KAMKUS COLLEGE OF LAW

B.A.LL.B VIII SEM

BANKING LAWS & NEGOTIABLE INSTRUMENT ACT
(CODE BL-804)

UNIT-1

¾ Descriptive Answers Questions

1. Discuss the role of Commercial Bank in a modern developing economy in India ?

Ans. COMMERCIAL BANKS

• Meaning: A Banking company is one which transacts the business of banking which
means the accepting for the purpose of lending all investments, of deposits of money
from the public, repayable on demand or otherwise and withdrawble by cheque, draft or
otherwise.

They function as a catalytic agent for bringing about economic, industrial and
agricultural growth and prosperity of the country. The banking can therefore be conceived as a 'a
sector of economy on the one hand and as a lubricant for the whole economy on the other'.

• Functions :

The functions of the commercial banks are now wide and diverse. They have assumed great
significance in the role of an agent for economic renaissance and social transformation because
of their vital role in mobilization of resources well as their deployment for meeting the said
objectives. They are no longer considered as institutions only for affluent sections of the
population. They have acquired broad base and have emerged as effective catalytic agents of
social economic change.

In order to understand better the functions of commercial banks, it will be better to study them
under the following two categories.

(I) Primary Functions of commercial Banks.

(II) Secondary Functions of commercial Banks.

I. Primary Functions of Commercial Banks:

The primary functions of commercial banks are:

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(i) Accepting of deposits, and

(ii) Lending of money.

¾ Accepting of Deposits: Deposits are an important source of a banks funds. They can
broadly be classified into three categories.

(a) Savings Deposits: These deposits are of small amounts and are accepted by banks to
encourage persons of small means to make savings; frequent withdrawals are not
allowed.

(b) Fixed Deposits: These deposits are made with the banks for fixed periods specified in
advance. They are also known as term deposits.

(c) Current Deposits: These deposits are repayable on demand. The banks undertake the
obligation of paying all cheques drawn against these deposits by the customers till they
have adequate funds of the customer. The banks usually do not pay any interest in respect
of such deposits. These deposits accounts are usually kept by large business houses.

¾ Lending of Money: A major portion of the deposits received by a bank is lent by it.
This is also the major source of a bank's income. However, lending money is not without
risk and, therefore, a banker must take proper precautions in this process. The lending
may be in any of the following forms:

(a) Loan: It is a kind of advance made with or without security. It is given for a fixed period
at an agreed rate of interest. The amount of loan is usually credited to the credit of the
customer's account who may withdraw from there as per his requirements. The loan may
be secured or unsecured.

(b) Cash Credit: It is an arrangement by which a banker allows his customer to borrow
money upto a certain limit against security of goods.

(c) Overdraft: It is an arrangement whereby a customer has been allowed temporarily to

overdraw his current account. It is without any security.

(d) Discounting and Purchasing of Bills: Time bills are discounted while demand bills are
purchased by the banks. In both the cases the banks credit the account of their customers
by the amount of bills less any discount or commission charged for such discounting or
purchasing of the bills. Thus, commercial banks render a unique service by tapping
savings from a wide spectrum of people and lending to those who really need and use
them for various productive purposes. They play an active and not a passive role in the
economic development of the country.
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II Secondary Functions of Commercial Banks :

These functions can be classified into the following two categories:

(a)Agency Service: In many cases the commercial banks act as the agents of their customers.

As agents they provide the following services:

(i) Collection of drafts, bills, cheques, dividend etc. on behalf of customers.

(ii) Execution of standing orders of the customers viz-payment of subscription, rent, bills,
promissory notes, insurance premium etc.

(iii) Conducting stock exchange transactions i.e., purchasing and selling of securities for the
customers.

(iv) Acting as a correspondent on representative of customers, other banks and financial

corporations.

(v) Functioning as an executor, trustee or administrator of an estate of a customer.

(vi) Preparation of income tax return, claiming of tax refunds and checking of assessments on
behalf of the customers.

(b) General Utility Services: Commercial banks provide a variety of general utility services viz.
issue of letters of credit, travelers cheques, accept valuables for safe custody, acting as a referee
as to the respectability and financial standing of the customers, providing specialized advisory
services to customer, issue of credit cards, providing of information through regular bulletins
about general trade and economic conditions both inside and outside the country etc.

With the opening up of the insurance sectors, banks can now take up insurance business. In the
discussion paper issued by the RBI in 1999, it was stated that insurance comes within the scope
of universal banking. The term universal banking refers to the combination of commercial
banking and investment banking. In other words universal banks refer to those banks that offer a
wide range of financial services beyond commercial banking and investment banking such as
Insurance. However, as per the guidelines issued by the Reserve Bank of India, banks are not
allowed to conduct insurance business departmentally. They cannot also set up separately
subsidiary companies for this purpose. However, they can set up joint venture companies for
insurance as per government or insurance regulatory and development authority guidelines and
with prior permission of Reserve Bank of India.

2. Explain the meaning and the features of a Bank system in India?

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Ans.

• Definition of Banking :

According to some economists, the word 'Bank' has been derived from the German word
'BANC' which means a joint stock firm. But some other economists say that it has been derived
from the Italian word 'BANCO' which means a heap or mound. As the matter of fact, at the time
of establishment of Bank of Venice in 1157, the Germans were influential and hence, perhaps
the word Banc or 'Banco' was used by Italians to denote the accumulation of securities or
money with a joint stock firm which later on with the passage of time came to be known as
'Bank'.

There is still another group of people who believe that the word 'Bank' has been derived from
the Greek word 'BANQUE' which means a bench. In the older days, when Jews started their
money transactions business as bankers they started using a bench for sitting and if they were not
able to pay their obligations, the bench would be broken into pieces and he was taken as
Bankrupt. Thus, both the words Bank or Bankrupt are said to have their origin from the word
'Banque'.

¾ Banking Regulation Act 1949.

Sec. 5 (b) "Banking" means the accepting for the purpose of lending or investment, of deposit
of money from public, repayable on demand or otherwise, and withdraw able by cheque, draft,
order or otherwise.

According to, Sir John Paget "No person or body, corporate or otherwise, can be a banker who
does not (1) take deposit accounts (2) take current account (3) issue and pay cheque and (4)
collect cheques, crossed and uncrossed, for his customers."

This definition denotes only the essential feature of Banking company stead of Banking.
'Banking company' means that which transacts the business of banking in India.

Explanation: Any company which is engaged in the manufacture of goods or carries on any
trade and which accepts deposits of money from the public merely for the purpose of financing
its business; as such manufacturer or trader shall not be deemed to transact the business of
banking within the meaning of this clause. (Sec 5c of Banking Regulation Act 1949)

• Forms of Business in which banking company may engage:

According to sec 6, the following business may be undertaken by a banking company–

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 a) The following functions form the bulk of a bank's activities and are called its main
functions:

I The borrowing, raising or taking of money;

II The lending or advancing of money either upon security or without security;

III The drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills
of exchange, hundis, promissory notes, coupons, drafts, bills of lending, railway receipts,
warrants, debentures, certificates, scripts and other instruments and securities whether
transferable or negotiable or not;

IV The granting and issuing of letters of credit, travellers' cheques and circular notes;

I. The buying, selling and dealing in bullion and species;

II. The buying and selling of foreign exchange including foreign bank notes;

III. The acquiring, holding, issuing on commission, underwriting and dealing in stock, funds,
shares, debentures, debenture stock, bonds, obligations, securities and investments of all
kinds;

IV. The purchasing and selling of bonds, scrips and other forms of securities on behalf of
constituents or others;

V. the negotiating of loans and advances;

VI. The receiving of all kinds of bonds, scrips and other forms of securities on behalf of
constituents or others;

VII. The providing of safe deposit vaults; and

VIII. The collecting and transmitting of money and securities.

a) It may act as an agent of the Government, local authority or person and can carry on agency
business but it cannot act as secretary and treasurer of a company.

b) It may contract for public and private loans and negotiate and issue the same.

c) It may effect, insure, guarantee, underwrite, participate in managing and carrying out of any
issue of State, municipal or other loans or of shares, stock, debenture stock of companies and
may lend money for the purpose of any such issue.
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d) It may carry on and transact every kind of guarantee and indemnity business.

e) It may manage, sell and realize any property which may come into its possession in
satisfaction of its claims.

f) It may acquire and hold and deal with any property or any right, title or interest in any such
property which may form the security for any loan or advance.

g) It may undertake and execute trusts.

h) It may undertake the administration of estate as executor, trustee or otherwise.

i) It may establish, support and aid associations, institutions, funds, trusts, etc., for the benefit
of its present or past employees and may grant money for charitable purposes.

j) It may acquire, construct and maintain any building for its own purpose.

k) It may sell, improve, manage, develop, exchange, lease, mortgage, dispose of all or any part
of the property and rights of the economy.

l) It may acquire and undertake the whole or any part of the business of any person or
company, when such business is of a nature described in Sec. 6(1).

m) It may do all such things which are incidental or conducive to the promotion or advancement
of the business of the company.

n) It may undertake any other form of business which the Central Government may specify as a
form of business in which it is lawful for a banking company to engage.

• SYSTEMS OF BANKING

¾ UNIT BANKING

Unit banking is a system where the operations of a bank are confined to a single office located
in a particular area. A unit bank has virtually no branches. In order to provide facilities to its
customers in remittance and collection of funds, a unit bank resorts to correspondent banking
system. In case of this system small banks serving small communities place deposits in nearby
city banks which in turn hold deposits in giant banks located in giant cities. The giant banks also
hold reciprocal deposits of one another. Consequently, every bank gets connected directly or
indirectly with each other and it can safely make payment on behalf of other banks.

¾ BRANCH BANKING

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 • Branch Banking is a system where a bank with a network of branches throughout the
country carries out its banking operations. Sometimes branches are also opened outside
the country. However, small banks may like to restrict their branches or offices to a
certain region of the country.

ƒ Features : The main features of branch banking system are as follows:

(i) The bank is owned by a group of shareholders and controlled by a single Board of
Directors.

(ii) The bank has a central office popularly termed as the Head Office of the bank which
controls the operations of different branches.

(iii) Each branch is managed by a branch manager who manages the affairs of the branch as
per the directives and policies of the Head office.

(iv) For external reporting the assets and liabilities of the branches and the Head Office are

aggregated.

The branch banking system which developed in England is prevalent in

most countries of the world including Australia, Canada, South Africa, India, Pakistan etc. In
India the public sector banks, numbering 27 in all have more than 90% of the branches of all
commercial banks. They also control more than 90% of the banking business in all.

ƒ Advantages of Brach Banking : The protagonist of branch banking put forward the
following arguments in favour of branch banking:

1. Economies of Scale: In case of branch banking the level of operations is quite large as
compared to unit banking. As such the cost per unit of service in case of the former is
lower as compared to the latter. Moreover, under branch banking system it is possible to
hire more competent and qualified staff and have better division of work resulting in
increase in overall efficiency.

2. Lower Cash Reserves: A large bank with a number of branches can manage its business
with lower cash reserves since each of its branch can draw upon the resources of another
branch or branches, if an emergency arises. However, a unit bank cannot confidently
depend upon the resources of another unit bank. Hence, it may be required to keep higher
cash reserves to run its operations smoothly.

3. Diversification of Risk: In branch banking industrial as well geographical diversification

of loan risks is possible. As a result the loss suffered by branches on account of fall in

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 industrial activity in a particular area may be more than compensated on account of profit
made by branches in areas where there may be boom in business and industrial activity.
This is not possible in case of unit banking where a bank is having its operation only in a
particular area.

4. Better Customer Service: Branch banking provides better service to customers in

remittance and collection of funds. Moreover, the objective of opening branches is to take
banking service to the doors of the people who need them. Thus, service is cheap as well
as convenient. Each branch has to handle a limited number of customers of the locality,
hence the branch manager can personally look to their problems.

5. Greater Mobility of Capital: Branch banking permits better mobility of capital and thus
bring more uniformity in interest rates. Surplus funds can be transferred from one area to
another with convenience and speed and thus bring equilibrium in demand and supply of
funds resulting in better returns to the investors.

6. Safety of Loans: While lending money, the branches of banks follow the policies as laid
down by their Head office. The chances of favouritism are therefore reduced to the
minimum. Moreover, loans beyond a particular limit are to be approved by the Head
Office as per the prescribed procedure. This all ensured safety of loans and reduces the
chances of banks suffering losses due to bad loans.

7. Emergence of Strong and Solvent Banks: Branch banks have large resources, better
management; and greater diversification of risk. All this results in emergence of strong
and solvent banks. The chances of bank failures are reduced to the minimum.

• Disadvantages of Branch Banking: The protagonists of unit banking raise the following
objections against branch banking:

1. Individual Needs Ignored: In case of branch banking the branches are guided by the
policies laid down by the Head Office which is quite unaware of the individual needs.
The Branch Manager has not much role to play, while a unit bank operates only in a
limited area and hence it is possible for it to take personal care of the individual needs of
each of its customers.

2. Red Tapism : In branch banking, a branch manager is required to take the instructions of
the Head office from time to time. He cannot take several decisions at this level. Thus,
there is bound to be red tapism and delay in processing loan applications etc. In unit
banking all matters are decided at the unit bank level itself. Thus, there is quicker and
better service.

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 3. Lack of Effective Control: In case of branch banking, the banks sometimes become
unmanageable due to large increase in the number of branches. As a result, the control
gets slackened and it increases the chances of frauds and manipulations.

4. Local Needs Ignore: Branch banks do not have attachment with a particular place.
Branch managers are also not local people. They are subject to frequent transfers. The
funds collected from local sources may be used for meeting the requirements of other
places where the bank may find the investment more lucrative. Thus, local needs are not
given that much of attention in case of branch banking as is done in case of unit banking.

5. Failure of Banks: In branch banking unremunerative and inefficient branches continue

to exist at the expense of remunerative and efficient branches. In case this practice goes
too far, it may cause failure of banks having repercussions throughout the country.

6. Concentration of Economic Power: The branch banks have huge resources raised from a
wide spectrum of people. The Boards of Directors of these banks, therefore, possess
immense economic power which they may use for promoting their own business
interests. It may thus cause concentration of economic power in a few hands. As a matter
of fact, this was one of the important reasons for the first phase of nationalisation of 14
major commercial banks in India.

Here we have explained the advantages and disadvantage of branch

banking versus unit banking. A close perusal of the disadvantages of branch banking show that
they are not too serious as they are made out to be. Proper orientation of lending policies,
delegation of authority at different levels and proper fixation of priorities can improve the matter.
As a matter of fact, branch banking is the logical development of growth of banking industry in
any country.

• Group Banking and Chain Banking :

Chain Banking and Group Banking are the outcome of unit banking system devised to avail
some of the advantages of branch banking system. They are both common in United State of
America.

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 ¾ GROUP BANKING

It is a system where two or more banks are controlled by a holding company. Thus, group
banking is similar to chain banking except with the difference that instead of an individual or
group of individuals or members of family, an incorporated company having a separate legal
entity holds majority of the voting power in the companies of the group. Such holding company
mayor may not be engaged in the banking business.

¾ CHAIN BANKING

Chain Banking is a system where an individual or group of individuals or members of a family

control the operations of two or more banks. The control is exercised either through holding
majority of shares in each bank or inter-locking directorships. However, each bank retains its
individual entity.

Chain banking or group banking brings the advantages of pooling of

resources, economies of scale and reducing idle cash balances etc., to the member banks.
However, it has the disadvantages of lack of effective control over member units, and mis
utilisation of resources of the member units particularly by the holding company. Moreover, it
leads to concentration of economic power in a few hands. Due to these disadvantages, the system
of chain banking or group banking is considered to be unworthy of adoption.

3. What was the need of passing the Bank Regulation Act and Discuss the scope of the
Banking Act.

Ans.

• Banking Reforms and Regulations

Bank is the main confluence that maintains and controls the “flow of money” to make the
commerce of the land possible. Government uses it to control the flow of money by managing
Cash Reserve Ratio (CRR) and thereby influencing the inflation level. The functions of the bank
include accepting deposits from the public and other institutions and then to direct as loans and
advances to parties mainly for growth and development of industries. It extends loans for the
purpose of education, housing etc. and as a part of social duty, some percentage to Agricultural
sector as decided by the RBI.

Banking in India has undergone startling changes in terms of growth and structure. Organized
Banking was active in India since the establishment of The General Bank of India in 1786. The
Reserve Bank of India (RBI) was established as the central bank and in 1955. The Imperial bank
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of India, the biggest bank at that time, was taken over by the government to form State owned
State Bank of India (SBI).

• THE BANKING REGULATION ACT

Legislation for safeguarding the business of banking companies most intensively was undertaken
after the failure of the Travancore National and Quilon Bank. Between January 1937 and
September 1948, three amendments to the Indian Companies Act were promoted. Meanwhile, a
bill regulating the business of banking introduced in November 1944 lapsed in October 1945.
Another bill introduced in March 1946 was withdrawn because of numerous amendments which
were found necessary and reintroduced in March 1948. This final version of the bill as modified
by the select committee became law. The Banking Regulation Act came into effect on 16 March,
1949 and applies to the whole of India.

¾ Needs of passing the Bank Regulation Act : The Banking Regulation Act was passed
to consolidate and amend the law relating to banking companies. The need for such an
Act was felt to check the abuse of power by managers of Banks and also to safeguard the
interests to the country in general. Since its enactment in 1949 the Act was suitably
amended a numbers of times, the new provisions were inserted and existing ones
amended to suit the needs of changing circumstances.

¾ The Scope of the Banking Act. The Banking Regulation Act, 1949 has been divided
into the following parts:

Part I Preliminary (Section 1 to SA)

Part II Business of Banking Companies (Section 6 to 36A)

Part II A Control over Management (Sections 36AA to 36AC)

Part II B Prohibition of certain activities in relation to Banking companies (Section 36AD)

Part II C Acquisitions of the undertakings of Banking companies in certain cases (Sections

36 AE to 36 AJ)

Part III Suspension of Business and Winding up of Banking Companies (Sections 36B to
45)
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Part III A Special provisions for speedy disposal of winding up proceeding (Section 45A to
45X)

Part III B Miscellaneous Section (46 to 55A)

Part IV Application of the Act to cooperative Banks (Sections 56, effective from 1st
March, 1966).

• Principal Provisions of Banking Regulation Act, 1949

The following important principal provisions of Banking Regulation Act, 1949 i.e.,

• Definition

¾ Banking: According to Section 5(b) of the Act '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."

The chief characteristics of banking business are:

i) There should be acceptance of deposits: Generally, when a mounts are borrowed on

condition that they should be repaid on the expiry of a term, they are regarded as
loans rather than deposits. In case of deposits, the liability to repay arises only when a
demand for repayment has been made.

ii) Deposits should be from the public.

iii) Repayable on demand or otherwise.

iv) Withdrawable by Cheque, draft order or otherwise: Withdrawal may be permitted in any
other form ego a request may be made to transfer funds from one account to some
other account.

v) Purpose of Acceptance of Deposits: The purpose of accepting deposit should be 'lending'

or 'investment' .

• Banking Company ['Sec. 5(c)]: Banking company means "any company which transacts
the business of banking in India"

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 • Banking policy [Section 5(ea)]: Banking policy means any policy which is specified
from time to time by the Reserve Bank in the interest of the banking system or in the
interest of monetary stability or sound economic growth, having due regard to the
interests of the depositors, the volume of deposits and other resources of the bank and the
need for equitable allocation and the efficient use of these deposits and resources.

• Branch" or "Branch Office" [See 5(cc)]: Branch or branch office in relation to banking
company, means any branch or branch office, whether called a pay office or sub pay
office or by any other name, at which deposits are received, cheques cashed or moneys
sent.

• Company [See 5(d)]: Company means any company as defined in section 3 of the
Companies Act 1956, and includes a foreign company within the meaning of section 591
of that Act.

According to section 3 of the companies Act, "company means a company formed and registered
under this Act or an existing company".

• 'Demand' and 'Time' Liabilities [Sec. 5(f)]: 'Demand' liabilities means liabilities which
must be met on demand, and 'Time' liability means liabilities which are not demand
liabilities.

• Secured Loan or Advance [Sec. 5(n)] : 'Secured loan or advance' means a loan or
advance made on the security of assets the market value of which is not at any time less
than the amount of such loan or advance and "unsecured loan or advance" means a loan
or advance not so secured.

Banking may engage in the following forms of business (Sec. 6)

a) The main functions of a bank include:

i) Borrowing raising or taking up of money.

ii) Lending or advancing secured or unsecured loan

iii) The drawing, making, accepting, discounting, buying, selling, collecting and
dealing in negotiable instruments.

iv) The granting and issuing of letters of credit, travellers cheques and circular notes.
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 v) Providing of safe deposit vaults.

vi) Negotiating of loans and advances.

b) Acting as an agent for any government or local authority or any other person or persons.

c) It may carry on and transact every kind of guarantee and indemnity business.

d) It may carry on any other form of business which the central government may, by notification
in the official gazette, specify as a form of business in which it is lawful for a banking company
to engage.

(1) Prohibition of Trading, (Sec. 8)

According to Sec. 8 of the Banking Regulation Act, a banking company cannot directly or
indirectly deal in buying or selling or bartering of goods. But it may, however, buy, sell or barter
the transactions relating to bills of exchange received for collection or negotiation.

(2) Non-Banking Assets, (Sec. 9):

According to Sec. 9 “A banking company cannot hold any immovable property, howsoever
acquired, except for its own use, for any period exceeding seven years from the date of
acquisition thereof.

(3) Management and Control (Sec. 10):

Restrictions regarding Employment of Managerial Personnel; Restrictions on certain forms of

Employment (Sec. 10) A banking company shall not employ or continue the employment of any
of the following persons:

i) Who is or at any time has been adjudicated insolvent or has suspended payment or has
compounded with his creditors, or who is or has been convicted by a criminal court of
an offence involving moral turpitude.
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 ii) Whose remuneration or part of whose remuneration takes the form of commission or of a
share in the profits of the company. However, the above provision shall not apply to
the payment by a banking company of:

a) any bonus in pursuance of settlement or award arrived at or made under any law relating
to industrial disputes or in accordance with any scheme framed by such banking company
or in accordance with the usual practice prevailing in banking business.

b) Any commission to any broker, cashier, contractor, clearing and forwarding agent,
auctioneer or any other person, employed by the banking company under a contract
otherwise than as a regular member of the staff of the company.

iii) Whose remuneration is, in the opinion of the Reserve Bank, excessive.

iv) A banking company shall not be managed by a person

v) Who is Director of any other company; or

vi) Whose term of office as a person managing the company is for a period exceeding 5
years at one time.

Provided that, the term of office of any such person may be renewed or extended by
further periods not exceeding 5 years on each occasion, subject to the condition that such
renewal or extension shall not be sanctioned earlier than 2 years from the date on which it is to
come into force.

(4) Minimum Capital, (Sec. 11):

Sec. 11 (2) of the Banking Regulation Act, 1949, provides that no banking company shall
commence or carry on business in India, unless it has minimum paid-up capital and reserve of
such aggregate value.

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(5) Capital Structure (Sec. 12):

According to Sec. 12, no banking company can carry on business in India, unless it satisfies the
following conditions:

(a) Its subscribed capital is not less than half of its authorized capital, and its paid-up capital is
not less than half of its subscribed capital.

(b) Its capital consists of ordinary shares only or ordinary or equity shares and such preference
shares as may have been issued prior to 1st April 1944. This restriction does not apply to a
banking company incorporated before 15th January 1937.

(c) The voting right of any shareholder shall not exceed 5% of the total voting right of all the
shareholders of the company.

(6) Payment of Commission, (Sec. 13):

According to Sec. 13, a banking company is not permitted to pay directly or indirectly by way of
commission, brokerage, discount or remuneration on issues of its shares in excess of 2½% of the
paid-up value of such shares.

(7) Payment of Dividend, and Others (Sec. 15):

According to Sec. 15, no banking company shall pay any dividend on its shares until all its
capital expenses (including preliminary expenses, organisation expenses, share selling
commission, brokerage, amount of losses incurred and other items of expenditure not represented
by tangible assets) have been completely written-off.

4. Discuss the functions of Commercial or Modern Banks ?

Ans.

• Functions of Commercial or Modern Banks :

The functions of the commercial banks are now wide and diverse. They have assumed great
significance in the role of an agent for economic renaissance and social transformation because
of their vital role in mobilization of resources well as their deployment for meeting the said
objectives. They are no longer considered as institutions only for affluent sections of the
16
population. They have acquired broad base and have emerged as effective catalytic agents of
social economic change.

In order to understand better the functions of commercial banks, it will be better to study them
under the following two categories.

(I) Primary Functions of commercial Banks.

(II) Secondary Functions of commercial Banks.

I Primary Functions of Commercial Banks:

The primary functions of commercial banks are:

(i) Accepting of deposits, and

(ii) Lending of money.

¾ Accepting of Deposits: Deposits are an important source of banks funds. They can
broadly be classified into three categories.

(d) Savings Deposits: These deposits are of small amounts and are accepted by banks to
encourage persons of small means to make savings; frequent withdrawals are not
allowed.

(e) Fixed Deposits: These deposits are made with the banks for fixed periods specified in
advance. They are also known as term deposits.

(f) Current Deposits: These deposits are repayable on demand. The banks undertake the
obligation of paying all cheques drawn against these deposits by the customers till they
have adequate funds of the customer. The banks usually do not pay any interest in respect
of such deposits. These deposits accounts are usually kept by large business houses.

¾ Lending of Money: A major portion of the deposits received by a bank is lent by it.
This is also the major source of a bank's income. However, lending money is not without

17
 risk and, therefore, a banker must take proper precautions in this process. The lending
may be in any of the following forms:

(e) Loan: It is a kind of advance made with or without security. It is given for a fixed period
at an agreed rate of interest. The amount of loan is usually credited to the credit of the
customer's account who may withdraw from there as per his requirements. The loan may
be secured or unsecured.

(f) Cash Credit: It is an arrangement by which a banker allows his customer to borrow
money upto a certain limit against security of goods.

(g) Overdraft: It is an arrangement whereby a customer has been allowed temporarily to

overdraw his current account. It is without any security.

(h) Discounting and Purchasing of Bills: Time bills are discounted while demand bills are
purchased by the banks. In both the cases the banks credit the account of their customers
by the amount of bills less any discount or commission charged for such discounting or
purchasing of the bills. Thus, commercial banks render a unique service by tapping
savings from a wide spectrum of people and lending to those who really need and use
them for various productive purposes. They play an active and not a passive role in the
economic development of the country.

II Secondary Functions of Commercial Banks :

These functions can be classified into the following two categories:

(a) Agency Service: In many cases the commercial banks act as the agents of their customers.

As agents they provide the following services:

18
(i) Collection of drafts, bills, cheques, dividend etc. on behalf of customers.

(ii) Execution of standing orders of the customers viz- payment of subscription, rent, bills,
promissory notes, insurance premium etc.

(iii) Conducting stock exchange transactions i.e., purchasing and selling of securities for the
customers.

(iv) Acting as a correspondent on representative of customers, other banks and financial

corporations.

(v) Functioning as an executor, trustee or administrator of an estate of a customer.

(vi) Preparation of income tax return, claiming of tax refunds and checking of assessments on
behalf of the customers.

(b) General Utility Services: Commercial banks provide a variety of general utility
services viz. issue of letters of credit, travelers cheques, accept valuables for safe custody, acting
as a referee as to the respectability and financial standing of the customers, providing specialized
advisory services to customer, issue of credit cards, providing of information through regular
bulletins about general trade and economic conditions both inside and outside the country etc.

With the opening up of the insurance sectors, banks can now take up insurance business. In the
discussion paper issued by the RBI in 1999, it was stated that insurance comes within the scope
of universal banking. The term universal banking refers to the combination of commercial
banking and investment banking. In other words universal banks refer to those banks that offer a
wide range of financial services beyond commercial banking and investment banking such as
Insurance. However, as per the guidelines issued by the Reserve Bank of India, banks are not
allowed to conduct insurance business departmentally. They cannot also set up separately
subsidiary companies for this purpose. However, they can set up joint venture companies for
insurance as per government or insurance regulatory and development authority guidelines and
with prior permission of Reserve Bank of India.

19
 ¾ Short Answers Questions

5 What is Branch Banking and Unit Banking ?

Ans.

Branch Banking

A. Branch Banking

Branch Banking is a system where a bank with a network of branches throughout the country
carries out its banking operations. Sometimes branches are also opened outside the country

¾ Features: The main features of branch banking system are as follows:

(i) The bank is owned by a group of shareholders and controlled by a single Board of
Directors.

(ii) The bank has a central office popularly termed as the Head Office of the bank which
controls the operations of different branches.

(iii) Each branch is managed by a branch manager who manages the affairs of the branch as
per the directives and policies of the Head office.

The branch banking system which developed in England is prevalent in most

countries of the world including Australia, Canada, South Africa, India, Pakistan etc.

¾ In India the public sector banks, numbering 27 in all have more than 90% of the
branches of all commercial banks.

¾ Advantages of Branch Banking: The protagonist of branch banking put forward the
following arguments in favour of branch banking:

1. Economies of Scale: In case of branch banking the level of operations is quite large as
compared to unit banking.

20
 2. Lower Cash Reserves: A large bank with a number of branches can manage its business
with lower cash reserves since each of its branch can draw upon the resources of another
branch or branches, if an emergency arises

3. Diversification of Risk: In branch banking industrial as well geographical diversification

of loan risks is possible.

4. Better Customer Service: Branch banking provides better service to customers in

remittance and collection of funds.

5. Greater Mobility of Capital: Branch banking permits better mobility of capital and thus
bring more uniformity in interest rates.

6. Safety of Loans: While lending money, the branches of banks follow the policies as laid
down by their Head office.

7. Emergence of Strong and Solvent Banks: Branch banks have large resources, better
management; and greater diversification of risk.

¾ Disadvantages of Branch Banking: The protagonists of unit banking raise the following
objections against branch banking:

1. Individual Needs Ignored: In case of branch banking the branches are guided by the
policies laid down by the Head Office which is quite unaware of the individual needs.

2. Red Tapism: In branch banking, a branch manager is required to take the instructions of
the Head office from time to time.

3. Lack of Effective Control: In case of branch banking, the banks sometimes become
unmanageable due to large increase in the number of branches.

4. Local Needs Ignore: Branch banks do not have attachment with a particular place.
Branch managers are also not local people. They are subject to frequent transfers.

5. Failure of Banks: In branch banking unremunerative and inefficient branches continue

to exist at the expense of remunerative and efficient branches.

Concentration of Economic Power: The branch banks have huge resources raised from a wide
spectrum of people.

Unit banking

21
B. Unit banking

Unit banking is a system where the operations of a bank are confined to a single office located
in a particular area. A unit bank has virtually no branches. In order to provide facilities to its
customers in remittance and collection of funds, a unit bank resorts to correspondent banking
system

6. What are the disadvantages of Unit Banking ?

Ans.

¾ Unit banking

Unit banking is a system where the operations of a bank are confined to a single office located
in a particular area. A unit bank has virtually no branches. In order to provide facilities to its
customers in remittance and collection of funds, a unit bank resorts to correspondent banking
system.

¾ Disadvantages of Unit Banking

The following are the disadvantages of unit banking system:

1. No. Distribution of Risks:

Under unit banking, the bank operations are highly localised. Therefore, there is little possibility
of distribution and diversification of risks in various areas and industries.

2. Inability to Face Crisis:

Limited resources of the unit banks also restrict their ability to face financial crisis. These banks
are not in a position to stand a sudden rush of withdrawals.

3. No Banking Development in Backward Areas:

Unit banks, because of their limits resources, cannot afford to open uneconomic banking
business is smaller towns and rural area. As such, these area remain unbanked.

4. Lack of Specialization:

Unit banks, because of their small size, are not able to introduce, and get advantages of, division
of labor and specialization. Such banks cannot afford to employ highly trained and specialized
staff.

5. Costly Remittance of Funds:

22
A unit bank has no branches at other place. As a result, it has to depend upon the correspondent
banks for transfer of funds which is very expensive.

6. Disparity in Interest Rates:

Since easy and cheap movement of does not exist under the unit banking system, interest rates
vary considerably at different places.

7. Local Pressures:

Since unit banks are highly localised in their business, local pressures and interferences generally
disrupt their normal functioning.

8. Undesirable Competition:

Unit banks are independently run by different managements. This results in undesirable
competition among different unit banks.

• Conclusion:

Although both branch banking system and unit banking system have their relative merits and
demerits, but the merits of the former outweigh those of the latter. There has grown a general
tendency in favour of the branch banking system mainly because of large financial resources,
economies of large operations and effective control by the central bank. Experience has shown
that unit baking system in hampered by limited resources and does not work under economic
depression. Today, the branch banking system is specially suitable for the underdeveloped
countries. The entire banking system in India has developed on the lines of branch banking
system.

7. Explain the concept of Chain Banking and Group Banking?

Ans.

• Group Banking and Chain Banking :

¾ Chain Banking and Group Banking are the outcome of unit banking system devised to
avail some of the advantages of branch banking system. They are both common in United
State of America.

23
 • GROUP BANKING It is a system where two or more banks are controlled by
a holding company.

• What is Group Banking?

Group banking is a plan offered by banks that generally provides incentives for groups,
such as employees at a company, if the group establishes a banking relationship with the
institution. For example, a bank may offer loans or other banking products to all employees of
an organization through a promotion. Or, a bank might offer employees of a large employer
special perks if they open a checking account with direct deposit, lower rates on home-equity
loans or mortgages, or higher interest rates on

• Breaking down Group Banking

Potential incentives for group banking can include lower interest rates, lower fees and discounts.
Members of a group banking arrangement will usually have access to better perks than they
would otherwise be able to obtain on their own. Employees are usually able to choose the
account types and financial products that meet their individual needs. Some banks may offer
group banking members reward points that can be redeemed for travel, gift cards, cash or
merchandise.

• Other Benefits of Group Banking

Some other benefits of group banking plans include a single point of contact for the group, and a
bank contact who is generally more knowledgeable of the group's plan and needs. This leads to a
more personalized banking experience for all members of the group. Banks may offer group
members seminars on personal finance topics, or one-on-one financial advice to help them reach
their financial goals.

Employers benefit from offering their employees group banking plans because
many employees consider group banking an employment benefit on a par with paid time off, sick
leave, health insurance and retirement savings plans. Therefore, partnering with a bank to offer
group banking can help businesses attract and retain high-quality talent. Group banking plans can
allow employers to expand their employee benefits package for minimal additional cost. Group
banking provides banks with a pool of customers they do not have to actively recruit, and
reduces costs associated with transactions like direct deposit of paychecks. Group banking also
gives banks access to more capital via the money deposited by group members. Members of a
group banking plan do not have to be employees of the same company; members of any
organization or cooperative may be able to take advantage of a group banking plan.
24
 • CHAIN BANKING : Chain Banking is a system where an individual or group
of individuals or members of a family control the operations of two or more
banks.

• Definition of Chain Banking :

Conceptually, chain banking is a form of bank governance that occurs when a small group of
people control at least three banks that are independently chartered. In general, the controlling
parties are majority shareholders or the heads of interlocking directorates. Chain banking as an
entity has declined along with the surge in interstate banking.

• Breaking down Chain Banking

Chain banking is not like branch banking, which involves conducting banking activities (e.g.
accepting deposits or making loans) at facilities away from a bank's home office. Branch banking
has gone through significant changes since the 1980s. It also differs from group banking.

In group banking, several affiliate banks exist under a single bank holding company.
In chain banking, three or more banks function independently without the traditional obstacles
of a holding company. A bank holding company is a parent corporation, limited liability
company or limited partnership that owns enough of the original bank’s voting stock to control
its policies and management. The activities of separate banks within chain banking don't overlap
(as occasionally occurs in a holding company) so that the revenue is maximized as much as
possible.

¾ Very Short Answers Questions :

8. Advantages of Branch Banking.

Ans.

¾ Advantages of Brach Banking : The protagonist of branch banking put forward the
following arguments in favour of branch banking:

• Economies of Scale: In case of branch banking the level of operations is quite large as
compared to unit banking.

25
 • Cash Reserves: A large bank with a number of branches can manage its business with
lower cash reserves since each of its branch can draw upon the resources of another
branch or branches, if an emergency arises.

• Diversification of Risk: In branch banking industrial as well geographical diversification

of loan risks is possible.

• Better Customer Service: Branch banking provides better service to customers in

remittance and collection of funds. Moreover, the objective of opening branches is to take
banking service to the doors of the people who need them.

• Greater Mobility of Capital: Branch banking permits better mobility of capital and thus
bring more uniformity in interest rates.

• Safety of Loans: While lending money, the branches of banks follow the policies as laid
down by their Head office. The chances of favouritism are therefore reduced to the
minimum..

• Emergence of Strong and Solvent Banks: Branch banks have large resources, better
management; and greater diversification of risk. All this results in emergence of strong
and solvent banks. The chances of bank failures are reduced to the minimum.

9. Explain the following provisions of Banking Act.

Ans.

i. Suspension of Business. (Sec. 37): The high court may, on the application of a
banking company which is temporarily unable to meet its obligations, make an order stating the
commencement or continuance of all actions and proceedings against the company for some
period. This temporary suspension of the enforcement of liability against the banking company is
called "Moratorium". The period of "Moratorium" shall not exceed 6 months in all.

ii. Winding up of a Banking company.

Winding Up by the Court: The high court shall order the winding up of a banking
company:

• If the banking company is unable to pay its debts; or

• If an application for its winding up has been made by the Reserve Bank.

26
A banking company shall be deemed to be unable to pay its debts in the following
circumstances:

a) If it has refused to meet any lawful demand made at any of its offices within two working
days, if such demand is made at a place where there is office, branch, or agency of the
Reserve bank or within five working days if such demand is made elsewhere; and

b) If the Reserve Bank certifies in writing that the banking company is unable to pay its
debts.

iii. Control over management.

Restrictions regarding Employment of Managerial Personnel; Restrictions on certain forms of

Employment (Sec. 10)

A banking company shall not employ or continue the employment of any of the following
persons:

iii) Who is or at any time has been adjudicated insolvent or has suspended payment or has
compounded with his creditors, or who is or has been convicted by a criminal court of
an offence involving moral turpitude.

iv) Whose remuneration or part of whose remuneration takes the form of commission or of a
share in the profits of the company. However, the above provision shall not apply to
the payment by a banking company of:

c) any bonus in pursuance of settlement or award arrived at or made under any law relating
to industrial disputes or in accordance with any scheme framed by such banking company
or in accordance with the usual practice prevailing in banking business.

d) Any commission to any broker, cashier, contractor, clearing and forwarding agent,
auctioneer or any other person, employed by the banking company under a contract
otherwise than as a regular member of the staff of the company.

iii) Whose remuneration is, in the opinion of the Reserve Bank, excessive.

iv) A banking company shall not be managed by a person

27
v) Who is Director of any other company; or

vi) Whose term of office as a person managing the company is for a period exceeding 5
years at one time.

Provided that, the term of office of any such person may be renewed or extended by
further periods not exceeding 5 years on each occasion, subject to the condition that such
renewal or extension shall not be sanctioned earlier than 2 years from the date on which it is to
come into force.

iv. Accounts and Audit.

• Profit and Loss Account and Balance Sheet (Sec. 29): At the expiration of each
calendar year or at the expiration of a period of 12 months ending with such date as the
central government may, by notification in official gazette specify in this behalf, every
banking company incorporated outside India, in respect of all business transacted through
its branches in India, shall prepare with reference to that year or the period, as the case
may be a balance sheet and a profit and loss account as on the last working day of the
year of the period in the forms set out in the third schedule or as near thereto as
circumstances admit :

The balance sheet and profit and loss account shall be signed:

In the case of a banking company incorporated in India, by the manager or the principal officer
of the company and where there are more than three directors of the company, by at least three of
those directors, or where there are not more than three directors, by all the directors, and In the
case of a banking company incorporated outside India, by the manager or principal officer of the
company in India.

• Audit of Bank Accounts (Sec. 30) : According to Sec. 30, the balance sheet and
profit and loss account prepared in accordance with Sec. 29 shall be audited:

In the case of a banking company incorporated in India, by a person duly qualified under any law
for the time being in force to be auditor of companies;

In the case of banking company incorporated outside India, either by such an auditor as aforesaid
or by a person duly qualified to be an auditor under the law of the country in which the company
is incorporated.

10. Explain the meaning, definition and features of Bank?

28
Ans.

• Meaning of Bank:

The term bank has originated from the term ‘Banchi’. In olden days, the traders of Italy who
performed the job of exchanging money were known as Banchi or Bancheri because the table
which they used for making payment was called a Banchi. According to some people, the term
bank is derived from the Greek word ‘Banque.’

• Definitions Of Bank :

(1) “Banking is the business of accepting for the purpose of lending or investment, of deposits of
money from the public repayable on demand or otherwise and withdraw-able by cheque, draft,
and order or otherwise.” Indian Banking Regulation Act, 1949

(2) “A bank is an organisation whose principal operations are concerned with the accumulation
of the temporarily idle money of the general public for the purpose of advancing to others for
expenditure.”-R.P. Kent

• Features of Bank :
• Money Dealing
• Acceptance of Deposit
• Grant of loan and advances
• Payment and withdrawal of deposits
• Transfer of funds
• Portfolio management
• Foreign Exchange dealing

29
 UNIT-II

¾ Descriptive Answers Questions

Q.1. Define Central Bank and Explain the necessity of Central Bank?

Ans.

¾ DEFINITION OF CENTRAL BANK :

A central bank or monetary authority is a monopolized and often nationalized institution given
privileged control over the production and distribution of money and credit. In modern
economies, the central bank is usually responsible for the formulation of monetary policy and
the regulation of member banks.

Central banks are generally associated with fiat money, under the international gold standard of
the nineteenth and early twentieth century’s central banks developed in most of Europe and in
Japan, though elsewhere free banking or currency boards were more usual at this time After
World War II, central banks became much more widespread. The US Federal Reserve was
created by the U.S. Congress through the passing of the Glass-Owen Bill, signed by President
Woodrow Wilson on December 23, 1913, whilst Australia established its first central bank in
1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New Zealand in the
aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that
did not possess a central bank was Brazil, which developed a precursor thereto in 1945 and
created its present central bank twenty years later.

¾ CHARACTERISTICS OF CENTRAL BANK.

The main characteristics of a central bank are given as below –

1 Note Issue:- The main feature of a central bank is the issue of currency notes in the
country.

2. Banker to The Govt.:-The Central bank is the banker to the government and also acts
as its fiscal agent. The government keeps its balances with it free of interest. It receives and
disburses the payments on behalf of the government and also makes advances to the government.

3. Banker’s Bank: – The Central bank also acts as the banker to the scheduled and other
banks.
30
 4. Lender of Last Resort: – The Central bank is the lender of last resort. It maintains a close
relationship with the commercial banks.

5 Controller of Credit: – One of the important functions of Central bank is to regulate and
control the credit in the country according to the varying economic situations.

6 Adviser to The Govt.:- It also acts an adviser to government on financial and economic
matters.

7. Clearing House: -The Central bank acts as the clearing house for other banks

8. Controller of Foreign Exchange: –The Central bank is responsible for the management of
foreign exchange & maintaining external value of taka.

¾ THE NECESSITY OF CENTRAL BANK :

A Central Bank (RBI in India) is an integral part of the financial and economic system. They
are usually owned by the government and given certain functions to fulfill. These include
printing money, operating monetary policy, lender of last resort and ensuring the stability of
financial system.

Central bank was created to ensure that there are no major crisis that would devastate a nation.
The central bank tries to assure that the economy is running smoothly through monetary policy
(setting short term interest rates).
Now the question whether, if the central bank is needed as a guide and a stabilizer is debated.
Some argue that central banks are part of the economic evolution. They are needed to finance the
government and the nation. In contrast, some economists argue that central banks cannot
reasonably manage the interest rates because nobody is knows more than the markets.
Furthermore, central banks may do more damage than good by fueling bubbles and overreacting
in times of crisis. I believe that central banks are part of the economic evolution and are needed
by the government. However, the way it runs now is quite questionable

¾ FUNCTIONS OF CENTRAL BANK :

31
The important functions of Central Banks are as flows:

• Sole Right of Note Issue: The Central Bank in every country, now, has the monopoly
note issue. The issue of notes is governed by certain regulation which is enforced by the
state.

• Banker to the State : A Central Bank acts as a banker to the government. It holds cash
balances of the government free of interest.

• Banker's Bank: The central bank acts as a banker to the commercial banks.

• Banker's Clearing House: The Central Bank acts as a clearing house for the settlement
of mutual obligations of different commercial banks. If a difference exists, it is paid by a
cheque drawn on the banks accounts carried at the Central Bank.

• Lender to the Last Resort: The Central Bank helps the member banks in times of crisis.

• Financial Agent: The Central Banks act as financial agents for the government. It is an
agent for the government in purchasing and selling of gold and foreign exchange.

• Effective Monetary Policy: The aim of the government is to create employment in the
country, resist undue inflation and achieve a favorable balance of payment.

Q 2. Discuss the organizational structure objectives and functions of RBI ?

32
Ans.

RESERVE BANK OF INDIA

¾ DEFINITION OF RBI. :

The Reserve Bank of India (RBI) is the Central Bank Of India, which was established on
April 1, 1935, under the Reserve Bank of India Act. The Reserve Bank of India uses monetary
policy to create financial stability in India, and it is charged with regulating the country's
currency and credit systems. The RBI was originally set up as a private entity but was
nationalized in 1949. The reserve bank is governed by a central board of directors appointed by
the national government.

¾ OBJECTIVES OF RBI :

The basic objectives of RBI are to issue bank notes, to maintain the currency and credit system
of the country to utilize it in its best advantage, and to maintain the reserves. RBI maintains the
economic structure of the country so that it can achieve the objective of price stability as well as
economic development, because both objectives are diverse in themselves.

¾ ORGANIZATIONAL STRUCTURE :

The affairs of RBI are managed by the Central Board and Local Boards.

¾ Central Board

The control board consists of following members under section 8 of RBI Act 1934.

• A Governor and not more than four Deputy Governor appointed by the Central
Government.

• Four Directors nominated by the Central Government one from each of the four Local
Boards.

• Ten Directors nominated by the Central Government.

33
 • One government official nominated by the central government.

¾ LEGAL STATUS AND FUNCTIONS :

A bank is a body corporate by the name of the Reserve Bank of India, having
perpetual succession and a common seal, and shall by the said name sue and be sued.

¾ MAIN FUNCTIONS :

• Monetary Authority: The Reserve Bank of India Formulates, implements and monitors
the monetary policy. Its main objective is maintaining price stability and ensuring
adequate flow of credit to productive sectors.

• Regulator and Supervisor of the Financial System: Prescribes broad parameters of

banking operations within which the country's banking and financial system functions.
Their main objective is to maintain public confidence in the system, protect depositors'
interest and provide cost- effective banking services to the public.

• Manager of Exchange Control: The manager of the exchange control department

manages the Foreign Exchange Management Act, 1999. His main objective is to facilitate
external trade and payment and promote orderly development and maintenance of
foreign exchange market in India.

• Issuer of Currency: Under Section 22 of the Reserve Bank of India Act, the Bank has
the sole right to issue bank notes of all denominations. The distribution of one rupee
notes and coins and small coins all over the country is undertaken by the Reserve Bank as
agent of the Government.

• Banker to Government: The Reserve Bank of India is to act as Government banker,

agent and adviser. The Reserve Bank is agent of Central Government and of all State
Governments in India.

• Controller of Credit: The Reserve Bank of India is the controller of credit i.e. it has the
power to influence the volume of credit created by banks in India.

• Developmental Role : The Reserve Bank of India performs a wide range of promotional
functions to support national objectives. The promotional functions are such as contests,
coupons, maintaining good public relations.

34
 • Banker to Banks: The Reserve Bank of India acts as the bankers' bank. According to the
provisions of the Banking Companies Act of 1949, every scheduled bank was required to
maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites
and 2 percent of its time liabilities in India.

• Amalgamation of Banking Company by Reserve Bank: No banking company shall be

amalgamated with another banking company, unless a scheme containing the term of
such amalgamation, drafted by the companies, has been approved by the reserve bank of
India.

• Issuing of Bank Notes: This function which was once considered to be the most paying
part of a banker's business, is in modern times performed generally by central banking
institutions in most of the countries of the world

• Transferring Money from Place to Place: Modern banks are, generally, in a position to
remit money, from one place or country to another, by means of drafts drawn upon their
branches or agents.

• Granting Licenses to Banking Companies: The RBI is empowered to grant licenses for
banking companies which have requested for them under Section 22 of the RBI Act, for
carrying on the business of banking in India.

• Official Liquidator: In any proceeding for the winding up of a Banking Company, upon
an application made to High Court, the High Court shall appoint Reserve Bank as the
official liquidator of the Banking Company.

• Supervisory Functions

In addition to its traditional central banking functions, the Reserve bank has certain
non-monetary functions of the nature of supervision of banks and promotion of sound banking in
India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI
wide powers of supervision and control over commercial and co-operative banks, relating to
licensing and establishments, branch expansion, liquidity of their assets, management and
methods of working, amalgamation, reconstruction, and liquidation.

• Promotional Functions

The Bank now performs a variety of developmental and promotional functions, which, at one
time, were regarded as outside the normal scope of central banking. The Reserve Bank was
asked to promote banking habit, extend banking facilities to rural and semi-urban areas, and
establish and promote new specialized financing agencies.
35
Q. 3 Explain the relationship between RBI and Commercial Bank?

Ans.

¾ Definition of Central Bank (rbi)

Central Bank is the supreme financial institution that regulates the banking and monetary
system of the country. It is formed to bring monetary stability, issue notes and maintain the value
of a country’s currency in the international market. It administers the currency and credit system
of the nation.

A central bank is a banker's bank. It is normally part of or connected to the government

of a country and manages the country's financial system. A commercial bank provides banking
services to businesses, institutions and some individuals. The money it takes in from its
customers is deposited at its local central bank. Nearly all the country's banks have accounts at
the central bank to keep their money and for borrowing to offset any temporary shortages of
cash.

In India, the Reserve Bank of India plays the role of a central bank, which came into
existence, after passing an act in parliament in 1934. The bank is headquartered in Mumbai,
Maharashtra. The following are the main functions of the Central Bank

• It is authorized to issue currency notes except coins and notes of small magnitude.

• It has the power to control, direct and supervise the commercial banks. It also helps them
at the time of need.

• It employs various measures to control the credit operations of the commercial banks.

• It is the banker and advisor to the government of the country.

• It acts as a manager of foreign exchange reserves.

• It collects and publishes the information relating to banking and financial sector.

• It oversees the credit and monetary policy of the nation

¾ Definition of Commercial Bank :

The entities that provide banking and financial services to a large number of people are known as
Commercial Banks. They act as a mediator between the borrowers and savers. The Commercial
Banks receive deposits from the general public and lends it on high interest to the individuals and

36
organizations. In this way, the mobilization of savings takes place, and the economic cycle goes
on smoothly.

• The essential functions of a Commercial Bank are:

• It accepts deposits from the general public, firms, institutions and organization. Further, it
gives the facility to withdraw money on demand. Banks pay interest on deposits at
various rates on different deposits.

• It lends money to public, institutions, and organization in the form of long term and short
term loans for a particular period and charges interest on the amount lent. Moreover, it
provides overdraft and cash credit facilities to the customer.

• It performs agency functions like collections of bills of exchange and promissory notes,
trading of shares and debentures, payment to third parties on standing instructions of the
customer, etc.

• It provides the facility of safe keeping of valuables like jewelry and documents.

• It collects, transfers and makes payment of funds on behalf of the customer.

• It provides the facility of ATM card, Debit Card, Credit Card, Cheques, etc., to its
account

¾ DIFFERENCES BETWEEN CENTRAL BANK AND COMMERCIAL BANK :

The following are the differences between central bank and commercial bank:

1. The bank, which monitors, regulates and controls the financial system of the economy is
known as Central Bank. The financial institution which receives the deposits from
people and advances them money is known as Commercial Bank.

2. Central Bank is the banker to banks, government, and financial institution, whereas
Commercial Bank is the banker to the citizens.

3. The Central Bank is the supreme monetary authority of the country. As against this, the
commercial bank does not have such authority and powers.

4. The Central Bank of India i.e. the Reserve Bank of India is governed by RBI Act, 1934.
Conversely, the Commercial Bank are regulated by the Banking Regulation Act, 1949.

37
 5. The Central Bank is a publicly owned institution while the Commercial Bank can be
publicly or privately owned institution.

6. The Central Bank does not exist for making a profit, whereas commercial bank
operates for making a profit for its owners.

7. The Central Bank is the fundamental source of money supply in the economy. On the
contrary, the commercial bank does not perform such function.

8. The Central Bank does not deal with the general public, but Commercial Bank does.

9. The Central Bank has got the authority to print and issue the notes. On the other hand,
the commercial bank does not have such authority.

10. The main purpose of Central Bank is public welfare and economic development. In
contrast Commercial Bank, which runs for-profit motive.

11. There is only one Central Bank in every country, but the Commercial Banks are many
which serve the whole country.

¾ Conclusion :

The Central Bank is the leading public financial institution that governs the entire banking
system in the country. It has full control over all the commercial banks in the country. The
Central Bank regulates the flow of money in the economy. The apex bank adopts various
measures like Cash Reserve Ratio, Statutory Liquidity Ratio, Bank Rate, Repo Rate, Reverse
Repo Rate, etc. to control the supply of money.

¾ Short Answers Questions

Q. 4 Explain the functions of Central Bank?

Ans.

A central bank is a banker's bank. It is normally part of or connected to the government

of a country and manages the country's financial system. A commercial bank provides banking
services to businesses, institutions and some individuals. The money it takes in from its
customers is deposited at its local central bank. Nearly all the country's banks have accounts at
the central bank to keep their money and for borrowing to offset any temporary shortages of
cash.

38
 In India, the Reserve Bank of India plays the role of a central bank, which came
into existence, after passing an act in parliament in 1934. The bank is headquartered in Mumbai,
Maharashtra. The following are the main functions of the Central Bank

• It is authorized to issue currency notes except coins and notes of small magnitude.

• It has the power to control, direct and supervise the commercial banks. It also helps them
at the time of need.

• It employs various measures to control the credit operations of the commercial banks.

• It is the banker and advisor to the government of the country.

• It acts as a manager of foreign exchange reserves.

• It collects and publishes the information relating to banking and financial sector.

• It oversees the credit and monetary policy of the nation

The important functions of Central Banks are as follows:

1. Sole Right of Note Issue: The Central Bank in every country, now, has the monopoly
note issue. The issue of notes is governed by certain regulation which is enforced by the
state.

2. Banker to the State : A Central Bank acts as a banker to the government. It holds cash
balances of the government free of interest.

3. Banker's Bank: The central bank acts as a banker to the commercial banks.

4. Banker's Clearing House: The Central Bank acts as a clearing house for the settlement
of mutual obligations of different commercial banks. If a difference exists, it is paid by a
cheque drawn on the banks accounts carried at the Central Bank.

5. Lender to the Last Resort: The Central Bank helps the member banks in times of crisis.

6. Financial Agent: The Central Banks act as financial agents for the government. It is an
agent for the government in purchasing and selling of gold and foreign exchange.

7. Effective Monetary Policy: The aim of the government is to create employment in the
country, resist undue inflation and achieve a favorable balance of payment.

39
Q. 5. What are the necessity of Central Bank?

Ans.

¾ THE NECESSITY OF CENTRAL BANK :

A Central Bank (RBI in India) is an integral part of the financial and economic system. They
are usually owned by the government and given certain functions to fulfill. These include
printing money, operating monetary policy, lender of last resort and ensuring the stability of
financial system.

Central bank was created to ensure that there are no major crisis that would devastate a nation.
The central bank tries to assure that the economy is running smoothly through monetary policy
(setting short term interest rates).Now the question whether, if the central bank is needed as a
guide and a stabilizer is debated. Some argue that central banks are part of the economic
evolution. They are needed to finance the government and the nation. In contrast, some
economists argue that central banks cannot reasonably manage the interest rates because nobody
is knows more than the markets. Furthermore, central banks may do more damage than good by
fueling bubbles and overreacting in times of crisis. I believe that central banks are part of the
economic evolution and are needed by the government. However, the way it runs now is quite
questionable

Q. 6. Distinguish between Central Banking and Commercial Banking?

Ans.

¾ Definition of Central Bank (rbi)

Central Bank is the supreme financial institution that regulates the banking and monetary
system of the country. It is formed to bring monetary stability, issue notes and maintain the value
of a country’s currency in the international market. It administers the currency and credit system
of the nation.

¾ DEFINITION OF COMMERCIAL BANK :

The entities that provide banking and financial services to a large number of people are known as
Commercial Banks. They act as a mediator between the borrowers and savers. The Commercial
Banks receive deposits from the general public and lends it on high interest to the individuals and
organizations. In this way, the mobilization of savings takes place, and the economic cycle goes
on smoothly.

40
 ¾ DIFFERENCES BETWEEN CENTRAL BANK AND COMMERCIAL BANK :

The following are the differences between central bank and commercial bank:

1. The bank, which monitors, regulates and controls the financial system of the economy is
known as Central Bank. The financial institution which receives the deposits from
people and advances them money is known as Commercial Bank.

Central Bank is the banker to banks, government, and financial institution, whereas
Commercial Bank is the banker to the citizens.

2. The Central Bank is the supreme monetary authority of the country. As against this, the
commercial bank does not have such authority and powers.

3. The Central Bank of India i.e. the Reserve Bank of India is governed by RBI Act, 1934.
Conversely, the Commercial Bank are regulated by the Banking Regulation Act, 1949.

4. The Central Bank is a publicly owned institution while the Commercial Bank can be
publicly or privately owned institution.

5. The Central Bank does not exist for making a profit, whereas commercial bank
operates for making a profit for its owners.

6. The Central Bank is the fundamental source of money supply in the economy. On the
contrary, the commercial bank does not perform such function.

7. The Central Bank does not deal with the general public, but Commercial Bank does.

8. The Central Bank has got the authority to print and issue the notes. On the other hand,
the commercial bank does not have such authority.

9. The main purpose of Central Bank is public welfare and economic development. In
contrast Commercial Bank, which runs for-profit motive.

10. There is only one Central Bank in every country, but the Commercial Banks are many
which serve the whole country.

¾ Conclusion :

The Central Bank is the leading public financial institution that governs the entire banking
system in the country. It has full control over all the commercial banks in the country. The
Central Bank regulates the flow of money in the economy. The apex bank adopts various

41
measures like Cash Reserve Ratio, Statutory Liquidity Ratio, Bank Rate, Repo Rate, Reverse
Repo Rate, etc. to control the supply of money.

¾ Very Short Answers Questions

Q.7 Discuss the functions of RBI?

Ans.

¾ MAIN FUNCTIONS :

• Monetary Authority: The Reserve Bank of India formulates, implements and monitors
the monetary policy. Its main objective is maintaining price stability and ensuring
adequate flow of credit to productive sectors.

• Regulator and Supervisor of the Financial System: Prescribes broad parameters of

banking operations within which the country's banking and financial system functions.
Their main objective is to maintain public confidence in the system, protect depositors'
interest and provide cost- effective banking services to the public.

• Manager of Exchange Control: The manager of the exchange control department

manages the Foreign Exchange Management Act, 1999. His main objective is to facilitate
external trade and payment and promote orderly development and maintenance of
foreign exchange market in India.

• Issuer of Currency: Under Section 22 of the Reserve Bank of India Act, the Bank has
the sole right to issue bank notes of all denominations. The distribution of one rupee
notes and coins and small coins all over the country is undertaken by the Reserve Bank as
agent of the Government.

• Banker to Government: The Reserve Bank of India is to act as Government banker,

agent and adviser. The Reserve Bank is agent of Central Government and of all State
Governments in India.

• Controller of Credit: The Reserve Bank of India is the controller of credit i.e. it has the
power to influence the volume of credit created by banks in India.

Q. 8. Explain the Principal of Central Banking?

42
Ans.

The principles on which a central bank is run as follows:

(i) A central bank, on the other hand, is primarily meant to shoulder the responsibility of safe
guarding the financial and economic stability of the country.

(ii) Since the central bank is not a profit or dividend- hunting institution, it does not act as a
rival of other banking institutions. It is primarily concerned with the maintenance of the solvency
of the entire banking system of the country. It must, therefore keep Its own assets as liquid as
possible.

(iii) The central bank is a reservoir of credit and a lender of last resort. All other bank and
financial houses can look to it for accommodation of course at a price. But the central bank
cannot rely on any other institution to come to its aid and give it cash or take bills and securities
off its hands.

(iv) The central bank must follow an active policy. It should not be merely all idle spectator
when something goes wrong with the credit machinery of the nation

(v) The open market operations.’ and their working is explained the sections below. We may
also adopt other measures of credit control, general or selective credit controls.

(vi) For the efficient discharge of its functions, the central bank is provided with special
equipment: It is given the monopoly of the note issue.

(vii) It is made a banker to the government. It is a bankers’ bank.

(viii) Finally, a central bank should not be subservient to any political party. It must be
independent of all political influence, so that it can act freely, without fear or favour, in the best
interests of the nation as a whole, However, there is usually very close co-operation between the
government and the bank.

Q. 9. Explain the definition of Central Bank?

Ans.

¾ Definition of Central Bank

Central Bank is the supreme financial institution that regulates the banking and monetary
system of the country. It is formed to bring monetary stability, issue notes and maintain the value

43
of a country’s currency in the international market. It administers the currency and credit system
of the nation. A central bank is a banker's bank. It is normally part of or connected to the
government of a country and manages the country's financial system. A commercial bank
provides banking services to businesses, institutions and some individuals. The money it takes in
from its customers is deposited at its local central bank. Nearly all the country's banks have
accounts at the central bank to keep their money and for borrowing to offset any temporary
shortages of cash.

Q. 10. What are the objectives of RBI?

Ans.

¾ OBJECTIVES OF RBI :

The basic objectives of RBI are to issue bank notes, to maintain the currency and credit system
of the country to utilize it in its best advantage, and to maintain the reserves. RBI maintains the
economic structure of the country so that it can achieve the objective of price stability as well as
economic development, because both objectives are diverse in themselves.

44
 UNIT-III

¾ Descriptive Answers Questions

1. Define Contract of Guarantee. Discuss the Rights and liabilities of a Surety?

Ans.

¾ Rights and Discharge of Surety

A contract of guarantee refers to a contract to perform the promise or discharge the liability of
a third person in case of any default by him. Surety is the person giving the guarantee. The
person for whom the guarantee is given is the Principle Debtor. The person to whom the surety
gives the guarantee is the Creditor. A guarantee may be oral or in writing. Here we will discuss
the Discharge and Rights.

Discharge and Rights of Surety

A contract of guarantee shall also satisfy all the necessary conditions or elements of a valid
contract. As per section 127, anything is done or any promise made for the benefit of the
principal debtor provides a sufficient consideration to the surety for giving the guarantee to
the creditor.

¾ Rights of a Surety: A surety has the following rights:

1. Rights against the Creditor

45
As per section 141, a surety is eligible to the benefit of every security which the creditor has
against the principal debtor. This holds true even if at the time of entering into the contract of
guarantee the surety was unaware of the existence of such a security.

Also, when the creditor losses or parts with such security without the consent of the surety, this
discharges the surety to the extent of the value of such security.

2. Rights against the Principal Debtor

Once the surety discharges the debt, he obtains the rights of a creditor against the principal
debtor. He can now sue the principal debtor for the amount of debt paid by him to the creditor
due to the default of the principal debtor.

In a case where the principal debtor on discovering that the debt has become due, starts disposing
of his properties in order to prevent seizure by the surety, the surety can compel the debtor to pay
the debt and discharge him from his liability to pay.

3. Surety’s rights against the co-sureties

When a surety pays more than his share to the creditor, he has a right of contribution from the
co-sureties, who are equally liable to pay. For example, Anthony, Barkha and Chaya are the
co-sureties to David for a sum of 30000 lent to Erwin who made default in payment.

¾ Discharge of a Surety (Sec.130 – 141)

A surety is discharged from his liability on:

1. The death of a surety as regards future transactions in case of a continuing guarantee in

the absence of a contract to the contrary.

2. Notice of revocation as regards future transactions in case of a continuing guarantee. For.

3. Any variation in the terms of the contract between the principal debtor and the creditor
without surety’s consent.

4. If the creditor releases the principal debtor, the surety also automatically discharges.

5. When the creditor makes an arrangement for composition or promises to give time or not
sue the principal debtor without surety’s consent, the surety will be discharged.

6. Any act or omission to do an act by the creditor which results in harming the rights of the
surety, and also impairs the eventual remedy of the surety himself against the principal
debtor, discharges the surety.

46
 7. Where the creditor loses or parts with any security which he receives from the principal
debtor without the consent of the surety, this discharges the surety to the extent of the
value of such security.

2. “A bank generally insist upon securities before the advancement of loans to the
borrowers.’’ Discuss the main types of Securities?

Ans.

The words security means safety or guarantee of any kind, which may be verbal, personal or in
the form of any property. It is very essential for a creditor to secure his loan or advances through
different securities. A security is a right possessed by a creditor in property or anything to
convert the same into cash, if the debtor fails to refund the amount advanced with the interest.
Bankers, whenever advancing loans, first ask for the security to be put for the loans requested.
Different types of securities are used depending upon the nature of the advances issued by the
banks. A good security must be enough to cover the risk, highly liquid, free from any
encumbrance, clean in ownership and easy to handle.

To understand what the different types of securities are we should know about what security is?
The words security means safety or guarantee of any kind, which may be verbal, personal or in
the form of any property. It is very essential for a creditor to secure his loan or advances through
different securities. A security is a right possessed by a creditor in property or anything to
convert the same into cash, if the debtor fails to refund the amount advanced with the interest.
Bankers, whenever advancing loans, first ask for the security to be put for the loans requested.
Different types of securities are used depending upon the nature of the advances issued by the
banks. A good security must be enough to cover the risk, highly liquid, free from any
encumbrance, clean in ownership and easy to handle.

¾ Types of Securities

There are four types of securities which are as under:-

• Lien

• Pledge

• Mortgage

• Hypothecation

1. Lien

47
Lien is first kind of security which is the right of holdings the goods of the borrower until the
loan is repaid. The borrower remains the owner of the goods, but the possession is given to the
lender. The agreement of lien explains whether it relates a particular debt or debts in general. In
ordinary lien creditor has only the right of possession of goods. He has no right to sell it, but the
banker’s lien is not the same. The banker has a right to sell the good after a proper notice. The
banker gets the property of the customer as his banker. Thus, papers of money or goods with the
banker are not for the purpose other than lien. The banker takes the possession lawfully. There
must not imply or expressed agreement against lien.

2. Pledge

Pledge is also from one of the types of securities. It can be defines as “Bailment of goods as
protection for payment of a money owing or act of a promise”. The borrower is called pledger
and the banker is called pledge. In case of pledge there should be bailment of goods and the
bailment should be on behalf of the debtor or an intending debtor. The delivery of goods is
necessary for the contract of bailment. The delivery may be actual or constructive. The
constructive delivery is made when the bailee puts his lock on the doors of Godowns storing the
pledged goods or merely key of the lock on the Godowns door is received. It is essential that the
bailee should return the same goods to the bailer or dispose them of according to his instructions.

3Mortgage Mortgage another type of security which can be defines as “A mortgage is the
reassigning of interest in particular fixed property for the reason of protection of payment of
funds advanced by means of loan, an presenting of future balanced due, or the act of
commitment which maybe rise to a financial liability”. The transferor may be known as
mortgager. The transferee may be known as mortgagee. The contract is treated as mortgage deed.

4 Hypothecation

Hypothecation is also from one of the types of securities and can be defines as “A lawful
transaction and essential goods are always accessible as security for a balance due without
transferring either the property or the possession to the lender”. It is clear that possession and
ownership of the goods remain with the borrower and an equitable charge is created in favor of
the lender. The borrower agrees to give the possession of the goods to the banker whenever the
banker requires him to do so. It is possible when the transfer of possession is either inconvenient
or impracticable. If the borrower offers raw material or goods in possession as security, the
transfer of possession will stop the functioning of borrowers business. The creditor possesses the
right of a pledge under the hypothecation deed. The position of the banker under hypothecation
is not as safe as under a pledge. If the borrower fails to give the possession of eth goods
hypothecated, the bank can file a suit in the court of law for the recovery of amount lent.

48
 ¾ Collateral vs. Security

• What is Collateral?

Collateral is an asset or property that an individual offers to a lender whenever he wants to

acquire a loan. It is used as a way to obtain a loan which, at the same time, acts as a protection
for the lender should the borrower default in his payments. In such an event, the collateral
becomes the property of the lender to compensate for the unreturned borrowed money. For
example, if a person wants to take out a loan from the bank, he may use his car or the title of a
piece of property as collateral. If he fails to repay the loan, the collateral may be seized by the
bank, based on the two parties’ agreement. If the borrower has finished paying back his loan,
then the collateral is returned to his possession.

• Types of Collateral

In order to be able to take out a loan successfully, every business owner or individual should
know the different types of collateral that can be used when borrowing.

1. Real estate

The most common type of collateral used by most borrowers is real estate, such as one’s home or
lot parcel. Aside from being easily available, such properties come with a high value and low
depreciation. However, it can also be risky because if the property is sequestered due to a
default, it cannot any longer be taken back.

2. Cash secured loan

Cash is another common type of collateral because it works very simply. An individual can take
a loan from the bank where he maintains active accounts and in the event of a default, the bank
can liquidate his accounts in order to recoup the borrowed money.

3. Inventory financing

This involves an inventory that serves as the basis for the release of a loan. Should a default
happen, the things listed in the inventory will be sold

4. Invoice collateral

Invoices are one of the types of collateral used by small businesses, wherein invoices that are
still unpaid are used as collateral.

5. Blanket liens

49
This involves the use of a lien, which is a legal claim allowing a lender to dispose of the assets of
a business that is in default of its loan.

• Borrowing without Collateral

Not all loans require collateral, especially if the borrower doesn’t own any property to offer. In
such a case, there are several ways to borrow money, including:

1. Unsecured loans

From the name itself, unsecured loans don’t give the lender any form of assurance or protection
that the money will be returned. However, they usually involve just small amounts. Examples of
unsecured loans include credit card debts.

2. Online loans

With the advancement of technology, there are many more ways to get a loan. In fact, people can
now obtain online loans that don’t require collateral and are often approved quickly. After filling
out an application form, the lender will let the applicant know if he or she is approved, how
much the loan amount is, and how the payments are supposed to be made.

3. Using a co-maker or co-signer

Such types of loans don’t require a property for collateral but another individual who will
co-sign the loan. If the borrower defaults, the co-signer is obliged to pay the loan.

• Collateral vs. Security

Collateral and security are two terms that often confuse people who think both terms are one and
the same. However, the two concepts are different from each other, and the differences are
explained below:

• Collateral is any property or asset that is given by a borrower to a lender in order to

secure a loan. It serves as an assurance that the former will repay to the latter the amount
he owes, plus interest. Security, on the hand, refers to a broad set of financial assets used
as collateral for a loan. Using securities when taking out a loan is called securities-based
lending.

• Collateral can be the title of a parcel of land, a car, or a house and lot, while securities are
things such as bonds, futures, swaps, options, and stocks.

• Collateral stays with the lender throughout the time the borrower is paying the loan.
Thus, the borrower does not derive any benefit from the property during that time.
50
 Securities, on the other hand, allow the borrower to benefit from both the loan and the
securities portfolio even while the loan is still being paid back, because the securities
portfolio is left trading in the market. However, the lender assumes a greater risk because
the value of the security fluctuates.

3. Discuss the constitution, functioning and powers of debt recovery tribunals(DRT)?

Ans DEBT RECOVERY TRIBUNALS(DRT)

¾ Recovery Tribunals (DRTs)

The Debts Recovery Tribunals (DRTs) and Debts Recovery Appellate Tribunal (DRATs)
were established under the Recovery of Debts Due to Banks and Financial Institutions Act
(RDDBFI Act), 1993 with the specific objective of providing expeditious adjudication and
recovery of debts due to Banks and Financial Institution Debt Recovery Tribunals were
established to facilitate the debt recovery involving banks and other financial institutions with
their customers. DRTs were set up after the passing of Recovery of Debts due to Banks and
Financial Institutions Act (RDBBFI), 1993. Appeals against orders passed by DRTs lie before
Debts Recovery Appellate Tribunal (DRAT). DRTs can take cases from banks for disputed loans
above Rs 10 Lakhs. At present, there are 33 DRTs and 5 DRATs functioning at various parts of
the country. In 2014, the government has created six new DRTs to speed up loan related dispute
settlement.

Compared to the ordinary court procedures, DRTs were able to handle large number of
cases with low delay during the initial phases. Though the DRTs have made impact on recovery
front, several issues related to their performance in the background of rising volume of NPAs
have appeared in later period. Inadequate infrastructure coupled with insufficient number of
DRTs has made them incompetent to handle the rising volume of disputes.

¾ Recent issues related with DRTs

The leading issue related with debt recovery through DRTs is the slow process of resolution
(settling debts and finding end to defaults). Like several other debt recovery mechanisms, the
DRTs are slow to work out on pending disputes. Nearly 93000 cases are pending in front of all
the DRTs in the country at the end of 2016. The World Bank estimated that it took 4.3 years on
average in India to resolve insolvency under the old laws, more than twice as long as in China.
Similarly, the average recoveries were just 25.7 cents on the dollar in India. This is one of the
worst among the similar economies. In India there are total thirty-three Debt Recovery Tribunal
and five Debt Recovery Appellate Tribunal. The tribunals speed up the cases of financial
recovery as the banks and financial institutions were facing a lot delay in recovering the money
lent by them and to enforce the pledged securities
51
The tribunals speed up the cases of financial recovery as the banks and financial institutions were
facing a lot delay in recovering the money lent by them and to enforce the pledged securities. A
case can be filed before the DRT where the amount to be recovered is from the borrower is more
than Rs 10 lakhs.

The cases for recovering money are filed before the Debt Recovery Tribunal. The first step in
filing a case in labour court is to hire best debt recovery lawyer. Consult a recovery lawyer for
filing a case against employer. Recovery lawyer will assist you right from the stage of legal
notice till the disposal of case.

¾ Procedure of Debt Recovery Tribunal -

The Procedure of Debt Recovery Tribunal is similar to the procedure of the court and the person
aggrieved from the decision of the Debt Recovery Tribunal can file an appeal within forty-five
days from the date of decision of Debt Recovery Tribunal before the Debt Recovery Appellate
Tribunal.

In the Debt Recovery Tribunal, the bank through the debt recovery lawyer files a petition before
the tribunal for seeking an interim order against the borrower of the debt for recovery of the due
amount. The tribunal then sends the notice to the borrower to be present before the tribunal to
explain his side as to why there is no cause of action against them. If the borrower after the
receipt of notice does not appear before the tribunal, the tribunal will pass an ex parte order
against him. However, if the borrower appears before the tribunal then the similar procedure
which is followed in court will be followed before passing of order i.e., production of documents
in support, examination and cross examination of both the parties i.e., bank officials and
borrower and their respective witnesses. After verbal and written arguments, the Debt Recovery
Tribunal will pass an order on the merits of the case.

¾ Short Answers Questions:

4. What are the Principles of good lending?

Ans.

Principles of good lending

The principle that bank notes are a form of credit and should be issued freely in order to
maintain an elastic currency. Compare currency principle also called banking doctrine.

Banks follow the following principles of lending:

1. Liquidity:

52
Liquidity is an important principle of bank lending. Bank lend for short periods only because
they lend public money which can be withdrawn at any time by depositors. They, therefore,
advance loans on the security of such assets which are easily marketable and convertible into
cash at a short notice. A bank chooses such securities in its investment portfolio which possess
sufficient liquidity. It is essential because if the bank needs cash to meet the urgent requirements
of its customers, it should be in a position to sell some of the securities at a very short notice
without disturbing their market prices much. There are certain securities such as central, state
and local government bonds which are easily saleable without affecting their market prices. The
shares and debentures of large industrial concerns also fall in this category. But the shares and
debentures of ordinary firms are not easily marketable without bringing down their market
prices. So the banks should make investments in government securities and shares and
debentures of reputed industrial houses.

2. Safety:

The safety of funds lent is another principle of lending. Safety means that the borrower should be
able to repay the loan and interest in time at regular intervals without default. The repayment of
the loan depends upon the nature of security, the character of the borrower, his capacity to repay
and his financial standing. It is very safe to invest in the securities of a government having large
tax revenue and high borrowing capacity. The same is the case with the securities of a rich
municipality or local body and state government of a prosperous region. So in making
investments the bank should choose securities, shares and debentures of such governments, local
bodies and industrial concerns which satisfy the principle of safety

3. Diversity:

In choosing its investment portfolio, a commercial bank should follow the principle of diversity.
It should not invest its surplus funds in a particular type of security but in different types of
securities. It should choose the shares and debentures of different types of industries situated in
different regions of the country. The same principle should be followed in the case of state
governments and local bodies. Diversification aims at minimising risk of the investment
portfolio of a bank.

4. Stability:

Another important principle of a bank’s investment policy should be to invest in those stocks and
securities which possess a high degree of stability in their prices. The bank cannot afford any
loss on the value of its securities. It should, therefore, invest it funds in the shares of reputed
companies where the possibility of decline in their prices is remote.

5. Profitability:
53
This is the cardinal principle for making investment by a bank. It must earn sufficient profits. It
should, therefore, invest in such securities which was sure a fair and stable return on the funds
invested. The earning capacity of securities and shares depends upon the interest rate and the
dividend rate and the tax benefits they carry. It is largely the government securities of the centre,
state and local bodies that largely carry the exemption of their interest from taxes. The bank
should invest more in such securities rather than in the shares of new companies which also carry
tax exemption. This is because shares of new companies are not safe investments

5. Explain the Kinds of Contract of Guarantee?

Ans.

¾ Contract of Guarantee

Contract of Guarantee means a contract to perform the promises made or discharge the
liabilities of the third person in case of his failure to discharge such liabilities. As per section 126
of Indian Contract Act, 1872, a contract of guarantee has three parties: –

Surety: A surety is a person giving a guarantee in a contract of guarantee. A person who takes
responsibility to pay a sum of money, perform any duty for another person in case that person
fails to perform such work.

Principal Debtor: A principal debtor is a person for whom the guarantee is given in a contract
of guarantee.

Creditor: The person to whom the guarantee is given is known as the creditor.

For example, Mr. X advances a loan of 25000 to Mr. Y and Mr. Z promise that in case Mr. Y
fails to repay the loan, then he will repay the same. In this case of a contract of guarantee, Mr. X
is a Creditor, Mr. Y is a principal debtor and Mr. Z is a Surety.

¾ Kinds of Guarantees

A contract of guarantee may be for an existing liability or for future liability. A contract of
guarantee can be a specific guarantee (for any specific transaction only) or continuing guarantee.

• Specific Guarantee: A specific guarantee is for a single debt or any specified

transaction. It comes to an end when such debt has been paid.

• Continuing Guarantee: A continuing guarantee is a type of guarantee which applies to a

series of transactions.

54
 A continuing guarantee applies to all the transactions entered into by the principal debtor until
it is revoked by the surety. A continuing guarantee can be revoked anytime by surety for future
transactions by giving notice to the creditors. However, the liability of a surety is not reduced for
transactions entered into before such revocation of guarantee.

6. Write a short note on Rights of a bankers as a Pledge?

Ans.

A pledge occurs when goods are delivered for getting advance

¾ Pledge

Bailment of goods as security for payment of a debt or performance of a promise.” The person
who offers the security is called the ‘pawnor’ or ‘pledger’ and the bailee is called the ‘pawnee’
or the ‘pledgee’.

Delivery of goods from one person to another for some purpose upon the contract that the goods
will be returned back when the purpose is accomplished or otherwise disposed of according to
the instructions of the bailor.
From the above definitions, we observe that,

1. A pledge occurs when goods are delivered for getting advance.

2. The goods pledged will be returned to the owner on repayment of the debt.

3. The goods serve as a security for the debt.

¾ Essentials of Pledge

Delivery of goods: Delivery’ of goods is essential to complete a pledge. The delivery may be
physical or symbolic. Physical delivery refers to the physical transfer of goods from a pledger to
the pledgee.

Symbolic delivery requires no actual delivery of goods. But the possession of goods must be
transferred to a pledgee. This may be done in any one of the following ways:

ƒ Delivery of the key of the warehouse in which the goods are stored.

ƒ Delivery of the document of title to goods like a bill of lading, railway receipt, warehouse
warrants etc.

ƒ Delivery of transferable warehouse warrant if the goods are kept in a public warehouse.

55
 ƒ Transfer of ownership: The ownership of goods remains with the pledger. The possession
of the goods vests with pledgee till the loan is repaid.

¾ Rights of a banker as a Pledgee

1. The pledgee has the right to retain the goods pledged until he is paid the debt along with
the interest thereon and all other necessary expenses incurred for the possession and
preservation of the goods.

2. The pledgee has the right to retain the goods pledged only for the particular debt and not
for any other debt unless the contract provides otherwise.

3. The pledgee is entitled to receive from the pledger extraordinary expenses incurred by
him for the preservation of the goods pledged.

4. If the pledger makes a default in payment, the following courses are open to the pledgee:

ƒ He may file a suit for the recovery of the amount.

ƒ He may sue for the sale of the goods.

ƒ He may himself sell the goods after giving reasonable notice.

5. If the proceeds of such sale are less than the amount due in respect of the debt or
performance, the pledger is still liable to pay the balance. If the proceeds of the sale are
greater than the amount so due, the pledgee shall pay over the surplus to the pledger.

6. If a third person wrongfully deprives the pledgee of the use or the possession of the goods
pledged, he has the remedies against the third person as the owner would have had. The
pledgee may file a suit for damages.

7. If the pledgee suffers any damage as a result of non-disclosure of any fault by the
pledger, the hitter is responsible for it.

8. If the pledgee suffers a loss when the title of the pledger to the goods pledged is defective
the pledger shall be responsible.

¾ Duties of the Pledgee

1. The pledgee is bound to take that much care of the goods pledged which an ordinary’ prudent
man would take of his own goods under similar circumstances.

56
2. The pledgee must make use of the goods pledged according to the agreement between the
two parties. If lie/she makes any unauthorized use, the pledger is entitled to terminate the
contract and claim damages, if any.

3. The pledgee must deliver the goods to the pledger on repayment of the debt. It is the duty of
the pledgee to deliver the goods according to the direction of the pledger.

4. The pledgee must deliver to the pledger any increase or profit which may have occurred from
the goods pledged. For example, dividend on shares.

5. The pledgee is responsible to the pledger for any loss, destruction or deterioration of the
goods if the goods are not returned at the proper time.

¾ Difference between Lien and pledge

In case of lien, the lender has the right to retain but not to sell the asset. For banks, a lien is an
implied pledge, i.e. the bank has the right to sell the asset if the borrower defaults.But in case of
a pledge, the lender has the right to retain as well as sell the pledged asset if the borrower
defaults.

¾ Very Short Answers Questions

7. What is Surety’s Liability ?

Ans.

¾ Surety’s Liability

According to section 128 of Indian Contract Act, 1872, the liability of a surety is co-extensive
with that of principal debtor’s unless the contract provides. Liability of surety is same as that of
the principal debtor. A creditor can directly proceed against the surety. A creditor can sue the
surety directly without sueing principal debtor. Surety becomes liable to make payment
immediately when the principal debtor makes default in such payment. However, primary
liability to make payment is of the principal debtor, surety’s liability is secondary. Also, where
the principal debtor cannot be held liable for any payment due to any defect in documents, then
surety is also not responsible for such payment.

8. What is meant of Charging of Securities. Discuss its modes of charging of Securities ?

Ans. The process of secured lending is done through 'Charging of Securities'. A charge means
an interest or right which a lender or creditor obtains in the property of the company, by way
of security that the borrower will pay back the debt

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 ¾ Modes of Charging Security

1. Lien

2. Pledge

3. Hypothecation

4. Mortgage

5. Assignment

• Lien: Lien means the right to retain the goods of the borrower until the debts are repaid.

• Pledge: Pledge is the bailment of goods as security for payment of a debt. Only movable
goods can be pledged.

• Hypothecation: Hypothecation creates on equitable charge on movable property without

possession. However, the hypothecation deed provides that the banker will have the right
to take the goods hypothecated in its possession if the the need arises.

• Mortgage: A mortgage is a conveyance of an interest in property (land or any

immovable property) for securing a debt. A legal mortgage is created by a registered deed
and gives the mortgagee the right of sale in case of default of the borrower.

• Assignment: Assignment is transfer of ownership from one person/authority to another

person/authority.

• Set-off: Set-off means the total or partial merging of a claim of one person against
another in a counter claim by the latter against the former.

9. Write a note on Letters of Credit.

Ans.

¾ Letters Of Credit – Definition, Types & Process

A letter of credit is a document that guarantees the buyer’s payment to the sellers. It is Issued by
a bank and ensures the timely and full payment to the seller. If the buyer is unable to make such
a payment, the bank covers the full or the remaining amount on behalf of the buyer. A letter of
credit is issued against a pledge of securities or cash. Banks typically collect a fee, ie, a
percentage of the size/amount of the letter of credit.
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 ¾ Importance of letters of credit

Since the nature of international trade includes factors such as distance, different laws in each
country and the lack of personal contact during international trade, letters of credit make a
reliable payment mechanism. The International Chamber of Commerce Uniform Customs and
Practice for Documentary Credits oversees letters of credit used in international transactions

¾ Parties to a letter of credit

• Applicant (importer) requests the bank to issue the LC

• Issuing bank (importer’s bank which issues the LC [also known as the Opening banker of
LC])

• Beneficiary (exporter)

¾ Types of a letter of credit

The letters of credit can be divided into the following categories:

• Sight Credit

Under this LC, documents are payable at the sight/ upon presentation of the correct
documentation.
For example, a businessman can present a bill of exchange to a lender along with a sight letter of
credit and take the necessary funds right away. A sight letter of credit is more immediate than
other forms of letters of credit.

• Acceptance Credit/ Time Credit

The Bills of Exchange which are drawn and payable after a period, are called usance bills. Under
acceptance credit, these usance bills are accepted upon presentation and eventually honoured on
their respective due dates. For example, a company purchases materials from a supplier and
receives the goods on the same day. The bill will be delivered with the shipment of goods, but
the company may have up to 30 days to pay it. This 30 day period marks the usance for the sale.

• Revocable and Irrevocable Credit

A revocable LC is a credit, the terms and conditions of which can be amended cancelled by the
Issuing Bank. This cancellation can be done without prior notice to the beneficiaries. An

59
irrevocable credit is a credit, the terms and conditions of which can neither be amended nor
cancelled. Hence, the opening bank is bound by the commitments given in the LC.

• Confirmed Credit

Only Irrevocable LC can be confirmed. A confirmed LC is one when a banker other than the
Issuing bank, adds its own confirmation to the credit. In case of confirmed LCs, the beneficiary’s
bank would submit the documents to the confirming banker.

• Back-to-Back credit

In a back to back credit, the exporter (the beneficiary) requests his banker to issue an LC in
favour of his supplier to procure raw materials, goods on the basis of the export LC received by
him. This type of LC is known as Back-to-Back credit. Example: An Indian exporter receives an
export LC from his overseas client in the Netherlands. The Indian exporter approaches his
banker with a request to issue an LC in favour of his local supplier of raw materials. The bank
issues an LC backed by the export LC.

• Transferable Credit

While an LC is not a negotiable instrument, the Bills of Exchange drawn under it are negotiable.
A Transferable Credit is one in which a beneficiary can transfer his rights to third parties. Such
LC should clearly indicate that it is a ‘Transferable’ LC

6. Write a Short note on Banks Investment?

Ans.

¾ Banks Investment

The advisory division of an investment bank (IB) is paid a fee for their services, while the
trading division experiences profit or loss based on its market performance. Professionals who
work for investment banks may have careers as financial advisors, traders or salespeople. An
investment banking career can be very lucrative, but it typically comes with long hours and
significant stress. Investment banks are most known for their work as financial intermediaries.
That is, they help corporations’ issue new shares of stock in an initial public offering (IPO) or
follow-on offering. They also help corporations obtain debt financing by finding investors for
corporate bonds. The investment bank's role begins with pre-underwriting counseling and
continues after the distribution of securities in the form of advice. The investment bank will also
examine the company’s financial statements for accuracy and publish a prospectus that explains
the offering to investors before the securities are made available for purchase.

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Investment banks’ clients include corporations, pension funds, other financial institutions,
governments, and hedge funds. Size is an asset for investment banks. The more connections the
bank has within the market, the more likely it is to profit by matching buyers and sellers,
especially for unique transactions. The largest investment banks have clients around the globe.

¾ Types of an Investment Bank - IB

• Investment Banks as Financial Advisors

As a financial advisor to large institutional investors, the job of an investment bank is to act as a
trusted partner that delivers strategic advice on a variety of financial matters. They accomplish
this mission by combining a thorough understanding of their clients' objectives, industry and
global markets with strategic vision trained to spot and evaluate short- and long-term
opportunities and challenges facing their client.

• Mergers and Acquisitions

Handling mergers and acquisitions is a key element of an investment bank's work. The main
contribution of an investment bank in a merger or acquisition is evaluating the worth of a
possible acquisition and helping parties arrive at a fair price. An investment bank also assists in
structuring and facilitating the acquisition in order to make the deal go as smoothly as possible.

• The Research Division

The research divisions of investment banks review companies and author reports about their
prospects, often with "buy", "hold" or "sell" ratings. While research may not generate revenue
itself, the resulting knowledge is used to assist traders and sales. Investment bankers, meanwhile,
receive publicity for their clients. Research also provides investment advice to outside clients in
the hopes that these clients will take their advice and complete a trade through the trading desk
of the bank, which would generate revenue for the bank. Research maintains an investment
bank's institutional knowledge on credit research, fixed income research, macroeconomic
research, and quantitative analysis, all of which are used internally and externally to advise
clients.

10. Explain Bankers right of Lien?

Ans.

¾ Bankers Right Of Lien

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Lien is defined as the right of a creditor to retain the procession of the goods and securities
owned by the debtor until the debt has been paid. It does not include the right of sale of goods
and securities. Lien is available as bills, cheques, promissory notes, share certificates, bonds and
debentures. Lien is not available on deposits, since deposits are neither good nor securities.

¾ Types of Lien

• Particular Lien

In case of a particular lien the creditor gets the right to retain possessions only of goods or
securities for which the dues have arisen and not for other dues

Example: A laptop-repairer can withhold the delivery of laptop until his charges of repairing the
watch are paid to him.

• General Lien

A general Lien gives the right to the creditor to retain the possession till all amounts due from
debtor are paid or discharged. This is available to bankers, factors, and attorneys of High Court
and Policy Brokers only

Banker’s Lien

• Banker has right of general lien

• To exercise the right of lien the bank must lawfully take over its possession

• A banker should sell the securities only after a giving a notice to the debtor

¾ Features of general lien – Banker’s

Implied pledge and right of sale

• To create general lien, no special contract is required. The right to sell the property is also
available under bank’s right of lien because a banker’s general lien tantamount to an
implied pledge

Limitation

• The right is not restricted by law of limitation. The act only restricts the remedy through
court and not discharges the debt. Hence, bank can recover debts even when time have
exceeded also.
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Ownership/possession

• The possession is with the bank but the ownership remains the same

Conversion to particular lien

• If it is indicated that a particular security was obtained for one particular debt only, then
the general lien gets converted into a particular lien.

Criminal Action

• When the banker exercises his right of general lien, no criminal action is available
because there is no criminal act behind it.

Lien Can be Exercised Where

• The right of general lien is available and is always entrusted to bank in the capacity as a
banker

• The right is available for goods and securities that are in the name of the borrower or in
the name of guarantor.

• Right can be exercised for other dues of same borrower, on goods and securities
remaining in its procession even after the other loan taken against them, has been paid.

• Lien can be used by giving a reasonable period notice. Sale Without notice, even if there
is an agreement, is unlawful.

• Lien Cannot be Exercised

• Where there is any contract inconsistent with this right between banker and the customer

• Where the goods and securities are entrusted to the bank as a trustee or as an agent

• Where the goods and securities are entrusted for some specific purpose

• Where the loan is granted to one person and the goods and securities are owned by more
than one persons

• Goods/securities handed over for safe custody

• Where the bills of exchange or other documents have been handed over by the customer
with specific instructions to utilize their proceeds for the specific purpose

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 • In case of shares that are given for selling them in a future and apply the sale proceeds for
a specific purpose

• Where some documents or valuables are left in bank’s possession by the customer by
mistake or negligence

• Where securities are given to bank to secure a loan, but that has not been granted as yet.

UNIT-IV

¾ Descriptive Answers Questions

1. Discuss the meaning and kinds of Negotiable Instrument?

Negotiable Instruments are a document that promises to pay a certain sum of money to the bearer
or assignee either at a specific future date or on demand. Negotiable Instrument is generally a
signed document which is freely transferable in nature and once it is transferred, a transferee or
the holder of an instrument will get legal right to use it in whatsoever manner as he deems
appropriate.

• There are so many types of negotiable instruments those are primarily in use such
as Promissory Notes, Cheques, Bills of Exchanges, Currencies etc.

• In India, The Negotiable Instruments Act, 1881 was originally enforced to govern the
practices of using the above instruments in an effective way including rights, duties, and
obligations of parties involved in the transactions.

• People face ease in doing businesses due to the availability of various types of negotiable
instruments which are very reliable and having different unique features.

¾ Meaning of Negotiable Instruments

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Negotiable Instruments are a written order which guarantees the payment of money on a
pre-determined date or on demand of the party name on it or to any other person in order or
the bearer of an instrument. It has characteristics of a valid contract like consideration should be
transferred from one party to another. Negotiable Instruments is nothing but an evidence of
indebtedness, as the holder of the instrument has an unconditional right to recover the amount of
money stated in the instrument from its maker. These Instruments are used as a substitute of
money to safely transfer the payments between the merchants and have a risk free business
transactions. As per Section 13(a) of the Act, “Negotiable instrument means a promissory
note, bill of exchange or cheque payable either to order or to bearer, whether the word “order”
or “ bearer” appear on the instrument or not.”

¾ Characteristics Of Negotiable Instruments

1. Property: The possessor of negotiable instrument is acknowledged to be the owner of

property contained therein. Negotiable instrument does not simply give ownership of the
instrument but right to property as well. The property in negotiable instrument can be
moved without any formality. In the case of bearer instrument, the possessions pass by
meager delivery to the transferee. In case of order instrument, endorsement & delivery
are necessary for transfer of property.

2. Title: The transferee of negotiable instrument is called ‘holder in due course.’ A genuine
transferee for value is not affected by any flaw of title on the part of transferor or of any
of the previous holders of instrument.

3. Rights: The transferee of negotiable instrument can take legal action in his own name, in
case of dishonor. A negotiable instrument can be reassigned any number of times till it is
attaining maturity. The holder of instrument need not give notice of transfer to the party
legally responsible on the instrument to pay.

4. Presumptions: Certain presumptions are applicable to all negotiable instruments i.e., a

presumption that deliberation has been paid under it. It is not essential to write in
promissory note the words ‘for value received’ or alike expressions for the reason that the
payment of consideration is acknowledged. The words are typically included to generate
additional substantiation of consideration.

5. Prompt payment: A negotiable instrument facilitates the holder to anticipate prompt

payment because dishonour refers to the ruin of credit of all persons who are parties to
the instrument.

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 ¾ Types of Negotiable Instruments

There are various types of Negotiable Instruments that we use in our daily life and few of them
are listed below;

1. Promissory Notes

2. Bills of Exchange

3. Cheques

Promissory Notes

A Promissory Note means one party (the maker) promises to pay a sum of rupees to a person
whose name is mentioned on the note on a fixed future date. Generally, it is used as short-term
trade credit and the maker will pay the due amount on or before the expiry of the note. It is also a
very safe mode of transferring money and business people frequently use it to have smooth
business transactions. One can claim his fund in the court of law on mere non-delivery of
promised money to him after the expiry of the term. It is also considered and used as debt
instrument and corporation who need to finance their short-term projects will issue the
promissory note

Bills of Exchanges

Bills of Exchanges are similar to promissory notes where one party promises to pay the sum of
money to other party or to any other person in his order on a fixed future date. Just like
promissory note, business people use it to provide short-term trade credits to their business
partners. The person on whose name it is endorsed (the Drawee) will have the valid claim on the
bill writer (the Drawer) for the amount mentioned on the bill. In case of urgency of a fund, the
Drawee can discount his bill before the due date from any bank and get the bill amount from the
bank after deducting some discount on it and thereafter bank will collect the full billing amount
from the Drawer on the due date and this entire transaction is called as Bill Discounting.

Cheques

The Cheques are the substitute of the currencies and a very safe mode of transfer of payments
among the merchants. It can either be a bearer cheque and one who possesses that will get the
amount mentioned on it or an account payee cheque endorsed in the name of the particular
entity. Unlike currencies, it generally has a specific expiry date and hence can’t be stored for a
longer time period. It has no risk of stolen unless it is a bearer cheque. A Cheque generally takes
time to transfer funds in the accounts of the beneficiary and hence it is considered as the less
liquid form of transfer.
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Conclusion

The Negotiable Instruments are very effective business channels in the financial market of any
country. Negotiable Instruments helps in smoothing secured commercial and other transactions
for money or monies worth. The unique features like transferability, the legality of documents,
safety, liquidity etc make them more popular in having businesses domestically and globally as
well. However, in today’s modern world technology bring the businesses at a very high level and
use of above Negotiable Instruments is reducing day-by-day. There are so many effective
banking channels are established now that will reduce the time and cost of execution of
commercial transactions worldwide. Now a day people are more comfortable to do transactions
through Internet Banking, NEFT, RTGS, Debit & Credit Cards, Virtual Cards, and availability of
so many modern instruments that may cause the end of traditional Negotiable Instruments.

2 .Examine the main provisions of the SEBI (Merchant Bankers) regulations 1992?

Ans.

¾ Merchant Banking in India:

Merchant banking services, in India, were started only in 1967 by National Grindlays. Bank
followed by Citi Bank in 1970. The State Bank of India was the first Indian commercial bank to
set up a separate merchant banking division in 1972.Later, the ICICI set up its merchant banking
division in 1973 followed by a number of other commercial banks like Canara Bank, Bank of
Baroda, Bank of India, Syndicate Bank, Punjab National Bank, Central Bank of India, UCO
Bank, etc.

The FERA regulations in 1973, which required a large number of foreign companies to dilute
their shareholdings in India, gave a boost to the merchant banking activities in India. Since then,
a number of development banks and financial institutions such as IFCI and IDBI have also
entered this field. Some leading banks have floated wholly owned subsidiaries for carrying out
these activities. Private brokers and financial consultancy firms have also been quite active in the
field of merchant banking. They infact, have given a tough competition to the commercial banks
in the operations of merchant banking.

¾ Thus, at present merchant banking services in our country are provided by the
following types of organisations:

(i) Commercial banks and their subsidiaries

(ii) Foreign banks including National Grindlays Bank, Citi Bank, Hongkong Bank etc
67
(iii) All India Financial Institutions and Development Banks such as, ICICI, IFCI, IDBI.

(iv) State Level Financial Institutions, such as, State Industrial Development Corporations
(SIDC’s) and State Financial Corporations.

(v) Private Financial Consultancy Firms and Brokers, such as J.M. Financial and Investment
Services Ltd.; DSP Financial Consultants, Fnam Financial Consultants, Kotak Mohindra, Ceat
Financial Services, etc.

vi) Technical Consultancy Organisations

(vii) Professional Merchant Banking Houses, such as VMC Project Technologies.

¾ Merchant banking in India can be categorised in four broad sections:

1. To provide long-term source of funds required by the corporate sector. The merchant banker
primarily came into being as corporate counsellors for restructuring base of capital, thereafter for
issue management and underwriting of the same

2. Project counselling which includes credit-syndication and the working capital.

3. Capital structuring.

4. Portfolio management.

• The buoyancy in the capital market in 1980s created a lot of scope for merchant
banking activities in our country. The year 1985 was an epoch-making year in the
history of merchant banking when a large number of issues were oversubscribed by
several times and the importance of merchant banking activities was made evident
in managing issues and their underwriting.

• Deregulation and liberalisation of the industry in India has accounted for changes
in the financial sector. With the passage of time merchant banking activities have
changed in line with the changing need pattern of the enterprises in the wake of
economic development.

• Since August 1990, merchant bankers engaged in issue management, corporate

advisory services, underwriting and portfolio management have to obtain
authorisation from the Securities and Exchange Board of India (SEBI) after

68
 meeting the requirements of capital adequacy norms. In 1993, there were 568
merchant bankers in our country out of which 312 were authorised by the
Securities and Exchange board of India.

• The number of registered merchant bankers with SEBI increased to 422 at the end
of August 1994. The total number of merchant bankers in all categories increased
to 1163 by the end of 1997-98. As the liberalisation policy continues and the
financial market is expanding rapidly, the future for the country’s merchant
bankers seems to be buoyant. But their roles are changing with the change in the
needs of the customers.

¾ Merchant Banking Regulations:

SEBI (Merchant Bankers’) Regulation Act, 1992 defines a ‘merchant banker’ as “any person
who is engaged in the business of issue management either by making arrangements regarding
selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering
corporate advisory service in relation to such issue management”. At present no organisation can
act as a ‘merchant banker’ without obtaining a certificate of registration from the SEBI
.However, It must be noted that a person/ organisation has to get himself registered under these
regulations if he wants to carry on or undertake any of the authorised activities, i.e., issue
management assignment as manager, consultant, advisor, underwriter or portfolio manager. To
obtain the certificate of registration, one had to apply in the prescribed form and fulfill two sets
of norms (i) operational capabilities and (ii) capital adequacy norms.

¾ Classification of Merchant Bankers:

The SEBI has classified ‘merchant bankers’ under four categories for the purpose of
registration:

1. Category I Merchant Bankers:

These merchant bankers can act as issue manager, advisor, consultant, underwriter and portfolio
manager.

2. Category II Merchant Bankers:

Such merchant bankers can act as advisor, consultant, underwriter and portfolio manager. They
cannot act as issue manager of their own but can act co-manager.

3. Category III Merchant Bankers:

69
They are allowed to act as underwriter, advisor and consultant only. They can neither undertake
issue management of their own nor they act as co-manager. They cannot undertake the activities
of portfolio management also.

4. Category IV Merchant Bankers:

A category IV merchant banker can merely act as consultant or advisor to an issue of capital.

• Capital Adequacy Norms:

SEBI has prescribed capital adequacy norms for registration of the various categories of
merchant bankers. The capital adequacy is expressed in terms of minimum net worth, i.e., capital
contributed to the business plus free reserves.

According to the SEBI (Merchant Bankers) Amendment Regulations, 1999, w.e.f. 30.9.1999,
every merchant banker shall pay a sum of Rs. 5 lakhs as registration fees at the time of grant of
certificate by the Board. The fee shall be paid by the merchant banker within 15 days of receipt
of intimation from the Board.

Further, a merchant banker to keep registration in force shall pay renewal fee of Rs. 2.5 lakhs
every three years from the fourth year from the date of initial registration.

¾ Government Policy for Merchant Banking:

The Government issued policy guidelines for merchant bankers to ensure sufficient physical
infrastructure, necessary expertise, good financial standing, professional integrity and fairness in
their transactions. The merchant bankers have to be competent to serve the investors also. On 1st
March, 1993 new policy guidelines have been issued by SEBI for the merchant bankers to ensure
greater transparency in their operations and to make them accountable so as to protect the
investor’s interest. The guidelines relate to pre-issue obligations, underwriting, advertisements
and post-issue obligations of the merchant bankers.

3. “All Cheque is a Bill of Exchange but all Bill of Exchange is not Cheque.” Explain?

Ans.

Bill of Exchange and Cheque are the most common documents which are used widely by all
most every person to make payments easily. Both these documents have many differences and
similarities which contribute to their uniqueness in terms of functionality. We have also written
an article about the

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 ¾ CHEQUE( Sec 6 )

A Cheque generally is an order by the customer of a bank directing the bank to pay on demand,
the specified amount to the bearer of the cheque or for the person which the cheque is issued. A
Cheque is a usual method of withdrawing money from a current account of the customer with the
bank. Savings accounts are also permitted to use cheque by maintaining a certain amount of
balance in the account.

• PARTIES OF CHEQUE

Drawer – the drawer is the person who writes or issues the check
Payee – the payee is the person to whom the order the check is made out

Drawee – the drawee is the bank which the drawer has a bank account with. It pays from the
balance in customer bank account.

• TYPES OF CHEQUE

The Cheques are of various types and most common of them are

1. ELECTRONIC CHEQUE – The electronic image form of the cheque is called as ‘Electronic
Cheque’. It is written and signed in a secure system using a digital signature.

2. TRUNCATED CHEQUE – The cheque which is the paper form is called as ‘Truncated
cheque’. It has a physical structure and can be moved from one person to other by hand.

Every bank has its own cheque forms printed and is given to the customers after the opening of
the account with the bank. These Cheque forms are printed on special security papers to protect
the customers from fraud.

¾ BILL OF EXCHANGE( Sec 5 )

A Bill of Exchange is one of the Negotiable Instruments and it has certain features like It must be
in writing form, It must contain an order to pay and not a promise or request. The Bill of
Exchange document must be unconditional in nature. The document of the Bill of Exchange
must be signed by the drawer and it must contain a specified date on which the payment should
be made to the payee by the drawer.

• PARTIES OF BILL OF EXCHANGE

Drawer – The person to whom the amount of bill is payable.

Drawee – The person who is responsible acceptance and payment of the bill.
Payee – The person to whom the bill is payable.
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 • KINDS OF BILLS OF EXCHANGE

Bills of Exchange are of different types based on their functionality and nature. Some of them
are as follows:

Inland Bills
Foreign Bills
Trade and Accommodation Bills
Time Bills
Demand Bills
Documentary Bill

Acceptance of a Bill shows the acceptance and responsibility of the drawee to pay the money to
the drawer of the bill. The Bill of Exchange must be presented for acceptance before the maturity
of the bill. When a period of maturity is specified in the document, it must be presented within
that period.

¾ Short Answers Questions

4. What is Promissory Note? Discuss its Characteristics?

Ans.

¾ Promissory Note( Sec 4 )

• Definition: A Promissory Note, as the name itself gives a brief description, is a legal
financial instrument issued by one party, promising to pay the debt owed to another party

• It is a written negotiable instrument duly signed by the maker that contains an

unconditional promise to pay the stated sum of money to a particular person or to any
other person, on the order of that particular person, either on demand or on a specified
date, under given terms. It is a short-term credit instrument which does not amount to
a bank note or a currency note.

¾ Characteristics of Promissory Note

ƒ It is a written document.

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 ƒ There must be a clear and unconditional promise to pay a certain sum to a specified
person or on demand.

ƒ It must be drawn and duly signed by the maker.

ƒ It must be properly stamped.

ƒ It specifies the name of the maker and payee

ƒ The amount to be paid must be certain, given in both figures and words.

ƒ Payment is to be made in the country’s legal currency.

A promissory note may consist of various terms and conditions related to indebtedness like the
principal amount, date of maturity, the rate of interest, terms of repayment, issue date, name and
signature of the drawer, name of the drawee and so forth. A promissory note needs no
acceptance.

¾ Parties to Promissory Note

1. Drawer: The one who makes the promise to another, to pay the debt is the drawer of the
instrument. He/She is the debtor or borrower.

2. Drawee: The one, in whose favour the note is drawn is the drawee. He/She is the creditor
who provides goods on credit or lender, who lends money.

3. Payee: The one, to whom payment is to be made is the payee of the negotiable
instrument.

The drawee and payee can be the same person when the amount is to be paid to the person in
whose favour the note is drawn. However, when the amount is to be paid to another person, on
the order of the drawee, meaning that if the drawee transfers the instrument in favour of another
person then, in that case, payee would be different. Further, the party that owes money to another
party holds the promissory note and after discharging the obligation completely, the drawee or
payee (whatever the case may be) cancels the note and returns to the drawer

¾ Can I write my own promissory note?

Writing Your Own Promissory Note. Meet the required elements to create an
enforceable promissory note. In order to be enforceable, the note must include certain elements.
Without any these you may not be able to collect the money you loaned out.

5. Difference between Promissory Note and Bills of Exchange?

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Ans.

¾ Introduction

• Bill of exchange and promissory note are types of negotiable instrument act. A bill of
exchange or a promissory note is payables either to the order or bearer deemed as the
instruments under the negotiable instrument act, 1881.A bill of exchange is a type of
negotiable instrument raised from the trade transactions. A promissory note is
undertaken from the borrower to pay a certain sum of amount to the lender.

¾ Bill of Exchange

• Bill of exchange comes under section 5 of Negotiable Instrument Act, 1881

"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 to the order a certain
person or to the bearer of the instrument". It is an agreement between two party customer and
seller used mainly in global trade. Bill of exchange is a documentation that a buyer party has
accepted to pay a selling party a sum of money at a proposed time for delivered goods and
services. Both the parties generally engage with the bank to issue a bill of exchange due to a risk
associated with trading. The acceptor of a bill of exchange is liable to settle his liability as a
principal debtor under the act.

¾ Characteristics of Bill of Exchange

• In a bill of exchange, there must be a proper dated and amount must be specific.

• It must carry an order it means the drawer of the bill of exchange directs the drawee to
pay a certain sum to the payee.

• The drawee must accept the bill.

¾ Promissory Note

• The promissory note comes under the Section 4 Of Negotiable Instrument Act, 1881 " A
promissory note is an instrument in writing, contains an unconditional undertaking,
signed by the maker to pay a certain sum of a company only to the order of the certain
person to the bearer of the instrument. The promissory note is in written and signed by
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 the maker, who is a promisor, is a negotiable instrument. It is an undertaking from the
buyer to pay a certain sum of money to the lender. The person to whom payment is
guaranteed is called a payee or owner. A promissory note can be either payable on
demand or at a specific time.

¾ Characteristics of Promissory Note

• The promissory note is a written promise with specific due to pay money to the lender

• There must be a signature of the drawer.

• Both the promisor and promise must be certain.

¾ Bills of Exchange vs Promissory Note

As you already know there are many differences between bills of exchange and promissory note.
Here are the key differences between them which stand out –

• Bill of exchange is a negotiable instrument that is issued when an order needs to be given
to the debtor to pay the due amount to the creditor within a stipulated period of time.
Promissory note, on the other hand, is a written contract between the drawer and the
drawee, where the drawer promises to pay off a certain amount within a stipulated time.

The parties involved in the bill of exchange are drawer, drawee, and payee. In the promissory
note, the parties involved are drawer and payee/drawee.

In the case of a bill of exchange, the debtor needs to accept the bill in order to call it valid. In the
case of promissory note, there’s no need for acceptance from drawee.

If the bill of exchange is dishonored, a notice is issued to all parties involved. In the case of
promissory note, no notice is issued to the “maker” of the promissory note for the dishonor.

In the case of a bill of exchange, no asset is kept as security. In some cases, in the case of
promissory notes, an asset can be kept for security against a loan.

¾ Conclusion

Bills of exchange and promissory notes are as important as cheques in business. But rarely do we
talk about these concepts which are vital for business transactions and loan purposes. Bills of
exchange are one of the most significant negotiable instruments that are issued when the debtor
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purchases goods on credit. Through bills of exchange, the creditor sends an order to the debtor
that latter should pay the amount within the stipulated time

6. Explain Holder and Holder in due Course ?

Ans.

¾ Holder and Holder in due Course Holder

The holder of a negotiable instrument means any person entitled to the possession of the
instrument in his own name and to receive or recover the amount due there on from the
parties liable thereto. Thus, in order to be called a ‘holder’ a person must satisfy the following
two conditions: (Sec. 8).

1. He must be entitled to the possession of the instrument in his own Name. Actual possession of
the instrument is not essential. What is required is a right to possession under some legal or valid
title. He should be a ‘de jure holder’ and not necessarily ‘de facto holder’. It means that the
person must be named in the instrument as the payee or the indorsee, or he must be the bearer
thereof, if it is a bearer instrument. However, the heir of a deceased holder or any other person
becoming entitled by operation of law is a holder although he is not the payee or indorse or
bearer thereof.

If a person is in possession of a negotiable instrument without having a right to possess the same
he cannot be called the holder. Thus, a thief, or a finder on the road, or an indorsee under a
forged endorsement, although may be having the possession of the instrument, cannot be called
its holder because he does not acquire legal title thereto and hence is not entitled in his own to
the possession thereof. Similarly, a beneficial owner claiming through a ‘benamidar’ in whose
favour the instrument had been made or drawn is not a holder because he is not entitled to the
possession in his own name and cannot by himself maintain an action on the instrument.

(2) He must be entitled to receive or recover the amount due there on from the parties liable
thereto. In order to be called a holder, besides being entitled to the possession of the instrument
in his own name, the person must also have the right to receive or recover the amount of the
instrument and give a valid discharge to the payer. Thus, one may be the bearer or the payee or
the indorse of an instrument, but he may not be called a holder if he is prohibited by a Court
order from receiving the amount due on the instrument.

Where a person obtains possession of an instrument by theft, fraud or under a forged

endorsement, he is not a holder and can not a holder and cannot claim payment from liable
parties.

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 ¾ Holder in due Course

The despotic but necessary principle relating to negotiable instruments is that a person taking a
negotiable instrument in good faith and for value obtains a valid title though he takes from one
who had none or who was merely a thief. The property in a negotiable instrument is acquired by
anyone who takes it bona-fide and for value, notwithstanding any defect of title in the person
from whom he took it. Now such a person who takes an instrument “in good faith and for value”
becomes the true owner of the instrument and is known as a “holder in due course”.

According to Section 9 “Holder in due course” means any person who for consideration
became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or
the payee or endorsee thereof, if payable to order, before the amount mentioned in it became
payable and without having sufficient cause to believe that any defect existed in the title of the
person from whom he derived his title.

The essential qualifications of a “holder in due course” may be summed up as follows:

1. He must be a holder for valuable consideration. All the prerequisite of consideration should
be met so as to result in a valuable consideration.

2. That he became the holder of the instrument before its maturity. Thus the person who takes a
negotiable instrument after maturity does not become a holder in due course.

3. That the instrument should be complete and regular on the fact of it. Face here includes the
back also.

4. The last requirement is that the holder should have received the instrument in “good faith”.
There are two methods of ascertaining a person’s good faith, “subjective” and objective”. In
subjective test the Court has to see the holder’s own mind and the only question is “did he take
the instrument honestly”? In objective test, on the other hand, we have to go beyond the holder’s
mind and see whether he exercised as much care in taking the security as a reasonably careful
person ought to have done. Subjective test requires “honesty”, objective “due care and caution”.
Good faith indicates a person takes the instrument without sufficient cause to believe that any
defect existed in the title of the person from whom he derived his title.

¾ Right of a holder in due course

1. Once a negotiable instrument passes through the hands of a holder in due course, it get
cleansed of all defects, unless he himself was a party to fraud or illegality committed regarding
the instrument (S. 53).

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2. The maker of a note, or drawer of a bill or cheque, and no accepts of a bill for the honour of
the drawer, will be permitted to deny the validity of the instrument, as originally drawn, in a suit
thereon by a holder in due course.

3. In case of a suit by holder in due course, no maker of a note, or acceptor of a bill payable to
order, will be permitted to deny the validity of the payee’s capacity at the date of the note of a
bill to endorse the same (S.121).

4. Upon a suit by a holder in due course the acceptor cannot take the defence or accommodation
acceptance (S. 36).

5. The holder in due course gets a better title than that of the transferor of the instrument, even if
the title of the transferor was defective, the holder in due course will get a good title. But in case
of a forged instrument, even a holder in due course will get no title, as it is a case of total absence
of title and not a mere defect of title (S. 58).

6. If a note or a bill is negotiated to a holder in due course the liable parties cannot avoid
liability on the ground, that delivery of the instrument was conditional or for a special purpose
(S. 46, 47).

7. When a bill is drawn payable to the drawer’s order on a fictitious name, and is endorsed by
the same hand as drawer’s signature, the acceptor cannot take the plea that the payee was a
fictitious person (S. 42).

8. Where a duly stamped and signed instrument is either left wholly blank or in complete in
some material requirements such as date, amount, payee’s name, and is delivered by one person
to another for the purpose of filling it up. If such a person or any holder fills up more amount,
than what he was authorized to do. The holder in due course of such an instrument can recover
the whole amount, provided the stamp affixed upon it is sufficient to cover the filled sum (S.20).

¾ Very Short Answers Questions :

7. What do you understand by Inland and foreign Instrument?

Ans.

• Inland and foreign Instrument

Negotiable instruments may be classified as follows:

1. Inland and Foreign Instruments:

Instruments may be inland or foreign.

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(a) Inland instrument (Sec. 11). A promissory note, bill of exchange or cheque drawn or made
in India and made payable in or drawn upon any person resident of India shall be deemed to
be an inland instrument.

Thus, an instrument will be an inland instrument if it is (i) made or drawn in India and payable
in India, or (ii) drawn upon a person resident of India, although payment is to be made outside
India.

If we analyse the above rules, we come to the following conclusion:

(b) Foreign instrument (Sec. 12) An instrument which is not an inland instrument is a foreign
instrument:

(i) A promissory note made in India but payable outside India.

(ii) A promissory note made outside India and payable outside India and accepted payable
outside India.

(iii) A bill drawn in India on a person who is residing outside India and accepted payable outside
India.

(iv) A bill drawn outside India made payable in India or outside India.

(v) A bill drawn outside India on a person who is residing outside India.

Examples:

(a) A writes a promissory note in India in favour of B of London, which is payable in London.

A writes a promissory note in London payable in London.

A draws a bill in Delhi on B of London and accepted payable in London.

A draws a bill in London and it is accepted payable in Delhi. If the above bill is accepted payable
in London, even then it is a foreign bill.

A draws a bill in London on B, a resident of Paris.

Usance:

A usance is the time fixed for the payment of bills drawn in one country and made payable in
another. It is fixed by the custom of the country. The length of usance differs from country to
country.

Via:
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A foreign bill is generally drawn in sets of three. Each set is called 'via'. The three copies are sent
by different mails so that at least one copy may reach the acceptor as there are greater chances of
loss during transit over long distances.

Rules Regarding Bills in Sets:

The rules regarding bills inlets are given in Sees. 132 and 133. These are as follows:

(i) A foreign bill may be drawn in parts (two, three or four, as the case may be).

(ii) Each part of a bill in set must be numbered and must contain a provision that it shall continue
to be payable only so long as the other parts remain unpaid. Each part must contain a reference to
the other parts. All the parts together constitute a set and the whole set constitutes one bill.

(iii) The entire bill is extinguished when payment is made on one part.

(iv) The drawer must sign each part. However, the acceptor should accept only one part of the
set.

(v) Where a person accepts or endorses different parts of the bill to different persons, he and the
subsequent endorsers of each part are liable on each part as if it were a separate bill.

(vi) Where two or more parts of a set are endorsed to different holders in due course, he who first
acquired title to his part is entitled to the other parts and the money represented by the bill.

2. Ambiguous Instruments:

Where the instrument is written in such a manner that it can be treated as a bill or a note, it is
called an ambiguous instrument. Where an instrument may be construed either as a promissory
note or a bill of exchange, the holder may at his option treat it as a bill or a note and the
instrument thereafter shall be treated accordingly (Sec. 17).The Negotiable Instrument Act, 1881
does not give the cases in which such a situation may arise. However, Sec. 5 (2) of the English
Bills of Exchange Act, 1882 lays down that where sec. 5 (2) of the drawer and the drawee are the
same persons or where the drawer is a fictitious person or a person not having the capacity to
contract, the holder may treat the instrument at this option either as a bill or note.

Example:

A draws a bill on B. The bill is endorsed to C.B. is a fictitious person. Although it is a bill but C
can treat it as a note because B is a fictitious person, as such A is liable to pay money to C.

It should be noted that the terminology used is not important, see above example. Again the
option to treat the instrument as a bill or note is to be exercised once for all. No change later on is
80
allowed. If the amount in the instrument differs in figures and words, the amount stated in words
shall be the amount payable (Sec. 18).

3. Inchoate Instruments (Sec. 20):

A blank but stamped instrument is called inchoate instrument. Where one person signs and
delivers to another a paper stamped in accordance with the law relating to negotiable instrument
then in force in India, and either wholly blank or having written thereon an incomplete
negotiable instrument, he thereby has given prima facie authority to the holder to make or
complete it as a negotiable instrument for any amount specified therein and not exceeding the
amount covered by the stamp.

It further provides that the person so signing shall be liable upon such instrument in the capacity
in which he signed the same, to any holder in due course for such amount. A person who is not a
holder in due course cannot recover anything in excess of the amount intended by him to be paid
there under.

Example:

A signed as maker a blank stamped paper and gave it to B and authorized him to fill it as a note
for Rs. 500 to secure an advance which C was to make to B. B fraudulently filled it up as a note
for Rs. 2,000 payable to C, who is entitled to Rs. 2,000 from A. [Lloyds Banks v. Cooke].

To make a person liable on an inchoate instrument, the following conditions must be satisfied.

(i) Liability arises only when the blank space is filled in:

Unless the blank spaces are filled, the liability does not arise as the instrument is not valid.

(ii) Delivery and stamp necessary:

Delivery of an instrument is necessary in all cases to pass property (ownership). An inchoate

instrument is valid only when it is stamped in accordance with the law in force.

(iii) Only holder has the authority to fill up the instrument:

No one else has the right to fill up. For example, an agent has no right to fill up such an
instrument.

(iv) Holder can recover only that amount:

Which was intended by the person signing?

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(v) Holder in due course can recover, the amount mentioned in the instrument, provided it is
covered by the stamp.

4. (i) Instrument payable on demand:

Payable on demand implies that the payment is to be made immediately or at once on demand.

1. A cheque is always payable on demand (Sec.6 and 19).

2. A promissory note or bill of exchange is payable on demand in the following cases:

(a) When it is marked "payable on demand".

(b) When it is marked 'payable at sight", or "payable on presentment" (Sec. 21).

(c) When no time for payment is specified (Sec. 19).

It should be noted that an instrument marked "payable on demand" is not required to be

presented before payment, whereas the documents marked "payable at sight or payable on
presentment" must be presented for payment before payment is demanded.

From the point of view of law of limitation, the term "at sight" or "on demand" is regarded as
different. In the case of a bill marked "at sight" the period of limitation starts from the date of
presentation, whereas in the case of a bill marked "on demand", it starts from the date of the bill
of note.

(ii) Instrument payable at a future time:

An instrument marked "after sight" or "after date' means an instrument payable at a future date.
Again, an instrument payable on the happening of an event which is bound to happen, although
the time of its happening may be uncertain, e.g. the death of a certain person, is an instrument
which is payable at a future date. Thus an instrument may be made payable "60 days after sight"
or "60 days after date". Again it may be marked payable "60 days after the death of X".

These instruments are not payable on demand but are payable on maturity, i.e. after the period
for which these were drawn.

In case the instrument is a bill of exchange and it is marked "after sight" then its payment cannot
be demanded unless it has been presented for acceptance before payment and the specified
period has been over.

5. Instrument payable to the bearer on demand:

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At the outset, it was pointed out that Sec. 31 of the Reserve bank of India Act, 1934 prohibits
issue of bill of exchange or promissory note payable to bearer on demand. It is only the Reserve
Bank of India and the Central Government which can issue bills or notes payable to bearer on
demand. Any person who issues such bill or notes payable to bearer on demand is punishable
with fine which may extend to the amount of the instrument.

8. What is Crossing of Cheque?

Ans.

Crossing of Cheque

A cheque is negotiable instrument. Any informed individual will be aware that during the
process of circulation, a cheque might get stolen, lost or may even have forged signature of
payee. This type of situation may result in wrong use of the cheque.

Therefore, crossing of the cheques is a popular device for protecting the drawer and the payee.
The bearer and order cheques both can be crossed. Hence, crossing of cheques prevents fraud
and wrong payments

¾ Definition of Crossed Check/ Cheque

Any cheque can be crossed by crossed with two parallel lines. Crossing means drawing of two
parallel transverse lines across the cheque with or without the words in between those lines.

The crossing of cheque gives a direction to the drawee bank to not pay the mentioned amount at
the counter, instead the payment should be done through a bank. This guards payment against
forgery by any unscrupulous persons because a crossed cheque can only be deposited directly
into a bank account and cannot be cashed immediately.

¾ Importance of Crossing of Cheque:

The significance of crossing of a cheque is that a crossed cheque cannot be encashed by the
bearer but can only be collected from the drawee bank in the bank account. (Sec. 123 and 126
of the Negotiable Instruments Act) Therefore, Crossing of cheque provides protection and
safeguard to the issuer of the cheque. In case of a crossed cheque one can easily detect who
encashed the said cheque, unlike the case of non-crossed cheque. Hence, Crossing protects both
payer and the payee of the cheque. Also, both bearer and order cheques can be crossed.

• Rules of Crossing of Cheque

Negotiable Cheques are generally crossed as a measure of safety.

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 • A cheque can be crossed generally, may be crossed specially by the holder.

• The Cheque holder has the right to add the words “not negotiable” to it.

• When an uncrossed cheque or a crossed cheque generally is sent to a banker for the
collection, the person may cross it specially to himself. In this case, he does not enjoy the
statutory protection against being sued for conversion.

¾ Types of Crossing of Cheque :

There are two types of crossing of cheques – General and Special crossing of cheques.

• General Crossing of Cheque

Section 123 of the Negotiable Instruments Act has defined General Crossing – “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, and
either with or without the words ‘not negotiable’, that addition shall be deemed to be a
crossing of cheque and the cheque shall be deemed to be crossed general.

General Crossing involves two parallel transverse lines across the face of the cheque with or
without ‘not negotiable’ written on it. Such addition shall be considered to be a crossing.

A cheque is considered to be generally crossed in the following cases:

• When there are two transverse parallel lines marked across the face of cheque

• When the cheque bears an abbreviation “& Co.” between the two transverse parallel lines

• When the cheque bears the words “Not Negotiable” written between the two parallel
lines

• When the cheque bears the words “A/c. Payee” between the two transverse parallel lines.

• Special And Restrictive Crossing of Cheque

A cheque is said to be specially crossed when a particular bank’s name is written in between the
two transverse parallel lines on the cheque. According to the Section 124 of the Negotiable
Instruments Act, Special Crossing is defined as, the cheque which “bears across its face an
addition of the name of a banker, 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”.

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In a special crossed cheque, the amount written in cheque is payable by the drawee only, and
only to the bank named in the crossing.

• Not negotiable Crossing of Cheque

The effect of writing ‘not negotiable’ crossing of cheque is that the cheque can be transferred
but transferee will not be able to acquire a better title to the cheque. Thus, such a cheque is
deprived of its essential feature of negotiability. The payment of such a cheque is not made
unless the bank named in the crossing of cheque is presenting the cheque.

UNIT-V

¾ Descriptive Answers Questions

1. What is Indorsement? What are its essential? Discuss the various kinds of
Indorsement?

Ans. Indorsement

• What Is Indorsement?

The act of a payee, drawee, accommodation indorser, or holder of a bill, note, check, or other
negotiable instrument, in writing his name upon the back of the same, with or without further or
qualifying words, whereby the property in the same is assigned and transferred to another. That
which is so written upon the back of a negotiable instrument one who writes his name upon a
negotiable instrument, otherwise than as a maker or acceptor, and delivers it with his name
thereon, to another person, is called an “indorser,” and his act is called “indorsement.”

There are five (5) types of endorsements with which a check casher should be familiar. The
majority of check cashers will only accept “blank” endorsements. It is the most common and
least risky type of endorsement.

• Conditional Endorsement

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A “conditional” endorsement is one of the ways in which a check may be endorsed. This type of
endorsement places a limit or restriction upon the time when a check can be paid. For example,
Larry Smith has written a check payable to John Doe. John Doe conditionally endorses the check
as “Payable to Billy Cooper upon satisfactory completion of drywall job, (signed) John Doe.”For
this item, a condition must be met in order for the check to be negotiated further, i.e. Billy
Cooper must have satisfactorily completed the drywall job. A check casher would most likely
want to avoid taking this item. The potential risks for this item include:

• Restrictive Endorsement

A restrictive endorsement restricts or limits negotiability.

“For deposit only” is the most common form of restrictive endorsement and is used to prevent
further negotiation of the check. For example, a check payable to John Doe signed by John Doe,
i.e. a “blank” endorsement, can be cashed or deposited by anyone holding the item in the event
that it is lost or stolen. A “blank” endorsement makes the item like cash.

By placing “For deposit only” after the blank endorsement, further negotiation of the item is
restricted. One of the ways in which check cashers minimize their risk of loss is by placing their
own restrictive endorsement on cashed checks after the payee has endorsed the item.

It is unlikely that there would be a reason for a check casher to accept any check with a
restrictive endorsement for cashing.

• Special Endorsement

A “special” endorsement allows a payee to make a check payable to another person or entity.

For example, if John Doe, the payee, wants to make the check payable to his wife, Susan Doe, he
would write “Pay to the order of Susan Doe,” on the back of the check and then endorse it.

A check casher shouldn’t normally cash such an item unless the payee is present and identified.

For example, how do you know that the special endorsement is legitimate? What if the Does are
in the process of obtaining a divorce? The endorsement of John could potentially be a forgery.
You could take a loss and then be forced into seeking restitution from Susan.

• Blank Endorsement

In order for a check to be cashed or further negotiated, it must be properly endorsed. A “blank”
endorsement is the most common type of check endorsement.

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With a blank endorsement, the payee (person to whom the check is made payable) signs his/her
name as it appears on the face of the check. If the person’s name is misspelled on the face of the
check, the person endorses exactly as the name is misspelled and then signs again with the
correct spelling.

If there are more than one payee is identified on the check, the form of a blank endorsement
depends on how the payees are listed. If the check is payable to A and B, then both A and B must
endorse the check. If the check is payable to A OR B, then either A or B must endorse the check.

A blank endorsement is the most common type of endorsement and is the least restrictive in that
it does not limit negotiability. Any other person can further negotiate a check with a blank
endorsement. Prior to cashing a check, the check casher should confirm the identity of the person
presenting the check, verify that person is the named payee, then obtain a blank endorsement.

• Qualified Endorsement

A qualified endorsement limits the responsibility of the endorser. With a qualified endorsement,
the endorser will not assume any responsibility for paying the check if it is returned for any
reason. The payee adds words such as “without recourse” to the back of the cheque.

2. What is criminal liability of drawer for issuing the Cheque without fund.

Ans.

¾ DISHONOUR OF CHEQUE

• General

In the advent of payment through cheques, monetary transactions became much easier. In place
of bundle of notes a piece of cheques is much easier to carry. It has facilitated trade and
commerce tremendously. But with the arrival of cheque system the problem of bouncing or
dishonouring of cheque also started. People started to issue cheques without intention of
honouring them. This led to decline in the value system of trade and credibility of business.
Some step was needed to curb this. For commerce to flourish it was needed that some law, which
could ensure credibility to the holder of the negotiable instrument, should be enacted. Before
1988 there was no effective legal provision to restrain people from issuing cheques without
having sufficient funds in their account or any stringent provision to punish them on cheque not

87
being honored by their bankers and returned unpaid. The money could be recovered on filing a
civil suit by the holder but it would take a lot of time.

• Object

To ensure promptitude and remedy against defaulters and to ensure credibility of the holders of
the negotiable instrument, a criminal remedy of penalty was inserted in Negotiable Instruments
Act,1881 in the form of Banking, Public Financial Institutes and Negotiable Instruments Laws
(Amendment) Act,1988 which were further modified by the Negotiable Instruments
(Amendment and Miscellaneous Provisions) Act ,2002. The object and purpose of bringing in
the act was to make the person dealing in commercial transactions work with a sense of
responsibility and for that reason under the amended provisions of law lapse on their part to
honour their commitment renders the persons liable for criminal prosecution.

Section 138 to 142 of chapter XVII, of the negotiable Instrument Act,1881, deals
with dishonouring of cheques.. The Parliament in its wisdom had chosen to bring section 138 on
the statute book in order to introduce financial discipline in business dealings. Prior to insertion
of 138 of NI, a dishonored cheque left the person aggrieved with the only remedy of filing a
claim. The remedy available in civil court is a long drawn matter and an unscrupulous drawer
normally takes various pleas to defeat the genuine claim of the payeeSection 138 has converted
civil liability into criminal offence. This has been inserted by the parliament with the object and
purpose of holding a person criminally responsible for his acts in commercial transactions trade
and business dealings with people carried out carelessly or without sense of responsibility

Offence under 138 is an offence without any mensrea .It is not a criminal offence in real sense as
it does not require mens rea, like few other criminal offences, but as public interest is hampered
by such offence so it has been made a punishable offence. It includes strict liability.

Creation of the strict liability is an effective measure by encouraging greater vigilance to prevent
usual callous attitude of drawers of cheques in discharge of debts.

The circumstances under which such a dishonour takes place are not of much importance. Any
reason for dishonour is an offence under section 138 of the NI Act. Marginal Note stating
"Dishonour of cheque for insufficiency etc. of funds in accounts" addition of word "etc." cannot
be considered to be an accident.8

Ingredients
The essential ingredients of sec138 are as follows:-
1. Drawing of a cheque by a person on an account of any debt or other liability.
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2. Presentation of the cheque to the bank within a period of 6 months from date of its drawing or
within the period of its validity.
3. Returning of the cheque unpaid by the drawee bank.
4. Notice in writing to the drawer of cheque within 30 days of receipt of information regarding
return of cheque as unpaid in form of debit advance or return memo.
5. Failure of the drawer to make payment within 15 days of receipt of notice.
The provisions of section 138 will be attracted only when the cheque has been issued for the
discharge of any debt or other legally enforceable liability.The maker of the cheque is not liable
for prosecution if cheque which is dishnoured, is the one, which is given as gift, present or
donation. The offence gets completed only after notice is served and payment as required by
notice is not made.
Letters written by complainant can be construed as notice under Section 138 NIA.-Complaint
can be filed on 16th day.Notice need not be sent through registered post –notice/letter sent under
certificate of posting is presumed to have received by accused. Notice served on company but
not MD and director who are parties in complaint, is valid notice U/S 138. Notice to
reasonably correct address is sufficient notice refused to be accepted by the addressee can be
presumed to have been served on him.

Drawer of cheque is alone liable. Even it is true that the cheque was issued by the first accused
towards the discharge of the liability of the petitioner/second accused company. Still the 2nd
accused company cannot be prosecuted as it is not the drawer.
When a cheque of joint account is return as “signature required from another director”, 138 will
lie. Cheque returned as ‘account operation jointly, another director signature required’ it amounts
to dishonor. Even if notice is issued stopping payment before the payee deposited the cheque in
his bank, offence is complete18. In the case of dishonour of cheque period of one month for
filing the complaint will be reckoned from the day immediately following the day on which the
period of fifteen days from the date of receipt of the notice by the drawer expires

Jurisdiction
Presence of all the above mentioned ingredients is necessary to attract the provision of section
138 of the N.I. Act. It is not necessary that all the above five acts should have been perpetrated at
the same locality, they may have been performed in five different localities. Complaint can be
filed at any of the places mentioned below.

One of the Courts exercising jurisdiction in one of the five local areas can become the place of
trail for the offence under sec. 138 of the Act

1.Where the cheque was drawn.

2. Where the cheque was presented for encashment.

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3. Where the cheque was returned unpaid by drawee bank.
4. Where notice in writing was given to drawer of cheque demanding payment.
5. Where drawer of cheque failed to make payment within 15 days of receipt of notice.

• Cognizance of Offences

Under Section 142, courts take cognizance of offences punishable under Section 138 only
upon a complaint made by the payee or, as the case may be, the holder in due course of the
cheque. The complaint must be in writing and be made within one month of the date on which
the cause of action i.e. after the person drew the cheque fails to pay the amount within 15 days of
the receipt of notice of its dishonor. No court inferior to that of a Metropolitan Magistrate or a
Judicial Magistrate of the first class has the power to try any offence punishable under section
138.
By the 2002 amendment Courts have been provided discretion to waive the period of one month,
which has been prescribed for taking cognizance of the case under the Act; Cognizance of a
complaint may be taken by the Court after the prescribed period, if the complainant satisfies the
Court that he had sufficient cause for not making a complaint within such period.21
The Magistrate while taking cognizance has to look into the question whether the ingredients of
an offence have been made out or not22. So long as the period of notice does not expire there can
be no cause of action with the payee to make the drawer liable criminally23

• Limitation

The time period laid down in the act has to be strictly followed. Any lapse in adhering to the
schedule, shall take away a cause of action under Sec. 138. The time limits placed cannot be
condoned by the Courts. The limitations which has to be kept in mind and taken into account are
as follows:

• Cheque should be presented to the bank for encashment within its validity period.

• Within fifteen days from the receipt of return memo indicating reason of dishonour, a notice
should be sent demanding the amount of dishonoured cheque.
• If the drawer does not pay the amount of dishonoured cheque within the grace period, a
complaint thereafter should be filed within one month in the relevant court having jurisdiction.

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Limitation for filing complaint limit defined as from a particular day . The first day is to be
excluded. Period of 15 days from the date of receipt of notice ending on 14-10-1995 –so, 30 days
period begins on 15-10-1995. Complaint filed on15-11-1995 is within time24
Death of complainant will not terminate proceedings U/S 138 NI Act. Complainant’s presence is
not necessary .Legal heirs can be impleaded25

• Punishment
Punishment for accused if proved guilty under section 138 N.I. Act:
1. Imprisonment of up to 2 years
2. Penalty of up to twice the amount of the bounced cheque.
Beside the punishments, the court can grant compensation to the complainant under
section 357 of the Code of Criminal Procedure, 1973 and no limit has been provided for
the amount of compensation.
By the 2002 amendment the term of imprisonment has been increased to two years.

Compoundable Offence
By an amendment introduced in 2002, under Section 147, an offence related to the
dishonour of a cheque and every other offence punishable under the Negotiable
Instruments Act, 1881 can be privately settled.

Offence under 138 by Company

If the person committing an offence under Section 138 is a company, every person who, at the
time the offence was committed, was in charge of, and was responsible to, the company for the
conduct of the business of the company, as well as the company, shall be deemed to be guilty of
the offence and shall be liable to be proceeded against and punished accordingly. A person shall
not be liable if he proves that the offence was committed without his knowledge, or that he had
exercised all due diligence to prevent the commission of such offence. Where a person is
nominated as a Director of a company by virtue of his holding any office or employment in the
Central Government or State Government or a financial corporation owned or controlled by the
Central Government or the State Government, as the case may be, he shall not be liable for
prosecution. Where any offence under this Act has been committed by a company and it is
proved that the offence has been committed with the consent or connivance of, or is attributable
to, any neglect on the part of, any director, manager, secretary or other officer of the company,
such director, manager, secretary or other officer shall also be deemed to be guilty of that offence
and shall be liable to be proceeded against and punished accordingly. Notice served on company
but not MD and director who are parties in complaint , is valid notice U/S 138

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 ¾ Civil or Criminal Wrong

Merely because an act has a civil remedy is not sufficient to denude it of its criminal outfit. Both
criminal law and civil law remedy can be pursued in diverse situations. As a matter of fact they
are not mutually exclusive but clearly co-extensive and essentially differ in their content and
consequence. The object of criminal law is to punish an offender who commits an offence
against a person, property or the State for which the accused, on proof of the offence, is deprived
of his liberty and in some cases even his life. This does not, however, affect civil remedies at all
for suing the wrongdoer in case like arson, accidents etc. It is anathema to suppose that when a
civil remedy is available, a criminal prosecution is completely barred.30 Filing of civil suit and
filing of criminal compliant are not alternative remedies and they are different type of rights
There is nothing in law to prevent the criminal courts from taking cognizance of the
offence merely because on the same facts, the person concerned might also be subjected to civil
liability or because civil remedy is obtainable. Sec.420 is valid even after Sec.138 is introduced.
Section 420 Indian Penal Code can be clubbed with complaints filed Under Section 138 of NI
Act33. If Section 138 not made out then Section 420 IPC can be drawn such complaint was
dismissed by magistrate under Section 138 and 141 of NI Act. High Court directed to take
cognizance under Section 120-B and 420 IPC. Such decision of the High Court held to be valid
by the Supreme Court. When the cheque was dishonoured for insufficiency of funds such person
issuing a cheque is liable for offence of section 138 of N.I.Act but not u/s 420 of IPC

In case of prosecution launched under Section 420 IPC in respect of dishonour of cheques,
prosecution has to establish facts which prima facie point to the conclusion that the failure to
meet the cheque was not accidental but was a consequence expected and was intended by the
accused

Conclusion

Section 138 creates statutory offence in the matter of dishonor of cheques on the ground of
insufficiency of funds in the account maintained by a person with the banker. It makes the matter
of dishonoring of cheques on grounds of insufficient fund, a statutory offence. In the cases of
dishonour of cheques mens rea is not required. Offence under 138 is an offence without any
mens rea but it is based on a negotiable instrument ie cheque, If a cheque is issued in discharge
of a legally enforceable debt and on presentation of the cheque for encashment the same is
dishonoured and offence will come into existence under section 138 of the N.I act. The
circumstances under which the dishonour took place is irrelevant. The law only takes cognizance
of the fact that the payment has not been forthcoming, and it matters little that any of the
manifold reasons may have caused that situation defect in structure cheque will not attract Sec.

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138. Dishonour of cheque because of incomplete signature on cheque of drawer did not attract
section 138.
Complaint under section 138 of the Act cannot be quashed or dismissed merely because the
notice was not served on the accused or drawer, without enquiring into the circumstances leading
to the non serving of the notice. Burden is on the complainant to show that the accused has
managed to get incorrect postal order endorsement made. It is erroneous to construe that section
138 would not apply from a closed bank account, section 138 does not call for such a narrow
construction, and such an interpretation would defeat the provision of the act. The burden of
proof as to cheque has not been issued for legal debt or liability, is always on the accused.
Complainant is not required to adduce number of witnesses and bulk of documentary evidence
on the question.

¾ Short Answers Questions

3. What are the different ways of dishonoring a Negotiable Instrument ?

Ans.

¾ Dishonour of negotiable instrument

Dishonour of negotiable instrument means loss of honour or respect for the instrument in
question on the part of the maker, drawee, or acceptor, as the case may be, which eventually
results in non-realization of payment due on the instrument.

• Dishonour by non-acceptance:

Any type of negotiable instruments, i.e., bill of exchange, promissory note, or cheque may be
dishonoured by non-payment by the drawee/acceptor thereof. But a bill may also be dishonoured
by non-acceptance because bill of exchange is the only negotiable instrument which requires its
presentment for acceptance and non-acceptance thereof, can amount to dishonour.

¾ When is a bill said to be dishonoured by Non-Acceptance

A bill is said to be dishonoured by non-acceptance in the following circumstances.

1. When the drawee or one of the several drawees, not being partners, commit default in
acceptance upon being duly required to accept the bill. In this regard Section 63 expressly
provides that the holder must, if so required by the drawee of a bill of
exchange presented to for acceptance, allow the drawee forty-eight hours (exclusive of
public holidays) to consider whether he will accept it.

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 2. Where presentment is required and the bill remains unrepresented.

3. Where the drawee is incompetent to enter into a valid contract.

4. Where the bill is given a qualified acceptance.

5. If the drawee is a fictitious person.

6. If the drawee cannot be found even after reasonable search.

7. Where the drawee has either become insolvent or is dead and the holder does not present
the bill to the assignee or legal representative of the insolvent or deceased drawee.

It is relevant to note that where a drawee-in-case-of-need is named in a bill of exchange or in any

endorsement thereon, the bill is not dishonoured until it has been dishonoured by such drawee.

¾ Dishonour of negotiable instrument by Non-payment:

A promissory note, bill of exchange, or cheque is said to be dishonoured by non-payment when

the maker of the note, acceptor of the bill, or drawee of the cheque commit default in payment
upon being duly required to pay the same. Also the holder of a bill or pro-note may treat it as
dishonoured, without placing for payment when presentment for payment is excused expressly
by the maker of the pro-note, or acceptor of the bill and the note or bill when overdue remains
unpaid.

• Dishonour by non-acceptance vs Dishonour by non-payment:

If a bill is dishonoured either by non-acceptance or by non-payment, the drawer and all the
endorsers of the bill are liable to the holder, provided notice of such dishonour is given to them.
The drawee, on the other hand, shall be liable to the holder only in the event of dishonour by
non-payment.

• Dishonour of Cheque for insufficient of funds in the account:

A cheque drawn by a person on an account maintained by him with a bank for payment of any
amount of money to another person can be returned unpaid for lack of enough funds in the said
account. This is called dishonour of cheques for insufficiency of funds (in the drawer’s
account). In such cases, the drawer is also criminally liable for this offense and may be punished

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with imprisonment for a term, which may extend to one year, or with fine that may extend to
twice the amount of the cheque, or with both.

4. How a negotiable instrument is discharged?

Ans

¾ DISCHARGE OF NEGOTIABLE INSTRUMENTS

Sec. 119. A negotiable instrument is discharged:

(a) By payment in due course by or on behalf of the principal debtor;

(b) By payment in due course by the party accommodated, where the

instrument is made or accepted for his accommodation;

(c) By the intentional cancellation thereof by the holder;

(d) By any other act which will discharge a simple contract for the payment of money;

(e) When the principal debtor becomes the holder of the instrument at or after
maturity in his own right.

• PAYMENT BY PRINCIPAL DEBTOR

In order to discharge the instrument, the payment must be a payment in due course, and second,
a payment made by the principal debtor If payment is made before the date of maturity, the
instrument is not discharged as the payment is not in due course Where payment is made by a
party who is not a primary obligor or an accommodation party, his payment only conceals his
own liability and those who are obligated after him.

All prior parties primarily or secondarily liable on the bill, are liable to such a payer, and the
payer may cancel indorsements subsequent to his own and reissue the paper, and it will
be valid as against the prior parties

• PAYMENT BY THIRD PERSONS

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 If payment is made by a third person, the instrument is not discharged because payment is not
made by the person principally liable. Not any one who desires may pay the instrument and then
recover of the maker. He must be a person who has in some way made himself liable for the
payment of the instrument.
Exception: where an instrument has been protested and someone
voluntarily makes payment supra protest or for honor and if the
instrument was to give money in payment, the instrument is discharged.

¾ DISCHARGE BY PAYMENT

1. Payment by a person ultimately liable, whatever his position in the paper, is a discharge of
the instrument
2. Payment by an accommodation party isn’t a discharge of the
instrument, whatever his position thereon and whether the indorsement be regular or
anomalous
3. Payment by the drawer or indorser is not a discharge of the instrument

PRINCIPAL DEBTOR Person ultimately bound to pay the debt

¾ PAYMENT BY CHECK OR OTHER NEGOTIABLE PAPER

1. When they actually have been cashed or

2. When, through the fault of the creditor, they have been impaired
• A creditor isn’t bound to accept a check in satisfaction of his demand
because a check, even if good when offered, doesn’t meet the requirements of legal
tender

¾ WAIVER OF OBJECTION TO TENDER OF PAYMENT BY CHECK

It is the general rule that an object to a tender must, to be available to the creditor, be made in
good time and that the grounds for objection must be specified; and that an objection to tender on
one ground is a waiver of all other objections which could have been made at that time It is
ordinarily required of one to whom payment is offered in the form of a check, that he makes his
objection at the time of the offer of by check instead of an offer of payment in money Reason
for the rule—to afford the debtor the opportunity to secure the specific money which the law
prescribes shall be accepted in payment of debts

5. Explain the law relating to the protection granted to the collecting bank in respect of
a crossing of cheque?
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Ans.
When a person receives a cheque drawn on any other banker he has two options before him:
Either to receive the payment personally or through his agent at the counter of the drawee bank
or to send it his banker for the purpose of the collection from the drawee bank. (collecting
bank) While collecting cheques on behalf of the customer, a banker acts either as holder for
value or as agent of the customer.

Collecting of cheques takes some time in case of outstanding cheques. If the collecting
banker pays to the customer the amount of the cheque or credits such amount to his account and
allows him to draw it, before the amount of the cheque is actually realized from the drawee
banker (paying banker), the collecting banker is deemed to be its ‘holder for value’. The banker
would be regarded as a holder for value in the following ways:

a) If bank allows his customer to withdraw money before cheque paid in for collection are
actually collected and credited.

b) If any open cheque is accepted and the value is paid before collection and/or

c) If there is a reduction in the overdraft amount of the customer before the cheque is collected
and credited in the respective account.

d) If he gives its value to the customer by lending further on the strength of the cheques.

e) If he gives its value to the customer by paying over the amount of the cheque or part of it in
cash or in account before it is cleared.

f) If he gives cash over the counter for the cheque at the time it is paid in for collection.

1. If the bank acts as a holder, his rights will be the same as of holder in due course. Hence, the
collecting banker enjoys all the rights and liabilities of a holder and hence, a holder in due
course. Note that the title of holder in due course is superior to the title of true owner.

2. If there is a forged endorsement on the back of the cheque then the paying banker is liable to
compensate the damage caused to the true owner and the collecting banker possesses the right to
recover this damage from the last endorser. So, in case of an instrument containing forgery the
title of true owner is superior. If the last endorser i.e. the customer is unable to meet the liability,
then the banker will have to bear the burden.

3. If the cheque sent for collection is dishonoured, then the collecting banker can sue all
previous parties after giving them notice of dishonour. It is however essential that the amount of
cheque is paid to the customer in good faith.

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4 A collecting banker acts as an Agent of the customer when the customer’s cheque is collected
and actually realized from the drawee banker. The customer is entitled to draw the amount from
his account when the amount of cheque has been credited to his account. Thus the bank is
acting as an agent of the customer and charges him the commission for collecting the amount
from outstation bank. If the cheque collected by the bank does not belong to his customer, he
will be held liable for ‘Conversion of money’.

5 Conversion means wrongful meddling or interference with the goods of others. Here, goods
includes Bill of Exchange, Cheque or Promissory note. It can be committed innocently.
Conversion is the act which renders the person liable committing it. This liability exists even
when the person is merely acts as an agent to his principal. Therefore, a banker however
innocently may have converted the goods of another, bank will be held personally liable. This
liability exists because the banker is acting as an agent and not as an holder for value. If it is so,
no banker will be in opposition to collect cheques for his customer. Hence the collecting banker
should take due precautions to avoid the risk of conversion involved therein. It is a difficult task
for collecting banker to examine the validity of the title of his customer, when one has to collect
so many cheques daily in ordinary course of his business.

6 Section 131 of the Negotiable Instrument Act 1881 provides the protection to the collecting
banker against the risk of conversion as follows: “A banker who has in good faith and without
negligence received payment of a cheque for a customer, crossed generally or specially to
himself, shall not, in case of the title to the cheque proves defective , incur any liability to the
true owner of the cheque, by reason only of having received such payment.”

The protection will be available to the collecting banker if the following conditions are satisfied:

1. The cheque must be crossed cheque.

2. The payment must be received for a customer.

3. Payment must be received in good faith and without negligence.

7 Crossed Cheques only: To avail the protection under section 131, the collecting banker should
only accept crossed cheques. Open or bearer cheques generally do not require the service from
the collecting bank. (Drawee bank becomes the collecting bank) The banker cannot cross the
cheque afterwards; it must be a crossed cheque before it is presented at the counter for
encashment. Payment collected must be for a customer: Section 131 provides protection to the
banker if he is working as an agent of the banker and not a holder for value. If the banker is

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having interest in the collection of cheque and is acting as a holder, i.e. not collecting cheque as
an agent then the banker cannot avail protection against the conversion

8. The payment procedure must be with good faith and without any negligence. Grounds of
Negligence:

a) Opening of account without proper introduction

b) Irregularity of Endorsement.

c) No enquiry is being made in doubtful case.

d) Failure to take note of ‘Not Negotiable’ crossing.

e) Collection of ‘Account Payee’ cheque for any other person. (non customer)

¾ Very Short Answers Questions

6. Write a note on Presentment for Payment.

Ans.

¾ Presentment for Acceptance

A bill of exchange is a negotiable instrument in writing containing an unconditional order,

directing a certain person to pay a certain amount only to or to the order of a certain person or to
the bearer. The drawer is the person who draws the bill and presents it to the drawee for
acceptance. Out of all the negotiable instruments, only bills of exchange require presentment for
acceptance.

¾ Presentment for Acceptance

A drawee has no liability regarding any bill addressed to him for acceptance or payment until he
accepts the bill. He needs to write the word ‘accepted’ on the bill and sign his name below in
order to complete the acceptance. By accepting the bill the drawee gives is assent to the order of
the drawer. Thus, the primary liability on a bill is of the acceptor. The acceptance can be either
general or qualified. As a rule, an acceptance needs to be general. General acceptance is
absolute. A qualified acceptance is made subject to some condition or qualification. It thus varies
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the effect of the bill. The holder of a bill may refuse to take a qualified acceptance. In this case,
he may treat the bill as dishonoured by non-acceptance and sue the drawer.

¾ Acceptance for Honour

Any person who is not already liable on the bill, with the holder’s consent may accept the bill for
honour of any party thereto, by writing on the bill when the bill has been noted or protested for
non-acceptance or better security.

This person is the Acceptor for Honour. He is liable to pay only after the proper presentment of
the bill on maturity to the drawee for payment and he refuses to pay and the bill is noted or
protested for non-payment.

¾ Presentment for Acceptance

All kinds of bills of exchange do not require presentment for acceptance. Bills payable on
demand or on a fixed date do not require this. However, the following bills require presentment
for acceptance in the absence of which the parties to it will not be liable on it:

1. Bill payable after sight in order to fix the maturity of the bills.

2. A bill that consists of an express stipulation that presentment for acceptance is necessary
before presentment for payment.

As per section 15, the presentment for acceptance shall be made to the drawee or his duly
authorized agent, in case of drawee’s death to his legal representative and in case of his
insolvency to his official receiver or assigner.

Present the bill to the following persons:

1. Drawee or his duly authorized agent.

2. In case of more than one drawee, to all the drawees.

3. In case of drawee’s death, to his legal representative.

4. Where the drawee becomes insolvent, to his official receiver.

5. When the original drawee refuses to accept the bill, to a drawee in case of need.

6. The acceptor for honour.

The presentment for acceptance shall be done before maturity, within a reasonable time after it is
drawn, on a business day during business hours at a business place or residence of the drawee.
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 7. What are the liabilities to the parties to the Negotiable Instrument?

Ans.

The provisions relating to the liability of parties to negotiable instruments are under section 30
to 32 and 35 to 42 of the Negotiable Instrument Act, 1881

a. Liability of Drawer (Section 30)

Drawer means a person who signs a cheque or a bill of exchange ordering his or her bank to pay
the amount to the payee.

In case of dishonour of cheque or bill of exchange by the drawee or the acceptor, the drawer of
such cheque or bill of exchange needs to compensate the holder such amount. But, the drawer
needs to receive due notice of dishonor.So, the nature of the drawer’s liability on drawing a bill
is:(

i) On due presentation:- It should be accepted and paid accordingly.

(ii) In the case of dishonor:- Drawer needs to compensate the holder such amount, only when he
receives a notice of dishonor by the drawee.

b. Liability of the Drawee of Cheque (Section 31)

The person who draws a cheque i.e drawer having sufficient funds of the drawer in his hands
properly applicable to the payment of such cheque must pay the cheque when duly required to do
so and, or in default of such payment, he shall compensate the drawer for any loss or damage
caused by such default.The drawee of a cheque will always be a banker. As a cheque is a bill of
exchange, drawn on a specified banker by the drawer, the banker is bound to pay the cheque of
the drawer, i.e., the customer. For the following conditions are need to be satisfied:

(i) Sufficient amount of funds to the credit of customer’s account should be there with the
banker.

(ii) Such funds are required to be properly applied against the payment of such cheque, e.g., the
funds are not under any kind of lien etc.

(iii) The cheque is duly required to be paid, during banking hours and on or after the date on
which it is made payable.

If the banker unjustifiably refuses to honor the cheque of its customer, it shall be liable for
damages.

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c. Liability of Acceptor of Bill and Maker of Note (Section 32)

As per section 32 of negotiable instrument act, in the absence of a contract to the contrary, the
maker of a promissory note and the acceptor before maturity of a bill of exchange are under the
liability to pay the amount thereof at maturity.

They need to pay the amount according to the apparent tenor of the note or acceptance
respectively. The acceptor of a bill of exchange at or after maturity is liable to pay the amount
thereof to the holder on demand.

The liability of the acceptor of a bill or the maker of a note is absolute and unconditional but is
subject to a contract to the contrary and may be excluded or modified by a collateral agreement.

d. Liability of Endorser (Section 35)

An endorser is the one who endorses and delivers a negotiable instrument before maturity.
Every endorser has a liability to the parties that are subsequent to him.

Also, he is bound thereby to every subsequent holder in case of dishonor of the instrument by the
drawee, acceptor or maker, to compensate such holder of any loss or damage caused to him by
such dishonor. However, he is to compensate only after the fulfillment of the following
conditions:

(i) There is no contract to the contrary

(ii) The Endorser has not expressly excluded, limited or made conditional his own liability

(iii)And, such endorser shall receive due notice of

e. Liability of Prior Parties (Section 36)

Until the instrument is duly satisfied, every prior party to a negotiable instrument has a liability
towards the holder in due course. The prior parties include the maker or drawer, the acceptor and
all the intervening endorsers. Also, there liability to a holder in due course is joint and several. In
the case of dishonor, the holder in due course may declare any or all prior parties liable for the
amount.

f. Liability of Acceptor when Endorsement is Forged (Section 41)

An acceptor of a bill of exchange who had already endorsed the bill is not relieved from liability
even if such endorsement is forged. This is so even if he knew or had reason to believe that the
endorsement was forged when he accepted the bill.

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g. Acceptor’s Liability when Bill is drawn in a Fictitious Name

An acceptor of a bill of exchange who draws a bill in a fictitious name, payable to the drawer’s
order will be liable to pay any holder in due course. He or she will not be relieved from such
liability by reason that such name is fictitious.

8. Explain the relationship between Bank and Customers.?

Ans.The relationship between a banker and a customer depends on the activities; products or
services provided by bank to its customers or availed by the customer. Thus the relationship
between a banker and customer is the transactional relationship. Bank’s business depends much
on the strong bondage with the customer. “Trust” plays an important role in building healthy
relationship between a banker and customer.

¾ DEFINITION OF A‘BANKER’

The Banking Regulations Act (B R Act) 1949 does not define the term ‘banker’ but defines what
banking is? As per Sec.5 (b) of the B R Act “Banking' means 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."

As per Sec. 3 of the Indian Negotiable Instruments Act 1881, the word “banker includes any
person acting as banker and any post office savings bank”.

According to Sec. 2 of the Bill of Exchange Act, 1882, ‘banker includes a body of persons,
whether incorporated or not who carry on the business of banking.’

Sec.5(c) of BR Act defines "banking company" as a company that transacts the business of
banking in India. Since a banker or a banking company undertakes banking related activities we
can derive the meaning of banker or a banking company from Sec 5(b) as a body corporate that:
(a) Accepts deposits from public.

(b) Lends or

(c) Invests the money so collected by way of deposits.

(d) Allows withdrawals of deposits on demand or by any other means.

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 Accepting deposits from the ‘public’ means that a bank accepts deposits from anyone
who offers money for the purpose. Unless a person has an account with the bank, it does not
accept deposit. For depositing or borrowing money there has to be an account relationship with
the bank. A bank can refuse to open an account for undesirable persons. It is banks right to open
an account. Reserve Bank of India has stipulated certain norms “Know Your Customer”
(KYC) guidelines for opening account and banks have to strictly follow them. In addition to the
activities mentioned in Sec.5 (b) of B R Act, banks can also carry out activities mentioned in
Sec. 6 of the Act.

¾ Who is a ‘Customer’?

The term Customer has not been defined by any act. The word ‘customer’ has been derived
from the word ‘custom’, which means a ‘habit or tendency’ to-do certain things in a regular
or a particular manner’s .In terms of Sec.131 of Negotiable Instrument Act, when a banker
receives payment of a crossed cheque in good faith and without negligence for a customer, the
bank does not incur any liability to the true owner of the cheque by reason only of having
received such payment. It obviously means that to become a customer account relationship is
must. Account relationship is a contractual relationship.

The term 'customer' is used only with respect to the branch, where the account is
maintained. He cannot be treated as a ‘customer' for other branches of the same bank. However
with the implementation of’ ‘Core Banking Solution’ the customer is the customer of the bank
and not of a particular branch as he can operate his account from any branch of the bank and
from anywhere. In the event of arising any cause of action, the customer is required to approach
the branch with which it had opened account and not with any other branch.

• ‘Know Your Customer’ Guidelines and Customer:

As per ‘Know Your Customer’ guidelines issued by Reserve Bank of India, customer has been
defined as:

a) A person or entity that maintains an account and/or has a business relationship

with the bank;

b) One on whose behalf the account is maintained (i.e. the beneficial owner);

c) Beneficiaries of transactions conducted by professional intermediaries, such as

Stock Brokers, Chartered Accountants, Solicitors etc. as permitted under the
law, and

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 d) Any person or entity connected with a financial transaction, which can pose
significant reputational or other risks to the bank, say, a wire transfer or
issue of a high value demand draft as a single transaction.

¾ Banker-Customer Relationship:

Banking is a trust-based relationship. There are numerous kinds of relationship between the bank
and the customer. The relationship between a banker and a customer depends on the type of
transaction. Thus the relationship is based on contract, and on certain terms and conditions.
These relationships confer certain rights and obligations both on the part of the banker and on the
customer. However, the personal relationship between the bank and its customers is the long
lasting relationship. Some banks even say that they have generation-to-generation banking
relationship with their customers. The banker customer relationship is fiducial relationship. The
terms and conditions governing the relationship is not be leaked by the banker to a third party.

¾ Classification of Relationship:

The relationship between a bank and its customers can be broadly categorized in to General
Relationship and Special Relationship. If we look at Sec 5(b) of Banking Regulation Act, we
would notice that bank’s business hovers around accepting of deposits for the purposes of
lending. Thus the relationship arising out of these two main activities are known as General
Relationship. In addition to these two activities banks also undertake other activities mentioned
in Sec.6 of Banking Regulation Act. Relationship arising out of the activities mentioned in Sec.6
of the act is termed as special relationship.

• General Relationship:

1. Debtor-Creditor:

When a 'customer' opens an account with a bank, he fills in and signs the account opening form.
By signing the form he enters into an agreement/contract with the bank. When customer deposits
money in his account the bank becomes a debtor of the customer and customer a creditor. The
money so deposited by customer becomes bank’s property and bank has a right to use the money
as it likes. The bank is not bound to inform the depositor the manner of utilization of funds
deposited by him. Bank does not give any security to the depositor i.e. debtor. The bank has
borrowed money and it is only when the depositor demands, banker pays. Bank’s position is
quite different from normal debtors. Banker does not pay money on its own, as banker is not

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required to repay the debt voluntarily. The demand is to be made at the branch where the account
exists and in a proper manner and during working days and working hours.

2. Creditor–Debtor:

Lending money is the most important activities of a bank. The resources mobilized by banks are
utilized for lending operations. Customer who borrows money from bank owns money to the
bank. In the case of any loan/advances account, the banker is the creditor and the customer is the
debtor. The relationship in the first case when a person deposits money with the bank reverses
when he borrows money from the bank. Borrower executes documents and offer security to the
bank before utilizing the credit facility.

In addition to opening of a deposit/loan account banks provide variety of services, which

makes the relationship more wide and complex. Depending upon the type of services rendered
and the nature of transaction, the banker acts as a bailee, trustee, principal, agent, lessor,
custodian etc.

• Special Relationship:

1. Bank as a Trustee:

As per Sec. 3 of Indian Trust Act, 1882 ‘

A "trust" is an obligation annexed to the ownership of property, and arising out of a confidence
reposed in and accepted by the owner, or declared and accepted by him, for the benefit of
another, or of another and the owner.’ Thus trustee is the holder of property on behalf of a
beneficiary.

As per Sec. 15 of the ‘Indian Trust Act, 1882 ‘A trustee is bound to deal with the trust-property
as carefully as a man of ordinary prudence would deal with such property if it were his own; and,
in the absence of a contract to the contrary, a trustee so dealing is not responsible for the loss,
destruction or deterioration of the trust-property.’ A trustee has the right to reimbursement of
expenses (Sec.32 of Indian Trust Act.).

In case of trust banker customer relationship is a special contract. When a person entrusts
valuable items with another person with an intention that such items would be returned on
demand to the keeper the relationship becomes of a trustee and trustier. Customers keep certain
valuables or securities with the bank for safekeeping or deposits certain money for a specific
purpose (Escrow accounts) the banker in such cases acts as a trustee. Banks charge fee for
safekeeping valuables

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2. Bailee – Bailor:

Sec.148 of Indian Contract Act, 1872, defines "Bailment" "bailor" and "bailee".

A "bailment" is the delivery of goods by one person to another for some purpose, upon a
contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering them.
The person delivering the goods is called the "bailor". The person to whom they
are delivered is called, the "bailee".

Banks secure their advances by obtaining tangible securities. In some cases physical possession
of securities goods (Pledge), valuables, bonds etc., are taken. While taking physical possession of
securities the bank becomes bailee and the customer bailor. Banks also keeps articles, valuables,
securities etc., of its customers in Safe Custody and acts as a Bailee. As a bailee the bank is
required to take care of the goods bailed.

3. Lessor and Lessee:

Sec.105 of ‘Transfer of property Act 1882’ defines lease, Lessor, lessee, premium and rent. As
per the section “A lease of immovable property is a transfer of a right to enjoy such property,
made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or
promised, or of money, a share of crops, service or any other thing of value, to be rendered
periodically or on specified occasions to the transferor by the transferee, who accepts the
transfer on such terms.”Definition of Lessor, lessee, premium and rent:

(1)The transferor is called the lessor,

(2)The transferee is called the lessee,

(3)The price is called the premium, and

(4)The money, share, service or other thing to be so rendered is called the rent.”

Providing safe deposit lockers is as an ancillary service provided by banks to customers.

While providing Safe Deposit Vault/locker facility to their customers bank enters into an
agreement with the customer. The agreement is known as “Memorandum of letting” and attracts
stamp duty.
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 The relationship between the bank and the customer is that of lessor and lessee. Banks
lease (hire lockers to their customers) their immovable property to the customer and give them
the right to enjoy such property during the specified period i.e. during the office/ banking hours
and charge rentals. Bank has the right to break-open the locker in case the locker holder defaults
in payment of rent. Banks do not assume any liability or responsibility in case of any damage to
the contents kept in the locker. Banks do not insure the contents kept in the lockers by customers.

4. Agent and Principal: Sec.182 of ‘The Indian Contract Act, 1872’ defines “an agent” as a
person employed to do any act for another or to represent another in dealings with third
persons. The person for whom such act is done or who is so represented is called “the
Principal”.

Banks collect cheques, bills, and makes payment to various authorities viz., rent,
telephone bills, insurance premium etc., on behalf of customers. . Banks also abides by the
standing instructions given by its customers. In all such cases bank acts as an agent of its
customer, and charges for these services. As per Indian contract Act agent is entitled to charges.
No charges are levied in collection of local cheques through clearing house. Charges are levied
in only when the cheque is returned in the clearinghouse.

5 As a Custodian: A custodian is a person who acts as a caretaker of something. Banks take

legal responsibility for a customer’s securities. While opening a dmat account bank becomes a
custodian.

6. As a Guarantor: Banks give guarantee on behalf of their customers and enter in to their
shoes. Guarantee is a contingent contract. As per sec 31,of Indian contract Act guarantee is a "
contingent contract ". Contingent contract is a contract to do or not to do something, if some
event, collateral to such contract, does or does not happen.

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