

Following are some of the basic principles that banks follow while lending:
1) Safety of funds: It is the most important principle of lending because the money that banks lend comes
from public, so the safety is the first concern. Bank must ensure that money is in safe hands and will
come back as agreed with interest and without any default. Safety mainly comes from the character of the
borrower, capacity of borrower to do the business and his stake involved in the business. Besides this, the
nature of security offered by borrower to the bank is also of utmost importance.
2) Liquidity: Liquidity means ready availability of funds to meet financial commitments. It is also as important
as safety. This is because major portion of bank deposits is repayable on demand or at a short notice.
Therefore banks need to ensure availability of funds, so that when depositors demand repayment of their
deposits at their maturity, bank has sufficient funds to repay. Bank grants loans on the security of assets
which are easily marketable without much loss of time and value, if the borrower defaults repayment of
loans/advances granted.
3) Profitability: It is important because banking is a business and any business survives and grows only on
profits. Bank incurs expenses to maintain deposits such as interest, rent, stationary, infra structure staff
salaries etc. Such expenditure also must be recovered. The sound principle of lending is not to sacrifice
safety or liquidity for the sake of higher profitability.
4) Purpose: Purpose of the loan should be productive. Loans/Advances granted to a borrower should be
properly used by a borrower to expand business activity. This ensures increase in sales and realization
of sales proceeds generate additional income from which repayment of loan instalment with interest is
made. Banks also lend money for consumption purpose e.g. for purchasing consumer durables, where
repayment comes from fixed income of the borrower. Loans are not advanced for speculative and
unproductive purpose. RBI has in it’s Master Directions indicates the sectors/activities for which loans
need to be curtailed by banks from time to time.
5) Spread or Diversification: Diversification of lending avoids the risk of concentration. Banks lend money
under different facilities like: term loan, cash credit, overdraft, bills, etc., for different purposes like
business, housing, education, etc., to different industries like cement, pharmaceutical, agriculture, steel,
IT, trade etc., in different geographical areas and so on to spread the risk. In short, banks should follow the
principle of “Not putting all the eggs in one basket.”
Keeping in mind the concept of spread, RBI too has specified Exposure Norms applicable to an
individual borrower or as well as to a group borrower. A bank’s exposures to its borrowers may result
in concentration of its assets to a single borrower or a group of connected borrowers. As a first step
to address the concentration risk, the Reserve Bank, in March 1989, fixed limits on bank exposures
to an individual business concern and to business concerns of a group. RBI’s prudential exposure
norms have evolved since then and a bank’s exposure to a single borrower and a borrower group
stood restricted to 15 percent and 40 percent of capital funds respectively. Where Infrastructure as
an activity is involved, RBI allowed an additional relaxation of 5% in both cases.
However keeping in mind the prescriptions/guidance of Basel Committee on Banking Supervision
(BCBS) on large exposures, Reserve Bank has decided to suitably adopt these standards for banks
in India. In terms of this Under the Large Exposures Framework, (subject to some exemptions) as
indicated by RBI from time to time, the sum of all exposure values of a bank to a borrower or a group
of connected borrowers is defined as a ‘Large Exposure (LE)’, if it is equal to or above 10 percent of
the bank’s eligible capital base. LE was made effective from April 1, 2019.
Exposure Limits
Single Counterparty: The sum of all the exposure values of a bank to a single borrower must not be
higher than 20 percent of the bank’s available eligible capital base at all times. In exceptional cases,
Board of banks may allow an additional 5 percent exposure of the bank’s available eligible capital
base. Banks shall lay down a Board approved policy in this regard. (However, in case of a single NBFC
the exposure is limited to 15 percent)
Groups of Connected Counterparties: The sum of all the exposure values of a bank to a group of
connected counterparties (as defined in paragraph 6 of this circular) must not be higher than 25
percent of the bank’s available eligible capital base at all times. (exposures to a group of connected
NBFCs or groups of connected borrowers having NBFCs in the group will be restricted to 25 percent
of their Tier I Capital)
6) Security: Securities against which banks lend must be marketable, ascertainable, stable and transferable.
Borrower should have clear and transferable title over the security given to the bank, so that if required
can be effectively sold in the market by the bank.
DIFFERENT TYPES OF BORROWERS
There are different types of bank borrowers. They may be classified as individuals, partnership firms,
companies–public as well as private, public sector undertakings, multinational companies etc. The financial
and non- financial credit facilities required to the above customers are many. We can divide them into retail
borrowers and corporate borrowers.
Retail Borrowers
The type of borrowers in retail segment may include individuals, retail traders, Micro, Small and Medium
enterprises (MSMEs), self-help groups, farmers, agricultural borrowers etc. Individuals borrow from banks
for financial assistance in buying homes, vehicles, consumer items etc. Besides banks extend credit facilities
to individuals under educational loans, consumer loans and personal loan schemes. Banks are issuing credit
cards to their customers as well as general public. The credit cards are issued in the form of revolving line of
credit. The retail traders and self-help groups enjoy working capital facilities from banks. MSMEs get financial
assistance from banks both for working capital and for purchase of machinery and equipment required for
their business usages. Farmers avail crop loans, tractor loans and loans for allied activities.
Credit flow to Micro, Small and Medium Enterprises Sector

After change in criteria of classification of MSME by the Government of India, vide Gazette Notification S.O.
2119 (E) dated June 26, 2020, the Reserve Bank of India has also issued a notification to initiate necessary
action for reclassification of enterprises as per the new definition w.e.f. July 1, 2020 and issue necessary
instructions to all Commercial Banks/FIs/NBFCs/UCBs/SCBs for their branches /controlling offices in
this regard, at the earliest.
Revised Classification of MSME
An enterprise shall be classified as a Micro, Small or Medium enterprise on the basis of the following
criteria, namely:
i. a micro enterprise, where the investment in plant and machinery or equipment does not exceed one
crore rupees and turnover does not exceed five crore rupees;
ii. a small enterprise, where the investment in plant and machinery or equipment does not exceed ten
crore rupees and turnover does not exceed fifty crore rupees; and
iii. a medium enterprise, where the investment in plant and machinery or equipment does not exceed
fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.
Corporate Borrowers
Banks offer credit facility to corporate customers such as trading houses, multinational companies, exceptionally
large domestic, industrial and business houses, public sector companies etc. Fund based and non- fund-based
facilities extended to corporates are term lending, short term finance, working capital finance, bill discounting,
export credit, bank guarantee, letter of credit, collection of bills and documents etc. Besides, banks extend
financial assistance like channel financing (extending working capital finance to dealers having business
relationships with large companies), Vendor Finance (money lent to be used by the borrower to buy the vendor’s
products or property), Syndication (allows banks to pool their resources and share risks with other banks
while handling large transactions like Project finance, Corporate term loans, working capital loans, acquisition
finance etc.). Analysis of financial soundness of any business is generally based on the financial ratios and other
accounting variables. The unhealthy position of financial statements directly leads to bankruptcy.
When a bank lends money, it enters into a contract with the borrower. To make that contract enforceable in the
court of law, when the need arises, the contract must be a valid contract. In terms of Indian Contract Act, 1872
essential features of a contract are enumerated below:
The essentials of valid contract are:
1. Offer and acceptance: It is an offer by one party and acceptance by other. Agreement by both parties is a
primary criterion for making a contract.
2. Mutual Consent: Parties must agree upon the same thing, in the same sense and at the same time.
3. Intention to create legal obligation: Both the parties must have intention to go to court of law, if the
other party fails to meet the promise/obligations.
4. Free Consent: Consent of parties must be free. It means there should not be force, undue influence, fraud
or misrepresentation while obtaining consent.
5. Parties must be Competent: Every party to the contract must be major (completed 18 years of age), of
sound mind (at the time of making a contract he can understand it and forming a rational judgment so as
to its effect on his interest), and not disqualified by law to enter into a contract.
6. Lawful object: The object of the contract must be lawful. (not fraudulent, illegal, immoral or opposed to
public policy)
7. Lawful consideration: Both the parties must get something lawful and real, in return for the promise
made.
8. Not expressly declared as void.
Different Types of Borrowers for Lending In Banks

Banks lend money to following types of borrowers:
1. Individuals: Individuals can apply for loan in single name or two or more individuals jointly can apply
for bank loan. All applicants should individually be capable of entering into contract. In case of joint
borrowers, the documents are to be executed jointly. On the death, insanity or insolvency of one of the
joint borrowers, the survivor must pay the outstanding dues.
Position of Individuals in Different Capacities:
a) Minors: Minors, insane individuals and insolvents are legally incompetent and hence cannot apply
for loan. Loan given to a minor cannot be secured and recovered from a competent major person
by obtaining his guarantee as here the original contract will be invalid so the subsequent contract
(guarantee) cannot be enforceable.
b) Illiterate Person: An illiterate person is one who cannot read or write. Especially he is an uneducated
who cannot read. However, if he is otherwise competent, he can enter into a valid contract. Since he
cannot read and write he must be explained the contents of all the documents in language known to
him and a separate declaration to that effect is to be kept on record. Instead of signature, an illiterate
person will put his thump impression on all the documents in presence of bank officials.
c) Blind Person: Blind person can be competent to contract. He can be different from an illiterate if he
is educated, but banks will treat him like an illiterate when it comes to executing documents.
d) Married Woman: A married woman has a legal entity separate from her husband. She can be
adjudicated insolvent in respect of her own debts. Husband shall be liable for a loan raised by a
married woman only if loan is granted with the consent of her husband who stands as a guarantor
and when loan is availed for necessities of her life.
e) Pardanashin Woman: A pardanashin lady is a woman who remains in complete seclusion and
does not transact any business with people other than her family members. In a contract with her, a
presumption of undue influence always exists, and she can avoid the contract where she complains
of undue influence. The onus of proving absence of undue influence lies on other party.
2. Firms: In case of a proprietary firm, the proprietor is treated just like as individual except that he carries
out business in the name of the firm instead of his individual name. In a partnership firm, liability of
partners is unlimited, and the partners are jointly and severally liable for the debt of the firm. The firm is
not a separate legal entity. Partners are principal, and they act as agent for each other. As per the provisions
of Section 464 of Companies Act 2013 the maximum number of partners in a firm can be 100. A joint stock
company can be a partner in a partnership firm. It will be treated as one partner.
Firm’s bank account: On receipt of an application from one or more of the partners, a bank account in the
name of the firm can be opened. A firm’s bank account should be opened in the name of a firm and not in
the name or names of the individual partner/partners.
Liability of partners in respect of firm’s debt: The liability of the partners is unlimited, and every
partner is liable to pay the debts of the firm to an unlimited extent. The liability of partners in different
positions is as follows:
(i) If debts are due from the firm as well as from partners: If the partners are personally indebted,
the personal assets of the partners shall be applied first to meet the claims of their individual
creditors. Out of the remainder, if any, claims of the firm’s creditors will be met.
(ii) If the partners sign the loan documents in both of their capacity i.e., individual as well as
jointly: In this case the creditor can recover their debt simultaneously from the assets of the firm and
the partners. The personal property of a partner may be attached even before judgement is delivered
in a suit against the firm and its partners.
(iii) In case of death of a partner:
(a) If the firm stands dissolved: On receipt of intimation about the partner’s death, the banker
will close the firm’s account immediately. This is necessary to decide the liability of deceased
partner. If this is not done than rule in Clayton’s case will apply.
Clayton’s Rule
In the absence of any specific directions by a customer, a banker enjoys the right to
appropriate the money paid by the customer in to his account to any of the loans including
a time- barred debt. But, however, if there is specific direction from the customer regarding
appropriation, the banker has to follow the same and does not have power to alter them. In
the absence of any directions from the customer banker can appropriate the money paid
by the customer as per his own discretion but should keep the customer informed of his
action.
In case both the banker and the customer fail to act as per their powers, the rule given in
Clayton’s case of 1816 would be applied. Under this rule if there is no specific appropriation
is made, either by the’ debtor or the creditor, the law allows to appropriate the money paid
by the customer in to his account by reducing the first item on the debit side of the current
account by the first item on its credit side in chronological order. In short, this rule the sets
off sum first paid in with the sum that is first paid out. This rule is popularly known as the
Rule in Clayton’s case and affects current an account, especially when overdrawn. In order
to nullify the applicability of this rule, the operations in the account are stopped especially
when the current account shows a debit balance especially when there is a death of partner
in a partnership firm and other specific circumstances.
(b) If the firm does not stand dissolved: If it is reconstituted by the remaining partners, the
banker should open a new account in the name of the reconstituted firm.
In any case, the cheques issued by the deceased partner should not be honoured by the banker
without confirmation from the surviving partners.
(iv) Retirement of a partner: On the retirement of a partner if bank account shows a debit balance,
the banker must close the account immediately, to retain its right to claim money from the retiring
partner. In absence of this, Rule in Clayton’s case will apply. The liability for debts arising out of
financial facility would continue in respect of retired partners till the date of notice. Their liability for
future loans ceases immediately on serving such notice.
(v) Insolvency of a partner: The insolvent partner ceases to be a partner from the date of declaration
of his/her insolvency and he shall not be liable for any act of the firm thereafter. The insolvent
partner does not remain competent to operate the firm’s account. Banker should honour the
cheques drawn by the insolvent partner before his adjudication only after getting confirmation
from the solvent partners. Normally bankers must close the account and open a new account in the
name of reconstituted firm to determine the liability of the insolvent partner. Otherwise, the rule in
Clayton’s case will apply.
3. Limited Liability Partnership (LLP) is a legal entity separate from its partners. The liability of a partner
is limited to his contribution. They are not liable for one another. Public disclosure is the critical feature
of an LLP. An LLP must have at least two members. In a LLP that has only two members , if one member
chooses to leave the partnership, the LLP may have to be dissolved.
4. Joint Stock Companies: In case of Private Limited Company minimum members should be 2 and
maximum can be 200. Minimum directors should be 2 and no ceiling as to maximum no of directors. In
case of Public Limited Company minimum members should be 7 and no ceiling for maximum numbers.
Minimum numbers of directors should be 3 and numbers ceiling for maximum numbers.
– Borrowing Powers of a Company: Borrowing powers of the Board of Directors of a company are
stated in Articles of Association (which deals with the internal management), for loans other than
short term loans. If powers are not stated, these are deemed to be equal to paid up capital plus free
reserves of the company. This restriction does not apply to short-term loans and seasonal loans.
Where the Board does not have adequate powers, shareholders can enhance these powers by
passing a resolution.
– The Board of Directors shall exercise the power to borrow money otherwise than on debentures
only by means of resolutions passed at the meeting of the Board. The Board may, by a resolution
delegate the power to borrow to any committee of directors, the managing director, secretaries and
treasurer etc., and shall specify the total amount outstanding at any one time up to which money
may be borrowed by the delegates.
– Borrowing by Board of Directors without Authorization: If loan has been taken by Board without
authority and used the sum for the benefits of the company, company cannot repudiate its liability
to repay. In this regard it should be noted that any borrowings by the company may be ultra vires
the directors but not ultra vires the company.
5. Hindu Undivided Family (HUF): HUF is not governed by Indian Partnership Act. Senior most coparcener
is a Karta. When the Karta expires or is declared as insolvent or becomes insane, the next senior coparcener
becomes the Karta. He has powers to raise loan for family business and legal necessities of the family. His
liability is unlimited. He can, without the consent of coparceners, create charge on the assets of family
and execute documents. Banks obtain signatures of all major coparceners in their personal capacity, on
all loan documents, to make them personally liable.
Points to be considered by the banker:
i. Though Karta has implied authority to take a loan, to execute necessary documents and to pledge
the securities yet to be on safe side, the loan document should be executed by all the adult members
of the family or with their consent by the head of the family.
ii. Banker must check the purpose of the loan taken. Karta can take the loan and pledge the property
of the family only for using the same in family business and not for speculation purposes.
iii. The coparceners’ liability in case of loans granted to HUF is limited to the extent of their interest in
joint property. If the adult coparceners themselves contract along with Karta or ratify the contract
entered by the Karta, then they become personally liable for the amount borrowed.
iv. In case of minor as coparcener in HUF, then his guardians must sign the loan documents on his behalf.
After attaining majority, he should also sign the documents to give his consent to the undertaking
given by major coparceners.
Societies, Clubs, Associations etc.: These are non-profit making entities and represent group of people.
These get legal status only after incorporation. Banks must ensure that the loan applied is consistent with
objectives of the institution, loan amount is within the borrowing capacity and the managing committee
has passed necessary resolution to that effect.
Points to be consider by the bankers:
(a) Ensure that the applicant society is an incorporated body under The Society Registration Act, 1860
as unregistered society cannot be sued.
(b) Obtain a copy of rules and by-laws of the society to know the powers and functions of the persons
managing the affairs of the society.
(c) Obtain a copy of the resolution of the managing committee regarding appointing the bank concerned
as the banker of the society, mentioning the name of the persons who are authorized to operate the
bank account and giving other directions for the operations of the said account.
(d) Ascertain the borrowing powers of the society from its Charter of Memorandum, Note the purpose
for which borrowings is permissible. Check the powers of members of the society to create charge
over the assets of the society.
(e) If a person who is authorized to take loan on behalf of the society dies or resigns, the banker should
stop the operations of the society’s account till society nominates another person.
(f) If the person authorized to operate society’s account also have his personal account in the same
branch, banker must ensure that funds of the society are not credited to the personal account of the
said office bearer.
6. Trusts: Trust can be private or public. Trustees do not have implied authority to borrow. Loans can be
granted if it is for the trust. Trustee is authorized to borrow as per the trust deed.
FUND BASED CREDIT FACILITIES

Bank finance is tailor made to suit different needs
of customers. The loans and advances wherein
immediate flow of funds is made available to
borrowers, are called funds-based facility. Banks
earn interest income from this. In non- funds-based
facilities like issuance of letter of guarantee, letter
of credit etc., banks get fee income/ commission
and there is no immediate outflow of funds from
the bank.
1. Demand Loan: It is generally granted
for short period from few days to several
months. It has open ended repayment
schedule or must be paid on demand by the
lender. Normally there is no penalty for pre-
payment. The purpose for which demand
loan is sanctioned is generally purchase of
raw material, paying of short term liabilities
etc. The security can be stock, shares or other
tangible assets, land building etc.
2. Term Loans: These are granted for specific period with fixed repayment schedule. The interest rates
are fixed or floating. The tenure may range from one year to five years or even more. Generally, penalty
is charged for prepayment. These loans are sanctioned for procuring land and building, plant and
machinery and other fixed assets to start or expand business. The security is charge on the asset for which
or against which loan is sanctioned.
2.1 While funding a project, through a term loan, a banker generally takes into consideration the
following aspects/factors:
1. Land:
i. Land Sales Deeds (Land purchased agreement)
ii. Legal Search Report
iii. Location and accessibility
iv. No Objection certificate from statutory bodies including local bodies for use of land.
2. Building:
i. Approved Building Plan
ii. Building permission from the town planning commission
iii. Architects detailed cost estimates
iv. Type and nature of structure.
3. Plant and machinery:
i. Full detail and description of the plant & machinery, whether imported or indigenously available
ii. Details of the technology and its suitability, the rate of obsolescence
iii. The profile of the supplier
iv. Post sales service support extended by the supplier
v. Manufacturers catalogue
vi. The profile and standing of the project management consultant
vii. Any unique feature of the machinery, from the project angle to be clearly specified
viii. Copy of the Performa invoices/quotations etc. for the plant and machinery are to be submitted
in full.
4. Miscellaneous Fixed Assets:
Details and description of miscellaneous fixed assets, copy of invoices.
5. Preliminary and Preoperative Expenses:
Complete break up and details.
6. Working Capital Margin:
Source of working capital and its Working and calculation.
7. Project implementation and draw down schedule:
The project implementation schedule with details and item wise break up and likely date of
completion of the project. The draw down schedule of the project and timings of drawdown linked
to the progress of the project.
8. Assumptions underlying the projections and their basis:
The detailed assumptions underlying the projections and the basis of the same supported with
conclusive evidence in respect of various cost factors and revenue projections assumed.
9. Details of securities:
The prime, collateral securities, personnel guarantee offered etc.
10. Technical/project Details:
a) Manpower details – requirement of Technically qualified persons, key managerial personnel,
process of recruitment, availability and quality of the manpower/labour force, salary structure
etc
b) The infrastructure availability and its details
c) Raw material– Consumption, Prices, duty element, price volatility, source and availability of
supply etc.
d) Utilities Details
– Power –requirement, connected load (For calculation of power consumption), power
sanction letter, standby arrangement etc.
– Water – requirement, source of supply, suitability of water, chemical test report, storage
arrangement etc.
– Fuel and Oil and lubricants etc.
11. Company Specific Information:
a) Copy of Memorandum of Association and Articles of Association, Certificate of Incorporation by
Company Registrar.
b) Copy of the project report.
c) Extent of expenditure already incurred on the project with item wise breakup; the balance
expenditure to be incurred.
d) The source of funds for the promoters’ contribution and extent of funds already brought in with
break up and details, and bank statements, suppliers receipts etc.
e) Last three years income tax returns and income tax returns of the company/group concerns
and income tax assessment orders.
f) Opinion letter (OPL) on the company/group accounts from the existing bankers.
g) Shareholders agreement.
h) Technical support agreement.
i) SWOT (Strength, Weakness, Opportunities, Threats) analysis as perceived by the management
Banks have their own project parameters which are considered by them for long term funding.
Few project parameters considered by banks for evaluation are given below:
Project Parameters
Parameter Benchmark
Promoters’ Contribution Not less than 11% of the project cost
Debt Equity Ratio (DER) 2:1 up to 3:1
Fixed Asset Coverage Ratio (FACR) Not less than 1.25
Repayment Period Not exceeding 12 years excluding moratorium
period
Debt Service Coverage Ratio (DSCR) Not less than 1.50
Internal Rate Return (IRR) 4% and above from the estimated weighted
average cost of funds
Resolution Framework for COVID-19-related Stress – Financial Parameters

The Reserve Bank had set up an Expert Committee with Shri K. V. Kamath as the Chairperson,
as announced in the press release dated August 7, 2020. The Expert Committee has since
submitted its recommendations to the Reserve Bank on September 4, 2020, which have
been broadly accepted by the Reserve Bank.
Accordingly, all lending institutions shall mandatorily consider the key ratios (i.e., Total
Outside Liabilities / Adjusted Tangible Net Worth (TOL/ATNW), Total Debt / EBITDA,
Current Ratio, Debt Service Coverage Ratio (DSCR) and Average Debt Service Coverage
Ratio (ADSCR) while finalizing the resolution plans in respect of eligible borrowers.
3. Overdraft (O/D Account): It means allowing the customer to draw cheques over and above credit
balance in his account. Overdraft is normally allowed to Current Account customers and in exceptional
cases Savings Bank account customers are also allowed to overdraw their account. High rate of interest is
charged on daily debit balance of overdraft account. Generally, an overdraft facility is given by a bank on
the basis of a written application and a promissory note signed by the customer.
Types of overdraft accounts:
(a) Temporary or Clean overdraft: Temporary overdrafts are allowed purely on personal credit of the
customer and it is for customer to meet some urgent commitments on rare occasions. Allowing a
customer to draw against his cheque sent in clearing also falls under this category.
(b) Secured overdraft: Secured overdraft is allowed up to a certain limit against some tangible security
like bank deposits, LIC policy, National Savings Certificates, Shares and other similar assets. Secured
overdraft is most popular with traders as it involves lesser operating cost, simple procedure of
application and document formalities.
4. Cash Credit (CC account): It is short term finance to a borrower having a tenure up to one year which
can be renewed for further period by the bank based on projected sales and satisfactory operation in the
account during the period of finance. Cash Credit facility is extended in two forms – Open cash credit and
Key cash credit (KCC). Open cash credit account is a running account just like a current account where the
borrower can maintain debit balance in the account up to a sanctioned limit or drawing power whichever
is lower. The cash credit facility is offered to a borrower normally either against pledge (Key Cash Credit)
or hypothecation of stocks of raw materials, semi-finished goods and finished goods and book debts
(Receivables).
In KCC, the borrower lodges the stock in his warehouse and the key of the warehouse will be handed
over to the bank. The goods lodged in the warehouse is pledged to the bank and they are allowed to be
removed by the borrower on remitting into his CC account the amount equivalent to value of the goods.
The bank would release further funds to the borrower within the Drawing Power (DP) / sanctioned limit
on borrower depositing (pledge) more stock in the warehouse. Therefore, such facility is called Key Cash
Credit.
Cash credit limits are also sanctioned to a borrower against security of term deposits, LIC policies, NSCs
or Gold jewels. This type of limit is offered mainly to traders who find it difficult to maintain stock register
and submission of periodic stock statements. In case of manufacturing units this facility is required for
purchase of raw materials, processing and converting them into finished goods. In case of traders, the
limit is allowed for purchase of goods which they deal.
Electronic Cards for Overdraft Accounts:
RBI has decided to permit banks to issue electronic cards to natural persons having overdraft accounts
that are only in the nature of personal loan without any specific end-use restrictions. The card shall be
issued for a period not exceeding the validity of the facility and shall also be subject to the usual rights of
the banks as lenders.
The card shall be allowed to be used for domestic transactions only. Adequate check and balances shall be
put in place to ensure that the usage of such cards is restricted to facilitate online / non-cash transactions.
The restriction on cash transaction will not apply to overdraft facility provided.
Prior to launching the product, the banks shall frame a Board approval policy on issuance of electronic
cards to above mentioned overdraft accounts, encompassing appropriate risk management, periodic
review procedures, grievance redressal mechanism, etc., which will be subject to supervisory review.
The card shall be issued subject to instructions on terms and conditions, security, grievance redressal,
confidentiality of customer information as applicable for debit cards and all other relevant instructions on
card operations issued by RBI.
Maximum Permissible Bank Finance (MPBF) - Tandon Committee
As credit availability is scarce in India, RBI set up a study group in 1974 under the chairmanship of Mr.
P.L. Tandon, popularly referred to as The Tandon Committee to rationalize computation and assessment
of working capital by banks as well as ushering in credit discipline among borrowers.
The committee has recommended the following:
1. Borrowers must observe a proper fund discipline. They should provide to the banker all the
information regarding his operational plans well in advance. Accordingly, the banker must carry out
a realistic credit appraisal of such plans.
2. The main function of the banker as a lender is to supplement the borrower’s resources to carry on
acceptable level of current assets. This has two implications:
(i) Current assets must be reasonable and based on norms, and
(ii) A part of funds requirement for carrying out current assets must be financed from long term
funds.
3. The bank should know the end use of bank credit so that it is used only for purposes for which it was
made available.
4. The bank should follow inventory and receivable norms and lending norms. It has suggested
inventory and receivable norms for fifteen major industries. It has also suggested three lending
norms / methods which are as follows:
(i) I Method: The borrower must contribute a minimum of 25% of working capital gap from long
term funds.
MPBF = 75% of [Current Assets Less Current Liabilities] i.e., 75% of Net Working Capital
(ii) II Method: The borrower must contribute a minimum of 25% of the total current assets from
long term funds.
MPBF = [75% of Current Assets] Less Current Liabilities
(iii) III Method: The borrower has to contribute the entire hard-core current assets and a minimum
of 25% of the balance of the current assets from long term funds.
MPBF = [75% of Soft-Core Current Assets] Less Current Liabilities
Core current assets is permanent component of current assets which are required throughout the year
for a company to run continuously and to stay viable. The III method could not be implemented due to
practical difficulties.
RBI has withdrawn the prescription, with regard to assessment of working capital needs, based on the
concept of Maximum Permissible Bank Finance (MPBF), in April 1997. Banks are now free to evolve,
with the approval of their Boards, methods for assessing the working capital requirements of borrowers,
within the prudential guidelines and exposure norms prescribed.
Micro and Small Enterprise (MSE) units having working capital limits of up to Rupees five crore from the
banking system should be provided working capital finance computed on the basis of 20 percent of their
projected annual turnover. The banks should adopt the simplified procedure in respect of all MSE units.
Example: From the following data, calculate the maximum permissible bank finance under the three
methods suggested by the Tandon Committee:
Liabilities Rs. in lacs Current Assets Rs. in lacs
Bank Borrowings 400 Raw Material 150
Creditors 150 Work in Progress 90
Other Current Liabilities 50 Finished Goods 190
Receivables 160
Other Current assets 110
Total 600 Total 700
The total Core Current Assets (CCA) are Rs. 280 lacs.
Solution: The maximum permissible bank finance (MPBF) for the firm, under three methods may be
ascertained as follows: (CL – Current liabilities less bank borrowings)
Method I = 0.75 (CA- CL)
= 0.75 (700-200)
= Rs. 375 lacs
Method II = 0.75 (CA) – CL
= 0.75(700) - 200
= Rs. 325 lacs
Method III = 0.75 (CA-CCA) - CL
= 0.75 (700-280) - 200
= Rs. 115 lacs
It is noted that the MPBF decreases gradually from the first method to second method and then to third
method. As the firm has already avai led the bank loan of Rs. 400 lacs, it is eligible to get finance of Rs. 375
lacs only under Method 1.
5. Bills Finance is a short-term funding and is self-liquidating in nature. The bills can be classified as Demand
Bills and Usance Bills. Demand Bills are payable on Demand. In Usance Bills, the seller gives certain period
(Usance) to buyer to pay the bill. The bills are expressed to be payable after some time (30 days / 45 days
/ 90 days / one month / two months… etc.) from either the date of bill or from the sight of bill. Demand
Bills are purchased, and Usance Bills are discounted by the banks. Banks negotiate these bills and seller
gets credit against these bills immediately for the goods sold. The bank adjusts the money lent from the
realization proceeds of the bill (called as self-liquidating advance).
Bills (Demand / Usance) can be clean or documentary (without or with document of title to the goods
accompanying it respectively). The ‘Document of Title to Goods’ include Railway Receipt (RR), Motor
Transport Receipt (MTR), Lorry Receipt (LR), Airway Bill or Bill of Lading. It depends on the mode of
transportation used by the seller to send the goods to buyer. The documentary bills are drawn on DP
term (documents to be delivered to the buyer against payment of the bill) or DA term (documents to
be delivered to the buyer on accepting the bill). The terms DA or DP depend on factors such as seller /
buyer relationship, market conditions, nature of goods (perishable or not) etc. Advance against Usance
documentary bill with DA term becomes ‘Clean’ after the document of title is delivered to the buyer.
Therefore, while lending money to seller against Usance documentary Bill with DA term, banks take into
consideration the credit worthiness of both the seller (drawer) and the buyer (drawee) of the bills and
genuineness of underlying transactions / documents.
6. Packing Credit facility is sanctioned to an exporter to procure raw material and manufacture goods as
required by the buyer, at pre-shipment stage. Bank secures this advance by creating hypothecation charge
on the stock of goods and other current assets and debtors. The period for which a packing credit advance
is given by a bank will depend upon the circumstances of the individual case, such as the time required for
procuring, manufacturing or processing (where necessary) and shipping the relative goods / rendering of
services. If pre-shipment advances are not adjusted by submission of export documents within 360 days
from the date of advance, the advances will cease to qualify for prescribed (concessional) rate of interest
for export credit to the exporter ab initio.
7. Buyer’s Credit is the credit a buyer (importer) avails from a bank in exporter’s country under export
credit scheme. The loan is drawn, and exporter is paid fully. Another way is, bank in exporter’s country
establishes a line of credit in favour of a bank in the importer’s country. This bank in turn makes the credit
available to the importer. This is mainly for import of capital goods. Banks are permitted to issue Bank
Guarantee/Letter of Guarantee in favour of overseas lenders/Bankers up to USD 50 million per transaction
(USD 150 million for oil/gas refining & marketing, airline and shipping companies) for a period up to one
year for import of all non-capital goods permissible under Foreign Trade Policy and up to 3 years for
import of capital goods subject to prudential guidelines issued by RBI from time to time.
8. Supplier’s Credit is where the exporter supplier extends a credit to the buyer importer of capital goods.
Some amount is paid initially and the balance payment in instalments. The interest on the balance payment
is as per the contract of agreement. The deferred payments are supported by the promissory notes or bill
of exchange by the importer guaranteed by his banker. The exporter in turn raises loan from his banker
under export credit scheme.
9. Leasing Finance: Lease is a contract between the owner of an asset (Lessor) and a user of the asset
(Lessee). As per terms of lease agreement, the lessor pays money to the supplier who delivers asset to
the lessee. The owner of the asset (lessor) transfers the right to another person to use the asset against,
payment of fixed lease rents. Owner (lessor) and User (lessee) are the two parties of lease agreement.
The lessor remains the owner of the asset and the possession of asset remains with lessee. Banks finance
activities of leasing companies. Advance is sanctioned against fully paid new machinery / equipment by
creating hypothecation change on the same. The repayment is received from rentals of the machinery /
equipment leased out. Lease rentals are decided in advance for the entire leased period. The accelerated
lease rental means low rental in the beginning and gradually increasing later. In general, five years or the
economic life of the asset, whichever is less is the maximum repayment period allowed.
10. Hire-Purchase finance takes place mostly in automobile sector. Here the ownership of the asset continues
to remain with the Company till the agreement period ends. At the time of the termination of the agreement
the hirer has options either to return the asset to company or purchase the asset upon the terms set out
in the hire-purchase agreement. The assets in hire-purchase appears in the balance sheet of hirer, who
also claims depreciation. The instalment is partly treated as capital repayment and balance as interest
expenditure. Only amount of interest is considered for tax purpose. Since hire-purchase finance takes
place mostly in automobile sector, banks have started direct finance to transport operators as the advance
under certain conditions is classified as priority sector advance.
RBI has permitted banks to undertake business of leasing and hire-purchase within a limit of 10% of their
total advance.
11. Loan System for Delivery of Bank Credit: RBI has issued guidelines in Dec 2018 on enhancing credit
discipline among the larger borrowers enjoying working capital facility from the banking system. In
respect of borrowers having aggregate fund based working capital limit of Rs. 1500 million and above
from the banking system, a minimum level of ‘loan component’ of 40 percent (to be increased to 60 %
later on) shall be effective from April 1, 2019. Accordingly, for such borrowers, the outstanding ‘loan
component’ (Working Capital Loan) must be equal to at least 40 percent of the sanctioned fund based
working capital limit, including ad hoc limits and TODs. Hence, for such borrowers, drawings up to 40
percent of the total fund based working capital limits shall only be allowed from the ‘loan component’.
Drawings in excess of the minimum ‘loan component’ threshold may be allowed in the form of cash credit
facility. The bifurcation of the working capital limit into loan and cash credit components shall be affected
after excluding the export credit limits (pre-shipment and post-shipment) and bills limit for inland sales
from the working capital limit. Investment by the bank in the commercial papers issued by the borrower
shall form part of the loan component, provided the investment is sanctioned as part of the working capital
limit. The amount and tenor of the loan component is fixed by banks in consultation with the borrowers,
subject to the tenor being not less than seven days. Banks may decide to split the loan component into
WCLs with different maturity periods as per the needs of the borrowers.
NON FUND BASED LIMITS

Non-fund Based facilities are those, which do not involve outflow of bank’s funds at the time of sanction.
Non-fund-based limits may turn into fund-based facility on due date /occurrence of the specified event like
devolvement of bills under LC, invocation of Bank Guarantee, etc.
BANK GUARANTEES
It is a non-fund-based facility required by the borrowers. Banks are often required to issue guarantees on behalf
of their customers. A bank guarantee ensures that the liabilities of the debtor will be met in the event he fails
to fulfil his contractual obligations. It is an agreement between three parties – the bank, the beneficiary and
the applicant who seeks the guarantee from the bank. This agreement acts as an undertaking assuring the
beneficiary that the bank would pay the specified amount, in the case of applicant’s default in delivering the
“financial” or “performance” obligation as mentioned in the guarantee.
While issuing guarantee bank should carefully note the following:
• The guarantee period is specific and clearly mentioned.
• The amount stated is specific.
• The purpose is clearly mentioned and is consistent with applicant’s business.
• The grace period allowed to enforce guarantee rights is mentioned.
• The ‘default’ should by clearly mentioned.
• In a bank guarantee, the extent of monetary liability and the period of validity should be specific. For this
reason the limitation clause is included.
Types of Bank Guarantees:

1. Financial Guarantee – Under this, bank guarantees
that the applicant will meet the financial obligation
and in case he fails, the bank as a guarantor is bound
to pay (e.g. guarantees towards revenue dues, taxes,
duties and for disputed liabilities for litigations
pending at courts; credit enhancement; repayment
of financial securities etc.).
2. Performance Guarantee – Under this, guarantee issued is for honouring a particular task and completion
of the same in the prescribed / agreed upon manner as stated in the guarantee document. (e.g. bid bonds,
retention money guarantee etc,).
3. Deferred payment guarantee – Here, the bank guarantees the payment of instalments payable by the
buyer of capital goods such as machinery, on term credit by the supplier.
Under Deferred Payment Guarantee normally 15 to 20% of the invoice price of the capital goods is paid by the
borrower and the remaining amount along with the interest at the agreed rate is payable in instalments spread
over agreed period – 3 to 5 years or more. The seller draws usance bills which are accepted by the buyer and are
either co-accepted by the banker or a guarantee is issued. Seller in turn can get these bills discounted from his
banker. On due dates of the instalments buyer’s bank arranges the remittance of instalments. Guarantee issuing
bank creates charge on assets so purchased and also obtains counter-guarantee from the said applicant buyer.
Invocation of bank guarantee – Amount claimed should be paid to the beneficiary immediately if invocation
is in accordance with the terms and conditions of the guarantee contract.
Expiry of guarantee – On the expiry of guarantee period the beneficiary should be intimated by letter
with registered acknowledgement, indicating that the liability of the bank under the said guarantee stands
discharge and the original guarantee be returned for cancellation. If no reply is received from the beneficiary in
a reasonable time, the guarantee is treated as expired and cancelled.
Limitation period – Although the limitation clause is specified in the guarantee contract, the beneficiary can
enforce his rights till the limitation period is alive. It is 30 years in case of Government and 3 years in other cases
from the stipulated expiry date / invocation whichever is earlier.
RBI guidelines to banks for issuing guarantees on behalf of their customers:
• As a general rule, banks may provide only financial guarantees. However, scheduled banks may issue
performance guarantees subject to exercising due caution in the matter.
• Guarantees should not be issued for periods exceeding ten years. Guarantees beyond ten years are allowed
under a policy approved by the Boards of respective banks.
• Total volume of guarantee obligations outstanding at any time may not exceed 10% of the total owned
resources of the bank comprising paid-up capital, reserves and deposits. Within the overall ceiling,
proportion of unsecured guarantees outstanding at any time may be limited to an amount equivalent
to 25% of the owned funds (paid up capital and reserves) of the bank or 25% of the total amount of
guarantees, whichever is less.
• Banks should preferably issue secured guarantees. A secured guarantee means a guarantee made on
security of assets (including cash margin), the market value of which will not at any time be less than
the amount of the contingent liability on guarantee, or a guarantee fully covered by counter guarantee(s)
of the Central or state governments, public sector financial institutions and / or insurance companies.
Banks should generally provide deferred payment guarantees backed by adequate tangible securities or
by counter guarantees of the Central or state governments, public sector financial institutions and / or
insurance companies and other banks.
• Banks should avoid undue concentration of unsecured guarantee commitments to particular group of
customers and / or traders.
• In case of deferred payment guarantees bank should ensure that the total credit facilities including the
proposed deferred payment guarantees does not exceed the prescribed exposure ceilings.
The proposals for deferred payment guarantees should be examined having regard to profitability / cash flows
of the project to ensure that sufficient surpluses are generated by the borrowing unit to meet the commitments,
as a bank has to meet the liability at regular intervals, in respect of due instalments.
• The bank guarantee is a commitment made by the issuing bank to make payment to beneficiary. Failure on
the part of the bank to honour the invocation claim legitimately made on it projects a distorted picture of
its functioning.
• While co-accepting bills of customers, banks should ensure that they are out of genuine trade transactions
and not accommodation bills. Before co-accepting bills, financial position and capacity of the parties to
honour the bills, in the event of need should be assessed.
• Banks should adopt the Model Form of Bank Guarantee Bond and ensure that alterations/additions
to the clauses whenever considered necessary are not one-sided and are made in agreement with the
guaranteeing bank.
LETTER OF CREDIT (LC)

Letter of Credit (‘LC’), also known as a documentary credit is a payment mechanism used specially in international
trade. In an LC, buyer’s bank undertakes to make payment to seller on production of documents stipulated in
the document of LC. LC play an important role in the trade of a country, especially in its international trade. In
most of the cases, the exporters (sellers) are personally not acquainted with the importers (buyers) in foreign
countries. In such cases the exporters bear great risk, if they draw bills on importers, after having dispatched
the goods as per their orders, because if the latter default in accepting the bills or making the payment, the
exporter will suffer heavy losses. To avoid such risks, the exporters ask the importers to arrange a letter of
credit from their banker in favour of themselves, on the basis of which goods may be exported to the foreign
importers.
Uniform Customs and Practices for Documentary Credits - 600 (UCPDC-600) apply to any LC when its text
expressly indicates that it is subject to these rules. The rules are binding to all parties unless expressly modified
or excluded. The Uniform Customs & Practice for Documentary Credits (UCP 600) is a set of rules agreed by
the International Chamber of Commerce, which apply to finance institutions which issue Letters of Credit –
financial instruments helping companies finance trade. Many banks and lenders are subject to this regulation,
which aims to standardise international trade, reduce the risks of trading goods and services, and govern trade.
Parties to Letter of Credit (LC)

There are following four main parties to LC transaction:
1. Applicant or he is also called as Opener of LC. The bank opens LC on behalf of the applicant customer who
is buyer / importer of goods.
2. Issuing bank is a bank which opens LC and undertakes to make payment to the beneficiary (seller/
exporter) on submission of document as per the terms of LC.
3. Beneficiary is the seller / exporter of goods in whose favour LC is opened.
4. Advising Bank is the bank through whom LC is advised to the beneficiary. Normally it is located in seller’s
location / country.
In addition to above four parties, following parties may also be involved in LC transaction.
• Confirming Bank is the bank which in addition to LC issuing bank, undertakes the responsibility of
payment under LC. This is required since the LC issuing bank may not be known to the exporter and he
therefore needs reputed bank from his country to add confirmation to the LC.
• Negotiating Bank negotiates the documents under LC.
• Paying Bank or Nominated Bank is the bank nominated or authorized by the LC issuing bank to make
payment under LC. In practice, the paying bank presents the documents received by it either to issuing
bank or Reimbursing Bank for payment and transfers the proceeds to the beneficiary’s account.
• Reimbursing Bank is a bank with whom the LC issuing bank maintains foreign currency account (NOSTRO
account). LC issuing bank authorizes the reimbursing bank to honor the LC reimbursement claim of
negotiating bank.
Documents under LC
To receive payment, an exporter must present the documents required by LC. Typical types of documents in
such contract include –
• Financial documents: Bill of Exchange, co –accepted draft.
It is the basic document drawn by the beneficiary (exporter / seller) and has to be drawn as per the terms
of the LC.
• Commercial documents – Invoice, packing list.
• It is addressed to the buyer (importer), signed by the seller (exporter) and contains details of sales like
quantity, rate , specification and total amount.
• Shipping documents – bill of lading, airway bill, lorry/truck receipt, railway receipt etc. It is a document of
title to the goods, proof that the exporter has dispatched the goods.
• Official documents – license, certificate of origin, inspection certificate, health certificate. These are the
documents as specified in the LC document.
• Insurance documents – insurance policy or certificate but not a cover note.
• The dispatched goods must be insured for the amount and the kind of risks as specified in LC document.
The policy / certificate should be signed by the insurance company.
Types of LCs
1. Documentary LC and Clean LC: When the LC contains a clause that the payment is conditional on
submission of document of title to goods such as bill of lading (evidence of dispatch of good), it is called
Documentary LC. If no such clause is in the LC, it is called a clean LC.
2. Fixed Credit and Revolving Credit: Fixed credit is where LC specifies the amount up to which one or
more bills can be drawn by the beneficiary within the specified time. The LC remains effective till the
specified amount is exhausted within specified time.
In Revolving Credit, the LC opening bank does not specify the total amount up to which bills may be
drawn, but mentions total amount up to which the bills may remain outstanding at a time. Thus after
reaching that amount, as soon as the importer pays the bill, to that extent the limit gets reinstated. It is
thus automatic and does not need renewal within the specified period of time.
3. Revocable and Irrevocable LC: In case of revocable LC, the opening bank reserves the right to cancel
or modify the credit at any moment without prior notice to beneficiary. It therefore does not constitute
a legally binding undertaking between the opening bank and the beneficiary. If, however, the negotiating
bank makes payment to the beneficiary before receiving notice of cancellation or amendment, the opening
bank has to honour the liability. Such a credit provides no real security to exporter but a mere intimation
to draw bills under credit. As such exporter accepts such LC only from buyers of known integrity.
Irrevocable credit constitutes a definite undertaking of the issuing bank. Such a LC once established and
advised cannot be cancelled or amended except with the consent of interested parties – beneficiary and
negotiating bank.
If nothing is mentioned in LC, it is treated as irrevocable under UCPDC regulations.
4. Confirmed and Unconfirmed LCs: When the opening bank requests the advising bank in the exporter’s
country to add its confirmation to an irrevocable LC and the advising bank does so, the LC is “irrevocable
and confirmed”. The advising bank is then called as ‘confirming bank’ and its liability then becomes similar
to the issuing bank. The confirmation cannot be cancelled or amended unless agreed by all the parties. A
confirmed irrevocable LC provides absolute security to the beneficiary.
If the advising bank does not add its confirmation, the LC remains as unconfirmed. In such case there will
be no such obligation on the advising bank.
5. ‘With’ and ‘Without Recourse’ Credit: In case of “with Recourse” bills, the banker as a holder of the bill,
can recover the amount of the bill from the drawer, in case the drawee of the bill fails to pay it. In order to
avoid such liability, the seller / exporter / drawer asks the importer / buyer to arrange credit “Without
Recourse” to the drawer. In such a credit the issuing bank will have no recourse to the drawer (exporter)
if the drawee (importer) fails to honour the bill. The liability of such a bill ends as soon as the bill is
negotiated.
6. Transferable LCs: Ordinarily the beneficiary is authorized to draw bills of exchange under LC. But if the
beneficiary is an intermediary in the transaction and the goods are actually to be supplied by someone
else, the beneficiary may request the opener to arrange a transferable credit. Under transferable credit,
the beneficiary can transfer the credit to one or more persons. But it can be done only if the credit is
expressly designated “transferable” by the issuing bank. The credit can be transferred only on the terms
and conditions specified in the original credit. The second beneficiary, however, cannot transfer it further,
but can transfer the unused portion back to the beneficiary.
7. Back to Back LC: When a beneficiary receives a non-transferable LC, he may request a bank to open a
new LC in favour of some other person (may be local supplier), on the security of LC issued in his favour.
Such LC is called Back to Back LC. The terms of such LC are identical except that the amount (price) may
be lower and the validity earlier.
8. LC with Red Clause / Green Clause: LC with a clause printed in red ink, contains authority from the
issuing bank to the advising / negotiating bank to grant advances (packing credit) to the beneficiary up to
a specified amount at the responsibility of former. It is a short term advance recovered from the amount,
payable by the negotiating bank to the beneficiary when it negotiates the documents under LC submitted
by the beneficiary.
Green Clause is an extension of red clause LC allowing advances for storage of goods in warehouse in
addition to packing credit.
9. Instalment Credit: LC is issued for full value of goods but part-shipments of specific quantities of
goods within nominated period are required. Credit is not available for missed shipment and shipments
thereafter unless permitted in LC document.
Advantages of LCs to the Exporter (seller) and the Importer (buyer)

• Facilitates trade transactions between two parties who are not known to each other and located in two
different countries.
• Beneficiary is assured of payment as long as it complies with the terms and conditions of LC.
• The credit risk is borne by the issuing bank and not the applicant (buyer).
• LC accelerates payment of receivables and helps beneficiary (seller) in minimizing collection time.
• The beneficiary’s foreign exchange risk is eliminated with LC issued in the currency of seller’s country.
• On the basis of LC the exporter may obtain advance from the bank for procuring and processing or
manufacturing goods to be exported.
• Buyer is enabled to import goods.
• LC assures importer that bills drawn under LC will be honoured only when they are strictly in accordance
with the conditions stipulated in LC document and the documents are duly submitted.
RBI guidelines for grant of LCs Facility

For Commodities covered under Selective Credit Controls, there is no restriction for banks in opening LCs for
import of essential items. However, banks are not permitted to open inland LCs, providing a clause therein
which would enable other banks to discount Usance Bills under LCs.
• Before issuing LCs, banks should ensure that –
i) LCs are issued in security forms only.
ii) Large LCs are issued under two signatures, one of the signatory being from HO / Controlling office.
iii) LCs are not issued for amounts out of proportion to the borrower’s genuine requirements, and are
issued only after ensuring that the borrowers have made adequate arrangements for retiring the
bills.
iv) Where LCs are for purchase of raw materials, borrowers do not maintain unduly high inventory of
raw materials in relation to the norms/past trends.
v) In case of borrowers having banking arrangements on a consortium basis, the LCs are opened within
the sanctioned limit on the basis of agreed share of each bank.
vi) If there is no formal consortium arrangements for financing the borrower, LCs should not be opened
by the existing bank or new bank, without the knowledge of other banks.
vii) LCs for acquisition of capital goods should be opened only after banks have satisfied themselves
about tying up of funds for meeting the relative liability by way of providing for long term funds or
term loans.
viii) In no case working capital limits should be allowed to be utilized for retiring bills pertaining to
acquisition of capital assets.
• The exposure ceilings and other restrictions prescribed for total credit exposure including non-fund based
facility, advances to bank’s directors, loans and advances to relatives of directors, unsecured guarantees
etc., must be strictly observed.
• Unauthorized LCs are not to be issued.
FACTORING
Factoring is a financial transaction and a type of debtor finance in which a business (client) sells its accounts
receivables (invoices) to a third party (called a factor) at a discount. It is the oldest form of business financing.
For many companies it is the cash management tool of choice.
Factoring process
• The seller sells the goods to the buyer and raises the invoice on him.
• Invoices are then submitted to the factor for funding.
• Factor pays the seller, after deducting some discount on the invoice value. It pays around 75 to 80 percent
of invoice value after deducting the discount.
• Factor then waits till the buyer to make the payment to him.
• On receiving the payment from buyer on due date, the factor pays remaining 20 to 25 percent of the
amount to the client after deducting his fee.
• It can be with recourse factoring in which the loss due to non-payment by the buyer is borne by the client
or in a without recourse factoring the non-payment risk is borne by the factor.
• Generally in India with recourse factoring is widely done.
Advantages of Factoring
• Since the factor performs the duty of collection of debtors, the client can focus on other areas of business.
• Credit risk of client is reduced, especially in without recourse factoring.
• Working capital is not locked-up, as factor immediately gives funds to the client.
• Reduces cost as the sales ledger and the recovery function is performed by the factor.
• Cash flow and the liquidity position in the business is improved.
• Business creditors can be paid timely or before time thus help in negotiating better discount terms from
the suppliers.
• Reduces need for raising new capital in the business.
Disadvantages of Factoring
• Bad behaviour of factor with the debtors may affect the business relationship and the goodwill of the
company.
• Factors often avoid risky debtors, so the responsibility of such debtors remains with the company.
RBI guidelines on provision of Factoring services by Banks

• Banks should adhere to the provisions of Factoring Regulation Act, 2011.
• Banks may formulate policy approved by their Boards. The policy may specifically address issues pertaining
to the various risks associated with this activity and put in place suitable risk mitigation measures.
• Factoring services may be provided either with recourse or without recourse or on limited recourse basis.
• Proper and adequate control and reporting mechanisms should be put in place before such business is
undertaken.
• Receivables acquired under factoring should not exceed 80% of the invoice value.
• Thorough credit appraisal of debtors should be done before entering into factoring arrangement.
• Invoices should represent genuine trade transactions.
• Under without recourse factoring, where the factor is underwriting the credit risk on the debtor, there
should be clearly laid down board – approved limit.
• Factoring should be treated at par with loans and advances and accordingly extant prudential norms on
loans and advances would be applicable to this activity.
• The facilities extended would be covered within the overall exposure ceiling.
• Interest charged will be subject to the guidelines on interest rates on advances and fees charged will be
subject to the guidelines on reasonableness of bank charges.
• Credit information regarding overdue receivables should be furnished to the Credit Information
Companies.
• The instructions / guidelines issued in respect of KYC / AML / CFT should be strictly adhered to.
• International factoring arrangements should be in compliance with FEMA guidelines.
• Engagement of Recovery Agents should be strictly as per the guidelines issued from time to time.
• Outsourcing of activities should adhere to the guidelines on “Managing Risks and Code of Conduct in
Outsourcing of Financial Services by Banks.”
• To increase liquidity support for the MSME sector, RBI has told Bankers that factoring transactions on
‘with recourse’ basis shall be eligible for priority sector classification by banks, which are carrying out the
business of factoring departmentally.
COMMERCIAL PAPERS (CP)

Further to details indicated under Lesson 4, a summary regarding CP is as below:
Commercial Paper (CP) is an unsecured money market instrument issued in form of a promissory note
(negotiable instrument). It was introduced in 1990 with a view to enable highly rated corporate borrowers to
meet their short-term funding requirements for their operations and to provide an additional instrument to
investors.
Corporates, Primary Dealers (PDs) and All-India Financial Institutions (‘FIs’) are eligible to issue CP subject to –
• The tangible net worth of the company, as per the latest audited balance sheet , is not less than Rs. 4 crore.
• Company has been sanctioned working capital limit by bank/s or FIs.
• The borrowal account of the company is classified as a Standard Asset by the financing bank/s, FIs. All
eligible participants shall obtain the credit rating for issuance of CP from credit rating agencies specified
by RBI from time to time for the purpose. Minimum credit rating shall be A-2 (as prescribed by Securities
Exchange Board of India) and issuer shall ensure at the time of issuance of CP that the rating so obtained
is current and has not fallen due for review.
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date
of issue (the maturity date of the CP should not go beyond the date up to which the rating of the issuer is valid).
CP can be issued in denominations of Rs. 5 lakh or multiples thereof. The aggregate amount of CP from an issuer
shall be within the limit as approved by its Board or the quantum indicated by the credit rating agency for the
specified rating. CP will be issued at a discount to face value as may be determined by the issuer.
Only a schedule bank can act as an Issuing and Paying Agent (‘IPA’) and investors can be individuals, banking
companies, other corporate bodies, Non-Resident Indians (‘NRI’s) and Foreign Institutional Investors (within the
limits set for them by SEBI from time to time). No issuer shall have the issue of CP underwritten or co-accepted.
CPs can be issued either in form of a promissory note or in a dematerialized form. Banks, FIs and PDs can hold
CP only in dematerialized form. Initially the investor in CP is required to pay only the discounted value of CP by
means of a crossed account payee cheque to the account of the issuer through IPA. On maturity of CP, the holder
of CP shall present the instrument for payment to the issuer through IPA if CP is held in physical form. If held in
demat form, the holder will have to get it redeemed through the depository and receive payment through IPA.
Standardised procedures and documentation for CPs are prescribed in consultation with Fixed Income Money
Market and Derivatives Association of India (FIMMDA) in consonance with international best practices. CP being
a ‘stand alone’ product, it would not be obligatory in any manner on the part of banks and Financial Institutes
to provide stand-by facility to the issuer. However they can provide credit enhancement by way of stand-by
assistance/credit backstop facility etc. Non-banking entities including corporates can provide unconditional
and irrevocable guarantee for credit enhancement for CP issue.
BILLS PURCHASE AND DISCOUNT

The bills of exchange are classified into Demand Bills and Usance Bills. A demand bill is one which is payable ‘at
sight’ or ‘on demand’ or ‘on presentation’. Usance bill is one where drawer (seller) allows certain period of time
(Usance) say 30, 60 or 90 days to drawee (buyer) to make the payment. The bills can further be classified as
Clean Bill or Documentary Bill. If drawer of a bill encloses document of title to the goods (Railway Receipt, Lorry
Receipt, Motor Transport Receipt, Bill of Lading) it is documentary bill, and if no such document is enclosed, it
is a clean bill.
In case of Purchase and Discount of bills, the banker credits the customer’s account with the amount of the
bill after deducting his charges (called discount). This facility extended against Demand bills is called Bills
Purchased facility and facility extended against Usance bills is called Bills Discounting facility.
Advantages of Discounting of Bills

• Safety of Bank’s funds : Though bank does not get charge over any tangible asset here, the security that the
bill is negotiable legal instrument and if it is not paid by the drawee (buyer), bank can always recover by
debiting drawer’s (seller) account.
• Certainty of payment : As bill finance is of short term nature, bill maturing for payment on demand or after
the usance is completed (which is maximum of 90 to 180 days), the advance is self-liquidating. Monitoring
also becomes easy as when the bill of a particular party remains unpaid, further discounting bills of such
party can be stopped.
• Facility of refinance : In case of need of funds, banks can rediscount the eligible bills with the Reserve Bank
of India/SIDBI.
• Stability in the value : The value of the bill as security does not fluctuate. Amount advanced and amount
payable are fixed.
• Profitability : Bank credits the amount of bill by recovering its interest (discount) from the amount of bill,
hence the yield is more.
Banks have to take into consideration following points while sanctioning Bills facility:
• Clean bills are treated by banks as unsecured advance and hence sanctioned only to borrowers of high
repute. Documentary bills are safer and advance against it is secured.
• Usance Documentary bills with DP term (documents against payment) are considered safer than DA term
(documents against acceptance) as in latter case the goods are parted first and the payment is made by the
buyer later.
• The purpose of the facility should be carefully verified.
• Adequate information about the parties on whom the bills are drawn by the borrower should be gathered
from the market and their creditworthiness should be assessed, before discounting.
• If borrower draws bills on number of parties, party wise limits within the overall limit should be sanctioned,
depending on percentage of sales of each party in total sales.
• Ensure that bills are drawn out of genuine trade and commercial transactions and are not of accommodation
nature.
Grant of Non Fund Based Limits (standalone basis):

Scheduled Commercial Banks are permitted by RBI to grant non-fund based facilities including Partial Credit
Enhancement (PCE) to those customers, who do not avail any fund based facility from any bank in India, subject
to the following conditions:
a) Banks shall formulate a comprehensive Board approved loan policy for grant of non-fund based facility to
such borrowers.
b) Verification of Customer credentials: The banks shall ensure that the borrower has not availed any fund
based facility from any bank operating in India. However, at the time of granting non-fund based facilities,
banks shall obtain declaration from the customer about the non- fund based credit facilities already
enjoyed by them from other banks.
c) Credit Appraisal and due-diligence: Banks shall undertake the same level of credit appraisal as has been
laid down for fund based facilities.
d) The instructions/ guidelines on Know Your Customer (KYC)/Anti- Money Laundering (AML)/ Combating
of Financing of Terrorism (CFT) applicable to banks, issued by RBI from time to time, shall be adhered to
in respect of all such credit facility.
e) Submission of Credit Information to CICs: Credit information relating to grant of such facility shall
mandatorily be furnished to the Credit Information Companies (specifically authorized by RBI). Such
reporting shall be subject to the guidelines under Credit Information Companies (Regulation) Act, 2005.
f) Exposure Norms: Banks shall adhere to the exposure norms as prescribed by RBI from time to time.
Traders who import goods and services from abroad, can now apply for credit facilities in the form of Letter
of Credits, Bank Guarantees, all important financial instruments, required to transact overseas mostly, without
availing vanilla bank loans.
RESTRICTION ON LENDING
As already indicated under Lesson 4, under Banking Regulation Act, 1949, there are statutory restrictions on
banks for lending. Brief of such restrictions is given below:
i) Advances against bank’s own shares: In terms of Section 20(1) of the Banking Regulation Act, 1949, a
bank cannot grant any loans and advances on the security of its own shares.
ii) Advances to bank’s Directors: Section 20(1) of the Banking Regulation Act, 1949 lays down the
restrictions on loans and advances to the directors and the firms in which they hold substantial interest.
iii) Advances to Companies for Buy-back of their Securities: As per provisions of the Companies Act,
2013, companies are permitted to purchase their own shares or other specified securities out of their
free reserves/securities premium account or from the proceeds of any shares or other specified securities
subject to compliance of statutory conditions. In view of the above, banks should not provide loans to
companies for buy-back of shares/securities.
iv) Granting loans and advances to relatives of Directors: Without prior approval of the Board or
without the knowledge of the Board, no loans and advances should be granted to relatives of the bank’s
Chairman/ Managing Director or other Directors, Directors (including Chairman/Managing Director) of

other banks and their relatives, Directors of Scheduled Co-operative Banks and their relatives, Directors
of Subsidiaries/ Trustees of Mutual Funds/Venture Capital Funds set up by the financing banks or other
banks.
v) Restrictions on Grant of Financial Assistance to Industries Producing / Consuming Ozone Depleting
Substances (ODS): Banks should not extend finance for setting up of new units consuming/ producing
the Ozone Depleting Substances (ODS). No financial assistance should be extended to small/medium scale
units engaged in the manufacture of the aerosol units using chlorofluorocarbons (CFC) and no refinance
would be extended to any project assisted in this sector.
vi) Restrictions on Advances against Sensitive Commodities under Selective Credit Control (SCC):
With a view to prevent speculative holding of essential commodities with the help of bank credit and the
resultant rise in their prices, Reserve Bank of India issues directives from time to time to all commercial
banks, stipulating specific restrictions on bank advances against specified sensitive commodities.
vii) Banks and their subsidiaries should not undertake financing of ‘Badla’ transactions.
viii) Banks should not extend bridge loans against amounts receivable from Central/State Governments by
way of subsidies, refunds, reimbursements, capital contributions, etc. subject to certain exemptions like
financing against receivables from Government by exporters (viz. Duty Draw Back and IPRS).
ix) Banks should not extend bridge loans against amounts receivable from Central/State Governments by
way of subsidies, refunds, reimbursements, capital contributions, etc. subject to certain exemptions like
financing against receivables from Government by exporters (viz. Duty Draw Back and IPRS).
CASE LAWS
1. In the matter of Bank of India vs. M/s. Brindavan Agro Industries Pvt. Ltd. [Civil Appeal No. 1720 of
2020 arising out of SLP. (Civil) No. 2007 of 2019], Honorable Supreme Court set aside the orders passed
by the NCDRC and SCDRC. It was found that though, the Bank agreed to refund Rs.9.16 lakhs from
the processing charges through email dated 29th June 2012 but the Consumer had not accepted such
proposal in its e-mail dated 24th July, 2012. Therefore, the Court held that the Consumer is entitled to
refund of Rs.9.16 lakhs only in terms of the decision of the Bank communicated to the Consumer rather
than waiver of TEV charges in its entirety. The request was to give concession of 50% of all charges,
therefore, it is the cumulative amount of charges which is to be taken into consideration and not the
charges under a particular head.
2. Vicky vs. State (Govt . of NCT of Delhi) (13.01.2020 Supreme Court)
The substantive sentences in first two groups and that in respect of the case in the third group would
run consecutively.
The Honorable court has referred the case of V.K. Bansal, wherein the appellant-accused was facing
fifteen cases and the Supreme Court has grouped fifteen cases into three different groups:-
(i) the first having twelve cases relating to advancement of 8 loan / banking facility to M/s Arawali
Tubes Ltd. acting through the appellant thereon as Director;
(ii) the second having two cases relating to advancement of loan to the appellant M/s Arawali Alloys
Ltd. acting through the appellant as its Director; and
(iii) the third having a single case qua the criminal complaint by the State Bank of Patiala.
The Court directed that the substantive sentences within first two groups would run inter-se
concurrently. The Supreme Court directed that the substantive sentences in first two groups and that
in respect of the case in the third group would run consecutively.
3. Canara Bank vs. United India Insurance Co. Ltd. (06.02.2020 Supreme Court)
Beneficiaries of the policies taken out by the insured are also ‘consumers’ under the Consumer
Protection Act

In the above case, some farmers had stored their agricultural produce in the cold storage run by a
partnership firm and took loan from the Canara Bank against the agricultural produce stored in the
cold storage. The cold store was insured with United India Insurance Co. Ltd. A fire took place in cold
store, the entire building with agricultural produce was destroyed. The cold store owners had taken
out a comprehensive insurance policy and raised claim with the insurance company but the claim was
repudiated on the ground that the fire was not an accidental fire. The farmers also issued notice to
insurance company in respect of the plant, machinery and building but this claim was also repudiated
by the insurance company on additional ground that the farmers had no locus standi to make the
claim and there was no privity between the farmers and insurance company. The farmers filed a claim
against cold store, Canara Bank and the Insurance Company.
It was found that in the tripartite agreement among the farmers, Canara Bank and Cold store, it was
mandatory to insure the agricultural produce hypothecated with the Canara Bank.
The Honorable Supreme Court held that the beneficiaries of the policies taken out by the insured are
also ‘consumers’ under the Consumer Protection Act, even though they are not parties to the contract
of insurance.
4. Bank of Baroda vs. Kotak Mahindra Bank Ltd. (17.03.2020 Supreme Court)
The period of limitation shall be governed by the Act and not by Section 44A of the CPC, since the
latter provides only for the procedure to be followed for executing a foreign decree
Kotak Mahindra Bank Ltd., issued a Letter of Credit for US $1,794,258 on behalf of its customer M/s.
Aditya Steel Industries Limited in favour of M/s. Granada Worldwide Investment Company, London.
The appellant Bank of Baroda was the confirming bank to the said letter of credit. The Vysya Bank
issued instructions to the London branch of the appellant on 12.10.1992 to honour the Letter of
Credit. Acting on this instruction the London branch of the appellant discounted the Letter of Credit
for a sum of US $ 1,742,376.41 and payment of this amount was made to M/s Granada Worldwide
Investment Company on 13.10.1992.
Later in 2009, Bank of Baroda filed an Execution Petition against Kotak Mahindra Bank under
Section 44A read with Order 21 Rule 3 of the CPC for recovery of Rs.16,43,88,187.86. The Execution
Petition was filed in view of the decree passed by the High Court of Justice, Queens Bench, Divisional
Commercial Court of London (UK Court) on 20 February 1995 for US$ 1,267,909.26 in favour of
Bank of Baroda. The maintainability of the Execution Petition was challenged primarily on the
ground of limitation.
One major Issue in the case for the court to decide ‘What is the limitation for filing an application for
execution of a foreign decree of a reciprocating country in India?’
For this major issue of the case that related to the limitation period, the Supreme Court had rejected
the argument that there is no limitation period for execution of foreign decree in India while observing
that the term “application” in Section 3 of the Act shall be deemed to include execution petitions. The
period of limitation shall be governed by the Act and not by Section 44A of the CPC, since the latter
provides only for the procedure to be followed for executing a foreign decree
LESSON ROUND UP
• There is a sense of debt in loan, where as an advance is a facility being availed of by the borrower.
However, like loans, advances are also repaid. Thus a credit facility repayable in instalments over a
period is termed as loan while acredit facility repayable within one year may be known as advances.
• Basic principles that banks must follow while lending are: safety of funds, liquidity, profitability,
purpose, spread or diversification & security. There are two types of borrowers viz: Retail Borrowers
& Corporate Borrowers. When bank lend money, it enters into a contract and all essentials of a valid
contract must be present in the contract. Different types of credit facilities include demand loans,
term loans, over draft and cash credit. While extending loans, banks have to follow directives of RBI
regarding exposure norms and other such applicable norms in terms of credit policy guidelines. While
extending working capital, banks follow the Tandon committee norms of MPBF. Banks also extend bills
financing, packing credit; they also arrange Buyers credit, Suppliers credit, leasing and hire purchase.
While lending money banks obtain security from the customer/borrower to safe guard itself as well
as to fall back upon in case borrower defaults. The security is therefore examined properly using the
MAST (Marketability, Ascertainability, Stability and Transferability) principle. Depending upon type of
advance and the nature of security, appropriate charge like Lien, Hypothecation, Pledge, Assignment,
Mortgage is created on the security.
TEST YOURSELF
a. MPBF under 1st method of lending is ______________.
b. Borrower’s contribution under 2nd method of lending is ______________.
c. MAST is – M ______________ A ______________ S ______________ T ______________.
d. In case of a Public Limited Co., minimum members should be ______________ and maximum should
be.
e. RBI has permitted banks to undertake business of leasing and hire-purchase within limit of
______________% of their ______________.
a. The CIN number is 21 digits numerical number.
b. Packing credit facility is sanctioned to the exporter.
c. In cash credit facility bank can effectively manage the funds.
d. HUF is governed by Indian Partnership Act, 1932.
e. In Public limited company there is no restriction on transfer of shares.
f. A bank can grant loans and advances against the security of its own shares
a. What are the principles of lending?
b. What are the essentials of valid contract?
c. Distinguish between Lease finance and hire purchase.
d. What is packing credit?
e. Compare buyer’s credit and supplier’s credit.

f. Name the various types of institutional customers.
g. What are the precautions taken by the banker while giving loan to a society?
h. What do you understand by MPBF? Explain recommendations of Tandon Committee Report.
i. How many types of credit facilities are there? Explain all.
j. Distinguish between Bank Guarantee and Letter of Credit.
k. What are the precautions to be taken by the banker while granting loans to HUF?
l. Explain issuance of electronic cards to overdraft account holders.
m. Write a note on Exposure norms of RBI.
n. Briefly describe the statutory restrictions on banks for lending?

• Banking Law & Practiceby – P. N. Varshney
• Principles of Practices of Banking–Indian Institute of Banking & Finance.
• The Indian Partnership Act, 1932.
• The Companies Act, 2013
• Articles on Banking –Shodganga
Lesson 13 • Securities for Banker’s Loan 381
Lesson 13 Securities for Banker’s Loan

Should Know
• Assignments This lesson will enable a reader to • The Indian Contract Act,1872
• Pledge understand – • The Transfer of Property Act,
• Mortgage • What is a charge and types of 1882
charges? • The Securitisation and
• Hypothecation
• Types of securities. Reconstruction of Financial
• Lien Assets and Enforcement of
• Care to be taken while handling
• MAST different securities. Securities Interest Act, 2002
(SARFESI Act)
• RBI guideline while granting
loans against various securities. • The Insurance Act, 1938
• Sale of Goods Act, 1930
Lesson Outline
• Introduction • Indemnities and Guarantees
• Types of Securities • Book debts
• Assignment • Corporate Securities
• Lien • LESSON ROUND UP
• Set-off • GLOSSARY
• Hypothecation • TEST YOURSELF
• Pledge • LIST OF FURTHER READINGS
• Mortgage
381
INTRODUCTION
Whenever banks advance loan generally securities
are obtained. This is to safeguard advances extended
by them in the event of a default by a borrower. Banks
obtain movable and immovable properties as securities
and create a charge on these securities so as to enforce
their security interests later when a need arises.
Creating a charge over a property depends upon the
nature of property as well the nature of charge sought to
be created. Keeping these aspects in mind, the chapter
covers various aspects of securities accepted by banks
as securities towards loans as well as different types of
charges that are created thereon. This is an important
aspect for any student of banking as one of the principal
business of banking is lending. Several examples are also
given for an easy understanding of concepts.
Securities for Banker’s Loan

Banks sanction loans to borrowers against some security. These securities help bankers in case the borrower
fails to repay the loan for one reason or other. Bankers in such cases sale / liquidate the securities and adjust
the proceeds to outstanding loan balance including interest and other charges. As such selection of security,
stipulating margin of safety, creating appropriate charge on the security etc. assume lot of importance in the
process of lending.
Security can be Main (Principal / Primary) or Collateral (Secondary)

Main security is an asset against which or for the
acquisition of which loan is sanctioned by the bank.
For instance, if bank sanctions loan to a borrower
for purchase of machinery or sanctions loan to a
borrower to meet his medical expenses and borrower
offers his gold ornaments to the bank as security,
then in both these cases the machinery and the gold
ornaments are Main securities. However, in case the
borrower in addition also offers his Fixed Deposit Receipt to bank as a security, then the FDR becomes collateral
security. Thus, the collateral is an additional security that borrower offers to the bank with the main security.
Thus, any security like house property, stock of raw materials, plant and equipment etc. can be main security or
collateral security depending on whether bank gives loan for it / against it or it is additional security obtained
by the bank, respectively.
Security can be Personal (Intangible) or Tangible

Personal security is the surety given by the borrower
himself or other individual, firm, company by way
of guarantee. This gives a bank a right to sue them
in their personal capacity in case of need. Tangible
security is in the form of plant, machinery, stock, land
and building, etc., which is impersonal in nature.
Attributes of Good Security (MAST Principle)

• Marketability (Freely traded in the market and easily convertible in cash).
• Ascertainability (Value and location of security should be easily ascertainable).
• Stability (Value of security should not fluctuate widely).
• Transferability (Ownership of security should be legally transferable).
What is MARGIN and Why MARGIN is required?

When bank lends money to borrowers against securities, it stipulates certain percentage of the value of security
(Market price or book value, whichever is less) as a contribution from the borrower, which is called a Margin. If
borrower offers his machinery of Rs. 1,00,000.00 as security, bank generally lends Rs. 70,000.00 (70% of value
of security) and asks borrower to bring Rs. 30,000.00 (30%) of his own contribution (margin). The percentage
of margin varies depending on the nature of the security and risk profile of the borrower.
Margin is necessary for following reasons:
1. Compulsion by regulatory authority. RBI makes it obligatory upon bankers to insist some minimum
margin while lending.
2. Margin ensures involvement of borrower in the activity as his stake (own money) is in the asset purchased.
3. Margin acts as a buffer in deterioration in the quality and depreciation in the value of asset.
4. It also acts as a cushion against price fluctuations, non- payment of interest, charges debited to borrower’s
account and to some extent non-payment of loan installments.
The right of a lender (bank) to be paid from a debtor’s (borrower) asset if the debt is not paid is called Charge
on asset. Borrower creates charge on the securities offered to the bank for availing loan. This gives the bank,
right to get payment out of the charged security, however the ownership of asset is not transferred to the
creditor (bank).
When charge is created on Fixed Assets like plant and machinery, land and building etc. whose identity do not
change during the period of loan is called Fixed Charge.
Charge created on Current Assets like stocks, debtors which undergo changes (from raw material to work in
process to finished goods to debtors) is called Floating Charge. It is an equitable charge on the assets of a
going concern. The charge becomes fixed when the going concern ceases to be a going concern (winding up,
appointment of receiver). This is called Crystallization of the charge.
Pari Passu (is a Latin word which means “with an equal step” or “on equal footing”).
Charge is created in favour of several creditors each having proportionate right on the asset on the basis of the
ratio of their loans. This generally happens when several banks jointly finance a single borrower (consortium
advance).
In case of Exclusive Charge only one creditor has charge in his favour without intervention of any other
creditor. The creditor who is given credit facility security over the property on which the charge is created has a
right over the security above all other people. When a charge is created on the assets already charged to another
creditor, the second creditor has a charge which is called as Second Charge. The right of second charge holder
is subject to first charge holder.
aSSIGNMENT
It is transfer of ownership of a property, or of benefits, interests, liabilities, rights under a contract (such as
an insurance policy), by one party (the assignor) to another (assignee) by signing a document called deed of
assignment. It is transfer of an actionable claim, which may be existing or in future, as a security for loan.
Legal assignment is an absolute transfer of actionable claim. It must be in writing. Signed by the assignor (in
case of LIC policy, by the policy holder), and should be informed to the debtor (LIC).
In Equitable assignment the possession of document representing actionable claim is handed over but no
other formalities are observed. However, debtor (LIC) has to be informed.
Assignment must be in writing and signed by the assignor or his legal representative and must be witnessed. To
make the assignment valid, consideration is not must, however notice to the debtor and his acknowledgement is
necessary to make debtor liable to assignee. A borrower can assign the book debts, money due from Government
Departments, LIC policies to bank as security for an advance.
Assignment only takes place after the original contract has been made. As a general rule, assignment of rights
and benefits under a contract may be done freely, but the assignment of liabilities and obligations may not be
done without the consent of the original contracting party.
The difference between assignment and transfer is that assignment means it’s legal to transfer property or a
legal right from one person to another, while transfer means it’s legal to arrange for something to be controlled
by or officially belong to another person.
LIEN
Lien is defined in Indian Contract Act, 1872. It is a right of a creditor to retain the possession of goods and
securities owned by the debtor, till the debts are fully paid off. However, creditor does not get right to sell the
securities.
The lien can be Particular lien or General lien. In case of particular lien only those goods and securities in
respect of which debts are incurred, can be retained by the creditor (if a wrist-watch is given to watch repairer
for repairing, till the repairing charges are paid, the watch repairer has right to retain the wrist watch in his
possession). He cannot sell the watch for the recovery of service charges or also cannot retain any other security
of the debtor for these repairing charges. In case of general lien, for the general balance due, the creditor can
retain the goods and securities of the debtor. Banks in India enjoy not only right of general lien, they can even
sell the goods and securities of the debtor in case of need to recover debts. Banker’s lien is therefore called as an
Implied Pledge. Since Limitation Act is not applicable to right of lien, banks can recover time barred debts also.
Differences between Particular Lien and General Lien

Lien is a right to keep possession of property belonging to another person until a debt owed by that person is
discharged. A particular lien is one in which the person has a right to retain the possession of goods for which
the charges are due. A bailee is entitled to a particular lien only. When the bailee is entitled to retain any goods
bailed to him for any amount due to him in respect of those goods or any other goods, it is called General Lien.
A general lien is available to bankers, factors, and attorneys of High Court and policy brokers.
Conditions necessary for exercising right of lien:
1. Goods and securities (cheques, bills, shares, debentures etc.) must be owned by the debtor in his own
name. Banks may sanction advance to a borrower against third party securities. Such securities cannot be
subject matter of lien (except in the name of guarantor).
2. Securities must be received in the capacity of Banker. It means for securing loan and not for other purpose
like safe custody, safe deposit vaults, specifically for selling, inadvertently left in the bank, bank handling
the securities as trustee or agent etc.
3. Reasonable notice must be given before the sale of securities.

4. There should not be any contract inconsistent to the right of lien.
Sometimes borrower gives an undertaking to the banker as regards his assets that, the assets are free from
any charge and without the permission of the bank no charge will be created on it. This undertaking is called
Negative Lien. This undertaking, however, has no legal standing and has moral value only.
SET-OFF
Set-off is total or partial merging of a claim of one person against another, in the counter claim of latter against
former.
For example, if A, in one transaction, owes Rs. 10,000/- to B and in another transaction, B owes Rs. 15,000/- to
A. Then it is not necessary that these two transactions should be settled separately. A and B can combine these
two transactions, and B can pay Rs. 5,000/- to A. Thus, they can set-off the mutual debts. In banker - customer
relationship, bank through this process recovers borrower’s dues from his deposit account. Since this right is
statutorily available to bank, the time-barred debts can also be recovered through this right of set-off.
Conditions necessary for exercising right of set-off:
1. Mutual debts must be in same name and capacity. This means if Deposit Account is in the name of A
jointly with B and loan is in the name of A, then set-off cannot be exercised. Similarly, loan given to Mr.
X cannot be recovered from the savings account of his minor son where Mr. X is guardian. Loan given
to an individual Mr. Y cannot be recovered from the account of a partnership firm where Mr. Y is one of
the partners. However, loan given to a partnership firm can be recovered from the deposit accounts of
individual partners, since partners are jointly and severally (individually) liable for firms act.
2. Debts must be due and payable. This means, in case of term loan the installment which is due on 10th day
of a month cannot be recovered before 10th.
3. In case the deposit account is in the nature of “Term Deposit”, the right can still be exercised, for a lawful
debt; however only on maturity of the deposit account.
4. Set-off can be exercised in case of guarantor’s account after money is demanded from him.
APPROPRIATION
Appropriation is a right of a debtor. When borrower having more than one debt to the bank, makes payment
with an instruction to apply the same to a particular debt, then if the bank accepts this payment, must apply
it as per the instructions of the borrower. Instructions can be expressed or implied. Banks need not accept the
payment made by the borrower with a condition but if accepts then it cannot ignore the condition (instruction).
When borrower fails to give instruction where the amount is to be applied and even the circumstances also do
not indicate to which debt the payment is to be applied then the creditor can apply the payment to any lawful
debt which is due and payable.
If neither the debtor nor the creditor exercise right of appropriation then the payment will be applied to
discharge the debt in order of time, that is in chronological order (first debit entry will be cleared by first credit
entry).
The Rule in case of Clayton’s Case is applicable to running accounts like cash credit and overdrafts where the
borrower deposits as well as withdraws money from the account continuously. Here the rule states that the
debit entry will be set-off by the credit entry by chronological order (first debit by subsequent first credit).
In order to crystallize the liability of a deceased, insane, insolvent or retired partner in cash credit / overdraft
accounts of partnership firms, banks stop operations in such accounts and allow further operations in fresh
account. Similar steps are taken when loan accounts are secured by the guarantee and the guarantor is deceased,
becomes insane or insolvent or guarantee is revoked by the guarantor. If the operations in the same account are
continued, the subsequent credits will reduce the liability of such partner / guarantor.
PLEDGE
Pledge is defined in Indian Contract Act, 1872. It is bailment of goods as security for payment of a debt or
performance of promise. The person who delivers goods (borrower) is Pledger or Pawnor and the person to
whom the goods are delivered (bank) is Pledgee or Pawnee. The owner of the goods, the joint owner with
the consent of other owner(s), the agent of the owner can pledge the goods. Here the possession of goods is
with the creditor (bank) and ownership remains with the debtor (borrower). The possession can be actual
or constructive (by handing over the key of godown where the goods are stored, acknowledgement from the
warehouseman, handing over document of title to the goods like railway receipt, bill of lading). The possession
is till the repayment of loan. The creditor (bank) has to take proper care of the goods pledged. It is a legal charge
and fixed one. The charge is not affected by law of limitation and does not require any registration. The creditor
(bank) has right to sale the goods after giving notice.
HYPOTHECATION
It is defined under SARFAESI Act as “Charge on movable property (stock, machinery, vehicle etc.) in favour of
secured creditor without delivery of possession of the assets. It is an equitable charge where the possession
and the ownership of the assets remain with the borrower. The borrower is called Hypothecator and the bank
(creditor) is called Hypothecatee. The right of sale is available to creditor only through a court. Under SARFAESI
Act, sale is possible after possession. Creditor cannot take possession without the consent of borrower, however
on getting possession, a creditor can sell the security as in case of pledge. Hypothecation is thus a charge against
property for an amount of debt, where neither the ownership nor the possession, is passed to the creditor. The
document (letter of hypothecation) signed by the borrower provides for an agreement, whereby the borrower
agrees to give possession of goods when called upon to do so by the creditor. The charge is required to be
registered with the Registrar of Companies (ROC) under section 77 of Companies Act, 2013 (earlier Under
Section125 of Companies Act, 1956). Limitation period of 3 years is applicable under Limitation Act. It is
different from Mortgage as mortgage relates to immovable properties.
MORTGAGE
It is defined in Transfer of Property Act, 1882 as, transfer of interest in specific immovable property (land,
benefits arising out of land, things attached and permanently fastened to earth) to secure an advanced loan, or
an existing debt or a future debt or performance of an obligation. Once the amount due is paid to the lender,
the interest in the property is restored back to the borrower. Lender gets right to recover the dues in case of
default but does not become owner of the property. Mortgagor is the transferor of interest in the property and
Mortgagee is the transferee. The principal money and the interest of which payment is secured is called the
mortgage money and the instrument by which the transfer is affected is called the mortgage deed.
The mortgagor has right to redeem the document relating to mortgage property, where possession has been
given, to get back the possession and where title has been transferred, to get retransferred, on liquidation of
money borrowed. This right of redemption can be exercised before the decree for sale or foreclosure is passed
by a court.
On default by the mortgagor, the mortgagee has right to obtain a decree from a court to the effect that the
mortgagor be debarred for ever to redeem the mortgage. This is called right of foreclosure. The right of
foreclosure describes a lender’s ability to take possession of a property through a legal process called foreclosure.
Lenders must abide by specific procedures in order for a foreclosure to be legal. The transfer of Property Act
contemplates following six types of mortgages:
1. Simple Mortgage
• Court intervention required for mortgagee to sell the property.
• Rent and produce on the property, is not the right of mortgagee.
• Registration is compulsory.
• Mortgagor retains the possession of the property.
• Mortgagor is personally liable too.
2. Mortgage by conditional sale
• Mortgagor is not personally liable for repayment of money borrowed.
• Mortgagee by applying to court can get decree in his favor and can sue for foreclosure.
• Right of foreclosure is available for Mortgage by Conditional Sale only.
3. Usufructuary mortgage
• Mortgagee has legal possession of the property till the borrower repays the money borrowed,
however sale is not allowed.
• Mortgagee has right to receive rent and benefits accruing from the property.
• Mortgagor is not liable personally.
• Law of limitation is not applicable.
4. English Mortgage
• Mortgagee gets absolute transfer of property on condition that the same will be retransferred if the
debt is fully paid.
• Mortgagor personally liable to pay debt on a specified date.
5. Mortgage by deposit of title deeds (Equitable Mortgage/ EMT)
• Property can be located anywhere but the deposit of title deeds has to be made at towns notified by
State Government.
• The title deed deposited should be original. In case original title deed is lost or not in existence, a
certified true copy by the sub-registrar can be deposited.
• The intention should be to secure debt.
• Registration with Registrar of Assurances is not required. In case of Company, registration of
mortgage is required within 30 days.
6. Reverse Mortgage
It is a type of home loan for older homeowners that require no
monthly mortgage payments. The amount of loan is determined
on the basis of borrower’s age, value of property, rate of interest
and norms of lending institution. The purpose is to help Senior
Citizens to convert their dwelling house property into liquid
cash flows to meet their living expenses. Borrowers are still the
owners of property and responsible for property taxes and home
owner’s insurance. Reverse mortgage allows elders to access the
home equity they have built up in their homes now, and defer
payment of loan until they die, sell or move out of the home. Because there are no required mortgage
payments on a reverse mortgage, the interest is added to the loan balance each month. Over the loan’s
life, the homeowner’s debt increases and home equity decreases. When the homeowner dies or moves,
the proceeds from the home’s sale go to the lender to repay the reverse mortgage’s principal, interest,
mortgage insurance and fees and balance amount to legal heirs.
Generally, no loan is given against ancestral property since it involves legal issues. Loan in joint names of
owner and spouse can be given irrespective of title of property, however one person should be above 60
years and the other above 55 years. Generally, loan is given with a repayment period of 15 years.
When borrower take out a reverse mortgage, he/she can choose to receive the proceeds in one of
six ways:
1. Lump sum: Get all the proceeds at once when your loan closes. This is the only option that comes
with a fixed interest rate. The other five have adjustable interest rates.
2. Equal monthly payments (annuity): For as long as at least one borrower lives in the home as a
principal residence, the lender will make steady payments to the borrower. This is also known as a
tenure plan.
3. Term payments: The lender gives the borrower equal monthly payments for a set period of the
borrower’s choosing, such as 10 years.
4. Line of credit: Money is available for the homeowner to borrow as needed. The homeowner only
pays interest on the amounts actually borrowed from the credit line.
5. Equal monthly payments plus a line of credit: The lender provides steady monthly payments for
as long as at least one borrower occupies the home as a principal residence. If the borrower needs
more money at any point, they can access the line of credit.
Term payments plus a line of credit: The lender gives the borrower equal monthly payments for a set
period of the borrower’s choosing, such as 10 years. If the borrower needs more money during or after
that term, they can access the line of credit.
7. Anomalous Mortgage
• Any mortgage other than one described above, falls in this category.
The mortgagor can create subsequent mortgage(s) on the same property. The rule of priority is in
the order of time they are created. Limitation period for filing suit for sale of mortgaged property is
twelve years from the date mortgage debt becomes due. For filing a suit for foreclosure, limitation
is thirty years from the date mortgage debt becomes due. Enforcement of mortgage is governed by
the Code of Civil Procedure. Suit for sale of mortgage properties should be filed in the court, within
whose jurisdiction the mortgaged property is situated.
Key Differences Between Pledge and Hypothecation

The significant differences between pledge and hypothecation are specified below:
1. The pledge is defined as the form of bailment in which goods are held as security for the payment of
the debt or the performance of an obligation. Hypothecation is slightly different from the pledge, in
which the collateral asset is not delivered to the lender.
2. The pledge is defined in section 172 of the Indian Contract Act, 1872. On the other hand, Hypothecation
is defined in Section 2 of Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002.
3. In the pledge, the possession of the asset is transferred, but in the case of hypothecation, possession
lies with the debtor only.
4. Parties to the contract of the pledge are pawnor (borrower) and Pawnee (lender) whereas in
hypothecation the parties are hypothecator (borrower) and hypothecatee (lender).
5. In the pledge, when the borrower default in payment, the lender can exercise his right to sell the asset
to recover the debt amount. Conversely, in hypothecation, the lender does not have the possession of
goods so he can file a suit to realize his dues to take the possession first and then disposing off them.
INDEMNITIES AND GUARANTEES

Guarantees and Indemnities are a common way in which creditors protect themselves from the risk of debt
default. Lenders will often seek a guarantee or indemnity if they have doubts about borrower’s ability to fulfill
his obligations under a loan agreement.
Contract of Guarantee and contract of Indemnity are defined in Indian Contract Act.
“A contract of Guarantee is a contract to perform the promise or discharge the liability of a third person in
case of his default.”
“A contract of Indemnity is a contract by which one party promises to save other from loss caused to him
by the conduct of promissor himself or by the conduct of any other person.”
In a simple way it can be explained as under:
If A says to B, you lend money to C. If he doesn’t pay, I will pay; is a guarantee. If A says to B, you lend money to
C and I will see to it that you get your money back; is an Indemnity.
Contract of Guarantee has following three parties:
1. Guarantor, also called as Surety, who gives guarantee.
2. Creditor, the person to whom guarantee is given.
3. Principal Debtor, the person in respect of who’s default the guarantee is given.
Thus there are three contracts involved. One between the debtor and the creditor, where the debtor agrees to
pay the debts. Second between the creditor and guarantor, who agrees to pay in case the debtor makes default
and third between the debtor and the guarantor, who accepts the request of debtor and gives guarantee to the
creditor. Guarantee is thus a secondary contract, the primary being between the debtor and the creditor. As
such if the primary contract is invalid the secondary contract is not enforceable in the court of law. Example - If
loan is sanctioned to a minor, it becomes invalid contract as contract with a minor is void ab initio. Such loan
cannot be recovered even if a third party guarantee is obtained at the time of lending. Guarantor’s liability
arises only after the default committed by the principal debtor.
Contract of Indemnity has following two parties:

1. Indemnifier, the person who makes promise of indemnity
2. Indemnified, the person with whom the promise is made.
The indemnified in a contract of indemnity is entitled to recover from his indemnifier, the damages, cost and
sums when sued.
Salient features of contract of guarantee:
• The contract of guarantee can be either oral or written. Bankers however take a written guarantee to bind
the surety by his words.
• Consideration: Anything done or any promise made by the Principal Debtor is sufficient consideration to
surety for giving guarantee.
• Types of guarantees: A guarantee given for a particular transaction, undertaking or debt is a specific
guarantee. This guarantee once given cannot be revoked. A guarantee which extends to a series of
transactions is called continuing guarantee. This guarantee can be revoked (called back) by the surety by
giving notice to the creditor, but only for future transactions.
• Invalid guarantee: Guarantee obtained by misrepresentation or concealment of the facts makes the
guarantee invalid.
• Nature and extent of guarantor’s liability: The liability of the surety is secondary and arises only after the
principal debtor making default. If at the time of making a contract, surety sets a limit of his liability then
he is liable only to that extent. In the absence of such contract, the liability of guarantor is co-extensive
with the principal debtor.
Rights of guarantor:
• Right of subrogation: The surety is entitled to the benefit of every security of the debtor which was in the
possession of the creditor at the time a contract of guarantee was signed. This right is not affected even if
the surety was not aware about the securities of the debtor with the creditor. If the creditor loses or parts
with such security, without the consent of the surety, the surety is discharged from his liability to the
extent of value of the security so lost or parted with.
• Right to be indemnified by the principal debtor: There is implied promise by the principal debtor to
indemnify the surety. The surety has the right to recover from the principal debtor the amounts which he
has rightfully paid under the contract.
• Right to revoke continuing guarantee: The surety has the right to revoke at any time a continuing guarantee
by giving a notice of such revocation to the creditor. The surety however remains liable in respect of the
transactions which have already taken place.
Liability of the guarantor:
• The extent of liability: The liability of the surety is to the same extent to which the principal debtor is
liable to the creditor, provided the surety does not restrict his liability in the contact of guarantee. If the
liability of principal debtor increases the liability of surety also increases to the same extent but cannot
exceed that of principal debtor. The surety however can undertake fixed liability (lesser than the principal
debtor) by specifying in the contract of guarantee. The extent of guarantee may be limited in either of the
following ways-
1. Surety may guarantee only part of the entire debt.
2. Surety may guarantee full debt but specify the amount up to which he makes himself liable to the
creditor.
• The time liability arises: The liability of surety arises on the principal debtor making default. The liability
of the surety does not arise unless the liability of the principal debtor is determined. It is not necessary
that the creditor should exhaust all his remedies against the principal debtor before proceeding against
the surety for recovery.
• Liability of co-sureties: The co-sureties are liable to contribute equal amounts towards the liability
of the debtor, provided - there is no agreement to the contrary and they are co-sureties for the same
amount of debt. It is immaterial whether the contract of guarantee was the same or separate between
each one of them and the creditor and whether they knew about the guarantee given by the other person
or not. The contribution of each co-surety shall be equal and not proportionate. The actual amount of such
contribution shall, however, not exceed the amount for which the guarantee is given by any one of them. If
the creditor releases one of the co-sureties, other sureties are not discharged and the surety so released is
also not discharged from his responsibilities to other sureties.
Obligations of Creditor towards surety
• The creditor must not change the original terms of the contract between himself and the principal debtor
without taking consent of the surety(ies). Any variance, made without the surety’s consent, in the terms
of the contract between the principal debtor and the creditor, discharges the surety as to transactions
subsequent to the variance.
• The creditor should not release or discharge the principal debtor. The surety is discharged from his
obligation if there is a contract between the creditor and the principal debtor, by which the principal
debtor is released or if there is any act or omission on the part of the creditor, the legal consequence of
which is the discharge of the principal debtor.
• The creditor should not give any indulgence to the debtor. If the creditor enters into a contract whereby,
he makes a composition with or he agrees not to sue principal debtor or to extend the time of repayment
of debt, the surety will be discharged from his liability unless the surety gives consent to such contract.
• The credit or should not do any act which is inconsistent with the right of the surety and should not omit
to do any act which is required of him.
• As soon as the liability of the surety arises, the creditor is entitled to demand payment from him. The
banker is also entitled to exercise his right of lien on the securities of the surety in his possession on
arising liability of the surety.
• If the surety becomes insolvent, the creditor is entitled to recover the dues from the estate of the insolvent
party after determining the surety’s liability by recalling the debt from the principal debtor and in case of
his default.
Guarantee is not a contract of ‘uberrimae fidie’ (utmost good faith): A contract of guarantee does not require
full disclosure of all material facts by the principal debtor or the creditor to the surety before the contract is
entered into. Fraud on the part of principal debtor is not enough to set aside the contract, unless the surety can
show that the creditor knew of the fraud and was a party to it. When a guarantee is given to a banker, there is
no obligation on the banker to inform the intending surety of matters affecting the credit of the debtor or any
circumstances connected with the transaction.
BOOK DEBTS
Book debts mean the amount that the customers of business owe to the business. Thus the trade receivables
(debtors and bills receivable) are the book debts of the business. Debtors are the customers (persons or
companies) who purchase goods or services from the business and pay money for the same later. Sometimes
businesses after selling goods or services to customers, draw bill, which are accepted by them and amount is
paid by them on due dates. These are called Bills receivables. Both are current assets of the business and are
financed by the banks. It is a short-term finance and is called working capital finance. Banks finance debtors
which are not exceeding 90 days of age.
CORPORATE SECURITIES (SHARES / DEBENTURES / BONDS)

Securities issued by joint stock companies broadly fall into two categories:
1. Ownership securities - equity shares and preference shares and
2. Creditor ship securities - debentures.
Preference shares of a company are those shares which carry certain preference rights for their holders over
those of equity shareholders. Preference shares carry prescribed rate of dividend, which company will have to
pay before any dividend can be distributed to the equity shareholders. Preference shares can be cumulative or
non-cumulative. In case of cumulative preference shares, if company is unable to pay the prescribed dividend
during any year (s), the same will be payable out of profits of the company in future years. This right is not
available to non-cumulative preference shareholders. Preference shares may be redeemable or non- redeemable.
Redeemable shares are paid after specified period.
Debentures are generally secured by mortgage of immovable property of the company. The owners of such
debentures are the secured creditors of the company. Unsecured debenture holders do not posses any such
charge over the assets of company. Debentures are generally redeemable after specified time. Interest payable
on debentures is at half yearly rest with an option of either cumulative or non-cumulative basis. Debentures can
be fully or partly convertible. ‘Debentures with Right Attached’ gives holder, a right to subscribe to the shares of
the company against cash payment (at a low premium) at a future date.
Bonds are issued by corporations, municipalities or governments to raise money for funding their projects. The
bond issuer pays interest to the bond holder at regular intervals at specified rate called coupon rate. The bond
amount is paid on maturity. The zero coupon bonds are issued at discount and on maturity paid at face value.
Convertible bonds give option to investors to convert bond into equity at fixed conversion price.
RBI guidelines on Loans and Advances against Shares, debentures and Bonds
• Advances may be granted to individuals against these securities held by them.
• The purpose of advance may be to meet contingencies and personal needs or for subscribing to new or
right issues of shares/debentures/bonds or for purchase in the secondary market.
• Limit of advance should not exceed Rs. 10.00 lakhs per individual where securities are held in physical
form and Rs. 20.00 lakhs per individual if securities are held in dematerialized form.
• Margin should be minimum 50% of the market value of equity shares / convertible debentures held on
physical form, and minimum 25% if in dematerialized form. The margins for advances against preference
shares, non-convertible debentures and bonds can be decided by individual banks.
• Each bank to formulate its loan policy with the approval of their Board of Directors.
• Share and stock brokers may be provided need-based overdraft facility / line of credit after careful
assessment of need. The ceiling of Rs. 10.00 and 20.00 lakhs will not be applicable in their cases.
Share and stock brokers registered with SEBI and who comply with prescribed capital adequacy norms
are only eligible for loans.
• While granting advances against shares held in joint names to joint holders or third-party beneficiaries,
banks should be circumspect and ensure that the objective of the regulation is not defeated by granting
loans to other joint holders or third-party beneficiaries to circumvent the above limits placed on loans
against shares and other securities.
• Banks may grant advances to individuals for subscribing to IPOs. Loans/advances to any individual from
banking system against security of shares, convertible debentures, convertible bonds, units of equity
oriented mutual funds and PSU bonds should not exceed the limit Rs.10.00laks for subscribing to IPO.
The corporate should not be extended credit by banks for investment in other companies’ IPOs. Similarly,
banks should not provide finance to NBFCs for further lending to individuals for IPOs.
• Banks may extend finance to employees for purchasing shares of their own companies under Employee
Stock Option Plan (ESOP) / reserved by way of employees’ quota under IPO to the extent of 90% of the
purchase price of the share or Rs. 20.00 lakhs whichever is less. Bank employees can not avail loan to
purchase shares of their own bank under ESOP/IPOs or from secondary market.
• While advancing against Units of Mutual Funds, bank should ensure that - units are listed on Stock
Exchange, units have completed minimum lock-in-period, amount of advance is linked to NAV/ repurchase
price or market value, whichever is less and the advance is purpose oriented. The units issued by Mutual
Funds relating to tax saving equity plans are not to be treated as approved securities for the purpose of
considering loans / advances since they are not traded / listed in the stock exchanges.
• Banks should not undertake arbitrage operations themselves or extend credit facilities directly or indirectly
to stockbrokers for arbitrage operations in Stock Exchange. While banks are permitted to acquire shares
from the secondary market, they should ensure that no sale transaction is undertaken without actually
holding the shares in their investment accounts.
• Advances against primary security of shares/ debentures / bonds should be kept separate and not
combined with other advances.
• No advances against partly paid shares to be granted.
CERSAI
A Central Registry has come into effect from 31 st March 2011. Government of India has made it compulsory
that Equitable Mortgages created by way of deposit of title deeds are registered with the Central Registry. As
per provision of SARFAESI Act, a company has been formed named ‘Central Registry of Securitisation Asset
Reconstruction and Security Interest of India’(CERSAI) with 51% paid up capital held by Central Government
and the remaining 49% of the paid-up capital shared amongst the top 10 PSBs and National Housing Bank.
CERSAI has been established as a company under section 8 of the Companies Act, 2013 by the Government of
India. The object of the company is to maintain and operate a Registration System for the purpose of registration
of transactions of securitisation, asset reconstruction of financial assets and creation of security interest over
property, as contemplated under the Securitisation and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2002 (SARFAESI Act). CERSAI is providing the platform for filing registrations of
transactions of securitisation, asset reconstruction and security interest by the banks and financial institutions.
CERSAI is a risk mitigation tool for the Banks / Housing Finance companies, FIs and public at large to prevent
multiple financing against the same property. Any bank, financial institution or an individual can access the
registration platform of CERSAI for a certain fee. By registering themselves with CERSAI, the lenders can pull
up the information on an asset or property to validate that whether any previous security interest has been
created by a different lender ((banks, financial institutions etc.) in the past. Usually, this is done before the
sanction of a loan to a borrower.
Agricultural property is excluded from the purview of SARFAESI Act. Hence bank need not register with Central
Registry mortgage/security interest created on agricultural land.
The Government of India has subsequently issued a Gazette Notification dated January 22, 2016 for filing of the
following types of security interest on the CERSAI portal:
a. Particulars of creation, modification or satisfaction of security interest in immovable property by mortgage
other than mortgage by deposit of title deeds.
b. Particulars of creation, modification or satisfaction of security interest in hypothecation of plant and
machinery, stocks, debts including book debts or receivables, whether existing or future.
c. Particulars of creation, modification or satisfaction of security interest in intangible assets, being know
how, patent, copyright, trademark, licence, franchise or any other business or commercial right of similar
nature.
d. Particulars of creation, modification or satisfaction of security interest in any ‘under construction’
residential or commercial or a part thereof by an agreement or instrument other than mortgage.
In order to proceed under SARFAESI Act, it is now mandatory to register charge under CERSAI. After registration
of security interest with Central Registry, Banks will have priority over all other debts, revenues, taxes, cesses
and other rates payable to the central government or state government or local authority. Satisfaction of SI
(Security Interest) has to be done on the CERSAI portal when all the loans on the asset have been repaid.
CHARGE CREATION
Charge Creation is required to be registered when charge created on by way of Hypothecation of stocks,
book debts, mortgage of immovable properties, ship, goodwill, uncalled share capital of the company. Charge
registration is not required in case of Pledge of goods or securities or against Fixed Deposits. Section 77 to 87 of
the Companies Act 2013 provides the procedure for registration of Charges. Charges created on a company’s
assets (except pledge) have to be registered with Registrar of Companies within 30 days of creation of the
charge. When charge in favour of two banks is registered, priority of charge is in favour of bank, in whose favour
it is created first i.e. date of documents.
Note: For detail of charge creation refer chapter-5 : Charges of Company Law subject of Executive Level.
CASE LAWS
1. In the matter of Aarifaben Yunusbhai Patel and Ors. vs. Mukul Thakorebhai Amin and Ors (2020),
the the honorable Supreme Court has come to the conclusion that the auction of both the properties
were vitiated on account of lack of notice to the judgment-debtor, and that being an error fatal to
the validity of auction sale, in light of the decision of the Supreme Court the auction sale cannot be
permitted to remain and they have to be quashed. Other submissions of the counsel for the auction
purchasers therefore need not be elaborately dealt with, but suffice it to say that the Court is quashing
the auction sale on ground of non-compliance with the mandatory provision of notice to the judgment-
debtor.” The court was constrained to observe that the High Court totally ignored the order of this
Court quoted hereinabove. This Court had specifically directed the executing court to decide both, the
issue of limitation and objections on merits. This was obviously done with the purpose that in case
later if the issue of limitation is decided in favour of the objectors, R-1 and R-3, then the matter again
should not be remanded for decision on merits of the case. The issue of limitation could not have been
ignored and should have been decided by the High Court.
2. In the matter of Appeal in Connectwell Industries Pvt . Ltd . vs . Union of India (UOI) and Ors.
(06.03.2020 - SC) (17.03.2020 - Supreme Court), the Honorable Supreme Court held that there is
no dispute regarding the facts of this case. The property in dispute was mortgaged by BPIL to the
Union Bank of India in 2000 and the DRT passed an order of recovery against the BPIL in 2002. The
recovery certificate was issued immediately, pursuant to which an attachment order was passed prior
to the date on which notice was issued by the Tax Recovery Officer- Respondent No.4 under Rule 2 of
Schedule II to the Act. It is true that the sale was conducted after the issuance of the notice as well as
the attachment order passed by Respondent No.4 in 2003, but the fact remains that a charge over the
property was created much prior to the notice issued by Respondent No.4 on 16.11.2003. The High
Court held that Rule 16(2) is applicable to this case on the ground that the actual sale took place after
the order of attachment was passed by Respondent No.4. The High Court failed to take into account
the fact that the sale of the property was pursuant to the order passed by the DRT with regard to the
property over which a charge was already created prior to the issuance of notice on 11.02.2003. As the
charge over the property was created much prior to the issuance of notice under Rule 2 of Schedule II
to the Act by Respondent No.4, we find force in the submissions made on behalf of the Appellant.
The judgment of the High Court is set aside and the Appeal is allowed. The MIDC is directed to issue a
‘No Objection” certificate to the Appellant.
3. In Anuj Jain vs. Axis Bank Limited and Ors. (26.02.2020 - Supreme Court), the honorable Supreme
Court on the issue as to whether lenders of JAL could be treated as financial creditors, hold that
such lenders of JAL, on the strength of the mortgages in question, may fall in the category of secured
creditors, but such mortgages being neither towards any loan, facility or advance to the corporate
debtor nor towards protecting any facility or security of the corporate debtor, it cannot be said that
the corporate debtor owes them any ‘financial debt’ within the meaning of Section 5(8) of the Code;
and hence, such lenders of JAL do not fall in the category of the ‘financial creditors’ of the corporate
debtor JIL.
4. In K. Virupaksha and Ors. vs . The State of Karnataka and Ors. (03.03.2020 -Supreme Court)
Criminal proceeding would not be sustainable in a matter of the present nature, exposing the appellants
even on that count to the proceedings before the Investigating Officer or the criminal court would not
be justified.
The appellants herein had also referred to the provision as contained in Section 32 of the SARFAESI
Act which provides for the immunity from prosecution since protection is provided thereunder for the
action taken in good faith.
The learned senior counsel for the Complainant has in that regard referred to the decision of this Court
in the case of General Officer Commanding, Rashtriya Rifles vs. Central Bureau of Investigation &
Anr. (2012) 6 SCC 228 to contend that the defence relating to good faith and public good are questions
of fact and they are required to be proved by adducing evidence.
Though on the proposition of law as enunciated therein there could be no cavil, which aspect of the
matter is also an aspect which can be examined in the proceedings provided under the SARFAESI
Act, 2002. In a circumstance where we have already indicated that a criminal proceeding would not
be sustainable in a matter of the present nature, exposing the appellants even on that count to the
proceedings before the Investigating Officer or the criminal court would not be justified.
5. Pandurang Ganpati Chaugule vs. Vishwasrao Patil Murgud Sahakari Bank Limited (05.05.2020
Supreme Court)
Recovery is an essential part of banking; as such, the recovery procedure prescribed under section 13
of the SARFAESI Act, is applicable to Co-operative banks
The question in this matter for the determination was ‘Whether the ‘SARFAESI Act’ is applicable to
Cooperative Banks?
The Honorable Supreme held that the cooperative banks established under the State Legislation and
Multi State Cooperative Banks are ‘banks’ under section 2(1)(c) of Securitisation and Reconstruction
of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).
It was held that the recovery is an essential part of banking; as such, the recovery procedure prescribed
under section 13 of the SARFAESI Act, legislation relatable to Entry 45 List I of the Seventh Schedule to
the Constitution of India, is applicable.
It was further held that the Parliament has legislative competence under Entry 45 of List I of the
Seventh Schedule of the Constitution of India to provide additional procedures for recovery under
section 13 of the SARFAESI Act with respect to cooperative banks.
It was concluded that the provisions of Section 2(1)(c)(iva), of SARFESI Act, adding “ex abundanticautela”,
‘a multi State cooperative bank’ is not ultra vires as well as the notification dated 28.1.2003 issued with
respect to the cooperative banks registered under the State legislation.
LESSON ROUND UP
• Securities help a banker to recover the amount of advances, in case of borrowers’ default. Securities can
be principal or collateral one.
• Main security is the asset against which advances were given. Collateral security is an additional
security that borrower offers to the bank with the main security. A good security has the attributes of
MAST.
• Margin is a contribution from borrower which is insisted by a bank when advances are given. Margins
enable involvement from borrower, acts as fall back if loans turn bad, acts as a cushion against
fluctuations in the value of security.
• Banks create types of different types of ‘charge’ over securities given by a borrower to enforce their
rights. Some of the charges which banks create are Assignment, Lien, Pledge, Hypothecation, Mortgage.
Banks also obtain Guarantees and Indemnities from borrowers to safe guard themselves against
defaults in certain cases.
• Lien a right of a creditor to retain the possession of goods and securities owned by the debtor, till
the debts are fully paid off. However, creditor does not get right to sell the securities. The lien can be
Particular lien or General lien. Banks in India enjoy not only right of general lien, they can even sell the
goods and securities of the debtor in case of need to recover debts.
Set-off is total or partial merging of a claim of one person against another, in the counter claim of latter
against former. This right is statutorily available to banks.
Appropriation is a right of a debtor/ borrower. A borrower having more than one debt to the bank, makes
payment with an instructions to apply the same to a particular debt his instruction has to be followed.
When borrower fails to give instruction, right is of creditor the apply the payment to any lawful debt
which is due and payable. If neither the debtor nor the creditor exercise right of appropriation then the
payment will be applied to discharge the debt in chronological order.
• Hypothecation is a charge on movable property (stock, machinery, vehicle etc) in favour of secured
creditor without delivery of possession of the assets. It is an equitable charge where the possession and
the ownership of the assets remain with the borrower. Guarantees and Indemnities are a common way
in which creditors protect themselves from the risk of debt default.
GLOSSARY
Assignments Assignment is transfer of an actionable claim, which may be existing or in
future, as a security for loan.
Pledge Pledge is Bailment of goods as security for payment of a debt or performance
of promise.
Mortgage Mortgage is a transfer of interest in specific immovable property (land, benefits
arising out of land, things attached and permanently fastened to earth) to
secure an advanced loan, or an existing debt or a future debt or performance
of an obligation. Transfer of Property Act contemplates six types of mortgages.
Contract of Guarantee Contract of Guarantee is a contract to perform the promise or discharge the
liability of a third person in case of his default.
A Contract of A Contract of Indemnity is a contract by which one party promises to save other
Indemnity from loss caused to him by the conduct of promissor himself or by the conduct
of any other person.
TEST YOURSELF
a. In Hypothecation the possession of goods is with where as in Pledge it is with ______________.
b. Liability of a guarantor is ______________ while that of indemnifier is ______________.
c. In MAST principle: M ______________ A ______________ S ______________ T ______________.
d. Charge created by banks while giving loan against the security of Life Insurance policy is
______________.
e. ______________ is a risk mitigation tool for the Banks / Housing Finance companies, FIs and public at
large to prevent multiple financing against the same property.
a. The disadvantage of Factoring is that money remains blocked with factor and is not available for
business.
b. Bankers Lien is called as an Implied pledge because it gives right to the bank to sell the securities.
c. Charge created on land, building, plant and machinery is Floating charge.
d. Right of appropriation is that of a Creditor.
e. Commercial Paper (CP) is a short term money market instrument issued as secured demand
promissory note.
a. What are the various types of Mortgages?
b. Compare Pledge and Hypothecation.
c. What are the conditions necessary to exercise right of set-off?
LIST OF further readingS

• The Indian Contract Act, 1872.
• Law of Sale of Goods Act, 1932.
• The SARFESI Act, 2002.
• The Insurance Act, 1938.
• RBI Master Circulars on Credit/Money Market Instruments.
• Circulars of IBA.
Other Modules of ICSI having reference of Securities, Charge Creation
• Company Law
Lesson 14 • Documentation 399
Lesson 14 Documentation
Should Know
• Execution This lesson will enable the reader to • Limitation Act, 1963.
• CERSAI understand : • Companies Act, 2013.
• Limitation • What is document and • Indian Partnership Act, 1932.
Documentation ?
• Stamping • Indian Stamp Act, 1899.
• Why documentation?
• Charge Creation • The Securitisation and
• The Process – Selection, Reconstruction of Financial
• ROC stamping and execution Assets and Enforcement of
• Hypothecation • Limitation Period Securities Interest Act, 2002.
• Pledge • Securitization
• Lien
Lesson Outline
• Documents & Purpose of Documents
• Procedure
• Stamping
• Securitisation
• LESSON ROUND UP
• TEST YOURSELF
399
DOCUMENT AND PURPOSES OF DOCUMENTS

One of the important areas in Bank credit, is documentation. The purpose of a bank taking documents is multi
fold. Documents help banks to identify:
• The borrower and the capacity in which money is borrowed (Individual, partnership firm, company,
trustee etc.);
• Type of security (land, building, plant, machinery, stock, debtors, Life Insurance Policy etc.);
• The charge created on it (Pledge, hypothecation, mortgage, assignment etc.);
• To count the limitation period, as the documents have expiry date;
• Present in a court of law the evidence for the recovery of money from the defaulting borrower.
The execution of documents depend on capacity in which money is borrowed.
Borrower Signatories
Individual Himself / Herself or his / her Agent
Joint Borrower All of them jointly or their respective Agents
Proprietorship firm Proprietor or Agent
Partnership Firm All the partners
HUF The Karta. All the major coparceners if they are to be made personally liable.
Joint stock company Persons authorized as per the resolution passed by the Board
Trust / Society / Club Persons authorized as per the resolution
Procedure of Documentation
SELECTION OF DOCUMENTS
Requirement of documents depends on what is the type of facility (e.g. security may be debtors but facility
can be cash credit, bill discounting / purchases), who is the borrower (individual - whether singly or jointly,
partnership firm, HUF, joint stock company etc.), what is the charge to be created (security may be stock
but charge to be created can be hypothecation or pledge). Documents also depend on additional terms and
conditions, if any, stipulated in the letter of sanction. Generally, banks have printed forms of documents approved
by their legal department. It should therefore be ensured that appropriate sets of documents are selected for
the facility sanctioned to the borrower.
STAMPING OF DOCUMENTS
Documents attracting stamp duty and should be stamped before or at the time of execution (not later), by paying
appropriate amount of stamp duty. There are documents like Demand Promissory Note, Share Transfer Form,
Insurance Policy etc. where the stamp duty is decided by the Central Government, hence it is same throughout
the country. Documents like Letter of Hypothecation, Pledge, Guarantee etc., the stamp duty is decided by the
State Government, hence it may differ from state to state. There are certain transactions where the stamp duty
is not fixed but is ad-valorem that means depends on the value of the transaction represented in the document.
Bank documents are affixed with Non-judicial stamps. The stamp paper should bear the date prior to its
execution and also should be less than six months old.
Other stamps in use are:
• Judicial - used for filing of suits and postal stamps.
• Non-judicial stamps are of three types:
– Adhesive stamps such as revenue stamp, share transfer stamp, notary stamp etc.,
– Special Adhesive stamps which are affixed on letter of guarantee, agreements of pledge, hypothecation
etc. and
– Embossed stamps which are impressed on non-judicial papers used in place of special adhesive
stamps.
Documents if unstamped or under stamped at the time of execution are not documents and are not accepted in
the court. However, before submitting in the court they can be brought in to order by paying penalty, which is
ten times the deficit and then putting the deficit amount of stamps on the document.
For example: a document where stamp duty payable is Rs. 100.00 but is affixed with stamps of Rs. 60.00 (deficit
of Rs. 40.00), then after paying penalty of Rs.400.00 (ten times deficit), the deficit amount of Rs. 40.00 will be
affixed on document (Total amount Rs.440.00) to bring it in order.
FILLING OF DOCUMENTS
Although banks have printed documents, it is necessary to fill the blanks and also to be completed with
alterations, overwriting, cutting etc., if any, with proper authentication. It is to be ensured that the documents
are completed in all respects and no blank places are left. One person in one sitting should complete the
documents in the same ink and same handwriting. Otherwise, it may give impression that the documents were
blank at the time of execution. Subsequent filling of documents without the consent of executants makes the
document invalid.
EXECUTION OF DOCUMENTS
Documents must be executed in the presence of bank officials. Each and every page of the document should be
signed by each and every executant. The signatures on the documents must agree with the signatures on the
loan application form. All alterations, insertions, deletions, additions must be authenticated under full signature
of the executant. If a single document is signed by more than one executant on different dates and at different
places, each executant on the last page of each document must put the date and place below the signature.
If the executant does not understand the language of the document: A separate declaration from him,
in the language known to him must be taken stating that the contents of documents are explained to him and
he has signed the document after having understood the same. The declaration letter should be witnessed by
another person and the same should be attached to the document.
If the person who executes the documents is illiterate: In this case he / she will affix the thumb impression
instead of signature. The bank official in whose presence such documents are executed should give separate
declaration that the contents of the documents are explained to the executant in a language known to him and
thumb impression is affixed after having understood the same. The declaration has to be witnessed by third
person and the same should be attached to the document.
If the person who executes the documents is blind: Then the declaration should be obtained by the lawyer
or the notary and the same should be attached to the document.
If documents are executed by a partnership firm and the minor is admitted for the benefits of partnership
firm: In this case the minor should not sign the documents. When such minor becomes major and if opts to be a
partner, a separate declaration from him to be obtained to make him liable for the firm’s dues. He then becomes
liable for the firm’s acts right from the date of his admission to the benefits of the firm. Minor is not liable for
the losses of the firm. When minor becomes major or becomes aware of the fact that he has been admitted to the
benefits of the firm - whichever date is later - from that day within 6 months he can repudiate the liability as a
partner by giving public notice. In case of partnership firm, the documents should be signed by all the partners
(irrespective of operating instructions in current account), in their representative (under the rubber stamp) as
well as personal capacity.
In case of HUF only the Karta should sign the documents and not the coparceners. However, if the bank wants to
make the coparceners personally liable then all the major coparceners of HUF should also sign the documents.
In case of a company, only those officials who are authorized to sign documents as per the resolution of the
Board, should sign the documents. Bank should obtain a copy of resolution and place on record.
Every company creating a charge on its assets, within or outside India, must register it within 30 days of its
creation, with Registrar of Companies (ROC). If a charge is registered, a person acquiring such assets shall
be deemed to have notice of charge from date of registration. If charge is not registered and a certificate of
registration is not issued by ROC, charge created by a company shall not be taken into account by the liquidator
or any other creditor.
It is the duty of a company to file the details with the Registrar. In case a company fails, the creditor may apply
to the Registrar within prescribed period. ROC, within 14 days, after giving notice to company, allow such
registration.
A company shall give intimation to ROC of the satisfaction in full, of any charge registered, within a period of
30 days from the date of such satisfaction.
When a charge is registered, the priority of charge will be determined by the date of execution of documents
(creation) and not the date of registration.
For example, documents are dated June 5, 2018 with Bank-A (creation of charge) and the charge is registered
on June 25, 2018 (within the stipulated time of 30 days). Whereas on the same assets Bank-B has documents
dated June 7, 2018 and the charge registered on June 22, 2018. Here although Bank-B has registration done on
22nd June 2018, earlier than Bank-A, who has done registration on 25th June, still Bank-A will have priority as
the creation of charge is earlier (and of course registration is done in stipulated time period).
The prescribed details for creation and modification to be filed in form CHG -1 (other than debentures) & CHG
- 9 (for debentures) and satisfaction of the charge should be filed using CHG-4. A duly certified copy of each
document evidencing any creation, modification, satisfaction should be filed with the forms.
In case of Co-operative Societies, documents should be executed by the office bearers as per the resolution
passed in the general body meeting. Bank should have certified up-to-date true copy of Bye-laws on record and
adhere strictly to the procedure / provisions in it as regards credit limit.
Clubs / Institutions / Schools must be incorporated otherwise they are not legal entities and do not have
contracting powers. If they are incorporated, their borrowing powers and procedure is mentioned in their Bye-
laws. Execution of documents should be as per the resolution passed.
When documents are signed in different states by different parties, then the procedure is, the document will be
stamped as per the stamp duty applicable in the state where it is first signed. Then if the document travels to a
state where stamp duty payable is more, then the difference will be paid first and then the second person will
sign. If the document travels to a state where stamp duty payable is less then there is no need to pay any stamp
duty. Any document other than bill of exchange and promissory note, executed out of India, and subsequently
brought to India, will have to be stamped again by the first holder within 3 months from the arrival in India.
When documents are executed by Power of Attorney (PA) holders instead of principals, a notice should be sent to
principal, intimating him about the same and the acknowledgement should be obtained. Such acknowledgement
and the certified copy of PA should be kept on record.
REGISTRATION OF LOAN DOCUMENTS

The purpose of registration of a document is to give notice to public that such a document is executed and also
to ensure that anyone who would like to deal with the property should have complete knowledge of all the
transactions affecting the title to the asset / property. It can also help in preventing frauds and forgeries.
The documents are to be registered at the office of Registrar of Assurances under whose jurisdiction the
property falls (and not where the documents are executed). The time limit for registration is four months from
the execution of document.
Witnessing of documents
It is the attestation of documents by two or more persons who must see the executants signing or putting the
thumb impression, as the case may be, on the documents. Witnessing persons should be third party / should not
be the party to the transaction. Documents which require witnessing, if not witnessed, will not be considered
as duly executed documents.
The documents which need witnessing are:

• All types of deeds - mortgage, sale, guarantee.
• Power of attorney.
• Assignment of LIC on the policy itself.
Documents in the form of agreements (hypothecation, pledge, guarantee), lien, set-off, etc. need not be
witnessed.
Limitation Act, 1963

The documents taken by banks for a credit facility, do not have perpetual life. The provisions of Limitation Act,
1963 apply to them. The Act prescribes the period of limitation for different types of documents. Limitation
period is the time limit within which the parties to a legal agreement, can take action in a court of law to
enforce their legal rights. A suit cannot be filed for recovery on the strength of a time barred document. Hence,
if the documents are time barred, the bank’s right of legal remedy is lost. There are certain rights like lien, set-
off, selling the securities which are pledged where remedy through court is not required. As such there is no
limitation period for these rights.
Extension of Limitation period
A limitation period can be extended in following ways-

• Acknowledgement of Debt
It is an acceptance of liability by the party liable by Letter of Acknowledgement of Debt (LAD), balance
confirmation letter or even ordinary letter. If can be in the form of signing of a balance sheet by authorized
person. It has to be before expiry of limitation period.
• Part payment
If a debtor makes a part payment before expiry of limitation period, himself or if it is made by his authorized
agent, a fresh limitation period starts from the date of such payment. The pay-in-slip has to be filled in
by the debtor himself or signed by him or his agent. It cannot be signed by any other person including
employee of the debtor.
• Obtaining fresh set of documents
When the bank obtains the fresh set of documents before expiry of the original documents, fresh period
of limitation starts from the date of execution of the fresh documents. A time barred debt can be revived
under section 25(3) of Contract Act only by fresh promise in writing and signed by the borrower or his
authorized agent. A promissory note / fresh documents executed for the old or a barred debt will give rise
to a fresh cause of action and a fresh limitation period will start from the date of such documents.
Some important points to be noted as regards the Limitation Act, 1963
• The limitation period cannot be altered (shortened / extended) by mutual consent.
• While computing the limitation period, the document execution date is considered. It means a Demand
Promissory Note (which has a limitation period 3 years from the date of execution) executed on 1st June ,
2018 will have a limitation period up to 1st July, 2021.
• If the court is closed on the day when limitation period expires, suit can be filed on the next working day
of the court.
• The period of person’s absence in India and also where a person is restrained by way of injunction from a
court to enforce a legal remedy are excluded for computing the period.
• Most of the documents have limitation period of three years, and the banks therefore should maintain
proper register to exercise control.
• When different people sign documents on different dates, the limitation period will start from the date,
the last executant has signed.
• It was held by the Supreme Court in one of the cases that the limitation period against the guarantor will
start from the day on which demand is made on the guarantor to pay the money.
Some limitation periods

Demand Loans 3 years from the date of loan.
Demand promissory note 3 years from the date of execution / date of the document.
Term Loan 3 years from the due date of each instalment.
Cash Credit 3 years from the date of documents’ execution.
Facility under charge of pledge Limitation period not applicable.
Bill Discounted 3 years from the due date of the bill.
Bill Purchased 3 years from the date of bill.
Loan under mortgage 12 years from the date of documents’ execution.
Recover of money lost in fraud 3 years from the date on which fraud is detected.
Deposit Accounts 3 years from the date of demand.
Execution of decree 12 years from the date of decree.
SECURITIZATION
Prior to June 21st, 2002 when the Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act was enacted, banks and financial institutions had to enforce their security
through courts for the recovery of their advances. The process was slow and time consuming. Moreover,
hypothecation, the charge against which majority of advances is granted by banks, had no provision in any law.
The SARFAESI Act takes care of these issues.
Securitization is the process of acquisition of Non-Performing Assets (NPA) portfolio of a bank or a financial
institution by Securitization or Reconstruction Company on mutually agreed terms and conditions as regards
sale or transfer price, with or without recourses, transfer or sale etc. Bank gets price in the form of cash or
debentures / bonds as mutually agreed upon. This process provides the banks and FIs a summary procedure for
recovery of their secured dues which have been classified as NPA in their books, by setting up of Securitization
and Reconstruction Company for taking over the defaulted loans.
Securitization or Reconstruction Company may be raising funds for acquisition from their own resources or
from the Qualified Institutional Buyers by issuing security receipts representing undivided interest in the
financial assets or otherwise. The security receipt is transferable in the market. SARFAESI Act, thus makes the
secured NPA portfolio of a bank transferable.
The SARFAESI Act empowers the secured creditor (Bank / FI) as under, if the borrower and or guarantor
defaults:
• To take possession, sell or lease the secured assets (prior to this, a notice has to be served to the borrower
/ guarantor, to clear dues within a time period of 60 days).
• Take over the management of the business or appoint a manager.
• Instruct any person at any time, who holds secured assets of the borrower and from whom any money is
due or becoming due to the borrower; to pay such money to the bank (secured creditor).
• To initiate action in Debt Recovery Tribunal.
In case of consortium or multiple lending arrangement, if 60% of the secured creditors in value, agree to initiate
recovery action, it will be binding on all secured creditors.
Loans not
covered under
SARFAESI Act
Important Provisions and terms in SARFAESI Act

• “Asset reconstruction” means acquisition by any securitization company or reconstruction company, of
any right or interest of any Bank / Financial Institution (‘FI’) in any financial assistance for the purpose of
realization of such financial assistance.
• “Bank” includes all banks - Nationalized, RRBs, Co-operative etc. and any such banks which the Central
Government may by notification, specify for the purpose of this Act, and also FIs.
• “Borrower” is any person who has been granted financial assistance by bank / FI, who has given guarantee
or created any mortgage or pledge as security for the financial assistance granted by any bank / FI. It
also includes a person who becomes borrower of a securitization company or reconstruction company
consequent upon acquisition.
• “Central Registry” means the registration office set up by the Central Government for the purpose of
registration of all the transactions of asset securitization, reconstruction and transactions of creation of
security interests. The registration system operates on the priority of registration basis - person who
registers first gets priority over the one who registers later.
• “Default” means non-payment of any principal debt or interest thereon or any other amount payable by
a borrower to any secured creditor consequent upon which the account of the borrower is classified as
non-performing asset in the books of secured creditor.
• “Financial Assistance” means any credit facility extended by bank or FI such as loan or advance granted,
debentures or bonds subscribed, guarantee given, letter of credit established etc.
• “Financial Asset” means any debt or receivables including -

a. Secured or unsecured claim to any debt or receivables.
b. Any debt or receivables secured by mortgage or charge on immovable property.
c. A mortgage, charge hypothecation, or pledge of movable property.
d. Any right or interest in the security, whether full or part underlying such debt or receivables.
e. Any beneficial interest (existing, future, accruing, conditional or contingent) in the property, whether
movable or immovable, or in such debt, receivables.
f. Any financial assistance.
• “Hypothecation” means a charge in or upon any movable property, existing or future, created by the
borrower in favour of a secured creditor without delivery of possession of the moveable property to such
creditor, as a security for financial assistance and includes floating charge and crystallization of such
charge into fixed charge on movable property.
• “Non-performing Asset” means an asset or account of a borrower, which has been classified by a bank or
FI as sub-standard, doubtful or loss asset in accordance with the directives or guidelines relating to assets
classifications issued by RBI.
• “Property” means -
a. Immovable property.
b. Movable property.
c. Debt or right to receive payment of money, whether secured or unsecured.
d. Existing and future receivables.
e. Intangible assets - know-how, patent, copyright, trade mark, license, franchise or any other business
or commercial right of similar nature.
• “Qualified Institutional Buyer” (QIB) means a FI, insurance company, bank, state financial corporation,
state industrial development corporation or a foreign industrial investor registered under SEBI Act.
• “Reconstruction Company” means a company formed and registered under Companies Act for the
purpose of asset reconstruction.
• “Securitization” means acquisition of financial assets by any securitization / reconstruction company
from any originator, whether by raising of funds by such company on its own or from QIB by issue of
security receipts representing undivided interest in such financial assets or otherwise.
• “Securitization Company” means any company formed and registered under Companies Act for the
purpose of securitization.
• “Secured Asset” means the property on which security interest is created.
• “Secured Creditor” means any bank or FI or any consortium or group of banks or FIs, including - debenture
trustee appointed by any bank or FI or securitization company or reconstruction company.
• “Secured Debt” means a debt which is secured by any security interest.
• “Security Interest” means right, title and interest of any kind whatsoever upon property, created in
favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment.
• “Security Receipt” means a receipt or other security, issued by a securitization company or reconstruction
company to any QIB pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of
an undivided right, title or interest in the financial asset involved in securitization.
Central Registry of Securitization Assets Reconstruction and Security Interest of India (CERSAI) has been
established as a company under Section 8 of the Companies Act, 2013.
Transactions to be registered are - securitization and asset reconstruction, all mortgages, securities
hypothecated, security interest in intangible assets, security interest in under-construction buildings.
The registration should be done within 30 days of transaction. Permission of Central registrar is required
if 30 days delay thereafter. For further delay the permission of Central Government is required.
Banks can take possession of only those securities in respect of which the charge is registered with CERSAI.
Banks will have priority of recovery over Government dues where charge is registered with CERSAI.
RBI guidelines on sale of NPAs
• At least once in a year - preferably in the beginning - banks shall identify and list internally specific financial
assets identified for sale.
• Board should review, at a minimum, all assets classified as ‘doubtful’, above a threshold amount.
• The invitation for bids should preferably be publicly solicited using e-auction platform.
• Prospective buyers must be provided at least 2 week’s time for due diligence.
• Banks should have policy for valuation of assets. In case of exposure beyond Rs. 50.00 crore, banks shall
obtain two external valuation reports.
• The discount rate used in the valuation exercise may be either cost of equity or average cost of funds or
opportunity cost subject to a floor of the contracted interest rate plus penalty, if any.
Obligations of selling bank
• Any NPA asset in the books, is eligible for sale.
• Banks shall sell NPAs on ‘without recourse’ basis.
• Only on receiving the entire sale consideration, the asset can be taken out of books.
• The selling bank can re-purchase the NPAs sold by it, only after specified period and only where SC/RC
have successfully implemented the restructuring plan for the NPAs acquired.
Obligations of the purchasing bank
• Estimated cash flows should normally be realized in 3 years period.
• Can not sell purchased NPAs for a minimum period of one year.
• For the first 90 days from the date of purchase the assets will be classified as standard assets. Thereafter
it will be based on the recovery.
• The risk weight for the purpose of capital adequacy will be considered 100%.
LESSON ROUND UP
• One of the important requirements of the lending banker is to hold valid legal documents. The process of
execution of required documents in the proper form and according to law is known as documentation.
Proper documentation helps in recovery of loans and advances. Banks have their own standard forms
for promissory notes and other documents and no deviations are normally permitted. The borrowers
are expected to execute these documents as required by the bank. Banks also do not generally give
copies of these documents to the borrower which sometimes creates difficulty when these documents
become subject matter of a legal dispute.
• Collateral security if properly obtained with all collateral documents as appropriate would assist the
banks to protect the interests of the banks in case the borrower defaults. These securities supported by
correct and valid documents would assist the banks in recovery process as well.
• Banks should be careful while accepting various securities and ensure such securities are properly
charged (like lien, hypothecation, pledge, assignment, set off and mortgages) in favour of the banks.
TEST YOURSELF
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation)
a. Every company creating a charge on its assets, must register it within ___________ days of its
creation, with ___________.
b. Bank documents are affixed with ___________ stamps.
c. For NPAs purchasing bank, the assets for first 90 days will be classified as ___________.
d. Prospective buyers of NPAs must be provided minimum ___________ for due diligence.
e. Loan with outstanding amount up to ___________ is not eligible under SARFAESI Act.
a. Registration is not required in case of a mortgage deed.
b. Limitation period cannot be shortened or extended by mutual consent.
c. Agreement of Hypothecation need not be witnessed.
d. Charge on the Company’s movable assets pledged to a bank, need not be registered.
e. When a charge is registered, the priority of charge will be determined by the date of registration
and not by the date of creation.
a. List out the documents which require witnessing and documents which do not require witnessing.
b. List out the documents which require registration and documents which don’t.
c. Which charges on the company’s assets are required to be registered with ROC?
d. What are the different ways in which limitation period can be extended?
e. What is securitization?

• www.rbi.org.
Lesson 15 • Calculation of Interest and Annuities 411
Lesson 15
Calculation of Interest and
Annuities
Should Know
• Interest This lesson will enable a student to • Banking Regulation Act, 1949
• Annuity understand
• EMI • the concepts of simple, compound

interest.
• Sinking Fund
• the concepts of annuities and
sinking funds.
• the calculations of equated
monthly installments.
• the concept of annuities.
• the concept and application of
interest calculations based on
products.
• the concept of amortization.
• the concept of sinking funds.
Lesson Outline
• Introduction
• Calculation of Simple Interest
• Calculation of Compound Interest
• Equated Monthly Instalments
• Fixed Interest Rate
• Floating Interest Rate
• Calculation of Annuities
• Interest Calculation using Products/Balances
• Amortisation of a Debt
• Concept of Sinking Funds
• LESSON ROUND UP
• TEST YOURSELF
411
INTRODUCTION
Interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an
amount above repayment of the principal sum (i.e., the amount borrowed), at a particular rate. It is distinct
from a fee which the borrower may pay the lender or some third party. It is also distinct from dividend which is
paid by a company to its shareholders (owners) from its profit or reserve, but not at a particular rate decided
beforehand, rather on a pro rata basis as a share in the reward gained by risk taking entrepreneurs when the
revenue earned exceeds the total costs.
For example, a customer would usually pay interest to borrow from a bank, so they pay the bank an amount
which is more than the amount they borrowed; or a customer may earn interest on their savings, and so they
may withdraw more than they originally deposited. In the case of savings, the customer is the lender, and the
bank plays the role of the borrower.
Interest differs from profit, in that interest is received by a lender, whereas profit is received by the owner of an
asset, investment or enterprise. (Interest may be part or the whole of the profit on an investment, but the two
concepts are distinct from each other from an accounting perspective.)
In economics, the rate of interest is the price of credit, and it plays the role of the cost of capital. In a free market
economy, interest rates are subject to the law of supply and demand of the money supply, and one explanation
of the tendency of interest rates to be generally greater than zero is the scarcity of loanable funds.
Interest income is always considered as the main pillar of any banking institution. As we all know, the definition
of Banking is accepting deposits for the purpose of lending. Whenever a customer takes a loan from a bank, it
charges him/ her certain interest at a predefined and specific rate. The actual meaning of interest is the rate at
which a return is paid by the borrower to compensate the bank for a loss in value of money over period of time.
The payment of the same is either at some time intervals or at the end of the loan period. The said interest is
calculated based on the terms of the agreement between the borrower and the Bank. Many times, based on the
borrower’s needs and the type of the loan, the type of interest is ascertained.
Therefore, the contents of this chapter cover concepts of interests such as simple interest, compound interest,
equated monthly instalment, fixed and floating interest rates, annuities, interest calculations based on products,
concept of amortization and also about sinking funds.
The contents are of practical utility for a student and aimed to make him thorough with all concepts relating to
interest rates. In that sense these contents are of Level 1 orientation enabling students to reinforce themselves
with deeper operational knowledge. Though due to core banking adopted by banks calculation of interest is
done by computers, it is imperative that a student learns the principles on which interest calculations are made
so that these can be explained convincingly where necessary, apart from gaining mastery over the same.
Interest Rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited or
borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal
sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited or
borrowed.
It is defined as the proportion of an amount loaned which a lender charges as

interest to the borrower, normally expressed as an annual percentage. It is the
rate a bank or other lender charges to borrow its money, or the rate a bank pays
its savers for keeping money in an account.
Annual interest rate is the rate over a period of one year. Other interest rates
apply over different periods, such as a month or a day, but they are usually
annualised. Interest rates vary according to:
• the government’s directives to the central bank to accomplish the government’s goals
• the currency of the principal sum lent or borrowed
• the term to maturity of the investment
• the perceived default probability of the borrower
• supply and demand in the market
Reasons for Interest Rate changes

• Political short-term gain: Lowering interest rates can give the economy a short-run boost. Under normal
conditions, most economists think a cut in interest rates will only give a short-term gain in economic
activity that will soon be offset by inflation. The quick boost can influence elections. Most economists
advocate independent central banks to limit the influence of politics on interest rates.
• Deferred consumption: When money is loaned the lender delays spending the money on consumption
goods. Since according to time preference theory people prefer goods now to goods later, in a free market
there will be a positive interest rate.
• Inflationary expectations: Most economies generally exhibit inflation, meaning a given amount of money
buys fewer goods in the future than it will now. The borrower needs to compensate the lender for this.
• Alternative investments: The lender has a choice between using his money in different investments. If
he chooses one, he forgoes the returns from all the others. Different investments effectively compete for
funds.
• Risks of investment: There is always a risk that the borrower will go bankrupt, abscond, die, or otherwise
default on the loan. This means that a lender generally charges a risk premium to ensure that, across his
investments, he is compensated for those that fail.
• Liquidity preference: People prefer to have their resources available in a form that can immediately be
exchanged, rather than a form that takes time to realize.
• Taxes: Because some of the gains from interest may be subject to taxes, the lender may insist on a higher
rate to make up for this loss.
• Banks: Banks can tend to change the interest rate to either slow
down or speed up economy growth. This involves either raising
interest rates to slow the economy down, or lowering interest
rates to promote economic growth.
• Economy: Interest rates can fluctuate according to the status
of the economy. It will generally be found that if the economy is
strong then the interest rates will be high, if the economy is weak
the interest rates will be low.
CALCULATION OF SIMPLE INTEREST

Simple interest is a type of interest that is applied to the amount borrowed for the entire duration of the loan,
without considering any other factors, such as past interest (paid or charged) or any other financial aspects.
Simple interest is generally applied to short-term loans, usually one year or less. It is also called as ‘Flat rate’ as
its the amount charged for each year at a fixed percentage for the amount borrowed.
Following is the formula for calculation of simple interest:
Interest =
In above formula
Interest = Total interest charged for the given period
P = Principal amount that was borrowed
R = Rate of interest specified
T = Time or duration of the loan in years
If Mr. A has borrowed Rs. 10000/- from ABC bank at 15% rate for one year, the interest the Bank would charge is
Interest =
Interest =
Interest = 1500/-
Similarly using the above equation, we can get the value of other variations also.
Example 1:
A sum of Rs. 30000 becomes Rs. 33000 at the end of 2 years when calculated at simple interest. The rate of
interest would be-.
Solution:
Simple interest = 33000 – 30000 = 3000 Time = 2 years.
Interest =
R = 3000 * 100 / 30000 * 2

R = 5%.
Example 2:
At what rate percent per annum simple interest will a sum of money double itself in 6 years?
Solution:
Let P = x, then A = 2x
Also, S.I. = A – P
= 2x – x
=x
T = 6 years
We know that S.I. = (P × R × T)/100 (x × R × 6)/100 = x
R = 100x/6x = 16.6 %
Example 3:
A sum amounted to Rs 2520 at 10% p.a. for the period of 4 years. Find them sum.
Solution:
Let A = Rs. 2520
R = 10% p.a.
T = 4 years
P=?
Let the principal be x
S.I = (x × 10 × 4)/100 = 2x/5 A = P + I
A = x + 2x/5
A = (5x + 2x)/5 = 7x/5 [But given that A = Rs. 2520] 7x/5 = 2520
7x = 2520 × 5
x = (2520 × 5)/7 = Rs. 1800
CALCULATION OF COMPOUND INTEREST

In simple interest calculation, the assumption is that the interest would be charged only once during the given
period. In contrary to this, if the interest is charged more than once in the prescribed duration, the interest has
to be re-invested. It is called as the compound interest. It is the addition of interest to the principal amount, or
in other words, it is interest on interest. It is the result of reinvesting interest, rather than paying it out, so that
interest in the next period is then earned on the principal sum plus previously accumulated interest.
Simple Interest Compound Interest
It is calculated on the total principal amount for the It is calculated on the principal amount periodically
total tenure. (monthly, quarterly, half-yearly or annually).
The accumulated interest on the principal is not added The interest that you accumulate periodically is added
to the calculation of interest for the next period. to the calculation of interest for the next period.
The interest earned/paid will not increase even if the The interest earned or paid will increase if the
calculation is done periodically. frequency of interest generation or payment is more.
The accumulation of interest is slow. The accumulation of interest is fast since you get
interest on the growing interest amount as well.
Simple interest will not earn you enough for savings Compound interest will earn you more in savings and
and investments but will benefit you if you take a loan. investments but will be costlier on a loan.
It is not good for wealth creation. It is good for wealth creation.
It is beneficial to the borrower but not to the lender. It is beneficial to the lender but not to the borrower.
You will be paying less on a loan that is taken on You will be paying more on a loan that is taken on
simple interest. compound interest.
Simple interest is easy to calculate. Compound interest is complicated to calculate.
Comparative analysis of Simple Interest and Compound Interest The formula for compound interest is
A = P (1 + R)n
Where
P = Principal Amount
R = Rate of interest (Annual) n = Number of years
A = Amount of money accumulated after n year including interest
Financial institutions vary in terms of their compounding rates - daily, monthly, yearly, etc.
As a simple example, a savings account with Rs. 1000 principal and 10% interest per year (compounded yearly)
would have a balance of Rs. 1100 at the end of the first year. By the end of the second year, the Rs. 1100 amount
would have received 10% more, making Rs. 1210. And this will continue for the end of the tenure of the principal
borrowed.
The formula for annual compound interest, including principal sum, is:
A = P (1 + r/n)(nt)
Where:
A = the future value of the investment/loan, including interest
P = the principal investment amount (the initial deposit or loan amount)
r = the annual interest rate (decimal)
n = the number of times that interest is compounded per year
t = the number of years the money is invested or borrowed for
Note that this formula gives you the future value of an investment or loan, which is compound interest plus the
principal. If we want to derive at the compound interest only, following formula is useful:
Total compounded interest = P (1 + r/n)(nt) – P
Example 4:
If Mr. Darshan invests Rs. 20000/- into a Fixed Deposit, paying 10% annual interest the accumulation of the
interest is quarterly, how much money will he get after 10 years?
Solution:
Given information P = 20000, r = 0.1, n = 4, t = 10
A = 20000 1 + 0.1/44(10)
A = 20000 X 2.685063838
A= 53701.27
So, Mr. Darshan will get Rs. 53701.27 after 10 years.
Example 5:
If Mr. Sudhakar wants have Rs. 25000 after 4 years, how much money he would need to deposit today at 8%
annual interest compounded monthly?
Solution:
Given information-
P = ?, r = 0.8, n = 12, t = 4, A = 25000 25000 = P 1 + 0.08/1212(4)
25000 = P 1.375666
P = 18173.01
So, Mr. Sudhakar should invest Rs. 18173.01.
Equated Monthly Instalments (EMI)

An equated monthly instalment (EMI) is a fixed payment amount made by a borrower to the lender on a
specified date each calendar month. Equated monthly instalments are used to pay off interest and principal
each month so that over a specified number of years, the loan is paid off in full. It consists of both, payment
towards interest and payment towards principal. EMI is derived based on the amount borrowed, interest rate
and the time for which the loan is taken.
E M I
Equated Monthly Instalments
The formula to calculate the EMI is
EMI = [P × r × (1 + r)n] / [(1 + r)n – 1]
where, P = loan amount or principal,
r = interest rate per month [if the interest rate per annum is 9%, then the rate of interest will be 9/(12 x 100)],
and
n = the number of monthly instalments.
Example 6:
Calculate EMI if Loan amount = Rs. 10,00,000, interest rate is 11% and loan period is 15 year.
Solution:
P = Rs.10,00,000
Interest rate (r) = (11% rate) / 12 months = 11% / 12 months = 0.0091
Loan period (N)= 15 years = 180 months
EMI = [P x r x (1 + r)n] / [(1 + r)n – 1]
EMI =
EMI = Rs. 11,365.96

As the interest calculation is on the reducing amount of the principal, the amount of EMI remains constant
throughout the period.
Following table can illustrate the calculation and the appropriation of the interest and the principal amount.
A loan of Rs. 2,00,000 is taken at 10% interest rate for 18 months.
Date on which the EMI Interest Calculated Net amount after Principal
EMI is paid @ 10% Interest adjusted outstanding
towards principal
1/1/2018 12011.42 1666.67 10344.75 189655.25
1/2/2018 12011.42 1580.46 10430.96 179224.30
1/3/2018 12011.42 1493.54 10517.88 168706.41
1/4/2018 12011.42 1405.89 10605.53 158100.89
1/5/2018 12011.42 1317.51 10693.91 147406.98
1/6/2018 12011.42 1228.39 10783.02 136623.95

1/7/2018 12011.42 1138.53 10872.88 125751.07
1/8/2018 12011.42 1047.93 10963.49 114787.58
1/9/2018 12011.42 956.56 11054.85 103732.73
1/10/2018 12011.42 864.44 11146.98 92585.75
1/11/2018 12011.42 771.55 11239.87 81345.88
1/12/2018 12011.42 677.88 11333.53 70012.35
1/1/2019 12011.42 583.44 11427.98 58584.37
1/2/2019 12011.42 488.20 11523.21 47061.16
1/3/2019 12011.42 392.18 11619.24 35441.92
1/4/2019 12011.42 295.35 11716.07 23725.85
1/5/2019 12011.42 197.72 11813.70 11912.15
1/6/2019 12011.42 99.27 11912.15 0.00
FIXED INTEREST RATE

A fixed interest rate is an unchanging rate charged on a liability, such as a loan or mortgage. It might apply
during the entire term of the loan or for just part of the term, but it remains the same throughout a set period.
Mortgages can have multiple interest-rate options, including one that combines a fixed rate for some portion of
the term and an adjustable rate for the balance. These are referred to as “hybrids.”
Salient points as regards fixed interest rate are as under:
• A fixed interest rate avoids the risk that a mortgage or loan payment can significantly increase over time.
• Fixed interest rates can be higher than variable rates.
• Borrowers are more likely to opt for fixed-rate loans during periods of low interest rates.
• Advantages and Disadvantages of Fixed Interest Rates
• Fixed rates are typically higher than adjustable rates. Loans with adjustable or variable rates usually offer
lower introductory rates than fixed-rate loans, making these loans more appealing than fixed-rate loans
when interest rates are high.
• Borrowers are more likely to opt for fixed interest rates during periods of low interest rates when locking
in the rate is particularly beneficial. The opportunity cost is still much less than during periods of high
interest rates if interest rates go lower.
FLOATING INTEREST RATE

As mentioned in the name, this rate is not fixed, it may change subject to the market conditions. That is to say
the rate of interest which is tied to a bench mark rate. As and when the bench mark rate undergoes a change
the rate of interest under floating rate will change. It is also called as variable rate. The bench mark rate should
be made known by the bank to the depositor or borrower at the time of making the deposit or taking advances.
Example of bench mark rates could be Repo rate or Bank rate or Marginal Cost of Lending Rate (MCLR). Let us
see an example of floating rate linked to repo rate. If the floating rate quoted by the bank is = Repo rate + 100
basis point (i.e., 1%)
Let’s us assume the repo rate for four quarters as:
1st Quarter = 5.50 %;
2nd Quarter = 5.75%;
3rd Quarter = 5.40%;

4th Quarter = 5.90%.
Then the corresponding interest rates will be :
1st Quarter = 6.50%;
2nd Quarter = 6.75%;
3rd Quarter = 6.40%;
4th Quarter = 6.90%.
It can be seen from the above that floating rates can increase or decrease depending upon the movement of
bench mark rate. It can be advantageous to the customer or it can be disadvantageous depending upon the
bench mark rate movement. These days banks offer floating rate-based deposits as well as loans such as housing
loans / personal loans. This is subject to the conditions that there has to be complete transparency regarding
the rate calculation from the bank side. Under the floating rate loan if the loan is being repaid by an EMI, the
repayment tenure will be changed without disturbing the amount of EMI.
Annuities
An annuity is a financial product that provides certain cash flows at equal time intervals. Annuities are created
by financial institutions, primarily life insurance companies, to provide regular income to a client.
An annuity is a reasonable alternative to some other investments as a source of income since it provides
guaranteed income to an individual. However, annuities are less liquid than investments in securities because
the initially deposited lump sum cannot be withdrawn without penalties.
Upon the issuance of an annuity, an individual pays a lump sum to the issuer of the annuity (financial institution).
Then, the issuer holds the amount for a certain period (called an accumulation period). After the accumulation
period, the issuer must make fixed payments to the individual according to predetermined time intervals.
Annuities are primarily bought by individuals who want to receive stable retirement income.
Types of Annuities
There are several types of annuities that are classified according to frequency and types of payments. For
example, the cash flows of annuities can be paid at different time intervals. The payments can be made weekly,
biweekly, or monthly.
The primary types of annuities are:
1. Fixed annuities
Annuities that provide fixed payments. The payments are guaranteed, but the rate of return is usually
minimal.
2. Variable annuities
Annuities that allow an individual to choose a selection of investments that will pay an income based on
the performance of the selected investments. Variable annuities do not guarantee the amount of income,
but the rate of return is generally higher relative to fixed annuities.
3. Life annuities
Life annuities provide fixed payments to their holders until his/her death.
4. Perpetuity
An annuity that provides perpetual cash flows with no end date. Examples of financial instruments that
grant the perpetual cash flows to its holders are extremely rare.
Timing of payments
Payments of an annuity-immediate are made at the end of payment periods, so that interest accrues
between the issue of the annuity and the first payment. Payments of an annuity-due are made at the
beginning of payment periods, so a payment is made immediately on issue.
Contingency of payments
Annuities that provide payments that will be paid over a period known in advance are annuities certain or
guaranteed annuities. Annuities paid only under certain circumstances are contingent annuities. A common
example is a life annuity, which is paid over the remaining lifetime of the annuitant. Certain and life annuities
are guaranteed to be paid for a number of years and then become contingent on the annuitant being alive.
Variability of payments
• Fixed annuities – These are annuities with fixed payments. If provided by an insurance company, the
company guarantees a fixed return on the initial investment.
• Variable annuities –A variable annuity is a type of annuity contract that allows for the accumulation
of capital on a tax-deferred basis. As opposed to a fixed annuity that offers a guaranteed interest rate
and a minimum payment at annuitization, variable annuities offer investors the opportunity to generate
higher rates of returns by investing in equity and bond subaccounts. If a variable annuity is annuitized for
income, the income payments can vary based on the performance of the subaccounts.
• Equity-indexed annuities – Annuities with payments linked to an index. Typically, the minimum payment
will be 0% and the maximum will be predetermined. The performance of an index determines whether
the minimum, the maximum or something in between is credited to the customer.
Deferral of payments
An annuity which begins payments only after a period is a deferred annuity. An annuity which begins payments
without a deferral period is an immediate annuity.
CALCULATION OF ANNUITIES
A series of fixed payments over a period of time or receipt of payments is known as Annuity. The fixed period
can be monthly, quarterly, half-yearly (semi-annual), and yearly (annual).
Under Ordinary Annuities payments are received at the end
of the period. The best example is fixed deposit interests
received at the end of every quarter or interest payments
received on bonds at the end of year.
Under Annuities Due, payments are received at the
commencement of the period. Rental payments which are
paid in advance to a land lord by a tenant.
Annuity calculations involve the concept of Present value and
future value of money. Present value of future receivables:
If we have to determine the present value of future cash flows or payments, we have to use the present value
table for ordinary annuity. We can also use the mathematical formula. In other words, we will arrive at the
discounted value or the present value of every future cash flow.
This can be mathematically done by using the following formula:
PV of ordinary annuity = Equation 1
Where, C = Cash flow per period

r = rate of interest
n = number of payments
Example 7:
Let us consider an example: You are receiving Rs. 10,000 every year as interest for the next 5 years and you
are investing the same @ 5%
Then the PV of ordinary annuity = 10000 [(1 + 0.05) 5 - 1) / 0.05 (1.05) 5]
= 10000 (0.27628) / 0.063814)
= 10000 (4.32948)
= 43294.80
For finding the future value of ordinary annuity the following formula can be used:
FV of Ordinary Annuity = C Equation 2
C = the cash flow per period

r = the rate of interest
n= number of payments
Example 8:
Let us take the same example as cited in the above example under Present value of ordinary annuity.
where C = 10,000, r = 5% n = 5. Substituting the value in the above formula
FV = 10000 [(1 + 0.05)5 - 1) / (0.05)5]
FV = 10000 × 5.52563
= 55256.30
PRESENT VALUE OF AN ANNUITY DUE

For the purpose of calculating present value of an annuity due, we need to use the discounted formula for a
period as payments are received in advance. It is very similar to the receiving rent in advance. For this purpose,
make use of the mathematical formula as given below:
PV of Annuity Due = Equation 3
Note: The notations C, r and n carry the same meaning and value as in Equation 1.
Example 9:
It can be noticed that equation 1 and 3 are more or less the same except for the modifying factor of (1 + r).
Talking the same values as mentioned in Example 1 if we substitute the same in Equation 3, the value works
out to as follows:
Then the PV of due = 10000 [(1 + 0.05)5 - 1) / 0.05(1.05)5] × 1.05
= 10000 (0.27628) / 0.063814) × 1.05
= 10000 (4.32948) × 1.05
= 45459. 56
FUTURE VALUE OF AN ANNUITY DUE

Under this calculation as payments are received in advance, (that is to say earlier when compared to ordinary
annuity) they are held for a longer period than payment or receipts received at the end of the period. This is
equal to receiving a payment on January 1 than receiving the same on December 31 of the same year. Under this
circumstance we have to modify Equation 2 in Example 2 as under:
FV of Ordinary Annuity = Equation 4
Substituting the values for C, r and n
Example 10:
FV Annuity Due = 10000 [ (1 + 0.05)5 - 1) / 0.05] × (1.05)
= 10000 × 5.52563 × 1.05
= 55256.30 × 1.05
= 58019. 12
Thus, it can be seen from examples 6, 7, 8 and 8 that there is a difference in monetary terms, between
payments made in advance and when payments are made in arrears.
INTEREST CALCULATION USING PRODUCTS / BALANCES

While making interest calculation on various credit facilities banks adopt the following methods of charging
interest rates.
Upfront charging of interest

While discounting of bills such as Documentary Bills or Time bills banks charge interest rates for the period of
the bill and only after deducting this amount along with other applicable charges such as postage, the balance
amount is paid to the customer. This is known as upfront charging or front-end charging of interest.
Let us say the bill is for Rs. 1,85,000 of 3 months duration. Discount rate is 14% p.a. and the postage is Rs. 150.
Then amount of credit that will be passed on to the customer is as below:

Amount of the bill = 1, 85,000
Less Discount = 6475 [(185000 × 0.14)] / 4)
Less Postage = 150
Amount of credit to the customer = 1,78,375
You will note that the bank will pass on the credit of Rs. 1,78,375 only after deducting interest and postage of
Rs. 6625.
End of the period charging of interest

On the contrary when a term loan is extended or cash credit extended, interest is charged at the end of the
month or quarter as per the sanctioned terms. In the case of Cash Credit facility, the daily outstanding, in the
form of closing balance is taken in to account. The closing balance is multiplied by the number of days it was
outstanding and products are arrived at. The product thus arrived is multiplied by the rate of interest specified
for the account and divided by 365 days to arrive at the exact interest rate.
The following example will illustrate the concept of end of the period or back-end charging of interest rate.
Let us assume following debit balances remain outstanding in a CC account. The CC limit sanctioned is
Rs.1,00,000 at an interest rate of 14% p.a. The interest is charged on monthly basis. Let us calculate products
and interest for the entire month of July.
Limit: Rs. 1,00,000
Rate of Interest: 14% p.a.
Date Closing Balance (Dr)| No. of days Products
(A) (B) outstanding (C) (B) × (C) = (D)
1.7.2018 20,000 6 120000
7.7.2018 35,000 3 105000
10.7.2018 45000 5 225000
15.7.2018 52000 6 312000
21.7.2018 72000 7 504000
28.7.2018 44000 3 132000
31.7.2018 39000 1 39000
1.8.2018 55000 ** **
Closing balance of 55000 falls in the month of August. Hence it will be taken in to account for the calculation of
interest for August. Therefore, it will not be included in July products.
Calculation of interest:
The total of the product (D) above, works out to 14,37,000 Applicable interest rate is 14% p.a. = 14/100 = 0.14
Interest would be = (1437000 * 0.14) / 365
= Rs. 551.17
Interest applicable for the month of July = Rs. 551.17 and the same will be debited to the customer’s account.
In the same manner interest for quarterly period may can also be calculated.
The above methodology is also applicable in the case of Savings Bank too. However, the interest calculated for
Savings Bank account will be credited to the account of the customer as it is a deposit account.
Amortisation of a Debt
The word amortisation means spread over a period. It means “to gradually write off the initial cost of (an asset)
over a period”. The term is also used in the context of “to reduce or pay off (a debt) with regular payments.”
The concept of amortization can be understood by the following example:
Mr. A has been granted a loan of Rs. 66,000 at an interest rate of 12% p.a. (i.e., 3% per quarter). The loan is to
be amortised through a quarterly instalment payment of Rs. 5000 each. Work out an amortization schedule for
this loan.
The amortization schedule is as follows:
Instalment Nr. Instalment Int Qrly 3% per Principal repaid Principal
quarter Outstanding
1 5000.00 1980.00 3020.00 62980.00
2 5000.00 1889.40 3110.60 59869.40
3 5000.00 1796.07 3203.93 56665.47
4 5000.00 1699.95 3300.05 53365.42
5 5000.00 1600.95 3399.05 49966.37
6 5000.00 1498.98 3501.02 46465.35
7 5000.00 1393.95 3606.05 42859.30
8 5000.00 1285.77 3714.23 39145.07
9 5000.00 1174.35 3825.65 35319.42
10 5000.00 1059.57 3940.43 31378.99
11 5000.00 941.34 4058.66 27320.33
12 5000.00 819.60 4180.40 23139.93
13 5000.00 694.17 4305.83 18834.10
14 5000.00 565.02 4434.98 14399.12
15 5000.00 431.97 4568.03 9831.09
16 5000.00 294.93 4705.07 5126.02
17 5000.00 153.78 4846.22 279.80
18 288.20 8.40 279.80 0.00
Total repaid 85288.20 19288.20 66000.00
CONCEPT OF SINKING FUNDS

A sinking fund is a means of repaying funds borrowed through a bond issue through periodic payments to
a trustee who retires part of the issue by purchasing the bonds in the open market. Rather than the issuer
repaying the entire principal of a bond issue on the maturity date, another company buys back a portion of the
issue annually and usually at a fixed par value or at the current market value of the bonds, whichever is less.
Sinking fund is an amount of money that is accumulated in a systematic way of over a period of time to meet
a future requirement or a contingency or cost of replacement of an asset. Since the amount of sinking fund
needed is known in advance along with other parameters such as interest rate are known, it is easy to work out
such a schedule. This is very similar to calculating the future value of annuity. Salient issue of the sinking fund
is highlighted as follows:
• A sinking fund is an account containing money set aside to pay off a debt or bond.
• Sinking funds may help pay off the debt at maturity or assist in buying back bonds on the open market.
• Callable bonds with sinking funds may be called back early removing future interest payments from the
investor.
• Paying off debt early via a sinking fund saves a company interest expense and prevents the company from
being put in financial difficulties in the future.
Advantages and Disadvantages of a Sinking Fund
A sinking fund improves a corporation’s credit worthiness, letting the business pay investors a lower interest
rate. Because of the interest savings, the corporation has more net income and cash flow for funding operations.
Also, businesses may deduct interest payments given to lenders from their taxes, helping increase cash flow as
well. Corporations may use the savings for covering sinking fund payments or other obligations. In addition,
investors appreciate the added protection a sinking fund provides, making investors more likely to lend a
company money. A business that is controlling its money is less likely to default on outstanding debt.
However, if interest rates decrease and bond prices increase, bonds may be called and investors may lose some
of their interest payments, resulting in less long-term income. Also, investors may have to put their funds
elsewhere at a lower interest rate, also missing out on potential long-term income.
The general formula for future value of annuity can be calculated by the formula is as below:
Here F is the future value of annuity ‘A’ is amount borrowed, ‘r’ is the rate of interest, n is the number of years
or period of loan. The following examples illustrate the concept of sinking fund:
1. A student borrows a sum of Rs. 1,00,000 per year at an interest rate of 6% for period of 5 years to complete
a professional degree from a bank. How much money the student owes to the bank at the end of 5 years?
Substituting the values in the equation mentioned above
= 100000 (0.34)/0.06
= 566666.67
The amount of money owed by the student will be Rs. 5,66,666.67.
2. A civil engineering company wish to buy a generator costing Rs. 700000 in 5 years. How much money the
company should save annually if the rate of interest on its return is 10%.?
The value of F = 700000 n = 5, r = 0.10. If we substitute the same in the equation
700000 =
Solving for A =
A = 114754.10
The company has to save a sum of Rs. 114754.10 per annum.
3. A company expects drilling machine of value 80,000 will last for 10 years’ time with a salvage value of Rs.
8000. A new machine may cost Rs. 104000 at that point in time. The company wishes to set up a sinking
fund with a return of 8%. What should be the annual savings by the company for contributing to the
sinking fund?
Here in the problem n = 10 r =0.08 F = (104000 – 8000) = 96000

Substituting the value in equation and solving for A
96000 =
A =
A = 6620.68
The company should be contributing a sum of Rs. 6620.68 every year to the sinking fund in this case.
estimation of annuity value of payment values over a period. A better understanding of these concepts will
improve effectiveness while working in a bank or otherwise.
LESSON ROUND UP
• Charging of interest is an essential part of operational banking. It also forms the income streams for
banks. Banks pay interest on certain products on simple interest basis and on other products they
also pay interest on compound interest basis. They also charge interest on loan products on simple
and compound interest basis as applicable in each case. Banks also use Equated Monthly Instalment
payment option while fixing loan repayment by borrowers mostly on term loans. Due to financial
innovation, banks also offer a choice of fixed or floating interest basis on certain products based on
specific terms and conditions. Banks also use the concept of annuities in interest calculations for
offering the same to customers. For borrowers of certain products like bill discounting banks collect
interest on front end basis while on facilities lime cash credit banks levy interest on daily product basis
on a backend basis. Loan repayments involving quarterly or half yearly or annual basis are based on
the principle of amortization. The concept of sinking fund is used both by banks and customers for
estimation of annuity value of payment values over a period. A better understanding of these concepts
will improve effectiveness while working in a bank or otherwise.
TEST YOURSELF
a. Simple interest is also known as _____________.
b. Compound interest is can be said to be interest on _______________.
c. ______________________ is an amount made by a borrower to the lender on a specified date each
calendar month.
d. Fixed interest rates do not get affected by _____________.
e. Floating interest rate is tied to ______________.
f. Annuities can be broadly classified ______________ and ________________.
g. Interest rates are charged by banks can be divided in to _____________ and _________ methods.
h. Amortization means _________________.
a. Simple interest is generally applied to short-term loans, usually one year or less.
b. Financial institutions levy compounding rates only on daily basis.

c. An equated monthly instalment (EMI) is a variable payment amount made by a borrower to the
lender on a specified date each calendar month.
d. In general, fixed interest rate is higher than floating rate and does not get affected by market
fluctuations.
e. Repo rate or Bank rate or Marginal Cost of Lending Rate (MCLR) are examples of fixed interest
rates.
f. Under annuities due, payments are received at the commencement of the period.
a. State the difference between simple interest rate and compound interest rate.
b. Explain the concept of EMI and its effect on repayment of loans.
c. State different types of annuities and briefly explain the same.
d. What is amortization debt? How it is practically used in real life?
e. Explain what is sinking funds with a few examples.

• Financial Management - Theory and Practice by Dr. Prasanna Chandra
• Reading Materials from internet
Lesson 16 • Calculation of YTM 429
Lesson 16 Calculation of YTM

Should Know
This lesson will enable a student to
• YTM understand: • Banking Regulation Act, 1949
• Financial Market • Various debt instruments.
• Risk • Important terms involved in
• Bonds and them definitions.
• Bonds and their characteristics.
• Bond value determination.
• Yield and calculation.
• Concept of YTM and its
calculation.
• Theorems of Bond valuation.
• Concept of duration and its
computation.
• Interest rate elasticity.
• Bond volatility.
Lesson Outline
• Introduction
• Debt-Definition, Meaning & Salient Features
• Introduction to Bonds
• Terms associated with Bonds
• Cost of Debt Capital
• Bond value with semi-annual Interest
• Current Yield on Bond
• Calculation of Yield-to-Maturity of Bond
• Theorems for Bond Value
• Duration of Bond
• Properties of Duration
• Bond Price Volatility
• LESSON ROUND UP
• TEST YOURSELF
• LIST OF THE FURTHER READINGS
429
INTRODUCTION
One of the core functions of banks, apart from accepting deposits and lending is investments in bonds and
securities etc. As a part of statutory compliance, banks have to invest in SLR securities which largely consist of a
portfolio of bonds, other long-term securities and money market securities. Income from securities also forms
an important component of profits of a banking entity. Though every operating banker may not be involved
in operational aspects of investments, an exposure to securities, enhances his understanding of the investible
avenues. Also, as several banks are involved in wealth management advisory work for clients, it is expected
that an exposure to securities will enhance the personal effectiveness of such persons who are involved in such
work.
Keeping this in view, this lesson focuses on securities which are dealt by banks as a matter of their routine
investment/trading decisions.
Accordingly, this lesson covers debt, definitions of various terms involved, Bonds and their characteristics,
calculation of bond values, calculation of yield, concept of YTM and its calculation, theorems of bond value,
duration and its properties, aspects of bond volatility. Suitable mathematical examples are included wherever
necessary to demonstrate the application of theoretical discussion for practical utility.
Structure of Indian Financial System
Fig. The Structure of Financial System

The financial structure refers to the shape, constituents and their order in the financial system. The financial
system consists of specialized and unspecialized financial institutions, organized and unorganized financial
markets, financial instruments and services which facilitate transfer of funds. A financial system consists of
financial institutions, financial markets, financial instruments and financial services which are all regulated by
regulators like Ministry of Finance, RBI, SEBI, IRDA, Department of Economic Affairs, Department of Corporate
Affairs, etc., which facilitate the process of smooth and efficient transfer of funds.
Fig. Structure of Indian Financial System

Classification of Financial Markets

There are different ways of classifying financial markets. One way of classifying the financial markets is by the
type of financial claim into the debt market and the equity market. The debt market is the financial market
for fixed claims like debt instruments. The equity market is the financial market for residual claims i.e., equity
instruments. A second way of classifying the financial markets into money market and capital market is on the
basis of maturity of claims.
Financial Market Classification

Criterion Features Examples
Products Tradability, transferability, ownership, Equity, debt instruments, derivatives
maturity, denomination, substance
Services Technical, advisory, information and IT support, research and analysis, custody
knowledge-based, administrative
Ways of trading Physical, electronic, virtual Over the counter, exchange, internet
Origin Domestic, cross-border, regional, National markets, regionally integrated
international markets, Euromarkets, domestic/foreign
currency markets, onshore/offshore markets
Money Market
Money market is a very important segment of the Indian
financial system. It is the market for dealing in monetary
assets of short-term nature. Short-term funds up to one year
and for financial assets that are close substitutes for money
are dealt in the money market. It is not a physical location
(like the stock market), but an activity that is conducted
over the telephone. Money market instruments have the
characteristics of liquidity (quick conversion into money),
minimum transaction cost and no loss in value. Excess funds
are deployed in the money market, which in turn is availed of
to meet temporary shortages of cash and other obligations.
Money market provides access to providers (financial and other institutions and individuals) and users
(comprising institutions and government and individuals) of short-term funds to fulfil their borrowings and
investment requirements at an efficient market-clearing price. The rates struck between borrowers and
lenders represent an array of money market rates. The interbank overnight money rate is referred to as the call
rate. There are also a number of other rates such as yields on treasury bills of varied maturities, commercial
paper rate and rates offered on certificates of deposit. Money market performs the crucial role of providing an
equilibrating mechanism to even out short-term liquidity and in the process, facilitating the conduct of monetary
policy. Short- term surpluses and deficits are evened out. The money market is the major mechanism through
which the Reserve Bank influences liquidity and the general level of interest rates. The Bank’s interventions to
influence liquidity serve as a signaling device for other segments of the financial system.
The Indian money market was segmented and highly regulated and lacked depth till the late eighties. A
limited number of participants, regulation of entry and limited availability of instruments characterized it.
The instruments were limited to call (overnight) and short notice (up to 14 days) money, inter-bank deposits
and loans and commercial bills. Interest rates on market instruments were regulated. Sustained efforts for
developing and deepening the money market were made only after the initiation of financial sector reforms in
early nineties.
DEBT
Definition: A debt is an obligation to pay a sum of money borrowed, with interest on the same at a fixed interval
or as agreed with a lender. Now-a-days Government, public sector companies or private corporate entities issue
debt instruments in the form of Bonds and Debentures to raise capital. Such types of instruments are called
debt securities. These debt securities are tradable in the debt markets.
When a legal entity issues a debt instrument in the form of a bond or a debenture, it amounts to borrowing
money from the investors (who assume the position of lender).
As a part of the terms of the debt, the lenders have a right to receive interest at a stipulated rate or guaranteed
rate from the legal entity during life of such debt instruments at fixed intervals. Another advantage for issuers
of debt capital is the tax deduction available for coupon payments under the Income tax regulations, unlike
equity capital where dividend payments are taxable. This feature results in lesser cost of capital in respect of
debt instruments for the issuer of debt.
As an investment, bonds are riskier, but pay a higher interest rate, than money market funds, demand deposits
or checkable deposits, but are safer than stocks, and usually less profitable, because they have no potential for
growth.
Bonds are long-term debt or funded debt, issued by corporations, and governments and their agencies to
finance operations or special projects. Corporations pay back interest and principal from earnings, whereas
governments pay from taxes, or revenues from special projects. Unlike preferred stock, a corporation must pay
interest on its bonds, and if the corporation goes bankrupt, bondholders are paid before stockholders.
Bonds are issued in the form of promissory note and therefore attract the provisions of Negotiable Instruments
Act, 1881. They are transferrable by endorsement and delivery without attracting stamp duty.
Though Bonds and debentures form part of debt instruments there are certain differences between them.
They are as follows:
Bonds Debentures
1. Issued in the form of Promissory Notes. 1. They are in the form of acknowledgement of debt.
2. They can be transferred by endorsement and 2. Transferability is not possible.
delivery.
3. Carries higher stamp duty. 3. Carries lesser stamp duty.
4. Normally are not convertible in to shares. 4. Options are available for conversion in to shares.
Broadly in India the following debt instruments are issued:

Sr. No. Type of Security Standard Features
1 Government of India securities Medium to Long term dated securities issued by RBI on behalf
of Government of India. Coupon payments are half yearly basis.
(Semi-annual).
2 State Government Securities Medium to Long term issued by RBI on behalf of State
Governments. Coupon payments are half-yearly.
3 Government Guaranteed Bonds Medium to Long term bonds issued by Government owned
agencies and guaranteed by either Central/State government/s.
Coupon payments are half-yearly.
4 Public Sector Undertaking Bonds Issued by either Central or State government owned enterprises
for medium to long term periods. Coupon payments are half-
yearly.
5 Private Corporate Debentures Issued by rated private companies, for short and medium terms.
Coupon payments can be annual or semi-annual or cumulative.
6 Money Market Instruments Specific debt instruments like Treasury bills/CPs/CDs with a
tenor of up to one year.
For example, if Larsen & Toubro Company Limited issues a bond of Face value of Rs. 1,000 carrying an interest
rate (also known as ‘Coupon rate’) 11% with a maturity of 8 years, the bond holder will get Rs.110 every year
for the next 8 years and also at the end of 8 years he would get back his principal amount of Rs. 1000.
An issuer of bond has to make compulsory payment of coupon rate to the bond holders and also at the time of
maturity it has to pay back the principal amount. If this is not so the bond holders can legally proceed against
the company including filing a bankruptcy or winding up case. This makes it safe for the lenders though they
may receive lesser coupon rate in comparison to other instruments. The advantage to the entity which raises
the debt, is that it enjoys a lower cost of funds through debt capital.
In India generally bonds can be purchased by individuals, business firms and others. Bonds are which are issued
by State and Central governments are secured by the guarantee of the concerned government. Private sector
companies can also issue bonds either on secured or unsecured basis.
Bond is a negotiable certificate evidencing indebtedness. It is normally unsecured. A debt security is generally
issued by a company, municipality or government. A bond investor lends money to the issuer and in exchange,
the issuer promises to repay the loan amount on a specified maturity date. The issuer usually pays the bond
holder periodic interest payments over the life of the bond.
Bonds are the instruments of borrowing by governments and corporate. They promise a fixed rate of return,
known as a coupon rate, till the date of maturity and the payback of the principal sum in a phased manner or
at maturity.
There are two categories of bonds- those issued by government and those issued by firms (also known as
debentures). From the perspective of risk, the bonds issued by the government are regarded as risk free, while
those issued by firms are deemed to bear default risk.
Most of the debentures are issued on a secured basis against some fixed assets. There would be a charge created
on these assets by the company in favour of the investors/ lenders/subscribers. In case the issuer is unable to
repay the coupon and principal the assets which are charged can be sold and investors/lenders/ subscribers
can get a compensation. Also, in respect of debentures the rights of subscribers/lenders /investors rights are
protected by way of appointment of a Trustee who would safeguard their interests. According to SEBI guidelines
in respect of public issue of debentures it is mandatory to appoint a debenture trustee.
Risks involved in holding Government Securities

Government securities are generally referred to as risk free instruments as sovereigns are not expected to
default on their payments. However, as is the case with any financial instrument, there are risks associated
with holding the Government securities. Hence, it is important to identify and understand such risks and take
appropriate measures for mitigation of the same.
The following are the major risks associated with holding Government securities.
(i) Market risk – Market risk arises out of adverse movement of prices of the securities that are held by
an investor due to changes in interest rates. This will result in booking losses on marking to market or
realizing a loss if the securities are sold at the adverse prices. Small investors, to some extent, can mitigate
market risk by holding the bonds till maturity so that they can realize the yield at which the securities
were actually bought.
(ii) Reinvestment risk – Cash flows on a Government security includes fixed coupon every half year and
repayment of principal at maturity. These cash flows need to be reinvested whenever they are paid. Hence
there is a risk that the investor may not be able to reinvest these proceeds at profitable rates due to changes
in interest rate scenario.
(iii) Liquidity risk – Liquidity risk refers to the inability of an investor to liquidate (sell) his holdings due to
non-availability of buyers for the security, i.e., no trading activity in that particular security. Usually, when
a liquid bond of fixed maturity is bought, its tenor gets reduced due to time decay. For example, a 10-year
security will become 8 years security after 2 years due to which it may become illiquid. Due to illiquidity,
the investor may need to sell at adverse prices in case of urgent funds requirement. However, in such
cases, eligible investors can participate in market repo and borrow the money against the collateral of the
securities.
Characteristics of debt instruments:
1. They are tradable: Due to business practices debt securities can be traded in the secondary market.
Hence, they are liquid securities. However, the liquidity may not be uniform for different classes of debt
securities.
2. Obligation to honour repayment of Principal: At the time of maturity the issuer of debt security is
obligated to repay the face value (also known as ‘Par value which represents the original amount borrowed
from lenders. The exception being Zero Coupon bond where the maturity value includes the face value and
coupon amount.
3. Maturity period or Tenor: Every security that is issued carries a specific maturity date by which time
the issuer has to repay. However, in some cases, the face value is repaid on instalment basis spread over
the life of the debt security. These types of debt instruments are called “amortizing” securities where the
repayments include principal and coupon (interest).
4. Built-in flexibility possible: These debt securities especially in the case of Bonds, the issuer can include
flexibility of “Callable or Puttable” options. Under a ‘Callable’ option the issuer can repay or redeem the
bond before its maturity date. Under ‘Puttable’ option the investors are given a right to seek redemption
from the issuer before the bond matures.
5. Periodic repayment of interest: Due to various market developments interest rates can be offered on a
fixed, compounded or floating basis depending upon the issuer. Floating rates are the rates of interest that
is linked to a standard bench mark rates; therefore, as and when the bench mark rates undergo changes
the interest rate also would change. However, the essential point is that interest payments have to be made
by the issuer at periodical intervals. Generally, all interest on debt securities is paid on half yearly or yearly
basis.
Some of the special types of bonds issued in India include:
i. Zero Coupon Bond: In these bonds the issuer does not pay interest/coupon periodically. It is paid at
maturity along with principal. Hence it is normally issued at a discount to face value. On maturity the
principal returned with interest.
ii. Convertible Bond: Under specified terms by the issuer at the time of issue, the holder of such bond can
convert the outstanding value of the bond in to equity of shares of the issuing company.
iii. Municipal Bond: These are issued by Municipalities in India, for meeting their funding requirements.
Bengaluru Municipal Corporation was the first one to issue such a bond in India in 1997, followed
subsequently by Ahmedabad. However Municipal Bond issues are not very active.
iv. Asset Backed Securities: These are issues by a borrower to raise finances on the basis of future
receivables.
v. Bearer Bonds: It is an official certificate issued without recording the name of the holder. These are very
risky because they can be either lost or stolen.
vi. Registered Bonds: It is a bond whose ownership is recorded by the issuer or by a transfer agent.
vii. Term Bonds: Most corporate bonds are term bonds, that is, they run for a specific term of years and then
become due and payable.
viii. Serial Bonds: While issuing bonds some corporate arrange them in such a way that specific principal
amounts become due on specified dates prior to maturity. They are termed as serial bonds.
ix. Puttable Bonds: A puttable bond grants the bondholder the right to sell the issue back to the issuer at par
value on designated dates.
x. Callable Bonds: These bonds refer to the ability of the issuer to pay off a debt obligation prior to its
maturity at the option of the issuer of debt.
xi. Exchangeable Bonds: It grants the bondholder the right to exchange the bonds for the common stock of
a firm other than that of the issuer of the bond.
xii. Fixed Rate Bonds: These are bonds with a coupon or a stated rate of interest which remains constant
throughout the life of the bond.
xiii. High Yield Bonds: They are bonds that are rated below investment grade by the credit rating agencies.
They are also called junk bonds.
xiv. Mortgage Bonds: A bond that is secured through a lien against the property of the firm is known as
mortgage bond.
xv. Subordinated Bonds: These bonds have a lower priority than secured debts, debentures and other bonds
and the general creditors of the issuer in case of liquidation.
xvi. Guaranteed Bonds: It is an obligation guaranteed by another entity. or the parent company. Although
these bonds are not risk-free, default risk is reduced since both companies would have to default.
xvii. Perpetual Bonds: These bonds are also called perpetuities. It has no maturity date.
xviii. Global bonds: Bonds that are designed so as to qualify for immediate trading in any domestic capital
market and in the Euro, market is called global bonds.
xix. Easy Exit Bonds: These are bonds which provide easy liquidity and exit route to investors by way of
redemption or buy back facility where investors can get the benefit of ready encashment in case of need
to withdraw before maturity.
xx. Option Bonds: These are cumulative and non-cumulative bonds where interest is payable on maturity or
periodically. Redemption premium is also offered to attract investors. These were issued by institutions
like IDBI, ICICI, etc.
xxi. Double Option Bonds: The face value of each bond is 5,000. The bond carries interest at 15% p.a.
compounded half-yearly from the date of allotment. The bond has a maturity period of 10 years. Each
bond has two parts in the form of two separate certificates, one for principal of 5,000 and other for interest
(including redemption premium) of 16,500. Both these certificates are listed on all major stock exchanges.
The Investor has the facility of selling either one or both parts at any time he wishes so.
xxii. Floating Rate Bonds: Here, Interest rate is not fixed and is allowed to float depending upon the market
conditions. This is an instrument used by the issuing Companies to hedge themselves against the volatility
in the interest rates. Financial institutions like IDBI, ICICI, etc. have raised funds from these bonds.
xxiii. Inflation Bonds: Inflation Bonds are bonds in which interest rate is adjusted for inflation. Thus, the
investor gets an interest free from the effects of inflation. For example, if the interest rate is 10% and the
inflation is 2%, the investor will earn 12.20% [i.e. (1 + Interest Rate) X (1 + Inflation Rate) -1]. This is
similar to Floating Rate Bonds, i.e., rate of return varies over a period of time.
TERMS ASSOCIATED WITH BONDS

The following terms are used when one deals with Bonds.
S. No. Terminology Meaning
1 Face Value Also known as Par value. Normally it is stated on the face of the bond. It
represents the principal amount borrowed by the issuer.
2 Coupon Rate The interest rate on the debt security.
3 Yield This represents the return on the bond, expressed as a percentage of the Face
value (par) value.
4 Yield curve It is a graphical representation of maturity value against yield to maturity.
5 Current yield Represents the return on a debt security vis-a-vis it’s current market price.
6 Yield to maturity It represents the overall return on a debt security if it is retained till maturity
with an assumption that all interest payments will be reinvested at the current
yield on the security. It represents the total income one can receive on a debt
security say a bond.
7 Maturity The period of the debt security.
8 Term to Maturity The remaining period of the debt security till maturity.
9 STRIPS Separate Trading of Interest and Principal Securities.
S. No. Terminology Meaning

10 Redemption value The maturity value that a debt security holder (bond) may get. It may be at par
value, at premium (higher than par value) or at a discount ( less than par value)
11 Market price/value The price at which a debt security is traded in the market. This may be less
than redemption or par value as the case may be.
VALUATION OF BONDS
A bond or debenture is a contractual financial instrument which obligates its issuer to pay a given sum of money
(face value) at a maturity date in future and a periodic interest payment at a fixed rate of interest (coupon rate).
Bond values are determined by 5 factors:
1. par value
2. coupon rate
3. prevailing interest rates
4. accrued interest
5. credit rating of the issuer
Bonds are issued by different organisations. The principal issuers of bonds in India are the central government,
state government, public sector undertakings, private Sector undertakings and municipal bodies.
The value of a bond is equal to the present value of the cash flows expected from it. Valuation of bond requires
(i) An estimate of expected cash flows
(ii) An estimate of the required return
Assumptions:
(i) The coupon interest rate is fixed for the term of the bond.
(ii) The coupon payments are made annually and the next coupon payment is receivable exactly a year from
now.
(iii) The bond will be redeemed at par on maturity.
COST OF DEBT CAPITAL
Bond Value
If an issuer is raising his capital through debt instruments, for efficient management of a business, the person
managing the business should know how bonds or securities are valued so that they can maximize their
earnings. The investors should also know how their securities can be valued so that they can make an informed
decision. We will focus now as to how the value of a bond can be determined. This is the same as cost of capital.
For an investor, a bond carries in it a series of interest payments at the coupon rate till its maturity. At maturity
the investor will also entitled to get back the principal sum invested. Therefore, a bond is said to be a sum
of interest payments plus the principal amount at maturity. This is known as intrinsic value. Therefore, an
intrinsic value of a bond is equal to the present value of its future benefits. This can be calculated by using a
formula given below:
V = Value in Rupees
n = Number of years
In = Interest or Coupon payment (In Rupees)

r = Periodic required return
MV = Maturity value
t = The time period when the payment is received
If the interest payments are annual, we can make use of the Present Value tables for an annuity for arriving at
the value of a bond.
Thus using the Present Value table V= In × PVIFA(r, n) + MV × PVIF(r, n)
Let us consider an example of comparing bond prices.
A bond of par value Rs. 1000 of 10 years maturity with a 10% coupon. Let us assume that the required coupon
rate is 11%; what will be value of the bond?
V = 100 × PVIFA (11%,10 yr) + 1000 × PVIF (11%, 10 year)
= 100 x 5.889 + 1000 x 0.352
= 588.9 + 352
V = 940.9 (Rupees)
BOND VALUE WITH SEMI-ANNUAL INTEREST

As major part of the bond issuers makes semi-annual (i.e., six monthly) coupon payments. This implies that to
arrive at a valuation of a bond we need to modify the formula used above. The required modification would be
in the following manner –
i. The annual interest payment (I) in the equation should be divided by 2
ii. The number of years to maturity is to be doubled (i.e., multiplied by 2) to get the total number of half
yearly period.
iii. The periodic required return rate should be divided by 2.
The modified equation will be as follows:
V = Value in Rupees
2n = maturity period in number of half years
I/2 = Semi-annual Interest or Coupon payment (In Rupees)
r/2 = periodic required return to a half year period
MV = Maturity value
t = the time period when the payment is received
Using the present value tables the value of the bond with semi-annual interest payments can be arrived at as
under:
V= (I/2) × PVIFA (r/2, 2n) + MV × PVIF (r/2, 2n)
Let us consider an example in this regard. Consider a 10 year bond with a 12% coupon of par value 1000.
Interest is payable semi-annual basis. If the required return is 14%, what will be the value of the bond?
In this case I/2= 120/2= 60;2n= 20; r/2 = 7%
V= 60 × (10.594) + 1000 (0.258) = 635.64 + 258 = Rs. 893.64
CURRENT YIELD ON BOND

Current yield on the bond represents the coupon rate related to market price of the bond which is traded in the
market. The following example may illustrate this concept.
A 10 year bond of par value of Rs. 1000 with a coupon of 12% is traded in the market at Rs. 940. What is the
current yield on the bond?
The Current yield =
The current yield is a just estimate of yield only as it does not take in to account the capital gain or loss in
purchasing and holding the bond till maturity.
CALCULATION OF YIELD-TO- MATURITY OF BOND

The yield to maturity is the total return that one can get if the instrument is held till maturity. It is also defined
as the interest rate (also known as discount rate) that equals the present value of cash flow that equals the
bonds current market value. It is also defined as a multiple period rate of return on a bond if the bond is held till
maturity. The assumptions that underly are:
i. Issuer does not default the coupon payments
ii. All coupon payments are immediately reinvested at the promised yield till maturity. Mathematically Yield
to maturity can be calculated as under:
Where P= Price of the Bond

AI = Annual Interest (in rupees)
MV = Maturity value (in rupees)
r = Interest rate
n = number of years left for maturity
YTM computation requires trial and error process. Let us understand this by an example.
A Rs. 1000 par value bond is carrying a coupon rate of 10% maturing after 10 years. The bond is selling at a
price of Rs. 800. What is the YTM of the Bond?
The problem can be represented by the following equation
The YTM will be the value of ‘r’ in the above equation.

In other words 800 = 100 (PVIFA r, 10 yrs) + 1000 (PVIF r, 10 yrs)
Let us try r = 14%, the RHS of the above equation can be represented & using the PV tables
= 100 (5.216) + 1000(0.270)
= 521.60 + 270.00
= 791.60
Since 791.60 is lesser than 800 we have to try a lower value for ‘r’.
Let us take the value of r =13%
The equation becomes 800 = 100 (PVIFA 13%, 10) + 1000 (PVIF 13%, 10)
The RHS of the equation = 100 (5.426) + 1000 (0.295)
= 542.60 + 295
= 837.60
From the above it is clear that the value of ‘r’ lies between 14% and 13%. We can use linear interpolation
technique to find the exact value as under –
= 10.82%
Therefore, the YTM in this case is = 10.82%
Yield to Call of Bonds
Some bonds carry a call feature that entitles the issuer to call (buy back) the bond prior to the stated maturity
date in accordance with a call schedule. The basic property of a bond is that its price varies inversely with
yield. If the required yield decreases, the present value of the cash flow increases; hence the price of the bond
increases. Conversely, when the required yield increases, the present value of cash flow decreases. The higher
the coupon rate, the smaller the percentage price change due to any given change in interest rate are positively
related. The graph of the price-yield relationship for the bond has a convex shape.
The relationship between the coupon rate, the required yield and the price of bond is as follows:
Consider, a bond carrying a coupon rate of 14% issued 3 years ago for 1000 (its par value) by XYZ Co. The
original maturity of bond was 10 years, so its residual maturity now is 7 years. The interest rate is fallen in the
last 3 years and investors now expect a return of 10% from this bond. So, the price of the bond now would be
1194.70 (based on the formula mentioned above).
THEOREMS FOR BOND VALUE

Based on the behavior of the bond market a set of theorems for bond valuation has been put forward by some
authors. The same is as under:
1. When the required rate of return (‘r’) is equal to the coupon rate the value of the bond is equal to the par
value.
2. When the required rate of return is greater than its coupon rates the value of the bond will be less than its
par value.
3. When the required rate of return is less than the coupon rates the value of the bond will be greater than
its par value.
4. When the required rate of return is greater than coupon rate the discount on the bond decreases as it
approaches maturity.
5. When the required return is less than coupon rate the premium on the bond declines as it approaches
maturity.
6. Bond price is inversely proportional to its YTM.
7. The longer the term to maturity, for a given difference between YTM & Coupon rate, the greater will be the
change in price with changes in price.
8. For an equal size increase or decrease in YTM, the bond price changes are not symmetrical. That is to say,
in given maturity of a bond, the bond price change will be greater with a decrease in bond’s YTM, than the
change in bond price with an equal increase in bond’s YTM.
9. Other things being the same, for a given change in YTM, the percentage of price change in respect of high
coupon rate bond will be smaller than in case of bonds of low coupon rate.
10. A change in YTM affects the bonds with higher YTM in comparison to bonds with lower YTM.
A few examples of theorems stated above:
Example 1: For Theorem 4:
Face value of a bond of Rs. 1000 with a coupon of 10%. Years to maturity is say 6 years. The required return is
12% the value of the bond will be –
= 100 × PVIFA (12%, 6) + 1000 × PVIF (12%, 6)
= 100 × (4.111) + 1000 (0.507)
= 411.10 + 507
= 918.10
Let us find one year later what will be the price at the same required rate of return.
In this case the maturity period will be 5 years. Hence the computation will be as under:
= 100 × PVIFA (12%, 5) + 1000 × PVIF (12%, 5)
= 100 × (3.605) + 1000 x 0.567
= 360.5 + 567
= 927.5
Similarly, we can find the value of the bond for r maturity periods of 4, 3, 2, 1 years as under:
For 4 years maturity
= 100 × PVIFA (12%, 4) + 1000 × PVIF (12%, 4)
= 100 × (3.037) + 1000 × (0.636)
= 303.70 + 636
= 939.70
= 100 × PVIFA (12%, 3) + 1000 × PVIF (12%, 3)
= 100 x (2.402) +1000 (0.712)
= 240.2 + 712
= 952.20
= 100 × PVIFA (12%, 2) + 1000 × PVIF (12%, 2)
= 100 × (1.690) + 1000 × (0.797)
= 169.0 + 797
= 966
For 1 year maturity

= 100 × PVIFA (12%,1) + 1000 × PVIF (12%, 1)
= 100 x (0.893) + 1000 x (0.893)
= 89.30 + 893
= 982.30
Thus, it can be seen that for a required rate of 12% the value of the bond increases as it moves towards maturity
given in the table below:
Time to maturity (years) Bond Value
6 918.10
5 927.50
4 939.70
3 952.20
2 966.00
1 982.30
0 1000.00
Example 2: For Theorem 7
Let us say a Bond A and Bond B, of face value of 1000 each with a coupon of 10%; let the years to maturity be
4 and 7 respectively. Let us through this example compute the market values of these two bonds to prove the
theorem.
Market value of Bond A with YTM 10% = 100 × PVIFA (10%, 4) + 1000 × (PVIF 10%, 4)
= 100 × (3.170) + 1000 (0.683)
= 317 + 683
= 1000
Market Value of Bond B with YTM 10% = 100 × PVIFA (10%, 7) + 1000 × PVIF (10%, 7)
= 100 × (4.868) + 1000 (0.513)
= 486.80 + 513
= 999.80, say 1000
Let us calculate market value for a YTM of 11% of these bonds
Market Value of Bond ‘A’ with YTM 11% = 100 × PVIFA (11%, 4) + 1000 × (PVIF 11%, 4)
= 100 × (3.102) + 1000 (0.659)
= 310.20 + 659
= 969.20
Market value of Bond B with YTM 11% = 100 × PVIFA (11%, 7) + 1000 × PVIF (11%, 7)
= 1000 x 4.712 + 1000 (0.482)
= 471.20 + 482
= 953.20
Let us look at the change in price due to change in YTM by 1% in case of Bond
A = (1000 – 969.20) = 30.80/1000 = 3.08%
Let us consider the change in price due to change in YTM by 1% in case of Bond
B = (1000- 953.20) = 46.80/1000= 4.68%
This proves that long term bonds are more price sensitive to interest rate changes compared to short term bonds.
The theorem states that for an equal size increase and decrease in YTM, price changes of a bond are not
symmetrical.
Let us consider a bond with Face value of 1000 with a coupon of 10%with maturity of 5 years. The market value
of this bond will be
= 100 (3.790) + 1000 (0.621)
= 379 + 621
= 1000
Let us consider a 1% increase in the YTM, the market value will be
= 100 × PVIFA (11%, 5) + 1000 PVIF (11%,5)
= 100 × 3.696 + 1000 × 0.593
= 369.60 + 593
= 962.60
The decrease in value is 3.74%.
Let us consider a 1% decrease in YTM, the market value will be
= 100 × PVIFA (9%, 5) + 1000 PVIF (9%, 5)
= 100 × (3.890) + 1000 (0.650)
= 389+ 650
= 1039
The increase in value is 3.9%
The decrease and increase in value is not symmetrical as per the calculation.
The theorem states that a change in YTM affects the bonds with higher YTM in comparison to bonds with lower
YTM.
We can understand the theorem with the help of the following example:
Bond X with a par value of Rs. 1000 with a coupon of 11% has a maturity period of 6 years. if the YTM is 9% the
bond will have a market value of
= 110 × PVIFA (9%, 6) + 1000 × PVIF (9%, 6)
= 110 (4.486) + 1000 (0.596)
= 493.46 + 596 = 1089.46
Let us consider another Bond Y with similar properties with YTM of 18%, this will have a market value of
= 110 × PVIFA (18%, 6) + 1000 × PVIF (18%, 6)
= 110 (3.498) + 1000 (0.370)
= 384.78 + 370 = 754.78
Let us increase the YTM of Bond X and Bond Y by 1/9th such that the revised YTM of Bond X will be 10% and
that of Bond Y will be 20%. The market value of Bond X and Bond Y will change in to as given below:
Bond X = 110 (4.355) + 1000 (0.564) = 479.05 + 564 = 1043.05
Bond Y = 110 (3.326) + 1000 (0.335) = 365.86 + 335 = 700. 86
We can notice that price decrease in respect of a bond with lower YTM is lesser than the decrease in the price
of the bond with higher YTM.
DURATION OF BOND
When an investment is made in a bond, there could be risks in the form of
a. the reinvestment of annual interest
b. the capital gain or loss on sale of the bond at the maturity of the bond.
Under the scenario of rising interest rates there will be a gain on reinvestments and a loss on liquidation.
However, for a given bond, there will be a period of holding, in which the above-mentioned risks will remain
balanced that is to say if there is a loss in reinvestment, it will be off-set by a capital gain while liquidating the
bond in the market. In other words, the risk on account of interest rates, will be nil. Such a holding period is
called “Duration”.
Hence the term “duration” can be defined as a holding period of a bond at the end of which a bond holder will
get his investment back.
How to calculate the duration period of a bond?
1. Arrive at the cash flows from holding the bond.
2. Determine the PV of these cash flows by discounting with the YTM rate.
3. Multiply the PVs by the respective number of years left before the PV is received.
4. Multiply the value arrived at 3 above, and divide by the present value.
5. Step 4 will give the duration.
Let us understand the concept of duration by an example.
Let us consider a Bond of par value 100 with a coupon of 12% with a maturity of 5 years. The expected YTM is
15%. Let us calculate the duration.
First let us determine the market value at YTM of 15%
Market value = 12 (3.352) + 100 (0.497) = 89.92
The cash flow can be listed as under:
Year Cash flow PV factor Present value Proportion of Proportion of
@15% @15% Bond value Bond value X
time years
1 12 0.87 10.440 0.116 0.116
2 12 0.756 9.072 0.101 0.202
3 12 0.658 7.896 0.088 0.264
4 12 0.572 6.864 0.076 0.304
5 112 0.497 55.664 0.619 3.095
89.936 3.981
The duration of the bond is 3.981 years.
This concept was first introduced by Macaulay F. and this is also known as Macaulay duration.
VOLATILITY
Bond volatility is a term used to describe how much the value of a bond fluctuates over time. The less volatile the
bond, the less risky the investment. More volatile bonds present more risk, but they also can present the higher
reward possibility. Tracking volatility can give your insight into the potential risks and rewards of purchasing
a bond.
Volatility of a bond price is related to its duration and yield.
The volatility of the Bond can be determined using the following formula:
Volatility = (This is also known as Modified Duration)
Taking the above example, the volatility of the bond can be worked out as under:
= 3.981/ (1+0.15)
= 3.981 /1.15
= 3.46.
This means that for a 1% increase or decrease in the required yield, will end up in 3.46 percent fall or rise in
the price of the bond.
PROPERTIES OF DURATION
The following can be summarized as properties of duration.
a. Duration is always less than the term to maturity.
b. Only in the case of zero coupon the bond’s duration will be equal to its term to maturity.
c. In respect of a perpetual bond the duration is equal to (1 + r)/r where r is equal to current yield of the
bond.
d. If a coupon paying bond’s maturity is longer, the greater will be the difference between its term to maturity
and duration.
e. There is an inverse relation between duration and YTM.
f. In case of a bond with a larger coupon rate, its duration will be smaller.
g. Frequency of coupon rate and duration are inversely related; that is to say an increase in the frequency of
coupon payments, there will be decrease in duration and vice versa.
h. Duration of a bond decreases as it approaches its maturity.
BOND PRICE VOLATILITY

Volatility often refers to the amount of uncertainty or risk related to the size of changes in a security’s value. A
higher volatility means that a security’s value can potentially be spread out over a larger range of values. This
means that the price of the security can change dramatically over a short time period in either direction. A
lower volatility means that a security’s value does not fluctuate dramatically, and tends to be steadier.
The sensitivity of the price of a bond in relation to change in interest rates is called ‘bond volatility. Whenever
there are changes in market yields, it causes the prices of the bonds change. For a given change in the price of a
bond for a change in YTM, gives us the measure of interest rate risk of a bond. The interest rate risk of a bond is
a function of its elasticity of the interest rate (denoted by ‘IE’).
Mathematically IE =
As bond prices and YTM are inversely related the IE is always a negative number.
Interest elasticity can also be stated as IE =
It is also evident from the equation, any increase in duration will also increase the IE of the bond. Let us consider
an example to understand the above.
Bond Y has a par value of 1000 with a coupon of 10% and period of maturity is 10 years. If the coupon rate is
changed to 11%the market price of the bond will work out to
= 100 × PVIFA (11%, 10) + 1000 × PVIF (11%, 10)
= 100 × (5.889) + 1000 × (0.352)
= 588.90 + 352
= 940.90
Price change is = (1000 - 940.90) 59.10 = 5.91%
IE =
*when the interest rates change to 11 % from 10%, the percentage change works out 10% (i.e. (1)/10 x100 = 10%
The negative sign indicates that if the YTM is increased by 1 % the market price of the bond is reduced by 5.91%.
Additional worked out example

Bond X has a Face value of Rs. 1000 and a coupon rate of 12% paid annually, with a term to maturity of 4 years,
is quoted in the market Rs. 840. Bond holder has to pay Income Tax of 30% and a capital gains tax of 15%.
Calculate the following:
1. Current yield and Post tax yield of the bond.
2. Duration of the Bond.
3. Interest rate elasticity
4. Interest rate risk when the interest rate falls by 2%
5. Interest rate risk when the interest rate increases by 1% Data Given
Face Value: Rs. 1000
Market Price: Rs. 840
Coupon: 12%
Income Tax: 30%
Capital Gains Tax: 15%
Term to maturity: 4 years
Calculation:
1. Interest income (annual) = Rs. 120 (i.e. 12% on 1000)
a. Post- Tax Income = Income – less tax = [120 – (30% of 120)] = 120- 36 = Rs. 84 Therefore the current
yield of the bond (Post-tax) = 84/840 = 10%
b. Bond redemption value after capital gains tax = [1000 – 15% of (1000-840)]
= [1000 – 24] = Rs. 976
c. The post-tax YTM is obtained by using the formula
= I (1 – t) + (F – P)/n 0.4F + 0.6P
Substituting the values, I (1 – t) = 84, F= 976, P= 840, n=4 in the above equation
= = 0.1319 or 13.19%
Therefore, the solution to question 1 is – Current yield on the bond = 10% & Post-tax yield (YTM) is
13.19%
2. For calculating the duration of the bond, the following formula can also be used:
= = 3.51 years
Since the calculations involve PVIFA for 13.19 the same has to be done through extra polation which will
be cumbersome. Hence computerized calculations can be used.
Therefore, Duration of the bond is = 3.51 years.
3. Interest rate elasticity Duration × YTM
= (1 + YTM)
= = 0.409019348 = 0.409
Therefore, interest rate elasticity will be 0.409.

4. The interest rate risk when the interest rate fall by 2%. This can be calculated by the following formula
= Interest rate elasticity ×
= 0.062019613
= 0.062 %
In this case the % change will be positive as the price will increase against the fall in interest rate.
5. Percentage change in price when interest rate rises by 1%
Using the formula as in question 4 above, the percentage change in price
= 0. 409 × (0.01/.1319)
= 0.0310083397
= 0.031%
In this case since there is an interest rate rise the price of the bond will fall.
[Note: In all the examples involving Present Value calculations standard PV tables has been used.]
LESSON ROUND UP
• Debt is an obligation to pay a sum of money borrowed, with interest on the same at a fixed interval
or as agreed with a lender. Nowadays Government, public sector companies or private corporate
entities issue debt instruments such as Bonds and Debentures to raise capital. These are called debt
securities. There are some differences exist between bonds and debentures. Government of India/
State Government securities, Government Guaranteed Bonds, Public Sector Undertaking bonds, Private
Corporate Debentures, Money Market Instruments are examples of debt securities issued in India.
• An issuer of bond has to make compulsory payment of coupon rate to the bond holders and also at the
time of maturity it has to pay back the principal amount. If this is not so the bond holders can legally
proceed against the company including filing a bankruptcy or winding up case. This makes it safe for an
investor. Some special type of bonds that are issued in India are - Zero Coupon Bond, Convertible Bond,
Municipal Bond, Asset Backed Securities.
• Following are some of the important terms used in the context of bonds and their definitions are
– Yield - This represents the return on the bond. Expressed as a percentage of the Face value (par)
value
– Yield curve - It is a graphical representation of maturity value against yield to maturity.
• Current yield - Represents the return on a debt security vis-à-vis it’s current market price. Yield to
maturity - It represents the overall return on a debt security if it is retained till maturity with an
assumption that all interest payments will be reinvested at the current yield on the security. It represents
the total income one can receive on a debt security say a bond.
• A bond is said to be a sum of interest payments plus the principal amount at maturity. This is known
as intrinsic value. If the interest payments are annual/semi-annual/, we can make use of the Present
Value tables for an annuity for arriving at the value of a bond. The yield to maturity is the total return
that one can get if the instrument is held till maturity. It is also defined as the interest rate (also known
as discount rate) that equals the present value of cash flow that equals the bonds current market value.
For arriving at values of Present values mathematical equations can be used.
• Based on the behaviors of the bond market a set of theorems for bond valuation has been put forward
by some authors. The term “duration” in bond valuation is the holding period of a bond at the end of
which a bond holder will get his investment back. Volatility of a bond price is related to its duration and
yield. Some important properties of duration are –
a. Duration is always less than the term to maturity
b. There is an inverse relation between duration and YTM
c. Frequency of coupon rate and duration are inversely related d.
d. Duration of a bond decreases as it approaches its maturity.
• The sensitivity of the price of a bond in relation to change in interest rates is called ‘bond volatility’. As
bond prices and YTM are inversely related the IE is always a negative number.
TEST YOURSELF
i. In bonds, the __________ does not pay interest/coupon periodical interest.
ii. __________ are issued in the form of promissory note.
iii. Most of the __________ are issued on a secured basis against some fixed assets.
iv. A __________ value of a bond is equal to the present value of its future benefits.
a. Advantage for issuers of debt capital is the tax deduction available for coupon payments under the
Income tax regulations.
b. Transferability is not possible in respect of debentures.
c. According to SEBI guidelines in respect of public issue of debentures, it is mandatory to appoint a
debenture trustee.
d. Under ‘Puttable’ option the investors are given a right to seek redemption from the issuer before
the bond matures.
e. Floating rates are the rates of interest that is linked to a standard bench mark rate.
f. Coupon rate is the interest rate on the debt security.
g. Intrinsic value of a bond is equal to the present value of its future benefits.
h. Major part of the bond issuers makes annual (i.e., six monthly) coupon payments.
i. Current yield on the bond represents the coupon rate related to market price of the bond.
j. The yield to maturity is the total return that one can get if the instrument is held till maturity.
k. Bond price is inversely proportional to it’s YTM.
i. What are the differences between bonds and debentures? What are the different types of?
securities issued in India?
ii. What are the characteristics of debt instruments? Explain briefly.
iii. Define the following terms and give an example for the same: -
• Coupon Rate
• Yield
• Yield curve
• Current yield
• Yield to maturity
• Maturity
• Term to Maturity
• Duration
iv. A bond of par value Rs. 1000 of 10 years maturity with a 10% coupon. The required coupon rate is
12%; what will be value of the bond? [Given The PVIFA (12%,10yr) = 5.650 and PVIF (12%,10yr)
= 0.322.]
v. Mention any five Theorems of Bond value.
vi. Explain what is duration. What are the properties of duration?
vii. What is Bond price volatility? Briefly explain the same.

• Financial Management – Theory and Practice – Dr. Prasanna Chandra – Tata McGraw Hill
• Money Market Instruments – Reserve Bank of India website.
• Securities Markets and Products – Indian Institute of Banking and Finance – Tax Mann Publication
Lesson 17 • Introduction to Foreign Exchange 451
Lesson 17
Introduction to Foreign
Exchange
Should Know
This lesson will enable the students
• FEMA to understand: • Foreign Exchange Management
• FERA Act, 1999 (FEMA)
• The need for foreign exchange
• Foreign Exchange business • Foreign Exchange Regulation Act,
1973 (FERA)
• Exchange Rate • Intricacies involved in Foreign
Exchange • Foreign Exchange Dealers
• Authorised Dealers Association of India (FEDAI)
• Forward Contract • Foreign Exchange Market
• Uniform Customs and Practices
• Various Exchange Rates quoted for Documentary Credits
by A.D. (UCPDC)
• Foreign Exchange Arithmetic etc.
Lesson Outline
• Introduction • Exchange Arithmetic
• Fundamentals of Foreign • Foreign Exchange Rates
Exchange • Forward Margin, Premium and
• Balance of Payment Discount
• Capital & Current Account • Calculation of Premium and
• Definition of Foreign Exchange Discount
• Foreign Exchange Management • Cross Rate, Chain Rule
Act, 1999 • Value Date
• Methods of Settlement of • Arbitrage
International Trade • Relevant Concepts
• Foreign Exchange Market • LESSON ROUND UP
• Exchange Rate Mechanism • TEST YOURSELF
• Rates–Fixed/Floating/Spot/ • LIST OF FURTHER READINGS
Forward/Cross
451
INTRODUCTION
The Foreign Exchange Market (Forex, FX, or currency market) is a form of exchange for the global decentralized
trading of international currencies. Financial centres around the world function as anchors of trading between
a wide range of different types of buyers and sellers round the clock, with the exception of weekends. The
foreign exchange market determines the relative values of different currencies. The foreign exchange market
assists international trade and investment by enabling currency conversion. For example, it permits a business
in the United States to import goods from the European Union member states, especially Euro zone members,
and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value
of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.
The foreign exchange market is unique because of the following characteristics:
• its huge trading volume representing the largest asset class in the world leading to high liquidity;
• its geographical dispersion;
• its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until
22:00 GMT Friday;
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with other markets of fixed income; and
• the use of leverage to enhance profit and loss margins and with respect to account size.
Functions of the Foreign Exchange Market

The foreign exchange market is merely a part of the money market in the financial centres. It is a place where
foreign currencies are bought and sold. The buyers and sellers of claims on foreign money and the intermediaries
together constitute a foreign exchange market. It is not restricted to any given country or a geographical area.
Thus, the foreign exchange market is the market for a national currency (foreign money) anywhere in the world,
as the financial centres of the world are united in a single market.
Functions of Foreign Exchange Market

(i) Transfer Function:

The basic function of the foreign exchange market is to facilitate the conversion of one currency into
another, i.e., to accomplish transfers of purchasing power between two countries. This transfer of
purchasing power is effected through a variety of credit instruments, such as telegraphic transfers, bank
drafts and foreign bills.
In performing the transfer function, the foreign exchange market carries out payments internationally by
clearing debts in both directions simultaneously, analogous to domestic clearings.
(ii) Credit Function:
Another function of the foreign exchange market is to provide credit, both national and international so as
to promote foreign trade. Obviously, when foreign bills of exchange are used in international payments, a
credit for about 3 months, till their maturity, is required.
(iii) Hedging Function:
A third function of the foreign exchange market is to hedge foreign exchange risks. In a free exchange market
when exchange rates, i.e., the price of one currency in terms of another currency change, there may be a
gain or loss to the party concerned. Under this condition, a person or a firm undertakes exchange risk to a
large extent if there are huge amounts of net claims or net liabilities which are to be met in foreign money.
Participants in Foreign Exchange Market

The following are the foreign exchange market participants:
1. Commercial Companies
An important part of this market comes from the financial activities of companies seeking foreign
exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared
to those of banks or speculators, and their trades often have little short-term impact on market rates.
Nevertheless, trade flows are an important factor in the long-term direction of a currency’s exchange rate.
Some multinational companies can have an unpredictable impact when very large positions are covered
due to exposures that are not widely known by other market participants.
2. Central Banks
National central banks play an important role in the foreign exchange markets. They try to control the
money supply, inflation, and/or interest rates and often have official or unofficial target rates for their
currencies.
They can use their often-substantial foreign exchange reserves to stabilize the market. Nevertheless,
the effectiveness of central bank “stabilizing speculation” is doubtful because central banks do not go
bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they
do make a profit trading.
3. Hedge Funds as Speculators
About 70% to 90%of the foreign exchange transactions are speculative. In other words, the person or
institution that buys or sells the currency has no plan to actually take delivery of the currency in the end,
rather, they are solely speculating on the movement of that particular currency. Hedge funds have gained
a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and
may borrow billions more, and thus may overwhelm intervention by central banks to support almost any
currency, if the economic fundamentals are in the hedge funds’ favour.
4. Investment Management Firms
Investment management firms (who typically manage large accounts on behalf of customers such as
pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign
securities.
For example, an investment manager holding an international equity portfolio needs to purchase and sell
several pairs of foreign currencies to pay for foreign securities purchases. Some investment management
firms also have more speculative specialist currency overlay operations, which manage clients’ currency
exposures with the aim of generating profits as well as limiting risk. While the number of this type of
specialist firms is quite small, many have a large value of assets under management and, hence, can
generate large trades.
5. Retail Foreign Exchange Traders
Individual Retail speculative traders constitute a growing segment of this market with the advent of retail
foreign exchange platforms, both in size and importance. Currently, they participate indirectly through
brokers or banks. There are two main types of retail FX brokers offering the opportunity for speculative
currency trading, brokers and dealers or market makers. Brokers serve as an agent of the customer in
the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf
of the retail customer. They charge a commission or mark-up in addition to the price obtained in the
market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the
retail customer, and quote a price they are willing to deal at.
6. Non-Bank Foreign Exchange Companies
Non-bank foreign exchange companies offer currency exchange and international payments to private
individuals and companies. These are also known as foreign exchange brokers but are distinct in that
they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a
physical delivery of currency to a bank account). These companies’ selling point is usually that they will
offer better exchange rates or cheaper payments than the customer’s bank. These companies differ from
Money Transfer / Remittance Companies in that they generally offer higher- value services.
7. Money Transfer / Remittance Companies and Bureaux De Change
Money transfer companies/remittance companies perform high-volume low-value transfers generally by
economic migrants back to their home country. The four largest markets receiving foreign remittances are
India, China, Mexico and the Philippines.
The largest and best known provider is Western Union with 345,000 agents globally followed by UAE
Exchange. Bureaux de change or currency transfer companies provide low value foreign exchange services
for travellers. These are typically located at airports and stations or at tourist locations and allow physical
notes to be exchanged from one currency to another. They access the foreign exchange markets via banks
or non-bank foreign exchange companies.
FUNDAMENTALS OF FOREIGN EXCHANGE

Foreign Trade: In the present day scenario, many countries in the world do trade with other countries. In
other words International trade plays a pivotal role in the present day context. International trade refers to
trade between countries. There is movement of goods and services between the countries due to enlargement
of trade and commerce as self sufficiency is not attained by many countries though production and productivity
has gone up on a large scale. A country producing some goods apart from selling in the domestic market try to
sell them to another country. This may be due to surplus availability of goods for the domestic market and the
deficit in the other country or otherwise the country which is in need of foreign exchange. Even if a country is
efficient to produce goods and services still it will be advantageous to import goods from country/countries
since it may be cheaper to import goods rather than manufacturing the goods in their own country. In this
trade transaction one country is an exporter and the other country is an importer. Each country functions as a
sovereign State with its own set of regulations and currency.
There are certain peculiar problems in the conduct of International Trade and Settlement of the transactions
arising there from and they are as under:
1. Different countries have different monetary units.
2. Restrictions imposed by countries on export and import of goods.
3. Restrictions imposed by nations on payment.
Why foreign exchange transactions are regulated in India?
India being a developing nation, needed precious foreign exchange to pay for imports of oil, goods and services.
In order to conserve foreign exchange, controls were introduced in India in 1939 itself. After independence,
Government of India (GoI) first enacted Foreign Exchange Regulation Act, 1947 and regulated the usage of
foreign exchange transactions through RBI. As the country’s foreign exchange reserves reached a very low
level, the then GoI, introduced a more stricter version of The Foreign Exchange Regulation Act, 1973 (FERA).
Subsequently due to economic liberalization in 1991-92, FERA was amended and replaced with a liberal FEMA,
from June 2000.
BALANCE OF PAYMENTS
Balance of payments is a record of value of all economic
transactions, i.e., record of flow of payments between
residents of one country and the rest of the world in a
specified period, i.e., given time. Balance of Payments
is a fundamental factor in determining the exchange
rates as rate of exchange if determined by the forces
of demand and supply. A change in the balance of
payments of a country will affect the exchange rate of
its currency.
Definition of Balance of Payments:

Balance of Payments is a systematic summary of the
economic transactions of the country with the rest of
the world during a specified period, normally a year.
Current Account transactions are those that are not capital account transactions and include the following:
Further current account transactions have been categorized as under:

a. Prohibited category & Schedule I transactions: Prohibited category includes transactions with Nepal
and Bhutan or with their citizens and Schedule I transactions include remittance of earnings from lottery/
racing etc., commission on exports under the Rupee State credit route or Exports against equity in a joint
venture abroad etc.
b. Schedule II transactions: These transactions require Government approvals.
c. Schedule III transactions: These are transactions where Authorized Dealers can allow remittances up to
the prescribed limits; beyond which, such remittances require Reserve Bank of India permission.
d. Schedule IV transactions: These include all other current account transactions for which Authorized
Dealers are permitted to allow remittances without monetary limits.
The difference between Exports and imports is called as trade balance. Surplus of exports over imports is called
as Trade Surplus and excess of imports over exports is called Trade Deficit. For the purpose of calculating the
trade balance normally exports are allowed on FOB basis and imports on CIF basis. Invisible trade surplus /
deficit is also accounted for arriving at the Balance of Payment in Current Account. The current account is the
difference between domestic savings and investments. If domestic savings exceed domestic investment there is
surplus in current account. On the contrary if domestic savings are not sufficient for domestic investment it is
called as deficit in current account.
Capital Account transactions are those which alter the assets or liabilities (including contingent liabilities)
outside India of persons resident in India or Assets or liabilities in India of persons resident outside India and
include:
DEFINITION OF FOREIGN EXCHANGE
The term ‘Foreign Exchange’ has been defined by section 2(n) of the Foreign Exchange Management Act, 1999
(FEMA) as, “foreign currency and includes:
(a) deposits, credits and balances payable in any foreign currency;
(b) drafts, travellers’ cheques, letters of credit or bills of exchange expressed or drawn in Indian currency but
payable in any foreign currency; and
(c) drafts, travellers’ cheques, letters of credit or bills of exchange drawn by banks, institutions or persons
outside India, but payable in Indian currency.”
FEMA also defines the term foreign currency “means any currency other than Indian currency”.
In simple words Foreign Exchange is the process of conversion of one currency into another currency. It is that
section of economic science which deals with the means and methods by which rights to wealth in terms of
another country’s currency. It involves an investigation of the method by which the currency of one country is
exchanged for that of another.
FOREIGN EXCHANGE MANAGEMENT ACT, 1999 (FEMA 1999)
The legal framework which deals with various aspects of foreign exchange management in India is Foreign
Exchange Management Act (FEMA 1999). It was implemented from 1.6.2000. It has replaced the earlier law
called as Foreign Exchange Regulation Act 1973.
There are certain differences in the features of FERA and FEMA and they are as under:
METHOD OF SETTLEMENT OF INTERNATIONAL TRADE

As seen already that the International trade involves both buying and selling of various commodities settlement
takes place in different currencies. But the trade term of settlement is in any one of the following ways.
FOREIGN EXCHANGE MARKET

Foreign Exchange market can be defined
as a market in which individuals, business
firms and banks purchase and sell foreign
currency. The term market mentioned here
does neither mean any centralized meeting
place nor any particular country. In other
words it is described as an OTC (Over the
Counter) market as there is no physical place
where the participants meet to execute the
deal as we see in the case of stock exchange.
The foreign exchange market refers to
communication system, viz., telephone,
other satellite communication network,
SWIFT through which participants remain
in continuous contact with others. Foreign
Exchange market for any currency such as
US Dollar consists of all locations where
US dollar is purchased and sold for other
national currencies. These locations include
Sydney, Tokyo, Hong Kong, Singapore, India
(Mumbai), Dubai, Bahrain, Frankfurt, Paris,
London, New York and San Francisco besides other locations. Trading among these locations is not subject to
any formal requirements for participation.
The term foreign exchange market is used to refer to the wholesale segment of the market where dealings
take place among the banks. The retail segment refers to the dealings taking place between banks and their
customers.
The leading foreign exchange market centres in India are Mumbai, Kolkata, Delhi, Chennai etc. where bulk
exchange dealings take place. Additional centres have emerged as new centres such as Ahmedabad, Bangalore,
Cochin, Goa etc. in view of policy of Reserve Bank of India to decentralize the exchange operations and to
develop more broad based exchange market.
History of Foreign Exchange Market System

The foundation for a modern global forex market was said to have launched in the year 1850 in United States
of America (US) when it had a few currency traders who exchanged various currencies on a rate determined
by them privately. Also due to colonial rule of the British Empire which had its presence in large number of
countries across the globe, British Pound Sterling remained as a common favourite of international dealings.
However, in 1880 many countries adopted Gold Standard as the basis for exchanging currencies. The Gold
standard takes in to account “guarantees a fixed exchange rate of currency of another country that uses a gold
standard (specie or bullion), regardless of what type of notes or coins are used as a means of exchange.”
Thus, Gold standard created means of exchange that had a “fixed external value in terms of gold that is
independent of the inherent value of the means of exchange itself”.
In simple terms Gold Standard depended upon value of Gold and the value of Gold held by a Government.
There were three different types of Gold Standards in vogue during the beginning of 20th century. They are:
• Gold Specie Standard: Under this system the monetary unit in circulation had certain amount of gold
content and the value of the gold determined the value of the currency. The success of the system depended
upon the government declaring the gold as medium for exchange for goods and services, government
allowing free import or export of gold.
• Gold Bullion Standard: Paper currency was circulated which was pegged against the gold stock held by
the Government which agreed to sell gold bullion against demand in exchange at a fixed price for paper
currency.
• Gold Exchange Standard: Under this standard the Government guaranteed a fixed exchange rate pegged
to a foreign currency that used gold standard (specie or bullion). The pegged currency was known as
Reserve currency which can be convertible in to gold as it was with the case of bullion standard.
With the start of the first World War this standard was abandoned by many countries during the early 20th
Century. Certain countries felt that larger amounts of gold were being transferred to other countries. In the
aftermath of Great Depression, gold standard was banned in USA. The start of World War II also created
situations where monetary authorities printed more currencies without the stock of adequate gold. Many
countries faced economic problems such as high inflation, low growth which contributed to the decline in their
currency value. The cumulative effect of these led to an introduction of a revised exchange rate system known
as Bretton Woods System.
Bretton Woods System

During the World War II, economies of almost all countries were affected. This resulted in the disequilibrium of
balance of payments. To set right the same, several countries devalued their currencies. This in turn resulted in
the revaluation of the currency of another country. As this chain of activity continued to be followed by country
after country to push their exports, there were wild fluctuations occurring frequently in the exchange rates
resulting in breakdown of exchange rates. In the absence of a viable alternate system, international trade suffered.
Considering the seriousness of this development, Great Britain (GB) and United States of America (USA) took
an initiative in this regard to create a free, stable and a multilateral monetary system which would bring in
stabilization of foreign exchange rates and restore back international trade to a viable level for all parties
concerned. Ultimately the proposal put forth by USA was accepted at a conference organized in Bretton Woods,
in New Hampshire State, USA. This conference was held in July 1944 and was attended by Forty four countries
including India (though under British rule then).
Apart from many developments, two significant developments that emerged out of Bretton Woods conference
are:
• Establishment of International Monetary Fund (‘IMF’).
• International Bank for Reconstruction and Development (‘IBRD’) now popularly known as “World Bank”.
We shall be discussing the effect of the former, as it has a direct relevance to the development of exchange
rates and international foreign exchange markets. Under Articles of IMF an international exchange rate system
known as “Bretton Woods System (BWS)” - a Monetary system - was evolved and introduced. This system was
followed by member countries of IMF from the year 1946 to 1971.
The objects of the monetary system proposed by IMF in 1946 were:
• To establish an international monetary system with stable exchange rate system.
• To eliminate existing exchange controls.
• To bring in free convertibility of all currencies.
In addition to the above the following were the key outcomes of the agreement relating to the exchange rates:
(i) The Monetary system introduced by BWS required the member countries to fix a parity of their respective
currencies vis-à-vis in terms of US Dollar (US$) or gold.
(ii) Member countries were required to maintain the fluctuation in their currency within a band of ±1 per cent
of their declared parity level vis a vis US$.
(iii) No change in parity would take place without the approval of IMF. This is to avoid unnecessary devaluation.
(iv) USA agreed to fix parity of its Dollar in terms of gold at US $ 35 per ounce of gold and also committed to
convert dollar balances held by monetary authorities of other countries freely in to gold at the fixed rate
to maintain stability of dollar against gold.
(v) The Monetary authorities were obligated to intervene in the forex market if the parity levels exceeds ±1
per cent of their declared parity levels against US$.
(vi) If there were any fundamental problems faced by a member country in its Balance of payment position the
declared parity can be changed with the permission of IMF.
As a result of these terms, the member countries were required to maintain foreign exchange reserves to
effectively intervene in the foreign exchange market. If a member country was unable to intervene in the forex
market due to lack of foreign exchange reserves they were permitted to approach IMF to draw from Special
Drawing Rights (SDR) a facility of reserve asset created by IMF then. SDR can be exchanged for a currency of a
member nation to the IMF.
Collapse of Bretton Woods System

As the U.S. economy prospered by leaps and bounds during 1950s and ‘60s, this resulted in huge deficits in
balance of payment situation for the U.S. economy. The massive deficit resulted in the increase in supply of U.S.
Dollars. This situation became chronic during 1970 and 1971. The foreign exchange market participants felt
that at this juncture the gold reserves held by U.S. may not be sufficient to meet the market supply of circulating
dollars, resulting in erosion of market confidence in the US$ for conversion at US$ 35 per ounce of gold. There
was a virtual run on US$ forcing the U.S. on August 15,1971 to disengage from it’s commitment of converting
US$ in to gold made to the IMF in 1946. As a result, most of the other members of IMF resorted to demand and
supply based, market determined exchange rate (known as ‘float’) arrangement like Germany and Holland.
Smithsonian Agreement
As the Beretton Wood System collapsed, members of IMF wanted to have an alternative exchange rate system
that effectively sub served the needs of the foreign exchange markets and participants. The consensus among
the members of IMF was that the main reason for collapse of Bretton Wood System was the narrow band of
parity adjustment of ±1 per cent of their declared parity levels against US$.
To arrive at a viable alternative, G-10 countries arranged a conference of IMF members in December 1971, and an
agreement was reached under which the U.S. agreed for a devaluation of it’s currency provided simultaneously
Japan and Germany also devalued their currencies. This agreement was known as Smithsonian Agreement, in
honour of the Institution where the conference was held.
Accordingly the USA devalued its US$ by 7.9 percent resulting in an effective increase in price at which Dollar
can be converted to gold from US$ 35 per ounce to US$ 38. Simultaneously Germany and Japan and some other
IMF members also revalued their currencies by 7 per cent. However, some other members of IMF decided to
continue to adhere to the floating rate system prevailing in their countries.
Under the Smithsonian agreement provided for a wider level of band of parity adjustment of ± 2¼ per cent
of their declared parity levels against US$ and for non-Dollar currencies a more wider band of ± 4½ per cent
against each other. However, neither the U.S. government nor Federal Reserve encouraged the discipline. Under
the circumstances prevailing then, “the dollar price in the gold free market continued to cause pressure on its
official rate”. In view of mounting pressures in the market though the U.S. devalued its currency by a further
10 per cent, its stubborn refusal to convert US$ in to gold, resulting in non-intervention of members of IMF in
their markets. Japan and OEEC (Other European Economic Community) countries decided to settle for a float
mechanism in their forex markets. Thus, the fixed rate of exchange of foreign currencies came to an end.
Though many members of IMF adopted floating rate system of foreign exchange, the global oil crisis of 1973,
resulted in high inflation and troubled balance of payment situation for many countries. To find an answer to
the global exchange rate system, IMF organized a conference in Jamaica in the beginning of 1976. IMF tried
the exchange values in terms of SDRs but the effective solution could not be found. Hence floating rate system
stayed put and became stronger subsequently.
The European Monetary System and Development of Euro

In 1979 European Monetary System (EMS) was established to promote monetary stability of members of
European Common Market otherwise known as European Community (EC). The objects of the EMS were -
(i) Stability of exchange rates of member states currencies.
(ii) To promote economic convergence of Europe by adopting common economic policies that brought
stability to the currencies of member countries.
(iii) To develop economic and monetary union of European community through a common currency
named EURO.
European Community members were signatories to the Smithsonian Agreement and agreed to maintain a
fluctuation band of ± 2¼ per cent of their declared parity levels against US$ while maintaining a fluctuation
band of ± 4½ per cent of their declared parity levels among European currencies, which was later reduced
to ± 2¼ per cent. EMS had also established a European Currency Unit (ECU) which played an important role
in EMS. ECU was widely used for borrowing and lending and raising invoices in commercial trade. Though
member countries of Europe had their own independent currencies, ECU was used as reference rate. During
early 1990s Great Britain could not maintain the fluctuation band against other European currencies due to
weakened economic fundamentals. Due to this in 1992 GB’s Pound Sterling along with Italian Lira were forced
out of Exchange Rate Mechanism of Europe. This forced EC authorities to fix the fluctuation band at ± 15 per
cent levels.
Maastricht Treaty and introduction of Euro

In 1991 an agreement between European countries at Maastricht, in Netherland was arrived at to introduce a
common currency named Euro by the year 1999 as well as establish European Central Bank (‘ECB’). The role
of ECM was:
i. Issuing a common currency
ii. Conducting a monetary policies for European Union on behalf of central governing authorities
iii. Acting as a last resort all Central banks of member countries
iv. Managing the exchange rate for a common currency.
Accordingly, Euro was introduced as a common currency in EC member countries except in Great Britain and
in Denmark from January 1, 1999. As on date 19 countries out of 28 member countries of European Union use
the Euro which according to the market sources, “is the second most traded currency in the foreign exchange
market after the United States dollar”.
The Euro is the second largest reserve currency as well as the second most traded currency in the world after
the US$. As of August 2018, the estimated circulation of Euro was more than 1.2 trillion.
Market Size of Foreign Exchange market:
The business in foreign exchange markets in India have shown a steady increase as a consequence of increase
in the volume of foreign trade of the country, improvement in the communication systems and greater access
to the international exchange markets. Though the volume of business of foreign exchange market in India
has increased which works out to US $ 5 billion per day cannot be compared with foreign exchange market of
well developed countries. One of the reasons for our much less business is that Rupee is not an internationally
traded currency and is not in great demand. Some of the actively traded currencies in the foreign exchange
market are US dollar, Sterling Pounds, Euro, Japanese Yen, Swiss Franc etc.
24 Hours Market: Foreign Exchange Market remains open 24 hours due to different time zones for different
countries in the globe. At any point of time one market or the other remains open. Therefore, it is stated that
foreign exchange market is functioning throughout 24 hours of the day.
In India the market is open till the banks are open for their regular banking business. No transactions take place
on Saturdays.
Efficiency: The participants keep abreast of current happenings by access to such services like Reuter, Telerate
etc. Any significant development in any market is almost instantaneously received by other markets and thus
has a global impact. This makes the foreign exchange market very efficient as if they are functioning at one roof.
Currencies Traded: US Dollar is the common/main currency used to denominate international transactions
though other currencies viz., Euro and Yen are gaining larger share and the share of US Dollar in the total
turnover is shrinking.
Participants: The Participants in the Foreign Exchange Market are as shown below:
Corporates: The business houses, multinational corporations, international investors may operate in the
market to meet their genuine trade or investment requirements. They may also sell or buy currencies with
a view to meet their requirements or speculate to the extent permitted by the Exchange Control Regulations.
They operate through commercial banks by placing orders with them.
Central Bank: It may intervene in the market to influence the exchange rate and change it from that which
would result only from private supplies and demands. The Central Bank may transact in the market on its own
for the above purpose or it may do so on behalf of the Government when it sells or buys bonds and settles other
transactions.
Reserve Bank of India is the Central Bank of our country. In India authorized dealers have recourse to Reserve
Bank to sell / buy US dollars to the extent the latter is prepared to transact in the currency at the given point
of time. Reserve Bank of India will not ordinarily buy/sell any other currency from/to authorized dealers. The
contract can be entered into on any working day of the dealing room of Reserve Bank. Due to global practice, no
transaction is entered into on Saturdays.
Normally Reserve Bank of India does not enter into the market in the ordinary course. Only when the exchange
rates are moving in a detrimental way due to speculative forces it may intervene in the market either directly
or through State Bank of India.
Commercial Banks: Commercial banks are the major players in the market. They buy and sell currencies for
their customers. They do cover operations, purchase or sale of foreign currencies for future date based on sale
or purchase of foreign currency on the present day. Such transactions constitute hardly 7% to 8% of the total
transactions done by them. A major portion of the volume is accounted by trading in currencies to gain from
exchange movements.
Exchange brokers: Exchange brokers facilitate deal between banks. In the absence of exchange brokers banks
have to contact each other for quotes. If there are 150 banks at a centre, for obtaining the best quotes for a single
currency a dealer may have to contact 149 banks. Exchange brokers ensure that most favourable quotation
is obtained and at low cost in terms of time and money. The banks may leave with the brokers the limit up to
which and the rate at which it wishes to buy or sell the foreign currency concerned. From the indents from
various banks the brokers will be able to match the requirements of both.
Settlement of Transactions: Foreign Exchange
markets make extensive use of the latest
developments in telecommunications for
transmitting as well settling foreign exchange
transactions. Banks use the exclusive network,
SWIFT to communicate messages and settle the
transactions at electronic clearing houses such
as CHIPS at New York.
SWIFT: SWIFT stands for Society for Worldwide
Interbank Financial Telecommunication. It is
owned by about 250 banks in Europe and North
America and registered as a Society in Brussels,
Belgium. It is a communication network for
international financial market transactions
linking effectively more than 25,000 financial
institutions throughout the world, who have been allotted bank identifier code. Through Swift messages
are transmitted from country to country via centrally interconnected operating centres located in Brussels
Amsterdam and Culpeper, Virginia.
The member countries are connected to the centres through Regional Processors in each Country. It has the
following advantages:
• It is time tested reliable and accurate method of sending and receiving messages.
• Its structured format gives the information very clearly and as such it is widely used for various types of
banking transactions.
• Access is available to a vast number of banks globally for launching new cross border initiatives. Message
relay is instantaneous.
CHIPS: It stands for Clearing House Interbank Payment System. It is an electronic payment system owned by 12
private commercial banks constituting the New York clearing House Association. CHIPS began its operation in
1971 and has grown to be the World’s largest payment system. Foreign Exchange and Euro dollar transactions
are settled through CHIPS. It provides the mechanism for settlement on daily basis.
The functioning of CHIPS arrangement is explained below with a hypothetical transaction. Union Bank of
India, maintaining a dollar account with Bank of America, New York sells US $ 5 million to State Bank of India
maintaining dollar account with Amex Bank.
How settlement for the transaction takes place is explained below:
Foreign Exchange Rate Management

A foreign exchange rate, which is also called a forex rate or currency rate, represents the value of a specific
currency compared to that of another country. For example, an interbank exchange rate of 91 Japanese yen
(JPY, ¥) to the United States dollar (US$) means that ¥91 will be exchanged for each US$1 or that US$1 will
be exchanged for each ¥91. Exchange rates are determined in the foreign exchange market, which is open to a
wide range of different types of buyers and sellers where currency trading is continuous: 24 hours a day except
weekends.
Currency rates are applicable only on currency pairs. The currency listed on the left is called the reference
(or base) currency while the one listed to the right is the quote (or term) currency. Exchange rates are always
written in the form of quotations. A quotation reflects the number of quote currencies that can be bought by
using a single unit of reference currency.
Foreign Exchange Rates - Determinants

1. Interest Rate Differentials: Higher rate of interest for an investment in a particular currency can push up
the demand for that currency, which will increase the exchange rate in favour of that currency.
2. Inflation Rate Differentials: Different countries’ have differing inflation rates, and as a result, purchasing
power of one currency may depreciate faster than currency of some other country. This contributes to
movement in exchange rate.
3. Government Policies: Government may impose restrictions on currency transactions. Through RBI, the
Government, may also buy or sell currencies in huge quantity to adjust the prevailing exchange rates.
4. Market Expectations: Expectations on changes in Government, changes in taxation policies, foreign
trade, inflation etc. contribute to demand for foreign currencies, thereby affecting the exchange rates.
5. Investment Opportunities: Increase in investment opportunities in one country leads to influx of foreign
currency funds to that country. Such huge inflow will amount to huge supply of that currency, thereby
bringing down the exchange rate.
6. Speculations: Speculators and Treasury Managers influence movement in exchange rates by buying and
selling foreign currencies with expectations of gains by exploiting market inefficiencies. The quantum of
their operations affects the exchange rates.
EXCHANGE RATE MECHANISM

Introduction: An exchange rate is a simple arithmetical expression which gives value of one currency in terms
of another. The exchange rate is therefore a bilateral rate expressing relative price of country’s money. Exchange
rates have developed over a period of time moving through different stages - controlled rates (fixed rates)
managed rates and independently floating rates.
The exchange rate between currencies in a foreign exchange market is affected by a number of factors. The
extent to which these fluctuations are allowed is mainly dependent upon the monetary system adopted by the
countries concerned.
When countries were under gold standard the value of currency of a country was fixed as the value of gold is of
definite weight and fineness. The exchange rate between the currencies was determined on the relative value of
gold content of currencies concerned.
Example: If gold content of Indian rupee was 5 grain of standard purity and that of US dollar 60 grains
standard purity, the exchange rate between Indian Rupee and the US Dollar is as under:
1 Rupee = 5/60 = US $ 0.0833
1 US$ = 60/12 = Rs.12
(Note: This is not the present rate)
This rate of exchange was known as the mint par of exchange because at the Indian mint one rupee would get 5
grains of gold and in the USA USD 0.0833 would get the same quantity of 5 grains of gold.
Exchange rates were stable under gold standard because any deviation in the exchange rate would be set right
automatically by the movement of gold between the countries.
Exchange Rates:
Exchange rate can be expressed either in direct or indirect Rate. It can be spot rate or forward rate. It may be
fixed or floating. In a forward exchange rate, interest factor is involved. Forward price can be either at premium
or at discount depending upon whether the currency dealt with is appreciating or depreciating during the
forward period. Forward Exchange Rate can be expressed as an outright price wherein the forward margin is
loaded in the spot price.
Typically, the quotation in the interbank market is a two way quotation. It means two prices are indicated one
for purchase and the other for sale of foreign currency. In other words the market player quotes two prices one
at which the banker is willing to buy and the other rate at which the banker is willing to sell the foreign currency.
Direct Quotation: Here foreign currency is fixed/constant and accordingly value of domestic currency varies.
In other words in a foreign exchange quotation the foreign currency is the commodity which is being bought
and sold and the exchange quotation which gives price for the foreign currency in terms of domestic currency
is known as direct quotation. In direct quotation the rule is “Buy Low and Sell High.”
US $ 1 = Rs. 67.2535/.2670
It is normally quoted as 0.2535/0.2670
In the aforementioned example viz., US $ 1 = Rs. 67.2535/.2670 there is a gross profit of Rs. 0.0135 (Rs. 67.2670
- Rs. 67.2535. It means that the quoting bank is willing to buy dollars at Rs. 67.2535 and sell dollars at Rs.67.2670.
There are two types of quotations viz., direct quotation and indirect quotation.
Indirect Quotation: Here the quantity of domestic currency is fixed and accordingly value of foreign currency
corresponding to domestic currency is given as a quote.
This is another way of quoting of value of currencies towards purchase or sale, e.g., Rs. 100 = US $ 1.4869/
1.4900 (foreign currency was taken at Rs.67.2535/67.1140 = 1 US $)
In this case the quoting bank will receive US $ 1.4900 per Rs.100 while buying and gives US $ 1.4869 per Rs.100
while selling dollars. In other words the maxim here is “Buy High Sell Low.”
The buying rate is also known as the ‘bid’ rate and the selling rate is called as ‘offer’ rate. The difference between
Bid and Offer is called ‘Spread’ representing the profit in the buying and selling transactions.
Spot and Forward Transactions:

The transactions in the interbank market may have place for settlement on the same day or Two days later or
After a month.
The transaction where the exchange of currencies take place upto two days after the date of contract is known
as the spot transaction, e.g., if a transaction has taken place on Monday the delivery should take place on
Wednesday. If Wednesday happens to be a holiday on the next working day i.e., Thursday.
The transaction in which the exchange of currencies takes place at a specified future date subsequent to the
spot date is known as a forward transaction. The forward transaction can be for delivery at one month or two
months or three months etc. A forward contract for delivery one month means the exchange of currencies will
take place after one month from the date of contract.
The market quotation for a currency consists of spot rate and forward margin.
The outright forward rate has to be calculated by loading the forward margin into the spot rate. e.g. US $ is
quoted as under in the interbank market on 5th March
Spot US $ 1 = Rs. 67.4000/4200
Spot /April .2000/.2100
Spot/ May .3500/.3600
The following points are to be noted in interpreting the above quotation.
The first one is spot rate for dollars. The buying rate is Rs.67.4000 and the selling rate is 67.4200
The second and the third are forward margins for forward delivery during the months of April and May
respectively. They are Rs. 0.20 and Rs.0.21
Under direct quotation the first rate is buying rate and the second rate is selling rate.
Buying rate Selling rate

April May April May
Spot Rate 67.4000 67.4000 67.4200 67.4200
Add: Premium 0.2000 0.3500 0.2100 0.3600
Forward Rate 67.6000 67.7500 67.6300 67.7800
From the above calculation we arrive at the following outright rates

Spot delivery 67.4000 67.4200
Forward delivery April 67.6000 67.6300
Forward delivery May 67.7500 67.7800
If the forward currency is at discount, it would be indicated by quoting the forward margin in the descending
order. Presume on 15th March the quotation for Pound Sterling in the interbank market is as follows:
Spot GBP 1 93.4000/.4300

Spot/April 93.3800/.3600
Spot/May 93.5700/.5400
As the forward margin is in descending order (.3800/.3600) forward rate of sterling pounds is at discount. The
outright forward rates are calculated by deducting the related discount from the spot rate. It is shown below:

April May April May
Spot Rate 93.4000 93.4000 93.4300 93.4300
Less: Discount 0.3800 0.5700 0.3600 0.5400
Forward Rate 93.0200 92.8300 93.0700 92.8900
From the above calculations the outright rates for Pound Sterling can be restated as under:
Buying Selling
Spot delivery GBP 1 = 93.4000 93.4300
Forward delivery April 93.0200 93.0700
Forward delivery May 93.8300 92.8900
Forward margin in ascending order = Add Premium to spot rate

Forward margin in descending order = Deduct discount from spot rate
Foreign Exchange Dealers’ Association of India (FEDAI) has issued guidelines on the quotation of merchant
rates - spot and forward. In Indian forward market availability of option forward contract is a peculiar one.
Forward contracts which provide for utilization on a specific date are called as fixed forward contracts. The date
of utilization is pre determined and it is a specific date. There is no option for delivery of utilization to either
party other than the pre determined date.
EXCHANGE RATES
Fixed Exchange Rate

It refers to the system under the gold standard where
the rate of exchange tends to stabilize around the mint
par value. Any large variation of the rate of exchange
from the mint par value would entail flow of gold into or
from the country. This would have the effect of bringing
the exchange rate back to the mint par value.
In the present day situation where gold standard no
longer exists, fixed rates of exchange refer to maintenance
of external value of the currency at a predetermined
level. Whenever the exchange rate differs from this level
it is corrected through official intervention, e.g., when
International Monetary Fund (IMF) was formed every
member country was required to declare the value of the currency in terms of gold and US Dollars (known as
the par value). The actual market rates were allowed to fluctuate only within a narrow band of margin from the
level. Though par value system was abolished with the second amendment to the articles of IMF in 1978 still the
system of fixed rates continues in many countries in the form of pegging their currencies to a major currency.
Floating/Flexible Exchange Rates
Floating or flexible exchange rate refers to the system where the exchange rates are determined by the
position/ condition of demand and supply of foreign exchange in the market. Normally the exchange rates are
free to fluctuate according to the demand and supply forces with no restrictions on buying and selling of foreign
currencies in the exchange market.
Under floating exchange rates no par value is declared and the Central Bank does not intervene in the market.
Any disparity in the balance of payments is adjusted through the changes in exchange rate that take place
automatically in the market. As Central Bank does not intervene in the market there is no change in the exchange
reserves of the country.
Factors affecting Exchange Rates:
So long as fixed exchange rate system was in vogue, rates could not go beyond the respective lower and upper
intervention points except when there was devaluation or revaluation of currency.
Whereas under Floating rate system, the exchange rates fluctuate on account of demand and supply of currency.
The principal factors affecting exchange rates are:

Long Term Periods
Purchasing power parity theory under a generalized system of clean floating exchange rates respond to inflation
differentials. This is good theory for long term exchange movements.
Short Term Periods
Country’s current account balance is a better indication of exchange rate trends. A surplus, i.e., foreign exchange
net inflows from export earnings pushes country’s currency higher.
A nation’s international competitiveness and with it the trend of its current account depends on different
factors.
(i) Higher economic growth.
(ii) Inflation will diminish export after certain future period and will increase imports.
EXCHANGE ARITHMETIC
Example 1: Bank’s export customer has presented a sight bill for US $ 1,00,000 for negotiation under a Letter
of Credit providing for value date TT reimbursement.
The following is the additional information:
Indian agent is entitled to a commission of 0.5% as mentioned in the L/C.
Calculate Rupee amount to be credited to customer’s current account taking into account the following:
Exchange margin is allowed at 0.15%.
Exchange to be quoted as per FEDAI guidelines. Rupee amount is to be expressed to the Rupee.
Solution:
Bill amount is US $ 1,00,000
Exchange rate (spot) = Rs. 67.150000
Less: Margin @ 0.15% Rs. 0. 100725
Rs.67. 049275
Rounded off to the multiples of 25 = Rs.67.0500
US $ 1,00,000 @ Rs. 67.0500 = Rs.67,05,000
Less: Commission to Indian Agent on the bill [email protected]%
= US $ 500 @ 67.0500 = Rs. 33,525
= Rs.66,71,475
Amount to be credited to customer’s a/c = Rs. 66,71,475
Example 2: On 1.2.2018 the bank had purchased a demand bill for US$ 10,000 @ Rs. 66.10 and the exporter
was paid in Rupee immediately. The bill when it was presented on 10th February, 2018 at New York was not
honoured.
The advice of non-payment was received and conveyed to the exporter on 13th February, 2018. The Exporter
requested that:
1. Bill amount plus charges of Rs.250 be recovered from him.
2. 5% rebate be allowed to the overseas importer.
3. The bill be treated on collection basis and represented for payment.
On 3rd March, 2018 the bank in New York faxed having conveyed the recovery of the amount and credited the
proceeds less their charges US $ 20 with value date on 3rd March, 2018.
Meanwhile the market has moved and the TT selling rate on 13th February, 2018 was Rs. 66.25. The TT buying
rate on 3rd March, 2018 was Rs. 66.05
Solution:
The repayment of the bill clearly means reversal of the deal and hence the bank has to sell ready dollars at the
TT selling rate on the date of reversal of the transaction.
In this process we have to find out what would be the probable Rupee loss or profit to the customer.
On the 13th February, 2018 the customer pays to the bank, the bill amount (overdue interest is ignored in our
calculation and separately recovered). The following amount would be paid.
Bill amount US$ 10,000
TT selling rate Rs. 66.25
Rupee amount payable by the customer Rs.6,62,500
Add: Bill amount charges 250
Rs.6,62,750
On the export bill realized on 3rd March, 2018, the dollar proceeds realized would be:
Bill Amount US$ 10,000
Less: 5% rebate $ 500
Less: Bank charges $ 20
$ 9,480
The dollar amount at the TT buying rate of
US$ 9,480 X 66.05 = Rs.6,26,154
Gain or loss to the customer
Amount refunded by the customer on 13th February, 2018 = Rs. 6,62,750
Amount received by the customer on 3rd March, 2018 = Rs.6,26,154
Loss = Rs. 36,596
Example 3: M/s XYZ corporation offered a sight bill to bank’s Mumbai Fort Branch for US Dollar 2,50,000 on
01.01.2018 drawn under Letter of Credit established by Citi Bank, New York. Calculate what is the amount bank
will credit exporter customer’s account taking into account the following:
1. Inter bank USD 1 = Rs. 66.5000/5100
2. Transit period 10 days. Interest Rate 11%
3. Exchange Margin 0.15%
Solution:
Spot rate USD 1 = Rs. 66.5000
Less: Margin 0.15% Rs. 0.0997
Rs. 66.4003
Rounded off to the multiples of 0.0025 Rs. 66.4000
US $ 2,50,000 @ 66.6000 Rs. 1,66,00,000.00
Less: Recover interest at 11% for 10 days Rs. 50027.40
Net payable Rs. 1,65,50,972.60
Example 4: You sold Pound Sterling 2,00,000 in the interbank market at Pd Stg 1 = Rs.90.80 in cover of an
inward TT reported by your branch in India. However, it was detected that the transaction had been erroneously
reported twice and you are therefore required to cancel your sale.
Assuming that Sterling Pounds was quoted in the local inter-bank market as under
Spot TT Pd. Sterling Rs.90.7075/7700
One month forward Rs.90.8000/8400
What will be the loss or gain to the bank bearing in mind that you are required to pay brokerage of Rs.2,000/-
for original sale transaction, as well cancellation transaction.
Solution:
1. As this is a cancellation of sale, we will have to buy from the market at interbank selling rate
Pd Sterling 1 = 90.7700
Pd Stg 2,00,000 @ 90.7700 = 1, 81,54,000
Add: Brokerage 2,000
= 1,81,56,000
2. Amount originally received for our sale
Pd Stg 2,00,000 @ 90.80 = 1,81,60,000
Less: Brokerage = 2,000
= 1,81,58,000
Profit = Rs. 2,000
Example 5: An importer-customer approached you on 1st January 2018 for sale to him
1. US Dollar 2,00,000 delivery on 31st March 2018
2. US Dollar 1,00,000 delivery on 30th April 2018
Assumptions:
Spot inter bank 66.5000/5100
Forward premia Jan 0.1350/0.1450
Feb 0.3050/0.3150
March 0.5500/0.5600
April 0.7700/0.7800
Exchange margin 0.130%
Last two digit in multiples of 25
Calculate the rates to be quoted to the customers.
Solution:
1. Importer customer approached on 1.1.2018 US $ 2,00,000 delivery on 31.3.2018
Spot inter bank Rate Rs.66.5100 (being import sale txn)
Add: Premium upto 31.3.2018 + 5600
Rs.67.0700
Add: Exchange margin 0.125% 0.0838
Rs.67.1538
Rounded off to Rs.67.1550
2. US $ 1,00,000 delivery in April 2018

Spot inter bank rate Rs.66.5100
Add: Premium up to 30.4.2018 + Rs.00.7800
Rs.67.2900
Add: Exchange margin @0.125% 0.0841
Rs.67.3741
Rounded off to Rs. 67.3750
Execution of Forward Contract

In forward contact the time and the amount of foreign exchange to be delivered are pre-determined and the
customer is bound by this agreement. So, theoretically, there should not be any variation and on the due date
of the forward contract the customer will either deliver or take delivery of the fixed sum of foreign exchange as
agreed upon. But in reality/practice often the delivery under a forward contract may take place either before
or after the due date, or delivery of foreign exchange may not take place at all. In these cases the bank will
generally agree for the same provided the customer agrees to bear the loss if any.
Now let us analyse the possibilities of the fate of a forward contract.
Forward contract
FORWARD EXCHANGE RATES

The transaction in which the exchange of currencies takes place at a specified future date subsequent to the
spot date is known as a forward transaction. In other words as against delivery of funds on the same day or on
the second working day from the date of transaction if it is on a specified future date the rate applied for such
transaction is called Forward Rate Transaction.
The forward transaction can be for delivery at one month or two months or three months etc. A forward
contract for delivery one month means the exchange of currencies will take place after one month from the
date of contract.
fORWARD MARGIN PREMIUM AND DISCOUNT

In a free market, the exchange rates would be based on the demand and supply system. A currency in excess
supply would tend to become cheaper and a scarce one becomes costlier till balance between demand and
supply is struck.
Besides given the connection between exchange rates and funds cost in a totally free market the interest rates
differential for the two currencies would be reflected in the forward exchange rates.
The relationship between spot rate and forward rate of any two currencies depend firstly on the relative rates
of interest obtainable on similar types of securities in the two Centre and secondly on the relationship between
the demand for and the supply of forward currency in the markets.
Interest factor is the basic factor in arriving at the forward rate. If the rate of interest in London for three
months prime bank bills rate is 7% p.a. while the same can be purchased in Switzerland at a rate of interest of
8% p.a. there will be a flow of funds from London to Switzerland to take advantage of higher yield shown by
Swiss bills. (assumption is that there are no exchange controls and hence movement of capital is allowed). The
London investor has to buy Swiss Fr / Euro and the same is to be reconverted back to Sterling on maturity. This
will lead to demand for Sterling in the forward.
The gain or loss will be adjusted in the forward rate of currencies.
The forward price of a currency against another can be worked out with the following factors:
1. Spot price of the currency
2. Interest rate differentials for the currencies
3. The term, i.e., the future period for which the price is worked out.
An important point to be kept in mind is that the forward rate so worked out is not an indicator of the future
trend of the currency.
Forward Margin - Premium

In simple terms it may be said that the forward value of that currency (forward rate) is higher than the spot
value (spot rate). A currency is said to be premium if its forward value is higher than the spot value.
The currency is said to be at premium if it commands more of the other currencies in the forward than in
the spot. The actual outright forward rate is obtained by allowing the forward margin over the spot rate. It is
arrived at by adding the forward margin to the spot to make it dearer.
Forward margin - Discount: If a currency is at discount, it means that the forward value of that currency is lower
than the spot value. A currency with a higher rate of interest is said to be at discount in the forward relative to
the currency with lower rate of interest. If a currency commands less of the other currency in the forward than
at the spot, it is said to be at a discount.
Factors determining forward Margin:

Rate of interest: The difference in the rate of interest prevailing at the home centre and the concerned foreign
centre determines the forward margin. If the rate of interest at the foreign centre is higher than that prevailing
at the home centre the forward margin would be at discount. Conversely, if the rate of interest at the foreign
centre is lower than that at the home centre the forward margin would be at premium.
The spot rate for US dollar is Rs.66.000. The rate of interest in India is 8% and at New York it is 5% p.a. the bank
has to quote 3 months selling rate to a customer. Assuming that the operation is for US Dollar 10,000 and the
entire interest loss / gain is passed on to the customer. The forward rate can be calculated as under:
To meet the needs of the customer the bank may buy spot US dollars and deposit them in New York for 3 months
so that it can deliver on due date the required dollars.
The calculation is as under:
Purchase $ & invest for 3 months US $ 10,000 Borrow for dollar to pay at Rs.6,60,000
Rs.66/-
Rs.66 x 10,000
Int earned at 5% for 3 months US$ 125 Int payable 3 months@ 8% Rs. 13,200
Receive after 3 months US$ 10,125 Pay after 3 months Rs.6,73,200
The bank should be able to get Rs. 6,73,200 against US $ 10,125. Therefore, the rate quoted is:
6,73,200 /10,125 = Rs.66.48
Thus, the forward premium is Re. 0.48
Demand and Supply: Forward margin is also determined by the demand for and the supply of foreign currency.
If the demand for foreign currency is more than its supply forward rate would be at Premium and the rate
would be at discount if the supply exceeds the demand.
Speculation about spot rates: Since the forward rates are based on spot rates any speculation about the
movement of spot rates would influence forward rates also. If the exchange dealers anticipate the spot rate
to appreciate, the forward rate would be quoted at premium and if they expect the spot rate to depreciate the
forward rates would be quoted at a discount.
CALCULATION OF FORWARD PREMIUM / DISCOUNT

Example 6: Customer requests his banker to book a forward sale contract for US$10,000 delivery after three
months. US $ are quoted in the local inter bank market as under:
Spot US $ 1 = Rs. 67.2400/.2500
One month forward premium 0.0850/0.0900
Two months forward premium 0.3650/0.3700
Three months forward premium 0. 6300/.6350
Additional information:
1. Exchange profit must be included in the rate quoted to the customer.
2. Rate quoted should be nearest to the fourth decimal in multiples of 0.0025.
3. Brokerage and other charges may be ignored.
4. Bank is entitled to exchange profit of 0.15% on the transaction.
Calculate the rate which will be quoted by you as a banker to your customer. What will be bank’s profit?
Solution:
Inter bank spot selling rate Rs. 67.2500
Add: Three months forward premium Rs. 0.6350
Rs. 67.8850
Add: Exchange profit 0.15% .1018275
Rs.67.9868275
Rounded off to Rs. 67.9875
Profit on the transaction
Rate quoted to the customer Rs. 67.9875
US $ 10,000 @ 67.9875 = Rs.6,79,875
Less: US $ 10,000 @ 67.8850 = Rs.6,78,850
Profit = Rs. 1,025
Example 7: On 1.3.2018 when a forward contract matured for execution bank was asked by an Importer
customer to extend the validity of the forward sale contract for US $ 10,000 for a further period of three months.
Contracted Rate US $ 1 = 67.00
US $ quoted as on 1.3.2018
Spot 66.5000/ 66.6000
Premium April 0.2950/0.3000
Premium May 0.5550/0.5600
Premium June 0.7700/0.7750
Calculate the cost for your customer in respect of the extension of the forward contract. Rupee values to be
rounded off to the nearest rupee. Margin 0.080% for buying rate Margin 0.30% for selling rate
Solution:
This is an Extension of Forward Contract and it is a sale contract.
Step 1. Cancel the contract at TT buying rate on 1.3.2018
Spot US $ 1 = Rs.66.5000
Less: Margin 0.080% 0.0532
=Rs.66.4468
Hence TT buying rate is Rs.66.4475 (rounded off)
US $ 10,000 @ Rs. 66.4475 = Rs. 6,64,475
US $ 10,000 @ Rs. 67.0000 = Rs. 6,70,000
Difference in favour of the bank = Rs. 5,525
Step 2. New contract is to be booked at the appropriate forward rate, with premium for full month. Three
month’s extension from 01.03.2018 is up to 31.05.2018.
Therefore, premium for May is to be taken. Three months forward rate is as under:
US $ 1 = Rs. 66.6000
Add: Premium for one month (May) = Rs. 0.5600
=Rs. 67.1600
Add: Margin 30% =Rs. 0.2014
= Rs.67.3614
Forward rate to be quoted to the customer is US $ 1 = Rs. 67.3625
Example 8: Bank’s importer customer requests that on 10th January book a forward exchange contract for
Japanese Yen 2 Million delivery in March.
Assuming US $ dollar are quoted in Singapore Market against Japanese Yen as under:
Spot US $ 1 = JPY 109.3000/.3110
1 month forward 100/90
2 months forward 200/190
and US $ in the local interbank market as

Spot US $ 1 = Rs. 66.1000/.1050
Spot /Feb 900/950
March 1200/1300
April 1900/2000
May 2500/2600
June 3200/3125
July 3725/3800
What rate will bank quote to its customer bearing in mind that bank is required to keep an exchange margin of
0.15% on TT selling and 0.20% on bills selling.
Solution:
Against Rupee, dollar is quoted at premium. Since this is a sale transaction late delivery will be taken. The
forward rate to the customer will be based on spot/March selling rate in the interbank market.
Dollar/Rupee spot selling rate = Rs.66.1050
Add: Premium for March= 0.1300
= Rs.66.2350
Add: Exchange margin for TT selling at 0.15% on 66.2350 = 0.0993
Forward TT selling rate for dollar = Rs.66.3343
Add: Exchange margin for bills selling Rate 0.20% on 0 .1326
Forward bills selling rate for dollar Rs.66.4669
Against Yen. Dollar is quoted at discount. Since the buying rate is reckoned.
For this leg of transaction, the latest delivery date of 31.3.2018 will be taken. This falls under third month from
10th Jan.
Dollar /Yen Spot buying rate = JPY 109.3000
Less: Discount for 3 months = JPY 0.0300
= JPY 109.2700
Forward bill selling rate for Jap Yen
Rounded off the rate quoted would be Rs. 60.8300 per 100 JPY.
Example 9: Bank’s exporter customer requests bank on 4th May to book a forward contract of CAD 70,000 for
delivery customer’s option July.
Assuming the bank covers its purchase of Canadian dollars in Singapore Market and US $ - CA$ are quoted as
under:
Spot US$ 1 = CA$1.2820/2840
1 month 40/30
2 months 60/50
3 months 80/70
and the Rupee - US Dollar are quoted in the interbank market as under:
Spot US $ 1 = Rs. 67.2425/2525
Spot /June 1150/1250
July 2250/2350
August 3350/3450
What rate will you quote to your customer bearing in mind that an exchange margin of 0.10% has to be loaded
in the exchange rate? What will be the rupee amount payable to the customer?
Solution:
Earliest delivery date will be taken, i.e., 1st July as
US dollar/Rupee spot buying rate Rs. 67.2425
Add: Premium for June Rs. 0.1150
Rs.67.3575
Less: Exchange margin at 0.10% on Rs.67.3575 Rs. 0.0673
Forward buying rate for US Dollar Rs.67.2902
US dollar is at discount against Canadian dollar. Since selling rate is reckoned earliest delivery date will be
considered which is 1st July and falls between first and second month. Rounding off to the earlier month, the
customer rate will be based on one month US dollar/Canadian dollar rate at Singapore Market.
US Dollar /Canadian dollar spot selling rate = CAD 1.2840
Less: Discount for one month = CAD 0.0030
= CAD 1.2810
Forward buying rate of for Canadian dollar
(67.2902 \ 1.2870) = Rs.52.5294
Rounded off, the rate quoted is Rs. 52.5300 per Canadian dollar
Rupee amount payable to the customer for CAD 70,000 is Rs. 36,77,100.
Example 10: An importer-customer of bank wishes to book a forward contract with you on 1st January for sale
to him SGD 4,00,000 delivery on 28th February.
The spot rates on 1st Jan are USD/Rs.66.2425/2525 and USD/SGD 1.3258/.3268 and the swap points are:
USD/Rs.
Spot/Jan 0300/0400
Spot/Feb 1100/1300
Spot /Mar 1900/2200
Spot /April 2700/3100
Spot /May 3500/4000
USD/SGD
1ST month forward 48/49
2nd month forward 96/97
3rd month forward 138/140
Calculate the rates to be quoted to the customer keeping an exchange margin of Re. 0.05. Fineness of quotation
as per FEDAI Rules.
Solution:
The customer requires the rate for fixed date delivery on 28th February. The rate quoted to him will be based on
Spot/Feb rate of US dollar / Rupee and second month forward rate US Dollar/Singapore dollar.
US Dollar/Rupee spot selling rate = Rs. 66.2525
Add: Forward premium for delivery Feb = Rs. 0.1300
= Rs. 66.3825
Add : Exchange Margin + Rs. 0.0500
Forward Selling rate for US Dollar = Rs. 66.4325
US Dollar /Singapore Dollar spot buying rate SGD 1.3258
Add : Forward premium for 2nd month SGD 0.0096
SGD Rs 1. 3354
Forward selling rate (66.4325 /1.3354) Rs. 49.74727
Rounded off the rate quoted is Rs. 49.75
Example 11: Your customer requested you on 5th April to book a forward contract cover an export bill for
Singapore Dollar 2,00,000 drawn on Singapore and payable 30 days after sight with an option to him over the
month June.
The following rates prevail in the interbank market for US dollars:
Spot US $ 1 = Rs. 66.2425/2475
Spot / April 1650/1750
May 3150/3250
June 4650/4750
July 6150/6250
August 7650/7750
September 9150/9250
At Singapore market, Singapore dollar is quoted for
Spot US $ 1 = SGD 1.3440/1.3514
5 monthly forward 240/250
6 monthly forward 280/290
Transit period is 25 days. Exchange margin required is 0.15% What rate will you quote to your customer?
Solution:
US Dollar is at premium against Rupee. Earliest delivery under the forward contract is on 1st June. Usance
period of 30 days and transit period of 25 days. Now up to 55 days making 25th July the due date of the bill. This
will be rounded off to the lower month and the exchange rate to the customer will be based on Spot/June rate
for US Dollar in the interbank market.
US Dollar/Rupee spot buying rate = Rs. 66.2425

Add: Premium for June + Rs. 0.4650
Rs.66.7075
Less: Exchange margin at 0.15% on Rs.66.7075 Rs. 0.1000
Forward buying rate for US dollar Rs.66.6075
US Dollar is at premium against Singapore dollar. Selling rate is to be considered taking latest delivery of 30th
June, the bill is expected to realize on 15th August which falls in the fifth month from April. The forward rate to
the customer will be calculated based on 5 months forward US Dollar/Singapore dollar rate.
US dollar/Singapore dollar spot selling rate = SGD 1.3514
Add: Premium for 5 months = SGD 0.0250
=SGD 1.3764
Forward buying rate for Singapore dollar (66.6074 /1.3764) Rs.48.3925
The rate quoted to the customer is Rs. 48.3925 per Singapore Dollar.
Example 12: On 18th April an Export customer seeks forward cover for Euro 100,000 with an option to him
over July covering an export bill for 30 days usance.
The interbank rates for US $ are as under:
Spot US $ 1 = Rs.67.2425/2500
Spot/April 500/600
May 1400/1500
June 2800/2900
July 4200/4300
Euro is quoted in Singapore Market as under:
Spot Euro 1 = US$ 0.835988

1 month 20/21
2 months 40/41
3 months 60/61
4 months 80/81
Transit period is 25 days. The bank requires an exchange margin of 0.10%. Calculate the rate to be quoted to
the customer.
Solution:
Dollar/rupee market spot buying rate = Rs. 67.2425
Add: Premium for July .2800
= Rs.67.5225
Less: Exchange margin at 0.10% on 67.5225 0.0675
Forward bill buying rate = Rs.67.4550
Euro is at premium at Singapore market. The notional due date falls in July. This may be rounded off to earlier
month. Premium for 3 months will be taken.
Euro dollar market spot buying rate = US D 1.1973
Add: 3 months premium 0.0060
Euro dollar forward bill buying rate = US D 1.2033

Euro dollar forward bill buying rate
(Rs. 67.4550 x 1.2033)
= Rs. 81.1686015
Rounded off to the nearest multiple of 0.0025 the rate quoted would be Rs.81.1700 per Euro
Example 13: Bank’s importer customer requests that on 10th January to book a forward exchange contract for
Japanese Yen 2 Million delivery in March.
Assuming US $ are quoted in Singapore Market against Japanese Yen as under:
Spot US $ 1 = JPY 109.3000/.3110
and US $ in the local interbank market as:
spot US $ 1 = Rs. 66.1000/.1050
Spot / Feb 900/950
March 1200/1300
April 1900/2000
May 2500/2600
June 3200/3125
July 3725/3800
What rate will bank quote to its customer bearing in mind that bank is required to keep an exchange margin of
0.15% on TT selling and 0.20% on bills selling.
Solution:
Against Rupee, dollar is quoted at premium. Since this is a sale transaction late delivery will be taken. The
forward rate to the customer will be based on spot/March selling rate in the interbank market:
Dollar/Rupee spot selling rate Add: Premium for March = Rs.66.1050
= .1300
= Rs.66.2350
Add: Exchange margin for TT selling at 0.15% on 66.2350 = 0.0993
Forward TT selling rate for dollar = Rs.66.3343
Add: Exchange margin for bills selling
Rate 0.20% on 0 .1326
Forward bills selling rate for dollar Rs.66.4669
Against Yen. Dollar is quoted at discount. Since the buying rate is reckoned for this leg of transaction, the latest
delivery date of 31.3.2018 will be taken. This falls under third month from 10th Jan.
Dollar /Yen Spot buying rate = JPY 109.3000

Less: Discount for 3 months = JPY 0.0300
= JPY 109.2700
Forward bill selling rate for Jap Yen
Rounded off the rate quoted would be Rs. 60.8300 per 100 JPY
CROSS RATE
Cross rate is one wherein the national currency does not figure in the transaction. In other words in foreign
exchange market where rates for some currencies are not available as they are not quoted and as such rate for
such currencies are arrived at through another currency or currency pairs which is called as cross rate. This
method of getting rates through another currency pair is known as cross rate mechanism.
It is a possible solution for calculation of rates for currency pairs which are not actively traded in the market in
general.
Calculation of TT buying rates based on cross rates
TT buying rate
Dollar/Rupee market spot buying rate = Rs.
Less Exchange Margin (-) Rs.
TT buying rate for dollar = Rs. (1)
Dollar/Foreign Currency market spot selling rate = FC (2)
T.T. buying rate for Foreign currency = (1) / (2)
Rounded off to nearest multiple of 0.0025
Calculation of bills buying rates based on cross rates.
Bills buying rate

Dollar/Rupee market spot buying rate = Rs.
Add: Forward premium (for transit and usance period Rs. (+)
rounded off to lower month) Or
Less: Forward discount (for transit and usance
Periods: rounded off to Higher month)
(-)
Less: Exchange margin (-)
Bills buying rate for dollar = Rs. (1)
Foreign currency/dollar market for spot selling rate = FC
Add: Forward premium (for transit and usance period
rounded off to lower month) Or
Less: Forward discount (for transit and usance +
Periods: rounded off to Higher month) - FC
=FC (2)
Bills buying rate for Foreign currency = (1)/(2)
Rounded off to nearest multiple of 0.0025
Example 14: X bank issued a demand draft on Montreal for Canadian dollar for 20,000 at CAD 1 = 52.4140.
However, after a few days of purchase the purchaser of the draft requested X bank to cancel it and repay the
rupee equivalent to him.
Assuming the Canadian dollars were quoted in the Singapore Foreign Exchange market as under:
US $ = cad 1.2830/.2852 and in the interbank market US Dollar 1 = 66.2525/2625. How much the customer will
gain or lose on cancellation of the draft. Exchange margin on TT buying is 0.08%
Solution:
The bank cancels the demand draft at TT buying rate
US Dollar/Rupee market buying rate Rs. = 66.2525
Less: Exchange margin at 0.08% on 66.2525 - 0.0530
Rs. =66.1995
US $ /Canadian dollar market selling rate = CAD 1.2852
Canadian Dollar TT buying Rate (66.1995/1.2852 = Rs.51.5091
Rounded off the rate applicable is = Rs.51.5100
Amount paid by the customer on purchase of DD for CAD 20,000 @ 52.4140 = Rs. 10,48,280
Amount received by the customer on cancellation of DD for 20,000 @ 51.5100 = Rs. 10,30,200
Loss to the customer
= Rs. 18,080
Your customer has requested you to purchase a 30 days sight bill for Euro Assuming Rupee /US Dollar are
quoted in the local interbank market as under:
Spot = US $ 1 = Rs.67.2525/.2600
One month forward 1800/1850
Two months forward 3600/3650
Three months forward 5600/5650
And Euro currency is quoted in Singapore market US $ 1= Euro 0.84736/.8573
One month forward 55/65
Two months forward 110/120
Three months forward 160/170
What rate will you quote to your customer provided you required an exchange margin of 0.10% bearing in mind
the following:
1. Transit period for bill is 25 days
2. Rate of Int @ 10% p.a.
3. Commission on export bill is Rs.500
4. Also show the net amount payable to the customer Rupee amount is to be quoted nearest to the whole
rupee.
The usance of the bill and transit period comes to 55 days. In the dollar/Rupee leg. Forward dollar is at premium.
In this case, since dollar buying rate is reckoned, 55 days will be rounded off to lower period viz., one month
Dollar /rupee market spot buying rate = Rs.67.2525
Add: premium for one month + Re. 0.1800
= Rs.67.4325
Less: Exchange margin at 0.10% on Rs.67.4325 = Re. 0.0674
Bills buying rate for dollar = Rs.67.4999
Dollar /Euro spot selling rate = Euro 0.8573
Add: Premium for 2 months + 0.0120
0.8693
Bills buying rate for Euro 67.4999/0.8693 = Rs.77.6485
Rounded off to the nearest multiple of 0.0025. Therefore, the rate quoted to the customer would be Rs.77.6500
per Euro.
CHAIN RULE
It is used in attaining a comparison or ratio between two quantities which are linked together through another
or other quantities and consists of a series of equations, commencing with a statement of the problem in the
form of a query and continuing the equation in the form of a chain in that each equation must start in terms of
the same quantity as that which concluded the previous equation.
VALUE DATE
The term value date is used to define the date on which a payment of funds or any entry to an account becomes
actually effective and are subjected to interest. In the case of payments on TT the value date is usually the same
in both centres, i.e., payment of the respective currency in each centre takes place on the same day. Here, no
gain or loss of interest accrues to either party. As against same date of settlement if there is a time lag between
the receipts of funds at one centre and payment of funds at another centre compensation should be paid to the
party which is out of funds. Normal mode of compensation is interest which should be recovered/ paid. This
may be by adjusting the value date if acceptable to both the parties.
ARBITRAGE
Arbitrage means simultaneous buying and selling of a currency in two or more markets to take advantage of
temporary difference in prices. This is explained here. If perfect conditions prevail in the market, the exchange
rate for a currency should be the same in all Centres. For example, if US $ is quoted at Rs. 67.2525 in Mumbai the
same rate is to be quoted in New York. But in reality, as imperfect conditions are prevailing the rates in different
centres are different. Thus in New York Indian Rupee in terms of US $ may be quoted at Rs. 67.3525. In such a
case it would be advantageous for a bank in Mumbai to buy US $ locally and arrange to sell them in New York
thereby make a profit.
Arbitrage consists of the purchase and sale of same currency in different centres viz., in three or four centres
and involving several currencies also. Transaction conducted at two centres only is known as simple or direct
arbitrage. If additional centres are involved, it is called as compound arbitrage. Such operations are to be
carried out with minimum of delay if advantage is to be taken of temporary price difference and it requires a
high degree of technical skill.
RELEVANT CONCEPTS /AREAS IN FOREIGN EXCHANGE

Authorised Dealers:
‘Authorised Dealers’ means persons who are authorized by Reserve Bank of India to deal with foreign exchange
without any restriction. As per Sec 10(1) of FEMA, 1999, RBI is empowered to authorize any person to deal
in foreign exchange as an Authorised Dealer. They are issued licence to deal with foreign exchange. They are
commercial banks. Normally banks which are having national presence are allowed to become Authorised
Dealer. All commercial banks are not Authorised Dealers.
According to RBI, whether a transaction is a Current Account transaction or a Capital Account transaction, each
of these transactions is to be carried out through a person authorized to deal in foreign exchange. In this regard
Section 10(1) of FEMA states as under:
“The Reserve Bank may, on an application made to it in this behalf, authorize any person to be known as
authorised person to deal in foreign exchange or in foreign securities, as an authorised dealer, money changer
or off-shore banking unit or in any other manner as it deems fit”.
Such authorization is conferred on these persons through a license. An AP may be Authorised Dealer belonging
to Category I, II, or III or can be a Money Changer. The details are as under:
1. Authorised Dealers Category I: This category comprises of Commercial Banks, State Co-operative
Banks and Urban Co-operative Banks. They are authorized to carry out all Current and Capital Account
transactions as per RBI directions issued from time to time.
2. Authorised Dealers Category II: This category consists of Co-operative Banks, Regional Rural Banks, Full
Fledged Money Changers and others. They are authorized to carry out specified non-trade related current
account transactions and also all activities permitted to Full Fledged Money Changers from time to time.
3. Authorized Dealers Category III: This category consists of select Financial Institutions and other
institutions who conduct transactions which are incidental to the foreign exchange activities incidental to
their business undertaken by them.
4. Full Fledged Money Changers (‘FFMC’): This category consists of Department of Post (Post offices),
certain Urban Co-operative Banks and others. They conduct the business of buying and selling foreign
currencies.
Authorised Money Changers

Authorised Money Changers are those firms, organisations who are permitted by Reserve Bank of India to
handle limited foreign exchange transaction viz., exchange of foreign currency notes, coins and travellers
cheques in order to facilitate the tourists. Here again there are two types viz., Full fledged Money Changers and
Restricted Money Changers.
Full fledged money changers are authorized to handle both purchase and sale of foreign currencies, coins and
Travellers Cheques. Restricted Money Changers are only permitted to purchase foreign currency notes. They
are functioning under the set of guidelines, Rules & Regulations, directions, instructions of Reserve Bank of
India.
Rules of the Foreign Exchange Dealers Association of India, (FEDAI)
Prior to the year 1939 financing of foreign trade and foreign exchange was looked after by foreign banks
operating in India. These banks as a group were known as Exchange Bank’s Association and members of this
Association included foreign banks operating in the cities of Mumbai, Kolkata, Delhi, Chennai and Amritsar. The
terms and conditions for foreign exchange business were laid down by them. With the introduction of exchange
control in India in 1939, rules and regulations of Exchange Banks were brought under RBI.
Subsequently, due to the growth of foreign trade of India, RBI permitted several scheduled commercial banks to
undertake foreign exchange business. To bring in uniformity in the conduct of foreign exchange business, it was
considered desirable to form an Association of all Authorised Dealers as members. Accordingly, an association
known as Foreign Exchange Dealers Association of India (‘FEDAI’) was formed in 1958. Undertaking was given
by each Authorised Dealer to RBI, to abide by the terms and conditions prescribed by FEDAI for transacting
foreign exchange business in India.
FEDAI was registered as a Company under Section 25 of the erstwhile Companies Act, 1956 and each of the
Authorized Dealer as it’s member. FEDAI is a self-regulatory body consisting of 104 Public Sector Banks,
Foreign Banks, Private Sector Banks, Co-operative Banks and Financial Institutions. FEDAI being a non-profit
organization, expenses are shared by all members on annual basis.
The main objective of FEDAI as stated in their Memorandum of Association “further the interests and regulate
dealings of and between Authorised Dealers in foreign exchange inter-se and with public, forex brokers, the
RBI and other bodies. FEDAI is also supported by Indian Banks Association (IBA) and Fixed Income and Money
Markey Dealers Association of India (FIMMDA) and other bodies in holding various programmes for the benefit
of foreign exchange market participants.
FEDAI plays significant and multifarious roles in the conduct of foreign exchange market activities in India.
These are as follows:-
1. Ensures a level playing field for foreign exchange market participants by formulating uniform rules and
guidelines and harmonizes interests of all.
2. Associates with RBI in promoting the growth of India’s external sector and also with various export
promotion councils/chambers of commerce to provide a fillip to India’s exports and imports.
3. Effectively presents India’s views in international forums like International Chamber of Commerce, Paris
in various revisions on the ground rules applicable to international trade financing arrangements like
Documentary Credits, Collections etc.
4. Provides training to bank officers by conducting various workshops, special programmes, seminars
to develop expertise in foreign exchange operations, improving processes and the quality of customer
service.
5. Grants accreditation to foreign exchange market intermediaries such a brokers and electronic service
providers. Also monitors foreign exchange brokers activities interbank foreign exchange market.
6. Offers guidance and information as well as various aspects of foreign exchange business to members.
7. Works with member banks industries key priorities, and concentrates on specific tasks and targets.
8. Contributes to the development of foreign exchange market in the areas of efficiency, depth and liquidity
with greater market discipline.
9. Acts as a catalyst in promoting the best business practices leading to the efficient conduct of foreign
exchange business, including development and maintenance of derivatives and associated documentation.
10. Play as a facilitator between its members, RBI, Export Organizations, various Chambers of Commerce and
other bodies as well as among its members.
Apart from the above FEDAI holds Annual Conferences for the benefit of interaction among its members as well
as with the regulator and discusses issues of concern.
FEDAI has been tasked with the responsibility of Administering the following benchmark rates for use by
member banks:
1. Spot fixing rates
2. FCNR (B) base rates
3. Month end Revaluation rates
4. US Dollar/ Indian Rupee option volatility.
International Commercial Rules /International Standard Banking Practice

To promote global trade and commerce on the principles of free enterprise on a harmonious business and trade
practices, it was necessary to standardize rules governing business policies, mechanics of trade and various
other related aspects of international trade and businesses. With this objective a global organization known
as International Chamber of Commerce (ICC) was founded in the year 1919 immediately after the cessation
of World War I, in Paris, France. Till that time there were no uniform rules or systems that governed global
commerce, trade, finance and investment. To fill this gap a few entrepreneurs joined together and founded ICC.
In 1923 ICC established International Court of Arbitration to settle commercial disputes through arbitration.
There are three principal areas of activities carried out by ICC. They are setting rules, resolving disputes and
“policy advocacy”. Banking being an integral part of global commerce and trade is also one of the important areas
of focus of ICC. Every year Trillions of dollars of global trade transactions are carried out through international
banks from almost all continents. Therefore, in order to ensure a harmonious and a smooth conduct of business
with each other across countries, banks also need common rules and guidelines to avoid “confusion that comes
along with national rules.” Therefore, ICC, took upon itself the responsibility of formulating a set of rules.
The first of such rules was brought out in the year 1930 covering Documentary Credits in which banks are
involved. The early 30s, was “a time of growing nationalism and protectionism” -and since then these rules have
become widely adopted and followed rules.
These rules facilitate the conduct of trade transactions amounting to over US$1 trillion annually. These rules are
adjusted continuously to cater to the evolving needs of the international trade which are routed through banks.
Presently the prevailing rule in use is Uniform Customs and Practice for Documentary Credits 600. (UCP 600).
UCP 600 a set of rules is extensively used in the area of Letters of Credit (otherwise known as Documentary
Credits) issued on behalf of buyers/importers by banks as a part of trade finance. UCP supports banks and
commercial buyers and sellers in more than 175 countries who are members of ICC. The first UCP document
was introduced in the year 1933. Subsequently several revisions have been made over the years and the current
version which is being in use is UCP 600, which was introduced on 1st July 2007. ICC has indicated that a
revision of the same is under progress and is expected to be revised in the year 2020.
UCP 600 like other publications of ICC is not a law. These aim at uniform rules for voluntary adoption and
implementation by commercial organizations including banks of member countries of ICC. UCP 600 has been
designed by experts in banking and representatives of commercial organizations including corporate legal
experts and not by any legislature and therefore free of any political, regional or locational bias. These rules
voluntarily incorporated in documentary credits by insertion of an indication as under - “This credit is subject
to the provisions of UCP 600”. These rules are flexible and provide a stable base for review as well as judicial
scrutiny.
The main object of UCP was establishing a uniformity of interpretation of rules and practice in documentary
credits and due to this the acceptance has been wide. Even non-members of ICC seem to informally follow the
rules in international dealings with a ICC member country.
A detailed discussion on UCP 600 and its application at this juncture, is beyond the scope of the chapter.
International Standard Banking Practice for Examination of Documents under Documentary

Credit
In one of the Letter of Credit (‘LC’) transactions relating to the export. the LC covered goods of “A 50,000
Kilogrammes of Cumin seeds”. The invoice submitted by the exporter stated “50 M. Tonnes of Cumin seeds”. The
importer’s bank (LC Issuing Bank) rejected the documents stating that discrepancy in documents.
In another case the LC mentioned as “Invoices of Amanda Flowers International Private Limited.” whereas
Invoice submitted by the exporter stated “Amanda Flowers Intl. Pvt. Ltd.” The importer’s bank rejected the
documents stating that documents have discrepancy.
In both cases mentioned above, rejection of documents were on account of insignificant discrepancies though
there are no material discrepancies. A LC appears very safe for contracting parties but in cases such as above
it fails to deliver the desired results. This also demonstrates that banks vary in their document-examination
practices.
Therefore, to bring in uniformity of practices adopted for scrutiny of documents ICC brought out a publication
titled as “International Standard Banking Practice for the Examination of Documents under Documentary
Credits”” (“ISBP”) bearing a publication number 645, in the year 2002. Since then a revised publication ISBP
745 was brought out in April 2013.
In a nutshell it can be stated that ISBP is a companion document to UCP 600 and both are to be read in
conjunction with each other by bankers so as to effectively enhance standard international practice of document
examinations.
In addition to the above, the following rules made by ICC help international trade and banks to conduct the
transactions smoothly reducing much of the ambiguities.
International Commercial Terms (‘INCO’ Terms): These rules have become international standard reference
terms for contracts of sale of goods. Developed first in the year 1936, these rules encompass trade terms used
both domestically and internationally. The first publication of INCO Terms included the following six viz., Free
Alongside Ship (‘FAS’), Free on Board (‘FOB’), Cost & Freight (‘C&F’), Cost, Insurance and Freight (‘CIF’), Ex- Ship
and Ex-Quay. These terms define the duties and responsibilities of contracting parties in trade transactions.
Successive revisions to the existing terms have kept pace with developments over the years in modes of
transport such as Air transport, carriage of goods like containers, couriers etc.
Uniform Rules for Collection (‘URC 522’)

Due to the complexity of international trade and local practices a necessity was felt by a group of business men,
under ICC in 1956 to bring forward uniform rules for collection practices so that a common understanding
prevails among buyers, sellers and the banks involved and thus were born Uniform Rules for Collection (URC).
Therefore, URC can be defined as a set of international standards of collection process for bankers involved in
the process. URC promotes a, “common understanding of terminology and expectations” between banks.
How does this mechanism work?
In international trade dealings, a seller of goods, forwards documents relating to the goods through his bank
along with suitable instructions to the buyer’s bank requesting buyer’s bank to present these documents to the
buyer for obtaining payment of the trade deal. The buyer’s bank should present the documents to the buyer
strictly in terms of the conditions specified by the seller and instructs his bank to collect the proceeds of the
same from buyer’s bank, indicating the conditions.
The buyer’s bank upon receipt of the documents from the seller’s bank, presents the same to the buyer and
is expected to follow the conditions of presentment as specified by the seller and obtains the payment from
the buyer and remits the same to the seller through his bank. This process is known as Collection method in
Banking.
The buyer will obtain the possession of goods only after getting the documents from his bank against payment (if
the bill specifies that “Documents against Payment”) or against acceptance (if the bill specifies that “Documents
against Acceptance”. the payment of the same will be made at a specified date in future depending upon the
terms agreed between buyer and seller).
In the absence of a Letter of Credit, documentary collection method is adopted in export transactions. Under the
collection process banks play a role of a channel for the transactions sans guarantee of payment. Documentary
collection method has some advantages for a buyer as well as a seller as indicated in the following table: -
For the seller For the buyer

1. Even if the seller and buyer have an ongoing 1. No need for providing advance payment, a
relationship and the seller can avoid the risk of guarantee or a Letter of Credit towards the
delivery of goods on ‘open account’ basis. payment to the buyer. Consequently costs of the
transaction is less.
2. Collection arrangement assures a seller that 2. The buyer gets the flexibility of time in making
documents will be released to the buyer only payment if documents are under “Against
after payment or acceptance, as the case may be. Acceptance” as the buyer can sell the goods first
and make payment to the seller later (but before
the due date).
3. Most suitable method, if: 3. Convenient method, if
• the seller has no doubt about the ability of • the buyer has no doubts about the seller’s
the buyer to make the payment, ability to ship the goods
• the political and economic situation in the • the political and economic situation in
buyer’s country is stable, seller’s country is stable
• there are no foreign exchange repatriation • there are no sanctions against selling
restrictions in the country of the buyer to goods to the buyer’s country.
that of the seller.
Additionally ICC has published the following, for ushering in uniformity of practices for banks and other parties
involved internationally:-
• Uniform Rules for Demand Guarantees (‘URDG’)
• Uniform Rules for Forfaiting (URF 800)
• Uniform Rules for Bank Payment Obligations
• ICC Banking Commission Opinions
Dealing Room
The Dealing Room of a Bank is a place where foreign exchange transactions of the bank are put through in the
interbank market, in parallel market or with customers. Therefore, Dealing Room occupies an important place in
the organization as a Profit Centre. This is because any business for that matter is run with the object of making
profit so also banks. In the banking scenario the two areas where they make profit are Credit Management and
Foreign Exchange Management. The said Foreign Exchange Management is done through Dealing Room which
is called as Front Office. They put through transactions viz., purchase and sale of foreign currencies and all
market related transactions through various quotes viz., direct, indirect, spot, forward, cross rates etc. At the
end of the day foreign exchange transaction position is consolidated for the Bank as a whole and accordingly in
the international market purchase and sale of foreign currencies take place.
LESSON ROUND UP
• The term Foreign Exchange denotes foreign currency and includes (a) deposits, credits and balances
payable in any foreign currency, (b) drafts, travellers cheques, letters of credit or bills of exchange
expressed or drawn in Indian currency but payable in any foreign currency, (c) drafts, travellers
cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India, but
payable in Indian currency. Foreign exchange transactions are regulated in India through provisions of
FEMA, Trade Control regulations, RBI directives, FEDAI regulations, International Commercial Rules,
International Standard Banking Practice etc. Foreign Exchange transactions are classified in to two
categories viz., Current Account and Capital Account transactions.
• Capital Account transactions are those which alter the assets or liabilities (including contingent
liabilities) outside India of persons resident in India or Assets or liabilities in India of persons resident
outside India. Other than capital account transactions form part of Current Account transactions. Any of
these transactions are to be carried out through an Authorised Persons in India. Banks are designated
as Authorised Dealers and are licensed to carry out foreign exchange transactions. While carrying out
forex transactions banks are to follow international commercial rules like UCP 600, URC 522 etc.
• Foreign Exchange market is a global set up where various currencies are traded. It can be said to
be an Over-the-Counter market for purchase or sale or exchange of foreign exchange, subject to
internationally accepted rules and conventions, by players therein. The international foreign exchange
market system started with Gold Standard and after its collapse in 1920s shifted to Bretton woods
System in 1945. The Bretton Woods System continued till 1971 after which briefly switched over
to Smithsonian Agreement. However, consequent to the oil crisis in 1973 and its fall out on foreign
exchange scenario free float of currencies gained prominence and has continued ever since. Parallel
European Monetary System emerged in late 1970s which gave rise to European Currency Unit that
gained prominence in dealings in European Monetary System. The Maastricht Treaty in 1991 signed
by the European community members gave rise to a new common European currency “Euro” in 2000.
Except Great Britain and Denmark all other members introduced Euro as a transaction currency in
their countries as per Maastricht Treaty provisions. Historically Indian Rupee was linked Great Britain
Pound Sterling. This continued till 1973 though for a brief intervening period between 1971 to 1975
it was linked to US$. However as British Sterling Pounds faced problems India delinked its Rupee from
the same and has linked the same against a basket of currencies to work out an exchange rate against
other currencies. From March 1, 1993 RBI has allowed the Rupee exchange to be quoted as per market
determined rates.
• International forex market is a 24 hours market. Variety of factors affect the market performance. In
fact, every minute, depending upon the political, economic, financial, market and trader psychology
the foreign exchange market reacts through the exchange rates. Major players in the international
forex market include individual customers, banks, Central Banks, Speculators, Brokers, Multinational
Corporations, Governments and Domestic companies.
• Exchange Rate: The rate at which one currency is exchanged for another currency. Exchange rates
can be quoted as Direct rate or indirect rate. In India Direct quote rates are in vogue since August 2,
1993. Rates are always quoted as a pair namely bid and offer rate. In direct quotes the first rate is the
Bid rate (buying rate) and the second rate is the Offer rate (Selling rate). The difference between Bid
and Offer is called ‘Spread’ representing the profit in the buying and selling transactions. A ‘pip’ is an
abbreviation for Price Interest Point. A pip is the fourth decimal place in a currency pair. When currency
pairs displayed is up to 4 decimal places. Cross rate is (a derived rate) a method through which if price
of one currency is not available against the other, the exchange rate between them is obtained with the
help of a common third currency. Buying rate and Selling rate can be arrived through cross rates.
• Value date is the actual date on which the exchange of currencies take place in full settlement of a
foreign exchange transaction, irrespective of the date of the deal. Based on the value date concept,
there are internationally accepted rules for value dates various transactions such as Cash, Spot, Tom
and Forward. If the settlement for an exchange rate deal takes place beyond “Spot” date, it is known as
“Forward Rate”. A forward rate may be a quoted on a premium or a discount basis. When a currency is
quoted costlier compared to the spot rate the currency is said to be at a premium. When a currency is
quoted cheaper compared to the spot rate the currency is said to be at a discount.
• Simultaneous buying and selling a fixed quantity of a foreign currency in different market simultaneously
to take advantage of rate differences is known as Arbitrage transaction
TEST YOURSELF
1. State whether the following statements are True or False:
a. International markets operate at different time zones.
b. Authorised Money changers can handle all type of foreign exchange transaction.
c. Rates not available in case the home currency is not quoted in the international market.
d. Dealing room function is a back office function and not opened in many banks.
2. Who are the participants of Foreign Exchange Market. Briefly discuss.
3. How exchange rates are determined in the foreign exchange market?
4. What are all the variation quotations being used in foreign exchange market?
5. other,
the Analyse Forward Contract.
the exchange rate between them is obtained with the help of a common third currency. Buying rate
6. and
WriteSelling rate
a short canon
note befactors
arrivedaffecting
throughforward
cross rates.
margin
7.
• Value
What isdate
meant by Forward
is the margin
actual date - Premium
on which and Discount?
the exchange of currencies take place in full settlement of a
8. foreign exchange
Write short transaction,
notes on: Arbitrate,irrespective
Chain Rule, of the Rate
Cross dateandof the deal.
value Based on the value date concept,
date.
there are internationally accepted rules for value dates various transactions such as Cash, Spot, Tom
9. What is meant by capital account and current account in International Trade?
and Forward. If the settlement for an exchange rate deal takes place beyond “Spot” date, it is known as
10. “Forward
Attempt the following:
Rate”. A forward rate may be a quoted on a premium or a discount basis. When a currency is
a. On 16.7.2017 your exporter
quoted costlier compared customer
to the spot rate therequested
currencyyou to book
is said a forward
to be contract
at a premium. for fixed
When delivery
a currency is
2 months in respect of 30 days bill for Australian Dollar 50,000.
quoted cheaper compared to the spot rate the currency is said to be at a discount.
Simultaneous
• US Dollars wereand
buying quoted in the
selling interbank
a fixed quantitymarket a under:
of a foreign currency in different market simultaneously
to take advantage of rate differences is known as Arbitrage transaction
Spot USD 1 = 66.2525/3525
Spot/August 4200/4400
September 7700/7900
October 1.100/1.0800
November 1.400/1.4200
At Singapore Market the Australian Dollars were quoted as follows:
Spot USD 1 + 1.3319/3551
One month 110/100
Two months 200/190
Three months 300/290
Four months 390/380
Transit period is 25 days

Exchange margin is 0.10%
Calculate the rate to be quoted to the customer.
b. Solve the problem
Your exporter customer request you to quote him a rate for purchase of a Singapore Dollar
2,00,000 Assuming US Dollar quoted in the inter bank market is as under:
Spot US $ 66.5500/5600
1 month forward 66.3500/3600
2 months forward 66.0500/0600
3 months forward 65.7600/7700
And Singapore dollar are quoted in Singapore market as under:
Spot US $ 1= SGD 1.3422/3542
1 month 0.0040/0.0045
2 months 0.0060/0.0065
3 months 0.0080/0.0085
Transit period is 25 days
Exchange margin to be included in the rate is 0.10%
Interest to be recovered at 10%
What will be rate quoted to the customer? Also calculate the rupee amount payable to him and the
interest to be recovered?
c. On 26 July an Exporter customer tendered for purchase of a bill payable 60 days from sight and
drawn on New York for US $ 30,000. The dollar/Rupee rates in the inter bank exchange market
were as under:
Spot US 4 1 = 67.0500/67.2500
Spot /August 1600/1500
Spot /September 2900/2800
Spot /October 4300/4200
Spot /November 5700/5600
Rate of Interest is 10% p.a.
Exchange margin of 0.10% to the loaded
Fineness as per FEDAI Rules.
Out of pocket expenses Rs. 500 to be recovered.
What will be the exchange rate to be quoted to the customer and the rupee amount payable to
him?

• www.rbi.org.in
• www.incometaxindia.gov.in
Lesson 18 • Non-Performing Assets 493
Lesson 18 Non-Performing Assets

Should Know
• Non Performing Non-performing assets of the • Banking Regulation Act, 1949
Assets (NPA) banking system in India has assumed • Reserve Bank of India Act, 1934
• Corporate Debt lot of importance in view of its effect
• Securitisation and
Restructuring on the Banking system of India. Any
Reconstruction of Financial
(CDR) one learning about banking in India Assets and Enforcement of
• One Time should have a fair idea of the same. Security Interest Act, 2002
Settlement (OTS) The contents of this lesson will help
a reader to understand about :
• Asset
Reconstruction • Income Recognition
Companies (ACR) • Asset Classification
• Debt Recovery • Provisioning Norms
Tribunals (DRT)
• CDR
Lesson Outline
• Introduction
• Definition: NPA
• Income Recognition
• Asset Classification
• Provisioning Norms
• CDR
• Business Correspondent and Business Facilitators
• Re-structuring
• One Time Settlement
• Sale to ARC
• Recovery Through DRT
• Enforcement of Security under SARFEASI
• LESSON ROUND UP
• GLOSSARY
• TEST YOURSELF
493
INTRODUCTION
Prior to the introduction of NPA norms in India in 1991-92, profits announced by banks were inflated and not
real, as the interest debited in loan accounts where there was no possibility of its recovery was also included
in the income; there was no provision made for the monies lent where the recovery of instalments were not
forthcoming and no provision for the deterioration in the market value and realizable value of the security. The
accounting practices followed amongst bankers were not uniform.
However, in line with the international practices and as per the recommendations made by the Committee
on the Financial System (Narasimham Committee-1) the RBI has introduced, in a phased manner, prudential
norms for income recognition, asset classification and provisioning for the advances portfolio of the banks so
as to move towards greater consistency and transparency in the published accounts. Over the years Prudential
norms and Asset classification have assumed lot of importance and every student of banking is expected to be
aware of the same.
The policy of income recognition should be objective and based on record of recovery rather than any subjective
considerations. The classification of assets of bank also has to be done objectively. The provisioning should
be made on the basis of classification of assets based on the period for which the asset has remained non-
performing and the availability of the security and its realizable value.
Banks have to ensure that while granting loans and advances, realistic repayment schedules are fixed on the
basis of cash flows of borrowers. This would facilitate prompt repayment by the borrowers and there by improve
the record of recovery. Banks also undertake debt restructuring exercise for corporates for the benefit of all stake
holders a knowledge of which will be useful. Banks also undertake financial inclusion on a large scale with the
help of business correspondents and business facilitators with active use of technology for speedier, accurate
and at affordable costs for helping rural poor. Mobile banking services are also being extended to customers as a
part of digital banking initiatives. Banks are also involved in setting up of RSETIs for providing training and skill
development in respect of rural below poverty line unemployed youth. A comprehensive exposure to these topics
in this lesson will increase the awareness of a reader to the range of services provided by banks in this regard.
The contents are based principally on RBI Master Directions / Master circulars and will be useful in practical
understanding of the concept of NPA, Income recognition, provisioning norms. The contents have been
elaborated to the extent necessary to offer rationale for various norms adopted by banks in this regard.
Classification of Bank Advances on basis of Performance

The Banks have to classify their advances into two broad groups:
1. Performing Assets; and
2. Non Performing Assets.
Performing assets are also called as Standard Assets. The Non Performing Assets is again classified into three
categories and they are (i) sub standard Assets (ii) doubtful assets & (iii) Loss Assets.
Classification of Bank Advances

PERFORMING ASSETS
Standard Assets - Standard asset is one which does not disclose any problems and which does not carry
more than normal risk attached to the business. The operations in the loan account is satisfactory in terms of
timely repayment of principal and interest, availability of security, no adverse features in the operations of the
accounts etc.
NON-PERFORMING ASSET (NPA)

An asset, including a leased asset, when stops generating income for the bank, it becomes Non-performing. A
loan or an advance is non-performing asset (NPA) where:
(i) Interest and /or instalment of principal remain overdue for a period of more than 90 days in case of a term
loan. In case of interest payments, banks should, classify an account as NPA only if the interest due and
charged during any quarter is not serviced fully within 90 days from the end of the quarter.
(ii) The account remains “out of order” in case of cash credit / overdraft. An account should be treated as
“out of order”, if the outstanding balance remains continuously in excess of the sanctioned limit / drawing
power for 90 days. In case where the outstanding balance in the principal operating account is less than
the sanctioned limit / drawing power, but there are no credits continuously for 90 days as on the date
of Balance Sheet or credits are not enough to cover the interest debited during the same period, these
accounts should be treated as “out of order.”
If the cash credit facility or ad hoc limit sanctioned remains unreviewed or unrenewed for 180 days from
the due date or sanctioned date respectively.
(iii) The bill (purchased / discounted) remains overdue for more than 90 days.
(iv) The amount of liquidity facility remains outstanding for more than 90 days, in respect of securitization
transaction undertaken in terms of guidelines on securitization dated February 1, 2006.
(v) In respect of derivative transactions, the overdue receivables representing positive mark-to-market value
of derivative contract, if remain unpaid for a period of 90 days from the specific due date for payment.
(vi) Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by
the bank.
(vii) In case of Credit Cards, if minimum amount due, mentioned in monthly credit card statement, is not paid
fully within 90 days from the payment due date.
(viii) In case of Agriculture loans if instalment or the interest remains outstanding beyond due date for two crop
seasons (crop maturing within one year) and one crop season (for crops maturing after one year) In other
agricultural loans the norm is 90 days.
(ix) Advances against term deposits, NSCs eligible for surrender, Indira Vikas Patras and Life policies need
not be treated as NPAs if adequate margin is available in the account. Advances against gold ornaments,
government securities and other securities are not allowed this exemption.
(x) In case of consortium advances the classification can be different for different banks as it is based on the
record of recovery with the individual member bank.
(xi) On Account of GST implementation, standard MSME loan accounts up to Rs. 25 crores as on 31.08.2017
will be classified as standard, if payment due as on 01.09.2017 falling due up to 31.12 2018, not paid up to
180 days. 90 days norm to be apply from 1st January 2019.
(xii) The availability of security or net worth of borrower / guarantor should not be taken into account for the
purpose of treating an advance as NPA or otherwise.
Income Recognition
• Income from NPA is not recognized on accrual basis but is booked as income only when it is actually
received. The bank should not charge and take to income account interest on any NPA. This will apply to
Government guaranteed accounts also.
• Interest on advances against Term Deposits, National Savings Certificates (NSC), Indira Vikas Patra (IVP),
Kisan Vikas Patra (KVP) and Life insurance policies may be taken to income account on due date, provided
adequate margin is available in the accounts.
• Fees and commissions earned by the banks as a result of renegotiations or rescheduling of outstanding
debts should be recognized on an accrual basis over the period of time covered by the negotiated or
rescheduled extension of credit.
• If any advance, including bills purchased or discounted, become NPA, the entire interest accrued and
credited to income account in the past periods, should be reversed, if the same is not realized. This will
apply to government guaranteed accounts also.
• In respect of NPAs, fees, commissions, and other income that have accrued should cease to accrue in the
current period and should be reversed with respect to past periods, if uncollected.
• The finance charge component of finance income on the leased assets which has accrued and was credited
to income account before the asset became non performing, and remaining unrealized should be reversed
or provided for in the current accounting period.
• Interest realized on NPAs may be taken to income account provided the credits in the accounts towards
interest are not out of fresh / additional credit facilities sanctioned to the borrower concerned.
• On an account turning in to NPA, the bank should stop further application of interest. However, may
continue to record such accrued interest in a Memorandum account in their books.
INCOME RECOGNITION NORM

Interest income in respect of restructured accounts classified as ‘standard assets’ may be recognized on accrual
basis and that in respect of the restructured accounts classified as ‘non-performing assets’ shall be recognized
on cash basis.
In the case of additional finance in accounts where the pre-restructuring facilities were classified as NPA, the
interest income shall be recognised only on cash basis except when the restructuring is accompanied by a
change in ownership.
ASSET CLASSIFICATION
Banks are required to classify NPAs into three categories, based on the period for which the asset has remained
non performing - (i) Substandard Asset, the asset which has remained NPA for a period less than or equal to 12
months. (ii) Doubtful Asset, the asset which has remained in substandard category for a period of 12 months.
(iii) Loss Asset, the asset where loss has been identified by the bank or internal or external auditors or the RBI
inspectors but the amount has not been written off wholly.
Classification of assets should be done taking into account the degree of well defined credit weaknesses and the
extent of dependence on collateral security for realization of dues.
Upgradation of accounts to the category of Standard Assets:
• When the borrower makes payment of entire due amount in a NPA account, from the date of such payment
the account will be classified as standard asset.
• All restructured advances can be classified as Standard asset after satisfactory performance during a
period of one year from the commencement of the first payment of interest or principal.
A standard Asset which remained as irregular or out of order or overdue up to a period of 90 days will be
treated as Special Mention Account (SMA) in three categories as given below:
SMA Sub Categories Basis for classification - Principal or interest payment or any other
amount wholly or partly overdue between
SMA-1 01-30 days
SMA-2 31-60 days
SMA-3 61-90 days
Lenders shall report credit information, including classification of an account as SMA to Central Repository of
Information on Large Credits (CRILC) on all borrower entities having aggregate exposure of Rs 50 million and
above with them. The CRILC-Main Report will now be required to be submitted on a monthly basis effective April
1, 2018. In addition, the lenders shall report to CRILC, all borrower entities in default (with aggregate exposure
of Rs 50 million and above), on a weekly basis, at the close of business on every Friday, or the preceding working
day if Friday happens to be a holiday. The first such weekly report shall be submitted for the week ending
February 23, 2018.
Illustration: A Term Loan disbursed on April 15, 2014 where the first instalment was due on June 15, 2014.
The borrower did not pay the instalment. Then -
From To Asset classification
15.04.2014 15.06.2014 Standard
16.06.2014 15.09.2014 Overdue (Special Mention Account 0, 1, 2)
16.09.2014 15.09.2015 Sub-standard
16.09.2015 15.09.2016 Doubtful - category 1
16.09.2016 15.06.2018 Doubtful - category 2
16.09.2018 Further Doubtful - category 3
The classification of assets as NPA should be based on the record of recovery. Bank should not classify an advance
as NPA merely due to the existence of some deficiencies which are temporary in nature such as non- availability
of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the
limit temporarily, non-submission of stock statements, non-renewal of the limits on the due date etc.
• If arrears of interest and principal are paid by the borrower in case of loan accounts classified as NPAs, the
account should no longer be treated as NPA and may be classified as ‘standard’.
• The asset classification of borrowal accounts where a solitary or few credits are recorded before the
balance sheet date should be handled with care and without scope for subjectivity.
• Asset classification should be borrower-wise and not facility-wise.
• Asset classification of accounts under consortium should be based on the record of recovery of the
individual member banks.
• Accounts where there is erosion in the value of security / fraud committed by borrowers, the asset should
be straightaway classified as doubtful ( if realizable value of security is less than 50%) or loss (if realizable
value of security assessed is less than 10%) asset.
• Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and Life insurance policies need
not be treated as NPAs. Advances against gold ornaments, government securities and all other securities
are not covered by this exemption.
• In case of bank finance given for industrial projects or for agricultural plantations etc. where moratorium
is available for payment of interest, payment of interest becomes ‘due’ only after the moratorium or
gestation period is over. Therefore, such amounts of interest do not become overdue and hence NPA, with
reference to the date of debit of interest. They become overdue after due date for payment of interest, if
uncollected.
• The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA
only when the Government repudiates its guarantee when invoked. This exemption from classification
of Government guaranteed advances as NPA is not for the purpose of recognition of income. Advances
sanctioned against State Government guarantees should be classified as NPA in the normal course, if the
guarantee is invoked and remains in default for more than 180 days.
Conversion of Principal into Debt / Equity and Unpaid Interest into ‹Funded Interest Term Loan› (FITL), Debt
or Equity Instruments.
The FITL / debt / equity instruments created by conversion of part of principal / unpaid interest, as the case
may be, will be placed in the same asset classification category in which the restructured advance has been
classified.
These instruments shall be valued as per usual valuation norms and marked to market. Equity instruments,
whether classified as standard or NPA, shall be valued at market value, if quoted, or else at break-up value
(without considering the revaluation reserve, if any) as ascertained from the company’s balance sheet as on
March 31st of the immediate preceding financial year. In case balance sheet as on March 31st of the immediate
preceding financial year is not available, the entire portfolio of equity shares of the company held by the bank
shall be valued at Rs.1. Depreciation on these instruments shall not be offset against the appreciation in any
other securities held under the AFS category.
The unrealised income represented by FITL / Debt or equity instrument can only be recognised in the profit
and loss account as under:
a. FITL/debt instruments: only on sale or redemption, as the case may be;
b. Unquoted equity/ quoted equity (where classified as NPA): only on sale;
c. Quoted equity (where classified as standard): market value of the equity as on the date of upgradation, not
exceeding the amount of unrealised income converted to such equity. Subsequent changes to value of the
equity will be dealt as per the extant prudential norms on investment portfolio of banks.
Change in Ownership
In case of change in ownership of the borrowing entities, credit facilities of the concerned borrowing entities
may be continued/upgraded as ‘standard’ after the change in ownership is implemented, either under the IBC or
under this framework. If the change in ownership is implemented under this framework, then the classification
as ‘standard, shall be subject to the following conditions:
i. Banks shall conduct necessary due diligence in this regard and clearly establish that the acquirer is not a
person disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016.
ii. The new promoter shall have acquired at least 26 per cent of the paid up equity capital of the borrower
entity and shall be the single largest shareholder of the borrower entity.
iii. The new promoter shall be in ‘control’ of the borrower entity as per the definition of ‘control’ in the
Companies Act 2013 / regulations issued by the Securities and Exchange Board of India/any other
applicable regulations / accounting standards as the case may be.
iv. The conditions for implementation of RP as per Section I-C of the covering circular are complied with.
For such accounts to continue to be classified as standard, all the outstanding loans/credit facilities of
the borrowing entity need to demonstrate satisfactory performance during the specified period. If the
account fails to perform satisfactorily at any point of time during the specified period, the credit facilities
shall be immediately downgraded as non-performing assets (NPAs) i.e., ‘sub-standard’. Any future upgrade
for such accounts shall be contingent on implementation of a fresh RP (either under IBC, wherever
mandatory filings are applicable or initiated voluntarily by the lenders, or outside IBC) and demonstration
of satisfactory performance thereafter. Further, the quantum of provisions held by the bank against the
said account as on the date of change in ownership of the borrowing entities can be reversed only after
satisfactory performance during the specified period.
PROVISIONING NORMS
From the time when a loan account becomes NPA and till the time of recovery of dues banks are required to
make provisions RBI has prescribed following percentage of provisions:
Farm Credit within Agriculture, MSE and Individual home loans up to Rs. 75 lac (Standard Assets) 0.25%
Residential housing (Standard Assets) 0.75%
Commercial Real Estate (Standard assets) 1.00%
Sub-standard Unsecured (infrastructure) 20% 0.40%
Other standard loans 2%
Home Loans at Teaser rate Sub-standard Secured 15%
Sub-standard Unsecured 25%
Sub-standard Unsecured (infrastructure) 20%
Non-reporting to Central Repository for Information of Large Credit. (CRILC)
Secured sub-standard up to 6 months 15%
Above 6 months up to 12 months 25%
Unsecured sub-standard up to 6 months 25%
Unsecured sub-standard above 6 months to 12 months 40%
Doubtful up to 12 months (secured portion) (Doubtful 1) 25%
Doubtful up to 12 months (Unsecured portion) 100%
Doubtful - more than 12 months up to 3 years (Secured portion) (Doubtful2) 40%
Doubtful - more than 12 months up to 3 years (Unsecured portion) 100%
Doubtful - more than 3 years (secured / unsecured) (Doubtful 3) 100%
Non-reporting to CRILC
Secured doubtful -2 40%
Secured doubtful -3 100%
Loss Assets 100%
• Floating provisions - some banks make a “floating provision” over and above the specific provisions made
in respect of accounts identified as NPAs. The floating provisions, wherever available, could be set-off
against provisions required to be made as per above stated provisioning guidelines. Considering that
higher loan loss provisioning adds to the overall financial strength of the banks and the stability of the
financial sector, banks are urged to voluntarily set apart provisions much above the minimum prudential
levels as a desirable practice.
Banks should adopt an accounting principle and exercise the right of appropriation of recoveries - towards
principal and interest - in a uniform and consistent manner,
Treatment of NPA provisions:

• Additional provisions for NPAs at higher than prescribed rates - such higher rates are to be in the policy
of the bank, approved by the board. The policy should be applied consistently from year to year. This
provision amount can be netted off from the gross NPAs to arrive at net NPAs
• Excess provision on sale of Standard Assets / NPAs - If sale proceeds of a standard asset are more than its book
value the excess provision can be credited to profit and loss account. Excess provision in case of sale of NPA
asset can be credited to Tier II capital subject to the overall ceiling of 1.25% of total Risk Weighted Assets
Floating provisions - Cannot be netted from Gross NPA to arrive at net NPAs but can be a part of Tier II
capital subject to overall ceiling of 1.25% of Total Risk Weighted Assets.
• Provisioning Coverage Ratio (PCR) - PCR of 70% of gross NPAs was prescribed, as a macro prudential
measure by RBI, with a view to augmenting provisioning buffer in a counter-cyclical manner when the
banks were making good profits. Banks are advised that - (i) the PCR of 70% may be with reference to
the gross NPA position in banks as on September 2010, (ii) the surplus of the provision under PCR vis-à-
vis as required as per prudential norms should be segregated into an account styled as “countercyclical
provisioning buffer”, (iii) this buffer will be allowed to be used by banks for making specific provisions for
NPAs during periods of system wide downturn, with the prior approval of RBI.
Provision Coverage Ratio (PCR)

It is calculated as under as per RBI formula
Gross NPAs = The principal dues of NPAs plus Funded Interest Term Loan (FITL) where the corresponding
contra credit is parked in sundries account (interest capitalization - Restructured accounts), in respect of NPA
accounts.
NET NPA = Gross NPA - (Balance in interest suspense account + DICGC / ECGC claims received and held pending
adjustment + Part payment received and kept in suspense account + Total provisions held).
CORPORATE DEBT RESTRUCTURING (CDR)

Corporate Debt Restructuring is mechanism to restructure in a transparent way the borrowings of sticky
borrowal accounts of viable corporate entities outside the formal forums such as Board for Industrial and
Financial Reconstruction, Debt Recovery Tribunals, and Courts so as to benefit all stake holders in the entity
and was introduced in India as a result of recommendations of a Vepa Kamesam Committee and Mrs. Shyamala
Gopinath Committees. The guidelines evolved by RBI on the basis of these recommendations are fine amended
by RBI from time to time due to continuous developments in the banking scenario.
The Main features of CDR (Corporate Debt Restructuring) mechanism:
• The framework will aim at preserving viable corporate that are affected by certain internal and external
factors and minimize the losses to the creditors and other stakeholders through an orderly, timely and
coordinated restructuring program.
• CDR system in the country will have a three tier structure:
– CDR standing Forum
– CDR Empowered Group
– CDR Cell
CDR Standing Forum would be the representative general body of all financial institutions and banks participating
in CDR system. It will be a self-empowered body, which will lay down policies and guidelines, and monitor the
progress of corporate debt restructuring. The Forum will provide an official platform for both the creditors
and borrowers to amicably and collectively evolve policies and guidelines for working out debt restructuring
plans in the interest of all concerned. The RBI will not be a member of the Forum and Core Group. Its role will
be confined to providing broad guidelines. The Forum shall meet at least once every six months and would
review and monitor the progress of corporate debt restructuring system. A CDR Core Group will be carved out
of the Forum to assist the Forum in taking decisions relating to policy. The CDR Core Group would lay down
the policies and guidelines to be followed by the CDR Empowered Group and CDR Cell for debt restructuring.
The individual cases of corporate debt restructuring shall be decided by CDR Empowered Group. In order to
make the CDR Empowered Group effective and broad based and operate efficiently and smoothly, it would
have to be ensured that participating institutions / banks approve a panel of senior officers to represent
them in the CDR Empowered Group. There should be a general authorization by the respective Boards of the
participating institutions / banks in favour of their representatives on the CDR Empowered Group, authorizing
them to take decisions on behalf of their organization, regarding restructuring of debts of individual corporate.
The Group will consider the preliminary report of all cases of requests of restructuring, submitted to it by the
CDR Cell. After the Group decides that restructuring of the company is prima-facie feasible and the enterprise
is potentially viable in terms of the policies and guidelines evolved by the Forum, the detailed restructuring
package will be worked out by the CDR Cell in conjunction with the Lead Institution. The Group shall decide on
the acceptable viability benchmark levels on the following illustrative parameters, which may be applied on a
case-by-case basis, based on the merits of each case - ROCE (Return on Capital Employed), DSCR (Debt Service
Coverage Ratio), Gap between the Internal Rate of Return (IRR) and the Cost of Fund (CoF), Extent of sacrifice.
The decisions of the Group shall be final. If restructuring is not found viable, the creditors would then be free
to take necessary steps for immediate recovery of dues and / or liquidation or winding up of the company,
collectively or individually.
The Forum and the Group will be assisted by CDR Cell in all their functions. The Cell will make the initial
scrutiny of the proposals received from the borrowers / creditors, by calling the proposed rehabilitation plan
and other information within one month. The Cell will prepare the restructuring plan in terms of the general
policies and guidelines approved by Forum and place for consideration of Group within 30 days for decision.
Other features:
• The CDR mechanism will cover only multiple banking accounts / syndication /consortium accounts of
corporate borrowers with outstanding fund-based and non-fund based exposure of Rs. 10 crores and
above by banks and institutions.
• Category 1 CDR system will be applicable only to accounts classified as ‘standard’ and ‘sub-standard’.
• The accounts where recovery suits have been fi led by the creditors against company, may be eligible for
consideration under the CDR system provided, the initiative to resolve the case under CDR system is taken
by at least 75% of the creditors (by value) and 60% of creditors (by numbers).
• Cases involving frauds or diversion of funds with malafide intent are not covered.
• Reference to CDR System could be triggered by:
(i) any or more of the creditor who have minimum 20% share in either working capital or term finance; or
(ii) by the concerned corporate, if supported by a bank or financial institution having stake as in (i).
• CDR is a non-statutory mechanism which is a voluntary system based on Debtor - Creditor Agreement
(DCA) and Inter-Creditor Agreement (ICA). The DCA and ICA will provide the legal basis to CDR mechanism.
• In order to improve effectiveness of the CDR mechanism a clause may be incorporated in loan agreements
involving consortium / syndicate accounts where by all creditors, including those which are not members
of the CDR mechanism, agree to be bound by the terms of the restructuring package that may be approved
under the CDR mechanism, as and when restructuring may become necessary.
• One of the most important elements of Debtor - Creditor Agreement would be ‘stand still’ agreement
binding for 90 days or 180 days by both sides. Under this clause, both the debtor and creditor(s) shall
agree to a legally binding ‘stand still’ whereby both the parties commit themselves not to take recourse to
any other legal action during the ‘stand still’ period. This clause will be applicable only to any civil action
and will not cover any criminal action.
• During the pendency of the case with CDR System, the usual asset classification norms would continue to
apply.
• Additional finance, if any, is to be provided by all creditors of a ‘standard’ and ‘substandard’ account
irrespective of whether they are working capital or term loan creditors, on pro rata basis. The additional
finance may be treated as ‘standard asset’, up to a period of one year after the first interest / principal
payment, whichever is earlier, falls due under the approved restructuring package.
• The lenders who wish to exit from the package would have the option to sell their existing share to either the
existing lenders or fresh lenders, at an appropriate rate, mutually decided between the existing lender and
taking over lender. One Time Settlement (OTS) can also be considered as a part of the restructuring package.
• The Group should decide on the issue regarding convertibility (into equity) option as a part of restructuring
exercise.
CDR 2 (Category 2 CDR System) was introduced for cases where the accounts have been classified as
‘doubtful’ in the books of creditors, and if minimum of 75% of creditors (by value) and 60% creditors
(by number) satisfy themselves of the viability of the account and consent for such restructuring on two
conditions - (i) the existing loans will only be restructured and it would be up to the promoter to firm up
additional financial arrangement with new or existing creditors individually. (ii) all other norms of the
CDR system will continue to apply to this category also.
• Restructuring of corporate debts under CDR system could take place in stages -
(i) before commencement of commercial production,
(ii) after commencement of commercial production but before the asset has been classified as
‘substandard’,
(iii) after commencement of commercial production and the asset has been classified as ‘substandard’ or
‘doubtful’.
A special Note
The Reserve Bank of India has issued various instructions aimed at resolution of stressed assets in the economy,
including introduction of certain specific schemes at different points of time (It also includes CDR mechanism
discussed above). However, In view of the enactment of the Insolvency and Bankruptcy Code, 2016 (IBC), the
RBI had decided to substitute the then existing guidelines with a harmonised and simplified generic framework
for resolution of stressed assets vide circular No. RBI/2017-18/131 DBR.No.BP.BC.101/21.04.048/2017-18
February 12, 2018.
A summary of the simplified generic framework as this circular is as follows:
Revised Framework
A. Early identification and reporting of stress

• Lenders shall identify incipient stress in loan accounts, immediately on default2, by classifying
stressed assets as special mention accounts (SMA) as per the following categories:
SMA Sub-categories Basis for classification - Principal or interest
payment or any other amount wholly or partly
overdue between
SMA 0 01-30 days
SMA 1 31-60 days
SMA 2 61-90 days
• Lenders to report credit information, including classification of an account as SMA to Central

Repository of Information on Large Credits (CRILC) on all borrower entities having aggregate
exposure of Rs.50 million and above with them. The CRILC-Main Report will now be required to be
submitted on a monthly basis effective April 1, 2018. In addition, the lenders shall report to CRILC,
all borrower entities in default (with aggregate exposure of Rs. 50 million and above), on a weekly
basis, at the close of business on every Friday, or the preceding working day if Friday happens to be
a holiday.
• Implementation of Resolution Plan.
• All lenders should have in place Board-approved policies for resolution of stressed assets under
this framework, including the timelines for resolution. As soon as there is a default in the borrower
entity’s account with any lender, all lenders ? singly or jointly ? shall initiate steps to cure the default.
The resolution plan (RP) may involve any actions / plans / reorganization including, but not limited
to, regularisation of the account by payment of all over dues by the borrower entity, sale of the
exposures to other entities / investors, change in ownership, or restructuring4. The RP shall be
clearly documented by all the lenders (even if there is no change in any terms and conditions).
• Implementation Conditions for RP.
• A RP in respect of borrower entities to whom the lenders continue to have credit exposure, shall be
deemed to be ‘implemented’ only if the following conditions are met:
a. the borrower entity is no longer in default with any of the lenders;
b. if the resolution involves restructuring; then
i. all related documentation, including execution of necessary agreements between lenders
and borrower / creation of security charge / perfection of securities are completed by all
lenders; and
ii. the new capital structure and/or changes in the terms of conditions of the existing loans
get duly reflected in the books of all the lenders and the borrower.
Additionally, RPs involving restructuring / change in ownership in respect of ‘large’ accounts (i.e., accounts
where the aggregate exposure of lenders is Rs. 1 billion and above), shall require independent credit evaluation
(ICE) of the residual debt5 by credit rating agencies (CRAs) specifically authorised by the Reserve Bank for this
purpose. While accounts with aggregate exposure of Rs. 5 billion and above shall require two such ICEs, others
shall require one ICE. Only such RPs which receive a credit opinion of RP4 or better for the residual debt from
one or two CRAs, as the case may be, shall be considered for implementation.
Further, ICEs shall be subject to the following:

a. The CRAs shall be directly engaged by the lenders and the payment of fee for such assignments shall be
made by the lenders.
b. If lenders obtain ICE from more than the required number of CRAs, all such ICE opinions shall be RP4 or
better for the RP to be considered for implementation.
c. The above requirement of ICE shall be applicable to restructuring of all large accounts implemented from
the date of this circular, even if the restructuring is carried out before the ‘reference date’ stipulated in
paragraph below.
Timelines for Large Accounts to be Referred under IBC

• In respect of accounts with aggregate exposure of the lenders at Rs.20 billion and above, on or after March
1, 2018 (‘reference date’), including accounts where resolution may have been initiated under any of the
existing schemes as well as accounts classified as restructured standard assets which are currently in
respective specified periods (as per the previous guidelines), RP shall be implemented as per the following
timelines:
(i) If in default as on the reference date, then 180 days from the reference date.
(ii) If in default after the reference date, then 180 days from the date of first such default.
• If a RP in respect of such large accounts is not implemented as per the timelines specified in paragraphs,
lenders shall file insolvency application, singly or jointly, under the Insolvency and Bankruptcy Code 2016
(IBC) within 15 days from the expiry of the said timeline.
• In respect of such large accounts, where a RP involving restructuring/change in ownership is implemented
within the 180-day period, the account should not be in default at any point of time during the ‘specified
period’, failing which the lenders shall file an insolvency application, singly or jointly, under the IBC within
15 days from the date of such default.
• ‘Specified period’ means the period from the date of implementation of RP up to the date by which at least
20 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of
the restructuring, if any, is repaid.
• Provided that the specified period cannot end before one year from the commencement of the first payment
of interest or principal (whichever is later) on the credit facility with longest period of moratorium under
the terms of RP.
• Any default in payment after the expiry of the specified period shall be reckoned as a fresh default for the
purpose of this framework.
• For other accounts with aggregate exposure of the lenders below Rs. 20 billion and, at or above Rs. 1
billion, the Reserve Bank intends to announce, over a two-year period, reference dates for implementing
the RP to ensure calibrated, time-bound resolution of all such accounts in default.
• It is, however, clarified that the said transition arrangement shall not be available for borrower entities
in respect of which specific instructions have already been issued by the Reserve Bank to the banks for
reference under IBC. Lenders shall continue to pursue such cases as per the earlier instructions.
Prudential Norms
• The revised prudential norms applicable to any restructuring, whether under the IBC framework or outside
the IBC, are contained in Annexure 1 of Cir: No. RBI/2017-18/131 DBR.No.BP.BC.101/21.04.048/2017- 18
February 12, 2018. The provisioning in respect of exposure to borrower entities against whom insolvency
applications are filed under the IBC shall be as per their asset classification in terms of the Master Circular
on Prudential norms on Income Recognition, Asset Classification and Provisioning, as amended from time
to time.
Prudential Norms on Income Recognition, Asset Classification and provisioning pertaining to Advances -
Projects under Implementation.
Circular RBI/2019-20/158 DOR.No.BP.BC.33/21.04.048/2019-20 dated February 07, 2020
The revised guidelines for deferment of date of commencement of commercial operations (DCCO) for projects
in non-infrastructure and commercial real estate (CRE) sectors projects are as under:
i) revisions of the date of DCCO and consequential shift in repayment schedule for equal or shorter duration
will not be treated as restructuring provided - the revised DCCO falls within the period of oner year from
the original DCCO stipulated at the time of financial closure of CRE projects and other terms and conditions
of the loan remain unchanged.
ii) In case of CRE projects delayed for reasons beyond the control of promotor(s), banks may restructure
them by way of revision of DCCO up to another one year and retain the ‘standard asset’ classification. In
such CRE projects loans bank will have to ensure that the revised repayment schedule is extended only by
a period equal to or shorter than the extension in DCCO.
iii) Banks may fund cost overruns that arise on account of extension of DCCO.
iv) a loan for a project may be classified as NPA during any time before commencement of commercial
operations as per record of recovery.
v) At the time of extending DCCO, banks should satisfy themselves about the viability of the project and the
restructuring plan.
(It is decided to extend the above guidelines issued to banks, mutatis mutandis, to NBFCs as well)
Supervisory Review
• Any failure on the part of lenders in meeting the prescribed timelines or any actions by lenders with an
intent to conceal the actual status of accounts or evergreen the stressed accounts, will be subjected to
stringent supervisory / enforcement actions as deemed appropriate by the Reserve Bank, including, but
not limited to, higher provisioning on such accounts and monetary penalties.
Disclosure
• Banks are to make appropriate disclosures in their financial statements, under ‘Notes on Accounts’,
relating to resolution plans implemented as per detailed guidelines issued/ will be issued from time to
time.
Exceptions
• Restructuring in respect of projects under implementation involving deferment of date of commencement
of commercial operations (DCCO), will continue to be covered under the guidelines contained at paragraph
4.2.15 of the Master Circular of RBI dated July 1, 2015 on ‘Prudential norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances’.
• Withdrawal of extant instructions
The extant instructions on resolution of stressed assets such as Framework for Revitalising Distressed Assets,
Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt
Restructuring Scheme (SDR), Change in Ownership outside SDR, and Scheme for Sustainable Structuring of
Stressed Assets (S4A) stand withdrawn with immediate effect. Accordingly, the Joint Lenders’ Forum (JLF) as
an institutional mechanism for resolution of stressed accounts also stands discontinued. All accounts, including
such accounts where any of the schemes have been invoked but not yet implemented, shall be governed by the
revised framework.
However certain provisions of this circular was challenged by borrowers in Supreme Court. In pursuance of
that case on April 3, 2019 the Hon’ble Supreme Court has held the circular of RBI as ‘ultra vires’ of its powers.
Further developments in this regard are awaited.
Restructuring of Advances of MSME

Micro, Small and Medium Enterprises (MSME) sector - Restructuring of Advances (Circular No RBI/2019-
20/160 DOR.No.BP.BC.34/21.04.048/2019-20 dated February 11, 2020).
A one-time restructuring of existing loans to MSMEs classified as ‘standard’ without downgrade in the assest
classification is permitted subject to:
1. The aggregate exposure, including non-fund based facilities, of banks and NBFCs to the borrower does not
exceed Rs. 25 crore as on January 1, 2020. Due to Covid 19, RBI has decided on June 4, 2021 to increase
the limit under Resolution Framework-02 from Rs. 25 crore to Rs. 50 crore.
2. i. The borrower’s account was a ‘standard asset’ as on March 1, 2020.
ii. The restructuring of the borrower account is implemented by March 31, 2021.
iii. The borrowing entity is GST-registered on the date of implementation of the restructuring. However,
this condition will not apply to MSMEs that are exempt from GST-registration. This shall be determined
on the basis of exemption limit obtaining as on March 1, 2020.
iv. Asset classification of borrowers classified as standard may be retained as such, whereas the accounts
which may have slipped into NPA category between March 2, 2020 and date of implementation may
be upgraded as ‘standard asset’, as on the date of implementation of the restructuring plan.
v. The restructuring of the borrower account is implemented on or before March 31, 2020. A
restructuring would be treated as implemented if -
a. All related documentation are completed; and
b. The new capital structure and /or changes in the terms and conditions of the existing loans get
duly reflected in the books of all lenders and the borrower.
vi. A provision of 5% in addition to the provisions already held, has to be made in respect of accounts
restructured under these instructions. Banks will, however have the option of reversing such
provisions at the end of the specified period (a period of one year from the commencement of the
first payment of interest or principal, whichever is later, on the credit facility with longest period of
moratorium) subject to the account demonstrating satisfactory performance (no payment of interest
and /or principal shall remain overdue for a period of more than 30 days) during the specified period.
vii. Post-restructuring, NPA classification of these accounts shall be as per the extant IRAC norms.
viii. Banks and NBFCs have to make appropriate disclosures in their financial statement, under ‘Notes on
Accounts’, regarding Number of accounts restructured and amount in million.
ix. All other instructions applicable to restructuring of loans to MSME borrowers shall continue to be
applicable.
3. Banks and NBFCs who wish to adopt this scheme have to put in place a Board approved policy on
restructuring of MSME advances under these instructions. The policy has to include framework for
viability assessment of the stressed accounts and regular monitoring of the restructured accounts.
4. Accounts classified as NPA can be restructured; however, the extant asset classification norms governing
restructuring of NPAs will continue to apply.
5. Barring the above one-time exception, any MSME account which is restructured must be downgraded to
NPA upon restructuring and will slip into progressively lower asset classification and higher provisioning
requirements as per extant IRAC norms. Such an account may be considered for upgradation to ‘standard’
only if it demonstrates satisfactory performance during the specified period.
One Time Settlement (OTS)

It is a type of compromise settlement executed by the banks in order to recover NPAs. In OTS, the defaulter
borrower proposes to settle all the dues at once and the bank agrees the amount lesser than what is actually due.
The bank settles the loan and write offs against one-time instalment, compromising on a portion of its profits.
The RBI mandate states that banks must have a loan recovery policy for negotiations and settlement of non-
performing assets. OTS schemes are available in banks but not every borrower is given this provision. The
scheme is available at the sole discretion of the bank and not available to the willful defaulters.
The OTS affects the banks profits in the form of interest cut down and quality of balance sheet. The benefits
include prompt and speedy recovery of NPAs, increase in liquidity position, easy flow of funds for lending process.
BIFR (Board for Industrial and Financial Reconstruction)

It was an agency of the Government of India, part of the Department of Financial Services of the Ministry of
Finance. It was set up in January 1987 with objective to determine sickness of industrial companies and to
assist in reviewing those that may be viable and shutting down the others. A new Industrial policy was tabled
in Parliament aiming to maintain growth in productivity and gainful employment and to encourage the growth
of entrepreneurship and upgrades to technology.
The Board has a Chairman and from 2 to fourteen other members, all to be qualified as High Court judges or
to have at least fifteen years of relevant professional experience. The Board only handles large or medium-
sized sick industrial companies in which large amounts have been sunk. Under the Sick Industrial Companies
Act (SICA), its Board is legally obliged to report it to the BIFR, and the BIFR has the power to make whatever
enquires are needed to determine if the company is in fact sick.
Among other objectives the act was to provide a way to revive sick industrial companies and release public funds.
If a company is found to be sick, the BIFR can give the company reasonable time to regain health (bring total
assets above total liabilities) or it can recommend other measures. The Board can take other actions including
changes to management, amalgamation of the sick unit with a healthy one, sale or financial reconstruction. The
Board can recommend a sick industrial company for winding up.
The BIFR was intended to bridge the legal gap between sickness and revival. It would impose time schedules
for revival related activities to be completed, oversee their implementation and conduct periodic reviews of
sick accounts. The BIFR would provide a forum for sharing views, coordinating efforts and developing a unified
approach to dealing with sick companies, speeding up the start of corrective action. The BIFR was meant o
either turn companies around within six months or order closure.
BIFR has had mixed success. The BIFR in practice often became a way of prolonging the life of unviable
companies for years at taxpayer expense.
The SARFAESI Act 2002 placed corporate debt outside the purview of the BIFR. By preventing reference to
the BIFR, which had become a heaven for the promoters of sick companies, the Act gives banks and financial
institutions a better tool for recovering bad debts. It was complemented by the corporate debt restructuring
package under which lenders and borrowers would meet to agree on a way of recasting stressed debt.
In January 2016 BIFR was dissolved and referred all proceedings to the National Company Law Tribunal (NCLT)
and National Company Law Appellate Tribunal (NCLAT) as per provisions of Insolvency and Bankruptcy Code.
The NCLT and NCLAT would take over the functions of the BIFR and other bodies and speed up the process of
winding down sick companies.
Asset Reconstruction Companies (ARCs)

An ARC is a company incorporated under Companies Act, 2013 to engage itself in the activity of financial asset
reconstruction- such as securitization, takeover of management, sale of assets charged. Earlier they were called
as Securitization Companies (SCs) or Reconstruction Companies (RCs). To undertake such activity, the company
has to get registered with RBL under provisions of SARFAESI Act. RBI can conduct audit / inspection / issue
directives / levy penalties or remove directors of the company. As per RBL rules minimum net owned funds
of the company should be Rs. 100 crores on an ongoing basis. ARCs should maintain capital adequacy ratio of
minimum 15% of total risk weighted assets.
The term financial asset means the loans, advances and investments, made by the banks and the financial
institutions.
ARCs acquire non-performing loans from banks and financial institutions at discount and take steps to
recover these loans by way of securitization, reconstruction or sale of assets or in certain cases take over the
management. Before bidding company may conduct due diligence within a period of minimum 2 weeks. The
realization period can be 5 years which can be extended to 8 years.
For the purpose of take over of the loan, the ARC creates a Trust called Special Purpose Vehicle and ARC acts
a s a Trustee and managing agent for ultimate realisation of the financial asset. SPV holds the financial asset
on strength of the security available. It issues Security Receipts (SRs) to the investors, mainly the Qualified
Institutional Buyers (QIBs). The investors get cash on realization of the financial assets when the security
receipts are redeemed. SRs are not debt instruments and currently not listed on Stock Exchange and not traded.
It is mandatory for ARCs to invest in and continue to hold minimum 15% stake of the outstanding amount of the
security receipts issued by them till the redemption.
Asset classification
Assets are classified as Standard and non-performing assets. The NPAs to be further classified as -
1. ‘Sub- standard Asset’ for period not exceeding 12 months from the date it was classified as NPA.
2. ‘Doubtful asset’ if asset remains a substandard asset for a period exceeding 12 months.
3. ‘Loss asset’ if the asset is non- performing for a period exceeding 5 years or 8 years or the asset is adversely
affected by a potential threat of non-recoverability due to erosion or non-availability of the security or it
is identified as ‘loss asset’ by the company or the auditors.
Provisioning
• 10% of the outstanding for the Standard Assets.
• 100% for the asset not covered by the estimated realisable value of security and in addition 50% of
remaining outstanding in case of “doubtful assets’
• The entire asset to be written off if not 100% provision in case of ‘loss assets’
Debt Recovery Tribunals (DRTs)

DRTs are set-up under the provisions of Recovery of Debts Due to Banks and Financial Institutions Act. DRT
jurisdiction covers loans of banks and FIs with outstanding of Rs. 10 lac or more. In September 2018, Govt.
notified enhancement to Rs. 20 lac (Central Govt. Can reduce the amount to Rs. One lac) Other than DRT no
court has jurisdiction over such loans. It is headed by one Presiding Officer. There is one Registrar to take care
of administrative matters. Appeal against order of Registrar to DRT can be made within 15 days from the date
of order.
Debt Recovery Appellate Tribunal are headed by a Chair Person (Qualified to be High Court Judge with age not
exceeding 67 years.
On establishment of a DRT no other court is to hear the proceedings for eligible cases. All existing cases are also
to be transferred to a DRT.
After the claim is upheld by the Tribunal, a certificate is issued to the Recovery Officer who has powers in
execution such as attachment, sale, arrest, appointment of receivers or require the debtor to declare, on
affidavit, the particulars of his or its assets. Appeal against order of Recovery Officer to DRT can be made within
30 days from the date of order.
On receipt of application, RT issues summons within 30 days to defendants to show cause within 30 days which
can be extended by 15 days. For non-compliance of the order, the borrower can be detained in prison up to 3
months. DRT is expected to dispose of the application within 2 hearings. After hearing the parties, DRT issues
Recovery Certificate to Recovery Officer for recovery of the amount specified in the certificate. Borrower can
be allowed extra time by DRT to repay the loan, he deposits 25% amount and banks agree to that. If borrower
wants to appeal against order of Recovery Officer to DRT, he has to deposit 50% of the amount. The order
passed by DRT is appealable within 30 days from the date f the receipt of the order to the Appellate Tribunal
unless the appellant deposits 50% of the due amount. DRAT is expected to dispose of the appeal within 6
months from the date of receipt of the appeal.
Application in4 copies should be presented by authorised official of the bank or a legal practitioner to the
Registrar of DRT under whose jurisdiction the bank or FL is covered,
Enforcement of security under SARFEASI

If a borrower defaults, bank (a secured creditor), will have powers as to - take possession, sell or lease secured
assets / take over the management of the business / appoint a manager / recover any money payable by 3rd
party to the borrowers. (debts also include debt securities)
In case of consortium financing or multiple lending arrangement, if 60% of the secured creditors in value, agree
to initiate recovery action, the same is binding on all secured creditors.
Under the Securities Interest (Enforcement) Rules, the enders can dispose off the assets charged to the bank
after taking possession of the assets, after serving 60 days possession notice. The sale can be through private
treaty and / or public auction or bids. Possession process is allowed only if charge is registered with CERSAI.
If on notice from the lender, the borrower makes any representation or raises any objection, bank shall consider
such representation / objection. If the same is not acceptable, bank shall communicate the justification for
possession within 15 days of receipt of such representation / objection.
Conditions for sale of assets:
• Sale by way of public tenders or through public auction has to be backed by public notices in two
newspapers.
• Minimum 30 days’ notice to be given to the owner after taking possession by the authorised officer and
the eventual sale of both movable and immovable properties.
• The lenders have to make proper valuation of the assets prior to sale. The reserve price will have to be
arrived at only after the valuation exercise.in case of movable secured assets, authorised officer will
simply obtain an estimated value, for immovable assets valuation to be obtained from approved valuer by
the lender’s board of directors.
• If a price equal to reserve price cannot be obtained, the asset can be disposed off at a lower price with the
consent of the borrower and the lender except where the asset could have natural decay or where the cost
of possession might exceed the value of sale.
• Sale will be confirmed after deposit of 25% by the highest bidder. Balance will be payable within 15 days
pf confirmation of sale.
LESSON ROUND UP
• RBI started implementing the prudential guidelines on asset classification, income recognition and
provisioning on loan assets based on the recommendations of Narasimham Committee, in a phased
manner commencing with the accounting year beginning from 1.4.1992 and modified the original
guidelines on a number of occasions. Taking into account the time lag between an account becoming
doubtful of recovery, its recognition as such, the realisation of security and the erosion over time in the
value of security, provisions to be made are prescribed by RBI.
• CDR (Corporate Debt Restructuring) framework will aim at preserving viable corporate that are
affected by certain internal and external factors and minimize the losses to the creditors and other
stakeholders through an orderly and coordinated restructuring program. However, RBI has replaced
the debt restructuring schemes with a simplified generic framework for resolution of stressed assets.
GLOSSARY
Corporate Debt Corporate debt restructuring refers to the realignment of a business entity which
Restructuring (CDR) is under fiscal distress due to its outstanding commitments and obligations
and to infuse liquidity into business operations to keep it afloat. This process is
generally done by the creditors and the management of the company, which is
under distress.
One Time Settlement One-time settlement or OTS is a type of compromise settlement executed by the
(OTS) banks in order to recover non-performing assets (NPAs). OTS is a scheme where
the borrower (the one who has defaulted) proposes to settle all the dues at once,
and banks agree to accept an amount lesser than what was originally due.
Asset Reconstruction An ARC is a company incorporated under Companies Act, 2013 to engage itself
Companies (ACR) in the activity of financial asset reconstruction- such as securitization, takeover
of management, sale of assets charged. Earlier they were called as Securitization
Companies (SCs) or Reconstruction Companies (RCs).
Debt Recovery Debt Recovery Tribunals (DRTs) were established as special tribunals to deal
Tribunals (DRT) with loan recovery of cases involving a pecuniary limit of ?10 lakh (increased to
Rs.20 lakh in 2018). The DRTs were also authorised to form Lok Adalat to decide
on cases involving an amount of up to Rs.20 lakh.
TEST YOURSELF
(i) Any-where-Anytime banking is possible because of ______________.
(ii) ______________ facilitates bulk transfer of monies from one bank account to many bank accounts or
vice versa.
(iii) For Doubtful - more than 3 years (secured / unsecured) category, provision prescribed is
______________%.
(iv) Category 1 CDR system will be applicable only to accounts classified as ______________ and
______________.

(i) Only Indian Rupee based domestic services are provided under mobile banking facility.
(ii) Banks are not allowed to appoint an individual as Business Correspondent.
(iii) White Label ATM would provide ATM services to customers of all banks.
(iv) The availability of security or net worth of borrower / guarantor should not be taken into account
for the purpose of treating an advance as NPA or otherwise.
(v) Advances against gold ornaments and government securities are not be treated as NPAs.
(i) What is Asset Classification?
(ii) What is One Time Settlement of NPA?
(iii) Explain the procedure of recovery by banks through ARC.

• RBI Master Circular /Directions on Income Recognition and Asset classification.
Lesson 19 • Final Accounts of Banking Companies 513
Lesson 19
Final Accounts of Banking
Companies
Should Know
Financial Statements of Banking
• Ledgers Companies are an important source • Banking Regulation Act, 1949
• Registers of information for a variety of • Companies Act, 2013
• General Ledger stake holders such as, Employees, • Reserve Bank of India Act, 1934
Management, Depositors a wealth
• Revenue Reserves of useful information. • Accounting Standards - ICAI
• Divergence (Accounting Policies issued
In the light of this, the lesson will by the Institute of Chartered
• Basel III enable a reader to understand : Accountants of India).
• Requirements regarding
Accounts and Audit of Banking
Companies
• Features of accounting system
of banks
• Books of account of banks
• Presentation/formats of
Financial statements
• Accounting treatments of
various items
• Disclosure requirements
Lesson Outline
• Introduction • Comments on Profit and Loss
• Definition and Functions of a Bank Account
• Requirements of Banking • Important Items of Balance Sheet
Companies as to Accounts and • Disclosure Requirements of Banks
Audit • Additional Disclosures prescribed
• Significant Features of Accounting by RBI
Systems of Banks • Disclosures required under BASEL
• Principal Books of Accounts norms
• Preparation and Presentation of • LESSON ROUND UP
Financial Statements of Banks • GLOSSARY
• Accounting Treatment of Specific • TEST YOURSELF
Items
• Preparation of Profit and Loss
Account
513
INTRODUCTION
A financial statement is an organized collection of information or data prepared by a business entity (banking is
a business) as per acceptable accounting norms and procedures. The major financial statements are the balance
sheet and profit and loss account. These are supported by statements which include funds flow statement, cash
flow statement, profit and loss appropriation account etc.
• Balance sheet is a statement of financial position of the business entity as at a specified date (31st of
March), which represents on one side (right) the assets position of the business entity and on other side
(left) the liability position of the business entity.
Asset are the resources owned by the firm / they the applications or the uses of the funds / they are the
debit balances reflected in the General Ledger. Liabilities are the claims of various parties against the
assets owned by the firm / they are the sources of the funds / they are the credit balances reflected in the
General Ledger.
• Profit and Loss account or Income Statement provides the information relating to income and expenditure
of business entity over a period. It covers all the transactions that took place over a time period.
• Funds Flow Statement is the information which reflects the changes having taken place in the composition
or quantum of all the funds (the assets and the liabilities or the revenue or expenditure) over time period
of say a year. Within the said period it provides the information about various sources and their uses /
applications.
• Cash flow statement offers information which reflects the changes in cash position (the term cash takes
into account only cash and bank balances and not funds as in the case with funds flow statement) in a
given period.
Objective of Financial Statement Analysis

• Profitability measurement - Whether adequate profits are generated on the capital employed in the
business. The capacity of the business to pay interest, dividend and other obligations.
• Trend indicator - Regarding various types of expenses, purchases, sales, gross / operating and net profit
etc.
• Assessment of growth potential.
• Comparative position with other firms which are having business.
• Assess overall financial strength.
• Assess solvency of the business entity.
Every banking company in India has to comply with provisions of Banking Regulation Act, 1949 as well as
the Companies Act, 2013 apart from others. Under the Companies Act, 2013 a company has to prepare and
submit financial statements as per Schedule III of the Act. However, banks under the Banking Regulation Act,
1949 have to prepare and submit their Balance Sheet, Profit & Loss Account in specified formats - Form A and
Form B. RBI has also notified detailed guidelines in this regard in respect of these including disclosure norms.
As per Government of India guidelines every banking company has to close its books of account as on 31st
March every year and therefore they prepare their financial statements as on this date. This chapter is therefore
devoted to a detailed coverage on the final accounts of banking companies encompassing all topics with some
practical examples for an easy understanding. The contents will reinforce the basic knowledge of banking as
well as, how the accounts of banks are prepared and other technical inputs required preparing the same.
The contents are based on Banking Regulation Act, 1949, the Companies Act, 2013, RBI directions, ICAI
Accounting Standards and other applicable provisions. This will be useful in practical understanding of accounts
of banking companies.
DEFINITION AND FUNCTIONS OF A BANK

The term Bank has been defined as any company that transacts the business of banking in India. A bank can be
a body corporate under Companies Act, 1956 / 2013; it can be a body corporate under a special statute or it can
be a cooperative society registered under the cooperative laws of a State Government or Central Government.
Section 5 of Banking Regulation Act, 1949 defines “banking” as accepting deposits from public, for the purpose
of lending or investment, such deposits being repayable on demand by cheque, draft, order or otherwise. A
detailed account of main functions as well as other subsidiary functions, which are permitted to be performed
by banks.
Note: For detailed functions of banks please refer Chapter 2.
REQUIREMENTS OF BANKING COMPANIES AS TO ACCOUNTS AND AUDIT

A banking company being a body corporate has statutory obligation to present annual financial statements
in terms of formats prescribed under the Companies Act, 2013 / Banking Regulation Act, 1949. Section 29 to
34A of the Banking Regulation Act, 1949 deal with the accounts and audit of Banking Companies. Section 29 of
the Banking Regulation Act, 1949 casts a responsibility on every Banking company incorporated / operating
in India which are involved in transacting the business of banking through its branches, prepare and submit
Balance Sheet and Profit & Loss account for the financial year, in the specified formats set out in the III Schedule
of the Act, as on the last working day of that financial year. Such balance sheet and P & L account should be
signed by the Manager or the Principal officer and at least three directors if there are more than three directors
and if only three directors all of them should sign the same. For a foreign bank operating in India the Manager
or Principal officer of the concerned bank should sign. The central government has the powers to amend the
formats of Balance Sheet and P & L as in Section 29 of the Banking Regulation Act, 1949.
According to Section 30 of the Banking Regulation Act, 1949 ,the Balance Sheet and P & L account prepared are
to be audited by a duly qualified person as per applicable law for the time being in force. Without prejudice to
anything contained in the Companies Act, 2013 , or any other law for the time being in force, where the Reserve
Bank is of opinion that it is necessary in the public interest or in the interest of the banking company or its
depositors so to do, it may at any time by order direct that a special audit of the banking company’s accounts, for
any such transaction or class of transactions or for such period or periods as may be specified in the order, shall
be conducted and may by the same or a different order either appoint a person duly qualified under any law for
the time being in force to be an auditor of companies or direct the auditor of the banking company himself to
conduct such special audit and the auditor shall comply with such directions and make a report of such audit
to the Reserve Bank and forward a copy thereof to the company. Banking companies have to seek permission of
RBI for appointing, re-appointing or removing any auditor.
As per Section 31 of the Banking Regulation Act, 1949 every banking company has to submit three copies
of annual Accounts, Balance sheet along with P & L Account prepared in accordance with Sec 29 of Banking
Regulation Act, 1949 together with Auditor’s Report to RBI within three months from the end of the period to
which they relate.
Under Section 32 of the Banking Regulation Act, 1949 a banking company (not other types of banking entities)
has to submit three copies of Balance Sheet and P & L Account to the Registrar of Companies when it submits
the same to RBI. Also with in a period of six months of from the date of Accounts and Auditors Report, publish
the same in a news paper which is widely circulated where the banking company has its principal place of
business. This compliance has to be done according to Banking Companies Regulation (Rules) 1949. Also as per
Section 33 of the Banking Regulation Act, 1949, in the case of foreign banks operating in India have to display a
copy of audited Accounts and Balance sheet in a conspicuous place in their notice board for public display. This
has to be done before 1st Monday in the month of August every year.
SIGNIFICANT FEATURES OF ACCOUNTING SYSTEMS OF BANKS

Like any other business entity banks also follow the mercantile system of accounting. However, there is a slight
difference in methodology followed by banks when compared to other commercial entities. It arises on account
of banks entering transactions of customers first, in ledgers (which are subsidiary books under conventional
accounting) rather than in journals. This is so because, accounts of customers which are maintained in ledgers
should be accurate and without any errors.
Note: For details, please refer Chapter 5.
PRINCIPAL BOOKS OF ACCOUNT MAINTAINED BY BANKS

Banks in India maintain following main books of account.
(a) Ledgers of Savings Bank, Current Account, Cash credit, Loans, FD Accounts, Recurring Deposit Accounts,
Investment Ledgers, Bill discounted/purchase (Inland & Foreign) etc.
(b) Registers for collection (inland & for eign), cash, clearing, Safe deposit lockers, DD/Pay order issued, DD’s
paid, Bank Guarantee issued, Bills Margin, LC issued, Clearing
cheques returned, NEFT/RTGS issued etc. Pension payment,
PPF accounts, Demat accounts, etc.
(c) Registers for P & L heads, Suspense accounting etc.
(d) General Ledger
(e) Cash book/Day Book
(f) P& L registers
Note: There are differing practices among banks in maintaining
registers for various heads of accounts. However, under Core Banking
Principal books of account are maintained in different software
modules However, considering the importance of books from bank
accounting point of view we will learn about the them in detail.
General Ledger (GL)

The general ledger is a summary of control accounts of various deposit, loan heads as well as Profit and Loss.
The GL also contains balancing contra entry accounts for heads of accounts such as collection of bills (inland
and foreign), contingent liabilities (such as bank guarantees, LCs) etc. purely for keeping a control over such
transactions on a day-to-day basis.
Profit and Loss account registers

Some banks maintain a common control account in GL for P & L and maintain separate heads in individual
registers and income items as well as expenditure heads. Some other banks also maintain important P & L
heads separately also in GL.
Daily postings are done in P& L register heads through vouchers on account of various transactions or expenses.
In certain cases P & L registers carry detailed heads, much more than what is summarized in GL and published
accounts.
For example, under interest on deposit which is an expenditure head there could be specific subheads such as
FD, Cash Certificates, RDs, CDs, etc. Similarly, there could be separate heads in Interest on Advances (which is
an income head) which may carry sub-heads such as housing loans, personal loans, educational loans, Priority
Sector advances etc. Also, in respect of establishment expenses such as Salaries, allowances, bonus payments
etc. there could be different sub-heads.
Subsidiary Books - Ledgers

In operational banking, ledgers are the basic books of account whose balances are reflected in the control
balances of GL.
In banks subsidiaries in the form of ledgers are used for various deposit accounts and loans/cash credit
accounts etc.
Sometimes separate registers are maintained in respect of various deposits such as call money, short term
deposits, CDs etc. In respect of ledgers separate folios are allotted for each depositor. However, in registers there
could be more than one depositor per folio. Folios in registers are formatted in such a way that all particulars
in detail are entered in sections. Postings in ledgers as well as in registers are made directly from vouchers. All
these vouchers after entry are entered in a separate journal (these journals are also known as ‘sub-day book’
in some banks). They are subsequently checked and their summarized total is conveyed to the Cash book (in
some banks it is also known as ‘Day Book’) department to balance the day’s transaction. Subsequently these
figures are entered in GL to arrive at the control total. In the case ledgers relating to cash credit accounts limits
or drawing power is mentioned along with other particulars such as stock value, margin, rate of interest, Limit
sanctioned etc. Columns are also made available for putting products in respect of debit balances to enable
calculation of interest. Similarly in loan registers columns are provided for entering name and address of
borrower and guarantor, amount of loan sanctioned, rate of interest, balance outstanding, space for products,
initials etc. are provided.
Subsidiary Books - Bills Register

Banks handle different transactions relating to bills. Bills are discounted, collected, purchased. Specific registers
having different columns for entering various particulars such as serial no, Name of the drawer, Drawee, Amount
of bill, discount charged, other charges, address of the drawee bank, particulars of documents, remarks/ special
conditions, initial/signature of officials etc.
In respect of advances specific folios are allotted for different borrowers where in the respective folios the limit
up to which bills can be discounted is also mentioned in the space provided for. Such bills after discounting
are sent to the drawee bank for presentation and realization. Once such bills are realized by remittance from
drawee bank they are rounded off and accordingly date of realization is mentioned after due checking. At the
end of the day summary figures are arrived at and conveyed cash book department for preparing cash book and
subsequently preparing GL followed by trial balance.
Other registers maintained by banks

1. Proposal Received Register including details of processing fees collected/share linkage/valuation;
2. Limit / Drawing Power Register;
3. Stock Statement Received Register;
4. Inspections Register (for field visit/stock verification/stock audit etc.);
5. Security register (For paper securities);
6. Documents register;
7. Title Deeds register;
8. Register of Service/ Maintenance contracts;
9. Register of Death Claims;
10. Missing Persons Claim Record Register;
11. Stop payment Register;
12. Duplicate FDR / Pay slips / DD / Passbook register;
13. Sensitive Stock Register;
14. Inward / Outward Cheque returned register;
15. Cheque passed against clearing register;
16. Cheque held for payment register;
17. Cheque Book stock/delivery register;
18. Pay slip / DD issued register;
19. Fixed Asset register;
20. Attendance Register;
21. IBC / OBC register;
22. Locker Register (Locker Rent Received, Locker Rent Due Date, Locker Issued / Surrendered Register,
Locker Visit Register);
23. ATM Complaint Register;
24. Loose cheque leaves register;
25. Key register;
26. Vault Register;
27. Solvency Certificate Issued Register;
28. Complaint register;
29. Register of EDP Complaints;
30. Register for soiled notes;
31. Foreign LC Due Date register;
32. Forex A2 Currency Transaction register;
33. Other currency cheque collection register;
34. Bank Guarantee issuance register;
35. Margin money register;
36. Debit Cards/ATM card issued register etc.
From the registers listed above we will discuss a few, which are used on a day-to-day basis by banks. Many of
the registers listed above may not constitute core part of books of account, but are in the nature of supporting
in respect of agency services.
Registers linked to Advances

1. Proposal Received Register including details of processing fees collected/share linkage/ valuation:
Under the directions issued by RBI bank branches are required to maintain registers in respect of credit
proposals with particulars such as date of receipt of proposal, date of sanction, if rejected date of rejection
and reason for rejection. Along with these particulars they also record the details of processing fee collected
etc. In some banks they also note the collateral linkages to the proposal and value thereof of such securities.
2. Limit / Drawing Power Register: In respect of cash credit accounts granted against hypothecation of
stock- in-trade, work-in-process, finished goods, debtors etc. the branch has to fix drawing power every
month based on the value of these items less margin. This register is used for the purpose of recording
drawing powers that would be allowed during the month which would be authenticated by concerned
officials.
3. Stock statements received register: When banks allow cash credit limits based on stocks held by a
borrower. The value of stock held by the customer has to be submitted by 10th of succeeding month
to enable banks to fix drawing power for the current month. If they fail to submit by 10th of the month,
penal interest will be levied from the 1st of the current month as per agreed sanction terms. To monitor
submission of stock statements by a borrower such registers are maintained.
4. Security register: This register is used to record detailed particulars of securities tendered by a borrower
while availing an advance.
5. Document register: In this register particulars of documents executed by a borrower are entered a
separate record.
6. Title deeds Register: In this register documents of title given by borrowers are recorded and it is held in
safe custody.
PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS OF BANKS

Banks are required to prepare and present their Balance sheet and P & L accounts in the following format under
Schedule III.
FORM A :- Form of Balance Sheet
Balance sheet of Bank xxxxxxxxx
Balance sheet as on 31st March................ (Year)
Particulars Schedule As on 31-03- As on 31-03-
20XX 20XX
(current year) (previous year)
Liabilities
Capital
Reserve and surplus
Deposits
Borrowings
Other liabilities and provisions
Total
Assets
Cash and balances with Reserve Bank of India
Bank of India
Balance with banks and money at calls & short Notice
Investments
Loans & Advances
Fixed assets
Other assets
Total
Schedule 12.
Contingent liabilities
While presenting the balance sheet following schedules are to be furnished by a banking company.
Schedule 1: Capital
I. For Nationalized Banks
Capital (Fully owned by Central Government)
II. For Banks Incorporated Outside India
(i) Capital (The amount brought in by banks by way of start-up capital as prescribed by RBI should be
shown under this head).
(ii) Amount of deposit kept with the RBI under section 11(2) of the Banking Regulation Act, 1949
III. For Other Banks Authorized capital
(......................... shares of Rs. each)
Issued capital
(.........................shares of Rs. each)

Subscribed capital
(.........................shares of Rs. each)
Called-up capital
(.........................share of Rs. each)
Less: Calls unpaid
Add: Forfeited shares
Total _______________________ _______________________
Schedule 2: Reserves and surplus
I. Statutory reserves Opening balance
Additions during the year Deductions during the year
II. Capital reserves Opening balance Additions during the year
Deductions during the year
III. Share premium Opening balance
IV. Revenue and other reserves Opening balance
V. Balance in Profit and Loss Account
Total: (I + II + III+ IV + V) _______________________ _______________________
Schedule 3: Deposits
A. I. Demand deposits
(i) From banks
(ii)
From others
II. Savings bank deposits
III. Term deposits
(i) From banks
(ii)
From others
Total: (I + II + III) _______________________ _______________________
B. (i) Deposits of branches in India
(ii) Deposits of branches outside India
Total [(I)+(II)] _______________________ _______________________
Total [(A)+(B)] _______________________ _______________________
Schedule 4: Borrowings
I. Borrowings in India
(i) Reserve Bank of India
(ii) Other banks
(iii) Other institutions and agencies

II. Borrowings outside India
Total (I + II) _______________________ _______________________
Schedule 5: Other liabilities and provisions
I. Bills payable
II. Inter-office adjustments (net)
III. Interests accrued
IV. Others (including provisions)
Total [I+II+III+IV] _______________________ _______________________
Schedule 6: Cash and balances with Reserve Bank of India
I. Cash in hand (including foreign currency notes)
II. Balances with Reserve Bank of India
(i) in current account
(ii) in other accounts
Total [(I) + (II)] _______________________ _______________________
Schedule 7: Balances with banks and money at call and short notices
I. In India
(i) Balances with banks
(a) in current accounts
(b) in other deposit accounts
(ii) Money at call and short notice
(a)
with banks
(b) with other institutions
Total [(I) + (II)] _______________________ _______________________
II. Outside India
(i) in current accounts
(ii) in other deposit accounts
(iii) Money at call and short notice
Total ((I) + (II) +(III)) _______________________ _______________________
Grand total: (I + II) _______________________ _______________________
Schedule 8: Investments
1. Investment in India in
(i) Government securities
(ii) Other approved securities
(iii) Shares
(iv) Debentures and Bonds
(v) Subsidiaries and/or joint ventures
(vi) Other (to be specified)
Total : [(i)+(ii)+(iii)+(iv)+(v)+(vi)] _______________________ _______________________

II. Investment outside India in
(i) Government securities (including local authorities)
(ii) Subsidiaries and/or joint venture abroad
(iii) Other investments (to be specified)
Total [(I)+(II)+(III)] _______________________ _______________________
Grand total: (I + II) _______________________ _______________________
Schedule 9: Advances
I. (i) Bills purchased and discounted
(ii) Cash credits, overdrafts and loans repayable on demand
(iii) Term loans
Total: _______________________ _______________________
II. (i) Secured by tangible assets
(ii) Covered by bank / government guarantees
(iii) Unsecured
Total: _______________________ _______________________
III. Advances in India
(i) Priority sector
(ii) Public sector
(iii) Banks
(iv) Others
Total: _______________________ _______________________
IV. Advances outside India
(i) Due from banks
(ii) Due from others
(a) Bills purchased and discounted
(b)
Syndicated loans
(c)
Others
Total: _______________________ _______________________
Grand Total (I + II + III + IV) _______________________ _______________________
Schedule 10: Fixed assets
I. Premises
At cost on 31st March of the preceding Year Additions during the year Deductions during the year
Depreciation to date
II. Other fixed assets (including furniture and fixtures)
At cost as on 31st March of the preceding year
Addition during the year
Deductions during the year
Depreciation to date
Total (I+ II) _______________________ _______________________
Schedule 11: Other assets
I. Inter office adjustment (net)
II. Interest accrued
III. Tax paid in advance
IV. Stationery and stamps
V. Non-banking assets acquired in satisfaction of claims
VI. Others
Total [I+II+III+IV+V] _______________________ _______________________
Note: In case there is any unadjusted balance of loss the same may be shown under this item with appropriate
footnote
Schedule 12: Contingent liabilities
I. Claims against the bank not acknowledge as debts
II. Liability for partly paid investments
III. Liability on account of outstanding forward exchange contracts
IV. Guarantee given on behalf of constituents
(a) in India
(b) outside India
V. Acceptances, endorsements and other Obligations
VI. Other items for which the bank is liable
Total [I+II+III+IV+V] _______________________ _______________________
Balance Sheet items: Notes, Detailed comments and instructions for compilation
1. Capital
Capital includes the capital provided by Govt., and public issue in case of public sector banks. In case of
private banks, it comes from the promotors and through public issue.
a. Nationalised Banks: The Capital owned by Central Government as on the date of the balance sheet
should be shown.
b. Other Indian Banks: In the case of other Indian banks, Authorised, Issued, Subscribed, and Called up
capital should be given separately. Calls-in- arrears will be deducted from the called-up capital while
the paid-up value of forfeited shares should be added thus arriving at the paid-up capital. Where
necessary, items which can be combined should be shown under one head for instance ‘Issued and
Subscribed Capital’.
c. In the case of Banking Companies incorporated outside India, the amount of deposit kept with
Reserve Bank of India, under sub-section 2 of section 11 of the Banking Regulation Act, 1949 should
be shown under the head ‘capital’; the amount, however, should not be extended to the outer column.
Notes - General: The changes in the above items, if any, during the year, say, fresh contribution made by
the Government, fresh issue of capital, capitalisation of reserves, etc. may be explained in the notes.
2. Reserves
a. Statutory Reserves: Reserve created in terms of section 17 or any other section of Banking
Regulation Act, 1949 must be separately disclosed.
b. Capital Reserves: The expression ‘Capital Reserves’ not to include any amount regarded as free for
distribution through the profit & loss account. Surplus on revaluation or sale of fixed assets should
be treated as capital reserves. However, surplus on translation of financial statements of foreign
branches (including fixed assets of these branches) is not to be taken as revaluation reserve.
c. Share Premium: Premium on issue of share capital may be shown separately under this head.
d. Revenue Reserves & Others: The expression ‘Revenue Reserves’ shall mean any reserve other
than Capital Reserve. This item will include all reserves, other than those separately classified. The
expression ‘reserve’ shall not include any amount written off or retained by way of providing for
depreciation, renewals or domination in value of assets or retained by way of providing for any
known liability.
e. Balance of profit: Includes balance of profit after appropriations. In case of loss the balance may be
shown as a deduction.
Notes - General: Movements in various categories of reserves should be shown as indicated in the schedule.
3. Deposits:
A. Demand Deposits:
From banks: Includes all banks deposits repayable on demand.
From others: Includes all demand deposits of others. Credit balances in overdrafts, cash credit
accounts, deposits payable at call, overdue deposits, inoperative current accounts, matured time
deposits and cash certificates or certificates of deposit, etc. are to be included under this category.
Savings Bank: Includes all savings bank deposits including inoperative savings bank accounts.
Term Deposits From Banks: Includes all types of banks deposits repayable after a specified term.
Term Deposits From others: Includes all types of deposits of the nonbanking sector repayable
after a specified term. Fixed deposits, cumulative and recurring deposits, cash certificates, annuity
deposits, deposits mobilised under various schemes, ordinary staff deposits, foreign currency non-
resident deposits accounts, etc. are to be included under this category.
B. Deposits from branches in India & Deposits from branches outside India.
The total of these two items (A & B) will agree with the total deposits.
Notes - General
(a) Interest payable on deposits (whether accrued and due and accrued but not due) should not
be included but shown in Schedule 5 under other liabilities. Deposits, repayment of which is
subject to restrictions by its very nature, like margin deposits, security deposits from staff, etc.,
also should not be included under deposits but shown under ‘Other Liabilities.’
(b) Matured time deposits and cash certificates, etc., should be treated as demand deposits.
(c) Deposits under special schemes should be included under term deposits if they are not payable
on demand. When such deposits have matured for payments they should be shown under
demand deposits.
(d) Deposits from banks will include deposits from the banking system in India, co-operative banks,
foreign banks which may or may not have a presence in India.
4. Borrowings: (Includes borrowings/refinance and rediscount obtained from)
In India:
From Reserve Bank of India, from Commercial banks (including co-operative banks), from IDBI, Exim Bank,
NABARD, and other institutions/agencies (including liability against participation certificates, if any).
Outside India:
Includes borrowings and rediscounts of Indian branches abroad as well as borrowings of foreign branches.
Includes secured borrowings / refinance in India and outside India.
Notes - General
(i) Inter-office transactions should not be shown as borrowings.
(ii) Funds raised by foreign branches by way of certificates of deposits, notes, bonds, etc. should be
classified, depending upon documentation, as ‘Deposits’, ‘borrowings’ etc.
(iii) Refinance obtained by banks from Reserve Bank of India and various institutions are being brought
under the head ‘Borrowings’. Hence advances will be shown at the gross amount on the asset side.
5. Other Liabilities and Provisions:
Bills payable: Includes drafts, telegraphic transfers, mail transfers payable, pay slip, banker’s cheques,
other miscellaneous items, etc. remaining uncashed.
Inter-office liabilities: The inter-office adjustments balance, if in credit, should be shown under this
head. Only net position of inter-office accounts, inland as well as foreign should be shown here.
Interest accrued: Includes interest due and payable and interest accrued but not due on deposits and
borrowings
Others : Includes net provision for income tax and other taxes like interest tax (less advance payment,
tax deducted at source, etc.), surplus provisions in bad debts provision account, surplus provisions for
depreciation in securities, contingency funds which are not disclosed as reserves but are actually in the
nature of reserves, proposed dividend/transfer to Government, other liabilities which are not disclosed
under any of the major heads such as unclaimed dividend, provisions and funds kept for specific purposes,
unexpired discount, outstanding charges like rent, conveyance, etc. certain types of deposits like staff
security deposits, margin deposits, etc. where the repayment is not free, should also be included under
this head.
Notes - General
(i) For arriving at the net balance of inter-office adjustments all connected inter-office accounts should
be aggregated and the net balance only will be shown, representing mostly items in transit and
unadjusted items,
(ii) The interest accruing on all deposits, whether the payment is due or not, should be treated as a
liability,
(iii) It is proposed to show only pure deposits under the head ‘deposits’ and hence all surplus provisions
for bad and doubtful debts contingency funds, secret reserves, etc. which are not netted off against
the relative assets should be brought under the head ‘Others’ (including provisions).
Note: As per RBI’s guidelines on Capital and provisioning requirements for exposures to entities with
Unhedged Foreign Currency Exposure (UFCE) issued on February 17, 2021 mandate that information on
UFCE may be obtained by banks from entities on a quarterly basis, on self-certification basis, and preferably
should be internally audited by the entity concerned. We have received representation from banks expressing
their inability in obtaining UFCE certificates from listed entities for the latest quarter due to restrictions
on disclosure of such information prior to finalisation of accounts. It has been decided that in such cases,
banks may use data pertaining to the immediate preceding quarter for computing capital and provisioning
requirements in case of Unhedged Foreign Currency Exposures.
6. Cash and balances with the Reserve Bank of India:
I. Cash in hand (including foreign currency notes) and also of foreign branches in the case of banks
having such branches.

II. In Current Account with Reserve Bank of India (Includes the balance maintained with the Reserve
Bank of India in Current Account).
7. Balances with banks in India and Money at call and short notice;
I. In India
(i) Balances with Reserve Bank of India (other than in current account) Includes balances held
with the Reserve Bank of India other than in current accounts, if any.
(ii) Balances with other banks in India Current accounts Deposit accounts. Includes all balances
with banks in India (including co-operative banks). Balances in current accounts and deposit
accounts should be shown separately.
(iii) Money at call and short notice with banks and other institutions. Includes deposits repayable
within 15 days or less than 15 days’ notice lent in the inter-bank call money market.
(iv) Cash in hand including foreign currency notes.
II. Outside India
Usually classified in foreign countries as money at call Includes balances held by foreign branches
and balances held by Indian branches of the banks outside India. Balances held with foreign branches
by other branches of the bank should not be shown under this head but should be included in inter
branch accounts. The amounts held in ‘current accounts’ and ‘deposit accounts’ should be shown
separately. Includes deposits and short notice.
8. Investments:
I. Investments in India (Includes Central and State Government securities and Government treasury
bills. Securities other than Government securities, which according to the Statutes are treated as
approved securities, should be included here).
(i) Government securities.
(ii) Other approved Securities Investments in shares of companies and corporations not included
in item (i) should be included here.
(iii)
Shares.
(iv) Debentures and Bonds, Investments in debentures and bonds of companies and corporations
not included in item (ii) should be included here.
(v) Investments in subsidiaries/ Associate companies: Investments in subsidiaries/ associate
companies should be included here.
A company will be considered as an associate company for the purpose of this classification
if more than 25% of the share capital of that company is held by the bank. Includes residual
investments, if any, like gold.
(vi)
Others.
II. Investments outside India:
(i) Government securities (including local authorities);
(ii) Others All foreign Government securities including securities issued by local authorities may
be classified under this head. All other investments outside India may be shown under this
head.
9. Advances:
A. (i) Bills purchased and discounted
(ii) Cash Credits, Overdrafts and Loans repayable on demand

(iii)
Term loans
B. (i) Secured by tangible assets
(ii) Covered by bank/government guarantees
(iii) Unsecured
C. I. Advances in India
(i) Priority sectors
(ii)
Public sector
(iii)
Banks
(iv)
Others
II. Advances outside India
(i) Due from banks
(ii)
Due from others
(iii) Bills purchased and discounted
(iv)
Syndicated loans
(v)
Others
The item will include advances in India and outside India.
• Advances should be broadly classified into ‘Advances in India’ and ‘Advances outside India’.
Advances in India will be further classified on the sectoral basis as indicated.
• Advances to sectors which for the time being are classified as priority sectors according to the
instructions of the Reserve Bank is to be classified under the head ‘Priority Sector’.
• Advances to Central and State Governments and other Government undertakings including
Government companies and corporations which are, according to the statutes, to be treated as
‘public sector’.
• All advances to the banking sector including co-operative banks will come under the head
‘Banks’.
• All the remaining advances will be included under this head ‘Others’ and typically this category
will include non-priority advances to the private, joint and cooperative sector:
• A bank lends advances for various activities. Broadly, the advances it lends can be classified
into priority segment lending; public segment lending and non priority segment lending. The
priority segment consists of such advances as specified by RBI in its Master circulars to banks
and generally consist of agriculture, MSMEs and others.
Notes - General
(i) The gross amount of advances including refinance but excluding provisions made to the
satisfaction of auditors should be shown as advances.
(ii) Term loans will be loans not repayable on demand but over a period of time.
(iii) Consortium advances would be shown net of recoveries from other participating banks /
institutions.
(iv) As per RBI’s Monetary policy dated February 28, 2021, Scheduled commercial banks (SCBs)
will be allowed to deduct credit disbursed to ‘New MSME borrowers’ from their NDTL for
calculation of the CRR. Accordingly, the Reserve Bank on February 05, 2021 advised all SCBs to
report the exemption availed at the end of a fortnight, in prescribed format.
A. Bills purchased and discounted: In classification under Section ‘A’, all outstanding - in
(i)
India as well as outside - less provisions made, will be classified under three heads as
indicated and both secured and unsecured advances will be included under these heads.
(ii) Cash credits, overdrafts and loans repayable on demand.
(iii) Term loans (All advances or part of advances which are secured by tangible assets may be
shown here).
B. (i) Secured by tangible assets.
(ii) Covered by Bank/ Government Guarantee.
(iii) Unsecured.
C. I. Advances in India
(i)
Priority sectors.
(ii)
Public sector.
(iii)
Banks.
(iv)
Others.
II. Advances outside India (i) Due from banks (ii) Due from others
10. Fixed Assets:
These include premises and other fixed assets and are shown at cost on close of previous year, additions
and deductions during the year and depreciation till close of the year.
I. Premises
II. Other Fixed Assets (including furniture and fixtures)
III. Capital work-in-progress or premises under construction
Premises wholly or partly owned by the banking company for the purpose of business including residential
premises should be shown against ‘Premises’.
In the case of premises and other fixed assets, the previous balance, additions thereto and deductions
there from during the year as also the total depreciation written off should be shown. Where sums have
been written off on reduction of capital or revaluation of assets, every balance sheet after the first balance
sheet subsequent to the reduction or revaluation should show the revised figures for a period of five years
with the date and amount of revision made. Motor vehicles and all other fixed assets other than premises
but including furniture and fixtures should be shown under this head.
11. Other assets
I. Inter-office adjustments (net): The inter-office adjustments balance, if in debt, should be shown
under this head. Only net position of inter- office accounts, inland as well as foreign, should be shown
here. For arriving at the net balance of inter-office adjustment accounts, all connected inter-office
accounts should be aggregated and the net balances, if in debit, only should be shown representing
mostly items in transit and unadjusted items.
II. Interest accrued: Interest accrued but not due on investments and advances and interest due but
not collected on investments will be the main components of this item. As banks normally debit the
borrowers’ account with interest due on the balance sheet date, usually there may not be any amount
of interest due on advances. Only such interest as can be realised in the ordinary course should be
shown under this head.

Tax paid in advance/tax deducted at source: The amount of tax deducted at source on securities,
III.
advance tax paid, etc. to the extent that these items are not set off against relative tax provisions
should be shown against this item.
IV. Stationery and stamps: Only exceptional items of expenditure on stationery like bulk purchase of
security paper, loose leaf or other ledgers, etc. which are shown as quasi-asset to be written off over
a period of time should be shown here. The value should be on a realistic basis and cost escalation
should not be taken into account, as these items are for internal use.
V. Non-Banking Assets: This will include properties/tangible assets acquired in satisfaction of claims
to be shown. Others: Items like claims which have not been met, for instance, clearing items, debit
items representing addition to assets or reduction in liabilities which have not been adjusted for
technical reasons, want of particulars, etc. advances given to staff by a bank as employer and not as
a banker, etc. Items, which are in the nature of expenses, which are pending adjustments, should be
provided for and the provision netted against this item so that only realisable value is shown under
this head. Accrued income other than interest may also be included here.
12. Contingent liabilities:
I. Claims against the Bank not acknowledged as debts.
II. Liability for partly paid investments.
III. Liability on account of outstanding forward exchange contracts.
IV. Guarantee given on behalf of constituents. (a) In India (b) Outside India.
V. Acceptances, endorsements and other obligations.
VI. Other items for which the bank is contingently liable Bills for collection: Bills and other items in the
course of collection and not adjusted will be shown against this item in the summary.
Notes/Instructions for compilation

1. Formats of Balance Sheet and Profit and Loss account cover all items likely to appear in these statements.
If a bank does not have any particular item to report, it may be omitted from formats.
2. Corresponding comparative figures for previous year are to be disclosed as indicated in the formats. The
words ‘Current year’, ‘Previous year’ used in formats are only to indicate the order of presentation and
may not appear in accounts.
3. Figures should be rounded off to nearest thousand rupees.
4. Unless otherwise indicated the banks in these statements will include banking companies, nationalized
banks, State Bank of India and all other banks including cooperative banks carrying business of banking
whether or not incorporated in India or not or operating in India.
5. The Hindi version of balance sheet will be a part of annual report wherever applicable.
ACCOUNTING TREATMENT OF SPECIFIC ITEMS

The accounting treatments of certain specific items in Balance Sheet and Profit and Loss accounts are as follows:
Bad Debts and Provision for doubtful debts: This will include bad debts and provision for doubtful debts are
to be charged to “Provisions and Contingencies’ in the P& L account. Advances shown in the Balance Sheet is
net of bad debts and provisions for bad debts. Banks collect these details from their branches. The Schedule
of Advances filled and submitted by branches include doubtful debts in respect of Cash credit, over drafts,
unsecured loans as also bills purchased and discounted. However, at the Head office Advances figure shown is
net of bad as well as doubtful debts.

Provision of Taxation: This is chargeable under the head ‘”Provisions and Contingencies’ in the P & L account.
However, this will be shown in the Balance Sheet under the heading ‘Other Liabilities and Provisions’ on the
Liabilities side.
Rebate on Bills discounted

Rebate on bills represents the discount collected for unexpired period in advance. Banks normally collect
discount charges for the entire period of Bill of Exchange or Promissory Note.
For example, a Bill of Rs.1,00,000 payable 60 days at sight is discounted on say 23.03.2018. Let us also assume
the bill will fall due for payment on 23.05.2018. Assume that total discount collected is Rs. 600 and other
postage charges Rs.400 is levied.
At the time of discount as on 23.03.2018 following entries will be passed:
Dr Bill Discounted A/s 1,00,000
Cr Customer’s A/c 99,000
Cr Discount A/c 600
Cr Postage charges A/c 400
As on 31st March for the purposes of preparing P & L account the bank has collected Rs. 520 excess for the
period of 1st April to 22nd May which falls in the next accounting year. The amount of Rs.520 is adjusted in the
account of the branch in the following manner;
Dr Discount A/c 520
Cr. Rebate on Bills Discounted 520
Rebate will appear under the head ‘Liabilities’ side in the balance sheet.
Important Ratios for evaluation of performance of banks
The performance is evaluated by shareholders and Reserve Bank of India, with following important ratios.
• Capital adequacy ratio - It is calculated as ratio of capital funds to risk weighted assets. Capital funds
include Tier I capital and Tier II capital. The risk weightage has been assigned by RBI to various assets that
range from 0% to 125% and may be more. The ratio indicates strength of the bank to meet unexpected
losses.
• Net NPAs to net advances ratio - it indicates the quality of financial assets created by the bank. Lower ratio
indicates better quality of advances and investments. A higher ratio is a cause for worry as it affects profit
position in two ways - one non-recognition of interest income and provisions against gross NPAs.
• Return on assets - the ratio is calculated as net profit as percentage of average assets. It indicates efficiency
of use of assets for generation of profits. With increase in assets the return on assets should increase. This
ensures long time solvency of a bank.
PREPARATION OF PROFIT AND LOSS ACCOUNT

The format preparing the Profit and Loss Account is given below as per Schedule III Form B of the Banking
Regulation Act 1949.
FORM B
Profit and loss account for the year ended on 31st March (year)
Schedule 31-3-20......... 31-3-20.......

No. (current year) (previous
Year)
I. Income
Interest earned 13
Other income 14
Total
II. Expenditure
Interest expended 15
Operating expenses 16
Provisions and contingencies
Total
III. Profit / Loss
Net profit / loss (-) for the year
Profit / loss (-) brought forward
Total
IV. Appropriations
Transfer to statutory reserves
Transfer to other reserves
Transfer to government/ Proposed dividend
Balance carried over to Balance sheet
Total
Details of Schedules
Schedule 13 : Interest earned
As on As on
31-3-20....... 31-3- 20.....
I. Interest/discount on advance/bills
II. Income on investments
Ill. Interest on balances with Reserve Bank of India and other
inter-bank funds
IV. Others
Total
Schedule 14 : Other income

As on As on
31-3-20....... 31-3- 20.....
I. Commission, exchange and brokerage
II. Profit on sale of investments
Less: Loss on sale of investments
III. Profit on revaluation of investments
Less: Loss on revaluation of investments
IV. Profit on sale of land, buildings and other assets
Less: Loss on sale of land, buildings and other assets
V. Profit on exchange transactions
Less: Loss on exchange transactions
VI. Income earned by way of dividends, etc. from subsidiaries/
companies and/or joint ventures abroad/ in India
VII. Miscellaneous income
Total
Note: Under items II to V loss figures may be shown in brackets.
Schedule 15: Interest expended

As on As on
31-3-20....... 31-3- 20.....
I. Interest on deposits
II. Interest on Reserve Bank of India/Inter bank borrowings
III. Others
Total
Schedule 16: Operating expenses

As on As on
31-3-20....... 31-3- 20.....
I. Payment to and provisions of employees
II. Rent, taxes and lighting
III. Printing and stationery
IV. Advertisement and publicity
V. Depreciation on bank’s property
VI. Director’s fees, allowances and expenses
VII. Auditors’ fees and expenses (including branch auditors)
VIII. Law charges

IX. Postages, Telegrams, Telephones, etc.
X. Repairs and maintenance
XI. Insurance
XII. Other expenditure
Total
COMMENTS ON PROFIT AND LOSS ACCOUNT

Schedule 13: Interest earned: Includes interest, discount on all types of loans and advances, like Cash credit,
demand loans, overdraft, term loans, export loans, domestic/foreign bills purchased/discounted (including
those rediscounted), overdue interest and interest subsidy, if any relating to such advances.
I. Income on investments: Includes all income derived from investment portfolio by way interest and
dividend.
II. Interest on balances with Reserve Bank of India and other inter-bank funds: Includes interest on
balances with Reserve Bank of India and other banks, call loans, money market placements etc.
III. Others: Includes any other discount/interest not included in the above.
Schedule 14: Other Income:
I. Commission, exchange and brokerage: Includes commission on collection, on remittances, exchange on
DDs, commission earned on letters of credit, bank guarantees, letting out lockers, Government business,
agency business/consultancy services, brokerage on securities. Foreign exchange income is excluded.
II. Profit on sale of investments: From this reduce loss of sale of investments.
III. Profit on revaluation of investments: From this reduce loss on revaluation of investments.
IV. Profit on sale of land, buildings and other assets: Deduct loss of sale of land, buildings and other assets.
Includes profit on sale of securities, furniture, land and buildings, motor vehicles, gold, silver etc. Net
position should be only shown. If the net position is a loss, it should be shown as a deduction. Similarly net
profit/loss on revaluation of assets may be shown under this.
V. Profit on exchange transactions: Includes profit/loss on foreign exchange, all income earned by
exchange, commission and other charges on foreign exchange transactions excluding interest which will
be shown under interest. Net position only to be shown. If the net position is a loss, it should be shown as
a deduction.
VI. Income earned by way of dividends etc. from subsidiaries/companies and/or joint ventures abroad/ in
India.
VII. Miscellaneous income: Includes charges recovered as go-down rents, income from bank’s properties,
security charges, insurance, other miscellaneous income. If any individual item exceeds more than 1% of
the total income, particulars be given in the notes to accounts.
Schedule 15: Interest expended
I. Interest on deposits: All interest paid on deposits including banks and institutions to be included in this.
II. Interest on Reserve Bank of India/ Inter-bank, borrowings: Interest on all borrowings from banks as
well as on refinance from RBI to be included.
III. Others: Includes interest/discount on all borrowings and refinance, penal interest paid.
Schedule 16: Operating Expenses
I. Payment to and provisions of employees: This head includes all salaries/wages, allowances including
medical allowances, bonus, other staff benefits like provident fund, pension, gratuity, lave fare travel/
concession, staff welfare etc.
II. Rent, taxes and lighting: This head to include rent paid on building on rent, municipal taxes, other taxes
(except income tax, interest tax), electricity and similar types of charges. House Rent allowance paid to
staff should appear under, “ Payments to and Provisions for Employees’.
III. Printing and stationery: This head to include books and stationery used/consumed by the bank, other
printing charges (other than by way of publicity expenditure).
IV. Advertisement and publicity: Expenses incurred for publicity and advertising including printing charges
on publicity materials to be included under this head.
V. Depreciation on bank’s property: Depreciation bank’s own property, motor cars, other vehicles,
furniture, fixtures, electrical fittings, lockers, vaults, lease hold assets, other non-banking assets etc.
VI. Director’s fees, allowances and expenses: Expenses like sitting fee, hotel charges, daily allowances,
conveyance and other local expenditure incurred on behalf of directors to be included. Similarly, expenses
incurred on account of local committee members to be also included. Though these expenses may be of
reimbursable nature nevertheless these are to be included.
VII. Auditors’ fees and expenses: This head should also include fees expenses relating to branch auditors.
This expenditure fees and other expenses paid to statutory auditors for their professional services
rendered and for performing their duties. Though in practice these are in the nature of reimbursement
of such expenses. If external auditors are appointed for internal inspection, audit and other professional
services such expenses should be included under this head but under ‘other expenditure’.
VIII. Law charges: This head should include all legal expenses incurred including reimbursements expenses
incurred for providing legal services.
IX. Postages, Telegrams, Telephones, etc.: All expenses incurred towards stamps, postage, telegrams,
telephones etc. to be included.
X. Repairs and maintenance: Include expenses incurred for maintaining bank’s property.
XI. Insurance: Includes insurance premium paid for banks property, premium paid to DICGC for deposit
insurance/other loan which are not recovered from customers.
XII. Other expenditure: All other expenses which are not included in any of the above are included here. If
any such expenditure exceeds 1% of the total income details are to be given in the notes to accounts.
Note: There may be slight variations in the heads of expenditure maintained by banks.
For example, Newspapers & periodicals, Local conveyance, Entertainment expenses etc. and accordingly it
would be mentioned as a head under expenditure.
IMPORTANT ITEMS OF BALANCE SHEET

Banks balance sheets contain certain unusual items when compared to others. We shall have an over view of
the same.
Liabilities Side
1. Share Capital: Consist of Authorised, Issued, Subscribed and Paid-up share capital are shown separately.
Under the head, Paid-up Capital, calls in arrears are reduced and forfeited share amount is added.
2. Reserve Fund and others: As under Banking Regulation Act, 1949 every bank which is incorporated in
India has to transfer twenty percent of its profit before declaring dividend each year to the Reserve Fund.
3. Deposits and other accounts: Though it appears as a single head, it consists of Fixed Deposits (which
are held for a fixed period), Savings Bank as well as Current Account balances (which are repayable on
demand) and others.
Assets Side
1. Money at call and short notice: Money is borrowed by one bank from another usually for a short period
of 1 to 14 days for meeting certain commitments. For a bank which lends this money it is an asset in the
form of receivable. This type of transaction is known as inter-bank transaction. When banks have surplus
funds they lend and when they have shortage they borrow. Banks also approach RBI and other primary
dealers for the same purpose. Banks make use of ‘Repo’ facility for borrowing with RBI. These are included
under this head. The interest rates on such borrowings is charged as an expense. Rate of interest will
depend on market demand and supply (except in the case of Repo transaction which will be depend on
repo rate.)
2. Advances: The advances consist of Loans, Cash credit and overdraft. Loans are given a fixed period to
customer repayable over a period of time by way of EMI or instalments. Cash credit facility is given for
a period of one year by way of a hypothecation limit against securities in the form of current assets/
securities. Customers are permitted to draw money up to a limit sanctioned. It is a running account in
which deposits will also be made. In case of Overdraft a customer will be allowed to draw money from
current account against some collateral security like insurance policies, shares, NSC and other tangible
securities.
3. Bills receivable being Bills for collection as per contra: Bills are given by customers for collection and
subsequent credit to their accounts. Such bills are sent for collection and on realization these are credited
to customers’ account. During the year end when bills which remain outstanding for collection banks pass
the following entries:
Bills received being bills for collection Dr
To Bills for Collection being bills receivable account Cr
The first entry indicates the amount receivable and it is taken on the assets side. The second entry denotes
amount payable is taken on the liabilities side of the balance sheet. The amounts are identical and known
as contra items.
4. Acceptances, Endorsements and other obligations: During the course of their business banks open
letters of credit, issue bank guarantee, endorse promissory notes, accept or co-accept bills on behalf
of customers. Under such actions a bank is liable to third parties on behalf of customers. In such cases
banks obtain counter guarantees to protect themselves in case if liabilities devolve on them. Such counter
guarantees represent an asset. For all such outstanding transactions contra entries are passed:
Constituent liability for Acceptances, Endorsements / other obligations Dr
To Acceptances, Endorsements/other obligations Cr
The former entry is taken in the assets side and the latter is taken on the liabilities side.
Non-Banking Assets: These are non-financial Assets and are tangible. e.g., machinery, equipment, real estate,
inventory, vehicles. When a borrower is unable to repay the amount of the loan in cash and as a substitute offers
to the bank an asset. This is known as a non-banking asset. This one is provided apart from the asset already
given as collateral security to the bank to purchase so as to settle their dues. When these assets are purchased
by the banks, they are known as non banking assets. Banks are required to dispose off those assets within a
specified timeframe as mandated by RBI. They also have the responsibility to finally convert these non-cash
recoveries in to cash as recoveries. Profit or loss on disposal of such assets are to be disclosed in profit and loss
of account of the bank.
Gold and Silver: Gold appears as a part of assets and appears under the head ‘investments’. Silver appears
under “Other assets”.
Locker /Safe Deposit vaults: These are assets and as such are included under Furniture and fixtures.
Branch Adjustment Account: In a Bank there are many transactions take place. They may be between Head
office and branches vice-versa, between branches. They are properly reconciled at periodical intervals. However
at the year-end time there could be outstanding transactions pending reconciliation. Thus, there could be a
balance in the inter-office. The inter-office adjustment balance, if in debit, should be shown under this head.
Only net position of inter-office accounts inland as well as foreign should be shown here. For arriving at the net
balance of inter-office adjustment accounts all connected inter-office accounts should be aggregated and the
net balance, if in debit, only should be shown, representing mostly items in transit and unadjusted items. If the
balance is in credit it is shown under liabilities side.
An illustration of preparation of a bank’s Balance Sheet, P & L Account, as per the formats of Banking Regulation
Act, 1949.
Example 1
M/s Progressive Bank has given you the following information. Prepare Profit & Loss Account and Balance
Sheet as at 31st March xx as per the forms under Banking Regulation Act, 1949.
Share Capital 3,00,000
Statutory Reserve Fund 1,80,000
Bad debts 19,313
Establishment Expenses 1,91,588
Current Deposits 20,47,841
Interest paid 11,22,660
Savings Bank Deposits 25,80,000
Acceptance for customer 71,250
Discount 7,42,500
Profit & Loss Account - credit 12,30,600
Fixed Deposits 13,12,500
Commission & Exchange 4,39,350
Premises 7,20,000
Cash in hand 975
Balance in RBI 33,000
Interest received 19,29,600
Interest in shares (Market Value 3,00,000) 1,38,750
Cash with banks 4,26,750
Term loans in India 15,00,000
CC Account - Hypothecation 18,96,000
CC Account - Pledge 14,16,000
Bill Purchased 24,00,000
Employee loans 61,155
Salaries, Allowances, PF 6,68,201
Government Securities 1,80,000
Dividend on investments 12,000
Other Notes
CEO Salary 60000 p.a. included in salaries
Directors fee & Allowances 12000 included in salaries & Allowances

Rebate on bills as at year end is Rs. 72000
Establishment Expenses include
Stamp papers 2,250
Revenue Stamps 600
Postage and Telegrams 6,900
Audit fees 12,000
Lighting 4,500
Rent 27,000
Stationery 94,500
Advertisements 15,000
A CC limit of Rs. 12000 needs to be fully provided for.
Taxation at 35%
Solution:
Progressive Bank Limited
Profit & Loss Account for the year ended on 31st March XX
Schedule Rs.
I Income
Interest Earned 13 26,00,100
Other Income 14 4,51,350
Total 30,51,450
II Expenditure 15 11,22,660
Interest Expended 16 8,59,789
Operating Expenses Provision for contingencies 3,94,504
Total 23,76,953
III Profit
Net Profit 6,74,497
IV Appropriations
Transfer to statutory reserves 1,34,899
Carried Forward to Balance Sheet 5,39,598
Schedule 13: Interest Earned
Interest received 19,29,600

Discount 7,42,500
Less: Rebate -72,000 6,70,500
Total 26,00,100
Schedule 14: Other income
Commission & Exchange 4,39,350

Dividend on investment 12,000
Total 4,51,350
Schedule 15: Interest Expended
Interest expended 11,22,660

Total 11,22,660
Schedule 16: Operating Expenses
Salaries & Allowances 6,56,201

Rent & Lighting 31,500
Printing & Stationery 94,500
Advertisement & Publicity 15,000
Directors Fees 12,000
Auditors Fees & Exp. 12,000
Stamp papers 2,250
Postage, Telegrams, Revenue Stamp 7,500
Other Expenses 28,838
Total 8,59,789
Working Notes:
Establishment Expenses 1,91,588
Salaries Allowances etc. 6,68,201
Total 8,59,789
Other expenses is a balancing amount
Income 26,00,100
Other income 4,51,350
Total 30,51,450
Less: Interest Expended 11,22,660
Less: operating Expenses 8,59,789
less; Bad debts provision 31,313 20,13,762
Profit Before Tax 10,37,688
Income Tax @35% on 10,37,688 3,63,191
Net Profit After Tax 6,74,497
To Statutory Reserves 20% of Net Profit 1,34,899
C/F to Balance sheet 5,39,598
Provision for contingencies

Bad debts 19,313
Provision for bad debts 12,000
Provision for income tax 3,63,191
Total 3,94,504
Progressive Bank Limited

Balance Sheet as on 31st March 20XX
Schedule No. Rs.

Capital and Liabilities
Capital 1 3,00,000
Reserves & Surplus 2 20,85,097
Deposits 3 59,40,341
Borrowings 4 –
Other Liabilities and Provisions 5 4,47,192
Total 87,72,630
Assets
Cash and Balances with RBI 6 33,975
Balances with Banks and Money at Call and Short Notice 7 4,26,750
Investments 8 3,18,750
Advances 9 72,12,000
Fixed assets 10 7,20,000
Other Assets 11 61,155
Total 87,72,630
Contingent Liabilities 12 71,250
Schedule 1: Capital
Rs.
A. Authorised Capital
10000 shares of Rs. 100 each 10,00,000
Issued Capital
3000 shares of Rs.100 each 3,00,000
Subscribed Capital
Called up and Paid up Capital
Schedule 2: Reserves & Surplus

I Statutory reserve
Opening Balance 1,80,000
Add: Addition during the year 1,34,899 3,14,899
II Capital Reserve Nil
III Share Premium Nil
IV Revenue & other Reserves Nil
V Balance of Profit & Loss 17,70,198 17,70,198
Total 20,85,097
Schedule 3: Deposits
Rs.
A I. Demand Deposits
From Banks
From Others 20,47,841
II Savings Bank Deposits 25,80,000
III. Term Deposits
From Banks
From Others 13,12,500
Total (I+II+III) 59,40,341
B. I. Deposits of Branches in India 59,40,341
II. Deposits of Branches outside India 0
Schedule 4: Borrowings
I. Borrowings of branches in India 0
II. Borrowings of branches outside India
Schedule 5: Other Liabilities & Provisions

I. Bills Payable 0
II. Inter-office Adjustments 0
III. Interest accrued 0
IV. OTHERS 4,47,192
Schedule 6: Cash and Balances with RBI

I. Cash in hand 975
II. Balance with RBI 33,000
Total 33,975
Schedule 7: Balances with Banks and Money at Call and Short Notice
I. In India 4,26,750
II. Outside India 0
4,26,750
Schedule 8: Investments
I. Investments in India in
(i) Government Securities 1,80,000
(ii) Other Approved Securities 0
(iii) Shares 1,38,750
(iv) Debentures and Bonds –
(v) Subsidiaries and/or Joint ventures –
(vi) Others –
II. Investments outside India –
3,18,750
Schedule 9: Advances
Rs.
I. Bills Purchased and Discounted 24,00,000
II Cash Credit, Overdrafts, Loans repayable on demand 33,12,000
III Term Loans 15,00,000
72,12,000
Schedule 10: Fixed assets

Premises 7,20,000
Other fixed assets –
7,20,000
Schedule 11: Other Assets

I. Inter-office Adjustments –
II. Interest Accrued –
III. Stationery & Stamps –
IV. Taxes Paid in Advance & Deducted at Source –
V. Non-Banking Assets acquired in satisfaction of claims –
VI. Others- Loans to Employees 61,155
61,155
Schedule 12: Contingent Liabilities

Acceptances, Endorsements and other obligations 71,250
DISCLOSURE REQUIREMENTS OF BANKS

In order to encourage market discipline, Reserve Bank has over the years developed a set of disclosure
requirements, which allow the market participants to assess key pieces of information on capital adequacy, risk
exposures, risk assessment processes and key business parameters, to provide a consistent and understandable
disclosure framework that enhances comparability. Banks are also required to comply with the Accounting
Standard 1 (AS 1) on Disclosure of Accounting Policies issued by the Institute of Chartered Accountants of India
(ICAI). The enhanced disclosures have been achieved through revision of Balance Sheet and Profit & Loss Account
of banks and enlarging the scope of disclosures to be made in ‘Notes to Accounts’. In addition to the 16 detailed
prescribed schedules to the balance sheet, banks are required to furnish the following information In ‘Notes to
Accounts’. A brief on the same is given below. As a standard practice to bring in uniform reporting ‘Summary
of Significant Accounting Policies’ and ‘Notes to Accounts’ are to be shown in Schedules 17 and 18 by banks..
As per RBI directions, the disclosures are to be provided on the following:
1. Capital
2. Investments
3. Repo Transactions
4. Non SLR Investment Portfolio
5. Sale and Transfers to / from HTM Category
6. Derivatives
7. Forward Rate Agreement / Interest Rate Swap
8. Exchange Traded Interest Rate Derivatives

9. Disclosures on Risk Exposure in Derivatives
10. Asset Quality
11. Non Performing Asset
12. Particulars of Accounts Restructured
13. Details of Financial Assets sold to Securitisation / Reconstruction Company for Asset Reconstruction
14. Details of Non Performing Asset Purchased / Sold
15. Provisions on Standard Assets
16. Business Ratio
17. Asset Liability Management - Maturity Pattern of certain items of Assets and Liabilities
18. Exposures
19. Exposure to Real Estate Sector
20. Exposure to Capital Market
21. Risk Category wise Country Exposure
22. Details of Single Borrower Limit (SGL), Group Borrower Limit (GBL) exceeded by the bank
23. Unsecured Advances
24. Disclosure of Penalties imposed by RBI
25. Disclosure Requirements as per Accounting Standards where RBI has issued guidelines
26. Accounting Standard 5 - Net Profit or Loss for the period, Prior Period items and Changes in Accounting
Policies
27. Accounting Standard 9 - Revenue Recognition
28. Accounting Standard 15 - Employee Benefits
29. Accounting Standard 17 - Segment Reporting
30. Accounting Standard 18 - Related Party Disclosures
31. Accounting Standard 21 - Consolidated Financial Statements
32. Accounting Standard 22 - Accounting for Taxes on Income
33. Accounting Standard 23 - Accounting for Investments in Associates in Consolidated Financial
Statements
34. Accounting Standard 24 - Discontinuing Operations
35. Accounting Standard 25 - Interim Financial Reporting
36. Other Accounting Standards
37. Additional Disclosures
38. Provisions and Contingencies
39. Floating Provisions
40. Draw Down from Reserves
41. Disclosure of Complaints
42. Disclosure of Letters of Comfort (LoCs) issued by banks
43. Provisioning Coverage Ratio (PCR)
44. Insurance Business
45. Concentration of Deposits, Advances, Exposures and NPAs
46. Sector wise Advances

47. Movement of NPAs
48. Overseas Assets, NPAs and Revenue
49. Off Balance Sheet SPVs Sponsored
50. Unamortised Pension and Gratuity Liabilities
51. Disclosures on Remuneration
52. Disclosures relating to Securitisation
53. Credit Default Swaps
54. Intra Group Exposures
55. Transfers to Depositor Education and Awareness Fund (DEAF)
56. Unhedged Foreign Currency Exposure
57. Liquidity Coverage Ratio
Summary of Significant Accounting Policies

As per RBI’s directions banks should disclose the accounting policies regarding key areas of operations at one
place (under Schedule 17) along with ‘Notes to Accounts’ in their financial statements. A suggestive list includes
- Basis of Accounting, Transactions involving Foreign Exchange, Investments - Classification, Valuation, etc.,
Advances and Provisions thereon, Fixed Assets and Depreciation, Revenue Recognition, Employee Benefits,
Provision for Taxation, Net Profit, etc.
The model formats of some of such disclosures are as follows:
1. Basis of Accounting: The accompanying financial statements have been prepared on the historical cost
and conform to the statutory provisions and practices prevailing in the country.
2. Transactions involving Foreign Exchange:
(a) Monetary assets and liabilities have been translated at the exchange rates, prevailing at the close of
the year. Non-monetary assets have been carried in the books at the historical cost.
(b) Income and expenditure items in respect of Indian branches have been translated at the exchange
rates, ruling on the date of the transaction and in respect of overseas branches at the exchange rates
prevailing at the close of the year.
(c) Profit or loss on pending forward contracts have been accounted for.
3. Investments:
(a) Investment in governments and other approved securities in India are valued at the lower of cost or
market value.
(b) Investments in subsidiary companies and associate have been accounted for on the historical cost
basis.
(c) All other investments are valued at the lower of cost or market value.
4. Advances:
(a) Provisions for doubtful advances have been made to the satisfaction of the auditors:
(i) In respect of identified advances, based on a periodic review of advances and after taking into
account the portion of advance guaranteed by the Deposit Insurance and Credit Guarantee
Corporation, the Export Credit and Guarantee Corporation and similar statutory bodies;
(ii) In respect of general advances, as a percentage of total advances taking into account the
guidelines issued by the Government of India and the Reserve Bank of India.
(b) Provisions in respect of doubtful advances have been deducted from the advances to the extent
necessary and the excess have been included under “Other Liabilities and Provisions”.
(c) Provisions have been made on a gross basis. Tax relief, which will be available when the advance is
written-off, will be accounted for in the year of write-off.
5. Fixed Assets:
(a) Premises and other fixed assets have been accounted for at their historical cost. Premises which have
been revalued are accounted for at the value determined on the basis of such revaluation made by
the professional values, profit arising on revaluation has been credited to Capital Reserve.
(b) Depreciation has been provided for on the straight line/diminishing balance method.
(c) In respect of revalued assets, depreciation is provided for on the revalued figures and an amount
equal to the additional depreciation consequent of revaluation is transferred annually from the
Capital Reserve to the General Reserve / Profit and Loss Account.
6. Employee Benefits: Provision for gratuity pension benefits to staff have been made on an accrual casual
basis. Separate funds for gratuity / pension have been created.
7. Net Profit:
(a) The net profit disclosed in the Profit and Loss Account in after:
(i) provisions for taxes on income, in accordance with the statutory requirements.
(ii) Provisions for doubtful advances.
(iii) Adjustments to the value of “current investments” in government and other approved securities
in India, valued at lower of cost of market value.
(iv) Transfers to contingency funds.
(v) Other usual or necessary provisions.
(b) Contingency funds have teen grouped in the Balance Sheet under the head “Other Liabilities and
Provisions”.
Some Special Transactions Interest on Doubtful Debts when a debt is found to be doubtful at the end of the
accounting year, a question may arise whether the interest on that should be credited to interest Account or not.
There is no doubt that interest has accrued; but it is equally clear that the realization of this interest is doubtful.
Therefore, as prudent accounting policy, such interest should be transferred to Interest Suspense Account.
ADDITIONAL DISCLOSURES PRESCRIBED BY RBI
1. Provisions and Contingencies

To facilitate easy reading of the financial statements and to make the information on all Provisions and
Contingencies available at one place, banks are required to disclose in the ‘Notes to Accounts’ the following
information: (Amount in crore)
Current Year Previous Year

Break up of ‘Provisions and Contingencies’ shown under the head
Expenditure in Profit and Loss Account
Provisions for depreciation on Investment
Provision towards NPA

Provision made towards Income tax
Other Provision and Contingencies (with details)
2. Floating Provisions
Banks should make comprehensive disclosures on floating provisions in the ‘Notes to Accounts’ to the balance
sheet as follows:
(Amount in Rs. crore)
Particulars Current year Previous year
(a) Opening balance in the floating provisions account
(b) The quantum of floating provisions made in the accounting year
(c) Amount of draw down made during the accounting year
(d) Closing balance in the floating provisions account
Note: The purpose of draw down made during the accounting year may be mentioned
3. Draw Down from Reserves

Suitable disclosures are to be made regarding any draw down of reserves in the ‘Notes to Accounts’ to the
Balance Sheet.
4. Disclosure of Complaints
Banks are advised to disclose the following brief details along with their financial results.
A. Customer Complaints
Current year Previous year

(a) No. of complaints pending at beginning of the year
(b) No. of complaints received during the year
(c) No. of complaints redressed during the year
(d) No. of complaints pending at the end of the year
B. Awards passed by the Banking Ombudsman
(a) No. of unimplemented Awards at the beginning of the year
(b) No. of Awards passed by the Banking Ombudsmen during

the year
(c) No. of Awards implemented during the year
(d) No. of unimplemented Awards at the end of the year
It is clarified that banks should include all customer complaints pertaining to Automated Teller Machine (ATM)
cards issued by them in the disclosure format specified above. Where the card issuing bank can specifically
attribute ATM related customer complaints to the acquiring bank, the same may be clarified by way of a note
after including the same in the total number of complaints received.
5. Disclosure of Letters of Comfort (LoCs) issued by banks

Banks should disclose the full particulars of all the Letters of Comfort (LoCs) issued by them during the year,
including their assessed financial impact, as also their assessed cumulative financial obligations under the
LoCs issued by them in the past and outstanding, in its published financial statements, as part of the ‘Notes to
Accounts”.
6. Provisioning Coverage Ratio (PCR)

PCR (ratio of provisioning to gross non-performing assets) as at close of business for the current year and
previous year should be disclosed in the ‘Notes to Accounts’ to the Balance Sheet.
7. Insurance Business
The details of fees / brokerage earned in respect of insurance broking, agency and bancassurance business
undertaken by them should be disclosed in the ‘Notes to Accounts’ to their Balance Sheet. Disclosures should
be made for both the current year and previous year.
8. Concentration of Deposits, Advances, Exposures and NPAs

8.1 Concentration of Deposits
Total Deposits of twenty largest depositors
Percentage of Deposits of twenty largest depositors to Total
Deposits of the bank
8.2 Concentration of Advances*
Total Advances to twenty largest borrowers
Percentage of Advances to twenty largest borrowers to Total
Advances of the bank
*Advances should be computed as per definition of Credit Exposure including derivatives furnished in our
Master Circular on Exposure Norms.
8.3 Concentration of Exposures**
Total Exposure to twenty largest borrowers / customers
Percentage of Exposures to twenty largest borrowers / customers
to Total Exposure of the bank on borrowers / customers
**Exposures should be computed based on credit and investment exposure as prescribed in our Master
Circular on Exposure Norms.
8.4 Concentration of NPAs

Total Exposure to top four NPA accounts
9. Sector wise Advances

Sr. Sector* Current year Previous year
No.
Outstanding Gross Percentage Outstanding Gross Percentage
Total NPAs of Gross Total NPAs of Gross
Advances NPAs to Advances NPAs to
Total Total
Advances Advances
in that in that
sector sector
A Priority Sector
1 Agriculture and
allied activities
2 Advances to
industries
sector eligible a
s priority sector
lending
3 Services
4 Personal loans
Sub total (A)
B Non Priority
Sector
1 Agriculture and
allied activities
2 Industry
3 Services
4 Personal loans
Sub-total (B)
Total (A+B)
*Banks may also disclose in the format above, sub sectors where the outstanding advances exceeds 10 percent
of the outstanding total advances to that sector. For instance, if a bank’s outstanding advances to the mining
industry exceed 10 percent of the outstanding total advances to ‘Industry’ sector it should disclose details of its
outstanding advances to mining separately in the format above under the ‘Industry’ sector.
10. Movement of NPAs

Gross NPA as on April 1 of particular year (Opening Balance)
Additions (Fresh NPAs) during the year
Sub total (A)
Less:-
(i) Upgradations
(ii) Recoveries (excluding recoveries made from upgraded accounts)
(iii) Technical / Prudential Write offs
(iv) Write offs other than those under (iii) above
Sub-total (B)
Gross NPAs as on 31st March of following year (closing balance) (A-B)
* Further, banks should disclose the stock of technical write offs and the recoveries made thereon as per the
format below:
Opening balance of Technical / Prudential written off accounts as at April 1
Add: Technical / Prudential write offs during the Year
Sub total (A)
Less: Recoveries made from previously technical / prudential written off
accounts during the year (B)
Closing balance as at March 31 (A-B)
11. Overseas Assets, NPAs and Revenue

Total Assets
Total NPAs
Total Revenue
12. Off Balance Sheet SPVs Sponsored

(which are required to be consolidated as per accounting norms)
Name of the SPV sponsored
Domestic Overseas
13. Unamortised Pension and Gratuity Liabilities

Appropriate disclosures of the accounting policy followed in regard to amortization of pension and gratuity
expenditure may be made in ‘Notes to Accounts’ to the financial statements.
In addition, banks are required to include disclosures on the following as per formats provided by RBI.
Disclosures on Remuneration: Disclosures relating to Securitisation Credit Default Swaps Intra Group
Exposures Transfers to Depositor Education and Awareness Fund (DEAF) Unhedged Foreign Currency Exposure
Liquidity Coverage Ratio.
Further disclosures as per RBI directions are as follows:
• Disclosure in the “Notes to Accounts” to the Financial Statements - Divergence in the asset classification
and provisioning. In terms of RBI notifications RBI/2016-17/283 DBR.BP.BC.No.63/21.04.018/2016-
17 April 18, 2017 and RBI/2018-19/157 DBR.BP.BC.No.32/21.04.018/2018-19 April 1, 2019 banks
should disclose divergences, if either or both of the following conditions are satisfied: (a) the additional
provisioning for NPAs assessed by RBI exceeds 10 per cent of the reported profit before provisions and
contingencies for the reference period, and (b) the additional Gross NPAs identified by RBI exceed 15 per
cent of the published incremental Gross NPAs for the reference period.
• Disclosure on Exposure to Infrastructure Leasing & Financial Services Limited (ILFS) and its group entities
(V. In terms of National Company Law Appellate Tribunal’s (NCLAT) order dated February 25, 2019 in
respect of I.A No. 620 of 2019 in Company Appeal (AT) No. 346 of 2018, in terms of which “no financial
institution will declare the accounts of ‘Infrastructure Leasing & Financial Services Limited’ or its entities
as ‘NPA’ without prior permission of this Appellate Tribunal”.
Position as on .................. Rs. In Crores
Amount Outstanding Of (1) Total amount of Provisions required as Provisions actually
(1) exposures which are per IRAC norms held (4)
NPAs as per IRAC norms (3)
and not classified as NPA.
(2)
DISCLOSURES REQUIRED UNDER BASEL NORMS

In terms of Guidelines on Composition of Capital Disclosure Requirements issued vide circular DBOD. No. BP.
BC.98/21.06.201/2012-13 dated May 28, 2013, Pillar 3 disclosures as introduced under Basel III have become
effective from July 1, 2013. The first set of disclosures as required by these guidelines was to be made by banks
as on September 30, 2013 (with the exception of the Post March 31, 2017 template.).
RBI issued a notification on February 05, 2021 and said that due ongoing stress on account of COVID-19, it has
been decided to defer the implementation of Net Stable Funding Ratio (NSFR) guidelines by a further period of
six months. Accordingly, the NSFR Guidelines shall come into effect from October 1, 2021.
As per RBI’s Monetary policy dated February 28, 2021, the Reserve Bank has decided to defer the implementation
of the last tranche of the Capital Conservation Buffer (CCB) of 0.625 per cent from April 1, 2021 to October 1,
2021.
Scope and Frequency of Disclosures

1. Pillar III applies at the top consolidated level of the banking group to which the Capital Adequacy
Framework applies. Disclosures related to individual banks within the groups would not generally be
required to be made by the parent bank. An exception to this arises in the disclosure of capital ratios by the
top consolidated entity where an analysis of significant bank subsidiaries within the group is appropriate,
in order to recognise the need for these subsidiaries to comply with the Framework and other applicable
limitations on the transfer of funds or capital within the group. Pillar III disclosures will be required to be
made by the individual banks on a stand-alone basis when they are not the top consolidated entity in the
banking group.
2. Banks are required to make Pillar III disclosures at least on a half yearly basis, irrespective of whether
financial statements are audited, with the exception of following disclosures: (i) Capital Adequacy; (ii)
Credit Risk: General Disclosures for All Banks; and (iii) Credit Risk: Disclosures for Portfolios Subject to
the Standardised Approach. The disclosures as indicated at (i), (ii) and (iii) above will be made at least on
a quarterly basis by banks.
All disclosures must either be included in a bank’s published financial results / statements or, at a minimum,
must be disclosed on bank’s website. If a bank finds it operationally inconvenient to make these disclosures along
with published financial results / statements, the bank must provide in these financial results / statements, a
direct link to where the Pillar III disclosures can be found on the bank’s website. The Pillar III disclosures should
be made concurrent with publication of financial results / statements. That is to say Pillar III disclosures are
required to be made by all banks including those which are not listed on stock exchanges and / or not required
to publish financial results / statement. Therefore, such banks are also required to make Pillar III disclosures at
least on their websites within reasonable period.
Banks are required to update these disclosures concurrently whenever a new capital instrument is issued and
included in capital or whenever there is a redemption, conversion / write-down or other material change in the
nature of an existing capital instrument.
Banks have to maintain a ‘Regulatory Disclosures Section’ on their websites, where all the information
relating to disclosures will be made available to the market participants. The direct link to this page should be
prominently provided on the home page of a bank’s website and it should be easily accessible. This requirement
is essentially to ensure that the relevance / benefit of Pillar III disclosures is not diminished by the challenge
of finding the disclosure in the first place. An archive for at least three years of all templates relating to prior
reporting periods should be made available by banks on their websites.
In addition to the specific disclosure requirements as set out in the guidelines, banks operating in India should
also make additional disclosures in the following areas:
(i) Securitisation exposures in the trading book;
(ii) Sponsorship of off-balance sheet vehicles;
(iii) Valuation with regard to securitisation exposures; and
(iv) Pipeline and warehousing risks with regard to securitisation exposures.
In addition to the disclosure requirements set out in above paragraphs, banks are required to make the following
disclosure in respect of the composition of capital:
(i) Full Terms and Conditions: banks are required to make available on their web sites the full terms and
conditions of all instruments included in regulatory capital. The requirement for banks to make available
the full terms and conditions of instruments on their websites will allow supervisors and market
participants to investigate the specific features of individual capital instruments.
(ii) Banks are required to keep the terms and conditions of all capital instruments up-to-date Whenever there
is a change in the terms and conditions of a capital instrument, banks should update them promptly and
make publicly available such updated disclosure.
Banks listed on stock exchanges

Banks which have been listed in stock exchanges in India and abroad have to comply with terms of listing
agreement/ stock exchange rules under which they are listed including reporting and other compliances in a
timely manner failing which they would face penal action including fines.
Some terms used in Analysis of Bank Performance.
• Cash coverage ratio - (Cash divided by total business liabilities x 100). An upward trend indicates presence
of more of idle investments.
• Total business growth ratio - (business of the year divided by previous year business). Increasing trend is
desirable.
• Productivity indicators - (per employee Deposits / Advances / Profits) increasing trend shows improving
productivity.
• Business - (Aggregate Deposits plus aggregate advances), Increasing trend is healthy, shows growth.
• Interest income - the sum total of discount, interest from loans, advances, investments and balances with
other banks.
• Non-interest income - other income of the bank and includes commission, brokerage, gains on sales and
revaluation of investments and fixed assets, profits from exchange transactions etc.
• Interest spread - excess of total interest earned over total interest paid. It has strong influence on bank’s
bottom line.
• Working funds - they are total resources - total liabilities or total assets.
LESSON ROUND UP
• A Banking Company has to prepare it’s Financial Statements in specified formats under Banking
Regulation Act. These statements are required to be prepared in accordance with specific guidelines
issued by RBI and other authorities from the books of account maintained by banks, in which
transactions are accounted. In doing so banks have to comply with standard practices/procedures
prescribed.
• Banks have to maintain a ‘Regulatory Disclosures Section’ on their websites, where all the information
relating to disclosures will be made available to the market participants.
• Banks which have been listed in stock exchanges in India and abroad have to comply with terms of
listing agreement/stock exchange rules under which they are listed including reporting and other
compliances in a timely manner failing which they would face penal action including fines.
• Disclosures related to individual banks within the groups would not generally be required to be made
by the parent bank.
GLOSSARY
Ledgers A ledger is a book containing accounts in which the classified and summarized
information from the journals is posted as debits and credits.
Registers The word “register” can convey many different meanings, in the finance industry,
it usually refers to the process of inputting information into a record, or an official
list, that creates a document of various useful data in an organized fashion.
General Ledger A general ledger, or GL, is a means for keeping record of a company’s total
financial accounts. Accounts typically recorded in a general ledger include: assets,
liabilities, equity, expenses, and income or revenue.
Revenue Reserves Revenue reserve is created from the net profit generated from the company’s
core operations.
Divergence Divergence is when the price of an asset is moving in the opposite direction of
a technical indicator, such as an oscillator, or is moving contrary to other data.
Divergence warns that the current price trend may be weakening, and in some
cases may lead to the price changing direction.
Basel III Basel III is a 2009 international regulatory accord that introduced a set of reforms
designed to mitigate risk within the international banking sector, by requiring
banks to maintain proper leverage ratios and keep certain levels of reserve
capital on hand.
TEST YOURSELF
a. Section 29 to 34A of the _______________ Act deal with the accounts and audit of Banking Companies.
b. Banks enter transactions of customers first, in _______________ (which are subsidiary books under
conventional accounting) rather than in journals.
c. If customers fail to submit stock-statements by 10th of the month,_______________ will be levied
from the 1st of the current month as per agreed sanction terms.
d. When a borrower is unable to repay the amount of the loan in cash and as a substitute offers to the
bank an asset. This is known as a _______________.
e. Gold appears as a part of assets and appears under the head ‘investments’. Silver appears under
_______________.
f. Banks should disclose divergences for the reference period, if either or both, the additional
provisioning for NPAs assessed by RBI exceeds _______________ % of the reported profit before
provisions and contingencies, and the additional Gross NPAs identified by RBI exceed _______________
% of the published incremental Gross NPAs.
a. Copies of Annual Accounts, Balance sheet along with P& L Account prepared in accordance with
Section 29 of Banking Regulation Act, 1949 together with Auditor’s Report to be submitted to RBI
within six months from the end of the period to which they relate.
b. The general ledger is a summary of control accounts of various deposit, loan heads as well as
Profit and Loss.
c. Advances of a bank generally consist of (i) Bills purchased and discounted, (ii) Cash credits,
overdrafts and loans repayable on demand, (iii) Term loans
d. Rebate on bills represents the discount collected for unexpired period in advance.
e. Branch Adjustment Account is an account reflecting transactions between Head office and
branches and vice-versa. Also, it may take place between branches.
a. What are financial statements banking companies are required to compile and present?
b. Mention the principal books account and subsidiary books of account a banking company is
required to keep?
c. What are the contra entries passed by banks? Mention particulars of the same.
d. Mention at least five of the disclosures to be made by banks.
e. What are the significant accounting policies to be followed by banks? Write briefly about the
same.

• RBI Master circulars.
• Guidance note on Audit of Banks by ICAI.
• Stodging- Balance Sheet of Banks.
• The Banking Regulation Act, 1949.
Lesson 20 • Risk Management in Banks and Basel Accords 555
Lesson 20
Risk Management in Banks
and Basel Accords
Should Know
• Organizational understand: • Banking Regulation Act, 1949
Structure
• the concepts of simple,
• Liquidity Risk compound interest
• Market Risk • the concepts of annuities and
• Basel Accords sinking funds
• Countercyclical • the concept of risk in Banking
Buffer Industry
• Capital • the various types of risks that
Conservation impact the banking industry
• Liquidity • analyse and study management
Coverage Ratio and mitigation of risks
• Net Stable • apprise the learners about
Funding Ratio BASEL norms
• Liquidity
Coverage Ratio
Lesson Outline
• Introduction to Risk Management
• Credit Risk Management
• Liquidity and Market Risk Management
• Operational Risk Management
• Interest Rate Risk
• Reporting of Banking Risk
• Risk Adjusted Performance Evaluation
• Basel- I, II & III Accords
• LESSON ROUND UP
• GLOSSARY
• TEST YOURSELF
555
INTRODUCTION
In the assets’ portfolio of a bank, the investments of banks have significant impact after the funds involved
in loans and advances. The returns on investments are comparatively lower than the returns on loans and
advances.
Every organization faces risks in their operations. Banking organizations too are prone to risks which need to
be managed. Banks being financial sector organizations face risks - some originate within the organization and
some outside the organization. If these risks are not properly managed, they have potential to destabilize not
only a particular bank, but can create a system wide chaos. To manage these risks regulatory bodies have given
directions and guidelines which need to be followed and implemented as applicable in the respective cases of
each bank.
A student of banking therefore requires to be fully acquainted of this aspect of banking so that he/she remains
knowledgeable so as to safeguard the interests of the organization and its customers should he choose to join
banking later. Keeping this objective in mind the chapter covers areas of risks a bank faces and methods, tools to
handle the same as per prescriptions of regulatory authorities including Basel norms. In view of its importance
risk management has become a field of specialization for many professionals giving them a career path.
INTRODUCTION TO RISK MANAGEMENT

The Banking sector has a very important role in the development of an economy of any country. As one of the
key drivers of economic growth of a country, banking sector plays a pivotal role in making use of idle funds for
nation building. The foundation of a strong economy depends on how strong the Banking sector is and vice versa.
Banking is always considered to be a very risky business. In the context of Banking, ‘Risk’ can be defined as
the potential loss from a banking transaction - in the form of a loan, or investment in securities or any other
transaction that a bank undertakes for itself or for its customer. Banks are exposed to both, financial (e.g.,
monetary loss) as well as non-financial (e.g., reputation loss) risks. Basic function of any bank is to accept
funds from public for the purpose of lending and investment. In case something goes wrong, banks can collapse
and ‘failure of one bank is sufficient to send shock waves right through the economy.’ It is imperative that bank
managements must be very careful in identifying the types as well as the degrees of risk exposure and mitigate
them positively. Therefore, banks must recognise risk management as an ongoing and unavoidable activity with
the active participation of the Board of Directors.
In economic / financial / business activities risk is directly proportional to returns, higher the risk a bank takes,
it can expect to gain more profits. However, greater risk also increases the danger that the bank may incur big
losses and can be out of the business and perhaps out of existence. In fact, today, a bank must run its operations
with twin objectives in mind - generate profit and stay in business. However, banks must ensure that their risk
taking decisions are measured, informed and prudent.
Some Important Requirements

The following are some of the salient requirements in respect of risk management in banks.
• A comprehensive Risk Management Policy approved by the Board of Directors should be in place.
• A Training/Learning set up to inculcate and sensitize the risk management culture in the organization on
an ongoing basis.
• Information Technology department should be fully geared up for generating Management Information
System (‘MIS’). MIS plays a vital role in mitigation of risk.
• Strong internal control systems should be in place. Audit department of a Bank plays a significant role
in this.
Stages of Risk Management

1. Risk Identification
This is the first and the most important stage of risk management. The process starts with identifying the
risks. Risk identification originates from where the problem starts. Risk identification can be objective
based, scenario based, taxonomy based and common risk checking based. It will help the bank or any
organization to take the corrective measures.
2. Risk Analysis (Risk measurement or quantification)
It includes analysing the risk and measuring its vulnerability and impact on the organisation. Frequency
and severity of the risk can be analysed as well in this stage. Risk management can be both quantitative
as well as qualitative. Numerically determining the probabilities of various adverse events and expected
extent of losses if any unexpected event occurs, is termed as Quantitative Analysis whereas defining the
various threats, devising counter-measures for mitigation and determining the extent of vulnerabilities is
known as Qualitative Risk Analysis.
3. Risk Control (Risk mitigation)
Only after properly analyzing the risk, a bank can decide as to how it can be controlled. If the risk can be
controlled by in house efforts it is well and good; it can also seek professional help from outside. Risk
control is the entire process of procedures, systems, policies an organization needs to manage prudently
all risks which may arise.
4. Risk Transfer
If the risk is not manageable, one cannot retain that risk; then we have to transfer that risk to a third party.
This is the stage where insurance comes in to play. Insurance will be willing to take on those risks which
the organization can’t handle. But it should also be understood that insurance alone is not a solution or a
panacea for all risks.
5. Risk Review (Risk monitoring)
Risk review is the last stage in which all the foregoing steps are evaluated. Review must be regular and on
a continuous basis, as conditions and circumstances of the business as well as organizations are dynamic.
It should be monitored to see that the desired results of risk management are achieved. If not, then
identifying as to where the problem occurred and subsequently reviewing all stages and making changes
in the management of risk according to the scenario.
Types of Risks
Risks can be basically classified in to two types, viz., Financial and Non-Financial Risk. Financial risks would
involve all those aspects which deal mainly with financial aspects of the bank.
• Credit Risk: It is also called as a default risk (borrower not meeting his obligations to pay instalments
and or interest). It is prevalent in case of loans. A credit risk is the risk of default on a debt that may
arise from inability of a borrower to make required payments as per commitments. In the first resort, the
risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased
collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk
will be associated with higher borrowing costs. Because of this, measures of borrowing costs such as yield
spreads can be used to infer credit risk levels based on assessments by market participants. The recent
episodes of Nirav Modi, Vijay Mallya are the examples of Credit / Default risk.
• Market Risk: It is also called price risk. Market risk is the possibility of an investor experiencing losses
due to external factors that affect the overall performance of financial markets in which he or she is
involved. Market risk, also called “systematic risk,” cannot be eliminated through diversification, though
it can be hedged against. Sources of market risk include recessions, political turmoil, changes in interest
rates, natural disasters and terrorist attacks. The 2008 sub-prime crisis of US is an example in this regard.
The market risk arises due to adverse movement of value of the investments / trading portfolio during the
period when the specific securities are held by the bank. The price risk arises when investments are to be
sold before their maturity.
• Operational Risk: This risk arises due to failed internal processes, people, system, or from external
events. It includes number of risks such as - fraud, communication, documentation, competence, legal,
compliance etc. However, it will not include strategic risk or reputational risk. Operational risk is “the
risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal
processes, people and systems, or from external events (including legal risk), differ from the expected
losses”. This definition, adopted by the European Union Solvency II Directive for insurers, is a variation
from that adopted in the Basel II regulations for banks. In October 2014, the Basel Committee on Banking
Supervision proposed a revision to its operational risk capital framework that sets out a new standardized
approach to replace the basic indicator approach and the standardized approach for calculating operational
risk capital, it can also include other classes of risk, such as fraud, security, privacy protection, legal risks,
physical (e.g. infrastructure shutdown) or environmental risks. The study of operational risk is a broad
discipline, close to good management and quality management. The behaviour of staff of Punjab National
Bank, Fort Mumbai branch, in Nirav Modi’s case is an example in this regard.
• Strategic Risk: Strategic risks are those that arise from the fundamental / adverse decisions that directors
take concerning an organisation’s objectives / improper implementation of decisions. Essentially, strategic
risks are the risks of failing to achieve these business objectives.
• Reputation Risk: It arises from negative public opinion about a bank / financial institution. It may lead to
litigation, financial loss or decline in customer base.
• Liquidity Risk: A bank’s inability to meet its payment obligations as and when they are demanded is
known as Liquidity risk. Deposits of banks as liabilities and loans / advances as assets of the bank are the
prominent items in a bank’s balance sheet. Types of deposits held and the interest rates offered on them
on the one hand and types of loans and advances sanctioned and interest rates charged on them on the
other hand may not match. In view of this liquidity risk is encountered by the banks. It arises when bank
funds long term assets by short term liabilities.
• Political Risk: Political risk is the risk faced by investors, corporations, and governments due to political
decisions of Governments, events, or conditions. This will significantly affect the profitability of a business
or the expected value of an economic move. Political risk can be understood and managed with reasoned
anticipation and investment.
• Legal Risk: Legal risk is the risk of financial or reputational loss that can be caused to an organization
from lack of awareness or misunderstanding of, ambiguity in, or reckless indifference to, the way law
and regulation apply to a business, its relationships, processes, products and services. Some of the recent
examples in the Indian context are - the Auditors of Satyam Infotech Limited had to face legal risk due to a
reckless action of its personnel; Nestle India, faced the legal risk due to mislabelling over flavour enhancer
MSG in Maggi Noodles produced by them.
CREDIT RISK MANAGEMENT

In recent years the banking industry, globally as well as locally, has been affected by developments that have
highlighted the need to identify more sophisticated methods in Credit Risk Management and monitoring. These
developments have demonstrated that the process of risk management has assumed enormous importance, in
particular about the credit risk for banks.
For measurement of Credit Risk, RBI suggested banks to implement Internal Rating Based (IRB) approach from
April 1, 2012.
Forms of Credit Risks

Credit risk may take the following forms:
• In the case of direct lending: Non payment of principal / and or interest amount.
• In the case of guarantees or letters of credit: Not meeting financial commitments by constituents on
crystallization of these contingent liabilities.
• In the case of treasury operations: Default or cessation in payment or series of payments that have
fallen due from the counter parties under respective contracts.
• In the case of securities trading businesses: Non settlement of funds/ securities.
• In the case of cross-border exposure: Embargo or restrictions of free transfer of foreign currency funds
imposed by foreign governments. (Sovereigns).
Taking Measures for Credit Risk Management
(a) Policy and Strategy

The Board of Directors of every bank is responsible for approving and periodically reviewing the credit
risk strategy and significant credit risk policies.
i. Credit Risk Policy
• Every bank should have their Board of Directors’ (‘Board’) approved credit risk policy document.
The document should include risk identification, risk measurement, risk grading / aggregation
techniques, reporting and risk control / mitigation techniques, documentation, legal issues and
management of problem loans.
• Such credit risk policies should also define target markets, criteria for risk acceptance, credit
approval authority, credit origination / maintenance procedures and guidelines for portfolio
management.
• Board approved credit risk policies should be communicated to branches/controlling offices.
All operating officials should clearly understand the bank’s approach for credit sanction and
should be held accountable for complying with established policies and procedures. Senior
management of a bank shall be responsible for implementing such credit risk policy/policies.
ii. Credit Risk Strategy

• Each bank should develop, its own credit risk strategy or plan that establishes objectives, that
guide the bank’s credit-dispensing activities and adopt necessary policies/ procedures for
conducting such activities with the approval of its Board. This strategy should identify and
articulate clearly the organisation’s credit appetite and the acceptable level of risk-reward
trade-off for its activities.
• Such strategy should include a statement of the bank’s willingness to grant loans based on the
type of economic activity, geographical location, currency, market, maturity and anticipated
profitability. This would essentially result in identification of target markets and business
sectors, preferred levels of diversification and concentration, the cost of capital in granting
credit and the cost of bad debts.
• The credit risk strategy should provide continuity in approach. It should also take into account
cyclical aspects of the economy and attendant shifts in the composition / quality of the overall
credit portfolio. This strategy should be viable through various credit cycles on a long term
basis.
• Senior management of a bank will be responsible for implementing the credit risk strategy
approved by the Board.
(b) Organisational Structure
For a successful implementation of an effective credit risk management system, in a bank, a sound
organizational structure is a pre-requisite. The organizational structure should have the following basic
features:
• The Board should have the overall responsibility for management of risks.
• The Board should decide the risk management policy of the bank and set limits for liquidity, interest
rate, foreign exchange and equity price risks.
In terms of RBI’s directions every bank should have a Risk Management Committee (RMC) comprising
select directors as members. It will be a Board level sub-committee including CEO and heads of Credit,
Market and Operational Risk Management Committees. It will formulate the policy and strategy for
integrated risk management containing various risk exposures of the bank including the credit risk.
For this purpose, RMC should effectively coordinate between the Credit Risk Management Committee
(CRMC), the Asset Liability Management Committee (‘ALCO’) and other risk committees of the bank, if
any. It is imperative that the independence of this RMC is preserved and the Board should, ensure that
it is not compromised at any cost. In the event of the Board not accepting any recommendation of this
Committee, there should be proper systems in place to spell out the rationale for such an action and the
same properly documented. This document should be made available to the internal and external auditors
for their scrutiny and comments. The credit risk strategy and policies adopted by the committee should be
effectively communicated throughout the bank.
Each bank may, depending upon the size of the organization or loan/ investment portfolios, constitute a
high level Credit Risk Management Committee (CRMC). The Committee should be headed by the Chairman
/ CEO / ED, and should comprise of heads of Credit Department, Treasury, Credit Risk Management
Department (CRMD) and the Chief Economist. The scope and functions of the Credit Risk Management
Committee should be as spelt out below:
• Implement of the credit risk policy / strategy approved by the Board on a bank-wide basis.
• Monitor credit risk on a bank-wide basis and ensure compliance with limits approved by the Board.
• Recommend to the Board, clear policies on standards for presentation of credit/loan proposals,
financial covenants, rating standards and benchmarks for its approval.
• Decide delegation of credit approval powers, prudential limits on large credit exposures, standards
for loan collateral, portfolio management, loan review mechanism, risk concentrations, risk
monitoring and evaluation, pricing of loans, provisioning, regulatory/legal compliance, etc.
Summary of RBI directive on appointing Chief Risk Officer (CRO)

As part of risk management, banks are required, inter-alia, to have a system of separation of credit risk
management function from the credit sanction process. As banks follow diverse practices in this regard, to bring
uniformity in approach followed by banks and to align the risk management system with the best practices,
banks are advised as under:
a. Each bank to lay down a Board-approved policy clearly defining the role and responsibilities of the CRO.
b. Appointment of the CRO shall be for a fixed tenure with the approval of the Board of Directors. The CRO
may be transferred / removed from his post before completion of the tenure only with the approval of the
Board and such premature transfer/removal shall be reported to the Department of Banking Supervision,
RBI, Mumbai. In case of listed banks, any change in incumbency of CRO shall be reported to the stock
exchanges also.
c. CRO should be a senior official in the banks’ hierarchy and shall have the necessary and adequate
professional qualification/experience in the areas of risk management.
d. The CRO shall have direct reporting lines to the MD & CEO / Risk Management Committee (RMC) of the
Board. If the CRO reports to the MD & CEO, the RMC shall meet the CRO on one-to-one basis, without the
presence of the MD & CEO, at least every quarter.
e. The CRO not to have any reporting relationship with the business verticals of the bank and not be given
any business targets.
f. In case the CRO is associated with the credit sanction process, it has to be clearly spelt out whether the
CRO’s role would be that of an adviser or a decision maker. The policy to include the necessary safeguards
to ensure the independence of the CRO.
g. In banks that follow committee approach in credit sanction process for high value proposals, if the CRO
is one of the decision makers in the credit sanction process, he shall have voting power and all members
who are part of the credit sanction process, shall individually and severally be liable for all the aspects,
including risk perspective related to the credit proposal. If the CRO is not a part of the credit sanction
process, his role will be limited to that of an adviser.
h. In banks which do not follow committee approach for sanction of high value credits, the CRO can only be
an adviser in the sanction process and with no sanctioning power.
i. The CRO in his role as an adviser shall be an invitee to the credit sanction / approval committee without
any voting rights in the proceedings of the Committee.
j. There shall not be any ‘dual hatting’, i.e., the CRO shall not be given the responsibility of Chief Executive
Officer, Chief Operating Officer, Chief Financial Officer, Chief of the Internal Audit function or any other
function.
Operations / Systems
For a proper risk management, banks should have the following processes in place for credit administration,
credit risk measurement and monitoring. The process of credit administration essentially involves the following
phases:
• Relationship management phase, i.e., business development.
• Transaction management phase covering risk assessment, loan pricing, structuring facilities, internal
approvals / sanctions, documentation, loan administration, on going monitoring and risk measurement.
• Portfolio management phase involves monitoring of the portfolio at a macro level and the management of
problem loans.
Under the broad management framework stated above, banks should have the following credit risk measurement
and monitoring procedures:
• Proactive credit risk management practices like annual / half yearly industry studies and individual
payment (obligor) reviews, periodic credit calls that are documented, periodic visits of plant and business
site, and at least quarterly management reviews of troubled exposures / weak credits.
• A robust system of checks and balances in place for extension of credit viz.: o Separation of credit risk
management and credit sanction.
¡ Multiple credit approvers making financial sanction subject to approvals at various stages viz., credit
ratings, risk approvals, credit approval grid, etc.
¡ An independent audit and risk review function.
• The level of authority required to approve credit will increase as amounts and transaction risks increase
and as risk ratings worsen.
• Assigned/Specific risk rating for every borrower (obligor) and credit facility.
• Mechanism to price facilities linked to the risk grading of the customer, and to attribute accurately the
associated risk weightings to the facilities.
• Consistent standards for the origination, documentation and maintenance for extensions of credit.
• Consistent approach towards early problem recognition, the classification of problem exposures, and
remedial action.
• Maintain a diversified portfolio of risk assets; have a system to conduct regular portfolio analysis to ensure
ongoing control of risk concentrations.
• Obligor and concentration limits by industry or geography. Proper Board authorization for efficient and
effective credit approval processes for operating within the approval limits.
• Accurate, comprehensive and timely reporting of set of risk data to ensure transparency of risks taken,
into the independent risk system.
• Systems and procedures for monitoring financial performance of customers and for controlling outstanding
within limits.
• A conservative policy for provisioning in respect of non-performing advances may be adopted.
• A clear, well-documented scheme of delegation of powers for credit sanction.
Successful credit management requires experience, judgement and commitment to technical development. A
sound MIS, which should enable them to manage and measure the credit risk inherent in all on and off balance
sheet activities. The MIS should provide adequate information on the composition of the credit portfolio,
including identification of any concentration of risk. Pricing of loans should be linked to the risk profile of the
borrower and risks associated with loans.
Credit Risk Models

A credit risk model tries to determine, directly or indirectly, the answer to the following question:
Given our past experience and our assumptions about the future, what is the present value of a given loan or
fixed income security?
A credit risk model would also seek to determine the (quantifiable) risk that the promised cash flows will not
be forthcoming. Techniques for measuring credit risk that have evolved over the last twenty years are prompted
by these questions and dynamic changes in the loan market.
The increasing importance of credit risk modelling can be attributed to the following three factors: ·
1. Banks are becoming increasingly quantitative in their treatment of credit risk.
2. New markets are emerging in credit derivatives and the marketability of existing loans is increasing
through securitisation / loan sales market.
3. Regulators are concerned to improve the current system of bank capital requirements especially as it
relates to credit risk.
Credit Risk Models have assumed importance due to the fact that they provide the decision maker with insight
or knowledge that would not otherwise be readily available or that could be obtained at a high cost. In a
marketplace where margins are fast disappearing and the pressure to lower pricing is unrelenting, models give
their users a competitive edge. Credit risk models are intended to assist banks in quantifying, aggregating and
managing risk across geographical and product lines. The outputs of these models also play significant roles
in banks’ risk management and performance measurement processes, customer profitability analysis, risk
based pricing, active portfolio management and capital structure decisions. Credit risk modelling may lead to
better internal risk management and may have the potential to be used in the supervisory oversight of banking
organisations.
In the measurement of credit risk, models may be classified along three different dimensions: the techniques
employed, the domain of applications in the credit process and the products to which they are applied.
Techniques of Credit Risk Measurement

The following are the more commonly used techniques-
(a) Econometric Techniques such as linear and multiple discriminant analysis, multiple regression, logic
analysis and probability of default, etc.
(b) Neural networks are computer-based systems that use the same data employed in the econometric
techniques but arrive at the decision model using alternative implementations of a trial and error method.
(c) Optimisation models are mathematical programming techniques that discover the optimum weights for
borrower and loan attributes that minimize lender error and maximise profits.
(d) Rule-based or expert systems are characterised by a set of decision rules, a knowledge base consisting
of data such as industry financial ratios, and a structured inquiry process to be used by the analyst in
obtaining the data on a particular borrower.
(e) Hybrid Systems - In these systems simulations are driven in part by a direct causal relationship, the
parameters of which are determined through estimation techniques.
Type of Risks in Banking Business

The major risks in the banking business as commonly referred can be broadly classified into:
• Liquidity Risk
• Interest Rate Risk
• Market Risk
• Credit or Default Risk
• Operational Risk
1. Liquidity Risk
Liquidity is capacity of a bank to fund, increase in assets as well as meet both expected and unexpected
cash and collateral obligations at reasonable cost, at the same time without incurring unacceptable losses.
Liquidity risk is the inability of a bank to meet such obligations as they become due, without adversely
affecting the bank’s financial condition. Liquidity risk management helps a bank to meet its obligations
as they fall due and reduces the probability of an adverse situation developing. This assumes significance
due to the fact that liquidity crisis, even at a single institution, can have systemic implications or cascading
effect.
Traditionally, liquidity has been defined as the capacity of financial institutions to finance increases in their
assets and comply with their liabilities as these mature. Bank liquidity has two distinct but interrelated
dimensions: liability (or cash) liquidity, which refers to the ability to obtain funding from the market
and asset (or market) liquidity, associated with the possibility of selling the assets. Both concepts are
interrelated, and the interaction between them tends towards their mutual reinforcement.
However, under adverse conditions this dependency tends to weaken market liquidity because
adverse circumstances that affect one dimension can rapidly be transferred to the other. Under normal
circumstances liquidity management is basically a cost-benefit trade off because a financial institution
will be able to obtain funding provided it is willing to pay the prevailing market prices, or has the choice
of selling or committing its assets. In like manner a bank can store a stock of liquid assets to ensure
some liquidity (liquidity warehousing), although at the expense of smaller returns. However, in the event
of a crisis specific to a bank, its access to liquidity may be found to be severely restricted because its
counterparties may be unwilling to provide it neither with funds, not even providing collateral nor in
exchange for high rates. In a systemic liquidity crisis it may even be impossible for the bank to place its
assets on the market.
The liquidity risk in banks manifest in different dimensions -
(a) Funding Risk: Funding Liquidity Risk is defined as the inability to obtain funds to meet cash flow
obligations. For banks, funding liquidity risk is crucial. This arises from the need to replace net out
flow due to unanticipated withdrawal/ non-renewal of deposits (wholesale and retail).
(b) Time Risk: Time risk arises from the need to compensate for non-receipt of expected inflow of
funds, i.e., performing assets turning into non-performing assets.
(c) Call Risk: Call risk arises due to the crystallisation of contingent liabilities. It may also arise when a
bank may not be able to undertake profitable business opportunities when it arises.
Liquidity Risk Management
The liquidity risk of banks arises from funding of long-term assets by short-term liabilities, thereby
making the liabilities subject to rollover or refinancing risk.
For example, banks accept deposits for a maximum period of 10 years whereas they advance Housing
Loans for 20 or 30 years.
Liquidity risk is usually of an individual nature, but in certain situations may compromise the liquidity of the
financial system. In totality, it is about a situation that is very dependent on the individual characteristics of
each financial institution; defining the liquidity policy is the primary responsibility of each bank, in terms
of the way it operates and its specialization. Bank Deposits generally have a much shorter contractual
maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit
withdrawals. Liquidity is the ability to efficiently accommodate deposit as also reduction in liabilities and
to fund the loan growth and possible funding of the off-balance sheet claims. The cash flows are placed in
different time buckets based on future likely behaviour of assets, liabilities and off-balance sheet items.
The liquidity risk is closely linked to other dimensions of the financial structure of the financial institution,
like the interest rate and market risks, its profitability, and solvency etc. The interest rate risk that results
from mismatches of maturities or the dates for interest rate adjustments may appear as either market
or refinancing (and/or reinvestment) risk. Also, as it operates to transform maturities, subject to these
risks, the bank collects a yield that is related to its profitability. Having a larger amount of liquid assets or
improving the matching of asset and liability flows reduces the liquidity risk, but also its profitability. This
relationship also operates in the opposite direction as explained below. Loans in an irregular situation will
impact jointly on profitability and liquidity, as the expected cash flows do not appear. In addition, there is
a relationship with solvency - more capital reduces liquidity creation, but allows for more strength to face
financial crises.
Liquidity risk can be further segmented into funding liquidity risk and asset liquidity risk. Asset liquidity
risk means incurring a loss due to inability to affect a transaction at current market prices due to either
relative position size or a temporary drying up of markets. Having to sell in such circumstances can
result in significant losses. Funding liquidity risk means risk of incurring loss if an institution is unable
to meet its cash needs. This can create various problems, such as failure to meet margin calls or capital
withdrawal requests, comply with collateral requirements or achieve rollover of debt. These problems
may force an institution to liquidate assets; in such a case, asset liquidity and funding liquidity risks may
combine if the institution is forced to sell illiquid assets at fire- between falling prices (resulting in margin
calls) and additional rounds of forced selling. In the case of asset liquidity risk, it can be managed through
controlling concentrations and relative market sizes of portfolios. Similarly funding liquidity risk can be
managed through diversification, securing credit lines or other back-up funding, and limiting cash flow
gaps. In such a situation, if portfolio leverage is high, the forced selling may create a positive feedback loop
between falling prices (resulting in margin calls) and additional rounds of forced selling.
Risk Management Architecture
RISK MANAGEMENT ARCHITECURES FOLLOWED BY BANKS

At the apex level, there is the Supervisory Committee of Directors on Risk Management, which is a Board
level Committee and oversees the Risk Management functioning of the Bank. This followed by the Executive
level Committees such as Asset Liability Management Committee (ALCO) for Market Risk, Credit Risk
Management Committee for Credit Risk and Operational Risk Management Committee for Operational
Risk function at the Bank. These Committees meet regularly to supervise and monitor the risks in
various areas on an ongoing basis. Some Banks have appointed Consultants for advising and assisting the
Management in implementing the Risk Management Systems and making them Basel compliant. The shift
from transaction based supervision to Risk based Supervision was necessitated due to the complexity of
modern times. The most important of the risks viz., Credit Risk, Market Risks (Interest Rate Risk, Foreign
Exchange Risk and Liquidity Risk), Operational risk (People Risk, Control Risk, IT Risk, Legal / Regulatory
Risk and Reputational Risk) need skillful planning and careful handling by the Banks.
The Supervisory mechanism too needs to upgrade their skills for prompt detection of the failure of the Risk
Management systems. RBI has been directing the banks on setting up proper Risk Management Systems in
Banks. It is to the credit of the Indian Regulatory Agencies like the RBI, Securities Exchange Board of India
(SEBI) and the Insurance Regulatory and Development Authority (IRDA) that the Indian Financial System
remained comparatively unscathed despite the catastrophic failures of the financial systems elsewhere in
the world.
Liquidity risk management in banks is defined as the risk of being unable either to meet their obligations
to depositors or to fund increases in assets as they fall due without incurring unacceptable costs or
losses. This risk occurs when the depositors collectively decide to withdraw more funds than the bank
immediately has on hand, or when the borrowers fail to meet their financial obligation to the banks. In
other words, liquidity risk occurs in two cases.
Firstly, it arises symmetrically to the borrowers in their relationship with the banks, for example when the
banks decide to terminate the loans but the borrowers cannot afford it. Secondly, it arises in the context
of the banks’ relationships with their depositors, for example, when the depositors decide to redeem
their deposits but the banks cannot afford it. In practice, the banks regularly find imbalances (gaps)
between the asset and the liability side that need to be equalized because, by nature, banks accept liquid
liabilities but invest in illiquid. If a bank fails to balance such a gap, liquidity risk might occur, followed by
some undesirable consequences such as insolvency risk, government bailout risk, and reputation risk.
The failure or inefficiency of liquidity management is caused by the strength of liquidity pressure, the
preparation of a bank’s liquid instruments, the bank’s condition at the time of liquidity pressure, and the
inability of the bank to find internal or external liquid sources.
Liquidity risk can be managed by putting in place certain prudential limits to avoid liquidity crisis:
1. Cap on inter-bank borrowings, especially call borrowings;
2. Purchased funds vis-à-vis liquid assets;
3. Core deposits vis-à-vis Core Assets, i.e., Cash Reserve Ratio, Liquidity Reserve Ratio and Loans;
4. Duration of liabilities and investment portfolio;
5. Maximum Cumulative Outflows. Banks should fix cumulative mismatches across all time bands;
6. Commitment Ratio - track the total commitments given to Corporates/banks and other financial
institutions to limit the off-balance sheet exposure;
7. Swapped Funds Ratio, i.e., extent of Indian Rupees raised out of foreign currency.
The Reserve Bank of India on February 17, 2021 issued guidelines on Capital and provisioning
requirements for exposures to entities with Unhedged Foreign Currency Exposure. These
guidelines mandate that information on Unhedged Foreign Currency Exposure (UFCE) may be
obtained by banks from entities on a quarterly basis, on self-certification basis, and preferably
should be internally audited by the entity concerned.
Accordingly, it has been decided by the RBI that if banks are unable in obtaining UFCE
certificates from listed entities for the latest quarter due to restrictions on disclosure of such
information prior to finalisation of accounts then such cases, banks may use data pertaining to
the immediate preceding quarter for computing capital and provisioning requirements in case
of Unhedged Foreign Currency Exposures.
2. Interest Rate Risk

Interest Rate Risk arises when the Net Interest Margin or the Market Value of Equity (MVE) of an institution
is affected due to changes in the interest rates. IRR can be viewed in two ways - its impact is on the earnings
of the bank or its impact on the economic value of the bank’s assets, liabilities and Off-Balance Sheet (OBS)
positions. Interest rate Risk can take different forms.
3. Market Risk
The risk of adverse deviations of the mark-to-market value of the trading portfolio, due to market
movements, during the period required to liquidate the transactions is termed as Market Risk. This risk
results from adverse movements in the level or volatility of the market prices of interest rate instruments,
equities, commodities, and currencies. It is also referred to as Price Risk.
Market Risk Management
Market risk is the risk of price fluctuation of a financial instrument, as a result of market price changes,
irrespective of whether these changes are caused by factors typical for individual instruments or their
issuer (counterparty), or by factors pertaining to all the instruments traded on the market.
The four most common factors connected with market risk are
1. Interest rates;
2. Currency exchange rates;
3. Costs of investments in trade portfolio (regardless of the instruments’ character - debt or capital);
4. Prices of exchange commodities and other market variables related to the bank’s activity.
The market risk pertaining to both individual and portfolio instruments can be a function of one or more
or mix of all these factors, and in many cases, it can be very complex inter-play of all these factors. In
general, market risk can be defined as a risk arising from market movements - of prices, interest rates
and currency exchange rates. The policy for market risk control and management should be aligned to
several objectives as below:
• to protect the bank against unexpected losses and to maintain income stability via independent
identification, assessment and understanding of business market risks;
• to contribute in bringing the bank’s organizational structure and management process in line with
the best international practices and to set minimum standards for market risks control;
• to create transparent, objective and consistent information system of the market risks as a base for
reasonable decision-making;
• to establish a structure that will help the bank to realize the connection between the business
strategy and the operations on one hand, and between the purposes of risk control and monitoring,
on the other.
The admissible threshold of market risk is the amount of potential unexpected loss which the bank is willing
to assume because of unexpected and unfavourable changes in the market factors without damaging its
financial stability. The bank’s ability to counter losses caused by market risk depends on its capital and
reserves, on the potential losses originating from other non-market risks and on the regulatory capital
required for maintaining the business activity. Risk monitoring is fundamental for effective management
process. That is the reason why the banking institutions should have adequate internal reporting systems
reflecting their exposure to market risk. Sufficiently detailed regular reports should be submitted to the
top management and to the various management levels.
Types of Market Risk

1. Interest rate risk
Interest rate risk is the probability that variations in the interest rates will have a negative influence
on the quality of a given financial instrument or portfolio, as well as on the institution’s condition as
a whole. Assuming that risk is a normal aspect of the bank’s activity, it can be an important source of
profit and share value. However, excessive interest rate risk can significantly jeopardize the bank’s
income streams and capital base. Variations in the interest rates influence the bank’s incomes and
change its net interest revenues and the level of other interest-sensitive earnings and operative costs.
Interest rate variations also affect the basic value of the bank’s assets, liabilities and off-balance
instruments, because the present value of the future cash flows (and in some cases the cash flows
themselves) alters when interest rates change. Interest rates variations can also influence the level
of credit risk and the ability to retain the attracted resources. The effective interest risk management
keeps risk within reasonable limits is of vital importance for bank stability.
2. Currency risk
Currency risk is the risk where the fair value or future cash flows of a given financial instrument
fluctuate as a result from changes in the currency exchange rates. Currency exchange rates can be
subject to big and unexpected changes, and understanding and managing of the risk related to the
currency exchange rates’ volatility can be very complicated. Although it is important to acknowledge
that currency exchange rates are definitely a market risk factor, the currency instruments’ valuation
usually requires knowledge about the behaviour of both spot currency exchange rates and interest
rates. Each forward premium or value discount of a given foreign currency against the local one is
determined to a great extent by the relative interest rates on the two national markets. Like all market
risks, the currency risk evolves from both open and improperly balanced or hedged positions. The
imperfect correlations between the currencies and the international interest markets put forward
concrete challenges to the efficiency of the hedging currency strategies.
3. Price risk
Price risk occurs when the fair value or future cash flows of capital and debt financial instruments
(stocks, bonds, indexes and derivatives connected with them) fluctuate as a result from market prices’
changes, no matter whether these changes are caused by factors typical for individual instruments
or for their issuer (counter party), or by factors related to all the instruments traded on the market.
The risk connected with the commodity exchange prices is the probability of unfavourable changes
in the value of commodities traded by the bank. Price risks associated with commodities differ
significantly from interest rate and currency risks, and require careful monitoring and management
as most of the commodities are traded on markets where the supply concentration can increase the
price volatility. What is more, changes in the market liquidity are often accompanied by significant
price volatility. It is because of this commodities’ prices are in broad lines more unstable than those
of most financial assets commonly traded. The risk assessment associated with commodities prices
should be performed market by market and it should include not only analysis of historical price
movements, but also assessment of the supply and demand structure on the market, so that the
probability for unusually large price movements can be assessed.
4. Default or Credit Risk
Credit risk is more simply defined as the potential of a bank borrower or counterparty to fail to meet its
obligations in accordance with the agreed terms. For most banks, loans are the largest and most obvious
source of credit risk. It is the most significant risk, more so in the Indian scenario where the NPA level of
the banking system is significantly high.
Now, let’s discuss the two variants of credit risk -
Counterparty Risk: This is a variant of Credit risk and is related to non-performance of the trading
(a)
partners due to counterparty’s refusal and or inability to perform. The counterparty risk is generally
viewed as a transient financial risk associated with trading rather than standard credit risk.
Country Risk: This is also a type of credit risk where non-performance of a borrower or counter party
(b)
arises due to constraints or restrictions imposed by a country. Here, the reason of non-performance
is external factors on which the borrower or the counter party has no control. Credit Risk depends
on both external and internal factors.
The internal factors include Deficiency in credit policy and administration of loan portfolio, Deficiency in
appraising borrower’s financial position prior to lending, Excessive dependence on collaterals and Bank’s
failure in post sanction follow-up, etc.
The major external factors are the state of Economy, Swings in commodity price, foreign exchange rates
and interest rates, etc.
Credit Risk can’t be avoided but can be mitigated by applying various risk-mitigating processes - Banks
should assess the credit-worthiness of the borrower before sanctioning loan, i.e., the Credit rating of the
borrower should be done beforehand. Credit rating is the main tool for measuring credit risk and it also
facilitates pricing the loan.
By applying a regular evaluation and rating system of all investment opportunities, banks can reduce its
credit risk as it can get vital information of the inherent weaknesses of the account.
Banks should fix prudential limits on various aspects of credit - benchmarking Current Ratio, Debt-Equity
Ratio, Debt Service Coverage Ratio, Profitability Ratio etc.
There should be maximum limit exposure for single / group borrower.
There should be provision for flexibility to allow variations for very special circumstances.
Alertness on the part of operating staff at all stages of credit dispensation - appraisal, disbursement,
review/ renewal, post-sanction follow-up can also be useful for avoiding credit risk.
5. Operational Risk Management

What is operational risk?
It is the risk of loss resulting from inadequate or failed internal processes of an organization, in human
actions, systems or due to external events. Authors on the subject agree that problems related to
operational risks arise because of inadequate attention given to the processes and systems, or because
people fail in their performance, or their functions are poorly clarified. Operational risks are difficult to
define because of the broad spectrum of potential loss events, it covers. According to the segment where
the company acts, this may be subject to various operational risks inherent to the business.
Definition of operational risk has evolved rapidly over the past few years. Operational risk has been
defined by the Basel Committee on Banking Supervision as the risk of loss resulting from inadequate
or failed internal processes, people and systems or from external events. This definition includes legal
risk, but excludes strategic and reputational risk. This definition is based on the underlying causes of
operational risk.
It seeks to identify why a loss happened and at the broadest level includes the breakdown by four causes:
people, processes, systems and external factors.
Likely forms of manifestation of operational risk
A clear appreciation and understanding by banks of what is meant by operational risk is critical to the
effective management and control of this risk category. It is also important to consider the full range of
material operational risks facing the bank and capture all significant causes of severe operational losses.
Operational risk is pervasive, complex and dynamic. Unlike market and credit risk, which tend to be in
specific areas of business, operational risk encompasses in all business processes. It is also inherent in all
operations. It may manifest in a variety of ways in the banking industry. The examples of operational risks
listed at paragraph above can be considered as illustrative.
The Basel Committee has identified the following types of operational risk events as having the potential
to result in substantial losses:
• Internal fraud. Examples - Intentional misreporting of positions, employee theft, and insider trading
on an employee’s own account.
• External fraud. Examples - Robbery, forgery, cheque kiting, and damage from computer hacking.
• Employment practices and workplace safety. Examples - Workers compensation claims, violation
of employee health and safety rules, organised labour activities, discrimination claims, and general
liability.
• Clients, products and business practices. Examples - Fiduciary breaches, misuse of confidential
customer information, improper trading activities on the bank’s account, money laundering, and
sale of unauthorised products.
• Damage to physical assets. Examples - Terrorism, vandalism, earthquakes, fires and floods.
• Business disruption and system failures. Examples - Computer hardware and software failures,
telecommunication problems, and utility outages.
• Execution, delivery and process management. Examples - Data entry errors, collateral management
failures, incomplete legal documentation, and unauthorized access given to client accounts, non-
client counterparty under performance/non-performance and vendor disputes.
Monitoring of Operational Risk
• An effective monitoring process is essential for adequately managing operational risk. Regular
monitoring activities can offer the advantage of quick detection and correction of deficiencies in the
policies, processes and procedures for managing operational risk. Promptly detecting and addressing
these deficiencies can substantially reduce the potential frequency and/or severity of a loss event.
• In addition to monitoring operational loss events, banks should identify appropriate indicators that
provide early warning of an increased risk of future losses. Such indicators (often referred to as early
warning indicators) should be forward-looking and could reflect potential sources of operational
risk such as rapid growth, introduction of new products, employee turnover, transaction breaks,
system downtime, and so on.
• When thresholds are directly linked to these indicators, an effective monitoring process can help
identify key material risks in a transparent manner and enable the bank to act upon these risks
appropriately.
Other Risks
Apart from the above-mentioned risks, following are the other risks confronted by Banks in the course of
their business operations -
(a) Strategic Risk: Strategic Risk is the risk arising from adverse business decisions, improper
implementation of decisions or lack of responsiveness to industry changes.
(b) Reputation Risk: Reputation Risk is the risk arising from negative public opinion. This risk may
expose the institution to litigation, financial loss or decline in customer base.
(c) Systematic Risk: It is a risk inherent to the entire market segment and is not sector specific it is also
known as undiversifiable risk.
(d) Unsystematic Risk: It is kind of specific risk which comes with the industry you invest in also referred
to as diversifiable risk.
Risk Management is actually a combination of management of uncertainty, risk, equivocality and error.
Uncertainty - where the outcomes cannot be estimated even randomly, uncertainty arises due to lack of
information and this uncertainty gets transformed into risk (where the estimation of outcome is possible)
as information gathering progresses.
Initially, the Indian banks have used risk control systems that kept pace with legal environment and Indian
accounting standards. But with the growing pace of deregulation and associated changes in the customer’s
behaviour, banks are exposed to mark-to-market accounting.
Therefore, the challenge of Indian banks is to establish a coherent framework for measuring and managing
risk consistent with corporate goals and responsive to the developments in the market. As the market
is dynamic, banks should maintain vigil on the convergence of regulatory frameworks in the country,
changes in the International accounting standards and finally and most importantly changes in the clients’
business practices.
ROLE OF RBI IN RISK MANAGEMENT IN BANKS

Here, we will discuss the role of RBI in Risk Management and how the tools called CAMELS was used by RBI to
evaluate the financial soundness of the Banks. CAMELS is the collective tool of six components namely
Ratings are given from 1 (best) to 5 (worst) point scale of A to E in each of the above categories. Each of these
components is weighed on a scale of 1 to 100 and contains several sub parameters with individual weightages.
A - basically sound in every respect.
B - Fundamentally sound but with moderate weakness.
C - Financial, operational, compliance weaknesses that give cause for supervisory concern.
D - Serious finance, operational and managerial weaknesses that could impair future viability.
E - Critical financial weaknesses that render the possibility of failure high in near future.
In India, for supervision (inspection) of banks an extended framework is used which is names - C A M E L S
C where the alphabets C A M E L stand for what is mentioned above but S means System (like Management
Information System - MIS) and C mean Compliance to various rules, regulations Acts etc.
The CAMEL was recommended for the financial soundness of a bank in 1988 while the sixth component called
sensitivity to market risk (S) was added to CAMEL in 1997.
In India, the focus of the statutory regulation of commercial banks by RBI until the early 1990s was mainly
on licensing, administration of minimum capital requirements, pricing of services including administration of
interest rates on deposits as well as credit, reserves and liquid asset requirements.
RBI in 1999 recognised the need for an appropriate risk management and issued guidelines to banks regarding
assets liability management, management of credit, market and operational risks. The entire supervisory
mechanism has been realigned since 1994 under the directions of a newly constituted Board for Financial
Supervision (BFS), which functions under the aegis of the RBI, to suit the demanding needs of a strong and
stable financial system. A process of rating of banks on the basis of CAMELS in respect of Indian banks and CACS
(Capital, Asset Quality, Compliance and Systems & Control) in respect of foreign banks has been put in place
from 1999.
Reporting of Banking Risk

The frequency of monitoring should reflect the risks involved and the frequency and nature of changes in
the operating environment. Monitoring should be an integral part of a bank’s activities. The results of these
monitoring activities should be included in regular management and Board reports, as should compliance
reviews performed by the internal audit and / or risk management functions. Reports generated by (and/or
for) intermediate supervisory authorities may also inform the corporate monitoring unit which should likewise
be reported internally to senior management and the Board, where appropriate. Senior management should
receive regular reports from appropriate areas such as business units, group functions, the operational risk
management unit and internal audit.
The operational risk reports should contain internal financial, operational, and compliance data, as well as
external market information about events and conditions that are relevant to decision making. Reports should
be sent to appropriate levels of management and to areas of the bank on which areas of concern may have
an impact. Reports should fully reflect any identified problem areas and should motivate timely corrective
action on outstanding issues. To ensure the usefulness and reliability of these risk reports and audit reports,
management should regularly verify the timeliness, accuracy, and relevance of reporting systems and internal
controls in general. Management may also use reports prepared by external sources (auditors, supervisors) to
assess the usefulness and reliability of internal reports. Reports should be analysed with a view to improving
existing risk management performance as well as developing new risk management policies, procedures and
practices.
Management Information Systems

Banks should implement a process to regularly monitor operational risk profiles and material exposures to
losses. There should be regular reporting of pertinent information to senior management and the Board of
Directors that supports the proactive management of operational risk. In general, the Board of Directors should
receive sufficient higher-level information to enable them to understand the bank’s overall operational risk
profile and focus on the material and strategic implications for the business. Towards this end it would be
relevant to identify all activities and all loss events in a bank under well defined business lines.
RISK-ADJUSTED PERFORMANCE MEASUREMENT

Risk-adjusted performance Measurement consists of a set of concepts. Those concepts may vary in detail
depending on the context they are used in. However, all risk adjusted performance measures have one thing
in common: they compare the return on capital to the risk taken to earn this return - i.e., some kind of risk
adjustment is adopted.
Generally speaking, return in risk-adjusted performance measures is measured either by absolute returns or by
relative returns (i.e., excess returns), whereas disagreement prevails in literature on how exactly risk should be
taken into account. This has given rise to the development of a considerable number of alternative risk adjusted
performance measures. Thus, risk-adjusted performance measures can take many forms as shall be shown in
the following chapters. In the past, risk-adjusted performance measures have gained great importance. The
first reason for this development is the emergence of investment funds as an important investment category.
Investors needed an effective tool to evaluate the respective performance of the various funds compared to the
risk taken by the fund managers to choose the right option for capital allocation.
The second reason is the introduction of the Basel II regulatory framework, which requires financial institutions
to hold a certain amount of equity as a cushion against unexpected losses for each risky position taken. As
a result financial institutions have a great interest in efficiently allocating capital not only according to the
resulting return but also to the risk shouldered.
BASEL I, II AND III ACCORDS
Basel I
Since late 1970s, internationally several banks had experienced deterioration in their asset quality. More than
75% of IMF member countries were among them. Since assets have a direct linkage with profitability levels, the
banking sector stability started suffering. In short credit risk was the trigger of the stability problems of banks.
This in turn led to the question of stability and survival of banks. This problem engaged the attention of Bank of
International Settlements (BIS) an apex body of Central banks in the world. A series of deliberations led to The
Basel Capital Accord in 1988 proposed by Basel Committee of Bank Supervision (BCBS) which is a part of BIS.
The deliberation of BCBS focused on credit risk and prescribed a minimum Capital Risk Adjusted Ratio (CRAR)
of 8% of risk weighted assets. Although it was originally meant for banks in G10 countries, it was adopted by
more than 100 countries. This accord was known as Basel I, named after the town in Switzerland where BIS is
based. As was expected Basel I covered the credit risk and its standards prescribed minimum capital in terms of
risk weighted assets. It can be said the focus of Basel I was on capital and risk weighted assets.
India being a member of BIS since its inception, RBI had prescribed capital adequacy norms for the Indian
banks in 1992. It was also the year in which NPA norms were introduced in India. Banks were asked to identify
their Tier I and Tier-II capital and assign risk weights to the assets followed by an assessment of their Capital to
Risk Weighted Assets Ratio (CRAR).
According to Basel 1 norms Capital (known as regulatory capital) is derived as a sum of Tier I and Tier II capital
which a bank is required to maintain in relation to its risk-weighted assets. Under both Basel I (also later under
Basel II), the regulatory definition of capital is comprised of three levels (or ‘tiers’) of capital. Tier 1 Capital (also
called ‘core capital’) has only those elements which have the highest capacity for absorbing losses on an ongoing
basis. Tier 2 Capital (also known as ‘supplementary capital’) is made up a mix of near equity components and
hybrid capital / debt instruments, the total of which is restricted to 100 per cent of Tier 1 Capital. It is further
divided into two categories: (i) Upper Tier 2 consisting of items very close to common equity, like perpetual
subordinated debt; (ii) Lower Tier 2 consisting of items close to debt. It also includes various types of reserves
whose values and/or availability are more uncertain than disclosed reserves. Tier 3 Capital (or ‘additional
supplementary capital’) was added in 1996 and can only be used to meet capital requirements for market risk.
Tier-I Capital of banks in India consisted of
• Paid-up capital
• Statutory Reserves
• Disclosed free reserves
• Capital reserves representing surplus arising out of sale proceeds of assets [Equity investments in
subsidiaries, intangible assets and losses in the current period and those brought forward from previous
periods will be deducted from Tier I capital].
Elements of Additional Tier-I (AT-I) Capital (after making regulatory adjustments / deductions from total of 1
to 4 below)
1. PNCPS (Perpetual Non-Cumulative Preference Shares) which comply with regulatory requirements.
2. Share premium resulting from issue of instruments.
3. Debt Capital instruments, complying with regulatory requirements.
4. Any other instruments as notified by RBI.
Tier-II Capital
• Undisclosed Reserves and Cumulative Perpetual Preference Shares
• Revaluation Reserves
• General Provisions and Loss Reserves
Risk weighting
Additionally BCBS Committee recommended a weighted risk ratio in which capital is linked with different
categories of asset or off-balance-sheet exposure. The weighs were according to perceived broad categories of
relative risk of each asset class as the preferred method for assessing the capital adequacy.
The risk weighted approach was chosen over simple gearing ratio approach due to “(i) it provides a fairer basis
for making international comparisons between banking systems whose structures may differ; (ii) it allows
off-balance-sheet exposures to be incorporated more easily into the measure; (iii) it does not deter banks from
holding liquid or other assets which carry low risk.”
Advantages and Disadvantages of Basel I norm

Basel 1 norms had their advantages as well as disadvantages. Advantages were discipline in managing capital,
level playing field in competition among peer banks and the structure was simple. However, these norms had
certain weaknesses also such as it had considered only credit risk/market risks (though there are many other
risks a bank faces); market values were ignored in preference to book values; made no differentiation between
different classes of debtors among others. These were addressed by an amendment in 1996 and the amended
norms were brought for implementation.
The 1988 accord was amended in 1996. Under this frame work BCBS by removing trading positions in bonds,
equities, foreign exchange and commodities from the credit risk framework and gave capital charges related
to the bank’s open position for each. Essentially this introduced the element of market risk as a factor to be
considered for arriving at capital adequacy standards. The main purpose was to ensure “more level playing
field” by ensuring banks build business volume with adequate capital.
Basel II
In June 2004, BCBS announced a revised frame work of capital adequacy norms titled as “International
Convergence of Capital Measurement and Capital Standards: A revised Framework”- commonly known as Basel
II Accord. Basel II took cognizance of, Operational Risk apart from Credit & Market Risk in computing Capital
Adequacy Ratio.
In essence Basel II accord is based on the following norms. They are known as three Pillars structure as depicted
in the following table:
Pillar I Pillar II Pillar III

Minimum Regulatory Capital Supervisory Review Process Market Discipline
• Credit Risk
• Market Risk
• Operational Risk
Pillar 1: Minimum Regulatory Capital

The calculation of Minimum Regulatory Capital included operational risk also apart from Credit risk and Market
risk. Basel 1 and Basel II differed in Risk Weighted Assets calculation.
Under Basel 2, calculation of Capital to Risk (Weighted) Asset Ratio (CRAR), the formulae are similar to Basel 1.
BCBS had recommended at least 8% CRAR and 4% for Tier 1 CRAR signifying core capital should be at least
50% of total CRAR. However, in India RBI stipulated a stringent higher level of overall CRAR of 9% and Tier 1
CRAR of 6%.
It can be seen that CRAR is supported by 1. Eligible Capital Funds (Core capital) 2. Risk Weighted Assets
(Additional or Supporting) capital.
The components that formed Tier 1 & Tier 2 capital of banks are as follows:
Tier I Capital items Tier II Capital items

1. Paid up Capital, Statutory Reserves, disclosed 1. Revaluation Reserve (at a discount of 55%)
free reserves
2. Capital Reserve (E.g., Surplus from sales of 2. General Provision & Loss Reserves
assets)
3. Eligible Innovative Perpetual Debt Instruments 3. Hybrid Debt Capital Instruments: E.g., Perpetual
(IPDI)- up to 15% of Tier 1 Capital Cumulative Preference Shares, Redeemable
Non-Cumulative Preference Share, Redeemable
Cumulative Preference Share
4. Perpetual Non-Cumulative Preference Shares 4. Subordinate Debt: fully paid up, unsecured,
(PNPS) - 3 & 4 can be max 40% of Tier 1 subordinated to other creditors, free of
restrictive clauses
5. Remaining IPDI & PNPS from Tier 1 Capital (i.e.,
Surplus)
Risk Weighted Assets

Another Important dimension in calculation of CRAR is Risk weighted assets. Basel II seems to give an advantage
for banks with better asset quality as it reduces capital requirements which in turn results assigning of lesser
weights. In this regard RBI has suggested options for arriving at risk weighted assets. These are as follows:
Risks Approaches Credit Risk Market Risk Operational Risk

1* Standardised Approach Standardized Approach Basic Indicator Approach
Internal Model Approach
2** Foundation Internal Advanced Internal Rating Standardized Approach
Rating Based Approach Based Approach
3*** Advanced Internal – Advanced Measurement
Rating Based Approach Approach
* Represents Simple method,
** Intermediate method,
*** Sophisticated & Advanced method.
Credit Risk Assessment: Under Basel II BCBS had devised three
approaches for calculation of credit risk weighted assets:
1. Standardized Approach to Credit Risk: The standardized approach has fixed risk weights which
vary from 0 to 150%, corresponding to various risk categories based on ratings of approved external
credit rating agencies. Loans which are unrated carry 100% risk weight. This approach has widened
risk sensitivity by taking in to account a broad range of collateral, guarantees and credit derivatives. The
residential mortgage exposure carries a lesser risk weight vis-a -vis Basel I.
2. Foundation Internal Rating Based Approach: Credit risk under this approach is based on internal
ratings of a bank instead of external credit rating agencies. The ratings correspond to risk characteristics
of borrower and the transaction. Expected loss arrived at based on Probability of Default (PD) of borrower,
Loss Given Default (LGD), Bank’s Exposure at Default (EAD) and remaining Maturity (M) of exposure.
• Probability of Default is a measure of (PD) the likelihood
that a borrowers default over a time horizon.
• Loss Given Default (LGD) computes the proportion

On January 27, 2021, RBI has issued
of the exposure that will be lost if Default occurs.
notification regarding Prudential
• Exposure at Default (EAD) gives an estimate of Guidelines on Capital Adequacy
loan amount outstanding at the time of default. and Market Discipline - New Capital
• Maturity (M) measures the remaining economic Adequacy Framework (NCAF) - Eligible
maturity of the exposure. Credit Rating Agencies - CRISIL Ratings
Limited, according to the notification
Parameters PD, LGD, EAD and are useful in calculating
CRISIL Limited has been accredited for
types of losses.
the purpose of risk weighting the banks’
Types of losses can be classified in to two categories claims for capital adequacy purposes
- Expected loss and Unexpected loss. Expected Loss along with other credit rating agencies
(PL), is a normal business risk of a bank, can be found by (CRAs) registered with Securities and
multiplying PD, LGD, EAD and M. Exchange Board of India (SEBI). The rating
Expected Loss (EL)= PD X LGD X EAD X M business of CRISIL Limited has since been
transferred to CRISIL Ratings Limited.
Unexpected Loss (UL) is an inherent part of credit risk
for which pricing cannot be done and therefore banks Banks are advised to use the ratings of the
are required to provide capital for the same through risk CRISIL Ratings Limited for the purpose
weighing their assets. Unexpected Loss is an upward of risk weighting their claims for capital
variable of expected loss over a specified time horizon. adequacy purposes. The rating-risk
It can be calculated using the formula as under: UL = EL weight mapping for the long term and
x LGD x Standard Deviation of PD. short-term ratings assigned by CRISIL
Ratings Limited will be the same as was
• In Foundation IRB (‘FIRB’), PD can be calculated
in the case of CRISIL Limited and there is
and the remaining are based on values set by Basel
no change in the rating symbols earlier
Committee or RBI (in India).
assigned by CRISIL Limited.
3. Advanced Internal Rating Based Approach: It is an improved version of FIRB. Under this LGD, EAD, M
are estimated based on historical data by the bank itself.
• Assessment of Operational Risk
Operational risk is a risk of loss that can occur “from inadequate or failed internal control processes,
people, systems or from external events”. As defined by BIS, “it is the risk of loss arising from the
potential that inadequate information system; technology failures, breaches in internal controls,
fraud, unforeseen catastrophes, or other operational problems may result in unexpected losses or
reputation problems”
The Basel II specifies three methods of calculation of risk weighted assets which are:
(i) the Basic Indicator Approach (BIA);
(ii) the Standardized Approach (TSA); and
(iii) Advanced Measurement Approaches (AMA).
These are explained briefly as under:
1. Basic Indicator Approach (BIA): Under this method a fixed percentage of average previous
three years annual gross income, is held as a capital for operational risk. If there is loss in a
particular year which is under consideration, it should be excluded from calculation (both in
the numerator and denominator) when calculating the average. It is designated as Alpha.
2. (i) The Standardized Approach (TSA): Under this approach banks’ activities are divided into
eight business segments: corporate finance, trading & sales, retail banking, commercial
banking, payment & settlement, agency services, asset management, and retail brokerage.
The capital charge required for each business segment is calculated by multiplying gross
income by a factor (denoted beta-? as 12, 15 and 18) assigned to that segment. The sum of
gross income of all business line should be equal to gross income of the bank.
Alternative Standardized Approach (ASA): This is a variation of TSA. Method of
(ii)
computing capital charge is same as in TSA excepting for two segments - retail &
commercial banking. For these business segments loans and advances, they are multiplied
by a separate fixed factor ‘m’ - replaces gross income as the exposure indicator. The betas
for retail and commercial banking are same as in TSA.
3. Advanced Measurement Approach (‘AMA’): Under this approach the regulatory capital
requirement equals the risk measure generated by the bank’s internal Operational Risk
Measurement System (ORMS). After satisfying these criteria the required operational risk
capital charge is derived from the unexpected loss of Value at Risk (VaR) at the 99.9 percent
confidence level, across a one year time horizon subject to the expected loss is taken care
through provisions.
Basel III
In December 2010 Basel III guidelines were released by BCBS, in the aftermath of global financial crisis triggered
by sub-prime crisis of the United States. It will not be an exaggeration to say that the sub-prime crisis was the
trigger point for announcement of Basel III guidelines.
Objectives:
a. To improve banking sector’s ability to absorb shocks arising from financial and economic stress.
b. To reduce the risk of spill over from the financial sector to the real economy.
Scope:
The banks are to comply with the capital adequacy ratio (CAR) requirements at two levels - (a) the consolidated
level CAR requirements - after consolidating the assets and liabilities of it’s subsidiaries, except those engaged
in insurance and other non-financial activities and (b) CAR requirements as standalone.
Basel III framework is based on 3 components called 3 pillars as under:
Pillar 1 - Minimum capital standards. Pillar 2 - Supervisory review.
Pillar 3 - Market discipline.
Pillar 1 Minimum Capital Standards :

(i) Tier 1 capital (going concern capital) - Common Equity Tier 1 and Additional Tier 1
(ii) Tier 2 capital (gone concern capital)
The problems had their origin in banks of developed countries which were under-capitalised, over-leveraged
and relied excessively on short term funding through markets. It also came to the attention that “quantity
and quality” of capital under Basel II were found to be insufficient to withstand such crisis. In short, Basel III
norms were “the response of BCBS to improve banking sector ability to absorb shocks arising from financial
and economic stress, whatever be the source, thus reducing the risk of spill over from financial sector to real
economy”.
Basel III norms focus on making most of banking activities, including trading book activities” more capital
intensive”. With this in view, these norms focus on four vital banking parameters viz., Capital, Leverage, Funding
and Liquidity.
Features of the Basel III Accord:

1. Enhanced Capital Requirement
Tier 1 Capital requirements: Scheduled commercial banks (excluding LABs and RRBs) operating in India
shall maintain a minimum total capital (MTC) of 9% of total risk weighted assets (RWAs) i.e., capital to
risk weighted assets (CRAR). This will be further divided into different components. Common Equity Tier
1 (CET1) capital must be at least 5.5% of RWAs i.e., for credit risk + market risk + operational risk on an
ongoing basis. Tier 1 capital must be at least 7% of RWAs on an ongoing basis. Thus, within the minimum
Tier 1 capital, Additional Tier 1 capital can be admitted maximum at 1.5% of RWAs. Total Capital (Tier 1
Capital plus Tier 2 Capital) must be at least 9% of RWAs on an ongoing basis. Thus, within the minimum
CRAR of 9%, Tier 2 capital can be admitted maximum up to 2%.
If a bank has complied with the minimum Common Equity Tier 1 and Tier 1 capital ratios, then the excess
Additional Tier 1 capital can be admitted for compliance with the minimum CRAR of 9% of RWAs. In
addition to the minimum Common Equity Tier 1 capital of 5.5% of RWAs, banks are also required to
maintain a capital conservation buff (CCB) of 2.5% on September 30, 2020 of RWAs in the form of Common
Equity Tier 1 capital. Thus, with full implementation of capital ratios and CCB the capital requirements are
summarised as follows:
SI. No. Regulatory Capital As % to

RWAs
1 Minimum Common Equity Tier 1 Ratio 5.5%

2 Capital Conservation Buffer (comprised of Common Equity) 2.5%
3 Minimum Common Equity Tier 1 Ratio plus Capital Conservation Buffer [(1) + (2)] 8%
4 Additional Tier 1 Capital 1.5%
5 Minimum Tier 1 Capital Ratio [(1) + (4)] 7%
6 Tier 2 Capital 2%
7 Minimum Total Capital Ratio (MTC) [(5) + (6)] 9%
8 Minimum Total Capital Ratio plus Capital Conservation Buffer [(7) + (2)] 11.5%
Accordingly, under revised guidelines (Basel III), minimum total regulatory capital will consist of the sum
of the following categories:
(i) Tier 1 Capital (going-concern capital)
(a) Common Equity Tier 1 capital
(b) Additional Tier 1 capital
(ii) Tier 2 Capital (gone-concern capital)
2. Introduction of a Capital Conservation Buffer:
The Capital Conservation Buffer is an additional reserve buffer of 2.5% to “withstand future periods of
stress”, bringing the total Tier 1 Capital reserves required to 7%. This buffer is introduced to meet one
of the four key objectives identified by the Committee in the December 2009 Consultative Document
“Strengthening the resilience of the banking sector”; conserve enough capital to build buffers at individual
banks and the entire banking sector which can then be used in times of stress.
RBI has given minimum capital conservation standards for a bank as per the table below:
Minimum Capital Conservation Standards
Common Equity Tier 1 Ratio after including the Minimum Capital Conservation Ratios
current periods retained earnings (expressed as a percentage of earnings)
5.5% - 6.125% 100%
>6.125% - 6.75% 80%
>6.75% - 7.375% 60%
>7.375% - 8.0% 40%
>8.0% 0
If a bank has complied with the minimum Common Equity Tier 1 and Tier 1 capital ratios, then the excess
Additional Tier 1 capital can be considered for compliance with the minimum CRAR of 9% of RWAs. In
addition to the minimum Common Equity Tier 1 capital of 5.5% of RWAs, banks are also required to
maintain a capital conservation buffer (CCB) of 2.5% of RWAs in the form of Common Equity Tier 1 capital.
RBI has vide it’s circular RBI/2018-19/106 DBR.BP.BC.No.20/21.06.201/2018-19 dt. January 10, 2019
has decided to defer the implementation of the last tranche of 0.625% of Capital Conservation Buffer
(CCB) from March 31, 2019 to March 31, 2020 - now deferred to September 30, 2020 which is again
deferred to April 1, 2021 vide RBI’s Circular dated Sept. 29, 2020. However, considering the ongoing stress
of COVID, vide RBI’s Circular dated Feb 5, 2021 the implementation CCB has been deferred till Oct 1,
2021. Accordingly, minimum capital conservation ratios as applicable from March 31, 2018 will also apply
from March 31, 2019 till the CCB attains the level of 2.5% on March 31, 2020, now revised to apply from
April 1, 2021 which is again scheduled to apply from October 1, 2021. Further the pre-specified trigger
for loss absorption through conversion / write-down of Additional Tier 1 instruments (PNCPS and PDI)
shall remain at 5.5% of RWAs and will rise to 6.125% of RWAs on March 31, 2020; now as per revision,
on September 30, 2020 (vide RBI Circular - RBI/2019-20/ 188 DOR.BP.BC.No. 45/21.06.201/2019-20).
This is again deferred to April 1, 2021 vide RBI Circular dated September 29, 2020. Further in view of
continuing stress on account of COVID 19, RBI has again postponed the rise of trigger for loss absorption
to October 1, 2021.
3. Counter Cyclical Buffer: As per Basel III norms country regulators of banks are also responsible for
regulating credit volume in their national economies. Banks should build up a buffer of capital in good
times to be used to maintain flow of credit in difficult times. Banks operating in India shall be maintaining
CCCB on a solo / consolidated basis. If credit growth is rapidly expanding than GDP growth, bank regulators
can increase their capital requirements with the help of the Countercyclical Buffer to curb the excessive
credit growth. The counter cyclical buffer suggested varies between 0% - 2.5% and it is meant to restrict
excess credit growth which may turn out to be counter- productive. The aim of the Countercyclical Capital
Buffer (CCCB) regime is two fold. Firstly, it requires banks to build up a buffer of capital in good times
which may be used to maintain flow of credit to the real sector in difficult times. Secondly, it achieves
the broader macro-prudential goal of restricting the banking sector from indiscriminate lending in the
periods of excess credit growth that have often been associated with the building up of system-wide risk.
Utilisation of Floating Provisions/Counter Cyclical Provisioning Buffer

On May 05, 2021, RBI has announced that in order to mitigate the adverse impact of COVID 19 related
stress on banks, as a measure to enable capital conservation, it has been decided to allow banks to
utilise 100 per cent of floating provisions / countercyclical provisioning buffer held by them as on
December 31, 2020 for making specific provisions for non-performing assets with prior approval of
their Boards. Such utilisation is permitted with immediate effect and upto March 31, 2022.
4. Leverage Ratio: It is defined as Ratio of Tier 1 Capital to Total Assets. According to Basel III this ratio
should be a minimum of at least 3% even where there is no risk weighting. According to Basel III rules
BCBS agreed to test minimum Tier 1 leverage ratio of 3% during the parallel run period by 2017. This was
also made applicable for banks in India. During the period of parallel run, banks should strive to maintain
their existing level of leverage ratio but, in no case the leverage ratio should fall below 4.5%. A bank whose
leverage ratio is below 4.5% may endeavour to bring it above 4.5% as early as possible. According to the
data released by RBI, most of the banks are maintaining leverage ratio of over 4.5%.
5. Liquidity Risk Measurement: Basel III has introduced a new instrument for liquidity risk measurement
- Liquidity Coverage Ratio (LCR). The objective behind this is to make banks maintain an adequate level
of unencumbered, high-quality assets that can be converted into cash to meet its liquidity needs for a
30-day time horizon under an acute liquidity stress scenario specified by central banks of the respective
countries. The standard requires that the ratio be no lower than 100%. According to RBI by 2019 March
banks in India should reach a LCR of 100%.
At present the assets allowed as Level 1 High Quality Liquid Assets (HQLAs) for the purpose of computing
the LCR of banks, inter alia, include (a) Government securities in excess of the minimum SLR requirement
and, (b) within the mandatory SLR requirement, Government securities to the extent allowed by RBI
under (i) Marginal Standing Facility (MSF) [presently 2 per cent of the bank’s NDTL] and (ii) Facility to
Avail Liquidity for Liquidity Coverage Ratio (FALLCR) [presently 13 per cent of the bank’s NDTL]. RBI has
decided to permit banks to reckon an additional 2.0 percent Government securities held by them under
FALLCR within the mandatory SLR requirement as Level 1 HQLA for the purpose of computing LCR, in a
phased manner, as under:
Effective date FALLCR (per cent of NDTL) Total HQLA carve out from SLR
(per cent of NDTL)
April 4, 2019 13.50 15.50

August 1, 2019 14.00 16.00
December 1, 2019 14.50 16.50
April 1, 2020 15.00 17.00
For the purpose of LCR, banks are required to value such government securities reckoned as HQLA at an
amount not greater than their current market value (irrespective of the category under which the security
is held, i.e., HTM, AFS or HFT).
To meet their commitments under investment banking inventories, off-balance sheet items, securitization
deals, and such other assets and activities bank should have a minimum amount of stable liabilities in
relation to their liquidity risk profiles Basel III proposed Net Funding Stability Ratio (NFSR). It is defined
as the ratio, for a bank, of its “available amount of stable funding” divided by its “required amount of stable
funding”. The standard requires that the ratio be no lower than 100%.
Given that SLR has now been reduced to 18% of NDTL from April 11, 2020 and with increase in MSF from
2 % to 3% of NDTL (from March 27, 2020 and applicable up to June 30, 2020 entire SLR eligible assets
held by banks are now permitted to be reckoned as HLAs for meeting LCR.
Banks are permitted to maintain LCR as under:
From date of circular to September 30, 2020 80%

October 1, 2020 to March 31, 2021 90%
April 1, 2021 onwards - 100%
(RBI/2019-20/217 DOR.BP.BC.No.65/21.04.098/2019-20)
Transition Phase for the Liquidity Standards under Basel III: Both the LCR and NSFR were introduced
as on 1 January, 2015. Though RBI had instructed banks to comply with LCR and NSFR by January 1,
2019, through it’s circular RBI/2018-19/84 DBR.BP.BC.No.08/21.04.098/2018-19 November 29, 2018
it has indicated that the NSFR guidelines will come into effect from April 1, 2020. On a review it has
now been decided to defer the implementation of NSFR guidelines by six months. These guidelines were
expected to come into effect from October 1, 2020 as against April 1, 2020*. (RBI/2019-20/187. DOR.
BP.BC.No.46/21.04.098/2019-20.
*Note: On February 05, 2021 RBI has said that in view of the ongoing stress on account of COVID-19,
it has been decided to defer the implementation of NSFR guidelines by a further period of six months.
Accordingly, the NSFR Guidelines shall come into effect from October 1, 2021.
LESSON ROUND UP
A risk is indispensable for banking business, proper assessment of risk is an integral part of a bank’s risk
management system. Banks are focusing on the magnitude of their risk exposure and formulating strategies
to tackle those effectively. In the context of risk management practices, the introduction of Basel II norms and
its subsequent adoption by RBI is a significant measure that promises to promote sound risk management
practices. BASEL II seeks to enhance the risk sensitivity of capital requirements, promote a comprehensive
coverage of risks, offer a more flexible approach through a menu of options, and is intended to be applied to
banks worldwide. Moreover, the RBI has adopted a series of steps to ensure that individual banks tackle risks
effectively by setting up risk management cells and also through internal assessment of their risk exposure.
Apart from this, RBI has opted for on-site and off-site surveillance methods for effective risk management in
the Indian Banking sector, so that systemic risk and financial turmoil can be averted in the country.
GLOSSARY
Organizational An organizational structure is a system that outlines how certain activities are directed
Structure in order to achieve the goals of an organization. These activities can include rules, roles,
and responsibilities.
Liquidity Risk Liquidity risk is the inability of a bank to meet such obligations as they become due,
without adversely affecting the bank’s financial condition.
Market Risk Market risk is the risk of price fluctuation of a financial instrument, as a result of market
price changes, irrespective of whether these changes are caused by factors typical for
individual instruments or their issuer (counterparty), or by factors pertaining to all the
instruments traded on the market.
Liquidity The Liquidity Coverage Ratio (LCR) refers to the proportion of highly liquid assets held
Coverage Ratio by financial institutions, to ensure their ongoing ability to meet short-term obligations.
This ratio is essentially a generic stress test that aims to anticipate market-wide shocks
and make sure that financial institutions possess suitable capital preservation, to ride
out any short-term liquidity disruptions, that may plague the market.
Net Stable The net stable funding ratio is a liquidity standard requiring banks to hold enough
Funding Ratio stable funding to cover the duration of their long-term assets.
TEST YOURSELF
a. Risk ___________ includes analysing the risk and measuring its vulnerability and its impact on the
organisation.
b. ___________ risk is the risk of default on a debt that may arise from a borrower failing to make
required payments.
c. The liquidity risk of banks arises from funding of ___________ by ___________, thereby making the
liabilities subject to rollover or refinancing risk.
d. ___________ of each bank shall be responsible for approving and periodically reviewing the credit
risk strategy and significant credit risk policies.
e. A bank must hold equity capital to at least a fixed per cent (___________ per cent) of its risk-weighted
credit exposures as well as capital to cover market risks in the bank’s trading account.
a. Every Bank should have a Board of Directors approved comprehensive Risk Management Policy.
b. Market risk is experiencing losses due to external factors that affect the overall performance of
financial markets.
c. The liquidity risk of banks arises from funding of long-term assets by short-term liabilities.
d. Currency risk is a market risk.
e. Under Basel 1 norms Capital is derived as a sum of Tier I and Tier II capital which a bank is
required to maintain in relation to its risk-weighted assets.
a. Discuss briefly stages of Risk Management.
b. Discuss briefly different types of risks a bank faces.
c. What is Liquidity Risk? How it is managed?
d. How operational risks are measured?
e. What are the features of Basel III accord?

• Operational risk management in Financial Institutions- researchgate.net
• Guidance note on management of operational risk- RBI
• Guidance note on credit risk management, RBI.
• AIMA Journal of Management & Research, May 2013, volume 7, issue 2/4.
Lesson 21 • Audits in Banks 587
Lesson 21 Audits in Banks

Should Know
• Audit understand: • Reserve Bank of India, 1934
• LFAR • Different types of Audit in Banks. • Banking Regulation Act, 1949
• RBIA • Understanding legal framework
for Bank Audit.
• Why is Concurrent Audit
necessary?
• Credit Audit and its importance.
• How risk based supervision is
ensured by banks?
• How IS Audit is performed?
• How Government and other
authorities regulate audit in
banks?
Lesson Outline
• Introduction • Audit of Financial Statements of
• Auditing and Features of Audit Bank
• Principles of Internal Audit • Long Form Audit Form (LFAR)
• Risk Based Internal Audit • Special Audit
• Credit Audit • Stock & Receivables Audit
• Information System Audit • Forensic Audit
(overview) • Revenue Audit
• Computer assisted Audit Tools & • TEST YOURSELF
Techniques (CAATTs) • OTHER REFERENCES
• Concurrent Audit
Note: This Lesson has been given to Students for Information Purpose only.
587
LESSON OVERVIEW
INTRODUCTION
Banks play an important role in any financial system by virtue of the significant role they play in spurring
economic growth by undertaking maturity transformation and supporting the critical payment systems. The
specificity of banks, the volatility of financial markets, increased competition and diversification, however,
expose banks to risks and challenges. The protection of depositors’ interests and ensuring financial stability
are two of the major drivers for putting in place an effective system of supervision of banks.
Credibility of an institution, particularly that of financial institution depends on its internal control and
supervision mechanism which can promptly detect irregularities, if any, and take corrective measures and
ensure non recurrence of irregularities. Business of banking is susceptible to frauds. It is therefore necessary
to have an internal control and supervision mechanism for ensuring that no one person is in a position to
violate procedures, rules, regulations, guidelines, do an unauthorized act detrimental to the organization which
remains undetected for an indefinite period or long time. Therefore, inspection and audit plays crucial role in
success of banking operations.
AUDITING
An audit is a systematic and independent examination of books, accounts, statutory records, documents and
vouchers of an organization to ascertain how far the financial statements as well as non-financial disclosures
present a true and fair view of the concern. The word audit is derived from a Latin word “audire” which means
“to hear”. During the medieval times when manual book-keeping was prevalent, auditors in Britain used to hear
the accounts read out for them and checked that the organization’s personnel were not negligent or fraudulent.
The International Federation of Accountants has given the following definition of an audit, “audit is an
independent inspection of the financial information of any organization, whether profit-oriented or not profit-
oriented, irrespective of its legal form, status or size when such examination is conducted with a view to express
an opinion thereof”.
Auditing has become such a ubiquitous phenomenon in the corporate and the public sector that academics
started identifying an “Audit Society”. The auditor perceives and recognizes the propositions before them for
examination, obtains evidence, evaluates the same and formulates an opinion on the basis of his judgment
which is communicated through their audit report.
FEATURES OF AUDIT
1. Making a critical review of the system and procedures in an organisation.
2. Making such tests and enquiries into the results as well as the operation of such systems and procedures,
as the auditor may consider necessary to form an opinion.
3. Expressing that opinion in the accepted phraseology that has been developed.
4. Ensuring that the opinion covers all aspects which are required to be covered by law/statute or accepted
professional norms.
Auditing is a systematic process. It is a logical and scientific procedure to examine the accounts of an organization
for their accuracy. There are rules and procedures to follow.
STANDARDS ON AUDITING
To ensure that information provided in the financial statements are of high quality and are acceptable worldwide
the Auditing and Assurance Standards board under the council of Institute of Chartered Accountants (ICAI)
have formulated few Standards. These are in line with the International Standards issued by the International
Auditing and Assurance Board (IAASB) established by International Federation of Accountants (IFAC).
The Institute of Chartered Accountants of India has issued 35 (thirty five) Auditing and Assurance Standards
(AASs) (status as on 01.04.2019). All the Standards are mandatory in nature. This means that while carrying
out an attest function, it will be the duty of the auditor to ensure that these AASs are followed in the audit of
financial information covered by their audit reports. If for any reason a member has not been able to perform
an audit in accordance with the AASs, his report should draw attention to the material departures therefrom.
INTERNAL AUDIT
As defined by The Institute of Internal Auditors (IIA), “Internal auditing is an independent, objective
assurance and consulting activity designed to add value and improve an organization’s operations. It helps an
organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve
the effectiveness of risk management, control, and governance processes.
Internal auditing is a catalyst for improving an organization’s governance, risk management and management
controls by providing insight and recommendations based on analyses and assessments of data and business
processes.
PRINCIPLES OF INTERNAL AUDIT

Basic Principles of Internal Audit as enumerated by Institute of Chartered Accountants of India (ICAI) are given
below:
i) Independence- The independence of the internal audit function as a whole, and the Internal Auditor
within the organisation, plays a large part in establishing the independence of the Internal Auditor.
ii) Integrity and Objectivity- The Internal Auditor shall be honest, truthful and be a person of high integrity.
He shall operate in a highly professional manner and seen to be fair in all his dealings. He shall avoid all
conflicts of interest and not seek to derive any undue personal benefit or advantage from his position.
iii) Due Professional Care- The Internal Auditor shall exercise due professional care and diligence while
carrying out the internal audit. “Due professional care” signifies that the Internal Auditor exercises
reasonable care in carrying out the work to ensure the achievement of planned objectives.
iv) Confidentiality- Internal Auditor shall at all times, maintain utmost confidentiality of all information
acquired during the course of the audit work. He shall not disclose any such information to a party outside
the internal audit function and any disclosure shall be on a “need to know basis”.
v) Skills and Competence- Internal Auditor shall have sound knowledge, strong interpersonal skills,
practical experience and professional expertise in certain areas and other competence required to conduct
a quality audit. He shall undertake only those assignments for which he has the requisite competence.
vi) Risk Based Audit - An Internal Auditor shall identify the important audit areas through a risk assessment
exercise and tailor the audit activities such that the detailed audit procedures are prioritised and
conducted over high risk areas and issues, while less time is devoted to low risk areas through curtailed
audit procedures
vii) System and Process Focus - An Internal Auditor shall adopt a system and process focused methodology
in conducting audit procedures.
viii) Participation in Decision Making- In conducting internal audit assignments, the Internal Auditor shall
avoid passing any judgement or render an opinion on past management decisions. As part of his advisory
role, the Internal Auditor shall avoid participation in operational decision making which may be subject of
a subsequent audit.
ix) Sensitive to Multiple Stakeholder Interests- The Internal Auditor shall evaluate the implications of his
observations and recommendations on multiple stakeholders, especially where diverse interests may be
conflicting in nature. In such situations, the Internal Auditor shall remain objective and present a balanced
view.
x) Quality and Continuous Improvement- The quality of the internal audit work shall be paramount for the
Internal Auditor since the credibility of the audit reports depends on the reliability of reported findings.
Internal Audit:
Ø Bridges the gap between management and the board.
Ø Assesses the ethical climate and the effectiveness and efficiency of operations.
Ø Serves as an organization’s safety net for compliance with rules, regulations and overall best business
practices.
Ø Is a cornerstone of strong governance.
Ø Gives an assurance that:
– Internal controls are sufficient to mitigate risks.
– Governance processes are adequate.
– Organizations goals and objectives are met.
Ø While external audit confirms the validity of the financial position expressed by an organisation,
investigation may be supported by internal audit function.
Ø Internal audit confirms the effectiveness of business process controls in reducing financial risk.
Ø Assures compliance with the law.
Ø Indicates areas where business processes may be improved upon.
SCOPE OF INTERNAL AUDITOR IN BANK:

Scope of internal auditor in bank basically includes the following:
– Examination and evaluation of the adequacy and effectiveness of the internal control, risk
management and governance systems and processes of the entire bank.
– Preparation of Risk Audit Matrix based on intensity / magnitude and frequency of risk.
– Review of the application and effectiveness of the risk management procedures and risk assessment
methodologies.
– Suggesting measures for mitigating risks through risk focused audit
– Review of ICAAP (Internal Capital Adequacy Assessment Process) Processes, Risk Management
Framework & Risk Management System.
Internal auditors work within an organisation and report to its audit committee and/or directors.
BASEL GUIDANCE ON INTERNAL AUDIT

The Basel Committee on Banking Supervision updated its guidance for Supervisors in 2012, for assessing the
adequacy of the internal audit function in banks. It formed part of the Basel Committee’s on-going efforts to
address bank supervisory issues and enhance supervision through guidance that encourages sound practices
within banks. The guidance takes into account developments in supervisory practices and in banking
organisations and incorporates lessons drawn from the recent financial crisis.
The 20 principles issued by the Basel Committee were divided into 3 sections:
Ø Principles 1 to 15 related to the expectations relevant to the internal audit;
Ø Principle 16 related to the relationship of the supervisory authority with the internal audit function, and;
Ø Principles 17 to 20 related to the supervisor’s assessment of the internal audit function.
Risk Based Internal Audit (RBIA)

Over the last few years, the need to manage risks has become recognized as an essential part of good corporate
governance practice. This has put organisations under increasing pressure to identify all the business risks
they face and to explain how they manage them. In fact, the activities involved in managing risks have been
recognized as playing a central and essential role in maintaining a sound system of internal control.
RBIA is not about auditing risks but about auditing the management of risk. Its focus is on the processes applied
by the management team. The primary focus of risk-based internal audit is to provide reasonable assurance
to the Board and top management about the adequacy and effectiveness of the risk management and control
framework in the banks’ operations. Transaction testing would continue to remain an essential aspect of risk-
based internal audit. The extent of transaction testing will have to be determined based on the risk assessment.
The Risk Based Supervision Process (‘RBS’) is designed to work as a structured process that identifies the most
critical risks faced by an individual bank and systemic risks in the financial system.
Risk Audit Matrix

The Audit Plan should prioritize audit work to give greater attention to the areas of:
(i) High Magnitude and high frequency;
(ii) High Magnitude and medium frequency;
(iii) Medium magnitude and high frequency;
(iv) High magnitude and low frequency;
(v) Medium Magnitude and medium frequency.
Scope of RBIA
The precise scope of risk-based internal audit must be determined by each bank for low, medium, high, very
high and extremely high risk areas. However, at the minimum, it must review / report on:-
Ø process by which risks are identified and managed in various areas;
Ø the control environment in various areas;
Ø gaps, if any, in control mechanism which might lead to frauds, identification of fraud prone areas;
Ø data integrity, reliability and integrity of MIS;
Ø internal, regulatory and statutory compliance;
Ø budgetary control and performance reviews;
Ø transaction testing/verification of assets to the extent considered necessary;
Ø monitoring compliance with the risk-based internal audit report;
Ø variation, if any, in the assessment of risks under the audit plan vis-à-vis the risk-based internal audit;
Ø a review of the systems in place for ensuring compliance with money laundering controls;
Ø identifying potential inherent business risks and control risks, if any;
Ø suggesting various corrective measures; and
Ø undertaking follow up reviews to monitor the action taken thereon.
The communication channels between the risk-based internal audit staff and management should encourage
reporting of negative and sensitive findings. Significant issues posing a threat to the bank’s business should be
promptly brought to the notice of the Board of Directors, Audit Committee or top management, as appropriate.
Risk Based Internal Audit (RBIA) framework for Non-Banking Financial Companies (NBFCs) and Primary
(Urban) Co-operative Banks (UCBs) - The Reserve Bank of India has issued a notification on February 03,
2021 to cover the following Non-Banking Financial Companies (NBFCs) and Primary (Urban) Co-operative
Banks (UCBs) under RBIA: All deposit taking NBFCs, irrespective of their size;
a. All Non-deposit taking NBFCs (including Core Investment Companies) with asset size of ?5,000 crore and
above; and
b. All UCBs having asset size of ?500 crore and above.
Risk Based Internal Audit (RBIA)framework for Housing Finance Companies (HFCs)- The Reserve Bank of
India has issued a notification on February 03, 2021 to cover the following Housing Finance Companies (HFCs):
a. All deposit taking HFCs, irrespective of their size;
b. Non-deposit taking HFCs with asset size of Rs. 5,000 crore and above.
CREDIT AUDIT
Credit Risk is defined as “the possibility of losses associated with diminution in the credit quality of borrowers
or counter-parties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counterparty to meet commitments in relation to lending, trading, settlement and other financial
transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived
deterioration in credit quality. It is imperative that banks have a robust credit risk management system. The
effective management of credit risk is a critical component of comprehensive risk management and is essential
for the long term success of any banking organisation. Credit risk management encompasses identification,
measurement, monitoring and control of the credit risk exposures. Credit audit/Loan Review Mechanism is one
of the means to mitigate credit risk.
Credit Audit examines compliance with extant sanction and post-sanction processes/ procedures laid down
by the bank from time to time. Credit Audit is an integral part of risk based internal audit system, aimed at
identification of credit risk and may also suggest the remedial measures for controlling the credit risk underlying
the loan & investment portfolios of high value.
Credit Audit is an effective tool for periodic evaluation of quality of the credit portfolio and to bring about
qualitative improvement in credit administration. Loan Review Mechanism / Credit Audit for large value
accounts includes evaluating the effectiveness of loan appraisal and administration, maintaining the integrity
of credit rating process, portfolio quality, etc.
Objectives of Credit Audit

Ø To review sanction process and compliance status of large value loans vis-à-vis Bank’s loan policies,
procedures and laid down credit processes.
Ø To bring about improvement in the quality of Bank’s credit portfolio.
Ø To make an independent review of Credit Risk Assessment.
Ø To suggest /recommend corrective actions to improve credit quality, credit administration and credit
skills of the staff.
Ø Pick-up early warning signals and suggest remedial measures
Credit Auditable accounts (CAA) are identified by banks based on the quantum of loan and risk category of
borrower. For example, a sample of 10% of the CAAs falling in the bracket of Rs.10 crores to Rs.20 crores will be
subject to review by Credit Audit Division of bank.
Identification of signs of stress and initiation of adequate steps is crucial to ensure the quality of the credit
portfolio and therefore needs careful examination during the audit. CAAs identified as Medium and High Risk
are reviewed at shorter intervals at the discretion of Internal audit department of bank.
Scores/ risk ratings are awarded under credit risk & control risk areas separately at CAA level as High / Medium
/ Low / Very Low Risk. Final rating of CAA is arrived at based on the RBI’s Risk Matrix, considering inherent
business risk and control risk as under:
(i) Extremely High Risk
(ii) Very High Risk
(iii) High Risk
(iv) Medium Risk
(v) Low risk.
Learnings from analysis of credit audit report

The analysis of the Credit Audit Reports generally reveals irregularities. Certain such irregularities are given as
under: -
Ø Frequent irregularities observed in the accounts
Ø Equity not infused
Ø Opinion reports on borrowers/ guarantors not updated periodically.
Ø Reasonableness of valuation and ownership of property not verified.
Ø Common ‘’Stock & Receivable Audit’’ for the group accounts not conducted as per Sanctioned terms
Ø End - use of funds was not ensured
Ø Incomplete Loan document as arrangement letter was not signed by the borrower / individual guarantors
Ø The frequency of Stock & Receivable Audit was not adhered to.
Ø Periodicity of inspection not maintained.
INFORMATION SYSTEM AUDIT OR INFORMATION TECHNOLOGY AUDIT (IS AUDIT)

The deployment of Information Technology in banks and financial institutions, both in the front and back office
operations, has facilitated greater systemic efficiency in the banking and financial sector. It has, at the same
time, introduced new areas of risk. Risk is inherent in the traditional banking and financial activities. However,
risk in a computerized and networked environment is multifarious such as operational risk, reputational risk,
legal risk, credit risk, liquidity risk, interest rate risk, foreign exchange risk etc.
RBI vide its Notification No. DBS.CO.PP.BC. 10/11.01.005/2002-03 dated 27.12.2002 has advised banks to
implement IS Audit as a part of the risk-based internal audit system. IS audit system in banks has replaced the
earlier computer / EDP audit.
IS audit is a systematic process of objectively obtaining and evaluating evidence/ information regarding the
proper implementation, operation and control of information and the Information System resources.
IS Audit shall identify risks and methods to mitigate risk arising out of IT infrastructure such as server
architecture, local and wide area networks, physical and information security, telecommunications etc.
Coverage
IS Audit should cover effectiveness of policy and oversight of IT systems, evaluating adequacy of processes and
internal controls, recommend corrective action to address deficiencies and follow-up. IS Audit also evaluate
the effectiveness of business continuity planning, disaster recovery set up and ensure that BCP is effectively
implemented in the organization. During the process of IS Audit, due importance shall is given to compliance of
all the applicable legal and statutory requirements.
The Information Systems Audit encompasses the review and evaluation (wholly or partly) of automated
information processing systems, related non-automated processes and the interfaces among them.
Objectives
The major objectives of IS audit include, among others, the following:
a) Safeguarding of Information System Assets/Resources
b) Maintenance of Data Integrity
c) Maintenance of System Effectiveness
d) Ensuring System Efficiency
Information Systems Audit Approaches:

There are three approaches for conducting Information Systems Audit viz. auditing around the computer,
auditing through the computer and auditing with the computer.
I. Auditing around the Computer:
Under this approach, the emphasis is on checking the correctness of the output data/documents with
reference to the input of a process without going into the details of the processing involved. This approach
is preferred, where auditors themselves do not have the desired level of technical skills to adopt the other
approaches. This is also preferred, when high reliance is placed on the users rather than the computer
controls to safeguard the assets, maintain data integrity and attain effectiveness and efficiency objectives.
The focus is on the procedural controls rather than the computer controls.
II. Auditing through the Computer:
Auditing through the computer requires fair knowledge of the operating system, hardware being used and
certain technical expertise in systems development. Under this approach, the computer programs and the
data constitute the target of IS audit. Compliance and substantive tests are performed on the computer
system, its software (both operating system and application system) and the data. IS auditor can test the
application system effectively using this approach. The IS auditors can use computer to test logic and
controls existing within the system and also records produced by the system. This approach increases
the IS auditor’s confidence in the reliability and applicability of the evidence/information collected and
evaluated. This approach is time consuming, as it needs understanding of the internal working of an
application system. It also needs some technical expertise.
III. Auditing with the Computer:
Under this approach, the computer system and its programs are used as tools in the audit process.
The objective is to perform substantive tests using the computers and its programs. The data from the
auditee’s computer system are retrieved to an independent environment. Audit interrogation and query
is carried out on such data, using special programs designed for the purpose. This method is used where
Application system consists of a large volume of inputs, producing large volume of outputs and where the
direct examination of the inputs/ outputs is difficult and logic of the system is complex.
Computer-Assisted Audit Tools and Techniques (CAATTs): CAATTS are efficient and effective ways to audit
system-generated files, records and documents and to evaluate internal controls of an accounting system in
many Information Systems. Banks should adopt a proper mix of manual techniques and CAATs for conducting IS
Audit. CAATs may be used in critical areas (such as detection of revenue leakage, treasury functions, assessing
impact of control weaknesses, monitoring customer transactions under AML requirements and generally in
areas where a large volume of transactions are reported) particularly for critical functions or processes having
financial/regulatory/legal implications. There are five basic approaches, as under, for testing the application
controls using CAATT (Computer Aided Audit Tools and Techniques).
a) Test Data Method - This method is used to establish application integrity by processing specially prepared
sets of input data. The results of each test are compared with the pre-determined expected results. The
auditor first obtains the current version of the application and then generates the test transaction files and
test master files. Thereafter, the test transaction files are input into the program and the result in the form
of routine output reports, transaction listing and error reports are collected. The test results are compared
with the expected results, either manually or again through a computer program.
b) Base Case System Evaluation - Under this method, a base test set of transactions is prepared along with
the expected results. This set of transactions is comprehensive and all possible transaction types are
included. Whenever testing is done, the results are compared with the results of the base test data results,
which were obtained initially.
c) Tracing - Under this method, the test data does a virtual walk through the application logic. The application
under review must undergo a special compilation to activate a trace option. The test data, prepared for
tracing, is run and the result shows the exact listing of the programmed instructions, executed while the
test data was processed.
d) Integrated Test Facility - This is an automated test technique, where the audit module is designed in
the application program itself to be run in the normal course of operations by the application program
with a specific choice of test data and where the application program distinguishes between the actual
transactional data and test transactional data for simultaneous integrated audit and normal operations.
e) Parallel Simulation - This requires the auditor to write a program that simulates the key features and
processes of the application. The program is run on the pre-processed actual transactional data and the
results obtained are compared with the actual results obtained.
The IS auditors, while performing the software audit, should ensure from the system documents that the
database is properly normalized and there is not much redundancies and dependencies, as poorly normalized
database could affect the integrity of data. The database constraints will also required to be properly examined.
Network Audit
With the advent of Corporate Networks, Payment Gateways and new products
like Internet Banking, Anywhere Anytime Banking etc., which primarily rely on
various public and private networks for their operation, Network Audit forms a
key area of IS audit. Network Audit covers all aspects of the network, right from
the communication channels, network equipment like switches, bridges, routers,
firewalls to internetworking issues and security controls. To ensure continuous
adequacy of security controls in networked environment, each bank is required
to regularly conduct penetration testing in respect of the Information Systems
with the help of third parties under well specified terms and conditions, agreed
therefor with such third parties.
Audit activity is broadly divided into 5 major steps for the convenience and
effective conduct of audit:
Review of Policies and Compliance

The IS auditor is required to consider whether the policies issued cover all of the appropriate areas for which
board-level direction is necessary in order to provide reasonable assurance that the business objectives are
met. Such policies on board level direction will require to be documented ones only and such documented
policies shall, among others, include Security Policy, Human Resources Policy, Data Ownership Policy, End- user
Computing Policy, Copyright Policy, Data Retention Policy, System Acquisition and Implementation Policy and
Outsourcing Policy.
Reporting
The IS audit reports are placed before the top management and the compliance should be ensured within the
time frame as outlined in the audit policy. Such audits should be preferably undertaken prior to the statutory
audit so that the IS audit reports are available to the statutory auditors well in time for examination and
incorporating comments, if any, in the audit reports. The IS audit report on corporate governance of information
systems should, among others, include the following:
a) A statement that the Board of Directors is responsible for the organisation’s Information Systems and
formulation and implementation of the system of internal controls.
b) A statement that a system of internal controls can only provide reasonable and not absolute assurance
against material misstatement or loss.
c) A description of the key procedures, which the Board of Directors has approved/established, to provide
effective internal control and the related supporting documentation presented to the Board of Directors.
d) Information on any non-compliance with the national or industry codes of practice for corporate
governance.
e) Information on any major uncontrolled risks.
f) Information on any ineffective or inefficient control structures or control measures together with the IS
auditor’s recommendations for improvement.
g) The IS auditor’s overall conclusion on the corporate governance of the information systems, as defined in
the scope of audit.
CONCURRENT AUDIT
Concurrent audit aims at shortening the interval between a transaction and its independent examination. It
is, therefore, integral to the establishment of sound internal accounting functions and effective controls and is
regarded as part of a bank’s early warning system to ensure timely detection of serious errors and irregularities,
which also helps in averting fraudulent transactions and preventive vigilance in banks.
It is a continuous audit, which goes on all the year around, usually conducted by external auditors (Chartered
Accountants) on monthly basis.
RBI vide its circular no. RBI/2019-20/64, DBS.CO.ARS.No.BC.01/08.91.021/2019-20 dated 18.09.2019 has
reviewed the existing guidelines and issued the revised guidelines.
Coverage:
i) The scope of work to be entrusted to concurrent auditors, coverage of business/branches, etc. is left to the
discretion of the head of internal audit of banks, with the due prior approval of the Audit Committee of the
Board of Directors (ACB) / Local Management Committee ((LMC) in case of foreign banks) of the bank.
ii) Banks may, however, ensure that risk sensitive areas identified by them as per their specific business
models are covered under concurrent audit. The detailed scope of the concurrent audit may be determined
and approved by the ACB / LMC. The broad areas of coverage under concurrent audit shall be based on the
identified risk of the unit and must include random transaction testing of sufficiently large sample of such
transactions wherever required. Minimum areas of coverage are given in Annex.
iii) Care may be taken to ensure that all Centralized Processing Centres (business origination and monitoring)
are covered under concurrent audit.
Scope of concurrent audit

Concurrent audit is an examination which is contemporaneous with the occurrence of transactions or is carried
out as near thereto as possible. It attempts to shorten the interval between a transaction and its examination
by an independent person.
There is an emphasis in favour of substantive checking in key areas rather than test checking. This audit is
essentially a management process integral to the establishment of sound internal accounting functions and
effective controls and setting the tone for a vigilant internal audit to preclude the incidence of serious errors
and fraudulent manipulations.
A concurrent auditor may not sit in judgement of the decisions taken by a branch manager or an authorised
official. This is beyond the scope of concurrent audit. However, the audit will necessarily have to see whether
the transactions or decisions are within the policy parameters laid down by the Head Office, they do not violate
the instructions or policy prescriptions of the RBI, and that they are within the delegated authority.
The main role of concurrent audit is to supplement the efforts of the bank in carrying out simultaneous internal
check of the transactions and other verifications and compliance with the procedures laid down. The detailed
scope of the concurrent audit should is determined for the bank as a whole by the bank’s Inspection and Audit
Department in consultation with the bank’s Audit Committee of the Board of Directors (ACB).
Minimum areas of coverage under Concurrent Audit

1. Cash transactions including physical verification of cash, etc.
2. Loans & Advances including physical verification of securities, delegation of Powers for sanction, Security
Charge Creation, end use verification of funds, monitoring of accounts with excess drawings, monitoring
of projects, etc.
3. Adherence to KYC / AML guidelines including monitoring of transactions in accounts, compliance with
Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standards (CRS), monitoring of
transactions in new accounts/staff accounts, reporting of CTR/STR, etc.
4. Remittances/ Bills for Collection including SWIFT transactions, monitoring of overdue statements (bills
purchased / discounted / negotiated, etc.).
5. House Keeping including reconciliation of accounts, monitoring of General Ledger/Subsidiary General
Ledger/Parking Accounts, opening of internal accounts, etc.
6. Treasury operations.
7. Non fund based business.
8. Foreign Exchange transactions.
9. Clearing transactions.
10. Verification of Merchant Banking Business.
11. Verification of Credit Card / Debit card business.
12. Conduct of employees, mis-selling of products, etc.
13. Compliance to RBI guidelines and internal Policy guidelines issued from time to time.
Appointment of Auditors
The option to consider whether concurrent audit should be done by bank’s own staff or external auditors (which
may include retired staff of its own bank) is left to the discretion of individual banks. The head of internal audit
in the bank should participate in selection of concurrent auditors where such function is outsourced and should
be responsible for the quality review (including skills of the staff employed) of the work of the concurrent
auditors reporting to her/him. It may, however, be ensured that if any partner of a Chartered Accountant firm
is a Director on the Board of a bank, no partner of the same firm should be appointed as concurrent auditor in
the same bank.
Accountability
If external firms are appointed and any serious acts of omission or commission are noticed in their working,
their appointments may be cancelled after giving them reasonable opportunity to be heard and the fact shall be
reported to ACB/ LMC of the bank, RBI and ICAI.
The bank should frame a policy for fixing accountability in cases of serious acts of omission or commission
noticed in the working of bank’s own staff or retired staff, working as concurrent auditors.
Reporting System
i) Banks’ Internal Audit Department develops a reporting system for concurrent auditors with the approval of
ACB/LMC. The findings of the concurrent auditors are received in a structured format prescribed by the bank.
ii) Whenever fraudulent transactions are detected, they should immediately be reported to Internal Audit
Department (Head Office) as also to the Chief Vigilance Officer as well as Branch Managers concerned
(unless the branch manager is involved).
iii) Follow-up action on the concurrent audit reports and rectification of the deficiencies should be accorded
high priority by the Head Office/Controlling Office of the concerned branch/business unit of the bank.
Review of effectiveness of Concurrent Audit

ACB/ LMC of the bank should review the effectiveness of the Concurrent Audit system as well as the performance
of the concurrent auditors on an annual basis and take necessary measures to suitably strengthen the system.
AUDIT OF FINANCIAL STATEMENTS OF BANK

Every banking company’s account needs to be verified and certified by the Statutory Auditors as per the
provisions of legal frame work The purpose of an audit is to enhance the degree of confidence of intended users
in the financial statements. An audit conducted in accordance with (Standard on Auditing) SAs and relevant
ethical requirements enables the auditor to form that opinion.
The balance sheet and the profit and loss account of a banking company are audited in accordance with Section
30 of the Banking Regulation Act, 1949. Section 30 of Banking Regulation Act, 1949 states that the Balance-
Sheet and Profit and Loss Account prepared in accordance with section 29 shall be audited by a person duly
qualified under any law for the time being in force to be an auditor of companies.
Under section 143(3)(i) of the Companies Act 2013, the independent auditor is required to also report on the
adequacy and operating effectiveness of the internal financial controls. The auditor of the banking company or
a nationalised bank including SBI and a regional rural bank has the same powers as those of a company auditor
in the matter of access to the books, accounts, documents and vouchers.
Auditor in the case of a banking company incorporated in India is required to state the following in his report:
(a) whether in his opinion, the balance sheet is a full and fair balance sheet containing all the necessary
particulars and is properly drawn up so as to exhibit a true and fair view of the affairs of the bank, and
in case he had called for any information or explanation, whether it has been given and whether it is
satisfactory;
(b) whether or not the transactions of the bank which have come to his notice, have been within the powers
of the bank;
(c) whether or not the returns received from branch offices of the bank have been found adequate for the
purposes of his audit;
(d) whether the profit and loss account shows a true balance [of profit or loss]for the period covered by such
account;
(e) any other matter which he considers should be brought to the notice of the shareholders of the company.
Notwithstanding anything contained in any law for the time being in force or in any contract to the contrary,
every banking company shall, before appointing, re-appointing or removing any auditor or auditors, obtain
the previous approval of the Reserve Bank. Special responsibility is cast on the bank auditor in certifying the
bank’s balance sheet and profit and loss account, since that reflects the sound financial position of the banking
company.
The Statutory Auditors should ensure that the audit report issued by them complies with the requirements
of Revised SA 700 - Forming an Opinion and reporting on financial statements, SA 705 - Modifications to the
opinion in the Independent Auditor’s Report & SA 706 - Emphasis of matter paragraphs and other matter
paragraphs in the Independent Auditor’s Report.
Long Form Audit Report (LFAR)

Besides the normal audit report as per the statutory requirements, auditors are also required to furnish Long
Form Audit Report. The matters which the banks require their auditors to deal with in the LFAR have been
specified by Reserve Bank of India. The format of LFAR is in a questionnaire form. The LFAR is not a substitute
for Statutory Audit Report. Nor is it deemed to be a part of Statutory Audit Report. The Statutory Audit Report is
a self contained document and the auditor should not make any cross reference to the observation in the LFAR.
In case of any matter of emphasis, the auditor should mention the same in the report clearly.
LFAR is an elaborate reporting on the operations and controls in the branch which is based on the audit
observations made by the auditor during the course of the audit. The whole bank LFAR is drafted by the Central
Statutory Auditors based on the LFAR received from the Branch Auditors.
Enforcement action framework for the lapses in the statutory audit of commercial banks
Statutory Auditors (SAs) of banks play an important role in contributing to financial stability when they deliver
quality bank audits which foster market confidence in banks’ financial statements. Quality bank audits are also
a valuable input in the supervisory process of the Reserve Bank of India (RBI) for commercial banks.
Various statutes, viz., Banking Regulation Act, 1949, Banking Companies (Acquisition and Transfer of
Undertaking) Act 1970/1980 and State Bank of India Act, 1955 stipulate that commercial banks shall obtain
previous approval of the Reserve Bank of India (RBI) before appointing any SA. In exercise of these statutory
powers, in case of those auditors whose audit quality or conduct is not found satisfactory by the RBI, it decides
on enforcement action against them by way of not approving their appointments for undertaking statutory
audit in commercial banks for a specified period. Further, the RBI may also not approve auditor/s, who have
been debarred by other regulators/law-enforcement agencies/government agencies. As regards the cases
pending against auditors with the aforesaid agencies, the RBI would debar such audit firms, provided the case
is of serious nature, where public interest is involved and it is established, prima facie, that the firm is culpable,
either by the RBI or by the above entities and brought to the RBI’s notice.
Types of lapses to be considered

The lapses on the part of the SAs that are considered for invoking the enforcement framework would,
illustratively, cover the following areas:
a) Lapses in carrying out audit assignments resulting in misstatement of a bank’s financial statements;
b) Wrong certifications given by the auditors with respect to list of certifications as advised by the RBI to
banks;
c) Wrong information given in the Long Form Audit Report (LFAR);
d) Issues related to misconduct by auditors in respect of their bank audit assignments; and
e) Any other violations/lapses vis-à-vis the RBI’s directions/guidelines regarding the role and responsibilities
of the SAs in relation to banks.
SPECIAL AUDIT
Reserve Bank of India is empowered by the provisions of the Banking Regulation Act, 1949 to conduct/order a
special audit of the accounts of any banking company. The special audit may be conducted if in the opinion of
the Reserve Bank of India, special audit is necessary in the public interest and/or in the interest of the banking
company and/or in the interest of the depositors. The special audit report should be submitted to the Reserve
Bank of India with a copy to the banking company. The cost of the audit is to be borne by the banking company.
STOCK & RECEIVABLES AUDIT

The Stock Audit system is required to monitor the available Drawing power in relation to the balance outstanding
of borrowal accounts enjoying working capital limits (Both Fund and Non-fund based) with bank where the
primary security is hypothecation of Stock and/or Book Debts. In order to have uniform procedure and practice
and to regulate the system of stock audit process, a Policy document on Stock Audit is prepared by banks.
Generally, bank engages the services of External Stock Auditors to conduct Stock Audit every year. The External
Stock Auditors are instructed to institute receivables audit for large borrowal accounts to check the position of
book debts with the invoices, bills raised, book debt and age of book debts in relation to normal credit period.
FORENSIC AUDIT
The forensic audit is normally performed by a forensic accountant who has the skill in both accounting and
investigation. Forensic Accounting is the type of engagement that undertaking the Financial Investigation in
response to a particular subject matter, where the findings of the investigation normally are used as evidence in
court. The investigation is covering numbers of areas include fraud, crime, insurance claims as well as a dispute
among shareholders. A forensic audit is also needed to have a proper plan, procedure, and report like other
audit engagement.
A Forensic Audit is conducted in order to determine whether or not a fraud has taken place.
REVENUE AUDIT
Revenue audit is usually conducted at large and medium-sized branches and is aimed at identifying cases of
leakage of revenue due to wrong computation of interest, non-application of interest on time, application of
incorrect rates of interest/exchange/commission, non-application of penal interest, non-recovery or short-
recovery of service charges on guarantees and letters of credit, etc. This type of audit is also known as ‘income
and expenditure audit’ or ‘income leakage audit’.
TEST YOURSELF
1. Terminal Questions (MCQs):
a. ______________ are efficient and effective ways to audit system- generated files, records and documents
and to evaluate internal controls of an accounting system in many Information Systems
(i) Auditing with Computer
(ii) Computer-Assisted Audit Tools and Techniques
(iii)
Encryption
(iv) Hedging
b. From amongst the following, what is not true in case of Concurrent Audit?
(i) The emphasis is on substantive checking in key areas rather than test checking
(ii) Concurrent Auditor has to sit in judgement of decisions taken by the Branch Head /
authorized official
(iii) Concurrent Auditor may not sit in judgement of decisions taken by the Branch Head /
authorised official
(iv) Concurrent Auditor must see whether decisions / transactions are within prescribed policies
and delegated powers or constitute violations
c. IS Audit examines if the objectives of ______________, ______________and ______________ of data are
maintained.
(i) IS, IT and Cyber Security Policy
(ii) Audit Manual, Audit Policy and Audit Procedure
(iii) Confidentiality, Integrity and Availability
(iv) Encryption, Integration and Safety
d. As per Basant Seth Committee report, large Banks’ audit reports will be put up to ACB in case of
______________?
(i) High Risk Audit Reports (Below 60% marks)
(ii) Very High Risk Reports -Critical Findings (Below 40% marks)
(iii) Very High Risk Reports (Below 50% marks)
(iv) High Risk Audit Reports (Below 70% marks)
e. Multiplicity of audit results in ______________
(i) Audit excellence
(ii) Wastage of time and money
(iii) Audit inefficacy
(iv)
Audit fatigue
f. What role has the Internal Audit got vis-a-vis Regulatory function and risk management?
a. Internal Audit forms a policy for implementation
b. Lays down structure for implementation
c. Checks and provides counsel to top management
d. No role to play in these areas
2. State whether the following is True of False:
a. The LFAR is to be submitted before 30th June every year.
b. Sub- Section (1) of section 30 of Companies Act, 2013 requires that the balance sheet and profit
and loss account of a banking company should be audited by a person duly qualified under any
law for the time being in force to be an auditor of companies.
c. Regulatory body in case of banks is IRDA.
d. In the computerized environment, the auditor needs to be familiar with latest applicable RBI
circulars, guidelines that have bearing on the classification/provisions and income recognition
3. Write Short note on:
i. Forensic Audit
ii. Audit with computer
iii. LFAR
OTHER REFERENCES
• Secretarial Audit Compliance Management And Due Diligence Company Law
• Forensic Audit
Test Paper 604
BANKING – LAW & PRACTICE (ELECTIVE PAPER 9.1)
PP-BL&P
TEST PAPER
WARNING
It is brought to the notice of all students that use of any malpractice in Examination is misconduct as provided in the
explanation to Regulation 27 and accordingly the registration of such students is liable to be cancelled or terminated.
The text of regulation 27 is reproduced below for information:
“27. Suspension and cancellation of examination results or registration.
In the event of any misconduct by a registered student or a candidate enrolled for any examination conducted by
the Institute, the Council or any Committee formed by the Council in this regard, may suo motu or on receipt of a
complaint, if it is satisfied that, the misconduct is proved after such investigation as it may deem necessary and after
giving such student or candidate an opportunity of being heard, suspend or debar him from appearing in any one or
more examinations, cancel his examination result, or registration as student, or debar him from re-registration as a
student, or take such action as may be deemed fit.
605 PP-BL&P
BANKING ─ LAW & PRACTICE
TEST PAPER
(This test paper is for practice and self study only and not to be sent to the Institute)
Time allowed: 3 hours Maximum Mark: 100
• All questions are compulsory
• Marks for each question is indicated alongside of the question.
1. Read the case below carefully and answer the questions given at the end :
A Negotiable Instrument (NI) means a promissory note, bill of exchange or cheque payable either to
order or to bearer. Negotiable Instrument may be made payable to two or more payees jointly, or in the
alternative to one of the two, or one or some of several payees.
A Promissory Note is an instrument in writing containing an unconditional undertaking, signed by the
maker to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the
instrument.
A 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 Cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than
on demand and it includes the electronic image of a truncated cheque and a cheque in the electronic form.
The maker of a bill of exchange or cheque is called the drawer, the person thereby directed to pay is called
drawee, when in the bill or in any endorsement there on the name of any person is given in addition to
the drawee to be resorted to in case of need after the drawee of a bill has signed his assent upon the bill,
or if there are more parts thereof than one, one of such parts 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. The person name
in the instrument, to whom or to whose order the money is to be paid is called payee. The ‘holder’ of
Negotiable Instrument means any person entitled in his own name to possession thereof and to receive
or recover the amount due thereon from the parties thereto. The ‘Holder in due course’ mean any person
who for consideration became the possessor of Negotiable Instrument, if payable to bearer or the payee
or endorsee thereof if payable to order, before the amount mentioned in it became payable and without
having sufficient cause to believe his title of the person from whom he derived his title. When banker
dishonour a cheque of a customer, appropriate reason in writing, duly singed by its official must be given.
Such cheque may either be returned across the counter or through clearing.
(a) What are the Negotiable Instruments in the banking? Explain types and presumptions of Negotiable
Instruments. (8 marks)
(b) Define holder and holder in due course with their rights. Explain difference between them.
(8 marks)
(c) Mr. A draws a bill of exchange on XYZ Ltd. in consideration of sale of goods of Rs. 1,00,000 directing to
pay on demand to M/s BDS . From above Bill of Exchange explain who is drawee, drawer and payee.
Define the parties to a bill of exchange. (8 marks)
606 PP-BL&P
(d) X has issued a cheque of Rs.1,00,000 in favour of Y, but when Y deposited the cheque in bank, it gets
bounced. What are the common reasons behind the bouncing of a cheque? (8 marks)
(e) What are the duties of a Collecting Banker? (8 marks)
2. (a) An export customer has a bill for £ 100,000, the bank has to purchase £ (Pound Sterling) from him and
give an equivalent amount in rupees to the customer. Presuming the inter-bank market quotations
for spot delivery are as follows :
US$ 1 = Rs.60.8450/545
The London market is quoting as under:
£ 1 = US$ 1.9720/40
Calculate the amount in Rs. to be received by the customer.
(b) SBS Finance bank has financed a term loan of Rs. 240 lakh to a Micro Small Enterprises unit, which
was repayable in 60 monthly instalments of Rs. 4.00 lakh and Interest. The monthly instalments of
Rs. 4.00 lakh plus interest from 15th December, 2020 remained unpaid though the available security
is more than the outstanding balance (Rs.160 lakhs).
Explain the movement of Asset Classification of account and provision requirement (percentage and
amount) as per RBI guidelines. (6 marks each)
3. (a) “For a successful implementation of an effective Credit Risk Management System, in banks, a sound
organizational structure is a pre-requisite”. In this regard, briefly explain the recent RBI guidelines to
Banks on appointing Chief Risk Officer (CRO).
(b) Whether RBI has powers to supersede the Board of directors of a Banking company? If so, what are
the powers and duties of Administrator? (6 marks each)
4. (a) Information Technology (IT) has brought a revolution in the working of banks in India, it also carries
various risks. Explain the various types of IT risks and control mechanism for managing these risks.
(b) Explain the Composition of Regulatory Capital. What is the minimum regulatory capital requirement
for Banks in India as per Basel III Accord ? (6 marks each)
5. (a) Discuss various tools of monetary controls used by RBI.
(b) What is the responsibility of a bank with regard to deposits that are lying with a bank for 10 years and
above? What is the procedure to be followed by a bank under DEAF? (6 marks each)
6. (a) Who is a Banking Ombudsman? Mention the circumstances under which complaints can be made.
(b) Which charges on the company’s assets are required to be registered with ROC? (6 marks each)

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Study Material

BANKING – LAW & PRACTICE

ELECTIVE paper 9.1

Public Dealing Timings

PROFESSIONAL PROGRAMME – BANKING – LAW & PRACTICE

Reserve Bank of India Act, 1934

Adherence to Regulatory Guidelines

Formulation of Corporate Management Policies

Conducting Corporate Meetings

Liaison in the Audit Process

Advice to the Board of Directors

Risk Management Functions

1. Overview of Indian Banking System

2. Regulatory Framework of Banks

3. Control over Organization of Banks

4. Regulation of Banking Business

7. Payment and Collection of Cheques and Other Negotiable Instruments

8. Case Laws on Responsibility of Paying Bank

9. Case Laws on Responsibility of Collecting Bank

11. Consumer Protection

12. Loans and Advances

13. Securities for Banker’s Loans

16. Calculation of YTM

17. Introduction to Foreign Exchange

18. Non Performing Assets

19. Final Accounts of Banking Companies

21. Audits in Banks

MODULE 3 - Elective PAPER 9.1

Module-3 Elective Paper-9.1

S. No. Lesson Tittle

INDIAN BANKING SYSTEM - AN EVOLUTION

From the beginning till early 20th century

Agency House Banks/Presidency Banks/Imperial Bank of India

BRIEF OVERVIEW OF THE START OF RESERVE BANK OF INDIA (RBI)

Private / Joint Stock Banks

Establishment of State Bank of India / Associate Banks

Major reasons for nationalization can be summarized as under:

Second Phase of Nationalization

Consolidation of PSU Banks +

Details of merging PSU Banks

New Generation Private Sector Banks

Regional Rural Banks

Small Finance Banks and Payments Banks

Small Finance Banks

Salient Regulatory features of Small Finance Banks

NON-BANKING FINANCIAL COMPANIES (NBFC)

Classification of NBFCs based on Activity

Type of NBFC Activity

Special liquidity scheme for NBFCs/HFCs

Financial Institutions in India

Export- Import Bank of India

In addition to the above, EXIM Bank offers

National Bank for Agriculture and Rural Development (NABARD)

Small Industries Development Bank of India (SIDBI) (1990)

National Housing Bank (NHB)

For further reading

RESERVE BANK OF INDIA ACT, 1934 (AN OVERVIEW)

Amendments to RBI Act

THE BANKING REGULATION ACT, 1949 (AN OVERVIEW)