UNIT 1

NATIONALIZATION OF COMMERCIAL BANKS: OBJECTIVES AND PERFORMANCE

Objectives: Banks have been nationalized to fulfill various socioeconomic objectives.

The six major objectives of bank nationalization are:

1. To mobilize savings of the people to the maximum possible extent and utilize them for
productive purposes;

2. To ensure prompt operations of the banking system for a larger social purpose and subject it to
close public regulation;

3. To meet the legitimate credit needs of private sector industry and trade (big or small);

4. To ensure that the needs of the productive sectors of the economy and, in particular, those of
farmers, small-scale industrialists, and self-employed professional groups are met in an
increasing manner.

5. To instruct the banks to provide banking facilities to the hitherto neglected and backward areas
in different parts of the country; and

6. To check (stop) the use of the bank credit for speculative and other unproductive purposes.

Performance:

The philosophy of bank nationalization was that those financial institutions that mobilized the
savings of the public should broadly function as an instrument for promoting economic and
social development in a more purposive manner. In the post-nationalization period, there has
been a rapid growth of India’s banking system.

The following points may be highlighted in this context:

1. Deposit Mobilisation: There has occurred a significant increase in deposits of scheduled

commercial banks in the post-nationalization period. At the end of June 1969, deposits of these
banks were Rs. 4,564 crores. By March 2001, total deposits increased to Rs. 983,268 crores.
It may be noted that deposits mobilized by banks are utilized for two purposes:

(i) investments in Government securities and other approved securities in order to fulfil the
statutory liquidity requirement (which is 25% at present) and (ii) loans and advances to
borrowers.

2. Branch Expansion: As against 8,262 branches at the end of June 1969, the total number of
commercial bank branches at the end of March 2001 was 63,380. As a result of this, banking
coverage in the country as a whole has been improved from one office for 65,000 persons to
15,000 persons during the same period.

3. Coverage of Rural Areas: In the post-nationalisation period, the thrust of the branch
expansion policy of commercial banks has been on improving the availability of banking
facilities in rural areas. The number of rural branches increased from 1,860 in 1969 to 32,890 in
1997.

4. Credit Deployment: Advances in whatever form constitute the end objective or purpose of
banking. From a modest Rs. 3,599 crores in June 1969, total advances’ by public sector banks
increased to Rs. 265,554 crores in March 1999.

5. Sectoral Allocation: More significant than the increase in bank credit are the changes in
sectoral development. In the pre-nationalization period, large and medium industries as also
wholesale trade accounted for more than 79% of total commercial bank credit.

By March 1999, the share of these sectors (including credit for public food procurement) had
declined to about 21%; correspondingly, the share of priority sectors and food procurement
agencies had shown a significant increase. In recent years food credit by commercial banks
increased substantially because of large volumes of procurement and stock of food grains. Non-
food credit fell reflecting a slowdown in industrial activity.

6. Advances to Priority Sectors: The expansion of credit to small borrowers in the hitherto
neglected sectors of the economy has been one of the major tasks of public sector banks in the
post-nationalization period. To achieve this objective, banks have drawn up schemes to extend
credit to small borrowers in sectors like agriculture, small-scale industry, road and water
transport operators, retail trade, and small businesses, which traditionally had very little share in
credit extended by banks.

Taking into account the need to meet resource requirements of weaker sections, for specific
purposes, consumption credit (with certain limits) had been incorporated in priority sector
advances. Similarly, small housing loans (not exceeding Rs. 5,000) to the weaker section of
society (such as SCs and STs) are also classified as priority sector advances.

Total outstanding credit by banks to small-scale industries increased from Rs. 810 crores in June
1969 Rs. 42,591 crores in March 1999. Outstanding road and water transport operators stood at
Rs. 3,620 crores in March 1999.

7. Credit to Weaker Sections of Society: To increase the flow of bank credit to poorer sections
comprising small and marginal farmers, landless laborers, tenant farmers and share-croppers,
artisans, village and cottage industries, and small transport operators, several new credit schemes
have been evolved. This section received very little bank credit before nationalization. In March
1999 the out-standings to small businesses were Rs. 4,231 crores, professional and self-
employed persons 2,630 crores, housing Rs. 5,366 crores, and consumers and others Rs. 1,108
crores.

8. Direct Finance to Agriculture: Public sector banks were initially given a target of extending
15% of total advances as direct finance to agriculture, to be achieved by March 1985. As against
this, advances by public sector banks to priority sectors rose to 16.8% of their total advances by
March 1988. Direct finance to agriculture (outstanding) increased from Rs. 310 crores in June
1969 to Rs. 31,167 crores in March 1999. Indirect finance (outstanding) stood at Rs. 6,464
crores.

FUNCTIONS OF INDIGENOUS BANKERS

(For introduction refer to written notes.)

1. Accepting Deposits: The indigenous bankers accept deposits from the public which are of
current account and for a fixed period. Higher interest rate is paid on fixed account than on
current account. Entries relating to deposits received, amount withdrawn and interest paid are
made in the pass-books issued to the clients. The indigenous bankers also get funds from the
commercial banks, friends, relatives and even from each other.

2. Advancing Loans: The indigenous bankers advance loans against security of land, jewellery,
crops, goods, etc. Loans are given to known parties on the basis of the promissory notes. Loans
given on the security of land and buildings are based on mortgages registered with the Registrar
of the area.

3. Discounting Hundis: Discounting of hundis is an important function of indigenous bankers.

They write, buy and sell hundis which are bills of exchange.

4. Remittance Facilities: The indigenous bankers also provide remittance facilities to their
clients. This is done by writing a finance bill to their branches, if they have at other place or to
some other indigenous banker, with whom they have such arrangements.

5. Financing Inland Trade: They finance both wholesale and retail traders within the country and
thus help in buying, selling, and movement of goods to different trading centres.

6. Speculative Activities: They indulge in speculation of food and non-food crops, and other
articles of consumption.

7. Commission Agents: They act as commission agents to firms.

8. Run Firms: Some of the non-professional indigenous bankers run their own manufacturing
processing or service firms, and on the strength of that they provide expertise and working
capital to small industrialists.

9. Subscribe to Shares and Debentures: They provide long-term finance by subscribing to the
shares and debentures of large companies.
KINDS OF BANKS

Commercial Banks

1. Public Sector Banks - The term ‘public sector banks’ by itself connotes a situation where the
major/full stake in the banks is held by the Government. Till July 1969, there were only 8 Public
Sector Banks (SBI & and its 7 associate banks). When 14 commercial banks (a total of 20 banks)
were nationalized in 1969, 100% ownership of these banks was held by the Government of India.
Subsequently, six more private banks were nationalized in 1980. However, with the changes in
time and environment, these banks were allowed to raise capital through IPOs, thereby changing
the shareholding pattern. 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 the Central
Government. Since all these banks have ownership of the 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.

2. Private Sector Banks - The major stakeholders in the private sector banks are individuals and
corporations. When banks were nationalized under two tranches (in 1969 and 1980), all banks
were not included. Those non-nationalized banks that continue operations even today are
classified as Old Generation Private Sector Banks like The Jammu & Kashmir Bank Ltd, The
Federal Bank, The Laxmi Vilas Bank etc. In July 1993 on account of banking sector reforms, the
Reserve Bank of India allowed many new banks to start banking operations. Some of the leading
banks that were given licenses are: ICICI Bank, HDFC Bank, Kotak Mahindra Bank, Yes Bank
etc., these banks are recognized as New Generation Private Sector Banks. Private sector banks
have been rapidly increasing their presence in recent times offering a variety of newer services to
the customers and posing stiff competition to the group of public sector banks.

3. Foreign Banks - The other important segment of commercial banking is that of foreign banks.
Foreign banks have their registered offices outside India, and through their branches, they
operate in India. They are allowed to operate through branches or wholly owned subsidiaries.
These foreign banks are very active in Treasury (forex) and Trade Finance and Corporate
Banking activities. These banks assist their clients in raising External Commercial Borrowings
through their branches outside India or foreign correspondents. Foreign banks have to adhere to
all local laws as well as guidelines and directives of Indian Regulators such as the Reserve Bank
of India, the Insurance and Regulatory Development Authority, Securities Exchange Board of
India.

4. Regional Rural Banks - Regional Rural Banks are financial institutions in India that are
designed to provide banking services in rural areas. They were established under the Regional
Rural Banks Act of 1976, with the aim of bringing banking services closer to rural and
agricultural communities and promoting rural development.

RRBs are structured as scheduled commercial banks and are regulated by the Reserve Bank of
India (RBI). They operate in a specific region, generally consisting of districts within a state.

Regional Rural Banks’ Achievements

RRBs have played a crucial role in providing credit to the agricultural sector, which is vital for
rural development.
Also, RRBs have supported rural entrepreneurship and small businesses, contributing to
employment generation in rural areas. According to the National Bank for Agriculture and Rural
Development (NABARD), RRBs have created over 4 million jobs through their credit and
support to small-scale industries.

RRB's impact can also be gauged from the role they have played in promoting financial inclusion
in rural areas. They have opened a significant number of accounts for previously unbanked
individuals. According to the NABARD, RRBs have opened over 140 million accounts as of
March 2021, providing banking services to previously underserved rural populations.

Co-operative Banks

Cooperative banks play an important role in the Indian Financial System, especially at the village
level. The growth of the Cooperative Movement commenced with the passing of the Act of 1904.
A cooperative bank is a cooperative society registered or deemed to have been registered under
any State or Central Act. If a cooperative bank is operating in more than one State, the Central
Cooperative Societies Act is applicable. In other cases, the State laws are applicable. The
provisions of the RBI Act, of 1934, and the BR Act, of 1949 would also be applicable to
governing banking activities.

These cooperative banks cater to the needs of agriculture, retail trade, small and medium
industry, and self-employed businessmen usually in urban, semi-urban, and rural areas. In the
case of co-operative banks, the shareholders should be members of the co-operative banks. The
share linkage to borrowing is a distinctive feature of a cooperative bank. The rural cooperative
sector in India plays a vital role in fulfilling the credit requirements of the rural agricultural
sector of India. In recent times, the rural credit flow through the rural cooperative sector has risen
substantially in order to keep pace with the growing demand for credit in the rural parts of India.
The Cooperative rural Credit Structure in our country are of the following types:

1. Short-Term Agricultural Credit Institutions - The short-term credit structure consists of the
Primary Agricultural Credit Societies (PACS) at the base level, which are affiliated at the district
level with the District Central Cooperative Bank (DCCB) and further into the State Cooperative
Bank (SCB) at the State level. Being a federal structure, the membership of the DCCB comprises
all the affiliated PACS and other functional societies and for the SCB, the members are the
affiliated DCCBs. The DCCB being the middle tier of the Cooperative Credit Structure, is
functionally positioned to deal with the concerns of both the upper and lower tiers. This very
often puts the DCCB in a position of balancing competing concerns. These DCCBs are providing
finance to more than 35 lakh farmers through about 1.15 lacs Primary Agricultural Cooperative
Societies (PACS).

2. Long-Term Agricultural Credit Institutions - The long-term cooperative credit structure

consists of the State Cooperative Agriculture & Rural Development Banks (SCARDBs) and
Primary Cooperative Agriculture & Rural Development Banks (PCARDBs) which are affiliated
with the SCARDBs. Loans are given to members on the mortgages of their land usually up to
50% of their value in some states or up to 30 times the land revenue payable in other states, duly
taking into account their need and repayment capacity.

Development Banks

With the introduction of financial sector reforms, many changes have been witnessed in the
domain of development banking. There are more than 60 Development Banking Institutions at
both the Central and State level. There are four major development banks that assist in extending
long-term lending and re-finance facilities to different areas of economy for the economic
development pertaining to small-scale and Medium industries, the Agricultural Sector, and the
Housing Sector. These financial institutions play a crucial role in assisting different segments
including the rural economic development.

1. National Bank for Agriculture and Rural Development (NABARD)

The National Bank for Agriculture and Rural Development (NABARD) was established in July
1982 by an Act of Parliament. It is the apex institution concerned with the policy, planning, and
operations in the field of agriculture and other rural economic activities. NABARD has evolved
several refinance and promotional schemes over the years and has been making constant efforts
to liberalize, broaden the base, and refine/ rationalize the schemes in response to field-level
needs.

NABARD undertakes several inter-related activities/services which fall under three broad
categories:

(a) Credit Dispensation: NABARD prepares for each district annually a potential linked credit
plan which forms the basis for district credit plans. It participates in the finalization of the
Annual Action Plan at block, district, and state levels and monitors the implementation of credit
plans at the above levels. It also provides guidance in evolving the credit discipline to be
followed by the credit institutions in financing production, marketing and investment activities of
rural farm and non- farm sectors.

(b) Developmental & Promotional: The developmental role of NABARD can be broadly
classified as: -

- Nurturing and strengthening of - the Rural Financial Institutions (RFIs) like

SCBs/SCARDBs, CCBs, RRBs etc. by various institutional strengthening initiatives.

- Fostering the growth of the SHG Bank linkage programme and extending essential support
to SHPIs NGOs/VAs/ Development Agencies and client banks.

- Development and promotional initiatives in farm and non-farm sector.

- Extending assistance for Research and Development.

- Acting as a catalyst for Agriculture and rural development in rural areas.

(c) Supervisory Activities - As the Apex Development Bank, NABARD shares with the Central
Bank of the country (Reserve Bank of India) some of the supervisory functions in respect of
Cooperative Banks and RRBs.

2. Small Industries Development Bank of India (SIDBI)

SIDBI was established in October 1989 and commenced its operation from April 1990 with its
Head Office at Lucknow as a development bank. It is the principal and exclusive financial
institution for the promotion, financing, and development of the Micro, Small and Medium
Enterprise (MSME) sector and for co-ordination of the functions of the institutions engaged in
similar activities. The prime aim of SIDBI is to support MSMEs by providing them the valuable
factor of production finance. A unique scheme of the credit guarantee for Micro and Small
Enterprises called CGTMSE has provided coverage to about 1 million with guarantee covers for
an aggregate loan amount of over 48,000 crores.

3. National Housing Bank (NHB)

National Housing Bank was set up in July 1988 as the apex financing institution for the housing
sector with the mandate to promote efficient, viable and sound Housing Finance Companies
(HFCs). Its functions aim at to augment the flow of institutional credit for the housing sector and
regulate HFCs. NHB mobilizes resources and channelizes them to various schemes of housing
infrastructure development. It provides refinance for direct housing loans given by commercial
banks and non-banking financial institutions. The NHB also provides refinance to Housing
Finance Institutions for direct lending for construction/purchase of new housing/dwelling units,
public agencies for land development and shelter projects, primary cooperative housing societies,
property developers. At present, it is a wholly owned subsidiary of Reserve Bank of India.

4. Export Import Bank of India (EXIM Bank)

Export-Import Bank of India was set up in 1982 by an Act of Parliament for the purpose of
financing, facilitating, and promoting India’s foreign trade. It is the principal financial institution
in the country for coordinating the working of institutions engaged in financing exports and
imports. Exim Bank is fully owned by the Government of India. Exim Bank helps Indian
companies in their globalization efforts through a wide range of products and services offered at
all stages of the business cycle, starting from import of technology and export product
development to export production, export marketing, pre-shipment and post-shipment and
overseas investment. Exim Bank supplements its financing programmes with a wide range of
value-added information, advisory and support services, which enable exporters to evaluate
international risks, exploit export opportunities and improve competitiveness, thereby helping
them in their globalization efforts.

STATE BANK OF INDIA

State Bank of India (SBI) is the oldest commercial bank in India. It was constituted under the
State Bank of India Act, 1955 (Act No. 23 Of 1955). It is an Indian Multinational public sector
bank and financial services statutory body with its headquarters in Mumbai, Maharashtra.
Through this Act, SBI replaced the Imperial Bank of India, which was the largest commercial
bank at that time, and acted as the Central Bank for British India.

The Imperial Bank was formed by merging the Bank of Madras, the Bank of Calcutta, and the
Bank of Bombay. The Government of India took control of the Imperial Bank of India in 1955,
with the Reserve Bank of India taking a 60% stake and renaming it as the State Bank of India.
Later In 2008, the Government of India acquired the Reserve Bank of India's stake in SBI to
remove any conflict of interest as the RBI is the country's banking regulatory authority.

The Bank was created to expand the banking facilities to the rural and semi-urban areas and to
transfer to it the undertaking of the Imperial Bank. The State Bank of India has been established
to operate on normal commercial principles, with the only difference that, unlike other
commercial banks in the country, it takes into consideration and responds in a progressively
liberal manner to the financial requirements of cooperative institutions and small-scale
industries, particularly in the rural areas of the country. The State Bank of India acts as an agent
of the Reserve Bank in all those places where the latter does not have its branches.

The main objectives of the State Bank are:

(i) To act in accordance with the broad economic policies of the government;

(ii) To encourage and mobilise savings by opening branches in rural and semi-urban areas and to
promote rural credit;

(iii) To provide financial help to the small scale and cottage industries;

(iv) To provide remittance facilities to the banking institutions.

(v) To extend financial help for the establishment of licensed warehouses and cooperative
marketing societies;

(vi) To establish government partnership in the provision of cooperative credit.

Functions:

1. As an agent of the Reserve Bank, the State Bank performs the following functions:

(i) It acts as the government’s bank, i.e., it collects money and makes payments on behalf of the
government and manages public debt.

(ii) It acts as the bankers’ bank. It receives deposits from and gives loans to commercial banks. It
also acts as the clearing house for the commercial banks, rediscounts the bills of exchange of the
commercial banks and provides remittance facilities to the commercial banks.

2. Ordinary Banking Functions:

The State Bank of India performs all kinds of commercial banking functions:

(i) It receives deposits from the public.

(ii) It gives loans and advances against eligible securities including goods, bills of exchange,
promissory notes, fully paid shares of companies, immovable property or documents of title,
debentures, etc.

(iii) It invests its surplus funds in government securities, railway securities and securities of
corporations and treasury bills.

3. Other Functions:

The State Bank of India also performs the following other functions:

(i) It buys and sells gold and silver.

(ii) It underwrites issues of stocks, shares, debentures, and other securities in which it is
authorised to invest funds.

(iii) It acts as an agent of cooperative banks.

(iv) It draws bills of exchange and grants letters of credit payable out of India.

(v) It administers, singly or jointly, estates for any purpose as executor, trustee or otherwise.
(vi) It buys bills of exchange payable out of India with the approval of the Reserve Bank; it
subscribes buys, acquires, holds and sells shares in the capital of banking companies.

Subsidiaries: Through the State Bank of India (Subsidiary Banks) Act, of 1959, major state-
associated banks were converted into subsidiary banks of State Bank of India. SBI holds not less
than 55% of the issued capital of each subsidiary bank.

At present, there are seven subsidiary banks of the State Bank of India:

(a) The State Bank of Bikaner and Jaipur;

(b) The State Bank of Hyderabad;

(c) The State Bank of Mysore;

(d) The State Bank of Patiala;

(e) The State Bank of Saurashtra;

(f) The State Bank of Travancore; and

(g) The State Bank of Indore.

FUNCTIONS OF COMMERCIAL BANKS

Page 75-79 of R.N. Chaudhary

SCHEDULED AND NON-SCHEDULED BANKS

Banks can be classified into scheduled and non- scheduled banks based on certain factors.

(a) Scheduled Banks: Scheduled Banks in India are the banks which are listed in the Second
Schedule of the Reserve Bank of India Act of1934. The scheduled banks enjoy several privileges
as compared to non-scheduled banks. Scheduled banks are entitled to receive refinance facilities
from the Reserve Bank of India. They are also entitled for currency chest facilities. Besides
commercial banks, cooperative banks may also become scheduled banks if they fulfill the criteria
stipulated by RBI.
(b) 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.

UNIT 2

POWERS AND FUNCTIONS OF RBI

Page 58-64 (POWERS OF RBI UNDER BANKING REGULATION ACT, 1949) and 440-464 of R.N.
Chaudhary

CREDIT CONTROL

The core business of a banking company is to lend money in the form of loans and advances.
Lending may be for short-term, medium-term, or long-term. Lending money can be on a secured
or unsecured basis to different kinds of borrowers for various purposes. RBI has to facilitate the
flow of an adequate volume of bank credit to industry, agriculture, and trade to meet their
genuine needs. At the same time, to keep inflationary pressures under check, it has to restrain
undue credit expansion and also ensure that credit is not diverted for undesirable purposes. As
the central monetary authority, the Reserve Bank’s chief function is to ensure the availability of
credit to the extent that is appropriate to sustain the tempo of development and promote the
maintenance of internal price stability. The Reserve Bank is empowered under the Banking
Regulation Act to issue directions to control loans and advances by banking companies. Reserve
Bank at its discretion may issue directions to all banking companies or to any particular banking
company. The Reserve Bank may determine the policy in respect of banks’ loans and advances
and issue directions from time to time. The instruments of credit control are of two types:

(a) General or Quantitative (b) Selective or Qualitative

(a) Under the General Credit Control, the instruments often employed by RBI are discussed
below:
1. Bank Rate Policy - The Bank rate has been defined in Section 49 of RBI Act as “ the standard
rate at which it (RBI) is prepared to buy or rediscount bills of exchange or other commercial
paper eligible to purchase under this Act. By varying the rate, the RBI can to a certain extent
regulate the commercial bank credit and the general credit situation of the country. The impact of
this tool has not been very great because of the fact that RBI does not have a mechanism to
control the unorganized sector.

2. Reserve Requirements - The Reserve Bank of India is vested with the powers to vary the CRR
and SLR as explained above. By varying reserve requirements, the RBI restricts/frees the flow of
funds by way of credit to different sectors of the economy. When SLR or CRR is increased by
RBI, It reduces commercial banks’ capacity to create credit and thus helps to check inflationary
pressures

3. Open Market Operations - Open market operations are a flexible instrument of credit control
by means of which the Reserve Bank on its own initiative alters the liquidity position of the bank
by dealing directly in the market instead of using its influence indirectly by varying the cost of
credit. Open market operations can be carried out by purchases and sales, by Central Bank, of a
variety of assets such as government securities (G-sec), commercial bills of exchange, Foreign
exchange, gold and even company shares. In practice, however, RBI confines to the purchase and
sale purchase of government securities including treasury bills. When the RBI purchases
government securities from the banks, the latest deposits with it tend to increase adding to the
cash reserves of banks and hence their capacity to expand credit increase. Conversely, when the
RBI sells securities to the banks, their deposits with RBI would get reduced, contracting the
credit base. The net result would be a contraction of credit and a reduction in money supply.

Repo Rate and Reverse Repo Rate:

Repos: The RBI introduced repurchase auctions (Repos) since December,1992 with regards to
dated Central Government securities. When banking systems experiences liquidity shortages and
the rate of interest is increasing, the RBI will purchase Government securities from Banks,
payment is made to banks and it improves liquidity and expands credit.

Reverse Repos: Since November, 1996 RBI introduced Reverse Repos to sell Govt. securities
through auction at fixed cut-off rates of interest. It provides short term avenues to banks to park
their surplus funds, where there is considerable liquidity and call rate has a tendency to decline.
These two rates are, now-a- days, commonly applied for reducing money supply or increasing it.

4. Moral Suasion - Moral Suasion indicates the advice and exhortations given by the Reserve
Bank to the banks and other players in the financial system, with a view to regulate and control
the flow of credit, generally, or to any one particular segment of the economy. This may be
attempted through periodical discussions/communications. With a substantial share of banking
business being in the public sector, this tool has proved effective.

5. Direct Action - This technique indicates the denial of the Reserve Bank to extend facilities to
the banks which do not follow sound banking principles or where the Reserve Bank feels the
capital structure of the bank is very weak. This is not attempted frequently but is used in rare
cases involving continual and wilful violations of policies of the Reserve Bank/Govt. of India.

(b) Under the Selective Credit Control, the authority of the Reserve Bank is exercised by
virtue of the provisions of Section 21 and 35 A of Banking Regulation Act. The Reserve Bank
may give directions to banks generally or to any bank or a group of banks in particular on
different aspects of granting credit, namely, –

(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 or other financial accommodation which may be made by
a bank to or the maximum amount of guarantees which may be given by a bank on behalf of any
one company, firm, association of persons or individuals, having regard to the bank’s financial
position such as paid-up capital, reserves and deposits and other relevant considerations, and

(d) the rate of interest and other terms of conditions subject to which advances or other financial
accommodation may be granted or guarantees may be given.

While the first two instruments control the quantum of credit, the third instrument works as a
leverage on the cost of credit. Selective Credit Control is imposed to manage the balance
between the supply and demand of the essential commodities. The main purpose of the Selective
Credit Control is to restrict the speculative hoarding of essential commodities using bank credit.
The restrictions on different types of loans and advance may be imposed from time to time by the
Reserve Bank of India according to the requirement of the situation as well.

SALIENT FEATURES OF BANKING REGULATION ACT, 1949

Banking Regulation Act, 1949 is an Act that provides a framework for regulating the banks of
India. The Act came into force on 16th March 1949. This Act monitors the day-to-day operations
of the bank. Under this Act, the RBI can licence banks, put regulation over shareholding and
voting rights of shareholders, look over the appointment of the boards and management, and lay
down the instructions for audits. RBI also plays a role in mergers and liquidation.

The banks were supervised under the Companies Act, 1913, but this Act was not sufficient to
regulate banks. The economy was not performing well, and this started to damage the banks.
Also, the concept of banks was mostly used by the upper-class people. Frauds were also one of
the reasons for the decline in the usage of banks. This gave a need to regulate the banking system
of India. As a result, the Banking Regulation Act was introduced in 1949.

Salient features of the Act

 Definition of various banking term - The Act has defined some terms such as banking,
banking company, branch office, etc. The term banking is defined as per Sec 5(i) (b), as
acceptance of deposits of money from the public for the purpose of lending and/or
investment. Such deposits can be repayable on demand or otherwise and withdrawable by
means of cheque, drafts, order or otherwise. Sec 5(i)(c) defines a banking company as any
company which handles the business of banking.

 Powers of RBI - Widening the powers of the Reserve Bank of India to enable it to come to
the aid of banking companies in times of emergencies. Assign power to RBI to appoint,
reappoint and removal of chairman, director and officers of the banks.

 Accounts and balance-sheet - The banking companies shall prepare a balance sheet and
profit and loss account on the last working day. Prescription of a special form of balance
sheet and conferring of powers on the Reserve Bank to call for periodical returns.
Inspection of books and accounts of a bank by Reserve Bank.
 Licensing of Banks - No banking company can carry out business in India unless it has
obtained a license from the RBI. RBI can hold the inspection of books before granting the
license. RBI can also cancel the license if the company stops carrying on banking business
in India.

 Prohibition of trading under Section 8 - According to Section 8 of the Banking Regulation

Act, a bank cannot directly or indirectly deal with buying or selling or bartering of goods.
However, it may barter the transactions relating to bills of exchange received for collection
or negotiation.

 Non-banking asset under Section 9 - A bank cannot hold any immovable property,
howsoever acquired, except for its own use, for any period exceeding seven years from the
date of acquisition thereof. The company is permitted, within a period of seven years, to
deal or trade in any such property for facilitating its disposal.

 Management under Section 10 - This rule states that every bank shall have one of its
directors as Chairman on its Board of Directors. It also states that not less than 51% of the
total number of members of the Board of Directors of a bank shall consist of persons who
have special knowledge or practical experience in accountancy, agriculture, banking,
economics, finance, law and co-operatives.

 Minimum capital under Section 11 - Section 11 (2) of the Banking Regulation Act,
1949,states that no bank shall commence or carry on business in India, unless it has
minimum paid- up capital and cash reserve prescribed by the RBI

 Payment of commission under Section 13 - According to Section 13, a bank is not

permitted to pay directly or indirectly by way of commission, brokerage, discount or
remuneration on issues of its shares in excess of 2.5% of the paid-up value of such shares.

 Payment of dividend under Section 15 - According to Section 15, no bank shall pay any
dividend on its shares until all its capital expenses (including preliminary expenses,
organization expenses, share selling commission, brokerage, amount of losses incurred and
other items of expenditure not represented by tangible assets) have been completely
written-off.
Conclusion - All the banking companies will be controlled under the Banking Regulation Act,
1949. This Act provides a proper structure to the banking system in India. The Act puts
restrictions on the banks to avoid fraud and protect the interests of the depositors. It also states
the procedure for winding up the banking company. The Act also states the acquisition and
mergers of the banking companies. Thus, this Act led to the proper growth of the banking
companies which was lacking before 1949.

BANKING OMBUDSMAN

Refer to pages 419,420 and 421 of R.N. Chaudhary

The Banking Ombudsman Scheme was introduced under section 35A of the Banking Regulation
Act, 1949 by RBI. The Scheme was introduced in the Year 1995. The Banking Ombudsman
Scheme is a mechanism created by RBI to address the complaints raised by bank customers. It is
run by the RBI directly to ensure customer protection in the banking industry. The Banking
Ombudsman is a quasi-judicial authority functioning under the Banking Ombudsman Scheme,
2006.

According to RBI, “The Scheme enables an expeditious and inexpensive forum to bank
customers for resolution of complaints relating to certain services rendered by banks.”

The Banking Ombudsman is a senior official appointed by the RBI. He has the responsibility to
redress customer complaints against deficiencies in certain banking services. All Scheduled
Commercial Banks, Regional Rural Banks, and Scheduled Primary Co-operative Banks are
covered under the Scheme. The Banking Ombudsman can receive and consider any complaint
relating to a number of deficiencies related to banking operations including internet banking.

Scope of Banking Ombudsman Scheme:

Under the amended scheme, a customer would also be able to lodge a complaint against the bank
for its non-adherence to RBI instructions with regard to mobile banking/electronic banking
services in India.

As per the amendment, the pecuniary jurisdiction of the Banking Ombudsman to pass an award
has been increased from existing Rs. 10 lakhs to Rs. 20 lakhs.
Compensation not exceeding Rs. 1 Lakh can also be awarded by the Banking Ombudsman for
loss of time, expenses incurred, as also harassment, and mental anguish suffered by the
complainant.

The RBI extended the scope of the Banking Ombudsman Scheme under which banks could not
be penalized for mis-selling third-party products like insurance and mutual funds via mobile or
electronic banking.

Powers and Functions of Ombudsman:

1. An important function of the Ombudsman is to protect the rights and freedoms of citizens and
needless.

2. The ombudsman shall have the power to supervise the general civil administration. On this
point, the duty of the ombudsman is closely connected with the public administration. Because
the protection of freedom, execution of policies, and others fall within the jurisdiction of public
administration and whether these are properly performed or not requires to be examined by the
ombudsman.

A common experience is that people’s rights and freedoms are not properly protected, and public
administration does not always take care of it. In this regard, the Ombudsman has a lot of duties
to perform. In many states, the problems of common men are neglected and the general
administration does not always rise to the occasion.

3. In many states Ombudsman supervises the general administration. It is also called general
surveillance of the functioning of the government.

4. In some countries the Ombudsman enjoys enormous power. For example, in Sweden, the
Ombudsman has been empowered to investigate cases of corruption (in any form) not only
against government officers but also against the judges of the highest court. However, the
supervising power of the Ombudsman over the judges does not erode the independence of the
judiciary. The judges are prosecuted or fined for corruption, negligence of duties, or delay in
delivering judgment.
5. An important function of the Ombudsman is the exercise of discretionary powers. The
discretionary powers are really vast and how to use these powers depends upon the person
concerned.

6. To receive complaints relating to the provision of banking services to consider such

complaints and facilitate their satisfaction or settlement by agreement, by making a
recommendation, or award in accordance with this scheme.

7. The banking ombudsman's authority will include complaints concerning deficiency in service
such as:- non-payment/inordinate delay in the payment or collection of cheques, drafts/bills etc.;
non-acceptance, without sufficient cause, of small denomination notes tendered for any purpose,
and for charging of commission in respect thereof; non-issue of drafts to customers and others;
non-adherence to prescribed working hours by branches; failure to honour guarantee/letter of
credit commitments by banks.

Section 8 of the Reserve Bank - Integrated Ombudsman Scheme, 2021 enumerates the
Powers and Functions of the Ombudsman

(1) The Ombudsman/Deputy Ombudsman shall consider the complaints of customers of

Regulated Entities relating to deficiency in service.

(2) There is no limit on the amount in a dispute that can be brought before the Ombudsman for
which the Ombudsman can pass an Award. However, for any consequential loss suffered by the
complainant, the Ombudsman shall have the power to provide a compensation up to Rupees 20
lakh, in addition to, up to Rupees One lakh for the loss of the complainant’s time, expenses
incurred and for harassment/mental anguish suffered by the complainant.

(3) While the Ombudsman shall have the power to address and close all complaints, the Deputy
Ombudsman shall have the power to close those complaints falling under clause 10 of the
Scheme and complaints settled through facilitation as stated under clause 14 of the Scheme.

(4) The Ombudsman shall send to the Deputy Governor, Reserve Bank of India, a report, as on
March 31st of every year, containing a general review of the activities of the office during the
preceding financial year, and shall furnish such other information as the Reserve Bank may
direct.
(5) The Reserve Bank may, if it considers necessary in the public interest to do so, publish the
report and the information received from the Ombudsman in such consolidated form or
otherwise, as it may deem fit.

GROUNDS UNDER WHICH BANKING OMBUDSMAN MAY REJECT A COMPLAINT

Section 16 of the Reserve Bank - Integrated Ombudsman Scheme, 2021 enumerates when an
ombudsman can reject a complaint.

(1) The Deputy Ombudsman or the Ombudsman may reject a complaint at any stage if it appears
that the complaint made: (a) is non-maintainable under clause 10; or (b) is in the nature of
offering suggestions or seeking guidance or explanation

(2) The Ombudsman may reject a complaint at any stage if:

(a) in his opinion there is no deficiency in service; or

(b) the compensation sought for the consequential loss is beyond the power of the Ombudsman
to award the compensation as indicated in clause 8(2); or

(c) the complaint is not pursued by the complainant with reasonable diligence; or

(d) the complaint is without any sufficient cause; or

(e) the complaint requires consideration of elaborate documentary and oral evidence and the
proceedings before the Ombudsman are not appropriate for adjudication of such complaint; or

(f) in the opinion of the Ombudsman there is no financial loss or damage, or inconvenience
caused to the complainant.

DEPOSIT INSURANCE CORPORATION

After the banking crisis in Bengal in the years 1946 and 1948, it became an important task to
come up with a scheme to insure the deposits which were kept in banks by the general public and
the concept of deposit insurance came into the picture. After the crash of Laxmi Bank Ltd. and
later Palai Central Bank Ltd. in the year 1960, the Central Government as well as the Reserve
Bank of India became vigilant on this issue and subsequently introduced ‘The Deposit Insurance
Corporation (DIC) Bill in the parliament on 21st August 1961. The bill came into force on 1st
January 1962. Further, the Central Government introduced a Credit Guarantee scheme in 1960
after recommendations from the Reserve Bank of India. The Credit Guarantee Organization
guaranteed the advances (loans) by banks and other financial institutions to the people who
belonged to the weaker and neglected sections of the society. The two organizations, namely,
Deposit Insurance Corporation and Credit Guarantee Organization were merged on 15th July
1978, and a new organization in the name of Deposit Insurance and Credit Guarantee
Corporation (DICGC) came into existence.

DICGC is a subsidiary wholly owned by the Reserve Bank of India. The main purpose of the
organisations is to provide insurance to the deposits in banks and also to give a guarantee on loan
facilities from the banks to a selected class of society. The deposit insurance scheme is
mandatory for each and every bank currently present in India.

The Corporation maintains 3 different types of funds, namely, ‘Deposit Insurance Fund’, ‘Credit
Guarantee Fund’, and ‘General Fund’. The deposit insurance fund is maintained through
insurance premiums obtained from the banks and the credit guarantee funds are maintained from
guarantee fees received at the time of grant of loan. These two funds are used to settle any claims
occurring in respective fields. The general funds are utilized in maintaining the establishment of
the corporation and other administrative expenses. Any surplus amount from all these three
categories of funds is further invested in Central Government securities only as permitted under
Deposit Insurance and Credit Guarantee Corporation (DICGC) Act, 1961 and any income
obtained from such investments is added in these funds. The corporation has the power to
transfer amount from one category of a fund to another.

Salient features of the Act

1. Deposit insurance is a protection cover for deposit holders in a bank when the bank fails and
does not have money to pay its depositors.

2. This insurance is provided by Deposit Insurance and Credit Guarantee Corporation (DICGC)
which is a wholly owned subsidiary of the RBI.
3. DICGC insures all bank deposits, such as savings, fixed, current and recurring deposit for up
to the limit of Rs 5 lakh per bank.

4. If the total of all the deposits held by an individual in a single bank exceeds Rs 5 lakh, then he
will be able to get only Rs 5 lakh inclusive of principal and interest amount if the bank goes
bankrupt.

5. DICGC covers depositors of all commercial banks and foreign banks operating in India, state,
central and urban co-operative banks, local area banks and regional rural banks provided the
bank has bought the cover from DICGC.

What exactly does DICGC insure?

All Deposits such as savings, fixed, current, recurring, etc. are normally insured by DICGC
except for the deposits which are specifically mentioned below:

1. Any deposits made by any Foreign Government.

2. Deposits of Central Government or any of the State Governments.

3. Deposits made by any State Land Development Banks with a State Co-operative Bank.

4. On the amount due on account of any deposit which is received outside India which might be
of any amount.

5. Various inter-bank deposits.

6. The corporation can specifically exempt any deposit with prior approval from the Reserve
Bank of India
UNIT 3

RELATIONSHIP BETWEEN BANKER AND CUSTOMER

Synopsis:

1. Who is a bank or banker?

2. Who is a customer?

3. Services rendered by a bank

4. Relation of a bank vis-à-vis customers

Bank

There is a difference of opinion as to the origin of the word "Bank". According to some
authorities, the word "BANK" itself is derived from the word "BANCUS", "BANQUE" or
"BANGUE", which is a bench. Earlier, the Jews, transacted their business on benches in the
marketplace, whereas the word "BANKRUPT" is derived from the Italian word "BANCA
ROTTA", which means broken bench.

There are others who are of the opinion that the word "BANK" is originally derived from the
German word "BACK" meaning a joint stock fund that was Italianized into "BANCO".

The common approach of a bank is banking business and whoever does banking business is a
bank or banker.
Section 3 of the Negotiable Instruments Act, 1881 defines the term banker which includes any
person acting as a banker and any Public Office Savings Bank.

The Banking Regulation Act, of 1949 defines a banking company: "as a company which
transacts the business of banking in India." [Section 5(c)]

The definition of the words "Banking" and "Banking Company" under Sections 5(b) and 5(c)
respectively make them inter-dependent which reads as: "Banking means the accepting for the
purpose of lending or investment, of deposits of money from the public, repayable on demand or
otherwise and withdrawable by cheque, draft, order or otherwise. Banking Company means any
company which transacts the business of banking in India." [Section 5 (b)]

From the above definition, it is clear that if any institution fulfills the following conditions, it will
satisfy the definition of a banking company:

(a) Accepting of deposits from the public, repayable on demand or otherwise, the deposits may
be of different types, current, savings, fixed, etc. and on various terms and conditions.

(b) Such deposits must be withdrawable by cheques, drafts, order or otherwise.

(c) Any money accepted as deposits must be for the purpose of lending or investment.

(d) The institution must be a Company as defined in Section 3 of the Companies Act, 1956. Even
a foreign company within the meaning of Section 591 of the Companies Act, 1956, will be
considered a banking company if it performs the functions stated in (a), (b) and (c) above.

Customer

There is no statutory definition of customer in England or in India. To constitute a customer the

following requisites must be fulfilled:

1. a bank account-saving, current or fixed deposit must be opened in the name of customer.

2. the dealings between the banker and customer must be of the nature of the banking business.

Services rendered by Banks: (Banking Services)

Before we take up the relationship that exists between a banker and his customer, let us
understand the various types of services rendered by modern bankers to their customers. The
services rendered by commercial banks may be classified into :-

(i) General Services to Depositors and Borrowers

(ii) Ancillary Services

(iii) Special Services

(iv) General Utility Services for all.

(i) General Services: [Services to depositors and borrowers]

Banks open various types of deposit accounts and render the following services to the depositors
and borrowers:

1. Opening and maintaining various types of account, such as current account, saving bank
account, fixed deposit account.

2. Collection of cheques, demand drafts, bills of exchange, promissory notes, hundis, inland and
foreign documentary and clear bills.

3. Purchase and sale of local and foreign currency.

4. Purchase and sale of securities certificate, shares, bonds, debentures, foreign letters of credit,
depository etc.

5. Issuing of bank guarantees.

6. Carrying out the standing instructions for the payment of insurance, premium, subscriptions,
certain taxes and gifts remittances.

7. Granting of advances by means of cash credit, overdraft, and loan accounts.

8. Providing remittance facilities such as bank drafts, mail and telegraphic transfers, electronic
transfer.
(ii) Ancillary Service

9. Safe custody of deeds and securities.

10. Safe deposit vault.

11. Collection of interest on securities/debentures and dividend on shares, collection of pension

bills.

12. Executors and trustees.

13. Personal tax assistance, preparing income tax, sales tax, wealth tax returns.

14. Investment facilities-Underwriting, guidance to investment, guidance as to new issues, stock

exchange assistance.

15. Credit transfers.

16. Executors and Trustees.

(iii) Special Banking Services

17. Issue of Credit Cards, Smart Cards, Letter of Comfort, Letter of Indication.

18. E-Banking.

19. Online Banking.

20. Automated Teller Machine (ATM).

21. Universal Banking.

22. Bio-Banking,

(iv) General Utility Services for all

We shall now deal with the miscellaneous utility services rendered by modern banks, i.e.,
services in the performance of which the banker's position is not that of an agent for his
customer. The chief among these are:
Dealing in foreign exchanges; Providing a specialised advisory service to customers; Safe
Deposit Vault; Credit transfers; Credit cards; Travellers' cheques; Gift cheques; Emergency
vouchers; etc.

Relationship Between Banker and Customer

Relation between banker and customer is consensual depending on the express or implied
contract between the two. Thereby a contractual relationship springs between the banker and the
customer. In the case of banking where a person asks the banker to open an account for him and
the banker's acceptance thereof, constitutes an implied contract of relationship.

The main banking function was and is to keep in custody other people's money and lending a
part of it. Gradually, these functions were extended, and new others were added. It would be
proper to say that the banking system has assumed the blood vessel of the economy of the
country. Nowadays bankers have to deal with a large number of matters.

Relation of banker and customer depends upon the service given by the banker. In addition to his
primary functions, a banker renders a number of services to his customers. Having in view of the
functions of banks and services rendered by banks the relationship of banker and customer may
be classified under following heads:

1. Debtor and Creditor

2. Trustee and Beneficiary

3. Principal and Agent

4. Trader and Consumer

5. Bailee and Bailor

6. Guarantor and Beneficiary.

Besides these the following may also be mentioned:

7. Mortgager and Mortgagee

8. Pawnor and Pawnee

9. Lessor and Lessee

*Refer to written notes.

Trader and Customer (Consumer)

The Consumer Protection Act, of 1986 is one of the social legislations intended to protect
consumers from exploitation. Banking Institutions used to give banking services to their
customers for consideration (commission).

Section 2(7) of Consumer Protection Act, 2019 defines consumer and it includes any person
who:

1. buys or uses goods for consideration, and 2. hires or avails any service for consideration.

Banking is the business of banks and it includes services rendered by the bank. Banking means
the accepting, for the purpose of lending or investment of deposit of money from the public,
repayable on demand or otherwise, and withdrawable by cheque, draft, or otherwise. When
banks advance loans or accept deposit or provide facility of locker, they undoubtedly render
service. A State Bank or nationalised bank renders as much service as private banks. The
legislative intent is thus clear to protect consumers against services rendered even by statutory
bodies. Banks provide services/facilities to its customers and non-customers. A bank renders
various facilities or services such as provisions of remittances, accepting deposits, provisions of
lockers, facility of cheques, collection of cheques, issue of bank drafts or facility of loan etc., to
customers or non-customer.

In Vimal Chandra Grover v. Bank of India, the Supreme Court has held that banking is business
transaction of a bank and customers of bank are consumers within the meaning of Section 2(1)
(d) of the Consumer Protection Act, 1986.

Guarantor and Beneficiary

Bank Guarantee

Now-a-days bank guarantee has become very common. Guarantor is one who gives a promise to
answer for the payment of some debt or the performance of some duty in the case of failure of
another person, who, in the first instance, is liable to such payment or performance. A bank
issues letter of credit for its customers. It is a kind of credit facility to its customer, hence
customer's position remains as a beneficiary. The extent of the liability of the guarantor is
determined by the terms of the agreement or contract of guarantee. Such relation is governed
under Sections 124 to 147 of the Contract Act, 1872.

A bank is bound to pay the amount under a bank guarantee as soon as demanded unless there is a
Court stay order.

Mortgager and Mortgagee

"Mortgager" is one who transfers an interest in specific immovable property by creating a

mortgage. Generally, it is made for the purpose of securing the payment of money advanced or to
be advanced by way of a loan, an existing or future debt or performance of an agreement which
may give rise to pecuniary liability.

A customer of the bank often takes advances from the bank on the security of immovable
property. The customer is "mortgagor' and the bank is "mortgagee" and their relation is governed
under the provisions of the Transfer of Property Act, 1882.

Pawnor and Pawnee

A customer of the bank takes loan from the bank by way of security of moveable property is
called pawnor (pledgee) and the relation between customer and banker stands pawnor (pledgor)
or pawnee (pledgee). A pawn is a sort of bailment in which goods or chattels are delivered to
another as a pawn, to be a security of money borrowed.

Special Features of Relationship between Banker and Customer

These rights and duties of the bankers and customers are called the special features of the
relationship between them. This special relationship between bankers and their customers may be
studied in the following headings :

I. The general obligations of a banker towards a customer.

II. The rights of the bankers.

III. The obligations and rights of the customers.

I. Banker's Obligations: Statutory Duties of Banks

The general obligations of a banker towards its customers can be grouped as under :

1. Obligation (duty) to honour cheques.

2. Obligation to maintain secrecy of accounts.

3. Obligation to honour guarantee.

4. Obligation to honour letter of credit.

5. Obligation of recovery of debts by legal means.

6. Dropping box for collection of cheques and banks liability.

7. To maintain correct account of the customer.

8. Obligation of banker not to convert excess credit as overdraft.

1. Obligation (duty) to honour cheques

The deposits accepted by a banker are his liabilities repayable on demand or otherwise. The
banker is, therefore, under a statutory obligation to honor his customer's cheques in the usual
course. The banker is bound to honour his customer's cheques provided following conditions are
fulfilled:

i. There must be sufficient funds –

Sufficient funds are meant funds at least equal to the amount of the cheques presented. The funds
must be sufficient in the hands of the banker. The banker credits the amount of such cheques to
the account of the customer on their realisation. A banker should, therefore, be given sufficient
time to realise the amount of the cheques sent for collection before the said amount is drawn
upon by the customer. If the customer draws a cheque on such unrealised amounts, the banker
will be justified in dishonouring the cheques with the remark 'Effect not cleared'.
It is to be noted that the funds in the hands of the drawee banker must be equal to or more than
the amount of the cheques presented for payment. The banker is directed by the drawer to pay a
specified sum of money to the payee and if such sum is not in the hands of the banker at the time
of presentation of the cheque, the latter is under no obligation to make part payment of the
cheque. He would, therefore, be justified in refusing payment of the cheque.

ii. The funds must be properly applicable to the payment of the cheque –

A customer might be having several bank accounts in his various capacities. But it is essential
that the account on which a cheque is drawn must have sufficient funds. If some funds are
earmarked by the customer for some specific purpose, the said funds are not available for
honouring his cheque.

The banker's obligation to honour the cheques is further extended if an agreement is reached
between the banker and the customer, either expressly or impliedly, whereby the banker agrees to
sanction an overdraft to the customer. In such cases the banker's obligation to honour the
customer's cheques is extended up to the amount of overdraft sanctioned by him. If the banker
subsequently reduces the limit of overdraft or withdraws it altogether, he must honour the
cheques issued by the customer before the notice of such reduction or withdrawal is served upon
him. Sometimes an obligation also emerges out of the past practice followed by the banker. For
example, if the banker has honoured the cheques of a customer on several occasions in the past
without sufficient funds and later on requested the customer to make good the deficiency in his
account, an implied arrangement to overdraw the account is presumed to exist. The banker
should not discontinue such practice without giving prior notice to the customer.

iii. The banker must be duly required to pay and the presentment of the cheque should within a
reasonable time –

The banker is bound to honour the cheques only when he is duly required to pay. This means that
the cheques, complete and in order, must be presented before the banker at the proper time.
Ordinarily a period of six months is considered sufficient within which a cheque must be
presented for payment. On the expiry of this period the cheque is treated as stale and the banker
dishonours the cheque. Similarly, a post-dated cheque is also dishonoured by the banker because
the order of the drawer becomes effective only on the date given in the cheque.
iv. Presentation of cheques within working hours of business –

Cheque must be presented within working hours of the bank. According to Section 65 of
Negotiable Instruments Act presentment for payment must be made during the usual hours of
business and, at a bank within banking hours. The banker should honour the cheque if it is
presented within the 'working hours' on a 'working day' and should not pay after banking hours.

v. Presentment of cheque at the branch where account is kept –

The cheque should be presented at the branch where the account is maintained, therefore, the
customer must make demand on that branch. In Delhi Cloth and General Mills Co. Ltd. v.
Harnam Singh, it was held that the obligation of a bank to pay cheque of a customer rests
primarily on the branch at which he keeps his account and the bank can rightly refuse to cash a
cheque at any other branch.

vi. Not a case of justified dishonor –

There should not be cases of justified dishonour of cheque. The bank has valid conditions for
dishonour of cheques e.g., undated, post dated cheques, mutilated cheques, cheques with material
alteration, where amount differs in words and figures, death and insolvency of drawer etc., bank
is not liable to pay undated cheque.

Short Note on Garnishee Order -

Garnishee Order - The obligation of a banker to honour his customer's cheques is extinguished
on receipt of an order of the Court, known as the Garnishee Order, issued under Order XXI Rule
46 of the Code of Civil Procedure, 1908. If a debtor fails to pay the debt owed by him to his
creditor, the latter may apply to the Court for the issue of a Garnishee Order on the banker of his
debtor. Such order attaches the debts, not secured by a negotiable instrument, by prohibiting the
creditor from recovering the debt and the debtor from making payment thereof. The account of
the customer with the banker thus, becomes suspended and the banker is under an obligation not
to make any payment from the account concerned after the receipt of the Garnishee Order. The
creditor, on whose request the order is issued, is called the judgment creditor; the debtor whose
money is frozen is called judgment debtor and the banker who is the debtor of the judgment
debtor is called the Garnishee.
The Garnishee Order is issued in two parts. First, the Court directs the banker to stop payments
out of the account of the judgment debtor. Such order, called Order Nisi, also seeks explanation
from the banker as to why the funds in the said account should not be utilised for meeting the
judgment creditor's claim. The banker is prohibited from paying the amount due to his customer
on the date of receipt of the Order Nisi. He should, therefore, immediately inform the customer
so that dishonour of any cheque issued by him may be avoided. After the banker files his
explanation, if any, the Court may issue the final order, called Order Absolute whereby the entire
balance in the account or a specified amount is attached to be handed over to the judgment
creditor. On receipt of such an order the banker is bound to pay the garnished funds to the
judgment creditor and his liability towards his customer is discharged to that extent. The
suspended account may be revived after payment has been made to the judgment creditor as per
the directions of the Court.

2. Obligation to maintain Secrecy of Accounts

The account of the customer in the books of the banker records all of his financial dealings with
the latter and 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 banker should not disclose customer's financial position and the nature and the details of his
account to anybody, since it may effect his reputation, credit worthiness and business. Even
though, this practice came into vogue as early as in 1868 in Hardy v. Veasay, it was firmly rooted
only in 1924 in leading case, popularly known as Tournier case. Tournier was a temporary
employee in M/s. Kenyan Co. and he was to be made a permanent employee. He overdrew from
the said Bank Rs. 9856 and agreed to pay by weekly instalments. One day Tournier did not
attend to duty. The Director of the Kenyan & Co. telephoned the Bank Manager to know his
address. In their conversation the Bank Manager revealed that Tournier had taken an overdraft
and made payment to book maker. The Director misconceived the information and came to
conclusion that Tournier has turned to be a gambler and was in practice of betting, and also he
was insolvent. Hence, he did not make him permanent and ousted him from the employment.
This caused Tournier a grievance and he filed a suit against the banker for not keeping the
secrecy of the customer, and for the compensation of the job he lost. The Lower Court dismissed
his petition but the Court of Appeal allowed his appeal and gave judgment for him.

In India, the obligation of Indian Bankers to maintain secrecy was made compulsory in 1970.
The nationalised banks in India are also required to fulfil this obligation. Section 13 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, specifically requires
banks to observe 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 customary among bankers, necessary for
them to divulge such information. Thus, the general rule about the secrecy of customers'
accounts may be dispensed with in the following circumstances:

I. When the law requires such disclosure to be made; and

II. When the practices and usages amongst the bankers permit such disclosure.

I. Disclosure of Information Required by Law

A banker is under a statutory obligation to disclose the information relating to his customer's
account when the law specifically requires him to do so. The banker would therefore, be justified
in disclosing information to meet the following statutory requirements:

(i) Under the Income-Tax Act, 1961- According to Section 131, the income-tax authorities
possess the same powers as are vested in a Court. under the Code of Civil Procedure, 1908, for
enforcing the attendance of any person including any officer of a banking company and
examining him on oath and compelling the production of books of accounts and other documents
and issuing commissions. Section 133 empowers the income-tax authorities to require any
person, including a banking company or any officer thereof, to furnish information in relation to
such points or matters, or to furnish statements of accounts and affairs giving information in
relation to such points or matters, as in the opinion of the income-tax authorities will be useful
for or relevant to any proceedings under the Act. The income-tax authorities are thus authorised
to call for necessary information from the banker for the purpose of assessment of the bank's
customers.

(ii) Under the Companies Act, 1956 - When the Central Government appoints an Inspector to
investigate the affairs of any joint stock company under Section 235 or 237 of the Companies
Act, 1956, it shall be the duty of all officers and other employees and agents (including the
bankers) of the company to-

(a) produce all books and papers of or relating to the company, which are in their custody or
power, and

(b) otherwise to give to the Inspector all assistance in connection with the investigation which
they are reasonably able to give.

Thus, the banker is under an obligation to disclose all information regarding the company but not
to any other customer for the purpose of such investigation (Section 251).

(iii) By order of the Court under the Banker's Books Evidence Act, 1891 - When the Court orders
the banker to disclose information relating to a customer's account, the banker is bound to do so.
In order to avoid the inconveniences likely to be caused to the bankers from attending the Courts
and producing their account books as evidence, the Bankers' Books Evidence Act, 1891,
provides that certified copies of the entries in the bankers' books are to be treated as sufficient
evidence and production of the books in the Courts cannot be forced upon the bankers. Thus, if a
banker is not a party to a suit, a certified copy of the entries in his books will be sufficient
evidence. The Court is also empowered to allow any party to legal proceedings to inspect or copy
from the books of the banker for the purpose of such proceedings.

(iv) Under the Reserve Bank of India Act, 1934 - The Reserve Bank of India collects credit
information from banking companies and also furnishes consolidated credit information to any
banking company. Every banking company is under a statutory obligation under Section 45-B of
the Reserve Bank of India Act, 1934, to furnish such credit information to the Reserve Bank. The
Act, however, provides that the credit information supplied by the Reserve Bank to the banking
companies shall be kept confidential. After the enactment of the Reserve Bank of India
(Amendment) Act, 1974, the banks are granted statutory protection to exchange freely credit
information mutually among themselves.

(v) Under the Banking Regulation Act, 1949 - Under Section 26, every banking company is
required to submit a return annually of all such accounts in India that have not been operated
upon for 10 years. Banks are required to give particulars of the deposits standing to the credit of
each such account.

(vi) Under the Gifts Tax Act, 1958.- Section 36 of the Gifts Tax Act, 1958 confers on the Gift
Tax authorities powers similar to those conferred on Income-Tax authorities under Section 131 of
the Income-Tax Act [discussed above (i)].

(vii) Disclosure to Police - Under Section 94 of the Criminal Procedure Code, the banker is not
exempted from producing the account books before the police. The police officers conducting an
investigation may also inspect the banker's books for the purpose of such investigations.

(viii) Under the Foreign Exchange Regulation Act, 1973 - Banking companies dealing in foreign
exchange business are designated as 'authorized dealers' in foreign exchange. Section 43 of this
Act empowers the officers of the Directorate of Enforcement and the Reserve Bank to inspect the
books and accounts and other documents of any authorized dealer and also to examine on oath
such dealer or its director or officials in relation to its business. This Act stands now repealed.

(ix) Under the Industrial Development Bank of India Act, 1964. After the insertion of sub-section
(I-A) in Section 29 of this Act in 1975, the Industrial Development Bank of India is authorized to
collect from or furnish to the Central Government, the State Bank, any subsidiary bank,
nationalised bank or other scheduled bank, State Co-operative Bank, State Financial Corporation
credit information or other information as it may consider useful for the purpose of efficient
discharge of its functions, in such manner and at such times, as it may think fit. The term 'credit
information' shall have the same meaning as under the Reserve Bank of India Act, 1934.

II. Disclosure Permitted by Banker's Practices and Usages.

The practices and usages customary amongst bankers permit the disclosure of certain
information under the following circumstances:

(a) With Express or Implied Consent of the Customer - The banker will be justified in disclosing
any information relating to his customer's account with the latter's consent. The consent of the
customer may be express or implied. Express consent exists in case the customer directs the
banker in writing to intimate the balance in his account or any other information to his agent,
employee or consultant. The banker would be justified in furnishing to such person only the
required information and no more. It is to be noted that the banker must be very careful in
disclosing the required information to the customer or his authorised representative. For
example, if an oral enquiry is made at the counter, the bank employee should not speak in louder
voice so as to be heard by other customer. Similarly, the pass-book must be sent to the customer
through the messenger in a closed cover. A banker generally does not disclose such information
to the customer over the telephone unless he can recognise the voice of his customer, otherwise
he bears the risk inherent in such disclosure.

In certain circumstances, the implied consent of the customer permits the banker to disclose
necessary information. For example, if the banker sanctions a loan to a customer on the
guarantee of a third person and the latter asks the banker certain questions relating to the
customer's account the banker is authorised to do so because by furnishing the name of the
guarantor, the customer is presumed to have given his implied consent for such disclosure. The
banker should give the relevant information correctly and in good faith.

Implied consent should not be taken for granted in all cases even where the customer and the
enquirer happen to be very closely related. For example, the banker should not disclose the state
of a lady's account to her husband without the express consent of the customer.

(b) The banker may disclose the state of his customer's account in order to legally protect his
own interest. For example, if the banker has to recover the dues from the customer or the
guarantor, disclosure of necessary facts to the guarantor or the solicitor becomes necessary and is
quite justified.

(c) Banker's References - Banker follows the practice of making necessary enquiries about the
customers, their sureties or the acceptors of the bills from other bankers. This is an established
practice amongst the bankers and is justified on the ground that an implied consent of the
customer is presumed to exist. By custom and practice necessary information or opinion about
the customer is furnished by the banker confidentially. However, the banker should be very
careful in replying to such enquiries.

(d) Duty to the Public to Disclose - Banker may justifiably disclose any information relating to
his customer's account when it is his duty to the public to disclose such information. In practice
this qualification has remained vague and placed the banks in difficult situation. The Banking
Commission, therefore, recommended a statutory provision clarifying the circumstances when
banks should disclose in public interest information relating to the affairs of their customers by
enumerating some specific cases cited below:

(a) when a bank is asked for information by a Government official concerning the commission of
a crime and the bank has reasonable cause to believe that a crime has been committed and that
the information in the bank's possession may lead to the apprehension of the culprit;

(b) where the bank considers that the customer is involved in activities prejudicial to the interests
of the country;

(c) where the bank's books reveal that the customer is contravening the provisions of any law,
and

(d) where sizable funds are received from foreign countries by a constituent.

Risks of Unwarranted and Unjustifiable Disclosure

The obligation of the banker to keep secrecy of his customer's accounts except in circumstances
stated above continues even after the account is closed. If banker discloses information
unjustifiably, he shall be liable to his customer and the third party as follows:

(a) Liability to the customer - The customer may sue the banker for the damages suffered by
him as a result of such disclosure. A substantial amount may be claimed if the customer has
suffered material damages. Such damages may be suffered as a result of unjustifiable disclosure
of any information or extremely unfavorable opinions about the customer being expressed by the
banker.
(b) Liability to the third parties - The banker is responsible to the third parties also to whom
such information is given, if- (i) the banker furnishes such information with the knowledge that it
is false, and (ii) such party relies on the information and suffers losses.

Such a third party may require the banker to compensate him for the losses suffered by him for
relying on such information. But the banker shall be liable only if it is proved that he furnished
the wrong or exaggerated information deliberately and intentionally. Thus, he will be liable to the
third party on the charge of fraud but not for innocent misrepresentation Mere negligence on his
part will not make him liable to a third party as no contractual relationship exists between the
banker and the third party.

3. Obligation to honor guarantee

Bank guarantee plays a very significant role in credit transactions. Bankers usually give
guarantee for their customers in contractual or commercial transactions. Though there is no
specific statutory provision but according to uniform customs and practices for Documentary
Credits bank guarantee given by the bank must be honored, except in the following two
conditions: 1. In case of fraud, and 2. Where irreparable loss or damages may arise.

Bank guarantee amounts to service to the customer and, therefore, failure to honor it amounts to
deficiency in service.

4. Obligation to honor letter of Credit

Banks are also liable to honor letters of credit similar to Bank guarantees.

5. Obligation as to recovery of debts

Lending of money to needy person is the main function of the bank. The interest on the lending
of money is the main source of income of the bank. Recovery of loan is the moot question for
banks. It has been held in Manager, ICICI Bank Ltd. v. Prakash Kaur, that recovery of bank
loan should be made through legal means and not by hiring recovery agent, muscle-man. Banks
are under obligation to take recourse for recovery of load by lawful means only.

6. Dropping of cheques in drop boxes for collection

In all cases of cheques payments are made through bankers. These cheques may either be open or
cross cheques. Open cheques may be encashed by the payee or endorsee (in case of
endorsement). Whereas crossed cheques including account payee cheques are not allowed to be
paid in cash. Such cheques have to be deposited to the bank for collection; known as collecting
bank.

Who will be the collecting bank? It will depend upon the nature of the crossing. In case of
ordinary or general crossing any bank in India may act as a collecting bank. But in case of
specific crossing only that bank may act as a collecting bank in whose name it has been
specifically crossed and no other bank may act as a collecting bank, because Section 129
provides that crossed cheques are to be paid through bankers and specific crossed cheques
through banker in whose name it has been specifically crossed.

So, cheques have to be deposited for collection. A collecting bank gives this service to the
customer only. This service of the bank is very significant having in view of the working of the
cheques. To avail this service a person has to open a account in the bank. Deposit of cheques is
sine qua non for collection. It is to be borne in mind that not only crossed cheques are deposited
for collection but open cheques are also deposited for collection. If the holder of an open cheque
or holder having no account in any bank (which is not now possible for a person to go without
bank account) will encash the cheque at the counter of the bank. Payment of cheques through
collection has become order of the day because it is very convenient and quite safe for the person
who is entitled for payment i.e., payee or endorsee and the writer of cheques i.e., drawer as well.

Remedies for refusal

The following remedies are available to the customer in case where he is denied
acknowledgment of cheques :

1. Customer may approach the apex bank i.e., Reserve Bank of India. R.B.I. notification provides
that if a bank fails to comply with the drop box order, a customer can approach the R.B.I.'s
customer service department for non-observance of R.B.I.'s circular and notification.

2. Customer may approach the Banking Ombudsman for the denial of R.B.I.'s notification.
3. Customer may also complain to Consumer Forum since it very well comes within the
definition of service rendered by the banks to their customers.

4. Customer may also approach to Indian Banks Association (I.B.A.) since it also constitutes the
Banking Ombudsman as per R.B.I. official.

Now customers can send a photo of the cheque to the bank. Bank after verifying it can transfer
the amount to the account of the customer. For this customer must download an application on
the smartphone the photocheque. After that, a customer sending the photocheque on the website
of the bank can encash the cheque.

7. Obligation (duty) to maintain correct account of the customer

It is a very significant duty of the banker to maintain correct account of the customer because
maintenance of account is in the domain of the bank. Account holder cannot be held responsible
for the mistake which has been committed by the officials of the bank. It is the duty of the bank
to reconcile and give true statement of account to the account holder. That duty, cannot be shifted
to the account holder when this account holder has not availed any benefit either in terms of
overdraft facilities or loan facilities.

8. Not to convert excess credit as overdraft

It is evident from the principle laid down the Delhi High Court in State Bank of India v.
National Open School Society that excess credit with account of the customer due to mistake of
officials of Bank cannot be converted into overdraft. It is not the duty of the account holder to
reconcile or to discover the mistake committed by the Bank or its officials. If the mistake was not
discovered in time it is the bank who did not perform its statutory duty. More so, Bank cannot
claim interest on such amount treating it as overdraft. But it has been ruled that amount
inadvertently transferred in account is debt and can be recoverable.

II. Banker’s Right

The rights of the banker may be grouped as follows:

1. Banker's right of general lien.

2. Banker's right of set-off.

3. Banker's right of appropriation of payment.

4. Banker's right to claim incidental charges.

5. Banker's right to compound interest.

1. Right of General Lien

One of the important rights enjoyed by a banker is that of general lien. Lien means the right of
the creditor to retain the goods and securities owned by the debtor until the debt due from
him is paid. It confers upon the creditor the right to retain the security and not the right to sell
it. Such right can be exercised by the creditor in respect of goods and securities entrusted to him
by the debtor with the intention to be retained by him as security for a debt due by him (debtor).

Lien may be either (i) a general, or (ii) a particular lien. A particular lien can be exercised by a
craftsman or a person who has spent his time, labour and money on the goods retained. For
example, a tailor has the right to retain the clothes made by him for his customer until his
tailoring charges are paid by the customer. A general lien, on the other hand, is applicable in
respect of all amounts due from the debtor to the creditor. Section 171 of the Indian Contract Act,
1872, confers, in the absence of a contract to the contrary, the right of general lien on, besides
others, the bankers who are authorised to retain the goods and securities bailed to them in respect
of the general balance due by their owners to them.

Section 171 of Indian Contract Act provides general lien of the following persons:

(i) Bank or Bankers (ii) Factors (iii) Wharfingers (iv) Attorneys of High Courts (v) Policy
Brokers.

Special Features of a Banker's Lien

(i) The banker possesses the right of general lien on all the goods and securities entrusted to
him in his capacity as a banker and in the absence of a contract inconsistent with the right
of lien. Thus, he cannot exercise his right of general lien if-
 (a) the goods and commodities have been entrusted to the banker as a trustee or as agent of
the customer; and

(b) a contract-express or implied-exists, between the customer and the banker which is
inconsistent with the banker's right of general lien. In other words, if the goods or
securities are entrusted for some specific purpose, the banker cannot have a lien over them.

(ii) A banker's lien is tantamount to an implied pledge. As noted above the right of lien does
not confer on the creditor the right of sale but only the right to retain the goods till the loan is
repaid. In case of pledge the creditor enjoys the right of sale. A banker's right of lien is more than
a general lien. It confers upon him the power to sell the goods and securities in case of default by
the customer. Such right of lien thus resembles a pledge and is usually called an 'implied pledge'.
The banker thus enjoys the privileges of a pledge and can dispose of the securities after giving
proper notice to the customer.

(iii) The right of lien is conferred upon the banker by the Indian Contract Act. No separate
agreement or contract is, therefore, necessary for this purpose. However, to be on the safe side
the banker takes a letter of lien from the customer mentioning that the goods are entrusted to the
banker as security for a loan-existing or future-taken from the banker and that the latter can
exercise his right of lien over them. The banker is also authorised to sell the goods in case of
default on the part of the customer.

(iv) The right of lien can be exercised on goods or other securities standing in the name of
the borrower only and not jointly with others. For example, in case the securities are held in the
joint names of two or more persons the banker cannot exercise his right of general lien in respect
of a debt due from a single person.

(v) The banker can exercise his right of lien on the securities remaining in his possession after
the loan, for which they were lodged, is paid by the customer, if no contract to the contrary
exists. In such cases it is an implied presumption that the customer has re-offered the same
securities as a cover for any other advance outstanding on that date or taken subsequently.

Exceptions to the Right of Lien

As already noted the right of lien can be exercised by a banker on the commodities entrusted to
him in his capacity as a banker and without any contract contrary to such right. Thus, the right of
lien cannot be exercised in the following circumstances:

i. Safe custody deposits - When a customer deposits his valuables securities, documents,
ornaments, etc.,- with the banker for safe custody, he entrusts them to the banker as a bailee or
trustee with the purpose to ensure their safety from theft, fire, etc. The banker cannot exercise his
right of general lien over such valuables.

ii. Documents deposited for special purpose - If a customer sends a bill of exchange or any other
document with the specific instruction to utilise its proceeds for any specific purpose, a contract
inconsistent with the right of lien is presumed to exist. For example, if he directs the banker to
collect the process of a bill of exchange on its maturity and utilise the same for honouring a bill
of exchange on his behalf, the amount so realised will not be subject to the right of general lien.

But if no specific purpose is mentioned by the customer, the banker can have lien on bills or
cheques sent for collection or dividend warrants, etc. If the security comes into the possession of
the banker in the ordinary course of business, he can exercise his right of general lien.

iii. Money deposited for specific purpose - If a customer deposits money or earmarks a credit
balance for a specific purpose, e.g., for the purpose of purchasing securities, etc., the banker
cannot exercise his right of lien over it. It is essential that the intention of the customer is
communicated to the banker through a proper notice.

iv. Securities left with the banker negligently - The banker does not possess the right of lien on
the documents or valuables left in his possession by the customer by mistake or by negligence.

v. The banker cannot exercise his right of lien over the securities lodged with him for securing a
loan, before such loan is actually granted to him.

vi. Securities held in Trust - The banker cannot exercise his right of general lien over the
securities deposited by the customer as a trustee in respect of his personal loan.

vii. On deposit in accounts - A banker has lien upon the deposits account of the customer in
respect of a loan account due upon the same customer. In Brahammaya v. K.P. Thangavelu
Nadar, it was held that when moneys are deposited in a bank as a fixed deposit, the ownership of
the money passes to the bank and the right of the bank over the money lodged with it would not
be really a lien at all and it would be more correct to say of it as a right of set-off or adjustment.

2. Banker's Right of Set-off

In simple words, the mutual claims of debtor and creditor are adjusted and only the remainder
amount is payable by the debtor. A banker, like other debtors, possesses this right of set-off
which enables him to combine two accounts in the name of the same customer and to adjust the
debit balance in one account with the credit balance in the other. For example, A has taken an
overdraft from his banker to the extent of Rs. 5,000 and he has a credit balance of Rs. 2,000 in
his savings bank account, the banker can combine both of these accounts and claim the
remainder amount of Rs. 3,000 only. This right of set-off can be exercised by the banker if there
is no agreement-express or implied-contrary to this right and after a notice is served on the
customer intimating the latter about the former's intention to exercise the right of set-off. To be
on the safer side the banker takes a letter of set-off from the customer authorising the banker to
exercise the right of set-off without giving him any notice.

The right of set-off can be exercised subject to the fulfilment of the following conditions:

(i) The accounts must be in the same name and in the same right - The first and the most
important condition for the application of the right of set-off is that the accounts with the banker
must not only be in the same name but also in the same right. By the words 'the same right' is
meant that the capacity of the account-holder in both or all the accounts must be the same, i.e.,
the funds available in one account are held by him in the same right or capacity in which a debit
balance stands in another account. The underlying principle involved in this rule is that funds
belonging to someone else, but standing in the name of the account holder, should not be made
available to satisfy his personal debts.

(ii) The right can be exercised in respect of debts due and not in respect of future debts or
contingent debts - For example, a banker can set off a credit balance in the account of a
customer towards the payment of a bill which is already due but not in respect of a bill which
will mature in future. If a loan given to a customer is repayable on demand or at a future date, the
debt becomes due only when the banker makes a demand or on the specified date and not earlier.
(iii) The amount of debts must be certain - It is essential that the amount of debts due from
both the parties to each other must be certain. If liability of any one of them is not determined
exactly, the right of set-off cannot be exercised. For example, if A stands as guarantor for a loan
of Rs. 50,000 given by a Bank to B, his liability as guarantor will arise only after B defaults in
making payment. For this purpose, it is essential that the banker must first demand payment from
his debtor. If the latter defaults in making payment of his debt, only then the liability of the
guarantor arises, and the banker can exercise his right of set-off against the credit balance in the
account of the guarantor.

(iv) The Right may be exercised in the absence of an agreement to the contrary. - If there is
an agreement-express or implied-inconsistent with the right of set-off, the banker cannot exercise
such right.

(v) The banker may exercise this right at his discretion - For the purpose of exercising this
right all the branches of a bank constitute one entity and the bank can combine two or more
accounts in the name of the same customer at more than one branch.

(vi) The banker has the right to exercise this right before the Garnishee Order is made
effective - In case a banker receives a Garnishee Order in respect of the funds belonging to his
customer, he has the right first to exercise his right of set-off and thereafter to surrender only the
remainder amount to the judgment creditor.

Automatic Right of Set-off.

The right of set-off all accounts arises immediately in the following instances:

(1) on the death, mental incapacity or insolvency of a customer; (2) on the insolvency of a firm;
(3) on the liquidation (winding up) of a company; (4) on the receipt of a Garnishee Order; and
(5) on receiving the notice of a second mortgage over security charged to the bank.

3. Right of Appropriation (Rule in Clayton's Case)

In the course of his usual business, a banker receives payments for his customer. If the latter has
more than one account or has taken more than one loan from the banker, the question of
appropriation of the money subsequently deposited by him naturally arises. In such cases he has
the right to direct the banker to appropriate the amount to either of the two accounts. For
example, if a customer has taken an overdraft from the banker and also possesses a credit
balance in another account, he may direct the banker, at the time of depositing any sum, to credit
the same to any of the two accounts specified by him. In the absence of any such direction from
the customer, the banker shall have the right to appropriate the payment to any debt or account
according to his discretion. He should inform the customer accordingly.

The rule derived from the Clayton's case is of great practical significance to the bankers. In case
of death, retirement or insolvency of a partner of a firm, the then existing debt due from the firm
is adjusted or set-off by subsequent credits made in the account. The banker thus losses his right
to claim such debt from the assets of the deceased, retired or insolvent partner and may
ultimately suffer the loss if the debt cannot be recovered from the remaining partners. Therefore,
to avoid the operation of the rule given in the Clayton's case the banker closes the old account of
the firm and opens a new one in the name of the reconstituted firm. Thus, the liability of the
deceased, retired or insolvent partner, as the case may be, at the time of his death, retirement or
insolvency is determined and he may be held liable for the same. Subsequent deposits made by
surviving/solvent partners will not be applicable to discharge the same.

Rules as to appropriation have been provided under Sections 59 to 61 of Indian Contract Act,
1872.

They provide appropriation as follows:

(1) Appropriation by the Debtor. (Section 59)

(2) Appropriation by the Creditor. (Section 60)

(3) Appropriation by the Law. (Section 61)

(i) Appropriation by the Debtor Section 59 provides: "Where a debtor, owing several distinct
debts to one person, makes payment to him, either with express intimation or under
circumstances implying that the payment is to be applied to the discharge of some particular
debt, the payment if accepted must be applied accordingly."
In Vasudeo v. Mandeo, it has been held that where money is paid by a debtor with express or
implied intimation that money is to be applied to a particular debt, creditor, if accepts the
payment, must appropriate the money received accordingly to the direction of the debtor.

(ii) Appropriation by the Creditor - Section 60 provides: "Where the debtor has omitted to
indicate, and there are no other circumstances indicating to which debt the payment is to be
applied, the creditor may apply at his discretion to any lawful debt actually due and payable to
him from the debtor…"

(iii) Appropriation by Law - Section 61 provides: "Where neither party makes any
appropriation, the payment shall be applied in discharge of the debts in order of time, whether
they are or are not barred by the law in force for the time being as to the limitation of suits. If the
debts are of equal standing, the payment shall be applied in discharge of them proportionately."

4. Banker's Right to Charge Interest, Incidental Charges, etc.

As a creditor, a banker has implied right to charge interest on the advances granted to the
customer. Bankers usually follow the practice of debiting the customer's account periodically
with the amount of interest due from the customer. The agreement between the banker and the
customer may, on the other hand, stipulate that interest may be charged at compound rate also.
Banks also charge incidental charges on the current accounts to meet the incidental expenses on
such accounts.

5. Right to ask Succession Certificate

In Shanti Devi v. Bhojpur Rohtash Gramin Bank, National Commission has held unfair
practice of Bank to ask for succession certificate in all cases. In this case National Commission
has given a very significant judgment that asking succession certificate in all the cases by the
Bank is not just and proper.

6. Right to publish defaulting borrowers

Bank has right to prepare borrower's list and publish the same. This significant judgment was
given by the Madhya Pradesh High Court in Km. Archana Chaudhary v. State Bank of India. In
this case creditor Bank published photographs of defaulting borrowers under the provisions of
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 which was assailed by the borrowers as defamatory or arbitrary. In the opinion of the court
publication of photographs of the borrowers cannot be said to be an impermissible mode. Action
cannot be said to be defamatory, arbitrary or illegal in any manner, hence Court found no ground
to quash the publication. Principle of law laid down in this case warrants publication with
photographs of defaulting borrowers.

III. The obligations and rights of customers to his banker

By opening of an account with the banker, there will be some rights conferred and
responsibilities (duties) imposed on the customer. The customer has rights and duties too. There
are no specific statutory provisions in the Act but customers have such rights and duties by the
relationship between the banker and customer which they have. The obligations of customer may
be summarised as follows:

1. Not to draw cheques without sufficient fund.

2. Drawing cheques with reasonable care.

3. To repay overdrawings.

4. To pay reasonable charges for services rendered by the banker.

5. To inform or communicate facts affecting genuineness of the transaction.

6. To make a demand for repayment of deposits.

1. Not to draw cheques without sufficient fund

The customer on his part undertakes to draw cheques within the balance available to him. In case
the balance is not sufficient to meet the drawings, it is expected from a customer to make some
kind of arrangement to meet his cheques. In the absence of any arrangement, the banker is
justified in returning the cheques at the cost and consequences of the customer.

2. Drawing Cheques with reasonable care

It is expected that the customer undertakes to exercise reasonable care in drawing his cheques so
as to avoid misleading the banker or facilitating material alteration. As a result of customer's
fault, if the banker pays more than he ought to, the banker may not be held responsible for the
excess payment.

Banks particularly request the constituents to: (i) keep the cheque book under lock and key,(ii)
fill in the body of the cheques before delivery, (ii) fill in the amount in words as near as possible
to the word “Rupees” and the amount in figures as nearly as possible in “Rs.”

3. To repay overdrawings

Bankers generally allow overdraft facility having in view the credit worthiness, market
reputation etc. of the customer. No banker likes that the reputation of his valuable customer is
damaged on account of dishonour of cheque. It is the duty of the customer to repay such
overdrawings.

4. To pay charges of the bank

A customer is bound to pay all reasonable charges which the banker has incurred by providing
facilities to the customer. By right of customer, a banker is entitled to levy incidental charges on
current accounts and this practice is so well established that it would be legally enforceable.

A banker has a right to be fairly and adequately compensated for the services which he renders to
his customer. A banker makes available to his customers diversified services like issue of
demand draft, locker facility, traveler cheques, MICR cheques, credit cards, ATM facility etc.
Reasonable charges of these facilities may be adequately paid for.

5. To communicate or inform facts

It is the binding duty of the customer that he must communicate the banker as to forgery of his
signature on the cheque or missing of his cheque book or pass book etc. The customer should
immediately notify the bank if he discovers that another person has forged his signature to
cheques drawn on his account.

6. To make demand for repayment of deposit

Though banks borrow money from the public they are privileged debtors. The general principle
that a request by the creditor for payment is unnecessary, does not apply to banking. According
to the law of limitation in India, a debt payable on demand is time-barred after three years,
irrespective of whether a demand is made by the creditor on the debtor. In case of bank deposits,
however, the limitation starts running from the date the customer makes a demand on the banker.
A deposit may remain for more than three years, say, 10 or 12 years, but the amount can still be
claimed by the depositor from the bank. The period of limitation starts running from the date of
such a demand. Bankers have hardly been known to decline payment of the debts (deposits) on
grounds of limitation.

SPECIAL TYPES OF BANKER'S CUSTOMERS

A banking institution solicits deposits of money from the members of the public. An account in a
bank for this purpose may be opened by any person who (i) is legally capable of entering into a
valid contract, and (ii) applies to the banker in the proper manner, i.e., he follows the procedure
laid down by the banker and accepts the terms and conditions stipulated by the latter. The banker,
however, possesses the right to reject an application for opening an account, if he is not satisfied
with the identity of the applicant, i.e., if the latter is deemed to be an undesirable person. Some
persons like the minors, lunatics and drunkards, are not competent to enter into valid contracts.
Some persons who act on behalf of others have limitations on their power to contract, e.g., the
agents, trustees, executors, etc. Institutions like schools, colleges, clubs, societies, and corporate
bodies are the impersonal customers of a banker. The authority, powers and functions of the
persons managing these institutions are embodied in their respective constitutions. The banker
should, therefore, take special care and precautions to ensure that the accounts of these
institutions are being conducted in accordance with the provisions of their respective character.

Minor

A person who has not completed 18 years of age is a minor. If a guardian of his person or
property is appointed by the Court before he completes 18th year, he remains minor till he
completes his 21st year. According to the Indian Contract Act, 1872, a minor is not capable of
entering into a valid contract and a contract entered into by a minor is void. A banker should,
therefore, be very careful in dealing with a minor and take the following precautions:

1. The banker may open a savings bank account (and not a current account) in the name of a
minor in any of the following ways:

(i) In the name of the minor himself; (ii) In the joint names of the minor and his/her guardian;
and (iii) In the name of the guardian in the following style: "XYZ, natural guardian of minor
ABC." In case of (i) and (ii) above, it is essential that the minor must have attained the age of 14
years and he can read or write English, Hindi or a regional language.

2. The bank records the date of birth of the minor as given by the minor or his guardian. On the
attainment of majority, the account of the minor in the name of the guardian should be closed and
the balance paid to the minor (then major) or be transferred to a new account in his own name.

3. If the guardian dies before the minor attains majority, the balance appointed by a competent
should be paid to the minor on his/her attaining majority or to a person Court as the guardian of
the property of the minor.

4. In case the minor dies, the balance in the account is permitted to be withdrawn by the guardian
and in case of joint account the balance will be held at the absolute disposal of the guardian.

5. No risk is involved if an account is opened in the name of a minor so long as the account is not
overdrawn by the minor. But if an overdraft or advance is granted to a minor, even by mistake or
unintentionally, the banker has no legal remedy to recover the amount from the minor. The assets
of a minor pledged with the banker as security for the advance taken by the minor are not legally
available to the banker because such pledge itself is invalid. The banker shall have to return these
securities to the minor and he cannot exercise his right of sale in case of default by the minor.

6. If an advance is granted to a minor on the guarantee of a third party, such advance cannot be
recovered from the guarantor also because the contract of guarantee is invalid on the ground that
the contract between the creditor and the principal debtor (minor) itself is a void contract.
According to the law, a minor cannot enter into a valid contract and he cannot undertake a
liability upon himself. Thus, he cannot default.
7. A minor may draw, endorse or negotiate a cheque or a bill but he cannot be held liable on such
cheque or bill. He cannot be sued in respect of a bill accepted by him during his minority. The
banker should, therefore, be very cautious in dealing with a negotiable instrument, to which a
minor is a party.

8. A minor can be admitted to the benefit of partnership with the consent of all the partners but he
will not be liable for the losses or debts of the firm. Within six months after he attains majority
he should repudiate his liability as a partner otherwise he will be held liable as a partner of the
firm from the date he was admitted to the benefit of the partnership.

9. On attaining majority the guardian ceases to be account holder and such person will become
legally entitled to operate such account.

10. But no cheque book should be issued to the minor.

11. A minor may be appointed as an agent to act on behalf of his principal. According to Section
184 of the Indian Contract Act, 1872, as between the principal and third parties, any person may
become an agent; but no person who is not of the age of majority and of sound mind can be
appointed as an agent so as to be responsible to his principal. Thus, a minor agent cannot be held
responsible to his principal. The principal may be held responsible to the third parties in respect
of the acts of his minor agent. Therefore all of his dealings with the banker will be valid and
binding on his principal. The banker should obtain written authority of the principal specifying
the powers and the extent of authority entrusted to the agent in this regard and should see that the
minor agent does not deal beyond such declared powers.

Married Women

A married woman is competent to enter into a valid contract. The banker may, therefore, open an
account in the name of a married woman. In case of a debt taken by a married woman, her
husband shall not be liable except in the following circumstances :

(i) if the loan is taken with the consent or authority of the husband; and
(ii) if the debt is taken for the supply of necessaries of life to the wife, in case the husband
defaults in supplying the same to her.

The husband shall not be liable for the debts taken by his wife in any other circumstance. The
creditor may in that case recover his debt out of the personal assets of the married woman. While
granting a loan to a married woman, the banker should, therefore, examine her own assets and
ensure that the same are sufficient to cover the amount of the loan.

Pardanashin Women

A pardanashin woman observes complete seclusion in accordance with the custom of her own
community. She does not deal with the people, other than the members of her own family. As she
remains completely secluded, a presumption in law exists that:

(i) any contract entered into by her might have been subject to undue influence; and (ii) the same
might not have been made with her free will and with full understanding of what the contract
actually means. Thus, a contract entered into by a pardanashin woman is not a contract free from
all defects. The other party to the contract shall have to prove that the contract with her was free
from the abovementioned defects in order to enforce the same. The banker should, therefore, take
due precaution in opening an account in the name of a pardanashin woman. As the identity of
such a woman cannot be ascertained, the banker generally refuses to open an account in her
name.

Illiterate Persons

Illiterate persons cannot sign their names and hence the bankers take their thumb impressions as
a substitute for signature, and also a copy of their recent photograph, attested by a first class
Magistrate, for the purpose of identification.

Lunatics

According to the Indian Contract Act, 1872, a person of unsound mind is not competent to enter
into a valid contract. A person is said to be of sound mind for the purpose of making a contract if
he is capable of understanding it and of forming a rational judgment as to its effect upon his
interests. It is important that he should be of sound mind at the time he enters into a contract. If a
person is usually of unsound mind but occasionally of sound mind, he may make a contract when
he is of sound mind. A contract entered into by a person of unsound mind is a void contract
according to the Indian Contract Act, 1872. The banker should, therefore, not open an account in
the name of a person who is of unsound mind.

UNIT 4

Negotiable Instruments

The Negotiable Instruments play very significant role in modern commercial world. Now they
have attained fame as a principal instruments in making payments and to fulfil commercial
liabilities. A negotiable instrument is transferable instruments fulfilling prescribed conditions and
freely transferable to various hands to hands and in this way considered inseparable from modern
business mechanism.

Section 13 of the Negotiable Instruments Act, 1881 makes it clear that "negotiable instrument"
means:

(i) promissory note, or

(ii) bill of Exchange, or

(iii) Cheque.

Payable either to order or to bearer.

Having in view the working and characteristics of the these instruments we can sum up a
negotiable instrument as a piece of paper which entitles a person to a sum of money and
which is transferable from person to person by mere delivery or by endorsement and
delivery. The person to whom it is so transferred becomes entitled to the money and also to the
right to further transfer it.

I. Promissory Note (Section 4)

Promissory note is known as pronote and in local language Teep or Rukha. Section 4 of the Act
defines as: A "promissory note" is an instrument in writing (not being a bank-note or a currency-
note) 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.

Illustrations

A signs instruments in the following terms

(a) "I promise to pay B or order Rs. 500."

(b) "I acknowledge myself to be indebted to B in Rs. 1,000, to be paid on demand, for value
received."

(c) "Mr. B 1.O.U. Rs. 1,000."

(d) "I promise to pay B Rs. 500 and all other sums which shall be due to him."

(e) "I promise to pay B Rs. 500 first deducting thereout any money which he may owe me."

(f) "I promise to pay B Rs. 500 seven days after my marriage with C."

(g) "I promise to pay B Rs. 500 on D's death, provided D leaves me enough to pay that sum."

(h) "I promise to pay B Rs. 500 and to deliver to him my black horse on 1st January next."

II. The Bill of Exchange (Section 5)

Section 5 of the Negotiable Instruments Act, 1881 defines Bill of Exchange as follows:

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.

Parties to Bill of Exchange

In a bill of exchange there are three parties

1. Drawer, who draws bill of exchange and orders his debtor to pay a certain sum of money.

2. Drawee, the acceptor who is directed to pay under the instrument.

3. Payee; the person (holder) who is to be paid.

III. Cheque (Section 6)

Cheque is the most significant negotiable instrument. Section 6 of the Act defines cheque as
follows: A "cheque" is a bill of exchange drawn on a specified banker and not expressed to be
payable otherwise than on demand and it provides the electronic image of a truncated cheque and
a cheque in the electronic form.

Parties to a cheque

Like a bill of exchange, there are three parties of a cheque, namely:

(i) Drawer who draws cheque,

(ii) Drawee i.e., to whom order for payment is made. It is to be noted that under a cheque drawee
is always a banker who is directed to pay. This is the fundamental difference between a bill and a
cheque. Any person including a bank can be drawee in case of bill of exchange while only a
banker (bank) can only be drawee in case of a cheque.

(iii) Payee is the person who is to receive payment under a cheque.

DIFFERENCE BETWEEN PROMISSORY NOTE AND BILL OF EXCHANGE

Though there are many similarities between promissory note and bill of exchange namely: must
be in writing, payment of money, certain sum, stamping, negotiability of both and presumption
as to consideration, however there are following fundamental differences between them:

(1) As to Parties. There are two parties i.e., maker and payee in a promissory note whereas there
are three parties in a bill of exchange, namely, Drawer, Drawee and Payee.

(2) As to liability. In promissory note the liability of the maker is primary where as in bill
liability of the drawer is secondary and drawee's liability is primary.

(3) Regarding order. Promissory note involves unconditional promise or undertaking of

payment whereas bill of exchange contains an unconditional order for payment.

(4) As to acceptance. Bill of exchange requires acceptance of the drawee and without it privity
of the contract does not arise between the parties. Whereas promissory note does not require
acceptance. Since the date of issue it creates privity of contract between the parties.
(5) As to relation of parties. In promissory notes payee has direct relation to the maker where in
case of bill of exchange payee has direct relation with acceptor and not with maker (drawer) of
the bill.

(6) As to dishonour. (i) A promissory note is dishonoured only by non-payment whereas a bill of
exchange can be dishonoured by non-acceptance and by non-payment as well thereof. (ii) In case
of dishonour of promissory note the notice thereof to other parties is not required whereas in case
of dishonour of bill notice thereof to other parties is necessary.

(7) Debtor and Creditor. In promissory note there exist a relation of debtor and creditor
between maker and payee. Whereas in case of bill of exchange such relation of debtor and
creditor exist between drawee and drawer.

(8) Bill of exchange taken as promissory note. Section 17 provides that where an instrument
may be construed either as a promissory note or bill of exchange, the holder may at his discretion
treat it as either and the instrument shall be thenceforward treated accordingly. But in the
following cases the holder may treat bill of exchange as a promissory note: (i) Where in a bill of
exchange drawer and drawee is one person. (ii) Where in a bill of exchange drawee is
incompetent person.

DIFFERENCE BETWEEN CHEQUE AND BILLS OF EXCHANGE

In nature, cheque and bill of exchange are the same because a cheque is bill of exchange,
however there are fundamental differences between the two which can be explained in following
heads:

(1) As to drawee. A cheque is always drawn on a banker whereas a bill of exchange may be
drawn on any person including a bank.

(2) Payable on demand. A cheque is always payable on demand whereas a bill may be payable
on demand and otherwise i.e., after a fixed period.

(3) Payable to bearer on demand. A cheque may be issued payable to bearer on demand
whereas a bill cannot be issued payable to bearer on demand.
(4) Acceptance. A bill is required acceptance of the drawee before payment but a cheque is not
required any acceptance of the drawee bank.

(5) Drawn on funds. A cheque is always drawn on funds of the drawer (customer) but in bill of
exchange there is no such fund of the drawer in the hands of the drawee.

(6) Maturity. A cheque is mature for payment since the date of issue but a bill becomes mature
for payment according to maturity rules.

(7) Days of Grace. A bill is required 3 days of grace for the acceptance of drawee. There is no
such provision in case of cheques.

(8) Crossing. Cheques may be crossed but bill of exchange except the bank drafts cannot be
crossed.

(9) Stamping. Bill of exchange must be stamped but cheques do not require stamping.

(10) Printed form. Cheques are always in printed form but bills are not so.

(11) Penal Offence. Dishonour of cheques for insufficient fund constitutes a penal offence but
dishonour of bill of exchange does not constitute penal offence. (Section 138, Negotiable
Instruments Act)

(12) On death of drawer. Payment of cheque is stopped by the bank in case of death and
insanity of drawer. But death of drawer of bill makes the heirs liable for payment.

(13) Validity period. A cheque normally remains valid for six of months from its date of issue,
whereas there is no such provision in bill exchange.

DIFFERENCE BETWEEN CHEQUE AND PROMISSORY NOTES

Both are negotiable instruments; Section 4 defines promissory notes whereas Section 6 defines
cheque. Followings are the point of difference between them:

1. By whom written. Cheques are written by customer (creditor) upon the bank but promissory
notes are written by debtor for the creditor.
2. Parties. In cheques drawer, drawee and payee are three original parties but a promissory note
has only two parties i.e., maker and payee.

3. Nature. Cheque contains an order to pay while a note contains promise (undertaking) of
payment.

4. Certain Form. Every banks has its own printed cheque in a certain form whereas note has no
any prescribed form.

5. Payment in case of death of Noter/Drawer. Bank stops payment of cheque in case of death
or insanity of the drawer. But heirs of the deceased noter of the note becomes liable under the
note.

6. Crossing. Cheques can be crossed but there is no provisions of crossing of note.

7. Stamping. Cheques are not required to be stamped but note must be stamped.

8. Penal offence. Drawing of cheques for insufficiency of funds is a penal offence but there is no
such penal offence in note bill of exchange.

9. Discounting. Cheques are not discounted whereas notes are discounted.

10. Validity period. A cheque remains valid for payment within six months from the date of
issue but there is no such provision in case of note.

11. Electronic form. There is statutory provision that a cheque may be in electronic form with
digital signature but there is no such provision for promissory note.

ENDORSEMENT
Meaning of Endorsement -

Endorsement means signing at the back of the instrument for the purpose of negotiation.
The act of the signing a cheque, for the purpose of transferring to the someone else, is called the
endorsement of Cheque. The endorsement is usually made on the back of the cheque. If no space
is left on the Cheque, the Endorsement may be made on a separate slip to be attached to the
Cheque.
Section 15 of the Act defines as: "When the maker or holder of a negotiable instrument signs the
same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof or
on a slip of paper annexed thereto, or so signs for the same purpose a stamped paper intended to
be completed as a negotiable instrument, he is said to endorse the same, and is called 'endorser'.

Place of endorsement

Section 15 of the Act makes it clear and according to it will be made:

(i) on the face of the instrument, or

(ii) on the back of the instrument, or

(iii) on a slip annexed thereto, called 'allonge", or (iv) on a stamp paper.

Generally endorsement is made on the back of the instrument and if there is no place, vacant for
further endorsement then it is made on a separate piece of paper called 'allonge'. Endorsement
may also made on the face of it, but since all material facts are written on the face, so it is
generally avoided on the face of the instrument.

General Principles of Endorsement, or Conditions to a valid Endorsement, or Rules of

Endorsement.

In order to be effective endorsement it must be regular and valid. Followings are the general
principles or conditions of a valid endorsement:

(1) Endorsement must be made on the instrument itself. If there is no place then on a separate
piece of paper known "allonge".

(2) It must be signed by the endorser or his duly authorised person. Where there are joint
endorser then it must be signed by all of them. Signing in block letters will not amount to
signature of the endorser.

(3) All endorsement should be made in ink only. Endorsement in pencil will also be valid but
such endorsement are liable to alteration so they are discouraged.
(4) Typewritten endorsement is also allowed. Even endorsement in printed character can be
accepted. But in practice, bankers do not normally allow it, as it can be duplicated very easily.

(5) A rubber stamp endorsement must be followed by the handwritten signature of the endorser.

(6) Endorsement shall be made by the authorised person. No stranger can make endorsement.

(7) Endorsement must be followed by the delivery because without delivery no endorsement will
be complete.

(8) Endorsement must be made for whole of the amount of endorsement.

(9) The endorser should spell his name in the same way as his name appears on the instrument as
its payee or endorsee. If his name is misspelled or his designation has been given incorrectly he
should sign the instrument in the same manner as given in the instrument, thereafter he may also
put his proper signature if he likes to do so.

Merely writing the correct name will not be the regular endorsement. An initial or name should
neither be added nor omitted from the name of the payee or endorsee as given in the cheque. For
example, a cheque payable to S.C. Gupta should not be endorsed as S. Gupta or vice versa.

(10) Endorsement by illiterate person. If the payee of a negotiable instrument is an illiterate

person, he may endorse the instrument by affixing his thumb impression thereon. It should be
duly witnessed or attested by somebody who should give his full address thereon.

(11) The prefixes or suffixes to the names of the payee or endorsee nino no need not be included
in the endorsement. For example, the words "Mr., Messrs, Mrs., Miss, Shri, Shrimati, Lala,
Babu, General, Dr., Major, etc". need not be given by the endorser otherwise the endorsement
will not be regular. However, an endorser may indicate his title or rank, etc., after his signature.
For example, a cheque payable to Major Raja Ram or Dr. Laxmi Chandra may be endorsed as
'Raja Ram, Major' or 'Laxmi Chandra, Dr.".

(12) If the cheque or bill of exchange is payable to a married woman, the endorsement should be
as follows:
If a cheque is payable to a woman in her maiden name, e.g., to Miss Asha Rastogi now married
to Mr. S.C. Gupta, she may endorse it as follows:

Asha Rastogi

(Now Mrs. S.C. Gupta) Or

Asha Gupta

nee (or formerly) Asha Rastogie

(13) In case of a partnership firm, the name of the firm must be signed by a person (partner,
manager, etc.) who is duly authorised to sign on behalf of the partnership firm. But if the two
partners sign without showing that they are the partners in the firm, the endorsement will not be a
regular one.

(14) A person may duly authorise his agent to endorse the cheques on his behalf. The agent
should, therefore, use the words 'for', for and on behalf of", 'on behalf of". Per Procurationem or
'Per Pro', etc., in the endorsement which will indicate that he is signing as the representative of
his principal and not as principal himself.

(15) In case of joint stock companies, institutions and associations, etc., endorsement should be
made by persons who are duly authorised to sign on behalf of these institutions. The signatory
must give his capacity or official position to indicate his authority to sign the cheques on behalf
of his institution.

Types of Endorsement
#1 – Blank/General

In this case, the endorser places only their signature on the negotiable instrument and does not
write the name of a party who will receive the payment.

#2 – Full/Special

If the endorser, in addition to his signature, also 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 [Sec.
16(1)]. If, for example, A, the holder of a bill of exchange, wants to make an endorsement in full
to B, he would write thus: “Pay to B or order, SdA4.” After such an endorsement it is only the
endorsee, i.e., B, who is entitled to receive the payment of the instrument and to further negotiate
the instrument by his endorsement. A blank endorsement can easily be converted into an
endorsement in full.

#3 – Restrictive

This limits the principal features of an instrument and restricts its further negotiability. Endorsers
have the right to prohibit the subsequent transfer of an instrument. It prevents the risk of the
drawer losing their money owing to fraud or forgery.
The endorsee under a restrictive endorsement gets all the rights of an endorser except the right of
further negotiation. In other words, such an endorsement entitles the endorsee to receive the
payment on due date and sue the parties for it but he cannot further negotiate the instrument.
Illustrations: (a) B, the holder of the bill, makes an endorsement on the bill saying “Pay C only.”
It is a restrictive endorsement as C cannot negotiate the bill further.

#4 – Conditional

In this case, the endorser places their signature under such writing, which makes their liability
due thereon depending upon the occurrence of a particular event.

The law permits a conditional endorsement and therefore it does not in any way affect the
negotiability of the instrument. Thus, endorsements can validly be made in the following terms:
(i) “Pay B or order on his marriage;”

In the case of a conditional endorsement the liability of the endorser would arise only upon the
happening of the event specified. But the endorsee can sue other prior parties, e.g., the maker,
acceptor, etc., if the instrument is not duly met at maturity, even though the specified event did
happen.

#5 – Facultative

Here, the endorser gives up some right to which they have entitlement.

Thus, “Pay X or order, notice of dishonour waived” is a facultative endorsement. As a result of

such an endorsement the endorsee is relieved of his duty to give notice of dishonour to the
endorser and the latter remains liable to the endorsee for the non-payment of the instrument, even
though no notice of dishonour has been given to him.

#6 – Partial

This arrangement allows the transfer of only a portion of the amount payable on an instrument to
the endorsed.

Section 56 provides that a negotiable instrument cannot be endorsed for a part of the amount
appearing to be due on the instrument. In other words, a partial endorsement which transfers the
rights to receive only a part payment of the amount due on the instrument is invalid. Such an
endorsement has been declared invalid because it would subject the prior parties to plurality of
actions (one action by holder for part value and another action by endorsee for part value) “and
will thus cause inconvenience to them. Moreover, it would also interfere with the free circulation
of negotiable instruments. It may be noted that an endorsement which purports to transfer the
instrument to two or more endorses separately, and not jointly is also treated as partial
endorsement and hence would be invalid.

#7 – Sans Recourse

This type of endorsement relieves the endorser from all the liability against subsequent holders
of the negotiable instrument. When the endorser expressly excludes his own liability on the
negotiable instrument to the endorsee or any subsequent holder in case of dishonour of the
instrument, the endorsement is known as ‘sans recourse’ endorsement. Such an endorsement is
generally made by adding the words ‘sans recourse’ or ‘without recourse.’ Thus, “Pay X or order
sans recourse” or “Pay X without recourse to me” or “Pay X or order at his own risk” is
examples of this type of endorsement

Example #1

Suppose Nick issued a check for his son, Jim, to help him meet some urgent expenses. The
former put his signature on the check correctly, and the latter endorsed the check with his
signature only. This is an example of endorsement in blank. In this case, the check becomes
payable to the bearer. It means that if Jim misplaces it and it falls into the wrong hands, Nick can
lose his funds to an unknown person.

Example #2

Let us say that Jack holds a check endorsed by John. Jack writes over John’s signature, “Pay to
the order of Ross”.

Jack will not have the liability of an endorser. This is an endorsement in full from John to Ross.

CROSSING OF CHEQUES

Section 123-131of the NI Act, 1881 deal with crossing of cheques.

Object of the Crossing: Why crossing?

A cheque involves an order on a specified banker to pay a certain sum of money and drawer of
cheque cannot impose any condition on bankers. He can give directions for payment. Banker
generally fulfils his obligation by paying the holder of the cheque during banking hours on a
business day. Payment of cheques may be made to wrong persons and particularly of bearer
cheques because bank did not require identification of holder of bearer cheques while getting
payment. Only in case of order cheques bank makes payment after being satisfied with the
identification of the holder. In this way open cheques may be misused and undesirable person by
their fraud and forgery may cause damage to the banks and customers.

An open cheque is always subject to risk that it can be encashed by unauthorised persons and it
may not be traced as to who has actually encashed it. Moreover an open cheque may also be
deposited in any body else's account other than that of the holder. When a open cheque is lost or
stolen, the finder or the thief may be able to get it encashed at the drawee bank unless the drawer
has meanwhile countermanded payment. To avoid this the business community started crossing
of cheques and it became so popular that soon it was recognised by statute and sanction of law.

Crossing of a cheque does not affect its negotiability but affords security and protection to the
true owner since payment of such a cheque has to be made through a banker. In this way it
reduces the danger of unauthorised persons getting the cheques and encashing them. It can be
easily detected to whom and whose account the money has been paid. Thus, cheque are crossed,
in order to avoid losses arising from open cheques falling into the hands of wrong persons. The
function of crossing of cheque is that such cheques cannot be paid at the counter of the bank and
they are deposited through a bank for collection and after collection such amount is credited in
the account of the depositor of cheque (holder).

In crossed cheques there are role of two banks:

(i) Paying banker i.e., the drawee bank, and

(ii) Collecting banker i.e., the bank which collects the money i.e., the bank of the holder where
he keeps his account but in case of special crossed cheques the collecting bank will be a bank
mentioned in the crossing.
What is Crossing?

A cheque may be open or crossed. When a cheque bears across its face two parallel transverse
lines on the left hand top corner, the cheque is said to be crossed and such cheque is called a
"crossed cheque".

On perusal of Sections 123 and 124 crossing of cheques simply means drawing of two parallel
transverse lines with or without some abbreviated words like "& Co". etc. on the face of a cheque
is called crossing of cheques.

A crossing is a direction to the paying banker to pay the money generally to a banker or to a
particular bank, as the case may be, and when this has been done the whole purpose of the
crossing has been served. The object of crossing is to secure payment to a banker, in order that it
may be easily traced for whose use the money was received, and to compel the holder to present
it through a bank. The crossing operates as a caution to the paying banker.

To be crossing such lines must be :

(i) On the face of the cheque, (ii) Parallel, (iii) Transverse (iv) With or without some abbreviated
words like "& Co", "not negotiable" etc

Kinds and modes of Crossing

There are two kinds of crossing-

First, general crossing and

Secondly, special crossing but either kind may take several forms.

(A) General Crossing (Section 123)

Section 123 provides: 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.
A cheque is said to be crossed generally when there are two parallel transverse lines on the face
of the cheque with or without some abbreviated words. This is also called simple crossing.

Essential of General Crossing

(i) Drawing of the parallel transverse lines is necessary. Two parallel transverse lines themselves
constitute crossing.

(ii) It should be generally drawn on the face of the cheque on the left upper corner.

(iii) The words "& Co"., "and company" may be written in between the lines.

(iv) The words "Not Negotiable" may also be added.

(v) The words "& Co." and "Not Negotiable" may also be added with "A/c Payee".

(vi) The words "A/c Payee" without parallel lines may also constitute crossing.

(B) Special Crossing (Section 124)

Section 124 provides: Where a cheque bears across its face an addition of the name of the
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. A cheque is said to be crossed specially where the lines of crossing bear the name of a
banker with or without any additional words.

Essentials of Special Crossing

(i) Drawing of two parallel transverse lines. However writing of simply name of the bank or the
words "A/c payee" without these lines constitutes special crossing.

(ii) Name of a specific bank other than drawee bank is essential. The writing of the name of the
bank without these lines also constitute special crossing.

(iii) The words "Not negotiable" may also be added to special crossing.

Effects of Crossing
The very purpose of the crossing is to provide security and protection to the cheques to its true
owner, since payment of such cheque has to be made through a banker. Thus, it reduces the
danger of unauthorised persons getting the cheques and encashing them. In case of payment to
unauthorised persons it can be 'easily traced and ascertained. The effects of it may be explained
as:

(1) Payment of such cheques should not be made at the counter of the bank, since crossing is a
direction of mode of payment of crossed cheques. Section 126 of the Act provides:

(a) Payment of cheque crossed generally-Where a cheque is crossed generally, the banker on
whom it is drawn shall not pay it otherwise than to a banker.

(b) Payment of cheque crossed specially-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.

(2) If a crossed cheque is paid in contravention of the crossing, such payment –

(i) does not amount to payment in due course. (ii) the paying banker shall not be entitled to the
statutory protection. (iii) the paying banker shall be liable to the drawer any loss, which he may
suffer. (iv) the paying banker cannot debit such payment from the account of the drawer.

(3) 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.

(4) "Crossing with the words "not negotiable" signifies that a person taking a cheque crossing
generally or specially, bearing in either case such words, shall not have and shall not be capable
of giving, a better title to the cheque than that which the person from he took it had. Such
cheques can be transferred but, everyone who takes such a cheques takes at his own risk."

(5) Crossing with "Account Payee", "A/c Payee" is considered restrictive crossing. These words
constitute a direction to the collecting banker that the amount collected of the cheque is to be
credited to the account of the payee.

(6) A special crossing affords more protection to the cheque than a general crossing.
(7) Crossing constitutes material part of the cheque and its obliteration or alteration amounts
forgery.

(8) Crossing of cheque is not considered as a material alteration of the cheque so as to discharge
the person liable on it.