UNIT-1

A) KINDS OF BANKS AND THEIR FUNCTIONS

RBI

RBI or Reserve Bank of India is the Central Bank. It is a bank which is entrusted with the function of
guiding and regulating banking system of the country. It is a Government’s bank and it generally does not
deal with public. It provides guidance to the other banks whenever they face any difficulty. It is known as
the bankers bank. It issues currency notes and advices the government on various monetary and credit
policies. The following banks are under the control and governance of the RBI:

1) Scheduled Banks
By definition, any bank which is listed in the 2nd schedule of the Reserve Bank of India Act, 1934 is
considered a scheduled bank. The Schedule consists of those banks which satisfy various parameters,
criteria under clause 42 of this act.The list includes the State Bank of India and its subsidiaries, all
nationalised banks, regional rural banks (RRBs), foreign banks and some co-operative banks. These also
include private sector banks, both classified as old and new. To qualify as a scheduled bank, the paid-up
capital and collected funds of the bank must not be less than Rs5 lakh. Scheduled banks are eligible for
loans from the Reserve Bank of India at bank rate, and are given membership to clearing-houses. These
can be classified into:
 A) Commercial Banks: they accept deposits and grant short-term loans to its customers. It gives long-
term and medium term loans to business enterprises. They also provide housing loans on a long term
basis to individuals. These are further classified into:
I. Public Sector Banks: By default the minimum 51% shares would be kept by the Government of India,
and the management control of these nationalized banks is only with Central Government. Since all
these banks have ownership of Central Government, they can be classified as public sector banks. Apart
from the nationalized banks, State Bank of India, and its associate banks, IDBI Bank and Regional Rural
Banks are also included in the category of Public Sector banks.
II. Private Sector Banks: The major stakeholders in the private sector banks are individuals and
corporate. Private sector banks have been rapidly increasing their presence in the recent times and
offering a variety of newer services to the customers and posing a stiff competition to the group of
public sector banks. Total private sector banks as on 31st March 2013 were 22. Besides these, four
Local Area Banks are also categorized as private banks.
III. Regional Rural Banks (RRBs): 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.
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 allowed RRBs to issue Perpetual Debt Instruments (PDIs) eligible for inclusion
as Tier 1 capital under specified terms and conditions. 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.
IV. 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 24 March 2023 there were forty five licensed foreign banks
operated in India.
B) Cooperative Banks: Co-operative societies are formed by people who come together and form a
society jointly so as to serve their common interest. These societies are formed under the co-operative
Societies Act. When a co-operative society engages in banking business it is called a Co-operative Bank.
They have to obtain a license from the RBI. These are further classified into:
I) State Co-operative Banks: They are the highest level of Co-operative Banks in every state of our
country. They mobilize funds and help in proper channelization among various other societies.
II) Central Co-operative Banks: They operate at district level. They have some of the primary-credit
societies belonging to the same district as their members. They provide loans to their members.

2) Non-Scheduled Banks
These are those banks which are not included in the Second Schedule of the Reserve Bank of India.
Usually those banks which do not conform to the norms of the Reserve Bank of India within the
meaning of the RBI Act or according to specific functions etc. or according to the judgement of the
Reserve Bank, are not capable of serving and protecting the interest of depositors are classified as non-
scheduled banks.

3) 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 of Development Banks set up in India over the years:
 Industrial Finance Corporation of India (IFCI): 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).
 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.
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.
NABARD is involved directly and indirectly in an extensive manner in financing of agriculture, rural
development apart from extension activities and supervisory roles.
 Export- Import Bank of India (Exim Bank): Exim Bank 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.
 Small Industries Development Bank of India (SIDBI): 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.”
 Mudra: Mudra Yojana is a financial initiative for facilitating micro-units and providing them with
sufficient funds to help them develop their business. Under the Jan Dhan Yojana, the government
launched its MUDRA Bank (Micro Units Development and Refinance Agency) initiative on 8th April
2015.

4) NBFCs
NBFC is “a company registered under the Companies Act, 1956/2013 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 an
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.

B) HISTORY OF BANKING IN INDIA

Banks form the backbone 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 (NBFCs). Besides these, the services offered by banks also have
expanded over the years in the light of various national and international developments.

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, Cooperative Banks, Regional Rural Banks, Small Banks and Payments Banks and Financial
Institutions known as Development Banks and Non-Banking Financial Companies.

In 1927, 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 it’s statutory role from January 01, 1949.
Scheduled Banks
All banks which are included in the Second Schedule to the Reserve Bank of India Act, 1934 are Scheduled
Banks. These banks comprise Scheduled Commercial Banks and Scheduled Co-operative Banks.

Commercial Banks
The term Commercial Bank refers to a Financial Institution (FI) that accepts deposits, offers checking
account services, makes various loans, and offers basic financial products like Certificates of Deposit (CDs)
and Savings Banks Accounts to individuals and small businesses. They make money by providing and
earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer
deposits provide banks with the capital to make these loans.

Public Sector Banks

Public Sector Banks are those banks where majority of the stake in the bank is held by Government.

State Bank Of India

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.

C) BANKING REGULATION LAWS

Banking companies are regulated in India through various laws. The principal ones among them are Reserve
Bank of India Act, 1934 and Banking Regulations Act, 1949. 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 The Reserve Bank of India 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.

I. RESERVE BANK OF INDIA ACT, 1934

Reserve Bank of India Act, 1934 ( 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. The RBI Act, 1934 came into force on 6th March
1934. 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 functions of RBI are divided into three categories:

1. Main Functions: These are the following functions:
 The RBI has the sole authority of not only issuing the currency notes but also has the authority to
destroy the currency which is not fir for circulation. This gives the public the supply of good quality of
currency. RBI maintains both external as well as internal value of the currency.
 It performs the financial functions of both Central as well as the State Governments. It undertakes to
accept the money on behalf of Government as well as it makes payment of behalf of the Government. It
manages the securities issued by the Government and also the Public Debt.
 The RBI maintains the banking account of all the scheduled banks. Every commercial bank maintains
an account with the RBI. The commercial banks have to deposit a certain amount with the RBI before
carrying out any banking business. The RBI also lends to the commercial banks.
 Under Section 35 of the Banking Regulation Act, the RBI has the power of inspecting other banks. It
can under Section 35A issue directions to other banks and can even control the management of the
banking companies under sections 36AA and 36AB of the Act.
 And many more functions such as making the monetary and credit policies, managing foreign exchange
and development of rural banking system.
2. Promotional Functions: RBI promotes financial institutions, commercial banking, industrial finance,
rural credit, cooperative credit and export credit.
3. Development Functions: These include the development of Bill-Market and economic development.
The following are the powers of RBI:
 Section 4: The RBI has the power to make representation to the Government of India to suspend any
provision of this Act. Such suspension shall not be for a period of more than 60 days.
 Section 9: As per the provision, the period within which a Banking Company has to dispose off its non-
banking asset is of 7 years. The RBI has the power to increase this period further by 5 years in the
interest of depositors.
 Section 11: According to this Section, whenever any question arises on the point of computation of
minimum paid-up capital, the decision of the RBI is final.
 Section 12: Every banking institution has to comply with certain regulation which deal with paid-up
capital, subscribed capital and authorised capital. The RBI is empowered to extend the period in which
the banking institution has to comply with the regulation.
 Section 19: if any banking company which is formed in India wishes to form a subsidiary only for the
purpose of banking activities outside India then such banking company has to take a prior approval of
the RBI.
 Any many other such powers given under the Act.

II. BANKING REGULATION ACT, 1949

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
along with 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.

The definition of ‘Banking’ in Section 5(1)(b) makes it clear that the essential functions of a banking
company are:
(1) Acceptance of deposits, and
(2) Lending or investing them.

A business will not be called a banking business if the purpose of accepting deposits is not to lend or invest.

Any company which transacts the business of banking in India is called a banking company.

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 has replaced the Banking Regulation (Amendment)
Ordinance, 2020.

Features of Banking Regulation (Amendment) Act, 2020 are:

1. substitution of Section 3 to provide that the Act shall not apply to—
(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.

D) BANK NATIONALISATION AND SOCIAL CONTROL OVER

BANKING

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.

A similar exercise was also carried out in 1980 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.
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.

The purpose of nationalization was:

(a) to increase the presence of banks across the nation.
(b) to provide banking services to different segments of the Society.
(c) to change the concept of class banking into mass banking, and
(d) to support priority sector lending and growth.

Later on the New Bank of India was merged with Punjab Nationalized Bank.

The nationalization of banks resulted in rapid branch expansion and the number of commercial bank
branches have increased many folds in Metro, Urban, Semi banks to mobilize deposits and lot of economic
activities have been started on account of priority sector lending.

In 1967, the Indian government introduced the policy of social control over banks. The objective of this
policy framework was to bring structural changes in the management of banks by delinking the nexus
between big business houses and big commercial banks. Under this policy, new guidelines on the
management of banks were issued to ensure that persons with specialized knowledge and experience could
join the board of directors of a bank. The Reserve Bank of India also got new powers to appoint or sack
senior management in a bank. Another policy objective of social control was to improve the distribution of
credit towards agricultural and developmental sectors.

Despite such laudable policy measures envisaged under the social control framework, a large segment of the
population (particularly in rural areas) had no access to the institutionalized credit. Based on this largely
failed experiment, the government realized that the nationalization was the only option to channelize
banking resources to the neglected sectors of the economy and rural areas.

There were several policy objectives behind the bank nationalization strategy including expanding the
geographical and functional spread of institutionalized credit, mobilizing savings from rural and remote
areas and reaching out to neglected sectors such as agriculture and small-scale industries. Another policy
objective was to ensure that no viable, productive business should suffer for lack of credit support,
irrespective of its size. In sum, the bank nationalization drive was inspired by a larger social objective to
sub-serve national development priorities.

E) RELATIONSHIP BETWEEN BANKER AND CUSTOMER

i and ii. LEGAL CHARACTER AND CONTRACT BETWEEN BANKER AND
CUSTOMER

Since the banker-customer relationship is contractual, a bank follows that any person who is competent to
contract can open a deposit account with a bank branch of his/her choice and convenience. For entering into
a valid contract, a person needs to fulfill the basic requirements of being a major (18 years of age or above)
and possessing sound mental health (i.e. not being a lunatic). A person who fulfils these basic requirements,
as also other requirements of the banks as mentioned below, can open a bank account. However, minors
(below 18 years of age) can also open savings account with certain restrictions.

The inadequacy of describing the relationship of banker and depositor as merely that of debtor and creditor
is illustrated by a recent English case. In Tournier v. National Provincial & Union Bank of England, the
defendant bank had informed the plaintiff's employer that checks payable to the plaintiff had been endorsed
by him to a bookmaker, and intimated that the plaintiff's over-draft of his account was due to his having
engaged heavily in betting. In a suit for breach of an implied duty not to disclose information concerning the
plaintiff or his account, the lower court instructed the jury that if the disclosure was made on a reasonable
and proper occasion, the bank was not liable. In reversing a judgment for the defendant, the Court of Appeal
held that the jury should have been more definitely instructed as to the nature of the duty owed by the bank,
that there was such a duty implied from the contract,' although a disclosure for the bank's own needs, or with
the consent of the customer, or in discharge of a legal or public duty, would be legally privileged. It is
remarkable that such an important problem seems never to have been definitely decided by either the
American or English courts.

That the relationship of banker and customer is one which the courts are astute to protect is illustrated by
those cases which hold that libellous communications by a bank to its customer are conditionally privileged.
The credit structure is strengthened if bankers keep their customers fully informed about such matters as
may affect their interests. Not only is the bank privileged thus to serve its customer but it is placed under a
duty to pay substantial damages for a wrongful dishonor of a merchant's check. Some courts award
substantial damages because they regard banks as "quasi-public" institutions.

Others reach the same result by analogy to slander of a merchant in his trade. In either case the result reflects
an appreciation of the closeness of the relationship and the social advantage of creating certain special rights
and privileges in the parties. The classic examples of confidential relationships are those of attorney and
client, and physician and patient. There, as with the banker the relationships are furthered by privileging
communications of the attorney to his client or physician to his patient. Furthermore the attorney or
physician is under a duty not to disclose confidential communications of his client or patient. The law goes
even further in such cases and requires such communications to be kept secret even as against the interest of
the community in the ascertainment of truth in court, a greater social advantage being seen in secrecy than in
disclosure.

KYC, or "Know Your Customer," is a vital protocol employed by financial institutions to verify the
identities of their clients and assess the risk associated with their activities. At its core, KYC is designed to
ensure that banks have a comprehensive knowledge of their customers, thereby mitigating risks related to
money laundering, terrorist financing, fraud, and other financial crimes. But KYC is more than just a
regulatory obligation; it is a means to establish trust and transparency between banks and their clients.

Banks embrace KYC for a number of reasons, with risk management and regulatory compliance taking
center stage. By verifying the identity of customers and understanding the nature of their financial activities,
banks can proactively detect suspicious transactions and reduce their exposure to potential risks.
Furthermore, KYC is not just about protecting the bank's interests; it also safeguards customers from
identity theft and fraud, contributing to a safer financial ecosystem for all.

RELATIONSHIP AS DEBTOR AND CREDITOR

On the opening of an account the banker assumes the position of a debtor. He is not a depository or trustee
of the customer’s money because the money over to the banker becomes a debt due from him to the
customer. A banker does not accept the depositors’ money on such condition. The money deposited by the
customer with the banker is, in legal terms, lent by the customer to the banker, who makes use of the same
according to his discretion. The creditor has the right to demand back his money from the banker, and the
banker is under and obligation to repay the debt as and when he is required to do so. But it is not necessary
that the repayment is made in terms of the same currency notes and coins. The payment, of course, must be
made in terms of legal tender currency of the country.

A depositor remains a creditor of his banker so long as his account carries a credit balance. But he does not
get any charge over the assets of his debtor/banker and remains an unsecured creditor of the banker. Since
the introduction of deposit insurance in India in 1962, the element of risk to the depositor is minimized as
the Deposit Insurance and Credit Guarantee Corporation undertakes to insure the deposits up to a specified
amount.

Banker’s relationship with the customer is reversed as soon as the customer’s account is overdrawn. Banker
becomes creditor of the customer who has taken a loan from the banker and continues in that capacity till the
loan is repaid. As the loans and advances granted by a banker are usually secured by the tangible assets of
the borrower, the banker becomes a secured creditor of his customer.

RELATIONSHIP AS TRUSTEE AND BENEFICIARY

A trustee holds money or assets and performs certain functions for the benefit of some other person called
the beneficiary. For example, if the customer deposits securities or other valuables with the banker for safe
custody, the latter acts as a trustee of his customer. The customer continues to be the owner of the valuables
deposited with the banker.

The relationship between the banker and his customer as a trustee and beneficiary depends upon the specific
instructions given by the latter to the farmer regarding the purpose of use of the money or documents
entrusted to the banker. In New Bank of India Ltd. vs. Pearey Lal, the Supreme Court observed in the
absence of other evidence a person paying into a bank, whether he is a constituent of the bank or not, may be
presumed to have paid the money to be held as banker ordinarily held the money of their constituent. If no
specific instructions are given at the time of payment or thereafter and even if the money is held in a
Suspense Account the bank does not thereby become a trustee for the amount paid.

In case the borrower transfers to the banker certain shares in a company as a collateral security and the
transfer is duly registered in the books of the issuing company, no trust is created in respect of such shares
and the banks’ position remains that of a pledge rather than as trustee. Pronouncing the above verdict, in
New Bank of India vs. Union of India, the Delhi High Court observed that a trustee is generally not
entitled to dispose of or appropriate trust property for his benefit. “In the present case the banker was
entitled to dispose of the shares and utilize the amount thereof for adjustment to the loan amount if the
debtor defaults. The banker’s obligation to transfer back the shares can arise only when the debtor clears
dues of the bank was not considered as trustee.

RELATIONSHIP AS BAILOR / BAILEE

Section 148 of Indian Contract Act,1872, defines bailment, bailor, and bailee. A bailment is the delivery of
goods by one person to another for some purpose upon a contract. As per the contract, the goods should
when the purpose is accomplished, be returned or disposed off as per the directions of the person delivering
the goods. The person delivering the goods is called the bailer and the person to whom the goods are
delivered is called the bailee.
Banks secure their loans and advances by obtaining tangible securities. In certain cases banks hold the
physical possession of secured goods (pledge) – cash credit against inventories; valuables – gold jewels
(gold loans); bonds and shares (loans against shares and financial instruments) In such loans and advances,
the collateral securities are held by banks and the relationship between banks and customers are that of
bailee (bank) and bailer.(borrowing customer).

For example. If Surbhi goes to her bank to deposit her gold jewellery for safe custody in her bank then a
contract of bailment arises and her bank becomes her bailee.

In the case of Sheikh Mohamod vs The British Indian Steam Navigation Co. Ltd., it was held that a
bailee may by any special contract under take a greater liability but he cannot by contract reduce the liability
imposed by Section 151 of the Indian Contract Act, 1872.

RELATIONSHIP AS LESSER / LESSEE

Section 105 of ‘Transfer & Property Act’ deals with lease, lesser, lessee. In case of safe deposit locker
accounts, the banker and customer relationship of lesser/lessee is applicable. Banks lease the safe deposit
lockers (bank’s immovable property) to the clients on hire basis. Banks allow their locker account holders
the right to enjoy (make use of ) the property for a specific period against payment of rent.

RELATIONSHIP AS PRINCIPAL AND AGENT

A banker acts as an agent of his customer and performs a number of agency functions for the convenience of
his customers. For example, he buys or sells securities on behalf of his customer, collects cheques on his
behalf and makes payment of various dues of his customers, e.g.. insurance premium, etc. The range of such
agency functions has become much wider and the banks are now rendering large number of agency services
of diverse nature. For example, some banks have established Tax Services Departments to take up the tax
problems of their customers.

RELATIONSHIP AS MORTGAGOR AND MORTGAGEE

Section 58 of the Transfer of Property Act, 1882 defines a mortgage. The transferor is called a mortgagor,
the transferee a mortgagee, the principal money and interest of which payment is secured for the time being
are called the mortgage money, and the instrument (if any) by which the transfer is effected is called a
mortgage-deed.

iii. BANK’S DUTY TO CUSTOMERS

Though the primary relationship between a banker and his customer is that of a debtor and creditor or vice
versa, the special features of this relationship, impose the following additional obligations on the banker:

OBLIGATIONS TO HONOUR THE CHEQUES

The deposits accepted by a banker are his liabilities repayable on demand or otherwise. The banker is,
therefore, under a statutory obligation to honour his customer’s cheques in the usual course. Section 31 of
the Negotiable Instruments Act, 1881, lays down that:
“The drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable to the
payment must compensate the drawer for any loss or damage caused by such default.”

OBLIGATION TO MAINTAIN SECRECY OF ACCOUNT

The account of the customer in the books of the banker records all of his financial dealings with the latter
and the depicts the true state of his financial position. If any of these facts is made known to others, the
customer’s reputation may suffer and he may incur losses also. The banker is, therefore, under an
obligation to take utmost care in keeping secrecy about the accounts of his customers. By keeping secrecy
is meant that the account books of the bank will not be thrown open to the public or Government officials
and the banker will take all necessary precautions to ensure that the state of affairs of a customer’s account
is not made known to others by any means. The banker is thus under an obligation not to disclose—
deliberately or intentionally—any information regarding his customer’s accounts to a third party and also to
take all necessary precautions and care to ensure that no such information leaks out of the account books.
The nationalized banks in India are also required to fulfill this obligation. Section 13 of the Banking
Companies (Acquisition and Transfer of Undertakings) Act, 1970, specially requires them to “observe,
except as otherwise required by law, the practices and usages customary amongst bankers and in
particular not to divulge any information relating to the affairs of the constituents except in circumstances
in which they are, in accordance with law or practices and usages or appropriate for them to divulge such
information.”

iv. LIABILITY UNDER THE CONSUMER PROTECTION ACT, 1986

The Consumer Protection Act was enacted in India in the year 1986 to protect the interest of the consumers
of goods and services. The basic thrust of the Act is on speedy and inexpensive redressal consumer’s
grievances.

The Act applies to both Goods and Services, Banking, Financing, and Insurance are included amongst the
services, in respect of which a complaint can be filed by a consumer.

Banker renders various services to his customers as well as general public. The act applies to all the services
rendered by a banker to both the categories of persons. Provided the service is rendered for a consideration
that is a fee, commission or like. So far, the main functions of the banker are concerned with acceptance of
deposits and lending of funds to the customers, the banker-customer relationship is that of debtor-creditor or
creditor-debtor. Any deposit received from depositor is legally speaking a loan taken by the banker from the
customer and when a customer draws a cheque on his deposit account, it deemed as repayment of the loan
taken by the banker. Similar is the legal position of banker in relation to loans granted to the account holders.
Hence in such transaction with the customers, a banker does not render a service for a consideration as
envisaged in the Act. However, any negligence on the part of the banker in such cases do attract the
provisions of the Act.

There are many types of grievances felt by the bank customers. Some of them may relate to minor mistakes
or irregularities or acts of omission or commission on the part of the bank employees. Other grievances may
be in connection with serious irregularities or wrong decisions/steps taken by the bank, resulting losses to
the customer. The customer has the following options available for redressal of his complaints. There are
two levels of grievances which can be filed with bank concerned and at Reserve Bank of India level. In 2006
Reserve Bank of India set up a separate customer department includes administering Banking Ombudsman
Scheme, acting as nodal department for Banking Codes and Standard Board of India and ensuring redressal
of complaints directly by Reserve Bank of India.

The Reserve Bank of India have come long way since then recognised the significance of customer service
and consumer protection in banking sector early on. The Reserve Bank of India taken measures in the area
of Consumer Protection. Consumer confidence and trust in a well-functioning market for financial services
promotes financial stability, growth, efficiency and innovation over the long term. Effective customer
protection regulations together with an easily accessible mechanism to resolve disputes between customers
and the regulated entities in a timely manner are essential for promoting consumer confidence. Further
awareness measures for customers on financial matters instils in them knowledge about their rights and
responsibilities and helps them to make right decisions.

In the case of Malti Bhatt vs SBI, the demand draft which was requested by the plaintiff was issued by the
bank without the signature of the concerned authority. It was held that there was a clear cut case of
deficiency in service. Rs. 35,000 was awarded to the plaintiff by the district and national forum.

In Consumer Unit and Trust Society (CUTS) vs Chairman of Bank of Baroda, the question which arose
was whether a bank can be held liable for deficiency of service which was caused due to strike by its
employees. It was held that the short coming in the service by the bank did not arise due to the failure on the
part of the bank in performing its duty but was due to the strike resorted by the employees. Therefore, the
bank could not be held liable.
In the case of Vimal Chandra Grover vs Bank of India, the Supreme Court held that while rendering the
services by the bank by providing over-draft facility to a customer by charging him for the same will make
the bank liable for banking services and the customer will come under the purview of Consumer Protection
Act, 1986 and that over-draft facilities is certainly a part of banking services and falls under the meaning of
services under the Act.